Vision Beats Numbers – How Apple Showed Intel A Better Way to Grow

Can you believe it has been only 12 years since Apple introduced the iPod?  Since then Apple's value has risen from about $11 (January, 2001) to over $500 (today) – an astounding 45X increase. 

With all that success it is easy to forget that it was not a "gimme" that the iPod would succeed.  At that time Sony dominated the personal music world with its Walkman hardware products and massive distribution through consumer electronics chains such as Best Buy, and broad-line retailers like Wal-Mart.  Additionally, Sony had its own CD label, from its acquisition of Columbia Records (renamed CBS Records,) producing music.  Sony's leadership looked impenetrable.

But, despite all the data pointing to Sony's inevitable long-term domination, Apple launched the iPod.  Derided as lacking CD quality, due to MP3's compression algorithms, industry leaders felt that nobody wanted MP3 products.  Sony said it tried MP3, but customers didn't want it.

All the iPod had going for it was a trend.  Millions of people had downloaded MP3 songs from Napster.  Napster was illegal, and users knew it.  Some heavy users were even prosecuted.  But, worse, the site was riddled with viruses creating havoc with all users as they downloaded hundreds of millions of songs. 

Eventually Napster was closed by the government for widespread copyright infreingement.  Sony, et.al., felt the threat of low-priced MP3 music was gone, as people would keep buying $20 CDs.  But Apple's new iPod provided mobility in a way that was previously unattainable.  Combined with legal downloads, including the emerging Apple Store, meant people could buy music at lower prices, buy only what they wanted and literally listen to it anywhere, remarkably conveniently.

The forecasted "numbers" did not predict Apple's iPod success.  If anything, good analysis led experts to expect the iPod to be a limited success, or possibly failure.  (Interestingly, all predictions by experts such as IDC and Gartner for iPhone and iPad sales dramatically underestimated their success, as well – more later.) It was leadership at Apple (led by the returned Steve Jobs) that recognized the trend toward mobility was more important than historical sales analysis, and the new product would not only sell well but change the game on historical leaders.

Which takes us to the mistake Intel made by focusing on "the numbers" when given the opportunity to build chips for the iPhone.  Intel was a very successful company, making key components for all Microsoft PCs (the famous WinTel [for Windows+Intel] platform) as well as the Macintosh.  So when Apple asked Intel to make new processors for its mobile iPhone, Intel's leaders looked at the history of what it cost to make chips, and the most likely future volumes.  When told Apple's price target, Intel's leaders decided they would pass.  "The numbers" said it didn't make sense.

Uh oh.  The cost and volume estimates were wrong.  Intel made its assessments expecting PCs to remain strong indefinitely, and its costs and prices to remain consistent based on historical trends.  Intel used hard, engineering and MBA-style analysis to build forecasts based on models of the past.  Intel's leaders did not anticipate that the new mobile trend, which had decimated Sony's profits in music as the iPod took off, would have the same impact on future sales of new phones (and eventually tablets) running very thin apps.

Harvard innovation guru Clayton Christensen tells audiences that we have complete knowledge about the past.  And absolutely no knowledge about the future.  Those who love numbers and analysis can wallow in reams and reams of historical information.  Today we love the "Big Data" movement which uses the world's most powerful computers to rip through unbelievable quantities of historical data to look for links in an effort to more accurately predict the future.  We take comfort in thinking the future will look like the past, and if we just study the past hard enough we can have a very predictible future.

But that isn't the way the business world works.  Business markets are incredibly dynamic, subject to multiple variables all changing simultaneously.  Chaos Theory lecturers love telling us how a butterfly flapping its wings in China can cause severe thunderstorms in America's midwest.  In business, small trends can suddenly blossom, becoming major trends; trends which are easily missed, or overlooked, possibly as "rounding errors" by planners fixated on past markets and historical trends. 

Markets shift – and do so much, much faster than we anticipate.  Old winners can drop remarkably fast, while new competitors that adopt the trends become "game changers" that capture the market growth.

In 2000 Apple was the "Mac" company.  Pretty much a one-product company in a niche market.  And Apple could easily have kept trying to defend & extend that niche, with ever more problems as Wintel products improved.

But by understanding the emerging mobility trend leadership changed Apple's investment portfolio to capture the new trend.  First was the iPod, a product wholly outside the "core strengths" of Apple and requiring new engineering, new distribution and new branding.  And a product few people wanted, and industry leaders rejected.

Then Apple's leaders showed this talent again, by launching the iPhone in a market where it had no history, and was dominated by Motorola and RIMM/BlackBerry.  Where, again, analysts and industry leaders felt the product was unlikely to succeed because it lacked a keyboard interface, was priced too high and had no "enterprise" resources.  The incumbents focused on their past success to predict the future, rather than understanding trends and how they can change a market. 

Too bad for Intel.  And Blackberry, which this week failed in its effort to sell itself, and once again changed CEOs as the stock hit new lows.

Then Apple did it again. Years after Microsoft attempted to launch a tablet, and gave up, Apple built on the mobility trend to launch the iPad.  Analysts again said the product would have limited acceptance. Looking at history, market leaders claimed the iPad was a product lacking usability due to insufficient office productivity software and enterprise integration.  The numbers just did not support the notion of investing in a tablet.

Anyone can analyze numbers.  And today, we have more numbers than ever.  But, numbers analysis without insight can be devastating.  Understanding the past, in grave detail, and with insight as to what used to work, can lead to incredibly bad decisions.  Because what really matters is vision.  Vision to understand how trends – even small trends – can make an enormous difference leading to major market shifts — often before there is much, if any, data.

