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.

Drop 2011 Dogs for 2012's Stars - Avoid Kodak, Sears, Nokia, RIMM, HP, Sony - Buy Apple, Amazon, Google, Netflix

The S&P 500 ended 2011 almost exactly where it started.  If ever there was a year when being invested in the right companies, and selling the dogs, mattered for higher portfolio returns it was 2011.  The good news is that many of the 2011 dogs were easy to spot, and easy to sell before ruining your portfolio. 

There were many bad performers.  However, there was a common theme.  Most simply did not adjust to market shifts.  Environmental changes, from technology to regulations, made them less competitive thus producing declining returns as newer competitors benefitted.  Additionally, these companies chose - often over the course of several years - to eschew innovation and new product launches.  They chose to keep investing in efforts to defend and extend historical, but troubled, businesses rather than innovate toward a more successful future.

Looking at the trends that put these companies into trouble we can recognize the need to continue avoiding these companies, even though many analysts are starting to say they may be "value stocks." Instead we can invest in the trends by buying companies likely to grow and increase portfolio returns in 2012.

Avoid Kodak - Buy Apple or Google

Few companies are as iconic as Eastman Kodak, inventor of amateur photography and creator of the star product in the hit 1973 Paul Simon song "Kodachrome." However, it was clear in the late 1980s that digital cameras were going to change photography.  Kodak itself was one of the primary inventors of the core technology, but licensed it to others in order to generate cash it invested trying to defend and extend photographic film and paper sales.  In my 2008 book "Create Marketplace Disruption" I highlighted Kodak as a company so locked-in to film sales that it was unwilling to even consider moving into new markets.

In 2011 EK lost almost all its value, falling from $3.85 share to about 60 cents.  The whole company is now worth only $175M as it rapidly moves toward NYSE delisting and bankruptcy, and complete failure.  The trend that doomed EK has been 2 decades in the making, yet like an ocean freighter collision management simply let momentum kill the company.  The long slide has gone on for years, and will not reverse.  If you want to invest in photography your best plays are smart phone suppliers Apple, and Google for not only the Android software but the Chrome apps that are being used to photoshop images right inside browser windows.

Avoid Sears - Buy Amazon

When hedge fund manager Ed Lampert took over KMart by buying their bonds in bankruptcy, then used that platform to buy Sears back in 2006 the Wall Street folks hailed him as a genius. "Mad Money" Jim Cramer said "Fast Eddie" Lampert was his former college roommate, and that was all he needed to recommend buying the stock.  On the strength of such spurrious recommendations, Sears Holdings initially did quite well.

However, I was quoted in The Chicago Tribune the day of the Sears acquisition announcement saying the merged company was doomed - because the trends were clear.  Wal-Mart was in pitched battle with Target to "own" the discount market which had crushed KMart.  Sears was pinched by them on the low end, and by better operators of vertically focused companies such as Kohl's for clothing, Best Buy for appliances and Home Depot for repair and landscape tools.  Sears was swimming against the trends, and Ed Lampert had no plans to re-invent the company.  What lay ahead was cost-cutting and store closings which would kill both brands in a market already overly saturated with traditional brick-and-mortar retailers as long-term more sales moved on-line.

Now Sears Holdings has gone full circle.  In the last 12 months the stock has dropped from $95 to $31.50 - a decline of more than two thirds (a loss of over $7B in investor value.)  Sears and KMart have no future, nor do the Craftsman or Kenmore brands.  After Christmas management announced a new round of store closings as same stores sales continues its never-ending slide, and finally most industry analysts are saying Sears has nowhere to go but down. 

The retail future belongs to Amazon.com - which is where you should invest if you want to grow portfolio value in 2012.  Look to Kindle Fire and other tablets to accelerate the retail movement on-line, while out-of-date Sears becomes even less relevant and of lower value.

Stay out of Nokia and Research in Motion - Buy Apple

On February 15 I wrote that Nokia had made a horrible CEO selection, and was a stock to avoid.  Nokia invesors lost about $18B of value in 2001 as the stock lost  50% of its market cap in 2011 (62% peak to trough.) May 20 I pounded the table to sell RIMM, which lost nearly 80% of its investor value in 2011 - nearly $60B! 

Both companies simply missed the market shift in smart phones.  Nokia did its best Motorola imitation, which missed the shift from analog to digital cell phones - and then completely missed the shift to smart phones - driving the company to near bankruptcy and acquisition by Google for its patent library.  With no game at all, the Nokia Board hired a former Microsoft executive to arrange a shotgun wedding for launching a new platform - 3 years too late.  Now Apple and Android have over 400,000 apps each, growing weekly, while Microsoft is struggling with 50k apps, no compelling reason to switch and struggles to build a developer network.  Nokia's road to oblivion appears clear.

