Facing Challenges

Challenges don’t affect only large companies.  Since the internet has become part of our lives, many small businesses have seen the emergence of enormous Challenges.  Many have altered industries completely, wiping out several small businesses.  For example, on-line book shopping has pretty well killed off the small bookselller.

Another example is developing in real estate (see article here).  We probably are all familiar with the need to have an appraisal when refinancing a home.  We want these appraisals fast, so we can close on the loan, and cheap – because who wants to pay more for closing costs than necessary.  In response, Automated Value Models were developed.  These created a change in appraisals from 100% being done by appraisers to only 25%.  Yet, because of the huge boom in construction and refinancing the number of appraisers still continued to grow.

But now, a company out of Calgary named ZAIO (see chart here) is creating a database of 100% of homes in America’s top 250 cities.  This will provide far more accurate appraisals than AVMs yet at a cost possibly lower.  This database will have photographs of every home, as well as assessor’s data and the company’s own valuation.  It should be complete by 2010.  Yes, this is a huge undertaking.  And it will cost $75million.  But, in the future lenders will be able to get immediate appraisals, cutting the loan processing time by a week, while lowering the appraisal cost from $300 to $125.  Do you remember when we all thought no one could map the entire United States and make it available on line?  And now we all use MapQuest or Google maps.  For free to us, as this database access is paid for by advertisers.  So is it really hard to imagine a database of all our homes?  And a consistent appraisal application?

This makes huge senes to everyone but —- appraisers.  ZAIO is making the database available to local appraisers.  They can purchase a "zone" of 10,000 homes for $9,500.  But many are saying "no thanks" fearing it will hasten the decline in demand for their services.  Others are hoping to retrench to supporting executive relocations and other niche opportunities.  But, the fact is that this service will do to the 100,000 appraisers what Amazon did to the corner bookstore.  Very few appraisers will survive except those using the automated ZAIO database.

If you are an appraiser, you have to face either buying into the ZAIO model or finding a new occupation.  For the self-employed appraiser, or the small business, this is tough to face.  But trying to Defend & Extend their old occupation in the face of this new Challenge can only create a disaster.  While some revenue is possible, it’s time to Disrupt and find personal White Space.  It’s time to create a new Success Formula before the revenue runs out.

And possibly time to consider investing in ZAIO.  Their database will be used for not only appraisals, but evaluating mortgate portfolios of lenders and possibly insurance value estimations.  It’s not a big jump to imagine a future when insurance adjusters can use the ZAIO database to start their process, and possibly use satellite pictures from Google to determine the damages.  Possibly leading to insurance estimates made fast – from the office.   And then a whole new market, insurance adjusters, might face the Challenge appraisers now face.

Finding Optimism

Lately I’ve been pretty hard on companies in this blog, so today I’m taking time to highlight two examples of companies following The Phoenix Principle on the road to long-term evergreen success.

Firstly is Motorola (see chart here).  As previously blogged, Motorola is under attack by corporate raider Carl Icahn who would like to borrow a lot of money and pay it, as well as existing cash, out in a special dividend to investors.  In other words, do to Motorola what Sam Zell is doing to Tribune Company.  In the face of this effort, Motorola announced Tuesday it is buying Terayon Communications Systems to gain more capability (specifically software for delivering video) to it’s television set-top box business (see article here).  Keep in mind, in 2009 the television system switches from analog to digital and the demand for set-top boxes to go with all the existing analog TVs is sure to grow – possibly exponentially.  This acquisition is a great example of continuing to fund the White Space in a market that is in the early stages of the Rapids.  Now that’s a great use of corporate cash – and will provide a real return to Motorola investors.  If Motorola leadership and investors can keep the shark away.

