Buy Facebook, P&G's CEO told you to

Buy Facebook.  I don't care what the IPO price is.

Since Facebook informed us it was going public, and it's estimated IPO valuation was reported, debate has raged over whether the company could possibly be worth $75-$100B.  Almost nobody writes that Facebook is undervalued, but many question whether it is overvalued. 

If you are a trader, moving in and out of positions monthly and using options to leverage short-term price swings then this article is not for you.  But, if you are an investor, someone who holds most stock purchases for a year or longer, then Facebook's IPO may be undervalued.  The longer you can hold it, the more you'll likely make.  Buy it in your IRA if possible, then let it build you a nice nest egg.

About 85% of Facebook's nearly $4B revenues, which almost doubled in 2011, are from advertising.  So understanding advertising is critical to knowing why you want to buy, and hold, Facebook. 

Facebook has 28% of the on-line display ad market, but only 5% of all on-line advertising.  On-line advertising itself is generally predicted to grow at 16%/year.  But there is a tremendous case to be made that the market will grow a whole lot faster, and Facebook's share will become a whole lot larger.

At the end of January Proctor & Gamble's stock took a hit as earnings missed expectations, and the CEO projected a tough year going forward.  He announced 1,600 layoffs, many in marketing, as he admitted the ad budget was going to be "moderated" - code for cut.  While advertising had grown at 24%/year sales were only growing at 6%.  He then admitted that the "efficiency" of on-line advertising was demonstrating the ability to be much higher than traditional advertising.  In other words, he is planning to cut traditional marketing and advertising, such as coupon printing and ads in newspapers and television, and spend more on-line.

P&G spends about $10B/year on advertising.  2.5x the Facebook revenue.  Now, imagine if P&G moves 10% - or 25% - of its advertising from television (which is now a $250B market) on-line.  That is $1-$2.5B per year, from just one company!  Such a "marginal" move, by just one company, adds 1-3% to the total on-line market.  Now, magnify that across Unilever, Danon, Kimberly-Clark, Colgate, Avon, Coke, Pepsi ...... the 200 or 300 largest advertisers and it becomes a REALLY BIG number.

The trend is clear.  People spend less time watching TV and reading newspapers.  We all interact with information and entertainment more and more on computers and mobile devices.  Ad declines have already killed newspapers, and television is on the precipice of following its print brethren.  The market shift toward advertising on-line will continue, and the trend is bound to accelerate. 

Last year P&G launched an on-line marketing program for Old Spice.  The CEO singled out the 1.8 billion free impressions that received on-line.  When the CEO of one of the world's largest advertisers takes note, and says he's going to move that way, you can bet everyone is going to head that direction.  Especially as they recognize the poor "efficiency" of traditional media spending.

And don't forget the thousands of small businesses that have much smaller budgets.  Most of them rarely, or never, could afford traditional media.  On-line is not only more effective, but far cheaper.  Especially as mobile devices makes local marketing even more targeted and effective.  So as big companies shift to on-line we can expect small to medium sized businesses to shift as well, and new advertisers are being created which will expand the market even further.  This trend could lead to a much faster organic market growth rate beyond 16% - perhaps 25% or even more!

Which brings us back to Facebook, which will be the primary beneficiary of this market shift. 

Facebook is rapidly catching up with Google in the referral business.  850 million users is important, because it shows the ability Facebook has to bring people on-line, keep them on-line and then refer them somewhere.  The kind of thing that made Google famous, big and valuable with search a decade ago.  In fact, people spend much more time on Facebook than they do Google.  When advertisers want to reach their audience they go where the people are (and are being referred) and that is Facebook.  Nobody else is even close. 

The good thing about having a big user base, and one that shares information, is the ability to gather data.  Just like Google kept all those billions of searches to analyze and share data, increasingly Facebook is able to do the same.  Facebook will be able to tell advertisers how people interact, how they move between pages, what keeps them on a page and what leads to buying behavior.  Facebook uses this data to help users be more effective, just like Google does to help us do great searches.  But in the future Facebook can package and sell this data to advertisers, helping  them be more effective, and they can use it for selling, and placing, ads.

Facebook usage is dominant in social media, but becoming more dominant in all internet use.  Like how Windows became the dominant platform for PC users, Facebook is well on its way to being the platform for how we use the web.  Email will be less necessary as we communicate across Facebook with those we really want to know.  Information on topics of interest will stream to us through Facebook because we select them, or our friends refer them.  Solving problems will use referrals more, and searching less.  The platform will help us be much more efficient at using the internet, and that reinforces more usage and more users.  All the while attracting more advertisers.

The big losers will be traditional media.  We may watch sports live, but increasingly we'll be unwilling to watch streaming TV as the networks trained boomers.  Companies like NBC will suffer just as newspaper giants such as Tribune Corp., New York Times and Dow Jones.  Ad agencies will have a very tough time, as ad budgets drop their placement fees will decline concomittantly.  Lavish spending on big budget ads will also decline. 

Anyone in on-line advertising is likely to be a winner initially.  Linked-in, Twitter, Pinterest and Google will all benefit from the market shift.  But the biggest winner of all will be Facebook.

What if the on-line ad market grows 25%/year (think not possible? look at how fast the smartphone and tablet markets have grown while PC sales have stagnated last 2 years as that market shifted.  And don't forget that incremental amount could easily happen just by the top 50 CPG companies moving 10% of their budget!)?   That adds $20-$25B incrementally.  If Facebook's share shifts from 5% to 10% that would add $2-2.5B to Facebook first year; more than 50%! 

Blow those numbers up just a bit more.  Say double on-line advertising and give Facebook 20% share as people drop email and traditional search for Facebook - plus mobile device use continues escalating.  Facebook revenues could double up, or more, for several years as trends obsolete newspapers, magazines, televisions, radios, PCs and traditional thoughts about advertising.

If you missed out on AT&T in the 1950s, IBM in the 1960s, Microsoft in 1980, or Apple in 2000, don't miss this one.  Forget about all those spreadsheets and short-term analyst forecasts and buy the trend.  Buy Facebook.

Wal-Mart's "Shoot Yourself in the Head" Strategy

For the last decade, Wal-Mart has been "dead money" in investor parlance.  After a big jump between 1995 and 2000, the stock today is still worth less than it was in 2000.  There has been volatility, which might have benefited some traders.  But for most of the decade Wal-Mart's price has been lower.  There has been excitement because recently the price has been catching up with where it was in 2002, even though there have been no real gains for long term investors.

Source: YahooFinance 1/30/12

What happened to Wal-Mart was the market shifted.  For many years being the market leader with every day low pricing was a winning strategy.  Wal-Mart was able to expand from town to town opening new stores, all pretty much alike, doing the same thing and making really good money.

Then competitors took aim at Wal-Mart, and found out they could beat the giant.

Eventually the number of towns that both needed, and justified, a new Wal-Mart (or Sam's Club) dried up.  Wal-Mart reacted by expanding many stores, making them "bigger and better," even adding groceries to some.  But that added only marginally to revenue, and even less marginally to profits. 

And Wal-Mart tried exporting its stores internationally, but that flopped as local market competitors found ways to better attract local customers than Wal-Mart's success formula offered.

Other U.S. discounters, like Target and Kohl's, offered nicer stores with more varieties or classier merchandise - and often their pricing was not much higher, or even the same.  And a new category of retailer, called "dollar stores" emerged that beat Wal-Mart's price on almost everything for the true price shopper.  These 99 cent stores became really popular, and the fastest growing traditional retail concept in America. Simultaneously, big box retailers like Best Buy expanded their merchandise and footprint into more locations, dramatically increasing the competition against local Wal-Mart's stores. 

