I will reply to comments that have been piling up, though.
Monthly Archives: December 2013
Wikipedia–what’s happening to you?
Wikipedia is/was a great idea–a crowdsourced encyclopedia, growing and changing with the times. It’s central enough to the internet culture that if you Google “searchterm wiki” you go straight to the appropriate Wikipedia entry.
Incomplete? …maybe. Reliable? …of course!
My first personal hint that this assessment is incorrect was about a half-decade ago. One of my MBA students suggested for a project I was supervising that we could improve our client’s reputation by crafting what amounts to a Wikipedia infomercial. By avoiding being too blatantly commercial, we could write an article that would stake a claim to industry expertise for our client, endorsing him as the de facto “go to” source of information/opinion about his industry. At the very least, this would improve his Google search positioning.
Since that time, professional reputation “enhancement” services have done further damage to Wikipedia’s reliability, as well as to the usefulness of Google searches in finding out about past shady activities of prominent personalities.
This development came home to me forcefully when I decided to write about Michael Milken, whom I consider to be on a par with Bernie Madoff in the annals of financial wrongdoing. Googling his name to make sure I had my dates and places correct, I was surprised to find that the top-positioned Google entry heralded Milken as a philanthropist–and said nothing about his criminal past.
To some degree, the press is giving an assist to this Orwellian enterprise of rewriting history. Many newspaper archives are either only open to paying subscribers or have–for cost reasons, I assume–been truncated to include only stories from, say, the past ten years. So reputation “defenders” have free rein to reshape the facts for prior periods.
Yes, many of the financial criminals of the past have been barred from direct participation in the securities industry. And most of the reinventess have resurfaced merely as personalities on cable TV shows or on Yahoo, so in one sense they’re less of a threat to our financial well-being than they used to be.
On the other hand, it;s a little disheartening to find that as altruistic an information source as Wikipedia must also now be taken with a hefty dose of salt.
long-term market themes (iii)
software as a service/ cloud computing
Once, when I was younger and more foolish, I owned shares in the Japanese company Olympus for a short time (this was in the late 1980s – early 1990s, long before the financial scandal that ultimately brought the firm to ruin).
What interested me was Olympus’s endoscope business. An endoscope is an apparatus that consists of a monitor, a computer and a long fiber optic cable encased in a hose. Doctors feed the cable into the body of a patient to check out the state of his insides.
This business is supposed to work on the razor/razor blade model. That is, the big money is in replacing the cable-in-a-hose, which Olympus recommended doctors do every three years or so.
Olympus had a problem, though. Its salesmen could never persuade doctors to replace their cable/hoses. They’d have marketing campaigns where they’d warn the docs that the cable might snap off inside the patient’s body if it got too old. But even that cut no ice. I guess doctors figured the patient is sedated and that they could extract the broken pieces, if need be, without anyone being the wiser.
So far, there’s no obvious investment angle–just a recipe for trouble.
But…
…in the US Olympus had switched from selling endoscopes to doctors to leasing them. The sales pitch was that monthly payments matched the doctor’s cash inflow better. The buyer also took on no debt and was no longer responsible for maintenance/upgrades.
US sales skyrocketed. So, too, did profits–because factored into the “more convenient” lease payments was cable replacement every three years.
The lightbulb’s gone on, I figured. Next step is rolling out the leasing model worldwide. So I bought the stock and sat back waiting for the earnings surprises–and stock price appreciation–to roll in.
They never did. In a dot-connecting failure I’ve come to think of as characteristic of most Japanese manufacturers, Olympus thought leasing was ok for Americans but for no one else. Once I realized this, I sold–without making or losing much money, as I recall (meaning it probably was worse than that).
Nevertheless, this experience taught me a valuable thing about market dynamics:
–when people, particularly medium- or small-sized businesses, own expensive equipment, they’ll ride it until it dies. Then they’ll revive it, with duct tape and string if necessary, and continue to use it until it falls apart. Even then, they may keep it around for spare parts.
This is a particular problem with software, since it doesn’t often cease to function. All the power resides with the buyer.
–on the other hand, when people lease stuff, and the large initial capital outlay is turned into a much smaller recurring expense, the obsessive desire to squeeze the final dollar of value out of the equipment disappears. Market power swings decisively to the seller.
In the case of software, the benefits of this move are especially big, since many of the costs of distribution of the product go away. Everything is done automatically over the internet.
That’s the power of software as a service.
