investiledysfunction

David Hasselhoff has started a social network.  I will let those words sink in for a bit before I move on….

Okay here goes.

He talks about it on his website.  In Brilliont’s Top 10 Un-Commandments of Innovation, we talk about things corporations should not do as they go after innovation.  Without the authority to do so, I’m adding an 11th.

11th Un-Commandment of Innovation - If David Hasselhoff is doing it, it’s time to think of something else.

When growing up, I was a fan of Knight Rider, but is this is a sign that this whole social networking thing is going just a bit too far?  On his website, Hasselhoff (herein referred to as The Hoff) writes about Hoffspace as follows.  I’m unable to detect irony in any of the below so I assume he is serious.

In my travels round the world I have always been surprised that no matter where I go people recognize and know me, from Europe, Australia and India to the Philippines and the Zulu Nation in South Africa. This got me thinking… I realized that while two people from two entirely different countries and backgrounds may seem to have nothing in common, the only thing they might have in common is me… So I decided to start a network where people from across the world might come together and get a conversation started over me. Where it will lead, I don’t know but the world would be a better place if everyone talked a little more to each other…

So here is HoffSpace. There are videos and photos of the adventures of my life (THAT NO ONE ELSE GETS TO SEE) and also from the lives of other members. Read the discussions or start a forum on a topic that interests you. Check out Hoff TV, where I go live often. Chat with other members from around the world and make friends. Design your own home page. Add music and share your lives with others. Send me the weird, wonderful and wacky things that are happening in your life. Tell me the stories of how you are making a difference in your life and, if you need my help, ask… One man or woman CAN make a difference…

That not crazy enough for you?  Well, as of today, there are 14,217 members of Hoffspace.  Facebook, MySpace and LinkedIn needn’t worry.  That is 14,216 more than I would have expected, but who knew?

In all seriousness, perhaps the craziest part of all this is that The Hoff’s social network will likely do better than many of the new half-brained ones being launched today dubbing themselves the next Facebook, LinkedIn, MySpace.  (Read my colleague’s post on one such perpetrator, TalkBizNow by clicking here).  That said, the verdict is out on whether even these big boys of social networking really have a business.

While it won’t be valued at billions of dollars, HoffSpace will allow rabid fans of The Hoff to follow him in his exploits and let him sell more t-shirts, shot glasses, autographed pics and other assorted items to his fanbase.  The Hoff has this base and has actually figured out a way to tap into it.  Other social networks which are emerging don’t have this base and because of the network effects required for a social network, they will likely crash and burn quicker than you can say Baywatch.

For corporations, what does The Hoff’s emergence on the social networking scene really mean?  The one thing I’d take away from this is that before some innovation consultant tells you to start a social network for your customers or employees, ensure your customers or employees are engaged and care enough about you to join your social network.   In essence, does your company pass The Hoff test which is “Could you realistically get 14,217 people to your company’s social network interacting on a regular basis and doing something meaningful which strengthens your relationship with them?”  If you’re not sure or the answer is no, move on to another, better idea and leave the social networking to Facebook, LinkedIn and The Hoff.

I talked recently about why I don’t think the Red Mango & PinkBerry thing will end very well (see my recent post here).  Today’s AM New York had a similar article with a lengthy title - Pinkberry, Red Mango ignite new frozen yogur craze with a tart spin, but will it last?.

While many of our viewpoints are similar, there were a couple of choice quotes which I thought were useful/interesting or which added to the case for why this might not end well.

1st quote

“The question is, are you going to just be a niche player or will you be a national chain,” said Harry Balzer, vice president of NPD Group, a consumer marketing research firm that tracks how Americans eat. “They clearly are getting a nice buzz within the population. But we often mistake our willingness to try new things as a trend.”

2nd quote

“Still, this could be a fad that comes and goes like the last, something that Heidi Miller knows about. In 1981, the former bodybuilder opened Heidi’s Frogen Yozurt in a cramped storefront tucked into a shopping center in Irvine, Calif. She built the company to 120 locations before cashing out by selling an 86 percent stake in the company in 1989. The chain is no longer in operation.”

