Google Show Greed Trumps Values Every Day

Google once promised that is mission was “to organize the world’s information”. Nominally that remains its mission today.

On the 10th anniversary of its IPO, in this morning's WSJ, Rolfe Winkler shows how that all changed:

Just before Google Inc. went public 10 years ago, co-founder Larry Page said he wanted to get the search engine's users "out of Google and to the right place as fast as possible."

Today, Mr. Page's Google often is doing the opposite: Providing as much information as possible to keep users in Google's virtual universe.

At first, leveraging its dominant share in search, Google was content to have people linger longer (ala Yahoo or later Facebook) to sell them to more advertisers. Now they want to monetize that customer hold directly by doing transactions and taking a piece of the action. The dead tree (and online edition) shows the before and after — Google the indexer of the Internet vs. Google the horizontally diversified Internet portal:

In other words, Google once created an ecosystem (including APIs and a two-sided advertising market) and wanted to make its ecosystem partners successful. Now, in its relentless pursuit of growth, it is crowding aside its onetime partners and trying to take more money from its customers.

This is exactly what DEC, Apple, Microsoft, Oracle and countless other tech companies have done over the decades. Joining an ecosystem is a viable startup business until the ecosystem sponsor wants to take that business away. The book Keystone Advantage refers to this as an ecosystem “dominator.” Among tech companies, only IBM seems to be a reliable partner for win-win alliances, in part because its integration services business model allows it to make money with almost any sort of component.

Of course, this was inevitable. Companies like Google want to grow, because it supports the stock price and puts more money into the hands of shareholders, employees and executives. Since Larry Page and Sergey Brin are now worth $32 billion apiece, I’m guessing it’s less about the money and more about the control, the ego, the success of making the world’s most dominant influential company of all time.

As we teach in strategy, there’s only two ways to grow: reach more customers or make more money out of your existing customers. If Google is serving almost everyone on the Internet, it either has to connect more people to the Internet (who will be less profitable than their existing customers) or sell more stuff to those already locked into Google. Obviously (with its $50 billion in cash horde and 60+% gross margins) it’s doing all of these things.

Unfortunately, a dominant vertically integrated (and horizontally diversified) monoculture is bad for the economy, bad for consumers and bad for society. It takes transactions that should be happening in the market and internalizes them into an internal hierarchy. Europe has been trying to nibble at the edges of Google’s efforts at Total World Domination for years, but had little impact. The U.S. seems disinterested, because the GOP believes in free markets and the Democrats receive millions in campaign donations from Google's wealth.

Normally we can count on the curse of success to eventually kick in: big companies either become complacent, bureaucratic or otherwise lose their way (cf. GM, Microsoft). The Google founders seem determined to make sure this doesn’t happen during their lifetime, which could be 30 years (with a normal retirement) or 50 (if they last like Warren Buffett). Since I’m older than both men, I may not live to see the end game — which is a depressing thought.

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.

Who's killing camera companies?

The Wall Street Journal Tuesday noted the financial difficulties faced by the world’s two leading camera makers, Canon and Nikon, sold 44% of the world’s cameras last year — pocket cameras, point-and-shoot, and SLRs. For these Japanese makers, Q2 sales of “compact digital cameras” (presumably all non-SLR) are down 26% and 30% respectively. Revenues from SLR systems (cameras, lenses, accessories) are also down, but less sharply.

Author Aaron Black are right to say “there may be more pain to come.” I particularly worry about Nikon, and not just because 20+ years ago I switched from Canon to Nikon after my insurance company (with the help of a burglar) gave me a chance to replace my manual focus system with an autofocus one.

Nikon was once the pre-eminent maker of SLR cameras for professional press (newspaper and magazine) photographers, of which I was briefly a member. You don’t need to a front page headline on a dead tree paper to know that this is a declining market that’s never coming back.

More seriously, Nikon is far less diversified: for it, the WSJ says that cameras make up 78% of revenues for Nikon (which also provides semiconductor lithography equipment) but only 40% of revenue for Canon (which makes copiers, laser printers and medical imaging). So if stand-alone camera revenues go to zero, then there won’t be much of Nikon left. This may be delayed by attrition of its Japanese camera rivals — Olympus, Konica Minolta, maybe Sony — but the end result is the same.