RIM was first to the smartphone market, and had it locked up for years.  Unfortunately, top management and many investors felt that the huge installed base of corporate accounts, using Blackberry secure servers, would protect the company from competition.  Now the New York Times has reported RIM leadership as one of the worst in 2011, because an installed base is no longer the competitive entry barrier Michael Porter waxed about in the early 1980s.  Corporations are following their users to better productivty by moving fast as possible to the iOS and Android worlds. 

RIM's doomed effort to launch an ill-devised, weakly performing tablet against the Apple iPod juggernaut only served to embarrass the company, at great expense.  At this point, there's little reason to think RIM will do any better than Palm did when the technology shifted, and anyone holding RIMM will likely end up with nothing (as did holders of PALM.)  If you want to be in mobile your best pick is market leading and profitably growing Apple, with a second position in Google as it builds up ancillary products like Chrome to leverage its growing Android base.

 Avoid HP and Sony - Buy Apple

Speaking of Palm, to paraphrase Senator Dirkson "that billion here, a billion there" that added up to some real money lost for HP.  Mark Hurd consolidated HP into a company focused on building volume largely in other people's technology - otherwise known as PCs.  As printing declines, and people shift to tablets and cloud apps, HP has less and less ability to build its profit base. The trends were all going in the wrong direction as market shifts make HP less and less relevant to consumer and corporate customers. 

Selecting Mr. Apotheker was a disastrous choice, and I called for investors to dump the stock when he was hired in January.  An ERP executive, he was firmly planted in the technology of the 1990s.  With a diminished R&D, and an atrophied new product development organization HP is nothing like the organization of its founders, and the newest CEO has offered no clear path for finding the trends and re-igniting growth at HP.  If you want to grow in what we used to call the PC business you need to be in tablets now - and that gets you back, once again, to Apple first, and Google second.

Which opens the door for discussing what in the 1960s through 1980s was the most innovative of all consumer electronics companies, Sony.  But when Mr. Morita was replaced by an MBA CEO that began focusing the company on the bottom line, instead of new gadgets, the pipeline rapidly dried.  Acquisitions, such as a music label, replaced R&D and new product development.  Allegiance to protecting the CD and DVD business, and the players Sony made - along with traditional TVs and PCs - meant Sony missed the wave to MP3, to mobile digital entertainment devices, to DVRs and the emerging market for interactive TV.  What was once a leader is now a follower. 

As a result Sony has lost $4.5B in investor value the last 3 year, and in 2011 lost half its value falling from $37 to $18/share.  As Apple emerges as the top consumer electronics technology leader and profit creator, closely chased by Google, it is unlikely Sony will ever recover that lost value. 

Buying Apple, Amazon, Google and Netflix

This column has already made the case for Apple.  It is almost incomprehensible how far a lead Apple has over its competition, causing investors to fear for its revenue growth prospects.  As a result, the companies P/E multiple is a remarkably low single-digit number, even though its growth is well into the double digits!  But its existing position in growth markets, technology leadership and well oiled new product development capability nearly assures continued profitbale growth for at least 5 years.  Even though the stock, which I recommended as my number 1 buy in January, 2011, has risen some 30% maintaining a big position is remains an investors best portfolio enhancer.

Amazon was a wild ride in 2011, and today is worth almost the same as it was one year ago.  Given that the company is now larger, has a more dominant position in publishing and is the world leader on the trend to on-line retail it is a very good stock to own.  The choice to think long-term and build its user links through sales of Kindle Fire at cost has limited short-term profits, but every action Amazon has taken to grow has paid off handsomely because they accelerate the natural trends and position Amazon as the leader.  Remaining with the trends, and the growth, offers the potential for big payoff this year and for years to come.

Google remains #2 in most markets, but remains aligned with the trends.  It was disappointing that the company cancelled so many great products in 2011 - such as Gear and Wave. And it faces stiff competition in its historical ad markets from the shift toward social media and Facebook's emergence.  However, Google is the best positioned company to displace Microsoft on all those tablets out there with its Chrome apps, and it still is a competitor with the potential for long-term value creation.  It's just hard to be as excited about Google as Apple and Amazon. 

Netflix started 2011 great, but then stumbled.  Starting the year at $190, Netflix rose to $305 before falling to $75.  Investors have seen an 80% decline from the peak, and a 60% decline from beginning of the year.  But this was notably not because company revenues or profits fell, because they didn't.  Rather concerns about price changes and long-term competition caused the stock to drop.  And that's why I remain bullish for owning Netflix in 2012.

