Migrate, don’t Milk

Lots of people have the idea that you can "milk" a business of cash.  The notion goes that you can take a viable, but slow (or no) growth business and stop investing.  Then "milk" the cash out of it.  What a great idea.  Too bad it doesn’t work.

Take Sears for example (see chart here).  Eddie Lampert got KMart out of bankruptcy, and then bought up Sears.  He quit investing in Sears, and revenues and profits dived.  He told investors that was OK, because he was improving profit margins.  He said he would keep flying the plane well, just at a lower altitude.  But sales and profits have continued to dive even further.  Just recently (see article here) Sears had to announce that profits were off yet another 40%.  Margins have declined from 28.4% to 27.7T.  Even though the company has been buying its own shares to prop up earnings per share, even that figure is down almost 40%.  And, revenues are down (not the growth rate down, the actual revenues have again declined) by 4%.  Same store sales at both Sears and KMart are down by about 4%.  The President of Sears, Aylwin Lewis, said he was disappointed.  Oh really?

Many investors have said not to worry about Sears slide.  After all, they said Mr. Lampert would "milk" Sears of its cash to make hedge fund investments – which are supposed to be wildly profitable.  Especially since that is ostensibly Mr. Lampert’s forte.  But, there are now more hedge funds than you can shake a stick at.  The price of deals has been bid up, and returns have fallen.  So those investments haven’t paid off.  Now the Sears war chest has declined by almost 50% – so much for "milking" to maintain cash.

Sears went into a growth stall, and those who ignored it have lost 27% on their equity investments.  The reality is that in today’s competitive global marketplace, no one has the option to slow investing and "milk" the business.  Competitors swoop in and push you down faster, and harder.  Competitors find those who want to "milk" easy prey.  Especially when they are as good as Target, Kohl’s and JC Penney – or as large and desperate for growth as WalMart. 

When a Success Formula grows old and tired, the portfolio notion of "milk it" so you can invest in another investment is, well, hopelessy out of date.  Portfolio theory is a great idea, but do you really think slow-growth, defensible cash-rich businesses exist?  Let’s get real.  When a Success Formula stops producing good returns management has to move fast to set up White Space and MIGRATE to a new Success Formula.  That’s the only option to keep from losing everything in the Whirlpool.  "Milking" is not possible.  Migrating is what management has to do.  By migrating to a new Success Formula companies can be reborn- like the Phoenix.  But Sears has no White Space – none.  Leadership keeps bleeding out cash, revenues fall, profits fall, and there’s no great saving alternative investment.  With every month, that option gets farther away for Sears and its inevitable demise becomes clearer.

I posted to this blog the day Lampert announced his acquisition of Sears that the company would not resurrect.  But a lot of people wanted to believe in Mr. Lampert.  Better to believe in reality.  Company’s have to migrate toward a new Success Formula by using Disruptions, White Space and working hard at it.  Not by wishing for portfolio theory, clever transactions and efforts at "milking" to somehow miraculously create value.

Goals are not enough

Kraft, the venerable American producer of cheese and other branded foodstuffs, has performed terribly for several years (see chart here.)  It’s operating margin is lowest in its peer group, its revenue growth has been nonexistent, and it has sold off valuable, and growing, brands – like Altoids – to fund its outdated Success Formula by Defending such old brands as Velveeta.  This last year Kraft was fully spun away from previous owner Altria (the old Phillip Morris), and a new CEO was put in place.  But so far, investors and employees have nothing beneficial to show from these changes.

On Tuesday the CEO said she intended to improve the performance at Kraft by setting higher goals, and tying compensation to those goals (read article here).  Her plans include incentive compensation ties to profits, cash flow and revenue growth.  And she intends to link how much is paid to Kraft’s ad agency to the growth in brand sales.  All of this may sound good, but it is unlikely to make any difference.

