Stuck in the Swamp

Thursday of last week Dell (see chart here) announced that it would be restating four YEARS of previous accounts because the numbers had been manipulated at the request of senior executives.  The company admitted that account balances were reviewed by senior exexcutives with the goal of seeking adjustments to meet quarterly objectives.  The Dell CFO said that the company had found evidence of fraud in revenue transactions that would have to be completely redone.  (see article here)

This shows the power of Lock-in when an organization finds itself stuck in the lifecycle Swamp.  The business is Locked-in to its Success Formula, but a market shift causes the results to no longer be as good as they used to be.  Although the overall market continues to grow, the company doesn't do as well.  From the prosperity of the Rapids leaders find themselves fighting to find faster water as growth, for them, slows.  And in most companies, Dell being stereotypical, the answer is to try working harder, doing more, and seeking to be somehow cheaper in order to save the poorly performing Success Formula.  When the results just don't meet expectations, huge pressure is felt to Defend the Lock-ins & Extend the Success Formula.  And, in too many cases, under great pressure to perform executives will resort to financial machinations.  Sometimes these accounting tricks are completely legal.  But, sometimes pressure causes leaders  to falsify records in order to preserve the Success Formula.

As we saw during the infamous trials at WorldCom and Enron, (and more recently Tyco and Conrad Black) leaders vocally proclaim all innocence.  They become so blinded by their Lock-in, and the need to protect the Success Formula which previously served them and investors so well, that they slowly inch toward taking more dangerous acts.  When they start realizing they cannot meet objectives simply by operating the Success Formula, they look for more creative methods.

While some few execs will likely get blamed for this 4-year fiasco, in reality Michael Dell and the existing executives are equally to blame.  They remained so Locked-in and unwilling to consider modifying the Success Formula that they created the environment which bred this problem.  Dell has never maintained White Space, nor has it ever tried to migrate to new solutions for market Challenges.  Dell kept pressuring management to do more, better, faster, cheaper.  And with that approach he created a no-win environment for divisional presidents and vice-presidents.  They didn't have the option of using White Space to find a better solution, and with that avenue cut off they either fell on the sword of failure or they had to find some way to keep the emporer feeling he was wearing beautiful clothing.

I blogged months ago that Dell was stuck in the Swamp.  Now we know it is.  A 4-year (I still can't believe it) ongoing accounting falsification goes to show just how deeply the company is stuck.  It takes a significant commitment to Lock-in to overlook something being wrong for that long.  And Dell's current answer is that the errors were not really significant.  Give me a break - any time someone can get away with chicanery for 4 years it's a significant problem.  And just by taking that point of view Dell reinforces its intent to remain Locked-in and stuck in the swamp.  The company still shows absolutely no indication it will ever set up some White Space to evolve forward to a better competitive Success Formula.

Once stuck in the Swamp fewer than 7% of companies ever get out alive.  Most fight off the aligators and mosquitos only so long before being pulled into the Whirlpool of failure.  Dell looks to be far too deep in the Swamp to ever get out.  And that's too bad for a lot of suppliers, employees, customers and investors.

Making Excuses

So, has the American consumer quitting its spending, or are some retailers running weak Success Formulas?  That's really an important question to answer when assessing management at Wal-Mart [see chart here].

Today Wal-Mart missed its earnings forecast (again) [see article here.]  After sorting through all the financial machinations from previous year divestiture charges, this year's tax adjustments, etc. this most recent quarter had earnings per share exactly equal to last year.  Does anyone not think this number was manipulated to be sure it wasn't worse by 1 cent?  Wal-Mart blamed its problems on the fallback in consumer spending.  Of course, Wal-Mart's primary customrs have long spent 100% of their bi-weekly pay, so what is supposedly different now?  Are we to presume these lower-income folks are saving more now?  As their real estate prices and saving rates are falling? 

Interestingly, stock market analysts built on the Wal-Mart announcement to beat up the entire Dow Jones Industrial Average [see article here.]  Analysts at Wall Street firms like Jefferies & Company said that if Wal-Mart is doing badly, it must mean that consumer's are spending, and going to spend, less.  The assumption in this logic is that Wal-Mart is running a good Success Formula allowing its results to be a proxy for all consumer spending.  To accept this, investors have to believe that Wal-Mart's Success Formula is meeting customers needs so well that it would not be possible to serve customers and get a better performance than Wal-Mart.

In reality, the Wal-Mart Success Formula is seriously out of step with consumer needs.  Sheer size does not make Wal-Mart a proxy, because once Wal-Mart's Success Formula misses serving customer needs consumers keep spending - just somewhere else.  Sears Holdings has been missing targets for a long time, but no market analyst says the misses at Sears and KMart are not considered market barometers because market analysts know the Success Formulas there are problematic. 

The DJIA has seen higher volatility lately (see chart here).  And it is off of its recent highs.  Is the cause weak consumer spending?  Certainly no one focused on consumer weakness as the cause the last two weeks.  But Wal-Mart saw this market destabilization as an opportunity to make an excuse for its poor performance.  And via size, some important people are buying that excuse.  But the reality behind Wal-Mart's poor performance has nothing to do with the U.S. economy, aggregate spending patterns by consumers or even changes in the money supply affecting interest rates.  The problem at Wal-Mart is Lock-in to an outdated and poorly performing Success Formula.  And everything else is just making excuses for not using White Space to solve this problem

No Bad Markets

Frequently investors look for "good markets" when seeking a place to put money to work.  On the flip side, frequently management that is performing poorly will blame their weak results on a "bad market."  Listening to this, it would be easy to conclude that if you want to make money you need to be in "good" markets, while avoiding "bad" ones.  And that begs the question, what's a good or bad market?

