Product Development Fiascos

Wednesday's Wall Street Journal contained a review of "Why Smart Companies Do Dumb Things," by Calvin Hodock. Daniel Akst wrote the review.

The article is a great read about some really inept and stupid corporate mistakes. It's hysterical to read about these marketing snafus. Specifically product development mistakes.

For instance, Mr. Akst writes, of Mr. Hodock's book,

"Coca-Cola executives were traumatized in the early 1980s by "Pepsi Challenge" commercials that showed real people, in blind taste tests, repeatedly choosing Pepsi over Coke. The folks in the taste tests really did prefer Pepsi, and in response Coca-Cola decided to reformulate its flagship product. The problem, Mr. Hodock says, is that a sweeter beverage -- in this case, Pepsi -- will always win in a "sip test." But real people, in the real world, don't take just one sip. They drink perhaps 16 ounces, and that's a different story. Millions of consumers had long ago decided that they preferred a less sweet cola -- as they loudly let Coca-Cola know when their favorite drink was supplanted by a sugary replacement."

I vividly recall this particular story. It was a major business headline for months, and called Coke's entire franchise, and its management, into question. Ironically, though, it also unleashed both Coke and Pepsi to realize something about shelf facings.

When Coke brought back the original formula as "Coke Classic," retailers were obliged to assign it substantial shelf space, as well. The result was that Coke's initial blunder actually increased its shelf space at the expense of smaller bottlers' products.

Still, it's quite revealing that the Coke executives failed to distinguish the differences between sipping tests, and satisfaction with full bottles of the soft drinks.

Says about all you need to know regarding creativity and confidence in senior management ranks at Coke in that era, doesn't it? Pepsi's Roger Enrico managed to put the entire senior management of his major, larger rival off balance with one simple marketing trick.

Another great story highlighted in the review is this one,

"One of the most interesting case studies in the book concerns a failed effort in the late 1980s by Campbell Soup Co. to launch a line of frozen soup-and-sandwich products called Souper Combos. Early tests indicated that consumers liked the concept, and Campbell projected $68 million in annual sales, just about hitting the company's target for new products. But as more data became available, the forecast was cut to about $40 million. "The innovation team didn't want to hear talk about a revised forecast," Mr. Hodock reports. "It was too far off the mark from the $70 million threshold level."

Nor did anyone at Campbell seem to want to take aboard the idea that, as Mr. Hodock says, "the product was a nightmare to work with." The frozen soup took twice as long to microwave as anticipated, and the directions required consumers to repeatedly insert and remove the soup and the sandwich. Mr. Hodock observes: "It was easier to prepare a bowl of soup and a sandwich from scratch." "

This is classic product development-gone-wrong material. Corporate denial and an insistence on customer acceptance of the product, despite warning signs to the contrary.

It reminds me of two additional product development fiascos, one of which was also a Campbell's flop.

The first was a staple of product development classes when I was a college and graduate school student- DuPont's legendaery Corfam. The synthetic shoe material was to revolutionize footwear and vault DuPont into another large, engineered product market, just like nylon and rayon.

But it wasn't to be. The material didn't really wear well. Even some of DuPont's own employees, recruited to test the idea, reported this. But, as with the Campbell's soup-and-sandwich example, DuPont's management refused to acknowledge the feedback. This led to an embarrassing failure of the product in the market.

The other Campbell's new product disaster was dry soups.

When I worked at the Wharton Applied Research Center as a graduate student, one of my projects involved the study of using Campbell's soup for dieting. Without going into details, this, too, flopped.

Howeve, a friend of mine who ran the overall project told me of a Campbell's initiative a few years earlier. The company had studied the dry soup market, and determined that there was room for a Campbell's product line.

Being Campbell, the packaging was, of course- a can!

That's right. Rather than a smallish, rectangular box, like Knorr or Lipton, Campbell's put their dry soup in a can.

Not unexpectedly, it, too, failed in the marketplace. The firm's management was simply too narrow-minded to consider other packaging than its standard approach.


I agree with the book's explanation for these mistakes, as Akst summarizes,

"Why do such innovation blunders occur? Mr. Hodock cites several convincing reasons: a company's me-too impulses, which can lead to me-too products that people don't need or want; the high turnover rate among marketers, who are often young MBAs with more attitude than experience; an unwillingness to give the boss bad news ("That Apple Newton you've been counting on to save the company? It doesn't work."); chummy and inattentive boards of directors; and the short-term focus of chief executives, which can lead to the hasty development of new products.

Worst of all, marketers are just human. "People fall in love with what they create," Mr. Hodock says. "All too often that love is blind . . . normally rational people become evangelical salesmen for their dreams rather than practical, objective business executives." "

Of all the reasons, though, I think the last is the most significant. It's significant because, with an effective product development process in place, it should be easily avoidable. In my marketing education, at two separate business schools, product development was taught from the perspective that companies need to successfully balance and reconcile two opposing forces: a need to generate many potentially profitable new product ideas, and a need to efficiently and effectively winnow these ideas, via routine, objective procedures. The result should be genuinely creative, profitable products which have been objectively vetted, tested, improved and molded to have a good chance of market success.

Maybe they don't teach this in business schools anymore. Or perhaps the ever-more frenetic pace of business in the past few decades has resulted in the shredding of a carefully-designed and managed new product development process.

Or perhaps too many inexperienced MBAs have gotten involved, and the process has degenerated into individual attempts to ride a new product to fame, riches and success.

Whatever the reason, it makes for very entertaining reading. And reminds us that not all new products become iPods, iPhones or Crocs.

Yahoo's Continuing Troubles

A Wall Street Journal article released just prior to the announcement of Microsoft's proposed takeover of Yahoo catalogued the company's dilemma.

In part, it read,

"Yahoo Inc. issued a sober revenue outlook, saying it faces "headwinds" in 2008 amid weak online spending by some advertisers, prompting an 8.5% drop in its shares to 2003 levels.

The Sunnyvale, Calif., Internet company also announced it is laying off about 1,000 of its 14,300 employees in mid-February as it reported a 23% drop in fourth-quarter profit and an 8% rise in revenue. Some of the employees targeted by the layoffs will have the opportunity to find other posts at Yahoo in its priority business areas.