Growth can hide a multitude of sins, as I pointed out when making the case to buy in October.  And Netflix has done a spectacular job of preparing itself to transition from physical DVDs to video downloads.  The "game" is not over, and there is a lot of content warring left.  But Netflix was first, and has the largest user base.  Techcrunch recently reported on a Citi survey that found Netflix still has nearly twice the viewership of #2 Hulu (27% vs. 15%.) 

Those who worry about Amazon, Google or Apple taking the Netflix position forget that those companies are making huge bets to compete in other markets and have shown less interest in making the big investments to compete on the content that is critical in the download market.  AOL and Yahoo are also bound up trying to define new strategies, and look unlikely to ever be the content companies they once were.

For those who are banking on competitive war with Comcast and other cable companies to kill off Netflix look no further than how they define themselves (cable operators,) and their horrific customer relationship scores to realize that they are more interested in trying to preserve their old business than rapidly enter a new one.  Perhaps one will try to buy Netflix, but they don't have the management teams or organization to compete effectively.

The fact is that Netflix still has the best strategy for its market, which is still growing exponentially, has the best pricing and is rapidly growing its content to remain in the top position.  That makes it a likely pick for "turnaround of the year" by end of 2012 (at least in the tech/media industry) - even as investments rise over the next 12 months.

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.

Leadership Matters - Ballmer vs. Bezos

Not far from each other, in the area around Seattle, are two striking contrasts in leadership.  They provide significant insight to what creates success today.

Steve Ballmer leads Microsoft, America's largest software company.  Unfortunately, the value of Microsoft has gone nowhere for 10 years.  Steve Ballmer has steadfastly defended the Windows and Office products, telling anyone who will listen that he is confident Windows will be part of computing's future landscape.  Looking backward, he reminds people that Windows has had a 20 year run, and because of that past he is certain it will continue to dominate.

Unfortunately, far too many investors see things differently.  They recognize that nearly all areas of Microsoft are struggling to maintain sales.  It is quite clear that the shift to mobile devices and cloud architectures are reducing the need, and desire, for PCs in homes, offices and data centers.  Microsoft appears years late recognizing the market shift, and too often CEO Ballmer seems in denial it is happening - or at least that it is happening so quickly.  His fixation on past success appears to blind him to how people will use technology in 2014, and investors are seriously concerned that Microsoft could topple as quickly DEC., Sun, Palm and RIM. 

Comparatively, across town, Mr. Bezos leads the largest on-line retailer Amazon.  That company's value has skyrocketed to a near 90 times earnings!  Over the last decade, investors have captured an astounding 10x capital gain!  Contrary to Mr. Ballmer, Mr. Bezos talks rarely about the past, and almost almost exclusively about the future.  He regularly discusses how markets are shifting, and how Amazon is going to change the way people do things. 

Mr. Bezos' fixation on the future has created incredible growth for Amazon.  In its "core" book business, when publishers did not move quickly toward trends for digitization Amazon created and launched Kindle, forever altering publishing.  When large retailers did not address the trend toward on-line shopping Amazon expanded its retail presence far beyond books, including more products  and a small armyt of supplier/partners.  When large PC manufacturers did not capitalize on the trend toward mobility with tablets for daily use Amazon launched Kindle Fire, which is projected to sell as many as 12 million units next year (AllThingsD.com). 

Where Mr. Ballmer remains fixated on the past, constantly reinvesting  in defending and extending what worked 20 years ago for Microsoft, Mr. Bezos is investing heavily in the future.  Where Mr. Ballmer increasingly looks like a CEO in denial about market shift, Mr. Bezos has embraced the shifts and is pushing them forward. 

Clearly, the latter is much better at producing revenue growth and higher valuation than the former.

As we look around, a number of companies need to heed the insight of this Seattle comparison:

• At AOL it is unclear that Mr. Armstrong has a clear view of how AOL will change markets to become a content powerhouse.  AOL's various investments are incoherent, and managers struggle to see a strong future for AOL.  On the other hand, Ms. Huffington does have a clear sense of the future, and the insight for an entirely different business model at AOL.  The Board would be well advised to consider handing the reigns to Ms. Huffington, and pushing AOL much more rapidly toward a different, and more competitive future.
• Dell's chronic inability to identify new products and markets has left it, at best, uninteresting.  It's supply chain focused strategy has been copied, leaving the company with practically no cost/price advantage.  Mr. Dell remains fixated on what worked for his initial launch 30 years ago, and offers no exciting description of how Dell will remain viable as PC sales diminish.  Unless new leadership takes the helm at Dell, the company's future  5 years hence looks bleak.
• HP's new CEO Meg Whitman is less than reassuring as she projects a terrible 2012 for HP, and a commitment to remaining in PCs - but with some amorphous pledge toward more internal innovation.  Lacking a clear sense of what Ms. Whitman thinks the world will look like in 2017, and how HP will be impactful, it's hard for investors, managers or customers to become excited about the company.  HP needs rapid acceleration toward shifting customer needs, not a relaxed, lethargic year of internal analysis while competitors continue moving demand further away from HP offerings.
• Groupon has had an explosive start.  But the company is attacked on all fronts by the media.  There is consistent questioning of how leadership will maintain growth as reports emerge about founders cashing out their shares, highly uneconomic deals offered by customers, lack of operating scale leverage, and increasing competition from more established management teams like Google and Amazon.  After having its IPO challenged by the press, the stock has performed poorly and now sells for less than the offering price.  Groupon desperately needs leadership that can explain what the markets of 2015 will look like, and how Groupon will remain successful.

What investors, customers, suppliers and employees want from leadership is clarity around what leaders see as the future markets and competition.  They want to know how the company is going to be successful in 2 or 5 years.  In today's rapidly shifting, global markets it is not enough to talk about historical results, and to exhibit confidence that what brought the company to this point will propel it forward successfully. And everyone recognizes that managing quarter to quarter will not create long term success.

Leaders must  demonstrate a keen eye for market shifts, and invest in opportunities to participate in game changers.  Leaders must recognize trends, be clear about how those trends are shaping future markets and competitors, and align investments with those trends.  Leadership is not about what the company did before, but is entirely about what their organization is going to do next. 

Update 30 Nov, 2011

In the latest defend & extend action at Microsoft Ballmer has decided to port Office onto the iPad (TheDaily.com).  Short term likely to increase revenue.  But clearly at the expense of long-term competitiveness in tablet platforms.  And, it misses the fact that people are already switching to cloud-based apps which obviate the need for Office.  This will extend the dying period for Office, but does not come close to being an innovative solution which will propel revenues over the next decade.

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? 

Gladiators get killed. Dump Wal-Mart; Buy Amazon

Wal-Mart has had 9 consecutive quarters of declining same-store sales (Reuters.)  Now that's a serious growth stall, which should worry all investors.  Unfortunately, the odds are almost non-existent that the company will reverse its situation, and like Montgomery Wards, KMart and Sears is already well on the way to retail oblivion.  Faster than most people think.

After 4 decades of defending and extending its success formula, Wal-Mart is in a gladiator war against a slew of competitors.  Not just Target, that is almost as low price and has better merchandise.  Wal-Mart's monolithic strategy has been an easy to identify bulls-eye, taking a lot of shots.  Dollar General and Family Dollar have gone after the really low-priced shopper for general merchandise.  Aldi beats Wal-Mart hands-down in groceries.  Category killers like PetSmart and Best Buy offer wider merchandise selection and comparable (or lower) prices.  And companies like Kohl's and J.C. Penney offer more fashionable goods at just slightly higher prices.  On all fronts, traditional retailers are chiseling away at Wal-Mart's #1 position - and at its margins!

Yet, the company has eschewed all opportunities to shift with the market.  It's primary growth projects are designed to do more of the same, such as opening smaller stores with the same strategy in the northeast (Boston.com).  Or trying to lure customers into existing stores by showing low-price deals in nearby stores on Facebook (Chicago Tribune) - sort of a Facebook as local newspaper approach to advertising. None of these extensions of the old strategy makes Wal-Mart more competitive - as shown by the last 9 quarters.

On top of this, the retail market is shifting pretty dramatically.  The big trend isn't the growth of discount retailing, which Wal-Mart rode to its great success.  Now the trend is toward on-line shopping.  MediaPost.com reports results from a Kanter Retail survey of shoppers the accelerating trend:

• In 2010, preparing for the holiday shopping season, 60% of shoppers planned going to Wal-Mart, 45% to Target, 40% on-line
• Today, 52% plan to go to Wal-Mart, 40% to Target and 45% on-line.

This trend has been emerging for over a decade.  The "retail revolution" was reported on at the Harvard Business School website, where the case was made that traditional brick-and-mortar retail is considerably overbuilt.  And that problem is worsening as the trend on-line keeps shrinking the traditional market.  Several retailers are expected to fail.  Entire categories of stores.  As an executive from retailer REI told me recently, that chain increasingly struggles with customers using its outlets to look at merchandise, fit themselves with ideal sizes and equipment, then buying on-line where pricing is lower, options more plentiful and returns easier!

