Is it worth it?

Last week Coca Cola (see chart here) announced it was ponying up over $4 billion to buy Glaceau, a company with only $355 million in revenue (see PR announcement here, see article here).  Rarely are such lofty prices paid for a company not in high tech, so investors have to wonder if Glaceau is worth it.  After all, Glaceau's products are just another form of flavored water - in this case vitamin enriched water and energy drinks.

There are two criteria which determine if the price is right on this acquisition.  Firstly, where is Glaceau and its products in the life cycle?  If late in the cycle, then such a premium is not warranted.  But if you believe that these are a new category of drink, and that this category will have rapid growth by eating into plain water, traditional sodas and possibly sport drinks you could claim that these products are just at the beginning of their lifecycle.  And this is critical.  Coke has had practically no White Space, so the company has nothing early in the lifecycle.  Organically, Coke could spend years trying to develop something on its own, and who knows if they could pull it off.  If you believe that Energy Brands have the potential to grow like sports drinks, then this price will look absolutely cheap in just a few years.

The second criteria is how will Coke manage this acquisition?  Should Coke decide to buy the company and integrate its products and marketing into Coke then this would be just $4 billion thrown down the proverbial rat hole.  The Coke Success Formula is so powerful around traditional soft drinks it would kill the learning necessary to grow a new Success Formula and develop this new market.  As we can read in the press release, Coke has chosen to keep Glaceau as a completely separate business unit, and the existing management team has been given 3 year contracts to stay and run the business.  In a nutshell, Coke is setting up White Space for Glaceau, and that dramatically improves the chances of the acquisition fulfilling its potential and value.

If Coke can follow through on allowing Glaceau to develop its new market, this could be an important turning point for the moribund Coke organization.  Glaceau could develop a new Success Formula which Coke could migrate toward.  Revenue could regain old growth rates, and margins could improve as focus shifts to innovation rather price wars.  Big companies need new businesses which are early in the Rapids - not just a lot of Wellspring ideas.  They need to catch waves early, give the new business White Space (money and permission to try new things) and then learn how to migrate forward.  And Glaceau could be just the right acquisition for Coke.  If Glaceau can help migrate Coke forward, and out of it's Locked-in ways, then $4.1 billion was not too much to pay at all.

A Drunk can spoil the party

In January of this year I blogged about the White Space prevalent in the highly Disruptive Virgin culture.  Sir Richard Branson has built an empire from small beginnings by constantly Disrupting his organization and creating White Space.  Many high paying jobs have been created, and lots of money made for investors, due to this Phoenix Principle culture.

But there can be a definite downside if a Phoenix Principle culture is not managed well.  Disruptions and White Space can be opportunities to overspend, and overinvest, leading to losses and failure.  White Space is not child's play.  It is where new Success Formulas are formed via the crucible of competition.  It is critical that managers in these environments have their "feet held to the fire" to produce results.  Otherwise, cash flow is negative and profits never materialize.  That's bad news. 

All businesses need a mix of Explorers and Stabilizers.  Explorers usually become in short supply in Locked-in cultures, because optimization of the old Success Formula says that these kinds of managers are unnecessary.  So Locked-in companies have to recruit Explorers to identify and create Disruptions, and then to have the skills for managing the creation of a new Success Formula. 

White Space companies, and projects, need Stabilizers as well.  Activities need to be disciplined and directed toward managing for cash flow and profit in the Rapids.  As we saw all too well in the 1990s internet boom, too many Explorers make short shrift of these requirements, and their businesses simply flame out. 

And that risk is now at Virgin Media.  Using clever planning and intense hard work, Virgin Media has built itself into a large and powerful company that delivers mobile phone service, land-line service, internet service and satellite television service across Europe and other parts of the world.  The company has made several growth-oriented acquisitions in the process, and those acquisitions have saddled the company with a huge debt load (see article here).  This is big trouble for a business in the media game, because assets are not long-lived.  So the debt payments go on after the technology needs to change - sucking up cash that should be used for changes and growth.  Virgin Media is now losing money, and forced to make debt payments, while its primary competitors (the Murdoch-controlled Sky and British Telecom) are in far healthier financial shape.  This is a risky situation, that may require someone buy out Virgin Media or it risks a precipitous decline that will be bad for Virgin as well as its investors, suppliers, employees and customers.