But, even more dramatically, the whole retail market began shifting on-line. 

Amazon, and its brethren, kept selling more and more products.  And at prices even lower than Wal-Mart.  And again, for price shoppers, the growth of eBay, Craigslist and vertical market sites made it possible for shoppers to find slightly used, or even new, products at prices lower than Wal-Mart, and shipped right into the customer's home.  With each year, people found less need to buy at Wal-Mart as the on-line options exploded.

More recently, traditional price-focused retailers have been attacked by mobile devices.  Firstly, there's the new Kindle Fire.  In just one quarter it has gone from nowhere to tied as the #1 Android tablet

Source: BusinessInsider.com

The Kindle Fire is squarely targeted at growing retail sales for Amazon, making it easier than ever for customers to ignore the brick-and-mortar store in favor of on-line retailers. 

On top of this, according to Pew Research 52% of in-store shoppers now use a mobile device to check price and availability on-line of products as they look in the store.  Thus a customer can look at products in Wal-Mart, and while standing in the aisle look for that same product, or comparable, in another store on-line.  They can decide they like the work boots at Wal-Mart, and even try them on for size. Then they can order from Zappos or another on-line retailer to have those boots shipped to their home at an even lower price, or better warranty, even before leaving the Wal-Mart store.

It's no wonder then that Wal-Mart has struggled to grow its revenues.  Wal-Mart has been a victim of intense competition that found ways to attack its success formula effectively. 

Then Wal-Mart implemented its "Shoot Yourself in the Head" strategy

What did Wal-Mart recently do?  According to Reuters Wal-Mart decided to transfer its entire marketing department to work for merchandising.  Marketing was moved from reporting to the CEO, to reporting into Sales.  The objective was to put all the energy of marketing into trying to further defend the Wal-Mart business, and drive up same-store sales.  In other words, to make sure marketing was fully focused on better executing the old, struggling success formula.

The marketing department at Wal-Mart does all the market research on customers, trends and advertising - traditional and on-line.  Marketing is the organization charged with looking outside, learning and adapting the organization to any market shifts. In this role marketing is expected to identify new competitors, new market solutions that are working better, and adapt the organization to shifting market needs.  It is responsible to be the eyes and ears of the organization, and then think up new solutions addressing these external inputs.  That's why it needs to report to the CEO, so it can drive toward new solutions that can revitalize the organization and keep it growing with new market trends.

But now, it's been shot.  Reporting to sales, marketing's role directed at driving same store sales is purely limiting the function to defending and extending the success formula that has produced lackluster results for 12 years.  Marketing is no longer in a position to adapt Wal-Mart.  Instead, it is tasked to find ways to do more, better, faster, cheaper under the leadership of the sales organization.

When faced with market shifts, winning companies adapt.  Look at how skillfully Amazon has moved from book seller to general merchandise seller to offering a consumer electronic device. 

Unfortunately, too many businesses react to market shifts like Wal-Mart.  They hunker down, do more of the same and re-organize to "increase focus" on the traditional business as results suffer.  Instead of adapting the company hopes more focus on execution will somehow improve results.

Not likely.  Expect results to go the other direction.  There might be a short-term improvement from the massive influx of resource, but long term the trends are taking customers to new solutions.  Regardless of the industry leader's size.  Don't expect Wal-Mart to be a long-term winner.  Better to invest in competitors taking advantage of trends.

 

 

Who's CEO of the Year? Bezo's (Amazon) or Page (Google)?

Turning over a new year inevitably leads to selections for "CEO of the Year."  Investor Business Daily selected Larry Page of Google 3 weeks ago, and last week Marketwatch.com selected Jeff Bezos of Amazon.  Comparing the two is worthwhile, because there is almost nothing similar about what the two have done - and one is almost sure to dramatically outperform the other.

Focusing on the Future

What both share is a willingness to focus their companies on the future.  Both have introduced major new products, targeted at developing new markets and entirely new revenue streams for their companies.  Both have significantly sacrificed short-term profits seeking long-term strategic positioning for sustainable, higher future returns.  Both have, and continue to, spend vast sums of money in search of competitive advantage for their organizations.

And both have seen their stock value clobbered.  In 2011 Amazon rose from $150/share low to almost $250 before collapsing at year's end to about $175 - actually lower than it started the calendar year.  Google's stock dropped from $625/share to below $475 before recovering all the way to $670 - only to crater all the way to $585 last week.  Clearly the analysts awarding these CEOs were looking way beyond short-term investor returns when making their selections.  So it is more important than ever we understand what both have done, and are planning to do in the future, if we are to support either, or both, as award winners.  Or buy their stock.

Google participates in great growth markets

The good news for Google is its participation in high growth markets.  Search ads continue growing, supplying the bulk of revenues and profits for the company.  Its Android product gives Google great position in mobile devices, and supporting Chrome applications help clients move from traditional architectures and applications to cloud-based solutions at lower cost and frequently higher user satisfaction.  Additionally, Google is growing internet display ad sales, a fast growing market, by increasing participation in social networks. 

Because Google is in high growth markets, its revenues keep growing healthily.  But CEO Page's "focus" leadership has led to the killing of several products, retrenching from several markets, and remarkably huge bets in 2 markets where Google's revenues and profits lag dramatically - mobile devices and search.

Because Android produces no revenue Google bought near-bankrupt Motorola to enter the hardware and applications business becoming similar to Apple - a big bet using some old technology against what is the #1 technology company on the planet.  Whether this will be a market share winner for Google, and whether it will make or lose money, is far from certain. 

Simultaneously, the Google+ launch is an attempt to take on the King Kong of social - Facebook - which has 800million users and remarkable success.  The Google+ effort has been (and will continue to be) very expensive and far from convincing.  Its product efforts have even angered some people as Google tried steering social networkers rather heavy-handidly toward Google products - as it did with "Search plus Your World" recently.

Mr. Page has positioned Google as a gladiator in some serious "battles to the death" that are investment intensive.  Google must keep fighting the wounded, hurting and desperate Microsoft in search against Bing+Yahoo.  While Google is the clear winner, desperate but well funded competitors are known to behave suicidally, and Google will find the competition intensive.  Meanwhile, its offerings in mobile and social are not unique.  Google is going toe-to-toe with Apple and Facebook with products which show no great superiority.  And the market leaders are wildly profitable while continuously introducing new innovations.  It will be tough fighting in these markets, consuming lots of resources. 

Entering 3 gladiator battles simultaneously is ambitious, to say the least.  Whether Google can afford the cost, and can win, is debatable.  As a result it only takes a small miss, comparing actual results to analyst expectations, for investors to run - as they did last week.

 Amazon redefines competition in its markets

CEO Bezos' leadership at Amazon is very different.  Rather than gladiator wars, Amazon brings out products that are very different and avoids head-to-head competition.  Amazon expands new markets by meeting under- or unserved needs with products that change the way customers behave - and keeps competitors from attacking Amazon head-on:

• Amazon moved from simply selling books to selling a vast array of products on the web.  It changed retail buying not by competing directly with traditional retailers, but by offering better (and different) on-line solutions which traditional retailers ignored or adopted far too slowly.  Amazon was very early to offer web solutions for independent retailers to use the Amazon site, and was very early to offer a mobile interface making shopping from smartphones fast and easy.  Because it wasn't trying to defend and extend a traditional brick-and-mortar retail model, like Wal-Mart, Amazon has redefined retail and dramatically expanded shopping on-line.
• Amazon changed the book market with Kindle.  It utilized new technology to do what publishers, locked into traditional mindsets (and business models) would not do.  As the print market struggled, Amazon moved fast to take the lead in digital publishing and media sales, something nobody else was doing, producing fast revenue growth with higher margins.
• When retailers were loath to adopt tablets as a primary interface for shoppers, Amazon brought out Kindle Fire.  Cleverly the Kindle Fire is not directly positioned against the king of all tablets - iPad - but rather as a product that does less, but does things like published media and retail very well -- and at a significantly lower price.  It brings the new user on-line fast, if they've been an Amazon customer, and makes life simple and easy for them.  Perhaps even easier than the famously easy Apple products.