When Tom Monaghan entered the home-delivered pizza business with Domino's restaurants were growing at less than 3 percent a year, the competition was largely cut throat small pizzerias with no entry barriers, and there was a huge, dominant, branded player in pizza restaurants named Pizza Hut which was owned by PepsiCo and had enormous resources.  Was that a good or bad market?  Tom Monaghan became a billionaire competing there.

When Sir Richard Branson launched Virgin Atlantic his prime competitor, British Airways, had 90% market share and was losing money.  The only other competitor was Freddie Laker, and he had just gone bust.  Were airlines a good or bad market?  Sir Richard made more than a billion dollars from Virgin Atlantic.

Now, Virgin America is launching service (see article here.)  United has just emerged from protracted bankruptcy, while Delta and Northwest are on the brink.  All the major national airlines (except Southwest) are claiming that fuel and labor costs are so high they can't re-invest to upgrade their aging fleets.  Meanwhile they are laying off workers, cutting customer services and on-time performance is declining as they struggle to fly planes.  So is Sir Richard crazy?  Are U.S. airlines a good or bad market?

Rupert Murdoch of News Corp. fame has just paid an enormous premium to purchase Dow Jones & Company (read article here). But investors have been bailing out of newspapers for 6 years.  Knight-Ridder busted itself up selling its assets.  Tribune Company is going private to try and cut additional costs.  Subscriptions and advertising revenues have declined for 4 years as customers have left for internet news in droves. Is Murdoch crazy?  Are newspapers a good or bad market?

Success in business is not about "good" or "bad" markets.  Success requires understanding how to compete in the future.  When customers have a demand, but old Success Formulas produce poor results it indicates an opportunity to make money.  Just not using the old Success Formula.  Virgin America will not be like United or American.  It has a new approach to customers, and therefore it has a plan to operate a different Success Formula and make money.  Likewise, News Corp intends to radically change the Wall Street Journal, including putting a lot more emphasis toward the on-line editions.  If Murdoch successfully Disrupts Dow Jones, and invests in White Space to create a new Success Formula, he has a tremendous opportunity to make money.  People want to fly in North America, and people want to read business news on this continent as well.  The problem is that the existing management teams are so Locked-in to their Success Formulas that they accept lousy results as they do the same things day after day.  These new competitors don't need a "good market", they just need to apply new Success Formulas to these old markets.

The myth is that growing markets offer an easier place to compete.  That growth creates more resources is true, but growth also attracts a lot more competitors.  When you find a gold nugget, within minutes you'll be surrounded by hundreds of additional prospectors.  While the gold may be more available in that part of the stream, those trying to grab it are far more plentiful as well.  No matter what the growth rate, high or not, returns go to those businesses that develop new Success Formulas which overcome market Challenges.  And that is what we're seeing at Virgin and News Corp.  The leaders of these companies are not afraid of any market.  And they have shown they can make money by building new Success Formulas that reap profits while Locked-in competitors stall and fail.

Double up - then out?

The headline in the business section of The Chicago Tribune screamed "United Doubles Up On Profit" (see article here).  You would think United airlines (see chart here) was a great story of turnaround success.  After all, the airline only returned out of bankruptcy about 18 months ago.  And the stock has doubled from its 12 month lows.  But is all well at UAL?

When we read the article we learn that profits are up largely due to United's ongoing cost cutting programs.  They keep beating up on employees to do more work for less money.  And United used bankruptcy to strip down much of its pension payouts, further giving to employees (past and present) on the chin.  United didn't improve it's performance with customers or improve its productivity and thereby improve profits.  It just spent less.

Closely tied to United's long-term profits is its charges for airplanes.  And a different article (see article here), which preceded the earnings announcement by 3 days, stated that United was falling behind on its new airplane orders.  United has stopped buying replacement planes, and that has helped the company lower its expenses.  In other words, United is squeezing down the company to be smaller, and not reinvesting even for maintenance, much less growth.  In fact, according to the article, United is so far behind on placing orders for new planes the company is at jeopardy of being able to get any replacement aircraft to keep its fleet in the air!  The aircraft manufacturying industry capacity is sold out for several years into the future, and United isn't on the list to get any new equipment.

So while United is cheering about its LAST quarter, its FUTURE prospects look bleak.  UAL has literally traded its future for today.  Management is de-investing in order to produce current profits, while simultaneously asking employees to sacrifice in order to keep the company alive.  This is the ultimate in Defend & Extend Management, where the leadership gives up the future, and gives up its employees future, in order to defend its own decisions and actions.  The United leadership team is so Locked-in to trying to present its outdated Success Formaul as capable that it is killing the company in its effort to present immediate profits.

Investors should not cheer this latest profit news.  Rather, they should recognize that United has probably turned the corner from the Swamp into the Whirlpool.  Without the wherewithal to purchase more airplanes, in the future there will be no airline.  No matter what last quarter's profits were.