They stayed too long at the (holiday) party - The Oracle and Best Buy Hangover

It's a wise person who knows never to be the last person at a business holiday party.  Things never go well for those who stay too late. 

Yet, far too many businesses stay way, way too long at their market party, focusing on the same strategy when they should have moved into new competition a whole lot earlier.

This week Oracle missed earnings estimates, and the stock fell some 14%, from $30 to under $26.  For the year, Oracle is down about a third, from it's high of $37.  The question any investor needs to ask is the one headlined by ZDnet.com "Oracle Earnings: An Aberration or Trend?"

Oracle is very, very poorly positioned for future earnings growth.  Like most big software companies, including Microsoft and SAP, Oracle built its business on the formula of large data centers running large "enterprise applications" supporting lots of independent corporate PC users. 

And it was clear fully a year (or 2) ago that market simply isn't growing.  Organizations are rapidly shifting away from hard to use, one-size-fits-all (at very high cost) enterprise software applications.  Users are moving away from PCs to mobile devices, and refusing to use clunky enterprise interfaces.  Worse, software is moving away from data centers in client-server configurations tied to PCs.  Instead, companies small and large are rapidly shifting to software-as-service (SAS) environments where the company can pay "by the use" for software maintained in the "cloud."  These solutions are scalable, cheaper to buy, cheaper to implement, vastly more flexible and operate on mobile devices a whole lot better.  If you've ever used Salesforce.com you've experienced the benefit compared to more clunky enterprise Customer Resource Management (CRM) applications.

Oracle missed this trend.  Despite all the dozens of acquisitions Oracle has made - such as buying Unix hardware provider Sun Microsystems, it largely missed the shift to cloud architectures.  It has remained far, far too long at its party, enjoying the profit-laden punch, and hoping the market would never shift.  As the customer base shrank to fewer, and ever larger, big corporations Oracle did not prepare for changes in its business the next day.  Oracle has stayed too long, and its ability to compete in new markets against more flexible solution providers such as IFS with better user interface capabilities looks really weak. 

Somehow, Best Buy fell into the same trap.  In early December the country's largest "big box" retailer announced lower earnings after cutting prices to shore up revenues.  As a result the stock dropped 20%, from about $28 to $22 - continuing a pretty much downhill slide all year of nearly 40% from its high of $36.

Best Buy felt like it was doing great after Circuit City failed.  Circuit City had been a darling of the infamous "Good to Great" text.  But Circuit City demonstrated that in a market dominated by a long-term trend away from fixed stores and toward on-line purchases, every retailer is bound to struggle. 

When Circuit City failed in 2008 investors worried that a weak economy would tank Best Buy as well.  But as all that Circuit City capacity disappeared, Best Buy was a short-term winner.

Unfortunately, Best Buy leadership confused short-term sales re-allocation with long-term trends.  They, along with a lot of other locked-in brick-and-mortar retailers, felt that things would quickly "return to normal" and Circuit City was the company caught out in the cold when the music stopped.  Best Buy chose to stay at its party too long - hoping the dancing would never stop.  Its leaders chose to ignore the long-term trend away from traditional retail toward on-line shopping.  No wonder BusinessInsider.com headlined a famed investor "Marc Andreessen: Retailers Should Be Scared About 2012."

What's surprising is how many people in business think the party will simply never end.  That everyone can keep drinking and dancing and rolling in the profits.  Even when the trends are obvious.

This 2011 holiday season, every business team should be asking itself "are we staying at the party too long?  What trends are affecting our business - and likely to bring this party to a crashing end?  What are we doing to prepare for a tough competition tomorrow." 

If you don't, it's far too easy you could end up on the downhill slide, with one heck of a horrible hangover - like Oracle and Best Buy - in 2012.

 

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.

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.

From the Frying Pan into the Fire - Google's Motorola Problem

The business world was surprised this week when Google announced it was acquiring Motorola Mobility for $12.5B - a 63% premium to its trading price (Crain's Chicago Business).  Surprised for 3 reasons:

1. because few software companies move into hardware
2. effectively Google will now compete with its customers like Samsung and HTC that offer Android-based phones and tablets,  and
3. because Motorola Mobility had pretty much been written off as a viable long-term competitor in the mobile marketplace.  With less than 9% share, Motorola is the last place finisher - behind even crashing RIM.

Truth is, Google had a hard choice.  Android doesn't make much money.  Android was launched, and priced for free, as a way for Google to try holding onto search revenues as people migrated from PCs to cloud devices.  Android was envisioned as a way to defend the search business, rather than as a profitable growth opportunity.  Unfortunately, Google didn't really think through the ramifications of the product, or its business model, before taking it to market.  Sort of like Sun Microsystems giving away Java as a way to defend its Unix server business. Oops.

In early August, Google was slammed when the German courts held that the Samsung Galaxy Tab 10.1 could not be sold - putting a stop to all sales in Europe (Phandroid.com "Samsung Galaxy Tab 10.1 Sales Now Blocked in Europe Thanks to Apple.") Clearly, Android's future in Europe was now in serious jeapardy - and the same could be true in the USA.

This wasn't really a surprise.  The legal battles had been on for some time, and Tab had already been blocked in Australia.  Apple has a well established patent thicket, and after losing its initial Macintosh Graphical User Interface lead to Windows 25 years ago Apple plans on better defending its busiensses these days.  It was also well known that Microsoft was on the prowl to buy a set of patents, or licenses, to protect its new Windows Phone O/S planned for launch soon. 

