Opinion

Felix Salmon

GoldieBlox, fair use, and the cult of disruption

Felix Salmon
Nov 26, 2013 05:29 UTC

If you google “disrupt the pink aisle”, you’ll get 36,800 results, all of which concern a San Francisco-based toy company named GoldieBlox. The company first came to public attention in September of last year, when it launched a highly-successful Kickstarter campaign which ultimately raised $285,881. Like all successful Kickstarter campaigns, there was a viral video; this one featured a highly-photogenic CEO called Debbie, a recent graduate of — you probably don’t need me to tell you this — Stanford University. And yes, before the Kickstarter campaign, there was “a seed round from friends, family and angel investors”. When the viral video kept on generating pre-orders even after the Kickstarter campaign ended, GoldieBlox looked like a classic Silicon Valley startup: young, exciting, fast-growing, and — of course — disruptive.

Not wanting to mess with a proven formula, GoldieBlox kept on producing those viral videos: “GoldieBlox Breaks into Toys R Us” was based on Queen’s “We Are The Champions”, and got over a million views. But that was nothing compared to their latest video, uploaded only a week ago, and already well on its way to getting ten times that figure. This one was based on an early Beastie Boys song, “Girls”, and deliciously subverted it to turn it into an empowering anthem.

Under what Paul Carr has diagnosed as the rules of the Cult of Disruption, GoldieBlox neither sought nor received permission to create these videos: it never licensed the music it used from the artists who wrote it. That wouldn’t be the Silicon Valley way. First you make your own rules — and then, if anybody tries to slap you down, you don’t apologize, you fight. For your right. To parody.

In a complete inversion of what you might expect to happen in this case, it is GoldieBlox which is suing the Beastie Boys. And they’re doing so in the most aggressive way possible. There’s no respect, here, for the merits of the song which has helped their video go massively viral and which is surely helping to sell a huge number of toys. Instead, there’s just sneering antagonism:

In the lyrics of the Beastie Boys’ song entitled Girls, girls are limited (at best) to household chores, and are presented as useful only to the extent they fulfill the wishes of the male subjects. The GoldieBlox Girls Parody Video takes direct aim at the song both visually and with a revised set of lyrics celebrating the many capabilities of girls. Set to the tune of Girls but with a new recording of the music and new lyrics, girls are heard singing an anthem celebrating their broad set of capabilities—exactly the opposite of the message of the original. They are also shown engaging in activities far beyond what the Beastie Boys song would permit.

This is faux-naïveté at its worst, deliberately ignoring the fact that Girls, the original song, is itself a parody of machismo rap. The complaint is also look-at-me move, positively daring the Beasties to rise to the bait and enjoin the fight. Which the Beasties, in turn, are trying very hard not to do. In their letter to GoldieBlox, the Beasties make three simple points. They support the creativity of the video, and its message; they’re the defendants in this suit, rather than the people suing anybody; and, most importantly, they have a long-standing policy that no Beastie Boys songs shall ever be used in commercial advertisements. (They don’t mention, although they could, that this last was actually an explicit dying wish of Adam Yauch, a/k/a MCA, and an integral part of his will.)

Given the speed with which the GoldieBlox complaint appeared, indeed, it’s reasonable to assume that they had it in their back pocket all along, ready to whip out the minute anybody from the Beastie Boys, or their record label, so much as inquired about what was going on. The strategy here is to maximize ill-will: don’t ask permission, make no attempt to negotiate in good faith, antagonize the other party as much as possible.

This way, at least, the battle lines get drawn pretty clearly. The jurisprudential analysis comes out, defending GoldieBlox and its right to use the Beasties’ song as parody. After all, fair use is a protection under the law, which means that if it applies, then it doesn’t matter what the Beasties think, or want: GoldieBlox can do anything it likes. On the other hand, in the key precedent for such issues, Campbell vs Acuff-Rose Music, Justice Souter explicitly said that “the use of a copyrighted work to advertise a product, even in a parody, will be entitled to less indulgence” under the law than “the sale of a parody for its own sake”.

This is a distinction the Beasties intuitively understand. After all, this version of Girls has been viewed more than 3 million times on YouTube, without so much as a peep from the Beasties. And if you simply lop off the last few seconds of the GoldieBlox version — the bit where they shoehorn in the GoldieBlox branding — then that, too, would surely have been fine. If all GoldieBlox wanted to do was get out a viral message about empowering girls, they could easily have done that without gratuitously antagonizing the Beastie Boys, or putting the Beasties in their current impossible situation.

Instead, however, GoldieBlox did exactly what you’d expect an entitled and well-lawyered Silicon Valley startup to do, which is pick a fight. It’s the way of the Valley — you can’t be winning unless some household-name dinosaur is losing. (The Beasties are actually the second big name to find themselves in the GoldieBlox crosshairs; the first was Toys R Us.) The real target of the GoldieBlox lawsuit, I’m quite sure, is not the Beastie Boys. Instead, it’s the set of investors who are currently being pitched to put money into a fast-growing, Stanford-incubated, web-native, viral, aggressive, disruptive company with massive room for future growth — a company which isn’t afraid to pick fights with any big name you care to mention.

Because in Silicon Valley, people will always prefer to invest in that kind of company, rather than in a toy company whose toys, in truth, aren’t actually very good.

Update: Turns out that GoldieBlox CEO Debbie Sterling was making deliberately-controversial viral videos long before she conceived of GoldieBlox. I’m not sure what to say about this, except that if you played any part in making it, you should never, ever get the benefit of the doubt.

Update 2: And here is Debbie’s blog from when she was in India, it has to be read to be believed. To think that this woman is trying to claim the moral high ground over Adam Yauch.

Update 3: GoldieBlox has now removed the video, saying that it does want to respect the Beasties’ wishes after all.

COMMENT

Gilson, above, makes a misrepresentation by only quoting the first sentence from one of the products on the GoldieBlox website: “In this much-anticipated sequel, Goldie’s friends Ruby and Katinka compete in a princess pageant with the hopes of riding in the town parade.”

Yeah that does sound hypocritical as Gilson suggests. Except when you read the next sentence and put it in context it makes a lot more sense: “When Katinka loses the crown, Ruby and Goldie build something great together, teaching their friends that creativity and friendship are more important than any pageant.”

So obviously Goldieblox is not promoting princess pageant culture but critiquing it.

As for the song issue, it’s kind of a tough one. As a musician who wouldn’t want works to be used in advertising, I think the creator correctly has certain rights over its use. And the Beastie Boys are cool guys, so why target them? There are loads of way more genuinely sexist male acts who could be parodied.

BUT, it’s also not a great song, by the band’s own admission, with embarrassing misogynistic lyrics. In that sense it deserves to be made fun of and turned upside down.

