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.

The Day TV Died – Winners and Losers (Comcast, Disney, CBS)

Remember when almost everyone read a daily newspaper? 

Newspaper readership peaked around 2000.  Since then printed media has declined, as readers shifted on-line.  Magazines have folded, and newspapers have disappeared, quit printing, dramatically cut page numbers and even more dramatically cut staff. 

Amazingly, almost no major print publisher prepared for this, even though the trend was becoming clear in the late 1990s. 

Newspapers are no longer a viable business.  While industry revenue grew for
almost 2 centuries, it collapsed in a mere decade.

Chart Source: BusinessInsider.com

This market shift created clear winners, and losers.  On-line news sites like Marketwatch and HuffingtonPost were clear winners.  Losers were traditional newspaper companies such as Tribune Corporation, Gannett, McClatchey, Dow Jones and even the New York Times Company.  And investors in these companies either saw their values soar, or practically disintegrate. 

In 2012 it is equally clear that television is on the brink of a major transition.  Fewer people are content to have their entertainment programmed for them when they can program it themselves on-line.  Even though the number of television channels has exploded with pervasive cable access, the time spent watching television is not growing.  While simultaneously the amount of time people spend looking at mobile internet displays (tablets, smartphones and laptops) is growing at double digit rates.

Chart Source: Silicone Alley Insider Chart of the Day 12/5/12

It would be easy to act like newspaper defenders and pretend that television as we've known it will not change.  But that would be, at best, naive.  Just look around at broadband access, the use of mobile devices, the convenience of mobile and the number of people that don't even watch traditional TV any more (especially younger people) and the trend is clear.  One-way preprogrammed advertising laden television is not a sustainable business. 

So, now is the time to prepare.  And change your business to align with impending new realities.

Losers, and winners, will be varied – and not entirely obvious.  Firstly, a look at those trying to maintain the status quo, and likely to lose the most.

Giant consumer goods and retail companies benefitted from the domination of television.  Only huge companies like P&G, Kraft, GM and Target could afford to lay out billions of dollars for television ads to build, and defend, a brand.  But what advantage will they have when TV budgets no longer control brand building?  They will become extremely vulnerable to more innovative companies that have better products and move on fast lifecycles. Their size, hierarchy and arcane business practices will lead to huge problems.  Imagine a raft of new Hostess Brands experiences.

Even as the trends have started changing these companies have continued pumping billions into the traditional TV networks as they spend to defend their brand position.  This has driven up the value of companies like CBS, Comcast (owns NBC) and Disney (owns ABC) over the last 3 years substantially. But don't expect that to last forever. Or even a few more years.

Just like newspaper ad spending fell off a cliff when it was clear the eyeballs were no longer there, expect the same for television ad spending.  As giant advertisers find the cost of television harder and harder to justify their outlays will eventually take the kind of cliff dive observed in the chart (above) for newspaper advertising.  Already some consumer goods and ad agency executives are alluding to the fact that the rate of return on traditional TV is becoming sketchy.

So far, we've seen little at the companies which own TV networks to demonstrate they are prepared for the floor to fall out of their revenue stream.  While some have positions in a few internet production and delivery companies, most are clearly still doing their best to defend & extend the old business – just like newspaper owners did.  Just as newspapers never found a way to replace the print ad dollars, these television companies look very much like businesses that have no apparent solution for future growth.  I would not want my 401K invested in any major network company.

And there will be winners.

For smaller businesses, there has never been a better time to compete.  A company as small as Tesla or Fisker can now create a brand on-line at a fraction of the old cost.  And that brand can be as powerful as Ford, and potentially a lot more trendy. There are very low entry barriers for on-line brand building using not only ad words and web page display ads, but also using social media to build loyal followers who use and promote a brand.  What was once considered a niche can become well known almost overnight simply by applying the new dynamics of reaching customers on-line, and increasingly via mobile.  Look at the success of Toms Shoes.

Zappos and Amazon have shown that with almost no television ads they can create powerhouse retail brands.  The new retailers do not compete just on price, but are able to offer selection, availability and customer service at levels unachievable by traditional brick-and-mortar retailers.  They can suggest products and prices of things you're likely to need, even before you realize you need them.  They can educate better, and faster, than most retail store employees.  And they can offer great prices due to less overhead, along with the convenience of shipping the product right into your home. 

And as people quit watching preprogrammed TV, where will they go for content?  Anybody streaming will have an advantage – so think Netflix (which recently contracted for all the Disney content,) Amazon, Pandora, Spotify and even AOL.  But, this will also benefit those companies providing content access such as Apple TV, Google TV, YouTube (owned by Google) to offer content channels and the increasingly omnipresent Facebook will deliver up not only friends, but content — and ads. 

As for content creation, the deep pockets of traditional TV production companies will likely disappear along with their ability to control distribution.  That means fewer big-budget productions as risk goes up without revenue assurances. 

But that means even more ability for newer, smaller companies to create competitive content seeking audiences.  Where once a very clever, hard working Seth McFarlane (creator of Family Guy) had to hardscrabble with networks to achieve distribution, and live in fear of a single person controlling his destiny, in the future these creative people will be able to own their content and capture the value directly as they build a direct audience.  A phenomenon like George Lucas will be more achievable than ever before as what might look like chaos during transition will migrate to a much more competitive world where audiences, rather than network executives, will decide what content wins – and loses.

So, with due respects to Don McLean, will today be the day TV Died?  We will only know in historical context.  Nobody predicted newspapers had peaked in 2000, but it was clear the internet was changing news consumption behavior.  And we don't know if TV viewership will begin its rapid decline in 2013, or in a couple more years. But the inevitable change is clear – we just don't know exactly when.

So it would be foolish to not think that the industry is going to change dramatically.  And the impact on advertising will be even more profound, much more profound, than it was in print.  And that will have an even more profound impact on American society – and how business is done. 

What are you doing to prepare?

 

 

4 Myths and 1 Truth About Investing

Today is the 25th anniversary of the 1987 stock market crash that saw the worst ever one-day percentage decline on Wall Street.  Worse even than during the Great Depression.  It's a reminder that the market has had several October "crashes;" not only 1929 and 1987 but 1989, 1998, 2001 and 2007. 

For some people this serves as a reminder to invest very, very cautiously.  For others it is seen as market hiccups that present buying opportunities. For many it is an admonition to follow the investing advice of Mark Twain (although often attributed to Will Rogers) and pay more attention to the return of your money than the return on your money.

I've been investing for 30 years, and like most people I did it pretty badly.  For the first 20 years the annual review with my Merrill Lynch stock broker sounded like "Kent, why is it I'm paying fees to you, yet would have done better if I simply bought the Dow Jones Industrial Average?"  Across 20 years, almost every year, my "managed" account did more poorly than this collection of big, largely dull, corporations. 