 

How the Game Changed Against Big Pharma – Creating New Opportunities

In 1985 there was universal agreement that investors should
be heavily in pharmaceuticals. 
Companies like Merck, Eli Lilly, Pfizer, Sanofi, Roche, Glaxo and Abbott
were touted as the surest route to high portfolio returns.

Today, not so much.

Merck, once a leader in antibiotics, is laying off 20% of
its staff.  Half in R&D; the
lifeblood of future products and profits. 
 Lilly is undertaking
another round of 2013 cost cuts.  Over
the last year about 100,000 jobs have been eliminated in big pharma companies,
which have implemented spin-outs and split-ups as well as RIFs.

What happened? In the old days pharma companies had to demonstrate
their drug worked; called product efficacy.  It did not have to be better than existing drugs.  If the drug worked, without big safety
issues, the company could launch it.

Then the business folks took over with ads, distribution,
salespeople and convention booths, convincing doctors to prescribe and us to
buy.

Big pharma companies grew into large, masterful consumer
products companies. Leadership’s view of the market changed, as it was
perceived safer to invest in Pepsi vs. Coke marketing tactics and sales warfare
to dominate a blockbuster category than product development.  Think of the marketing cost in the
Celebrex vs. Vioxx war.  Or Viagra
vs. Cialis.

But the market shifted when the FDA decided new drugs had to
be not only efficacious, they had to enhance the standard of care.  New drugs actually had to prove better in clinical trials than existing
drugs.  And often safer, too.

Hurrumph. Big pharma’s enormous scale advantages in
marketing and communication weren’t enough to assure new product success.  It actually took new products.  But that meant bigger R&D investments,
perceived as more risky, than the new consumer-oriented pharma companies could
tolerate.  Shortly pipelines
thinned, generics emerged and much lower margins ensued.

In some disease areas, this evolution was disastrous for
patients.  In antibiotics,
development of new drugs had halted. 
Doctors repeatedly prescribed (some say overprescribed) the same antibiotics.  As the bacteria evolved, infections
became more difficult to treat.

With no new antibiotics on the market the risk of death from
bacterial infections grew, leading to a national public health crisis.  According to the Centers for Disease
Control (CDC) there are over 2 million cases of antibiotic resistant infections
annually.  Today just one type of
resistant “staph infection,” known as MRSA, kills more people in the USA than
HIV/AIDs – killing more people every year than polio did at its peak. The most
difficult to treat pathogens (called ESKAPE) are the cause of 66% of hospital
infections.

And that led to an important market shift – via regulation
(Congress?!?!)

With help from the CDC and NIH, the Infectious Diseases
Society of America pushed through the GAIN (Generating Antibiotic Incentives
Now) Act (H.R. 2182.)  This gave
creators of new antibiotics the opportunity for new, faster pathways through
clinical trials and review in order to expedite approvals and market launch.

Additionally new product market exclusivity was lengthened an additional 5
years (beyond the normal 5 years) to enhance investor returns.

Which allowed new game changers like Melinta Therapeutics
into the game.

Melinta (formerly Rib-X) was once considered a “biopharma science
company” with Nobel Prize-winning technology, but little hope of commercial
product launch.  But now the large
unmet need is far clearer, the playing field has few to no large company
competitors, the commercialization process has been shortened and cheapened,
and the opportunity for extended returns is greater!

Venture firm Vatera Healthcare Partners, with a history of investing in game changers (especially transformational technology,) entered the picture as lead investor.  Vatera's founder Michael Jaharis quickly hired Mary Szela, the former head of U.S.
Pharmaceuticals for Abbott (now Abbvie) as CEO.  Her resume includes leading the growth of Humira, one of
the world’s largest pharma brands with multi-billion dollar annual sales.

Under her guidance Melinta has taken fast action to work
with the FDA on a much quicker clinical trials pathway of under 18 months for
commercializing delafloxacin.  In layman’s
language, early trials of delafloxacin appeared to provide better performance
for a broad spectrum of resistant bacteria in skin infections.  And as a one-dose oral (or IV)
application it could be a simpler, high quality solution for gonorrhea.

Melinta continues adding key management resources as it
seeks “breakthrough product” designation under GAIN from the FDA for its RX-04
product.  RX-04 is an entirely
different scientific approach to infectious disease control, based on that previously
mentioned proprietary, Nobel-winning ribosome science.   It’s a potential product category
game changer that could open the door for a pipeline of follow-on products.

Melinta is using GAIN to do something big pharma, with its
shrinking R&D and commercial staff, is unable to accomplish. Melinta is helping
redefine the rules for approving antibiotics, in order to push through new,
life-saving products.

The best news is that this game change is great for investors.
 Those companies who understand the
trend (in this case, the urgent need for new antibiotics) and how the market
has shifted (GAIN,) are putting in place teams to leverage newly invented drugs
working with the FDA.  Investment timelines and dollars are looking
far more manageable – and less risky.

Twenty-five years ago pharma looked like a big-company-only
market with little competition and huge returns for a handful of companies.  But things changed.  Now companies (like Melinta) with new
solutions have the opportunity to move much faster to prove efficacy and safety
– and save lives.  They are the
game changers, and the ones more likely to provide not only solutions to the
market but high investor returns.

Why Apple Investors Are Deservedly Worried

Apple announced the new iPhones recently.  And mostly, nobody cared.

Remember when users waited anxiously for new products from Apple?  Even the media became addicted to a new round of Apple products every few months.  Apple announcements seemed a sure-fire way to excite folks with new possibilities for getting things done in a fast changing world. 

But the new iPhones, and the underlying new iPhone software called iOS7, has almost nobody excited. 

