28 December 2012

The Untapped Power of Corporations

Around this time last year, I posed the question of whether companies, in addition to producing bottom line results, should be expected to improve its surroundings, spearhead charitable efforts, and contribute to the general welfare of society.  While this topic is debatable, the power of the business community to actually do so is not.  Businesses have a much broader reach, resource base, and capability than other types of organizations to help address the world's problems.  So why then do they remain silent on most of the issues that matter?  Given business entities unique strengths, shouldn't it be imperative they have a seat at the table when it comes to influencing policies and solving society's problems?

If today's climate in Washington is how government is supposed to work, then clearly something is wrong.  Generally speaking, the business community has rightly stayed clear of politics.  They have long subscribed to the notion of the less they deal with lawmakers, the better off they are to be left alone to manage their own businesses.  Since enterprise leaders have a better handle of how issues affect people and how to craft possible solutions, this practice is a shame.  Amongst the fiscal cliff debacle, it is refreshing to see business leaders come together to form the Fix the Debt coalition.  A few, like Starbucks CEO Howard Schultz, have taken a stand to end lobbying and the influence of special interests in Washington.  Only time will tell if its too late, but at least some business leaders are stepping out of the boardrooms.  Don't get me wrong, corporate lobbying has no doubt created much of the political mess, but I think a broader effort among business could certainly help rise above the ineffective voices of partisan, agenda-based politicians.  

The same sense of indifference can be seen on the charitable front.  While individuals have been very active, large corporate outreach programs have typically been PR campaigns or a way to build employee morale.  As movements in small business such as social entrepreneurship continue to grow rapidly, large corporations have largely been absent from newer trends in giving.  Whether it be microfinance or businesslike operations like the Gates Foundation, capitalistic-based solutions have long been very effective ways in addressing the world's problems.  So its too bad that the largest concerns with the most business experience are on the sidelines.  Some newer companies like Google are aggressively building their foundations, but these are small efforts compared to the opportunity.  And in the long run, CEOs know that a healthy macro climate creates an environment for enterprises to thrive.  Just like a category leader has an obligation to grow the market, the same should be felt from corporations to affect societal change.

It's not all about giving back though; over 90% of CEOs interviewed in a recent Accenture survey linked better corporate performance to sustainability and community efforts.  Certainly with larger and more complex problems looming ahead, businesses see the need to become engaged in solutions to protect the markets in which they participate.  From a societal standpoint, the benefits of corporate involvement are clear - they have the resources, capital, independence, and track record to solve problems larger than what governments or even non-profits can.  It is also a largely untapped resource as corporations have been inwardly focused for so long.  A large resource reallocation is definitely not needed as the collective power of the business community is so great, but rather a mindset shift that focusing solely on a company's P&L may not be enough to yield the same success in the future.  Perhaps with Starbucks and Google in, we can finally get the Republicans and Democrats out. 

14 December 2012

The Curse of the Defensive Deal

I've written extensively about how acquisitions, despite Management's gravitation towards them, generally fail to produce the expected results.  Defensive transactions in which a Company has fallen behind or fears disruptive players or technology is one of the most popular deal rationales.  In the short-term, buying the capability seems to be an easy way to catch up; but they are categorically the worst poorest performers of all deals.  They destroy shareholder value, fail to rejuvenate the acquirer, and slows the momentum of the targeted company.

Technology disruption is a classic area of defensive deals.  During dot com mania, traditional companies were scrambling to figure out the internet revolution.  Time Warner merged with AOL.  Barry Diller bought Ask.com, Match.com, and other properties. Valuations would never prove in not only because of price but also because of the struggle between cannibalizing existing business and investing in competitive areas.  The “do both” strategy may leave a company well hedged but far from market leadership.  Legacy companies have even tried to build barriers around competitive threats by forming consortia such as Hulu and Orbitz, but ultimately spun them out when they realized the upstarts were better off without their larger agendas involved.

Cost deals are another example.  These generally occur in declining markets with hopes of building stronger cash cow market positions.  Alcatel tried it with Lucent as Daimler did with Chrysler.  These were both on Businessweek's worst deals of all time list.  As HP doubled down with Compaq, IBM divested its PC business on a road to a successful transformation.  You can't stop a downward moving train - declining markets tend to fall quicker than any cost synergy model can offset.  The "more of the same" strategy fails to address the underlying problem of changing market dynamics. 

Even today’s best tech companies can fall prey to the prevent defense.  In hopes of buying some time to figure out mobile, Facebook paid a whopping $1B for pre-revenue Instagram.   Amazon’s acquisition of Kiva Systems screams defense as they try to take their robots away from its competitors.  Does Amazon not think new technology will not spring up in the marketplace?  It is ironic because the spread of ground-breaking concepts is how Amazon itself rose to ubiquity.  As the pace of change continues to accelerate, even the new leaders cannot rest on their relative positions.  Apple's erratic stock price clearly shows the markets are uncertain of whether it will be able stay ahead of the pack. 

To me, the biggest drawback is that consumers lose out when these deals stifle the offerings of the acquired company.  Google killed Dodgeball which years later came back as the white-hot Foursquare. Sprint eliminated Nextel's push to talk as signs point to competition vying for those consumers.  Do you think if Visa bought Square early on we would see the spread of mobile commerce as quickly as we do today?   Whether entities can't maximize the benefits or struggle to integrate into existing products,  stand-alone offerings oftentimes perform better when they are not clouded by alternative agendas or red tape.

