What's Wrong With Technology's Four Horsemen?

It's the season for IBM, Cisco, H-P, and Microsoft to be in the financial news, with earnings results at the front of investor and customer psyches.

IBM

On the face of it, IBM appears to be remaking the portfolio with the sale of the commodity server business, semiconductor manufacturing, and exiting the low margin BPO business.  Acquisitions have continued, and the acquisition of SoftLayer looks like a good one, both timely and strategic. 

Along the way of this portfolio make-over, however, execution has really been poor, no matter what the geography and what the business, in constant currency terms. As a corollary to this, the Road Map finally lost any credibility and had to be abandoned.  For all the talk about seamless succession of executives, since this was a cornerstone of CEO Rometty's predecessor, it shows how quickly market changes can overtake even the industry leaders.  

Finally, we have noted before an undercurrent of frustration in the CEO's otherwise aggressively sunny presentation when she talks of "execution" issues.  Whenever this happens, an executive change within the CEO's senior leadership is announced, as it has for IBM and H-P.  More on this later.

Microsoft

Microsoft is trying to be two companies, one consumer-focused and the other aimed at the enterprise customer.  The new CEO was the right choice at the right time and seems to be doing and saying the right things.  This organization, however, isn't doing a great job on the consumer side, as we've said many times before.  

Look at Windows Phone.  Despite having a pretty neat OS that works on good Nokia phones, CEO Nadella's commitment to app developers to work on the Windows marketplace hasn't yielded any increase in the the share of Windows Phone.  Even Windows 10, which looks promising, is all about an operating system; consumers care about their experience on a device, whether a laptop, phone or a tablet. Somehow, in the Microsoft world, it's never as idiot proof to do things as it is in Apple's world. Surface Pro has had a tremendous ad campaign and exposure with the NFL, but it doesn't seem to be gaining meaningful share.

With recent product introductions by Dell and H-P in the laptop/hybrid form factors, maybe MSFT's intention was to force the OEM's to innovate more in response to Surface and Macbooks.  Maybe.

Microsoft's organization can use some serious rationalizing--the ill-chosen Ballmer reorg notwithstanding--- both in numbers and in the way the dual market-facing company works.

The stock has done exceptionally well, and the Enterprises businesses seem to be gaining a lot of traction.  After the recent quarterly results, brokerage houses have meaningfully trimmed EPS estimates for fiscal years ended 6/15-6/17.

Cisco

Besides managing the fortress balance sheet, their questions about margin compression in their core business product lines while managing their transformation into cloud, data center, and security products are largely unanswered.  The stock looks somewhat less expensive than their peers, but with the financial and operational murkiness, one wonders where this company is going over the next one-two years.

H-P

Breaking into two companies, which of course they now admit to discussing over the past year or two, shines a light away from the core concerns about the future, including the board, the M&A process, and how much more heavy lifting has to be done to truly transform the company, as opposed to the impressive and difficult financial realignment that has taken place so far.  

HP, Inc. based on 2014 results would have had $57.3 billion in revenue and $5.45 billion in earnings from operations, with a return on average assets of 24%, driven by a 40% return in Printing.  Future cash flows should be attractive and stable, and thiscompany won't grow too fast but can support debt and perhaps consolidate the printing business over time.  

HP Enterprise would have had $57.6 billion in revenue, $6.1 billion in earnings from operations, and an ROAA of 8.9%.  It is carrying a small, under performing Software segment with a 7.4% ROAA and only $3.9 billion in revenues, with too many small products.  The Services segment carries a 5.4% ROAA, the lowest in the portfolio, lower even than the rebounding Personal Systems group in HP, Inc. 

This business can do much better, but there are still many open questions.  Although the stock has rebounded since 2012, over the past five years it has dramatically under performed the S+P500 and the S+P IT Technology index, according to the 10-K.  

What's wrong with all these companies?  What's the common thread, the elephant in the room?

Going to market---it's the sales forces! Let's think about everything we've been fed by the company CEOs in conference calls, the CIOs, the industry gurus, the software gurus, and corporate governance gurus and put it together.