Instead of the product launches speaking for themselves, the CEO (Tim Cook) and his top product development lieutenants (Jony Ive and Craig Federighi) have been making the media rounds at BloombergBusinessWeek and USAToday telling us that Apple is still a really innovative place.  Unfortunately, their words aren't that convincing.  Not nearly as convincing as former product launches.

CEO Cook is trying to convince us that Apple's big loss of market share should not be troubling. iPhone owners still use their smartphones more than Android owners, and that's all we should care about.  Unfortunately, Apple profits come from unit sales (and app sales) rather than minutes used.  So the chronic share loss is quite concerning. 

Especially since unit sales are now growing barely in single digits, and revenue growth quarter-over-quarter, which sailed through 2012 in the 50-75% range, have suddenly gone completely flat (less than 1% last quarter.)  And margins have plunged from nearly 50% to about 35% – more like 2009 (and briefly in 2010) than what investors had grown accustomed to during Apple's great value rise.  The numbers do not align with executive optimism.

For industry aficianados iOS7 is a big deal.  Forbes Haydn Shaughnessy does a great job of laying out why Apple will benefit from giving its ecosystem of suppliers a new operating system on which to build enhanced features and functionality.  Such product updates will keep many developers writing for the iOS devices, and keep the battle tight with Samsung and others using Google's Android OS while making it ever more difficult for Microsoft to gain Windows8 traction in mobile. 

And that is good for Apple.  It insures ongoing sales, and ongoing profits.  In the slog-through-the-tech-trench-warfare Apple is continuing to bring new guns to the battle, making sure it doesn't get blown up.

But that isn't why Apple became the most valuable publicly traded company in America. 

We became addicted to a company that brought us things which were great, even when we didn't know we wanted them – much less think we needed them.  We were happy with CDs and Walkmen until we discovered much smaller, lighter iPods and 99cent iTunes.  We were happy with our Blackberries until we learned the great benefits of apps, and all the things we could do with a simple smartphone.  We were happy working on laptops until we discovered smaller, lighter tablets could accomplish almost everything we couldn't do on our iPhone, while keeping us 24×7 connected to the cloud (that we didn't even know or care about before,) allowing us to leave the laptop at the office.

Now we hear about upgrades.  A better operating system (sort of sounds like Microsoft talking, to be honest.)  Great for hard core techies, but what do users care?  A better Siri; which we aren't yet sure we really like, or trust.  A new fingerprint reader which may be better security, but leaves us wondering if it will have Siri-like problems actually working.  New cheaper color cases – which don't matter at all unless you are trying to downgrade your product (sounds sort of like P&G trying to convince us that cheaper, less good "Basic" Bounty was an innovation.) 

More (upgrades) Better (voice interface, camera capability, security) and Cheaper (plastic cases) is not innovation.  It is defending and extending your past success.  There's nothing wrong with that, but it doesn't excite us.  And it doesn't make your brand something people can't live without.  And, while it keeps the battle for sales going, it doesn't grow your margin, or dramatically grow your sales (it has declining marginal returns, in fact.)

And it won't get your stock price from $450-$475/share back to $700.

We all know what we want from Apple.  We long for the days when the old CEO would have said "You like Google Glass?  Look at this…….  This will change the way you work forever!!" 

We've been waiting for an Apple TV that let's us bypass clunky remote controls, rapidly find favorite shows and helps us avoid unwanted ads and clutter.  But we've been getting a tease of Dick Tracy-esque smart watches. 

From the world's #1 tech brand (in market cap – and probably user opinion) we want something disruptive!  Something that changes the game on old companies we less than love like Comcast and DirecTV.  Something that helps us get rid of annoying problems like expensive and bad electric service, or routers in our basements and bedrooms, or navigation devices in our cars, or thumb drives hooked up to our flat screen TVs —- or doctor visits.  We want something Game Changing!

Apple's new CEO seems to be great at the Sustaining Innovation game.  And that pretty much assures Apple of at least a few more years of nicely profitable sales.  But it won't keep Apple on top of the tech, or market cap, heap.  For that Apple needs to bring the market something big.  We've waited 2 years, which is an eternity in tech and financial markets.  If something doesn't happen soon, Apple investors deserve to be worried, and wary.

Be Really Glad Bezos Bought The Washington Post

Jeff Bezos, founder of Amazon worth $25.2B just paid $250 million to become sole owner of The Washington Post. 

Some think the recent rash of of billionaires buying newspapers is simply rich folks buying themselves trophies.  Probably true in some instances – and that benefits no one.  Just look at how Sam Zell ruined The Chicago Tribune and Los Angeles Times.  Or Rupert Murdoch's less than stellar performance owning The Wall Street Journal.  It's hard to be excited about a financially astute commodities manager, like John Henry, buying The Boston Globe – as it has all the earmarks of someone simply jumping in where angels fear to tread.

These companies lost their way long ago.  For decades they defined themselves as newspaper companies.  They linked everything about what they did to printing a daily paper.  The service they provided, which was a mix of hard news and entertainment reporting, was lost in the productization of that service into a print deliverable. 

So when people started to look for news and entertainment on-line, these companies chose to ignore the trend.  They continued to believe that readers would always want the product – the paper – rather than the service. And they allowed themselves to remain fixated on old processes and outdated business models long after the market shifted.

The leaders ignored the fact that advertisers could obtain much more directed placement at targets, at far lower cost, on-line than through the broad-based, general ads placed in newspapers.  And that consumers could get a much faster, and cheaper, sale via eBay, CraigsList or Vehix.com than via overpriced classified ads. 