My UCI students predicted 11 years ago that cameras would supplant video cameras and smartphones would supplant cameras as digital convergence took hold. But there’s more to this story than just smartphones. I think the camera makers bear their own share of responsibility, since they seem to have stopped the wave of innovation that drove camera sales for at least 50 years.

In the 1960s, interchangeable lens SLRs supplanted the earlier rangefinder designs, due to their inherent accuracy (particularly for wide and telephoto lenses). In the remainder of the century, it was computer-aided automation that made (technically correct) photos nearly effortless, as SLRs acquired zoom lenses while adding auto-exposure, programmed auto-exposure, auto flash, auto-advance and auto-focus capabilities. Ease of use both broadened the market to the average consumer, although the zoom point-and-shoot cameras gradually offered most of what people need for a fraction of the price.

In this century, sales were driven by the shift from film to digital, and then the increasing quality of the digital image. My first digital SLR, the (Nikon-compatible) Fuji FinePix S1 Pro, had a 3 megapixel sensor. Last week, a houseguest showed me his 36MP Nikon D800, which exceeds the detail provided by National Geographic’s 20th century benchmark, Kodachrome 64.

Most people don’t need better resolution, or at least won’t spend $500+ to supplant their 10MP camera with a 20, 30 or 40 MP one. Camera resolution seems to be increasing faster than the size of “hard disks” (i.e. solid state disks) on computers, fueled in part by a shifts from desktops to laptops, laptops to notebooks, and notebooks to tablets (and thus a reduction or cap on storage space). And smartphones will always be better for emailing, texting or tweeting photos than cameras are.

So what can camera makers do to cause people to purchase a stand-alone device instead of a smartphone? Or if they can’t beat ’em, can they join ’em, e.g. as a lens supplier to smartphones (as Zeiss has done in providing lenses for Nokia and soon Sony).

Over the next decade, I think it should be possible to drive one more round of upgrades. I predict than in 10 years, one (but not both) of these two companies will still be developing new products to sell to loyal (i.e. locked in) customers of its SLR systems.

HP matters, Leo didn't

In the latest example of its incompetence, HP’s board of directors fired CEO Léo Apotheker, the same man it inexplicably hired less than a year ago after it fired its most financially successful CEO in a generation.

Into his place comes HP board member (and former eBay CEO) Meg Whitman, who told All Things Digital:

I took this job, because HP really matters to Silicon Valley, to California, to this country and to the world. …This is an icon and the place where the initial spark to create Silicon Valley came from and I am resolved to restore it to its rightful place.

At one level I agree with and admire Whitman. My work as an HP subcontractor in the 1980s and 1990s paid for my house, and I have nothing but respect for the company’s historic role in creating Silicon Valley. Twenty years ago, HP was the best in several segments that mattered. However, the company has largely faded to irrelevance in the past decade: first in some declining businesses, and second, third or worse in growth businesses.

On the other hand, Whitman (seconded by chairman Ray Lane) is promoting the spin that Apotheker was axed because he was a bad communicator. He certainly was awful — more suited for a top-down command and control German bureaucracy (NB: SAP) than an innovative Silicon Valley pioneer. But there was nothing in the latest news to suggest that Whitman is going to repudiate the series of bad decisions promulgated by Apotheker.

In particular, the HP of Apotheker was exactly the opposite of that of Mark Hurd — which was completely consistent with the (controversial) vision of his predecessor Carly Fiorina. A $125 billion company with 300,000 employees can’t turn on a dime — or even as quickly as an aircraft carrier.

As the seventh CEO since 1999, I could easily see Whitman lurching HP into yet another direction with yet another strategy and yet another reorg and yet another grand acquisition and divestiture strategy. This is — and I have to say it — the woman who inexplicability spent $2.5b to buy Skype to complement her online flea market.

Thanks to generous union spending — and daunting party registration figures — Whitman (like Fiorina) failed in her effort to become an elected California official last fall. However, while her skill set is better suited to being appointed HP CEO than being elected governor, I’m not sure the former job is any easier. (I say this as California continues to imitate Greece-style deficit spending without the public employee cutbacks that the latter has reluctantly embraced.)

So running HP is not (as the AllthingsD interview suggests) about better communication skills, or meeting with executing on Apotheker’s inexplicable (and apparently irreversible) $10b acquisition of Autonomy, an obscure UK software company. Nor is it about building upon the unmatched legacy and once vaunted brand name.