While Wal-Mart is huge, and won't die overnight, as sure as the dinosaurs failed when the earth's weather shifted, Wal-Mart cannot grow or increase investor returns in an intensely competitive and shifting retail environment.

The winners will be on-line retailers, who like David versus Goliath use techology to change the competition.  And the clear winner at this, so far, is the one who's identified trends and invested heavily to bring customers what they want while changing the battlefield.  Increasingly it is obvious that Amazon has the leadership and organizational structure to follow trends creating growth:

• Amazon moved fairly quickly from a retailer of out-of-inventory books into best-sellers, rapidly dominating book sales bankrupting thousands of independents and retailers like B.Dalton and Borders.
• Amazon expanded into general merchandise, offering thousands of products to expand its revenues to site visitors.
• Amazon developed an on-line storefront easily usable by any retailer, allowing Amazon to expand its offerings by millions of line items without increasing inventory (and allowing many small retailers to move onto the on-line trend.)
• Amazon created an easy-to-use application for authors so they could self-publish books for print-on-demand and sell via Amazon when no other retailer would take their product.
• Amazon recognized the mobile movement early and developed a mobile interface rather than relying on its web interface for on-line customers, improving usability and expanding sales.
• Amazon built on the mobility trend when its suppliers, publishers, didn't respond by creating Kindle - which has revolutionized book sales.
• Amazon recently launched an inexpensive, easy to use tablet (Kindle Fire) allowing customers to purchase products from Amazon while mobile. MediaPost.com called it the "Wal-Mart Slayer"

 Each of these actions were directly related to identifying trends and offering new solutions.  Because it did not try to remain tightly focused on its original success formula, Amazon has grown terrifically, even in the recent slow/no growth economy.  Just look at sales of Kindle books:

Source: BusinessInsider.com

Unlike Wal-Mart customers, Amazon's keep growing at double digit rates.  In Q3 unique visitors rose 19% versus 2010, and September had a 26% increase.  Kindle Fire sales were 100,000 first day, and 250,000 first 5 days, compared to  80,000 per day unit sales for iPad2.  Kindle Fire sales are expected to reach 15million over the next 24 months, expanding the Amazon reach and easily accessible customers.

While GroupOn is the big leader in daily coupon deals, and Living Social is #2, Amazon is #3 and growing at triple digit rates as it explores this new marketplace with its embedded user base.  Despite only a few month's experience, Amazon is bigger than Google Offers, and is growing at least 20% faster. 

After 1980 investors used to say that General Motors might not be run well, but it would never go broke.  It was considered a safe investment.  In hindsight we know management burned through company resources trying to unsuccessfully defend its old business model.  Wal-Mart is an identical story, only it won't have 3 decades of slow decline.  The gladiators are whacking away at it every month, while the real winner is simply changing competition in a way that is rapidly making Wal-Mart obsolete. 

Given that gladiators, at best, end up bloody - and most often dead - investing in one is not a good approach to wealth creation.  However, investing in those who find ways to compete indirectly, and change the battlefield (like Apple,) make enormous returns for investors.  Amazon today is a really good opportunity.

Will Meg Whitman be more like Steve Jobs, or Carol Bartz?

The media has enjoyed a field day last week amidst the ouster of Leo Apotheker as Hewlett Packard's CEO and appointments of former Oracle executive Ray Lane as Executive Chairman and former eBay CEO Meg Whitman as CEO.  There have been plenty of jabs at the Board, which apparently hired Mr. Apotheker without everyone even meeting him (New York Times), and plenty of complaining about HP's deteriorating performance and stock price.  But the big question is, will Meg Whitman be able to turn around HP?

Ms. Whitman is the 7th HP CEO in a mere 12 years.  Of those CEOs, the only one pointed to with any attraction was Mark Hurd.  He did not take any strategic actions, but merely slashed costs - which immediately improved the profit line and drove up the short-term stock price.  Actions taken at the expense of R&D, new product development and creating new markets, leaving HP short on a future strategy when he was summarily let go by the Baord that hired Apotheker. 

And that indicates the strategy problem at HP - which is pretty much a lack of strategy.

HP was once a highly innovative company. We all can thank HP for a world of color.  Before HP brought us the low-priced ink-jet printer all office printing was black.  HP unleashed the color in desktop publishing, and was critical to the growth of office and home printing, as well as faxing with their all-in-one, integrated devices. 

But then someone - largely Ms. Fiorina - had the idea to expand on the HP presence in desktop publishing by expanding into PC manufacturing and sales, even though there was no HP innovation in that market.  Mr. Hurd expanded that direction by buying a service organization to support field-based PCs. 