After careful consideration, I would have to side with the Boys. It may be a crap song, but it’s still their crap song and an advertisement is an advertisement is an advertisement.

What I really don’t get though is how people on this thread go from discussing this issue to vilifying “feminists”.

Get a grip! The issue of whether or not Goldieblox’s appropriation of “Girls” constitutes Fair Use, under the law, doesn’t actually have anything whatsoever to do with feminism!

Posted by Dianimal | Report as abusive

The definitive Twitter value play

Felix Salmon
Nov 7, 2013 07:29 UTC

Twitter is about to raise more than $2 billion, on a valuation of more than $18 billion, in its IPO. At some point on Thursday morning, an opening price for the stock will be set — a price which will almost certainly be north of the official IPO price of $26 per share — and after that, it’s off to the races. Will Twitter stock go up? Will it go down? Is it a buy? Is it a sell? Is the company worth what the market says it’s worth? It’s a pretty silly game to play, at heart, since no one has a clue what the answers are, not even Twitter’s underwriters, who had to raise the valuation of the company twice.

Still, silly games are often the most fun, so, go knock yourself out with the official Breakingviews Twitter valuation calculator! Or, you can use Lex’s version, which is a relatively pure discounted cash flow model, not dissimilar to the back-of-the-envelope calculations by which the Economist managed to come to a “reasonable” valuation of $18 per share. Anything north of that level, intones the venerable weekly, constitutes “a poor long-term investment”.

But the fact is that when it comes to valuing a technology stock, it’s stupidly easy to get any number you want. Here’s one extreme: the valuation of any company should be equal to the net present value of its future dividends. Twitter is going to pay no dividends for the foreseeable future, therefore, its value is zero. Or, here’s another extreme: Twitter should easily be able to generate $5 billion a year in revenue pretty soon, and grow to that level very quickly, which would justify a multiple of, I dunno, 12X revenues. Which would mean a capitalization of $60 billion, or about $110 per share.

The point is that any valuation for Twitter is a result of guess upon guess upon guess. Take Henry Blodget’s attempt, for instance. We know with reasonable certainty that Twitter is going to generate about $625 million in revenue this year, so why not treble that number, and declare that its revenues are going to grow to $2 billion in 2015. Then, multiply that number by 10, since that’s more or less where Facebook and LinkedIn are trading — and you get a valuation of $20 billion, or about $35 per share.

If you wanted to get a bit more sophisticated, you could try using probability distributions instead of hard numbers — but we have no more insight into the probability distribution for Twitter’s 2015 revenues than we do into a single forecast for those revenues. And there are certain valuation metrics, like “the amount of money Twitter might get bought for”, which are even more tenuous — yet clearly important.

So if anybody has any real conviction, one way or another, with regard to whether Twitter’s stock is overvalued or undervalued, you can be pretty sure that they don’t really know what they’re talking about. It’s going to be a trading vehicle for the first few days, with investors jockeying to get in or out at the best possible price. All of which is going to make the price-discovery process even more drawn-out and unreliable than it normally is. We are living, after all, in a world where a single bitcoin is worth more than $250, even though it has no cashflows at all.

So how is the individual investor supposed to navigate these treacherous waters? It’s actually incredibly easy. And it works like this. Twitter’s profits, if and when they ever appear, are going to be some fraction of its revenues. Its revenues, in turn, are going to be some fraction of the value it provides to its users. I have personally already extracted many thousands of dollars in value out of Twitter, over the past five years, and it hasn’t cost me a penny. On an ROI basis, I’m doing unbelievably well — and my returns are only going to keep on growing into the future.

Here’s my advice, then: take the amount of money you were thinking of investing in Twitter, and divide it by the rate at which you value your own time. So, if you were going to invest $5,000 and you value your time at $50 per hour, then you’d end up with a figure of 100 hours. Then, instead of spending the $5,000 on Twitter stock, spend 100 hours on Twitter: the cost is the same. The value you get from being on Twitter — from interacting with people you admire, from learning new things, from being able to express yourself so easily and concisely — will be much greater than the value you’d ever get from buying $5,000 of Twitter stock. And you’ll still have $5,000 left over to do whatever you want with, whether it’s putting it into some other investment or spending it on something awesome — a holiday, perhaps, or a gift to a friend, or even some fine wine.

Twitter is an amazing platform, where nearly all of the value ultimately accrues to the people who use it. If you don’t use it, you’re missing out. And maybe you think that it’s a silly distraction, and that you don’t have the time for such things. If you do think that way, then go ahead and buy yourself that time, with the money you were thinking of investing in Twitter stock. Leave the noise trading to others: you’ll be on to a much more certain thing.

COMMENT

From my experience every moment of interaction with Twitter is a net loss, so this investment heuristic doesn’t work very well for me.

I am going to buy (correction: just bought in the middle of composing this) some Twitter stock to hold for the long term. It seems like it’s more likely to go the way of Google/Amazon than disappear or be supplanted.

If the people to whom it’s best targeted–like our esteemed host–are extracting thousands of dollars of value, I expect that it will find a way to capture some of that.

Posted by TWAndrews | Report as abusive

Is Amazon bad for publishers?

Felix Salmon
Nov 3, 2013 17:58 UTC

Duff McDonald has a wonderful review of Brad Stone’s new book on Amazon in the NYT; he’s a fantastic nonfiction book reviewer. There is one part of the review, however, which could do with a bit more explanation:

Bezos does appear to revel in outwitting even his best partners. The publishing industry, for example, still doesn’t quite know how it willingly gave him the sword with which he would slice off its head…

Publishers were shocked when he sandbagged them with $9.99 e-book pricing in 2007. Where had they been?*

It’s something of an article of faith, in book-publishing circles, that Amazon has been a Bad Thing for the book publishing industry. And certainly it is an article of faith in this review. (Authors, by contrast seem to have gotten more upset at Google than at Amazon.)

What I can’t ever recall seeing, however, is a clear and concise encapsulation of the publishing industry’s beef with Amazon. How is Bezos supposed to have sliced off their head?

I come at this from what might be an overly naive position. Firstly, and most obviously, Amazon has made it vastly easier to buy and to read books. Anybody with a smartphone, anybody with an internet connection, can now order any book in print, and get it delivered straight to their door, in any moment of enthusiasm. If they’re even more impatient, or prefer e-books to physical books, they can even buy the book and start reading it in seconds. I can’t see how that can possibly be anything but great news for the publishing industry.

McDonald makes it seem — and I think he’s right about this — that the industry’s main problem with Amazon is the fact that it discounts aggressively, and sometimes sells books (both physical and electronic) for less than the amount that it’s charged by the publishers. In other words, it subsidizes book purchases, something any industry ought to embrace with open arms. And this industry thinks it some kind of mortal threat?