Companies certainly can use M&A to reinvent themselves as part of larger turnaround strategy.  They should be careful to gain a solid understanding of the target's capability and market, build an integration plan to scale it, and protect the DNA of the acquired company.  Whether it be the result of the Innovator's Dilemma or a poor strategy for reacting to market changes, many continue to utilize a flawed defense-based acquisition strategy that leaves them worse off.   While buying might be a quick fix, a company that is facing new competition or a declining market must ultimately face those bigger challenges head on.

09 November 2012

Amazon's Strategy Problem

I used to write about Amazon often.  What's not to like - a prototypical fast growing entrepreneurial concern that created new markets and beat up the incumbents.  Nowadays, I just can't seem figure the company out.  I looked to Amazon as a big box category killer, but its' investments in new businesses and out of scope areas leaves me scratching my head a bit.  What really is Amazon's strategy?
I thought their ultimate desire was to take on Walmart.  And they were successful at it.  They surprised many by successfully building out efficient distribution capabilities.  While traditional retailers were good with logistics, they were slow to adapt to ecommerce.  Amazon has both.  In addition, online competitors were no match for Amazon's low pricing and world-class customer service experience.  They simply outperformed online and bricks and mortar competitors while taking share from both.  All of this success was compounded by the 15% overall annual growth in the e-commerce industry.  Carving out a greater piece of the pie in a growing market is a great recipe for success. So why is Amazon changing its course?
Traditional ecommerce is now on the backburner. Apple, Netflix and other projects seem to be on Bezos' mind.   I realize that digital products may pay off over time given their better margins, but isn't it a distraction from their core business?  Amazon Web Services (AWS) is a great growth story, but what does it have to do with diaper sales ?  From buying companies that build distribution robots to its recent decision to open an online bank, they seem to invest time and money into anything and everything.  
Business Schools tell you to pick a strategy and focus on building strengths and a sustainable advantage around it.  Trying to to do too much could leave a firm "stuck in the middle."  Apparently Jeff Bezos never got the message.  Does Amazon have the management discipline and capability to run seemingly disparate set of businesses?  These are not separate portfolio companies that run independently - they all seem to tie in somehow to Amazon's special sauce. I just can't figure out how.
Unseating Walmart is a full-time job and retailers are catching up (Walmart's online and site to store capability is really good).  Amazon's sales tax advantage is gone.  Online competitors are better funded and managed now.  My anecdotal experience on Amazon's site shows prices creeping up and the service experience dropping.  The sky is not falling, but Amazon does seem to be putting its core business at risk by delving into other endeavors. 
One thing I can say is that it is hard to bet against Amazon.  Their recent operating loss for the first time since 2003 has spooked many investors, but makes no difference in the long run.  Amazon has consistently defied the odds for so many years that quarterly results and business school textbooks may not apply in the end.  With its execution so good in core retail, I thought that Amazon's Seattle Headquarters should point at Bentonville not Cupertino.  Perhaps Bezos' quest for worldwide domination leaves room for both - its just hard to see a clear path to it from here.

18 October 2012

The Post-PC World?

With everyone now claiming the death of the personal computer, it is hard to swim against a moving tide.  According to a recent WSJ article, PC shipments may have hit its peak and actually decline this year for the first time in history.  Dell and HP stock prices are at ten year lows.  Tablets, phones, and all things smart have been growing at a torrid pace.  All signs point to the inevitable end of an era; so why, then, am I so skeptical? Is the Atma Business Blog trying to "party like its 1999"?

Make no mistake, PC manufacturers are being squeezed and will continue to be so.  On the one end there is mass move to smarter, smaller devices.  On the other end, Asian manufacturers such as Acer and Lenovo are dropping prices and stealing share from incumbents.  In the enterprise space, cloud based solutions and the growth of data centers is diminishing the need for computing capacity on a local level.  We're not dealing with a growth story here.    

However, the buzz for the new devices is probably overdone right now since they are in the early stages (remember when PCs were supposed to replace servers?).  Even in today's "smart" world, PC's are still the most intelligent devices out there.  PCs provide more computing power, storage, and access to software applications.  Tablets have great functionality but do less.  Whether it be enterprise level data mining or consumer internet shopping, the need for horsepower and the desire to do more will continue to grow.  Also, as I alluded to in a post a few years ago, we will not be satisfied with keeping all of our valuables exclusively in the hands of third-party cloud providers and will require some level of local storage . 
Tablets and other gadgets are nice to have but seem to be incremental to PCs.  Mass use of the internet is still best done on a PC.  While Twitter gives us instant information, it is no substitute for the New York Times. Good luck trying to utilize your CRM or ERP system in a meaningful way through a tablet.  And to this day, software "apps" like Powerpoint are head and shoulders above iOs "apps."   Perhaps households and corporations will need fewer PCs in the future, but I don't they can get by without them. 

What will change is how tomorrow's PCs will look and who will bring them to us.  To this day, I still can't figure out how HP and Dell missed tablets and smartphones.  How did Intel give away low power processing chips to ARM ? Certainly Innovator's Dilemma was at play.  Perhaps manufacturers like Samsung or Apple who seem to have successfully changed their products with the times will continue to gain share.  There also seems to be an unmet need in which new players could emerge through innovation.

Expect a convergence of the things we like from a PC with the UI and ease of smart devices.  Today's gadgets appeal to our "wow" need rather than taking a comprehensive approach.  The need for intelligence and personal computing will continue to rise and tomorrow's PC's will need to reflect that need. The next generation will be more robust and remain the center of our computing needs.  Call me crazy, but  I wouldn't be surprised to start seeing VC investment into the next generation of PCs. And perhaps those entrepreneurs will take their sales pitch on the road in their little red corvette.   

