Last Thursday's post concerning Jon Corzine's bungling at MF Global evidently drew plenty of traffic yesterday, despite my being unable to post due to power outages.
Imagine my horror though, reading this weekend, pre-Chapter 11 filing, of- you guessed it- J. Christopher Flowers' potential bid for the firm's wreckage.
Did I not predict this one? I did, in this passage from that post,
"The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquisition target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.
That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year."
What's curious is how silent all the cable news media are about this. Neither CNBC nor Bloomberg, nor even the Journal, bothered to note Flowers' original intrusion into MF Global's board to force Corzine's selection as CEO. Nor do any of them now note how Flowers must have been on board with Corzine's strategy.
Regarding that strategy, I heard it lampooned on CNBC last night as having basically gone all in on a specific European debt play. It's hard to believe Corzine would be so stupid, or Flowers would consent.
Funny, though, isn't it? All that silence on the original Corzine-Flowers connection? Even now they don't remind us that Corzine is a partner in Flowers' group.
Or is it more of being muzzled to power, because nobody with a network with hours of programming to fill wants to cross a private equity mogul like Chris Flowers?
Perhaps the Chapter 11 filing will take Flowers out of contention for swallowing the whole of MF Global on the cheap. We can only hope so.
Showing posts with label Strategy. Show all posts
Showing posts with label Strategy. Show all posts
Tuesday, November 01, 2011
Thursday, October 27, 2011
More Upward Failure- MF Global's Jon Corzine
Yesterday morning's Wall Street Journal featured an article in the Money & Investing section detailing MF Global's troubles stemming from newly-hired CEO Jon Corzine's drive to turn the firm into a replica of the old Goldman Sachs which he once ran.
Two days ago, on Bloomberg television, Corzine was described as stumbling at MF Global, and having lost his last gig as governor of New Jersey. That was before he led MF Global to a 48% drop in its market value after announcing the firm's quarterly loss earlier this week, as well as an out sized risk exposure to European securities for a paltry $12MM of related earnings.
But Corzine's been on an upward failure trajectory for much longer than that.
A one-time bond group head, Corzine was co-head of Goldman Sachs with the less-remembered Stephen Friedman. The latter has recently attained prominence for his alleged conflict of interests during the financial crisis of 2008, when he was chairman of the board of the New York Fed.
As I began writing this post, I remembered that I wrote about Corzine's arrival at MF Global early this year, and his connection with private equity mogul J. Christopher Flowers. In that post, I described the Wall Street Journal's sarcastic asides regarding Corzine's being run out of his job as co-head at Goldman Sachs.
His next post, which he bought, was the job of US Senator from New Jersey. For a Democrat, a veritable walk-in. But Corzine showed poor judgement, leaving the Senate just before the Democrats regained the majority which would have put the former fox in regulatory control of the financial hen house.
Perhaps Corzine had presidential ambitions, because he won election as New Jersey governor after leaving his Senate seat. But, as the Bloomberg anchor noted, Corzine only lasted one term before his poor performance caught up with him by way of Chris Christie.
Now, one imagines at the behest of Chris Flowers, Corzine's attempt to morph MF Global into a miniature version of the Goldman Sachs he and his backing partner once knew, has managed to chop half the market value from the firm.
If you are unlucky enough to be an MF shareholder, perhaps you are now wondering just how a private equity guy has managed to take control of your firm, then ruin it, within a calendar year.
The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquistion target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.
That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year.
Perhaps people should be wary when a failed CEO of a financial firm is installed in the same job in their firm.
Upward failure- it seems more widespread than many people realize.
Two days ago, on Bloomberg television, Corzine was described as stumbling at MF Global, and having lost his last gig as governor of New Jersey. That was before he led MF Global to a 48% drop in its market value after announcing the firm's quarterly loss earlier this week, as well as an out sized risk exposure to European securities for a paltry $12MM of related earnings.
But Corzine's been on an upward failure trajectory for much longer than that.
A one-time bond group head, Corzine was co-head of Goldman Sachs with the less-remembered Stephen Friedman. The latter has recently attained prominence for his alleged conflict of interests during the financial crisis of 2008, when he was chairman of the board of the New York Fed.
As I began writing this post, I remembered that I wrote about Corzine's arrival at MF Global early this year, and his connection with private equity mogul J. Christopher Flowers. In that post, I described the Wall Street Journal's sarcastic asides regarding Corzine's being run out of his job as co-head at Goldman Sachs.
His next post, which he bought, was the job of US Senator from New Jersey. For a Democrat, a veritable walk-in. But Corzine showed poor judgement, leaving the Senate just before the Democrats regained the majority which would have put the former fox in regulatory control of the financial hen house.
Perhaps Corzine had presidential ambitions, because he won election as New Jersey governor after leaving his Senate seat. But, as the Bloomberg anchor noted, Corzine only lasted one term before his poor performance caught up with him by way of Chris Christie.
Now, one imagines at the behest of Chris Flowers, Corzine's attempt to morph MF Global into a miniature version of the Goldman Sachs he and his backing partner once knew, has managed to chop half the market value from the firm.
If you are unlucky enough to be an MF shareholder, perhaps you are now wondering just how a private equity guy has managed to take control of your firm, then ruin it, within a calendar year.
The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquistion target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.
That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year.
Perhaps people should be wary when a failed CEO of a financial firm is installed in the same job in their firm.
Upward failure- it seems more widespread than many people realize.
Tuesday, October 25, 2011
Netflix's About Face On Splitting Services
According to its stock price history, it is clear that Netflix has yet to recoup the massive shareholder value damage which occurred when the firm's CEO first announced the splitting of the firm into online and physical dics video delivery. The nearby 3-month price chart for NFLX and the S&P500 Index, through Friday, clearly displays that. It got worse after the close yesterday when Netflix released earnings and reduced projections for the fourth quarter.
Now about a month old, the furor which the move touched off among investors and customers prompted the firm to reverse its decision a few weeks ago. I wrote in this post a little over a month ago,
"Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.
As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.
As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates."
Looking at a 6-month chart of the same two series, and noting Hasting's reference, in his September 20 email to customers, that the firm had announced its new pricing structures a few months earlier, one can see that the firm's equity price stopped rising at that point. The formal announcement of a split caused a cliff-like drop in the share price.
Contrary to my own hopes, Netflix has totally reversed itself on splitting, but kept the pricing changes. Probably the worst of all worlds.
Now we'll never know how the online component would have fared alone, although, as I originally noted, there would have been some short term challenges to cost allocations of content acquisition deals.
Unlike the initially-disastrous New Coke introduction decades ago, which ultimately resulted in a new flavor becoming permanent, and more shelf facings for Coke products, I think the longer term consequences of Hastings' dithering, then reversing his company-splitting decision will be negative.
To me, Hastings' actions reflect one or both of two negative components of his decisions as the firm's CEO. To reverse himself on such a crucial customer service issue as splitting the company into online and disc suggests that either Hastings and/or his staff didn't possess a high level of confidence in their knowledge of their customers. One would hope they would have conducted some primary research with a sample of their customers, chosen by usage patterns, to get a good sense of their reactions before even announcing the price changes. That's profoundly poor general and marketing management.
For Hastings to compound this with his missteps regarding splitting the firm shows weakness as Netflix's CEO in understanding what is essential for the firm, going forward, in order to continue to deliver total return to shareholders. Because the decision involved not just investors, but customers, as well, that, too, should have been researched. The reversal of the decision again suggests it was not.
Prior to this past summer, Netflix appeared to be a dominant, well-managed video content delivery firm. In the wake of its actions since the summer involving pricing structure changes, and then corporate structure changes, the core competence of its management team is now in question.
That's reason enough for an investor to be open to reassessing the firm's attractiveness as an investment.
Now about a month old, the furor which the move touched off among investors and customers prompted the firm to reverse its decision a few weeks ago. I wrote in this post a little over a month ago,
"Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.
As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.
As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates."
Contrary to my own hopes, Netflix has totally reversed itself on splitting, but kept the pricing changes. Probably the worst of all worlds.
Now we'll never know how the online component would have fared alone, although, as I originally noted, there would have been some short term challenges to cost allocations of content acquisition deals.
Unlike the initially-disastrous New Coke introduction decades ago, which ultimately resulted in a new flavor becoming permanent, and more shelf facings for Coke products, I think the longer term consequences of Hastings' dithering, then reversing his company-splitting decision will be negative.
To me, Hastings' actions reflect one or both of two negative components of his decisions as the firm's CEO. To reverse himself on such a crucial customer service issue as splitting the company into online and disc suggests that either Hastings and/or his staff didn't possess a high level of confidence in their knowledge of their customers. One would hope they would have conducted some primary research with a sample of their customers, chosen by usage patterns, to get a good sense of their reactions before even announcing the price changes. That's profoundly poor general and marketing management.
For Hastings to compound this with his missteps regarding splitting the firm shows weakness as Netflix's CEO in understanding what is essential for the firm, going forward, in order to continue to deliver total return to shareholders. Because the decision involved not just investors, but customers, as well, that, too, should have been researched. The reversal of the decision again suggests it was not.
Prior to this past summer, Netflix appeared to be a dominant, well-managed video content delivery firm. In the wake of its actions since the summer involving pricing structure changes, and then corporate structure changes, the core competence of its management team is now in question.
That's reason enough for an investor to be open to reassessing the firm's attractiveness as an investment.
Friday, October 14, 2011
Great by Accident?- More Flawed Research by Jim Collins
Several years ago, after seeing multiple references to it, I bought a used copy of Jim Collins' Good To Great, published originally in 2001. I wrote this brief review in 2005 and, judging by the lack of subsequent pieces on the topic, didn't really find more of interest in the book to bother critiquing. Some of my key observations were captured in these passages from that post,
"Much of my work for the last decade has involved measuring the performance of publicly-held U.S. corporations. There is really only one body of work of which I am aware that sounds remotely similar to mine.
What I found upon reading Collins’ methodology was an odd mixture of quantitative and qualitative bases of analyses. There are a variety of problems with his methods, which I will address.....here ......."
I must admit, I was rather shocked that such slipshod and simplistic quantitative definitions of “good” and “great” performances would exist in a book so seemingly well-regarded in the business community. Perhaps it is yet another case of the broad class of mediocre managers and leaders being unable to distinguish “great” work when they see it.
Between his use of market value, rather than total return, and a simple point-to-point measurement, Collins' metrics in his original book left a lot to be desired. As did his mixing in of qualitative measures which tend to be so judgemental as to be nearly useless for interpretation or application in other contexts.
Unless, of course, you were using the book as a marketing tool for your consulting efforts. Which Collins does.
Thus, I was interested to read in this past Tuesday's edition of the Wall Street Journal a review, by longtime Journal executive Alan Murray, of Collins' recently-published book, Great by Choice. The review's title was Turbulent Times, Steady Success, which I found a bit of a reach, for reasons I'll explain later in this post. The highlight, or subheadline for the review read How certain companies achieved shareholder returns at least 10 times greater than their industry.
To start with, Collins uses cumulative returns over long periods of time to judge a company as “good” and/or “great.”
However, my own research on large U.S. publicly-held companies reveals that among companies which outperform the S&P 500 average total return over a period of years, firms which consistently outperform the S&P index, on average, create shareholder wealth at a much higher rate than companies which earn most of their total returns with a few years of outstanding performance.
