Yahoo's last hurrah

Monday began the final act of Yahoo, as it announced the purchase by Verizon of its traditional business for $4.8 billion. The WSJ noted

The sale doesn’t include, among other things, Yahoo’s cash, its shares in Alibaba Group Holding Ltd., its shares in Yahoo Japan, and Yahoo’s noncore patents, called the Excalibur portfolio. These assets will continue to be held by Yahoo, which will change its name at closing and become a registered, publicly traded investment company.

Also excluded was the Excalibur patent portfolio (excluding patents purchased by Verizon) valued at $1 billion.

At the close of business Monday, Yahoo’s market cap was $36.4b, suggesting that these residual assets are worth about $32b — or 6.5x as much as Yahoo’s traditional businesses. (It seems misleading to call 13% of the company’s value “core”). TechCrunch values the Alibaba and Yahoo Japan shares at $31.2b and $8.3b so something doesn’t add up.

The bible of Silicon Valley, the San Jose Merc, says the market cap of Yahoo is about where it was before 2008 market crash. USA Today says that CEO Melissa Mayer had the best outcome (as measured by share price) of the six CEOs of Yahoo’s 20 years as a public company. Her 152% stock price increase made up about half of the stock value lost by (interim) CEO Jerry Yang, who held the reins during the heart of the stock market crash. The 152% increase compares to the 175% rise in the NASDAQ composite index during the same period.

Yang had a chance to sell the company to Microsoft in 2008 but refused to do so; in response, I said “Yahoo is toast.” As with other tech stocks, whether you made money over the past few years depends on whether you bought at the bottom or near the top.

Still, crediting Mayer with the stock price increase over the past four years seems somewhat generous, given that the “traditional” business continued to decline in value. Instead, (as predicted) the increase came from the two strategic investments by Yang in Alibaba and Yahoo Japan.

Under the circumstances, things turned out better than feared. Over the last four years, Yahoo was no Google, Apple or Microsoft — let alone Facebook — but at least it is a positive outcome during a period when other mature tech stocks declined.

Mayer will be moving on, but hopefully (as with Verizon’s acquisition of AOL) many of the Yahoo employees will keep their jobs. The Yahoo company (if not the brand) will be disappearing, but given its waning interest, the backing of America’s most profitable (and second most valuable) firm will provide reasons for potential partners to take it seriously again.

Apple's curious acquisition

Apple’s reported efforts to buy Beats Electronics for $3.2 billion have been the subject of endless speculation since it was first reported Thursday. We don’t know Apple’s actual reason for interest — or even if the deal will happen — since Apple has yet to make any official announcement. (As with all such leaks, this leak seems intended to influence the deal — presumably by the sellers to force Apple to follow through.)

Certainly this is out of character for Apple, since its largest previous deal was $0.4 billion to buy NeXT, the basis of its OS X. But the press frenzy about how precedented the deal is seems a bit exaggerated. After all, there’s always a first time for anything, including its successful acquisitions such as the purchase of NeXT, PA Semi, and Siri. (Google got a lot of flack in 2006 for spending $1.65 billion to buy YouTube).

Is the acquisition a good idea? When we (i.e. strategy professors) teach related diversification by acquisition, there is a standard list of pros and cons.

On the pro side, an acquisition is usually about time to market — accomplishing something more quickly than you could do on your own. It can acquire technology, customers, distribution, products and people. For the latter, Silicon Valley normally thinks in terms of engineers. However, an acquisition can also bring new executives: the NeXT purchase brought in the new management team of Apple — not only Steve Jobs, but essentially it’s entire management team other than the CFO that Gil Amelio installed (Fred Anderson) and the COO Jobs stole from Compaq (Tim Cook).

Finally, there is the opportunity for the newly acquired company to be more successful under its new owner than as a stand-alone company. This might be due to better management, better distribution or more available capital. For example, in our recently completed business plan competition at KGI, most of the proposed startups would sell out to a large pharma or biotech company before bringing products to market, rather than build a global retail sales force from scratch.

On the con side, there is the question of strategic fit: do the new assets fit with the organization, how will the products, people and culture be integrated — and are the business models compatible? The post-acquisition integration can be a huge distraction (but usually when buying a larger company, as with Microsoft-Nokia, Oracle-Sun or HP-Compaq).

And with any acquisition, there’s always the risk of over-paying. Perhaps the assets are valuable, but CEOs have a tendency to overpay — whether to put their mark on their company, grab the headlines or just to run a larger company.

In Beats Electronics, Apple is buying two lines of business. One is Beats by Dre, the headphones division that has nearly two-thirds (61.7%) of the US premium headphone market — nearly 3x that of Bose, which created the segment.

It’s a monstrously successful brand, but there’s little technology there. The two music industry execs who formed Beats outsourced their initial headset design to the father-son team that runs Monster Cable Products (which, lacking negotiating savvy, failed to get an equity stake in the venture they helped create). The success of the company (even more so than for Bose) is based on marketing rather than technology:

"They certainly don’t need the headphone company, which makes second rate headphones based on marketing," says music industry analyst Bob Lefsetz. He thinks Apple would be a lot more interested in Beats’ music streaming service. Steve Jobs famously opposed the subscription music model and, instead, championed iTunes' current model, where you buy a song outright.

This points to its other line of business. The nascent Beats Music steaming service leverages the value of the Beats brand with teens, but (like Apple and Amazon) is far behind market leader Spotify.

By one standard, Apple is certainly overpaying. The company’s exponential growth is not sustainable and its revenues are less than $2 billion. As a company with little technology and strong emphasis on style and brand, Beats is essentially a fashion company. Any fashion acquisition is a risky acquisition.

Will Beats by Apple seem as authentic or appealing to teens as Beats by Dre (when Dre was still the owner)? For that matter, how many fashion companies are able to sustain their position of a period of decades? In my adult lifetime, I can only think of one firm that has been successful: Nike.

Which brings us to the final possible value of Beats. The company has shown it has been able to understand teen fashion and create markets that didn’t exist. Is that because of the cofounders, Dr. Dre (aka Andre Romelle Young) and music mogul Jimmy Iovine? Or is there a depth of marketing — both market sensing and market creating — within Beats that could help Apple better sell unnecessary luxuries to middle class teens and college students?

Although it’s a large deal for Apple, it’s essentially a minor bet — hardly on the scale of Google buying YouTube or WhatsApp, let alone Microsoft’s purchase of Nokia.. Apple has more than $150 billion in cash (mostly offshore), and has few other options to create meaningful growth. With annual revenues of more than $170 billion, the Beats sales would not be material to Apple any time in the near future — if ever.

So if Apple gains an additional window into the soul of the 13-25 year-old set — or rebuilds its foothold in the music industry — then the deal could prove to be a shrewd one. As it is, it’s a gamble — but Apple didn’t get to where it is without taking gambles (such as the iPhone). It may be Tim Cook’s largest gamble to date, but it won’t be the last one he takes as CEO.

Cold Fusion

This week, I got to revisit the IT world through the efforts of my students. In a class on innovation strategy that I recently completed at UCI, four MBA student teams presented final projects on the current business dilemmas of tech companies.

The most intriguing was that of Fusion-io (FIO), a company that provides faster solid state disc (SSD) systems for server farms — 40x faster than a conventional SSD. The company was founded in 2005 and IPO'd in June 2011.

The story sounds pretty daunting. Although it has plenty of cash, the company has lost money the last two years (on revenues of $432 million and $359 million, respectively). It historically has depended on Apple and Facebook server farms for the majority of its revenue, and has been unable to land another comparable sized customer. It’s also competing with a number of much bigger and more diversified rivals in a segment (like any IT) that is commoditizing.

At a $11.88 close Wednesday, the stock is up 40% from a historic low of $8.32 in January. Still, the company has lost nearly 40% of its market cap since the IPO. Stock coverage is thin and mixed. Pac Crest rates the stock as a outperform with a $14 target. The Street rates it “as a Sell with a ratings score of D.”

Appointed last August, CEO Shane Robison (former Compaq and HP CTO) has brought in Yelp and some other moderately large clients. He’s resisted calls to sell the company: it’s not clear whether he likes being CEO or really thinks he can turn things around.

