I find myself confused each day I hear the arguments being made in Washington concerning the automakers plight for a handout from the US taxpayer. If this was any other industry or company, the markets would have corrected this mistake years ago and we would not be dealing with the stories headlining our media outlets today.
When a company focuses its efforts on what it makes and itself, and loses the focus on its consumer, I refer to this as a production orientation versus a market orientation approach. Simply stated, when your prime focus is not on the consumer and is on yourself, the chances for success are greatly minimized.
I reference the buildup of technology and all its hype in the 1990’s. Many technology companies were engaging some very creative and intelligent engineers and mathematicians in the development of cutting edge applications and technologies. These very smart people got the financial world caught up in their development. The venture capitalists and investment bankers began the “spin” which created a highly frothy and expectation ridden investment market. It was not uncommon to hear an entrepreneur tell me that “if I can only capture 1/10 of one percent of this market, my company will be worth millions”. Many fell for this line and made the investment.
These technological entrepreneurs were correct in their analyses that their technologies were truly unique and capable of creating dramatic change in the marketplaces in which they competed. I am sure that the bits and bytes that they were developing were nothing less than creative genius. However, for so many of these technology upstarts, they had a production orientation and assumed that consumers would buy their technology. These technologies might have changed the way things performed; however, consumers did not see the value of this change versus the cost that would be incurred. Had these companies had a marketing orientation and done the requisite analyses, they would have found that consumers would not pay for this new technology because its benefit was not worth the cost. Some of the same technologies that were developed at the beginning of the “tech boom” are just being accepted in the markets today. It was not the technology, it was the consumer’s lack of acceptance that led to the downfall of so many technology companies of our not so distant past. So many of these companies were just ahead of their time.
A case in point from the summer of 2008 involves a company we advised which used the satellite communication service Iridium. Sky Connect leads the industry in Iridium-based voice and tracking systems for aircraft, with certified systems flying on every type of aircraft throughout the world. Sky Connect was sold to EMS Technologies, Inc. (NASDAQ: ELMG) in August 2008. This transaction displays that the services Sky Connect was offering its customers were truly unique and were seen as a value added offering. I cite this example with the following background. Iridium was originally launched in 1998 and subsequently went bankrupt in 1999. In 2001, it was re-capitalized and launched with a new emphasis and approach. The initial commercial failure of Iridium had a dampening effect on other proposed commercial satellite constellation projects, including Teledesic. Other networks (Orbcomm, ICO Global Communications, and Globalstar) followed Iridium into bankruptcy protection, while a number of other proposed schemes were never constructed. The concept would eventually have consumer application, but in the late 1990’s and early 2000’s, these communication networks were not being accepted by the buying public.
So what does all of this have to do with the automobile industry in the United States today?
A lot.
It was a former General Motors CEO and Chairman of the Board -- the legendary Alfred P. Sloan Jr. -- who foresaw the problems that are now causing such consternation at his former company today. "Any rigidity by an automobile manufacturer, no matter how large or how well established, is severely penalized in the market," Sloan wrote in his 1965 memoir, My Years With General Motors. At the time of this writing, Sloan was talking about his chief competitor, Henry Ford, and the refusal of Ford Motor Company in the 1920s to change its business model to build different cars to suit the changing tastes of American consumers. Interestingly, Sloan's indictment of Ford in the 1920’s is exactly what has been the precipice to the failure occurring at General Motors today.
General Motors has seen a 42 year continual decline in its US market share (from 53% to 20%) even amidst many announcements of “change” within the company. GM has built a company of 8 US brands with about 7,000 dealers. Its chief market competitors Toyota (19% market share) and Honda (11% market share) have approximately 1,500 and 1,000 dealers respectively. To build upon this tremendous difference is the cost of employees and retirees. General Motors has an all in cost per employee (present and retired) of approximately $70/hour, in stark contrast to its foreign rivals who maintain a $40/hour cost. The foreign car manufacturers who build their cars with American workers pay current wages similar to what GM is paying its active workers. But the expenses associated with retiree benefits and the UAW’s “Jobs Bank” program, which guarantees nearly full wages and benefits for workers who lose their jobs due to automation or plant closures, push the actual costs much higher.