Just reading those few lines told me a few things about problems with Collins' latest work. In fact, Murray's review contains enough information for me to find significant problems with Collins' latest work without having to actually waste time reading the whole thing.
First, I'm suspicious of published work of this type because no sane, intelligent person in the business world has published complete information on any market-beating strategies for decades. Whether a business school professor, consultant or equity portfolio manager, it doesn't pay to tell all. You always save something so that your published work can't be totally replicated or reverse-engineered, and prospective customers have to engage your services professionally to really benefit from your research findings.
One thing I discovered in my own proprietary research on US corporate performance over many years is that there is a limited timeframe within which most companies can demonstrate superior performance. And it's not a sufficient length of time to typically exhibit "steady success" during "turbulent times."
But, let me get to Murray's review. He begins with this telling paragraph,
'Great by Choice" is a sequel to Jim Collins's best-selling "Good to Great" (2001), which identified seven characteristics that enabled companies to become truly great over an extended period of time. Never mind that one of the 11 featured companies is now bankrupt (Circuit City) and another is in government receivership (Fannie Mae). Mr. Collins has a knack for analysis that business readers find compelling."
Murray may have written that with his tongue in his cheek, but it lays bare a serious weakness with that type of approach. One I mentioned in an email to Murray after reading his review. I likened Collins' work to that of long-ago consulting guru Tom Peters, of "In Search of Excellence" fame. As I explained to Murray in my note,
"But the other aspect of his work which I noticed, having the benefit now of being aware of two of his works, is how much it reminds me of the Tom Peters' old type of 'great companies' books. Being, like me, of that certain age, I'm sure you recall the book which launched Peters out of McKinsey. Sadly, only a few years later, his great companies were no longer so.
I'd expect Collins' companies are likely to experience similar fates, because both authors use fixed timeframes of specific companies to construct their measures of greatness, rather than observe statistically-valid large samples that include many different time periods.
Peters wrote before the era of cheap desktop computing and inexpensive, exhaustive corporate data. But Collins hasn't. Yet his work still smacks of that 'hit parade' style of spotlighting a few companies for specific time periods, then extrapolating their idiosyncracies into strategic wisdom, rather than the other way around."
Suffice to say, starting with Peters, and now continued by Collins, this type of misleadingly shallow analysis provides business execs with easily-consumable 'best practices' candy, without actually being rigorous or deep in its methodology.
Murray describes the book's objective next,
"Mr. Collins's new book tackles the question of how to steer a company to lasting success in an environment characterized by change, uncertainty and even chaos."
Unfortunately, the objective is a chimera. I'm not going to divulge my own proprietary findings, because, among other uses, they help drive my own equity portfolio management process. Let me just assure readers that 'lasting success' is a good deal shorter time period than you'd ever believe. If more boards knew this, they'd be radically restructuring CEO compensation over time.
But, to provide a little more insight, all truly exceptionally-performing companies fall victim, within a definable number of years, to one or more of three forces: adjusted investor expectations; competition, and/or; regulatory scrutiny and action. Between the three, no company succeeds for too long. Here's a brief list of the once-great, now-fallen: Home Depot, Microsoft, Dell, Compaq, and Wal-Mart.
Murray then provides the reader with some information on the data which drove Collins' latest book,
"The data set that Messrs. Collins and Hansen examine so carefully ends in 2002, well ahead of the change, uncertainty and chaos of the 2008 financial meltdown. The intervening years were spent conducting their research. Still, the lessons of "Great by Choice" are not meant to apply to a particular moment of economic turbulence but to a continuous condition—a business world "full of rapid change and dramatic disruption."
For their study, the authors chose a set of major companies that achieved spectacular results over 15 or more years while operating in unstable environments; Messrs. Collins and Hansen call them "10Xers" for providing shareholder returns at least 10 times greater than their industry. Then the authors compared those companies—Amgen, Biomet, Intel, Microsoft, Progressive Insurance, Southwest Airlines, Stryker—to similar, but less successful, "control" companies: Genentech, Kirschner, AMD, Apple, Safeco, PSA and United States Surgical. It is an indication of the volatile nature of today's business success that, using 2002 numbers, Microsoft came out as a "10Xer" while Apple was its less successful "control" company, a ranking now reversed. More on that below."
Right away, I find serious flaws with Collins' approach.
First, no company posts "spectacular results" for 15 years. Yes, perhaps "over" 15 years, i.e., from point to point, over 15 years, there were some spectacular periods. But consistency has a value beyond a mere endpoint to endpoint total return value.
I've seen this sort of simplistic apparent performance phenomenon many times. Consider the nearby price chart for Dell, Microsoft, Apple, Home Depot and Google. Taken over the right timeframe, early years of stratospheric performance can offset a full decade of subsequent flatlining, as Microsoft's curve demonstrates.
Further, Collins' industry-specific metric renders his whole enterprise useless- except for, well, someone who wants to consult with his results to rather mediocre senior managers who read his book.
Here's why.
Investors can choose from among all public companies in which to invest. Even among private companies, in some cases. So to be truly exceptional, a manager should perform at a level among the best of, say, a broad equity market average. Not just his own industry.
By the way, just what defines an industry, anyway? Some companies don't have directly-comparable industry competitors. Others do, but only a very few. Consider auto makers. Do you count three- Ford, GM and Chrysler? Or two, when Chrysler was privately-held? Do you count Mercedes, Toyota, Honda, BMW, et.al., although their parents and sizable operations are located outside the US?
And who believes Microsoft's badly-performing look-alike was ever Apple? Historically, Apple's integrated software and hardware competed with the Wintel combine of Intel and early PC makers IBM, Compaq or Gateway. Microsoft's Bill Gates was actually a guest at one of Steve Jobs' early Apple product debuts, as an example of a collaborative software publisher who appreciated having two platforms for which to create their products. Apple didn't do application software- just its proprietary operating system.
But that would make Collins' simplistic approach nearly impossible to use. So, instead, he opted for a comparison that has no credibility.
Having a point-to-point 15 year total return that is "10X" that of the average of three other firms in a poorly-performing sector like autos is hardly laudable. But if you plan to consult to Ford or GM, well, you could probably hoodwink those CEOs into at least listening to your sales pitch.
It's amazing how often people form impressions, a priori, on what constitutes a high-growth company. I've had some companies in my equity portfolios which few people would have thought would qualify if they knew the criteria for inclusion. Trust me, growth companies aren't just in technology sectors of the US economy.
Murray then provides his meatier treatment of the newly-published book,
"Messrs. Collins and Hansen draw some interesting and counterintuitive conclusions from their research. First, the successful leaders were not the most "visionary" or the biggest risk-takers; instead, they tended to be more empirical and disciplined, relying on evidence over gut instinct and preferring consistent gains to blow-out winners. The successful companies were not more innovative than the control companies; indeed, they were in some cases less innovative. Rather, they managed to "scale innovation"—introducing changes gradually, then moving quickly to capitalize on those that showed promise. The successful companies weren't necessarily the most likely to adopt internal changes as a response to a changing environment. "The 10X companies changed less in reaction to their changing world than the comparison cases," the authors conclude.
The book's organizing metaphor is built around the story of Roald Amundsen and Robert Falcon Scott, the two men who set out separately, in October 1911, to become the first explorers to reach the South Pole. Amundsen won the race by setting ambitious goals for each day's progress but also by being careful not to overshoot on good days or undershoot on bad ones, a disciplined approach shared by the 10Xers, according to Messrs. Collins and Hansen. Scott, by contrast, overreached on the good days and fell apart on the bad, mirroring the control companies in "Great by Choice."
If "Great by Choice" shares the qualities that made "Good to Great" so popular, it also shares some that drew criticism. The authors' conclusions sometimes feel like the claims of a well-written horoscope—so broadly stated that they are hard to disprove. Their 10X leaders are both "disciplined" and "creative," "prudent" and "bold"; they go fast when they must but slow when they can; they are consistent but open to change. This encompassing approach allows the authors to fit pretty much any leader who achieves 10X performance into their analysis. Would it ever be possible, one wonders, to find a leader whose success contradicted their thesis?"
Not content to critique the book generally, Murray fortunately, and shrewdly, provides an accidental example to which he referred earlier in his review,
"Which brings us back to Apple. Messrs. Collins and Hansen had no way of knowing, when they began sifting through their data in 2002, that Apple would become one of the most stunning turnaround stories in business history, soaring past Microsoft in market value. The late Steve Jobs accomplished that turnaround with a run of boldness, innovation, visionary thinking and egotism that might seem counter to the studied conclusions of "Great by Choice" as well as those of "Good to Great," in which Mr. Collins found that one of the leading attributes of the best business leaders was "humility." Steve Jobs?"
All of which satisfies me that Collins hasn't changed his approach much at all. He's still mixing hard-to-define qualitative assessments with quantitative ones. And applying them with, as Murray notes, considerably less than the precision one would wish.
Mr. Murray is not in the business of offending either an author who may advertise his book in the Journal, nor his readers. So he isn't about to land hard punches in his review by concluding that Collins' work is so vague and flawed as to be practically meaningless.
But I don't share Murray's constraints.
As I noted earlier, Collins' recent effort is perfect if what you hope to do is sell a book, for profits, that becomes a resident sales tool in many C-suites. And it even has an impressively-titled co-author from an equally-impressive university. But that doesn't make it valid or profound.
On that note, here's anecdote I learned years ago when I worked for Accenture's predecessor, Andersen Consulting. I had been chatting with Bob Gach, then a partner in the financial service group whose clients included Morgan Stanley and a few other investment banks. Since then, Bob has risen to become a very senior global partner in Accenture's financial services practice.
Back then, Bob was fretting because of the difficulty he was having closing a consulting contract with a Morgan Stanley executive.
As we discussed the firm's, and executive's behavior, Bob enunciated a principle which I've found to be pretty much universally true ever since. To paraphrase his remarks,
'This guy at Morgan Stanley really frustrates me. He's smart enough to force me to keep giving him enough examples of our work in his area, and to sign small pieces of work, that he keeps me from selling him the larger, more profitable interpretative and application modules.
When you think about it, the worst consulting customers are executives who are either really smart or really stupid. The smart ones know how to cherry pick a consultant's work and do the high value-added application of results to the rest of his businesses or operations.
The stupid ones are so thick they don't even understand why they need the consultant.
A consultant's best prospects are in the middle. Smart enough to know they need help. Dumb enough not to be able to get ahead of you in the thought process and rein in the scope of the project.'
Collins' work strikes me as designed to hit that middle group. It's too simplistic and flawed to sell to really intelligent business leaders. And the really slow ones will just never realize where to start to fix their problems.
But I can imagine quite a few middling companies with average executives jumping on Collins' rather shallow analyses as the answer to their prayers for some path out of mediocre performance.
And the beauty of Collins' approach, as Murray so deftly illustrates, is that there's always some other qualitative variable to blame when a CEO pays Collins for a lengthy engagement, follows his advice, and his business still doesn't outperform his peers.
I actually thought through all these issues when I was actively marketing the consulting application of my proprietary research on corporate performance. I even sold an engagement to the current chairman of the NYSE when he ran State Street Bank. Suffice to say, my consulting approach, as well as the research methods underpinning it, remains proprietary. But I will divulge that it is all quantitative, with no qualitative wiggle room.
"Much of my work for the last decade has involved measuring the performance of publicly-held U.S. corporations. There is really only one body of work of which I am aware that sounds remotely similar to mine.