Newspaper leadership kept trying to defend their "core" business of collecting news for daily publication in a paper format.  They kept trying to defend their local advertising base.  Even though every month more people abandoned them for an on-line format.  Not one major newspaper headmast made a strong commitment to go on-line.  None tried to be #1 in news dissemination via the web, or take a leadership role in associating ad placement with news and entertainment. 

They could have addressed the market shift, and changed their approach and delivery.  But they did not.

Money manager Mr. Henry has done a good job of turning the Boston Red Sox into a profitable institution.  But there is nothing in common between the Red Sox, for which you can grow the fan base, bring people to the ballpark and sell viewing rights, and The Boston Globe.  The former is unique.  The latter is obsolete.  Yes, the New York Times company paid $1.1B for the Globe in 1993, but that doesn't mean it's worth $70M today.  Given its revenue and cost structure, as a newspaper it is probably worth nothing.

But, we all still want news.  Nobody wants the information infrastructure collecting what we need to know to crumble.  Nobody wants journalism to die.  But it is unreasonable to expect business people to keep investing in newspapers just to fulfill a public good.  Even Mr. Zell abandoned that idea. 

Thus, we need the news, as a service, to be transformed into a new, profitable enterprise.  Somehow these organizations have to abandon the old ways of doing things, including print and paper distribution, and transform to meet modern needs.  The 6 year revenue slide at Washington Post has to stop, and instead of thinking about survival company leadership needs to focus on how to thrive with a new, profitable business model.

And that's why we all should be glad Jeff Bezos bought The Washington Post.  As head of Amazon.com  The Harvard Business Review ranked him the second best performing CEO of the last decade.  CNNMoney.com named him Business Person of the Year 2012, and called him "the ultimate disruptor."

By not doing what everyone else did, breaking all the rules of traditional retail, Mr. Bezos built Amazon.com into a $61B general merchandise retailer in 20 years.  When publishers refused to create electronic books he led Amazon into competing with its suppliers by becoming a publisher.  When Microsoft wouldn't produce an e-reader, retailer and publisher Amazon.com jumped into the intensely competitive world of personal electroncs creating and launching Kindle.  And then upped the stakes against competitors by enhancing that into Kindle Fire.  And when traditional IT suppliers like HP and Dell were slow to help small (or any) business move toward cloud computing Amazon launched its own network services to help the market shift.

Mr. Bezos' language regarding his intentions post acquisition are quite telling, "change… is essential… with or without new ownership….need to invent…need to experiment." 

And that is exactly what the news industry needs today.  Today's leaders are HuffingtonPost.com, Marketwatch.com and other web sites with wildly different business models than traditional paper media.  WaPo success will require transforming a dying company, tied to an old success formula, into a trend-aligned organization that give people what they want, when they want it, at a profit.

And it's hard to think of someone better experienced, or skilled, than Jeff Bezos to provide that kind of leadership.  With just a little imagination we can imagine some rapid moves:

• distribution of all content via Kindle style eReaders, rather than print.  Along with dramatically increasing the cost of paper subscriptions and daily paper delivery
• Instead of a "one size fits all" general purpose daily paper, packaging news into more fitting targeted products.  Sports stories on sports sites.  Business stories on business sites.  Deeper, longer stories into ebooks available for $.99 purchase.  And repackaging of stories that cover longer time spans into electronic short-books for purchase.
• Packaging content into Facebook locations for targeted readers.  Tying ads into these social media sites, and promoting ad sales for small, local businesses to the Facebook sites.
• Or creating an ala carte approach to buying various news and entertainment in an iTunes or Netflix style environment (or on those sites)
• Robustly attracting readers via connecting content with social media, including Twitter, to meet modern needs for immediacy, headline knowledge and links to deeper stories — with sales of ads onto social media
• Tying electronic coupons, and buy-it-now capabilities to ads linked to appropriate content
• Retargeting advertising sales from general purpose to targeted delivery at specific readers, with robust packages of on-line coupons, links to specials and fast, impulse purchase capability
• Increased use of bloggers and ad hoc writers to supplement staff in order to offer opinions and insights quickly, but at lower cost.
• Changes in compensation linked to page views and readership, just as revenue is linked to same.

We've watched a raft of newspapers and magazines disappear. This has not been a failure of journalism, but rather a failure of business leaders to address shifting markets and transform old organizations to meet modern needs.  It's not a quality problem, but rather a failure of strategy to adapt to shifting markets.  And that's a lesson every business leaders needs to note, because today, as I wrote in April, 2012, every company has to behave like a tech company!

Doing more of the same, cutting costs and rich egos won't fix a newspaper.  Only the willingness to experiment and find new solutions which transform these organizations into something very different, well beyond print, will work.  Let's hope Mr. Bezos brings the same zest for addressing these challenges and aligning with market needs he brought to Amazon.  To a large extent, the future of news and "freedom of the press" may well depend upon it.

 

Why Tesla Beats GM, Ford, Nissan

The last 12 months Tesla Motors stock has been on a tear.  From $25 it has more than quadrupled to over $100.  And most analysts still recommend owning the stock, even though the company has never made a net profit. 

There is no doubt that each of the major car companies has more money, engineers, other resources and industry experience than Tesla.  Yet, Tesla has been able to capture the attention of more buyers.  Through May of 2013 the Tesla Model S has outsold every other electric car – even though at $70,000 it is over twice the price of competitors! 

During the Bush administration the Department of Energy awarded loans via the Advanced Technology Vehicle Manufacturing Program to Ford ($5.9B), Nissan ($1.4B), Fiskar ($529M) and Tesla ($465M.)  And even though the most recent Republican Presidential candidate, Mitt Romney, called Tesla a "loser," it is the only auto company to have repaid its loan. And did so some 9 years early!  Even paying a $26M early payment penalty!

