Other side of the storm

Today the U.S. Congress failed to pass a bail-out bill to buy up bad bank assets.  Before the vote, the Dow Jones Industrial Average was down about 300 points.  After the vote, the DJIA fell to close down about 700 points (read about the vote and market reaction on Marketwatch here.)  So, is the end near - or is everything going to work out OK?

I'm reminded of the scene in It's a Wonderful Life where George Bailey (played by Jimmy Stewart) is invited by the town patriarch, Mr. Potter, to take a job for Mr. Potter.  As he starts the conversation Mr. Potter says something close to "George, back in the Depression when everyone lost their heads you and I kept ours.  You ended up with the Building and Loan, and I ended up with everything else."  The crisis happened, and lots of people got hurt.  Some came out OK, and some did very well.  On the other side of a crisis, there are winners.  It's just that often those winners are not the same people who were winners going into the crisis.

Over the last several months we've seen some big changes in financial services.  We're seeing some losers already.  But we're also seeing some plays being made that could become winners.  It was the announced losses at Citibank, which led to the firing of their CEO Mr. Prince, that first alerted people to the reality of this crisis.  Today, Citi announced it is buying Wachovia bank in its play to be a long-term winner.  The new CEO says this is a rare opportunity for huge gain with almost no risk.  It was JPMorganChase that first took a play to expand in this crisis with the acquisition of Bear Sterns, which many people at the time thought was done for a remarkably small amount of money.  Later JPMC bought Washington Mutual for a fraction of its asset value.  And Bank of America has moved aggressively, buying up the very troubled Countrywide Financial that was the first mortgage institution to fall, and later taking over Merrill Lynch the weekend when Lehman Brothers went bankrupt.

Will Jamie Dimon of JPMC be the next Mr. Potter, taking over control of his local market during a crisis? Some of these may become big winners.  On the other hand, all 3 may falter. 

What we know is that the demand for loans (the product that banks sell) is not going to disappear.  That market may hiccup, but demand will continue to grow.  Government, corporations and individuals all will continue to need loans.  As the standard of living rises in China, India and elsewhere demand for loans will go up.  And the winner will be the business that develops a solution to the future market need.  You can't judge the value of these actions by looking at how these businesses did in the past - because that past is gone.  It's all about the future.  So, what should be the scenario for 2015?

• Will the dollar continue to be the world currency - the source of denominating oil and other commodities as well as most transactions?  Or will we see a change to the Euro, or perhaps a basket of currencies put into some sort of as yet unavailable currency instrument?
• Will people continue to save their money in currencies, as deposits in banks, or will there be a re-emergence of keeping stores of value in silver, gold, and other commodities (in India, many people still carry their savings as jewelry on their arms).
• Will U.S. based companies dominate the equity markets, or will companies from the "emerging tiger" countries become relatively more powerful?
• Will the primary source of deposits be in the USA, Europe, China, India, or elsewhere? 
• What rate of return will depositors require on their investments?  Will this vary by region?
• Will real estate values in the USA, Britain, France, Germany, Japan, Brazil, Russia, Taiwan, Hong Kong, Singapore, Taiwan, China and India go down?  Go up?  Will there be big differences between regions?  How will the differences vary?
• Where will deposits, regulations and legal devices converge to be the primary source of loan origination?  The USA?  Elsewhere?

Who wins depends on who has a good set of scenarios about the future.  Not because they can predict, but because they are prepared for different potential outcomes, and they can shift to meet Challenges.  And if you are an investor, your pick between the 3 mentioned - or possibly ICBC, HSBC, Banco Santander, Mitsubishi, ABN Amro, BNP Paribas, UBS or Royal Bank of Scotland?  How will the big U.S. banks compare in a global market - and one that is less dominated by the USA?

Too many investors don't have future scenarios when they invest.  They buy equities, or make loans (buying bonds), on the basis of company history.  But the value you receive for investing has nothing to do with what the company did in the past - it's all dependent upon the future.  When an industry crisis occurs, like the one in financial services today, those who survive - and those who thrive - do so because they have a good set of scenarios about the future.  There is no doubt some will come out of this crisis as winners.  They may be players who had nothing to do with the past - or they may be companies people in the USA know very poorly.  But if you are going to invest in financial services, you better have a good set of scenarios - and you better watch closely to see how things develop.

Note:  Looking at the 3 companies referred to here, one is acting quite differently than the others.  While Citibank and Bank of America are moving fairly slowly to change, JPMC is moving very, very fast with its acquisitions.  Within 3 months of buying Bear Sterns, JPMC had dismantled the company, consolidated its assets and let go its employees.  After acquisition many companies spend months trying to work their way toward some sort of "merged" solution - only to spend huge quantities of cash and end up with higher costs and lower revenues.  At JPMC we see one company forcing its Success Formula onto its acquisitions - no belabored effort.  Rather fast moves taken to consolidate assets and keep the Success Formula in place.  Whether the JPMC Success Formula is the right one for the future is yet to be seen.  But the leader's actions at JPMC are far more likely to be effective for shareholders than the actions being taken at the other institutions.  Especially if JPMC is able to shift with the marketplace.

Good survivors

General Electric (see chart here) today announced earnings will decline (read article here).  Its very large GE Capital unit, which produced 45% of last year's corporate earnings, is seeing its unit earnings hit hard in this financial crisis.  With its admission of the expected decline, many analysts are angry and say the senior leadership has no credibility (read article here).  They are crying for heads to roll.  So, should you sell GE stock if you own it?