Heidi’s Frozen Yogurt which I never heard of could definitely be the trajectory of these guys.  The point that I raised in my earlier post still holds true here.  Similar to Heidi, the founders of Red Mango, Pinkberry and the early investors may (and will likely) do quite well.  It’s the later guys who will get burned as that is when the fad or the growth runway will end.

I was at a Wegmans, a regional supermarket chain, in NJ earlier today and noticed a small touch which made an impression.  They have checkout lanes which are marked “No Candy Lanes”.

Companies spend significant effort attracting new customers and often try lavish loyalty programs, but sometimes, its little gestures that show you understand your customers that make a real impression.  For all those parents who now don’t have to worry about their children begging for candy at checkout, Wegmans has made grocery shopping a bit more pleasant.  And all of this by some simple signs above the checkout lines.

Walking in the city today and noticed one of the best (or maybe worst) examples of accidental branding I’ve seen in a long time.  This one was a clothing retailer.  I’ve just included the picture of the store’s name below as I’m sure those of you who are fashion conscious will definitely want to check this store out.

I wanted to share a great article by my colleague Dominic Paniccia which is being featured in the coming issue of the Journal of Accounting & Finance.  The pre-edited article is titled “Budgets: All Bad Things Must Come to an End” and in it, Dominic covers the problems with traditional budgeting and discusses methods he has developed and built as the former VP, Planning & Forecasting at American Express.

To see a pdf version of the article, click here.
To see a text version of the article, click here.

Yesterday’s NY Times Dealbook contained information about a $12 million Series A round raised by Red Mango “led by a former chief executive of Blockbuster and the Dallas-based private equity firm CIC Partners. The announcement came 10 months after Pinkberry unveiled a $27.5 million round last October, spearheaded by Maveron, a venture capital firm co-founded by Starbucks chief executive Howard Schultz.”

versus

For those who don’t know about Red Mango or PinkBerry, they are hot new retail concepts hawking high-end frozen yogurt.  Uber-cool hipsters in NYC and LA love PinkBerry and paying really high prices for ‘tangy’ yogurt.  I must admit it’s pretty tasty.

Taste and naming unoriginality aside (color + fruit), here is why this won’t end well.  I’m not talking about this not ending well for series A investors who may be rewarded for their early stage risk taking, but I’m talking more about late stage investors - the series C/D guys or even the public stockholders if they ever IPO.

Why?

Primarily because one hit wonders have a pretty terrible track record in the market (see chart at end of this post).  While people point to Starbucks as an example, there will never be a need for ubiquity amongst frozen yogurt shops no matter how tasty.  Let’s remember some of the much hyped and now struggling, dead or soon to be dead brethren of Red Mango and PinkBerry.

• Cold Stone Creamery - Poor franchising
• SmoothieKing - the original JambaJuice
• JambaJuice - the new SmoothieKing
• TCBY - Anyone remember them?
• The Cheesecake Factory - Limited market for 4000 calorie meals
• Pizzeria Uno’s - Today’s Wall Street Journal talked about impending bankruptcy

A friend of mine knows the PinkBerry folks and per him, their desire is to stay exclusive and grow in high-end locales (places like Dubai, NYC, Vegas, Paris, etc I’d imagine).  If they can do that, PinkBerry could turn into a very solid, profitable business.  The problem is the $27.5 million venture capital round they raised.  With that money comes expectations of growth and lots of it, e.g., there are strings attached.  And that means aggressive over-expansion unfortunately.  And the uber-cool won’t like PinkBerry so much when the local mall has it and your uncool aunt and uncle are talking about it.

Starbucks which has been lauded as a growth company did the same thing.  The thing Starbucks had going for it, however, was a massive and growing appetite for coffee so the ceiling at which growth would stall was very high.  But nevertheless, they hit the ceiling.  To keep up with Street expectations of growth, they kept expanding.  Instead of saying to the Street, “we’re going to slow down our growth and as a result, you should lower your view of us from a growth company to a value or GARP (growth at a reasonable price) company”, they said “we’ll just keep growing.”  Nothing grows indefinitely.  Never happened - never will.  PinkBerry and Red Mango will have the same expectations of them and this will lead to bad things at some point.  I’m not smart enough to know when but it will.