What I found upon reading Collins’ methodology was an odd mixture of quantitative and qualitative bases of analyses. There are a variety of problems with his methods, which I will address.....here ......."
I must admit, I was rather shocked that such slipshod and simplistic quantitative definitions of “good” and “great” performances would exist in a book so seemingly well-regarded in the business community. Perhaps it is yet another case of the broad class of mediocre managers and leaders being unable to distinguish “great” work when they see it.
Between his use of market value, rather than total return, and a simple point-to-point measurement, Collins' metrics in his original book left a lot to be desired. As did his mixing in of qualitative measures which tend to be so judgemental as to be nearly useless for interpretation or application in other contexts.
Unless, of course, you were using the book as a marketing tool for your consulting efforts. Which Collins does.
Thus, I was interested to read in this past Tuesday's edition of the Wall Street Journal a review, by longtime Journal executive Alan Murray, of Collins' recently-published book, Great by Choice. The review's title was Turbulent Times, Steady Success, which I found a bit of a reach, for reasons I'll explain later in this post. The highlight, or subheadline for the review read How certain companies achieved shareholder returns at least 10 times greater than their industry.
To start with, Collins uses cumulative returns over long periods of time to judge a company as “good” and/or “great.”
However, my own research on large U.S. publicly-held companies reveals that among companies which outperform the S&P 500 average total return over a period of years, firms which consistently outperform the S&P index, on average, create shareholder wealth at a much higher rate than companies which earn most of their total returns with a few years of outstanding performance.
Just reading those few lines told me a few things about problems with Collins' latest work. In fact, Murray's review contains enough information for me to find significant problems with Collins' latest work without having to actually waste time reading the whole thing.
First, I'm suspicious of published work of this type because no sane, intelligent person in the business world has published complete information on any market-beating strategies for decades. Whether a business school professor, consultant or equity portfolio manager, it doesn't pay to tell all. You always save something so that your published work can't be totally replicated or reverse-engineered, and prospective customers have to engage your services professionally to really benefit from your research findings.
One thing I discovered in my own proprietary research on US corporate performance over many years is that there is a limited timeframe within which most companies can demonstrate superior performance. And it's not a sufficient length of time to typically exhibit "steady success" during "turbulent times."
But, let me get to Murray's review. He begins with this telling paragraph,
'Great by Choice" is a sequel to Jim Collins's best-selling "Good to Great" (2001), which identified seven characteristics that enabled companies to become truly great over an extended period of time. Never mind that one of the 11 featured companies is now bankrupt (Circuit City) and another is in government receivership (Fannie Mae). Mr. Collins has a knack for analysis that business readers find compelling."
Murray may have written that with his tongue in his cheek, but it lays bare a serious weakness with that type of approach. One I mentioned in an email to Murray after reading his review. I likened Collins' work to that of long-ago consulting guru Tom Peters, of "In Search of Excellence" fame. As I explained to Murray in my note,
"But the other aspect of his work which I noticed, having the benefit now of being aware of two of his works, is how much it reminds me of the Tom Peters' old type of 'great companies' books. Being, like me, of that certain age, I'm sure you recall the book which launched Peters out of McKinsey. Sadly, only a few years later, his great companies were no longer so.
I'd expect Collins' companies are likely to experience similar fates, because both authors use fixed timeframes of specific companies to construct their measures of greatness, rather than observe statistically-valid large samples that include many different time periods.
Peters wrote before the era of cheap desktop computing and inexpensive, exhaustive corporate data. But Collins hasn't. Yet his work still smacks of that 'hit parade' style of spotlighting a few companies for specific time periods, then extrapolating their idiosyncracies into strategic wisdom, rather than the other way around."
Suffice to say, starting with Peters, and now continued by Collins, this type of misleadingly shallow analysis provides business execs with easily-consumable 'best practices' candy, without actually being rigorous or deep in its methodology.
Murray describes the book's objective next,
"Mr. Collins's new book tackles the question of how to steer a company to lasting success in an environment characterized by change, uncertainty and even chaos."
Unfortunately, the objective is a chimera. I'm not going to divulge my own proprietary findings, because, among other uses, they help drive my own equity portfolio management process. Let me just assure readers that 'lasting success' is a good deal shorter time period than you'd ever believe. If more boards knew this, they'd be radically restructuring CEO compensation over time.
But, to provide a little more insight, all truly exceptionally-performing companies fall victim, within a definable number of years, to one or more of three forces: adjusted investor expectations; competition, and/or; regulatory scrutiny and action. Between the three, no company succeeds for too long. Here's a brief list of the once-great, now-fallen: Home Depot, Microsoft, Dell, Compaq, and Wal-Mart.
Murray then provides the reader with some information on the data which drove Collins' latest book,
"The data set that Messrs. Collins and Hansen examine so carefully ends in 2002, well ahead of the change, uncertainty and chaos of the 2008 financial meltdown. The intervening years were spent conducting their research. Still, the lessons of "Great by Choice" are not meant to apply to a particular moment of economic turbulence but to a continuous condition—a business world "full of rapid change and dramatic disruption."
For their study, the authors chose a set of major companies that achieved spectacular results over 15 or more years while operating in unstable environments; Messrs. Collins and Hansen call them "10Xers" for providing shareholder returns at least 10 times greater than their industry. Then the authors compared those companies—Amgen, Biomet, Intel, Microsoft, Progressive Insurance, Southwest Airlines, Stryker—to similar, but less successful, "control" companies: Genentech, Kirschner, AMD, Apple, Safeco, PSA and United States Surgical. It is an indication of the volatile nature of today's business success that, using 2002 numbers, Microsoft came out as a "10Xer" while Apple was its less successful "control" company, a ranking now reversed. More on that below."
Right away, I find serious flaws with Collins' approach.
First, no company posts "spectacular results" for 15 years. Yes, perhaps "over" 15 years, i.e., from point to point, over 15 years, there were some spectacular periods. But consistency has a value beyond a mere endpoint to endpoint total return value.
Further, Collins' industry-specific metric renders his whole enterprise useless- except for, well, someone who wants to consult with his results to rather mediocre senior managers who read his book.
Here's why.
Investors can choose from among all public companies in which to invest. Even among private companies, in some cases. So to be truly exceptional, a manager should perform at a level among the best of, say, a broad equity market average. Not just his own industry.
By the way, just what defines an industry, anyway? Some companies don't have directly-comparable industry competitors. Others do, but only a very few. Consider auto makers. Do you count three- Ford, GM and Chrysler? Or two, when Chrysler was privately-held? Do you count Mercedes, Toyota, Honda, BMW, et.al., although their parents and sizable operations are located outside the US?
And who believes Microsoft's badly-performing look-alike was ever Apple? Historically, Apple's integrated software and hardware competed with the Wintel combine of Intel and early PC makers IBM, Compaq or Gateway. Microsoft's Bill Gates was actually a guest at one of Steve Jobs' early Apple product debuts, as an example of a collaborative software publisher who appreciated having two platforms for which to create their products. Apple didn't do application software- just its proprietary operating system.
But that would make Collins' simplistic approach nearly impossible to use. So, instead, he opted for a comparison that has no credibility.
Having a point-to-point 15 year total return that is "10X" that of the average of three other firms in a poorly-performing sector like autos is hardly laudable. But if you plan to consult to Ford or GM, well, you could probably hoodwink those CEOs into at least listening to your sales pitch.
It's amazing how often people form impressions, a priori, on what constitutes a high-growth company. I've had some companies in my equity portfolios which few people would have thought would qualify if they knew the criteria for inclusion. Trust me, growth companies aren't just in technology sectors of the US economy.
Murray then provides his meatier treatment of the newly-published book,
"Messrs. Collins and Hansen draw some interesting and counterintuitive conclusions from their research. First, the successful leaders were not the most "visionary" or the biggest risk-takers; instead, they tended to be more empirical and disciplined, relying on evidence over gut instinct and preferring consistent gains to blow-out winners. The successful companies were not more innovative than the control companies; indeed, they were in some cases less innovative. Rather, they managed to "scale innovation"—introducing changes gradually, then moving quickly to capitalize on those that showed promise. The successful companies weren't necessarily the most likely to adopt internal changes as a response to a changing environment. "The 10X companies changed less in reaction to their changing world than the comparison cases," the authors conclude.
The book's organizing metaphor is built around the story of Roald Amundsen and Robert Falcon Scott, the two men who set out separately, in October 1911, to become the first explorers to reach the South Pole. Amundsen won the race by setting ambitious goals for each day's progress but also by being careful not to overshoot on good days or undershoot on bad ones, a disciplined approach shared by the 10Xers, according to Messrs. Collins and Hansen. Scott, by contrast, overreached on the good days and fell apart on the bad, mirroring the control companies in "Great by Choice."
If "Great by Choice" shares the qualities that made "Good to Great" so popular, it also shares some that drew criticism. The authors' conclusions sometimes feel like the claims of a well-written horoscope—so broadly stated that they are hard to disprove. Their 10X leaders are both "disciplined" and "creative," "prudent" and "bold"; they go fast when they must but slow when they can; they are consistent but open to change. This encompassing approach allows the authors to fit pretty much any leader who achieves 10X performance into their analysis. Would it ever be possible, one wonders, to find a leader whose success contradicted their thesis?"
Not content to critique the book generally, Murray fortunately, and shrewdly, provides an accidental example to which he referred earlier in his review,
"Which brings us back to Apple. Messrs. Collins and Hansen had no way of knowing, when they began sifting through their data in 2002, that Apple would become one of the most stunning turnaround stories in business history, soaring past Microsoft in market value. The late Steve Jobs accomplished that turnaround with a run of boldness, innovation, visionary thinking and egotism that might seem counter to the studied conclusions of "Great by Choice" as well as those of "Good to Great," in which Mr. Collins found that one of the leading attributes of the best business leaders was "humility." Steve Jobs?"
All of which satisfies me that Collins hasn't changed his approach much at all. He's still mixing hard-to-define qualitative assessments with quantitative ones. And applying them with, as Murray notes, considerably less than the precision one would wish.
Mr. Murray is not in the business of offending either an author who may advertise his book in the Journal, nor his readers. So he isn't about to land hard punches in his review by concluding that Collins' work is so vague and flawed as to be practically meaningless.
But I don't share Murray's constraints.
As I noted earlier, Collins' recent effort is perfect if what you hope to do is sell a book, for profits, that becomes a resident sales tool in many C-suites. And it even has an impressively-titled co-author from an equally-impressive university. But that doesn't make it valid or profound.
On that note, here's anecdote I learned years ago when I worked for Accenture's predecessor, Andersen Consulting. I had been chatting with Bob Gach, then a partner in the financial service group whose clients included Morgan Stanley and a few other investment banks. Since then, Bob has risen to become a very senior global partner in Accenture's financial services practice.
Back then, Bob was fretting because of the difficulty he was having closing a consulting contract with a Morgan Stanley executive.
As we discussed the firm's, and executive's behavior, Bob enunciated a principle which I've found to be pretty much universally true ever since. To paraphrase his remarks,
'This guy at Morgan Stanley really frustrates me. He's smart enough to force me to keep giving him enough examples of our work in his area, and to sign small pieces of work, that he keeps me from selling him the larger, more profitable interpretative and application modules.