Secondly is J.P. Morgan Chase (see chart here.) J.P. Morgan Chase is run by Jamie Dimon.  Mr. Dimon is a very colorful character well known for short patience.  When Jack Welch institutionalized White Space he was nicknamed Neutron Jack.  Mr. Dimon may someday get a similar monicker for his willingness to Disrupt his own people and organization.  And this week J.P. Morgan announced the acquisition of technology company Xign (see article here).  Xign has been a pioneering company in developing the e-payments system for automated commercial (or busineess-to-business) transactions.  This is projected to become a $1.7 billion market by 2010, even though you may never have heard of Dynamic Discount Management (DDM for short).  Here we see a Disruptive leader investing in a new business opportunity at the front end of very high growth – exactly the kind of White Space that should excite investors.  Compare this with the actions taken by J.P. Morgan’s primary competitor – Citigroup – last week when they laid off 5% of their work force and starting shutting offices and centralizing decision-making in order to protect their faltering old Success Formula.

Far too many leaders use Defend & Extend Management and kill the growth of their company.  They manage for protection of the old Success Formula and wipe out all capabilities to Disrupt.  They refuse to invest in White Space in favor of trying to prop up the old Success Formula.  But there are reasons to be optimistic.  There are companies using The Phoenix Principle and positioning themselves to migrate their Success Formulas forward to meet new Market Challenges.  You just have to keep your eyes open and look.

Financial Machinations

I have spoken in this blog about Financial Machinations.  These are actions taken by management to manipulate the financial results in order to make the Success Formula look better than it really is.  In short, financial accounting provides so much flexibility for how to "book" things that it is possible for any business leader to manipulate revenues, expenses and assets from quarter to quarter without breaking any rules (auditors will approve the changes) or laws.  Beyond these accounting manipulations, there also exists manipulation of the company growth rate and earnings per share by simply reporting quarter to quarter numbers without highlighting critical adjustments – such as an acquisition that inflates revenue or a stock buyback that reduces the number of shares.

IBM (see  chart here) gives us an example this week.  While IBM is a great company with a rich history and actually quite a bit of White Space, this week the company announced it will use classical financial machinations in an effort to protect its Success Formula (see article here).  Shareholders benefit when companies pay dividends, or when the share price goes up.  IBM announced it was going to borrow money in order to buy back shares.  This means that without any change (better or worse) in the company’s ability to address market Challenges the earnings per share can be manipulated by leadership simply by deciding to buy additional shares – using borrowed money (in other words, without affecting operating cash flow). 

This is a warning sign.  When companies do well, management does not need to manipulate financial results.  The only reason to undertake such an action is to protect the existing Success Formula.  In IBM’s case the company’s most recent earnings announcement (last week) saw earnings increase in North America only 1%.  Even Gartner (the notable analysts that cover technology companies) showed concern over these results stating "There are mixed signals about how much businesses are prepared to lay out for new technology initiatives." (see article here)

IBM is not alone.  In the last year such notable companies as Microsoft, Hewlett Packrd and Motorola have all undertaken similar actions to increasing a pond of funds for buying back shares in order to manipulate earnings per share and stock price.  In the last year, stock buybacks doubled increases in dividends.  And the S&P 500 spent more on share buybacks ($432billion) than the U.S. government spent on Medicare (see Chicago Tribune source article here.) 

In these days of financial transparency, augmented by the internet, such manipulations are unnecessary.  They indicate companies that are interested in Defending & Extending their Success Formulas.  Phoenix Principle companies are focused upon market Challenges and addressing them with White Space to remain evergreen.

You Can See It Coming

When you can predict behavior in business it is the first step to taking competitive advantage.  When you can predict competitors, you know what to do to beat them.  And you can take steps as an investor, employee, supplier or customer to decide how you’ll interact with them in your own best interest.

I blogged several days ago that the buyout of Tribune Company would force them to continue taking actions operate their Success Formula More, Better, Faster, Cheaper rather than addressing changing market factors.  Even though it is certain this behavior will continue to hurt performance because that Success Formula is woefully out of date and not meeting market needs in world where news travels via the web.  The debt load alone would create that Lock-in since it dramatically limits options.  Further, the leaders last year were manipulating results (all very legal I’m sure) in order to maximize their bonuses and mask bad business performance. 

