The Ugly Leadership Horsefly in the Record DJIA Economic Ointment

The Dow Jones Industrial Average (DJIA) jumped to record levels - over 15,000 - today after a favorable U.S. jobs report showed 165K new jobs and a drop in unemployment to 7.5%.  Politicians, economists, business leaders and investors were buoyed by economic improvements and the hope for further growth.  A higher stock market is considered a great ointment for what has hurt America the last several years.

But there's a big, ugly fly in this ointment.  While the indices are rising, revenues at many very large, key component companies are actually declining.  And possibly worse, the revenue growth rate for large companies has been declining for at least 3 years.

Source: Marketwatch "The Tell" 5/3/13 Matt Andrejczak

As the chart shows, Caterpillar has led the revenue decline, dropping a whopping 17.5% year-over-year.  But noteworthy declines included JPMorganChase dropping 15.5%, Pfizer down 12.4% and Merck down 9%.  It's hard to imagine a great long-term bull market when revenues are distinctly going in a bearish direction for several stalwart companies.

It is also important to note that the rate of DJIA growth has declined markedly.  In 2011 first quarter growth was 11.4% over 2010.  But 2012 was only 9.4% over 2011 and 2013 came in only a paltry 3.8% over 2012.  Ouch!  Clearly, jobs growth will not be sustained if these organizations cannot put more money on the top line.

So why aren't these companies growing? 

For companies to grow they must invest in new products, new markets and the resources to sell and deliver these new products and new markets.  And that creates jobs.  Think about easy to identify revenue successes like Apple (iPads,) Samsung (smartphones,) Amazon.com, Netflix, Tesla, Facebook.  Proper investment leads to revenue growth opportunities.

But, unfortunately, America's leaders have reduced their investment in growth projects the last 15 years.  Instead, they've been giving more money to investors -- and increasingly dumping money into stock buybacks that manipulate price and help improve management bonuses!

Source: Business Insider 4/8/13; Sam Ro; Reproduced from Goldman Sachs Research

As the chart demonstrates, in 1998 42% of corporate cash was reinvested into the means of production - which creates growth.  Today this has declined to only about 1/3 of available cash; a whopping 25% decline!  Additionally, R&D investments which should lead to new products and higher sales, dropped from 16% of cash used a decade ago to a more meager 12%! 

Where has the money gone?  13% of cash was going directly to investors, who could then invest in other companies with higher rate of return growth projects.  That number has risen to 18%, which is inherently a good thing as we can hope a lot of that has been re-invested in other companies. 

But 13-17% used to be spent on stock buybacks, which create no revenue or economic growth.  All share buybacks do is exchange cash for shares, reducing the number of shares and changing metrics like earnings per share and thus the price/earnings (P/E) multiple.  It does not create any new investment.  That number has risen to a staggering 22-34% of revenues! 

Net/net, in the not too distant past America's leaders were putting 70-74% of their cash to work by investing in growth projects.  And 12% was going to investors for projects elsewhere.  By in the mid-1990s this reinvestment rate declined to 52-55%, ushering in the Great Recession.  After improving this rate has started declining again, and remains stuck no better than 60% of cash.  Coupled with the 5% increase in cash being robbed from growth projects to buy back stock,  the net reinvestment remains mired at 55%!

American's want jobs and a growing economy.  As do people everywhere!  We are excited when we see improvement.  But today, the ugly horsefly in the ointment is the lack of revenue growth - and the lack of investment in growth projects.  Until business leaders begin putting their corporate cash hoards into growth projects again the long-term outlook remains problematic, even if the market is hitting record DJIA highs.

 

2 Wrongs Don't Fix JC Penney

JCPenney's board fired the company CEO 18 months ago.  Frustrated with weak performance, they replaced him with the most famous person in retail at the time. Ron Johnson was running Apple's stores, which had the highest profit per square foot of any retail chain in America.  Sure he would bring the Midas touch to JC Penney they gave him a $50M sign-on bonus and complete latitude to do as he wished.

Things didn't work out so well.  Sales fell some 25%.  The stock dropped 50%.  So about 2 weeks ago the Board fired Ron Johnson.

The first mistake:  Ron Johnson didn't try solving the real problem at JC Penney.  He spent lavishly trying to remake the brand.  He modernized the logo, upped the TV ad spend, spruced up stores and implemented a more consistent pricing strategy.  But that all was designed to help JC Penney compete in traditional brick-and-mortar retail. Against traditional companies like Wal-Mart, Kohl's, Sears, etc.  But that wasn't (and isn't) JC Penney's problem.

The problem in all of traditional retail is the growth of on-line.  In a small margin business with high fixed costs, like traditional retail, even a small revenue loss has a big impact on net profit.  For every 5% revenue decline 50-90% of that lost cash comes directly off the bottom line - because costs don't fall with revenues.  And these days every quarter - every month - more and more customers are buying more and more stuff from Amazon.com and its on-line brethren rather than brick and mortar stores.  It is these lost revenues that are destroying revenues and profits at Sears and JC Penney, and stagnating nearly everyone else including Wal-Mart. 

Coming from the tech world, you would have expected CEO Johnson to recognize this problem and radically change the strategy, rather than messing with tactics.  He should have looked to close stores to lower fixed costs, developed a powerful on-line presence and marketed hard to grab more customers showrooming or shopping from home.  He should have targeted to grow JCP on-line, stealing revenues from other traditional retailers, while making the company more of a hybrid retailer that profitably met customer needs in stores, or on-line, as suits them.  He should have used on-line retail to take customers from locked-in competitors unable to deal with "cannibalization."