When you think about it, the worst consulting customers are executives who are either really smart or really stupid. The smart ones know how to cherry pick a consultant's work and do the high value-added application of results to the rest of his businesses or operations.
The stupid ones are so thick they don't even understand why they need the consultant.
A consultant's best prospects are in the middle. Smart enough to know they need help. Dumb enough not to be able to get ahead of you in the thought process and rein in the scope of the project.'
Collins' work strikes me as designed to hit that middle group. It's too simplistic and flawed to sell to really intelligent business leaders. And the really slow ones will just never realize where to start to fix their problems.
But I can imagine quite a few middling companies with average executives jumping on Collins' rather shallow analyses as the answer to their prayers for some path out of mediocre performance.
And the beauty of Collins' approach, as Murray so deftly illustrates, is that there's always some other qualitative variable to blame when a CEO pays Collins for a lengthy engagement, follows his advice, and his business still doesn't outperform his peers.
I actually thought through all these issues when I was actively marketing the consulting application of my proprietary research on corporate performance. I even sold an engagement to the current chairman of the NYSE when he ran State Street Bank. Suffice to say, my consulting approach, as well as the research methods underpinning it, remains proprietary. But I will divulge that it is all quantitative, with no qualitative wiggle room.
Thursday, October 13, 2011
Regarding $2Trillion of Cash On Corporate Balance Sheets
Last week's Wednesday edition of the Wall Street Journal carried an article discussing the $2 trillion of cash on US non-financial corporate balance sheets.
It's an eye-popping number, to be sure. According to the article, the level of corporate cash was $1.4 trillion in 2008.
Thus, a nearly 50% increase in cash levels on those balance sheets in 3 years is one of the costs of the continuing turbulence in financial markets and global economies.
After seeing firms go bankrupt as a consequence of relying on short term funding during the financial crisis of 2008, it appears that many US non-financial corporations simply have ceased to trust or depend on their commercial banks and financial markets for operating funds.
Some view this large amount of cash as an impediment to a US expansion, as companies conserve those resources, rather than spend or invest them. And that's true.
But it's a consequence, rather than a first cause. That is, its CFOs' distrust of their prior, typical funding sources that caused them to essentially shift to self-funding. So it really identifies a heretofore hidden, lingering cost of the financial problems of three years ago. And the continuing global economic weakness.
Determined not to be caught out by unreliable funding sources again, US corporations have adapted to current circumstances. And that adaptation does seem to be resulting in a lack of expansive spending and investment.
Yet another source of uncertainty, along with tax and regulatory uncertainties, which drives US business behavior to be more prudent than it otherwise might be. With real consequences for the US economy.
It's an eye-popping number, to be sure. According to the article, the level of corporate cash was $1.4 trillion in 2008.
Thus, a nearly 50% increase in cash levels on those balance sheets in 3 years is one of the costs of the continuing turbulence in financial markets and global economies.
After seeing firms go bankrupt as a consequence of relying on short term funding during the financial crisis of 2008, it appears that many US non-financial corporations simply have ceased to trust or depend on their commercial banks and financial markets for operating funds.
Some view this large amount of cash as an impediment to a US expansion, as companies conserve those resources, rather than spend or invest them. And that's true.
But it's a consequence, rather than a first cause. That is, its CFOs' distrust of their prior, typical funding sources that caused them to essentially shift to self-funding. So it really identifies a heretofore hidden, lingering cost of the financial problems of three years ago. And the continuing global economic weakness.
Determined not to be caught out by unreliable funding sources again, US corporations have adapted to current circumstances. And that adaptation does seem to be resulting in a lack of expansive spending and investment.
Yet another source of uncertainty, along with tax and regulatory uncertainties, which drives US business behavior to be more prudent than it otherwise might be. With real consequences for the US economy.
Wednesday, October 05, 2011
Regarding GE's China Avionics Deal
The potential for conflict between economic growth of US companies and US employment is perhaps no better exemplified than in the recent reports of GE setting up an avionics venture in China. Especially since GE's underperforming CEO, Jeff Immelt, the man ultimately responsible for this offshore business and job-creating venture, is also chairman of the president's special US job creation council.
Last week, the Wall Street Journal ran this piece about the venture,
"During a factory tour in South Carolina, Jeffrey Immelt smiles and cuts me off after I ask another question about his new venture in China:
"I'm done," says the chief executive of General Electric. "This was reviewed by the Commerce Department and the Defense Department."
If Mr. Immelt's response seems a bit edgy, it's probably because I raised a topic that has much of U.S. business on edge too: How to compete in China without giving away the store. And specific to General Electric: What's to keep GE's new avionics joint venture with China from transferring the best of U.S. technology abroad, empowering a new set of Chinese companies to challenge U.S. aircraft makers?
China watchers are anxious about this venture. Avionics— the "brains" guiding navigation, communications and other operations on an airplane—are at the pinnacle of American know-how, where the U.S. is still highly competitive. It's also technology the Chinese military covets.
GE says it has built protections into the venture, but the debate can get heated.
"To suggest that there are going to be firewalls that will stop this technology from going to the Chinese military is approaching laughable," says Rep. Randy Forbes (R., Va.), who sits on the House Armed Services Committee. "The fact that GE would say that is shocking."
You could substitute many industrial companies for GE in this equation, because over the last 30 years most have struck their own difficult bargains with China's many state-owned companies. China is the world's fastest-growing major market, and in return for access the country frequently demands technology or other know-how. China then absorbs that technology and uses it to battle global competitors, selling products that are often heavily subsidized by China.
That has happened in a range of industries, including autos, electronics and energy. Siemens now competes internationally against Chinese high-speed rail companies that sell products partly based on technology gleaned from an earlier joint venture with the German firm.
The U.S. has restrictions on the export of certain technology that could threaten U.S. security, but it appears less equipped, or less organized, to contend with this broader challenge: what to do about the threat to many business sectors posed by China's state-sponsored industrial juggernaut.
"We've been passive in deciding how to deal with China's aggressive industrial policies," says James Lewis, who worked on technology-transfer issues at the Commerce Department and is now at the Center for Strategic and International Studies.
"U.S. companies are making the right decision from a business point of view, but it might not be the right decision for the country," Mr. Lewis adds.
"It's unclear whether anyone in the U.S. government took a look at the GE deal in terms of U.S. competitiveness—the future of the aviation industry 10 or 20 years out," says an executive who advises companies working in China. He worries that a heavily subsidized Chinese jet program, enhanced with U.S. avionics, could eventually clobber Boeing. "China has an incredible ability to distort markets, and we can't be reacting after the distortion has taken place."
Clyde Prestowitz, a former U.S. trade negotiator who writes on global economics and business, says China is violating World Trade Organization rules that prohibit making technology transfer a condition of market access. "In a normal market the avionics would be done for that plane in the U.S. and we'd sell it to China," he argues.
GE says it wasn't forced to give up its technology for market access. Instead, it sees this joint venture as a valuable piece of an existing global network of joint ventures and supplier relationships between the world's big aviation companies.
"Technology is the heart and soul of our company," says Rick Kennedy, a GE spokesman. "Why would we give away our future?"
In its China project, GE will develop a new generation of its avionics operating system with state-owned Aviation Industry Corp. of China, which supplies China's commercial and military aircraft industries. The business will be based in Shanghai and owned 50-50 by the two firms.
GE says its half of the work load will chiefly be handled out of GE facilities in Florida, Michigan and Britain. And it expects that capturing new business through the joint venture will both boost exports from its U.S. operations and add jobs.
The venture's first big customer: Commercial Aircraft Corp. of China, which is developing the C919 passenger jet to compete with Airbus and Boeing. The joint venture will also sell its avionics to aircraft makers globally. GE's current operating system is already on the Boeing 787.
As for the Chinese military, GE says it has spent nearly three years developing a compliance program that it believes won't let the military near its technology. GE will run the compliance office and will vet all hiring. AVIC is forbidden from sharing information with its military business. And people who leave the venture must wait two years before they can take any Chinese military-related assignment.
Still, China is an authoritarian country with a weak legal system. It is difficult to imagine that any technology deemed worthwhile in the GE/AVIC venture wouldn't somehow find its way onto the next-generation Chinese jet fighter. GE says that its system is specific to commercial use, not military. And if there were evidence that information had gotten to the Chinese generals, the joint venture would be shut down.
Kathleen Palma, who handles trade compliance for GE Aviation, says GE determined that U.S. export licenses weren't required for the technology involved, but the company nonetheless briefed the Commerce Department and the Defense Technology Security Administration several times. She says the U.S. government appeared satisfied. A spokeswoman for DTSA said GE said it was "complying with all applicable laws." A spokesman for the Commerce Department referred questions back to GE.
GE has manufacturing operations elsewhere in China, and it isn't alone in giving a lift to China's commercial jet program. Other U.S. companies have a piece of the action, including Honeywell, Hamilton Sundstrand, Rockwell Collins, Eaton and Parker Aerospace. Airbus has manufacturing operations in China.
What is uncertain is whether these companies will remain part of China's aviation calculus once they are done being useful, and whether Chinese companies will supplant them. That transition has happened in other industries and is a mainstay of China's "indigenous innovation" industrial strategy, which is explicit about "metabolizing" foreign technology and making it China's own.
GE says that if it hadn't linked with AVIC in a joint venture a competitor would have, which is very likely. Mr. Immelt, the CEO, says he'll take responsibility if the venture goes wrong. "It's on me," he says. "It's on me."
But the reality is more complicated. When it comes to China and its ability to shake global industries, the ramifications of GE's decisions—and the decisions of many other American companies—are on everyone."
There are a number of interesting aspects to the GE avionics venture.
First, Immelt claims he is 'responsible' for the venture if it "goes wrong."
"It's on me" he was quoted as saying.
Well, GE's decade of shareholder value destruction has been "on him," too, it would seem, but that hasn't led Immelt to do anything to address the problem, has he? He's still being paid millions each year by the firm's equally-ineffectual board while continuing to run a lackluster, needlessly-diversified conglomerate.
Second, it's pretty clear that the place where most of the jobs will be created by this China-based venture will be....China! So much for Jeff demonstrating to other US executives how to create US jobs.
Third, Clyde Prestowitz' charge that GE's, and other major corporations' being forced by China to surrender technology as a term of operating in the country is a clear violation of international trade laws to which China has agreed to operate. Why isn't GE, the US government, or any other company pursuing these issues through appropriate international venues?
Fourth, if GE is a leader in this business, wouldn't it's refusal to cede its technology to the Chinese leave the latter with second-tier vendors whose new commercial aircraft would be inferior to those of Boeing and Airbus? Thus making GE's decision the very reason it will be problematic?
Fifth, who, with a brain, really believes that if GE ever discovers evidence of its technology inappropriately being transferred to the Chinese military complex, it will ever be able to do anything about it? The technology will be gone. The venture's closure will only hurt GE. And it's not likely the Chinese would let GE remove anything- money, people, equipment- if they didn't choose to. Just imagine the prospect of GE employees and property seized by Chinese, and subjected to interminable holding while the Chinese dared anyone, including the US government, to act to get them back.
Sixth, contrary to GE manager Rick Kennedy's contention that technology is the "heart and soul" of GE, so why would they compromise future returns, the answer is simple. Pressure to meet short term profit goals by a poorly-performing CEO- Immelt.
Seventh, there is clear evidence across several other product markets that the Chinese will take the technology they want, then kick the US venture to the curb and compete with those same companies internationally. Why does GE think it will be any different?