The UAW has created this dramatic cost differential as a result of its strength within the Detroit based automakers. The unionized employees have the opportunity to retire in their mid 50’s and to enjoy a lifelong retirement and benefit structure that most American’s would envy.
But labor costs are not the only expense category that is weighing the automaker down. Dealers received an average of just over $3,400 per car sold in incentive money from GM in October, 2008. Combined, these two costs alone push GM into a cost prohibitive position.
Normally a company in such straits reduces its costs until it reaches a sustainable level of cash flow. But for GM, shrinkage is not much of an option. Because of its union agreements, the auto maker can't close plants or lay off workers without paying a stiff penalty, no matter how far its sales or profits fall. It must run plants at 80% capacity, minimum, whether they make money or not. Even if it halts its assembly lines, GM must pay laid-off workers and foot their extraordinarily generous health-care and pension costs. Unless GM scores major givebacks from the union, those costs are fixed, at least until the next round of contract talks. The plan has been to run out the clock until actuarial tables tilt in GM's favor (a nice way of saying that older retirees eventually will die off). But with decreasing sales and a smaller slice of the market, that plan backfires -- leaving GM open to an array of highly unattractive possibilities.
So what does this situation tell us?
According to the noted Harvard Business School Professor Michael Porter in his 1980 bestselling book Competitive Strategy -- in order for enterprises competing in a truly competitive market to thrive they must have the combination of the following attributes: be a low cost provider or provide a differentiated product or service.
GM has done neither of these and there is still no real plan which provides them the opportunity to build on this premise.
So if we are going to provide them the money to stay afloat and keep so many laborers employed, when will the gravy train stop? I continue to look to the leaders of the automotive industry to provide a truly believable plan, one in which I cannot fathom.
What do we tell Toyota, Honda and Kia when we as US taxpayers bail out a failed industry which is only looking for a way to compete? Each of these foreign manufacturers are paying US taxes, employing US workers and being solid business citizens. Many towns have prospered in the wake of investment from these profitable companies. In West Point, Georgia, Kia Motors has invested over $1.2 billion to build a production facility that will cause employment to rise by over 5,000 jobs when considering all the suppliers that will come to the area. If we bail out GM, we tell them to stop spending their money in the US, take their jobs elsewhere because they are just too good and have beaten our companies to a pulp. What incentive do they have to stay here if every time they become more competitive, we support the US companies who could not defend themselves.
My take is that we need to take a good hard look at the unions and the value they are bringing to the economy. What makes a GM vehicle have more value to the consumer because of the total union inspired costs that are poured into the vehicle being produced? I understand why the worker wants this situation but am hard pressed to see the consumers’ benefit. Why can the foreign manufacturers keep the unions out and still pay a reasonable wage and provide outstanding working conditions? I do not think Upton Sinclair had this model in mind when he wrote so prolifically about the abhorrent conditions in the manufacturing world at the turn of the 20th century. The US automakers may be unfixable and we need to be really careful when making these looming decisions on if and how we bail them out.
My advice to GM and the other automakers asking for a handout ---- make a car that is valuable enough to pay the extra money to cover your costs, or eliminate those costs that add no value to consumers.
Sunday, December 7, 2008
Saturday, November 29, 2008
A Company at Rest....Dies
It would seem funny to think that I am posting a scientific theory as the first basis of my observations on this blog site. Way back in the 7th grade at MacDonald Middle School in East Lansing, Michigan, I earned a failing grade in science. Not that this fact has left any scars in my life, but it was always great conversation for my mother to tell my kids during the holidays while I was busy beating them up about studying for their finals. So while I was not cut out to be a scientist, I am still keenly aware of some principal facts about how the world works.
