Archive for the ‘Strategy’ Category

Krugman on Schumpeter

Tuesday, October 6th, 2009

Krugman wrote the other day that Schumpeter’s macroeconomics falls apart because:

[Schumpeter says] mass unemployment is necessary, because you have to shift resources away from sectors that got too big, stimulus is a bad thing because it slows the necessary adjustment. And now as then, the whole notion falls apart when you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

Thus urged, I did ask myself why there would be unemployment in a housing bust, but not a boom.  The answer, Mr. Krugman, seems pretty obvious:

  1. Investment bubbles collapse much faster than they inflate.  In the real world, labor can only redeploy so fast.  If capital reallocation exceeds that rate, you get unemployment.  So on the way up, capital redeploys slowly enough for labor to react smoothly.  No unemployment.  On the way down, capital redeploys much faster than labor can.  Presto, unemployment.
  2. (more speculatively)  In the short run, bubbles increase the blended rate of return on capital for the whole economy.  Higher ROI permits overall employment to rise above the rate that would have prevailed without a bubble.  When it bursts, ROI falls, so unemployment rises.

Stop or I'll shoot… myself

Monday, August 10th, 2009

Microsoft’s latest competitive brainstorm is to give away Office, its flagship product, in online form.  This recalls an old comedy scene, in which a thief, cornered by police, points his gun at his own head and says, “Let me go or I’ll shoot!”

The media inexplicably painted this as a countermove against Google.  But, ah, how is dropping your own price to zero an offensive maneuver?

Microsoft still has momentum, but two big things changed in July 2009.

  1. For the first time, a competitor with vast engineering resources pledged to release a free alternative operating system.  It will run on netbooks, the fastest-growing computer segment, and where Microsoft is weakest due to performance problems.
  2. For the first time, Microsoft pledged to give away a version of Office.

Most of Microsoft’s profit comes from those two products, and ever-increasing price pressure is now nearly certain.  I had purchased MSFT very cheaply last November at about 20, on the stock market swoon, and was only too happy to dump it at a 20% profit last month.

One risks later embarrassment by mentioning specific trades, and that may well happen here.  I prefer to hold for years, so this runs against style.  Moreover, I still think MSFT could have years of stability ahead.  But I’m less sure of it than before.  Selling now offered over 30% CAGR pretax.  A very pretty bird in the hand.

Knowing industry competition

Tuesday, August 4th, 2009

It’s surprising to see big companies fail simply by misunderstanding the nature of competition in their own industry.  I do not mean misunderstanding their competitors — that is more common, and more understandable.  But to misunderstand the nature of competition itself, the terrain on which the battle is fought, never ceases to amaze.

Contemplate the decline of Network Solutions (hereafter NS), which was the #1 Internet domain name registrar in 2000, but now a fraction the size of GoDaddy (hereafter GD), which has registered 5x more names.

NS was a pain to use, but not unusable.  Support was bad, but not terrible.  GD beat them somewhat on these fronts, but they are not the reason for the lopsided outcome.

The battlefield was simply price. Domain name registration is a nearly pure commodity, and GD took over simply by charging less.

It didn’t have to end this way.  NS was much bigger, and hence presumably had at least a small cost advantage a decade ago.  If NS had simply charged a penny less than GD, there would be no GD.  That option no longer works, because GD now has huge scale and presumably the lowest costs.  Inexplicably, NS never reacted.

At the time, I recall reading that NS treated the business as a cash cow.  Rightly so:  domain registration is a good business for a sustainably low-cost producer, as with any commodity business.  But you have to connect the dots tactically, watch the competition, etc.

GoDaddy management, though undoubtedly sharp, really owes its biggest thanks to the mistakes of Network Solutions (which still charges triple vs GD).  If NS had done the right thing, no amount of brilliance at GD would have worked.

Another business facing this same situation is the Corporation Service Company, which most people have never heard of.  Venerable CSC provides “registered agent” services in Delaware.  Tons of corporations form in Delaware, because it has a huge stack of corporate case law, making lawsuits cheaper for both sides to resolve.  But to form there, you need a “registered agent” there.  CSC is the gorilla of that business.