The students think that a sale is inevitable, and I find their logic persuasive. They suggest three potential buyers: Seagate, EMC and NetApp. They say EMC is best positioned to buy the company, but I think Seagate has the more urgent need to diversify as its core HDD business continues to decline. With 27% of the shares held by large institutional investors, I think the pressure to sell will eventually become irresistible (unless they decide to use the recent runup to bail out).

Either way, it points to a problem that I’ve remarked almost since the first days of this blog: it’s really hard to build a stand-alone tech business nowadays. The complete offering that firms need to provide are complex and diversified, and the incumbents have strong distribution channels and financial positions to keep out any newcomer. Unlike in the early PC era, they are no longer complacent and ignoring new threats and opportunities.

Bob Galvin turning in his grave

Wednesday Google announced it is dumping Motorola by selling it to Lenovo, the same company that bought IBM’s PC business when it decided to exit.

CEO-founder Larry Page wrote:

We acquired Motorola in 2012 to help supercharge the Android ecosystem by creating a stronger patent portfolio for Google and great smartphones for users. … But the smartphone market is super competitive, and to thrive it helps to be all-in when it comes to making mobile devices. It’s why we believe that Motorola will be better served by Lenovo—which has a rapidly growing smartphone business and is the largest (and fastest-growing) PC manufacturer in the world. This move will enable Google to devote our energy to driving innovation across the Android ecosystem, for the benefit of smartphone users everywhere.

Just to be clear, Google is abandoning commodity markets, not hardware:

As a side note, this does not signal a larger shift for our other hardware efforts. The dynamics and maturity of the wearable and home markets, for example, are very different from that of the mobile industry. We’re excited by the opportunities to build amazing new products for users within these emerging ecosystems.

This is obviously a big deal for Google, for the smartphone industry — and readers of this blog. There are so many angles that went through my head — but then I went off to spend 36 hours seriously focused on teaching (plus meetings). Fortunately, I can summarize most of the angles from the reporting that’s happened since then.

Google's Losses

Google spent over $12 billion to buy Motorola in mid-2012, and is selling it for $2.9b. Only $0.66b is cash and the rest is stock and IOUs. In an article entitled “Buy High, Sell Low,” John Paczkowski (formerly of the Merc and AllthingsD) wrote “the whole affair is arguably one of the worst investments in Google’s history.”

However, the net is a little better than a $9b loss. Minutes after the announcement, Tom Gara of the WSJ calculated

Google paid about $12.5 billion for Motorola Mobility when it acquired the company in 2012, and that came with about $3 billion of cash. It later sold off the company’s unit that makes cable TV set-top boxes for $2.35 billion. Now it’s selling off much of what’s left for $2.9 billion, but keeping all those patents.

The WSJ reminded us Thursday that “Google had absorbed roughly $2 billion of operating losses through the third quarter of last year,” bringing the net cost to $6b.

Friday, the WSJ had a second-day story “How Google's Costly Motorola Maneuver May Pay Off”. This is a fairly transparent effort by the company (or key executives or allies) to try to put a positive face on their huge loss. While the Google goals (promoting Android, fighting Apple) made sense, the purchase had only a small impact on the industry and was a terribly inefficient way to accomplish these minimal results.

The bottom line is that Google ended up spending more than $6b, and all they have to show for it is the 17,000 patents of MMI. Not only did they overpay, but with the losses this is even worse than what they booked on their balance sheet. As Bloomberg reported last April:

Google…estimated in regulatory filings that $5.5 billion of the purchase price for Motorola was for patents and developed technology. Chief Executive Officer Larry Page in August 2011 said Motorola’s patent portfolio would “help protect Android from anticompetitive threats from Microsoft, Apple and other companies.”

Of course, Google has had difficulty monetizing these patents — either offensively or defensively — in support of Android. (The one exception was this week’s cross-license deal with its major Android customer, Samsung, on undisclosed financial terms).

Google’s Mobile Patent Strategy

So how’s that investment working out? As with any mobile patent issue, the definitive source is the FOSS Patents blog. Florian Mueller didn’t pull any punches Thursday:

Things haven't been going too well for Google in the patent litigation arena recently.
…
At the moment Google appears to be on a losing streak in U.S. patent courts, and as I said further above, more bad news is probably coming in the near term. Google's patent infringement issues are definitely a key reason for its push for patent reform legislation, and I doubt that Congress will solve Google's problems anytime soon. There will either be a quick agreement between both chambers of Congress on a targeted and limited reform bill or things will take much longer.

He lists Google patent lawsuit losses to SimpleAir and Vringo, and Samsung’s loss on Apple’s auto-correct patent (presumably signaling future losses by the remaining Android handset makers). In addition, major licensee Huawei settled with the Rockstar Consortium — which suggests to me that Android licensees except Samsung will probably do likewise. (Wikipedia helpfully explains that this patent troll paid $4.5b for the Nortel patents — the largest patent portfolio ever sold — and that Apple, Microsoft and Sony are part-owners.

If that’s not bad enough, Mueller predicts that Motorola is also likely to lose its case to Intellectual Ventures (the Nathan Myhrvold patent troll).

In defense of Google execs, this mobile phone patent litigation among handset makers is relatively new, and it was not obvious how it would turn out. Still, it’s clear Google knew little about this business model, didn’t have a lot of their own patents, and took the shareholder’s cash to buy the biggest stash of patents they could find (valuation be damned).

Greater Fool Theory

Of course, for every seller there is a buyer. Lenovo seems to think that what’s left of the Moto mobile franchise is worth $2.1b in cash and IOUs (plus 5% of their company).

A friend of mine noted that parallels the habit of Asian companies over the past two decades to buy money-losing US PC companies:

• AST Research: bought by Samsung (1996)
• Packard Bell: bought by NEC (1996)
• Gateway: bought by Acer (2007)
• IBN’s hard disk division: bought by Hitachi (2002)
• IBM's PC division: bought by Lenovo (2005)
• IBM’s PC server division: being bought by Lenovo (2014)

So far, it appears that the first two (market-leading IBM businesses) were worth buying. The others (top 10 but not top 3) only transferred value from Asian CEO egos to struggling American shareholders.

Death of an Icon

All this aside, what occurred to me when I heard the news was that the late great Bob Galvin (1922-2011) must be turning in his grave. Here is the an excerpt from the obit I wrote:

Robert Galvin died last week at aged 89. The second of three generations of Galvin CEOs at Motorola, he was clearly the best, guiding the company to its period of greatest success (1959-1997).

In addition to serving as Motorola president, CEO and chairman, Galvin was chairman of Sematech and helped create the Six Sigma movement in the United States. For more than 20 years, Galvin was a Notre Dame trustee and later fellow.

There is a great video on Galvin’s seminal contributions to the wireless industry, prepared by the Marconi Society when they gave him a lifetime achievement award. In that video, I argued that Galvin’s two great contribution was to create the system of competing US licensees in cellphones (something that no other market had yet considered) and to push portability, miniaturization and mobility in cellphones — i.e., to create our modern industry. Yes, without Motorola we would have eventually had such a mobile industry, but the company shape how we got here and got us here sooner.

Bob Galvin spent his last years at Motorola doing two things: fighting against trade barriers for Motorola products overseas (notably in Japan), and promoting a resurgence in manufacturing quality for American electronics to be able to compete with foreign (i.e. Asian) producers. In 1988, Motorola won the Malcom Baldrige National Quality Award for manufacturing in its inaugural year.

His company is no longer the market leader it once was, having come late to the digital era and wasted $7b on Iridium (back when that was real money). Before he died, the company’s decline was palpable and surely known to him. Still, I have to imagine he is turning in his grave.

Handset sideshow doesn't solve Microsoft's core problems

Facing the expiration of the distribution agreement with its main mobile phone licensee, Microsoft bought Nokia. The deal fulfills Steve Ballmer’s ambition to recast Microsoft as the next Apple by allowing it to vertically integrate downstream into hardware.

Here’s the key passage from Ballmer’s press conference Tuesday:

The company I joined 33 years ago was a company focused on software for personal computers. And software is a great skill and will always be a core strength of Microsoft. The PC is an important device, the most productive device on the planet, and will continue to be so. And yet for us not only to grow but for us to really fulfill the vision of what we can do for our customers, we've evolved our thinking.