Google had to either acquire some patents, or licenses, or serously consider dropping Android (as it did Wave, Google PowerMeter and a number of other products.)  It was clear Google had severe intellectual property problems, and would incur big legal expenses trying to keep Android in the market.  And it still might well fail if it did not come up with a patent portfolio - and before Microsoft!

So, Google leadership clearly decided "in for penny, in for a pound" and bought Motorola. The acquisition now gives Google some 16-17,000 patents.  With that kind of I.P. war chest, it is able to defend Android in the internicine wars of intellectual property courts - where license trading dominates resolutions between behemoth competitors.

Only, what is Google going to do with Motorola (and Android) now?  This acquisition doesn't really fix the business model problem.  Android still isn't making any money for Google.  And Motorola's flat Android product sales don't make any money either. 

Source: Business Insider.com

In fact, the Android manufacturers as a group don't make much money - especially compared to industry leader Apple:

Source: Business Insider.com

There was a lot of speculation that Google would sell the manufacturing business and keep the patents.  Only - who would want it?  Nobody needs to buy the industry laggard.  Regardless of what the McKinsey-styled strategists might like to offer as options, Google really has no choice but to try running Motorola, and figuring out how to make both Android and Motorola profitable.

And that's where the big problem happens for Google.  Already locked into battles to maintain search revenue against Bing and others, Google recently launched Google+ in an all-out war to take on the market-leading Facebook.  In cloud computing it has to support Chrome, where it is up against Microsoft, and again Apple.  Oh my, but Google is now in some enormously large competitive situations, on multiple fronts, against very well-heeled competitors.

As mentioned before, what will Samsung and HTC do now that Google is making its own phones?  Will this push them toward Microsoft's Windows offering?  That would dampen enthusiasm for Android, while breathing life into a currently non-competitor in Microsoft.  Late to the game, Microsoft has ample resources to pour into the market, making competition very, very expensive for Google.  It shows all the signs of two gladiators willing to fight to the loss-amassing death.

And Google will be going into this battle with less-than-stellar resources.  Motorola is the market also ran.  Its products are not as good as competitors, and its years of turmoil - and near failure - leading to the split-up of Motorola has left its talent ranks decimated - even though it still has 19,000 employees Google must figure out how to manage ("Motorola Bought a Dysfunctional Company and the Worst Android Handset Maker, says Insider").  

Acquisitions that "work" are  ones where the acquirer buys a leader (technology, products, market) usually in a high growth area - then gives that acquisition the permission and resources to keep adapting and growing - what I call White Space.  That's what went right in Google's acquisitions of YouTube and DoubleClick, for example.  With Motorola, the business is so bad that simply giving it permssion and resources will lead to greater losses.  It's hard to disaagree with 24/7 Wall Street.com when divulging "S&P Gives Big Downgrade on Google-Moto Deal."

Some would like to think of Google as creating some transformative future for mobility and copmuting.  Sort of like Apple. 

Yea, right.

Google is now stuck defending & extending its old businesses - search, Chrome O/S for laptops, Google+ for mail and social media, and Android for mobility products.  And, as is true with all D&E management, its costs are escalating dramatically.  In every market except search Google has entered into gladiator battles late against very well resourced competitors with products that are, at best, very similar - lacking game-changing characteristics. Despite Mr. Page's potentially grand vision, he has mis-positioned Google in almost all markets, taken on market-leading and well funded competition, and set Google up for a diasaster as it burns through resources flailing in efforts to find success.

If you weren't convinced of selling Google before, strongly consider it now.  The upcoming battles will be very, very expensive.  This acquisition is just so much chum in the water - confusing but not beneficial.

And if you still don't own Apple - why not?  Nothing in this move threatens the technology, product and market leader which continues bringing game-changers to market every few months.

How Harry Potter predicts Success for AOL

Evolution doesn't happen like we think.  It's not slow and gradual (like line A, below.)  Things don't go from one level of performance slowly to the next level in a nice continuous way.  Rather, evolutionary change happens brutally fast.  Usually the potential for change is building for a long time, but then there is some event - some environmental shift (visually depcted as B, below) - and the old is made obsolete while the new grows aggressively.  Economists call this "punctuated equilibrium."  Everyone was on an old equilibrium, then they quickly shift to something new establishing a new equilibrium.

Momentum has been building for change in publishing for several years.  Books are heavy, a pain to carry and often a pain to buy.  Now eReaders, tablets and web downloads have changed the environment.  And in June  J.K. Rowling, author of those famous Harry Potter books, opened her new web site as the location to exclusively sell Harry Potter e-books (see TheWeek.com "How Pottermore Will Revolutionized Publishing.") 

Ms. Rowling has realized that the market has shifted, the old equilibrium is gone, and she can be part of the new one.  She'll let the dinosaur-ish publisher handle physical books, especially since Amazon has already shown us that physical books are a smaller market than ebooks.  Going forward she doesn't need the publisher, or the bookstore (not even Amazon) to capture the value of her series.  She's jumping to the new equilibrium.

And that's why I'm encouraged about AOL these days.  Since acquiring The Huffington Post company, things are changing at AOL.  According to Forbes writer Jeff Bercovici, in "AOL After the Honeymoon," AOL's big slide down in users has begun to reverse direction.  Many were surprised to learn, as the FinancialPost.com recently headlined, "Huffington Post Outstrips NYT Web Traffic in May."
Source: BusinessInsider.com

The old equilibrium in news publishing is obsolete.  Those trying to maintain it keep failing, as recently headlined on PaidContent.org "Citing Weak Economy, Gannett Turns to Job Cuts, Furloughs." Nobody should own a traditional publisher, that business is not viable.