Every body continues in its state of rest, or of uniform motion in a straight line, unless it is compelled to change that state by forces impressed upon it
Successful business leaders clearly did not fail 7th grade science as they learned that this very important principal of physics has a 100% correlation to economic markets. Many economists have shown that efficient markets behave in cycles. History has shown that periods of economic upswings are followed by periods of economic downswings. While many factors may contribute to these swings, one thing is true – change is a constant when cycles move in either direction. Another constant for the vast majority of markets is competition. In most industries a characteristic of competition is that most firms feel the effects of each other’s moves and are prone to react to the outcomes of those moves. When faced with economic conditions that are turbulent, changes in markets can happen in many different ways. Customer demand can fluctuate, technology can shift product and services offerings, money supply can enhance or stall opportunities, competitors may appear where there were none in the past. This last concept, a term I refer to as “Boundary Blurring”, is a byproduct of competitive firms making changes so they may remain competitive. For instance, years ago life insurance was bought and sold primarily at the kitchen table. Today, life insurance is sold in so many ways by so many channels of distribution that for many, price can become the sole differentiator. Next time you are shopping at Sears, stop in and get a life insurance quote and see what I mean. Sears & Roebuck, the store where many of us as kids watched dad buy his tools – is now selling insurance.
So with all this change in markets, both internally and externally generated, how can anyone believe that the results of the past can so easily be replicated into the future? I ask every one of my MBA students if they can name the highest quality buggy whip maker in Maryland. To no surprise, I am met with a room of blank stares. It is not that the highest quality buggy whip makers of over 100 years ago ceased to make quality buggy whips, markets and products developed and their products were no longer required.
This simple but real example has been lost on so many entrepreneurs and employees that I encounter today. The world economic markets are going through a change that even highly educated and respected business leaders cannot explain. Changes are occurring rapidly and swiftly. Names like Lehman Brothers, Merrill Lynch, General Motors, Ford and Citibank are all corporate giants that so many thought would remain and prosper for many years to come. It is easy to look in the rear view mirror and see the causes for these Fortune 100 giants’ woes, but how did the leaders of these companies not see this coming? As another point of reference, of the top 10 companies on the Fortune 100 list in 1980, only 5 are still in the top 10 today. The top company in the 2008 Fortune 100, Wal-Mart, did not even make the top 500 until 1995.
Not a single one of these companies had a strategic initiative in their business plan that said they would fail, I am sure of this fact. But then why do so many companies not continue to achieve success when they achieved success in the past. Because “it worked before it will work again” mentalities are pervasive in today’s boardrooms and in the minds of many privately held company owners.
I highlight three real world examples of this rudimentary concept to you.
Public Company faced with Technological Change
This publicly traded firm specialized in consumer products and had achieved great success. They became the second largest firm in the United States in their industry and were achieving incredible profit margins of over 20% even though their products were seen as highly competitive and commoditized. The management team had been together for a long period of time and they worked very well together. And then a change occurred, the internet became a reality. As they had relied so heavily on print advertising for so many years, the change in consumer buying habits caused by the internet hit them dramatically. Their marketing staff and its leadership did not understand the internet or its capability of marketing and communicating to its current customers or potential customers. They continued to pour money into newspaper print advertising even though the response rates were declining and numerous outlets for this advertising were going out of business. “Our customers will continue to buy this way” was an often heard response from the long time senior executive running the marketing department.
Over time, this company saw its sales stagnate and its margins begin to erode. Price increases were allowing it to hold steady but at what cost? The CEO maintained that the senior executive of marketing was the right one for the job and did not make a change to replace him with a more knowledgeable executive with internet sales and marketing experience. Ultimately, the institutional investors said enough was enough and sold the company to a private equity firm. Not long after the deal closed, the new owners saw the need to make changes and the marketing department was quickly overhauled.
