A New Theory about HP

The H-P boardroom has seen the circus come to town on prior occasions, with the board spying on itself. Now, CEO Mark Hurd walks the plank over seeming peccadilloes amounting to $20,000 of expense reports which were reimbursed after audit. These compare to a four-fold rise in the share price over a five year tenure. Institutional investors quoted in the press said that the 8% first day decline in the stock price was overdone, so in their minds, the CEO's management of corporate assets and above-market returns are what matters. Never mind that much of it was market timing, but these investors prefer profits and ROE over peccadilloes.

Meanwhile, much of our avowed governance reform is about codes of ethics, and like the Old West, there's only one code for everybody. In reality, the board made the only decision that it could possibly have made, by taking control of the issue. Had the contractor-in-question remained a mystery, the issue would have been framed in the tabloids and she would have had a much bigger stage, with the company constantly on the defensive. However, just like the Toyota sudden acceleration story, the HP episode makes very little sense, starting from the process of hiring the contractor, to the supposed marketing duties, to the efforts to conceal the ongoing relationship. For the ongoing lack of judgment and circumspection, and for any additional risk down the road, the board took the only appropriate decision it could.

Now, the newspaper stories report employees delirious with delight at Mr. Hurd's resignation because of his"Chainsaw Al"-like crimes of cost-cutting. Quite a few people quoted are engineers. It has always seemed that HP has been dominated from its founding by an engineering culture. I suspect that former CEO Carly Fiorina's difficulties with the board and company culture were not so much about Compaq as they were about offending the inbred, engineering culture.

One of the lead marketing tag lines from her time was "HP: Invent," and that legacy lives one in the "Invent" centers in Geneva and Mumbai. This was probably dismissed internally as being the product of a marketing person who didn't understand innovation anyway. CEO Hurd further went on to attack a bloated cost structure, something that engineers really don't like. In their view, ordinary executives aren't smart enough to understand how difficult good (read perfect) engineering is; putting out new products isn't something that can be held to a quarterly timetable, they whine.

HP is positioned well as a result of decisions taken by recent CEO's, including Ms. Fiorina and Mr. Hurd, but it really hasn't fulfilled its potential yet. I suspect that it still relies too much on profits from its consumables businesses, where it has marginally innovated and effectively raised prices, while completely defeating movements like the refillable cartridge businesses. This was done mainly through marketing and only secondarily by engineering. Giving away printers didn't hurt either, another marketing decision.

So, HP shares continue to look like a value play, but I suspect that there's a very large, cultural elephant in the room that could slow any transformation into a sustainable, growth story. The next choice of a CEO might best be someone who is known and acceptable to the insiders, rather than another, charismatic outsider.

What Recovery?

The Minneapolis Fed has updated charts comparing the current recovery to the ten postwar recoveries, in terms of output and employment. The beginning of the last downturn is dated July 2007, and the recovery is said to have begun in July 2009. What is shown is not a pretty picture.

The decline in employment during the last downturn was significantly steeper than other downturns, and U.S. employment is shown to have declined overall by 5.6% from the onset of the recession. What's worse is that the decline shows no sign of turning upward, and overall U.S. employment numbers are still 1% below those at the start of the recovery in July 2009. This is unprecedented. The consternation in financial markets today is a reaction to what's suggested in these comparisons and in recent monthly data.

The bullish economic commentators, like Joseph Carson at AllianceBernstein, point out rightly that the contribution of consumer spending and housing to the current recovery is about 25% of the contribution expected at this stage of other postwar economic recoveries. However, AB then appeals to strength in manufacturing and exports as reflecting a changing mix of contributors to the economic recovery. I just can't understand how exports can sustain a contribution to growth when it's only China whose economy appears to be having robust growth, and the Chinese economy has not traditionally had a large appetite for high tech, manufactured U.S. exports.

A more fundamental issue is the long-term damage caused by discouragement and loss of productivity and employability of large segments of the labor force imposed by the reluctance of large and small employers to add workers. Extending unemployment benefits for some workers may earn votes but little of any significance for the economy as a whole.