A decade ago I dropped my broker, changed my approach, and things have gone much, much better.  Simply put I realized that everything I had been taught about investing, including my MBA, assured I would have, at best, returns no better than the overall market.  If I used the collective wisdom, I was destined to perform no better than the collective market.  Duh.  And that is if I remained unemotional and disciplined – which I didn't assuring I would do worse than the collective market! 

Remember, I am not a licensed financial advisor.  Below are the insights upon which I based my new investing philosophy.   First, the 4 myths that I think steered me wrong, and then the 1 thing that has produced above-average returns, consistently.

Myth 1 – Equities are Risky

Somewhere, somebody came up with a fancy notion that physical things – like buildings – are less risky than financial assets like equities in corporations.  Every homeowner in America now knows this is untrue.  As does anybody who owns a car, or tractor or even a strip mall or manufacturing plant.  Markets shift, and land and buildings – or equipment – can lose value amazingly quickly in a globally competitive world. 

The best thing about equities is they can adapt to markets.  A smart CEO leading a smart company can change strategy, and investments, overnight.  Flexible, adaptable supply chains and distribution channels reduce the risk of ownership, while creating ongoing value.  So equities can be the least risky investment option, if you keep yourself flexible and invest in flexible companies.

Hand-in-glove with this is recognizing that the best equities are not steeped in physical assets.  Lots of land, buildings and equipment locks-in the P&L costs, even though competitors can obsolete those assets very quickly.  And costs remain locked-in even though competition drives down prices.  So investing in companies with lots of "hard" assets is riskier than investing in companies where the value lies in intellectual capital and flexibility.

Myth 2 – Invest Only In What You Know

This is profoundly ridiculous.  We are humans.  There is infinitely more we don't know than what we do know.  If we invest only in what we know we become horrifically non-diversified.  And worse, just because we know something does not mean it is able to produce good returns – for anybody! 

This was the mantra Warren Buffet used to turn down a chance to invest in Microsoft in 1980.  Oops. Not that Berkshire Hathaway didn't find other investments, but that sure was an easy one Mr. Buffett missed.

To invest smartly I don't need to know a lot more than the really important trends.  I don't have to know electrical engineering, software engineering or be
an IT professional to understand that the desire to use digital mobile
products, and networks, is growing.  I don't have to be a bio-engineer to know that pharmaceutical solutions are coming very infrequently now, and the future is all in genetic developments and bio-engineered solutions.  I don't have to be a retail expert to know that the market for on-line sales is growing at a double digit rate, while brick-and-mortar retail is becoming a no-growth, dog-eat-margin competitive world (with all those buildings – see Myth 1 again.)  I don't have to be a utility expert to know that nobody wants a nuclear or coal plant nearby, so alternatives will be the long-term answer.

Investing in trends has a much, much higher probability of making good returns than investing in things that are not on major trends.  Investing in what we know would leave most people broke; because lots of businesses have more competition than growth.  Investing in businesses that are developing major trends puts the wind at your back, and puts time on your side for eventually making high returns.

Oh, and there are a lot fewer companies that invest in trends.  So I don't have to study nearly as many to figure out which have the best investment options, solutions and leadership.

Myth 3 – Dividends Are Important to Valuation

Dividends (or stock buybacks) are the admission of management that they don't have anything high value into which they can invest, so they are giving me the money.  But I am an investor.  I don't need them to give me money, I am giving them money so they will invest it to earn a rate of return higher than I can get on my own.  Dividends are the opposite of what I want. 

High dividends are required of some investments – like Real Estate Investment Trusts – which must return a percentage of cash flow to investors.  But for everyone else, dividends (or stock buybacks) are used to manipulate the stock price in the short-term, at the expense of long-term value creation. 

To make better than average returns we should invest in companies that have so many high return investment opportunities (on major trends) that the company really, really needs the cash.  We invest in the company, which is a conduit for investing in high-return projects.  Not paying a dividend.

Myth 4 – Long Term Investors Do Best By Purchasing an Index (or Giant Portfolio)

Go back to my introductory paragraphs.  Saying you do best by doing average isn't saying much, is it?  And, honestly, average hasn't been that good the last decade.  And index investing leaves you completely vulnerable to the kind of "crashes" leading to this article – something every investor would like to avoid.  Nobody invests to win sometimes, and lose sometimes. You want to avoid crashes, and make good rates of return.

Investors want winners.  And investing in an index means you own total dogs – companies that almost nobody thinks will ever be competitive again – like Sears, HP, GM, Research in Motion (RIM), Sprint, Nokia, etc. You would only do that if you really had no idea what you are doing.

If you are buying an index, perhaps you should reconsider investing in equities altogether, and instead go buy a new car. You aren't really investing, you are just buying a hodge-podge of stuff that has no relationship to trends or value cration. If you can't invest in winners, should you be an investor?

1 Truth – Growing Companies Create Value

Not all companies are great.  Really.  Actually, most are far from great, simply trying to get by, doing what they've always done and hoping, somehow, the world comes back around to what it was like when they had high returns.  There is no reason to own those companies.  Hope is not a good investment theory.

Some companies are magnificent manipulators.  They are in so many markets you have no idea what they do, or where they do it, and it is impossible to figure out their markets or growth.  They buy and sell businesses, constantly confusing investors (like Kraft and Abbott.)  They use money to buy shares trying to manipulate the EPS and P/E multiple.  But they don't grow, because their acquired revenues cost too much when bought, and have insufficient margin. 

Most CEOs, especially if they have a background in finance, are experts at this game.  Good for executive compensation, but not much good for investors.  If the company looks like an acquisition whore, or is in confusing markets, and has little organic growth there is no reason to own it.

Companies that are developing major trends create growth.  They generate internal projects which bring them more customers, higher share of wallet with their customers, and create new markets for new revenues where they have few, if any competition.  By investing in trends they keep changing the marketplace, and the competition, giving them more opportunities to sell more, and generate higher margins. 

Growing companies apply new technologies and new business practices to innovate new solutions solving new needs, and better solve old needs.  They don't compete head-on in gladiator style, lowering margins as they desperately seek share while cutting costs that kills innovation.  Instead they ferret out new solutions which give them a unique market proposition, and allow them to produce lots of cash for adding to my cash in order to invest in even more new market opportunities.

If you had used these 4 myths, and 1 truth, what would your investments have been like since the year 2000?  Rather than an index, or a manufacturer like GE, you would have bought Apple and Google. Remember, if you want to make money as an investor it's not about how many equities you own, but rather owning equities that grow.

Growth hides a multitude of sins.  If a company has high growth investors don't care about free lunches for workers, private company planes, free iPhones for employees or even the CEO's compensation.  They aren't trying to figure out if some acquisition is accretive, or if the desired synergies are findable for lowering cost. None of that matters if there is ample growth.