There are so many reasons to doubt the wisdom of this GE venture that its truly shocking that the US government has allowed it to go forward.
I had one thought while reading the Journal account of this disaster in the making. It was the Soviet Union's Nikita Kruschev chortling that Western capitalists would sell (to Communists) the rope with which they would eventually be hung, so hungry for profits, and shortsighted were they.
Sound like Immelt's GE? It does to me.
Last week, the Wall Street Journal ran this piece about the venture,
"During a factory tour in South Carolina, Jeffrey Immelt smiles and cuts me off after I ask another question about his new venture in China:
"I'm done," says the chief executive of General Electric. "This was reviewed by the Commerce Department and the Defense Department."
If Mr. Immelt's response seems a bit edgy, it's probably because I raised a topic that has much of U.S. business on edge too: How to compete in China without giving away the store. And specific to General Electric: What's to keep GE's new avionics joint venture with China from transferring the best of U.S. technology abroad, empowering a new set of Chinese companies to challenge U.S. aircraft makers?
China watchers are anxious about this venture. Avionics— the "brains" guiding navigation, communications and other operations on an airplane—are at the pinnacle of American know-how, where the U.S. is still highly competitive. It's also technology the Chinese military covets.
GE says it has built protections into the venture, but the debate can get heated.
"To suggest that there are going to be firewalls that will stop this technology from going to the Chinese military is approaching laughable," says Rep. Randy Forbes (R., Va.), who sits on the House Armed Services Committee. "The fact that GE would say that is shocking."
You could substitute many industrial companies for GE in this equation, because over the last 30 years most have struck their own difficult bargains with China's many state-owned companies. China is the world's fastest-growing major market, and in return for access the country frequently demands technology or other know-how. China then absorbs that technology and uses it to battle global competitors, selling products that are often heavily subsidized by China.
That has happened in a range of industries, including autos, electronics and energy. Siemens now competes internationally against Chinese high-speed rail companies that sell products partly based on technology gleaned from an earlier joint venture with the German firm.
The U.S. has restrictions on the export of certain technology that could threaten U.S. security, but it appears less equipped, or less organized, to contend with this broader challenge: what to do about the threat to many business sectors posed by China's state-sponsored industrial juggernaut.
"We've been passive in deciding how to deal with China's aggressive industrial policies," says James Lewis, who worked on technology-transfer issues at the Commerce Department and is now at the Center for Strategic and International Studies.
"U.S. companies are making the right decision from a business point of view, but it might not be the right decision for the country," Mr. Lewis adds.
"It's unclear whether anyone in the U.S. government took a look at the GE deal in terms of U.S. competitiveness—the future of the aviation industry 10 or 20 years out," says an executive who advises companies working in China. He worries that a heavily subsidized Chinese jet program, enhanced with U.S. avionics, could eventually clobber Boeing. "China has an incredible ability to distort markets, and we can't be reacting after the distortion has taken place."
Clyde Prestowitz, a former U.S. trade negotiator who writes on global economics and business, says China is violating World Trade Organization rules that prohibit making technology transfer a condition of market access. "In a normal market the avionics would be done for that plane in the U.S. and we'd sell it to China," he argues.
GE says it wasn't forced to give up its technology for market access. Instead, it sees this joint venture as a valuable piece of an existing global network of joint ventures and supplier relationships between the world's big aviation companies.
"Technology is the heart and soul of our company," says Rick Kennedy, a GE spokesman. "Why would we give away our future?"
In its China project, GE will develop a new generation of its avionics operating system with state-owned Aviation Industry Corp. of China, which supplies China's commercial and military aircraft industries. The business will be based in Shanghai and owned 50-50 by the two firms.
GE says its half of the work load will chiefly be handled out of GE facilities in Florida, Michigan and Britain. And it expects that capturing new business through the joint venture will both boost exports from its U.S. operations and add jobs.
The venture's first big customer: Commercial Aircraft Corp. of China, which is developing the C919 passenger jet to compete with Airbus and Boeing. The joint venture will also sell its avionics to aircraft makers globally. GE's current operating system is already on the Boeing 787.
As for the Chinese military, GE says it has spent nearly three years developing a compliance program that it believes won't let the military near its technology. GE will run the compliance office and will vet all hiring. AVIC is forbidden from sharing information with its military business. And people who leave the venture must wait two years before they can take any Chinese military-related assignment.
Still, China is an authoritarian country with a weak legal system. It is difficult to imagine that any technology deemed worthwhile in the GE/AVIC venture wouldn't somehow find its way onto the next-generation Chinese jet fighter. GE says that its system is specific to commercial use, not military. And if there were evidence that information had gotten to the Chinese generals, the joint venture would be shut down.
Kathleen Palma, who handles trade compliance for GE Aviation, says GE determined that U.S. export licenses weren't required for the technology involved, but the company nonetheless briefed the Commerce Department and the Defense Technology Security Administration several times. She says the U.S. government appeared satisfied. A spokeswoman for DTSA said GE said it was "complying with all applicable laws." A spokesman for the Commerce Department referred questions back to GE.
GE has manufacturing operations elsewhere in China, and it isn't alone in giving a lift to China's commercial jet program. Other U.S. companies have a piece of the action, including Honeywell, Hamilton Sundstrand, Rockwell Collins, Eaton and Parker Aerospace. Airbus has manufacturing operations in China.
What is uncertain is whether these companies will remain part of China's aviation calculus once they are done being useful, and whether Chinese companies will supplant them. That transition has happened in other industries and is a mainstay of China's "indigenous innovation" industrial strategy, which is explicit about "metabolizing" foreign technology and making it China's own.
GE says that if it hadn't linked with AVIC in a joint venture a competitor would have, which is very likely. Mr. Immelt, the CEO, says he'll take responsibility if the venture goes wrong. "It's on me," he says. "It's on me."
But the reality is more complicated. When it comes to China and its ability to shake global industries, the ramifications of GE's decisions—and the decisions of many other American companies—are on everyone."
There are a number of interesting aspects to the GE avionics venture.
First, Immelt claims he is 'responsible' for the venture if it "goes wrong."
"It's on me" he was quoted as saying.
Well, GE's decade of shareholder value destruction has been "on him," too, it would seem, but that hasn't led Immelt to do anything to address the problem, has he? He's still being paid millions each year by the firm's equally-ineffectual board while continuing to run a lackluster, needlessly-diversified conglomerate.
Second, it's pretty clear that the place where most of the jobs will be created by this China-based venture will be....China! So much for Jeff demonstrating to other US executives how to create US jobs.
Third, Clyde Prestowitz' charge that GE's, and other major corporations' being forced by China to surrender technology as a term of operating in the country is a clear violation of international trade laws to which China has agreed to operate. Why isn't GE, the US government, or any other company pursuing these issues through appropriate international venues?
Fourth, if GE is a leader in this business, wouldn't it's refusal to cede its technology to the Chinese leave the latter with second-tier vendors whose new commercial aircraft would be inferior to those of Boeing and Airbus? Thus making GE's decision the very reason it will be problematic?
Fifth, who, with a brain, really believes that if GE ever discovers evidence of its technology inappropriately being transferred to the Chinese military complex, it will ever be able to do anything about it? The technology will be gone. The venture's closure will only hurt GE. And it's not likely the Chinese would let GE remove anything- money, people, equipment- if they didn't choose to. Just imagine the prospect of GE employees and property seized by Chinese, and subjected to interminable holding while the Chinese dared anyone, including the US government, to act to get them back.
Sixth, contrary to GE manager Rick Kennedy's contention that technology is the "heart and soul" of GE, so why would they compromise future returns, the answer is simple. Pressure to meet short term profit goals by a poorly-performing CEO- Immelt.
Seventh, there is clear evidence across several other product markets that the Chinese will take the technology they want, then kick the US venture to the curb and compete with those same companies internationally. Why does GE think it will be any different?
There are so many reasons to doubt the wisdom of this GE venture that its truly shocking that the US government has allowed it to go forward.
I had one thought while reading the Journal account of this disaster in the making. It was the Soviet Union's Nikita Kruschev chortling that Western capitalists would sell (to Communists) the rope with which they would eventually be hung, so hungry for profits, and shortsighted were they.
Sound like Immelt's GE? It does to me.
Tuesday, October 04, 2011
Regarding Amazon's Fire Tablet- And Apple
The big news in online business last week was Amazon's unveiling of its Fire tablet. By now, you've doubtless read plenty of reviews of the product, comparisons with Apple's iPad, heard and seen countless pundits pontificate on the new entry.
Here's my take.
First, as I've always contended, and several pundits reinforced, Amazon will always trail Apple in this product space, by virtue of its entirely outsourcing the design and manufacture. For example, from what I've read, the Fire has no camera and lacks some connectivity options.
Second, the real and most important aspect of the Fire is its $200 price point. While it technically exploits a market segment which Apple doesn't care to currently address, it does begin to exert more downward pressure on pricing and margins in the product/market. In fact, the Wall Street Journal's report on the Fire alleged that Amazon is not only pricing to profit on the downloadable content, but that the $200 list price doesn't even cover the Fire's production costs.
Thus, as I told a friend over lunch last Friday, Amazon is embarking down a very dangerous road- using a sprawling, integrated business model including its entire online general store to subsidize the cost of its latest deliverable tablet. Sooner or later, some aspect of Amazon's business will probably begin to experience pricing problems as the transfer pricing and allocation of overheads begin to distort the prices and margins of products which effectively fund the Fire.
Mixed into that mess is Amazon's tying the Fire to an automatic Premium subscription. So various shipping and other discounts on content are included with the tablet, but it's unclear that buyers of the Fire actually want, prefer or will use much of that content. Or spend more money to buy or rent what isn't free with the Fire.
In contrast, Apple's business model seems simpler and cleaner.
As I also explained to my friend last Friday, this development is why Apple won't be in my equity portfolios forever. Eventually, one or more of three forces tend to drive equities from the buy list: investor expectations adjust to the firm's actual performance, resulting in the equity's price no longer rises so smartly; competitive forces attenuate the firm's revenue and profit growth, and/or; regulatory action puts a stop to the firm's previously-unstoppable growth.
I've seen a succession of former portfolio holdings fall victim to one or more of these forces over time: Kohls, Dell, Microsoft, Home Depot and Wal-Mart.
Now Apple and Amazon seem to be heading in that direction. Both have been recent portfolio members. But now their evolving struggle involving tablets and online-delivered content- music, video and books- is likely to limit margins and pricing power for both.
Thus, Amazon's Fire has accelerated the move of the tablets and their content toward commoditization. Good for consumers, not so great for investors in the providers of these services.
Interestingly, in his weekend Wall Street Journal column, Holman Jenkins, Jr. contended that the real reason for the demise of technology firms Microsoft and HP has been that their product lines are devoid of the social media content which Apple, Amazon, Google, and Facebook have so zealously and successfully pursued. Including, for the first three, developing special-application computers, a/k/a tablets and smartphones, which undercut general-purpose computers and emphasize media consumption.
Certainly, that's one view. But personal computers became commoditized some years ago- well before the rise of Facebook, social media and the general accessibility of media content via cheap, ubiquitous wireless connections.
Still, as I contended in today's companion post, competitive forces tend to affect every product/market, even if at different speeds.
Here's my take.