In all markets Amazon moves early and deftly to fulfill unmet needs at a very good price.  And then it captures more and more customers as the solution becomes more powerful.  Amazon finds ways to compete with giants, but not head-on, and thus rapidly grow revenues and market position while positioning itself as the long term winner.  Amazon has destroyed all the big booksellers - with the exception of Barnes & Noble which doesn't look too great - and one can only wonder what its impact in 5 years will be on traditional retailers like Kohl's, Penney's and even Wal-Mart.  Amazon doesn't have to "win" a battle with Apple's iPad to have a wildly successful, and profitable, Kindle offering.

The successful CEO's role is different than many expect

A recent RHR International poll of 83 mid-tier company CEOs (reported at Business Insider) discovered that while most felt prepared for the job, most simultaneously discovered the requirements were not what they expected.  In the past we used to think of a CEO as a steward, someone to be very careful with investor money.  And someone expected to know the business' core strengths, then be very selective to constantly reinforce those strengths without venturing into unknown businesses.

But today markets shift quickly.  Technology and global competition means all businesses are subject to market changes, with big moves in pricing, costs and customer expectations, very fast.  Caretaker CEOs are being crushed - look at Kodak, Hostess and Sears.  Successful CEOs have to guide their businesses away from investing in money-losing businesses, even if they are part of the company's history, and toward rapidly growing opportunities created by being part of the shift.  Disruptors are now leading the success curve, while followers are often sucking up a lot of profit-killing dust.

Amazon bears similarities to the Apple of a decade ago.  Introducing new products that are very different, and changing markets.  It is competing against traditional giants, but with very untraditional solutions.  It finds unmet needs, and fills them in unique ways to capture new customers - and creates market shifts.

Google, on the other hand, looks a lot like the lumbering Microsoft.  It has a near monopoly in a growing market, but its investments in new markets come late, and don't offer a lot of innovation.  Google's products end up competing directly, somewhat like xBox did with other game consoles, in very, very expensive - usually money-losing - competition that can go on for years. Google looks like a company trying to use money rather than innovation to topple an existing market leader, and killing a lot of good product ideas to keep pouring money into markets where it is late and not terribly creative.

Which CEO do you think will be the winner in 2015?  Into which company are you prepared to invest?  Both are in high growth markets, but they are being led very, very differently.  And their strategies could not be more different.  Which one you choose to own - as a product customer or investor - will have significant consequences for you (and them) in 3 years. 

It's worth taking the time to decide which you think is the right leadership today.  And be sure you know what leadership principles you are adopting, and following in your organization.

Creative Destruction is not inevitable - Kodak, Hostess, Microsoft

A lot of excitement was generated this week when Mitt Romney said the words "I like to fire people."  I'm sure he wishes he could rephrase his comment, as he easily could have made his point about changing service providers without those words.  Nonetheless, the aftermath turned to a discussion of job losses, and why Bain Capital has eliminated jobs while simultaneously creating some. 

Surprisingly, a number of economists suddenly started saying that firms like Bain Capital are justified in their job eliminations because they are merely implementing "creative destruction."  Although the leap is not obvious, the argument goes that some businesses are made inefficient and unprofitable by new technologies or business processes - so buyers (like Bain Capital) of hurting businesses often cannot "fix" the situation and have no choice but to close them.  Bain Capital inevitably will be stuck with losers it has no choice but to shutter - eliminating the jobs with the company.

Unfortunately, that argument is simply not true. The only thing that allows "creative destruction" to kill a company is a lack of good leadership.  Any company can find a growth path if its leaders are willing to learn from trends and steer in the growing direction.

Start by looking at recent events surrounding Kodak and Hostess, both quickly heading for Chapter 11.  Neither needed to fail. Management made the decisions which steered them into the whirlpool of failure. 

Kodak watched the market for amateur photography shrink for 30 years - drying up profits for film and paper.  Yet, management consistently - quarter after quarter and year after year - made the decision to try defending and extending the historical market rather than move the company into faster growing, more profitable opportunities.  Kodak even invented much of the technology for digital photography, but chose to license it to others rather than develop the market because Kodak feared cannibalizing existing sales - as they became increasingly at risk! 

Hostess is making a return trip to Chapter 11 this decade.  But it's not like the trend away from highly processed, shelf stable white bread and sugary pastry snacks is anything new.  While 1960s parents and youth might have enjoyed the vitamin enriched Wonder Bread "helping grow bodies 12 ways" the trend toward fresher, and healthier, staples has been happening for 40 years.  In the 1980s when the company was known as Continental Baking profits were problematic, and it was clear that to keep what was then the nation's largest truck fleet profitable required new products as consumers were shifting to fresher "bake off" goods in the grocery store as well as brands promising more fiber and taste.  But despite these obvious trends, leadership continued trying to defend and extend the business rather than shift it.

These stories weren't "creative destruction."  They were simply bad leadership.  Decisions were made to do more of the same, when clearly something desperately different was needed! At the Harvard Business School Working Knowledge web site famed strategiest Michael Porter states "the granddaddy of all mistakes is competing to be the best, going down the same path as everybody else and thinking that somehow you can achieve better results."  Failure happened because the leaders were so internally focused they chose to ignore external inputs, trends, which would have driven better decisions!

In the 1980s Singer realized that the sewing machine market was destined to decline as women left homemaking for paying jobs, and as textile industry advances made purchased clothing cheaper than self-made.  Over a few years the company transitioned out of the traditional, but dying, business and became a very successful defense industry contractor!  Rather than letting itself be "creatively destroyed" Singer identified the market trends and moved from decline to growth!

Similarly, IBM almost failed as the computer market shifted from mainframes to PCs, but before all was lost (including jobs as well as investor value) leaders changed company focus from hardware to services and vertical market solutions allowing IBM to grow and thrive. 

The failure of Digital Equipment (DEC) at the same time was not "creative destruction" but company leadership unwillingness to shift from declining mini-computer and high priced workstation sales into new businesses.

More recently, over the last decade a nearly dead Apple resurrected itself by tying into the large trend for mobility, rather than focusing on its niche Mac product sales.  Company leaders took the company into consumer electronics (ipod, ipod touch,) tablet computing and cloud-based solutions (iPad) and mobile telephony with digital apps (iPhone.)  Apple had no legacy in any of these markets, but by linking to trends rather than fixating on past businesses "creative destruction" was avoided.

There are many businesses today that are in trouble because leaders simply won't pay attention to trends.  Avon, Sears and Barnes & Noble are three companies with limited futures simply because leaders seem unable to pull their heads out of the internal strategic planning sand and look at environmental trends in order to shift.

My favorite target is, of course, Microsoft.  Nobody thinks we will be carrying laptop PCs around in 5 years.  Yet, Microsoft has been unable to recognize the trend away from PCs and do anything effective.  Its efforts in music (Zune) and mobile handsets have been indifferent, insufficiently supported and mostly dropped.  Mr. Ballmer continues to speak about a long future for PC sales even as Q4 volume dropped 1.4% according to IDC and Gartner.  Even though everyone knows this trend is due to limited PC innovation and rapidly accelerating mobile-based solutions, Microsoft blamed the problem on, of all things, floods in Thailand that restricted manufacturing output.  Really.