This approach of expanding on HPs "core" printer business, almost all by acquisition, cost HP a lot of money.  Further, supply chain and retail program investments to sell largely undifferentiated products and services in a hotly contested PC market sucked all the money out of new products development.  Every year HP was spending more to grow sales of products becoming increasingly generic, while falling farther behind in any sort of new market creation.

Into that innovation void jumped Apple, Google and Amazon.  They pushed new mobile solutions to market in smartphones and tablets.  And now PCs, and the printers they used, are seeing declining growth.  All future projections show an increase in mobile devices, and a sales cliff emerging for PCs and their supporting devices.  Simultaneously as mobile devices have become more popular the trend away from printing has grown, with users in business and consumer markets finding digital devices less costly, more user friendly and more adaptable than printed material (just compare Kindle sales and printed book sales - or the volume of tablet newspaper and magazine subscriptions to printed subscriptions.)  HP invested heavily in PC products, and now that market is dying. 

Now HP is in big trouble.  There are plenty of skeptics that think Ms. Whitman is not right for the job. What should HP under Ms. Whitman do next?  Keep doubling down on investments in existing markets?  That direction looks pretty dangerous.  IBM jumped out years ago, selling its laptop line to Lenovo for a tidy profit before sales slackened.  With all the growth in smartphones and tablets, it's hard to imagine that strategy would work.  Even Mr. Apotheker took action to deal with the market shift by redirecting HP away from PCs with his announced intention to spin off that business while buying an ERP (enterprise ressource planning) software company to take HP into a new direction.  But that backfired on him, and investors.

Mr. Apotheker and Carol Bartz, recently fired CEO of Yahoo, made similar mistakes.  They relied heavily on their personal past when taking leadership of a struggling enterprise. They looked to their personal success formulas - what had worked for them in the past - when setting their plans for their new companies.  Unfortunately, what worked in the past rarely works in the future, because markets shift.  And both of these companies suffered dramatically as the new CEO efforts took them further from market trends. 

The job Ms. Whitman is entering at HP is wildly different from her job at eBay.  eBay was a small company taking advantage of the internet explosion.  It was an early leader in capitalizing on web networking and the capability of low-cost on-line transactions.  At eBay Ms. Whitman needed to keep the company focused on investing in new solutions that transformed PC and internet connectivity into value for users.  As long as the number of users on the internet, and the time they spent on the web, grew eBay could capitalize on that trend for its own growth.  eBay was in the right place at the right time, and Ms. Whitman helped guide the company's product development so that it helped users enjoy their on-line experience.  The trends supported eBay's early direction, and growth was built opon making on-line selling better, faster and easier.

The situation could not be more different at HP.  It's products are almost all out of the trend.  If Ms. Whitman does what she did at eBay, trying to promote more, better and faster PCs, printers and traditional IT services things will not go well.  That was Mr. Hurd's strategy.  "Been there, done that" as people like to say.  That strategy ran its course, and more cost-cutting will not save HP.

In 2020 if we are to discuss HP the way we now discuss Apple's dramatic turnaround from the brink of failure, Ms. Whitman will have to behave very differently than her past - and from what her predecessor and Ms. Bartz did.  She has to refocus HP on future markets.  She has to identify triggers for market change - like Steve Jobs did when he recognized that the growing trend to mobility would explode once WiFi services reached 50% of users - and push HP toward developing solutions which take advantage of those market shifts.

HP has under-invested in new market development for years.  It's acquisition of Palm was supposed to somehow rectify that problem, only Palm was a failing company with a failing platform when HP bought it.  And the HP tablet launch with its own proprietary solution was far too late (years too late) in a market that requires thousands of developers and a hundred thousand apps if it is to succeed.  The investment in Palm and WebOS was too late, and based on trying to be a "me too" in a market where competitors are rapidly advancing new solutions. 

There are a world of market opportunities out there that HP can develop.  To reach them Ms. Whitman must take some quick actions:

1. Develop future scenarios that define the direction of HP.  Not necessarily a "vision" of HP in 2020, but certainly an identification of the big trends that will guide HP's future direction for product and market development.  Globalization (like IBM's "smarter planet") or mobility are starts - but HP will have to go beyond the obvious to identify opportunities requiring the resources of a company with HP's revenue and resources.  HP desperately needs a pathway to future markets.  It needs to be developing for the emerging trends.
2. A recognition of how HP will compete.  What is the market gap that HP will fulfill - like Apple did in mobility?  And how will it fulfill it?  Google and Facebook are emerging giants in software, offering a host of new capabilities every day to better network users and make them more productive.  HP must find a way to compete that is not toe-to-toe with existing leaders like Apple that have more market knowledge and extensive resoureces.
3. HP needs to dramatically up the ante in new product development.  Innovation has been sorely lacking, and the hierarchical structure at HP needs to be changed.  White Space projects designed to identify opportunities in market trends need to be created that have permission to rapidly develop new solutions and take them to market - regardless of HP historical strengths.  Resources need to shift - rapidly - from supporting the aging, and growth challenged, historical product lines to new opportunities that show greater growth promise.