No wonder the results tanked, and CEO Johnson was fired.  Doing more of the tired, old strategies in a shifting market never works.  In Apple parlance, he needed to be focused on an iPad strategy, when instead he kept trying to sell more Macs.

But now the Board has made its second mistake.  Bringing back the old CEO, Myron Ullman, has deepened JP Penney's lock-in to that old, traditional and uncompetitve brick-and-mortar strategy. He intends to return to JCP's legacy, buy more newspaper coupons, and keep doing more of the same.  While hoping for a better outcome.

What was that old description of insanity?  Something about repeating yourself.....

Expectedly, Penney's stock dropped another 10% after announcing the old CEO would return.  Investors are smart enough to recognize the retail market has shifted.  That newsapaper coupons, circulars and traditional advertising is not enough to compete with on-line merchants which have lower fixed costs, faster inventory turns and wider product selection. 

It certainly appears Mr. Johnson was not the right person to grow JC Penney.  All the more reason JCP needs to accelerate its strategy toward the on-line retail trend.  Going backward will only worsen an already terrible situation.

United - this is NOT "any way to run an airline"

The good folks at Wichita State (a final four contender as U.S. basketball fans know) and Purdue released their 2013 Airline Quality Rating.  United Airlines came in dead last.  To which United responded that they simply did not care.  Oh my.

Interestingly, this study is based wholly on statistical performance, rather than customer input.  The academics utilize on-time flight performance, denied passenger boardings, mishandled bags and complaints filed with the Department of Transportation.  It does not even begin to explore surveying customers about their satisfaction.  Anyone who flies regularly can well imagine those results.  Oh my.

So how would you expect an innovative, adaptive growth-oriented company (think like Amazon, Apple, Samsung, Virgin, Neimann-Marcus, Lulu Lemon) to react to declining customer performance metrics?  They might actually change the product, to make it more desirable by customers.  They might hire more customer service representatives to identify customer issues and fix problems quicker.  They might adjust their processes to achieve higher customer satisfaction.  They might train their employees to be more customer-oriented. 

But, United decidedly is not an innovative, adaptive organization.  So it responded by denying the situation.  Claiming things are getting better.  And talking about how it is spending more money on its long-term strategy.

United doesn't care about customers - and really never has.  United is focused on "operational excellence" (using the word excellence very loosely) as Messrs. Treacy and Wiersema called this strategy in their mega-popular book "The Discipline of Market Leaders" from 1995. United's strategy, like many, many businesses, is to constantly strive for better execution of an old strategy (in their case, hub-and-spoke flight operations) by hammering away at cutting costs. 

Locked in to this strategy, United invests in more airplanes and gates (including making acquisitions like Continental) believing that being bigger will lead to more cost cutting opportunities (code named "synergies".)  They beat up on employees, fight with unions, remove anything unessential (like food) invent ways to create charges (like checked bags or change fees), fiddle with fuel costs, ignore customers and constantly try to engineer minute enhancements to operations in efforts to save pennies.

Like many companies, United is fixated on this strategy, even if it can't make any money.  Even if this strategy once drove it to bankruptcy.  Even if its employees are miserable. Even if quality metrics decline. Even if every year customers are less and less happy with the product.  All of that be darned!  United just keeps doing what it has always done, for over 3 decades, hoping that somehow - magically - results will improve.

Today people have choices.  More choices than ever.  That's true for transportation as well.  As customers have become less happy, they simply won't pay as much to fly.  The impact of all this operational focus, but let the customer be danged, management is price degradation to the point that United, like all the airlines, barely (or doesn't - like American) cover costs.  And because of all the competition each airline constantly chases the other to the bottom of customer satisfaction - each  lowering its price as it mimics the others with cost cuts.

In 1963 National Airlines ran ads asking "is this any way to run an airline?" Well, no. 

Success today - everywhere, not just airlines - requires more than operational focus.  Constantly cutting costs ruins the brand, customer satisfaction, eliminates investment in new products and inevitably kills profitability.  The litany of failed airlines demonstrates just how ineffective this strategy has become.  Because operational improvements are so easily matched by competitors, and ignores alternatives (like trains, buses and automobiles for airlines) it leads to price wars, lower profits and bankruptcy.

Nobody looks to airlines as a model of management.  But many companies still believe operational excellence will lead to success.  They need to look at the long-term implications of this strategy, and recognize that without innovation, new products and highly satisfied new customers no business will thrive - or even survive.

Why Yahoo Investors Should Worry about Marissa Mayer

Marissa Mayer created a firestorm this week by issuing an email requiring all employees who work from home to begin daily commuting to Yahoo offices.  Some folks are saying this is going to be a blow to long-term employees, hamper productivity and will harm the company. Others are saying this will improve communications and cooperation, thin out unproductive employees and help Yahoo.

While there are arguments to be made on both sides, the issue is far simpler than many people make it out to be - and the implications for shareholders are downright scary.

Yahoo has been a strugging company for several years.  And the reason has nothing to do with its work from home policy.  Yahoo has lacked an effective strategy for a decade - and changing its work from home policy does nothing to fix that problem.

In the late 1990s almost every computer browser had Yahoo as its home page.  But Yahoo long ago lost its leadership position in content aggregation, search and ad placement.    Now, Yahoo is irrelevant.  It has no technology advantage, no product advantage and no market advantage.  It is so weak in all markets that its only value has been as a second competitor that keeps the market leader from being attacked as a monopolist! 