When e-books started being a real mass-market phenomenon, I do recall a reasonably recondite debate about consumer expectations. Amazon was selling those books at $9.99 apiece, which meant that it took a loss on every purchase, but which also meant that more people were buying them — and, of course, were buying the devices on which to read them. This might have been nefarious if Amazon were making money on selling kindles, but it wasn’t, it was selling those, too, at a loss. It just wanted to bring e-books to as many people as possible — and was willing to make a substantial investment to do so.

The nay-sayers argued that once the public was conditioned into expecting e-books to be priced at $9.99, they would never pay more than that. The publishers didn’t particularly want the first e-books to be sold at such a low price, but Amazon went ahead and implemented its loss-making policy anyway. Remember that Amazon’s ultimate goal was to sell the maximum number of e-books, and, eventually, make lots of money by doing so. So this was just a dispute about short-term tactics: over the long term, the interests of Amazon and the publishers were aligned. (And frankly, Amazon is likely to always get the benefit of the doubt when it comes to “which company has the better sales tactics” questions.)

So here’s my question: what’s the argument which says that Amazon has proved itself to be a mortal, existential threat to the publishing industry? It’s not like Amazon has disintermediated publishers, allowing readers to buy millions of books directly from authors. There’s a very small business along those lines, but I don’t think that’s what publishers are worried about.

The only argument I can think of is the one surrounding physical bookstores. The small, friendly, neighborhood bookstore lives on, romantically, in the minds of most authors, and indeed publishers as well. But customers didn’t love them as much as book types did: that’s why they ended up going to Barnes & Noble instead. And as a result, the number of booksellers declined significantly. Then, just as B&N stomped on the small booksellers, Amazon ended up stomping on B&N. Customers value convenience more than they do any real-world book-buying experience — and while B&N was more convenient than the small stores, Amazon was more convenient than B&N.

The result is that there are fewer real-world triggers which remind us about how wonderful books can be. In a world with lots of small bookshops, you pass such things regularly, and even if you don’t go in and buy something most of those times, at least you’re reminded of their existence, and you nearly always have a good feeling about the store and its ambience. Just about every book reader thinks that bookstores are wonderful, magical places — and, of course, that their contents are wonderful, magical things. As such, small booksellers were the best marketing devices that the publishing industry had. Not through anything they particularly did, so much as just by dint of their simple existence.

It’s a bit like the secret to the continued success of The Economist: it puts a lot of effort into its covers, and those covers are featured prominently on pretty much every newsstand in the world. Even if you’re a subscriber and never buy the magazine at a newsstand, seeing it so regularly in the real world is a great way of reminding you how much you like it. As a result, the next time you pick up your iPad, you’re more likely to read The Economist, and therefore more likely to renew your subscription, when that time comes around. If the number of newsstands in the world fell substantially, that would hurt The Economist much more than its newsstand sales alone might suggest.

Similarly, a world where you’d see a Barnes & Noble in every shopping mall, where you’d see these monster bookstores by the side of every urban highway, was a world which was constantly reminding you of how many books there are, and of how popular those books are. After all, those bookstores were kept in business by a steady stream of book lovers coming in to buy books. In their own way, B&N stores were just as good an advertisement for books in general as were the small booksellers they replaced.

So while there are just as many media-based book discussions as there always were — book reviews, book excerpts, talk shows, radio interviews, that kind of thing — the real-world reminders of the book industry as a whole have definitely shrunk. There are still lots of ways we can find out about individual books that we might want to read — and, thanks to Amazon, it has never been easier to order and read those books. But Amazon’s size and reach isn’t nearly as obvious as the networks of physical stores were — especially since Amazon sells so many different types of things, the sight of an empty Amazon box doesn’t make you think “books” any more. (Although, for historical reasons, the Amazon bookmark in my web browser still says “Amazon.com Books! Earth’s Biggest Bookstore.”)

Still, I don’t think it’s really fair for publishers to blame Amazon for the fact that people like to do their shopping online, and that easily-digitizable content is going to exist mainly in a virtual world rather than the real world. Indeed, there’s an argument that Amazon has saved the publishing industry from going the way of the record labels — that it’s made buying e-books so easy that the number of free pirated versions out there is still tiny. (Amazon has made it easier to find second-hand books, which publishers don’t directly benefit from, but at the same time it’s at the forefront of pushing e-books, which can’t be resold after you’ve bought them. Net-net, let’s call that one a wash.)

Publishers have always been conservative, and Amazon represents a massive change in their industry. What’s more, the move from small booksellers to B&N to Amazon has been a move where the booksellers have ever-increasing amounts of leverage over the publishers; it’s understandable that the publishers don’t like that. But I just can’t believe that Amazon is, or would ever want to be, an existential threat to the publishing industry.

*Update: The blockquote from McDonald’s review was originally longer, and included a section about Amazon matching the prices of “mysterious third-party sellers” in order to justify its price cuts. But McDonald emails to tell me that that section was not about publishers or booksellers, so I’ve taken it out.

COMMENT

handleym99, Amazon’s system of discovery works well for mainstream published books, which is a few thousand titles a year for most people (in their field of interest).

What happens when there are no mainstream publishers, and now there are a 100,000 to 1,000,000 titles to choose among, none of which have any reviews (I’m talking about discovering new authors – old authors will do just fine until book reading slowly becomes irrelevant).

Use advertising? Not correlated to quality. Use reviews? Ha. Think about the quality of reviews when a book by an unknown gets 0.01 reviews on average. You can be almost certain that any review you read is a sympathetic/paid for/faked review at those levels.

Imagine looking for SF novels published this month and getting 50,000 hits. Now, Amazon may well show you some top 50, quantified by how much they pay Amazon. But how many of them will be readable when willingness to promote doesn’t correlate with need to make money?

There’s simply nothing we have to filter the tsunami of the not-publishable-quality material that finds its way on to Amazon. Amazon’s current response is to essentially hide the self-published stuff by unknown authors most of the time, so you don’t get swamped (and on occasion when they don’t, Amazon is useless for finding anything useful, as I found to my sorrow).

We have no tools and no discovery mechanism for finding good books among millions instead of thousands that doesn’t involve a gatekeeper who only cares about promoting what customers will buy, and that’s not nearly a profitable enough industry for Amazon. Far more profitable to sell to the would-be writers.

I’m hoping my apocalypse scenario doesn’t come to pass in the next 10-20 years. But neither anything that Amazon is doing now, nor has incentive to do in future, is likely to prevent it.