First, look at the announcement.  In addition to saying earnings are going to decline, the company has said it intends to diminish its financial business and grow its global industrial business.  While it is cutting the dividend the financial unit pays to the parent, it is also cutting the debt in the financial unit.  And, most importantly, GE is halting its stock buyback.  "We have suspended the stock buyback to reduce GE Capital leverage, while still being able to pursue opportunistic acquisitions" is what Chairman Immelt said.

This is great news for investors.  This management team has said it is less interested in manipulating earnings per share by buying back stock, and instead wants to make sure it has cash to make acquisitions at a time when many business values are declining.  GE is preparing to keep its growth going, primarily outside financial services, by making sure it has cash and continuing its  hunt for acquisitions.  Meanwhile, its actions allowed the rating agencies to re-affirm GE's triple A credit rating - making it a company able to raise debt from around the globe as this crisis continues.

This is exactly what you want to see in a Phoenix Principle company.  GE is a portfolio of businesses, which it works aggressively to keep growing.  Selling things that don't grow, and buying things that do.  It keeps moving people around in the company to challenge them, and thus help both employees and their units grow.  It isn't stuck in its old business, but is ready to keep moving forward.  And it is planning to move forward by admitting it intends to make acquisitions if the markets remain troubled and asset values keep falling.  Rather than pulling back to protect its core - especially its core financial services unit - GE leadership is taking action to move forward with less emphasis on financial services and a plan to invest in other businesses with better return potential.

If you are an employee, a vendor, a customer or an investor in GE - could you ask for more?  With its eyes firmly on the future, a passion for beating competitors, a willingness to Disrupt even during turbulent markets and the willingness to continue creating and maintaining White Space GE will continue to be a long-term survivor with above average performance long term.  Preparing to grow, regardless of market conditions, is part of what makes GE stand out - despite its critics.

Ga-Ga over Google G1 phone?

Yesterday, amidst all the brouhaha over the dissolving of America's financial system, Google (see chart here) launched a new phone (read article here.)  This would have surely been the #1 front-page news, except - again - the Congressional effort to deal with a trillion dollar investment decision in bad loans.  So, is this a big deal that was given short shrift, or is it an announcement we can ignore?

There is debate about whether the Google phone is a game changer or not.  And that debate cannot be resolved by phone gurus.  Quite simply, mobile phones are no longer simply phones.  All the new products are built with new operating systems which let them operate various applications making them quasi-personal computers with mobile telephony capability.  There are now several players in the game, and to assess the likely winner's you would be best served to read Geoffrey Moore's book The Gorilla Game in which he chronicles the requirements for success when launching technology products.  So, does this mean we should reserve opinion about the importance of this launch until more is observed about sales and market share generation?

Hardly.  I've blogged a fair bit about Google lately - and it's been positive - and once again I think you should be impressed with this launch.  It shows Google getting into yet another growing market, and with yet another new technology.  Once again Google has chosen not to sit on its laurels in search or ad placement and invest big money in White Space with permission to do what's necessary to succeed.  One thing Google has a lot of right now is money - and instead of hoarding it the company is creating and maintaining White Space which can keep Google in the growth Rapids.  I doubt that everything Google does will make money, and I doubt all its products will succeed.  But the fact that Google is investing its ample cash in projects inside growing markets which can sustain the growth is the best move the company could take now.

Also, it's impressive that Google made its launch knowing that it wouldn't get the top headline.  This shows an organization more intent on White Space than headlines.  Instead of creating a "splash" about itself the company put out a new product, using new technology, that operates on a new network, with new functionality - and did it during a very uncertain time for most investors and the economy.  Obviously, Google is looking forward and sees it must get into the market now and compete to learn how it will succeed.  While many other companies which are less cash rich are forced to pull back their horns, or with management that prefers to be conservative because of shifting markets, Google is keeping its eyes squarely on the future and sees that getting in now, during a period of great uncertainty, only increases its odds of success.  When markets shift it most benefits the new entrant willing to create marketplace disruptions - and that's what we see Google doing now.

We all were impressed with how IBM practically monopolized the mainframe computer business.  We were impressed with how Wang dominated word processing.  And how Digital Equipment dominated engineering mini-computers.  We were impressed that Microsoft took total domination of the desktop market, Dell created domination in selling and distributing PCs, and Sun Microsystems garnered huge share in Unix servers.  But each of these got into trouble when markets shifted and they weren't part of the market shift.  As they tried to "milk" their market position and disparage upstart competitors, they fell into Defending & Extending their outdated Success Formulas - until they either (a) had a big, dramatic turnaround, or (b) went out of business, or (c) saw their growth slow and their value plummet.  What's impressive is that Google is showing us the willingness to Disrupt what made them great and enter dispirate new markets with new solutions using White Space to develop new Success Formulas around those markets.  With this behavior, they are much more likely to demonstrate long-term value creation than the companies listed above.

And for customers who recognize the value in new technology, as well as employees looking for ways to grow, and vendors ready to support the effort, as well as investors, this is a very good sign. 

$700 billion for what?

By now, everyone knows the story.  After all the cost to take over Freddie Mac and Fannie Mae, plus the guarantees given to J.P. Morgan Chase for their acquisition of Bear Sterns, and the cost to keep AIG alive - in the range of $300million to $600million - the Treasury secretary now says the U.S. taxpayers need to spend at least (it could be more - even more than 2x this amount) $700billion to purchase the bad loans sitting on the books of banks, investment firms, insurance companies and hedge funds. 

So what does the taxpayer get for this?  So far, all the taxpayer is told is "it'll stave off an even worse crisis."  I'm reminded of the words attributed to Illinois Senator Everett Dirkson "a billion here and a billion there and pretty soon it adds up to real money."  This is a lollapalooza of a bunch of money - and yet no one seems interested in saying what the taxpayer gets.  The proposal is pinned on "things will be worse if you don't", without much talk about how things will ever get better.  There's no talk about how this will create more jobs, create rising incomes, or improve asset values.  Just "it can get a lot worse." 