A New Selling Paradigm

1. Tech sales people have generally always made a great living, whether they sold hardware of software.  Marginal product improvements and enhancements, new models, and industry gurus crying wolf about security or energy efficiency were all enough to generally carry the day over a cycle.
2. IT executives were generally left alone by senior management, unless a VP were brought into the CEO's office to fix a printer or reboot a system.  Despite the governance gurus and folks Accenture and McKinsey protesting,  CIOs weren't real players in the C-suite.  I would bet most investors couldn't name the CIO of their portfolio companies. 
3. Business segment leaders cried directly to the CIOs about what they needed, and because they were the profit centers, they got it.  As long as the big budget came in where it needed to, nobody cared.
4. Sales were organized by geography, by product line, by type of account (national, global, key strategic etc) with lots of cross-over "sales teams" which never worked for the insiders or for the customers.
5. Going forward, things have to change.

• Issues like data security, especially in the case of global financial firms, e.g. JP Morgan Chase , now land right in the board room and the CEO's office.  It has to be a new kind of CIO, probably supported by other key executives like a Chief Data Security Officer, who is in the CEO's office answering questions and having accountability for lots more than a budget.  
• This new CIO will have to have a new relationship with the heads of business units, actually trying to understand their businesses, as opposed to just IT.  This CIO will have to respond quickly, without time for multi year major system makeovers or delayed data center openings. 
• IT, whether hardware, software, or services, probably won't be bought blindly from one vendor, just because of a history with a key sales person. The CIO and her staff won't have time for sexy sales presentations.
• The corporate sales staff too will have to understand their business unit customers and how they actually work, much better than in the past.
• In a sense, a new sales force will have to be more like Accenture-style consultants, but with specific product, software and application knowledge across a variety of offerings.
• This means a new kind of sales team, but a real team with accountability for more than hitting a quota or making the President's Club by individuals.  

IBM and H-P for sure have these issues to address, and the repeated references to "execution" during conference calls over the past two years have made this clear.  The Enterprise businesses within Microsoft have probably operated under the radar because all analysts used to care about was PC sales and Windows licensing.  VARs and other channels should be rationalized and used where appropriate, not just to move volume for reporting periods.  

Taking care of the new CIO and their more complex demands in a unique way with a best-of-breed offering and hands on service, perhaps at lower margins, will carry the day in the "new IT."  

Telecoms Start Racing to the Bottom

We wrote a while back about Masayoshi Son's potential impact on US retail cellular phone users, particularly because he wants to become number one in his markets.

Predictably, his first efforts at taking over T-Mobile met federal regulatory veto.

T-Mobile has forced some innovation on the industry by making it easier for consumers to get phone upgrades and by doing away with contracts. Their subscriber growth turned around.

Meanwhile, however, spectrum auctions are indicating that others perhaps have a better economic model and can pay more for spectrum that ATT, Verizon, T-Mobile, and Sprint.

So, the major carriers have put forward their "race to the bottom" business model of promising to cut monthly bills in half while offering unlimited data and phone service.  Clearly, this is not sustainable, as we have noted for years.  With spectrum prices rising, the cost of building out different network or adding other services is becoming prohibitive.

So, the WSJ notes,

"What difference does a month make? In telecom, the answer is about $45 billion.

That’s how much market value Verizon Communications Inc., AT&T Inc., Sprint Corp. and T-Mobile US Inc. have lost collectively since mid-November amid a fast-moving reassessment of the industry’s value by investors. The lost value is greater than the current market capitalization of Sprint and T-Mobile combined, and it reflects concern that cellphone service will be costlier to deliver and less lucrative to sell."

The carriers also got dinged on behalf of consumers by the Feds because although they promised "unlimited text and data" to all customers, heavier users faced slower download speeds, of course a form of rationing and making the whales pay for their consumption. If the fines levied are paid, then they either have to adopt some kind of utility pricing which is transparent, or face growing losses because their business models don't create value. 

Marketing Indian Textiles

More than sixty years ago, the Government of India began a noble experiment to promote Indian textiles, specifically those handcrafted textiles produced by small scale producers throughout the country.  Given the quality, unique designs, colors and dyes, the global markets seemed ripe for the introduction of products that would introduce Indian artistry and craftsmanship to consumers in developed countries through tourist sales.