Posted by TomWest | Report as abusive

Apple should be like Bloomberg

Felix Salmon
Oct 29, 2013 20:20 UTC

I’m very glad that the WSJ has published today’s debate between Farhad Manjoo and Dennis Berman on the subject of Apple. Manjoo has been writing some very insightful columns about the company, including the one yesterday which explained that Apple has many better options, when it comes to spending its cash, than taking Carl Icahn’s advice and essentially mortgaging the entire pile to conduct a stock buyback.

The Manjoo vs Berman debate displays two important phenomena surrounding nearly all public companies. Firstly, there’s the confusion between a company and a stock; and secondly, there’s the bigger problem with going public in the first place.

Upon going public, every company is doomed to be judged by its share price — and, all too often, it’s doomed for the share price to become more salient, in the public’s mind, than the company itself. Icahn, as a speculative shareholder, has only one interest in this game: he wants the share price to rise, so that he can then sell his shares at a profit. And Berman is, conceptually, on Icahn’s side. He talks about what investors want, and says that if Apple makes a lot of money, “there will be no choice but to give back significant sums to shareholders.” He also likes the idea of Apple racking up vastly more debt than it already has:

Right now, Apple has 30 cents of debt for every dollar it brings in yearly EBITDA. The median figure for the Standard & Poor’s 5000-stock index is $1.90 – or basically six times Apple’s current ratio, according to figures compiled using CapitalIQ. Were Apple to have a median amount, its current debt would move from $17 billion to $108 billion. Is that crazy? No.

In short, Apple’s business model exhibits the rarest traits seen in nature: relatively low capital demands and immense profit generation.

This would be funny, if it weren’t so depressing. Berman concedes that Apple is an extremely rare outlier in the corporate world: it makes a lot of money without having to invest a huge amount up front. Most companies which aren’t Apple, by contrast, have to borrow and invest a huge amount of money before they can start generating earnings. Berman’s bright idea, here, is that if Apple is fortunate enough not to have to go into massive debt to finance its investments, then, er, it should go into massive debt anyway, just because everybody else is doing it.

What good would that huge new debt pile actually serve? Well, it might help increase the share price — or it might not, who knows. (Icahn, for his part, is convinced that the share price will rise either way: he says in his letter to Apple that “the opportunity will not last forever”.) Obviously, it would also burden Apple with billions of dollars of fresh liabilities, in the form of new interest and principal payments. But Berman is unfazed: in his world, liabilities are assets, and assets are liabilities. Seriously: he says, on the liability front, that “the key to keeping Apple sharp will be actually to push more money than comfortable back to shareholders”. And on asset side of the balance sheet, he describes Apple’s cash hoard as “something of a liability”, on the grounds that it is “stranded and unproductive”. (Never mind that even under the Icahn plan, the cash hoard will remain untouched, and be just as stranded and unproductive in future as it is right now.)

This is the mindset of the financial engineer, and while it can make lots of money for corporate raiders, that doesn’t make it a good idea. Berman is a fan of Icahn: “the man doesn’t have stadiums named after himself for no reason,” he writes. Well, yes: the reason is that he spent lots of money to have his name put on those stadiums. He’s a wealthy individual. But Berman seems to think that anything which makes Carl Icahn rich must therefore be the right thing to do.

But here’s the thing: Tim Cook is a caretaker of a company which is designed to be around in perpetuity. Icahn, on the other hand, for all that he claims that “there is nothing short term” about his intentions, still has an exit strategy: he wants to buy low, drive the share price up through shareholder activism, and sell high. Apple should go along with Icahn’s plans only if they increase the long-term value of the company — and it’s pretty obvious that they don’t: Icahn is, at heart, advising Apple to have both large borrowings and a large cash pile at the same time. Which is bonkers.

Manjoo, on the other hand, definitely sees Apple as a company — a company navigating a highly fluid environment, and one where most of its profits come from a single product, the iPhone. Apple needs to stay one step ahead of what consumers want, says Manjoo, and it’s much easier to do that if you’re not saddled with interest payments. Even Manjoo, however, has internalized Silicon Valley’s fetish for endless growth, even when the company in question is already a giant. “What I’m arguing,” writes Manjoo, “is that Apple begin using its cash to act like a different kind of company — that it act like the big-thinking, future-proofing, market-share-buying behemoth it could be… the boldest thing Apple could do with its cash is transform itself into a different kind of company.”

Manjoo’s “different kind of company” is a lower-margin company: one where Apple decides to “give away a lot more free stuff”, and buys market share, or even buys a cellular carrier. This is much less stupid than Berman’s idea. The single most exciting thing about my new iPhone 5s has nothing to do with Apple: instead, it’s T-Mobile’s free international data.

But even Manjoo is working on the assumption that all companies must always want to grow at all times — even if that means becoming “a different kind of company” altogether. Hidden just beneath Manjoo’s writing is a pretty Berman-esque assumption: that the share price should go up rather than down, and that Apple should do everything it can to ensure that outcome. When Manjoo exhorts Apple to “act before trouble hits”, the trouble he has in mind is basically anything which causes the stock price to fall significantly lower than it is already.

So let me put forward an even more radical idea: Apple should just keep on doing exactly what it’s doing. For substantially all of its history, Apple has been a luxury retailer, making beautiful, functional, high-end goods. Its retail stores are in the most expensive neighborhoods, and it never discounts — much like Louis Vuitton. Its products are status symbols. And they can cost eyebrow-raising sums of money: the new Mac Pro, for instance, starts at $3,000 — and that doesn’t even include a screen.

In general, companies are good at doing what they do well, and they’re not good at doing what they don’t do well. That’s one big reason why mergers, and pivots, generally fail. Apple is fantastic at product design, and at maintaining extraordinarily high quality standards on everything it produces. At some points in time, its products touch the public nerve more than they do at other points. No one expects the iPhone’s dominance to last forever: that’s why Apple is trading at about 13 times earnings, while Google’s multiple is more than twice as high. (Don’t even get me started on Amazon.)

Debt makes sense when you need money to invest today, and can repay that money with a substantial future income stream. Apple is in the exact opposite situation: it needs no money to invest today, while its long-term future income stream is quite uncertain. So it makes sense to save up in flush years, like it has been doing. It will continue to create amazing new products; what’s less clear is whether any of those new products will have the ability to become a world-conquering profit monster like the iPhone. The job of the markets is simply to price the shares accordingly; it’s not the job of management to change the deep structure of the company just to make the markets happy.

Steve Jobs always regretted going public. He raised very little money by doing so, and in return he ended up with people like Carl Icahn constantly second-guessing his decisions. Jobs was good at ignoring such gadflies; his successor, Tim Cook, is a little more shareholder-friendly. But shareholders really do nothing for Apple, which hasn’t had a public stock offering in living memory, and which has so much money now that it can pay its employees large amounts of cash to retain talent, instead of having to force them to gamble with restricted stock units.