So, put yourself in the role of CEO.  If someone came into your office saying "I think we made a whopper of a mistake, and you need to agree to pony up something like $1 to $1.3trillion dollars to bail us out."  After you get back up, what would you ask?  How about, "what's this for?"  To which you hear "Well, it seems we simply made a bunch of bad investments, and now we have to buy them all back."  Nothing about how your business will be better for having done it.

Now, it might occur to ask, "if I do this, how do I know it won't happen again?"  And that's the question you really should be asking today.  Have you heard before about this problem, and told your previous actions would stop the problem?  If yes, wouldn't you say "hey, I'm a bit tired of running around this tree and getting these recurrent bad news meetings.  Seems like every Monday is something of a 'here's the newest crisis' environment.  What's your plan to adjust to the market requirement?"  And if the plan is to do more of the same, but now with more resources, done harder, and working smarter you'd be pretty smart to say "if the previous actions didn't work, why should these work?" 

In the end, this $700billion to $1.6trillion isn't changing anything.  It's just putting the proverbial "finger in the dyke."  Only what started out as a few hundred million dollars (the finger in the first hole) has exploded into over $1trillion and the dyke hole isn't the size of a finger - it's the Holland Tunnel!  Clearly, what was tried hasn't worked.  Yet, this is asking more of the same.  So, in the legislation the person who's been watching and saying "things will be fine" and spending the hundreds of millions has now said "just to make sure this works, I want not only all this money but no oversight on what I might need to spend additionally - and no controls over what actions I might need to take - in order to finally stop the flooding problem."  Uh, right.  Since everything you've done before didn't work the obvious right answer is to give you more money than I ever imagined, and on top of that give you unbridled permission to do anything else you want to keep trying more of the same to stop the problem.

When do you say "no"?  Confronted week after week with crisis after crisis, when do you say "I don't think this is working?"  It's so easy to go along.  It's so easy to say "this has been the way we've always done it.  Things haven't worked so far, so clearly all we need to do is do more of it.  Possibly more than any of us ever dreamed imaginable - but surely if we do enough, do more, eventually it will work." 

Now, more than ever, we need White Space.  The financial markets have shifted.  Competition has shifted.  The balance of competitiveness has shifted to those who have access to lower cost resources of everything from oil to labor.  Those who focus on industrial production can now see that it is dominated by those who have more people, who are equally trained and who work for less.  Whether that is the production of shirts, or software code.  Trying to prop up a global financial system based on the "full faith and credit of the U.S. government" is difficult when that government is significantly in debt, has lost its position as #1 in manufacturing output, and no longer controls the financing of everything from dams to auto purchases.  Trying to "fix" this situation with solutions designed to work in another era, under a different set of circumstances, will not produce better results.

At the very least, when confronted with this kind of situation it is the time for leaders to say "where is the White Space to develop a new solution?  If I have $1.3trillion to buy the problem - either by giving up the money or by printing more - and I forego all other expenditures (like health care, or defense against competitors) to put the money here - I deserve to see some money spent on developing a new solution.  One that is built upon the new market characteristics."  This is not the S&L crisis again, nor is it the failure of a single big bank.  We are seeing the results of a market shift which the industry was not prepared for.  And the only way to come out successful is to have White Space to develop a new solution.

So far, no one has asked for permission to develop a new solution - nor has anyone even proposed it.  No one has even asked for resources to develop a new financial system.  All the money is going to attempt propping up the old system - and the more we dig, the deeper we get. 

At the very least, for $700billion, we need White Space.  We don't need hedge fund managers who are salivating to buy up beaten down assets.  We don't need regulators trying to roll back the clock.  Nor do we need "do nothing" recommendations with "have faith this will all work out in a capitalistic system."  We are in the information age - not the industrial age.  We are in a global economy - not a U.S.-led international economy.  We are facing new competitors, with different advantages, doing very different things.  And we need new solutions.  Without those, each Monday will continue to feel like the movie "Groundhog Day" as we relive over and again the problems we don't address by simply throwing money at it.  We have to find a way to move beyond "more of the same."

Mr. Paulson is willing to bet the U.S. Treasury on doing more of the same.  He's ready to spend money Americans don't have (since there is a negative U.S. government budget and huge deficit.)  This means either higher taxes, or turning on the printing press and creating inflation.  That's a bet he's willing to take.  Are you?  Or would you like to see some options?  Some new solutions?  Or even some teams that are working on new solutions? If he's your V.P., your CFO, do you approve his recommendation, or do you ask for something more - some White Space to develop a solution that does more than stave off future crisis.  Do you look to the future, and how to win, or do you try to preserve the past and put all your money on the bet that old solutions will work?

Effective Scenarios

After my blog on Tuesday, I was bashed by a number of folks as a pessimist - or worse.  Some have said my willingness to discuss America's financial crisis in a negative light based on the assessment it is likely to worsen, as well as the loss of America's manufacturing base and jobs, is far too negative.  I've also been accused of being Chicken Little and claiming the sky is falling - when we're only in for a patch of rough weather.  Some have quoted presidential candidate John McCain and said that our best days are surely ahead of us, and I should be less gloomy.  So are my detractors right?