Niche Private Company believing nothing can change
A unique offering to a highly segmented market allowed this owner the opportunity to expand his revenue and earnings without much effort. He had come upon a model that worked and found that by adding more telephonic salespeople to his work force, customer expansion occurred. This owner grew to enjoy a very comfortable lifestyle accentuated by high priced cars and expensive vacations. His product and service offering did not change and he found that the business would run virtually on auto pilot.
He was approached by several large corporations that had noticed his success in the marketplace and they determined that he would be an attractive acquisition target. After many meetings, several of these firms placed highly lucrative cash offers on the table. After getting the bidding to a premium level, he said that the offers needed to be 10% higher or he could not continue to have the cash flow that he currently enjoyed. This analysis was completely flawed as he would have made over 10 years + in cash flow, after tax, in a guaranteed lump sum payment. In turning down these offers, he said that he could continue to run his business and only work a few hours a week and would maintain his lifestyle.
Within months of turning down these lucrative offers, his business began to crumble under the pressures of the current economic environment. His customers no longer wished to spend the money to buy his service even though it was a proven service which increased their profits. His profits have been reduced by over 50% and the prospect for recovery to the levels of revenue previously seen is many years away. Most importantly, he must now change his lifestyle which is loaded with fixed costs and expenses that he believed would always be able to be paid because his business was doing so well.
Internet Technology competing with the Big Boys
The members of the board of directors of this profitable small business were asking themselves if they should take the profits made over the past two years and re-invest them into a new idea and attempt to double their money, or should they take their chips off the table, cash in, and go home. The management team was not working well together because the President would not deal with confrontation or conflict, the sales force was littered with employees not producing or being managed to produce, the business did not demonstrate a technologically scalable foundation and the opportunity to expand into a new niche market was just beginning to look promising.
One of the largest individual shareholders was faced with a dilemma. Her personal goals were driving her decisions, not the broader reality of what situation she was facing. Could this company and her investment really be worth double?
Her cajoling of the other board members with a persistent promise of making this new opportunity work succeeded. She was given the green light to double down and make the opportunity a reality.
One problem – she did not change anything and tried to build this future opportunity on the back of a business that was not capable of growing under its current management structure and operating plan. She did not believe that the large public companies that competed against them in this space would be able to be nimble enough to capture first mover’s advantage in this highly promising niche of the market. She could not imagine that she could not will this opportunity across the finish line.
Within months of this decision, her business was in big trouble. Her opportunity was going nowhere – sales were not happening and momentum was slipping through their fingers. How could this happen, “we had grown considerably so far and there was no reason that this new opportunity should not work” – and she was right. The management team tried to build everything on an operation that had passed its useful life and under the changing market conditions; their collective hopes never had a fighting chance.
Today, the company is losing money and has spent most of the cash that it had saved – millions of dollars. Layoffs have occurred, and the basic business model has only recently been changed to reflect the changing market realities.
Lessons Learned
Every body continues in its state of rest, or of uniform motion in a straight line, unless it is compelled to change that state by forces impressed upon it
- Newton's First Law of Motion, translated from the Principia's Latin
Successful business leaders clearly did not fail 7th grade science as they learned that this very important principal of physics has a 100% correlation to economic markets. Many economists have shown that efficient markets behave in cycles. History has shown that periods of economic upswings are followed by periods of economic downswings. While many factors may contribute to these swings, one thing is true – change is a constant when cycles move in either direction. Another constant for the vast majority of markets is competition. In most industries a characteristic of competition is that most firms feel the effects of each other’s moves and are prone to react to the outcomes of those moves. When faced with economic conditions that are turbulent, changes in markets can happen in many different ways. Customer demand can fluctuate, technology can shift product and services offerings, money supply can enhance or stall opportunities, competitors may appear where there were none in the past. This last concept, a term I refer to as “Boundary Blurring”, is a byproduct of competitive firms making changes so they may remain competitive. For instance, years ago life insurance was bought and sold primarily at the kitchen table. Today, life insurance is sold in so many ways by so many channels of distribution that for many, price can become the sole differentiator. Next time you are shopping at Sears, stop in and get a life insurance quote and see what I mean. Sears & Roebuck, the store where many of us as kids watched dad buy his tools – is now selling insurance.