In other words, Apple should be run a bit like Bloomberg: as a profitable company which pays well, which concentrates first and foremost on making its product as great as possible, and which doesn’t try to be something it’s not, or allow itself to be distracted with financial engineering. Sometimes its stock will go up, and sometimes its stock will go down. But the company, and its core values, will endure.

COMMENT

In a slight defense of the new Mac Pro, while its price does represent some level of Apple premium, nobody is selling Xeon-class workstations with dual GPUs for real cheap, either.

But as a long-time Apple customer (going back to an Apple II+ in 1979), I’ve been pretty disappointed in the iOSsification of the Mac that’s been happening over the past few years, and having been moving a lot of my work to Linux.

Posted by Moopheus | Report as abusive

When information systems fail

Felix Salmon
Oct 24, 2013 19:37 UTC

I’m reading Megan McArdle’s new book in galleys right now; its title is “The Up Side of Down: Why Failing Well Is the Key to Success”. Given the subject matter, McArdle spends just as much time discussing bad failures as she does discussing good ones — not the things which turned out in the end to be “the best thing that ever happened to me”, but rather the truly catastrophic things which result in wholesale destruction of wealth, health, or people’s lives.

Given the way in which the world is becoming increasingly dominated by complex technological systems, a lot of these failures are going to be technological in nature. Recent publicity, of course, has focused on healthcare.gov — a highly complex website devoted to solving the enormous problem of how millions of Americans will be able to access affordable medical care. And the general tone of the criticism, which is coming from all sides, is that if only the government had ______, then all of these problems, or at least most of them, could have been avoided.

That kind of criticism is always easy in hindsight, which doesn’t make it wrong. Virtually all problems are foreseen by someone, or should have been. But in no organization are all foreseen problems addressed promptly and directly. If they were, then nothing would ever happen. Which means that the real problem is often understood to be a managerial one: the lines of communication weren’t clear enough, the managers didn’t have their priorities right, how on earth could they have been so stupid as to _______.

David Wilson has found a wonderful example in the SEC’s censure of Knight Capital. Knight blew up as a result of badly-designed computer systems, and the cascade of mistakes in this case was particularly egregious: it kept important deprecated code on its active servers, it didn’t double-check to ensure that new code was installed correctly, it had no real procedures to ensure that mistakes like this couldn’t happen, it had no ability to work out why something called the 33 Account was filling up with billions of dollars in random stocks, despite the fact that the account in question had a $2 million gross position limit, it seemingly had no controls in place to stop its computers from doing massive naked shorting in the market, and so on and so forth.

In the end, over the course of a 45-minute period, Knight bought $3.5 billion of 80 stocks, sold $3.15 billion of another 74 stocks, and ended up losing a total of $460 million. Markets were definitely disrupted:

As to 37 of those stocks, the price moved by greater than ten percent, and Knight’s executions constituted more than 50 percent of the trading volume. These share price movements affected other market participants, with some participants receiving less favorable prices than they would have in the absence of these executions and others receiving more favorable prices.

Given the size of Knight’s losses, the only silver lining here is that Knight itself was the main actor receiving less favorable prices, while the rest of the market, in aggregate, ended up making more money that day than it otherwise would have done. But the SEC is right to fine Knight all the same, just as it was right to fine JP Morgan for its London Whale losses: legitimate trading losses are fine, but major risk-management failures are not allowed, and need to be punished by more than just trading losses.

Or, for a smaller-scale example, look at Dan Tynan’s misadventures with Box. Again, there was a series of management and permissioning failures, which ultimately resulted in Tynan’s entire account being vaporized, along with all its content. As he explains:

- Box handed control over my account to someone who was a complete stranger to me;

- They did it because of a one-time association with someone else, who happened to have access to some of my folders;

- They failed to notify me or any of my other collaborators that they were giving control of my account to someone else;

- They failed to confirm deletion of the account with the person who created it (i.e., me); and

- Box.com support was helpless to do anything about it or give me any information. Had I not pulled the journalist card, I’d still be scratching my head over what had happened.

That’s a lot of mistakes; nearly as many as can be seen in the Knight Capital case. But when you see a list this long, the first thing you should think about is Swiss cheese. Specifically, you should think about the Swiss cheese model of failure prevention, as posited by James Reason, of the University of Manchester:

In the Swiss Cheese model, an organization’s defenses against failure are modeled as a series of barriers, represented as slices of cheese. The holes in the slices represent weaknesses in individual parts of the system and are continually varying in size and position across the slices. The system produces failures when a hole in each slice momentarily aligns, permitting (in Reason’s words) “a trajectory of accident opportunity”, so that a hazard passes through holes in all of the slices, leading to a failure.

In other words, we should maybe be a little bit reassured that so many things needed to go wrong in order to produce a fail. The Swiss cheese model isn’t foolproof: sometimes those holes will indeed align. But a long list of failures like this is evidence of a reasonably thick stack of cheese slices. And in general, the thicker the stack, the less likely failure is going to be.

That said, there’s an important countervailing force, which mitigates in favor of more frequent failure, and which is getting steadily larger and scarier — and that’s the sheer complexity of all kinds of information systems. I mentioned this when Knight blew up, quoting Dave Cliff and Linda Northrop:

The concerns expressed here about modern computer-based trading in the global financial markets are really just a detailed instance of a more general story: it seems likely, or at least plausible, that major advanced economies are becoming increasingly reliant on large-scale complex IT systems (LSCITS): the complexity of these LSCITS is increasing rapidly; their socio-economic criticality is also increasing rapidly; our ability to manage them, and to predict their failures before it is too late, may not be keeping up. That is, we may be becoming critically dependent on LSCITS that we simply do not understand and hence are simply not capable of managing.

Under this view, it’s important to try to prevent failures by adding extra layers of Swiss cheese, and by assiduously trying to minimize the size of the holes in any given layer. But as IT systems grow in size and complexity, they will fail in increasingly unpredictable and catastrophic ways. No amount of post-mortem analysis, from Congress or the SEC or anybody else, will have any real ability to stop those catastrophic failures from happening. What’s more, it’s futile to expect that we can somehow design these systems to “fail well” and thereby lessen the chances of even worse failures in the future.

COMMENT

Please don’t refer to Reason’s swiss cheese model, it’s inadequate for explanation and prevention of these sorts of events, and has unfortunately been through a confusing history in the domains in which Reason originally spoke about (aviation, patient safety, power plants, etc.)