The vehicle was a Government enterprise called the Central Cottage Industries Emporium, with showrooms in centers like Delhi, Mumbai, Kolkata, Chennai, and Bangalore. Having first visited the Delhi showroom with my family in the Sixties, we always took home unique items for women friends of the family, who were always excited by the unique look and feel of the apparel; wearing them on a regular basis in a Western lifestyle was, however, always a different matter, I noticed.

Coming back to that same showroom during our most recent trip to India a few weeks ago, I was appalled by what I saw.  The fixtures looked like the same particle board shelves from the Seventies, with chips and dents visible everywhere.  Displays were full of merchandise, stacked in neat piles which were good for inventory but not for pulling out and piquing customer engagement.  The floor staff, who have no incentives, were as disinterested and sullen as ever.  Light fixtures were ancient, but they now featured compact fluorescent bulbs providing awful lighting with large areas of shadows. Forget 2014, this was an experience worse than 1960.

Design is supplied largely by the suppliers themselves, who really have no idea about modern tastes and preferences among customers in the developed world, or even of affluent customers in India or in the rest of the developing world.  It is as if time had stood still, and so have the inventory turns.

My teenage daughter, looking for gifts for her friends, and my wife struggled to find merchandise that would be worn, as opposed to admired.

I thought about a proposal to privatize this business, with a revenue sharing arrangement with the government. I could already see the easy ways to rip apart the space and create an inviting store.  My cousin's daughter Shalini James had created a successful retailing operation in several of the largest international malls in Cochin.  Her expertise, along with others in our family, could be the backbone of a new model for Cottage Industries Emporium. I was excited thinking about what could be done.

However, we had already been shopping in some very attractive outlets of a fifty-year old retailer Fabindia, founded by an American in New Delhi, and now run by his son. My family, including my son and nephew, were excited to be shopping here.  I didn't realize how big their volume was, and how many stores they had throughout the country.  Their original mission was the same as that of the Cottage Industries Emporium.

Some of the big differences in the model?  First and foremost, Fabindia have their own international design staff who are connected to fashion centers in the U.S., Paris, Milan and the rest of the world.  The design input went to the artisans, who obviously weren't in a position to afford this kind of expense.  No problem: that barrier was eliminated.  Concepts of sustainability and fair compensation to artisans are corporate values.  Supply chain management is an established corporate function: no one can accept merchandise sitting on shelves as they do in Cottage Industries. The brand and values are being extended into home, including furniture recently, food and personal care items.

Another conversation ensued with a cousin who is a corporate marketing executive.  He said that Cottage Industries were already a zombie enterprise, whose largest volumes were sold to overseas visitors from foreign government delegations who were force fed into their outlets with limited time.  Other than that, he said, there was almost nothing left.  Yet, like all government enterprises, it will not be shuttered to improve the government's use of assets, but it will soldier on to oblivion, to the detriment of artisans and employees.

Indian textile exports are around $40.2 billion, about 5.2% of global textile exports. Last year, India assumed second place globally behind China.  While government may have primed the pump decades ago, it's time to abandon being a fabric retailer.

A Coupon For The Groupon IPO

What could be better than daily deal coupon issuer Groupon giving a rebate on itself?  Back in June, we posted on the absurd $15-20 billion valuation range  being suggested  for Groupon. Many investment bankers are probably poker wizards with the requisite "poker face," which allows them to make the most ridiculous statements without blushing or bursting out laughing.

In today's Wall Street Journal, we see that investors can get a coupon on Groupon:

"In a stark comedown for what was expected to be one of the hottest stock offerings of the year, Groupon Inc. is scaling back plans for its public debut. The Chicago company and its bankers will begin meeting with investors in the next few days to sell them on a deal that values the daily deals pioneer at less than $12 billion, according to people familiar with the matter. While that would still mark one of the biggest Internet IPOs since Google Inc. in 2004, it is well below the valuations that were bandied about when the company filed to go public in June. Groupon's IPO was originally expected to value the three-year-old company at between $15 billion and $20 billion, according to people familiar with the matter"

In the meantime, we've had IPO metrics blessed by the company and its auditors, and then the same metrics were withdrawn.  An email from the CEO suggests that investors should ignore marketing costs because they can be scaled back at any time, which could sound like "managing earnings," assuming that Groupon had earnings.