But Forbes reports that Ms. Huffington has been given real White Space at AOL.  She has permission to do what she needs to do to succeed, unbridled by past AOL business practices.  That has included hiring a stable of the best talent in editing, at high pay packages, during this time when everyone else is cutting jobs and pay for journalists.  This sort of behavior is anethema to the historically metric-driven "AOL Way," which was very industrial management.  That sort of permission is rarely given to an acquisition, but key to making it an engine for turn-around. 

And HuffPo is being given the resources to implement a new model.  Where HuffPo was something like 70 journalists, AOL is now cranking out content from some 2,000 journalists and editors!  More than The Washington Post or The Wall Street Journal.  Ms. Huffington, as the new leader, is less about "managing for results" looking at history, and more about identifying market needs then filling them.  By giving people what they want Huffington Post is accumulating readers - which leads to display ad revenue.  Which, as my last blog reported, is the fastest growing area in on-line advertising

Where the people are, you can find advertsing.  As people are shift away from newspapers, toward the web, advertising dollars are following.  Internet now trails only television for ad dollars - and is likely to be #1 soon:

Chart source: Business Insider

So now we can see a route for AOL to succeed.  As traditional AOL subscribers disappear - which is likely to accelerate - AOL is building out an on-line publishing environment which can generate ad revenue.  And that's how AOL can survive the market shift.  To use an old marketing term, AOL can "jump the curve" from its declining business to a growing one.

This is by no means a given to succeed.  AOL has to move very quickly to create the new revenues.  Subscribers and traditional AOL ad revenues are falling precipitously.

Source: Forbes.com

But, HuffPo is the engine that can take AOL from its dying business to a new one.  Just like we want Harry Potter digitally, and are happy to obtain it from Ms. Rowlings directly, we want information digitally - and free - and from someone who can get it to us.  HuffPo is now winning the battle for on-line readers against traditional media companies. And it is expanding, announced just this week on MediaPost.com "HuffPo Debuts in the UK."  Just as the News Corp UK tabloid, News of the World,  dies (The Guardian - "James Murdoch's News of the World Closure is the Shrewdest of Surrenders.")

News Corp. once had a shot at jumping the curve with its big investment in MySpace.  But leadership wouldn't give MySpace permission and resources to do whatever it needed to do to grow.  Instead, by applying "professional management" it limited MySpace's future and allowed Facebook to end-run it.  Too much energy was spent on maintaining old practices - which led to disaster.  And that's the risk at AOL - will it really keep giving HuffPo permission to do what it needs to do, and the resources to make it happen?  Will it stick to letting Ms. Huffington build her empire, and focus on the product and its market fit rather than short-term revenues?  If so, this really could be a great story for investors. 

So far, it's looking very good indeed. 

 

 

 

Precipice of success, or failure? - Don't buy Cisco

Will Cisco be like Apple and go on to continued greatness?  Or will it be more like Sun Microsystems?  The answer isn't clear yet, but the negatives are looking a lot clearer than the positives.

Cisco grew like the internet - because it supplied a lot of the internet's infrastructure.  Most of those wi-fi connections, wired and wireless, were supplied by the highly talented team at Cisco.  And yet today, revenues for internet routers, switches and company services for networks account for 90% of Cisco's sales -- and its non-cash value (see chart at Trefis.com.)  The problem is that those markets aren't growing like they used to, and some are shrinking, as companies are increasingly switching to common carrier services to access cloud-based services supporting corporate needs.  Just like cloud-based IT architectures put risk on Microsoft PC usage, they create similar risks for private network suppliers.  Even corporations, the (in)famous "enterprise" customers for Cisco, are finding they can create security and reliability by giving up proprietary networks.

The market capitalization for Cisco has plunged some 40% the last year, and over 55% since peaking in late 2007. Those who support investing in Cisco think like the SeekingAlpha.com headline "3 Reasons Why Cisco is Oversold." They cite a huge cash hoard (some 25% of market cap) and Cisco's dominance in its historical "core" product markets.  They hope that a revived economy will create an uptick in infrastructure spending by corporations and public entities.  Or big buying in emerging countries.

Detractors become vitriolic about the company's lost valuation, blaming Chairman/CEO John Chambers in articles like the SeekingAlpha.com "Cisco, Either Chambers Goes or I Go."  Their arguments are less about product miscues, and more intensely claiming the CEO misdirected funds into bad consumer market opportunities (Flip phone,) undeveloped new projects like virtual conferencing and an overly complicated organization structure.

What Cisco really needs is more new products in growth markets.  Places where demand is growing, and the company can flourish like it did in the hey-day halcyon growth days of the internet.  That was why CEO Chambers implemented a market-focused organization structure - complete with multi-layered committees - in an effort to seek out growth opportunities and fund them.  Only, the organization lacked the permission and resource commitment to really allow developing most new markets and was overly complex in the resource allocation process.  Instead of moving rapidly to identify and develop growth, the organization stalled in endless discussions. A couple of months ago the new org was gutted in a "refocusing" effort (typical reaction: BusinessInsider.com "Cisco's Crazy Management Structure Wasn't Working, So Chambers is Changing It".)