There is very little that the Federal Reserve has left in its toolbox to address lack of income and employment growth as well as deficient demand. It has to get its balance sheet in order and get out of the Greenspan economic wizard business. Business leaders have to get beyond reporting the next quarter and start investing in their businesses. The business leaders should demand that Washington stop trying to phony up numbers for November elections and start working on rational fiscal policies, including revenue raising through an efficient tax system, in order to generate a real recovery.

No Rabbits Out of the Hat

Changing the top kick in charge of the Afghanistan theater and believing that this will have a material, long-term impact on the success of our effort there is delusional. There won't be any rabbits to pull out of the hat, like another surge, to turn things around quickly.

In the Spring of 2009, we spoke to a number of academic and international experts fresh from Central Asia; putting the current reports together with my own . In the post from a year ago, I wrote:

"Pakistan as a state, is near collapse and the policy choices here are not attractive, in the short run. The Inter-Services Intelligence (ISI) is a shadow government in Pakistan, operating outside of the control of a moribund civilian government and of the divided, discouraged military."


That is hardly news to any knowledgeable observer of the India-Pakistan disputes since Independence. The Wikileaks undifferentiated trove of documents will make the discussion too diffuse. Like the shadow banking system in our own financial crisis, the ISI will defy attempts to characterize it or regulate it; it will operate freely and independently, unless a cataclysmic event intervenes, which I hope does not happen.

The material about the Haqqani network is old news also. United Nations reports from 2004-6, as well as Human Rights Watch reports from 2007 painted a picture of a very dangerous and effective military operations and training organization with ties to Al Qaeda. Jalauddin Haqqani was a CIA asset in the 2001 time frame when the US propped up the Afghan jihad against the former Soviet Union. His son, Sirajuddin, has been in charge of daily operations of the organization for the past several years, and he is said by knowledgeable observers to have extensive connections in the Pakistan tribal areas with all interested parties.


The foreign policy machinery of the current US Administration seems to be chasing its tail on this whole issue. Despite energetic and intensive personal diplomacy on the part of the Secretary of State, there doesn't appear to be any real consensus on what to do about the significant divergence in interests between the U.S., Pakistan and other external actors in Afghanistan.

Humanistic Education

Professor Roosevelt Montas of Columbia University gave a lecture that I attended last year in New York, about the Core Curriculum, which is the distinctive foundation of undergraduate education at Columbia College, my alma mater.

It turns out that institutions in Asia are looking at making their undergraduate education more humanistic and less mechanistic. It's ironic that as they are humanizing their model, we are frantically trying to emulate the model that they're abandoning, but that's another topic.

In 2009, the University of Hong Kong and Lingnan University held their 3+3+4 Symposium on Core Curriculum, at which Professor Montas delivered a Keynote Address. With some of the volunteer teaching I do, and with a history of undergraduate and graduate teaching, it really made me think about the value of humanistic education and its relation to our recent financial misadventures.

Here's a quote from Professor Montas, "...education, true education involves personal transformation...college must be a place of moral education in a deepest sense, education about how to be human, education that fosters habits of self-examination, critical skepticism and an openness to the new."

Looking at the financial meltdown apart from the arcane discussion about derivatives, value-at-risk models and financial regulation one comes back to some of the fundamentals qualities of education that were lacking among the small and large actors in the crisis. Where was the self-examination during the lengthy process of foisting off toxic products onto customers for whom they were not suited? Where was the critical skepticism when looking at misleading and incomplete disclosures or risk models with poor foundations? What if the efficient market tenets didn't hold and a massive bubble was building? Then, some new thinking would have been in order.

Trading floors, executive suites, and board rooms may have been rife with mechanistically trained number crunchers who were all indoctrinated with the EMH and the CAPM, but their moral educations were sorely lacking.

For my undergraduate vintage of the Core Curriculum, we had to read Virginia Woolf's "To the Lighthouse." I confess to not remembering a great deal about the novel, but I was very taken by this quote from the author, writing in 1938 as European elites built up to the inevitability of World War II. Virginia Woolf wrote that she felt compelled to "doubt and criticize and question the value of professional life--not its cash value;that is great;but its spiritual value, its moral, its intellectual value...If people are highly successful in their profession, they lose their senses."