Apple and IBM were once given almost no chance of survival.  But new leadership recognized that there were growth markets, and those leaders altered the resource allocation toward things that could grow.  Investments in the old strategy were dropped as money was pushed to new solutions that built on market trends and headed toward future scenarios.  HP is not doomed to failure, but Ms. Whitman has to start acting quickly to redirect resources or it could easily be the next Sun Microsystems, Digital Equipment, Wang, Lanier or Cray

Where Bartz Blew It, and What Yahoo! Needs To Do Now

Carol Bartz was unceremoniously fired as CEO by Yahoo's Board last week.  Fearing their decision might leak, the Chairman called Ms. Bartz and fired her over the phone.  Expeditious, but not too tactful.  Ms. Bartz then informed the company employees of this action via an email from her smartphone - and the next day called the Board of Directors a bunch of doofusses in a media interview.  Salacious fodder for the news media, but a distraction from fixing the real problems affecting Yahoo!

Unfortunately, the Yahoo Board seems to have no idea what to do now.  A small executive committee is running the company - which assures no bold actions.  And a pair of investment banks have been hired to provide advice - which can only lead to recommendations for selling all, or pieces, of the company.  Most people seem to think Yahoo's value is worth more sold off in chunks than it is as an operating company.  Wow - what went so wrong?  Can Yahoo not be "fixed"?

There was a time, a decade or so back, when Yahoo was the #1 home page for browsers.  Yahoo! was the #1 internet location for reading news, and for doing internet searches.  And, it pioneered the model of selling internet ads to support the content aggregation and search functions.  Yahoo was early in the market, and was a tremendous success.

Like most companies, Yahoo kept doing more of the same as its market shifted.  Alta Vista, Microsoft and others made runs at Yahoo's business, but it was Google primarily that changed the game on Yahoo!  Google invested heavily in technology to create superior searches, offered a superior user experience for visitors, gave unique content (Google Maps as an example) and created a tremendously superior engine for advertisers to place their ads on searches - or web pages. 

Google was run by technologists who used technology to dramatically improve what Yahoo started - seeing a future which would take advantage of an explosion in users and advertisers as well as web pages and internet use.  Yahoo had been run by advertising folks who missed the technology upgrades.  Yahoo's leadership was locked-in to what it new (advertising) and they were slow with new solutions and products, falling further behind Google every year.

In an effort to turn the tide, Yahoo hired what they thought was a technologist in Carol Bartz to run the company.  She had previously led AutoCad, which famously ran companies like IBM, Intergraph, DEC (Digital Equipment) and General Electric owned CALMA out of the CAD/CAM (computer aided design and manufacturing) business.  She had been the CEO of a big technology winner - so she looked to many like the salvation for Yahoo!

But Ms. Bartz really wasn't familiar with how to turn an ad agency into a tech company - nor was she particularly skilled at new product development.  Her skills were mostly in operations, and developing next generation software.  AutoCad was one of the first PC-based CAD products, and over 2 decades AutoCad leveraged the increasing power of PCs to make its products better, faster and relatively cheaper.  This constant improvement, and close attention to cost control, made it possible for AutoCad on a PC to come closer and closer to doing what the $250,000 workstations had done.  Users switched to the cheaper AutoCad not because it suddenly changed the game, but because PC enhancements made the older, more costly technology obsolete.

Ms. Bartz was stuck on her success formula.  Constantly trying to improve.  At Yahoo she implemented cost controls, like at AutoCad.  But she didn't create anything significantly new.  She didn't pioneer any new platforms (software or hardware) nor any dramatically new advertising or search products.  She tried to do deals, such as with Bing, to somehow partner into better competitiveness, but each year Yahoo fell further behind Google.  In a real way, Ms. Bartz fell victim to Google just as DEC had fallen victim to AutoCad.  Trying to Defend & Extend Yahoo was insufficient to compete with the game changing Google.

The Board was right to fire Ms. Bartz.  She simply did what she knew how to do, and what she had done at AutoCad.  But it was not what Yahoo needed - nor what Yahoo needs now.  Cost cutting and improvements are not going to catch the ad markets now driven by Google (search and adwords) and Facebook (display ads.)  Yahoo is now out of the rapidly growing market - social media - that is driving the next big advertising wave.