Yahoo also announced that it renegotiated a contract set to expire this spring with AT&T Inc. that shifts from focusing on selling Internet access together to sharing ad revenue and offering content on AT&T's TV service, Web portal and mobile services.

The new financial terms weren't disclosed but Yahoo said it expects to receive $300 million to $400 million upfront from AT&T as part of the contract. In exchange, AT&T will "retain full ownership of the customer relationship," an AT&T spokesman said, and will no longer share revenue from broadband subscriptions with Yahoo.


But one person familiar with the matter said that Yahoo expects to exceed its annual revenue from the current deal -- which has been estimated around $250 million -- on average over the four-year life of the new agreement, when the upfront payment is factored in."

One has to ask, irrespective of Microsoft's bid, is:

"Does Yahoo have much value as a going concern, rather than, say, a marketing partner or just some assets to strip?"

It's retro-CEO, Jerry Yang, hasn't really moved the needle at the firm in six months. Now they acknowledge facing 'headwinds' in 2008.

They renegotiated the ATT deal, but at what ultimate price? Yes, they get greater upfront cash flow, but they lost any direct connection with the customers. How long before ATT replaces Yahoo's content, or offers less for it? Is there really that much content on Yahoo that is proprietary?

The Microsoft bid offers some consolation to Yahoo shareholders that they might soon have a way out of their current mess. From the looks of the latter's management's recent statements, it's about the only hope their shareholders have anymore.

On Market Volatility & Downturns

Market downturns are historically difficult to gauge, ex ante, in terms of their depth and length.

Further, it would appear that no two are alike.

To wit, the proprietary long/short allocation signals we employ have been useful, but not perfect, in this downturn.

Developed in the timeframe of the technology bubble collapse early this decade, the two indicators which comprise the signal alerted us that a downturn worthy of exiting long positions and taking short ones was imminent.

However, the actual January S&P500 plunge of more than 6% came faster than the signal for it.

What went wrong?

I suspect two things are different, with respect to the indicators. One is the much larger amount of investment assets now controlled by fast-moving hedge funds, relative to early in the decade. The other is the sheer speed of market reaction, helped in part by modern, high-speed, multi-channel dissemination of business and other news.

I don't typically focus on daily market changes, at least for investing purposes. I follow the market on a daily basis, but more to remain in touch with investor sentiment than to attempt to take advantage of any short-term market moves.

Further, not only are no two market downturns exactly alike, due to the evolution of environments surrounding equity investment over time. There are also few significant lengthy equity market downturns to study. Thus, unlike performing quantitative research on what works in typically upward-trending S&P500 equity markets, doing research on lengthy down markets is much tougher because there's simply less data, from fewer instances. Perforce, the certainty with which one can draw inferences and build indicators is much less than that for long-allocation periods.

Nevertheless, my partner and I fretted that we should have seen, by the beginning of December, that a large-scale decay in equity values was looming.

As a result of our move to options portfolios last year, we had a string of call portfolios which, beginning in late October, were showing consistently worsening losses, despite gains in our companion small equity portfolio.

After revisiting our current indicators and making some ad hoc modifications, we were still dissatisfied with the sense that we were engaged in 'fine tuning' a rather less-sensitive pair of indicators.

As we discussed this, I conjectured that there was probably some much shorter-term volatility-oriented measure that might inform us. Perhaps a monthly-based measure of daily change.

Ironically, I had posted this piece on a measure we labelled MFQ, for "Market Fluctuation Quotient," in late November. In that post, I concluded,

"If you are a frequent trader, than the MFQ is relevant. It clearly captures the recent, heightened day-to-day volatility, when that term means changes in closing market value direction.

We, however, are longer-term investors. Even in our equity options portfolios. As such, the MFQ doesn't really affect our investment decisions very much.
Still, it's interesting to note how divergent the two different perspectives on market 'volatility' can be- a series of standard deviations of month-to-month S&P returns, and a series measuring S&P daily close sign changes.

Clearly, volatility is in the eye of the beholder, and his/her frame of reference."

Technically, that was correct. However, the MFQ, as my partner still complained, lacked a magnitude component.

Building on this, after our recent discussions of a few weeks ago, I went back to something more classic. Taking the daily S&P returns for each month since 1990, I calculated a straightforward standard deviation of daily total returns of the index.

When this is plotted with to one of our two existing allocation indicators, we believe the two become leading indicators of a significant, longish equity market downturn.

The degree to which the monthly intra-day standard deviation of the S&P rose significantly, and remained high, shortly before a pronounced and lengthy market downturn of 2001 and the recent spate of losing index months, is unerring.

When put in context by the other, existing indicator, labelled "Factor A" on the nearby chart, it is a perfect pairing of leading indicators. Factor A turns steadily down just when the intra-day standard deviation skyrockets, in advance of a market downturn. But either one, on its own, is not predictive.

Armed with this new indicator, we are viewing the current market turmoil through new lenses, and, thus, with a new perspective.

The monthly intra-day standard deviation rose ominously in November. Had we been using this measure at the time, when I wrote the prior, linked post, we would have been out of long positions as of December. And probably already into put portfolios.

January's standard deviation rose again, to near-November levels. The evolving value for February is near January's level.

We think it's going to be at least a few more months before it is safe to remain long in equities or their derivatives.

More Market Populism on CNBC: Jim Cramer & Doug Dachille

This morning's CNBC Squawkbox program featured populist market commentator Jim Cramer as guest host. As is now typical, Cramer used his temporary platform to bash the Fed, Treasury Secretary Henry Paulson, and for good measure, economist Brian Wesbury.

For a brief segment, First Principles Capital Management debt instrument manager Doug Dachille also joined the conversation. A video clip of this segment can be seen here, at least for today, for free, on CNBC's website:

http://www.cnbc.com/id/15840232?video=641887391

What struck me most about Cramer's comments was his unfailingly populist, pseudo-working-class focus in his diagnosis of the economy and financial markets conditions, and prescriptions for their condition.

Suffice to say, in Cramer's world, the economy is in near-Depression straits, financial markets are just inches away from meltdown, and the 'working poor' need forgiveness and bailouts.

For example, Cramer believes that we need to do whatever possible to reverse the recent trends in housing price declines. Nevermind that for going on four years, pundits have decried the rise in housing prices as unsustainable, unwarranted, and economically unhealthy. Affordability became a real concern at the peak of housing prices.