What have we seen this week?  On Friday the Chicago Tribune reported (see article here) that the company cash flow was off 12%.  Of course!  The leadership did everything possible to goose up cash flow at the end of the last year in order to maximize bonuses and attract a buyer for the company.  It was easy to predict that cash flow would decline, and results would lag peers even in the struggling media industry.  Then today Tribune Company announced it is cutting jobs across all its properties (see article here.)  Of course, it has to cut costs to protect the old Success Formula.  (When what the leadership needs to do is invest in internet projects to transform the company.)

Tribune once made a lot of money.  Then the market changed as people moved from newspapers to the internet.  But Tribune company did not adjust to that market change nearly rapidly or powerfullly enough.  The company tried to tweak it’s Success Formula with cost cutting exercises while hoping the business would return to its prior state.  Now, it’s More Of The Same while management keeps hoping that the past will return.  But it won’t happen.  And things will keep getting worse as cost cuts lead to further problems with the paper and fewer readers and fewer advertisers leading to more cost cuts – a vicious cycle.  The business needs to change remarkably toward the internet – but now leadership and ownership is so Locked-in to the old Success Formula they can’t.  They’ve refused to Disrupt and there is no White Space.  And so Tribune Company is becoming very predictable.  That’s bad for the employees, suppliers and new debt-holders.  Good for competitors.

Fake-Out

In sports we talk about a player looking to go right and then going left and call that a "fake-out."  We’re seeing the business equivalent today at Tribune company.  In their own paper the company featured an article on a new "hyperlocal" web site being rolled out that is supposed to indicate a new approach for Tribune Company (see article here).  This a a fake-out.

On the face of it, the new web sites may look like White Space and therefore a good thing.  But the reality is that Tribune is incredibly Locked-in to its outdated Success Formula – and as I’ve blogged they are loading up on debt which will insure they remain Locked-in.  This venture lacks 3 critical criteria for it to be considered White Space:

1 – the company has not Disrupted any of its old Lock-ins.  They have not admitted that the Success Formula is outdated, and they have not attacked any of the Lock-ins keeping the company doing what it has always done.  Without an attack on the Lock-in this kind of venture will soon run into all kinds of obstacles (from editorial to ad sales) and find itself without nurturing or any chance of success.

2 – the company has not committed any significant resources to this effort.  They admitted it is only a small test.  They have no promises to see it through to any kind of success, and have said they have concerns about how it will even work.

3 – this project is not something in the front of the Rapids which they can get behind big and hope to change the company.  Cars.com or CareerBuilder.com are examples of things in the Rapids they could move into White Space and use to change Tribune company’s Success Formula.  This project is so small and market-early that it is in the Wellspring and unable to make any real impact on results or the operations of Tribune.

It’s not just claiming you have a White Space project that makes it true.  You first have to Disrupt your Lock-ins to give it a chance for success, you have to commit resources to see the project through, and you have to pick projects that are big enough to push your business back into the Rapids.

Clever competition

Readers of this blog know I think WalMart (see chart here) is horribly Locked-in and thus well into the Swamp.  As the chart shows, this has left them with maudlin performance (at best.) I recently posted on their fiasco firing the ad agency as part of firing their own advertising director in an effort to preserve that Lock-in and outdated Success Formula. 

Today we learn (see article here) that WalMart’s fired agency, DraftFCB, is going to get the KMart account.  This is a sharp move for Kmart.  After WalMart and DraftFCB spend millions to study the discount retail marketplace, WalMart walks away from that research in order to preserve its own beliefs.  So, KMart now gets all that research for free.  And it is a very smart competitive move.  KMart is using WalMart’s Lock-in to their advantage.  And any time you do that, you improve your odds of succeeding.