Breaking up Yahoo is the easy answer.  If the Board can get enough money for the pieces, it fulfills its fiduciary responsibility.  The stock has traded near $15/share for 3 years, and the Board can likely obtain the $18B market value for investors.  But "another one bites the dust" as the song lyrics go - and Yahoo will follow DEC, Atari, Cray, Compaq, Silicon Graphics and Sun Microsystems into the technology history on Wikipedia.  And those Yahoo employees will have to find jobs elsewhere (oh yeah, that pesky jobs problem leading to 9%+ U.S. unemployment comes up again.)

A better answer would be to turn around Yahoo!  Yahoo isn't in any worse condition than Apple was when Steve Jobs took over as CEO.  It's in no worse condition than IBM was when Louis Gerstner took over as its CEO.  It can be done.  If done, as those examples have shown, the return for shareholders could be far higher than breaking Yahoo apart.  

So here's what Yahoo needs to do now if it really wants to create shareholder value:

1. Put in place a CEO that is future oriented.  Yahoo doesn't need a superb cost-cutter.  It doesn't need a hatchet wielder, like the old "Chainsaw Al Dunlap" that tore up Scott Paper.  Yahoo needs a leader that can understand trends, develop future scenarios and direct resources into developing new products that people want and need.  A CEO who knows that investing in innovation is critical.
2. Quit trying to win the last war with Google.  That one is lost, and Google isn't going to give up its position.  Specifically, the just announced Yahoo+AOL+Microsoft venture to sell ad remnants is NOT where Yahoo needs to spend its resources.  Every one of these 3 companies has its own problems dealing with market shifts (AOL with content management as dial-up revenues die, Microsoft with PC market declines and mobile device growth.)  None is good at competing against Google, and together its a bit like asking 3 losers in a 100 meter dash if they think by forming a relay team they could somehow suddenly become a "world class" group.  This project is doomed to failure, and a diversion Yahoo cannot afford now.
3. In that same vein, quit trying to figure out if AOL or Microsoft will buy Yahoo.  Microsoft could probably afford it - but like I said - Microsoft has its hands full trying to deal with the shift from PCs to tablets and smartphones.  Buying Yahoo would be a resource sink that could possibly kill Microsoft - and it's assured Microsoft would end up shutting down the company piecemeal (as it does all acquisitions.)  AOL has seen its value plummet because investors are unsure if it will turn the corner before it runs out of cash.  While there are new signs of life since buying Huffington Post, ongoing struggles like firing the head of TechCrunch keep AOL fully occupied fighting to find its future.  Any deal with either company should send investors quickly to the sell post, and probably escalate the Yahoo demise with the lowest possible value.
4. Give business heads the permission to develop markets as they see fit.  Ms. Bartz was far too controlling of the business units, and many good ideas were not implemented.  Specifically, for example, Right Media should be given permission to really advance its technology base and go after customers unencumbered by the Yahoo brand and organization.  Right Media has a chance of being really valuable - that's why people would ostensibly buy it - so give the leaders the chance to make it successful.  Maybe then the revolving door of execs at Right (and other Yahoo business units) would stop and something good would happen.  
5. Hold existing business units "feet to the fire" on results.  Yahoo has notoriously not delivered on new ad platforms and other products - missing development targets and revenue goals.  Innovation does not succeed if those in leadership are not compelled to achieve results.  Being lax on performance has killed new product development - and those things that aren't achieving results need to stop.  Specifically, it's probably time to stop the APT platform that is now years behind, and because it's targeted against Google unlikely to ever succeed.
6. Invest in new solutions.  Take all that wonderful trend data that Yahoo has (maybe not as much as Google - but a lot more than most companies) and figure out what Yahoo needs to do next.  Rip off a page from Apple, which flattened spending on the Mac in order to invest in the iPod.  Learn from Amazon, which followed the trends in retail to new storefronts, expanded offerings, a mobile interface and Kindle launch.  Yahoo needs to quit trying to gladiator fight with Google - where it can't win - and identify new markets and solutions where it can.  Yahoo must quit being a hostage to its history, and go do the next big thing! Create some white space in the company to invest in new solutions on the trends!

Of course, this is harder than just giving up and selling the company.  But the potential returns are much, much higher.  Yahoo's predicament is tough, but it's been a management failure that got it here.  If management changes course, and focuses on the future, Yahoo can once again become a market leading company.  Sure would like to see that kind of leadership.  It's how America creates jobs.