But, if the previously more open organization couldn't find permission to identify, fund and develop new markets, how will a "more focused" organization do so?  Focus isn't going to make companies (or households) buy more switches and routers.  Or buy more network consulting services.  The market has shifted, so as people move to smartphones and tablets, and cloud-based apps they access over common networks, how will an organization focused on old customers and products prove more successful?  While the old organization may have been problematic, is abandoning a market-focused organization going to be an improvement?  Sounds like a set-up for future layoffs.

In the drive for new products Cisco bought a very successful business in the Flip camera two years ago, which according to MediaPost.com had 26% market share.  But, "Flip Camera: Dream Becomes a Nightmare" details the story of how Cisco was too late.  The market quickly was shifting from digital cameras to smart phones - and sales stagnated.  Cisco didn't learn much about consumer products, or smart phones or how to launch new products outside its "core" from the experience, choosing to shut the business down and withdraw the product this spring ("Cisco Kills the Flip Camera".)  Ouch! 

Clearly, Flip was a financially unsuccessful venture.  But that could be forgiven if Cisco learned from the experience so it could move, like Apple, toward launching something really good (like Apple did with iPods.)  But we don't hear of any organizational learning from Flip, just failure.

And that's too bad, because Cisco's virtual conferencing could have great promise.  Most of us now hate to travel (thanks TSA and all that great airline service!)  And most corporate controllers hate to pay for business travel.  The trends all point toward more and more virtual conferencing.  For everything from one-on-one meetings to multi-site meetings to industry conferences for learning.  This is a BIG trend, that will go well beyond a simple WebEx.  Someone is going to make money with this - taking Skype to an entirely new level of performance.  But given how badly Cisco managed Flip, and the new "refocusing" effort, it's hard to see how that winner will be Cisco.

Cisco's not yet a Sun Microsystems, so locked-in to old products it cannot do anything else and unable to grow at all.  It's not yet a Dell or Microsoft that's missed the market shifts and is trying to spend too much money, too late on weak products against well funded, fast growing and profitable competitors. 

But, the signs don't look good.  There's no discussion about what Cisco sees itself doing new and differently in 5 years.  We don't see Cisco offering leading edge products like it did 15 years ago in its old "core" market.  It's historical market is not growing like it once did, and new competitors are changing the market entirely.  The layered organization was an effort to attack old sacred cows, and limit the power of old status quo police, but now the new "focused" re-organization is reversing those efforts to find new markets for growth.  "Focus" rarely goes hand-in-hand with successful innovation.  We cannot find an obvious group of people focusing on new markets, with permission and resources to bring out the "next big thing" that could drive a doubling of revenues by 2017. 

Unlike RIMM, the game isn't over for CSCO.  It's markets still have some longevity.  But the organization has been failing at doing the kind of new things, bringing out the new innovations, that would make it a good investment.  Until management shows it knows how to find new markets and launch disruptive innovations, CSCO is not a place to invest.  Don't expect a fat dividend, and don't expect revisiting old growth rates any time soon. 

There are likely to be some good, and bad quarters.  Cost management, and occasional big orders, combined with manipulating the timing of revenues and costs will allow for management to say "things are all better."  But there will be miscues and problems, and blaming of competitors and weak economic conditions in the bad quarters.  Defend and extend management does not work when markets shift.  Sideways is not moving forward.  It's more like treading water in the ocean - not a good strategy for rescue.  Overall, I wouldn't be optimistic.

 

Avoid Value Traps - Sell Dell and Hewlett Packard

In "Screening Large Cap Value Stocks" 24x7WallSt.com tries making the investment case for Dell.  And backhandedly, for Hewlett Packard.  The argument is as simple as both companies were once growing, but growth slowed and now they are more mature companies migrating from products into services.  They have mounds of cash, and will soon start paying a big, fat dividend.  So investors can rest comfortably that these big companies are a good value, sitting on big businesses, and less risky than growth stocks.

Nice story.  Makes for good myth. Reality is that these companies are a lousy value, and very risky.

Dell grew remarkably fast during the PC growth heyday.  Dell innovated computer sales, eschewing expensive distribution for direct-to-customer marketing and order-taking.  Dell could sell individuals, or corporations, computers off-the-shelf or custom designed machines in minutes, delivered in days.  Further, Dell eschewed the costly product development of competitors like Compaq in favor of using a limited number of component suppliers (Microsoft, Intel, etc.) and focusing on assembly.  With Wal-Mart style supply chain execution Dell could deliver a custom order and be paid before the bill was due for parts.  Quickly Dell was a money-making, high growth machine as it rode the growth of PC sales expansion.

But competitors learned to match Dell's supply chain cost-cutting capabilities. Manufacturers teamed with retailers like Best Buy to lower distribution cost. As competition copied the use of common components product differences disappeared and prices dropped every month.  Dell's advantages started disappearing, and as they continued to follow the historical cost-cutting success formula with more outsourcing, problems developed across customer services.  Competitors wreaked havoc on Dell's success formula, hurting revenue growth and margins.

HP followed a similar path, chasing Dell down the cost curve and expanding distribution.  To gain volume, in hopes that it would create "scale advantages," HP acquired Compaq.  But the longer HP poured printer profits into PCs, the more it fed the price war between the two big companies.

Worst for both, the market started shifting.  People bought fewer PCs.  Saturation developed, and reasons to buy new ones were few.  Users began buying more smartphones, and later tablets.  And neither Dell nor HP had any products in development where the market was headed, nor did their "core" suppliers - Microsoft or Intel. 