We need to be a company that provides a family of devices in some cases we'll build the devices, in many cases third parties, our OEMs, can build the devices but a family of devices with integrated services that best empower people and businesses for the activities that they value the most.

Like the dog who caught the car, now what? Microsoft under its next CEO will be a hardware company, but is there any evidence it will be a successful hardware company?

One of the problems is that Microsoft had more than a decade to offer a compelling mobile platform. Its smartphone market share has been falling since before the iPhone and Android.

Now with Windows Phone 8, it has a good product, but so what? Four years ago, another dying mobile company — Palm — brought out an innovative device to great reviews, but it didn’t matter. Less than a year later, the company — the US smartphone pioneer and onetime market leader — was gone, like Nokia bought up at a firesale price.

Microsoft has already had a chance to try its fully integrated mobile strategy with its Surface tablet, which enjoyed great reviews and a huge marketing push. In one year, Microsoft spend $900m to advertise the Surface and WP8, but generated only $850m in sales and took a $900m write-off on inventory.

Fortunately for MSFT shareholders, Nokia’s handset division is available at a firesale price, less than 10% of the company’s cash on hand. Unfortunately, the man who ran the division into the ground will be heading it for Microsoft and is now a favorite to become Ballmer’s replacement

The deal would also reward Nokia’s CEO Stephen Elop, the ex-Microsoft executive who torched Nokia’s Symbian platform in favor of Windows, and led the failed effort to regain share using Windows. (In mid-2012, Nokia’s Symbian platform had a higher market share than Windows had then or now). Elop has shrunk the company , cutting the company’s market cap in half from $40b to $20b.

Perhaps Elop won’t rewarded for his Nokia failures, but the early betting is that Microsoft’s board (a captive of Ballmer and founder Bill Gates) will pick a conventional leader who, as the WSJ put it, “won’t rock the boat.” Because of this influence, the article predicts the board will go for more of the same, someone who can run a large bureaucratic Fortune 500 company, rather than a visionary leader who will break free from the lost decade of stagnation under Ballmer. The company needs a Lou Gerstner but (at best) will end up with another Lew Platt.

The problem is, Ballmer has historically confused monopoly profits with premium pricing. People pay more for Apple products because they want to; people pay more for Microsoft products when they have to, and they don’t if there’s a good alternative.

While Nokia didn’t get software, they historically were a hardware innovator with screen, cameras, sensors and other features. Now Samsung has assumed that mantle — along with overall market share leadership — while Apple remains the software and integration leader.

The Nokia deal will reduce near-term EPS and long-term profitability ratios. The company hopes to save $600m annually, presumably by laying off 3,000-5,000 workers. I would expect most of those would be in Finland, where Nokia has for the past few year playing a shrinking role in the local economy.

Even if Nokia is a modest success, it will at best replace Microsoft’s declines in its slowly dying PC business. Buying the former market leader — which now longer even ranks in the top 10 in global market share — won’t transform it into a major player in the industry. Given its huge cash hoard, Microsoft’s phone business will last longer than Blackberry’s, but that’s not saying much.

As with all such mergers, the odds of actual success are large. Two quotes from this morning’s WSJ illustrate the problem:

When executives "can't figure out what to do, they go buy something, particularly when they have a lot of cash," says Jeffrey Pfeffer, a professor at Stanford University's Graduate School of Business. "It seldom works."
…
Juan Alcacer, a Harvard Business School associate professor who has studied Nokia, says companies with small market shares typically "are in a bad position for a good reason." Combining two of them, rarely works, he says: "Two bad companies don't make a good company."

The stock has given back the gains that it had with Ballmer’s retirement announcement. Hopes that Microsoft would fix its broken corporate culture, becoming faster and more responsive are now dashed. We long-suffering Microsoft shareholders own a utility, that pays out a fraction of its declining monopoly profits with no replacement in sight.

The ignominious end of Nokia's handset hegemony

On Tuesday morning (Finnish time), Nokia announced that it was selling its handset business to Microsoft for €5.44b. The payment includes €3.79b for the division and €1.65b for a 10-year (non-exclusive) license to the Nokia patents necessary to operate that business. The deal is funded by Microsoft’s offshore profits that (as with most US-based multinationals) it has been unable to repatriate due to the US tax law.

A PDF published by Microsoft summarizes the deal:

• Microsoft acquires Nokia’s phone business
• Microsoft acquires Nokia’s Qualcomm, other key IP licenses
• Microsoft licenses Nokia’s patents for use across all Microsoft products
• Microsoft licenses ability to use Nokia HERE broadly in its products
• Nokia retains NSN [Nokia Siemens Networks], HERE, its CTO Office, and its patent portfolio
• Nokia and Microsoft cement original partnership with this deal before 2014 recommitment date

As a Microsoft shareholder, this seems like a final failed effort by Steve Ballmer to make big strategic moves to distract from the failure of his efforts to execute on the core businesses he inherited when becoming CEO in 2000.

Want proof? In the same PDF, Microsoft projects in 2018 an “assumed market share” of 15% for the Nokia (or Windows Phone) business. Microsoft hasn’t had 15% share since 2005, and its most recently quarterly share (like Nokia’s) was under 4%. As with all of Microsoft’s mobile strategy since then, the deal is more about hope than feasible strategies.

About the only good news is that the troubled Microsoft is acquiring the even-more-troubled Nokia for a song. Three years ago, Nokia’s handset division was grossing more than €6 billion per quarter; two years ago, Microsoft paid 20% more to buy Skype, a company without a business model.

Meanwhile, what about Nokia? Basically, its current and previous CEO have panicked as they have driven the company into the ground. Since the 2007 introduction of the iPhone, bought full control of Symbian Ltd. (and then killed it), switched from the once-dominant Symbian to the also-ran Windows platform, and now is exiting the business. All this from the company that was the world’s largest handset maker from 1998 until 2012.

The urgency of the deal for Nokia is evidenced by the key financial terms. Microsoft is “immediately” advancing Nokia €1.5b so it can keep the doors open until the deal closes — and Microsoft presumably assumes the salaries of 32,000 Nokia employees in the money-losing division.

It’s hard to see how losers buying losers (cheap) creates a winner. Yes, the mobile market is growing as Microsoft’s core business is dying. Yes, having a captive† handset manufacturer will justify keeping open the Windows Mobile division. But how will having a distant third place product with single-digit market share solve Microsoft’s numerous growth and profitability problems?

† Microsoft claims other licensees will continue, despite decades of failed licensing efforts by vertically integrated platform owners. Licensing didn’t work for Nokia with Symbian, didn’t work for Palm with Palm OS, didn’t work for Apple with Mac OS 8, and didn’t work for IBM with OS/2.

For Dell, the future ain't what it used to be

Thursday’s decision by Blackstone’s private equity partners to give up on buying Dell marks the end of an era.

The failed bid is an important story on many levels. I'll ignore for now the temptation for schaudenfreude after Michael Dell’s faulty prediction 15 years ago that Apple was worthless and should be liquidated. (Friday’s closing market cap: Apple $367 billion, Dell Inc. $23 billion).

Let’s also ignore that the end of the Blackstone bid appears to assure the success of Michael Dell’s $13.65/share offer to buy Dell Inc., funded by Silver Lake Partners. With this, shareholders must set aside very real concerns about Mr. Dell’s proposed buyout, particularly the conflict of interest from a CEO-founder who IPO'd his company and now wants to buy it back after the shares have fallen 2x since he returned as CEO in January 2007.

Instead, let me focus on two key insights Friday — from stories Friday by Bloomberg and the Wall Street Journal — on the real story on why the buyout collapsed.

The first reason was the collapse of the PC industry. As the Blackstone notice to Dell Inc. remarked (as quoted by the New York Times):

While we still believe that Dell is a leading global company with strong market positions, a number of significant adverse issues have surfaced since we submitted our letter proposal to you on March 22nd, including: (1) an unprecedented 14 percent market decline in PC volume in the first quarter of 2013, its steepest drop in history, and inconsistent with Management’s projections for modest industry growth; and (2) the rapidly eroding financial profile of Dell.

Or as IDC reported on April 10:

Worldwide PC shipments totaled 76.3 million units in the first quarter of 2013 (1Q13), down -13.9% compared to the same quarter in 2012 and worse than the forecast decline of -7.7%, according to the International Data Corporation (IDC) Worldwide Quarterly PC Tracker. The extent of the year-on-year contraction marked the worst quarter since IDC began tracking the PC market quarterly in 1994. The results also marked the fourth consecutive quarter of year-on-year shipment declines.

