Navigating The Future by Francis McInerney

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The Media Blues

Tokyo — NBC’s Beijing Olympics coverage was over
the top, with more coverage over the air, on its cable networks, and
online than in all the years since the 1960 Olympics, combined. But
here’s the shocker: despite streaming most of this — thousands of hours
— over nbcolympics.com, the Games drew less than $6 million in online
advertising revenues. That’s a tiny fraction of the $1 Billion NBC
recouped on legacy media toward what it spent to acquire American
broadcasting rights.

On a revenue-per-hour basis, the web is a bust. A great public
service maybe, but neither NBC nor anyone else can make money like this.

Is this one more sign that the end times are near for traditional media?

By all accounts, the Olympics provide the kind of content that still
attracts advertisers with wide-open wallets: it’s live, it’s big, it’s
must-see TV. NBC broadcast in the high definition medium, which is as
unlike TV as is radio, and for which the Olympics are made. NBC even
released extra advertising inventory in the middle of the games in
order to meet demand. But online died where it stood.

To make the new web media work will take the kind of major innovation initiatives for which we designed our Corporate Innovation Project.

We know that consumers are more and more willing to pay for content.
The time they devote to paid content is rising at a healthy pace: up
16% over the last five years. This content includes pay TV on cable and
satellite, movies (rentals and in theater), recorded music, video
games, books and expenditures on the Internet and for mobile content.

But, advertising-based media (including broadcast TV, radio, newspapers and magazines) are off 8%.

To read on, visit North River Course Corrections

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Microsoft and Apple

New York — Talk about asymmetric innovation, today the big story was Microsoft hiring comedian Jerry Seinfeld for $10 million to help rebuild its stodgy image in what the Wall Street Journal called its “Battle to Beat Apple.” While the blogosphere chattered away about how Seinfeld used Macs on his show and once appeared in an Apple ad, the real story is in this chart.

Microsoft’s growth rate is decelerating, from 12.5% CAGR over the last five years to 4.3% during the last four quarters. Apple’s rate is decelerating too, from 33.1% to 8.4%. Still, all Microsoft sees is that Apple is growing twice as fast.

Apple’s cash velocity fundamentals are better too and getting better all the time. Microsoft’s are deteriorating rapidly. MSFT’s overheated capital velocity and poor cash velocity makes it what Michael Dell calls, “a pool of cash” waiting to be siphoned off by faster innovators.

Microsoft’s biggest mistake, as I said in my August 2003 North River Advisor, MICROSOFT 2003 was entering the browser wars in the mid 1990s. Once MSFT went after Netscape, it lost its market focus completely and never recovered.

To read on, visit http://www.northriver.com/coursecorrections

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Innovation in The Air

New York — Our new CORPORATE INNOVATION PROJECT shows what types of innovation are accretive and why. Look at the commercial aircraft business. Airlines are being killed by today’s fuel costs and many are reconsidering orders placed in recent years with EADS (Airbus) and Boeing. Which will suffer most? Which can scale profitability in a down market?

The chart shows that EADS, which gets a NORTH RIVER MANAGEMENT GRADE F (it takes half a year to turn a sale into cash) is moving in the opposite direction from B- Boeing. As I advised in October, 2006, this would create an opening for a newcomer.

Any newcomer would, however, take business from mostly Airbus because of its relative weakness. Bombardier, also an F grade operation but one that is improving rapidly, read the numbers the same way and moved into the core of Airbus’ business: low-to-middle capacity planes.

Of Airbus order book of 3,634 aircraft, 83.5% are for small and medium sized planes. It has orders for only 200 of the $15 billion super jumbo A380, about 26% of expectations and less than half way to break even. And it has committed another $15 billion to a plane, the A350, to compete with Boeing’s fast selling 787. You can see from the chart that what made very little sense several years ago makes still less today and the company cannot survive in its current form.

Boeing, by contrast, has a quarter of its order book in only one plane, the 787, which outsells the A380 and A350 combined by 50%.

