Big Red Horseshoe - Vanderbilt Owen MBA Students on Business Strategy

Only Slightly Related...

...but very funny. I hope a student or professor puts this slide into a corporate social responsibility presentation this year. Also good for financial statement analysis guffaws.

(from Indexed)

GM Is Back In Black, Back To Incentives

A few months back I followed GM for a core strategy course. Researching a storied, legendary company could not have been any more depressing. Legacy costs -- pensions, health care -- were dragging down the company just as much as its bloated corporate structure and poorly aimed product lines. There looked to be hope on the horizon, but when and how soon? Turning around a big ship isn't like doing a U-turn in a Yugo.

Well look here, GM posted a $891MM profit in Q2. In Q2 last year the company lost $3.4B. That's an improvement of $4.3B, for those of you keeping score at home. The improvement came mainly from "key growth markets." North American operations lost reproted a net loss of $39MM. That was a big improvement from last year's $3.95B loss in Q2 last year. How did GM improve North America?

"GM said that its North American results reflect reduced fixed costs and that a high percentage of its vehicle sales last quarter were of profitable large trucks and well-equipped vehicles."

Back to the SUVs, are we? Kind of like McDonalds going back to the 42-ounce soda this summer. If I were an analyst or investor, I'd want to see North American operations buoyed by something other than large trucks. GM can't go to the same well forever. At least one analyst thinks North America will turn around.

From Bloomberg:

"'One of the most overlooked benefits of GM is its global strength,'' said Brandon Ferro, an analyst with KeyBanc Capital Markets in Cleveland. 'It goes to show you that once they get North America on track, you've got a potentially pretty profitable company over the long term.'"

Related news: GM is offering 0%, five-year financing that is a break from the company's previous strategy of selling vehicles without rebates. Seems that inventories and competitors are to blame.

"Joseph Amaturo, an analyst with Buckingham Research, said in a note yesterday that full-size trucks and sport-utility vehicles are 'clearly GM's most profitable' vehicles, representing an estimated $7,000 to $10,000 in per-vehicle profit margins. He said sales and production of the vehicles will 'come under pressure during the second half of 2007 and into 2008 as a result of higher fuel costs and the aging of the vehicle(s).' He also said 'irrational incentives from competitors' could add extra pressure."

PR Ink Bomb at Adobe

Adobe's PDF has become the "xerox" of today's document exchange, but some printing companies are complaining they have been cut out of the loop.  In the latest version of their software, the option of sending your document to be professionally printed at a FedEx Kinko's is available on a dropdown menu. From the Memphis Commercial Appeal:

"Through a partnership FedEx Kinko's and Adobe announced in early June, people using the most recent version of Adobe Acrobat and Reader 8.1 can electronically transfer documents for printing to FedEx Kinko's by clicking on a "Send to FedEx Kinko's" button that shows up as an option under file choices."

Although this functionality has been available in Adobe for years, small printers are now starting to push back, perhaps due to the increased visibility of the option. Underlying the obvious competitive concern of the small printers is the industry trend towards on-demand printing. Instead of printing large volumes of material that could soon be outdated, the FedEx Kinko's model leverages their retail network to send small quantities of collateral to the city where it is needed. This variable cost model avoids obsolete inventory, shipping, and the warehouse storage costs. This approach seems to make more sense in our digital world.

The printing groups took their concern's to Adobe's CEO Bruce Chizen in June, but that did not seem work. Now they are waging the battle in the press.  Some printers are shouting for a FedEx boycott. I predict that this call will likely go unheeded as FedEx is so embedded in the high priority shipping needs of the printing industry. With the recent acquisition of Macromedia's Flash video suite, the Adobe authoring software has become even more ubiquitous in the desktop publishing world. It is hard to imagine a world without PDF. It will be interesting to see how Adobe responds to the offended printing associations who are part of their core customer base. This may be just minor PR gaffe or it could snowball into a major strategic blunder. Is an alliance with one large company is worth alienating a large number of small users? Or are the small printers a dying breed?

Weekend Reading

(A day late thanks to a dead laptop.)