What an investor should care about, more than anything else, is whether or not there are a slew of new projects in the pipeline to keep fueling the growth. And if those projects are pursuing major trends.  Keep your eye on that prize, and you just might avoid any future market crashes while improving your investment returns. 

Innovation Matters; or Why You Care More About Apple than Kraft

Apple is launching the iPhone 5, and the market cap is hitting record highs.  No wonder, what with pre-orders on the Apple site selling out in an hour, and over 2 million units being presold in the first 24 hours after announcement. 

We care a lot about Apple, largely because the company has made us all so productive.  Instead of chained to PCs with their weight and processor-centric architecture (not to mention problems crashing and corrupting files) while simultaneously carrying limited function cell phones, we all now feel easily interconnected 24×7 from lightweight, always-on smart devices.  We feel more productive as we access our work colleagues, work tools, social media or favorite internet sites with ease.  We are entertained by music, videos and games at our leisure.  And we enjoy the benefits of rapid problem solving – everything from navigation to time management and enterprise demands – with easy to use apps utilizing cloud-based data.

In short, what was a tired, nearly bankrupt Macintosh company has become the leading marketer of innovation that makes our lives remarkably better.  So we care – a lot – about the products Apple offers, how it sells them and how much they cost.  We want to know how we can apply them to solve even more problems for ourselves, colleagues, customers and suppliers.

Amidst all this hoopla, as you figure out how fast you can buy an iPhone 5 and what to do with your older phone, you very likely forgot that Kraft will be splitting itself into 2 parts in about 2 weeks (October 1).  And, most likely, you don't really care. 

And you can't imagine why I would even compare Kraft with Apple.

Kraft was once an innovation leader.  Velveeta, a much maligned product today, gave Americans a fast, easy solution to cheese sauces that were difficult to make.  Instant Mac & Cheese was a meal-in-a-box for people on the run, and at a low budget.  Cheeze Whiz offered a ready-to-eat spread for canape's.  Individually wrapped American cheese slices solved the problem of sticky product for homemakers putting together lunch sandwiches for school children.  Miracle Whip added spice to boring sandwiches.  Philadelphia brand cream cheese was a tasty, less fattening alternative to butter while also a great product for sauces. 

But, the world changed and these innovations have grown a lot less interesting.  Frozen food replaced homemade sauces and boxed solutions.  Simultaneously, cooking skills improved.  Better options for appetizers emerged than stuffed celery or something on a cracker.  School lunches changed, and sandwich alternatives flourished.  Across Kraft's product lines, demand changed as new technologies were developed that better fit customers' needs leading to revenue stagnation, margin erosion and an increasing irrelevancy of Kraft in the marketplace – despite its enormous size.

Apple turned itself around by focusing on innovation, becoming the most valuable American publicly traded company.  Kraft eschewed innovation for cost cutting, doing more of the same trying to defend its "core," leaving investors with virtually no returns.  Meanwhile thousands of Kraft employees have lost their jobs, even though revenues per employee at Kraft are 1/6th those at Apple.   And supplier margins are a never-ending cycle of forced reductions as Kraft tries to capture their margin for itself.

Chart Source:  Yahoo Finance 18 September, 2012

Apple's value went up because it's revenues went up.  In 2007 Apple had #24B in revenues, while Kraft was 150% bigger at $37B.  Ending 2011 Apple's revenues, all from organic growth, were up 4x (400%) at $108B.  But Kraft's 2011 revenues were only $54B, including roughly $10B of purchased revenues from its Cadbury acquisition, meaning comparative Kraft revenues were $44B; a growth of (ho-hum) 3.5%/year. 

Lacking innovation Kraft could not grow the topline, and simply could not grow its value.  And paying a premium price for someone else's revenues has led to…. splitting the company in 2 in only 2 years, mystifying everyone as to what sort of strategy the company ever had to grow!

But Kraft's new CEO is not deterred.  In an Ad Age interview he promised to ramp up advertising while slashing more jobs to cut costs.  As if somehow advertising Velveeta, Miracle Whip, Philadelphia and Mac & Cheese will reverse 30 years of market trends toward different products which better serve customer needs!

Apple spends nearly nothing on advertising.  But it does spend on innovation.  Innovation adds value.  Advertising aging products that solve no new needs does not.

Unfortunately for employees, suppliers and shareholders we can expect Kraft to end up just like Hostess Brands, owner of Wonder Bread and Twinkies, which recently filed bankruptcy due to 40 years of sticking to its core business as the market shifted.  Industry leaders know this, as they announced this week they are using Kraft's split to remove the company from the Dow Jones Industrial Average. 

Companies that innovate change markets and reap the rewards.  By delivering on trends they excite customers who flock to their solutions. Companies that focus on defending and extending their past, especially in times of market shifts, end up failing. Failure may not happen overnight, but it is inevitable. 

Better, faster, cheaper is not innovation – Kodak and Microsoft

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There is a big cry for innovation these days.  Unfortunately, despite spending a lot of money on it, most innovation simply isn't. And that's why companies don't grow.

The giant consulting firm Booz & Co. just completed its most recent survey on innovation.  Like most analysts, they tried using R&D spending as yardstick for measuring innovation.  Unfortunately, as a lot of us already knew, there is no correlation:

"There is no statistically significant relationship between financial performance and innovation spending, in terms of either total R&D dollars or R&D as a percentage of revenues. Many companies — notably, Apple — consistently underspend their peers on R&D investments while outperforming them on a broad range of measures of corporate success, such as revenue growth, profit growth, margins, and total shareholder return. Meanwhile, entire industries, such as pharmaceuticals, continue to devote relatively large shares of their resources to innovation, yet end up with much less to show for it than they — and their shareholders — might hope for."

(Uh-hum, did you hear about this Abbott? Pfizer? Readers that missed it might want to glance at last week's blog about Abbott, and why it is a sell after announcing plans to split the company.)

Far too often, companies spend most of their R&D dollars on making their products cheaper, operate better, faster or do more.  Clayton Christensen pointed this out some 15 years ago in his groundbreaking book "The Innovator's Dilemma" (HBS Press, 1997).  Most R&D, in most industries, and for most companies, is spent trying to sustain an existing technology – not identify or develop a disruptive technology that would have far higher rates of return. 

While this is easy to conceptualize, it is much harder to understand.  Until we look at a storied company like Kodak – which has received a lot of news this last month.

Kodak invented amateur photography, and was rewarded with decades of profitable revenue growth as its string of cheap cameras, film products and photographic papers changed the way people thought about photographs.  Kodak was the world leader in photographic film and paper sales, at great margins, and its value grew exponentially!