The second reason was the rapid collapse of the financial prospects of Dell Inc. To quote from the WSJ,

Another issue, some of the people said, was a seeming freefall in Dell's forecasted operating income. While some Blackstone executives initially had hoped the predictions were worst-case scenarios, in due diligence they concluded the predicted outcomes were spot on, and the numbers could come in even lower, the people said.
…
Dell, in the March 29 filling, predicted adjusted operating income of $3 billion for the fiscal year ending next January—a stark contrast to the $5.6 billion the company had predicted the previous July.

Dell hoped to diversify into other areas, but that has failed. As the Bloomberg story reported: “the enterprise-solution business, heralded by analysts as Dell’s future, was years away from competing meaningfully in that market…”

In other words, we’re at the tail end of the PC era. Although it’s coming more rapidly than expected, the outcome is as predictable as it was for bookstores, record stores or newspapers. Dell had hoped to diversity its way out of the problem, but so far those efforts have failed.

The implications seem as bleak for the rest of the PC industry. As part of a “Dogs of the Dow” value investing strategy, I own a few hundred shares of Intel, which has gone nowhere in the past two years. Microsoft has done only slightly better, due to hopes (IMHO unfounded) that it will someday benefit from the shift to smartphones and tablets. Even Apple has major exposure to personal computers, where it has been gaining share as its tablet share (but not unit sales) has fallen.

More significantly, in the late 20th century Dell was the winner of the commodity PC industry, but then was out-commoditized by Mark Hurd at HP. Right now the commodity business is going badly for both.

From 1960-2000, we saw the collapse of the mainframe, minicomputer and workstation industry. It wasn’t the low-cost firms that survived to the bitter end, but the high value-added ones. The others morphed into something else (NCR: ATM machines; Burroughs and Univac: IT services), exited or died.

Given that HP and Dell have negligible presence in the most rapidly growing computing segments — smartphones and tablets — what’s left 10 years from now will be two very different companies. HP’s done a better job of diversifying than Dell, but neither’s prospects are terribly attractive.

T-Mobile's exit strategy

Since having its $39b sale of T-Mobile USA to AT&T nixed on antitrust grounds, Deutsche Telekom AG has been trying to figure out another way to exit the US market.

Today DT announced that its US subsidiary (#4 with 33.2 million subs) will be merged with the #5 US carrier, MetroPCS (with 9.3 million subs). The press release is here and the story is covered by Fierce Wireless (among many others)

It’s being called a “merger” but it’s clearly an acquisition (structured as a recapitalization), since T-Mobile USA will retain its name, technology, HQ and CEO — while MetroPCS will lose all four. It will retain its NYSE stock listing but presumably not its PCS ticker.

Although the cash payout is only $1.5b — funded by a $2.4b sale/leaseback of T-Mobile USA towers — MetroPCS shareholders will own 26% share of the new company. I haven’t seen any estimate of the value of the acquisition. The market suggests that the cash only accounts for one third of the value: today MetroPCS has a market cap (on inter-day trading) of about $4.5b, vs. $4.2b yesterday and $3.5b a month ago.

So instead of being paid $39b to exit, DT is paying $1.5b cash to build up a more stable company. I would presume that DT hopes that it will be able to gradually unload its 74% holding in the combined company through open market sales.

The two companies will be run as separate operations until T-Mobile can get all MetroPCS customers to phase out their CDMA handsets in favor of GSM ones. At today’s press conference, T-Mobile said it hopes to pull the plug on the MetroPCS network by the end of 2015. In the meantime, T-Mobile gets cheap LTE spectrum that both types of customers can share as the CDMA voice footprint goes down and the GSM voice footprint goes up. Or perhaps both end up on VoIP, i.e. VoLTE) which MetroPCS announced it plans to introduce in 14 US markets by early next year.

The acquisition puts pressure on #3 Sprint (56.4 million subs), which was a more obvious buyer for MetroPCS (which would have avoided the disastrous technology incompatibilities of its Nextel purchase). But so far, Sprint shareholders seem not to have reacted (either way) to the news.

One thing I haven’t seen mentioned: this is the merger of the iPhone outsiders: the #1, #2 and #3 carriers have the iPhone but #4 and #5 do not. Perhaps this will make Sprint want to buy the #6 carrier (which does have the iPhone): San Diego’s Leap Wireless which has 5.9m subscribers on its Cricket network.

However, the two hitches are technology and pride. Sprint is migrating its 4G strategy from WiMax to LTE, while Cricket uses TD-LTE, the Chinese variant not used by the top 5 carriers. (However, Cricket only offers LTE service in Tuscon right now, so perhaps it could drop the incompatible LTE if its acquired soon).

The other problem is that Leap turned down acquisition efforts by MetroPCS since 2007. Perhaps its due to bad blood between the companies that wouldn’t apply to Sprint, or perhaps Leap will realize that it lacks scale to operate its own network indefinitely in an ever-commoditized market.

Whither T-Mobile USA?

The Obama Justice Department filed suit Thursday to block AT&T’s proposed acquisition of T-Mobile USA. The case against the merger is compelling, but I never thought the administration would make the political decision to block the merger.

Perhaps the Justice officials bought into a slippery slope argument: if they don’t say “no” to AT&T buying T-Mobile, how could they say no to Verizon buying Sprint. Or maybe it was the strong signs of opposition from the Democrat majority in the Senate.

Even the Wall Street Journal reported that Ma Bell’s efforts to build political support never solved the legal condurum:

If breadth of backers was the main criteria, AT&T's $39 billion purchase of T-Mobile USA would have sailed through regulatory review. … But good corporate citizenry and lobbying expertise aren't the only criteria. And as the Justice Department's court challenge to the deal Wednesday demonstrated, the deal was always long on hype for how it would help consumers, and short on robust legal arguments.
…
AT&T's problem is that the legal issues aren't on its side. Antitrust lawyers had said in recent days that the company's chances of winning approval rested on political issues trumping legal concerns. The fact that the government challenged—months earlier than observers had expected—demonstrates that the legal issues won the day.

On the most basic level, it was evident before the filing, the combination exceeds concentration of market share levels—as defined by the Herfindahl-Hirschman index—that the federal government generally finds acceptable. Divestitures could resolve the concentration risk, of course. But AT&T will find it harder to get around the reality that a merger would reduce the number of national wireless firms from four to three—in the process eliminating a low-priced competitor.

Given that reality, it’s hard to understand why AT&T claimed to be surprised. Shareholders should demand an immediate investigation as to what Kool-Aid® they’ve been passing out at Whitacre Tower, headquarters for SBC AT&T in San Antonio.

AT&T may fight for half a loaf, but any partial AT&T victory would leave T-Mobile in even weaker shape that when the deal was announced — except for the temporary salve of the $3 billion breakup fee.

The problem is, T-Mobile USA (misleading ads with spokesbabe notwithstanding) has no 4G strategy and has been under-investing in the business as an endgame strategy. It’s too expensive to compete with Metro PCS (or Sprint’s Virgin Mobile) and lacks the phones or service quality to compete with the big three.

Of course, if #2 AT&T can’t buy #4 T-Mobile then #1 Verizon certainly can’t. That leaves #3 Sprint, or perhaps some foreign entrant.

Some may claim that this will force a Sprint-T-Mobile merger, but it’s hard to see how. The two have incompatible technologies, and buying the Nextel incompatible technology almost killed Sprint. Also, Sprint’s market cap today is about $11 billion so there’s no scenario where they could approach AT&T’s $39 billion offer or even the $20-25 billion that analysts estimated last Christmas.

My best guess: T-Mobile AG will run the property further into the ground, with no 4G strategy and its advertising-driven price war. Then in a few years, the world’s richest man (not Mr. Bill) will buy T-Mobile USA for less than half of the $39 billion, and integrate it with América Móvil, Latin America’s most successful mobile phone business. It could put together special roaming agreements for the millions who live and call on both sides of the 30th parallel.

Meanwhile, T-Mobile USA won’t have the spectrum or money to build a 4G network, so someday it will have to rent time on a virtual 4G network, whether Sprint’s partner Clearwire or Leap’s Lightsquared.