That's when management started focusing on how to defend and extend the historical business, rather than enter growth markets.  Rather than moving rapidly to push suppliers into new products the market wanted, both extended by acquiring large consulting businesses (Dell famously bought Perot Systems and HP bought EDS) in the hopes they could defend their PC installed base and create future sales. Both wanted to do more of what they had always done, rather than shift with emerging market needs.

But not only product sales were stagnating.  Services were becoming more intensely competitive - from domestic and offshore services providers - hampering sales growth while driving down margins.  Hopes of regaining growth in the "core" business - especially in the "core" enterprise markets - were proving illusory.  Buyers didn't want more PCs, or more PC services.  They wanted (and now want) new solutions, and neither Dell nor HP is offering them.

So the big "cash hoard" that 24x7 would like investors to think will become dividends is frittered away by company leadership - spent on acquisitions, or "special projects," intended to save the "core" business.  When allocating resources, forecasts are manipulated to make defensive investments look better than realistic.  Then the "business necessity" argument is trotted out to explain why acquisitions, or price reductions, are necessary to remain viable, against competitors, even when "the numbers" are hard to justify - or don't even add up to investor gains.  Instead of investing in growth, money is spent trying to delay the market shift. 

Take for example Microsoft's recent acquisition of Skype for $8.5B.  As Arstechnia.com headlined "Why Skype?" This acquisition is another really expensive effort by Microsoft to try keeping people using PCs.  Even though Microsoft Live has been in the market for years, Microsoft keeps trying to find ways to invest in what it knows - PCs - rather than invest in solutions where the market is shifting.  New smartphone/tablet products come with video capability, and are already hooked into networks.  Skype is the old generation technology, now purchased for an enormous sum in an effort to defend and extend the historical base. 

There is no doubt people are quickly shifting toward smartphones and tablets rather than PCs.  This is an irreversable trend: Chart source BusinessInsider.com

Executive teams locked-in to defending their past spend resources over-investing in the old market, hoping they can somehow keep people from shifting.  Meanwhile competitors keep bringing out new solutions that make the old obsolete.  While Microsoft was betting big on Skype last week Mediapost.com headlined "Google Pushes Chromebook Notebooks."  In a direct attack on the "core" customers of Dell and HP (and Microsoft) Google is offering a product to replace the PC that is far cheaper, easier to use, has fewer breakdowns and higher user satisfaction. 

Chromebooks don't have to replace all PCs, or even a majority, to be horrific for Dell and HP.  They just have to keep sucking off all the growth.  Even a few percentage points in the market throws the historical competitors into further price warring trying to maintain PC revenues - thus further depleting that cash hoard.  While the old gladiators stand in the colliseum, swinging axes at each other becoming increasingly bloody waiting for one to die, the emerging competitors avoid the bloodbath by bringing out new products creating incremental growth.

People love to believe in "value stocks."  It sounds so appealing.  They will roll along, making money, paying dividends.  But there really is no such thing.  New competitors pressure sales, and beat down margins.  Markets shift wtih new solutions, leaving fewer customers buying what all the old competitors are selling, further driving down margins.  And internal decision mechanisms keep leadership spending money trying to defend old customers, defend old solutions, by making investments and acquisitions into defensive products extending the business but that really have no growth, creating declining margins and simply sucking away all that cash.  Long before investors have a chance to get those dreamed-of dividends.

This isn't just a  high-tech story.  GM dominated autos, but frittered away its cash for 30 years before going bankrupt.  Sears once dominated retailing, now its an irrelevent player using its cash to preserve declining revenues (did you know Woolworth's was a Dow Jones company until 1997?).  AIG kept writing riskier insurance to maintain its position, until it would have failed if not for a buyout.  Kodak never quit investing in film (remember 110 cameras? Ektachrome) until competitors made film obsolete. Xerox was the "copier company" long after users switched to desktop publishing and now paperless offices.

All of these were once called "value investments."  However, all were really traps.  Although Dell's stock has gyrated wildly for the last decade, investors have lost money as the stock has gone from $25 to $15. HP investors have fared a bit better, but the long-term trending has only had the company move from about $40 to $45.  Dell and HP keep investing cash in trying to find past glory in old markets, but customers shift to the new market and money is wasted.

When companies stop growing, it's because markets shift.  After markets shift, there isn't any value left.  And management efforts to defend the old success formula with investments in extensions simply fritter away investor money.  That's why they are really value traps.  They are actually risky investments, because without growth there is little likelihood investors will ever see a higher stock price, and eventually they always collapse - it's just a matter of when.  Meanwhile, riding the swings up and down is best left for day traders - and you sure don't want to be long the stock when the final downturn hits.

Let Sears Go! No Subsidies, and Sell the Stock. Invest in Groupon

Sears is threatening to move its headquarters out of the Chicago area.  It's been in Chicago since the 1880s.  Now the company Chairman is threatening to move its headquarters to another state, in order to find lower operating costs and lower taxes. 

Predictably "Officals Scrambling to Keep Sears in Illinois" is the Chicago Tribune headlined.  That is stupid.  Let Sears go.  Giving Sears subsidies would be tantamount to putting a 95 year old alcoholic, smoking paraplegic at the top of the heart/lung transplant list!  When it comes to subsidies, triage is the most important thing to keep in mind.  And honestly, Sears ain't worth trying to save (even if subsidies could potentially do it!)