A series of CEOs have been unable to develop a new strategy for Yahoo to make it more like Amazon or Apple and less like - well, Yahoo.  With much fanfare Ms. Mayer was brought into the flailing company from Google, which is a market leader, to turn around Yahoo.  Only she's been on the job 7 months, and there still is no apparent strategy to return Yahoo to greatness. 

Instead, Ms. Mayer has delivered to investors a series of tactical decisions, such as changing the home page layout and now the work from home policy.  If tactical decisions alone could fix Yahoo Carol Bartz would have been a hero - instead of being pushed out by the Board in disgrace. 

Many leading pundits are enthused with CEO Mayer's decision to force all employees into offices.  They are saying she is "making the tough decisions" to "cut the corporate cost structure" and "push people to be more productive." Underlying this lies thinking that the employees are lazy and to blame for Yahoo's failure. 

Balderdash.  It's not employees' fault Yahoo, and Ms. Mayer, lack an effective strategy to earn a high return on their efforts. 

It isn't hard for a new CEO to change policies that make it harder for people to do their jobs - by cutting hours out of their day via commuting.  Or lowering productivity as they are forced into endless meetings that "enhance communication and cooperation." Or forcing them out of the company entirely with arcane work rules in a misguided effort to lower operating costs or overhead.  Any strategy-free CEO can do those sorts of things. 

Just look at how effective this approach was for

• "Chainsaw" Al Dunlap at Scott Paper
• "Fast Eddie" Lampert at Sears
• Carol Bartz at Yahoo
• Meg Whitman at HP
• Brian Dunn at Best Buy
• Gregory Rayburn at Hostess
• Antonio Perez at Kodak

The the fact that some Yahoo employees work from home has nothing to do with the lack of strategy, innovation and growth at Yahoo.  That failure is due to leadership.  Bringing these employees into offices will only hurt morale, increase real estate costs and push out several valuable workers who have been diligently keeping afloat a severely damaged Yahoo ship. These employees, whether in an office or working at home, will not create a new strategy for Yahoo.  And bringing them into offices will not improve the strategy development or innovation processes. 

Regardless of anyone's personal opinions about working from home, it has been the trend for over a decade.  Work has changed dramatically the last 30 years, and increasingly productivity relies on having time, alone, to think and produce charts, graphs, documents, lines of code, letters, etc.  Technologies, from PCs to mobile devices and the software used on them (including communications applications like WebEx, Skype and other conferencing tools) make it possible for people to be as productive remotely as in person. Usually more productive removed from interruptions.

Taking advantage of this trend helps any company to hire better, and be more productive.  Going against this trend is simply foolish - regardless the intellectual arguments made to support such a decision. Apple fought the trend to PCs and almost failed.  When it wholesale adopted the trend to mobile, seriously reducing its commitment to PC markets, Apple flourished.  It is ALWAYS easier to succeed when you work with, and augment trends.  Fighting trends ALWAYS fails.

Yahoo investors have plenty to be worried about.  Yahoo doesn't need a "tough" CEO.  Yahoo needs a CEO with the insight to create, and implement, a new strategy.  And a series of tactical actions do not sum to a new strategy.  As importantly, the new strategy - and its implementation - needs to augment trends.  Not go against trends while demonstrating the clout of a new CEO. 

If you've been waiting to figure out if Ms. Mayer is the CEO that can make Yahoo a great company again, the answer is becoming clear.  She increasingly appears very unlikely to have what it takes.

Innovation REALLY Matters - Lessons Learned from Detroit

Forbes republished its annual "Most Miserable Cities" list.  It looks at employment/unemployment, inflation, incomes and cost of living, crime, weather, commute times - a pretty good overview of things tied to living somewhere.  Detroit ranked first, as the most miserable city, with Flint, MI second.  And my home-sweet-home Chicago came in fourth.  Ouch! 

There is an important lesson here for every city - and for our country.

Detroit was a thriving city during the industrial revolution.  Innovation in all things mechanical led to the modern automobile; a marvelous innovation which, literally, everyone wanted.  As demand skyrocketed, Henry Ford's management team developed the modern assembly line which allowed production volumes to skyrocket as well.  Detroit was a hotbed of industrial innovation.

This fueled growth in jobs, which led to massive immigration to Detroit.  With growth the tax base expanded, and quickly Detroit was a leading city with all the best things people could want.  In the 1950s and 1960s Detroit reaped the benefits of the local auto companies, and their suppliers, as ongoing innovations drove better cars, more sales, more revenue taxes, higher property values and higher property taxes.  It was a glorious virtuous circle.

But things changed.

Offshore competitors came into the market creating different kinds of autos appealing to different customers.  Initially they had lower costs, and less expensive designs.  Their cars weren't as good as GM, Ford or Chrysler - but they were cheap.  And when gasoline prices took off in the 1970s people suddenly realized these cars were also more fuel efficient and cheaper to maintain.  As these offshore competitors gained more sales they invested in making better cars, until they had quality as good as the Detroit companies, plus better fuel efficiency.

But the Detroit companies had become stuck in their processes that worked in earlier days.  Even though the market shifted, they didn't.  What passed for innovations were increasingly simple appearance changes as bottom-line focus reduced willingness to do new things, and offered fewer new things to do.  GM and its brethren didn't shift with the market, and by the 1980s the seeds of big problems already were showing.  By the 1990s profits were increasingly variable and elusive.