We'll learn soon enough just how many jobs Bain Capital created, and killed.  But those lost were not due to "creative destruction."  They were due to leadership decisions to discontinue the business rather than invest in trends and transitioning to new markets.  Creative destruction is an easy excuse to avoid blaming leaders for failures caused by their unwillingness to recognize trends and take actions to invest in them which will create winning businesses.

What's wrong at the U.S. Postal Service - Market Shift

There are few organizations as efficient as the U.S. Postal Service.  Really. But it is still going out of business.

Think about the Post Office's value proposition.  They send someone to almost every single home and business in the entire United States 6 days/week on the hope that there will be a demand for their service - sold at a starting price of 44 cents!  For that mere $.44 they will deliver your hand crafted, signed message anywhere else in the entire United States!  And, if you want it delivered fairly close they will actually deliver your physical document the very next day!  All for 44 cents! And, if you are a large volume customer rates can be even cheaper. 

And the Post Office has been a remarkably operationally innovative organizations. Literally billions of items are processed every week (about 700million/day;) picked up, sorted and distributed across one of the physically largest countries in the world.  The distance from Anchorage to Miami (let's ignore Hawaii for now) is a staggering 5,100 miles, which works out to a miniscule .009 cent/mile for a first class letter! Compare that to the Pony Express cost (in 1860 $10/oz and 10 days Missouri to California,) and adjusted for inflation you'll be hard pressed to find any business that has continually improved its service, at ever lower (constantly declining when adjusted for inflation) prices.

And while AMR is filing bankruptcy largely to force a new union contract, the Post Office has accomplished its record improvements wtih an almost entirely union workforce. 

Executive compensation is surprisingly low.  The CEO makes about $800,000/year. Competitor CEOs make much more.  At Fedex (the Post Office delivers more items every day that Fedex does in a whole  year) the CEO made over $7,400,000, and at UPS (the Post Office delivers more items each week than UPS does annually) the CEO made $9,500,000.  So, despite this remarkable effectiveness, the CEO makes only about 1/10th CEOs of much smaller organizations.

The Post Office understands what it must do, and does it extremely efficiently.  It knows its "hedgehog concept" and relentlessly pursues it to unparalleled performance. Yet, it is barred from raising prices, is losing money, and is now planning to close 3,700 locations and dramatically curtail services - such as overnight and Saturday delivery in a radical cost reduction effort. 

Simply put, the U.S. Postal Service is becoming irrelevant.  In the 1980s faxing was the first attack on the mail, but the big market shift began 15 years ago with the advent of email.   Now with mobile devices, texting and social media the shift away from physical letters is  accelerating.  Fewer people write letters, send bills or even pay bills via physical mail.  Are you mailing any physical holiday cards this year?  How many? 

Even the veritable "junk mail" is far less viable these days.  Coupons are used less and less - and to the extent they are used they have to be much more immediate and compelling - such as offerings from GroupOn and FourSquare et.al. which arrive at consumers by email and social media usually through a smartphone or tablet mobile device.

The Post Office didn't really do anything wrong.  The market shifted.  The Post Office value proposition simply isn't as valuable.  We don't really care if the mail delivery comes daily, in fact many people forget to check their mailbox for several consecutive day.  We don't much care that a physical letter can transit the continent overnight, because we usually want to communicate immediately.  And we don't need a physical legacy for 99.99% of our communications.

The Post Office is really good at what it does, we just don't need it.  Not any more than we need a good horse shoe or small offset printing press.

The Post Office saw this coming.  Over a decade ago the Post Office asked if it could enter new businesses in record retention (medical, income, taxation), automated bill payment, social security check administration and a raft of other opportunities that would provide government delivery and storage services to various agencies and to under-served users such as low-income and the elderly.  But its mandate did not include these services, and expansion into new markets required a change in charter which was not approved by Congress.  Thus, USPS was stuck doing what it has always done, as market shift pushed the Post Office increasingly into irrelevancy.

And that's what happens to most failed businesses.  They don't fail because they are lousy at execution.  Or because of lousy, inattentive managers.  Or even because of unions and high variable costs such as energy.  They fall into trouble because they either don't recognize, or for some other reason don't move to take advantage of market shifts.  It's not a lack of focus, management laziness or worker intransigence that kills the business.  It's an inability to do what customers really want and value, and spending too much time and money trying to ever optimize something customers increasingly don't care about.

To their credit, both FedEx and UPS have shifted their businesses along with the market.  Both do much, much more than deliver packages.  Fedex bought Kinko's and offers people their "office away from the office" globally, as well as multiple small business solutions.  UPS offers a vast array of corporate transportation and logistics services, including e-commerce solutions for businesses of all sizes.  Their ability to move with markets, and meet emerging needs has helped both companies justify higher prices and earn substantially better profitability.

The U.S. Post Office is the poster child for what goes wrong when all a company does is focus on efficiency.  More, better, faster, cheaper is NOT enough to compete.  Being operationally efficient, even low-cost, is not enough to succeed in fast shifting markets where customers have ever-growing and changing needs.  Leadership has to be able to recognize market shifts early, and invest in new growth opportunities allowing the company to remain viable in changing markets.

My generation will wax nostalgic about the post office.  We'll weave in "mail" stories with others about days before ubiquitious air conditioning, when all we had was AM radio in the car and 3 stations of black & white television stations at home.  They will be fun to reminisce. 

But our children, and certainly grandchildren, simply won't care.  Not at all.  And we better remember to keep the stories short, so they can be related in 140 characters or less if we want them saved for posterity!

Yes AMR, Bankruptcy is failure

Airline company AMR, owner of popular American Airlines, filed bankruptcy this week.  To which most people responded "again?"  The reaction was less about AMR, which is having a first-time filing, and more about airline bankruptcies overall.  People are simply used to airlines failing. 

Most people are so used to everything about airlines sucking that news a major filed bankruptcy simply wasn't surprising.  What they cared most about were two questions: "Is my ticket any good?" and "Do I get to keep my frequent flyer miles?"

Conceptually, business is not hard to understand.  Create a product or service that people want.  Make it appealing enough so people will pay enough to cover costs and make a profit, allowing you to re-invest in growth and repay your investors.  Pretty simple. 

But AMR, like most airlines, simply doesn't understand this concept.  Yes, people want to fly.  But ever since deregulation, service has become worse and worse.  Ask anyone what they think of American (or United or Delta or any "major" airline) and answers are the same.  They hate them. 

• Pricing is incomprehensible.  You may pay $800 for a ticket, and the person beside you $200 and the reason is completely unclear.
• There is never enough room on the plane for all the carry-on luggage, but that is free while the airline charges for checking bags. What they don't want (carry-ons) is free, what they want (check your bags) requires you pay?
• You are charged for a checked bag, but if the bag is late, damaged or items stolen you have no recourse to the airline
• When planes are late or cancelled, nobody cares how much customers are inconvenienced. Literally. You have no recourse to bad, or failed, service.
• Planes are cramped and dirty, often looking well worn - or worn out.
• Every year planes are becoming smaller and less comfortable.
• The food is gone - or wildly expensive.  And that little botttle of rum costs as much as a fifth at home.
• Empllyees appear uncaring at best, or simply rude.  It's like there are way too many customers, and not enough of them, so "PLEASE stay back and do what we tell you to do!"

This list could go on forever (readers, feel free to comment on your favorite stupid policy or practice of any airline.)  Why?  Because the airline's leaders have completely lost track of what business is all about.  In the rush to cut prices, trying to sell that last empty seat on that midnight feeder flight to Omaha, the entire industry has driven out all the customer satisfaction, and profitability.  Everyone has learned that it doesn't matter how much you pay, the experience is going to suck.  So the industry has taught customers to be price sensitive, above all else.