"Fast Eddie Lampert" was the hedge fund manager who created Sears Holdings by using his takeover of bankrupt KMart to acquire the former Sears in 2003. Although he was nothing more than a financier and arbitrager, Mr. Lampert claimed he was a retailing genius, having "turned around" Auto Zone. And he promised to turn around the ailing Sears. In his corner he had the modern "Mad Money" screaming investor advocate, Jim Cramer, who endorsed Mr. Lampert because...... the two were once in college togehter.  Mr. Cramer promised investors would do well, because he was simply sure Mr. Lampert was smart.  Even if he didn't have a plan for fixing the company.

Sears had once been a retailing goliath, the originator of home shopping with the famous Sears catalogue, and a pioneer in financing purchases.  At one time you could obtain all your insurance, banking and brokerage needs at a Sears, while buying clothes, tools and appliances.  An innovator, Sears for many years was part of the Dow Jones Industrial Average.  But the world had shifted, Home Depot displaced Sears on the DJIA, and the company's profits and revenues sagged as competitors picked apart the product lines and locations.

Simultaneously KMart had been destroyed by the faster moving and more aggressive Wal-Mart.  Wal-Mart's cost were lower, and its prices lower.  Even though KMart had pioneered discount retailing, it could not compete with the fast growing, low cost Wal-Mart. When its bonds were worth pennies, Mr. Lampert bought them and took over the money-losing company.

By combining two losers, Mr. Lampert promised he would make a winner.  How, nobody knew.  There was no plan to change either chain.  Just a claim that both were "great brands" that had within them other "great brands" like Martha Stewart (started before she was convicted and sent to jail), Craftsman and Kenmore. And there was a lot of real estate.  Somehow, all those assets simlply had to be worth more than the market value.  At least that's what Mr. Lampert said, and people were ready to believe.  And if they had doubts, they could listen to Jim Cramer during his daily Howard Beale impersonation.

Only they all were wrong.

Retailing had shifted.  Smarter competitors were everywhere.  Wal-Mart, Target, Dollar General, Home Depot, Best Buy, Kohl's, JCPenney, Harbor Freight Tools, Amazon.com and a plethora of other compeltitors had changed the retail market forever.  Likewise, manufacturers in apparel, appliances and tools had brough forward better products at better prices.  And financing was now readily available from credit card companies. 

Surely the real estate would be worth a fortune everyone thought.  After all, there was so much of it.  And there would never be too much retail space.  And real estate never went down in value.  At least, that's what everyone said.

But they were wrong.  Real estate was at historic highs compared to income, and ability to pay.  Real estate was about to crater.  And hardest hit in the commercial market was retail space, as the "great recession" wiped out home values, killed personal credit lines, and wiped out disposable income.  Additionally, consumers increasingly were buying on-line instead of trudging off to stores fueling growth at Amazon and its peers rather than Sears - which had no on-line presence.

Those who were optimistic for Sears were looking backward.  What had once been valuable they felt surely must be valuable again.  But those looking forward could see that market shifts had rendered both KMart and Sears obsolete.  They were uncompetitive in an increasingly more competitive marketplace.  As competitors kept working harder, doing more, better, faster and cheaper Sears was not even in the game.  The merger only made the likelihood of failure greater, because it made the scale fo change even greater. 

The results since 2003 have been abysmal.  Sales per store, a key retail benchmark, have declined every quarter since Mr. Lampert took over.  In an effort to prove his financial acumen, Mr. Lampert led the charge for lower costs.  And slash his management team did - cutting jobs at stores, in merchandising and everywhere.  Stores were closed every quarter in an effort to keep cutting costs.  All Mr. Lampert discussed were earnings, which he kept trying to keep from disintegrating.  But with every quarter Sears has become smaller, and smaller.  Now, Crains Chicago Business headlined, even the (in)famous chairman has to admit his past failure "Sears Chief Lampert: We Ought to be Doing a Lot Better."

Sears once built, and owned, America's tallest structure.  But long ago Sears left the Sears Tower.  Now it's called the Willis Tower by the way - there is no Sears Tower any longer.  Sears headquarters are offices in suburban Hoffman Estates, and are half empty.  Eighty percent of the apparel merchandisers were let go in a recent move, taking that group to California where the outcome has been no better. Constant cost cutting does that.  Makes you smaller, and less viable.

And now Sears is, well..... who cares?  Do you even know where the closest Sears or Kmart store is to you?  Do you know what they sell?  Do you know the comparative prices?  Do you know what products they carry?  Do you know if they have any unique products, or value proposition?  Do you know anyone who works at Sears?  Or shops there?  If the store nearest you closed, would you miss it amidst the Home Depot, Kohl's or Best Buy competitors?  If all Sears stores closed - every single location - would you care? 

And now Illinois is considering giving this company subsidies to keep the headquarters here?

Here's an alternative idea. Using whatever logic the state leaders can develop, using whatever dream scenario and whatever desperation economics they have in mind to save a handful of jobs, figure out what the subsidy might be.  Then invest it in Groupon.  Groupon is currently the most famous technology start-up in Illinois.  Over the next 10 years the Groupon investment just might create a few thousand jobs, and return a nice bit of loot to the state treasury.  The Sears money will be gone, and Sears is going to disappear anyway.  Really, if you want to give a subsidy, if you want to "double down," why not bet on a winner?

