Friday, May 30, 2008

Blackberries and the Information Sharing Problem

At first glance, you might think that a Blackberry is a powerful tool for sharing information. After all, it enables people to stay in constant communication with others if necessary. It provides rapid access to data, regardless of where you are located. However, I have come to believe that Blackberries impede information sharing in one very important way.

Let's step back and consider the research on information sharing in teams. We know from academic research (by Gerald Stasser) that groups do not share information effectively when members possess private information. When members of a group have different pieces of information, Stasser observed an interesting phenomenon: people tend to discuss the information that they all posses in common, and they do not always share or emphasize the information privately held by each group member. The lack of proper information sharing and integration inhibits group problem-solving effectiveness.

Now consider what you surely have observed at many management meetings over the past few years. Someone is presenting at the front of the room, while others around the table listen and ask questions. However, people frequently duck their hands under the table to read an email on their Blackberry or to type out a quick reply. Sometimes, people duck out to take "important" phone calls. It's hard to imagine that effective listening takes place in such environments.

Given this behavior, consider this fact: Stasser's research shows a lack of information sharing in groups, even when everyone appears to be paying close attention! Imagine how much worse the information sharing problem has become given the distraction of Blackberries.

Thursday, May 29, 2008

China's Cheap Gasoline

Donald Straszheim has a fascinating article about oil prices in China on the Forbes website. Here is what he reports:

Consider the following: Since January 2007, global crude oil prices have risen by 109%; gasoline prices in the U.S. have risen by 77% (roughly apace); gasoline prices in China have risen only 9%.

Gasoline in the U.S. now sells for around $4 per gallon, but it sells for $2.49 per gallon in China. Beijing last raised domestic gasoline prices in November 2007, by 9%, and that was the first and only hike since January 2007, when crude was $87 per barrel.

Given this information, we clearly can see that artificial price controls have driven the voracious demand for oil within China. Is it sustainable though? Straszheim estimates that the Chinese government is providing $40 billion per year in subsidies to maintain cheap gasoline throughout the nation. The Chinese government is in a bit of a quandary though. Inflation has hit 8% in China, and if the government lifts the price controls on gasoline, it will rise substantially - moving well into double digits perhaps. How will the Chinese economic growth engine be affected if inflation gets uncomfortably higher? Meanwhile, we have to remember that China is the second biggest consumer of oil in the world. If prices rise substantially, how much will that curtail demand in that nation? A correction in the Chinese domestic market could stem the rapid increase in the global price of oil that we have been experiencing.

Wednesday, May 28, 2008

GE Appliances

There has been a great deal of talk recently about GE selling its appliances division. Some observers seem to think that selling off this "low margin, low growth" business will help boost the company's stock price, which has languished for some time, and which took a hit when the firm missed its earnings target last quarter. However, I think that there are three big questions that must be answered before making a judgment on a potential appliance division sale. First, can we really expect the stock to make a substantial leap when the appliance division only accounts for $7 billion of the firm's $173 billion in annual revenue? Talk about a drop in the bucket. I do not think the sale of appliances is a panacea for the stock price. Second, how will GE deal with the brand name? A potential buyer clearly would want the GE brand name, which has such significance with the consumer. Allowing a buyer to license the brand name is risky. Third, and most importantly, what precisely are GE's criteria moving forward for what should and should not be part of the company's portfolio? Until GE answers that question clearly and concisely, I do not think investors will be completely pleased. It's not enough to say that the firm wants to be in higher growth, higher margin businesses, as some observers suggest that GE should be. That's not very limiting. Does any high growth, high margin business on earth fit at GE? Moreover, what about some of the other businesses within the portfolio, such as NBC? Broadcast networks clearly are not a high growth, promising business these days. Why does it stay and appliances have to leave? Clear answers to these questions must be provided for investors to feel comfortable with the GE strategy moving forward.