It’s about deciding what HP’s unique competencies are, and how they are relevant to today’s highly commoditized, slow growth IT market. Even badly run, the State of California is guaranteed to exist for another 150 years, but the same cannot be said for a private company. Executing an IBM-style turnaround — rather than a Dell or DEC-style slide into oblivion — is longshot prospect for any executive.

Now that HP has a new CEO, it needs a new board. As I wrote a month ago, HP’s board consists of

Two insiders, three private equity investors, a failed startup technologist turned investor (Mark Andreessen), a former consumer products exec (Meg Whitman), execs of two failing telecom companies, the CEO of a successful software lock-in business, CEO of a major consulting company, chairman of a specialty chemicals business, and Larry Elison’s longtime sidekick (turned nemesis and Kleiner Perkins managing partner).

In many ways, it resembles the Apple board during the Jobs-free interregnum, where being on the board was the best job many of these people had ever enjoyed. Apparently others are finally joining Vitaliy Katsenelson of Seeking Alpha and me in noticing the board that can’t shoot straight — as this Reuters article Thursday:

Interviews with insiders, former executives and experts paint a picture of an ever-changing roster of board directors who lacked a good grasp of the company's fundamentals and vacillated over what its business should be.

Having a weak board has suited the goals of the last six HP CEOs, but shareholders have been cheated out of a fair return for their investment. If Whitman is really going to save HP, she needs to swap out the indecisive with actual competence. There should be others that share her (nominal) passion for saving this Silicon Valley legend, rather than just enjoying the sinecure. Let’s see if the institutional investors also push for a better board, or merely mark time for the opportune moment to dump their shares.

But in upgrading the board, Whitman and HP also need to confront a fundamental strategic question that the company has been avoiding for a decade: is it an enterprise company like IBM, or a consumer company like Apple? It has not been effective competing with either. Instead, it become the leader in low-margin consumer PCs — a business both IBM and Apple eschewed and Apotheker said HP should dump.

So where will HP lead? I’m guessing it will try to get there by acquisition, but the next acquisition will have to be transformative, unlike 3Com, Palm, Autonomy — or for that matter, Skype.

Perils of diversification

Thursday was the first of my honors student presentations to their industry sponsors. This team — Kevin Dines, David Hsu, Clifford Jung and Vanessa Silveira — gave the concluding presentation of their three-month consulting project to researchers at IBM’s Almaden Research Center.

The student project was to find an eventual market for a research project by the PhD researchers. To do so, their project required interviewing government agencies and associated private firms such as real estate developers and urban planning consultants.

When for their project they contacted the various consultants on behalf of — large and small — the initial reaction was almost always “IBM is a potential competitor.” The scientists were amused at this, but if you put “urban planning consulting” into Google, you get an IBM-sponsored link:

I think IBMers would see the company as a supplier of IT and integration services to these consultants. However, as a multinational that increasingly supplies everything to everyone, it’s understandable that existing firms would worry that sharing information would enable further diversification or forward integration.

Oracle has spent the last 20 years buying some downstream customers and competing with others. Its market footprint in databases — approaching an monopsony — allows it to dictate terms or at least force these customer-partners to the table, even for big companies like HP, IBM or SAP.

Still, it makes sense that seeing everything as your potential market would cause everyone to see you as a potential competitor. This is not a risk of diversification we normally teach in strategy, although it’s commonly mentioned as a risk for upstream or downstream diversification.

Aside: as with my previous visits to ARC, the facility strikes me as a gorgeous site where the employees are as well treated as anywhere in any company in the world. As I tell my students, it’s always best to work for a high-margin company.

Note: This was ready to post Thursday afternoon, but posting was delayed due to Google’s 20-hour failure in running Blogger.

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.

"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.

Blockbuster's cash cow

Stuck in a declining business — storefront video rentals — Blockbuster today confirmed that it wants to buy another declining business. The nation’s largest video rental chain said today that it has offered $1-$1.35 billion cash for Circuit City, the country’s second largest electronics dealer. The news sent shares of Circuit City soaring.

The offer was made in February, but Circuit City has not cooperated with the friendly offer by opening its books. Until it does, Blockbuster can’t make a definitive offer.