With the powerhouse banks behind the deal, a deal will get done.  Lucky flippers will have a nice payday.  The Groupon model is not healthy for most restaurant businesses, but if this industry manages to get a footing, then it will take its profits out of the hides of their small business customers.  In the meantime, I can't wait to see which mutual funds wind up listing Groupon as 2% of their fund assets. An absurd valuation is now merely ridiculous. Caveat emptor!

Steve Jobs and The Engineering Culture

A previous post tried to put a damper on the Jobs hagiography in its most quasi-religious version.  I had to laugh when I saw a blog posting that the Jesuit journal La Civita Cattolica had compared the late Apple CEO to St. Ignatius Loyola and Pope Piux XI.  As Johnny Carson often said, "I kid you not!"

True engineering cultures are often inimical to running product businesses with fickle, demanding customers.  I'm not talking about engineering services firms, but that's another story.  When I was growing up, I got to meet quite a few IBM engineers and executives through our family's network in Westchester County.  One of them gave me a gift of a leather note pad, inscribed in gold leaf with Watson's motto, "Think!"  There's no doubt that their engineers were the best and brightest of their breed. 

Fast forward to the time before Lew Gerstner was brought on as IBM CEO in 1993, when market pundits were calling for the company to be sold off in pieces.  Coming from Amex and RJR Nabisco, the engineers in IBM were dismissive about what a non-engineer could do to help their business.  One of them said, "His biggest decision at Nabisco was probably to decide the new colors on a box of Shredded Wheat."  A bit arrogant, don't you think? 

IBM could always afford to be arrogant because in much of their product business, they had a quasi-monopoly and they shoved price increases down their customers' throats.  As technology and new competitors buffeted them, the engineers got further entrenched in their own ideas and lost touch with what customers in changing markets wanted from IBM.  Among the many other dimensions of Gerstner's turnaround, he managed to change this engineering culture to a customer-centric culture, while also funding basic research which had really put the company on the map in the first place. 

COMPAQ too had an engineering culture, and their products were known for their extremely rugged construction.  "Unbreakable," we were told as Merrill Lynch paid their high prices to get average performance and lots of ruggedness.  I had the pleasure of having to carry the first portable computer in the economy cabin to a client location for some forecasting work.  It worked fine, but it was unbelievably heavy and unwieldy to carry.  There was no thought about design beyond basic functionality.  Here's a picture in case anyone else had to deal with this elephant:

HP has a legendary engineering culture going back to the earliest days of Silicon Valley.  Imagine when the two engineering companies were merged.  Then investors had a company that was truly out of touch with the fickle and demanding consumer markets.  Carly Fiorina and her successors failed to change the engineering culture at HP. 

Engineers believe that customers should buy products based on the spec sheets.  They also like to endlessly tinker with product designs and specs, in the guise of seeking perfection which also kills product launch timetables.  They also believe in their hearts that product design reflecting consumer ergonomics and user experience is something that they can do also, because "it's easy, not like engineering."

That's how you release a product like that pictured above.  Steve Jobs was able to talk with engineers and get to the kernel of their issues, and he had their respect because of this ability.  I don't believe that he tried to be a product designer, but he really looked at product design as a sort of consumer ombudsman.

So when a button came back and he used it the way a consumer would, he would say, "It's too big. Make it smaller!"  This wasn't imperious or micromanaging, but he was a proxy for the Apple customer, and a good one.  There's no doubt too that he had some visionary insights about how businesses could work, as in electronic music distribution.  I really believe that his eventual taming of Apple's engineering culture saved them from depending on products like LISA, shown below, to products that redefined consumer experiences like the iPod and iPad.

When Apple had too many new products on its strategic plan menu, Jobs was able to cut through the knot of empire building and engineering egos to say, "Give me that phone and that music player."  He used his own passion, ego, market intuition and business savvy to prepare the market place for these products in a way that catapulted Apple from a niche player in the education and graphic design PC markets into a true technology leader.  It's a great story.  