Of course KMart is part of Sears Holdings (see chart here), and I’ve blogged often at how Locked-in Sears is.  So I’m really not that optimistic for KMart.  I think Eddie Lambert, Chairman at Sears Holdings probably took this move because he thinks he can save a few bucks.  And, DraftFCB is famous in its industry for having some of the best cost justification work there is, which appeals to Mr. Lambert’s cost reduction Lock-ins.  Nonetheless, it is a clever move that takes advantage of a competitor’s Lock-in, and any business that wants to succeed should look for such opportunities.

How to Read the Newspaper

Will Rogers once said "All I know is what i read in the newspapers."  While many have heard that phrase, few know that the back half was "and of course I’m the most ignorant man alive!"  It was his joke that newspapers often obscured important bits of information.

Dow Jones (see chart here) just announced earnings.  But, be careful what you read.  The headline boasted "a 63% drop in quarterly profit due to a year-earlier gain."  (Obtain full article here.)  Pretty clear Defend & Extend language telling investors to ignore the decline because the past and current aren’t really comparable.  Further on we real lots of D&E obfuscation as we learn revenue is up, but then again they bought half of Factiva not previously included in revenues.  And tax benefits positively affected resuls – which is code for "real tax payments and GAAP reported payments don’t match so we manipulate a bit year-to-year in GAAP to suit our needs."  These financial machinations are common in D&E management trying to sustain an old Success Formula nd make it look better than it is.

So you wold conclude that I think Dow Jones, like I’ve previously blogged on Tribune Company, is in dire straits.  Not so!

Read on in the article and we learn that Dow Jones is not just The Wall Street Journal and Barron’s.  It is also MarketWatch (a great website from which I get substantial business news), WSJ on-line and Barron’s on-line.  WSJ on-line paid subscriptions rose 20% last quarter, and ad revenue at the on-line Journal and Marketwatch climbed 30%!  And, in the on-line business units of the 8 daily and 15 weekly local newspapers owned by Dow Jones revenue jumped 66%!  Meanwhile the Index business grew 5.2% even after honestly comparing the business pre-Factiva and post-Factiva acquisition.

Yes, ad revenues at the print WSJ dropped 1.8% on a 3.1% volume decline.  And the local papers saw revenue fall 3.5% on a 4.6% volume decline.  But Dow Jones management should quit apologizing for this, such as stating that a small decline "is not really bad in this environment."  Dow Jones’ future is not about print products, it’s about the on-line world.  The world Tribune and other media companies has not effectively addressed.  Dow Jones is clearly in the market with their products and doing some good things growing readers and advertisers.

Get beyond the headlines.  Look if there is White Space inside the company.  No matter what management leads with, the winners will be those who play the game for the long-term market.  Dow Jones is clearly one of the old-media companies that at least has its eye on the market and some effective White Spce producing positive results that the company appears to be migrating towards.

Falling off the Cliff

Those blog readers from the U.S. could not miss the media bruhaha this week over Don Imus.  He was fired for saying some outrageous things on the radio.

Don Imus is a self-proclaimed "shock jock".  Don made a living for over a decade by saying outrageous things to public listeners of his radio show.  He made a fortune, well over $1,000,000 per year personally and multiples of that for his producers and syndicators. 

So, what happened?  He created a Success Formula all around being outrageous.  And the more outrageous he was, the more it appeared people listened, and the more advertisers wanted his show, and the more money he and his network (CBS) made.  Don Imus spent 10 years building this Success Formula, and Locking it in.  He was succeeding with this outrageousness, and his producers succeeded, and CBS succeeded and all the affiliate stations that aired his show succeeded.  So, they kept promoting outrageous behavior.  And, as more people listened, even very well known, very famous, very successful people appeared on his show.  They leveraged Don Imus’ success to give them access to more people and increase their awareness and success.  That’s what a Success Formula is all about.  People succeed by doing more of what they always did.  And they Lock it in.