She had it right then, and now.

Free Trade

Professor Jagdish Bhagwati of Columbia has a note about the twin barriers to freer global free trade being the US and India. He has a point, although how he doesn't include India's neighbor to the north, I don't know. He exaggerates to make a point, and that's okay here.

He theorizes that the US refusal to end its agricultural subsidies has triggered India's resistance to endorsing the Doha Round, because of fear that its subsistence farmers would be wiped by subsidized U.S. exports. This in turn hamstrings the government of Dr. Manmohan Singh, an economist by training and an orthodox, free trader. So, we are hurting one of our supposedly stronger allies. Ever heard this before? Typical U.S. issue-by-issue foreign policy.

The constituencies aligned in favor of ending agricultural subsidies, especially corn and other grains, are many and varied: those concerned about obesity and the links to high fructose corn syrup, to those concerned about the impacts of high intensity fertilization on dead zones in the Gulf of Mexico, all the way to orthodox economists and deficit hawks. Yet, the relatively few, but powerful Midwestern senators and representatives carry the day, and everybody pays.

Neither political party wants to spend the political currency to take on the problem of agricultural subsidies, but the benefits from addressing this issue, in spite of some near-term dislocations, would be substantial for our economy and for the economies of our trading partners.

Good Reading on Financial Reform

As the ham-handed, absurdly complex financial reform bill has just moved closer to Senate passage, I wanted to recommend a new, free down loadable book about the brave, new post-reform world published through the London School of Economics.

It features essays by, among others, Lord Adair Turner of the FSA and by Simon Johnson, former Chief Economist of the International Monetary Fund and frequent contributor to the reform debate. I respect the analysis and refreshing perspective that these knowledgeable observers bring to the table. It will take me a while to get through the book, but I really appreciate the distribution model LSE has taken to get the work out.

Incidentally, the Davis Polk law firm's initial analysis of the reform bill suggests that implementation will not be a walk in the park; some 67 studies are required by aspects of the bill, and the regulation development process is labyrinthine. In the meantime, the uncertainty created by the content and timing of the final regs will impose significant costs on businesses and consumers.

I am proud to say that Mick Jagger and I both have spent time studying at LSE. I suspect that his economics training is why the Stones have managed their musical business affairs so well over the years!

Global Telecom The Indian Way

On the right is a photo taken a few months ago by my cousin, who was an executive in the software industry in Mumbai for several years before moving into biopharma. It's almost too much for words, but it says everything about the reality of electrical, telecom and cellular infrastructure in India.

No entity controls the connections to the pole, and anyone is free to add theirs to the jumble, without any consideration for external effects on existing connections. The local utility doesn't care about this situation and has no power to enforce regulations anyway. Everyone shrugs their shoulders and life goes on, until the daily brownouts or a failure. When you hear about the need to invest in Indian infrastructure, this is an image to keep in mind.

A recent study by McKinsey estimates that by 2030 India will, for the first time in its history, pass from being a country of villages to the majority of its citizens being urbanized. Mumbai will have about 28 million inhabitants, Pune will have 6 million, and Chennai some 8 million. McKinsey estimates that $1.2 trillion will have to be spent on infrastructure alone by 2030 to accommodate the needs of the urban population throughout the country. Some big chunks in their calculation are water and sewers, the latter being something that never receives public investment to any meaningful degree. Roads, trains and subways are critical investments also. $120 billion is required on an annual basis, according to McKinsey. They size this by saying that it's equivalent to adding infrastructure for a city the size of Chicago every year for twenty years.

Now if something like this were done, there would be tremendous export potential for US companies, since the materials and services requirements would be beyond domestic capabilities. Of course, India would have to export more in order to pay for this effort, but these are the kinds of things that should be the subject of Indo-American dialogue, not just selling more fighter planes and arms to the Indian government.