But Cramer says they need to be reflated. His big idea? Government intervention, of course!

He wants Federal mortgage agency guarantees expanded, particularly at the FHA. Additionally, he calls for a Fed rescue- read 'another bailout'- of instrument insurers, i.e., MBIA, AMBAC, et.al.

Along the way, Cramer predictably bashes the Fed, Bernanke and Paulson. He rails against the Governors, demanding lower rates and mortgage rate actions to save 'homeowners hanging by a thread.'

Paradoxically, though, in another typical Cramer behavior, he simultaneously acknowledges that as much as 25% of delinquent or defaulting mortgages were taken by speculators. He doesn't mention the other major recent finding- that fraudsters frequently scammed lenders for cash ostensibly going to buy homes.

Then Cramer launched into his recession jag. First, he ticked off retail softness, as recent and current retail sales reports have shown weaker-than-expected consumer spending. Then Dachille chimed in, going over the top and claiming there is significant joblessness, and jobless people don't spend money at retailers.

What's interesting here is that only yesterday, on Larry Kudlow's show, the most negative of his guests admitted that recent wages data reflected reduced hours worked, not actual layoffs. It was generally agreed that, while weak, GDP growth was remaining non-negative, as were incomes.

So if Dachille is a debt maven, and he is convincing with his knowledge of fixed income spreads, evidently that proficiency doesn't extend, for him, to reading recent macroeconomic reports.

Picking up on Dachille's mistaken comment, Cramer weighed in and smeared Brian Wesbury in a brief aside, as if merely saying it discredits Wesbury's careful, sensible analysis that we are not in a recession. For more details on that, see this recent post, which includes a link to Wesbury's recent Wall Street Journal piece on the economy.

Cramer then declares,

"We're in the worst deflationary slump since the 1930s."

He continues to deride the Fed, claiming they want to punish borrowers and are out of touch with reality. Without citing any data, Cramer blithely disregards yesterday's Fed official's comments on looming inflationary pressures, and declares that we are, in fact, in the midst of a deflation.

For those of us trained in economics, we can observe that Cramer has confused inflation, which is a monetary phenomenon involving the loss of buying power of a currency, with liquidity, or the availability of capital.

An economy can experience deflation and a loss of liquidity. It can also experience inflation and adequate liquidity. But an economy can also experience inflation without any particular large-scale change in liquidity, such as in the US in the 1970s.

It could be that financial asset losses of the recent year have caused some consumers to consume less, feeling a (negative) wealth effect from the equity market effects of the recent credit market turmoil. But that does not mean we are, as an economy, experiencing severe price deflation.

In fact, as the Fed cuts interest rates, leading to the decline in the value of the dollar, expressed in other currencies, imported commodities, such as energy and metals, are becoming more expensive. That would be, ah, inflationary, Jim.

Doug Dachille, on the other hand, sensibly saw two outcomes of the ever-lower rates demanded by Cramer. He foresees either more excessive risk-taking by financial institutions, or no risk-taking at all, with banks simply buying higher-yielding, longer-term Treasuries.

Either alternative, Dachille noted, is unwanted.

Then, later in the hour, Cramer reversed himself and declared Wal-Mart's troubles to be self-inflicted. After having declared all retail in peril, and a general recession, Cramer accedes to Dana Telsey, a prominent and solid retail analyst, who contends that the big box retailers are in trouble, but the more nimble, smaller retailers are not.

Suddenly, Cramer forgot his earlier rant about widespread economic softness, signaled by Wal-Mart's disappointing January sales reports.

You have to remember, though, Jim Cramer is a conventional Wall Street liberal Democrat. It's a weird combination of buccaneer trading and capitalism for himself, but populist bailouts with Federal money for the "working poor," or even middle-class, from which he apparently came.

Thus, Cramer prefers, and demands, populist remedies to immediately end any economic or financial markets pain, no matter what the cause. If speculation and lax lending, securitization, rating and investing practices by private players and investors caused current credit market problems, so what? Just turn on the monetary taps and wash all those unpleasant losses away.

Long term inflation? Who cares? Again, remember, Cramer was a daily-focused hedge fund trader. He is on record as having shilled prices of securities his fund held via rumor and media manipulation, to make a buck for the day. Long term economics and financial market horizons for him may well be tomorrow afternoon.

It's a sobering, but important observation to make concerning Cramer and his ilk. There are those calling that we are on the brink of another Great Depression and market crash. Yet, more professionally-trained, well-regarded economists and analysts seem to think we are simply experiencing a natural part of the business cycle- slowing growth.

Confusing the two could be very damaging for the US economy, financial markets and dollar in the long term.

Is Apple's Golden Age Approaching An End?

My equity selection process began to include Apple in May of 2006. That's four months shy of two years in which it's been reasonably consistently included in the portfolio.

Having managed to better the S&P for quite a few years prior to the month of entry into my selections, Apple has now had a long, multi-year run of outperformance versus the S&P500 Index.

Maybe it's near an end. I know my partner won't want to hear this. He feels deeply about Apple's management and product strategies. For what it's worth, I agree with him.

But, unfortunately, that's not sufficient to keep Apple outperforming the index.

Today, as the firm announced a slew of new and improved products, reports indicated that, if anything, the company' faithful customers were actually angered. They felt deceived as larger-capacity and/or less expensive models were introduced just months after the last, pre-Christmas slate of new products.

Usually, one or more of three factors are involved in a company's cessation of consistent index outperformance.

One source is competition. In this case, that still doesn't seem to be Apple's weakness.

Another is anti-trust or regulatory pressure. Think Wal-Mart or Microsoft. Again, though, this doesn't seem to be a source of Apple's recent stock price problems.

Finally, there is the gradual, eventual catching up of investor expectations to a company's ongoing, though excellent, performance. It seems that something like this is now occurring.

Let's look at three Yahoo-sourced charts of Apple's stock price over time, including, in one case, the S&P500 Index as well.

In the first chart, we see Apple's stock performance for the past five years. With only a few brief declines, it's been on a steadily upward trajectory since 2003. From my proprietary research, I'm aware that Apple has already entered a zone in which significantly long periods of further outperformance are becoming less likely.