I don't know what the future will bring.  I have no crystal ball.  I have no ability to time travel. I cannot foresee the future.  And that was not my point.  Rather, what I'm recommending is that we all use scenario planning to help us create a strong future for our lives, our work teams, our functional groups, our businesses, our industries and our economies.  Whether our futures are bright or gray has everything to do with what actions we now take - and those must be based on our scenarios of the future.  If our actions prepare us to be more competitive in the future, we can be far more successful than we were in the past.  Yes, our best days will lie ahead for all of us who are preparing for the shifted marketplace - who are moving to implement based on future scenarios that are different from the past.  What these news headlines are telling us is that markets have shifted, and the future will not be like the past.

The risk is that our planning is not effective.  Too often planning is based on extending the past.  "This is what it was always like, and I'm sure things will return to the old ways soon enough."  When we build plans based on the past we start using confirmation bias to help us believe our extension planning is the most likely case.  After all, up until a market shift the planning has been right - hasn't it! Recently one fellow told me that while several of America's largest and most powerful financial institutions were failing he wasn't worried because a local bank he knew was doing quite well, according to its leaders.  His bias that things will work out allowed him to take this piece of information and use it to discount all the information in the news that America's financial system is in crisis.  He's not stupid or foolish - he just allows his Lock-in to the past to permit using data in a way that confirms what he wants to believe.  We all do this, and often it's no big deal.  But, when market shifts happen, confirmation bias that allows us to keep faith in a future similar to the past can be deadly.

The folks running Bear Stearns, Lehman Brothers, Merrill Lynch, AIG, Freddie Mac, Fannie Mae and Washington Mutual were/are some of the smartest people in business globally.  (Add up the incomes of the "C" level execs in these companies and you'd have enough money to operate several state governments). But their belief that "things would work out" allowed them to keep following a plan which did not meet market reality.  Shifts were happening in the worlds of real estate, manufacturing, commodities and finance that were preparing to upset their proverbial applecarts in a major way.  They weren't stupid, but they also weren't prepared.  Their scenarios of the future did not account for these shifts, and as a result they have been struck down.  For them, there best days definitely don't lie ahead.  For some of them, there is no future.  Not for the companies, and not for their employees or customers.  Not only are the shareholders being wiped out, but those customers that depended on these institutions for financing are now scrambling to figure out what to do next.  A lot of people are finding life very tough this week because these organizations had plans based upon extending the past - rather than cold assessments of what might happen in the future.

There will be winners coming out of this financial crisis.  Some will be in the USA. Some will be elsewhere.  Those who will succeed will be those who compete based upon where the markets are headed - not where they have been.  While some analysts are recommending people invest in Coke, Pepsi, General Mills and Kraft, the reality is that those recommendations are nothing more than looking for a life raft (any raft, no matter the quality) so you can escape the sinking ship (and ignores that the best life raft is simply cash or treasury bills).  The winners will be those competitors that build on the underlying factors which created this crisis, implementing new solutions.  Because there will be loans tomorrow, and there will be banks, and there will be a need for financing.  But the market will be different.  And those who are prepared for this difference, for this new market, will do much, much better than those who are not.  A situation like we're seeing now in American finance is only a problem if you aren't prepared. 

Those competitors that perform well year after year after year after year are the ones who don't simply plan by extending the past.  They build scenarios that take into account many factors - including factors which can doom their Success Formula.  They don't ignore the scenarios that put them at risk.  In fact, they invite outsiders to their planning (advisors, consultants, investors, lost customers, etc.) who will point out confirmation bias.  They invite the creation of scenarios that require a different Success Formula - so they can understand what they will have to do if they are to continue succeeding regardless of market shifts.

I'm not pessimistic about the future.  I'm optimistic.  Creative Destruction (see Joseph Schumpeter here) means that out of every failure you have the creation of a new opportunity.  I can only be seen as pessimistic by those who want the future to be like the past.  Only if you are wedded to past extension do you find this "crisis" something to ignore, avoid or hope simply isn't going to really happen.  If you are committed to a successful future then this is an opportunity.  It is an opportunity for those who are willing to Disrupt their Lock-in and use White Space to develop new Success Formulas that take advantage of the market shift.

Smoothing out the ups and downs is all about effective scenario planning.  If you are willing to use big trends to develop scenarios of the future you can prepare for almost any circumstance.  And those who are prepared find market shifts the time to take advantage of competitor weaknesses and grow.  Are you planning for the past to return, or are you developing scenarios of the future that could be very different from today?  If you're the former, it's going to be a rocky ride.  If you're the latter, you could be the next Google.  The DJIA can fall 1,000 points, and that is immaterial if your plans are based on the market requirements of the future.  Those companies which are focused on the future scenarios are the ones to invest in.

There's always room for a winner

There has been a lot of press recently about the terrible situation for retailers.  With house prices plunging, incomes stagnating for 6 years, and credit tight we've entered a consumer-led receission in the USA.  Analysts are giving plenty of reasons for retail companies to do poorly.  About all the big boys are seeing declining revenues - and even the behemoth Wal-Mart is barely growing and it's doing all the price-chopping it can.  Walgreens, the nation's fastest growing retailer, has slowed its store openings.  Jewelers are going bankrupt.  A single stumble seems to have led clothier Steve & Barry's into bankruptcy despite a great reputation with college students.  In the middle of this, one company is going into the retail business, opening new stores in hotly contested markets like Chicago.  L.L. Bean (read story here).

L.L. Bean has been around a long time, selling product via catalogs.  Of course as the internet blossomed and web pages replaced catalogs, their sales on-line grew as well.  They've long made money as a catalog-based retailer.  Their distinctive product line of outdoor-oriented gear, coupled with their catalog distribution, has been the L.L. Bean Success Formula.  Yet, now in one of the worst retail markets in recent history the company is moving into traditional brick-and-mortar retail.  To traditional analysts, this seems nuts.  But L.L. Bean is showing all the strengths of a Phoenix Principle organization.  Like Virgin, that launched a profitable airline when everyone said airlines were impossible to make money, L.L. Bean is moving now when the traditional retailer's Success Formulas are most at risk.