The one hit wonder concept isn’t just in food retailing.  Think of Crocs (you know - the horribly ugly shoe things) or American Apparel (remember CEO, Dov Charney, who called his CFO an idiot). Lots of hype, great stock prices for a while and then plop!  You can make money if you get out at the right time, but if you ever find yourself saying “They could be the next McDonalds”, it’s apparent you’re drinking the Kool-Aid and probably a good sign that it may be time to exit.

Consumer tastes are fickle.  Red Mango and PinkBerry still have lots of runway to grow so this is not to say they’ll flame out tomorrow, but it will happen.  Plus not being a frozen yogurt afficionado, is there really room for 2 similar players in the premium markets they’ll target?

Here’s a look at the 5 year chart for some of the publicly traded one-hit wonders (Starbucks, American Apparel, Cheesecake Factory, Crocs) I referenced above.  (note:  not all have been public for 5 years)

Perhaps there is a shorting strategy here?

I’d previously written about Time Warner Cable in a prior post (see Time Warner Cable - A Rant on Why I Don’t Like Monopolies) .  In that, I talked about how customer lifetime value doesn’t matter to a monopoly like Time Warner in NYC because in a monopoly, the customer is stuck with you for a lifetime.

Today, I’ll describe (in much less detail) how the matter ended.  Spoiler alert:  Time Warner’s performance got worse (if that is possible).

With my last bill not reflecting the credits it should have received, I called Time Warner over lunch to just inform them of my prior conversations and to get the credit I’d previously been told I’d get.

The summary of my conversation is that Time Warner informed me I wouldn’t get the credits I’d originally been told I’d receive because of Time Warner policy and that the prior customer service representative misspoke.  While I explained that TWC’s policies nor representative misstatements are not my problem, it was to no avail.

The beauty of this situation still remains that I have no choice but to stick with Time Warner Cable.  So once again, monopolies are great (for the company).  It also makes me look forward to the day when I can use the internet as my television.

More generally, this is worth noting for businesses that can lose customers (unlike TWC).  Organic growth is often best enhanced by maintaining existing customers and cross-selling them on new services and products instead of just aiming to acquire new customers.

The popular blog on all things technology, TechCrunch, recently had a post on something you don’t typically see on the blog - organic growth.  The entry entitled “Does Google Have an Organic Growth Problem” - discusses an analysis by Citi equity research analyst who argues that Google’s organic growth is decelerating.

It was an interesting post and something we were glad to see given our work on organic growth.  Below are our thoughts on the post and the findings about Google.  We’ve benchmarked and analyzed the entire S&P 500 (of which Google is a member) on organic revenue generation and efficiency over the period from 2003-2007, and our #s reveal a similar story, but the picture still is very positive.

We would agree with Citi’s analysis that the organic revenue as a % of total revenue for Google as well as a % of total revenue growth is declining over the longer period we studied.  As compared to Yahoo (the closest comparable to Google if there is one), we have seen that Google is destroying their peer from an organic revenue perspective.Our analysis goes beyond just organic revenue and looks at the efficiency of generating this organic growth, e.g., how much are companies like Google, Yahoo, etc spending to achieve organic revenue growth.  We call this efficiency ratio the Organic Growth Multiplier (OGM).  The logic behind the OGM is that if one company can spend $1 to get $3 of revenue and another can spend $1 to get $5 of revenue, the latter company is healthier and has more momentum in its business.

When we look at the OGM of Google versus Yahoo and versus the larger S&P500 tech financials category, the picture is actually quite pretty for Google.  They’re tops as it relates to OGM which means a dollar of investment into their core business generates more revenue than the average tech sector company.  They also outshine Yahoo on this count as well.