It really doesn't have to be Groupon.  The state residents will be much better off if the money goes into any  business that is growing.  Investing in the dying horse simply makes no sense.  Beg Amazon, Google or Apple to open a center in Illinois - give them the building for free if you must.  At least those will be jobs that won't disappear.  Or invest the money into venture funds that can invest in the next biotech or other company that might become a Groupon.  Invest in senior design projects from engineering students at the University of Illinois in Chicago or Urbana/Champaign.  Invest in the fillies that have a chance of winning the race!

Sentimenatality isn't bad.  We all deserve the right to "remember the good old days."  But don't invest your retirement fund, or state tax receipts, in sentimentality.  That's how you end up like Detroit.  Instead put that money into things that will grow.  So you can be more like silicon valley.  Invest in businesses that take advantage of market shifts, and leverage big trends to grow.  Let go of sentimentality.  And let go of Sears.  Before it makes you bankrupt!

 

You Should Love, and Buy, Netflix - the next Apple or Google

Summary:

• Most leaders optimize their core business
• This does not prepare the business for market shifts
• Motorola was a leader with Razr, but was killed when competitors matched their features and the market shifted to smart phones
• Netflix's leader is moving Netflix to capture the next big market (video downloads)
• Reed Hastings is doing a great job, and should be emulated
• Netflix is a great growth story, and a stock worth adding to your portfolio

"Reed Hastings: Leader of the Pack" is how Fortune magazine headlined its article making the Netflix CEO its BusinessPerson of the Year for 2010.  At least part of Fortune's exuberance is tied to Netflix's dramatic valuation increase, up 200% in just the last year.  Not bad for a stock called a "worthless piece of crap" in 2005 by a Wedbush Securities stock analyst.  At the time, popular wisdom was that Blockbuster, WalMart and Amazon would drive Netflix into obscurity.  One of these is now gone (Blockbuster) the other stalled (WalMart revenues unmoved in 2010) and the other well into digital delivery of books for its proprietary Kindle eReader.

But is this an honor, or a curse?  It was 2004 when Ed Zander was given the same notice as the head of Motorola.  After launching the Razr he was lauded as Motorola's stock jumped in price.  But it didn't take long for the bloom to fall off that rose. Razr profits went negative as prices were cut to drive share increases, and a lack of new products drove Motorola into competitive obscurity.  A joint venture with Apple to create Rokr gave Motorola no new sales, but opened Apple's eyes to the future of smartphone technology and paved the way for iPhone.  Mr. Zander soon ran out of Chicago and back to Silicon Valley, unemployed, with his tale between his legs.

Netflix is a far different story from Motorola, and although its valuation is high looks like a company you should have in your portfolio. 

Ed Zander simply took Motorola further out the cell phone curve that Motorola had once pioneered.  He brought out the next version of something that had long been "core" to Motorola.  It was easy for competitors to match the "features and functions" of Razr, and led to a price war.  Mr. Zander failed because he did not recognize that launching smartphones would change the game, and while it would cannibalize existing cell phone sales it would pave the way for a much more profitable, and longer term greater growth, marketplace.

Looking at classic "S Curve" theory, Mr. Zander and Motorola kept pushing the wave of cell phones, but growth was plateauing as the technology was doing less to bring in new users (in the developed world):

Meanwhile, Research in Motion (RIM) was pioneering a new market for smartphones, which was growing at a faster clip.  Apple, and later Google (with Android) added fuel to that market, causing it to explode.  The "old" market for cell phones fell into a price war as the growth, and profits, moved to the newer technology and product sets:

The Motorola story is remarkably common.  Companies develop leaders who understand one market, and have the skills to continue optimizing and exploiting that market.  But these leaders rarely understand, prepare for and implement change created by a market shift.  Inability to see these changes brought down Silicon Graphics and Sun Microsystems in 2010, and are pressuring Microsoft today as users are rapidly moving from laptops to mobile devices and cloud computing.  It explains how Sony lost the top spot in music, which it dominated as a CD recording company and consumer electronics giant with Walkman, to Apple when the market moved people from physical CDs to MP3 files and Apple's iPod.

Which brings us back to what makes Netflix a great company, and Mr. Hastings a remarkable leader.  Netflix pioneered the "ship to your home" DVD rental business.  This helped eliminate the need for brick-and-mortar stores (along with other market trends such as the very inexpensive "Red Box" video kiosk and low-cost purchase options from the web.)  Market shifts doomed Blockbuster, which remained locked-in to its traditional retail model, made obsolete by competitors that were cheaper and easier with which to do business.

But Netflix did not remain fixated on competing for DVD rentals and sales - on "protecting its core" business.  Looking into the future, the organization could see that digital movie rentals are destined to be dramatically greater than physical DVDs.  Although Hulu was a small competitor, and YouTube could be scoffed at as a Gen Y plaything, Netflix studied these "fringe" competitors and developed a superb solution that was the best of all worlds.  Without abandoning its traditional business, Netflix calmly moved forward with its digital download business -- which is cheaper than the traditional business and will not only cannibalize historical sales but make the traditional business completely obsolete!  

Although text books talk about "jumping the curve" from one product line to another, it rarely happens.  Devotion to the core business, and managing the processes which once led to success, keeps few companies from making the move.  When it happens, like when IBM moved from mainframes to services, or Apple's more recent shift from Mac-centric to iPod/iPhone/iPad, we are fascinated.  Or Google's move from search/ad placement company to software supplier.  While any company can do it, few do.  So it's no wonder that MediaPost.com headlines the Netflix transition story "Netflix Streams Its Way to Success."