The formerly weak and small competitors now were more competitive in a changed market favoring smaller cars with more, and better, technology.  The market had changed, but the big American auto companies had not.  They kept doing more of the same - hopefully better, faster and striving for cheaper.  But they were falling further behind.  By the 2000s decade failure had become the viable option, with both Chrysler and GM going bankrupt.

As this cycle played out, the impact on Detroit was clear.  Less success in the business base meant fewer revenue tax dollars from less profitable companies.  Cost reductions meant employment stagnated, then started falling.  Incomes stagnated, and people left Detroit to find better paying jobs. Property values began to fall.  Income and property taxes declined.  Governments had to borrow more, and cut costs, leading to declines in services.  What had been a virtuous circle became a violently destructive whirlpool.

Detroit's business leaders failed to invest in programs to drive more new jobs in non-auto, non-industrial, business development.  As competitors hurt the local industry, Detroit (and Michigan's) leaders kept trying to invest in saving the historical business, while the economy was shifting from an industrial base to an information one.  It wasn't just autos that were less valuable as companies, but everything industrial.  Yet, leaders failed at attracting new technology companies.  The economic shift - the market shift - was unaddressed, and now Detroit is bankrupt.

Much as I like living in Chicago, unfortunately the story is far too similar in my town.  Long an industrial hub, Chicago (and Illinois) enjoyed the benefits of growing companies, employment and taxes during the heyday of industrialism.  This led to well paid, and very well pensioned, government employees providing services.  The suburbs around Chicago exploded as people migrated to the Windy City for jobs - despite the brutal winters.

But Chicago has been dramatically affected by the shift to an information economy.  The old machine shops, tool and dye makers and myriad parts manufacturers were decimated as that work often went offshore to cheaper manufacturers.  Large manufacturers like Western Electric and International Harvester (renamed Navistar) failed.  Big retailers like Montgomery Wards disappeared, and even Sears has diminished to a ghost of its former self.  All businesses killed by market shifts. 

And as a result, people quit moving to Chicago - and actually started leaving.  There are now fewer jobs in Illinois than in the year 2000, and as a result people have left town.  They've gone to cities (and states) where they could find jobs in growth industries allowing for more opportunity, and rising incomes. 

Just like Detroit, Chicago shows early signs of big problems.  Crime is up, with an unpleasantly large increase in murders.  Insufficient income and property tax revenues led to budget crises across the board.  Dramatic actions like selling city parking meters to shore up finances has led to Chicago having the most expensive parking in the country - despite far from the highest incomes.  Property taxes in suburbs have escalated, with taxes in collar Lake county higher than Los Angeles! Yet the state pension system is bankrupt, causing the legislature to put in place a 50% state income tax increase!  Meanwhile the infrastructure is showing signs of needing desperate work, but there is no money. 

Like Detroit, Chicago's businesses (and governments) have invested insufficiently in innovation.  Recent Chicago Tribune columns on local consumer goods behemoth Kraft emphasized (and typified) the lack of new product development and stalled revenue growth.  Where Bay Area tech companies expect 50% of revenues (or more) from new products (or variations), Kraft has admitted it has relied on stalwarts like Velveeta and Mac & Cheese so much that fewer than 10% of revenues come from anything new. 

Culturally, too many decisions in the executive suites of both the companies, and the governments, are focused on what worked in the past rather than investing in innovation.  Even though the vaunted University of Illinois has one of the world's top 5 engineering schools, the majority of graduates find they leave the state for better paying jobs.  And a dearth of angel or venture funding means that start-ups simply are forced coastal if they hope to succeed.

And this reaches to our national policies as well.  Plenty of arguments abound for cutting costs - but are we effectively investing in innovation?  Do our tax policies, as well as our expenditures, drive innovation - or constrict it?  It was government programs which unleashed nuclear power and gave us a rash of innovations from putting a man on the moon.  Yet, today, we seem obsessed with cutting budgets, cutting costs and doing less - not even more - of the same. 

Growth is a wonderful thing.  But growth does not happen without investment in innovation.  When companies, or industries, stop investing in innovation growth slows - and eventually stops.  Communities, states and even nations cannot thrive unless there is a robust program of investing for, and implementing, innovation. 

With innovation you create renewal.  Without it you create Detroit.

Sell Microsoft NOW - Game over, Ballmer loses

Microsoft needed a great Christmas season.  After years of product stagnation, and a big market shift toward mobile devices from PCs, Microsoft's future relied on the company seeing customers demonstrate they were ready to jump in heavily for Windows8 products - including the new Surface tablet.

But that did not happen. 

With the data now coming it, it is clear the market movement away from Microsoft products, toward Apple and Android products, has not changed.  On Christmas eve, as people turned on their new devices and launched their first tweet, Surface came in dead last - a mere 2% compared to the number of people tweeting from iPads (Kindle was second, Android third.)  Looking at more traditional units shipped information, UBS analysts reported Surface sales were 5% of iPads shipped.  And the usability reviews continue to run highly negative for Surface and Win8.

This inability to make a big splash, and mount a serious attack on Apple/Android domination, is horrific for Microsoft primarily because we now know that traditional PC sales are well into decline.  Despite the big Win8 launch and promotion, holiday PC sales declined over 3% compared to 2011 as journalists reported customers found "no compelling reason to upgrade."  Ouch!