Shortly after deregulation Robert Crandall became AMR's Chairman.  He was a notorious cost cutter.  The Wall Street Journal ran a front page article highlighting his efforts to build American, highlighting how on a flight Mr. Crandall noticed that few customers were eating the 3 black olives on their salad.  He claimed to go back to company managers and tell them to remove the olives, thereby saving (ostensibly) $700,000/year.  Nobody would notice, he claimed, and money was saved.

And that's been the trajectory for American ever since. Cut this, cut that.  Shave costs everywhere, including employee pay, benefits and pensions.  And after 30 years, the sum total is that not only are the olives gone - the whole meal has disappeared!  Where working at an airline was once considered a great job (pilot, flight attendant, gate agent or baggage handler, ) today compensation has been cut and complicated (remember tiered compensation that has 2 people doing the same job, but at different pay just because of hire date?)  so that employees are largely overworked, under-appreciated and constantly being pushed by management one direction, while pulled by customers in another.  

Where once we didn't mind flying, maybe even enjoyed it,now everyone thinks of flying as the opportunity to learn what life is like as herded, and penned, livestock!

It has been a fallacy of "modern management" that leaders have a primary job to optimize the business - largely by limiting innovation and cutting costs.  The famous business guru, Jim Collins (author of Good to Great,) actively advocates (IndustryWeek.com 11/29/2011) that businesses focus exactly on the kind of business optimization that has driven AMR to bankruptcy!  His recommendations have inevitably lead businesses down a road of commoditization as they offer less and less to customers, and fall into vicious price wars.  Ineveitably a market shift happens that undercuts their ability to compete at all!

Great companies do not fall into this trap.  They constantly add customer value, utilizing new technology and business processes to improve performance.  They grow revenues, rather than focus on cutting costs.

Think about how Google has made doing research easier, and placing internet advertisements.  Or how Apple has improved personal music and mobile information access.  Or how Whole Foods has delivered more organic and tasty products.  Or how Amazon has made access to books, periodicals and much of retailing a better experience.  These companies have seen their market capitalization explode as they eschewed optimization in favor of innovation to make things better - not just cheaper.  Where AMR's value went from $40/share to zero the last 5 years, you would have had big gains in these companies that focused on innovation and delivering better customer results.

Chart Source Yahoo 1 December, 2011

AMR's leaders, and airline industry analysts, can try to put perfume on this bankruptcy pig by saying it is a "strategic action" taken to re-align costs (CuriousCapitalist.com.)  That's code for union-busting, in yet one more effort to ignore the real problem of no innovation.  Rather than actually improve the airline this is more of the same old strategy -  cut more olives (cost,) chasing the spiral yet further down toward even worse performance.

It's time to be honest.  AMR's bankruptcy is a failure.  Leadership's inability to address customer needs well enough to price at a profit.  Gimmicks like loyalty programs, bag charges, reservation fees, change fees, seat location fees and drink charges merely obscure the fact that the leaders cannot profitably run an airline!  Their service is so poor that they cannot charge enough to cover costs. Continuing to cut costs, further hindering service, is NOT the answer in a service industry! 

It certainly is prossble to make money in service industries.  Most do.  It is even possible to make money as an airline - just look at Southwest (which has made more profit than all its [much larager] competitors combined.) And the first step is for AMR to recognize that its strategy for 30 years is wrong!  The company needs to end the cost-price spiral and introduce some innovation!  Change the game AMR, or you'll forever remain a crappy company for investors, customers and employees.

Why Occupy Wall Street deserves more attention than the Tea Party

Both the Tea Party and Occupy Wall Street want to change America.  That is where the similarity ends. 

The Tea Party is a well organized political machine.  It has clear leaders, an agenda, and it has raised substantial money it uses to promote political candidates that support its agenda.  It is a marvelous example of how a grass-roots organization can become large, powerful and thrive in today's America. It has created significance - which is no small task!

Occupy Wall Street is so disorganized it doesn't even appear to have specific leadership, or hierarchy.  It's even hard to label.  OWS participants demonstrate a lot of anger at the status quo, but shows no clear agenda about what they would like done differently.  OWS appears to have some ability to raise money for its encampments, demonstrations and legal work, but it does not appear to support any particular candidates, or even any particular regulatory platforms or Congressional issues.  Easily enough, one could say it is not significant and deserves little attention.

Just looking at the Republican Presidential campaign, it is pretty clear that the Tea Party is making a difference in what candidates say, and what they do.  The Tea Party clearly has impacted the political process.  On the other hand, for all the media attention Occupy Wall Street receives, it is completely unclear how OWS affects government at all.  Overall, or even in the Democratic party where you would expect progressives to be its best allies.

Yet, I find Occupy Wall Street more interesting than the Tea Party, and there are specific reasons I think everyone should pay attention.

For all its organizing skills, the Tea Party doesn't seem to be growing.  Its communication clarity, and its ability to rally supporters, belies the fact that the group isn't becoming any larger.  It has a hard core group of supporters, who are quite homogeneous, but it isn't attracting waves of new followers.  As a trend, it seems to have plateaued.  Whether it will have any impact outside its own relatively small group and enclaves is unclear.  We have a way of seeing the same people light up at Sarah Palin speaking gigs, but we don't see much groundswell of endorsements otherwise.

On the other hand, the Occupy Wall Street participants seem to be growing (at least if we track rally participants and arrests!).  There are more events, in more cities with each one seeming to bring in larger audiences.  Despite incredibly weak traditional "management" OWS is growing participants, which are remarkably diverse. And apparently willing to accept criminal prosecution for their involvement!

People from all ethnicities and age groups - and even income levels - are becoming involved in OWS.  It is no longer a "bunch of out of work college kids" as we see more pictures of retirees, blue collar workers, blacks, whites, asians and latinos.  Each new police initiative gives us more pictures of people being pepper-sprayed, billyclubbed and dragged away that leads readers to say "that looks a lot like my (cousin, aunt, grandma, uncle, father, etc.) " 

And the number of participating cities keeps growing, even becoming international.  Occupy Wall Street looks like a trend, even if we don't know exactly what that trend represents!  Despite lacking the focus of anti-war protests circa 1964 ("Hey, hey LBJ, how many kids did you kill today?") the events keep growing in number and attendance. - and seem remarkably drug and crime free given that we assume most participants are  - well - homeless, unemployed and impoverished.

The Tea Party talks a lot about history.  From generalizations about "the way things used to be," to frequent references to the 200+ year old Constitution.  It appears to represent replacing the status quo with previous behaviors,  including reaching back to the era before Federal income taxes and most regulatory departments - as if American had no recessions or economic problems prior to the Great Depression. 

Unfortunately, even as a someone north of 50, I find it hard sometimes to connect what the Constitutional framers meant with the reality of 2011 America.  Trying to relate Tea Party generalizations about "limited government" in a world where I'm happy someone assures nuclear power plant security and food safety are hard dots to find a connecting line.  Often the headline sounds good ("lower taxes") but the details leave me asking how do we invest in infrastructure to compete with China in 2012?  

For those who are under 35, such connections to historical perspectives are a remarkable struggle for relevancy, and appropriateness.   These people want are new solutions to today's problems - and those seem to be in short supply from the Tea Party.  While OWS folks all know how Ronald Reagan is, he's much less a god than he is  just a former President (like Kennedy, Roosevelt, or even Lincoln.)

When reading the Tea Party agenda, there isn't a lot about innovation.  For all its Libertarian viewpoints, which followers of Ayn Rand surely enjoy, how America in 2012 is going to increase investments, create jobs and become more competitive in a highly dynamic, global economy against skillful businesses from China, India, Brazil, Russia, etc is remarkably unclear. 