But till recently, they were not a nimble gorilla.  As the world moved online, cheap one-person shops arose to provide the same service.  I saved 70% by changing to one of these.

Unlike Network Solutions, CSC got wise, simply phoned all their lost customers, matched the low offer, and got all their business back.  This is not brilliant — it’s simply doing the obvious, which NS didn’t.

Joyride around the Maginot

Saturday, July 11th, 2009

Google’s OS announcement is reported as a frontal assault on Microsoft, because that’s a story the media loves to tell.  Reporters just can’t help casting it that way.  They love the battle royal.

But this is not frontal assault. More like a joyride around the Maginot.

Logically GOOG would attack MSFT at its weakest, most inflexible point: netbooks, where Vista doesn’t run at all, and Windows 7 Beta is reportedly slow (and also unfinished).

Just as logically, GOOG would attack MSFT where switching costs are lowest. Netbooks are not used for heavyweight desktop software, and hence their users have lower OS switching costs than users of, say, Windows-based accounting software.

Why do it? Because user-friendly netbooks would hugely increase the total number of Google users. For now, netbook adoption is limited by the expense, footprint and slowness of Windows, and by the user-unfriendliness of Linux.

Linux distros, though super useful (I run several), have low consumer adoption because of less polished UI and peripheral support. These are solvable problems, but remain unsolved because no one entity has had both the resources and interest to polish up free software.

But given is an economic reason, it can be done. Apple built its slick UI and driver stack atop BSD Unix to sell more hardware. If Google thinks it can sell more ads and services atop a consumer-friendly Linux, they certainly have the resources to make Linux friendly to Peoria, Shenzen or Santiago.

Summary: they have no intention of moving up the ladder to heavyweight PCs. Instead, this is an “Innovator’s Dilemma” move, creating a low-end mass market product that will always remain economically unviable for Microsoft.

Offshoring retail

Tuesday, June 16th, 2009

Nostradoofus prediction for 2010:  Web retail is increasingly offshored.

To see why, pay a quick visit to the World’s Scariest E-commerce Site.  Savor the broken English, salted with nonsequitur French and Italian.  Admire the ragged formatting and non-matching fonts.

The site claims its location is “Alabama,” but they ask 20 business days for delivery, and the domain is registered in Shenzen, China.  Er, Alabama is far from California, but not that far.

If you actually buy something at that site, as I did, you’re greeted with the chilling purchase completion message, “Dummy string.  Actual purchase completion message goes here.” You then experience two weeks of deafening silence from “customer service” before your order arrives. But it does arrive.

What?  You’re not running out to buy from this site?  Before deciding, consider this:  on my first $100 purchase there, I saved 70% off the price of an equivalent item from a US site.  Including shipping costs.

So don’t look at the site itself, but rather what this site is trying to do.  Where is that $70 being saved?  They are cutting out the entire wholesale-retail chain, and shipping directly to your door from factories in Shenzen.  This is quite interesting.

And it gets better with scale. Once they are receiving 50 or 100 orders a day, they can ship them all in one box to the US, then break them up to trans-ship domestically.  Inventory? All in China, almost free to store.  Website?  Maintained in China, nearly free.

Perhaps most interesting is that, by locating near the factories, the retailer can eliminate inventory entirely, simply buying as needed directly from the factory.  This, in turn, permits the retailer to list a vastly larger catalog, since need not actually stock anything, but has immediate access to everything.

In the most extreme manifestation, the end buyer becomes the endpoint of a just-in-time delivery system, in which retail orders directly trigger production runs in China.

Yes, there are site quality issues. For now. But I would not bet against the ability of the industrial titans of Guangdong to solve that problem.  Web vendors of imported durable goods should be squirming, because this system is inherently and vastly more efficient.

Palm ruins another career

Thursday, June 11th, 2009

Ed Colligan today is officially out as CEO of Palm, ostensibly due to the fizzled Palm Pre product launch.  Perfect example of Warren Buffett’s aphorism that when a good manager runs a bad business, only the reputation of the business survives.