Looking at the next chart, Apple's price performance since 1985, it's clear that these last five years of outperformance have been unique in the company's history. Except for its brief spurt in the mid-1980s and late 1990s, the company's stock has actually treaded water for most of 12 years.

But this last run has been longer and steadier than the earlier ones. Consequently, it provides a longer, steadier performance track record for observers, i.e., analysts and investors, to finally get their expectations fixed for Apple's future performance.

Adding the S&P500 to the second chart, we get a clearer picture of Apple's performance relative to the market. Through 2000, it was essentially even for 15 years. For the next four, it actually underperformed the index.

The recent outperformance by Apple's stock of the index essentially means that the company has been surprising the market with its well-managed, consistent operational and financial performance.

Now, the firm's continual upgrading of products and price cuts are seeming to upset its customers. They feel that every time they buy an Apple product, a better price/performance version comes out within a year.

Meanwhile, such superb product development and price management is becoming expected by the market. And, honestly, the firm's dominance of the digital music player and content download business has become so solid and long-lived that it's natural for observers to wonder if the next move isn't downward.

AppleTV hasn't taken off as the platform crossover "killer product" it was intended to be. Recent new product introductions aren't apparently 'wowing' customers and reviewers.

Historically, after two years in my portfolio selections, companies are excluded due to my research on senescence. That is, I have found that, after a fairly continuous presence in my equity portfolios, companies begin to bear an outsized risk of failing to surprise the market with their performance. Thus, some lesser-known company has a higher probability of posting an S&P-beating total return than a well-known, still-operationally successful firm.

This occurred with my holding of Kohls some years ago. The same has been true of some bio-pharma companies, as well, like Gilead.

Sad to say, I think Apple is approaching this point. The odds of its being able to consistently, significantly outperform heightened investor expectations are probably dropping with each new month.

As always, time will tell. But the law of large numbers isn't on Apple's side this time.

Starbuck's Latest Turnaround Strategy

This weekend's Wall Street Journal's "Heard On The Street" column discussed Starbuck's turnaround strategy.

For the second time in a few days, I read an article about Starbucks in which the word "segmentation" is used in quotes?

What's with that?

The context is that, according to this piece,

"Mr. Schultz is looking at "segmentation." strategies that would provide an entry point for new customers amid a weak economy."

Now, it was news to me that the Seattle's Best Coffee brand is owned by Starbucks. I think that's fantastic, because I like that brand much better than their flagship one. And as I've written here, about Les Wexner's Limited Brands, it's can be a very smart way to market different product lines.

However, only a few months ago, I wrote this post, which noted, from another Wall Street Journal article of that timeframe,

" 'Much of that may not be Starbucks's fault. Pressures on consumer spending haven't made it any easier for Starbucks to increase sales, particularly because Starbucks's customer base has gradually broadened to include Americans with lower average incomes, a group more likely to cut back. This summer, a spike in dairy costs caused the company to implement its second price increase in less than a year.'

To me, the most telling sentences are those in the fourth paragraph which I have quoted from the article. The company, in order to sustain growth over the past few years, headed down market. Now, those less-wealthy customers are being more affected by recent economic events, including prices of gasoline and food, while even Starbucks' ingredients' price rises are driving them to increase prices, too."

So Starbucks is, in fact, looking to reposition itself with its lower-income, newer customers. Apparently through the provision of inexpensive, simple brewed coffee. The Journal piece suggests,

"...and adding a lower-priced tier inside its own stores would be tricky for a brand that built its reputation on upscale cachet."

No kidding. Mr. Schultz, have you taken a look at Wal-Mart's failed 'upmarket' retail strategy of a few years past? It flopped. In their case, new, upscale customers wouldn't rub elbows with lower ones, and Wal-Mart's merchandising was not credible.

In the Starbucks case, you can imagine hordes of teenagers fleeing Starbucks as lower-priced, un-chiche, lower-priced coffees are shoehorned into the stores.

Schultz is also ditching the breakfast sandwich menu. Surprisingly, according to the article, this accounts for about $35,000 of revenue per location per year. That equates to something like $100/day. Isn't that only about 20 breakfasts/day?

Perhaps what's surprising is that they even kept this offering for so long. And that, with McDonalds revving up their coffee offerings, along with the constant pressure from Dunkin' Donuts, anyone wanting food won't visit Starbucks at all now, when they can just buy the same thing, for less money, at either of the other two purveyors.

Schultz holds out hope for Starbucks' line of summer drinks to help it out in the second half of the year. But isn't that a seasonal effect? Don't they already have a summer drink menu?

As the article suggests,

"Starbucks was one of the first major consumer brands to be built using word of mouth- and there are few precedents for how to resurrect a tarnished brand that was built that way."

As the nearby, Yahoo-sourced price chart of Starbucks and the S&P, for the last three months, demonstrates, the coffee roaster's stock is essentially in free-fall.

Schultz has one heck of a job to try to rescue this firm. Personally, I think he's fighting the force of Schumpeterian dynamics. Competition and consumer tastes have altered the competitive and market landscapes since the firm's heyday of some years ago. It's unlikely that Schultz can regain its long term, consistently outperforming total return record anytime soon, if ever.

Google Weighs In On Microsoft's Takeover Attempt

This morning's Wall Street Journal contains a feature story on Google's self-insertion into Microsoft's bid to acquire Yahoo, about which I wrote here on Friday.

Rather than wax extensively about the various moves and counter moves, I'd like to dwell, instead, on the tremendous amount of bile and misinformation flowing around this event.

First we have Google disingenuously claiming that Microsoft's acquisition of Yahoo would dangerously concentrate 'competition' in the sectors affected. According to the Journal,

"Google identified instant messaging and Web email accounts as areas where a Microsoft-Yahoo combination would have "an overwhelming" market share. In the blog post, Google also questioned whether Microsoft could use its "PC software monopoly to unfairly limit the ability of consumers to freely access competitors' email, [instant messaging] and Web-based services." "

Is Schmidt nuts? How can there be a monopoly of free goods or services? Nobody in their right mind has to pay for 'instant messaging and Web email accounts' anymore. Nobody.

So how in the world could Microsoft and Yahoo somehow collude and monopolize this product/market? Where's the beef? Ad revenues? Google already controls that market. Adding the second and third-rate online advertisers' revenues from their own IM and email systems can't possibly worry Schmidt and Google.