In the headlong rush to grow at Virgin Media, the managers may have been short a sufficient number of Stabilizers.  The Explorers, which are sure to be popular in the Virgin culture, have been allowed to push the company growth.  But now the entire Virgin Media organization is at risk.  If there had been a more balanced management, with more Stabilizers, it is very likely the company would be in better financial shape and more competitive. 

Everyone loves a party.  And we all want to have a good time.  But, if someone gets drunk the party can come to a crashing, unpleasant end.  White Space can not be run like a party.  It is a business.  And if there aren't Stabilizers around to control the consumption of resources, then the White Space business can find itself crashing.

Signalling Lock-In

On May 5 the rumor hit the newspapers that Microsoft was considering buying Yahoo (see article here).  Both companies insisted this rumor was unfounded.  Then, on May 10 it was reported that Microsoft bought a 4% stake in CareerBuilder (see article here), competitor of Monster and Yahoo! HotJobs, for an undisclosed sum.  These reports drive home the differing viewpoints between investors, who want White Space to drive value, and management, that wants to Defend & Extend the past.

Microsoft built its empire upon a Success Formula as a near monopoly.  Systematically and effectively Microsoft first dominated the market for small computer operating systems with MS-DOS.  They leveraged that knowledge and kept the company in the Rapids with the hugely successful Windows operating system.  Then they overwhelmed all competitors making their suite of personal automation products (Word, Excel and Powerpoint supported with the Access database and a slew of supporting free products such as Internet Explorer and Outlook) a near monopoly as well.  This Success Formula of building a totally dominant position in software products for PCs now dominates all decision-making. 

Unfortunately, the market for personal computers no longer has the high growth rate it once did.  Customers don't feel compelled to purchase upgrades, as the recently released Vista has shown.  Instead, they are doing more with other tools such as PDAs, mobile phones and even MP3 players.  Additionally, the growth in PC usage has turned much more to internet environments such as search and entertainment (such as Google and YouTube) rather than the PC as a personal productivity tool.  But Microsoft's Lock-in to their old Success Formula has kept them out of these new markets.

Investors look at the slower growth and huge cash pool at Microsoft and long for the company to find new White Space.  Yahoo! would be large enough and in a market with enough growth to actually represent an opportunity for Microsoft to move from its low-growth Swamp back into the high-growth Rapids.  So investors are pushing the company to make moves to create and fund White Space to drive future value enhancement.

But Microsoft is so Locked-in it shows no inclination to take such a move.  Dabbling into a segment such as career tools keeps the investment very low.  Four percent of CareerBuilder in no way Challenges the Lock-in, and does not offer an opportunity to create a new Success Formula.  By making this investment Microsoft tells investors "we have no intention of addressing new Market Challenges. We intend to remain Locked-in and hope Vista will someday give us the kind of growth we used to obtain from such new releases."

Investors will remain disappointed with Microsoft.  But management, which is insulated from external investors by the large holdings of Bill Gates and its extremely large market capitalization, can ignore this disappointment.  And by overlooking the White Space opportunities in favor of near meaningless small investments management signals investors the company has no intention of doing anything different any time soon.

Which should make the executives at Google extremely happy!

Swimming Toward the Whirlpool

Eddie Lampert has finished yet another year at the helm of Sears Holdings.  And during that time he's proven he can cut costs.  He hasn't proven he can make money - even by selling assets.  The stock remains highly priced largely on the belief he's building a war chest to do great hedge fund deals, but so far he's not demonstrated Sears and KMart give him the resources to pull that off.  Instead of looking like Warren Buffet, his idle who turned a worn out textile company named into Berkshire Hathaway into a tremendous investment vehicle, Mr. Lampert looks more like the captain of the Titanic who kept up reassurances until imminent peril took down the ship.