21 September 2012

The IPO Quandry

While only a few have the luxury to debate whether it should file an IPO,  it is a decision that should not be taken lightly.  The monetary benefits come with numerous downsides such as constant analyst scrutiny, restrictive disclosure and governance, and an overall focus on short-term financial results.  Facebook, which had no need for the cash or extra distractions, is a recent example of a company that is probably second guessing its decision.  If there are so many drawbacks, why are all the IPO-worthy candidates going forward with it?   Do these companies have other options besides a public equity offering ?

Firstly, thanks to the recent JOBS act, Facebook did not have to go public.  It chose this route for probably the same reasons that other similarly situated companies do.  Top talent (from Sandberg on down) were poached from other Valley successes with the promise of liquidity and Menlo Park real estate.  The VC investors were silently pushing to  pad their fund returns.  Perhaps a little envy from the competition either going out or ballooning in market value weighed in.  Let's face it, a $100B stock offering is hard to pass up in many ways. But as Fortune's Dan Primack eloquently put it, going public made Facebook "uncool."

Many of the most successful companies in the world have paved their own way while staying out of the public limelight. Of the top privately held companies (excluding state run and PE gone private deals), many, such as Ikea and Koch, are still owned and operated by the founding family.  They have been able to maintain their culture, quality, and ultimate corporate mission while realizing growth comparable (or better) to publicly traded peers.  Some, such as Cargill, have even tapped public debt markets while keeping their equity off limits.  The $23B Wrigley acquisition by Mars shows private companies' wherwithal to execute blockbuster deals (many public deals are cash/debt anyway).  While difficult to keep stakeholder interests aligned as private companies experience rapid growth, many have shown success in doing so.

Some new trends may help companies stay private.  Crowdfunding's torrid growth on the early stage end  may help avoid VC-mandated exits.  For later stage companies, private exchanges such as SecondMarket are becoming widely used  platforms for individual stock transactions (in fact FB was valued more privately than it is today).  I wonder if IPO-tepid companies like Google would have delayed or cancelled IPOs if these markets were well established at that time.   Private equity is still a traditional option but still requires to play by the five year exit time horizon rules.  Debt instruments work for larger growth companies, but smaller ones either can't get it or require risky personal guarantees.  And even if going public ended up being a mistake, the excess money on the sidelines creates opportunities for founders to buy back their company  as Best Buy's Dick Schultze is currently attempting to do.

The IPO is a logical exit for many companies who are looking for cash or easily tradeable currency.   Trulia's first day pop today shows that the end of the IPO is not happening anytime soon.  Perhaps those that chose to take the long view for their companies will be less inclined  feel less to do so thanks to recent debacles like FB or expensive Sarbanes-Oxley requirements.  Maybe the democratization of information and the availability of alternate market vehicles will bring required investor returns low enough to avoid the pressure of going public.  Since the Silicon Valley techies hate the public markets so much, you would think their uber-creativity would have brought some innovative alternatives.   But then again, why would all the VC firms be on Sand Hill Road?

31 August 2012

The Entrepreneurs of Sport

Ever since I read Moneyball many years ago, I could not help but to seek parallels between the sports world and business.  In Michael Lewis' chronicle of the Oakland A's baseball club,  GM Billy Beane used novel analytics and an outsider approach to build a perennial winner despite having 1/3 of the payroll of teams such as the Yankees.  The compelling tale reads like an entrepreneur's blueprint for success; a cash-strapped upstart completely changes the industry through innovation and creativity.  Are there other examples of game-changing entrepreneurs in the cut-throat world of big sports?

Certainly one of the biggest changes in recent history is the almost instantaneous access to almost any sport thanks to the rise of ESPN.  Similar to other founders, Bill Rasmussen turned his personal desire (Connecticut Sports) into a businesses phenomenon.  Several early moves, such as the negotiations of NCAA basketball rights and launch of SportsCenter, turned the fledgling network into an almost overnight success.  Like other startups, unfortunately, the need for early cash diluted Rasmussen's power and equity forcing him out well before the real money came in.  The rest of the story is pretty well documented as ESPN has become the most influential network in modern day sports.

Due to the strict revenue share rules, it is hard to find innovators in the greatest sports cash machine that is the NFL.  Robert Kraft's unorthodox acquisition and success of the New England Patriots might be the closest thing.  Starting with an option to buy the adjacent land next to the Pats' old stadium, he later acquired the stadium and eventually the team through a decade long series of transactions.  Smart personnel moves (Brady and Bellichek in 2000) and a unique focus on the collective team versus star players (managed like an interchangeable "portfolio of 53 stocks") has led the team to three super bowl titles and the best winning percentage in the league during his ownership.  Oh by the way, it doesn't hurt that the team is worth at least ten times more than Kraft's initial purchase price.

Kraft's story was a bit unusual as the traditional sports franchise ownership story is pretty uninspiring.   A billionaire hobby owner buys the team at a premium using debt, raises ticket prices, and throws alot of cash at the team in hopes for championships.  Sometimes this results in an increase in franchise value (Mavericks, Yankees) and other times they land in bankruptcy (Dodgers, Rangers).  The most recent example of this is Manchester United's IPO where it is still too early to assess whether the Glazer's investment will ultimately pay off.  But in the end, it usually doesn't matter for the billionaire owner who has made their money elsewhere.

Hobby owners aside, from apparel juggernauts we all know such as Nike to the latest social media sport startups, savvy entrepreneurs have channeled their unbridaled passion for sport into thriving businesses throughout the years.  Of course, just as in the business world, there have been some slip ups along the way (remember the USFL?).  As power continues to shift to fewer and fewer hands (don't get me started on the BCS), it will be interesting to see the creative destruction that new startups can create as a counterbalance. Certainly the passion for sport will not dissipate which should keep the business side thriving - let's just hope future Billy Beane's continue to emerge among the clout of billion dollar TV deals.     