Then we have Ballmer claiming that the combination will bring more 'creativity' to the sector.

Really? How's that going to happen?

Let's think about this. What is 'creative,' in this context? You would think that 'creative' would involve developing a truly new, non-imitative product or service from Microsoft.

Instead, the firm simply proposes to buy a failed quasi-competitor. Nothing created there.

Why isn't Microsoft using the roughly $25B premium it's willing to pay for Yahoo to develop truly creative products or services?

Probably because Ballmer (and Gates) failed at this, post-Office and Windows systems, for the past decade. They've bought businesses, like WebPC, that vanished into the giant maw that is Microsoft. Their MSN network has struggled constantly. The browser war 'victory' was hollow, in that it brought no added revenue, but alerted anti-trust regulators everywhere to Microsoft's predatory approaches.

All that is being 'created' in the Microsoft acquisition of Yahoo is the consolidation of eyeballs into the online websites of one, rather than two, firms. If Microsoft could better ad-related software, wouldn't they just do it, for less than $25B? Or already deploy it to MSN?

If Yahoo's system was so good, would it be in such trouble now?

How would combining two mediocre ad revenue systems, and their creators, magically introduce 'creativity' into that product/market?

Google's supposedly friendly gesture to Jerry Yang is the predictable result of Schmidt's animus toward Gates, Ballmer and Microsoft, as Dennis Kneale theorized, and on whose theory I wrote, here.

Ballmer's (and Gates') Microsoft's bid for Yahoo is, similarly, aimed at their nemesis, Schmidt and Google.

The reality is that Google has already won the online ad revenue and search wars. They really don't need to harass Microsoft anymore, or worry about who would be so bereft of their own ideas to have to buy Yahoo to get new ones.

And Microsoft is simply past its prime. And will stay past its prime. Buying Yahoo won't change that. If anything, I believe it will hasten the software maker's decline.

Simply put, what could Yahoo have, of value, that it can't already monetize? What, of value, could it bring Microsoft that the latter can't get for less than the $25B premium?

The more this deal circulates in the media, the worse it looks for Microsoft. And the worse Google's reaction looks.

The only winners, I maintain, continue to be the suffering current shareholders of Yahoo.

Reinventing Sales Management?

Last Monday's Wall Street Journal featured an article in the "Managing" column concerning Ram Charan's latest consulting-what would you call it- fad? scam?

According to the article's opening passage,

"Ram Charan is known for his platinum clients and his relentless schedule. The business professor-turned-management consultant says he's worked seven days a week for 30-plus years, advising executives at the likes of General Electric Co. and Verizon Communications Inc. on such topics as improving results and execution."

As a reference, I've pasted two Yahoo-sourced stock price charts for Verizon, GE and the S&P500 for the past 5 years, and beyond.

I don't know the timeframe in which Charan has advised the two firms. If it's within the last five years, they should get their money back.

As this chart clearly shos, neither firm has outperformed the S&P in total return over the period. GE barely mirrored the index, but still fell short. With dividends, maybe it was close for GE, but surely not sufficiently better to justfiy the excessive senior executive compensation the firm pays.

Verizon has barely earned a total return that is even 1/5 of that of the index.


This second chart shows a longer term of performance for GE, Verizon, and the index.

Again, not knowing when he worked with the two firms, if it were prior to five years ago, that isn't necessarily so impressive, either.

As far back as 2000, both firms began to fade, in performance terms.

With that as some empirical perspective on performance at two of the firms the Journal alleges Charan has 'helped,' let's move onto the interview. It opens with this passage,

"Recently, Mr. Charan turned his attention to sales, particularly from one business to another. He doesn't like what he sees. In "What the Customer Wants You to Know," published last year by Portfolio, he argues that companies need to "reinvent" the way they sell, to focus on their customers rather than product features. Mr. Charan talked to The Wall Street Journal about the problems with sales and how to fix them."

I think this would be news to most marketing professors in the better business schools around America. Sales management and process has been taught since I was in undergradate school, back in the late 1970s.

Beginning to quote Charan in the interview, the article relates,

"Mr. Charan: The sales function has traditionally been about execution. Most sales people are very good at connecting with the purchasing customer. They get training to know the product. And they beat the competition on price.

Now the world has changed. Copying a product became very quick. You now have competition on the Internet to beat down prices.

It has become very hard to differentiate yourself in the eyes of the customer, for business-to-business sales. So salespeople should not sell the product any more. They should find out what the customer needs, which will be a combination of products and services and thought leadership.
WSJ:Can you explain this new approach?

Mr. Charan: Salespeople need to work backwards from what the business need of the company is. Let's say I'm going to sell you this BlackBerry. I come to you and I say, "I've done some homework on your company. I think you're going to need 1,000 BlackBerrys. And in order to make your BlackBerrys fruitful, I'm going to need some information. How many users are in selling, how many in manufacturing, how many in research, how many in finance, how many on the road?"

With that information, I can design something that is useful to them. That information is proprietary. If you don't trust me, I will not get that information. Salespeople need to learn the business of the customer. They need to learn how to ask the right questions. They need to have analytic skills to diagnose a customer's business. They need to figure out who makes the decisions in a company."

Hasn't Charan, or, for that matter, the Journal's Phred Dvorak, ever heard of 'consultative selling?'

It's a little marketing and sales thing that's over 40 years old. IBM salesmen used it to sell the original 'big iron' mainframe System 360s and 370s.

Dvorak continues,

"WSJ:Don't most companies do this already?
Mr. Charan: No. They say how their products will reduce customers' costs. They don't touch on improvement of revenues, margins or brand image."

Honestly, I simply do not believe this. Just look at this post which I recently wrote about Tennant. This passage,

"As a result, the cleaned area would dry in about 30 minutes -- a pressing concern for institutions such as casinos that otherwise have to rope off cleaned areas for as long as 24 hours, Mr. Swenson says,"

clearly indicates that Tennant focused on improving their customers' revenues through value-added product features.

Finally, Dvorak closes his interview with Charan, having apparently sat there simply nodding his head and being totally accepting of Charan's contentions, with these questions and answers,

"WSJ:How does the sales force have to change?
Mr. Charan: The old salesperson: gregarious personality, very sociable. Plays golf. Goes to ballgames. Quick to link with people. Highly motivated. Long hours. Very perceptive in reading other people. The more successful ones know how to close the deal. It's still useful.
Going forward, the salesperson must build trust with the customers' people that's deeper than before and sustained over time. You cannot design a solution without information from the customer. And if the customer does not trust you, he or she will not give you information.