Looking deeper, for the 4th quarter PC sales declined by almost 5% according to Gartner research, and by almost 6.5% according to IDC.  Both groups no longer expect a rebound in PC shipments, as they believe homes will no longer have more than 1 PC due to the mobile device penetration  - the market where Surface and Win8 phones have failed to make any significant impact or move beyond a tiny market share.  Users increasingly see the complexity of shifting to Win8 as not worth the effort; and if a switch is to be made consumer and businesses now favor iOS and Android.

Microsoft's monopoly over personal computing has evaporated.  From 95% market domination in 2005 share has fallen to just 20% in 2012 (IDC, Goldman Sachs.)  Comparing devices, in 2005 there were 55 Windows devices sold for every Apple device; today explosive Apple sales has lowered that multiple to a mere 2! (Asymco).  Universally the desire to upgrade Microsoft products has simply disappeared, as XP still has 40% of the Windows market - and even Vista at 5.7% has more users than Win8 which has only achieved a 1.75% Windows market share despite the long wait and launch hoopla. And with all future market growth coming in tablets, which are expected to more than double unit volume sales by 2016, Microsoft is simply not in the game.

These trends mean nothing short of the ruin of Microsoft.  Microsoft makes more than 75% of its profits from Windows and Office.  Less than 25% comes from its vaunted servers and tools.  And Microsoft makes nothing from its xBox/Kinect entertainment division, while losing vast sums on-line (negative $350M-$750M/quarter).  No matter how much anyone likes the non-Windows Microsoft products, without the historical Windows/Office sales and profits Microsoft is not sustainable.

So what can we expect at Microsoft:

1. Ballmer has committed to fight to the death in his effort to defend & extend Windows.  So expect death as resources are poured into the unwinnable battle to convert users from iOS and Android.
2. As resources are poured out of the company in the Quixotic effort to prolong Windows/Office, any hope of future dividends falls to zero.
3. Expect enormous layoffs over the next 3 years.  Something like 50-60%, or more, of employees will go away.
4. Expect closure of the long-suffering on-line division in order to conserve resources.
5. The entertainment division will be spun off, sold to someone like Sony or even Barnes & Noble, or dramatically reduced in size.  Unable to make a profit it will increasingly be seen as a distraction to the battle for saving Windows - and Microsoft leadership has long shown they have no idea how to profitably grow this business unit.
6. As more and more of the market shifts to competitive cloud businesses Apple, Amazon and others will grow significantly.  Microsoft, losing its user base, will demonstrate its inability to build a new business in the cloud, mimicking its historical experiences with Zune (mobile music) and Microsoft mobile phones.  Microsoft server and tool sales will suffer, creating a much more difficult profit environment for the sole remaining profitable division.

Missing the market shift to mobile has already forever tarnished the Microsoft brand.  No longer is Microsoft seen as a leader, and instead it is rapidly losing market relevancy as people look to Apple, Google, Amazon, Samsung, Facebook and others for leadership.   The declining sales, and lack of customer interest will lead to a tailspin at Microsoft not unlike what happened to RIM.  Cash will be burned in what Microsoft will consider an "epic" struggle to save the "core of the company." 

But failure is already inevitable.  At this stage, not even a new CEO can save Microsoft.  Steve Ballmer played "Bet the Company" on the long-delayed release of Win8, losing the chance to refocus Microsoft on other growing divisions with greater chance of success.  Unfortunately, the other players already had enough chips to simply bid Microsoft out of the mobile game - and Microsoft's ante is now long gone - without holding a hand even remotely able to turn around the product situation.

Game over. Ballmer loses. And if you keep your money invested in Microsoft it will disappear along with the company.   

Related articles

Mobile Overtakes Desktops in 2013: Microsoft Be Warned

The iPad and the Surface: a tale of two tablets

Microsoft Sold 1 Million Surface Tablets During 2012's Q4

Who Wants a Big Mac for Christmas? Bah! Humbug! McDonald's Scrooge!

How would you recognize signs of a troubled business?  Often the key indicator is when leadership clearly takes "more of the same" to excess.

This week McDonald's leadership began encouraging franchisees to open on Christmas Day.  Their primary objective, clearly stated, was to produce more revenue and hopefully show a strong December. 

I nominate McDonald's for the 2012 Dickens' Award as the most Scrooge-est business behavior this season. 

"Christmas is but an excuse for workers to pick their employer's pockets every 25th December" is I believe how Charles Dickens put it in "A Christmas Carol."  Poor Bob Cratchet couldn't even have 1 day off per year.  And in McDonald's case the company founder actually made it corporate policy to never be open on Thanksgiving or Christmas days so employees could be with family. 

Bah! Humbug!

Now, there are a lot of trends McDonald's could legitimately cite when making a case for being open on Christmas - a case that could actually shed a positive light on the company:

• The number of single people has risen over the last decade.  This trend means that many more people now have a need for at least one meal not in a family setting on 25 December.
• America has a large and storied Jewish community for whom 25 December does not have a special religious meaning.  For these people enjoying their habitual norms such as eating at McDonald's would indicate an open-minded company supports all faiths.
• America is a nation of immigrants.  While the founders were European Christians, today America has a very diverse group of immigrants, especially from Asia and the Indian sub-continent, who follow Islam and other faiths for which 25 December has, again, no particular meaning.  Offering them a place to eat on their day off could show a connection with their growing importance to America's future.  An act of understanding to their impact on the country.