Even though supply side economics have been institutionalized since the Reagan era, there are no strong arguments that today's problems would be helped by doing more of the same.  Whereas there seems ample arguments that perhaps 30 years of doctrinaire implementation of such practices might have contributed to our current problems.

Regardless of your views on demand versus supply economics, there is a complete dearth of innovation in the Tea Party agenda, which is at the least troubling, if not problematic.  How is America to regain its growth agenda by voting into office Tea Party supported candidates?

On the other hand Occupy Wall Street seems to have at its core the notion that insufficient growth is precisely the issue.  The "99%" are people who, in a 2011 rendition of Howard Beale from the 1976 movie Network, have people throwing open their windows, sticking out their heads and shouting "I'm Mad As Hell and I'm Not Going to Take this Anymore." Protesters are screaming for innovation.  They clearly want more investment, particularly from banks, and more hands-on management of growth to create jobs.  Even if they lack any policy recommendations for how to make this happen.

It may sound a little like "mommy, I'm hungry, can you get me something to eat?" which would be naive for a 20-something to say.  But with millions of them living on futons in their parent's basements, using mobile phones paid for by parents, desperately in debt with college loans and with no prospects for work -- it's a cry worth hearing, don't you think?  What is the answer that will allow them to apply their skills, enhance their growth - and buy a house!

The OWS people are genuinely angry.  They cannot comprehend why America cannot seem to create more jobs, or provide affordable health care for its citizenry, or even deal effectively with wave after wave of property value declines and foreclosures while those at the top of the economic pyramid seem to keep doing better every year.

Even if the OWS tactics are off-putting to the vast majority, their message does attract a tremendous amount of sympathy.  A lot of "regular people" (what Richard Nixon might have called the "silent majority") are asking, "why didn't the bank bailout seem to create jobs?  Did we really gain by saving GM?  How could we use so much government money, and seemingly still be in the same swamp? Why can't I refinance my house? Why do bankers and CEOs receive $10M bonuses after we bail out their industry?"

America has a growth problem.  Has had one for a decade now.  An inability to create jobs turned the first decade of this millennium into "the lost decade."  For the first time ever, America ended a 10 year span with fewer people working, the stock market lower, wages lower, fewer people insured, interest income non-existent due to low yields and tax receipts down - leading all the largest population states to the edge of bankruptcy and pension-system meltdown.  Like post 1995 Japan, America seems to be in a permanent "Great Recession."

And that problem has spilled over into other developed countries, with the Eurozone now struggling to deal with economic stagnation in countries such as Greece, Italy and Spain.  Harsh government program belt-tightening in Greece is designed to lower the spending costs closer to revenues, but how that will put the huge number of unworking Greeks, especially younger ones, to work is completely unclear. 

Throngs of unworking people in Italy and Spain are hearing that their future, as well, will involve less government assistance.  But where any jobs will be created from belt-tightening is simply not addressed. 

Occupy Wall Street is easy for a traditionalist to ignore.  One could blame their attention on "left wing liberal media." But there's a trend here. Something worth understanding.  Unless we invest in innovation to put people to work, this "movement" could become a much more serious social issue.   

 

Do you think you can fix that? - Filene's, Syms, Home Depot, Sears, Wal-Mart

In the back half of the 1990s Apple was clearly on the route to bankruptcy.  Sun Micrososystems seriously investigated buying Apple.  After a review, leadership opted not to make the acquisition.  Sun's non-officer management, bouyed on rumors of the acquisition, was heartbroken upon hearing Sun would not proceed.  When Chairman Scott McNeely was asked at a management retreat why the executive team passed on Apple, he responded with "Do you think you can fix that?"

Sun leadership clearly had answered "no."  Good for a lot of us that Steve Jobs said "yes." 

Sun has largely disappeared, losing 95% of its market cap after 2000 and being acquired by Oracle.  Why did Mr. Jobs succeed where the leadership of Sun, which couldn't save itself much less Apple, feared it would fail?

For insight, look no further than the recent failure of Filene's Basement ("Filene's Saga Ends" Boston.com) and its acquirer Sym's ("Retailers's Sym's and Filene's Go Out of Business" Chicago Tribune.)  Most of the time, when a troubled business is acquirerd not only is the buyer unable to fix the poor performer, but investments incurred by the buyer jeapardizes its business to the point of failure as well.  Given the track record of corporations at fixing bad businesses, Mr. McNeely was on statistically sound footing to reject buying Apple.

Why is the track record of corporate management so bad at fixing problem businesses?  Largely because most of their time is spent tyring to extend the past, rather than create a business which can thrive in the future.

The leadership of Sun didn't see a future filled with mobile devices for music, movies or telephony.  They were fixated on the Unix-based computers Sun built and sold.  It was unclear how Apple would help them sell more servers, so it was a management diversion - a "poor strategic fit" - for Sun to acquire a technology intensive, talent rich organization.  They passed, stayed focused on Unix servers and high-end workstations, and failed as that market shifted to PC products.

Much is the same for Filene's Basement.  A great brand, Sym's bought Filene's in an effort to continue pushing the discount model both Filene's and Sym's had historically pursued.  Unfortunately, the market for discount department store merchandise was rapidly shifting to higher end middle-market players like Kohl's, and for deeply discounted goods the internet was making deal shopping a lot easier for everyone.  Because management was fixated on the old business, they missed the opportunity to make Filene's and Sym's a leader in new retail markets - like Amazon has done.

Remember in 2006 when Western Auto's leader (and former hedge fund manager) Ed Lampert bought up the bonds of KMart, then used that position to acquire Sears?  The market went gaga over the acquisition, heralding Mr. Lampert as a genius.  Jim Cramer urged on his television program Mad Money that everyone buy Sears.  Now the merged KMart/Sears company has lost much of its value, and 24x7 Wall Street claimed it was the #1 worst performing retail chain ("America's Eight Worst-Performing Retail Chains".)

Chart courtesy Yahoo.com 11/11/11 (note vertical scale is logarithmic)

Both KMart and Sears were deeply troubled when Mr. Lampert acquired them.  But he largely followed a program of cost cutting, hoping people would return to the stores once he lowered prices.  What he missed was a retail market which had shifted to Wal-Mart for the low-end products, and had fragmented into multiple competitors in the mid-priced market leaving Sears Holdings with no compelling value proposition. 

Mr. Lampert has turned over management, fired scores of employees, closed stores and largely led both brands to retail irrelevancy.  By trying to do more of the past, only better, faster and cheaper he ran into the buzz saw of competitors already positioned in the shifted market and created nothing new for shoppers, or investors.

And that's why investors need to worry about Home Depot.  The company was a shopper and investor darling as it maintained double digit growth through the 1980s and 1990s.  But as competition matched, or beat, Home Depot's prices - and often the capability of in-store help - growth slowed. 

The Board replaced the founding leader with a senior General Electric leader named Robert Nardelli.  He rapidly moved to operate the historical Home Depot success formula cheaper, better and faster by cutting costs -- from employees to store operations and inventory.  And customers moved even more quickly to the competition.

As the recessions worsened job growth remained scarce and eventually home values plummeted causing Home Depot's growth to disappear.  The company may be good at what it used to do, but that is simply a more competitive market that is a lot less interesting to shoppers today.  Because Home Depot has not shifted into new markets, it is in a difficult situation (and considered the 5th worst performing retailer.)  Who cares if you are a competitive home improvement store when your house is only worth 75% of the outstanding mortgage and you can't refinance?