Of course, we all know what happened.  Amateur photography went digital.  No more film, and no more film developing.  Even camera sales have disappeared as most folks simply use mobile phones.

But what most people don't know is that Kodak invented digital photography!  Really!  They were the first to create the technology, and the first to apply it.  But they didn't really market it, largely because of fears they would cannibalize their film sales.  In an effort to defend & extend their old business, Kodak licensed digital photography patents to camera manufacturers, abandoned R&D in the product line and maintained its focus on its core business.  Kodak kept making amateur film better, faster and cheaper – until nobody cared any more.

Of course, Kodak wasn't the first to fall into this trap.  Xerox invented desktop publishing but let that market go to Apple, Wintel suppliers and HP printers as it worked diligently trying to defend & extend its copier business.  With no click meter on the desktop publishing equipment, Xerox wasn't sure how to make money with it.  So they licensed it away.

DEC pretty much created and owned the CAD/CAM business before losing it to AutoCad.  Sears created at home shopping, a market now dominated by Amazon.  What's your favorite story?

It's a pattern we see a lot.  And nowhere worse than at Microsoft. 

Do you remember that Microsoft had the Zune player at least as early as the iPod, but didn't bother to develop the technology, or market, letting Apple take the lead in digital music and video devices? Did you remember that the Windows CE smartphone (built by HTC) beat the iPhone to market by years?  But Microsoft didn't really develop an app base, didn't really invest in the smartphone technology or market – and let first RIM and later Apple run away with that market as well. 

Now, several years too late Microsoft hopes its Nokia partnership will help it capture a piece of that market – despite its still rather apparent lack of an app base or breakthrough advantage.

Microsoft is a textbook example of over-investing in existing technology, in an effort to defend & extend an existing product line, to the point of  "over-serving" customer needs.  What new extensions do you want from your PC or office software? 

Do you remember Clippy?  That was the little paper clip that came up in Windows applications to help you do your job better.  It annoyed everyone, and was disabled by everyone.  A product development that nobody wanted, yet was created and marketed anyway.  It didn't sell any additional software products – but it did cost money. That's defend & extend spending.

How much a company spends on innovation doesn't matter, because what's important is what the company spends on real breakthroughs rather than sustaining ideas.  Microsoft spends a lot on Windows and Office – it doesn't spend enough on breakthrough innovation for mobile products or games. 

And it doesn't spend nearly enough on marketing non-PC innovations.  We are already well into the back end of the PC lifecycle.  Today more bandwidth is consumed from mobile devices than PC laptops and desktops.  Purchase rates of mobile devices are growing at double digits, while companies (and individuals) are curtailing PC purchases.  But Microsoft missed the boat because it chose to defend & extend PCs years ago, rather than really try to develop the technology and markets for CE and Zune. 

Just look at where Microsoft spends money today.  It's hottest innovation is Kinect.  But that investment is dwarfed by spending on Skype – intended to extend PC life – and ads promoting the use of PC technologies for families this holiday season.

Unfortunately, there are almost no examples of companies that miss the transition to a new technology thriving.  And that's why it is really important to revisit the Kodak chart, and then look at a Microsoft chart. 

(Chart 10/27/11)

Do you think Microsoft, after this long period of no value increase, is more likely to go up in value, or more likely to follow Kodak?  Unfortunately, there are few companies that make the transition.  But there have been thousands that have not.  Companies that had very high market share, once made a lot of money, but fell into failure because they invested in better, faster, cheaper rather than innovation.

If you are still holding Kodak, why?  If you're still holding Microsoft, Abbott, Kraft, Sara Lee, Sears or Wal-Mart — why? 

Baffle ’em with Bulls**t – Forget Kraft

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"If you can't dazzle 'em with brilliance – Baffle 'em with Bulls**t" – W. C. Fields

Just 18 months ago Kraft CEO Irene Rosenfeld was working very hard to convince investors she needed to grow Kraft with a $19B acquisition of Cadbury.  This was after her expensive acquisition of Lu Biscuits from Danone. Part of her justification for the massive expenditure was an out-of-date industrial manufacturing adage, "Scale is a source of great competitive advantage. " How these acquisitions provided scale advantage was never explained.

Now she wants to convince investors Kraft needs to be split into two companies, saying the acquisition trail has left her with "different portfolios."  (Quotes from the Wall Street Journal, "Activists Pressed for Kraft Spinoff") For some reason, scale is now less important than portfolio focus.  And the scale advantages that justified the acquisition premiums are now – unimportant?

If Ms. Rosenfeld was a politician, she might be accused of being a "flip-flopper." Remember John Kerry?

Ms. Rosenfeld would like to break Kraft into 2 parts.  Some brands would be in a new "grocery," or "domestic" business (Oscar Mayer, Cool Whip, Maxwell House, Jell-O, Philadelphia Cream Cheese, Kool Aid, Miracle Whip is a partial list.)  The rest of the company would be a "snack" or "international" business.  Although the latter would still include the North American snacks and confectionary brands.  (More detail in the Wall Street Journal "Kraft: Breaking Down the Breakup.")

We will ignore the obvious questions about why the acquisitions if your strategy was to split up the company.  Instead, looking forward, the critical questions to have answered would be "How will this break-up help Kraft grow? And what is the benefit for investors, employees and shareholders of this massive, and costly, change?" 

Kraft was split off from Altria at the end of 2006, with Ms. Rosenfeld at the helm.  At its rebirth, Kraft became a Dow Jones Industrial member.  Rich in revenues and resources, at the time, Kraft was valued at about $35/share.  Now, 5 years and all the M&A machinations later, Kraft is valued (with optimism about the breakup value) at about $35/share!  Between the two dates the company's value was almost always lower.  So investors have gained nothing for their 5 years of waiting for Ms. Rosenfeld to "transform" Kraft.

The big winners at Kraft have been their investment bankers.  They received enormous multi-million dollar fees for helping Ms. Rosenfeld buy and sell businesses.  And they will receive massive additional fees if the company is split in two.  In fact, given her focus on M&A as opposed to actually growing Kraft, one could well assess Ms. Rosenfeld's tenure as more investment banker than Chief Executive Officer.  She didn't really do anything to improve Kraft.  She just moved around the pieces, and swapped some.

Kraft has had no growth, other than from the expensive purchased acquisition revenues.  Despite its massive $50B revenue stream, what new innovation – what exciting new product – can you recall Kraft introducing?  Go ahead, take your time.  We can wait. 

What's that – you can't think of any.  Nor can anybody else. 

In Kraft's historical businesses, volume declined 1.5% over the last couple of years.  The company has been shrinking.  According to Crain's Chicago Business in "Kraft's Rosenfeld's About Face Spurred by Dwindling Options," the only reason revenues grew in the base business was due to rising commodity prices, which were passed along, with a premium added, in retail price increases to consumers!  A business doesn't have a sparkling future when it keeps selling less, and raising prices, on products that consumers largely could care less about. 

