The Inevitable Sleeping with the "Friend-emy"

Back when Apple was cool (circa 2012), the company liked to throw around its weight almost to a fault.  Everyone knows about the Google Maps fiasco and its decision to move entirely away from Samsung chips seems to be risky choice as well.  As companies such as Apple continue to grow, they will no doubt run into areas in which they end up partnering with competitors for a specific need.  Very few try to avoid this conflict like Apple seems to be; It leads me to the question of whether it is better to avoid enemies altogether or accept small collaboration to achieve a greater good?

There was a good Fortune article recently detailing the rationale for fierce rivals like Ford and Nissan to work collectively to develop hydrogen-based engines for cars. It seems to be obvious that sharing R&D, capital budgets, and know how will help get this emerging technology off the ground quicker and cheaper.  Plus, the expected demand for hydrogen-based cars is so huge that both should benefit from the expanding pie.  This seems to be a win-win all the way around, right? Well, it certainly seems so out of the gate.

Once this new technology matures, however, the tactical competition will most likely lure its ugly head. At some point, there will be a market share grab by Ford and Nissan, who compete for the same customers in the same markets. You see similar fates more broadly in Joint Ventures where resources are pooled by two or more companies to address new markets such as Ford and Nissan's project.  Differing incentives generally lead to withholding of information, divisive management, and jockeying power plays.   In the end, JV's usually are unwound or result in suboptimal results as the fight for market share outweighs the potential benefits of collaboration.  

Almost every large corporation deals with this kind of conflict on varying scales.  While its' channel partners have not loved Microsoft's investment in Dell and the Surface Tablet, they have no choice but to support the software giant.  AT&T, Verizon, and all the large telcos have "peering" arrangements set up to leverage the others' network infrastructure (usually for free).  Luxxotica sells frames to almost every independent eye doctor in the country, but also runs 1000 Lenscrafters stores that compete with them.  Google swallowed Motorola but Samsung still sells the bulk of the Android phones in the world.  Closed door conversations may one thing, but generally speaking, businesses seem to accept some level of channel conflict in the interest of their own bottom line.

Interdependencies are everywhere, not just in business.  China's anti-competitive behavior hurts the US Economy, but without a buyer for our cheaply priced bonds, the US would be in fiscal dire straits.  It is easier for smaller companies that are more narrowly focused to pick partners and avoid competitors.  For larger ones, it's almost impossible to avoid your rivals at least in some capacity.  While Apple's "axis of evil" list may be a psychological victory for the company,  the strategy generally doesn't make much business sense.  Long-term objectives should win over small pools of competitive partnership.  The trick is to pick the appropriate timing and level of collaboration.

A CEO's Search for Market Efficiency

One of the longest running MBA discussions is on whether capital markets truly price a security at its intrinsic value.  Whether you believe in market efficiency or not, erratic stock prices make it difficult for publicly traded companies  to manage for the long-term.  CEOs and Boards must balance its efforts between quarterly earnings targets and long term planning for company sustainability.  As most already know, these generally come in conflict.  So how can companies effectively manage these two opposing forces?  
    
First off, earnings don't mean as much as market expectations.  In an illustrative example, let’s say a company projects earnings of $10 per share and trades at the market P/E multiple of 15 for a $150 stock price.  If the company misses earnings by $1, the stock not only drops to reflect this miss, but also does  the P/E multiple oftentimes.   If the multiple drops to 12 in this example, the stock falls to $108 (12 x $9).  What’s interesting is that of the $42 drop in price, only $15 of it relates to the drop in earnings as the remainder results from a lowered expectation about the company's future.  An earnings miss means problems on the horizon to the market, whether or not it is actually true.  What's even worse, events or speculation outside the scope of a company's performance can affect the price significantly.  Ironically, while management teams almost solely focus on delivering on the financial budget, it is often outside forces such as an analyst upgrade or downgrade that really moves the price.  

So CEO's shouldn't worry about earnings or the stock price, right?  Of course they must. CEO pay is often tied to stock performance through options, equity grants, and other forms of compensation.  And if he or she can't deliver the short term earnings expected from analysts,  the CEO won't be around to benefit from some of those packages (but we can't lose sight of those healthy severance packages).  It seems counter-intuitive for shareholders to reward short-term results when a properly executed long-term vision should matter more, but patience is not a characteristic of the stock markets.  Bottom line, CEO's are expected to deliver every quarter and build a sustainable future with long-term stock appreciation at the same time. 

A few companies have been able to deliver on both fronts.  Jeff Bezos’ charisma and Amazon's sales growth allows it borrow at ultralow interest rates and command a high P/E despite an unproven earnings record.  Google’s search engine business continues to blow out earnings allowing it to invest in self driving cars and computing eyeglasses.  While very few have a cash cow like Adwords, even declining companies such as  Intel and Cisco can leverage their balance sheets and cash flow stability to delve into riskier investments that might produce a better future for them.  Building a day to day story still is step one.

Financial transactions are a  common way that companies attempt to influence stock price dynamics, but with mixed results.  Companies  that buyback their own stock do so at the highest prices.  Dividend payouts are good, but the market places little value on them (and can in fact lower stock prices due to reduced growth expectations of the company).  Many companies from Burger King to most recently Dell look to going private transactions as a way to generate value.  These transactions are usually highly leveraged and have other issues that may or may not make for stronger concerns over the long term.

Investments in innovation and new companies are another way to look to the future without impacting current results.  Spinoffs like Microsoft's home grown Expedia and EMC's divestiture of  VMWare were not only financial home runs, but also allowed these new ideas to thrive outside of the scope of a larger parent company with competing incentives.  Incubators such as ATT Foundry supports startup ecosystems while keeping the incumbent plugged into developing technologies.  Large companies can also benefit from innovation-based acquisitions, like Google's Android, to potentially develop a strong pipeline for the future.  Certainly there is more variability in the returns on these investments (which markets hate), but there is more upside in the long-run. 

In an ideal world, Management could manage companies for the long-term if markets were efficient.  But even if they are, its hard to chart a clear path to do so when quarterly earnings and outside forces seem to matter more.  Perhaps companies need to hire a psychologist to help manage market expectations.  Or perhaps companies should just stay on the sidelines like tech companies are now doing according to a recent WSJ article.  But if a company is poised to remain in the public realm, perhaps they need to develop a poker face by talking eloquently about mundane topics such as capital expenditures on the one hand, and invest in futuristic cars that drive themselves on the other hand.

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. 

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.

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.

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.   

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?