Best Buy Gets Yellow Tagged

Best Buy shares have gone on a yellow tag sale, as their price has fallen 32% year-to-date.  There is some good news for shareholders, namely in the current maturity cycle for their stores and without any significant plans to expand retail footage, the stores are throwing off cash.  Sales growth, however, is another story.

I've followed this stock from its early days when it was forecast by Wall Street to expire under pressure from the now defunct Circuit City.  I made money for my customers several times during the stock's short cycles.  However, in recent years, it has me scratching my head.

I can't answer one basic question: "Why would I get in a car and drive into a Best Buy?"  Music, which was a great traffic draw and a source of impulse purchases, has come and gone because of the revolution in how music is sold and enjoyed.  The appliance section, despite all the corporate best intentions, still seems out of place in the store and uninviting.  Sears is still the top of mind destination store for the top brands and Kenmore.

The service experience, which has had its ups and downs, is on a down cycle.  In some stores, the only person who ever says anything to the customer is the security person at the door who says, "Goodbye."

Televisions have been commoditized and subject to everyday discounts and sales by players from Target and Costco to Office Depot and Kmart/Sears.  The Magnolia store-within-the store usually looks like tumbleweeds are going through it.  Computers are about as exciting as toasters.

Some retailer used to have an interesting tag line, "What do you want to do?"  Maybe that's the pitch for Best Buy.  Solve the customer's problem by packaging the best-in-class product and service options for, say a mid size flat screen TV with good sound that can double as a computer screen for my son's Xbox and streaming NetFlix.  Perhaps the store could even guarantee the "lowest price" on the bundle, which of course will never be put to the test.  Throw in some freebies from smaller vendor-partners looking for exposure.

The problem is two-fold: no compelling reason to go the store, and an unmemorable customer experience when you go.  Lots of stores are struggling with the first aspect, and Apple's retail stores have mastered the customer experience part.  Until these problems are worked out, the same-store sales decline, absent significant new technology introductions, will continue.

Tata's Nano Experiment: Lessons Learned?

The Tata Nano experiment was a very noble undertaking. Ratan Tata, the Chairman of Tata, is said to have tasked his engineers to build an affordable car for Rs. 100,000. This is the repeat of the Volkswagen undertaking, which was to create the "people's car." When Fiat came to the United States market, it came with low end 128's aimed at students and new graduates taking their first jobs. The first Datsuns weren't bad, but they were cars powered by motor cycle engines. When the Yugo came to these shores the mission was the same: affordable transportation that would launch a brand and open up other market segments.

What went wrong in all these cases? First and foremost, they were all lousy cars, but the Volkswagen's were the best of the lot. Mr. Tata should have modified his charge to his engineers: "Build me a Rs. 100,000 car that's safe, reliable, fun, and that you and your families wouldn't be ashamed to be seen in!" That would have ruled out the Fiats and the Yugo right away. The next, primary mistake is that these cars weren't really designed for their markets or their customers. The Fiats were badly underpowered and couldn't merge onto an onramp at 55 mph. The Yugo was a laundry list of disasters: incompetent, post-Soviet style engineering and low manufacturing quality were the real problems.

The Nano has the advantage of derivative styling that looks stolen from Nissan and others, but it's passable. The wheels are way too small, and the tires way too narrow for the awful Indian roads. Building small cars well is not a skill that confers itself automatically from being able to build light trucks or large sedans. It's a completely different engineering and consumer mindset. The Chief Minister of Gujarat is photographed supposedly entering the passenger side of a Nano in the NY Times, but judging from his girth and the opening of the door, he might have needed a shoehorn. Again, this is a design issue that a small car maker should be able to deal with.

The worst part of this story? The communications debacle. The Nano has been reported to have experienced a small number of fires. Instead of dealing with it quickly and decisively, foot-in-mouth disease broke out. First the company denied there were any issues. Beating a retreat from that untenable position, the company blamed the problems on "foreign electrical equipment." I'm sure that their supplier-partners loved to read that news. Just to be mensches about it, the company extended the warranty period marginally and said that they were going to improve the exhaust and electrical equipment, just for kicks. This pattern is the same one followed by Suzlon when their carbon fiber composite wind turbine blades failed on deployment in Minnesota. The excuses were just that. Not understanding the markets, not doing the homework, and not dealing with issues head on are present at every post-mortem of these commnication fires.

