Category: Theory

Theory.

The End of Management – WSJ.com

When I asked members of The Wall Street Journal’s CEO Council, a group of chief executives who meet each year to deliberate on issues of public interest, to name the most influential business book they had read, many cited Clayton Christensen’s “The Innovator’s Dilemma.” That book documents how market-leading companies have missed game-changing transformations in industry after industry—computers (mainframes to PCs), telephony (landline to mobile), photography (film to digital), stock markets (floor to online)—not because of “bad” management, but because they followed the dictates of “good” management. They listened closely to their customers. They carefully studied market trends. They allocated capital to the innovations that promised the largest returns. And in the process, they missed disruptive innovations that opened up new customers and markets for lower-margin, blockbuster products.

via The End of Management – WSJ.com.

Here is the book: http://amzn.to/9jycyp

The Android abdication

When I wrote about Android’s pursuit of the biggest losers, I made the explicit claim, backed by data, that Android was most attractive to device vendors who were in financial distress. Android is a lifeline to sustain failing business models. But underlying that claim was the more sinister implication that Android is sustaining to the incumbent operator business models. That means that Android is subject to operator manipulation and its market access as well as those of competing platforms will be throttled to maintain control.

The article below makes an even stronger case.

As a result, we now have a situation where the U.S. telecoms are reconsolidating their power and putting customers at a disadvantage. And, their empowering factor is Android. The carriers and handset makers can do anything they want with it. Unfortunately, that now includes loading lots of their own crapware onto these Android devices, using marketing schemes that confuse buyers (see the Samsung Galaxy S), and nickle-and-diming customers with added fees to run certain apps such as tethering, GPS navigation, and mobile video.

The dirty little secret about Google Android | Tech Sanity Check | TechRepublic.com.

I would not say that Android is enabling the consolidation of operator power. I would say that operator power never wavered.

The article concludes:

Despite the ugly truth that Android is enabling the U.S. wireless carriers to exert too much control over the devices and keep the U.S. mobile market in a balkanized state of affairs, Android remains the antithesis of the closed Apple ecosystem that drives the iPhone and so it’s still very attractive to a lot of technologists and business professionals.

But, the consequence of not putting any walls around your product is that both the good guys and the bad guys can do anything they want with it. And for Android, that means that it’s being manipulated, modified, and maimed by companies that care more about preserving their old business models than empowering people with the next great wave of computing devices.

That sounds about right.

Analysts' categorical failure

Gartner explicitly explained so in its press release: “Gartner’s PC group does not track media tablet sales in this PC shipment data, so iPad sales are not included in these results

via Is Apple the real U.S. PC market share leader — or soon will be? | Betanews.

The reluctance of  industry analysts to measure the iPad as a computer is a fascinating and vivid symptom of how analysts conspire with their customers to smother visibility of impending failure.

Before we dive into the motivation to ignore iPads, we need to understand how analysts in general and companies in particular group products into comparable piles. This process of grouping is called categorization. It should be distinguished from segmentation which groups buyers in a market. Categorization is essential for competitive analysis and measurement of the performance of a product (relative to other products).

Categorization is a challenging problem for most companies. To illustrate why, consider four possible methods for categorizing products:

Continue reading “Analysts' categorical failure”

Dell's running

Once the pride and joy of the world’s largest computer systems builder, consumer products now make up just 18% of Dell’s total sales. That’s probably a good thing in the long run, because this segment is notoriously margin-poor when compared to the less price-sensitive corporate computing market. I can’t blame IBM for giving up on consumers years ago, and I think Dell should follow suit.

via Make a Hard Left, Dell! (AAPL, CTXS, DELL, HPQ, IBM, MSFT, VMW).

That’s right. Flee upmarket Dell. Run, run.

Quoting from the gospel:

Step 2: Entrants grow and improve; incumbents choose flight. As disruptive attackers follow their own sustaining trajectories, they make inroads into the low end of the market or begin pulling less demanding customers into a new context of use. What happens when the disruptive entrant begins to make inroads? […]

Incumbents naturally choose flight. What looks highly attractive to the entrant continues to look relatively unattractive to the incumbent. The asymmetric motivation leads to incumbents naturally fleeing the low end. They cede that market to the entrant. […]

Remember, incumbents focus on delivering up-market sustaining innovations that allow them to earn premium prices by reaching undershot customers. They view flight as a positive development.

Talk of mobile dominance is bunk

I’ve been asked in comments on this blog who will win the “mobile war”.

I use two analytical tools to answer this question: (1) history (2) value chain analysis.

History shows that operators are very important and hence very powerful in this market. That makes sense on many levels. They control what phones you get to buy, they decide the pricing and they decide frequently how you can use the phone. This is because the networks are expensive to build and maintain and there is an implicit bargain struck that the user and device should conform to the operator.

Value chain analysis tells me that as networks are not good enough, tight integration of the business models of the phone vendors and the operators is necessary to climb up the trajectory toward good enough as quickly as possible.