-- "Are We Heading Towards Another Internet Crash?" at The Independent: "Past technology revolutions suggest that there are two key factors that help companies survive burst bubbles. First, successful companies tend to ensure that they make their technology relevant and easy to use, rather than just promote its inherent qualities. The companies that survived the railway revolution, for example, did so by focusing not just on building new routes, but by providing toilets, new dining cars and better suspensions on the carriages. Similarly, websites such as Amazon, eBay and iTunes are all notable for their functionality. The iPod, too, provides not just mobile music but a great customer experience. Second, companies need to focus on operational execution. All too often, management attention is on strategy and the excitement of launching or acquiring new business ventures. The more mundane task of meeting customer requirements can get neglected."

-- "How Much of Leadership is About Control, Delegation or Theater" by Jim Heskett at HBS Working Knowledge: "Some leadership theater is unplanned, but it requires the right reflex action on the part of the leader. For example, I once observed Bill Pollard, then CEO of ServiceMaster, spill a cup of coffee at a board meeting at the company, one offering cleaning services whose leadership had long advocated 'servant leadership.' Without hesitating, he asked an associate to get him some cleaning materials and proceeded to get down on his hands and knees to soak the coffee out of the carpeting while his board of directors stood watching. No one commented on what was happening. It seemed taken for granted that it was a demonstration of what a leader should do in that case."

-- "Boxed Set" from Rob Walker's "Consumed" column in the New York Times' Sunday Magazine: "The crass use of the word 'unit' to describe a buyable collection of music makes a certain sense in this case. The $25 Buddha Machine is the size of a cigarette pack, with one button, an on-off dial and a rather tinny speaker. Inside is a chip containing nine digitally encoded music loops. The button allows the listener to switch from one to another, but that’s the extent of user control over the experience, leading some observers to refer to the thing as the anti-iPod."

Summer Beverage Strategies: Revisit Old Flames, Raise Prices

McDonalds posted its second ever loss for the quarter. Not the biggest deal in the world since the loss of $711MM came with a one-time charge of $1.6B from the sale of operations in Latin America. Revenues rose 12%.

Maybe it's just a coincidence that McDonalds went with an old profit-making strategy this summer. Even though the company dropped its "super size" options a few years back (in the wake of negative publicity after the release of the documentary "Supersize Me"), McDonalds introduced the Hugo, a limited-edition, 42-ounce cup of soda that sells for an incredible 89 cents. ("Price and participation may vary," claims the website.) With standard soda, the Hugo clocks in at 410 calories. Frankly, I'm disappointed that McDonalds went crawling back to its old flame when breaking up was the right thing to do.

From The New York Times:

"In 2003, company executives set about reinventing McDonald’s by focusing on getting better rather than bigger. In the last few years, McDonald’s has seemed to do just about everything right.

The chain has spruced up its restaurants, improved its advertising and introduced menu items that have helped to reshape its image and reinvigorate sales.

Premium salads and apple dippers brought moms back. Chicken wraps lured people during off-hours; higher-quality coffee turbocharged breakfast business.

McDonald’s stock price has quadrupled in the last four years, and the company has reported positive same-store sales, an important industry measure, every month since April 2003.

Given those results, a new McDonald’s menu item is a bit of a stunner. Remember Supersize sodas? They’re back, except this time the chain is trying a new name. ...

McDonald’s might as well have called it the Tubbo.

Making matters worse, Hugo ads are available in several languages, making sure that minorities — who are disproportionately affected by the obesity epidemic — are aware of the budget beverage."

Starbucks plans to raise its prices for the second time in the last year. Coffee beverages will cost nine cents more, which is about a 3% increase. (It announced a price increase of about five cents per drink in September of 2006.) Starbucks shares peaked in November 2006, and since then Wall Street has been on the company's case to improve margins.

The price increase was blamed on high dairy prices (which wiped out Hershey Co's profits in the second quarter).

The Starbucks Gossip blog has some analyst quotes that predict the nine-cent price increase will result in "some traffic fall-off" and "should help both comps and margins." I'd bet those analysts ten bucks that traffic fall-off will be either nothing or next to nothing. If Americans can get through the summer of 2007 without spending less on gas, they can get through another miniscule increase on the price of their coffee ritual(s). That brings up a good question: Are Americans more dependent on their cars or their coffee fix?