We routinely confuse great businesses with great leaders. For example, eBay, an unregulated natural monopoly, enjoys network effects so large that, after 1998, it would have wildly succeeded with a chimpanzee at the helm. Form that mental picture before voting in Ms. Whitman as governor.  Not to say she’s bad — maybe she’s great. But we have no evidence either way, because eBay’s strategic advantage renders good leadership almost immaterial.

As regards Palm, my opinion (as head of a top-5 Palm software developer during the peak of Palm’s popularity) is that Palm’s window of opportunity had already closed before Ed took command.

Colligan will do great in private equity.  It runs in the family:  his older brother Bud, also sharp, is a GP at  hoary VC firm Accel Partners. All longtime Palm folks who know Ed expect his best work is still ahead, now unencumbered by Palm’s limitations.

So now it’s Rubinstein’s turn to be tarred and/or feathered by Palm’s decline.  Judging from his Apple career, he is a brilliant product guy (caveat:  he’s the first Palm CEO that I’ve never met).  And Rubinstein’s own reasoning is obvious — no one can rise above VP at Apple. But Palm has none of Apple’s advantages: scale, the network effect of iTunes, retail distribution control, and the Apple brand.

Palm’s only realistic window was far earlier, ending in perhaps 2003.  At that point they had most of what Apple has now and a few things Apple doesn’t:  leading share in smartphones, multiple carrier relationships, and a huge, experienced software developer base, many times larger than that of any competitor.

That’s all gone now, and Palm is trying to scale a smooth teflon wall with its bare hands.  Maybe Rubinstein will find a career later in private equity.  It’s more forgiving, and intelligence is more predictably rewarded.

The calculus of joining a declining Palm

Palm’s executive headhunter approached me around 2004 as a potential VP of product marketing. Terrible fit, for a number of reasons on both sides. Two facets of that dialog are relevant here.

1.  Palm’s strategic options are hamstrung by its misplaced consumer ambitions

Our talks ended immediately after I proposed a product strategy:  abandon the hopeless quest for scale in consumer phones, and focus instead on ”enterprise” phones:  ruggedized, WiFi, barcode reader, high-resolution camera, and deep software API.  Acquire Symbol Technologies, the largest industrial PalmOS hardware vendor. Own the market for insurance claims adjusters, inventory clerks, security guards, etc.  Leverage Palm’s only hard-to-copy advantage — the world’s largest base of mobile software developers — with a more sophisticated OS and radically simplified software installation and update system.  (Apple did all of this a couple of years later.)

My position, then as now, was that Palm was already doomed as a consumer play, for lack of scale. Any ephemeral market share gain would be pyrrhic, because mass market consumer phones have very low margins. Motolora’s travails illustrate the problem.  Even for Apple, many times larger, with a strong brand and distribution advantages, success with the iPhone was by no means assured, and even now enjoys high margins mainly because of the network effect of iTunes.

2.  Promotion to First Officer — of the Titanic

From a career perspective, would it have been worthwhile for me to become VP of a public company in terminal decline (if offered, which it wasn’t)? Probably yes, but not at all clear.  So I can really appreciate Rubinstein’s calculus in joining and remaining at Palm.

Who knows?  Had I gone there, I might by now be settling into a comfortable semi-retirement in private equity…

Remaking the News

Saturday, May 30th, 2009

Even as the industry collapses around them, some newspapers seem not to fully understand their own business.

Traditional newspapers consist of reporters (gather content), editors (judge and shape content), ad sales staff, a printing facility and distribution trucks.  Reporters and editors provide the value to end users, and the ad sales pay for it all.

Newspapers were able to charge money largely because printing and distribution costs created barriers to entry for other newspapers.  You can’t afford to buy a printing plant and fleet of delivery trucks if you don’t have circulation, but you can’t get circulation without a printing plant and fleet of delivery trucks.  That’s a big barrier.  As a result, the city paper was the only way to reach a consumer in print on a daily basis.  Local monopoly.  They charged a lot for that, and this is why Warren Buffett loved to own newspapers.