Therefore, given the distribution of value/bargaining power in the chain, it’s reasonable to assume that it’s operators who will decide which platforms win/lose and to what degree.

That simply means that no single platform can win a disproportionate share because it would threaten the balance of control the operators require. So talk of “dominance” of one platform or another is hyperbole. The most likely scenario is an even distribution of share between 4 or 5 competitors, so I expect iPhone and Android to get 20% share each.

This is not “fair” or economical or efficient, but it’s the way it’s going to be for a long time. If you’re a fan, don’t despair. In a few years, it still means hundreds of millions of units a year for each platform.

If you want to dream or hope for a more efficient outcome, you’ll have to look outside the cellular network model. I.e. think how iPod/iPad and Android tablets will evolve into communications products.

(thanks to M for asking).

Android's Pursuit of the Biggest Losers

The mobile phone market is intertwined with the telecommunications industry which is vast and there are numerous competitors which are much more dynamic and better capitalized than the moribund PC or music player vendors. It’s also a regulated and fragmented global market with 1.2 billion units and 5 billion consumers—far greater than any of the markets Apple played in for its first 30 years.

Nevertheless, the iPhone has had a huge impact on the industry. To show just how much of an impact, I dove in and pulled over 500 data points on three years’ financial performance of seven competitors responsible for 80 percent of units being shipped today. The time frame covers the iPhone’s participation in the market so it allows for “before-and-after” comparisons.

I divided the findings into five articles:

  1. Unit Volumes. The evolution of market share.
  2. Revenues. The shift in where dollars are spent.
  3. Selling prices. The tale of ASP erosion.
  4. Operating margin. Profitability ratios over time.

Now I turn my attention to draw a bottom line from all the data above, namely the operating earnings (EBIT or Earnings before Interest and Taxation).

The first chart shows the EBIT from the top seven vendors of mobile phones since the quarter when the iPhone launched. I annotated Nokia and Apple’s bars to give perspective.

The total available profits in the industry dipped to a bit under $4 billion at the trough of the recession, and have recovered to nearly $6 billion in the holiday quarter last year. However, not all vendors are profitable. As you might expect from looking at the operating margins, Motorola and Sony Ericsson have been generating losses for most of this time period. They have both reached profitability in the last quarter, though at very low levels and after having lost a large part of their sales. LG has turned negative this past quarter after being a modest earner for some time. Samsung has maintained a fairly even consistency in its profit capture, though with its expanding market share, it seems to have come at the cost of pricing.

Finally, looking at the pure smartphone vendors RIM and Apple, the picture is nothing short of astonishing. This before-and-after share-of-available-profit chart shows that the two entrants went from about 7% profit share to 65% in three years.

Apple in particular is capturing about half of the available profits with three percent of the units. It dwarfs all the other vendors, more than double the nearest (Nokia). All that in three years and with the added burdens of only three models, a recession and limited distribution.

What does it all mean?

Here are my conclusions, enumerated:

  1. The lack of a real response. The recurring theme in this series of articles has been that giant multinational incumbents in a vast and rapidly growing industry, enjoying all the advantages that size and incumbency, have had their profits taken from them. And they don’t seem to have put up much of a fight.
  2. It’s all wealth transfer. Note the total amount of profit available has not increased markedly; this is not about incumbents growing the pie. Two thirds of what should have rightly been theirs moved from the incumbent shareholders to the entrant shareholders.
  3. Speed. This shift of profit occurred over an unprecedentedly short period of time.  Three years is no more than two product cycles in the industry and it’s an order of magnitude faster than what happened historically to other industries.
  4. Disruption is the diagnosis here. The incumbents were caught in the headlights. Disruptive innovation leads to asymmetric competition and this is what we just witnessed. History has shown that the shift of profits is usually the last stage of disruption and is usually irreversible because the change in business models cannot happen at the rate of change of profit transfer.

Which leads me to one final point.

When analyzing the potential for challengers to the new winners, the most cited is Android. Can Android affect this redistribution of profit once again? And to whom?

If Android is to become the dominant platform, does it depend on the success of its licensees? Who are these licensees and what are the chances that they will be able to align their businesses to what Android offers (a new revenue model based on services and advertising).

One problem I see is that Google is making a bet on those same vendors who are now squeezed in the middle of that last pie chart: Samsung, LG, Motorola and Sony Ericsson. Nokia, Apple and RIM will certainly not take the OS over what they already have as it dilutes their differentiation and margins. That means Android is aligned with the biggest losers in the industry.

So how likely are these disrupted ex-giants to recover and take Android forward? My bet: slim to none. Android does not offer more than a lifeline. It is not a foundation for long-term profitability as it presumes the profits accrue to the network and possibly to Google. Profit evaporation out of devices to Google may be a possibility at some time in the future, but only if the devices don’t need too much attention to remain competitive. But because they’re still not good enough (and they won’t be for years to come), it’s certain that attention to detail is what will be most important to stay abreast of Apple.[1]

So here we have the real challenge to Android:  partnership with defeated incumbents whose ability to build profitable and differentiated products is hamstrung by the licensing model and whose incentives to move up the steep trajectory of necessary improvements are limited.