First, as I've always contended, and several pundits reinforced, Amazon will always trail Apple in this product space, by virtue of its entirely outsourcing the design and manufacture. For example, from what I've read, the Fire has no camera and lacks some connectivity options.
Second, the real and most important aspect of the Fire is its $200 price point. While it technically exploits a market segment which Apple doesn't care to currently address, it does begin to exert more downward pressure on pricing and margins in the product/market. In fact, the Wall Street Journal's report on the Fire alleged that Amazon is not only pricing to profit on the downloadable content, but that the $200 list price doesn't even cover the Fire's production costs.
Thus, as I told a friend over lunch last Friday, Amazon is embarking down a very dangerous road- using a sprawling, integrated business model including its entire online general store to subsidize the cost of its latest deliverable tablet. Sooner or later, some aspect of Amazon's business will probably begin to experience pricing problems as the transfer pricing and allocation of overheads begin to distort the prices and margins of products which effectively fund the Fire.
Mixed into that mess is Amazon's tying the Fire to an automatic Premium subscription. So various shipping and other discounts on content are included with the tablet, but it's unclear that buyers of the Fire actually want, prefer or will use much of that content. Or spend more money to buy or rent what isn't free with the Fire.
In contrast, Apple's business model seems simpler and cleaner.
As I also explained to my friend last Friday, this development is why Apple won't be in my equity portfolios forever. Eventually, one or more of three forces tend to drive equities from the buy list: investor expectations adjust to the firm's actual performance, resulting in the equity's price no longer rises so smartly; competitive forces attenuate the firm's revenue and profit growth, and/or; regulatory action puts a stop to the firm's previously-unstoppable growth.
I've seen a succession of former portfolio holdings fall victim to one or more of these forces over time: Kohls, Dell, Microsoft, Home Depot and Wal-Mart.
Now Apple and Amazon seem to be heading in that direction. Both have been recent portfolio members. But now their evolving struggle involving tablets and online-delivered content- music, video and books- is likely to limit margins and pricing power for both.
Thus, Amazon's Fire has accelerated the move of the tablets and their content toward commoditization. Good for consumers, not so great for investors in the providers of these services.
Interestingly, in his weekend Wall Street Journal column, Holman Jenkins, Jr. contended that the real reason for the demise of technology firms Microsoft and HP has been that their product lines are devoid of the social media content which Apple, Amazon, Google, and Facebook have so zealously and successfully pursued. Including, for the first three, developing special-application computers, a/k/a tablets and smartphones, which undercut general-purpose computers and emphasize media consumption.
Certainly, that's one view. But personal computers became commoditized some years ago- well before the rise of Facebook, social media and the general accessibility of media content via cheap, ubiquitous wireless connections.
Still, as I contended in today's companion post, competitive forces tend to affect every product/market, even if at different speeds.
Competition Eventually Visits Every Product/Market
I wrote a post last year involving History Channel programs featuring a pawn broker and two Iowa-based "pickers."
Both History Channel programs have already spawned competitors.
The pickers now have competition on Lifetime. The new series stars two pretty young Southern sisters, Tanya McQueen and Tracy Hutson, who call themselves Picker Sisters. They differentiate themselves by focusing on the storefront gallery they run, and how they envision transforming their derelict picks into trendy furnishings. Their refurbishment guy is often included to discuss how the piece will be treated to arrive at the sisters' desired look.
Unlike the Iowa pickers, Frank and Mike, who seem to mostly just recycle their picks as-is, the sisters' and their program seeks to engage buyers' and viewers' sense of style, fashion and interior decorating.
Pawn Stars has provoked a low-rent version of itself on another network. The name escapes me, but it's pretty much a direct rip-off, but with far less humor, drama and educational value.
But it just goes to show that, even with what you'd think would be fairly innocuous products, like quirky cable television special-interest programs, knockoffs arrive with surprising speed.
Both History Channel programs have already spawned competitors.
The pickers now have competition on Lifetime. The new series stars two pretty young Southern sisters, Tanya McQueen and Tracy Hutson, who call themselves Picker Sisters. They differentiate themselves by focusing on the storefront gallery they run, and how they envision transforming their derelict picks into trendy furnishings. Their refurbishment guy is often included to discuss how the piece will be treated to arrive at the sisters' desired look.
Unlike the Iowa pickers, Frank and Mike, who seem to mostly just recycle their picks as-is, the sisters' and their program seeks to engage buyers' and viewers' sense of style, fashion and interior decorating.
Pawn Stars has provoked a low-rent version of itself on another network. The name escapes me, but it's pretty much a direct rip-off, but with far less humor, drama and educational value.
But it just goes to show that, even with what you'd think would be fairly innocuous products, like quirky cable television special-interest programs, knockoffs arrive with surprising speed.
Wednesday, September 28, 2011
Kodak's New Funding Troubles
"If that chart is Perez' idea of a turnaround, I'd hate to see his notion of failure.
According to the charts accompanying the Journal's article, sales at the firm have fallen from slightly over $10B in 2006 to an expected less than $3B this year. Kodak lost money in each of the past three years and is forecast to do so again this year."
Then I read Tuesday's Wall Street Journal article concerning Kodak's shares losing "more than a quarter of their value Monday."
The current five-year price chart for Kodak and the S&P500 Index, seen above, now reveals the former to have lost more than 80% of it's value over the period.
Back when I wrote last month's post about Kodak, its market value was already judged by some analysts to have fallen below the value of its patent portfolio.
What changed?
Kodak drew down its bank credit line by $160MM. It has $75MM left on the facility.
A Kodak official said that the drawdown was because money earned overseas was not being repatriated. Whether true, or not, the reality is that Kodak has been a basket case since January of 2009. The S&P has risen steadily since then, while Kodak's equity price has been a roller coaster, ending down.
I'm not surprised to learn that CEO Perez' contract runs out in 2013. No wonder he's moving heaven and earth to keep the victim...errr...company afloat a little longer.
I continue to believe, as I stated in prior posts concerning Kodak and Perez, that the firm should have been sold or liquidated long ago, to provide shareholders with some residual value. Now it may be too late for any significant value recapture.
Friday, September 23, 2011
The Sensible Industrial Conglomerate: UT's Bid for Goodrich
I find the recent news that United Technologies is buying Goodrich to be yet another example of how much better-managed UT is than GE. And how UT chooses a large acquisition that serves common customers and/or provides additional products to complement existing lines at the company.
In contrast, GE's last really large purchase was RCA, years ago under Jack Welch. The firm got rid of most of RCA, but kept NBC. But, after decades of disappointing performance and management distractions, current CEO Immelt finally threw in the towel and undid Welch's deal.
The other quasi-sizable deal done by Welch, buying investment bank Kidder Peabody, also blew up from a trading desk scandal. It didn't fit with the rest of GE Capital, other than, well, they both involved finance.
To see how these different approaches to conglomeration are expressed as performance, the first chart is of the past five years of prices for UT, GE and the S&P500 Index.
UT has clearly outperformed the diversified conglomerate, GE.
Looking back further, to 1970, before UT's restructuring, the two were rather similar in performance for almost 20 years. By the mid-1990s, UT's performance, which has been fairly consistent for 40 years, became even more consistent. In contrast, GE experienced more explosive short term growth due to GE Capital and some apparently generous accounting treatment of several units, which came under closer scrutiny after Welch departed. GE's performance fell significantly right away under Immelt, Welch's successor, then really disintegrated in 2008 due to GE Capital's precarious financial condition.
Diversified conglomerates went out of style, for good economic reasons, before Welch left GE. But UT's brand of related conglomeration which focuses on specific customer groups, technologies and/or products, continues to perform consistently well, when well-implemented.
Goodrich looks like another piece which will fit well into UT's operations.
In contrast, GE's last really large purchase was RCA, years ago under Jack Welch. The firm got rid of most of RCA, but kept NBC. But, after decades of disappointing performance and management distractions, current CEO Immelt finally threw in the towel and undid Welch's deal.
The other quasi-sizable deal done by Welch, buying investment bank Kidder Peabody, also blew up from a trading desk scandal. It didn't fit with the rest of GE Capital, other than, well, they both involved finance.
UT has clearly outperformed the diversified conglomerate, GE.
Looking back further, to 1970, before UT's restructuring, the two were rather similar in performance for almost 20 years. By the mid-1990s, UT's performance, which has been fairly consistent for 40 years, became even more consistent. In contrast, GE experienced more explosive short term growth due to GE Capital and some apparently generous accounting treatment of several units, which came under closer scrutiny after Welch departed. GE's performance fell significantly right away under Immelt, Welch's successor, then really disintegrated in 2008 due to GE Capital's precarious financial condition.
Diversified conglomerates went out of style, for good economic reasons, before Welch left GE. But UT's brand of related conglomeration which focuses on specific customer groups, technologies and/or products, continues to perform consistently well, when well-implemented.
Goodrich looks like another piece which will fit well into UT's operations.
Thursday, September 22, 2011
Regarding The Tyco Split
In Tuesday's post concerning Netflix and its apparent preparation for a split into two companies, I neglected to mention the companion disintegration story of the day: Tyco.
Long associated with the excesses of its senior management and CEO, Dennis Koslowski, Tyco was restructured in the wake of his departure. Now, the remaining businesses under the Tyco umbrella are splitting yet again.
It strikes me as odd that the general sentiment greeting Tyco's announcement was positive, calling some pundits to compare it to Irene Rosenfeld's dismantling of the Kraft conglomerate she just mashed together only a few years ago.
Why is it that those two are good de-conglomerations, but Netflix's more clear-cut separation of businesses isn't?
Furthermore, not to miss an opportunity to drive this point home yet again, how can investors embrace such unbundling of needless conglomeration, yet fail to push GE's CEO Jeff Immelt to finally split that firm into its natural, individual constituent parts? And save investors the pricey headquarters functions which include Immelt's own lavish compensation package?
Long associated with the excesses of its senior management and CEO, Dennis Koslowski, Tyco was restructured in the wake of his departure. Now, the remaining businesses under the Tyco umbrella are splitting yet again.
It strikes me as odd that the general sentiment greeting Tyco's announcement was positive, calling some pundits to compare it to Irene Rosenfeld's dismantling of the Kraft conglomerate she just mashed together only a few years ago.
Why is it that those two are good de-conglomerations, but Netflix's more clear-cut separation of businesses isn't?
Furthermore, not to miss an opportunity to drive this point home yet again, how can investors embrace such unbundling of needless conglomeration, yet fail to push GE's CEO Jeff Immelt to finally split that firm into its natural, individual constituent parts? And save investors the pricey headquarters functions which include Immelt's own lavish compensation package?
GM, China & Technology
I found the recent article in the Wall Street Journal discussing GM's China business to raise some interesting questions.
Unsurprisingly, GM management feels constrained by Chinese rules which demand technology sharing in exchange for investing for substantial growth.
Fortunately, one theme of the article is the risk both Ford and GM take if they expand, only to find themselves in an over-supplied market. Which would not be too hard to imagine, as every auto maker views China as the last great untapped market. I'd say it's more likely that there will be too many producers, driving prices and margins down.
But on the technology topic, there's something that puzzles me. Most vehicles are more assemblages of supplier components than they are totally manufactured by the company whose name is on the car. Thus, much of the technology in a modern car may be purchased off the shelf from existing vendors.