This reminds me of a favorite b-school case on related diversification. Viacom merged with Blockbuster in 1994 to get the cash flow to finance its purchase of Paramount Pictures (and later CBS). After a decade, it noticed that video rentals were a declining business and thus decided to dump the shares via a share distribution.

If the idea of combining Blockbuster with Circuit City is an end-to-end contender for delivering digital movies (in competition with Netflix and Apple), Seeking Alpha suggests that Blockbuster doesn’t have a clue. Instead, writer Scott Berry suggests that Blockbuster will have to partner to get a top quality hardware solution to compete with either.

Open innovation — partnering for success — seems like such an obvious concept. Except to media moguls used to controlling the end-to-end value chain.

Blockbuster movie distribution deal

Blockbuster has decided to buy Movielink, a struggling digital movie download site. The site was launched by the big movie studios who have been paranoid about IP issues even since their audio cousins got Napster’d. (Of course it’s not paranoia if everyone really is hoping to steal your stuff).

I’m not sure why the movie studios are buying. Perhaps they feel the need to be an honest broker to iTunes, Amazon and other alternative digital distribution channels. But my hunch (based on no data) is that they had trouble actually agreeing on how to run a business, and thus never were able to make the decisions necessary to make the company competitive.

The price wasn’t disclosed, nor was the financial performance of Movielink. Rick Aristotle (a Netflix shareholder on Motley Fool) thinks that it went very very cheap. I suspect it will be significant enough to be mentioned in the Blockbuster 10-K next March.

It’s pretty obvious why Blockbuster is buying. (So trivial that it’s not even worth leaving to the reader as an exercise). There is one physical video rental store, Blockbuster, competing against one mail-order video store (Netflix) with both a bricks-and-postal solution. In an earlier media distribution battle, there were two major physical bookstores — one got serious about having an online presence (Barnes & Noble) and one did not (Borders); both are losing business to Amazon.

So if driving to the corner video store becomes passé, and waiting for the USPS to deliver envelopes becomes passé, then Blockbuster needs to have a stake in other ways of delivering video content. (Netflix has been rumored to be planning a digital download for more than a year).

Of course, if paying for movies becomes passé, then both Blockbuster and Hollywood lose. So perhaps Hollywood wants someone to make a credible go of selling movies, just as Apple has done with music. But unlike with the iTunes Store, it helps Hollywood to have multiple online channels. (Class: which of the 5 forces is this?)

Technorati Tags: business models, diversification, information goods, Internet, movie industry, video

Nokia vs. Yahoo smackdown!

Yahoo bought the photo sharing service Flickr in 2005. This morning came the news that Nokia bought Twango, founded by Microsoft refugees in Redmond. Telecom blogger Om Malik calls Twang “a combo of YouTube, Flickr, Shutterfly, Photobucket and Xdrive.”

There are some odd aspects to this. #1 of course is that Nokia supports Flickr on its phones, and in fact Flickr made Nokia S60 phones the centerpiece of its ZoneTag location-aware photo sharing prototype (including a very recent update to support some S60 3rd Edition phones).

The 2nd odd thing is that Nokia is buying a content sharing service, when its biggest customers are mobile phone operators that see themselves as being in the content service business. Does this presage a broader push into consumer services — head to head with the operators as well as Internet behemoths like Google and Yahoo? I realize Nokia expects to be beholden to no one, but in Strategy 101 we teach that moving outside one’s competencies and competing with major customers are two very bad (and common) outcomes of vertical integration.

Caroline McCarthy of CNET says it best:

It's unlikely that this acquisition will affect a whole lot of people who aren't Nokia customers (and it's not yet very clear as to how Twango itself will change) but it'll be interesting to see how this affects mobile media-sharing.

Technorati Tags: diversification, Nokia, social networking, vertical integration, Yahoo

Limits to diversification

When we teach related (or unrelated) diversification, we emphasize the case where the competencies from the existing business don’t transfer to the new industry (or perhaps the rare case where participating in two industries has disadvantages).

However, there are cases where diversification runs aground by being too successful — at least in the IT industry with its increasing returns to scale. I recall in the 1990s, Microsoft spent a lot of money trying to sell settop boxes based on Windows CE, while the cable TV oligopoly was quite clear that they were not going to make IBM’s mistake and transfer their distribution channels and market power over to Microsoft.