In other words, Android’s licensees won’t have the profits or the motivation to spend on R&D so as to make exceptionally competitive products at a time when being competitive is what matters most.

[1]: I would argue the same lack of symmetry with licensed software vendor Microsoft is what led the the failure of the same incumbents to make a dent in the industry with Windows Mobile [2003 to 2010].

Apple growth trading at GE value

Speaking of correlation…

General Electric, the largest holding in the S&P 500 Value Index Fund, has a forward price-earnings ratio of fourteen. Apple, the quintessential growth stock and largest member in the S&P 500 Growth Index Fund, sports a P-E based on forward 12-month estimates of just 15.5 right now.

via CNBC’s Fast Money : Growth Vs. Value Confusion as Apple, GE Treated Equally – CNBC.

The near-death experience prerequisite

All phone vendors saw smartphones coming.  They hired all the right market research companies and spent lavishly on analysts to confirm that phones with operating systems were imminent.

Nokia was one of the early movers, establishing its own software platforms group as early as 2002 while others like Samsung licensed Windows Mobile or PalmOS as early as 2003. Yet not much happened to sales. The number of smartphones units sold as percent of total has been fairly low.

The following chart shows the number of smartphones sold as a percent of all phones sold for the top three vendors (as of the time when the chart starts early 2007). Note that the percent of smart products shipped did not accelerate or grow dramatically for the largest two vendors even into last year.  It’s still a pittance at Samsung (<5%) and even less at LG.

The one vendor that did stage a shift was Motorola. (and Sony Ericsson, though later and softer) Both converts did this shift when faced with near-death experiences of sequential earnings losses and catastrophic market share collapses.

Nokia is showing signs of a secular shift to smartphones but it’s been a decade-long process so far, a slowness that ripped shareholder value to pieces.

So is the precondition for a shift to smartphone focus a collapse in the core business?  It certainly seems so from the data. Motorola first, Sony Ericsson second, Nokia presently and Samsung and LG later.

Each of these decision points reflect precisely the timing of pain points with the core businesses.

Why this asymmetry? At first glance, the smartphone business should be sustaining and an attractive option to be exercised as soon as possible.  It offers better margins, better prices and a better return on capital.

So why is there this disconnect? As regular readers of this blog can probably guess, my hypothesis is that the smartphone business is disruptive.  Incumbents are motivated to ignore this business because it makes money in ways they cannot control. More importantly, their best customers are signaling (in non-transparent ways) that they don’t want their top vendors to participate in this market.

The parable of the transistor

This weblog could be read as a diary of the disruption of the mobile industry. There is lots of topical analysis and opinion, but sometimes I’ll post on the “theory” which describes what’s going on in a more abstract, and long-term, level. Theory is like a bullion cube: savory, but too concentrated to be enjoyed undiluted. For this reason, the most palatable way of administering theory is through example. So we kick off with an example of what happened to another technology industry as a result of the emergence of a disruptive technology.

The following is a draft article I wrote describing the “electronics industry” for POSTWAR AMERICA: AN ENCYCLOPEDIA OF SOCIAL, POLITICAL, CULTURAL, AND  ECONOMIC HISTORY. It is itself based on a presentation by Clayton Christensen at the Open Source Business Conference in 2004.

—-

The consumer electronics (CE) industry began in 1920 when radio broadcasting commenced in the United States. Radio technology sustained a growing electronics business throughout the 1930’s and 1940’s, however, the electronics industry underwent a major transformation after the war. The critical development came after 1948 when the transistor was first invented. The transistor and the subsequent development of solid-state semiconductors dramatically and profoundly changed the industry. The change the transistor brought was not just evident in measures of technical performance but also in the economics of the industry and the business models required of its participants

Continue reading “The parable of the transistor”

Why Apple's cash is worth more than Microsoft's cash

My recent exposé of Apple’s cash (and cash equivalents and long-term securities and short-term securities) drew quite a bit of attention, which is good. Because it needs to be demystified. However, the story does not end there. Part of the problem of cash is that the liquid stuff can often itself change in perceived value due to mis-management.

Cash has to be valued on the basis of what’s to become of it. So what can become of it?

The value in liquid assets can be returned to shareholders in the form of a dividend, which means double taxation on profits; not the best idea usually. Or it can be returned in the form of share re-purchase which tends to have only a temporary effect on share prices, again not a great return. The value can also be increased by means of investment in projects that return higher than what investors expect their cost of capital to be. This is the best option but investment is difficult when the amount involved is so big that no project or set of projects could possibly cost enough to employ the capital. Finally, the value can be completely destroyed through large acquisitions.

I say destroyed because the history of large acquisitions is almost universally known to be value destructive (1). The urge to M&A is why cash on the balance sheet for large companies is usually discounted and share prices “get no credit for it.” This is plaguing Apple with a P/E ex-cash in the teens.

Is this fair?

Continue reading “Why Apple's cash is worth more than Microsoft's cash”