When was the last time you asked for a Velveeta sandwich?  Interestly, Tang now seems to have outlived even NASA and the American space program.  Have you enjoyed that sugar-laden breakfast delight lately?  Or when did you last look for that special opportunity to use artificial ice-cream (Cool Whip) in your desert?

BusinessInsider.com tried valiantly to make the case "The Kraft Foods Split is the Grand Finale of an Epic Transformation." But as the author takes readers through the myriad re-organizations, in the end we realize that all these changes did nothing to actually improve the business – and managed to tick off Kraft's largest investor, Warren Buffet of Berkshire Hathaway, who has been selling shares!

The argument that Kraft has 2 portfolios as a justification for splitting the company makes no sense.  Every investor is taught to have a wide portfolio in order to maximize returns at lowest risk.  That Kraft has multiple product lines is a benefit to investors, not a negative! 

Unless the leaders have no idea how to use the resources from these businesses to innovate, and bring out new products building on market trends and creating growth!  And that's the one thing most lacking at Kraft.  It's not a portfolio issue – it's a complete lack of innovation issue! As Burt Flickingerof Strategic Resources Group pointed out, Kraft has been losing .5% to 1% market share every year for the last decade in its "core" business, and he understatedly commente that Kraft has "very little innovation."

Markets have shifted dramatically the last 5 years, and food is no exception.  People want fewer carbs, and fewer fats.  They want easily prepared foods, but without additives like sugar (or high fructose corn syrup,) salt and oil that have negative long-term health implications for blood pressure, heart disease and diabetes.  Also, they don't want hidden calories that make ease of preparation a trade-off with their wastelines!  Further, most families have changed from the traditional 3 times per day standard meals to more grazing habits, and from large portions to smaller portions with greater variety. 

But Kraft addressed none of these shifts with new products.  Instead, it kept pouring advertising dollars into the traditional foodstuffs, even as these were finding less and less fit with 2011 dietary needs – or consumer interest! When the most exciting thing anyone can say about a Kraft launch the last 5 years was the re-orientation of the Triscuit line (did you catch that, or did you somehow miss it?) then it's pretty clear innovation has been on the back burner.  Or maybe stuck in the shelf with the Cheez Whiz.

It is clear that Ms. Rosenfeld offered no brilliance as Kraft's leader.  Uninspiring to consumers, investors and employees.  She made very expensive acquisitions to create the illusion of revenue growth; financial machinations that hid declines in the traditional business which suffered from no innovation investment. After all that money was thrown around, and facing very little prospect of any growth, it was time for the biggest baffling bulls**t of all – split the company up so nobody can trace the value destruction!

Andrew Lazar at Barclay's Capital Plc gave a pretty good insight in another Crain's Chicago Business article ("Kraft Jettisons U. S. Brands so Global Snack Biz Can Fly Higher.")  He said Kraft (aka Ms. Rosenfeld) is "Taking action before it ever has to potentially disappoint investors in a struggle to reach overly optimistic sales growth targets."

Yes, I think Mr. Fields had it pretty right when it comes to describing the leadership of Ms. Rosenfeld and her team at Kraft.  They have been unable to dazzle us with any brilliance.  The question is whether we'll be foolish enough to let them baffle us with their ongoing bulls**t.   What Kraft needs is not a break-up.  What Kraft needs is new leadership that understands how to move beyond the past, tie investments to market needs, and start Kraft growing again!! 

This week most people don't really care about Kraft.  After the U.S. debt ceiling "crisis," followed by the Friday night announcement of the U.S. debt downgrade, the news has been dominated by mostly economic, rather than company, items.  The collapse of the DJIA has been a lot more important than a non-value-adding split-up of a single component.  And that is unfortunate, because the leadership of Kraft have been playing chess games with company pieces, rather than actually doing what it takes to help a company grow.  With the right leadership, Kraft could be creating the jobs everyone so desperately wants.

Will you grow in 2011? Create wealth like Apple, Amazon, Priceline, DeVry, Colgate

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“Goodbye 2010, the Year of Austerity” is the  headline from Mediapost.com‘s Marketing Daily.  And that could be the mantra for many, many companies.  Nobody is winning today by trying to save their way to prosperity!  As we move into this decade, it is important business leaders realize that the only way to create a strong bottom line (profit) is to develop a strong top line (revenue.)  Recommendations:

1. Never be desperate.  Go to where the growth is, and where you can make money.  Don’t chase any business, chase the business where you can profitably growth.  Be somewhat selective.
2. Focus efforts on markets you know best.  I add that it’s important you understand not to do just what you like, but learn to do what customers VALUE.
3. Let go of crap, traditions and “playing it safe” actions.  Growth is all about learning to do what the market wants, not trying to protect the past – whether processes, products or even customers.
4. More lemonade making. You can’t grow unless you’re willing to learn from everything around you. We constantly find ourselves holding lemons, but those who prosper don’t give up – they look for how to turn those into desirable lemonade.  What is your willingness to learn from the market?
5. Austerity measures are counterproductive 99% of the time. Efficiency is the biggest obstacle to innovation.  You don’t have to be a spendthrift to succeed, but you can’t be a miser investing in only the things you know, and have done before.
6. Communicate, communicate, communicate. We don’t learn if we don’t share.  Developing insight from the environment happens when all inputs are shared, and lots of people contribute to the process.
7. Get off the downbeat buss. There’s more to success than the power of positive thinking, but it is very hard to gain insight and push innovation when you’re a pessimist.  Growth is an opportunity to learn, and do exciting things. That should be a positive for everybody – except the status quo police.

Realizing that you can’t beat the cost-cutting horse forever (in fact, most are about ready for the proverbial glue factory), it’s time to realize that businesses have been under-investing in innovation for the last decade.  While GM, Circuit City, Blockbuster, Silicon Graphics and Sun Microsystems have been failing, Apple, Google, Cisco, Netflix, Facebook and Twitter have maintained double-digit growth!  Those who keep innovating realize that markets aren’t dead, they’re just shifting!  Growth is there for businesses who are willing to innovate new solutions that attract customers and their dollars! For every dead DVD store there’s somebody making money streaming downloads.  Businesses simply have to work harder at innovating.