These are just 3, and there are likely more and better ones (please offer your thoughts in the comments section.)  But truthfully, this is not why McDonald's is urging franchisees to toil on this national holiday.  Instead, it is just to make a buck. 

But then again, what trend has McDonald's successfully leveraged in the last... let's say 2 decades?  Despite the rapid growth of high end coffee, the "McCafe" concept was a decade late, and so missed the mark that it has made no impact when competing against Caribou Coffee, Peet's or Starbucks.  And it has had minimal benefit for McDonald's. 

To understand the dearth of new products just go to McDonald's web site where you'll see an animated ad for the "101 reasons to eat a McRib" - that mystery meat product which is at least 30 years old and rotated on and off the menu in the guise of "something new."

McDonald's had a very rough last quarter.  It's sales per store declined versus a year ago.  The number of stores has stagnated, sales are stagnant, new products are non-existent.  Even Ronald McDonald has aged, and apparently moved on to the nursing home.  What can you think about that is exciting about McDonald's?

Desperate to do something, McDonald's fired the head of North America.  But that doesn't fix the growth problem at McDonald's, it just demonstrates the company is internally fixated on blame rather understanding external market shifts and taking action.  McDonald's keeps doing more of the same, year after year; such as opening more stores in emerging markets, staying open longer hours at existing locations and even opening on Thanksgiving and Christmas in the U.S. 

McDonald's Ghost of Christmas past was its great strength, from its origin, of consistency.  In the 1960s when people traveled away from home they could never be quite sure what a restaurant offered.  McDonald's offered a consistent product, that people liked, at a consistent (and affordable) price.  This success formula launched tremendous growth, and a revolution in America's restaurant industry, creating a great string of joyous past Christmases. 

But the Ghost of Christmas present is far more bleak.  50 years have passed, and now people have a lot more options - and much higher expectations - regarding dining.  But McDonald's really has failed to adapt.  So now it is struggling to grow, struggling to meet goals, struggling to be a kind and gentle employer.  Now asking its employees to work on Christmas - and ostensibly eat Big Macs.

What is the Ghost of Christmas Future for McDonald's?  Not surprisingly, if it cannot adapt to changing markets things are likely to worsen.  No company can hope to succeed by simply doing more of the same forever.  Constantly focusing on efficiency, and beating on franchisees and employees to stay open longer, is a downward spiral.  Eventually every business HAS to innovate;  adapt to changing market conditions, or it will die.  Just look at the tombstones - Kodak, Hostess, Circuit City, Bennigan's ....

Take time between now and 2013 to ask yourself, what is your Ghost of Christmas past upon which your business was built?  How does that compare to the Ghost of Christmas present?  If there's a negative gap, what should you expect your Ghost of Christmas Future to look like?  Are you adapting to changing markets, or just hoping things will improve while you resist putting enough coal on the fire to keep everyone warm?

 

Irrelevancy leads to failure - Worry for Yahoo, Microsoft, HP, Sears, etc.

The web lit up yesterday when people started sharing a Fortune quote from Marissa Mayer, CEO of Yahoo, "We are literally moving the company from BlackBerrys to smartphones."  Why was this a big deal?  Because, in just a few words, Ms. Mayer pointed out that Research In Motion is no longer relevant.  The company may have created the smartphone market, but now its products are so irrelevant that it isn't even considered a market participant.

Ouch.  But, more importantly, this drove home that no matter how good RIM thinks Blackberry 10 may be, nobody cares.  And when nobody cares, nobody buys.  And if you weren't convinced RIM was headed for lousy returns and bankruptcy before, you certainly should be now.

But wait, this is certainly a good bit of the pot being derogatory toward the kettle.  Because, other than the highly personalized news about Yahoo's new CEO, very few people care about Yahoo these days as well.  After being thoroughly trounced in ad placement and search by Google, it is wholly unclear how Yahoo will create its own relevancy.  It may likely be soon when a major advertiser says "When placing our major internet ad program we are focused on the split between Google and Facebook," demonstrating that nobody really cares about Yahoo anymore, either. 

And how long will Yahoo survive?

The slip into irrelevancy is the inflection point into failure.  Very few companies ever return.  Once you are no longer relevant, customer quickly stop paying attention to practically anything you do.  Even if you were once great, it doesn't take long before the slide into no-growth, cost cutting and lousy financial performance happens. 

Consider:

• Garmin once led the market for navigation devices.  Now practically everyone uses their mobile phone for navigation. The big story is Apple's blunder with maps, while Google dominates the marketplace.  You probably even forgot Garmin exists.
• Radio Shack once was a consumer electronics powerhouse.  They ran superbowl ads, and had major actresses parlaying with professional sports celebrities in major network ads.  When was the last time you even thought about Radio Shack, much less visited a store?
• Sears was once America's premier, #1 retailer.  The place where everyone shopped for brands like Craftsman, DieHard and Kenmore.  But when did you last go into a Sears?  Or even consider going into one?  Do you even know where one is located?
• Kodak invented amateur photography.  But when that market went digital nobody cared about film any more.  Now Kodak is in bankruptcy.  Do you care?
• Motorola Razr phones dominated the last wave of traditional cell phones.  As sales plummeted they flirted with bankruptcy, until Motorola split into 2 pieces and the money losing phone business became Google - and nobody even noticed.
• When was the last time you thought about "building your body 12 ways" with Wonder bread?  Right.  Nobody else did either.  Now Hostess is liquidating.