At lunch today, I read in yesterday’s Wall Street Journal that Universal Music is threatening to not renew its annual contract with the iTunes store. In fact, today’s Information Week reports that Universal will not renew its contract at all, but instead offer its content at will, free to change the terms or pull out at any time.

Universal is taking a big risk: the NY Times article suggests that the iTunes store accounts for about 10% of the revenues of Universal Music (70% x 15%), or about €500 million of its €5 billion annual music sales.

Of course, there are a lot of disagreements between the record labels and Apple, the largest being that they want to charge consumers more per song and Steve Jobs thinks that’s a bad idea (except for its iTunes Plus premium service). But the WSJ (and other) articles make the explicit link to the label oligopoly being averse to surrendering any more of their supplier power than they already have:

Music companies generally consider the mobile market the next frontier for their business, and are loath to let Apple dominate it that market the way it has digital downloads.

In the short term, having Universal withdraw from iTunes would be bad for consumers (lack of one stop shopping), but it could be good in the long run if it increases competition. It wouldn’t matter much to me, since I have 10 purchased iTunes songs and 3,600 songs that I personally converted from CDs.

Still, having followed the music industry’s information age strategies for the past five years, I suspect that Universal is doing the wrong things for the wrong reasons. The record labels seem to be better at asserting their naked market power to protect an old order that will soon be gone, rather than aggressively creating a new future more to its liking. At least EMI is trying new strategies — there are risks to their strategies, but there is more risk in doing nothing.

Since Universal is owned by Paris-based Vivendi, perhaps its executives are spending too much time trying to emulate Louis XIV. Not a rewarding path to follow, unless you are eager to enjoy pie in the sky when you die or the attention of 72 willing virgins.

Technorati Tags: Apple, diversification, iTunes, music industry, Universal Music

Diversified embarrassment risk

After rah-rah enthusiasm during the 1960s and early 1970s, the strategy of unrelated diversification has fallen out of favor with strategists and financial markets. GE nothwithstanding, it’s been shown that firms waste a lot of managerial time trying to manage disparate businesses that have no synergies, and that stockholders can better diversify risk by buying their own shares in the underlying businesses. Such unrelated diversification still remains a pattern in countries where the aggregate market power overrules the underlying inefficiences, such as Korea’s chaebol and (until recently) Japan’s kigyō shūdan.

Today, the Wall Street Journal published a list of companies doing business with Iran to help finance its oil and gas development. American frustration with Iran is building since it seized 15 British sailors and Marines on March 23, and some in the Senate are proposing a boycott of firms that do any business with Iran.

Most of the companies on the WSJ list are energy companies, but one jumped out — Korean conglomerate LG. The LG Group doesn’t have much (any?) petrochemicals presence in the US, but instead it sells a lot of LCD screens via its joint venture with Philips. More visibily, its LG Electronics subsidiary is the world’s fifth largest maker of cell phones (at about 6% in 2006) and the largest maker of CDMA handsets.

LG has a potential exposure here, but it’s not clear how big. Right now, the US pressure on firms doing business with Iran is fairly weak: it’s not clear whether the ultimate pressure will begin to resemble the (successful) anti-apartheid divestment efforts of the 1980s, or whether it will just fizzle out.

In some cases, the risk of scandal in a diversified company is severe. The broad portfolio of clients (not technically diversification) held by Arthur Andersen & Co. proved to be its undoing, as the choice of one particular Houston-based company proved fatal. However, as a “Big Five” accounting firm, Andersen was in the business of renting its previously stellar reputation to validate the financial statements of public firms, so once it lost its reputation it had nothing. Obviously thousands of former Andersen employees wish that the Houston office had not taken that client (or had done a better job of protecting Andersen's storied 90-year-old reputation). And the damage to the Andersen brand accelerated the decision of its Andersen Consulting spinoff to rebrand itself as Accenture.

LG won’t face such a consequence, if for no other reason than the Korean government won’t allow it to happen. If the pressure increases, the RoK government will probably try to protect LG rather than a more pro-active strategy such as separating the electronics and petroleum companies into separately traded firms.

Also this week, the diversified company ITT was fined this week for transferring military technology to China. Given that Loral survived (despite bankruptcy) after transferring ballistic missile technology to China, ITT is likely to skate after paying its $100 million fine for the night-vision goggle technology.

Technorati Tags: LG, mobile phones, diversification

GE: Is 3 less than 2?