Ask who between EADS and Boeing will survive a market down turn better and the answer is Boeing. Its improving grades mean that its working capital efficiencies generate higher rates of OFCF and, therefore. greater OFCF-R&D and OFCF-SG&A ratios than EADS. And these are getting better all the time.

In addition, the higher the cash velocity, the higher the Customer Information Premium and the lower the risk of misjudging the market.

With its low cash velocity driving a customer information deficit, EADS is, on the other hand, leaving itself wide open.

China is already talking of entering, as I said it would in late 2006.

Bombardier has beefed up its own cash and capital velocities, and aimed at the soft underbelly of Airbus — the small to medium planes it needs to finance the A380 and A350 — using a scaled-up model of an existing product and innovative new supply chain. Bombardier is thinking more like Apple than General Motors.

Now that fuel cost-driven cancellations are coming in, the hardest hit is Brazilian Embraer, at 2.23%. Next comes Airbus at 1.84%. Then Boeing at 1.73%. Bombardier has none.

Bombardier launched it’s low-risk model into a recession, always a smart move. First, its planes will not be ready until the airlines have absorbed fuel costs into their business models. Those airlines that will not survive will already be gone, taking the incumbents order books with them. And Bombardier’s focused and recession-adjusted business model will have scalable profitability built in.

All this depends on Bombardier improving its Management Grades, which, while it shows every sign of trying to do, is no simple matter.

You can see, however, that the key innovation here is not product or technology. It is the supply chain. Airbus’ supply chain is a political invention and can only be changed by French President Nicholas Sarkozy and German Chancellor Angela Merkel deciding jointly. Bombardier can attack this with impunity by optimizing its own supply chain to gain the highest cash velocity in its business.

Airbus has struggled with this issue for years and I will advise more on this shortly. But, once again, the tight relationship between management grades and accretive innovation is the dominant force. You have to be a fool to ignore it. 

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Sharp Miscalculation

New York — The Wall Street Journal gave a big spread to Sharp’s $9 billion bet on LCD manufacturing today. But Sharp has had a NORTH RIVER MANAGEMENT GRADE  F since we began collecting data on it in 1996 and is deep in the type of trouble that NRV’s new CORPORATE INNOVATION PROJECT is designed to solve.

The chart shows the gravity of Sharp’s difficulties. In spite of some movement over the last decade, the company is well into the Dead Zone of our Soccer Ball System for gauging the speed of operations, core to accretive innovation.

The NRV system shows exactly where Sharp needs to innovate to get out of the Dead Zone and to make innovation accretive for the long term.

To take a bet of the size Sharp proposes — between a third and a quarter of its sales on an LCD factory at Sakai the size of 32 baseball stadiums — the company should already be testing 20 days of inventory instead of the 49 it has.

The theory is that Sharp will invest only $4.3 billion of the $9 billion cost and that its suppliers, who will be housed there too, will spend the rest. This proximity will, in principle, cut Sharp’s inventory days...

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Demand Management Failure

New York — Chrysler is a victim of a huge problem that plagues Japanese industry and which our new CORPORATE INNOVATION PROJECT is designed to obviate: a fatal lack of demand management. The lack of demand management in Japan is so bad that companies there have never heard of it. Chrysler’s inability to manage demand — a company problem in most of the world — plagues the entire Japanese nation, and that, in turn, is a problem for everybody who sells to, or buys from, Japan.

The chart shows how demand management works. Companies with IT good enough to generate high cash velocities also get the customer information premium that comes from those velocities. Companies without effective demand management IT have low cash velocities and, therefore, customer information deficits. Often they don’t know what they don’t know.

In Japan the chronic lack of demand management IT means that demand and supply are never synched well enough to ensure operating margins commensurate with market share or sales growth. This is how a large operator like Sony can have strong sales and weak operating margins while non-Japanese companies like Proctor and Gamble, Apple, and HTC get both high growth rates and high margins.

It is the difference between scaling profitably and not.

