Is there a good way to fire your customers?

During the Super Bowl, Radio Shack ran a (highly praised) 30 second ad about how they're abandoning their 1980s image to unveil a “new” Radio Shack. The ad featured 80s celebrities like Mary Lou Retton, Hulk Hogan, CHiPster Erik Estrada, Alf, the California Raisins and "Cliff" from Cheers.

In other words, they spent about $4 million to proudly announce they are firing some of their old customers to better appeal to new ones. And as part of the firing, they’ll be closing one store out of every nine.

The company certainly faces major challenges. Their original business of selling parts to hobbyists and tinkerers has gone away. The competition in selling electronics (from Best Buy, Target, Wal-Mart and others) is fierce. And, perhaps worst of all, the convenience of a neighborhood storefront where you make a quick stop is being destroyed by the depth of inventory and price-cutting of the seemingly unstoppable destroyer of retail, the Bezos Empire.

The intended makeover reminds me of JC Penney, whose new CEO fired all their old customers in a (vain) hope to win over new, up-market ones. When it failed, JCP fired him, brought back their old CEO and desperately tried to woo back their (once-loyal) customers.

You’re Fired!

This sort of decision has two key points. First, the company feels it needs to attract a type of customer they are currently not reaching. In the JCP case, it seems to be because they are higher margin, whereas for Radio Shack, it's because there are more of them.

But is there every a good time to fire your customers? Usually the firms that do it are desperate and are stuck between two bad choices.

In these two examples, I was fired twice. In Radio Shack’s case, I get it — the niche of people who own soldering irons is too small to support 4500 (soon 4000) stores. Besides, the company has already eliminated much of the inventory that once attracted us to the store, with only a fraction of the parts that it once had.

For JCP, I thought they made a major mistake, and apparently the board agreed. The value clothing segment is a large one — growing due to declining incomes over the past five years — and JCP held a strong position here. There's a lot to work with and this market segment isn’t going away.

My previous favorite clothing retailer was Mervyn’s before they died five years ago. Now I use Costco when I can — because of convenience, price and quality — but their selection means I rarely can. The selection at Target is limited, the quality at Wal-Mart is suspect, and so for most of my clothing I value having a full-service clothing retailer like JCP (particularly given I’m a nonstandard size). The only reason I don’t use it more is that (unlike Mervyn’s) it’s in the larger mall rather than more convenient strip mall.

Death of Freemium?

Finally, this week I was fired a third time. Instead of an iconic 20th century Main Street retailer, this was a (me too) 21st century Silicon Valley internet services company. The cause was also different: instead of declining customers and margins, this was a company with a freemium business model that never worked to begin with.

The company is SugarSync, a DropBox imitator that notified customers December 10 it was terminating the free part of its freemium business model, effective February 8. Although the early software was buggy, I loved the service because it worked with my hard disk organization rather than (as with Dropbox and later Google Drive) forcing me to adapt to its model.

Sugar’s decision meant that I’ll have to use Dropbox or Drive and work around their limitations. Not the end of the world. I forgot about it entirely until I got this week’s email, urging (imploring) me to convert to paid membership.

I don’t envy them: people are addicted to these services but (like the rest of the Internet) not paying for them. In a recent class of about thirty 21-39 year-old graduate students (at an elite biotech institute), I asked how many of them use Dropbox. Every hand went up. When I asked how many paid, not a single one of them raised their hand.

It appears Sugar is hoping to segment their market and serve those who need more than they (or their competitors) provide free. After having raised $60+M in venture and (now) debt financing, my guess is that the need to get to positive cash flow has become urgent.

Given how crowded the segment is — and how little traction they got — I wouldn’t be optimistic. The only hope is that other companies give up on free and condition people to pay, but it’s hard to imagine either Google or Microsoft pulling back from freemium entirely. And with Box recently offering 50gb free (vs. 2gb for Dropbox) the trend seems to be in the other direction.

At the same time, it calls into question the viability of the freemium business model, which always depended on a non-zero upgrade rate. I certainly wouldn’t want to start a company nowadays with a business plan that assumed freemium would generate enough revenue to pay the bills (let alone the investors).