Weekend Reading

- The Economist on Facebook's Mark Zuckerberg: "The venture capitalists backing Facebook may want to cash out, but Mr Zuckerberg is only 23 and doesn't need the money. He also happens to believe—rather as Google's young founders do—that he can, and should, change the world. A flotation would be a big distraction."

- The New York Times on General Electric: "There is growing pressure on (chief executive Jeffrey) Immelt to do something — anything — to get G.E.’s stock moving after six years of stagnation. Despite a 15 percent rally over the last two months, G.E. shares are still down 30 percent from their Welch-era peak. And in April, the analyst Jeffrey T. Sprague of Citigroup Investment Research stunned Wall Street by calling for a breakup of the company, urging Mr. Immelt to sell off NBC Universal, as well as the consumer finance and real estate units."

- The Guardian on the strength of the British pound and similarities to its highs 26 years ago. "At the start of the 1980s, Margaret Thatcher's government was convinced that the cure for Britain's recurrent inflation problem was to target the money supply. There was, ministers believed, a direct link between the amount of money sloshing around in the economy and what happened to prices. The answer was to make money more expensive, and that meant setting interest rates at punitive levels. Forget 5.75%. Back in 1980, bank rate stood at 17%. Fretting about the money supply, however, has come back into fashion."

Welcome to the dance. Don’t forget to pay the band!

(By guest blogger Oscar Atkinson, Owen Class of 2008)

Advisory fees in the marketplace for private companies

When a business owner decides to sell the equity in the company, it is often the beginning of a drawn-out courtship between buyer and seller that can last more than a year. Match-making bankers preside over this peculiar dance in exchange for an advisory fee based on the size of the transaction.

What follows is an introduction to the bankers who orchestrate the transaction. I will briefly discuss common practices among advisors, including large investment banks, regional firms, boutique shops and business brokers. 

Deal environment

Most of these intermediary advisors focus on the sell side of the equation because the scarce commodity is the seller, not the buyer. Advisory fees from 0.5% to 7% are paid by the seller based on the amount of money raised for the seller of the company.  Some intermediaries have gotten so picky that they will not touch a deal that does not net them more than $2MM in fees. It must be nice to not get out of bed unless there is a seven figure pay-day to spread around the company. The current M&A market has enabled the investment banking middlemen to command healthy fee-based compensation for orchestrating increasingly large deals.  Most often, the advisor's compensation will be derived as a percentage of the total enterprise value of the transaction. The fee structure is fully negotiable and can become a sore bone of contention amid big egos even though the advisory fee is a small percentage of the overall deal value.

The froth of the market

Although it is becoming increasingly common for sellers to engage multiple advisors on a single transaction, the bankers then have to fight over the fixed transaction fee. Accordingly, the larger banks seek to limit the number of parties engaged in a transaction. Large banks don’t want the small deals. Two reasons: They want to maximize their return on their fixed capacity, their people.  Banks rely on the talents number-crunching analysts and the face men and women who manage the relationships. Equally important, they want to build market share. League tables provide a ranking of the banks by the total dollar value of deals completed. The banks at the top of the stack rank will puff up with pride as they market their dominance. Banks want to continually build their brand to gain the next deal. You can hear them now: “We have the best deal flow because we have the best expertise – just look at our rankings from last year.” As you, the astute reader, may have guessed, the banks at the top of the stack can also charge the higher fees.

The Players

Bulge Bracket Investment banks

Fees are impacted by the M&A market conditions of supply and demand. Currently the best advisors are able to charge more since they are resource constrained and there is high deal flow. With liquidity high and rates low, the worldwide market for M&A has gone through the roof. The total dollar value of deals (inclusive of net debt) has risen from $1.1 trillion 2004 to almost $3 trillion in deals in 2006. In today’s frothy capital market, the larger banks prefer to deal with companies that have greater than have $50 MM in EBITDA. Fees will range from 0.5% for larger deals to as high as 2-3% for the smaller deals. Large brokerage houses are turning up their noses up at deals under $500MM in enterprise value.  Since the size of the deal has increased, the fees generally max out at 1.5% enterprise value. Some back of the envelope math tells you the large banks are looking for at least $7.5MM in fees before they will get excited. That being said, there are many mitigating factors that point to a more realistic floor of $2MM in fees.