Any reader of this blog could decide to set a goal of improving their income by 50% this year.  And readers could promise that spending on hobbies would be directly linked to growing income.  But, would that make any difference?  If you go to your boss and tell him your plan he’s likely to say "that’s interesting", but will that help you reach your income goal?  Of course not.  Changing the goal is not enough.  What’s critical is Disrupting the Lock-ins so that it’s possible to find a new Success Formula leading to that goal.  For example, to achieve a 50% revenue increase might well require getting additional education – which would likely mean killing the Lock-in to watching weekend football or enjoying evenings out with a spouse.  Or it might mean changing employers and careers, which could entail killing the Lock-in to a short commute, or to the corner office acquired over time, or even to the company 401K or pension plan.  Those Lock-ins stand in the way of Disrupting yourself, and that’s what really stands in the way of achieving higher goals.

CEO Rosenfield at Kraft has not created any Disruptions.  Nor has she set up any White Space.  Quite to the contrary, she is proposing to cut headcount – a typical business disturbance that increases Lock-in by reducing resources.  She has complained about rising costs of the grains and other raw materials going into Kraft products, but has done nothing to create White Space which would address this issue – thus leaving declining margins at the ongoing mercy of those outside Kraft.  She keeps trying to incrementally improve the Kraft Success Formula, which is obviously woefully out of date and thus producing insufficient returns.

Setting new goals and linking compensation to goals is a nice thing to do.  But it is meaningless unless Disruptions are implemented that create White Space where new Success Formulas can be created that will result in achieving higher goals.  Tweaking the model by cutting heads, and blaming outside cost factors, only serves to keep the Success Formula Locked-in.  Unfortunately for investors and employees, Kraft’s new goals will make no difference unless the CEO starts attacking the Lock-ins that are keeping Kraft results below average.

Giving Competitors Their White Space

A few weeks ago this blog talked about the mistake Ford (see chart here) was making by selling off its most profitable group (Jaguar and Land Rover) in order to generate cash to Defend & Extend the broken Success Formula in traditional Ford business.  Ford is selling it’s White Space for cash to defend in its old business.  Just the opposite action Ford should take to turn itself around.

And one very savvy competitor has seen the opportunity.  Tata Group of India is not well known outside its home country (see website for Tata here).  It’s best known business is TCS (Tata Consultancy Services) which provides IT services globally.  But inside India Tata is known for everything from electricity generation to automobile manufacturing.  While Tata makes a complete line of vehicles, from large trucks to very small cars, in India (see website here) these are not known outside it’s domestic marketplace.  The company has recently made a splash by developing a quality automobile that it will sell for only $2,000, and potentially taking this new vehicle global (see article here.) 

While Tata Motors is not yet regarded on the world stage, the company is very serious about learning how to compete.  And the commonly held view is that Tata should produce a cheap car, which is not expected to be very good, and eventually try to migrate up market.  This slow approach is what the Japanese auto companies did, and more recently the Korean auto competitors.  But Tata Group is very astute.  And they recognized an opportunity to take a very different approach.

It has been reported that Tata is considering buying Jaguar and Land Rover (see article here.)  And this sort of Phoenix Principle thinking is why Tata has become a very successful, high growth and extremely profitable company.  This acquisition would give Tata a fast growing and very profitable auto company operating across the globe.  Tata already knows how to make inexpensive high volume automobiles.  These companies would give Tata global market access, and two very positively positioned brands.  Tata could then migrate its business toward the global marketplace, learning what will work from its acquisition, while developing new skills and capabilities in its very large, domestic business.  These acquisitions will provide the White Space that can help Tata Motors continue its rapid growth by developing a new Success Formula which can meet future market needs and help Tata become a world -class competitor.

Ford should have migrated its Success Formula forward with the White Space it has in its premier auto gruop.  By selling these businesses it effectively hands over its White Space, probably its most valuable assets, to an emerging competitor very willing, eager and capable of learning from these businesses to accelerate its growth.  In effect, Ford will create a new global competitor that may well help accelerate the demise of Ford itself.

Tata has been brillliant in its efforts to expand its information services business globally.  It is one of the world’s largest suppliers.  And while TCS results are not reported, it is well known in the industry that TCS’s performance is right up there with Infosys (see chart here) – the fastest growing and most profitable competitor on earth.  Now, Tata is looking to move forward similarly with its auto business.  And Ford is handing the knowledge keys to Tata for some money to short-term protect its badly outdated traditional business.  When the fox comes home to eat the eggs, Ford will only have itself to blame.