Facebook won't repeat its one-time gains

This week, Facebook reported record sales, record profit and a record stock price. For shareholders, this is the perfect time to sell.

The good news is that the company has successfully adapted its desktop ad strategy to mobile phones.

The WSJ summarized it thusly:

The social network accounted for 18.44% of the world-wide mobile ad market in 2013, up from 5.35% in 2012, eMarketer estimates. That compares with a climb to 53.17% from 52.35% for Google.
…
Mobile-ad revenue as a percentage of overall ad revenue climbed to 53%, from 49% the prior quarter and 23% a year earlier. This was due to the ongoing shift of ad dollars to mobile away from more traditional media and Facebook's ability to capture a bigger slice of the fast-growing pie.

The problem is, Facebook will not see that level of growth again. It got 3.4x share growth in one year, and if it were to do it again — today or in 10 years — that would mean a 63.6% share of the mobile market. That isn’t going to happen.

Facebook is perhaps the world’s most popular Internet application, but it’s just one product. Even including Instagram, those products are not going to capture a majority of a market that includes search, news and the rest of the WWW.

What of its other products? Instagram is doing a good job of segmenting the market — providing difference social media for different demographics — but not helping it gain new categories. Paper is innovative enough to lock-in millions of millennial eyeballs, but again, it’s not going to take over the world.

The reality is that most of the large tech companies are one-trick ponies, with their subsequent efforts never matching up to the original. Yes, Microsoft added Office to Windows, but beyond that? IBM took decades before profits from its services business matched that from mainframes. Only 21st century Apple had the ability to create multiple multibillion business, and with Steve Jobs gone, that won’t happen again soon (if ever).

Instead, I expect Facebook will be like Google and Intel, where the core business is what makes money and the other activities are (at best) in support of the core business and (at worst) a good way to waste money.

Facebook has a P/E of 104 (49.3 times 2014 projected earnings) vs. 32 (21) for Google. That’s a huge growth premium, which is only justified if these current levels of growth can be sustained for many years.

When the growth slows, they’ll get a Netflix-style correction. So this would be a good time for investors to lock in their wins, or at least take some money off the table.

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.

When the brand trumps the product

In strategy, we often debate the cause and effect of success: how much is the product, and how much is the perception of the product? Fortune 500 companies spend billions trying to build the brand, in hopes that builds loyalty beyond (or instead) of anything the product does.

This question has come up in higher education, but I’ve never hear the brand value put so starkly as in this FT article this morning:

“A degree has value only if the degree is scarce, and the MBA is completely unscarce,” says Jeffrey Pfeffer, professor of organizational behavior at Stanford Graduate School of Business.

Prof Pfeffer has published on a wide range of topics but is well known for taking on the industry in which he works – business education. He argues that schools’ reputations have suffered from promoting themselves as a route to enhanced future salaries. The professor has been pointing out for a decade that the value of a degree is linked to the prestige of an institution rather than what it teaches – but few people have been listening.

“People don’t hear what they don’t want to hear,” he says, adding that he nonetheless believes that unless you go to an elite school – by which he means one ranked in the top 15 worldwide – an MBA is a complete waste of money.

So, Prof. Pfeffer’s argument goes, the value of the MBA is the transfer of the elite brand to your resume.

My coauthor, fellow blogger, former Apple and Palm executive and entrepreneur Michael Mace listed the bundle of services in a degree:

universities bundle several services in that thing called a degree:
--Teaching the students
--Credentialing (ensuring that the students have learned the material)
--Giving the students social connections (Yale, Stanford)
--Helping young people turn into adults in a semi-safe setting

The latter was on Mike’s mind as the parent of an undergraduate (now two), but the other three certainly apply to MBA programs.

By Pfeffer’s theory (or conjecture), the value of Stanford MBA is the credential, not the actual content of the courses. This is consistent with what other academics have wondered — are Stanford MBA students successful because of the selective admissions, i.e. is all the value of the MBA added by the admissions office letter?

In fact, in the FT article a soured MBA graduate recommend just that. Author of The MBA Bubble, Mariana Zanetti told the FT:

“But I don’t think it’s the MBA that adds the value – it’s the selection process that makes the difference,” she says. She would even recommend getting a place at a top school and turning it down to prove you were of a high calibre without wasting money.