Chart source Yahoo Finance 11/11/11

And it is worth taking some time to look at Wal-Mart.  The chain is famous for its rural and suburban stores selling at low prices, both as Wal-Mart and Sam's Club.  But looking forward, we see the company has failed at everything else it has tried.  It's offshore businesses have never met expectations and the company has left most markets.  It's efforts at more targeted merchandise, upscale stores and smaller stores have all been abandoned.  And the company remains a serious lagger in understanding on-line sales as it has continued pouring money into defending its historical business, providing almost no return to investors for a decade. 

The market is shifting, competitors have attacked its old "core," but Wal-Mart remains stuck trying to do more, better, faster, cheaper with no clear sign it will make any difference as people change buying patterns. How can any brick-and-mortar retailer compete on cost with a web page?

Chart Source Yahoo Finance 11/11/11

All markets shift.  All of them.  Poor performance is most often an indication that the company has not shifted with the market.  Competition in lower growth markets leads to weak revenue performance, and declining profits.  Trying to "fix" the business by doing more of the same is almost always a money-losing proposition that hastens failure. 

It is possble to fix a weak business.  Moving with shifting markets into mobile has been very valuable for Apple investors.  Two decades ago IBM shifted from hardware sales to a services focus, and the company not only escaped bankruptcy but now is worth more than Microsoft.  

"Fixing" requires focusing on the future, and figuring out how to compete in the shifting market.  Rather than applying cost-cutting and operational improvement, it is important to determine what future markets value, and deliver that.  Zappos figured out that it could take a big lead in footwear and apparel if it offered people on-line convenience, and guaranteed taking back any products customers didn't want ("What Other Businesses Can Learn from Zappos" CMSWire.com.)  It's sales exploded.  Toms Shoes tapped into the market desire for helping others by donating a pair of shoes every time someone bought a pair, and sales are growing in double digits (CNBC video on Tom's Shoes).

History has taught us to be pessimistic about fixing a troubled business.  But that is largely because most management is fixated on trying to defend & extend the past.  But turnarounds can be a lot more common if leaders instead focus on the future and meet emerging needs.  It simply takes a different approach. 

In the meantime, in retail it's a lot smarter to invest in Amazon and retailers meeting emerging needs than those fixated on cost cutting and operational improvement.  Be wary of Sears, Home Depot and Wal-Mart as long as management remains locked-in to its past.

Better, faster, cheaper is not innovation - Kodak and Microsoft

There is a big cry for innovation these days.  Unfortunately, despite spending a lot of money on it, most innovation simply isn't. And that's why companies don't grow.

The giant consulting firm Booz & Co. just completed its most recent survey on innovation.  Like most analysts, they tried using R&D spending as yardstick for measuring innovation.  Unfortunately, as a lot of us already knew, there is no correlation:

"There is no statistically significant relationship between financial performance and innovation spending, in terms of either total R&D dollars or R&D as a percentage of revenues. Many companies — notably, Apple — consistently underspend their peers on R&D investments while outperforming them on a broad range of measures of corporate success, such as revenue growth, profit growth, margins, and total shareholder return. Meanwhile, entire industries, such as pharmaceuticals, continue to devote relatively large shares of their resources to innovation, yet end up with much less to show for it than they — and their shareholders — might hope for."

(Uh-hum, did you hear about this Abbott? Pfizer? Readers that missed it might want to glance at last week's blog about Abbott, and why it is a sell after announcing plans to split the company.)

Far too often, companies spend most of their R&D dollars on making their products cheaper, operate better, faster or do more.  Clayton Christensen pointed this out some 15 years ago in his groundbreaking book "The Innovator's Dilemma" (HBS Press, 1997).  Most R&D, in most industries, and for most companies, is spent trying to sustain an existing technology - not identify or develop a disruptive technology that would have far higher rates of return. 

While this is easy to conceptualize, it is much harder to understand.  Until we look at a storied company like Kodak - which has received a lot of news this last month.

Kodak invented amateur photography, and was rewarded with decades of profitable revenue growth as its string of cheap cameras, film products and photographic papers changed the way people thought about photographs.  Kodak was the world leader in photographic film and paper sales, at great margins, and its value grew exponentially!

Of course, we all know what happened.  Amateur photography went digital.  No more film, and no more film developing.  Even camera sales have disappeared as most folks simply use mobile phones.

But what most people don't know is that Kodak invented digital photography!  Really!  They were the first to create the technology, and the first to apply it.  But they didn't really market it, largely because of fears they would cannibalize their film sales.  In an effort to defend & extend their old business, Kodak licensed digital photography patents to camera manufacturers, abandoned R&D in the product line and maintained its focus on its core business.  Kodak kept making amateur film better, faster and cheaper - until nobody cared any more.

Of course, Kodak wasn't the first to fall into this trap.  Xerox invented desktop publishing but let that market go to Apple, Wintel suppliers and HP printers as it worked diligently trying to defend & extend its copier business.  With no click meter on the desktop publishing equipment, Xerox wasn't sure how to make money with it.  So they licensed it away.

DEC pretty much created and owned the CAD/CAM business before losing it to AutoCad.  Sears created at home shopping, a market now dominated by Amazon.  What's your favorite story?

It's a pattern we see a lot.  And nowhere worse than at Microsoft. 

Do you remember that Microsoft had the Zune player at least as early as the iPod, but didn't bother to develop the technology, or market, letting Apple take the lead in digital music and video devices? Did you remember that the Windows CE smartphone (built by HTC) beat the iPhone to market by years?  But Microsoft didn't really develop an app base, didn't really invest in the smartphone technology or market - and let first RIM and later Apple run away with that market as well. 

Now, several years too late Microsoft hopes its Nokia partnership will help it capture a piece of that market - despite its still rather apparent lack of an app base or breakthrough advantage.

Microsoft is a textbook example of over-investing in existing technology, in an effort to defend & extend an existing product line, to the point of  "over-serving" customer needs.  What new extensions do you want from your PC or office software? 

Do you remember Clippy?  That was the little paper clip that came up in Windows applications to help you do your job better.  It annoyed everyone, and was disabled by everyone.  A product development that nobody wanted, yet was created and marketed anyway.  It didn't sell any additional software products - but it did cost money. That's defend & extend spending.

How much a company spends on innovation doesn't matter, because what's important is what the company spends on real breakthroughs rather than sustaining ideas.  Microsoft spends a lot on Windows and Office - it doesn't spend enough on breakthrough innovation for mobile products or games. 

And it doesn't spend nearly enough on marketing non-PC innovations.  We are already well into the back end of the PC lifecycle.  Today more bandwidth is consumed from mobile devices than PC laptops and desktops.  Purchase rates of mobile devices are growing at double digits, while companies (and individuals) are curtailing PC purchases.  But Microsoft missed the boat because it chose to defend & extend PCs years ago, rather than really try to develop the technology and markets for CE and Zune. 

Just look at where Microsoft spends money today.  It's hottest innovation is Kinect.  But that investment is dwarfed by spending on Skype - intended to extend PC life - and ads promoting the use of PC technologies for families this holiday season.

Unfortunately, there are almost no examples of companies that miss the transition to a new technology thriving.  And that's why it is really important to revisit the Kodak chart, and then look at a Microsoft chart. 

(Chart 10/27/11)

Do you think Microsoft, after this long period of no value increase, is more likely to go up in value, or more likely to follow Kodak?  Unfortunately, there are few companies that make the transition.  But there have been thousands that have not.  Companies that had very high market share, once made a lot of money, but fell into failure because they invested in better, faster, cheaper rather than innovation.

If you are still holding Kodak, why?  If you're still holding Microsoft, Abbott, Kraft, Sara Lee, Sears or Wal-Mart -- why? 