I’m (temporarily) a T-Mobile subscriber. I suspect the prices will remain attractive as long as T-Mobile is fighting to preserve its subscriber base and prop up the eventual sale price. I’m curious to see whether T-Mobile will start any price wars, or will remain reactive to MetroPCS and Virgin price wars, but in the end I don’t think it will have any bearing on its survival.

Airline mergers: half the competition, double the mediocrity

This week I flew Continental Airlines for the first time since it was acquired by United — and in fact the first time in three years. Where once Continental competed for customers with superior service, today — just as I feared — it offers the same customer hostile-policies that its corporate parent has so carefully pioneered over the past decade. The jetbridge slogans promising a better customer experience are just so much empty rhetoric.

If the processes have changed with the merger, so far the people have not. The Continental employees seem pleasant enough — certainly not like the surly TWA cabin crew in the years leading up to their acquisition.

Perhaps the Continental culture of pride and perhaps empowerment has yet to be destroyed by the penny-pinching bureaucracy that is the world’s largest airline. Or perhaps the Texas hospitality temporarily lingers, just as Delta once had a Southern charm before that was ground down by commoditization and its acquisition of an unhappy struggling airline.

There’s really nothing new here: big companies would rather force us to buy what they offer rather than compete for customers. Bigger is rarely better, except for the CEO egos and their paychecks. Mergers have not created better airlines, just ones with more market power and less accountability

Which of course brings us back to SBC, America’s largest telecom company, and its efforts to control 40% of the US cellphone market through purchase of T-Mobile USA. It's been over 10 weeks since the proposed acquisition was announced, but no real news from the FCC.

As with airlines, the promises of AT&T similarly ring hollow. At least United can offer some new destinations to its customers after gobbling up Continental.

Would the purchase of T-Mobile allow AT&T to serve another square mile that it doesn’t already cover? I doubt it, but it will end T-Mobile competing with AT&T to win customers.

Regulated duopoly vs. real competition

Last week, a Senate subcommittee held a hearing entitled “The AT&T/T-Mobile Merger: Is Humpty Dumpty Being Put Back Together Again?” The CEOs of three of the four major cellular companies got a chance to present their positions in between political grandstanding.

I was fortunate to catch the replay Sunday on C-SPAN (one of the few channels my monopolist cable company still provides on basic cable.) A low resolution version of the 2½ hour hearing is also available on the Senate website.

The expert (if self-interested) testimony confirmed what I already knew. As with any consolidation of four major firms down to three, the merger is about reducing rivalry, supplier power and buyer power — good for the surviving companies, bad for suppliers, customers and the smaller rivals.

The Case Against the Merger

The most enlightening testimony came from Victor Meena, CEO of small rural carrier (Cellular South) that (according to Wikipedia) is the 8th largest in the US (after Verizon, AT&T, Sprint, T-Mobile, MetroPCS, US Cellular and Cricket/Leap).

As someone who has spent 15 years studying the history of the US cellular industry — from the prehistory of the 60s and 70s to the boom era of the 90s — I believe Meena has it exactly right. Reducing competition back to a duopoly will bring us back to duopoly-style pricing and duoopoly-style non-competition.

Meena described the merger as a major step backwards for the industry and its customers:

When I began in this business in the late-1980s, there was a local duopoly in every market.… Carriers had virtually no market incentive to innovate or improve service offerings.… In a duopoly, the market can quickly reach equilibrium and, if both providers are reasonably happy with their position, innovation stagnates and prices rise.

The industry changed for the better in the late 1990s, when the FCC, pursuant to Congressional mandate, auctioned off PCS licenses and a substantial number of competitive carriers entered markets—launching a new, healthy competitive era of wireless in the U.S.
…
But this all began to change in the middle of the last decade. Through unfettered mergers and acquisitions, it has become clear that our industry is on a glide path toward Ma Bell reconstituting herself into the 2 Bell Sisters of the wireless industry: AT&T Wireless and Verizon Wireless.
…
Not surprisingly, this concentration of market power has led to less choice for consumers and the routine abuse of market power in an effort to prevent competition at every turn. Specifically, AT&T has used its enormous acquired scale to

1. restrict competitive carrier and consumer access to devices,
2. withhold roaming agreements, and
3. leverage its control over device and infrastructure vendors to Balkanize new spectrum and slow the deployment of 4G LTE technology in the U.S.

Meena and Sprint CEO Dan Hesse identified two other negative impacts of increased market power. As chairman of the CTIA, Hesse has been attempting to negotiate lower rates for wireline backhaul for cellular base stations — rates that AT&T and Verizon want to be high but the rest of the industry want to be low. And by consolidating carriers, Meena notes there will be fewer options for smaller carriers to find roaming agreements for 3G and 4G data, as mandated by the FCC last month.

Supporting Cast

As expected, AT&T CEO Randall Stephenson said little to convince me that the merger is good for anyone other than AT&T, while T-Mobile USA CEO Philipp Humm seemed intent on deferring to his new boss. Verizon’s CEO was strangely absent, either to avoid making arguments that would haunt him when he wants to buy Sprint, or to avoid reminding people that two companies will control 80% of the market if the merger goes through.

Among the leftist activists, the self-appointed “consumer” representative was far more persuasive and honest than the union president. At least she knows what a Herfindahl-Hirschman Index is. Tellingly, she also asked: “have you ever seen AT&T advertise against Metro PCS or Cricket?”

The quality of dialog from the top of the dais was also mixed. The two ranking members of the subcommittee — Sen. Kohl and Sen. Lee — asked intelligent questions that attempted to draw out the witnesses. Two other senators (Franken and Grassley) were dim bulbs acting like a prosecutor and defense attorney for the accused. (Sens. Klobuchar and Cornyn were only slightly better — but at least viewers were spared Chuckie Shumer).

If Not Competition, then What?

Meena offered a stark (and I believe accurate) contrast between the two paths forward:

The prospect of this transaction brings us to a critical decision point for policy-makers: are we are going to continue down the path toward an era of nationwide duopoly, or are we going to lay the foundation for a second competitive era in wireless. There is no third option – either AT&T will be allowed to acquire T-Mobile (paving the way for Verizon to acquire Sprint and cementing a national wireless duopoly); or it will not.

If AT&T’s takeover of T-Mobile is approved, all that will remain is the endgame, where the remaining non-Bell carriers wait their turn to be acquired or bled dry by the biggest two carriers.

And, Meena notes, the likely consequence of returning to duopoly is returning to FCC micromanagement:

[I]f the takeover goes forward, policymakers must begin preparations to regulate every aspect of the day-to-day business of the duopolists. Without effective competition as a check on market abuses, the government will have to interject itself to ensure that consumers – the true owners of wireless spectrum – are protected. This means subjecting a future wireless communications duopoly to the same type of regulatory oversight that wireline telephone and electrical power utilities have operated under for decades.

This idea was echoed by Sen. Klobuchar, who suggested that a more concentrated US market — like the rest of the world — would be a more tightly regulated market.

Of course we know that government (or any central command-and-control bureaucracy) usually does a bad job of assuring either innovation or efficiency. So if the choice for consumers — and app developers and handset makers and website owners — is real competition or regulated duopolists, the best option is obvious.

Saving T-Mobile

If the merger is killed, it still leaves the question of maintaining T-Mobile as an effective competitor. It will take more than just a cute spokesmodel and dishonest branding to have it maintain its market share.

In particular, both Stephenson and Humm pointed to T-Mobile’s looming quandary in the 4G era, given that it hasn’t bought new spectrum in the recent auctions. Actually, the solution for the #4 carrier is relatively simple: do what the #3 and #7 carriers are doing for a 4G network: rent one.

Clearly T-Mobile is not going to join Sprint using Clearwire’s WiMax network, but if Clearwire switches to LTE, it would be an attractive option.

If not, it can follow the lead of Leap Wireless (dba Cricket) in renting the LightSquared network. It’s LTE, it promises to be nationwide, and the T-Mobile/Cricket customer base would be enough to make an attractive business (at least until MetroPCS buys Leap).

I dumped Sprint, but they're right

As I threatened more than a year ago, today I finally quit Sprint after more than 13 years. The long term reason was their smartphone surcharge — $80 for any smartphone — which prevented me from using a Palm Pre that I owned without paying the surcharge.