Even if Pfeffer is correct, he leaves out a crucial factor in calculating the net value-added: cost, both out of pocket and opportunity cost.

Some MBA programs are more expensive than others. Obviously for the same cost-benefit, a low cost doesn’t have to deliver as much benefit. Forbes calculates the ROI on Stanford, which has the second highest prices (after Harvard). The public schools on the normal top 25 lists are charging market prices, but the Forbes list identifies some state schools (like Iowa, Michigan State or Washington) that gouge their students less than others.

The second cost is the opportunity cost. No one would argue that Bill Gates or Mark Zuckerberg would have been more successful if they had finished Harvard. During the dot-com mania, Stanford and Harvard MBA students were dropping out to start companies — both learning on the job (in a way new graduates rarely do) and getting lottery tickets (stock options) that could allow them to retire before 30.

Whether or not the (self-serving) observations of elite b-school professors are correct, the question of the value added by education is one that needs to be addressed. However, students who don’t get an elite credential might get other value from they bundle of services, i.e. if they actually learn something in college or grad school. To me, the acid test is what middle-aged students do with their own money: their careers are determined by their prior experience, not any burnishing of their resume by a mid-career degree. Instead, they go to school to improve their own human capital. These students are a breath of fresh air for any teacher.

And overall, I think Pfeffer’s analysis (true or not) sets a terrible example for his students. It’s a serious mistake for any business — including a nonprofit — to focus strictly on the brand and forget about the quality of the product. Even Apple — held out as a master of PR and branding — was left for dead in the 1990s due to its product execution, and only came back (and once again changed the world) because it made stuff people wanted to buy.

Nobody beats Amazon

This week, there were two data points on the irreversible transformation of distribution (and employment) wrought by Jeff Bezos.

The first came in Friday’s WSJ, reporting on Q4 results by Seattle’s fifth largest company:

Starbucks Corp. reported slightly lower-than-expected revenue and same-store sales growth in its fiscal first quarter due, in part, to consumers' shift to online shopping during the holidays.
…
Howard Schultz, Starbucks's chief executive and chairman, told investors on Thursday that "2013 was the first holiday that many traditional retailers saw in-store foot traffic give way to online shopping in a very big way. Customers watched, waited, compared prices and then bought the brands and products they wanted online—frequently using a mobile device to do so" and that Starbucks is well-positioned to benefit from the shift thanks to its investment in mobile-payment options and electronic gift cards.

What does it mean to society if Starbucks — Starbucks! — is losing sales because people are shopping in their PJs rather than the malls? Presumably Schultz will still get the commuters and business travelers, even if their seasonal bump is never again what it used to be.

The second data point came from entrepreneur Howard Lindzon, who makes his money collating stock insights on Twitter. In a (dead tree only) column in our local birdcage liner, he wrote this morning how “bricks and mortar” has become “bricks and mortuary,” as America’s largest e-tailer continues to put storefronts out of business:

Over time, more and more of us have become comfortable doing an increasing portion of our buying online. Amazon has won. With tortoise-like patience, it has conditioned us to expect low prices, vast selection, quick delivery and one-click transaction. it is hard to compete against it today. Ask Best Buy.

Best Buy was once the quintessential “big box” retailer. Of course, Blockbuster used to be the category killer for video rental, and look how that worked out.

Lindzon expressed skepticism about Best Buy’s plan to improve online sales efforts in hopes of catching Amazon:

Good luck competing with Amazon on price and selection or on customer awareness. They have already won this battle. Your only chance is customer service, but it has never been in Best Buy’s blood. It is hard to teach an old dog new tricks.

If I were still teaching undergraduate strategy, I’d point my seniors to the three essential truths here

1. The transformation of retailing is ongoing and unstoppable.
2. Traditional retailers will be unable to out-Amazon Amazon, and only a handful will come close to competitive parity.
3. The only hope firms have to compete with the volume leader is to offer superior service.

Some firms already value service, and may be able to find a way to monetize those competencies. For those that can’t or won’t, it’s hard to imagine a viable path forward (other than exit via M&A).