Fast Company gives us “Five Innovative New Year’s Resolutions:”

1. Associate.  Work harder at trying to “connect the dots.”  Pick up on weak signals, before others, and build scenarios to help understand the impact of these signals as they become stronger.  For example, 24x7WallStreet.com clues us in that greater use of mobile devices will wipe out some businesses in “The Ten Businesses The Smartphone Has Destroyed.”  But for each of these (and hundreds others over the next few years) there will be a large number of new business opportunities emerging.  Just look at the efforts of Foursquare and Groupon and the direction those growth businesses are headed.
2. Observe.  Pay attention to what’s happening in the world, and think about what it means for your (and every other) business.  $100/barrel oil has an impact; what opportunity does it create?  Declining network TV watching has an impact – how will you leverage this shift?  Don’t just wander through the market, and reacting.  Figure out what’s happening and learn to recognize the signs of growth opportunities. Use market events to drive being proactive.
3. Experiment.  If you don’t have White Space teams trying figure out new business models, how will you be a future winner?  Nobody “lucks” into a growth market.  It takes lots of trial and learning – and that means the willingness to experiment.  A lot.  Plan on experimenting.  Invest in it.  And then plan on the positive results.
4. Question. Keep asking “why” until the market participants are so tired they throw you out of the room.  Then, invent scenarios and ask “why not” until they throw you out again.  Markets won’t tell you what the next big thing is, but if you ask a lot of questions your scenarios about the future will be a whole lot better – and your experimentation will be significantly more productive.
5. Network. You can’t cast your net too wide in the effort to obtain multiple points of view.  Nothing is narrower than our own convictions.  Only by actively soliciting input from wide-ranging sources can you develop alternative solutions that have higher value.  We become so comfortable talking to the same people, inside our companies and outside, that we don’t realize how we start hearing only reinforcement for our biases.  Develop, and expand, your network as fast as possible.  Oil and water may be hard to mix, but it blending inputs creates a good salad dressing.

ChiefExecutive.net headlined “2010 CEO Wealth Creation Index Shows a Few Surprises.” Who creates wealth?  Included in thte Top 10 list are the CEOs of Priceline.com, Apple, Amazon, Colgate-Palmolive and DeVry.  These CEOs are driving industry innovation, and through that growth.  This has produced above-average cash flow, and higher valuations for their shareholders.  As well as more, and better quality jobs for employees.  Meanwhile suppliers are in a position to offer their own insights for ways to grow, rather than constantly battling price discussions.

Who destroys wealth?  In the Top 10 list are the CEOs of Dean Foods, Kraft, Computer Sciences (CSC) and Washington Post.  These companies have long eschewed innovation.  None have introduced any important innovations for over a decade.  Their efforts to defend & extend old practices has hurt revenue growth, providing ample opportunity for competitors to enter their markets and drive down margins through price wars.  Penny-pinching has not improved returns as revenues faltered, and investors have watched value languish.  Employees are constantly in turmoil, wondering what future opportunities may ever exist.  Suppliers never discuss anything but price.  These are not fun companies to work in, or with, and have not produced jobs to grow our economy.

Any company can grow in 2011.  Will you?  If you choose to keep doing what you’ve always done – well you shouldn’t plan on improved performance.  On the other hand, embracing market shifts and creating an adaptive organization that identifies and launches innovation could well make you into a big winner.  Next holiday season when you look at performance results for 2011 they will have more to do with management’s decisions about how to manage than any other factor.  Any company can grow, if it does the right things.

 

 

Size isn’t relevant – GM, Circuit City, Dell, Microsoft, GE

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Summary:

• Many people think it is OK for large companies to grow slowly
• Many people admire caretaker CEOs
• In dynamic markets, low-growth companies fail
• It is harder to generate $1B of new revenue, than grow a $100B company by $10B
• Large companies have vastly more resources, but they squander them badly
• We allow large company CEOs too much room for mediocrity and failure
• Good CEOs never lose a growth agenda, and everyone wins!

“I may just be your little rent collector Mr. Potter, but that George Bailey is making quite a bit happen in that new development of his.  If he keeps going it may just be time for this smart young man to go asking George Bailey for a job.” From “It’s a Wonderful Life“ an employee of the biggest employer in mythical Beford Falls talks about the growth of a smaller competitor.

My last post gathered a lot of reads, and a lot of feedback.  Most of it centered on how GE should not be compared to Facebook, largely because of size differences, and therefore how it was ridiculous to compare Jeff Immelt with Mark Zuckerberg.  Many readers felt that I overstated the good qualities of Mr. Zuckerberg, while not giving Mr. Immelt enough credit for his skills managing “lower growth businesses”  in a “tough economy.” Many viewed Mr. Immelt’s task as incomparably more difficult than that of managing a high growth, smaller tech company from nothing to several billion revenue in a few years.  One frequent claim was that it is enough to maintain revenue in a giant company, growth was less important. 

Why do so many people give the CEOs of big companies a break? Given that they make huge salaries and bonuses, have fantastic perquesites (private jets, etc.), phenominal benefits and pensions, and receive remarkable payouts whether they succeed or fail I would think we’d have very high standards for these leaders – and be incensed when their performance is sub-par.

Facebook started with almost no resources (as did Twitter and Groupon).  Most leaders of start-ups fail.  It is remarkably difficult to marshal resources – both enough of them and productively – to grow a company at double digit rates, produce higher revenue, generate cash flow (or loans) and keep employees happy.  Growing to a billion dollars revenue from nothing is inexplicably harder than adding $10B to a $100B company. Compared to Facebook, GE has massive resources.  Mr. Immelt entered the millenium with huge cash flow, huge revenues, and an army of very smart employees.  Mr. Zuckerberg had to come out of the blocks from a standing start and create ALL his company’s momentum, while comparatively Mr. Immelt took on his job riding a bullet out of a gun!  GE had huge momentum, a low cost of capital, and enough resources to do anything it wanted.

Yet somehow we should think that we don’t have as high expectations from Mr. Immelt as we do Mr. Zuckerberg?  That would seem, at the least, distorted. 

In business school I read the story of how American steel manufacturers were eclipsed by the Japanese.  Ending WWII America had almost all the steel capacity.  Manufacturers raked in the profits.  Japanese and German companies that were destroyed had to rebuild, which they progressively did with more efficient assets.  By the 1960s American companies were no longer competitive.  Were we to believe that having their industrial capacity destroyed somehow was a good thing for the foreign competitors?  That if you want to improve your competitiveness (say in autos) you should drop a nuclear bomb on the facilities (some may like that idea – but not many who live in Detroit I dare say.)  In reality the American leaders simply refused to invest in new technologies and growth markets, allowing competitors to end-run them.  The American leaders were busy acting as caretakers, and bragging about their success, instead of paying attention to market shifts and keeping their companies successful!

Big companies, like GE, are highly advantaged.  They not only have brand, and market position, but cash, assets, employees and vendors in position to help them be even more successful!  A smart CEO uses those resources to take the company into growth markets where it can grow revenues, and profits, faster than the marketplace.  For example Steve Jobs at Apple, and Eric Schmidt at Google have found new markets, revenues and cash flow beyond their original “core” markets.  That’s what Mr. Welch did as predecessor to Mr. Immelt.  He didn’t so much take advantage of a growth economy as help create it! Unfortunately, far too many large company CEOs squander their resources on low rate of return projects, trying to defend their existing business rather than push forward. 