Tata will eventually get better, but the corporate mindset will have to become more open to change and listening to the market.

VW Loses Its Way

VW is shaking up its top executive management and changing its strategy to focus on the American market, and it couldn't come at a worse moment. The North American market is probably permanently downshifting to a lower level of sales, and it is narrowing the mass market segment, while also increasing segmentation in the luxury segment.

VW's always had wonderful, German characteristics: tight, precise steering; great brakes; a good front suspension; reliable gearbox and short throws, to name a few. Plus, they were economical and flat-out, fun to drive. My last VW, a German-built diesel got 50 mpg in New York City driving in the eighties and cost me nothing to maintain.

Now comes the news that they are going to "Americanize" the car. Big mistake. They were so close to having the right car in the Jetta, which had Rabbit-like performance in a big, comfortable sedan. They never got it quite right, but they were very close. They should go over the finish line with the Jetta platform. Apparently, it's back to the drawing board, and I don't think it will work. We have Saturns, Hyundais, Accords, Camrys, Nissans and Mazdas. Another me-too model won't work, and without the Teutonic flavor, VW will lose all its distinctiveness.

Some consumers regarded VW higher-end Jettas as BMW for the Ordinary Joe. Now their cup of Joe is going to become a cup of Sanka. Too bad.

Marketing an Accent and Coming Clean

BBC America runs a funny series of commercials about how British accents elevate the receptivity of the audience to a character, and their good example is Patrick Stewart as Captain Picard on Star Trek. I definitely would take him more seriously than Captain Kirk!

I was in a Minneapolis restroom looking to dry my hands, and I came upon a new hand dryer that was different from the ubiquitous down spouted, hot air blowers we've all seen. This one was made of a familiar grey plastic, and was dubbed an "Air Blade" dryer or some such name. It was made by Dyson, the company that has made a fortune selling bagless vacuum cleaners that "never lose their suction." More on this later.

The Dyson dryer was said to be more efficient at drying and more sanitary than wiping your hands. You put your hands together, fingers pointing down, into a slit-type opening and air dries your hands. I couldn't see the difference compared to the old, Edsel-style dryers. Dyson's great advertisements feature its very studious, well coiffed founder speaking in a great British accent. The first time I heard him, I ran out and bought the first Dyson vacuum cleaner. After all, he was an engineer, an innovative problem solver, and he personally hated vacuums that lost their suction, just as I did! What could be better? He had my implicit trust, and the accent was key.

This wasn't David Orek, who sounds like a carnival side showman, lifting bowling balls with his little vacuum cleaner. Dyson had size, design, plastic, and style.

Where am I going with this? One of Dyson's messages is that it solves the important problems, like unsanitary conditions from poor hand washing and vacuum cleaners that clog and lose suction. A recent Mayo Clinic study looked at hand washing in public facilities and found no relation between the use of towels versus the use of air dryers and better sanitation. The important variable in reducing germs and improving sanitation was technique in washing and time spent drying. Spend the right amount of time, and good old, brown paper towels are just fine. So, Dyson didn't solve a problem that was specific to the drying medium (towels), but it might have fed our own laziness that we'd rather have blown air than our own muscle power to dry our hands. Not to mention that lower waste from towels is offset to some extent by the constant repair and replacement of the air units, in addition to their energy costs. To paraphrase Alexander Graham Bell, "What have we (sic) wrought?"

Finally, as I sit here cleaning out my Dyson vacuum , I can come clean. Yes, the vacuum cleaner has no bag, and therefore it cannot lose suction from a full bag or a blocked filter. However, it does lose suction, often and unpredictably. There are some vents in the cyclone housing that clog up easily with lint or dust. Once these are blocked, the Dyson, cyclonic moving air mechanism comes to a halt and nothing is picked up. Yes, they got rid of the bag problem, but they substituted another problem, which is really the same issue. I really wanted to believe Jim Dyson, I really did, but he wasn't honest with me or millions of other consumers.

He really does make the best commercials though, and he has that great accent.