Printing and distribution costs are now zero, thanks to the Web.  This lowers entry barriers, while pushing price down to marginal cost:  zero.  That’s why Web news is mostly free, and Web ads are nearly free.  Oddly, ten years into the collapse, news industry pundits still sometimes ask, “Why are we giving away content?”  They simply don’t understand that free-ness is a microeconomic certainty, given the conditions. Google internally describes the situation very simply:  ”information wants to be free.”  That was always true, but distribution costs created the opportunity for distribution control, which pushed up prices.  Until now.

So that whole industry is the walking dead, excepting a few very strongly branded papers.  What might replace the other 500 papers that disappear?

Go back to the second paragraph and look at the list of functions performed by newspapers.  Note how only two pieces of this puzzle are useful to the reader:  reporters and editors.  The rest, from the end user perspective, was just an unavoidable cost of getting the content.

So the real question in news is how to pay for information gathering and editing.  And we already have a partial answer to the editing problem:  bloggers.

Not all blogs are collections of random ruminations (as this one is).  There is a small but growing handful of blogs that act as meta-editors for the news.

For example, Calculated Risk and Naked Capitalism, two respected finance blogs, are increasingly quoted by traditional media.  They are written by industry professionals with over a decade each of experience in their respective specialties (mortgage and investment banking).

From the reader’s perspective, these two blogs do what the city newspaper editor used to do:  edit the news.  They read everything publicly available on a given story, condense it, and tell a pithy and interesting story.  

They also have a business model.  Each has a wide readership, which lets them sell ads.  Though each author could, so far, probably make more money doing something else, there are certainly cases where bloggers are already making a living by acting as meta-editors.

In short, the editing function may be a solved problem.  Each successful news blogger becomes a sort of one-person brand.  That brand sustains a readership, which in turn sustains an ad base.  

This leaves a harder problem:  news gathering.  Currently nearly all news bloggers are parasitical on newspaper reporting.  They don’t actually fly to Geneva to talk to a banker, but instead judge the comments the banker made to a NY Times reporter. Obviously this will fail when the newspapers go under.  What will pay for content gathering?

Basically, bloggers will eventually have to pay the Associated Press, or a lightweight Web-only equivalent of AP, for stories.  This will probably work once blogs completely replace news, but we are headed for a chasm, during which newspapers and AP have laid off all their reporters, but blogs (or their proxies) have not yet hired any back.

More hypothetically, there is probably a way to crowdsource some kinds of reporting.  If 100 people send “earthquake in Karachi” over Twitter, you know there is something going on.  This solves event reporting, but not the higher-end stuff like interviewing experts.

Whatever happens, there will be a transition period in which there is very little news gathering for print.  Reporting in that period will likely be done by non-newspaper sources:  government data, subsidized reporting (BBC, CS Monitor), television, and magazine investigative pieces.  The transition period might last years.

Remaking the GOP

Friday, May 29th, 2009

The Republican Party has, for the first time in 40 years, an opportunity to remake itself.

In the 1960s, Nixon made a Faustian bargain, essentially exploiting racist frustration in the Deep South over the Civil Rights Act to lure southern Democrats to change sides. Thus began an uncomfortable but enduring coalition between laissez-faire businesspeople and relatively poor, uneducated, conservative magical-thinkers that might euphemistically be called “social issue populists.”

One could argue the Reagan Revolution was no revolution, but an incremental extensions of that same basic alliance to include one more group of social issue populists: Southern Baptists.  Again, it worked, in the short run.

This coalition won elections, but was essentially unholy, combining two completely different political philosophies into one party.  This could not last forever, so it didn’t. The laissez-faire business elite were increasingly outnumbered in their own party by populist ideologues with no interest in government, big or small.  

In the past several years, as Bush Jr.’s GOP turned shrill and spendy, it was itself abandoned by its centrist, non-ideological leaders, leaving behind mostly know-nothings.  Centrist, non-ideological Republican voters naturally followed them out the door, leaving the impotent, free-falling GOP we see today.

