Market-Based Management®

Hurricanes Destroy Value, They Do NOT Create it...

An excerpt from an unfortunate story pointed out to me by Neal Kumar:

J.P. Morgan senior economist Anthony Chan agrees that higher energy prices will curb both regional  and national economic growth in the near-term.

"I think a 0.2 percent decline in economic growth due to Katrina's impact on oil and the regional economy is a realistic assumption," Chan said.  Longer-term, Chan believes hurricanes tend to stimulate overall growth.

Said Chan, "Preliminary estimates indicate 60 percent damage to downtown New Orleans.  Plenty of cleanup work and rebuilding will follow in all the areas.  That means over the next 12 months, there will be lots of job creation which is good for the economy."

Prof. Doug Woodward, with the Division of Research at the Moore School of Business at the University of South Carolina, has researched the economic impact of hurricanes.

"On a personal level, the loss of life is tragic.  But looking at the economic impact, our research shows that hurricanes tend to become god-given work projects," Woodward said.

Disasters are good for the economy, he said.  Within six months, he expects to see a construction boom and job creation offset the short-term negatives such as loss of business activity, loss of wealth in the form of housing, infrastructure, agriculture and tourism revenue in the Gulf Coast States.

Of course a disaster results in economic growth.   The question is, where are you drawing the starting line?!   The economy as a whole has suffered a huge loss -- the hurricane destroyed millions upon millions of dollars of personal wealth.   Any growth that occurs is effectively a wealth transfer of whatever remaining funds these poor, unfortunate people have (and the rest of us taxpayers who will be supporting the rebuilding efforts through federal initiatives) to the individuals who will provide the products and services necessary to replace what they already had. 

Walter Williams uses Bastiat's "Broken Window" story to get to the heart of the matter when addressing similarly disturbing statements by other journalists regarding a previous hurricane in Florida:

"This kind of reasoning, often put forth by poorly trained economists, doesn't even pass the smell test.  Think about it this way.  Using [these] statements, if 'from an economic point of view, it (hurricanes) is a plus," would the country have been better off if the entire East Coast shared Florida's damage and destruction?  If it would have been a plus for the East Coast, what about hurricane destruction for the entire nation east of the Mississippi?  Almost anyone with a speck of brains would recognize that equating economic growth with destruction is lunacy.

French economist Frederic Bastiat [said], 'There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.'  In the case of Florida's hurricane disaster, what is seen is the employment associated with rebuilding.  What is unseen is what Floridians would have spent the money on and the benefits therefrom had there not been a hurricane destruction."

Frederic Bastiat's essay, "What is Seen and What is Unseen"  contains the Broken Window section and it is well worth your time to read this simple, short, and powerful work just to get a perspective of how the statements quoted in the first story above border on the immoral. 

Gas Price Caps Revisted...

I was just telling someone the other day how amazing it was that we had reached the level of real (as opposed to nominal) price levels of gasoline without a clamor from politicians for price ceilings.  Perhaps we'd actually learned something from our past? 

I must have jinxed it.  Hawaii has just enacted a cap on wholesale gasoline prices beginning Sep 1.  California and other states are now actively investigating the option.  I suppose the good news is that this is being done at the state level rather than at the federal level...  hopefully some states will wait, watch the resulting fiasco, and avoid the mistake. 

The cynic in me says that the other states will simply cry foul when gasoline flows freely to states that haven't enacted caps, and attempt to hit the rest of us over the head with a federal bat by demanding national price caps. 

Ideas matter.  Folk economics (like pop-psychology in its field) has devestating results.  Here's an example of how a folk economist thinks...  quoting from this morning's Chicago Sun Times story:

"I think [the wholesale gasoline price cap] is initially going to hurt," said William Aila, Jr., 47, harbormaster of a marina in Waianae.  "But if we're looking at a world where gas goes to $5 but it's capped here at $3, then that wouldn't be bad."

A friend of mine reacted to the news of Hawaii's price caps by reflecting on his first hand experience of how anti-market price fixing worked in the former Soviet Union with gasoline:

"We wanted to buy gasoline for our scuba compressor and suggested going to a town nearby to buy some.  We said we would just pay someone who is driving around in a car (and there were many) an extra couple of dollars (i.e. a full day's salary) for a couple of gallons of gas...  Our Soviet host said, in all seriousness, 'No, gasoline is very cheap in Kandalaksha.  You can't buy any there.'  It looks as if the government of Hawaii studied at the same school of economics."