Being relevant is incredibly important, because markets shift quickly today. As they shift, either you are part of the trend going forward - or you are part of the "who cares" past.  If you are the former, you are focused on new products that customers want to evaluate. If you are the latter, you can disappear a whole lot faster than anyone expected as customers simply ignore you.

So now take a look at a few other easy-to-spot companies losing relevancy:

• HP headlines are dominated by write offs of its investments in services and software, causing people to doubt the viability of its CEO, Meg Whitman.  Who wants to buy products from a company that would spend billions on Palm, business services and Autonomy ERP software only to decide they overspent and can never make any money on those investments?  Once a great market leader, HP is rapidly becoming a company nobody cares about; except for what appears to be a bloody train wreck in the making.  In tech - lose customesr and you have a short half-life.
• Similarly Dell.  A leader in supply chain management, what Dell product now excites you?  As you think about the money you will spend this holiday, or in 2013, on tech products you're thinking about mobile devices --- and where is Dell?
• Best Buy was the big winner when Circuit City went bankrupt.  But Best Guy didn't change, and now margins have cratered as people showroom Amazon while in their store to negotiate prices.  How long can Best Buy survive when all TVs are the same, and price is all that matters?  And you download all your music and movies?
• Wal-Mart has built a huge on-line business.  Did you know that?  Do you care?  Regardless of Wal-mart's on-line efforts, the company is known for cheap looking stores with cheap merchandise and customers that can't maintain credit cards.  When you look at trends in retailing, is Wal-Mart ever the leader - in anything - anymore?  If not, Wal-mart becomes a "default" store location when all you care about is price, and you can't wait for an on-line delivery.  Unless you decide to go to the even cheaper Dollar General or Aldi.

And, the best for last, is Microsoft.  Steve Ballmer announced that Microsoft phone sales quadrupled!  Only, at 4 million units last quarter that is about 10% of Apple or Android.  Truth is, despite 3 years of development, a huge amount of pre-release PR and ad spending, nobody much cares about Win8, Surface or new Microsoft-based mobile phones.  People want an iPhone or Samsung product. 

After its "lost decade" when Microsoft simply missed every major technology shift, people now don't really care about Microsoft.  Yes, it has a few stores - but they dwarfed in number and customers by the Apple stores.  Yes, the shifting tiles and touch screen PCs are new - but nobody real talks about them; other than to say they take a lot of new training.  When it comes to "game changers" that are pushing trends, nobody is putting Microsoft in that category.

So the bad news about a  $6 billion write-down of aQuantive adds to the sense of "the gang that can't shoot straight" after the string of failures like Zune, Vista and early Microsoft phones and tablets.  Not to mention the lack of interest in Skype, while Internet Explorer falls to #2 in browser market share behind Chrome. 

Chart Courtesy Jay Yarrow, BusinessInsider.com 5-21-12

When a company is seen as never able to take the lead amidst changing trends, investors see accquisitions like $1.2B for Yammer as a likely future write down.  Customers lose interest and simply spend money elsewhere.

As investors we often hear about companies that were once great brands, but selling at low multiples, and therefore "value plays."  But the truth is these are death traps that wipe out returns.  Why?  These companies have lost relevancy, and that puts them one short step from failure. 

As company managers, where are you investing?  Are you struggling to be relevant as other competitors - maybe "fringe" companies that use "voodoo solutions" you don't consider "enterprise ready" or understand - are obtaining a lot more interest and media excitment?  You can work all you want to defend & extend your past glory, but as markets shift it is amazingly easy to lose relevancy.  And it's a very, very tough job to play catch- up. 

Just look at the money being spent trying at RIM, Microsoft, HP, Dell, Yahoo............

-

Why the Top 20 R&D spenders waste their money - lessons from Microsoft & GM

Many people equate spending on R&D with investing in innovation.  The logic goes that R&D spending is lab spending, and out of labs come innovations.  Hence, those that spend a lot on R&D are innovative.

That is faulty logic.

This chart shows R&D spending from the top 20 companies in 2011:

Chart reproduced with permission of Business Insider

Think of your own list of companies that are providing innovations which change your work, or life. Would you include Apple? Amazon? Facebook? Google? Genentech?  (Here's the link to Fast Company's 50 most innovative for 2012).  Note that none of these companies appear on the list of top R&D spenders. 

On the other hand, as you look at the big spender list some things might be apparent:

• Microsoft is #5, spending $9B and nearly 13% of revenue.  Yet, for this money in 2012 the world received updates to their aging operating system and office automation software.  Both of which failed to register favorable reviews by industry gurus, and are considered far from innovative.  And Nokia, which is so floundering some consider it a likely bankruptcy candidate soon, is #7! Despite spending nearly $8B on R&D Nokia is now completely reliant on Microsoft if it is to even survive.
• Autos make up a big part of the group.  Toyota, GM, Volkswagen, Honda and Daimler are all on the list, spending a whopping $36B.  Yet, even though they give us improvements nobody considers them (especially GM)  very innovative.  That award would go to little Tesla Motors.  Or maybe Tata Motors in India.
• Pharmaceuticals make up the dominant industry.  Novartis, Roche, Pfizer, Merck, Johnson & Johnson, Sanofi, GlaxoSmithKline and AstraZeneca are all here - spending a cumulative $54B!  Yet, they have all failed to give the world any incredible new drugs, all have profit struggles, and the industry is rife with discussions about weak product pipelines. The future of modern medicine increasingly is shifting to genetic solutions, biologics and more specific alternatives to the historical drug regimes from these aging pharma R&D programs.