I would be very surprised if John Chambers, CEO of Cisco, thought his salespeople filled their order book just by taking customers to baseball games. Or Larry Ellison's. High-value, big-ticket institutional sales between companies have always been a consultative selling proposition.

WSJ:What else has to change?
Mr. Charan: In the old game, one person could do the selling. In the new game, you need a team from your company. The reason you need a team is the solution you're going to create is going to come from different parts of your company."

Again, large, complex, long sales cycle, big-ticket business-to-business sales have always employed extensive teams to win a customer's business.

It was hard for me to read this Journal piece with a straight face. Is Charan really so clueless that he is ignorant of better sales practicies in business stretching back decades? And was his interviewer, Dvorak, similarly ignorant?

How did this article make it into the Wall Street Journal's "Managing" column? It's just completely fallacious in its portrayal of the best practices of consultative selling in American corporations.

What is it with Charan? Can only he invent "new" concepts? So whatever strikes his fancy is new and worthy of a book or new fad, even if he's overlooked existing, long-used practices which happen to be exactly what he is preaching as "new?"

On Microsoft's Bid To Acquire Yahoo

How could I not write about the hottest topic of the day? Not most important, mind you. But most shocking and popular. I am referring, of course, to Microsoft's hostile tender offer of cash or stock for Yahoo.

Yahoo was worth, as of yesterday, pre-offer, some $25-27B. That's taking the 1.34B outstanding shares at the closing share price of $19.1. Microsoft offered a 60% premium, or $44.6B, worth about $31/share of Yahoo.

The software giant currently has about $19B in cash, making the all-cash version of the offer seem very feasible, as it carries no debt.

By this point, 1PM EST, some six hours after the announcement, every pundit on the planet has probably weighed in on this takeover.

Here's my sense of it.

First, like one of my techie friends who happens to hold Yahoo share, this is clearly a godsend for Yahoo shareholders. As the nearby, Yahoo (naturally)-sourced price chart reveals, it's been at least March of last year before the stock's price was, even for short periods, routinely above Microsoft's offer price. Jerry Yang's resumption of the CEO role last summer has cratered his firm's stock decisively since then.

As for Microsoft, I pity their shareholders. If they didn't have half of this offer in cash on their balance sheet already, would any bank lend them all of the money for this takeover bid? Could even Goldman float a bond issue to fund this for them at reasonable rates?

If anything, I think it reminds us, per my many posts on Microsoft, Gates and Balmer (see appropriate labels), that the company has been very sloppily managed in a financial sense.

How many shareholders, had the $19B been dividended back to them, would gladly give it back to own Yahoo? I'm guessing not many.

As the nearby, Yahoo-sourced five-year price chart of Google, Yahoo, Microsoft and the S&P500 illustrates, neither the acquirer, nor the target in this deal has performed particularly well lately. Microsoft has underperformed the index for the bulk of the period, getting a brief, recent bump. Yahoo did well for the first two years, then crested and has been sliding ever since early 2006.



From a longer perspective, the same chart looks like this. Google's rate of increase far surpasses either of the other two. Since 2000, Microsoft hasn't outperformed the index, and Yahoo has fallen precipitously, on a net basis, with a valley and gentle hill in between.



Clearly, neither Microsoft, nor it's target has been the subject of appreciative investors for their fundamental performances.



Here's my post from last May, when this idea was last in circulation. And a related piece from last week, focused on eBay, but touching, generally, on the concept at issue here. In the first post, I wrote, in part,



"First, doesn't one of the partners usually have to be successful already for this sort of combination to work?



Second, why would a merger of these two huge, lumbering companies create more than a more focused, nimbler marketing alliance agreement between the two? The latter would be far more likely to succeed, in my opinion. These two technology giants are already past their prime and too sluggish to have a high probability of combining in a manner that can yield a consistently superior total return performer. The companies are not similar in their product/markets, so there won't be much in the way of cost savings, yet they will spend considerable time and money attempting to mesh and reorganize post-merger. I suspect it is a recipe for disaster.



Third, Yahoo is, in my parlance, the 'used car of the internet.' This is going to be Bill's/Steve's new ride? Hardly an inspiring last act for the software titan. Can't they do better than a bumbling online-oriented hodgepodge of businesses mismanaged by ...?



Fourth, together, these two still probably won't catch Google. It's not about the software....it's about the ideas. Neither has shown themselves capable of generating successful new ideas which have driven consistently superior total returns in the past five years. How will just mashing the two mediocre firms together change that?"



None of which, I believe, have changed in the intervening months. Except Yang, rather than Semel, is mismanaging Yahoo now. I concluded the post with,



"If this combination materializes, I will go on record predicting that it will not result in a firm that can regain a pattern of consistently superior total return performance. It will, over time, fail shareholders, relative to their option of simply buying the S&P index."



I still believe that, as well. Various pundits may extol Microsoft getting Yahoo cheaply. Or the back-end consolidation of their search engine and advertising businesses.



One bright pundit, Forbes' Dennis Kneale, opined, in a fashion similar to my partner, from this post, that Yahoo is a 'groups' type company, and Microsoft's Facebook investment might offer some value in relation to that. This post sheds some more light on the whole online 'community' business.

But even this begs the question of how all this value will be magically spun from the meger of these two aged, bloated tech titans?



Yes, it's a hot story today, alright. Very exciting for the tech, media and M&A crowds. Let's see how exciting it still is for Microsoft shareholders and/or Yahoo employees in, say, 15-24 months?

A Great Management Story: Tennant Co.

The Wall Street Journal spotlighted Tennant Co. in Monday's Marketplace Section. It's a heartening tale of Schumpeterian dynamics gone right, as well as good management and innovation.

As a cleaning equipment producer, the firm had long gone down the road of efficiency and cost-cutting. The article begins,

"Beset by cheap imports from overseas and facing a slowing U.S. economy in 2002, Tennant Co., a big name in the small market for industrial floor-cleaners, could have tightened its belt and sent more of its factory jobs overseas.

Instead, the Minneapolis company decided to place a big bet that it could outsmart its competitors with innovative products."