When I shared this with Doug Beach, his thought was, "different school, same sponsor."  Amen. 

You can't pass a law and get rid of high prices.  You will end up paying one way or another because price is just the messenger -- shooting it doesn't get rid of the problem, but it does get rid of a direct connection to reality that would allow creative solutions to emerge in attempts to solve that problem.

Take a picture of Creative Destruction - just make sure it's digital

Kodak is suffering. With conventional film demand expected to decrease another 30% this year the cash cow with which Kodak dominated the photographic industry is dying.

In 1988, at the height of its power, Kodak employed 145,300 people. By 2001 the workforce had dropped to 75,100 and with the planned layoffs announced today the total workforce will soon drop to below 50,000 employees. Kodak's "swelling digital business" is simply not growing fast enough to offset the quick death of last century's photographic mainstay - conventional silver-halide film.

If only Kodak had been mindful of Peter Drucker's quote " It is much cheaper to make yourself obsolete than to be made obsolete by your competitors." Kodak's unwillingness to creatively destroy their own product has resulted in competition for which Kodak was unprepared.

At Google, Pi stands for Price Seeking

Received this email from Doug Beach, a Trading leader with KS&T in London:

"The evolving Google story is interesting stuff, as well as pretty darn funny (to me).  Yesterday's Euro WSJ article was a classic. Google issues $3 bil of stock for no apparent reason, except the clearly stated one that they want the money, sell a volume of shares whose value is the first eight digits to the right of the decimal of Pi, and has analysts and numerologists alike scratching their heads to find the hidden meaning of it all beyond the obvious."

In yesterdays' US WSJ, Alan Murray commented (subscription required):

Let's try a little test.  If I offer you $100,000 for your Honda Civic, how would you respond?  Here are your choices:  (a) "No, thank you, my checking account is already full," (b) "Maybe, but let me look around first to see if there is another car I'd like to buy," or (c) "Here are the keys!"  If you answered (a) or (b) you have the makings of a Google analyst.  There's no mystery here, folks.  When companies think their stock is undervalued, they buy it back.  The Googlers are in the opposite fix.  Their stock is overvalued, so what do they do?  Sell more.  Quickly.  Before sanity returns to the marketplace. [...] It is always hardest to recognize a bubble when you are being lifted by it.

Their use of a Dutch Auction method to offer shares is also an innovative way to price seek, as opposed to the more price-taking behavior of transacting through an investment bank.

 

Bittersweet times at Krispy Kreme

I was saddened to read a recent headline in USA Today that reported that an internal investigation at Krispy Kreme will force the doughnut chain to restate earnings by over $25 million going back to 2000 and perhaps earlier."Saddened" because it appears that another corporation has placed the need to satisfy Wall Street above doing business lawfully and with integrity. 

And while the story could easily end here, a closer look reveals that ignoring the fundamental free market model of subjective value likely drove decisions that have resulted not only in various investigations but a loss of shareholder value that stood around $5o per share in 2000 and is around $7 per share today.

In fact , Krispy Kreme's decision to expand to todays 380 locations coincided with a change in consumer tastes to high protein, low carb foods such as meats, cheeses and nuts.  And yes, this has fueled prosperous times for companies such as Diamond Foods.  The success of Diamonds' Emerald-brand line of nuts is key to the company's July IPO.  As of today, Diamond's stock price is up 24% from the orignal offering at $17.

So the lesson, dear reader, is that we must always conduct our affairs lawfully and with integrity as well as constantly evaluating and satisfying the changing needs of our customers.   Only then do we create real long term value in society.

Exploration Place needs your (a) attendance, or (b) tax dollars

The Wichita Eagle is reporting today (no subscription required) that Exploration Place needs 2.8 million dollars per year to stay open.  With an operating budget of 4.7 million for next year the muesem is in financial trouble - even considering dipping into their endowment to pay for operating expenses.

"The consultant, Diane Frankel, said the museum would need permanent help from the public, either the city or county, and possibly even a special arts tax."

Just what we need, a special arts tax to go alone with our sports (arena) tax. It reminds me of a joke. 

Have you heard about the new simplified tax form for businesses? It has only three boxes. In the first box you write your revenue, in the second total expenses, and the third (the difference between box one and two) is the amount you remit to the government. 