Retail banks are getting increasingly aggressive because they provide the money for the large deals and covet the rich transaction fees that the pure-play brokers are getting.  Retail banks can leverage their corporate finance and commercial banking relationships, especially in the middle market.

Regional & Boutique firms

Smaller investment banks are a hard category to address because they are more creative in their compensation structure. There is much variation among boutique firms making it hard to give an industry standard. With the large investment banks chasing the larger deals, the retail banks, regional brokerages and boutique firms are moving up the ladder as well, handling deals that fall below the radar of the larger brokerage houses. Some boutiques will not take on a deal with less than $1.5MM in fee income. This threshold can be as low as $500,000 or even $100,000 if there is strategic value to doing a deal.

Deal brokers

This group is harder to pin down than the boutique firms because they are even more flexible in the way they receive compensation.  This tends to be a feast or famine segment of the industry as one or two deals can mean seven-figure income for the members of a small firm.  However, there may only one or two big deals that are closed in a given year. Since they are dealing with smaller companies, they will often take an equity stake in exchange for cash paid as a percentage of transaction value. In this category, the retainer may be a key revenue stream as there are fewer hands in the pot. Consulting income can smooth out cash flows and provide some stability for a smaller shop. Accordingly, many of these groups must be a jack-of-all-trades to the firms they advise. $50,000 in retainer income is commonplace, but by no means the rule.

Impact of Private Equity

Private Equity firms and other financial sponsors are flush with cash and impact the M&A market in a multitude of ways. They pay buy-side transaction fees to intermediary banks for increased deal flow and they also pay fees for the leverage that the banks add to their deals. The clients who put large sums of money into private equity funds expect their dollars to be put to work. Because they need the deal flow, private equity shops have an incentive to grease the wheels of the banks.

Exclusivity

The exclusivity clause is a hot potato for many reasons. The seller does not want to limit their options if another intermediary approaches them with a buyer. On the other hand, it is a powerful notion that you want your banker to be glad to see you. A banker that has a retainer or a promise of payment upon successful deal completion is likely to work harder. Bankers wish to avoid dead-end deals where they spend considerable resources, and receive no compensation.

Retainers

Advisors seek to smooth out their cash flows by charging retainers for the effort they put forth prior to closing a deal.  Retainers are less common with bulge bracket banks dealing with deals larger than $100MM. Often the retainer can serve as a screen to determine if the seller is really serious. Although the retainer is non-refundable, the advisor will generally credit the retainer towards the success fee. Depending on the difficulty of the work and the quality of the company, retainers can range from $10,000 to $100,000.

Parting thoughts

Although I have attempted to paint a picture of the brokers in the marketplace for private companies, the exceptions are often the rule. Fee structure can be negotiated if an advisor has hopes of a bigger payday down the road. Like any salesperson building a book of business, an advisor will participate in a small fund-raising project for a company that may have larger capital needs in the future. As any business owner knows, Everything is negotiable.

Modesty. What A Strategy!

I've worked in the entertainment business for nearly ten years, and it's always great to see an executive who understands there are two lines: A top line and a bottom line.  Yesterday's New York Times had a profile on Universal Studios Group president Ron Meyer. That he has held the same title for 17 years is a testament to his strategy of modesty.

"In a strategy that is starkly different from other top film studios, Mr. Meyer has determined that Universal should stay well behind the leaders, allowing the flashiest and most expensive projects — and typically the biggest payoffs — to go elsewhere.

'We gauge ourselves to be in the middle,' Mr. Meyer said. Universal currently ranks last among major studios at the domestic box office and hasn’t placed higher than third in the last seven years.

This approach appears to have put Universal on a permanent second tier, a strategy that could concede the future to a few 'superstudios' like, for instance, the higher volume distributor Warner Brothers. Warner has routinely invested much more than the amount that Universal spends — less than $1 billion — on production each year."

Meyer's people skills are said to be a reason for his long tenure, but his financial responsibility is the key. Rare is the entertainment exec who is content to make steady profits on mid-size sucesses.