03 August 2012

Can Entrepreneurs Multitask Companies ?

Entrepreneurs that have the capacity to change the world are hard to come by.   When they do, the smart money and resources tend to follow them in droves.   Two of my favorite ones that I've tracked for quite some time, Jack Dorsey and Elon Musk, have a good shot at transforming the entire landscape of media, automotive, energy, and financial sectors. While ambitious to say the least, they are both attempting this feat by leading multiple companies at the same time.  Are entrepreneurs in such short supply that we rely on them to take on multiple engagements?  And is it possible for them to effectively do so?

As a cofounder of Paypal, Elon Musk has made enough to spend it all in hopes of bringing space exploration and sustainable energy platforms to the masses.  To do so, he is attempting to build three multi-billion dollar businesses as the head of Tesla Motors, SpaceX, and SolarCity.   He generally splits his day between the companies;  he is notorious for being a stickler for details which makes the task even more daunting.  So how is he doing?  He's had his share of ups and downs but showing some signs of progress.  Earlier this year, he announced a successful rocket launch into space as well as Tesla's completion of significant safety test hurdles for its new electric sedan within days of each other.  Certainly too early to call (all in early stage, pre-profit), but Musk is showing no signs of restraint.  No wonder he was the inspiration for John Favreau's "Iron Man"  in the recent movie.

While no superhero, Jack Dorsey made his name in a big way as co-founder of Twitter.  His latest venture Square is a frontrunner in the white-hot mobile payment space.  Shortly after departing for his new company, Twitter experienced a major management and technological  implosion which almost derailed it.  Now Dorsey is back at the helm, leading both concerns.  In public, he articulates his vision and passion for both in great depth, but some inside think the dual role is taking a toll on the companies (see recent Fortune article  on Square employee frustration). To be sure, the imbedded large players that Twitter and Square both look to unseat have significant money and resources invested in competing with them.  Dorsey will need to successfully thwart the likes of Google, Facebook, Paypal, and Visa all at the same time.

Is there any precedent to Dorsey and Musk's attempt ?  Let's start from the top.  Steve Jobs was very successful in multiple endeavors, but not all at once.  Pixar's big splash occured between Jobs' stints at Apple; the IPOD and IPhone did not come out at the same time given different technologies and market strategies required.  It is debatable, but I don't think he would have been able  upend animation, PC, phone, and the music industry all at the same time.  In looking through all the major industrialists, it is hard to find one that has done so (or even attempted).  Certainly inventors throughout time have created multiple blockbuster innovations, but did not commercialize them into full fledged businesses.

 In today's laser quick internet pace, it is much more plausible than before.  Technology allows for scalability and virtualization and sophisticated investor backing provides management expertise and an earlier way out.  Perhaps the role of these entrepreneurs have changed with the times.  Maybe we don't need them to build huge businesses like Henry Ford did, but rather to incubate new ideas for experienced business management teams to grow.  I  tend to think you lose quite a bit of the cultural DNA when you separate a founder from his or her business (it didn't work for Apple).   Call me old fashioned, but isn't building a space-age travel company enough for one mere mortal?  Apparently not.

13 July 2012

Managed Care's ACO Scramble

Health reform is upon us.   As managed care companies struggle to adjust their business models to compensate, there is a frantic race to become integrated service providers by moving downstream.  They are making blockbuster acquisitions in the consumer and provider care space in order to move towards "accountable care organization" models that bring together patient care, reimbursement, and facilities all under one roof.  Will these managed care companies be able to pull it off? And more importantly, is it better for all of us in the end?

The deal activity is flourishing .  Wellpoint has announced several recent acquisitions including direct to consumer company 1-800 Contacts.  Examples such as Humana's deal for urgent care provider Concentra and UnitedHealth's purchase of physician network Monarch HealthCare further illustrate this growing trend.  On paper, these deals make a lot of sense.  If you control the consumer or provider, you can cut out inefficiencies, control costs, and reign in the current layers of external profit margins.  The downside is that they run the risk of alienating their third party panel in addition to the significant execution risk of historically pure play insurers successfully moving into patient care.  There is very little choice but to try however;  the stand-alone insurer model will face meaningful price reductions as part of the health care overhaul. 

But can this be good for end users?  On the one hand, these integrated models can help us move away from the current fee for service model that seems to be the underlying flaw of today's health care system.  It makes no sense to pay per procedure without any concern for medical results. By merging patient care with reimbursement vehicles, there is a greater incentive for preventative care measures and alignment with patient interests.  On the other hand, Americans are not accustomed to a closed network's perceived lack of choice.  The HMO model didn't work in the 80's and there is not a mad rush to go north of the border for medical treatment. 

Many think the integrated approach is the way to go and point to Kaiser Permanante as the poster child.  Kaiser's roughly 9m lives have been utilizing the provider's own doctors, hospitals, and insurance plans for many years now with many clinical measures of success.  They have yielded an improvement in patient care, a decrease in costs and emergency care, and a relatively healthy profit margin to boot.  Not having any firsthand experience with Kaiser, I can not comment on how the model is working from a consumer perspective.  But if the Kaiser approach is the right model, is it scalable?  And if so, isn't it the similar to the nationalized health care policies that so many countries are struggling with?

Although some of the latest moves by large managed care companies are potentially very interesting if done right, I am skeptical that all of them will be able to successfully transform from actuarial based businesses to ones that actually take care of patients. It almost seems to make sense to move from the other direction (ie. patient care to insurance), but providers lack the necessary resources as they are smaller and more regional in nature.  If Kaiser and the ACO model can yield even marginal improvements to the cost side with improved medical results, it would be vastly better than the unsustainable course of our current system.  And of course, amidst all the chaos and uncertainty, look for shareholders of provider and consumer networks to continue to cash in.