How Tennant did it is a pretty riveting story. Central to the tale is this incident,

"A key moment came in October 2002 when Chris Killingstad, then the recently installed head of North American operations, visited his first international trade show in the cleaning business, in Las Vegas. His main impression at the show was that "every machine looks like it's designed the same," recalls Mr. Killingstad, who became president and chief executive in 2005.

Mr. Killingstad returned to headquarters and helped push Tennant -- which makes vacuum cleaners, sweepers and scrubbers deployed in factories, schools, casinos and malls around the world and has 12% of the $5 billion world-wide market -- to boost research-and-development funding to fight back with better products."

Their bet on new features and, where necessary, technologies, worked well. Describing their two leading new products, the Journal article noted,

"The scrubber would tinker with the traditional cleaning method, which involves spraying water and cleansing chemicals onto the carpet, and then vacuuming it. Tennant's concept would inject water and cleaning fluid directly onto circular brushes under the machine. As a result, the cleaned area would dry in about 30 minutes -- a pressing concern for institutions such as casinos that otherwise have to rope off cleaned areas for as long as 24 hours, Mr. Swenson says.

ReadySpace, as the machine would be dubbed, was launched in 2004 and became the company's best-selling carpet-cleaning device.

Last fall, Tennant announced a product that used an electrical current to turn tap water into an industrial cleaner.

A top Tennant researcher who was in Japan about two years ago doing field-testing for a different product noticed a hospital there was using a technology that harnessed electricity to sanitize surfaces. The machines briefly split water into two flows: one an acid that kills some bacteria on a surface and the other an alkaline stream that removes grime and dirt.
Back in Minneapolis, the researcher developed a prototype using the technology. To help the opposing streams stay separate longer, prolonging their effects, he injected air bubbles."

As the nearby, Yahoo-sourced five-year price chart for Tennant and the S&P500 demonstrates, the company's efforts have paid off.

The past three years have been very impressive for Tennant's total return performance. And for four of the past five, the firm has outpaced the index's return.

Schumpeter's belief that innovation and constant forward movement in the quest to satisfy consumer preferences would pay off holds true in this case.

It's wonderful to read of the all-too rare case in which a firm engages in good, creative management and product development to maintain or increase their edge in a competitive product/market by adding more value, not merely reducing prices.

More On Lampert and Sears

Yesterday's Wall Street Journal featured a Marketplace Section article on Eddie Lampert and Sears. It's one of many recent pieces documenting changes at the seriously ailing retailer. I wrote a few posts recently about the once-great retailer's difficulties, here and here.

The latest Sears CEO, Aylwin Lewis, has been discharged. And now, Lampert swears he's getting out of the 'hands on' management of the company. Apparently, according to the article, he has finally realized it's the only way he has a hope in hell of attracting someone qualified to continue the attempted turnaround.

Lampert characterized the as-yet-to-be-located Messiah as,

"... as a "mission-driven" leader who feels comfortable balancing multiple interests. "I want someone who will be able to deal well with complexity, who will be able to make decisions under conditions of uncertainty, and is someone people will want to step up and work for,"

and that,

"He pointedly says he's not looking to give up his chairman's title."

That sure sounds like fun, doesn't it? Does anyone believe someone that good wants to inherit this mess of potage? In the meantime, a logistics guy is running Sears. Great. Just what you want in an intensely merchandising-dependent business. An operations wonk.

The interview began with this passage,

"Speaking by phone from the company's Hoffman Estates, Ill., headquarters, Mr. Lampert bristled at critics who lost faith in Sears as its share price fell from $195 in April 2007 to about $104 now,"

suggesting Lampert is still in denial about the gigantic, intractable mess he has on his hands. A near 50% loss of shareholder's value, and he's bristling? That's rich!

Further along, Lampert defended the recent plan to break Sears up into independent business units thusly,

"Other large, complex businesses have successfully adopted the business-portfolio model. He compares Sears with Warren Buffett's Berkshire Hathaway Inc., in which managers are given a long leash to run businesses, and Mr. Buffett doesn't get involved in their day-to-day operations. He also says Sears can be rebuilt with a strong management culture, similar to General Electric Co., and Procter & Gamble Inc."

This is pretty amazing. Lampert is equating himself with Buffett as a successful manager of diverse, complex businesses within a single corporate entity. I agree there's a comparison, as I wrote here recently. But this isn't it. As the nearby, Yahoo-sourced price chart shows, Buffett's company only pulled ahead of the S&P500, for the past two years, four months ago.

Talk about having to time a stock!

Lampert's Sears has been in a stall since late 2006, and a swoon since last spring. It would seem that whatever 'management culture' it is to which Lampert refers will have to be imported, doesn't it?

It's a sad story. Lampert now retreating from his mandatory briefings by the minions who would fly to Greenwich every few weeks (Ed doesn't like to fly), but remaining chairman, looming over the shoulder of anyone brave enough to try to rescue Sears. And, as the recent Journal article noted, Lampert's through injecting more funds into the still-breathing carcass of the retailer.

What fun Lewis' replacement as CEO will have! Maybe as much fun as Lampert's fellow shareholders have had since he bought the company?

There's Risk...and Then There's Risk

The Societe Generale story has become almost a parody of banking one would expect to see in a typical Hollywood movie.

Jerome Kerviel, the trader with the inferiority complex, works his way up from the humble back office to a fairly unimportant trading desk. He proceeds to wreak havoc on his employer's financial condition by stealing passwords, dummying up trades, counterparty emails, and ledger information. Using his knowledge of risk management and accounting software, he juggles his books for over two years, completely hoodwinking the bank's management.

For me, one line amidst the several Wall Street Journal pieces on this evolving risk scandal rang absolutely true. It was the one concerning the French trader behaving decidedly un-Frenchly, skipping vacations and working overtime. A lot.

Back in my days at Chase Manhattan, officers were required to take two consecutive weeks of vacation for risk management purposes. We were told that, although our function was not even within distant earshot of any P&L responsibilities, we would adhere to the bank's regulations regarding vacation-taking.

It had been learned long before the arrival of us newly-hired corporate strategists that a two week break from making book entries was almost always sufficient to reveal any one-person fraud.

Funny how this well-known banking practice was simply overridden for Kerviel. One of banking's simplest and most time-honored ways of tripping up fraudulent bookkeeping was short-circuited without a peep.