• Traditional retailers are suffering.  This shows that the industry Success Formula is producing diminishing returns.  The industry is primed for change, because Locked-in existing players are trying to "hunker down" and do "more of the same."  This provides a great opportunity for a new player with game-changing ideas to enter the market.
• L.L. Bean's stores are not targeted at existing retailers.  They are targeted at what will make retail stores successful in future years.  The plan is all around what people will want in the future to shop at retail, not what has worked in the past.
• L.L. Bean is focused on competitors, and how it can beat them.  This move is not about trying to Defend & Extend the old L.L. Bean business, it is about taking advantage of weakened competitors at a time of market shift.  L.L. Bean isn't opening these stores in Chicago (and other places far removed from its traditional market of Maine and the Northeastern U.S.) because customers told them to - they are doing it as a way to be more competitive.  For a long time the midwest was a difficult competitive market because of Lands End based in Dodgeville, WI.  But since being acquired by Sears Lands End has grown considerably weaker, creating an opportunity for L.L. Bean.
• L.L. Bean is disrupting it's old Success Formula.  These stores have nothing to do with the old centralized catalogue sales and distribution tactics.  And the stores are industry Disruptive environments that are as different from a Sears, Wal-Mart, Eddie Bauer or Aeropostale as they can be.  L.L. Bean isn't just trying to sell more stuff in new markets, it is creating an entirely new approach to how it sells.
• L.L. Bean is not trying to extend its old Success Formula.  It is using White Space to develop a new Success Formula that will allow the company to be far more successful in 2015 than it was in 2005 or 1995 or 1985.  By using White Space since launching its first stores, L.L. Bean is experimenting - trying new things - and learning how to be more successful in a shifting retail marketplace.

When markets shift the existing leaders often stumble.  By trying to Defend & Extend their old Lock-ins they hope to regain past results.  But shifting markets make old approaches create declining returns.  The result is an opening for new competitors, with new Success Formulas, to take advantage of the shift.  These new competitors, whether brand new, or a company willing to retool like L.L. Bean, use White Space to figure out what works in the new marketplace.  So even when you hear how bad things are in any market, and the existing players are talking about cutting back, there's always room for a winner.  If they are willing to undertake Disruptions, and use White Space to learn what creates the new Success Formula.

So Far, So Good?

Today the Dow Jones Industrial Average dropped over 500 points (read article here) despite the U.S. Federal Reserve pumping $70B into the system - the most since terror attacks on 9/11/01 shut down the markets for a week (read article here).  That's down more than 4% in one day.  From recent highs back in October, 2007 at over 14,000, the average is now down 16% (see chart here).  But as I listen to people talk about the stock market, and read the analysts, I'm reminded of the fellow who jumped off a 50 story building.  As he passed a balcony on the 38th floor he hollered, "so far, so good." 

People seem remarkably unaffected.  Like the fellow falling to earth, they seem willing to look up from where they came, rather than forward to what almost surely lies ahead.  Rationalization is the norm, as they expect old Success Formulas to work just fine.  They have become accustomed to big drops in the Dow, yet it has always found a way to come back - so that will happen this time, won't it?  Sure we have banks going broke, but in the 1980s we had a failure of the Savings & Loan industry and that didn't stop a rising market - did it?  We also had the failure of some big hedge funds that rocked Wall Street, but it only had a short-duration impact, right?  And when the Asian currencies all fell out of bed it scared a lot of people, but the markets recovered, so even though the American currency is at an all time low won't things get back to normal with currencies again this time?  Won't the market recover?  If you look backward, the Dow has always recovered.  So can't we just ignore this as a short-term problem? 

To succeed looking backward requires the future look like the past.  But things don't look like the past.  We've seen the failure of two very large brokerage institutions (Bear Sterns and Lehman Brothers) and the forced takeover of another (Merrill Lynch).  The underwriters of most of America's mortgages, Freddie Mac and Fannie Mae, have been taken over by the government to try and keep the real estate market from further collapse.  And the heads of America's government have already said the government cannot afford to take over many other institutions - if any - and that's why they decided to let Lehman Brothers file bankruptcy. 

General Motors (chart here), not long ago America's #1 employer, is worth about half what it was in January and trading at its lowest value in 50 years as it asks for a government bail-out to get through the next 2 years (read article here).  EDS was once the world's premier Information Technology company, and now it's a division of H-P after nearly failing. H-P (chart here) announced it will cut 24,600 IT jobs from EDS (read article here).  We know many of those jobs are going away, and the rest to India or another country we used to disparage as "third world" as if it was lesser than the USA.  But now these countries have become more competitive at everything from manufacturing to IT services. Even the small tool company known as "Vise-Grip" decided to move its plier manufacturing to China and close its plant in Nebraska (read article here.)

The world has changed.  Markets have shifted.  Banking is now international - not just national.  Manufacturing, and even keeping the internet viable, is now managed globally - with almost no organization remaining strictly a U.S. company.  The world is becoming Flat - to rip off the title of a popular book by Thomas Friedman (see book here). This isn't the world in 1978, or 1988 or 1998.  In 2008, the U.S. dollar is at record lows, employment gains over the last decade are at record lows, the transfer of wealth out of the USA to buy everything from oil to computers to children's toys is at record highs.  The U.S. deficit is at record highs, with no signal how it will be paid off coming from either political party.  War costs continue to escalate, driving up the deficit further, while tax receipts fall from a weakening economy.  Meanwhile the U.S. population is aging, and the federal pension program (social security) is without sufficient funds to maintain retirees. And corporate pension failures are at record highs.  As the costs of health care continue skyrocketing, the percentage of people who are insured, thus can afford health care, is at record lows - causing unfunded emergency room care costs to bring many hospitals in American cities to the brink of failure (read article here.)