As a mass market item, the digital camera enjoyed double digit growth from 1997-2005. But last year, US sales were up only 5% and IDC projects they will be flat at 30 million in 2007. In undergraduate strategic management, this is the classic definition of a looming shakeout, and in fact that’s what analysts are expecting. Also, camera phones have become an even more popular substitute, since nearly half of last year’s billion cell phones were camera phones.

In Michael Porter’s five forces model, an industry facing flattening growth, strengthening substitutes and high rivalry quickly watches profits disappear, and so it’s just about the worst possible time to enter. (Only a period of absolute decline would be worse). So I was really surprised to discover over the weekend that General Electric decided to announce its first digital cameras at last week’s annual PMA Show.

The announcement made so little sense that I spent several hours trying to find out more, not only surfing the web but asking my some of my colleagues in our strategy group. Like most strategy professors, we teach GE as an unusual case of unrelated diversification, and often quote Jack Welch’s famous dictum, paraphrased as “every business unit should be number one or number two in its market, or get out.”

The digicam market is already crowded with firms leveraging other competencies. Of the eight companies last year with market share over 5 percent, all have some form of related diversification:

• camera companies Canon (#1), Nikon (#4) and Olympus (#6) obviously know something about making and selling cameras;
• consumer electronic companies Sony (#2) and Samsung (#7) make high-volume consumer electronics products;
• scanner/printer company HP (#5) has experience in color management, imaging and software; and
• film companies Kodak (#3) and Fuji (#8) have top color scientists, a strong motivation to stay in photography, and at least some exposure to the camera industry with low-end cameras and disposables.

Shipping a digicam has historically been easy because of the opportunities for open innovation, by sourcing components or even whole cameras. Kodak partnered with Chinon to develop both the first consumer digital camera (for Apple in 1994) and its subsequent products, while HP entered by relabeling Pentax cameras. On the other hand, many early entrants have already given up or fallen out of the running.

Other than a love for diversification, what does GE bring to the table? After all, enforcing Welch’s dictum they dumped their consumer electronics division on Thomson in 1987. Sure, the generic GE brand was ranked #4 last year. But when I consulted the most frequent photographer in our household, my better half’s initial reaction was “neutral-to-negative” on a GE digital camera. Why? “I’ve never heard of GE doing anything with cameras.”

It turns out there’s less there than meets the eye. A GE camera has barely more to do with GE than a Polaroid camera has to do with Polaroid. GE wants to make a quick buck licensing its name, and has a smidgen of technology from its medical imaging group. The cameras are designed and sold by a new company called “General Imaging,” reflecting the ego and determination of its CEO Hiroshi Komiya. Komiya’s claim to fame is that was at the helm when Olympus led the ranks of digicam makers in 1996, before the market took off. Olympus remained #1 with 20+% share through 1998, but then was passed by Canon, Sony and Kodak. For the past five years, Olympus has had trouble making a profit and its digicam market share is now 6% and falling.

After retiring from Olympus in 2005, last summer Komiya decided to re-enter the maturing market. The company’s press release details the hubris:

Komiya said his goal is to be among the top three camera brands in the world within five years. “We believe digital cameras are still in a growth market,” he said. “With the replacement cycle now down to three years, many consumers are buying their second or third digital camera, while others have been waiting for just the right camera to come along to make their first purchase. With our excellent quality, advanced features, strong value proposition and the great GE name, we are in a position to lift the entire category.”

Even making #3 would not meet the Welch standard. And with minimal trepidation, I predict that General Imaging will never hit double digits, let alone the 15% it would take to be #3. Meanwhile, as
Business Week warns:

The licensing deal itself is raising questions as to whether GE might, in the long term, actually jeopardize its brand—one of top four most trusted brands in America—by expanding its consumer-electronics licensing program.

Today, GE has six consumer-electronics licensees, which make everything from phones to Web cameras to Christmas lights. The $163 billion company earns an estimated $250 million from those deals, according to Nick Heymann, an analyst with Prudential Equity Group. Sure, the company has few costs associated with its licensee sales, and licensing is commonly viewed as money that falls right to the bottom line. But if the General Imaging business—or another new licensee—were to run into problems, that could hurt the GE brand.

Technorati Tags: commoditization, digital cameras, GE, open innovation, diversification