How could a start-up company do so well competing against companies with much greater resources?

Firstly, never underestimate the ability of a large, entrenched competitor to ignore a profitable new opportunity.  Especially when that opportunity is outside its "core." 

A year ago when auto companies were giving huge discounts to sell cars in a weak market I pointed out that Tesla had a significant backlog and was changing the industry.  Long-time, outspoken industry executive Bob Lutz – who personally shepharded the Chevy Volt electric into the market – was so incensed that he wrote his own blog saying that it was nonsense to consider Tesla an industry changer.  He predicted Tesla would make little difference, and eventually fail.

For the big car companies electric cars, at 32,700 units January thru May, represent less than 2% of the market.  To them these cars are simply not seen as important.  So what if the Tesla Model S (8.8k units) outsold the Nissan Leaf (7.6k units) and Chevy Volt (7.1k units)?  These bigger companies are focusing on their core petroleum powered car business.  Electric cars are an unimportant "niche" that doesn't even make any money for the leading company with cars that are very expensive!

This is the kind of thinking that drove Kodak.  Early digital cameras had lots of limitations.  They were expensive.  They didn't have the resolution of film.  Very few people wanted them.  And the early manufacturers didn't make any money.  For Kodak it was obvious that the company needed to remain focused on its core film and camera business, as digital cameras just weren't important. 

Of course we know how that story ended.  With Kodak filing bankruptcy in 2012.  Because what initially looked like a limited market, with problematic products, eventually shifted.  The products became better, and other technologies came along making digital cameras a better fit for user needs. 

Tesla, smartly, has not  tried to make a gasoline car into an electric car – like, say, the Ford Focus Electric.  Instead Tesla set out to make the best car possible.  And the company used electricity as the power source.  By starting early, and putting its resources into the best possible solution, in 2013 Consumer Reports gave the Model S 99 out of 100 points.  That made it not just the highest rated electric car, but the highest rated car EVER REVIEWED!

As the big car companies point out limits to electric vehicles, Tesla keeps making them better and addresses market limitations.  Worries about how far an owner can drive on a charge creates "range anxiety."  To cope with this Tesla not only works on battery technology, but has launched a program to build charging stations across the USA and Canada.  Initially focused on the Los-Angeles to San Franciso and Boston to Washington corridors, Tesla is opening supercharger stations so owners are never less than 200 miles from a 30 minute fast charge.  And for those who can't wait Tesla is creating a 90 second battery swap program to put drivers back on the road quickly.

This is how the classic "Innovator's Dilemma" develops.  The existing competitors focus on their core business, even though big sales produce ever declining profits.  An upstart takes on a small segment, which the big companies don't care about.  The big companies say the upstart products are pretty much irrelevant, and the sales are immaterial.  The big companies choose to keep focusing on defending and extending their "core" even as competition drives down results and customer satisfaction wanes.

Meanwhile, the upstart keeps plugging away at solving problems.  Each month, quarter and year the new entrant learns how to make its products better.  It learns from the initial customers – who were easy for big companies to deride as oddballs – and identifies early limits to market growth.  It then invests in product improvements, and market enhancements, which enlarge the market. 

Eventually these improvements lead to a market shift.  Customers move from one solution to the other.  Not gradually, but instead quite quickly.  In what's called a "punctuated equilibrium" demand for one solution tapers off quickly, killing many competitors, while the new market suppliers flourish.  The "old guard" companies are simply too late, lack product knowledge and market savvy, and cannot catch up.

• The integrated steel companies were killed by upstart mini-mill manufacturers like Nucor Steel.  
• Healthier snacks and baked goods killed the market for Hostess Twinkies and Wonder Bread. 
• Minolta and Canon digital cameras destroyed sales of Kodak film – even though Kodak created the technology and licensed it to them. 
• Cell phones are destroying demand for land line phones. 
• Digital movie downloads from Netflix killed the DVD business and Blockbuster Video. 
• CraigsList plus Google stole the ad revenue from newspapers and magazines.
• Amazon killed bookstore profits, and Borders, and now has its sites set on WalMart. 
• IBM mainframes and DEC mini-computers were made obsolete by PCs from companies like Dell. 
• And now Android and iOS mobile devices are killing the market for PCs.

There is no doubt that GM, Ford, Nissan, et. al., with their vast resources and well educated leadership, could do what Tesla is doing.  Probably better.  All they need is to set up white space companies (like GM did once with Saturn to compete with small Japanese cars) that have resources and free reign to be disruptive and aggressively grow the emerging new marketplace.  But they won't, because they are busy focusing on their core business, trying to defend & extend it as long as possible.  Even though returns are highly problematic.

Tesla is a very, very good car. That's why it has a long backlog. And it is innovating the market for charging stations. Tesla leadership, with Elon Musk thought to be the next Steve Jobs by some, is demonstrating it can listen to customers and create solutions that meet their needs, wants and wishes.  By focusing on developing the new marketplace Tesla has taken the lead in the new marketplace.  And smart investors can see that long-term the odds are better to buy into the lead horse before the market shifts, rather than ride the old horse until it drops.

 

 

Octopus Pants: A Great Lesson for Business and win for Ralph Lauren

If you're not a golfer, you may not understand the title.  But it is important.

Sunday was the final, of four days, of the U.S. Open.  Golf is clearly not as fan-favorited as soccer, football, basketball or hockey.  But many people are aware of the "major" golf tournaments – just as non-horseracers know about the Kentucky Derby or Preakness.  So there was more awareness than average about the sport on Sunday, and a tremendously greater amount of media coverage.