But then, the market shifted.  Not clearly.  Not obviously.  Not with an announcement on the front page of the New York Times.  But public sentiment shifted about "shock radio."  We could see the signs.  Howard Stern and his producer (Clear Channel Communications) were severely fined by the FCC for things he said.  The pressure became so great Howard was forced to go from public radio (called terrestrial radio now) to pay radio (called satellite radio.)  And we could see that there were increasing negative articles appearing about off-color comments by everyone from Stern colorful characters like Rush Limbaugh.  But Don Imus and his producers ignored the signs of this market shift and continued to push their Success Formula.

Then, last week, it all came down.  Mr. Imus said something that got under the skin of too many people.  In a week, his sponsors (advertisers that paid for him to be on radio) refused to support him any longer.  His revenue dried up, and he was fired from his show.

Why did this happen?  Because he (and his producer and his station CBS) were so Locked-in to the Success Formula, which was working, that they ignored the signals of market shifts.  They kept right on going until they fell off the proverbial cliff.  That’s what happens to Locked-in businesses.  Too often, they work that Success Formula right up until it fails.  Rarely do we see an example that is so dramatic and quick.  But now, we have a very good example of the risk of following your Success Formula and ignoring market Challenges and shifts.

Save Your Way to Prosperity?

Today Citigroup announced it intends to dramatically overhaul operations (see stock chart here).  The company will cut 17,000 jobs as it strives to remove $1.2B in expenses.  Citigroup says it is doing this in order to grow.  Huh?

Setting the stage:  Citigroup is the country’s largest financial institution.  Until the last few years when oil prices drove up profit for oil companies, Citigroup was the most profitable company in the world.  But the last few years it’s profit growth has not kept pace with competitors such as J.P. Morgan and Bank of America (see full article here).  Several stock analysts have charged Citigroup with not keeping up its competitiveness, despite pioneering much of what is most successful in the industry today.  Expenses have risen at a 9% clip, which has been faster than revenue at 6%.  Quotes from Jim Huquet at money manager at Great Companies reflect the consensus view, "They are moving in the wrong direction, and probably going to end up trailing chief rivals…Our concern is that the company really doesn’t have a good sense of where it’s heading..they need someone in charge with a bigger vision…[asset management] is a very profitable.. it provides ocmplexities to management…key rivals have been able to work through those issues…They talk about cost-cutting and stratetgic planning as if they’re coming up with some huge revelations…well-managed businesses do that just like breathing…managing costs and growing revenue aren’t luxuries."

The key player is Chief Executive Charles Prince.  Mr. Prince is a a lawyer, and when he was appointed many people thought his background appropriate for dealing with compliance issues that became very important after 9/11/01 and passage of both the Patriot Act and Sarbanes-Oxley.   But now, Citigroup is facing a serious Market Challenge.  Its competitors have begun copying several of its successful businesses and products, and applying their own innovations to operate those businesses more profitably.  Citigroup needs to adjust to these changing industry forces that have impinged its profits.  Citigroup needs to revitalize the innovation that has been a cornerstone of its long-term success.

What did Mr. Prince and Citigroup do?  Like I said above, announced a 17,000 person layoff.  That’s about 5% of the workforce (across the board, of course.)  Citigroup will ship a lot of this work offshore – with Poland an apparent beneficiary (see article here.)  They also intend to centralize purchasing supplies and services. Now remember, Citigroup isn’t making physical product where purchasing is central to manufacturing.  We’re literally talking about buying paperclips, staplers and computer programmers.  Nonetheless, centralization is a core plank of the plan as they hope to move global purchasing from 65% of spending to 80% by year-end and 100% by end of 2009.  Let’s see, this is the CEO of a DJIA company taking on a significant market Challenge by focusing on how the company buys supplies!?!  The COO said "That’s the kind of philosophical change we’re looking at enforcing throughout the company."  (see full article here.)