The final impetus came when my third Treo failed exactly the same way, but they refused to replace it (despite a $50/year repair agreement) due to false claims of “water damage”. Hah! More than a decade of loyal service wiped out by a penny-pinching denial of a legitimate claim. (I went 2 weeks without a cellphone before walking into T-Mobile and getting a SIM card for the Symbian phone I only use in Europe.)

Still, I couldn’t agree more with Sprint’s full page ad (which ran Sunday in my copy of the Merc and apparently the San Francisco Chronicle as well) attacking SBC’s ongoing attempts to re-assemble Ma Bell.

Competition is everything
…
Competition is American, Competition plays fair.
Competition keeps us from returning to a Ma Bell-like, sorry-but-you-have-no-choice past.

As the #3 cellphone carrier, of course Sprint is fiercely opposed to the merger of #1 and #4. Right now T-Mobile is the industry’s sick child, but if the merger happens that dubious honor will pass to Sprint.

It doesn’t help that the early betting is that the Obama administration won’t block the deal, but let the deal happen with conditions.

The problem for consumers — but not Sprint — is that the arguments being used to justify the AT&T/T-Mobile merger would then justify Verizon Wireless buying Sprint.

This means an oligopoly would become a duopoly. After the two mergers, the top two carriers with 152 million and 130 million subscribers — with more than 90% of the US market of some 300 million subscribers. The next seven carriers would total 21 million, led by MetroPCS with slightly more than 8 million.

Independent analysts say that AT&T’s problems are of its own making — delayed LTE rollout, dropped calls, lack of capacity. It also removes T-Mobile scrapping for customers, offering a low priced alternative to the big two vendors.

So while I’m no longer a Sprint customer, I agree with its (self-interested) argument that the merger is bad for the US telecom industry. Unfortunately for Sprint, the new AT&T is the largest corporate donor and lobbyist in the US — and third overall after a Democrat PAC and a public employee union. No how many citizens file complaints, it seems like 2012 will have a very different competitive landscape than what we have today.

The Siren Call of Silicon Valley

The morning paper reports that Dell is the latest major IT company to be lured by the sirens of Silicon Valley. I suspect it won’t be much more successful than any of its predecessors.

The Merc leveraged Dell’s Tuesday press release to extend their report last week that the company was leasing 240,000 square feet in Santa Clara, and had 341 open jobs posted in the Bay Area.

The Dell news release summarized the decision:

Dell today announced plans to open the Dell Silicon Valley Research and Development Center, a new facility that will support Dell’s strategic expansion of solutions capabilities, including the areas of networking design and development, storage development and cloud computing. The new site complements Dell’s Israel Research and Development Center, announced last month in Ra’anana. Dell believes that with recruitment of additional staff, its workforce at the Silicon Valley site will grow to more than 1,500 team members over the next five years.

The new facility will allow Dell to consolidate much of its current Northern California operations in phases over the next several quarters. It will combine the operations of several area companies Dell has acquired, including Zing (Sunnyvale), Ocarina (San Jose), Scalent (Palo Alto), and Everdream (Fremont) into approximately 240,000 square feet of leased space in two adjacent buildings on Great America Parkway in Santa Clara.

In other words, Dell’s decision to expand here was largely motivated by the need to more effectively manage its SV acquisitions.

This is exactly parallel to Qualcomm’s decision almost four years ago to buy a 320,000 square foot campus to consolidate its own Bay Area acquisitions, notably SnapTrack (which later made Steve Poizner a household name) and most recently Atheros. The only difference is that Qualcomm bought its land — and thus appears here for the long haul.

The older Merc story notes two foreign telecom companies expanding here recently: Huawei and Nokia (although Nokia’s research center has been in Palo Alto for at least five years). Motorola, British Telecom and Deutsche Telekom are also here, as are most of the Japanese electronics companies and SAP of Germany.

But will it matter? Perhaps the sirens of Silicon Valley won’t be luring Fortune 500 (or Global 500) companies to their deaths, but will they actually help these firms succeed?

Digital Equipment Corp. (DECWRL) and Xerox (PARC) had major research labs in Palo Alto 30 years, but they did nothing to stem their eventual declines. IBM invented the disk drive and the floppy disk in San Jose, but then dumped that operation to Hitachi in 2002 and now the Cottle Road facility is a strip mall. (The still have their 1977 Santa Teresa Lab and their 1986 Almaden Research Center, but both are at the edges of the valley and not closely integrated into it.)

So for Dell, Qualcomm and others, the Silicon Valley branch office provides a convenient way to integrate acquisitions (and for the startups to find a friendly acquirer.) But I can’t think of a single example of a foreign or US company whose SV operations have made a significant difference in their ultimate success: the key decisions are made elsewhere, and most of the value is added elsewhere as well.

HP-Compaq Redux

Many of the most senior professors I’ve ever met — including some prize-winning engineering professors I interviewed in my research — say that to really understand something that you need to teach it.

Tonight in the capstone strategy class, our undergraduates revisited the 2002 HP-Compaq merger. We had a very healthy discussion, which I concluded by summarizing from my “Carly is right, I was wrong” posting earlier this year, particularly this passage:

• Opponents’s Claim: The merger would increase HP’s exposure to the commodity PC industry. Reality: True.
• Supporters’s Claim: The merger would give HP’s commodity business cost advantages through superior scale. Reality: True. Under Hurd, HP is a better commodity PC maker than even Dell.
• Supporters’s Claim: The merger would help HP increase service revenues. Reality: False. What was left of DEC wasn’t worth much, and so in 2008 HP spent $14 billion to buy EDS.
• Opponents’s Claim: Adding Compaq would dilute HP’s printer cash cow. Reality: True, but it didn’t matter.

However, from the student presentations I gained a few new insights:

• Many “experts” (including me) say that prior IT mergers failed and thus HP-Compaq would fail (cf. WSJ, CNET, USA Today, AP, Red Herring.) However most of the acquired companies were clear losers (Apollo, Sperry, NCR) or firms whose category was dying (Cray, DEC). Compaq was the global market share leader from 1994-1999, and still had almost twice the share of HP.
• HP didn’t beat Dell in PCs, Compaq did (using HP’s money, brand and distribution). HP was never any good at making PCs.
• As my student David Sheyman pointed out, at the time of the merger Compaq’s ProLiant servers were the market leader, preferred by IT buyers.

Yes, the PC business is a brutal low margin commodity business, but if nothing else HP deprived Dell of a profit sanctuary for attacking HP’s other businesses.

Consistent with one of major themes of this blog, commoditization is the reality of most segments for Silicon Valley IT companies. Commodity firms are less fun to work to work for, so students have to recognize the industries and firms that have become commoditized if they hope to avoid them.

Airline consolidation: bigger but not better

This year I’ve had the joy of spending lots of time experiencing mediocre airline service. In particular, United Airlines has truly refined the definition of steerage with their 4th class (ala the Titanic) below the traditional 3rd class service called coach.

Once upon a time, the full-service carriers provided service, but since 9/11 they have been cutting any semblance of quality or service in the name of cost reduction. (Delta and United seem to have fallen particularly far, American and Continental not so much.) Today we have the irony that Southwest provides more service for its tickets (e.g. checked bags) than its former full-service rivals.

Lacking innovation in a mature industry — and uninterested in improving quality — the response instead seems to be consolidation via merger. After Delta-Northwest, we now have the prospect of United-Continental. Bigger is not better, but it is bigger and perhaps there are minor scale efficiencies to be wrung out.

The lame duck president of the industry’s trade association, Giovanni Bisignani, was quoted as saying that the industry will consolidate into “a dozen global brands supported by regional and niche players”.

Certainly the existence of regional players makes sense – Southwest doesn’t need international linkages to survive, and for that matter neither does EasyJet (or RyanAir). But I’m not sure what’s magical about “a dozen.”

The same FT article had a snippy response by an Indian bureaucrat:

Praful Patel, India’s minister of state for civil aviation, said: “All I can say is if Giovanni is right and we have 12 global brands, three will be from India and three will be from China.”