A Politician's blind spot

Senator Lott will release his book Herding Cats: My life in Politics at the end of this month. I could go on and on but I think two points are worth noting.

#1 In the book he laments the timing of Frist's challenge to his leadership. Lott seems to believe that if Frist had not challenged his leadership he would still be in power today. But the reason he was imperiled to begin with was his comments at Strom Thurmond's retirement party, which many construed to be racist. Lott complains that President Bush also delivered a telling blow when he stated that "Lott has apologized and rightly so."  Of course Lott believes his removal was not necessary, but his comments had weakened his ability to lead. Instead of believing his thoughtless words were the root cause of his removal he sought and continues to blame others. The issue died shortly after he was replaced as the Senate majority leader. Lott believes the issue would have died even if he had remained in office - although  a view based in reality would suggest otherwise (Newt's post office fraud and Clinton's intern fling being just two examples that did not easily die). 

#2 Lott's partnering with Clinton (on health and welfare legislation the President was pushing) drew criticism from his own party and weakened Dole's push for the white house during the election campaign of 1996. Of course Lott describes his undercutting of his own colleague as doing what was in the best interests of his party.  Of course he fails to ascribe such high motives to those who removed him.

The ability of politicians to evade personal responsibility once again highlights the difference between the market and politics. A firm must translate intentions into results or it will fail to exist - in the end there is no place to hide. While in the political realm some politicians can build a successful career on being able to pay the blame game more effectively than their competition.

Customer Focus

Here's a message to the customer service department of Typepad, which provides our blogging service:

"Guys... Great -- no -- Awesome service. But if you can't handle problems like the one I am having then you're headed for a cliff. I am a customer who CAN and really really WANTS to pay you. You are not helping me... this is a little frustrating, which is enhanced by the fact that there's no way to talk to any of you... ever... even after multiple attempts via your ticketing system have failed to resolve this problem. Would you PLEASE have the owner of your company call me so I can get this resolved... If costs are an issue re: support then call me collect if you have to. -- Benjamin Pratt"

Sure, it's a bit whiny and annoying.  In my defense, this message is the culmination of several months of attempting to resolve a pretty basic billing isssue -- I'm using a valid credit card that works for Amazon and everyone else, they (according to my bank) aren't posting to my account (i.e. I am the typical customer and think it's their problem). 

Here's the response I got:

Hello Benjamin,

Thank you for your note, and the compliment.

I know billing issues can be very frustrating. I do apologize, but nobody is currently available to offer you telephone support. All of our support is done online through the Help Ticket System.

It looks like your account has been updated with a new card as of today, and is currently up-to-date. Presently, the system is showing that it has been accepted without a problem, but we will have to see if we receive a message from your creditor that payment has been verified and processed after the billing cycle runs again.

Please let us know if you have any further questions. We do appreciate your patience.

Thanks Benjamin,

Vanessa

The response, typical to the others I have received, was patient, curteous, and kind.   But not very helpful, since I've updated the credit card info every time to no avail - so this is  a "do the same thing and expect a different result" cycle.  In fact, given the long history, it was actually perplexing to me and I started thinking... What's driving this behavior?  Isn't it weird that someone would say that they can't use the phone?  Are they in India and the phone expenses would be cost prohibitive if they are a small company?  Are the service reps given the policy, "no phone calls, ever, no matter what?"  Is it the fact that the do have the authority to use good judgment and resolve issues by phone, but my case in comparison doesn't warrant that in Vanessa's opinion?

I don't know enough about the company's vision and operating model / competitive environment to say her approach  is right or wrong.  As a customer, though, I don't have to know anything other than it didn't address my issue to my satisfaction.  I'm left now with a choice -- is the value of the service greater than the cost of dealing with the service?   So far it is...  Basically because I contintue to receive premium service without getting charged.  But I have started shopping around to see if there are other blog services that are better, which I hadn't done up until this response...

I'm curious to hear what others think.  If you would be so kind,  and give me your thoughts by clicking on the "comment" just below the last line of this post.  Given the limited information at hand, is this company customer focused?  What else would you want to know?