The indexed OGM for Yahoo and Google over the period from 2003-2007 are 50.9 and 312.84, respectively.  Without getting into the quantitative models that underlie this, the point is that Google’s organic revenue efficiency is far superior to Yahoo.

Most importantly from all this work is that we’ve seen that higher OGM and total shareholder return are positively correlated.  So having the ability to generate organic growth efficiently is a good indicator of shareholder returns.

While the assertion that their organic revenue is declining does remain true, the news is not as dire as I’ve been reading elsewhere from those who’ve picked up on this TechCrunch entry.  Yes, if they can turn one of their acquisitions into a money maker, this will obviously supplement some of the organic revenue deceleration that might be evident in their historical core business, but on the whole Google is still a star when it comes to organic revenue generation and efficiency.  The fact that Citi retains its buy rating despite the organic picture is testament to this.

A bit on the methodology.

There are some notable differences from the Citi analysis which despite the similar conclusions do make our analysis more robust.

1.  We’ve looked at a more extensive time period (2003-2007)
2. We strip out market growth for each company.  In essence, if the market is growing at 10% and your company grows at 10%, we don’t give you credit for this.  This is rising tide growth and is not due to management’s actions and investments in the core business.   Organic revenue, therefore, in our models is only the growth we can attribute to management’s prowess (or lack thereof).
3. In our Organic Growth Multiplier, we also look at the efficiency of generating organic revenue by determining how much is spent by each company to achieve its organic revenue.  This gives a truer sense for the efficiency of the company’s organic revenue capabilities.

Yes what you’re looking at is a Krispy Kreme Cheeseburger.  This is having one of 3 impacts on you:

1. You’re completely revolted and think the person who came up with these is an idiot
2. You’re completely revolted but strangely want to have a bite of one of these
3. You’re hungry and are going to get one of these at the earliest

If you’re feeling #3, I’d recommend you purchase the burger and enjoy it at your friendly neighboorhood emergency room.  Unnatural combinations such as the above or even sometimes natural-seeming combinations often seem to lead to bad or suboptimal outcomes.  Ever buy a combo fax-copier-printer?  They generally work okay, but none of the components works as well as stand-alone units.

Some Corporate Combinations that Also Yield Dubious Results

Mergers & Acquisitions

Another example of unhealthy combinations often occurs when corporations acquire other organizations.  Whether it is done in the name of diversification, to build out a geographic footprint, synergistic value creation or some other non-sense, M&A combinations are notorious for falling flat and destroying value (Sprint-Nextel, AOL-Time Warner, Boston Scientific-Guidant).  We’ve just completed an exhaustive quantitative analysis of all mega-deals (M&A transactions over $10B) since 2000 and quantified the actual shareholder returns of such deals.  On average, they underperform the market.  Most notably, when they go bad, they go real bad.  Shareholders rarely benefit from these combinations yet they continue to happen.  (Note: We will be releasing the full mega-deal M&A analysis as a research report shortly)

Best Practices

Another unnatural and unfortunate combination we often see in corporations centers around best practices.  The logic with these combinations works something like this.

• The corporation has a broken process/strategy that is in need of fixing.  It can be anything from procurement to innovation to budgeting to strategic planning that is not working.
• To “fix” the issue, the corporation looks for best practices they can utilize based on what may have worked with other organizations - usually GE, P&G, Google, Apple, etc being favorites for practices to follow.  They find something that they like and then the magic is supposed to happen.

The recipe is:

1. Take broken process
2. Add best practice
3. The issue is fixed automagically

Unfortunately, it doesn’t work quite this way.  While researching what others have done can be useful, many organizations and managers seem content to follow the lead of others when it comes to making key organizational decisions. One of the most pervasive and damaging follower afflictions which has increasingly infested corporate psychology and behavior is a disease I call Best Practicism.

I’ve written an article entitled “The Myth of Best Practices” which just appeared in the Journal of Accounting & Finance.  A pre-print version of the article is available here as a pdf.  Click here to see it.  Some excerpts are below.