Tuesday, May 27, 2008

Anheuser Busch and Sam Adams

While Anheuser Busch worries about fending off a potential hostile takeover bid from InBev, leading craft brewer Sam Adams adopts an interesting strategy of actually helping the competition. What an interesting contrast... First, at Sam Adams, founder and CEO Jim Koch has described how he recently shared 10 tons of hops at cost with other craft brewers to help them deal with the rising cost of commodities. Why did he do it? Koch explains that he wants the craft brewing segment of the beer industry to thrive, and the price of commodities could cause some craft brewers to fail, and others to sacrifice quality to control costs. He doesn't think either is good for Sam Adams. Koch wants to grow the overall size of the craft brewing market, rather than fight for share with other microbrews. It's an interesting strategy of trying to cooperate with other craft brewers in their collective fight to continue taking share from large mass brewers, as well as other alcoholic beverages. Koch knows that he can make more money by growing the overall craft brewing segment than he can by fighting for tiny market share gains against other microbrews.

Meanwhile, at Anheuser Busch, the firm faces a hostile bid for a few reasons. First, the firm has struggled recently with a substantial change in consumer tastes in US. Consumers are buying more craft brews or imports when they drink beer, but the bigger problem is that they are substituting spirits and wine for beer. Spirits has grown with the innovations in that market in recent years (pre-mixed drinks, flavored spirits, etc.) Wine has grown with the continuing efforts to educate the public about the health benefits of wine, as well as with the branding efforts of major wineries. Second, Anheuser Busch is highly reliant on the North American market. They have not been able to expand successfully in many parts of the world. Thus, as American consumers have shifted away from beer, they have been quite vulnerable.

In general, the large brewers find themselves fighting for share in mature markets, and looking for growth in emerging markets. It's not surprising to see consolidation given the slower overall industry growth. The interesting question is whether further consolidation will yield the benefits that firms have seen to this point. How big is big enough?

In addition, the question is what will happen to diversified alcoholic beverage firms that own beer businesses. Will a firm such as Diageo, which is largely a spirits company, keep a hold of Guinness - its prime beer brand - in the face of beer industry consolidation? Will Foster's Group keep its beer businesses now that it's primarily a wine company (it owns Beringer's, Wolf Blass, Lindeman's, etc.)? Will these companies focus on wine and spirits and move out of beer? Or, will we see beer companies increasingly expand into wine and spirits to deal with the declining consumption of beer in some countries such as the US?

Thursday, May 22, 2008

Retrenchment and Rebirth

Many firms ultimately encounter two fundamental liabilities of being large. First, they reach a point where increased size no longer translates into lower costs, i.e. they face diseconomies of scale. Second, they must address a large numbers problem, namely that growing revenues at historical rates becomes mathematically difficult, if not impossible. For instance, suppose a firm has grown revenue at a historical rate of 12% per year. That means that they are doubling sales every six years. That may be fine when a firm has $50 million in revenue, but it becomes a much more formidable challenge when the firm has reached $50 billion in sales.

What can firms do about this problem? Companies may want to consider the benefits of shrinking in the short term, and then recharging growth from that smaller platform. I mean more than simply selling off underperforming businesses from time to time, or disposing of unrelated units. I mean actually purposefully shrinking the scope of the corporation, even if certain businesses are related and performing fairly well - simply for the purpose of bringing the corporation back to a more manageable size, solidifying the firm's financial position, and returning a chunk of cash to shareholders.

Have firms done this in the past? Let's take General Dynamics, for example. Back in the early 1990s, General Dynamics was a Fortune 50 company, almost entirely focused on defense (with the exception of a few small businesses, such as its Cessna aircraft unit). In 1991, the firm had $10 billion in revenue, putting it 48th on the Fortune 500 list. The company, however, was not performing well at all. Moreover, its prospects did not appear bright, given the fall of the Berlin Wall and the demise of the Soviet Union, which brought about defense spending cuts.

During Bill Anders' term as CEO, he shrunk the company dramatically. I remember it quite well, because I was working at the company at the time. By 1995, the company had $3.7 billion in revenue, and it was ranked 307th on the Fortune 500 list. Anders didn't simply sell underperforming assets, nor did he sell off only noncore businesses. For instance, Anders sold the company's fighter jet unit, which produced F-16s for the U.S. Air Force. That business was considered by many to be "the crown jewel" of the company at the time - a solid business that was clearly related to the firm's other defense units. By the time Anders was done shrinking the company, General Dynamics was a far smaller firm. The firm focused entirely on two major businesses - shipbuilding and land combat systems.