Interestingly, the big winner on the day was Octopus Pants. If you're confused – read on!

Monday morning if you opened a Yahoo! browser window and looked the top "trending now" box  there, plain as day, was "Octopus pants."  US Open was not there.  Nor was the name of the winner – Justin Rose (who came from behind to win.)  Nor the name of the leader for almost the entire tournament, and a huge crowd favorite in the sport, Phil Mickelson. 

But, back in the pack, was a very good golfer named Billy Horschel.  Although he's a great golfer, and a previous PGA tournament winner, was almost impossible to think he would win the U.S. Open on the final day, even though he shot a great second round (it takes 4 rounds to complete the tournament.)  Barring a near-miracle, the focus would be on the leaders Sunday so there was a chance the relative newcomer would not receive  much attention. [He did end up 6th – which is far better than the famous Tiger Woods, who came in 36th.]

In golf this is important because not only did it mean he would take home a smaller purse, but it also meant his value as an endorser for sponsors is lower.  As a fairly new golfer to the Professional Golf Association (PGA) tournaments Mr. Horschel is known in golf circles because he plays Ping brand clubs.  But few people know that for apparel Mr Horschel is sponsored by Ralph Lauren.

So, on Sunday he showed up wearing a pair of pants covered with images of Octopus. Pants that are part of the Ralph Lauren RXL line.  Mr. Horschel (and the Lauren team) was smart enough to use social media (Twitter, etc.)  to heighten interest in his appearance.  This bit of assault on the sensibilities of golf, combined with fashion, sent interest in Mr. Horschel's apparel – if not his golf – viral.  Not only were golfers looking for glimpses of Mr. Horschel's run for the leader board, but people not usually interested int the game were tuning in and keeping tabs via their mobile devices on his performance — and his pants!

Now, a combination of thinking ahead as to what he might wear, combined with some help from a smart sponsor like Lauren, and really smart use of social media marketing has helped Mr. Horschel, Lauren and Octopus Pants to become a global sensation.  More interesting to more people than the tournament winner, the tournament leader and even the biggest names (including Rory McElroy, Graham McDowell, Ian Poulter, Luke Donald) in the sport — and their sponsors.

Winning often means thinking, and doing things, outside the box.  Preparing to do something unconventional is important.  While I'm sure there was a plan for Mr. Horschel to be much more typically attired had he been the tournament leader, Lauren's team did a great job of figuring out multiple outcomes and how to be a winner under multiple scenarios.  Planning for how to win under multiple contingencies is critical in business. And having outside-the-box solutions thought through and ready to implement is the sign of a winning strategy – from different product to using unconventional marketing techniques. 

While we all should congratulate Justin Rose on a big win the U.S. Open, the big winner here was Ralph Lauren – and Octopus pants! 

 

How Samsung Changed the Game on Apple

The iPad is now 3 years old.  Hard to believe we've only had tablets such a short time, given how common they have become.  It's easy to forget that when launched almost all analysts thought the iPad was a toy that would be lucky to sell a few million units.  Apple blew away that prediction in just a few months, as people demonstrated their lust for mobility.  To date the iPad has sold 121million units – with an ongoing sales rate of nearly 20million per quarter.

Following very successful launches of the iPod (which transformed music from CDs to MP3) and iPhone (which turned everyone into smartphone users,) the iPad's transformation of personal technology made Apple look like an impenetrable juggernaut – practically untouchable by any competitor!  The stock soared from $200/share to over $700/share, and Apple became the most valuable publicly traded company on any American exchange!

But things look very different now.  Despite huge ongoing sales (iPad sales exceed Windows sales,) and a phenomenal $30B cash hoard ($100B if you include receivables) Apple's value has declined by 40%! 

In the tech world, people tend to think competition is all about the product.  Feature and functionality comparisons abound.  And by that metric, no one has impacted Apple.  After 3 years in development, Microsoft's much anticipated Surface has been a bust – selling only about 1.5million units in the first 6 months.  Nobody has created a product capable of outright dethroning the i product series.  Quite simply, there have been no "game changer" products that dramatically outperform Apple's.

But, any professor of introductory marketing will tell you that there are 4 P's in marketing: Product, Price, Place and Promotion.  And understanding that simple lesson was the basis for the successful onslaught Samsung has waged upon Apple in 2012 and 2013. 

Samsung did not change the game with technology or product.  It has used the same Android starting point as most competitors for phones and tablets.  It's products are comparable to Apple's – but not dramatically superior.  And while they are cheaper, in most instances that has not been the reason people switched.  Instead, Samsung changed the game by focusing on distribution and advertising!

 

Chart courtesy Jay Yarrow, Business Insider 4/2/13 and Horace Dediu, Asymco

The remarkable insight from this chart is that Samsung is spending almost 4.5 times Apple – and $1B more than perennial consumer goods brand leader Coca-Cola on advertising! Simultaneously, Samsung has set up kiosks and stores in malls and retail locations all over America.

Can you imagine having the following conversation in your company in 2010?:

"As Vice President of Marketing I propose we take on the market leader not by having a superior product.  We will change the game from features and function comparisons to availability and awareness.  I intend to spend more than anyone in our industry on advertising – even more than Coke.  And I will open so many information and sales locations that our products will be as available as Coke.  We'll be everywhere.  Our products may not be better, but they will be everywhere and everyone will know about them."