“Best Practicism is the errant belief that there are certain practices that are truly “best” and that replicating another organization’s processes, strategies and ideas within your organization will somehow miraculously yield a better reality or even leadership status. Best practices are not all bad, and some may actually exist, but when best practices become a crutch that replaces independent critical thought and innovation, it can have deleterious impacts on an organization. Best practicism is a follower’s disease and is often found in organizations who are risk-averse and unimaginative and who have lost the ability to be bold. Ironically, many organizations suffering from best practicism once were bold and risk-taking but over time, somehow that former competitive edge has been dulled.

It generally surfaces when people and organizations errantly believe that management and organizational performance are a science. The truth, however, is that there is no formula that guarantees corporate leadership or outperformance. Although obvious, organizations and managers enamored with best practices seem to have forgotten this. Phil Rosenzweig commented on this in his outstanding book, The Halo Effect, when he writes about the social science research done on company performance and states, “It’s just not very appealing to read that a given action has a measurable but small impact on company success. Managers don’t usually care to wade through discussions about data validity and methodology and statistical models and probabilities. We prefer explanations that are definitive and offer clear implications for action.”"

While M&A and best practices probably won’t lead to higher cholesterol and obesity like the wonderful Krispy Kreme Cheeseburger, the travails you are likely to encounter with them along with their uncertain results might lead to some stress and heartburn.

We do lots of work in the financial services industry and so we tend to look at what the sell side is saying about public companies we work with.

From past lives, we even know some of the guys on a social basis and will occassionally shoot the breeze with them.  Overall, they tend to be smart, driven and very good with Excel.  These are all essential ingredients for a good time.

But like the internet days when we had superstar analysts (Henry Blodget anyone?), we now have the new market guru of the financials arena in Meredith Whitney of Oppenheimer & Co.

She’s undoubtedly made some prescient calls and hasn’t been shy in making them aggressively and in an outspoken manner, but the question really is whether Meredith Whitney is more sizzle than steak?

When you look at her performance as reported in the August 18, 2008 issue of Fortune, you get some perspective into this.  They write:

“Whitney’s insights haven’t always translated into lucrative investment picks. Based on the performance of her buy and sell recommendations relative to her industry peer group - what analyst tracker Starmine refers to as an analyst’s “industry excess return” - Whitney’s stock picking ranked 1,205th out of 1,919 equity analysts last year and 919th out of 1,917 through the first half of 2008. That said, evaluating Whitney solely on the timing of her buys and sells misses the point. It’s not just that she’s bearish on the entire banking industry. What makes Whitney so interesting is the brutality of her arguments and the evidence she summons in making them.”

Based on the statistics aka something we call the facts, Meredith Whitney isn’t that great a stockpicker.  And if I’m a client or investor, I’m guessing that the correctness of stock picks is what makes me money and not the “brutality of her arguments and the evidence she summons in making them.”  Looking at her stock picks as a metric for measurement doesn’t “miss the point”.  It is the point.

However, the media love a story and Meredith Whitney provides it.  She is married to a WWE wrestler (JBL for those like me who are former WWE fans.  And no I’m not ashamed to admit that.  Okay, I kind of am).  And more importantly, she makes swing for the fences calls which attract attention.  If she was wrong, she’d have faded into obscurity.  But because she has been right on some of these big, hairy prognostications, she’s been appointed a guru and CEOs and CFOs spend time with her (most recently Ken Lewis, CEO of Bank of America, CFO Nelson Chai of Merrilly Lynch and CEO Ken Chenault of American Express).

Unfortunately, it seems the frequency of being right which I presume the folks who are ranked highly in the equity analyst crowd are is being drowned out by the magnitude of correctness no matter how frequent.

Let’s remember the primary objective of an equity analyst should be to make good calls that inform clients’ investment actions and enable their success.  As a result of this, they should be rewarded.  Somehow, being 919 out of 1917 equity analysts doesn’t seem worthy of much praise, but once again, style sells.

The question now is if Meredith Whitney’s stock picking skills don’t improve, how long will the hype last?