Do you see the obvious pattern?  Most big R&D spenders are not really seeking innovations.  They are spending money on historical programs, following historical patterns and trying to defend and extend the historical business.  In other words, they are spending vast sums attempting to sustain (or recapture) historical success.  And, as the list shows, largely doing a pretty lousy job of it. 

If you were given $10,000 to invest would you select these top 20 R&D spenders - or would you look for other, more innovative companies.  From a profitability, rate of return and trend perspective, most of these companies look weak - or downright horrible.

Innovators don't focus on what they spend, but where they spend it.

The companies most known for innovation don't keep spending money year after year on their old business.  Instead of digging deeper into what they already know, they invest laterally.  They spend money putting the pieces together in new, unique ways.  They try to find new solutions to old problems, using new - even fringe - technologies.  They try to develop disruptive solutions that actually change the marketplace, rather than trying to make something that already exists better, faster or cheaper.

Lots of people like to think there is "scale" in research.  Bigger is better.  What's more important, for investors, is that there is "diminishing returns."  The more you research an area the more you have to spend to find anything new.  The costs keep escalating, as the gains shrink.  After investing for a while, continuing to research an area is not a good investment (although it may be very intellectually interesting.) 

Most of the companies on this list would be smarter to scrap their existing R&D programs, cut the budget in half (at least,) and then invest it somewhere very different.  Instead of looking deeper, they need to look wider - broader.  They need to investigate alternative solutions, rather than more of the same.  They need to be putting more money on fringe opportunities, and a lot less into the core.

Until they do, few on this list are very good investment bets.  You'll do better investing like, and in, the real innovators.

 

Are American's Abusing Social Security Disability?

Does anyone remember the 1990s?  Economic growth was robust, the stock market was exploding and unemployment was low.  Even though outsourcing was just emerging as a new business practice, there were more jobs than employees in America, and the Federal Reserve Board Chairman worried about "irrational exuberance."  If you had a degree you had a job, and you had a car (or 2) and a house as you awaited ever rising income and asset values.

Oh my, how times have changed.  A third of U.S. homes are worth less than the mortgage, auto sales fell off a cliff as GM and Chrysler filed bankruptcy, trust in banks has disappeared, savers earn nearly 0% yet investors shun stocks and laugh at declining values of IPOs.  And unemployment remains stubbornly stuck just below double digits as job growth remains anemic, despite reduced outsourcing and rising oversees costs. 

So how do Americans react to limited economic growth?  Apparently, increasingly, by feigning disabilities in order to create their own form of social welfare net similar to Europe.  Regardless of what Americans say, it is important to look at what they do. 

This week I am pleased to offer you a guest blog from Jack Ablin, Chief Investment Officer of Harris Private Bank, a division of BMO Financial:

Working conditions in the United States are getting downright dangerous if the Social Security disability statistics are any indication.  The number of Americans collecting disability is rising at an unprecedented and alarming rate.  This belies Bureau of Labor Statistics data that tells the story of workplace safety that is constantly improving.  Everyone knows that injury incidence rates have been in secular decline since, well, always. 

When thinking about worker-related risks, "Lunch atop a Skyscraper," the famous Depression era photo by Charles C. Ebbets immediately comes to mind.  What we once accepted at the workplace is now wildly unacceptable:

In 2010, there were 3.5 total recordable cases of non-fatal occupational injury and illness per 100 full-time workers, down from 5.0 less than a decade ago.  In 1973 the rate was 11 per 100.  The net decline amounts to a 3.7 percent reduction in these hazards every year for four decades. 

Of course, not all injuries and illness are work related.  Then again, is there any aspect of our lives that has not become safer in the last two generations?  For example, auto injuries are always a factor.  But those risks have collapsed with the advent of airbags, anti-lock brakes and other technological breakthroughs. 
 
The Social Security Administration’s website cites two criteria for disability eligibility:
•      You must be unable to do any substantial work because of your medical condition(s); and
•      Your medical condition(s) must have lasted, or be expected to last at least 1 year, or be expected to result in your death.

Quizzically, from 1980 to 2002 there was no change in the percentage of the workforce claiming disability, yet the “disability participation rate” has embarked on a 4.5 percent ascent each year for the last decade.  There is now 1 person collecting disability for every 12 in the workforce. 

This occurred despite the evolution toward more of a “desk job” workforce.  The Bureau of Labor Statistics reports that today only 14% of working Americans are in goods producing jobs, down from more than 25% in 1973.  Yet, somehow, claims for disability benefits have headed in the opposite direction:

 
There are people out there that truly want to work but are too sick or injured to do so.  Sadly, many are unfortunately being branded with a stigma because of the legions that are out there gaming the system.  That is the only way we can explain how almost as many people collect disability (10.8 million) as there are working in the entirety of manufacturing (12 million). 

It is plain to see that permanently stagnant labor markets are making Social Security disability the new unemployment benefit.  
 
The impact of America's "no growth decade" from 2000-2010 is clearly impacting America.  I want to thank Jack for his analysis.  I urge your to sign up for Jack's newsletter, full of insight about the economy, interest rates, investing and jobs by contacting him at jack.ablin@harrisbank.com.  Jack is a graduate of Vassar and has his MBA from Boston University.  He is a CFA and frequent contributor to CNBC, Bloomberg, Barron's and The Wall Street Journal.