26 June 2012

Was I right?

As Atma Business Blog recently eclipsed its two year anniversary mark, I thought it would be interesting to take a look back at how its predictions have fared thus far (yes a bit narcissistic I know).  First and foremost, I would like to thank all of my readers who have been with me since 2010 (Is M&A still evil?) and those that have only recently been able to bear my ramblings.  The most rewarding element for me has been the interesting dialogue, comments, and push back generated which has changed my viewpoints on many of the topics addressed.  It's also been nice to be published on some leading business sites along the way.  On to the results:

Monetization versus Free: I predicted the demise of Netflix's power as the content guys gain more courage to charge.  This has happened much quicker than I expected.  Even Apple hasn't cracked the negotiations code with TV as their offerings have been less than modest so far.  More broadly, I wrote about the end of our honeymoon of all things free.  Everything from apps to entertainment are moving to pay-based models.  There is still room to go.  Most news content is still free; powerful services such as Maps and service tools we have taken for granted might require a credit card soon.  I still can't figure out how FB or app developers can monetize enough.  Can you imagine a monthly fee to remain a LinkedIn member ?

Meaningful Innovators: An area of particular passion for me, I've spent many characters on true disruptors that not only changed industries but also broader stakeholders that they affect.  All but 2 of Fortune's Top Entrepreneurs (sorry FedEx, Infosys for the oversight) have been featured in my posts in varying contexts (ie. Bill Gates' pledge).  I continue to seek those that leverage their success for the greater good and bring significant consumer-focused improvement to a given market. Continue to send me leads!

Transactions and Financial Sponsors: I've written about the perils and advantages of M&A and those that drive them.  Large scale transactions continue to fail while focused ones have a better chance at success.  Given the backdrop of slowing earnings and long-term debt of the country, expect the traditional tools of leverage and cluster investing to not be enough to generate returns for investment funds.  Since the Facebook disaster, there has not been an IPO executed.  It's not a bubble, I promise.

Social Entrepreneurs:  Traditional businesses, non-profits, and individual entrepreneurs all have an obligation and ability to lift society through efficient market-driven ways.  From microfinance to fair trade, I've written about many of these innovative efforts.  I was disappointed to learn about the lack of tech philanthropists, but happy to see "feel good" concepts being more integrated into daily transactions.  The internet is the ultimate scalable tool, let's use it to the fullest extent we can.  In addition, building sustainable platforms is just good business.
Other Notes:  I can't figure Amazon out.  It caved faster than I expected on sales taxes. I thought it was well equipped to swing at Walmart, but it seems to have refocused on digital products.  I loved GroupOnomics but its model has had less of an impact than I expected so far.  I still don't have clear visibility into the next US jobs engine or how to retrain the existing employee base, but let's hope our core strengths (innovation, entrepreneurship) can carry us beyond the strong headwinds that are coming our way.

In the end, it's about creative entrepreneurs that take on the oligarchs, large companies that eclipse the innovator's dilemma, and capitalistic efforts that yield powerful businesses and meaningful benefits to society.  I will continue to write along these lines as I hope to bring unique, unbiased perspectives on current business events and trends.  In return, I only have three requests from my reader base:  1) Do not spam my posts (rather pass along the interesting ones) 2) Continue to send me ideas and suggestions on content 3) Send ideas on outlets to approach or ways to market my site to a wider audience (since I have no idea on how to do so).   There you have it - I have now linked to more than 1/3 of my articles to date.  Thanks for reading.

Keep reading, commenting, and pass along to anyone that may be interested in reading.

07 June 2012

The Phantom Value Creation

There is nothing more exciting than watching creative entrepreneurs start something from scratch and build them into a successful business.  The very good ones quickly get to a crossroad in which they seek external capital either to accelerate growth or as an exit strategy.   Whether it be through private or public equity,  the mere transaction  itself somehow seems to increase the value of the enterprise.   While there certainly are benefits for bringing sophisticated investors in, does this incremental gain diminish the hard work and success that got the business where it is?  Are we undervaluing the entrepreneur and overvaluing the equity markets?
I’ve written about how private equity firms can generate returns merely by bringing in financial leverage. Another lever they pull relates to their savvy in buying and selling companies.  They generally can sell companies higher than what they buy them for.  In a simple example, lets say a company sells to a PE firm for $500M based on cash flow (EBITDA) of $100M (5x multiple).  The PE firm will then try to exit for 7-8x down the road.  So even if profits stay the same, the company is now worth $200-$300M more just by “multiple expansion”.  The financial sponsor knows how to negotiate deals and has a much wider network of potential buyers than the company did on its own. I don't want to diminish the value of private equity because strong firms do improve operating performance in addition to adding smart financing and deal sophistication.  But in this crude example, is the financial maneuvering worth $300M relative to the $500M the founder who built the business from the ground up?
Public markets are no better.  Since the 1870's, the average P/E ratio of the S&P 500 has been around 15.  If a small company sells to a publicly held one, they don't usually get the double digit multiple the public one commands.  Again, the enterprise value gets stepped up to the publicly traded multiple upon closing of the transaction..  The entrepreneur could try to take the company public itself, but it is very cumbersome to do so.  They usually rely on VC or PE firms to help them get there (If Facebook couldn’t do it, then who can?).  While doing so, the entrepreneur usually gets significantly diluted (although valuations typically rise at the same time).  Certainly there is a value to the liquidity and compliance that public markets bring, but it begs the question of why strong private companies are not worth close to 15 times earnings?