As to how indignant we can feel about Knight Capital’s shortcomings, we cannot take the SEC report as a postmortem document or accident investigation. I’ve written a good amount about that here:

http://www.kitchensoap.com/2013/10/29/co unterfactuals-knight-capital/

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The evolution of Lending Club

Felix Salmon
Sep 30, 2013 13:37 UTC

I have a piece in this week’s NY Mag about Lending Club, part of a series of profiles of what the magazine calls “boom brands“. I’ve been a fan of the Lending Club model since April 2009, and have watched its steady, disciplined growth with admiration since then. As I explain in my article, the company has changed over the years: at this point, it’s much more about the Lending than it is about the Club, and the peer-to-peer nature of the site is much less important than it was at the beginning.

But Renaud Laplanche, Lending Club’s founder, tells me that there are interesting developments ahead on that front, too: he has started talking to companies in Silicon Valley about the idea of providing low-cost loans to employees. As in, very low cost: you could borrow at a rate of as little as 3% from your employer, which in turn would still be making a higher return on its money than anything easily available to its Treasury operation. And because you’re an employee, you’re much more likely to be accepted into the program than a random applicant to Lending Club — and you’re also much less likely to default on your loan.

This kind of program wouldn’t make sense for, say, McDonald’s — but it does make sense for places like Apple or Intel. Again, it’s not an expansion of credit to places where it was formerly unavailable, but it is a way of disintermediating banks and strengthening bonds — in this case, between employer and employee.

And Laplanche thinks that there are areas where he might even be able to expand the size of the borrower pool — specifically, small businesses, which always have a devil of a time borrowing money, and which banks find very difficult to lend to. Lending Club will probably use its own money to start lending in a small way to small businesses in the first instance, rather than putting any peer money at risk. This is a whole new underwriting nut to crack, and there are too many things which could go wrong at the start. But if it works, then Lending Club could really become an engine of economic growth.

Lending Club will go public next year in what will surely be one of the easiest IPOs in memory. The company’s financials and quarterly reports have been publicly available for years, in fully SEC-approved form. In fact, thanks to something called blue sky laws, going public will actually reduce Lending Club’s regulatory burden, by putting the whole company under the aegis of federal regulators. No longer will it need to laboriously work with regulators in 50 different states. But there will be a short burst of publicity, much of which will concentrate on the company’s growth rate.

And the thing to note here is that although Lending Club is by far the world’s biggest peer-to-peer lender, it isn’t following the standard Silicon Valley model of growing as fast as possible. Loan quality changes over time, and it doesn’t want too much of its investors’ money to be tied up in a single cohort of borrowers, as would be the case if it expanded at a too-rapid clip.

Once Lending Club started being able to attract Wall Street money, a lot of things changed, including the fact that all accepted borrowers started getting funded, sometimes within minutes and always within a couple of days. In that sense, the growth constraint at Lending Club is the number of borrowers it accepts, rather than the amount of money available to be lent. But the pool of possible borrowers is still much larger than the one from which Lending Club is currently fishing — it doesn’t even need to expand its product line to be able to grow, at current rates of growth, for many years to come. There are lots of Americans out there who want to borrow money, or refinance. And over time, we’ll surely see a substantial proportion of the best credits among them moving online for their funding needs.

COMMENT

P2P lending has changed drastically over the last 3-4 years mainly due to the deployment of institutional capital. As a result, the bottleneck has become borrowers rather than lenders as Felix aptly notes.

P2P lending has also paved the way for accredited investor crowdfunding. Platforms like RealtyShares (www.realtyshares.com) and Circleup (www.circleup.com) are creating ways for investors to invest as little as $5,000 into real estate and small businesses and earn yields similar to what they earning with platforms like lending club and prosper.

Exciting times for the fintech space and I commend LendingClub and Prosper for being pioneers.

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Chart of the day, Microsoft edition

Felix Salmon
Sep 3, 2013 15:34 UTC

Many thanks to Ben Walsh for pulling together the data for this chart. The numbers speak for themselves, really: over the course of Steve Ballmer’s tenure as Microsoft CEO, the company’s stock price has gone nowhere, its market share has plunged — but its headcount has more than trebled. And that’s before adding another 32,000 employees as part of the Nokia acquisition.

Ben Thompson has a very smart analysis of Microsoft’s move here:

Guy English has already characterized Ballmer’s disastrous reorganization as a straitjacket for the next CEO; adding on a mobile phone business that Microsoft probably should abandon is like attaching an anchor to said straitjacket and tossing the patient into the ocean. It will be that much more difficult for the next CEO to look at Windows Phone rationally.

As Henry Blodget notes, Windows Phone is now going to account for a good quarter of Microsoft’s employees; integrating those two huge and very different cultures is going to take an enormous amount of effort, with no guarantee of success. And as Thompson notes, this acquisition essentially forces Microsoft to double down on its strategy (which has signally failed to date) of competing head-to-head with Android and iOS.

There is really zero consumer demand for an alternative smartphone OS: even the ultrageeks fell well short of raising the $32 million they needed to develop a version of Ubuntu for phones. Microsoft is pretty good at giving big organizations what they want — Windows and Office, the two great powerhouses which have between them accounted for all of Microsoft’s profits over the years. And somewhere, deep inside its institutional memory, it knows that once upon a time it came late to the browser game, entered with a big splash, and ended up demolishing Netscape.

The problem is that this second-mover strategy doesn’t work against Google and Apple. It doesn’t work in search, it doesn’t work in tablets, it doesn’t work in phones. (It has arguably worked in gaming systems, which is something of a Pyrrhic victory, given the way in which games are going mobile.) Nokia is a failing company — if Microsoft hadn’t swept in to save it, it would probably have gone bust pretty quickly — and one of the reasons that it’s failing is that no one wants to buy a Windows phone. And that’s especially true in the fastest-growing market of all.

Nokia’s fall has been most spectacular in Asia, a region that its phones once dominated. As recently as 2010, the company had a 64 percent share of the smartphone market in China, according to Canalys, a research firm. By the first half of this year, that had plunged to 1 percent.

With this acquisition, Nokia chief Stephen Elop becomes heir apparent to Ballmer. Elop knows how to navigate Microsoft’s poisonous bureaucracy, having worked there for many years, but he also counts as an outsider, able to bring in fresh ideas. He also — obviously — knows mobile, which is the single factor determining Microsoft’s future: if the company can navigate the move from the desktop to mobile, it will succeed; if it can’t, it will fail.

But the chart foretells how this game is going to play out: Microsoft is now simply too big to turn around. Elop saved Nokia in much the same way as John Thain saved Merrill Lynch, by selling a fundamentally worthless company to a much larger strategic buyer for billions of dollars. That strategy isn’t going to work for Microsoft. Probably, there is no strategy which would work out for Microsoft. The company’s heyday is far in the past, now; all that the new CEO can hope for is to maximize profits as it slowly, inexorably, declines.