Much as I’m a firm believer in the rise of China and India, both are years away from running even one world-class global airline, let alone three each. Perhaps they can acquire such competencies — for example if China folds in Cathay Pacific — and the one thing that these airlines (particularly the Chinese) have going for them is a wealthy state sponsor able to fund large acquisitions.

What will happen if Cathay combines with a Chinese airline, or Continental with United. I’d like to think the higher quality partner will be the surviving culture, but if the goal of consolidation is scale (or other forms of cost reduction) then there’s little reason for optimism.

Total Eclipse of Sun

InfoWorld chronicles the technological brain drain at Sun Microsystems after it was gobbled up by Oracle:

Key departures have included Java founder James Gosling, XML co-inventor Tim Bray, and Simon Phipps, Sun's chief open source officer. After serving as CTO of client software at Sun, Gosling worked for a couple months with the same title at Oracle before leaving in April under what appears to be acrimonious circumstances. Bray, who was director of Web technologies at Sun, also quickly left Oracle, becoming a developer advocate at Google. Phipps, never offered a job at Oracle, is open source strategy director at integrator and identity platform vendor ForgeRock.

Other departures include Sun engineers Charles Nutter and Thomas Enebo, who shepherded the development of the JRuby programming language at Sun but joined Engine Yard last summer several months after the Oracle acquisition of Sun was announced. A key developer on the open source Hudson continuous build project, Kohsuke Kawaguchi left in April to form a company to continue working on Hudson.

In his blog, Gosling even notes that he needed a lawyer to resign from Oracle:

Between all this [answering emails] and spending quality time with my lawyer, resigning has been a full time job (before I quit, several friends said I'd need a lawyer because "this is Oracle we're talking about"... sadly, they were right).

It is a sad commentary to say that Oracle is more bureaucratic than Sun, given Sun had become one of the most bureaucratic, least entrepreneurial tech companies in Silicon Valley.

It’s also telling that Oracle shareholders got a lot less technology than they were promised from the acquisition.

I wonder how much of a loss it really is to Oracle. First, while these were very capable people, they obviously weren’t enough to make Sun successful anymore. Was it because of a bad strategy? Lack of marketing? Or have the returns to innovation disappeared in the mature enterprise IT segment? I don’t know, but if the strategy had been working, Sun wouldn’t have needed to sell itself off.

Also, what use does Oracle have for innovation? Their focus is service, support, scope, reach, control, perhaps reliability. Again, the entire segment seems to be rewarding turnkey solutions — or successful lock-in strategies — rather than new technology.

Finally, I can’t say I’m all that surprised. Big acquisitions nearly always add revenue and destroy value.

An end to Grove's law?

As part of my reflections on the news of SAP spending $5.8 billion to buy Sybase, I wonder whether we will finally put an end to a piece of self-serving theorizing by Stanford adjunct professor Andy Grove.

Like so much in enterprise software nowadays, the deal is big, expensive, plays to gargantuan egos and does little to increase customer value. (At least this story has one happy ending — the bailout of Sybase shareholders who finally get what the stock was worth back in 1994.)

Apparently I am not the only one questioning the business logic of the deal. The Register headlined their story “SAP buys Sybase - but why?” while the MarketWatch headline said the acquisition “draws mixed reviews.”

One possible explanation is the standard one that I give my strategy undergraduates for most multibillion dollar acquisitions: the desire of CEOs and other execs to run a bigger company. On MarketWatch, a self-identified “SAP Insider” offered a similar explanation:

SAP is simply buying revenue. Their boards technology strategy talking is so inconsistent: they praise their own in-memory DB development, then the Sybase acquisition is mainly about the mobile business while widely avoiding the DB question which is still Sybase's main business. This proves inconsistency all over the place, maybe even panic. I think that SAP as a company is not at peace with itself. They don't trust their own potential anymore. The changes in the board haven't changed anything. Maybe the problem is beyond the board.

Buying revenue is common in mature industries, where firms unable to grow their core business buy other companies so the market cap and revenue graphs show an unbroken string of increases, in an attempt to hide that the core business has simply run out of steam.

However, there is another, more substantive possibility: an end to Grove’s law, which has been offered as a maxim of IT industry strategy for almost 20 years.

Everyone knows Moore’s Law, the 1965 prediction that the number of transistors will double every 18 months (at least until we get down to atom-scale transistors.) But his successor as Intel CEO, Andy Grove, claimed a new pattern of industrial organization in the IT industry, in which horizontal monopolies of components (such as x86 microprocessors) supplanted go-it-alone vertically integrated winners such as IBM and DEC.

In our 2000 paper on PC architecture, Jason Dedrick and I cite Grove’s 1996 book Only the Paranoid Survive (esp. page 44), but other data suggests that Grove was giving speeches to this effect at Harvard b-school during the early 1990s. (As a sidelight to his day job, Grove later became a lecturer at the Stanford Graduate School of Business.)

One of the problems I had with Grove’s claim was that it was so incredibly self-serving: the same claim by (say) Carliss Baldwin would be much more credible than coming from the CEO of a company accused of monopolistic behavior in restraint of trade.

Was the Wintel duoopoly a natural outcome of economies of scale, network effects and other “increasing returns to scale” (as might be argued by Brian Arthur)? Or was it merely two lucky companies that found a window (sigh) to dominate a market niche through a combination of normal and aggressive business practices?

Whatever the explanation, the stylized world described by Grove is just about gone, as IT companies integrate up and down the stack, vertically integrate along the value chain and otherwise increasingly pursue strategies of related diversification. Microsoft, Google, Sony and Nokia are just a few examples of such strategies, as are (to a much more mundane extent) the three enterprise software giants: IBM, Oracle and SAP.

Would it be more efficient to stick with modular component specialization and interoperability, rather than gathering more and more technologies under one roof? I don’t know, but the latter strategy is what firms are doing now, rendering Grove’s law now effectively obsolete.

HP's curious acquisition

I’m still not sure why HP spent $1.2 billion to buy Palm, other than it can. Yes, it has a minimal presence in mobile phones and other mobile devices, leading MarketWatch’s Therese Poletti on March 2 to predict an HP purchase of Palm:

Surely numbers-driven Chief Executive Mark Hurd is looking for ways for H-P to take advantage of the boom in smartphones. Buying Palm could be a way for H-P to get into the market for lower cost devices. It might have to abandon Windows, or offer two families of devices. H-P has often juggled competing product lines, diverse chip architectures and operating systems.

With its cash and global reach, HP can certainly do more with Palm’s technology that Palm has been able to do. And yes, Palm was available cheap, losing 73% of its market cap since its recent peak stock price of $17.07 last October.

It was a great victory for Palm and its investors, which despite good technology has been given up for dead for nearly two years. Elevation Partners, which took 25% sake in Palm three years ago, cashed in its (now) $460 million investment for an estimated $485 million — suggesting that it was worried about further deterioration rather than optimistic about a future upside. (Wednesday, Palm revealed Q2 revenues were expected to be 40% below analyst expectations, which would have punished the stock further.)

Obviously HP has been looking forward to the day when smartphones and other devices start to eat away at the Windows-based PCs that account for a nearly a third of the company’s revenues.

HP claimed the acquisition is even about the post-smartphone world:

"Smartphones are a part of this, but this is really about the Web operating system," Shane Robison, HP's chief strategy and technology officer, told Forbes. "It's a change in our business model to a connected device model." HP, he said, is assuming a world in which almost everything needs at least the potential to connect to the Internet.

But by taking on Palm and its webOS, HP is going down path it’s almost completely avoided during its 40+ years as a computer maker — as a sponsor of a proprietary computing platform.

Yes, it sold proprietary 16-bit mini computers in the 1970s, and it also bought two leading proprietary minicomputer companies: Tandem and Digital Equipment (when it bought Compaq).

However, its PCs have been DOS and Windows, and its servers Windows, Unix and Linux. The Unix (HP-UX) had its own development group, but the recent trend by HP and its customers has been away from HP-UX to Linux.

Of the world’s top five PC makers — HP, Dell, Acer, Lenovo and Toshiba — all have made mobile devices based on Windows Mobile (now Windows Phone) and Android. HP now seems to be abandoning this model and casting its lot with the leading proprietary vendors: Apple, Nokia and Research in Motion. (Yes, the operating system Nokia controls is open source, but its competitors are largely ignoring it.)