I suppose there are some proprietary transmission, engine and perhaps high-end electronics. But what can't be bought from suppliers can be bought, disassembled and reverse engineered.
The article mentions GM closely guarding its Volt technologies, which I found to be laughable. Nobody buys the thing in the US without hefty government subsidies. I have trouble believing China will have a ready-to-use, adapted power grid to handle the Volt.
To some extent, I think that companies wishing to do business in a country become embroiled in situations much like those of extractive industries. When you are bound to a location, the host country can pretty much demand whatever they like, even change terms, and the companies being victimized have to constantly reassess their decision to operate in that country.
It seems that GM and Ford will continue to experience this dilemma for the foreseeable future, with ongoing risk for their investment and whatever truly proprietary technology they offer.
Unsurprisingly, GM management feels constrained by Chinese rules which demand technology sharing in exchange for investing for substantial growth.
Fortunately, one theme of the article is the risk both Ford and GM take if they expand, only to find themselves in an over-supplied market. Which would not be too hard to imagine, as every auto maker views China as the last great untapped market. I'd say it's more likely that there will be too many producers, driving prices and margins down.
But on the technology topic, there's something that puzzles me. Most vehicles are more assemblages of supplier components than they are totally manufactured by the company whose name is on the car. Thus, much of the technology in a modern car may be purchased off the shelf from existing vendors.
I suppose there are some proprietary transmission, engine and perhaps high-end electronics. But what can't be bought from suppliers can be bought, disassembled and reverse engineered.
The article mentions GM closely guarding its Volt technologies, which I found to be laughable. Nobody buys the thing in the US without hefty government subsidies. I have trouble believing China will have a ready-to-use, adapted power grid to handle the Volt.
To some extent, I think that companies wishing to do business in a country become embroiled in situations much like those of extractive industries. When you are bound to a location, the host country can pretty much demand whatever they like, even change terms, and the companies being victimized have to constantly reassess their decision to operate in that country.
It seems that GM and Ford will continue to experience this dilemma for the foreseeable future, with ongoing risk for their investment and whatever truly proprietary technology they offer.
Tuesday, September 20, 2011
The Panic Over Netflix
I'm frankly a bit surprised at the panic and anger following Netflix's recent pricing changes. Here's the email Netflix CEO Reed Hastings sent to customers the other day:
"Dear (Customer name)-
I messed up. I owe you an explanation.
It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology. Let me explain what we are doing.
For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming. Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us). So we moved quickly into streaming, but I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do.
So here is what we are doing and why.
Many members love our DVD service, as I do, because nearly every movie ever made is published on DVD. DVD is a great option for those who want the huge and comprehensive selection of movies.
I also love our streaming service because it is integrated into my TV, and I can watch anytime I want. The benefits of our streaming service are really quite different from the benefits of DVD by mail. We need to focus on rapid improvement as streaming technology and the market evolves, without maintaining compatibility with our DVD by mail service.
So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently.
It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”. We chose the name Qwikster because it refers to quick delivery. We will keep the name “Netflix” for streaming.
Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to qwikster.com to access their DVD queues and choose movies. One improvement we will make at launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done. Other improvements will follow. A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated.
There are no pricing changes (we’re done with that!). If you subscribe to both services you will have two entries on your credit card statement, one for Qwikster and one for Netflix. The total will be the same as your current charges. We will let you know in a few weeks when the Qwikster.com website is up and ready.
For me the Netflix red envelope has always been a source of joy. The new envelope is still that lovely red, but now it will have a Qwikster logo. I know that logo will grow on me over time, but still, it is hard. I imagine it will be similar for many of you.
I want to acknowledge and thank you for sticking with us, and to apologize again to those members, both current and former, who felt we treated them thoughtlessly.
Both the Qwikster and Netflix teams will work hard to regain your trust. We know it will not be overnight. Actions speak louder than words. But words help people to understand actions.
Respectfully yours,
-Reed Hastings, Co-Founder and CEO, Netflix
p.s. I have a slightly longer explanation along with a video posted on our blog, where you can also post comments."
Punditry has come down on both sides of this issue. CNBC's Herb Greenberg renewed his customary energetic attack on the company, once more reminding one and all of the firm's balance sheet's store of unexpensed acquisition costs. And Greenberg asserts that providers like Netflix will become commodities, thus ruining the firm's business model.
Others, however, side with Netflix for sensibly now splitting two very different businesses. As well as prepare customers for the eventual arrival of bandwidth pricing, which will affect how they use online media.
As for me, I'm rather sick of the whining by pundits (like Greenberg) and customers who are shocked- SHOCKED!- that prices for the physical disc side of Netflix's business have risen.
They remind me of the people who are outraged that Social Security- correctly called a Ponzi scheme by Rick Perry- won't deliver on all of its phony, never-was-possible benefit promises.
In the case of Netflix, pricing was what it was while it was. Initially, they gave away metered online usage according to your pricing plan. Then it became unlimited, which of course encouraged migration to streaming.
But the streaming business has always had a distinctly smaller inventory of video to view. I don't know about other customers, but I viewed the two services- streaming and discs- as two separate vendors, anyway, because of the availability issue.
So it makes a lot of sense to me that Hastings & Co. have finally announced a formal split of what have been two different-looking businesses for at least a year.
Meanwhile, thanks to Tivo and Netflix streaming, I only need to have one disc available now. Much of my video consumption on Netflix is satisfied by selecting videos on the website for Tivo to access for my subsequent viewing on a television screen. My children preferred to view streaming material directly on their laptops.
My use of discs is for special material that is typically arcane, classic and/or no longer very popular, and, thus, not among the limited streaming inventory.
Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.
As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.
As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates.
Will the streaming business recoup the recent equity price decline? I have no idea. Investor reactions will determine that. If not, then I can confidently predict that the equity representing that business won't be in my portfolio.
Regardless, those who've had Netflix in their portfolios for some time, as my selection process has, enjoyed substantial gains, and if they rebalanced consistently, this recent slide won't be the end of the world. It hasn't even had a drastic effect on my portfolios which include Netflix, as other firms, such as Apple, have continued to gain value, offsetting Netflix's stock price drubbing.
After all, no equity grows in value forever. Not even Apple.
"Dear (Customer name)-
I messed up. I owe you an explanation.
It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology. Let me explain what we are doing.
For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming. Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us). So we moved quickly into streaming, but I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do.
So here is what we are doing and why.
Many members love our DVD service, as I do, because nearly every movie ever made is published on DVD. DVD is a great option for those who want the huge and comprehensive selection of movies.
I also love our streaming service because it is integrated into my TV, and I can watch anytime I want. The benefits of our streaming service are really quite different from the benefits of DVD by mail. We need to focus on rapid improvement as streaming technology and the market evolves, without maintaining compatibility with our DVD by mail service.
So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently.
It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”. We chose the name Qwikster because it refers to quick delivery. We will keep the name “Netflix” for streaming.
Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to qwikster.com to access their DVD queues and choose movies. One improvement we will make at launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done. Other improvements will follow. A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated.
There are no pricing changes (we’re done with that!). If you subscribe to both services you will have two entries on your credit card statement, one for Qwikster and one for Netflix. The total will be the same as your current charges. We will let you know in a few weeks when the Qwikster.com website is up and ready.
For me the Netflix red envelope has always been a source of joy. The new envelope is still that lovely red, but now it will have a Qwikster logo. I know that logo will grow on me over time, but still, it is hard. I imagine it will be similar for many of you.
I want to acknowledge and thank you for sticking with us, and to apologize again to those members, both current and former, who felt we treated them thoughtlessly.
Both the Qwikster and Netflix teams will work hard to regain your trust. We know it will not be overnight. Actions speak louder than words. But words help people to understand actions.
Respectfully yours,
-Reed Hastings, Co-Founder and CEO, Netflix
p.s. I have a slightly longer explanation along with a video posted on our blog, where you can also post comments."
Punditry has come down on both sides of this issue. CNBC's Herb Greenberg renewed his customary energetic attack on the company, once more reminding one and all of the firm's balance sheet's store of unexpensed acquisition costs. And Greenberg asserts that providers like Netflix will become commodities, thus ruining the firm's business model.
Others, however, side with Netflix for sensibly now splitting two very different businesses. As well as prepare customers for the eventual arrival of bandwidth pricing, which will affect how they use online media.
As for me, I'm rather sick of the whining by pundits (like Greenberg) and customers who are shocked- SHOCKED!- that prices for the physical disc side of Netflix's business have risen.
They remind me of the people who are outraged that Social Security- correctly called a Ponzi scheme by Rick Perry- won't deliver on all of its phony, never-was-possible benefit promises.
In the case of Netflix, pricing was what it was while it was. Initially, they gave away metered online usage according to your pricing plan. Then it became unlimited, which of course encouraged migration to streaming.
But the streaming business has always had a distinctly smaller inventory of video to view. I don't know about other customers, but I viewed the two services- streaming and discs- as two separate vendors, anyway, because of the availability issue.
So it makes a lot of sense to me that Hastings & Co. have finally announced a formal split of what have been two different-looking businesses for at least a year.
Meanwhile, thanks to Tivo and Netflix streaming, I only need to have one disc available now. Much of my video consumption on Netflix is satisfied by selecting videos on the website for Tivo to access for my subsequent viewing on a television screen. My children preferred to view streaming material directly on their laptops.
My use of discs is for special material that is typically arcane, classic and/or no longer very popular, and, thus, not among the limited streaming inventory.
Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.
As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.
As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates.
Will the streaming business recoup the recent equity price decline? I have no idea. Investor reactions will determine that. If not, then I can confidently predict that the equity representing that business won't be in my portfolio.
Regardless, those who've had Netflix in their portfolios for some time, as my selection process has, enjoyed substantial gains, and if they rebalanced consistently, this recent slide won't be the end of the world. It hasn't even had a drastic effect on my portfolios which include Netflix, as other firms, such as Apple, have continued to gain value, offsetting Netflix's stock price drubbing.
After all, no equity grows in value forever. Not even Apple.
Monday, September 12, 2011
An Interim Report On Glenn Beck's New Online-Only Venture
Back in July, I wrote this post discussing Glenn Beck's move from Fox News to his own online-only media base, as well as Oprah Winfrey's recent move to her own cable network. I closed the post with these passages,
"Beck made sure his new venture is easily found, cheap to join, and ubiquitous. By emphasizing smart phones and tablets, plus political action projects, he's opened up his venture to younger audiences, as well as older ones.
Whether Winfrey or Beck proves to be more financially successful might be less important for the old media world, in the long run, than that both former conventional media stars bolted their former homes to control their future media destinies with so much apparent ease. How they fare may vary, of course, as Winfrey's management headaches attest. But their example may begin to sink in with more conventional entertainment creators who, until now, have sold their television series to broadcast and cable networks.
How long will it be before Glee, MadMen and Psyche simply go to websites and enjoy 100% of subscriber fees, selling by the episode, season or more, via credit cards and PayPal?"
This morning's edition of the Wall Street Journal provides some interim information on Beck's move. First, it refers to "clashes with network management" as part of Beck's motivation for the move. I'm sure Fox was getting pressure from various sources, given Beck's unvarnished, in-your-face style of confrontational video journalism.
But, as Beck explained in his web-based infomercial for his new online network, which aired immediately after he closed his last Fox News program, he had been urged by others to make such a move earlier than just this year.