COMMENT

“over the course of Steve Ballmer’s tenure as Microsoft CEO… its market share has plunged.” Oh yes, its market share for operating systems worldwide is now down to a dismal 91% for Windows. Pathetic. For Office type products, it’s even higher. MSFT will have about $2 billion in cash flow this month, just like it does every month. Mr. Ballmer has been an unqualified disaster.

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Is Marissa Mayer the right CEO for Yahoo?

Felix Salmon
Aug 26, 2013 21:28 UTC

Nicholas Carlson, Joe Weisenthal, and Henry Blodget deserve many congratulations on Carlson’s monster 22,500-word profile of Marissa Mayer. It features the kind of deep reporting one normally only finds in books, and it sheds a lot of light on what is going on at Yahoo — both at the senior executive level and at board level. What’s more, Carlson was fortunate enough to get just the right amount of access to Mayer — enough to be able to fill in the necessary details, get lovely bits of color, and ask her the questions he needed to ask, but not so much that he became captured. (In general, with very few exceptions, the more time that a journalist spends with his subject, the more favorable the resulting profile will be.)

After reading Carlson’s piece, it’s clear that Mayer has genuinely changed Yahoo for the better, over the course of the year that she’s been running it. What’s not clear, yet, is whether Yahoo’s board made the right choice in picking Mayer over the alternative choice, Ross Levinsohn. Especially since the choice of Mayer was pushed through by two men — Dan Loeb and Michael Wolf — who aren’t even on the board any more.

When Loeb first took his large stake in Yahoo and pushed for a shake-up, his plan was clear. Yahoo was massively undervalued on any kind of sum-of-the-parts analysis, thanks to its large stakes in Alibaba and Yahoo Japan. As a result, if a new CEO were to come in and shake things up radically, the chances of value being destroyed were relatively low, while the amount of potential upside was enormous. So Loeb was itching to roll the dice.

What’s fascinating about Carlson’s account is the way in which Loeb, along with Wolf, his handpicked lieutenant, managed to override Yahoo’s chairman, Fred Amoroso, who favored Levinsohn over Mayer. Loeb’s 5% stake in the company was significant, but far from controlling — yet somehow, in practice, Loeb managed to get exactly what he wanted, even when he disagreed with the chairman of the board.

The choice of Mayer is particularly interesting in light of the fact that Levinsohn’s plan was in many ways more disruptive than Mayer’s. Yahoo has always struggled with the question of whether it is a media company or a technology company, and Levinsohn wanted to settle that question once and for all: he would sell Yahoo’s search business to Microsoft, while receiving MSN.com and lots of money in return, and move to using Google’s superior search product instead. And he could increase Yahoo’s Ebitda by 50%, even while he shrank Yahoo to a mere 4,000 employees — down from well over 15,000 as a technology company. At the end of the process, Yahoo would be a large, lean media machine, with more than 700 million unique visitors every month. Yahoo could sell those readers to advertisers, and make a fortune.

Given the inherent difficulty of competing over the long term not only with behemoths like Google and Apple but also with countless startups all wanting to eat your lunch, Levinsohn’s strategy made a lot of sense. You could get a lot of buzz by hiring a young, photogenic technology icon, who could then go on a massive shopping spree with shareholders’ money; that might well cause investors to boost your p/e multiples over the short term. But that basically would just turn Yahoo stock into a timing game, with the trick being to get out just as the honeymoon period is ending, and before shareholders start demanding financial returns on their M&A investments.

Loeb is a hedge fund manager: his job is to be good at timing games, buying low and selling high. And that’s exactly what he did at Yahoo. He sold his shareholding, and gave up his board seats, after the stock went up. But the job of the board, and of the board chairman, and of the CEO, is not to enrich and enable here-today-gone-tomorrow speculators. Rather, it’s to create permanent value. And it’s far too early to tell whether Mayer is capable of doing that.

Indeed, it’s still too early to tell what Mayer’s strategy really is. Levinsohn had a strategy — one which was clearly thought-out, and which would produce a focused, profitable company. Mayer, on the other hand, had, well, an excellent grasp of detail. Carlson has nailed down the timing: Yahoo’s board met with Mayer on July 11, 2012, and she gave an impressive presentation.

She described her long familiarity with Yahoo and its products. She described how Yahoo products would evolve over time under her watch. Her presentation included an extraordinary amount of detail on Yahoo’s search business, audience analytics, and data. She talked about fixing Yahoo’s culture with more transparency, perks, and accountability. She named her perceived weaknesses, and explained how she planned to address them — including by hiring people who had the skills she didn’t have.

That evening, the board decided to hire Mayer. The following morning, the board went through the motions of listening to a similar presentation from Levinsohn, along with his key lieutenants. But they’d made up their mind. Wolf started questioning Levinsohn aggressively, while Loeb spent a lot of the presentation playing with his BlackBerry (!) — and even disappeared off to the bathroom for a particularly important part of Levinsohn’s presentation.

Mayer did what she said she would do. She went on an aqui-hiring spree, buying more than 20 startups in her first year, culminating in the billion-dollar acquisition of Tumblr. She brought passion and buzz back to what had been a very demoralized company. And she sweated the small stuff: she would approve or reject, for instance, every single call or email that the PR team wanted to make to a reporter. She also dived head-first into a huge redesign of Yahoo Mail, taking personal responsibility to ship an awesome product in record-quick time.

On the surface, the results were fantastic. Yahoo’s new products, whether internal (Yahoo Mail, Flickr) or bought in (Tumblr) are best in class. Talented engineers actually want to work for the company again. And the stock price speaks for itself.

Screen Shot 2013-08-26 at 4.36.09 PM.png

But here’s the thing: it’s still far from clear what Mayer’s long-term strategy might be, or whether there even is one. Carlson does an excellent job of demonstrating how little she cared about anything on the business side of Google, and also of how distant she is when it comes to managing her direct reports at Yahoo — the people in charge of actually bringing in all the revenues. Mayer is more product manager than CEO, which maybe explains why she got on so well with David Karp — another person whose expertise is very much in the realm of product design rather than business-side nitty-gritty. When your company is your product, then the product manager as CEO can work very well. (See: Zuckerberg, Mark.) But Yahoo is not a product; it’s not even really a suite of products. To use the 90s terminology, it’s a portal — it’s a place where traffic can be aggregated and then monetized.