Deals from Hell - Book Review

Posted on behalf of Dick Anderson

Deals From Hell:  M&A Lessons That Rise Above the Ashes

By Robert F. Bruner

Valuable lessons can be learned by studying failure and business professor Robert Bruner looks at some of the most important lessons from the world of mergers and acquisitions.  He states that M&A’s fail because of a convergence of forces, a “perfect storm” of poor choices, poor execution, cognitive biases, and bad external conditions.  In Deals from Hell, Bruner reviews ten case studies of big M&A disasters and pairs each disaster with complementary cases that are different enough to be instructive in understanding the M&A process.  Bruner argues that all the failure of an acquisition could have been avoided or sharply mitigated by making wise choices in some critical areas.

Early in the book, Bruner refutes the notion that M&A is a loser’s game.  Bruner refers to more than 130 studies which claim M&A does pay.  These sources generally claim that barely 20% of all mergers really succeed…..most typically erode shareholder wealth and fail to achieve any real financial returns. Yet there is no empirical research that documents this low success rate of M&A activity with any level of consistency. 

Experience teaches us that all business activity (including M&A) is risky and there are very few guarantees in life.  The main purpose in studying failure is to better manage risk, not eliminate it.

The problem is developing and agreeing upon a common definition of “failure”.  It seems everyone has a different point of view on the topic and a different definition.  He claims that these studies show that the shareholders of the selling firms earn large returns from M&A and that the shareholders of buyers generally earn about the required rate of return on investment.

Bruner confronts the issue of defining M&A failure by focusing on the identifiable outcomes common in specific disasters including:

·         Destruction of market value

·         Financial instability

·         Impaired strategic position

·         Organizational weakness (culture)

·         Damaged reputation

·         Violation of ethical norms and laws

Bruner suggests that M&A is not homogeneous…..all deals are different.  He writes, “The best foundation for pursuing success and avoiding failure in M&A lies in seeing the important ways in which individual deals differ from one another.  In other words, all M&A is local.”  He identifies four common causes of M&A failure including:

1.       Strategy:  in the best deals, buyers acquire targets in industrially related areas…..in the worst deals, targets are in areas that are more distant.

2.       Strength of position:  in the best deals, buyers acquire from a position of strength…..the buyer brings something important to the deal.  In the worst, the buyer acquires from weakness…..the buyer hopes to fix problems by means of acquisition.

3.       Market conditions:  The best deals occur in cooler market conditions.  The worst deals occur in “hot” market conditions.

4.       Structuring:  The best deals are associated with payments by cash and earn-out schemes.  The worst deals are associated with payment by stock.

Deals from Hell is a timely reminder of a fundamental economic truth highlighted in Guiding Principle # 3, Value Creation:  the growth that matters most is growth in real economic value, not in share price, assets, or revenue.

The Entrepreneurship/Culture Connection

Why are some nations, cities, and companies more entrepreneurial than others? Interesting question, don't you think? A fellow employee passed on an article that summarized research conducted at the Stockholm School of Economics which studied the differences in levels of entrepreneurship across Swedish municipalities.

When faced with the above question, free market advocates automatically point to "system" issues such as tax structure, level of government intervention in the form of price controls, and the like. These policies and practices certainly make a difference on the whole and Sweden is no exception. What this study found, however, is a broad variance in entrepreneurial activity from one municipality to another within Sweden.

Why the variance? Culture. Aside from political and religious beliefs, municipalities with higher levels of entrepreneurial activity cultivate a feedback mechanism, meaning cities with more entrepreneurs tend to beget even more entrepreneurs. That is, once an entrepreneurial culture takes root, it typically spreads locally.

Economists tend to look at countries as a whole and emphasize national policies and attitudes when analyzing productivity or entrepreneurship. This study concludes that national success in entrepreneurship depends on the evolution of local cultures and their interaction with national policies.

What struck me as I read the article is our own company efforts to develop a culture of principled entrepreneurship.  Here are a few semi-random thoughts...

• It's not enough for top-level leaders to understand what they want/expect the culture to be.  All "regions" (departments, units) of the company need to embrace principled entrepreneurship as well.
• Leaders can talk about a culture of entrepreneurship, but can stifle it by micromanaging their employees, failing to delegate appropriately, and using poorly designed and/or implemented incentives.
• Company culture is obviously a combination of several things, but it is visibly displayed in the attitudes, behaviors, and actions of people.

A parting thought...Do the actions, attitudes, and behaviors of the all employees (front line, supervisors, middle managers, etc.) match those described by leaders as being "our culture"? A potential trap for any large entity is this: when the nation/company's overall results are positive, there is a false sense that the culture throughout is positive as well. Something to ponder...