According to the Journal piece,
"Because Mr. Beck owns the show and the network, he could make substantially more than the $2.5 million salary he got each year at Fox. GBTV is on track to take in more than $20 million in revenue in its debut year, according to a person close to the company.
The television industry will be watching closely to see whether the TV host can preserve his popularity while migrating to the Web, where efforts to get consumers to pay to watch online-only channels are just beginning.
When Mr. Beck announced GBTV in June, the network had 80,000 subscribers. In the months since, GBTV subscribers have swelled to more than 230,000, according to people close to the network, even though Mr. Beck's show hasn't yet begun.
The audience is far less than the more than 2.2 million daily viewers his program on Fox drew, on average, over its 27-month run, which ended in June after clashes with the network's management.
But it is more than the average 156,000 people who were watching the Oprah Winfrey Network in June.
Like GBTV, OWN was started by a major TV personality, but it's available through a traditional cable subscription. By contrast, Mr. Beck's network is available a la carte to subscribers who pay $9.95 a month to stream the network on gbtv.com and over interconnected devices such as tablets and mobile phones. The network's programming includes a reality show about the making of GBTV and a program anchored by Mr. Beck's co-hosts from his nationally syndicated radio show, which draws 10 million weekly listeners. A block of children's programming is slated to start later this month.
Mr. Beck said one of the reasons he ditched a network for the Web was a desire to reach out to young people. "I think networks are a thing of the past," he said. "I don't know anybody under 30 who is watching television the way I watched television. Technology has allowed people to change the way they consume the news, and we want to be where people are going." "
I'm impressed. Beck is already drawing almost 50% more in directly paying audience than Winfrey is via included cable distribution. Not to mention that Beck's program, which aired on Fox at 5PM, can now reach subscribers via wireless iPads and smartphones while the adults commute home from work. And Beck isn't wrong in his views, presented in the last paragraph of the quoted text. He's playing a long game for younger hearts and minds which don't see a few bucks per month as too much to pay for video programming.
In fact, Beck is teaching people to more aggressively disintermediate their cable television bills by beginning to pay directly for individual channels. The Journal article contends that Beck's subscription is $9.99/month, buy my July post, written soon after I watched the channel's infomercial, clearly states that the price closer to $5/month. I believe it was a charter-member price. But isn't it likely that, over time, Beck's channel will offer attractive renewal prices, or significantly lower rates for annual members? Not to mention begin to offer private social-networking marketing deals a la Groupon and LivingSocial? And discounts for referring friends to become subscribers?
Of course he will.
I don't have much doubt that Beck's experiment will succeed, even if not immediately. I believe he's shown insight in identifying how to secure editorial independence, the entire cashflow stream of a network, and adapt to video buying and viewing habits made possible and becoming predominant, thanks to evolving technology.
And, in time, I suspect, because of the nature of Beck's topics and audience, he'll have shown himself to be shrewder than Winfrey by assuming full ownership and risk, but retaining total control and financial rewards.
"Beck made sure his new venture is easily found, cheap to join, and ubiquitous. By emphasizing smart phones and tablets, plus political action projects, he's opened up his venture to younger audiences, as well as older ones.
Whether Winfrey or Beck proves to be more financially successful might be less important for the old media world, in the long run, than that both former conventional media stars bolted their former homes to control their future media destinies with so much apparent ease. How they fare may vary, of course, as Winfrey's management headaches attest. But their example may begin to sink in with more conventional entertainment creators who, until now, have sold their television series to broadcast and cable networks.
How long will it be before Glee, MadMen and Psyche simply go to websites and enjoy 100% of subscriber fees, selling by the episode, season or more, via credit cards and PayPal?"
This morning's edition of the Wall Street Journal provides some interim information on Beck's move. First, it refers to "clashes with network management" as part of Beck's motivation for the move. I'm sure Fox was getting pressure from various sources, given Beck's unvarnished, in-your-face style of confrontational video journalism.
But, as Beck explained in his web-based infomercial for his new online network, which aired immediately after he closed his last Fox News program, he had been urged by others to make such a move earlier than just this year.
According to the Journal piece,
"Because Mr. Beck owns the show and the network, he could make substantially more than the $2.5 million salary he got each year at Fox. GBTV is on track to take in more than $20 million in revenue in its debut year, according to a person close to the company.
The television industry will be watching closely to see whether the TV host can preserve his popularity while migrating to the Web, where efforts to get consumers to pay to watch online-only channels are just beginning.
When Mr. Beck announced GBTV in June, the network had 80,000 subscribers. In the months since, GBTV subscribers have swelled to more than 230,000, according to people close to the network, even though Mr. Beck's show hasn't yet begun.
The audience is far less than the more than 2.2 million daily viewers his program on Fox drew, on average, over its 27-month run, which ended in June after clashes with the network's management.
But it is more than the average 156,000 people who were watching the Oprah Winfrey Network in June.
Like GBTV, OWN was started by a major TV personality, but it's available through a traditional cable subscription. By contrast, Mr. Beck's network is available a la carte to subscribers who pay $9.95 a month to stream the network on gbtv.com and over interconnected devices such as tablets and mobile phones. The network's programming includes a reality show about the making of GBTV and a program anchored by Mr. Beck's co-hosts from his nationally syndicated radio show, which draws 10 million weekly listeners. A block of children's programming is slated to start later this month.
Mr. Beck said one of the reasons he ditched a network for the Web was a desire to reach out to young people. "I think networks are a thing of the past," he said. "I don't know anybody under 30 who is watching television the way I watched television. Technology has allowed people to change the way they consume the news, and we want to be where people are going." "
I'm impressed. Beck is already drawing almost 50% more in directly paying audience than Winfrey is via included cable distribution. Not to mention that Beck's program, which aired on Fox at 5PM, can now reach subscribers via wireless iPads and smartphones while the adults commute home from work. And Beck isn't wrong in his views, presented in the last paragraph of the quoted text. He's playing a long game for younger hearts and minds which don't see a few bucks per month as too much to pay for video programming.
In fact, Beck is teaching people to more aggressively disintermediate their cable television bills by beginning to pay directly for individual channels. The Journal article contends that Beck's subscription is $9.99/month, buy my July post, written soon after I watched the channel's infomercial, clearly states that the price closer to $5/month. I believe it was a charter-member price. But isn't it likely that, over time, Beck's channel will offer attractive renewal prices, or significantly lower rates for annual members? Not to mention begin to offer private social-networking marketing deals a la Groupon and LivingSocial? And discounts for referring friends to become subscribers?
Of course he will.
I don't have much doubt that Beck's experiment will succeed, even if not immediately. I believe he's shown insight in identifying how to secure editorial independence, the entire cashflow stream of a network, and adapt to video buying and viewing habits made possible and becoming predominant, thanks to evolving technology.
And, in time, I suspect, because of the nature of Beck's topics and audience, he'll have shown himself to be shrewder than Winfrey by assuming full ownership and risk, but retaining total control and financial rewards.
Friday, August 19, 2011
HP To Dump PC Business
HP surprised the market with its CEO's announcement yesterday that it is planning to spin its PC operation off from the rest of the firm.
This morning I listened to one pundit attribute this to CEO Leo Apotheker's software background, i.e., he isn't a hardware guy, so, *poof* goes the hardware unit.
I doubt it was really that simple.
Take a look at the nearby five-year price chart for HP and the S&P500 Index. Mark Hurd, the prior CEO, left under an ethical cloud at the end of summer last year. Prior to that, he'd led the firm as it decisively outperformed the index in the four years to that point. Since then, it's been largely downhill, with a few positive reversals.
For the entire period, however, HP shareholders essentially took more risk than the index for no different performance.
One of today's Wall Street Journal pieces about the HP announcement observed that the then-defining deal Carly Fiorina completed- the merger with Compaq- was now being reversed. That's true enough. And to an extent is a commentary on HP from a longer perspective.
To me, it's no accident that HP's plan to separate from its PC unit comes within a week of this post from nearly a month ago, in which I wrote,
"Despite Intel's attempts to rebut the analysts' 'death of the laptop' theme this week, I believe the latter are correct. Schumpeterian dynamics are hitting laptops with a vengeance.
Just as lighter, cheaper and better laptops eventually made consumer desktop computers obsolete, so, too, are the many X-pads, particularly the iPad, rapidly cannibalizing laptop sales growth.
Yet another reason not to sell Apple short, literally, just yet. But I wouldn't want to be caught holding equity in HP or Dell."
Dell's quarterly results disappointed investors earlier this week. Intel has been attempting to reassure one and all that its chips are too still vital, even as it has missed most of the smartphone and tablet markets.
Now HP essentially throws in the towel on a unit that it bought, rather than grew organically, while also announcing the end of its tablet and smartphone ventures.
Would Mark Hurd have been capable of leading/managing HP to a different end? Would he have materially affected the firm's outlook in the past twelve months, so that its share price wouldn't have cratered? I doubt it. Hurd couldn't personally change market demand for smartphones and tablets which affected PCs. Perhaps he'd have developed a stronger tablet entry. Perhaps not.
I see little more here than conventional Schumpeterian dynamics finally catching up to HP. It bought into business services and servers. It bought a computer business. What still works is the printer business which it has grown for decades. Printing isn't likely to entirely disappear, while PCs are fast becoming a niche commodity market. And every company depending upon PCs is fighting a losing trend.
I doubt it was really that simple.
Take a look at the nearby five-year price chart for HP and the S&P500 Index. Mark Hurd, the prior CEO, left under an ethical cloud at the end of summer last year. Prior to that, he'd led the firm as it decisively outperformed the index in the four years to that point. Since then, it's been largely downhill, with a few positive reversals.
For the entire period, however, HP shareholders essentially took more risk than the index for no different performance.
One of today's Wall Street Journal pieces about the HP announcement observed that the then-defining deal Carly Fiorina completed- the merger with Compaq- was now being reversed. That's true enough. And to an extent is a commentary on HP from a longer perspective.
To me, it's no accident that HP's plan to separate from its PC unit comes within a week of this post from nearly a month ago, in which I wrote,
"Despite Intel's attempts to rebut the analysts' 'death of the laptop' theme this week, I believe the latter are correct. Schumpeterian dynamics are hitting laptops with a vengeance.
Just as lighter, cheaper and better laptops eventually made consumer desktop computers obsolete, so, too, are the many X-pads, particularly the iPad, rapidly cannibalizing laptop sales growth.
Yet another reason not to sell Apple short, literally, just yet. But I wouldn't want to be caught holding equity in HP or Dell."
Dell's quarterly results disappointed investors earlier this week. Intel has been attempting to reassure one and all that its chips are too still vital, even as it has missed most of the smartphone and tablet markets.
Now HP essentially throws in the towel on a unit that it bought, rather than grew organically, while also announcing the end of its tablet and smartphone ventures.
Would Mark Hurd have been capable of leading/managing HP to a different end? Would he have materially affected the firm's outlook in the past twelve months, so that its share price wouldn't have cratered? I doubt it. Hurd couldn't personally change market demand for smartphones and tablets which affected PCs. Perhaps he'd have developed a stronger tablet entry. Perhaps not.
I see little more here than conventional Schumpeterian dynamics finally catching up to HP. It bought into business services and servers. It bought a computer business. What still works is the printer business which it has grown for decades. Printing isn't likely to entirely disappear, while PCs are fast becoming a niche commodity market. And every company depending upon PCs is fighting a losing trend.
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