This also means that HP hopes to use webOS to differentiate its mobile products, rather than merely shave pennies off of operating costs as CEO Mark Hurd loves to do. Perhaps the thought of competing against commodity Taiwanese and Chinese firms in the mobile segment prompted him to do something different.

It’s really too soon to say whether HP will have any luck here. However, in the short-term, I think the biggest negative is for Google. A lot of people have been assuming that Android will take over the world, coalescing all the various carriers, vendors and users into a single platform. Instead, fragmentation of mobile phone platforms — as well as tablets — will continue.

It‘s also bad for Microsoft and Dell. Perhaps this will be the nudge that gets Microsoft out of the handset OS business, or it may cause it to more aggressively ally with Dell (which previously aligned with Android.)

But in a perverse way, I think in the short-term it will be good for the other proprietary platform vendors. Together, Nokia, RIM, Apple and HP will be able to hold off Android, and may cause the other phone makers to reconsider whether they want to hand control of their future to Google.

The one sure thing is that the number of webOS applications is going to explode. The iPhone (nearly 200,000) and Android (around 40,000) application stores are already crowded, while webOS only has a few thousand. Developers looking to get noticed will flock to webOS, hoping to get in on the ground floor now that its survival is no longer an issue.

Because of this demand — and because the webOS tools are very friendly — I predict that HP/Palm will have more than 5,000 apps by the end of the year, and perhaps closer to 10,000 apps.

"What were they thinking" department

With my undergraduate strategy classes, we just got through talking about mergers and acquisitions. This year, as in previous years, I made three points:

1. Due to egos and compensation, CEOs bias towards creating bigger but not necessarily better companies.
2. Adding revenues without increasing profitability does not improve a company’s strategic position.
3. When you are doing a major acquisition, there are two types of companies available: expensive good companies and lousy cheap ones.

I also point out that 99% of “mergers” are actually acquisitions, with a clear dominant partner. (NB: HP-Compaq).

In this morning’s Merc, Chris O’Brien writes about tech companies that are both unwinding acquisitions gone bad while continuing to make other acquisitions. As O’Brien notes, this is not a particularly good time in the economic cycle to get a good price for divestitures (although presumably new acquisitions will be relatively cheap).

A number of these acquisitions were ill-conceived from Day One. Some are dumber than others, as when eBay spent billions to buy Skype but some lawyer (or biz dev guy) forgot to get rights to Skype’s technology.

O’Brien summarizes some of the broader trends of deals gone bad:

Bryan McLaughlin, a partner with PricewaterhouseCoopers' Transaction Services, … said that in the third quarter, which ended in September, about 40 percent of the acquisition deals involved some kind of divestiture, up from 25 percent for the same period one year ago. That is, companies weren't buying smaller, stand-alone outfits; they were buying essentially the castoffs of other companies.

And a recent survey by Pricewaterhouse found that 69 percent of the 215 companies polled expected divestiture activity to either stay the same or increase over the next year.

Many of these divestitures are the fruit of ill-considered acquisitions made over the past few years. This failure rate should come as a surprise to no one in the board room or executive cubicle. A few years ago, McKinsey & Co. published a study indicating that 70 percent of mergers failed to generate the expected returns. Hope, however, seems to spring eternal in boardrooms as companies keep making deals.

Small companies continue to get acquired as an exit strategy, and often these are a cheap way to gain access to talent and technologies. The problems seem to be around the big chest-thumping acquisitions that make headlines for a company and its CEO.

Interestingly, once a company overpays for an acquisition, there’s not much of a reason to divest it unless you can find some greater fool who’s also going to overpay. So the specter of firms divesting their acquisitions suggests they either bought a bad company, or at least the claimed synergy used to justify the acquisition never materialized.

Update 1:30pm: After I posted this article (and after the bell), HP announced it’s spending $2.7b to acquire commodity networking company 3Com, at a 39% premium to its closing price and more than 2x trailing revenues.

Arbitrary telecom regulation

Perhaps the above title is a redundant description, given that everyone knows that telecom is highly regulated, that the regulatees spend huge sums to loosen that regulation and their competitors (including other telecom companies, Google etc.) spend money to increase the regulation.

Still, some of the observations today about the FCC were very interesting — even for someone like me that’s researched and written about US telecom policy for the past 13 years. I spent this morning at the State of the Net West conference, hosted by (and at) the Santa Clara University law school.

The second panel was “Antitrust in the Internet Era,” and the lead-off speaker was Rep. Zoe Lofgren (D-San Jose). With a US Chamber of Commerce rating of 37%, Rep. Lofgren is not a business-friendly legislator overall. However, like a lot of Peninsula Democrat politicians, she has a soft spot for local high-tech companies (which provide high-wage employment in her district and the largest share of her campaign contributions).

Still, I was pleasantly surprised when Lofgren spent some of her time focusing on the chilling effect of regulators’ threats. She noted that nowadays, the greatest impact of antitrust enforcement comes from the threat of an enforcement action rather than taking actual action. She also noted that (if I caught it correctly) the antritrust inquiries are often driven by the concerns of rivals, with its obvious potential for abuse.

But the most damning remarks came from Prof. Michael Katz, the Berkeley economist who (with book author Carl Shapiro) invented the concept of network effects with their oft-cited 1985 paper. Katz spoke from his unique perspective on telecom regulation, having served as deputy assistant attorney general for economic policy in the Department of Justice (2001-2003) and chief economist of the FCC (1994-1996).

Katz made two important points bearing on FCC arbitrariness. (Arbitrariness being my word, not his).

The first is about the unpredictability of the FCC review process. Katz said the timing of merger regulatory approval by the DoJ is proscribed by law under HSR, and thus (as a consultant) there is a very tight deadline to get analysis done by a specific time. On the other hand, for FCC regulated mergers, the review process much more leisurely, because the process is open-ended and the parties can’t do anything until the get FCC approval.

The second was even more damning. When reviewing mergers, Katz noted

• “The FCC is a much less disciplined"
• “It pursues its decisions [with] much less use of the facts.”
• It makes “much greater use of threatening companies when it couldn’t prove it court”.

(The FCC has a habit of getting its regulatory decisions overridden in courts — most famously in indecency, but also in net neutrality and cable TV regulation.)

Katz concluded that the FCC “has a tremendous amount of power [that it can use] to essentially blackmail companies,” a position that he said that former FCC head Michael Powell also held. (In a quick search, I couldn’t find any public statement by Powell to that effect).

While Stanford economist Tim Bresnahan did not endorse Katz’s specific criticisms of the FCC, he said that government power must "be adequately constrained”. In particular, merger review should focus on the US standard of review — i.e. will the merger help/hurt consumer welfare? (When I openly asked Tim whether there were any cases in the past year where the competitor-focused EU antitrust standard would have helped consumers, he answered in one syllable: “No.”).

What was particularly striking was the divide on antitrust policy (and other policies) between the lawyers and economists. There were the two famous economists on the panel (and one obscure economics blogger in the audience), but we were clearly outnumbered by the lawyers — three panelists from the SCU law school and three J.D.-toting members of the House.

The economists argued from the standpoint of evidence, efficiencies, outcomes and results. (The token business and GOP representatives supported the same policies but did not make as strong an intellectual case).

The lawyers argued from anecdote, personal opinion, and beliefs. (In this matter, Rep. Lofgren was far disciplined than her colleagues). In other words, issues that he/she thinks are important are the ones that the law and policy should consider. This plays to the myth of the all-knowing, all-powerful benevolent regulator being the best way to remake society.

A great example of this came with grousing by audience and panel that repeated recent complaints about the closed nature of the iPhone (notably the Google Voice controversy). However, this is not a market failure or abuse of power. For every developer (or user) who gets fed up with the iPhone platform, there are choices like Android, Blackberry and Symbian — something that the competing platform owners know and use as a way to get adoption.

As Katz himself noted, “This is notion that iPhone is dominant handset … is just wildly overstated.” He predicted that a claim of a violation of an antitrust law “would never hold up in court” and thus the Justice Department won’t even investigate it. [Perhaps because the iPhone has less than 25% marketshare in the US — even if you count only smartphones — and less than 1% of the global mobile phone market..]

In other words, there’s no justification for government intervention if there’s no market failure. Meanwhile, there is no plan to intervene to fix the arbitrariness of FCC regulation.