Today, financial services is a digital business.  The work is all bits and bytes for traders and lenders, and digital documents for borrowers and lenders.  So, naturally, Citigroup is cutting $375million in technology this year and about $550million additionally each year through 2009.    The company is closing 40 Smith Barney offices and, according to the COO "closing down facilities where we have excess space, closing down some small businesses that we have been in for a long time….Because of the way we were structured internationally, there was a lot of duplication between global product capabilities and capabilities at a sector level and then in a regio an dthen in a country..we were able to take out a lot of those duplicate capabilities."  I’m reminded of Ralph Waldo Emerson’s famous line "needless consistency is the hobgoblin of small minds."

Citigroup has not hit a growth stall, but it has been impacted by rising competition.  The company is at an important junction.  It needs to deal with serious marketplace Challenges being wrought by well-funded, smart and large competitors.  And, it is taking action to Lock-in its old Success Formula! Rather than dealing with the market Challenge the top brass is focusing on The Problem (the earnings).  Instead of addressing the lack of performance in White Space projects, they are cutting costs and killing off these projects.  Citigroup isn’t using innovation to deal with the market and get back on track – the leadership is slashing costs to short-term beef up profits and in the process Locking-in even further the Success Formula which has recently seen weaker results.  They aren’t stepping up to maintain their position as global leader, but instead falling back into Defend & Extend management in hopes they can recapture old profit rates.

Of course, this plan completely ignores the competition.  While Citigroup is busy with cost cuts, BofA and JPM will keep marching forward with their customer acquisition and new product programs.  BofA and JPM will continue to push to lower their costs, greatly nullifying the supposed benefits of Citigroup’s efforts.  In fact Joseph Dickerson of Atlantic Equities believes BofA is likely to hire many of the Citigroup ousted folks to staff its rapidly growing European expansion!  While Citigroup is looking in the rear view mirror and trying to catch past results by whacking away at its old Success Formula, Jamie Dimon at JPM is whacking away at their customer base while matching their cost model – and then some.

Turning to Defend & Extend Management practices is absolutely the wrong thing for Citigroup to do.  The company isn’t in dire straits.  It’s not facing bankruptcy or being attacked like GM.  But Citigroup did take its eye of the marketplace while focusing on the compliance matters (by the way, everyone in the industry had to step up to the same compliance issues Citigroup faced).  This has allowed a re-invention gap to develop.  Instead of turning back to the marketplace with White Space projects, many of which already exist, to rebuild the Success Formula for better results the CEO and COO are turning inward, and slashing costs to Defend & Extend the problematic business.  After this enormous write-off we may see a few quarters of improved results (or maybe not), but long-term this is definitely not a good move for shareholders, bondholders and employees. 

Of excuses and successes

March auto results came out last week.  (See article here)

Toyota sold 12% more than a year ago.  Honda’s U.S. sales rose 11%.  Nissan’s rose 8%.  Hyundai and Kia also posted increases.  GM sales fell 4%.  Ford sales fell 9%.  Chrysler sales fell 5%. 

What’s interesting is the comments made by the U.S. manufacturers.  GM said sales were off because of "planned reductions in sales to rental fleets."  Ford said they also suffered from declining rental fleet sales, but they are dependent upon big-vehicle (SUV and truck) sales and the F-Series saw a 15 percent sales decline.  And, of course, last year saw record sales for these vehicles so this month should be ignored.   They also seemed to miss that sales of Toyota’s full-size truck sales quadrupled (that’s 4x) in the month. 

Defend & Extend management reacts to problems by pretending the problems don’t exist, or saying that there’s an explanation indicating the problem isn’t real.  Avoiding the problem is a common reaction to problems for D&E managers. 

GM, Ford and Chrysler are loaded with D&E managers more intent upon prolonging the Success Fomulas than dealing with the market Challenges.  Meanwhile, Toyota, Honda, Nissan, Hyundai and Kia are selling more cars.  When a Success Formula no longer produces positive results it needs to change.  But Defend & Extend managers are unwilling to admit it.  And until they do, it makes competing much easier for the small market players.