On the other end of the spectrum, Janet Jackson just signed to Island Def Jam, a label run by free-spending Antonio 'L.A.' Reid. No details were given on the size of the contract. From a February 2004 article about Reid's ousting from Arista:

"Media reports suggested that he was forced out because, in spite of artistic and sales successes, spending was way out of line. The New York Times reported that Reid was known as a big spender, giving artists extremely generous contracts and spending lavishly on marketing and videos."

That's the story of the music business. People would rather be a bankrupt #1 than a profitable #2 or #3.

Buying, Selling, Growing

Since reading about Applebee's woes in The Wall Street Journal a few weeks ago, I've paid extra attention to the restaurant chain and its financial situation. Though the company's last annual report didn't look too terrible (okay, so I took only a cursory glance at it), the article painted a rather gloomy picture. It seems Applebee's menu and image had become too static. The suburbs, which enthusiastically embrace the restaurant in its expansion mode, have moved on to other fare while Applebee's did too little to update its image.

Today comes news that IHOP is going to purchase Applebee's for $1.9 billion in cash. Odd that the AP article blamed Applebee's woes on "soaring commodities prices" and "consumers facing high gas prices". (Or was the company's publicist doing a great job deflecting criticism away from management?) I mean, how far is it from the typical home to the nearest Applebee's? About 400 yards? Maybe I'm missing something, but I don't think Americans treat a trip to Applebee's like a family vacation.

From today's New York Times, "Ford Is Said to Consider Selling Off Its Volvo Brand."

From yesterday's New York Times Sunday Magazine (yeah, annoying registration is required...but worth it), there's a great little article on Crocs in Rob Walker's "Consumers" column. My introduction to Crocs came in a finance course last school year, and I've seen them all over New York City this summer. An interesting success story:

"Aspiring lifestyle brands are a dime a dozen, but Crocs have trod an unusual path. The shoes caught on first in Middle America, then migrated toward the more trend-centric coasts, possibly aided by the most significant marketing campaign in the company’s brief history: ads in Vanity Fair and other magazines carried the theme “Ugly can be beautiful.” (Mattson says that Batali, previously much-photographed in Chuck Taylor sneakers, discovered Crocs on his own somewhere around 2005; he has his own Crocs line now.) Comfort is the consistent theme in testimonials on the company’s site — despite the presence nearby of, say, a woman wearing Crocs with her wedding dress."

Update: I should also point out this Crocs article at Slate that ran last Friday. A company knows its doing well when both Slate and the New York Times Sunday Magazine write about its product within a three-day span. I sense that Crocs case studies will be to future MBA marketing courses what Snapple and iPod are to current MBA courses.

New Brand or Line Extension?

The question, "New product or line extension," is basic and often asked in both undergrad and grad schools. It's a question at the heart of many marketing concepts and courses.

It's a question many automakers got wrong.

From a New York Times article about the success of the Toyota Prius:

"The Prius has become, in a sense, the four-wheel equivalent of those popular rubber 'issue bracelets' in yellow and other colors — it shows the world that its owner cares.

In fact, more than half of the Prius buyers surveyed this spring by CNW Marketing Research of Bandon, Ore., said the main reason they purchased their car was that 'it makes a statement about me.'"

And this:

"Honda actually beat Toyota to the hybrid market with its Insight, but it has since discontinued that car. And it is dropping a hybrid version of the Accord, whose gas mileage was not much better than the gas-powered Accord, and carried a higher price.

Honda, which sells a hybrid Civic, said it planned to come back with a new hybrid designed from the ground up as a hybrid, not a converted car."

Said an exec at the Sierra Club, "The Prius allowed you to make a green statement with a car for the first time ever." Being eco-friendly is important to many consumers, but what is driving their purchases is a brand that allows them to show off. In the Prius they have a total, unmistakable statement. In many other hybrid cars they have brands with connections to non-hybrid vehicles. Driving a Prius says much more to your neighbors than does driving a brand extension of the Civic.