Yet, a rash of pundits will tell you not to panic.  It's too late.  Better to do nothing; to wait. (read article here).  Perhaps, like the fellow who jumped and is now at the 25th floor, it is late to panic.  But by golly folks had better do something!  It's time to look forward, and see that an unpleasant future is coming at you pretty hard and fast.  It took more than a decade for the DJIA to recover from the collapse in 2009 - and over 25% of those who wanted to work could not find work.  That isn't the kind of future many folks want to look forward to.  If you depend on a 401K or your mutual fund nest egg to make your future mortgage payment - you better start thinking hard about whether you want to keep that in equities.  Coming out of the Great Depression Will Rogers said "it's more the return of my money than the return on my money I worry about."  How much of a hit are you, or your pension fund manager, going to take? 

The Phoenix Principle is all about understanding competition and being able to come out on top.  And the first step in survival is to have a clear view of likely future scenarios.  Not just the rosy ones that extend past success - but also those that portend a more difficult future.  Preparing for scenarios that could include changes which could wipe you out is one of the key characteristics of those who survive long term.  And a close second is being very aware, honest and clear about competitors.  We may wish them away, but what we know is that growing competitors get stronger and do better - and today those who live and work in other countries are showing the ability to out-compete the USA on many fronts (note my recent blog pointing out that China will overtake the USA as the #1 manufacturing country in 2009!)  Until you are able to be honest about future scenarios, and all the competitors who are reaching out for their own growth, you are not planning effectively for the future, and that puts you at great risk.

It would behoove readers to get very honest about what the future might be for the U.S. economy.  And to honestly understand what competitors are doing.  There are analysts who say the market could drop another 40% - or even more.  In Japan the Nikkei Index peaked in the early 1990s and has still never recovered to those highs. Japanese real estate values plummeted, and Japan has been in a near state of recession going on 2 decades.  The world has changed.  Globalization has happened.  Those who road the old Success Formulas too far, who Extended too far, are going out of business overnight (actually - over the weekends).  Just look at what's been wiped out in the last few months at the world's largest brokerages and banks.  It will take more than hard work and "belt tightening" for the DJIA to recover. 

Are you preparing - or are you saying "So Far, So Good."  It's easy to ignore a fact and hide inside an old Success Formula.  It's easy to accept existing Lock-ins and say "there's nothing I can do."  But that's what the folks in failed organizations all say they did.  They waited, and waited, and then it was over.  They didn't come out into the sunshine, but rather their organizations went away.  They smashed hard into the ground they did not prepare for.  It's time to start preparing.  Be honest about future scenarios, and honest about competitors.  Be coldly honest, without sentimentality for the past.  Then don't be fearful about taking action. It's sure that's how the competitors are behaving.

Toubled Leadership

Leaders of organizations, especially those with lots of employees and/or big revenues, have a leveraged impact when making decisions.  If a manager with 8 people in a group makes an error, it's felt by those 8, plus those all 9 work with.  If the CEO of a business with over $1B of revenue, or more than 1,000 employees makes a bad decision think about the leverage that creates. Lots of people suffer.  Not only the employees, but customers, investors and suppliers.

This is very apparent now at Tribune Company and especially the newspapers it controls - including the Los Angeles Times and the Chicago Tribune.  These aren't the only 2 businesses owned by Tribune Corp., but their success, or lack therof, has a serious impact on the 35-50 million people that are tightly connected to the markets where they report the news.  Yes, it is true that newspapers no longer have the power they once did.  But there's no doubt that lots of our news is still dependent upon writers and editors working at these two newspapers.  If we're to root out political corruption at the state or local level, or report on energy crises, or agricultural concerns we depend significantly on reporters at big city newspapers.  As reported in BusinessWeek recently (read article here), these newspapers are now at significant risk of failure due to the leadership of Sam Zell.

Back at the end of 2006 Tribune's equity value was down 65% from its high in 1999.  Revenues had been declining since 2004.  Cash flow was being propped up with draconian cuts across the organization.  Pink slips littered the hallways, and long-term employees were being handed early retirement plans.  It was clear that management was doing everything possible to dress up the corporation for a higher valuation to some potential suitor - which was proving hard to find.  Most people were very wary of the proposed pricing, recognizing that changing market dynamics in media were pushing advertising more toward the web, and coming right out of newspapers.  Meanwhile, in cable targeted channels were fragmenting the market leavng variety channels running reruns or second-rate programs (like CW) with precious few eyeballs and struggling ad revenues.  This was all bad news for Tribune Corporation.  Something needed to be done that would help Tribune find a new way to compete and grow against the ever-more-popular internet and ad-placement behemoth Google.

Enter Sam Zell, who had a Success Formula he was ready to apply.  Throughout his history he had bought beaten up real estate, borrowed a gob of money against it, done some fixing up, leased it out and then sold it for a big gain.  In real estate, this had always worked.  So he was ready to apply his Success Formula to newspapers.  He had no plans to change the operating Success Formula at Tribune Corporation, believing the revenue problems would self-correct.  He read 3 papers every day, so he figured people would be like him and return to reading newspapers soon enough.  And advertisers would follow.  He was going to own the Cubs and Wrigley field, but he didn't much like baseball, so to him this was just another asset to leverage and sell.  Same for those 25 second-tier television stations around the country.  He didn't intend to change the Tribune's operating Success Formula, just tweak it a bit.  And overlay his own Success Formula based on lots of debt, waiting for recovery, doing some simple sprucing, and being overbearing with employees.