Yahoo’s doing very well on the traffic front, coming in top of the most recent Comscore rankings. But revenue is falling, and product design is only one of very many skills that Yahoo’s CEO needs. It’s also not even clear that Mayer is very good at that: although the new Yahoo Mail turned out lovely in the end, Carlson also recounts how Shashi Seth, the Mail team leader, along with his lead designer and his product manager, all departed shortly after their new Yahoo Mail shipped. Like Dan Loeb, perhaps, they decided it might be best to quit while they were ahead, rather than stay hitched to Mayer’s star. And these are the people in Yahoo who know Mayer best.

Mayer was extremely good at the job she held at Google until 2010 — essentially doing everything in her power to make the user experience as great as possible. Yahoo’s current users, too, have every reason to be happy that she has the CEO job — their experience is almost certainly better, as a result, than it would have been under Levinsohn. And for the time being, Yahoo’s employees and its shareholders are all happy as well. But I can’t help but feel that the CEO of a public $30 billion company, especially one which makes nearly all of its money by selling ad space to media buyers, needs certain management skills, and a passion for improving the company’s bottom line. Otherwise, Yahoo is likely to join the long list of companies where the people who sold their stock into the aggressive corporate stock buyback program ended up much better off than the loyal shareholders who didn’t.

COMMENT

Marissa Mayer, the Stanford genius, began her career at Google and thirteen years later, Google’s Geek Goddess switched loyalties. Wooed by Yahoo in 2012, Mayer became the youngest female CEO of her time There’s one thing about Marissa Mayer that everyone agrees to: she is among the smartest people you could meet. Mayer went to STANFORD UNIVERSITY only after scrutinizing the PROS AND CONS of 10 colleges that she had been accepted at. http://www.bidnessetc.com/business/maris sa-mayer-one-of-silicon-valleys-most-pow erful-women/

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The incredible shrinking company

Felix Salmon
Aug 22, 2013 17:26 UTC

Christopher Mims has a good piece on Meg Whitman’s Hewlett-Packard today, pointing out that the company’s success (at least as measured by its stock price) over the past year or so is in large part due to her cost-cutting abilities.

Mims doesn’t mention that this strategy is hardly new for HP: it was executed with just as much success under Mark Hurd. The really big errors at HP have taken place at the board level, both in terms of hiring and firing CEOs and in terms of approving ridiculous over-ambitious acquisitions. When it puts its mind to it, HP turns out to be pretty good at shrinking. It’s growth which turns out to be where the pitfalls lie.

Which is why I’d take issue with Mims here:

A more efficient, better-managed HP doesn’t mean much in the long run if the company cannot move beyond the stagnating businesses that make half of its current revenue—PCs and printers…

Without any innovative consumer products to speak of, HP is essentially at the mercy of big businesses’ appetite for technology. And they seem to be wanting less and less of whatever HP is selling…

While she’s managing HP’s consolidation and retreat admirably, is she the CEO who can get the company to once again break the mold? Given her background as head of eBay, a company that changed little under her decade-long rule, we have to be dubious.

I can understand where Mims is coming from. HP is a technology company, and under the unspoken rules of the US stock market, all public companies, and especially all technology companies, should constantly be growing as fast as possible. It’s the inexorable mathematics of discounting: if a company can deliver consistent growth which is faster than the prevailing discount rate used to calculate net present value, then its stock price should, by rights, be infinite. Consequently, given that infinite upside, it’s worth risking quite a lot to achieve growth.

But the facts are pretty plain: (a) HP is very good at producing excellent products in the shrinking markets which make up most of its business right now; (b) HP has in recent years shown no particular ability to produce excellent products in other markets; (c) Meg Whitman is not by nature a visionary innovator. Given those facts, it makes perfect sense for HP to run its existing businesses as efficiently and as profitably as it can, and to extract as much value out of them as possible, in the knowledge that all companies are mortal. In fact, it makes more sense to do that than it does to follow the Tim Armstrong playbook, where AOL’s CEO decided to take his enviable dial-up revenue stream and invest it in doomed content plays like Patch.

John Kay had an excellent column on this subject yesterday, under the headline “sometimes the best that a company can hope for is death”. He finds the genesis for the Mims view in the work of marketing guru Theodore Levitt, who said 50 years ago that companies can and should reinvent themselves in imaginative ways. Levitt was wrong, says Kay: what really matters is not imaginative executives, but rather competitive advantage. HP has a competitive advantage making PCs and printers and servers; that doesn’t mean that it can readily apply that competitive advantage elsewhere.

Kay’s example of JC Penney is a good one. Bill Ackman looked at Penney and saw it as a company in the “retail” bucket, just as Mims looks at HP and sees a company in the “technology” bucket. Ackman then looked for the biggest retail success story he could find — Apple — and tried to inject Apple-style success into JC Penney by hiring Apple’s Ron Johnson as Penney’s CEO. That didn’t work:

The outlets of both JC Penney and Apple are shops but the age group and disposable incomes of their customers – and their reasons for visiting the stores – were entirely different: JC Penney and Apple were not really in the same business.

Penney was not going to succeed by looking at successes elsewhere in the retail space and trying to copy them with little regard for its own existing strengths. And similarly, if HP decides to “break the mold” again, the inevitable consequence will be yet further billions in avoidable write-downs. Once upon a time, HP had a legendary R&D operation — but that operation fell victim to Hurd’s cost-cutting, and in any case no R&D shop can maintain excellence forever. The HP board knows that, which is why they were open to ambitious acquisitions; they simply failed to notice that the acquisitions in question were fundamentally really bad deals.

In general, the stock market’s bias towards growth makes it very difficult for a public-company CEO to execute a strategy of shrinking profitably. Maybe at some point, as a result, Whitman will decide to take HP private, or will accept a takeover offer from a private-equity shop. But for the time being, an ambitious growth strategy is the last thing that HP needs.

It’s not easy to excel in a shrinking business: as Kay says, it goes against human nature to accept that there might be a natural life cycle for a company. But if you work with the cycle, rather than against it, it’s still possible to get extremely impressive results. Just look, for example, at Lehman Brothers International Europe — the bankrupt entity which has been spending the past five years quietly trying to repay its creditors as much money as it can. The latest news? Those creditors are going to be repaid 100 cents on the dollar — including statutory interest at 8%. As a result, some Lehman claims are trading at as much as 120 cents on the dollar.

The best thing for Whitman to do, then, is to accept that HP’s core business is in decline, but to still execute that core business as efficiently as possible. That takes a very different style of management than Silicon Valley is used to, but it can be done. And it’s much more likely to work than some Hail Mary acquisition attempt.

COMMENT

What percentage of total Lehman Bros. was LB International Europe? It looked like their liabilities were $8B which would be in the single-digit percentage of the full Lehman Brothers company.

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