So with all this change in markets, both internally and externally generated, how can anyone believe that the results of the past can so easily be replicated into the future? I ask every one of my MBA students if they can name the highest quality buggy whip maker in Maryland. To no surprise, I am met with a room of blank stares. It is not that the highest quality buggy whip makers of over 100 years ago ceased to make quality buggy whips, markets and products developed and their products were no longer required.
This simple but real example has been lost on so many entrepreneurs and employees that I encounter today. The world economic markets are going through a change that even highly educated and respected business leaders cannot explain. Changes are occurring rapidly and swiftly. Names like Lehman Brothers, Merrill Lynch, General Motors, Ford and Citibank are all corporate giants that so many thought would remain and prosper for many years to come. It is easy to look in the rear view mirror and see the causes for these Fortune 100 giants’ woes, but how did the leaders of these companies not see this coming? As another point of reference, of the top 10 companies on the Fortune 100 list in 1980, only 5 are still in the top 10 today. The top company in the 2008 Fortune 100, Wal-Mart, did not even make the top 500 until 1995.
Not a single one of these companies had a strategic initiative in their business plan that said they would fail, I am sure of this fact. But then why do so many companies not continue to achieve success when they achieved success in the past. Because “it worked before it will work again” mentalities are pervasive in today’s boardrooms and in the minds of many privately held company owners.
I highlight three real world examples of this rudimentary concept to you.
Public Company faced with Technological Change
This publicly traded firm specialized in consumer products and had achieved great success. They became the second largest firm in the United States in their industry and were achieving incredible profit margins of over 20% even though their products were seen as highly competitive and commoditized. The management team had been together for a long period of time and they worked very well together. And then a change occurred, the internet became a reality. As they had relied so heavily on print advertising for so many years, the change in consumer buying habits caused by the internet hit them dramatically. Their marketing staff and its leadership did not understand the internet or its capability of marketing and communicating to its current customers or potential customers. They continued to pour money into newspaper print advertising even though the response rates were declining and numerous outlets for this advertising were going out of business. “Our customers will continue to buy this way” was an often heard response from the long time senior executive running the marketing department.
Over time, this company saw its sales stagnate and its margins begin to erode. Price increases were allowing it to hold steady but at what cost? The CEO maintained that the senior executive of marketing was the right one for the job and did not make a change to replace him with a more knowledgeable executive with internet sales and marketing experience. Ultimately, the institutional investors said enough was enough and sold the company to a private equity firm. Not long after the deal closed, the new owners saw the need to make changes and the marketing department was quickly overhauled.
Niche Private Company believing nothing can change
A unique offering to a highly segmented market allowed this owner the opportunity to expand his revenue and earnings without much effort. He had come upon a model that worked and found that by adding more telephonic salespeople to his work force, customer expansion occurred. This owner grew to enjoy a very comfortable lifestyle accentuated by high priced cars and expensive vacations. His product and service offering did not change and he found that the business would run virtually on auto pilot.
He was approached by several large corporations that had noticed his success in the marketplace and they determined that he would be an attractive acquisition target. After many meetings, several of these firms placed highly lucrative cash offers on the table. After getting the bidding to a premium level, he said that the offers needed to be 10% higher or he could not continue to have the cash flow that he currently enjoyed. This analysis was completely flawed as he would have made over 10 years + in cash flow, after tax, in a guaranteed lump sum payment. In turning down these offers, he said that he could continue to run his business and only work a few hours a week and would maintain his lifestyle.
Within months of turning down these lucrative offers, his business began to crumble under the pressures of the current economic environment. His customers no longer wished to spend the money to buy his service even though it was a proven service which increased their profits. His profits have been reduced by over 50% and the prospect for recovery to the levels of revenue previously seen is many years away. Most importantly, he must now change his lifestyle which is loaded with fixed costs and expenses that he believed would always be able to be paid because his business was doing so well.