Is Netflix worth its premium?  Was Apple worth its premium earlier this decade?  Was Google worth its premium during the first 3 years after its Initial Public Offering?  Most investors fear the high valuations, and shy away.  Reality is that when a company pioneers a growth business, the value is far higher than analysts estimate.  Today, many traditionalists would say to stay with Comcast and set-top TV box makers like TiVo.  But Comcast is trying to buy NBC in order to move beyond its shrinking subscriber base, and "TiVo Widens Loss, Misses Street" is the Reuters' headline. Both are clearly fighting the problems of "technology A" (above.)

What we've long accepted as the traditional modes of delivering entertainment are well into the plateau, while Netflix is taking the lead with "technology B."  Buying into the traditionalists story is, well, like buying General Motors.  Hard to see any growth there, only an ongoing, slow demise.

On the other hand, we know that increasingly young people are abandoning traditional programing for 100% entertainment selection by download.  Modern televisions are computer monitors, capable of immediately viewing downloaded movies from a tablet or USB drive - and soon a built-in wifi connection.  The growth of movie (and other video) watching is going to keep exploding - just as the volume of videos on YouTube has exploded.  But it will be via new distribution.  And nobody today appears close to having the future scenarios, delivery capability and solutions of Netflix.  24x7 Wall Street says Netflix will be one of "The Next 7 American Monopolies."  The last time somebody used that kind of language was talking about Microsoft in the 1980s!  So, what do you think that makes Netflix worth in 2012, or 2015?

Netflix is a great story.  And likely a great investment as it takes on the market leadership for entertainment distribution.  But the bigger story is how this could be applied to your company.  Don't fear revenue cannibalization, or market shift.  Instead, learn from, and behave like, Mr. Hastings.  Develop scenarios of the future to which you can lead your company.  Study fringe competitors for ways to offer new solutions. Be proactive about delivering what the market wants, and as the shift leader you can be remarkably well positioned to capture extremely high value.

 

 

2 Losers Don't make a Winner - Ignore Yahoo and AOL

Summary:

• Creating value requires growth, not cost reductions
• Yahoo and AOL have no growth, and no new market development plans
• Yahoo and AOL lack the resources to battle existing competitors Google and Apple
• Don't invest in Yahoo or AOL individually, or if they merge
• Companies that generate high valuation, like Apple, do so by pioneering new markets with new products where they generate growth in revenue, profits and cash flow

Rumors have been swirling about Yahoo! and AOL merging - and Monday's refresh led to about a 2% gain in the former, and 4% gain in the latter. But unless you're a day trader, why would you care? Merging two failing companies does not create a more successful progeny.

AOL had a great past.  But since the days of dial-up, the value proposition has been hard to discern.  What innovations has AOL brought to market the last 2 years?  What new technologies is AOL championing?  What White Space projects are being trumpeted that will lead to new capabilities for web users if they purchase AOL products? 

And the same is true for Yahoo!  Although an early pioneer in on-line advertising, and to this day the location of many computer user's browser home page, what has Yahoo! brought to market the last 2 years?  In the search market, on-line content management, browser technology and internet ad placement the game has fully gone to competitor Google.  Although the new CEO, Ms. Bartz, was brought in to much fanfare, there's been nothing really new brought forward.  And we don't hear about any new projects in the company designed to pioneer some new market.

And from this merger, where would the cash be created to fight against the likes of Google and Apple?  Unless one of these companies has a silver bullet, the competitors' war chests assures "game over" for these two.

Sure, merging the two would likely lead to some capability to cut administrative costs.  But is that how you create value for an internet company?  What creates value is developing new markets - like AOL did when it brought millions of people to the internet for the first time.  And like Yahoo! did with its pioneering products delivering news, and placing ads for companies.  But since both companies have lost the willingness, capability and resources to develop new markets and products they've been unable to grow revenues and cash flow.  The road to prosperity most assuredly does not lie in "synergistic cost reductions" across administration, selling and product development for these two market laggards.

The reason Apple is skyrocketing in value is because it has pioneered new markets.  And produced enough cash to buy both these companies - if there was any value in them.  SeekingAlpha.com lays out the case for almost 100million iPad sales, and a lot more iPhones, in "What Could Justify a $500 Apple Stock Price."  But beyond selling more of what it's pioneered, Apple has not stopped pioneering new markets.  Another SeekingAlpha article points out the likelihood of Apple making video chat something people will really want to use, now that it can be done on mobile devices like iPads and iPhones, in "Apple's Future Revenue Driver: FaceTime."  It's because Apple has the one-two punch of growing the markets it has pioneered while simultaneously developing new markets that makes it worth so much.

If you've been thinking a merged Yahoo/AOL is a value play - well think again.  Both companies are well into the swamp of declining returns.  So focused on fighting off the alligators and mosquitos trying to eat them that they long ago forgot their mission was to create new markets with new products that could carry them out of the low-growth swamp.  Sell both, if you haven't already, and don't look back.  Whether you take a loss or gain, at least you'll leave with some money.  The longer you stay with these companies the less they'll be worth, because neither has a sail of any kind to catch any growth wind.

Apple at $500 might sound crazy - but it's a better bet than hoping to make any money in the individual, or merged, old-guard companies.  They don't have the cash, nor the cash flow, to drive new solutions.  And that's how value is created.