Mr. Lampert was once a banker, and he's never one to ignore the opportunities for financial machinations.  Sears most recent quarterly financials show a profit.  But all of that was engineered from one-time items like dividends from Sears Mexico and gains off a legal settlement with Sears Canada (see article here).  Meanwhile, sales at stores open a year turned out another decline - this time of nearly 5%.  Quarter by quarter Sears stores keep selling less and less.  And more stores are closed.  And the cash current is getting thinner and thinner.

Mr. Lampert closed the investor relations department.  So to know what's going on is opaque, to say the least.  At the recent annual meeting he declared that his plan is to rebuild the Sears and KMart brands (see article here).  After practically killing the previous ad budget, he intends to start new ad campaigns (although the budgets were not revealed.)  His plan, or should I say hope, is that by "positioning" Sears and KMart he can improve performance.  Yet, he's said nothing about why WalMart, Target, Kohl's, JCPenney, Loews and Home Depot would roll over and let him start eating into their market shares. 

Mr. Lampert would like to make some acquisitions.  But the problem is that 2007 is not 1977.  Mr. Buffet started Berkshire Hathaway when the world of deal-making was still pretty small.  There weren't dozens of multi-billion dollar hedge funds with ample resources chasing every imaginable deal.  Bershire Hathaway was able to pick and choose its deals, using very conservative financial analysis when valuing investments.  Today, only the most aggressive investors become buyers, and that means paying a pretty price for those acquisitions.  So Sears Holdings can't generate enough cash to play into the huge deals, and the competition is so intense on smaller deals that none can be had.  Mr. Lampert is reluctantly being drug into trying to keep Sears and KMart alive, but he has no idea how to do that.

Sears and KMart were companies in trouble when purchased by Mr. Lampert.  But he never Disrupted them.  He never set up White Space.  Instead, he tried to milk them of their cash in order to buy other companies, and he's proven he can't do that well.  So he keeps trying to string along the company another quarter, but meanwhile competitors are pounding away at the weaknesses of a company with no viable value proposition.  And as a result, Sears Holdings drifts closer toward the Whirlpool.

Defend to the Death

Sometimes market Challenges wipe out large numbers of businesses.  As I posted in my last blog, Amazon's approach to internet retailing of books wiped out thousands of independent booksellers, as well as most chains (anyone remember Crown Books?)  When such a Challenging tsunami appears on the horizon, trying to Defend & Extend your old Success Formula simply makes no difference.

Yesterday the National Association of Recording Merchandisers met in Chicago to try and figure out how they should respond to the Challenge posted by MP3 technology.  These are the people that retail CDs.  Do you remember going to the "record store."  Their top solution is to install machines in their stores allowing consumers to download songs onto a CD (see article here.) 

Never mind that any one of us can already accomplish this task at home with an internet connection, and a computer with a CD burner.  These in-store kiosks charge $.99/song (just like iTunes), then add on another $3.00 for the case and label.  On top of that, the process is intentionally extended out 5 to 15 minutes to force additional time in the store and encourage shopping.  So using this in-store process costs more, and takes longer than doing it in the comfort of your home.  And, at the end of this you get a CD.  When was the last time you saw someone on the street listening to music with a Walkman instead of  an iPod or other portable MP3 player?   These retailers do hope to give access to downloading songs to an MP3 player in the future, but they intend to put software on the songs so they can't be duplicated.  And the cost will remain at $.99.

Why would any music retailer think this is a good idea?  Because he's trying to find a way to Defend & Extend the Success Formula he built when music sales required a physical product.  Once Locked-in, this manager is most likely to deny the depth of the Challenge, or tweak the Success Formula in hopes it will somehow work.  As one retailer said "this machine...puts me back in the singles business."  Oh yeah, he admitted to starting 38 years ago selling 45s (for those too young to know, those were 6 inch vinyl records with big holes in the middle.)  To say he's hoping the past will return would be an understatement. 

The fact is that the percentage of people buying CDs has declined 15 percent since 2002.  CD shipments in the first quarter of 2007 were down 20 percent.  While digital downloading of songs keeps growing at 24%/year and greater.  Trying to overlay the cost and effort of an old approach on a new solution won't meet the market Challenge, instead it just moves the competitor another step toward the Whirlpool and disaster.