Internet Technology competing with the Big Boys
The members of the board of directors of this profitable small business were asking themselves if they should take the profits made over the past two years and re-invest them into a new idea and attempt to double their money, or should they take their chips off the table, cash in, and go home. The management team was not working well together because the President would not deal with confrontation or conflict, the sales force was littered with employees not producing or being managed to produce, the business did not demonstrate a technologically scalable foundation and the opportunity to expand into a new niche market was just beginning to look promising.
One of the largest individual shareholders was faced with a dilemma. Her personal goals were driving her decisions, not the broader reality of what situation she was facing. Could this company and her investment really be worth double?
Her cajoling of the other board members with a persistent promise of making this new opportunity work succeeded. She was given the green light to double down and make the opportunity a reality.
One problem – she did not change anything and tried to build this future opportunity on the back of a business that was not capable of growing under its current management structure and operating plan. She did not believe that the large public companies that competed against them in this space would be able to be nimble enough to capture first mover’s advantage in this highly promising niche of the market. She could not imagine that she could not will this opportunity across the finish line.
Within months of this decision, her business was in big trouble. Her opportunity was going nowhere – sales were not happening and momentum was slipping through their fingers. How could this happen, “we had grown considerably so far and there was no reason that this new opportunity should not work” – and she was right. The management team tried to build everything on an operation that had passed its useful life and under the changing market conditions; their collective hopes never had a fighting chance.
Today, the company is losing money and has spent most of the cash that it had saved – millions of dollars. Layoffs have occurred, and the basic business model has only recently been changed to reflect the changing market realities.
Lessons Learned
1. Did we prove Newton wrong in our examples? Each company would not change its actions even though the market and economic forces were creating forces which called for drastic change. No, Mr. Newton’s First Law of Motion remains intact. Because our companies did not change did not mean that the forces upon them were not compelling, it was their inability to understand these forces that caused the unfortunate results that occurred to each of them.
Size in this example really does not matter. Many pundits would state that larger companies are more likely to fight change and thus be more susceptible to being passed by their competitors. This may be true but it does not need to be that way.
Samuel J. Palmisano (a graduate of Johns Hopkins University) is the current chairman, chief executive officer, and president of IBM, one of the world's largest information technology companies. Sam joined IBM in 1973 and rose through the ranks of this Fortune 100 computer company. Several years ago, under his leadership, Sam and his management team made a market changing decision. IBM would no longer be a computer manufacturer and seller; it would become an information technology consulting firm. With over 350,000 employees worldwide, IBM is now the largest information technology employer in the world. IBM holds more patents than any other U.S. based technology company. It has engineers and consultants in over 170 countries and IBM Research has eight laboratories worldwide. IBM employees have earned three Nobel Prizes, four Turing Awards, five National Medals of Technology, and five National Medals of Science. Capitalizing on the "International" part of the company's name, IBM's focus on overseas business helped boost 2007 revenue numbers. IBM generated 63% of its revenue ($98 Billion) from overseas sales last year, helping it overcome U.S. economic woes. I guess you really can turn an aircraft carrier around on a dime.
2. The planning concept known as Scenario Planning is a practical development of scenario forecasting used to guide strategy. This tool was brought to the market forefront in 1971 as the Royal Dutch Shell group of companies began using this planning process which had primarily been used for more limited academic studies. At its foundation, this process calls for the understanding of what variables you can and cannot control. Once you understand this basic tenet, your planning revolves around these variables. IBM could control what it sold and how those products were sold, they could decide which markets to sell into, and they choose to make changes and capitalize on both of these variables over the past several years.
With these thoughts in mind, begin to challenge your strategic thinking and how you might deal with the current economic situation and conditions. Believing that the past will certainly predict the future is not a planning tool that I will use with my clients any time soon and I recommend that you do the same.
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