Entrepreneurs rightly spend their time building businesses instead of worrying about how much their company is worth.  They typically don't think about valuation until they have either decided to sell or in a poor bargaining position (i.e. cash flow problems).  If the net number is big enough to meet their lifestyles and monetary goals, they probably don't worry too much about any money they are leaving on the table.  Perhaps it is the entrepreneur's fault for selling the company too early or not seeking appropriate advice.  I wonder over time if the arbitrage opportunity for institutional investors diminishes as private companies gain more financial savvy or bargaining power.  You see some of that in today's bubble valuations as there are now over 20 privately held tech companies with billion dollar valuations according to the WSJ.   
The value creators are company founders that have trailblazed their way to successful business models.  In an ideal world, entrepreneurs would be able to bring in some of the intrinsic value that comes with equity sales of the company.  Certainly the use of debt (vis a vis PE firms) is one way but also much riskier to individuals.  Using advisors to market the company better can help but is virtually impossible to get to the level of sophistication that firms have.  In the end, the financial system is a certainly a valuable piece of the puzzle, but you can’t have the game without the pawns to play with.    

17 May 2012

Has the Source of Innovation Changed ?

In today's bubble 2.0 world, billions of VC dollars go into nascent concerns that will supposedly transform the world.  The truth is that very few of them survive and the ones that do generally yield incremental changes at best (thanks to "me-too" cluster investing).  I find some of the best innovation not on Sand Hill road but in new entrants to existing industries where oligopolies rule. Companies that have strong principled-based cultures can give consumers what they want, turn market leaders into followers, and provide long-term stability to an industry.  In other words, every market needs a Southwest Airlines.

Someone recently asked me if I thought the proposed US Airways / American merger would be good for the industry and consumers.  Many analysts think so under the assumption that three strong competitors will be better than numerous failing ones.  While that logic may be true, it doesn't really matter as long as Southwest is in the game.  Since its entrance, Southwest has forced price discipline, maintained quality service levels, and continue to bring innovation into the industry.  Despite the decades of turmoil in the domestic airline space, Southwest has consistently managed to Herb Kelleher's simple of goal of giving the ability to fly for all Americans (and made a tidy profit along the way).

Companies that do things their own way that bring meaningful change.  Sam Walton brought low costs and corporate distribution efficiencies to small towns in the US.  Despite the negative impact on mom and pop stores, Walmart has certainly kept all of its competitors in check by substantially bringing down prices for most consumer staples.  Amazon has had a similar effect online (although its unclear if its strategy will change in the long-term given its low margins).  It's not only about price - Whole Foods brought natural groceries on the map.  While business schools debate whether founders should remain CEO's, it is usually the ones that do that keep the disruption continuing.

What's next on the horizon?  Certainly struggling markets is a key area of potential.  Can Elon Musk's Tesla Motors be the next game changing event since the Japanese invasion?  Industries such as traditional media and housing have been on a significant decline and in need of transformation.  How about financial institutions that have been battered by greed, bad bets, and too much leverage?  Bringing efficiencies is one thing, but many of these laggards need a complete makeover in order to survive.  Necessity breeds innovation, right ?

With the myopic focus on technological enabling companies, many lose sight of the fact that true innovation still rests in the hands of visionary entrepreneurs.  However, now that it is commonplace for billion dollar industries to disappear overnight (just ask Apple), it will be very interesting to see what impact the accelerated pace of technology will have on business innovation.  It may very well be that a sound business model and management are no longer enough to transform an industry.  But I think in the end, people just want peanuts, free bag check, and a cost effective way to get to Abilene, Texas.

13 April 2012

Is Mobile App Development Sustainable?

The fact that Facebook spent $1B for mobile phone photo share company Instagram less than a week after it raised money at half that valuation shows the growing importance of mobile apps in today's economy (and the limitations of FB's net-centric model).  Since most are free or 99 cents, how will the economics ultimately work out for the people that develop them?  Is app development a viabile business or are we heading down the same path as the first e-commerce bust (remember Pets.com)?

For one, host companies like Apple don't care and aren't even focused on the standalone business.  When you dive into the numbers in an interesting article on the iOS economy, Apple made an astounding $300M last quarter (and growing) from its 30% cut of app downloads.  Despite it being a meaningful number, the hardware sales driven by the App Store is what's most critical to them.  Google doesn't care about making money on apps as its mobile search revenue is expected to more than double to $5.8B in 2012. In the long-term, these companies should care.  If you charge a 20% interest rate to loan money and noone can pay you back, how long will the party last ?

How does this translate to the typical developer?  The average selling price for an iOS paid app is about $1.55.  But once you take into consideration the ratio of free to paid downloads (~4.5x) and Apple's cut, it nets the average developer close to about 23 cents per app per user.  I'm not sure what business model can survive on a quarter a sale, but certainly there has to be more behind it for the channel to thrive. 

If you are a developer for corporations, it doesn't matter.  Schwab and Fidelity are using apps for customer retention and account access.  Pepsi uses it to build brand loyalty.  As with most marketing budgets, traditional media dollars are moving to more relevant channels with mobile apps being one of the fastest growing.  I would surmise that a corporate app developer is one of the hottest jobs around right now.

But what about the guys trying to make a living or a business? Jeff Bezos built a website and they came; can that happen in the mobile app world?  Certainly Instagram was a monetary success, but only because they sold the promise (eyeballs versus cash flow).  The other folks that are collecting a 23 cent toll for their niche app won't stay forever.  Ultimately, the crowd of creativity will dissipate unless they can find a way to make it worth their while.

You can see similarities in the blogosphere. There used to be millions of people writing their thoughts in hopes to monetize it in some shape or form (present company excluded of course).  Many have turned off the lights and went back to diaries.  Only a few blog sites have really generated a significant following.  And even with sites like Huffington Post or Seeking Alpha, I doubt they are tremendously profitable.  There are probably a few niche businesses in the blogsphere, but there is no Google.