Of course, as I predicted in my several blogs at the time, this was a recipe for disaster. The Tribune Corp needed a big dose of internal Disruption, and plenty of White Space to figure out where advertisers were going and how to appeal to them.   Tribune needed to move hard and fast to more web understanding, and dramatically rethink how to manage its independent television stations in a world where they were the weakest of weakening broadcast stations - as well as the most generic of cable stations.  Revenues were going to continue to decline - and facing a predictable economic weakening they would decline a lot and very fast.  The last thing Tribune Corporation needed was more debt.  It needed to conserve its assets to pay for a transformation of the company - after it could figure out what that transformation needed to be!

After adding an additional $8billion debt, growing it to $13.5billion,, and investing only $350million of his money, Sam Zell set off on a path of value destruction.  And who holds the bag?  The bondholders of course.  Someone once told me that debt was not supposed to carry risk - that's what equity was for.  But Zell convinced investment bankers to sell his extremely risky bonds to various holders (mostly pension funds) so he could finance an overpriced deal.  Now those bondholders have seen as much as a 65% reduction in the value of their investments.  Were the pensioners to know they wold be so glad!  Mr. Zell's Success Formula, so tied to real estate during boom times, was the worst thing that could be applied to the struggling newspapers at Tribune.  But he was able to apply it using other people's money - so he has little to lose and much to gain while the bondholders have much to lose and almost nothing to gain.

Meanwhile, employees across Tribune are falling like flies exposed to DDT.  And the news products in L.A. and Chicago are getting weaker with each passing month as journalists aren't there to write.  The people of these great cities are simply left knowing less about what's happening in their metropolises.  Everyone in both cities is getting a cold slap from this folly.

Mr. Zell keeps saying he'll do whatever he has to do to make money with Tribune Corporation.  But that's not true.  What he means is he'll do whatever his old Success Formula recommends he do.  So now, as his own newspaper boss says, they are chewing off a leg to try and get out of the falling revenue trap.  This is not an approach that will make for a strong Tribune Corporation.  It is a path toward a corporation with no resources, weak products and customers left without a solution.  What Tribune needs is White Space to figure out how to compete as a 21st century media company.  But instead all energy is being diverted toward paying off the bonds Mr. Zell sold to fund his all-too-risky bet on debt.

We all have a responsibility to understand our Success Formulas.  And to understand those of the people who would lead our organization.  If we see that Success Formula Locked-in, we can bet on more of the same - regardless of the outcome.  Mr. Zell would rather fail as a cost-cutter than lead Tribune Corporation to its next legacy of success.  But unfortunately, it is all the people dependent on Mr. Zell who will suffer most - the vendors, customers, investors and employees.  They will suffer from his outdated Success Formula even more than he will - as he jets each weekend to between his home in Malibu and his home in Chicago.  Leaders have the greatest responsibility to recognize their Success Formula Lock-ins, and be open to Disrupt and use White Space to find solutions which can succeed.  Because when they fail, everyone around them fails as well.

Merger Mistakes

CEOs and investment bankers love to talk about, and do, mergers.  So do journalists.  A big combination of two companies gets people all excited.  There is always a lot of talk about how "synergy" will allow the two companies to be worth more combined than they were worth independently.  Yet, there are no academic studies that prove this point.  Quite to the contrary, academicians will tell you over and over that the synergies don't appear, and the combined companies are worth less than they were worth independently.  Usually quite quickly.  So, if CEOs like to make these deals - why don't they work?  Why does Mercedez Benz buy Chrysler, only to see the value plummet and eventually sell the company off to a private equity firm?

Let's take a look at AOL/Time Warner (see chart here).  In the 1990s these two companies were leaders in their markets.  AOL had pioneered internet access to the home, and was clearly #1.  Time Warner had become the dominant player in cable television, also #1.  Both were growing at double digit rates.  To the CEOs, investment bankers, and most onlookers putting these two entities together brought together the best of both markets - creating a no-lose media company destined to be pre-eminent in the next decade.  But the cost of the merger ended up far outweighing any benefits.  The value of the combined company plummeted.  Worth almost $100/share in 2000, today the equity trades for about $15/share (an 85% value decline.)  Billions of dollars in investor equity was wiped out.  And today as AOL tries to revive itself as an internet player it is derisively referred to as "AO Hell" or "Albatross OnLine" (read about AOLs newest move here.)  Why didn't the great media company that was predicted develop?

All businesses have Success Formulas.  Whether profitable or not, whether growing or not, all businesses have Success Formulas.  These Success Formulas are a nested, tighly integrated combination of the business's very Identity, it's Strategy for growth and the Tactics which support the Identity and the Strategy.  All behaviors, internal sacred cows, hierarchy and organization, decision making systems, IT system, hiring procedures, asset utilization programs, metrics and costs are organized to support that Success Formula.  The business isn't an ideological being as often described by executives or journalists - it is a very tightly-knitted Success Formula operated day in and day out, every day, in pursuit of doing those things that made the business grow.

In a merger, the two business Success Formulas collide.  As sensible as a combination may be, as powerfullly as they share customers, as efficiently as they may use the same infrastructure, as aligned as their strategies appear, they have two different Success Formulas.  And when it comes time to merge - neither simply disappears.  Suddenly, to achieve the great projected value, it is expected that some kind of new Success Formula will appear that achieves the lofty future goals.  But how will that happen?  These Success Formulas grew out of years of development during the businesses' growth.  This sudden combination is no substitute for the evolutionary development of a Success Formula.  At the time of merger, regardless of the size or success of either business, they two suddently confront themselves as two gladiators in the colliseum.  Which will reign? 