Most big companies over-invest in known markets, or technologies, that have low growth rates, rather than invest in growth markets, or technologies they don’t know as well.  Think about how Motorola invented the smart phone technology, but kept investing in traditional cellular phones.  Or Sears, the inventor of “at home shopping” with catalogues closed that division to chase real-estate based retail, allowing Amazon to take industry leadership and market growth.  Circuit City ended up investing in its approach to retail until it went bankrupt in 2010 – even though it was a darling of “Good to Great.”  Or Microsoft, which launched a tablet and a smart phone, under leader Ballmer re-focused on its “core” operating system and office automation markets letting Apple grab the growth markets with R&D investments 1/8th of Microsoft’s.  These management decisions are not something we should accept as “natural.” Leaders of big companies have the ability to maintain, even accelerate, growth.  Or not.

Why give leaders in big companies a break just because their historical markets have slower growth?  Singer’s leadership realized women weren’t going to sew at home much longer, and converted the company into a defense contractor to maintain growth.  Netflix converted from a physical product company (DVDs) into a streaming download company in order to remain vital and grow while Blockbuster filed bankruptcy.  Apple transformed from a PC company into a multi-media company to create explosive growth generating enough cash to buy Dell outright – although who wants a distributor of yesterday’s technology (remember Circuit City.)  Any company can move forward to be anything it wants to be.  Excusing low growth due to industry, or economic, weakness merely gives the incumbent a pass.  Good CEOs don’t sit in a foxhole waiting to see if they survive, blaming a tough battleground, they develop strategies to change the battle and win, taking on new ground while the competition is making excuses.

GM was the world’s largest auto company when it went broke.  So how did size benefit GM?  In the 1980s Roger Smith moved GM into aerospace by acquiring Hughes electronics, and IT services by purchasing EDS – two remarkable growth businesses.  He “greenfielded” a new approach to auto manufucturing by opening the wildly successful Saturn division.  For his foresight, he was widely chastised.  But “caretaker” leadership sold off Hughes and EDS, then forced Saturn to “conform” to GM practices gutting the upstart division of its value.  Where one leader recognized the need to advance the company, followers drove GM to bankruptcy by selling out of growth businesses to re-invest in “core” but highly unprofitable traditional auto manufacturing and sales.  Meanwhile, as the giant failed, much smaller Kia, Tesla and Tata are reshaping the auto industry in ways most likely to make sure GM’s comeback is short-lived.

CEOs of big companies are paid a lot of money.  A LOT of money.  Much more than Mr. Zuckerberg at Facebook, or the leaders of Groupon and Netflix (for example).  So shouldn’t we expect more from them?  (Marketwatch.com “Top CEO Bonuses of 2010“) They control vast piles of cash and other resources, shouldn’t we expect them to be aggressively investing those resources in order to keep their companies growing, rather than blaming tax strategies for their unwillingness to invest?  (Wall Street Journal “Obama Pushes CEOs on Job Creation“) It’s precisely because they are so large that we should have high expectations of big companies investing in growth – because they can afford to, and need to!

At the end of the day, everyone wins when CEOs push for growth.  Investors obtain higher valuation (Apple is worth more than Microsoft, and almost more than 10x larger Exxon!,) employees receive more pay (see Google’s recent 10% across the board pay raise,) employees have more advancement opportunities as well as personal growth, suppliers have the opportunity to earn profits and bring forward new innovation – creating more jobs and their own growth – rather than constantly cutting price. Answering the Economist in “Why Do Firms Exist?” it is to deliver to people what they want.  When companies do that, they grow.  When they start looking inward, and try being caretakers of historical assets, products and markets then their value declines.

Can Mr. Zuckerberg run GE?  Probably.  I’d sure rather have him at the helm of GM, Chrysler, Kraft, Sara Lee, Motorola, AT&T or any of a host of other large companies that are going nowhere the caretaker CEOs currently making excuses for their lousy performance.  Think what the world would be like if the aggressive leaders in those smaller companies were in such positions?  Why, it might just be like having all of American business run the way Steve Jobs, Jeff Bezos and John Chambers have led their big companies.  I struggle to see how that would be a bad thing.

Look for Disruption, not Consistency, to Find Superior Returns – Kraft v Groupon

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Summary:

• Business leaders like consistency
• Consistency leads to repetition, sameness, and lower rates of return
• Kraft's product lines are consistent, but without growth
• Kraft's value has been stagnant for 10 years
• Disruptive competitors make higher rates of return, and grow
• Disruptive competitors have higher valuations – just look at Groupon

"Needless consistency is the hobgoblin of small minds" – Ralph Waldo Emerson

That was my first thought when I read the MediaPost.com Marketing Daily article "Kraft Mac & Cheese Gets New, Unified Look." Whether this 80-something year old brand has a "unified" look is wholly uninteresting.  I don't care if all varieties have the same picture – and if they do it doesn't make me want to eat more powdered cheese and curved noodles. 

In fact, I'm not at all interested in anything about this product line.  It is kind of amusing, in an historical way, to note that people (largely children) still eat the stuff which fueled my no-cash college years (much like ramen noodles does for today's college kids.)  While there's nothing I particularly dislike about the product, as an investor or marketer there's nothing really to like about it either.  Pasta products always do better in a recession, as people look for cheaper belly-fillers (especially for the kid,) so that more is being sold the last couple of years doesn't tell me anything I would not have guessed on my own.  That the entire category has grown to only $800M revenue across this 8 decade period only shows that it's a relatively small business with no excitement!  Once people feel their finances are on firm footing sales will soon taper off.

Kraft's Mac & Cheese is emblematic of management teams that lock-in on defending and extending old businesses – even though the lack of growth leaves them struggling to grow cash flow and create a decent valuation.  Introducing multiple varieties of this product has not produced growth that even matched inflation across the years.  Primarily, marketing programs have been designed to try keeping existing customers from buying something else.  This most recent Kraft program is designed to encourage adults to try a product they gave up eating many years ago.  This is, at best, "foxhole" marketing.  Spending money largely just to keep the brand from going away, rather than really expecting any growth.  Truly, does anyone think this kind of spending will generate a billion dollar product line in 2011 – or even 2012?