Avoid the 3 card monte - Sell Abbott

The giant pharmaceutical company Abbott Labs announced today it was splitting itself.  Abbott will sell baby formula, supplements (vitamins,) generic drugs and additional products.  The pharmaceutical company, (gee, I thought that's what Abbott was?) yet to be named, will spin out on its own.  Chairman and CEO Miles White will continue at the new non-pharma Abbott, and the Newco pharma company will be headed by the company's former COO, being brought back out of retirement for the job.

The big question is, "why?"  The CEO gamely has described the businesses as having different profiles, and therefore they should be split.  But this is from the fellow that has been the most acquisitive CEO in his industry, and one of the most acquisitive in business, putting this collection together. He spent $10B on acquisitions as recently as 2009, including dropping $6.6B on Belgian drug company Solvay - which will now be espunged from Abbott.  Why did he spend all that money if it didn't make sense? And how does this break-up help investors, employees and all us healthcare customers? 

Or is this action just confusion, to leave us wondering what's going on in the company - and why it hasn't done much for any constituency the last decade.  Except the CEO - who's been the highest paid in the industry, and one of the highest paid in America during his tenure.

Mr. White became CEO in 1998, and Chairman in 1999.  Just as the stock peaked.  Since then, investors have received almost nothing for holding the stock.  Dividend increases have not covered inflation for the last decade, and despite ups and downs the share price is just about where it was back then - $50

Source:  Yahoo Finance 10/19/11

Abbott has not increased in value because the company has had almost no organic growth.  Growth by acquisition takes a lot of capital, and because purchases have multiple bidders it is really tough to buy them at a price which will earn a high rate of return. All academic studies show that when big companies buy, they always overpay.  And that's the only growth Abbott has had - overly expensive acquisitions.

Mr. White hid an inability to grow behind a flurry of ongoing acquisitions (and some divestitures) that made it incredibly difficult to realize that the company itself was actually stagnant.  Internally in a growth stall, with no idea how to come out of it.  Hoping, again and again, that one of these acquisitions would refire the stalled engines. 

This latest action is another round in Abbott's 3 card monte routine.  Where's that bloody queen Mr. White keeps promising investors, as he keeps mixing the cards - and turning them over? 

Because his acquisitions didn't work he's upping the financial machinations.  By splitting the company he will make it impossible for anyone to figure out what all that exasperating activity has been for the last decade!  He won't be compared to all those pesky historically weak results, or asked about how he's managing all those big investments, or even held accountable for the tens of billions that he spent at the "old Abbott" when he's asked questions about the "new Abbott."

But re-arranging the deck chairs does not fix the ship, and there's nothing - absolutely nothing - in this action which creates more growth, and higher profits, for Abbott shareholders.  Because there's nothing in this that produces new solutions for health care customers. 

And look out employees - because now there's 2 CEOs looking for ways to cut costs and create layoffs - like the ones implemented in early 2011!  Expect the big knife to come out even harder as both companies struggle to show higher profits, with limited growth prospects.

Along the way, like any good 3 card monte routine, Abbott's CEO has had shills ready to encourage us that the flurry of activity is good for investors.  Chronically, they talked about how picking up this business or that was going to grow revenues - almost regardless of the price paid or whether Abbott had any plan for enhancing the acquisition's value.  Today, most analysts applauded his actions as "making sense." Of course these were all financial analysts, MBAs like Mr. White, more interested in accounting than actually developing new products.  Working mostly for investment banks, they had (and have) a vested interest in promoting the executive's actions - even if it hasn't created any value. 

Meanwhile, those betting for the queen to finally show up in this game will just have to keep waiting.

Abbott, like most pharmaceutical companies, has painted itself into a corner.  There are more lawyers, accountants, marketers, salespeople and PR folks at Abbott (like all its competitors, by the way) than there are real scientists developing new solutions.  Blaming regulators and dysfunctional health care processes, Abbott has insisted on building an enormous hierarchy of people focused on a handful of potential "blockbuster" solutions.  It's a bit like the king and his court, filling the castle with those making announcements, arguing about the value of the king's court, sending out messages decrying the barbarians at the gate - while the number of people actually growing corn and creating value keeps dwindling!

Barely 100 years ago most "medicine" was sold based on labels and claims - and practically no science.  Quackery dominated the profession.  If you wanted something to help your ails, you hoped the local chemist had the skills to mix something up in his apothecary shop, using his mortar and pestle.  Often it was best to just take a good shot of opiate (often included in the druggist's powder;) at least you felt a whole lot better even if it didn't cure your illness.

But Alexander Fleming discovered Penicillin (1928), and we realized there was the possibility of massive life improvement from chemistry - specifically what we call pharmacology.  Jonas Salk sort of founded the "modern medicine" industry with his polio vaccine in 1955 - eliminating polio epidemics.  Science could lead to breakthroughs capable of saving millions of lives!  The creation of those injections - and later little pills-  changed everything for humanity. And that created the industry. 

But now pharmacology is a technology that has mostly run its course.  Like all inventions, in the early days the gains were rapid and far, far outweighed the risks.  A few might suffer illness, even death, from the drugs - but literally millions were saved.  A more than fair trade-off.  But after decades, those "easy hits" are gone. 

Today we know that every incremental pharmacological innovation is increasingly valuable in a narrower and narrower context.  10% may see huge improvement, 30% some improvement, 30% marginal to no  improvement, 20% have negative reactions, and 10% hugely negative reactions.  And increasingly, due to science, we know that is because as we trace down the chemical path we are interacting with individuals - and their DNA has a lot to do with how they will react to any drug.  Pharmacology isn't nearly as simple as penicillin any more.  It's almost one-on-one application to genetic maps.

But Abbott failed (like most of its industry competitors) to evolve.  Even though the human genome has been mapped for some 10 years, and even though we now know that future breakthroughs will come from a deeper understanding of gene reactions, there has been precious little research into the new forms of medicine this entails.  Abbott remained stuck trying to develop new products on the same path it had taken before, and as the costs rose (almost asymptotically astronomically) the results grew slimmer.  Billions were going in, and a lot less discovery was coming out!  But the leaders did not change their R&D path.

Today we all hear about patients that have remarkable recoveries from new forms of biologic medicines.  We know we are on the cusp of entirely new solutions, that will make the brute force of pharmacology look as medieval as a civil war surgeon's amputation solution to bullet wounds.  But Abbott is not there developing those solutions, because it has been trying to defend & extend its old business model with acquisitions like Solvay - and a plethora of financial transactions that hide the abysmal performance of its R&D and new product development.

Mr. White is not a visionary.  Never was.  He wasn't a research scientist, deep into solving health issues.  He wasn't a leader in trying to solve America's health care issues during the last decade.  He never exhibited a keen understanding of his customer's needs, trends in the industry, or presience as to future scenarios that would help his markets and thus Abbott's growth. 

Mr. White has been an expert in shuffling the cards - moving around the pieces.  Misdirecting attention to something new in the middle of the game.  Amidst the split announcement today it was easy to overlook that Abbott is setting aside $1.5B for settling charges that it broke regulations by illegally marketing the drug Depakote.   Changing investments, changing executives, changing  the message - now even changing the company - has been the hallmark of Mr. White's leadership. 

Now Abbott joins the list of companies, and CEOs, that when unable to grow their companies lean on misdirection.  Kraft and Sara Lee, both Chicago area companies like Abbott, have announced split-ups after failing to create increased shareholder value and laying off thousands of employees.  These efforts almost always lead to more problems as organic growth remains stalled, and investors are bamboozled by snake oil claims regarding the future.  Hopefully the remaining Abbott investors won't be fooled this time, and they'll find better places for their money than Abbott - or its Newco.

Postscript - the day after publishing this blog 24x7 Wall Street published its annual list of most overpaid CEOs in America.  #4 was Miles White, for taking $25.5M in compensation despite a valuation decline of 11.3%!