What happened next? Starting in 1995, Anders' successor begin growing the business once again through a careful acquisition program - focusing first on the two major platforms remaining after the reorganization, and then gradually adding two other lines of business. General Dynamics begin by acquiring Bath Iron Works, a firm that fit nicely with the company's shipbuilding business (it already produced submarines at its Electric Boat subsidiary). Today, General Dynamics is 87th on the Fortune 500 list, with $27 billion in revenue.

During the intervening years, the company has produced an incredible amount of value for shareholders since the early 1990s. During Anders' time, the company sold off businesses and returned much of that cash to shareholders in the form of stock buybacks and special dividends. Later, the company enhanced shareholder wealth by producing a steady stream of earnings growth by driving revenue gains both organically and through acquisition, and by constantly improving productivity.

What's the moral of this story? Sometimes, retrenchment and rebirth can be an effective strategy. Diseconomies of scale are real, and managers must be aware that growing $50 billion behemoths at double digit rates simply may not be feasible - at least not in a profitable manner. Moreover, charging ahead for growth at that rate and scale may lead to some very poor strategic choices. But, how many CEOs do you know that want to see their company fall from 48th on the Fortune 500 list to a 307th? Therein lies the problem in many large companies...

Wednesday, May 21, 2008

Starbucks and Licensing

We have recently learned that activist investor Nelson Peltz has taken a stake in Starbucks. Peltz, of course, has taken stakes in companies such as Heinz, Wendy's, Kraft, and Cadbury Schweppes in recent years, and he's pushed for strategic changes to bolster shareholder value. In a Wall Street Journal story about Peltz's investment, we see some conjecture about the types of changes that he might propose:

"John Glass, an analyst at Morgan Stanley, said Mr. Peltz could urge Starbucks to cut spending and use more licensing or franchising in opening locations. The money saved from that could go to buying back shares or a larger dividend for shareholders."

I can see why Mr. Glass has come to this conclusion. There is no question that licensing or franchising would reduce the capital investment required to continue to expand the Starbucks footprint around the globe, and it would free up cash to be returned to shareholders. However, Starbucks has relied on owning a majority of its locations for good reason (it does use some licensing in locations such as airports, as well as in other countries).

There's an important lesson about vertical integration here. Many firms rightfully employ franchising, because it gives local entrepreneurs great incentive as they run their own businesses. Moreover, it conserves capital. However, a company tends to own its own retail locations when they have concerns about controlling the experience, atmosphere, and customer interaction that takes place. Starbucks sells much more than coffee.

Some firms with premium differentiated strategies face challenges when they try to write into contracts the specific behaviors and atmosphere that they want to create and stimulate in their stores. Thus, one can see why these firms tilt toward owning their retail locations. Take Apple, for example, which operates its own retail stores; the retail location is about the entire Apple experience, not just selling computers and iPods. Apple doesn't want to leave that responsibility for guarding the brand, the relationship, and the experience to a licensee. Similarly, a Starbucks location is supposed to be about much more than selling coffee. It entrusts that relationship and experience to others at some peril.

If you examine what Schultz has done since returning as CEO, he's focused extensively on the Starbucks experience within their stores. He has always talked about the importance of Starbucks as a "third place" - outside of home and office. Shifting dramatically in the direction of franchising and licensing would seem to be at odds with his strategic direction. Starbucks would not have full control over the quality and the experience if they don't own these retail locations.

Thursday, May 01, 2008

A Great Board of Directors

A recent article on Business Week's website discusses how a firm can create an excellent board of directors. The article makes a key point, namely that while a board can meet all of the structural requirements advocated by governance experts, that does not mean it is an effective board. In other words, one can have the correct percentage of outsiders, a nonexecutive chairman, and the like, and yet still not provide effective goverance. I have always believed that far too much attention is paid to structural dimensions of the board, and far too little attention is paid to process. Great boards of directors have highly effective group processes for dialogue and deliberation. Their process distinguishes them from less effective boards, not their structural characteristics.