What's wrong with defensive marketing, creating consistency across the product line – across the brand – and across history?  It doesn't produce high rates of return.  There are lots of pasta products, even lots of brands of mac & cheese.  While Kraft's product surely produces a positive margin, multiple competitors and lack of growth means increased spending over time merely leaves the brand producing a marginal rate of return. Incremental ad spending doesn't generate real growth, just a hope of not losing ground.  We know people aren't flocking to the store to buy more of the product.  New customers aren't being identified, and short-term growth in revenues does not yield the kinds of returns that would enhance valuation and make the world a better place for investors – or employees.

While Kraft is trying to create headlines with more spending in a very tired product, across town in Chicago Groupon has created a $500M revenue business in just 2 years!  And new reports from the failed acquisition attempt by Google indicate revenues are likely to reach $2B in 2011 (CNNMoney.com, Fortune, "Google's Groupon Groping Reveals the Shifting Power of the Web World.")  Where's Kraft in this kind of growth market?  After all, coupons for Kraft products have been in mailers and Sunday inserts for 50 years.  Why isn't Kraft putting money into a real growth business, which is producing enormous value while cash flow grows in multiples?  While Groupon has created somewhere around $6B of value in 2 years, Kraft's value has only gone sideways for the last decade (chart at Marketwatch.com.)

Kraft has not introduced a new product since — well — DiGiorno.  And that's been more than a decade.  While the company has big revenues – so did General Motors.  The longer a company plays defense, regardless of size, trying to extend its outdated products (and business model) the riskier that business becomes.  While big revenues appear to offer some kind of security, we all know that's not true.  Not only does competition drive down margins in these older businesses, but newer products make it harder and harder for the old products to compete at all.  Eventually, the effort to maintain historical consistency simply allows competitors to completely steal the business away with new products, creating a big revenue drop, or producing such low returns that failure is inevitable.

Lots of business people like consistency.  They like consistency in how the brand is executed, or how products are aligned.  They like consistency in the technology base, or production capabilities.  They like consistency in customers, and markets.  They like being consistent with company history – doing what "made the company famous."  They like the similarity of doing something again, and again, hoping that consistency will produce good returns. 

But consistency is the hobgoblin of small minds.  And those who are more clever find ways to change the game.  Xerox figured out how to let everyone be a one-button printer, and killed the small printing press manufacturers.  HP's desktop printers knocked the growth out of Xerox.  Google figured out a better way to find information, and place ads, just about killing newspapers (and magazines.)  Apple found a better way to use mobile minutes, taking a big bite out of cell phone manufacturers. Amazon found a better way to sell things, killing off bookstores and putting a world of hurt on many retailers.  Netflix found a better way of distributing DVDs and digital movies, sending Blockbuster to bankruptcy.  Infosys and Tata found a better way of doing IT services, wiping out PWC and nearly EDS.  Hulu (and soon Netflix, Google and Apple) has found a better way of delivering television programming, killing the growth in cable TV.  Groupon is finding a better way of delivering coupons, creating huge concerns for direct mail companies.  Now tablet makers (like Apple) are demonstrating a better way of working remotely, sending shivers of worry down the valuation of Microsoft. These companies, failed or in jeapardy, were very consistent.

Those who create disruptions show again and again that they can generate growth and above average returns, even in a recession.  While those who keep trying to defend and extend their old business are letting consistency drive their behavior – leading to intense competition, genericization, and lower rates of return.  Maybe Kraft should spend more money looking for the next food we would all like, rather than consistently trying to convince us we want more Mac & Cheese (or Velveeta).

Look to New Markets to Grow- RIM, Apple, Google, Kraft

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“Blackberry’s Era May Be Ending” is the New York Times title on a Reuter’s story about the pioneering leader in smartphones.  That RIM is in trouble is undoubtedly true – so much so it will not likely survive as a stand-alone company, if it survives at all!  The company is in a growth stall, with U.S. market share in the first quarter dropping to 41% from 55% last year.  Selling cheaply priced products outside the U.S. has masked the deep revenue problem developing at RIM – as the company tries to convince investors that it really isn’t falling way behind new competitors. 

It was just April 8 when I published  on this blog “Enterprise Customer Risk” in which I described how Blackberry’s ongoing focus on corporate customers allowed it to fall far behind in the applications development area ( see the 2 critical charts in previous blog showing the application weakness as well as market share problems).  Now Apple has 30 TIMES the number of apps available on the Blackberry.  On January 10 in “Winners and Losers from Shifts” this blog posted a chart showing how Apple hit 1 billion application downloads in its first 14 months of iPhone sales.  Two weeks ago MediaPost.com reported “Android Hits 1 Billion Downloads.”  Android now has about 100,000 apps, while Apple has about 225,000 apps.  RIM doesn’t even have 10,000 apps. 

RIM made a huge mistake.  It focused on its core market of enterprise Blackberry customers.  It tried to Defend its historical market share by focusing on its historical customers – and ignoring the smartphone non-user markets being developed by Apple (and now Google.)  As a result it’s price/earnings multiple has fallen to 10 – amidst clear indications that RIM is unlikely to ever regain much growth as this growth stall continues.

We might like to think this sort of rapid problem creation is limited to technology companies.  Unfortunately, not so.  Crain’s Chicago Business today reports that “Kraft Foods Sees Slowdown in U.S. Cookie and Cracker Sales, Complicating CEO Rosenfeld’s Growth Agenda.”  Kraft has had no measurable organic growth for over a decade, nor successful entries into new markets.  The last year Kraft’s CEO demonstrated no commitment to organic growth by putting all her energy into the acquisition of Cadbury in order to expand Kraft’s “core” market position – dominated by Oreo, Chips Ahoy, Ritz Crackers and Wheat Thins.  But now sales for the last quarter in the historical business are down 3.8%!

Kraft is another example of what happens when a company hits a growth stall.  It may have a few up periods, but overall it is 93% likely to never again consistently grow at a mere 2%!  Defend & Extend management uses obfuscation, like acquisitions, to hide underlying problems in the company’s ability to meet changing market needs.  Resources are poured into price cutting promotions and advertising, looking only at the marginal cost and the initial sales, which props up the over-spending on worn out products in a worn-out Success Formula – and in Kraft’s case even these aren’t able to keep customers buying brands that are over 50 years aged.  Ms. Rosenfeld will try to keep everyone’s attention on the top-line, hoping they forget that “growth” was manufactured by acquisition and that in fact both sales and margins are deteriorating in the “core” brands.

So, are you still trying to find your growth in this “Great Recession” by doing more of what you’ve always done – hoping customers will for some reason flock to your old way of doing business?  That, quite frankly, has almost no hope of working.  Customers are looking for new solutions every day.  If you focus on protecting old markets, maybe by asking old customers what to do, you’ll miss the emergence of new markets where underserved customers are creating all the growth.  If you don’t have plans to expand your business by 20% or more in new markets across the next 2 years you have more chance of burning up your resources than growing – and you might well end up like GM, FAO Schwarz or Sharper Image!