So will Apps just become a cost center as many creative things do?  Areas such as gaming and micro-transaction based models are gaining steam.  I imagine affiliate programs from FB and other mobile commerce efforts will continue to add big dollars to the pie just as it did on the web.  Perhaps it is too early in the cycle for a large scale disruptive business model to have emerged.  As much as I want the guy who created the tongue salivating Ilickit make a living, I might be better off with a couple of shares of Apple.

20 March 2012

Where is the Next Job Growth Engine?

While many will debate Apple's recent claim that its gadget ecosystem has created over 500k US jobs, its actual base (47k) is less than a tenth of General Motors at its peak in the 1970s.  Although the markets are up and companies are sitting on piles of money,  we have seen very little meaningful improvement in the unemployment situation. Significant employment bubbles such as finance and real estate have come and gone.  Given the US's knack for marrying innovation with commerce, where should we look to find the next great employment vehicle?

It's great to see the bubble back, but it is not making a big impact on the situation.  Michael Dell recently claimed that tech startups will plug the hole (ironic given its mass layoffs over the years), but it hasn't moved the needle that much.  The big 4 2011 IPOs (P, LNKD, Z, GRPN) have a current combined market cap of $32B but only employ 11,000 collectively.  The $100B juggernaut Facebook?  Just 3,000.  To add to the trend, the increased usage of crowdsourcing and contract help has created an on-demand labor pool without the steady paychecks to go with it.  Simply put, tech companies do more with less.

We can't really look to the government for help.  The post office is on the verge of collapse.  Every agency from local counties to the Federal government can't cut fast enough to stave off budget shortfalls (political angles aside).  Even if the administration's plans to build employee pools around infrastructure and energy were sound, the government is the last place to find market-based, sustainable industry growth.  I don't think another interstate system will solve our woes in the long-term.

So perhaps we should follow the money trail to find an answer?  Last year, VC's poured $28B into new companies.  Roughly half of the investments were in software and "internet" companies which we know are employee-lite concerns.  Industries such as manufacturing or retail which traditionally could employ large quantities were nowhere to be found.  Some large investment areas such as energy, bio-tech and medical devices might be fruitful depending on their level of success.   

What about the mass benefit of US corporations' export efforts?  They are flushed with cash generated abroad as economies around the world have opened up their markets.  While a boon for bottom lines, a WSJ article suggests that these companies have actually reduced their staff in the US while increasing bases overseas.  Worldwide offices in Asia and South America are growing at a torrid pace.  The now infamous Foxconn sweatshop employs over 1.3M and climbing.  While there is no question the US has benefited the most from globalization, it doesn't seem US-based employment has seen a similar level of benefit.

There are many factors which explain unemployment figures (participation rates, skills gap between jobs and employee base,etc..), but there doesn't seem to be a simple answer for the next engine of  job growth.  We will definitely need small businesses to start hiring again.  Hopefully, we'll see growth as emerging companies start to scale and spark new support industries.  Health care, technology and energy continue to look like strong prospects for the future. Given past history, it will more than likely it will come from someplace that we are not currently contemplating.     


09 February 2012

How Big Can Crowdsourcing Get?

By all accounts, the consumer submitted Doritos commercial that aired during the Super Bowl was a hit.  People liked its authenticity (cost $20) and Frito Lay saved millions in production costs.  More and more companies these days are turning to crowdsourcing techniques to help solve business problems by soliciting solutions from the general masses.  VC's poured almost $300M into crowdsourcing startups in 2011 as the industry is expected to explode in the coming years. But how big can it get? Will it be the next outsourcing phenomenon that will revolutionize existing corporate structures?  Or will it merely be a niche offering used in more modest contexts?

While the term crowdsourcing has been around since a Wired article in 2006 on the disruption of professional photography industry, it seems to be ripe for growth in the current business landscape.  With prolonged unemployment as the new normal, the workforce has become more flexible and open to part-time, one-off assignments. Many (like AtmaBus :) are willing to volunteer their talents for virtually nothing to gain exposure.  At the same time, companies realize that it is too expensive and impractical to hire sufficient talent for every requirement.  With the ease of internet distribution, companies can take advantage of the readily available cheap labor force.  They can get a broad reach, diverse input, and pay virtually nothing for it.  No need for expensive engineering and marketing departments, right?

Crowdsourcing hasn't deeply penetrated the business world just yet.  Certainly niches like funding and sites like crowdflower have gained steam.  The biggest splash was probably that Netflix paid $1M a few years ago to a team that built a better recommendation algorithm.  By and large, however, corporations so far have not significantly used crowd techniques for substantive tasks.  Many, in my opinion, are using it more for marketing then problem solving.  The Doritos commercial successfully reached its target market; any cost savings was a byproduct.  My fave Sam Adams is soliciting recipes to debut a new beer at SxSW.  Gap used it to test market a new logo on FB.  There are hundreds of contest/user input projects out there right now.   Do these companies care more about the end result or creating a buzz for their new product?  Its probably the latter as I suspect the cost of these projects are hitting marketing budgets as opposed to production ones.

Also, as I wrote about the end of all things free online, user-generated input will slowly increase in price much like traditional outsourcing has.  As crowdsourcing moves out of early adoption, the intersection of demand and supply will become more meaningful.  A pure play crowdsourced  model is also hard to sustain - which is why sites like Huffington Post are hiring more and more writers on staff.