And that is when things go wrong.  The only way the desired value can be achieved is if a new entity is created that actually develops an entirely new, third Success Formula.  But given the high stakes, who wants to take the time to develop this?  Who believes they can afford to define a new Identity, to craft a new Strategy out of market success, and to build a whole new set of Tactics that support the new Strategy?  Who will set up White Space to start bringing together pieces, testing the development of anything new and putting plans against the rigor of market acceptance?  The CEO and investors want results - and now!!!  So what happens? Inevitably, one of the Success Formulas gets picked as the winner (usually by the new CEO), and that one sets about to convert the other entity into the "designated winning" Success Formula.  At this point, many of the value creators of the losing Success Formula disappear.  People leave.  Products are dropped.  Customers, or whole markes, are dropped.  Manufacturing and service systems are eliminated.  Very rapidly, the exercise becomes a cost-cutting frenzy as two of everything is converted to one.  And the "winner" becomes a subset of what the two starters brought to the merger.

At AOL, Time Warner bought AOL.  The Time Warner guys remained in charge.  Pretty quickly, they set about converting AOL into a Time Warner Success Formula.  And in the fast-changing internet world, AOL quickly started losing value.  Time Warner froze AOL into place as a dial-up service with specific extras.  They flooded mailboxes with CDs begging people to sign up for a free 3 month service.  But as bandwidth expanded, and Comcast along with the phone companies installed broadband to more and more homes and businesses, the value simply evaporated out of AOL.  Time Warner remained Time Warner, but AOL soon became an out-of-date internet dinosaur. 

Creating value via merger is a very tough thing.  One company, ITW, does it very well (see chart here).  But ITW doesn't try to put its acquisitions onto common systems, or bring them into one operating unit.  ITW is quite unique in allowing its acquisitions to create value out of their markets as they see fit.  Most CEOs can't stand this sort of independence, and they move quickly to convert the merged company into the Success Formula of the acquirer.  And within months, much of the value originally sought is gone.  Just like at Time Warner and AOL.

Would you do it, if you had the chance?

Google (see chart here) is 10 years old.  That's right, it was just 1998 that $100,000 was invested to start up Google (read article here).  Today the company is worth almost $150billion, and its two 35 year old founders have stakes valued at approximately $19billion each. 

Now that Google is so successful, it's easy to say "of course."  But think about it.  In 1998 the leaders in internet search were Microsoft, Lycos and Yahoo!  At that time would you have taken the bet that this start-up company would succeed against the much larger and enormously better financed competitors?  What's more, would you have bet that the start-up could build a fortune by placing ads on the internet? 

Now let's put the shoe on the other foot.  Imagine you were offered a job in 1998 to work at Google.  Would you have been able to project the company could be a $10billion revenue company in 10  years?  Would you have been able to look into the future, analyze weaknesses in competitors, and say "this could be the most influential company in technology in 10 years?"  Or, would you have been more likely to say "given our humble beginnings, if we can achieve $10million revenue in 5 years we will be extremely successful.  After that, if we can grow at 12% per year we will exceed industry average growth and be very pleased"?

There's an old saying, "it's not where you start the race, it's where you finish that counts."  Most of us are leary of looking into the future, seeking out competitive weakness and undertaking Disruption to do new things. We are more comfortable doing what we've done in the past, setting low expectations we can likely meet and doing all planning based upon our past history.  And that approach means that even if you have all the technology, skill, market opportunity and resources of Google you still won't be Google - because you'll never achieve that success.  You'll be bounded by your past Success Formula to do no better than you did in the past, and therefore the opportunity will go to someone else.

Now Google is not only selling internet ads, it's selling TV ads to NBC, CNBC, MSNBC, Oxygen and Dish network (read article here.)  Last week Google launched a new internet browser (Chrome) in direct competition with Firefox and Internet Explorer.  Just 10 years old, Google isn't just a search engine company, it's in several businesses with White Space flourishing in several markets.  But this is only possible because

1. Google is totally focused on the future.  It doesn't plan from the past.  It isn't focused on its "core" markets, or how to maintain its share in historical businesses.  Google plans for a future using scenarios about what is likely to happen - and what "can be."
2. Google is obsessed about competitors.  It doesn't just look to defend its old business, but rather stuides all competitors to see what opportunities are created.  It doesn't hesitate to buy companies like DoubleClick and YouTube.  And it doesn't hesitate to take on Locked-in competitors like Microsoft.
3. Google is ready to Disrupt itself, and the markets it enters.  Google embraces Disruption, rather than avoiding it.  Rather than "stick to its knitting" in search it jumps into markets like browsers where it can be Disruptive.
4. Google is loaded with White Space.  That White Space allows Google to constantly develop new Success Formulas that grow the company at a stratospheric rate.

Every executive in every company has the opportunity to run a Google.  The trick is to get out of Lock-in.  To move from thinking that the future has to be about old markets, old ways of competing, and about doing more of the same but faster, better and cheaper.  To be a Google means getting the business into the Rapids of growth, wherever those Rapids may be.  Creating a Google means shedding old notions about "core focus" and using future scenarios to lead you into high growth opportunities - the willingness to Disrupt old patterns to consider new things - and keeping White Space very active to grow into new markets.

After all, that's what the leaders did at Virgin and Nike - a couple of other companies that have grown beyond everyone's expectation.  So, would you do it if you had the chance?  Or would you remain Locked-in to Defending & Extending your past even if it means results are suboptimal?