The Importance of Design Thinking (Without Getting Carried Away With It)

BusinessWeek.com's Bruce Nussbaum has a post titled "CEOs Must Be Designers, Not Just Hire Them. Think Steve Jobs And iPhone." Good reading. Here's a sample:

"In the US, CEOs and top managers hate the word 'design.' Just believe me. No matter what they tell you, they believe that 'design' only has something to do with curtains, wallpaper and maybe their suits. These guys, and they’re still mostly guys, prefer the term 'innovation' because it has a masculine, military, engineering, tone to it. Think Six Sigma and you want to salute, right? I’ve tried and tried to explain that design goes way beyond aesthetics. It can have process, metrics all the good hard stuff managers love. But no, I can’t budge this bunch. So I have given up. Innovation, design, technology -- I just call it all a banana. Peel that banana back and you find great design. Yummy design. The kind of design that can change business culture and all of our civil society as well. ...

Design is so popular today mostly because business sees design as connecting it to the consumer populace in a deep, fundamental and honest way. An honest way. If you are in the myth-making business, you don’t need design. You need a great ad agency. But if you are in the authenticity and integrity business then you have to think design. If you are in the co-creation business today—and you’d better be in this age of social networking—then you have to think of design. Indeed, your brand is increasingly shaped and defined by network communities, not your ad agency. Brand manager? Forget about it. Brand curator maybe."

Nussbaum is coming from a Web 2.0 angle here, but I get the point. As branding moves online, design plays a more integral role. Let us not forget, though, about the plain ol' sales, marketing and distribution networks that are the backbone of consumer products. Journalists get a little carried away sometimes and forget about the innovative processes that created the Dell computer, for example, on which some of them marvel at Web 2.0 companies.

Actually, Nussbaum sort of addresses that here:

"Hate me if you will, but I am a believer in Design Thinking. In the world of business, there is no value proposition left for most companies in controlling costs or even quality. All that outsourcing has leveled this playing field. Cost and quality are commoditized today, merely the price of entry to the competitive game. Design and design thinking—or innovation if you like -- are the fresh, new variables that can bring advantage and fat profit margins to global corporations."

That's an overstatement. Processes can always be improved. Companies have not yet squeezed every drop of effiency out of manufacturing, shipping, warehousing and selling. They don't make for a very sexy topic for business writers, but such improvements will always be made. But I'll agree with Nussbaum and say that most such improvements are going to be marginal. Design change can really move the needle.

I should note that some journalists call a standard change in a company's positioning statement a "design change." Same thing, new term. And contrary to what many articles might lead us to believe, not all successful changes need to be huge, design-based changed. I recall reading an article many years ago about an airline's quest to improve customer satisfaction. It had a long list of possible improvements (anything from more ice in a cup, for example, to a different magazine). Rather than shoot for a few big changes, the airline made a collection of many small changes -- and its customers responded positively. I'm sure it was a cost-efficient way to improve service quality. Design change, on the other hand, may not be so cheap.

More reading on Design Thinking:

-- Design Thinking at Wikipedia

-- "The Empathy Economy" by Nussbaum, BusinessWeek.com, March 8, 2005

-- "The Business of Design" by Bill Breen, Fast Company, April 2005

Nintendo's Wii Strategy Paying Off Almost Too Well

Since video games were the basis for the final in our core marketing class, I think it's time to revisit the incredible success of Nintendo's Wii.

Today, CNN.com (the redesigned site was launched today, by the way) has an article on the Wii's success and the product shortages that are the the result of high demand for the product.

What sets the Wii apart from its competitors is its "for everybody" attitude. While Microsoft and Sony have targeted hardcore gamers, Nintendo created a product for everybody else. And it's been a huge hit. There were reports soon after the Wii's release that people of all ages were playing Wii games -- even senior citizens. Makes perfect sense for me. I don't play video games -- no time to learn complex games, no interest in those games anyway -- but I could imagine myself playing Wii's easier, motion-control games.

Today's article showed that demand has not died down. Just the opposite. Demand is fierce. People are paying huge premiums online to get a console. According to the articles, analysts don't expect demand to drop until next year.

According to the Wii Wikipedia page, over 3.1 Wii units have been sold in North America through early June, 2007. This post at game blog Joystiq shows how Wii's first six months on the market compare to sales of other gaming consoles. Wii's 2,470,000 units are at the top of the list, better than PS2 (2,200,000) and Xbox (1,900,000).

Update: This BBC News article says Wii outsold PS3 in Japan by six-to-one in June of 2007.