But there is an obvious strategic path to their salvation. One type of small government — specifically, high-ROI government, in which economical regulation enforces property rights, growth in median income per work hour, and a level competitive playing field — is still the right answer.  This position constitutes the under-represented center of American politics.  In coming years, there will probably come an opportunity to exploit frustration with a new status quo of high inflation and low ROI on spending.  The question is how long it will take for reason again to take root in GOP leadership, which is currently bush league (no pun intended), after the death or departure of most of the wiser heads.

I say this with all due respect, as a laissez-faire fiscal conservative currently without representation in either party.  Here’s hoping.

Credit card optimization and inflexibility

Friday, March 20th, 2009

I’ve mentioned before the general principle that optimization creates inflexibility — in business, investing, computer programming, law and much else.

The credit card industry’s current travails offer an example.  Many have written on this subject recently, many good, but usually with the leftist or moralist subtext that 30% interest rates are somehow inherently wrong, so card issuers are getting what they deserve.  I’ll leave the Biblical debates to other writer.  This post just talks about the relationship between steady-state profit maximization and brittleness in economic shocks.

Credit card issuers mainly make money from so-called “revolvers” — people who endlessly pay interest on high balances, too high to pay down, but never quite high enough to trigger  default.  The issuer’s business revolves around revolvers, endlessly optimizing to maximize cash extraction from that particular group.  (Conceptually similar to the way casinos make much of their money by catering to and optimizing for “whales,” a gaming industry term for high-stakes compulsive gamblers.)

The 2005 bankruptcy reform, in force since 1/1/06, was intended as yet another credit card industry optimization.  By making Chapter 13 harder to qualify for, debtors could not easily write off consumer even in bankruptcy.  Instead, they were placed in repayment programs by the bankruptcy court.  According to at least one reliable source, issuers responded to this by lending more freely, assuming they would always be able to collect, even in bankruptcy.

This and other optimizations were in a sense too successful:  the more effectively the issuer optimizes, the closer it pushes the “revolver” to his absolute theoretical fiscal limit, the more exposed both borrower and issuer become to an economic shock.

Say you are a lender.  Would you want most of your customers to be paying you 100% of their EBIT in interest payments?  A residential lender would answer no.  Corporate bond issuers would say “no way.”  Too dangerous, no margin of safety.  A one-dollar decrease in the borrower’s income would trigger default.  Yet card issuers were actively seeking that 100%.  They tried to control losses with higher rates and better collections, but mainly just crossed their fingers on general economic stability.  That turned out to be an ill-placed hope.

Who's Daffy Duck?

Friday, March 13th, 2009

My favorite piñata for demonstrating the principal-agent problem is Microsoft marketing.  But Time Warner also offers good examples in which long-run earnings are sacrificed to serve short-run interests of individual ladder-climbers.

Last year, my kids received the entire Looney Toons collection from a generous uncle.  This vast DVD set includes nearly every Warner Brothers animated short from the 1930s to 1960s.  The kids absolutely loved it, because — and I didn’t yet realize the significance of this — they had never seen Bugs Bunny or Daffy Duck before.

My daughter, then 7, invited a friend over to see.  ”Let’s watch Daffy Duck,” she said.  ”Who?” replied her friend.  It was hard to get her interested, because, I finally realized, no one under 8 in this area has ever seen Bugs or Daffy before.  They are not broadcast here.

You can see how such a situation might arise.  The DVD collection is one-of-a-kind, exhaustive, and very expensive.  The people who buy such things are over 30 and not price sensitive.  So in the short run, if you make the cartoons unavailable on TV, enthusiasts are more likely to buy the DVD.  Sales go up.  For now.

But the TV shows drive DVD demand 20 years on.  In a couple of decades, DVD sales (more likely their digitally delivered equivalent) will collapse, as the first crop of parents arises who have never heard of Bugs and Daffy.

By then, the marketing strategist who came up with this bright idea will be long gone, perhaps even promoted for his ability to increase short-term contribution.  That guy is not necessarily evil — he may simply have responded to bad incentives.  Designing those incentives is the hardest problem in management.