Samsung found Apple's Achilles heel.  As Apple's revenues rose it did not keep its marketing growing.  SG&A (Selling, General and Administrative) expense declined from 14% of revenues in 2006 to 5% in 2012; of course aiding its skyrocketing profits.  And Apple continued to sell through its fairly limited distribution of Apple stores and network providers.  Apple started to "milk" its hard won brand position, rather than intensify it.

Samsung took advantage of Apple's oversight.  Samsung maintained its SG&A budget at 15% of revenues – even growing it to 24% for a brief time in 2009, before returning to 15%.  As its revenues grew, advertising and distribution grew.  Instead of looking back at its old ad budget in dollars, and maintaining that budget, Samsung allowed the budget to grow (to a huge number!) along with revenues. 

And that's how Samsung changed the game on Apple.  Once America's untouchable brand, the Apple brand has faltered.  People now question Apple's sustainability. Some now recognize Apple is vulnerable, and think its best times are behind it.  And it's all because Samsung ignored the industry lock-in to constantly focusing on product, and instead changed the game on Apple.

Something Microsoft should have thought about – but didn't.

Of course, Apple's profits are far, far higher than Samsung's.  And Apple is still a great company, and a well regarded brand, with tremendous sales.  There are ongoing rumors of a new iOS 7 operating system, an updated format for iPads, potentially a dramatically new iPhone and even an iTV.  And Apple is not without great engineers, and a HUGE war chest which it could use on advertising and distribution to go heads up with Samsung.

But, at least for now, Samsung has demonstrated how a competitor can change the game on a market leader.  Even a leader as successful and powerful as Apple.  And Samsung's leaders deserve a lot of credit for seeing the opportunity – and seizing it!

 

Why Small Business Leaders are Missing the Digital/Mobile Revolution

It is an unfortunate fact that small businesses fail at a higher rate than large businesses.  While we've come to accept this, it somewhat flies in the face of logic.  After all, small businesses are run by owners who can achieve entrepreneurial returns rather than managerial bonuses, so incentive is high.  Conventional wisdom is that small businesses have fewer, and closer relationships to customers (think Ace Hardware franchisees vs. Home Depot.)  And lacking layers of overhead and embedded management they should be more nimble.

Yet, they fail.  From as high as 9 out of 10 for restaurants to 4 out of 10 in more asset intensive business-to-business ventures.  That is far higher than large companies.

Why?  Despite conventional wisdom most small businesses are run by leaders committed to a single, narrow success formula.  Most are wedded to their core ideology, based on personal history, and unwilling to adapt until the business completely fails.  Most reject new technologies and other emerging innovations as long as possible, trying to conserve  cash and wait for "more proof" change will pay off.  Additionally, most spend little time investing time, or money, in innovation at all as they pour everything into defending and extending their historical business approach. 

Take for example the major trend to digital marketing.  Everyone knows that digital is the only growing ad market, while print is fast dying:

Chart republished with permission of Jay Yarow, Business Insider 3/19/2013

Yet AdWeek reported a new Boston Consulting Group study reveals that a mere 3% of small business ad dollars are in digital!

Digital marketing is one of the few places where ads can be purchased for as little as $100.  Digital ads are targeted at users based upon their searches and pages viewed, thus delivered directly to likely buyers.  And digital ads consistently demonstrate the highest rate of return.  That's why it's growing at over 20%/year!

Yet, small businesses continue to put most of their money into local newspapers and direct mail circulars.  The least targeted of all advertising, and increasingly the least read!  While print ad spending has declined over 80% the last few years, to 1950 levels (adjusted for inflation,) smarter businesses have abandoned the media.  At large companies in 2012 38% of advertising is on digital, second only to TV's 42% – and rapidly moving into first place!

A second major trend is the move to mobile and app usage.  In the last 2 years mobile users have grown and shown a distinct preference for apps over mobile web sites.  App use is growing while mobile web sites have stalled:

Chart republished with permission of Alex Cocotas, Business Insider 3/20/13

Even though there are over 1million apps available for iPhone and Android users, the vast majority of small businesses have no apps aligned with their business and customers.  Most small businesses, late to the game in digital marketing, are content to try and add mobile capability to their already existing web site – hoping that it will be sufficient for future growth. Meanwhile, customers are going directly for apps in accelerating numbers every month!

Chart republished with permission of Alex Cocotas, Business Insider 1/8/13

Rather than act like market leaders, using customer intimacy and nimbleness to jump ahead of lumbering giants, small business leaders complain they are unsure of app value – and keep spending money on historical artifacts (like their web site) rather than invest in higher return innovation opportunities.  Many small businesses are spending $20k+/year on printed brochures, coupons and newspaper or magazine PR when a like amount spent on an app could connect them much more tightly with customers, add higher value and expand their base more quickly and more profitably!

The trend to digital marketing – including the explosive growth in mobile app use – is proven.  And due to very low relative up-front cost, as well as low variable cost, both trends are a wonderful boon for small businesses ready to adopt, adapt and grow.  But, unfortunately, the vast majoritiy of small business leaders are behaving oppositely!  They remain wedded to outdated marketing and customer relationship processes that are too expensive, with lower yield! 

The opportunity is greater now than during most times for smaller competitors to be disruptive.  They can seize new innovations faster, and leverage them before larger competitors.  But as long as they cling to old practices and processes, and beliefs about historical markets, they will continue to fail, smashed under the heal of slower moving, bureaucratic large companies who have larger resources when they do finally take action.

 

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Innovation REALLY Matters – Lessons Learned from Detroit

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

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

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

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

But things changed.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Dell – Take the Money and Run! Innovation trumps execution.