And, then, we read that Kerviel would simply acknowledge suspect trades as 'mistakes,' make them right immediately. Then double back later that day and re-enter them. How many visits by the risk management or accounting folks would it have taken for SocGen's management to have suspected active and purposeful risk management evasion?

How many 'mistaken' trades per month, for a year, did the average trader experience?

Amidst all the talk of esoteric risks these days- CDOs, credit derivative swaps, and SIVs- here's a bank that got tripped up by the oldest scam of all. A simple fraudulent book-entry scheme that allowed the trader's position to balloon to many times his authorized limit.

It's probably going to take down the head of SocGen, and maybe two or three more senior officers. And it should.

I think it sustains my point from this recent post regarding bank consolidation. In it, I wrote,

"Kessler then writes,

"So who has the strong hand? As always, it's a capital game, whoever accumulates the most will be best positioned for what's next."

I disagree. Capital accumulation certainly matters, but I don't think it's a "most" sort of thing. If anything, Kessler misses the point that having so much- too much, actually- capital is precisely what has gotten many financial firms into trouble. They fail to diligently allocate it, and the result is what we see in recent months. Failed risk controls, sloppy capital allocations and wastes of funding. "

Large banks just seem to invite this sort of fraud and risk management failure. And what is the rumored reaction? That PNB wants to acquire the now-wounded SocGen.

Oy!

Thoughts On The Current Economic & Financial Markets Situations- Part Two

I wrote about the current economic situation in yesterday's post here.

Today, I'd like to conclude with a review of the other major question of the day- wither our US financial markets? Are they headed for a prolonged downturn of several to many months, or a short 'correction' of just a few months? Is the Fed 'behind the curve' on easing, or wrecking longer-term economic fundamentals involving inflation and the value of the dollar? Are financial markets panicking, or correctly reacting to both economic and financial market news?

From my own academic economic training, study of the field as a business person since the late 1970s, and reading of and listening to various pundits, I believe that the Fed is now easing unnecessarily. As Brian Wesbury contended Monday morning on CNBC, the Fed's easing of late 2007 and, more recently, the ad hoc 75bp, are "baking in" serious inflation risks for our economy in the next few years.

Even this morning's GDP-related core inflation number was up, +2.7%. Only last year, Fed Chairman Bernanke stated that he was uncomfortable when inflation began to rise above +2%.

Some believe, and I agree with them, that our current troubles stem, in part, from Fed Chairman Greenspan's excessive easing in the post-9/11 era. This laid the foundation for the housing bubble and related mortgage problems now beleaguering some of our financial institutions. As such, Greenspan put us on a roller coaster of easy money, overreaction by the financial sector, asset value destruction, and, then, more calls for even lower interest rates to reflate the economy and provide "liquidity."

Here's something to consider. Only two years ago, in the wake of hurricane Katrina, the government pushed ethanol as a long-term solution to looming, oil-price-based inflation. Leaving aside the separate inflationary effects of this misguided move on the price of corn, and all of its downstream derivative food products, this would argue that we should be concerned about anything that excessively, and unnecessarily drives the dollar-price of oil up.

And guess what is the number one way to do that, in a controlled fashion? Cut the US interest rate, thus cheapening the value of the dollar. This causes the dollar-denominated price of oil to rise, thus, automatically importing more inflation into the US economy.

Every Fed easing in the last 8 months has effectively goosed inflation for all dollar-priced commodities.

On this basis alone, the recent easing, combined with what fixed income futures tell us are 'market expectations' of further easing, will almost certainly continue to exacerbate the US inflation rate in coming years.

This is partially to what Wesbury referred in his comment about things now looking a lot like the 1970s.

In truth, as Wesbury has pointed out in his on-air comments and Wall Street Journal editorials, most of our economy is sound, or at least only slowly-growing, not shrinking. This morning's initial 4Q2007 GDP number was +.6%.

Of course, this was immediately seized upon by the always-gloomy CNBC staff- Liesman and Haines, to name two- as weaker than the expected +1.5%.

But it's still positive. And as former Fed Vice-Chair Alan Blinder noted, it's going to be revised, probably, but not necessarily, upward.

And today's ADP employment number came in unexpectedly high- something like +130,000 jobs. Again, the primary determinant of recession, falling job numbers and aggregate incomes- is still missing.

Against this backdrop, why is the Fed cutting rates?

I think it is, sadly, unwise political accommodation by Bernanke & Co. to the Congress and Wall Street. Rather than stay the course against inflation, and at least attempt to honor the spirit of the great, late US Nobel Laureate economist Milton Friedman by moderating the rate of monetary base creation, the Fed seems to be more concerned with its public image.

In my opinion, they are a select few economists who are supposed to be intelligent, reasonably well-educated in their craft, accomplished, and deliberative. And sufficiently confident to be as insensitive as possible to the constant clamor of financial markets and the populace for easy money.

As I have written before in this blog, and various pundits have also contended, our current financial markets turmoil has had more to do with counterparty risk than liquidity. Therefore, easing rates affects market psychology more than it actually provides needed, otherwise-absent liquidity.

Of course, it also causes a loss of value among foreign holders of dollar-denominated assets, causing more pressure to replace the buck as the world's reserve currency. That's a change for which our economy and financial system are totally unprepared.

So, in addition to the mistaken fiscal stimulus package working its way through Congress, we are adding to our economic troubles by the Fed's needlessly, in my opinion, cutting interest rates.

As Wesbury noted recently on CNBC, we're all going to be feeling some pain in about 24 months, when inflation begins to crest.

How will we react, as a society, to, say, a +3-4% GDP growth rate with a 5% annual inflation rate? That's negative real growth. And an inflation rate higher than the one that led Nixon to institute wage and price controls almost 40 years ago.

Somehow, we seem to have lost our memory of the post-Carter era solution to excess government taxation and spending, high inflation and too-easy money. So we seem to be heading that way again. Inflation rates of the Reagan era, well below 2%, are now a distant memory. So, it seems, are the low tax rates.

The final conclusion, for purposes of this blog, is how all this would affect equities in the longer term. That's a no-brainer, isn't it? Rates of inflation above 4% and growth not much more? Equities will struggle, as a reflection of the struggling economy that they represent.