Crowdsourcing can certainly give companies access to new ideas, help build a social following, and optimize certain corporate tasks.  Like all outsourced activities, crowdsourcing comes with its own limitations that must be weighed.  While there is no question crowdsourcing will move into the mainstream in a big way, I don't expect the next corporate structure to be centered around a free/cheap labor model as it is with offshore manufacturing.  In the interim, I'll continue to train my fifteen month old how to say "Where's the Beef?" (hello Superbowl 2013!).

21 January 2012

The Private Equity Enigma

Much like I do with Venture Capital investments, I've often wondered how much long-term value Private Equity firms create for their portfolio companies and society as a whole.  PE shops use a combination of financial engineering and operational savvy to generate the required above market returns that their limited partner investors seek.  But do these companies that “go private” end up as better run companies?  From an Atma perspective, do they become more sustainable as a result and create lasting value for the general public?  Or is it a case of corporate raiders manufacturing gains in the short-term while leaving portfolio companies in a weak long-term position?  
Many critics (and more recently, anti-Mitt Romney candidates) have the notion of "barbarians at the gate" in which these firms layoff employees in mass, burden the companies with unsustainable debt loads, and run the company merely for quick returns.  A recent WSJ article, which examined the performance of Bain Capital portfolio companies during Romney's tenure, might support this view.  Although creating nearly 50% return for investors,  roughly 30% of the companies went bankrupt within 8 years of investment.  Further, only 10 deals (out of 77) created the lion share of the returns (4 of which subsequently went bankrupt).  Bain Capital claims the data is skewed as it generally invests in more troubled companies than most; Either way, it surprising that a firm anchored by strategic prowess had significantly more losers than winners in its portfolio. 
The truth is that it is virtually impossible to get statistically significant data to analyze whether companies are better in the long run.  So I took a different approach.  I put together some hypothetical numbers to figure out what kind of financial improvement would be necessary to generate the required rate of returns (~20-30%) for PE investors within a typical investment period (five years).  The result of my high level experiment:  financing matters more than operational improvement. 
In the heyday, firms were able to borrow almost 80% of their purchase price.  In this scenario, a nominal 5% increase in operations (annualized EBITDA growth) would yield a whopping 29% annual internal rate of return (IRR) for investors five years later. Cutting back the debt to 50% would cut the return in half.  In the same example, doubling the improvement in performance (ie. 10% EBITDA growth), would only yield a 12% incremental IRR.   Even a slight decrease in operating performance would yield positive returns. And upon exit, the company is still left with almost four-fifths of the original debt load.  
I can send anyone who wants to see my analysis, but I would have hoped that company improvement would have mattered more.   Negotiations with suppliers, closure of underperforming locations, some minor changes in operations can readily achieve a 5% lift.  And it is clear that as debt becomes harder to come by, PE returns have significantly dropped.  It is also hard to find big successes through the PE umbrella.  Even the Bain home runs like Staples have struggled post-IPO.  And even if Staples created more jobs, what about the thousands of local office supply dealers that were forced to close its doors?
The fact that leverage matters most in these deals shows that investment performance has little to do with how the companies actually do long-term.  We are in the midst of the second PE hangover in which overleveraged companies bought up by firms at the debt market peak have yet to restructure (remember Chrysler or Hilton?).   It is clear that private equity firms will have to work harder on the operational side to generate the kinds of returns their limited partners are accustomed to.  Much like governments these days, firms have to work on both cleaning up their existing debt and investing with less borrowing capacity.  So if you are looking to invest in a PE firm, you may want to look at their ability to garner debt and sell companies much more than their track record of improving company operations.  

05 January 2012

A helping hand in a race to the bottom

Sears' holiday season was anything but as it announced sharp sales declines, shedding of locations, and reaffirmation that the Kmart acquisition was a disaster.  Sears is not alone; it is merely a recent example of  a failing company that reaches for a lifeline by partnering with another struggling one.  Why do companies repeatedly attempt this doomed strategy?  Isn't it better to try to fix your own woes instead of inheriting new ones?

It is not uncommon for large companies that lost their way to make a strong comeback.  Everyone knows the story of the resurrection of Apple and Jobs 2.0;  some, like IBM, diversified their way to higher growth businesses; others like Ford kept large cash reserves to protect itself from a market downturn.  Successful restructurings often require significant pain in terms of job losses, structural changes, and bets into new areas.  Strong management teams and sound strategy are the keys to navigating turbulent waters.

But a successful playbook never included a buyout of the weakest competitor.  No matter how cheap it is.  Companies often try it because its the easiest (or sometimes only) option.  Cut costs, raise prices, and hope things work out.  The Nextel deal put Sprint on a fast track to brinkdom.   Struggling railroaders in the 1960s were unsuccessful.  Remember Alcatel and Lucent? Even dotcoms like Lycos rolled the dice and lost. There are hundreds of examples across an array of industries that have tried and failed.

You can't fix a broken business model by adding more of the same.  Sure cost cuts can help, but surely you can do that on your own as many have done.  Ford, for example, initiated tremendous cuts (and yielded concessions from union on the heels of its struggling competitors) while revamping its focus to smaller cars. A large scale integration in a time of crisis leads to a misallocation of resources, a myopic focus on cost savings, and an opportunity for competition to steal customers and strengthen their market position.  The Japanese auto companies did so during the Daimler/Chrysler fiasco;  Southwest significantly increased share during the airline consolidation of the 1980s.  These companies had viable business models to begin with - a key ingredient that cost cutting along cannot solve.

So will Sirius and XM work ?  Given all the deal talk surrounding Yahoo these days, will a combination with AOL allow it to compete with Google ? Borders + Barnes would have been a disaster.  If history shows us anything, an announced merger of two subpar rivals might be a leading indicator to head for the exits. Generally speaking, at that point, it might already be too late.