Another thing: during the transition period between ownership and leasing, surprisingly large numbers of customers–who have previously been using what are, in relative terms, Stone Age tools–sign up. ADBE is a case in point.
sketching out long-term stock market themes (ii)
competition
1. Some (not many) domestic-oriented US companies are mentally living in a past that no longer exists, making them particularly vulnerable to competition.
How so?
WWII had two immediate effects on US industrial companies: their domestic installations were the only plant and equipment still left standing after the conflict in Europe and Japan, so they had eager customers, no matter what the quality of their output; and a generation of leaders abroad, grateful for American assistance in rebuilding, gave preferential treatment to American firms.
This wasn’t “normal,” and it’s no longer the case. Those leaders are long-since retired. When China thinks of the US, it thinks of the Boxer Rebellion, not WWII.
2a. The Internet has destroyed many barriers to entry, or “moats,” as the academics like to say.
–It allows large, established firms to control far-flung manufacturing and distribution networks remotely.
–It allows them to stitch these networks together out of both owned and third-party pieces, so they can keep high value-added pieces in-house and farm out the rest.
–It allows fledgling firms to mount low-cost social media product awareness campaigns, to open their own online storefronts and also to distribute through third-parties like Amazon.
As a result, the embedded value of many years of past advertising campaigns no longer sets the bar for creating public interest in a new product. Slowly building your own bricks-and-mortar retail presence, your own warehouses and your own fleet of delivery trucks isn’t needed to get wares into the hands of customers, either. And you don’t need to lay out tons of your own capital to build an effective supply chain.
2b. A recent article in the Financial Times points out that the US has about 5x the mall space per capita as the UK, 6x as much as in Japan and 8x as much as in Germany. To the extent that retailers have signed long-term leases to rent this space, it can act as a ball and chain around a firm’s ankles, as online replaces bricks-and-mortar.
3. Emerging economies understand that the ticket to entering the developed world is technology transfer. That requires offering multinationals a low-cost workforce and state-of-the-art plants to induce them to open up in their country so locals can learn how to work in, and ultimately run, a manufacturing business. This means a constant stream of new manufacturing plant coming into existence, undercutting the value of existing capacity (developing governments are looking for employment and technical education, not profits). Developed countries’ only effective response is continual modernization and innovation.
4. Hydraulic fracturing (“fracking”) is lowering the cost of producing natural gas and oil. So far, fracking is happening mostly in North America. So it’s principally a boon to manufacturers here, like chemical companies, that use hydrocarbons as feedstocks. It’s also putting more money into the hands of American consumers, who (thanks to a uniquely misguided government energy policy in the US) use double the oil and gas per capita of anyone else.
We’re already seeing foreigners building new energy-intensive plants in the US to try to level the paying field. Great for the balance of trade and for domestic employment.
The bottom line: this is no longer a rest-on-your-laurels world for established companies. For investors, this means the odds on backing younger “disruptive” competitors are better today than they have historically been.
sketching out long-term stock market themes (i)
I think next year will be one where secular forces rather than the business cycle will be the most important economic factor in determining stock performance. So I’m going to write a number of posts to try to work out, at least to myself, what those forces are and how they’ll affect stocks.
This post is probably just a warm-up.
WWII ended a very long time ago. But I think the mentality of that era still has an influence–most of it not so helpful today–on the way business is conducted in the US, especially for large, mature corporations. I see three important areas: organization, competition and communication.
organization
Many mature corporations in the US have been set up along military lines by citizen-soldiers returning from Europe and the Pacific. Hey, it worked in the war, didn’t it.
That is, the firms they built have a cascading management hierarchy that’s based on face-to-face communication and on control from the top of workers who have progressively diminishing amounts of decision-making responsibility as we go down the organization chart. At the top are “generals” who give orders; at the bottom are “privates,” who don;t think too much–they just execute. Everyone drinks the corporate Kool-aid. Seniority counts for infinitely more than brains.
Examples: governments, almost any financial company, publishing, MSFT.
This now-outmoded structure required large numbers of “lifers,” –willing, but not necessarily well-trained, workers who learned on the job. In the pre-internet world, their large size was a strong protective barrier against competitors. No longer.
Implications: As mature corporations continue to lose market share to sleeker, smarter, more nimble rivals, demand for worker bees, already shrinking, will continue to lessen. For a lot of industries, this is not news. The important thing, to my mind, is that there are still a lot of large domestic-oriented corporations with loads of labor fat (think: bank branches vs. peer-to-peer lending).
The political/social side of this issue is how to retrain displaced workers. The investment side is the huge scope for innovative firms to still take market share from inertia-bound behemoths.
More tomorrow.