Michael Dell has put together a hedge fund, one of his largest suppliers and some debt money to take his company, Dell, Inc. private.  There are large investors threatening to sue, claiming the price isn't high enough.  While they are wrangling, small investors should consider this privatization manna from heaven, take the new, higher price and run to invest elsewhere – thankful you're getting more than the company is worth.

In the 1990s everybody thought Dell was an incredible company.  With literally no innovation a young fellow built an enormously large, profitable company using other people's money, and technology.  Dell jumped into the PC business as it was born.  Suppliers were making the important bits, and looking for "partners" to build boxes.  Dell realized he could let other people invest in microprocessor, memory, disk drive, operating system and application software development.  All he had to do was put the pieces together. 

Dell was the rare example of a company that was built on nothing more than execution.  By marketing hard, selling hard, buying smart and building cheap Dell could produce a product for which demand was skyrocketing.  Every year brought out new advancements from suppliers Dell could package up and sell as the latest, greatest model.  All Dell had to do was stay focused on its "core" PC market, avoid distractions, and win at execution.  Heck, everyone was going to make money building and selling PCs.  How much you made boiled down to how hard you worked.  It wasn't about strategy or innovation – just execution. 

Dell's business worked for one simple reason.  Everybody wanted PCs.  More than one.  And everybody wanted bigger, more powerful PCs as they came available.  Market demand exploded as the PC became part of everything companies, and people, do.  As long as demand was growing, Dell was growing.  And with clever execution – primarily focused on speed (sell, build, deliver, get the cash before the supplier has to be paid) – Dell became a multi-billion dollar company, and its founder a billionaire with no college degree, and no claim to being a technology genius.

But, the market shifted.  As this column has pointed out many times, demand for PCs went flat – never to return to previous growth rates.  Users have moved to mobile devices such as smartphones and tablets, while corporate IT is transitioning from PC servers to cloud services.  iPad sales now nearly match all of Dell's sales.  Dell might well be the world's best PC maker, but when people don't want PCs that doesn't matter any more.

Which is why Dell's sales, and profits, began to fall several years ago.  And even though Michael Dell returned to run the company 6 years ago, the downward direction did not change.  At its "core" Dell has no ability to innovate, or create new products.  It is like HTC – merely a company that sells and assembles, with all of its "focus" on cost/price.  That's why Samsung became the leader in Android smartphones and tablets, and why Dell never launched a Chrome tablet.  Lacking any innovation capability, Dell relied on its suppliers to tell it what to build.  And its suppliers, notably Microsoft and Intel, entirely missed the shift to mobile.  Leaving Dell long on execution skills, but with nowhere to apply them.

Market watchers knew this. That's why  Dell's stock took a long ride from its lofty value on the rapids of growth to the recent distinctly low value as it slipped into the whirlpool of failure.

Now Dell has a trumped up story that it needs to go public in order to convert itself from a PC maker into an IT services company selling cloud and mobile capabilities to small and mid-sized businesses.  But Dell doesn't need to go private to do this, which alone makes the story ring hollow.  It's going private because doing so allows Michael Dell to recapitalize the company with mountains of debt, then use internal cash to buy out his stock before the company completely fails wiping out a big chunk of his remaining fortune.

If you think adding debt to Dell will save it from the market shift, just look at how well that strategy worked for fixing Tribune Corporation. A Sam Zell led LBO took over the company claiming he had plans for a new future, as advertisers shifted away from newspapers.  Bankruptcy came soon enough, employee pensions were wiped out, massive layoffs undertaken and 4 years of legal fighting followed to see if there was any plan that would keep the company afloat.  Debt never fixes a failing company, and Dell knows that.  Dell has no answer to changing market demand away from PCs.

Now the buzzards are circling.  HP has been caught in a rush to destruction ever since CEO Fiorina decided to buy Compaq and gut the HP R&D in an effort to follow Dell's wild revenue ride.  Only massive cost cutting by the following CEO Hurd kept HP alive, wiping out any remnants of innovation.  Now HP has a dismal future.  But it hopes that as the PC market shrinks the elimination of one competitor, Dell, will give newest CEO Whitman more time to somehow find something HP can do besides follow Dell into bankruptcy court.

Watching as its execution-oriented ecosystem manufacturers are struggling, supplier Microsoft is pulling out its wallet to try and extend the timeline.  Plundering its $85B war chest, Microsoft keeps adding features, with acquisitions such as Skype, that consume cash while offering no returns – or even strong reasons for people to stop the transition to tablets. 

Additionally it keeps putting up money for companies that it hopes will build end-user products on its software, such as its $500M investment in Barnes & Noble's Nook and now putting $2B into Dell.  $85B is a lot of money, but how much more will Microsoft have to spend to keep HP alive – or money losing Acer – or Lenovo?  A billion here, a billion there and pretty soon it adds up to a lot of money!  Not counting losses in its own entertainmnet and on-line divisions.  The transition to mobile devices is permanent and Microsoft has arrived at the game incredibly late – and with products that simply cannot obtain better than mixed reviews.

The lesson to learn is that management, and investors, take a big risk when they focus on execution.  Without innovation, organizations become reliant on vendors who may, or may not, stay ahead of market transitions.  When an organization fails to be an innovator, someone who creates its own game changers, and instead tries to succeed by being the best at execution eventually market shifts will kill it.  It is not a question of if, but when.

Being the world's best PC maker is no better than being the world's best maker of white bread (Hostess) or the world's best maker of photographic film (Kodak) or the world's best 5 and dime retailer (Woolworth's) or the world's best manufacturer of bicycles (Schwinn) or cold rolled steel (Bethlehem Steel.)  Being able to execute – even execute really, really well – is not a long-term viable strategy.  Eventually, innovation will create market shifts that will kill you.

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