07:30 am | 1 recommendation | 1 comment

A Tale of Two Innovators

New York — Here is an intriguing tale of two innovators. Apple gets a NORTH RIVER MANAGEMENT GRADE A+ and Microsoft gets an A-. Since 1999, Apple has seen sales grow by four times and stock by fifteen times. Microsoft, by contrast, has seen sales grow 2.7 times and its stock fall 40%. The big difference: how they innovate.

Apple has a well-defined brand message: we manage your entertainment. Microsoft once had a clear message: we manage your work experience. But, once the company attacked Netscape with its Explorer web browser in 1995, the company lost its way and fell into a “Let a thousand flowers bloom” strategy. The latest thing is to be in the search and advertising businesses. Why? Who knows. But it is what it is.

The results are startling. Apple will overtake Microsoft in sales in about 24 months. If current sales multiples hold — no sure thing — the company would be worth $417 billion. Microsoft would be worth $343 billion, though probably less because its market cap to sales ratio is falling with its stock price. Either way, it is likely that Apple will be worth more than Microsoft in the foreseeable future.

What drives the two apart is the way they innovate. Microsoft is all over the map, from games consoles to operating systems, from advertising to office tools. And it tries to do most of its innovation in house. Apple leverages other people’s IP to move its own IP to market fast and cost-effectively, and is focused on entertainment. Apple steers clear of upstream risks in operating systems and studiously ignores markets that do not benefit its core mission.

The core cash and capital velocity data of the two companies could not be more different. Apple is 58 Cash Velocity Index points ahead, giving it far more competitive endurance. What gives Microsoft its A Grade is its operating earnings as a percent of enterprise value, 49% as opposed to Apple’s none-to-shabby 30%. Of concern to Microsoft shareholders, it has eight days of inventory compared to Apple’s five: how can this be?

A good argument can be made — indeed will be made in business schools the world over — that Microsoft lost its way taking on Netscape in 1995. This was a big mistake that has cost shareholders dearly. Microsoft trades at the same price as it did ten years ago, almost to the day. The attempted takeover of Yahoo shows that management is still badly distracted a full thirteen years later.

Yesterday, Microsoft announced that it will not follow up its failed Yahoo bid with another buying spree. Perhaps management has begun to figure this out.

The price of mismanaging innovation can be steep. Don’t go there. Join our CORPORATE INNOVATION PROJECT and stay ahead of the curve

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Taking Advantage of Motorola

Tokyo – I’m often asked here what it would take to become a top player in the $400 billion global market for cellphones. Motorola’s troubles offer a once in a decade chance to displace a large supplier and the tools of NRV’s CORPORATE INNOVATION PROJECT show how this can be done.In CIP, the first step is to look at the numbers through the lens of the North River Cash and Capital Velocity Indices to see how the industry is structured. Clearly, Motorola’s departure would open a wide sales hole in the market, as the chart shows.The chart also shows other important features of the market: 

1. None of Motorola’s competitors stand to benefit from buying its cellphone business, now for sale.
2. Any Motorola combination with another low cash velocity performer would fail.
3. And none of the top cash velocity performers, like HTC and Apple, have anything to gain by acquiring Motorola.
4. The top cash velocity performers are in the premium end of the market and do not suffer Motorola’s price deflation problems.

Private equity could pick up Motorola, but none of these players has the expertise to increase Motorola’s North River Velocity of Cash and Capital Indices, let alone increase them fast enough to put off the Grim Reaper.This tells us that Motorola is being taken out of the play, one way or another. The way to entry seems clear: market demand is not going down, though it is mature in many markets, and the loss of Motorola will have to be made up by somebody. Why not us?Ten percent of the global market is $40 billion — nearly twice the size of Apple in 2007 — which certainly is not shabby. Should we enter?Let’s run thought this from the top as we do in THE CORPORATE INNOVATION PROJECT and see what a successful strategy to take advantage of Motorola’s misery would look like.The wireless business is entering a period of revolutionary change that is already disrupting global markets. The last such opportunity was the introduction of digital cellular in the mid 1990s. Another one will not emerge for a generation.This new discontinuity, ushered in by a rapid shift in price-performance―much more bandwidth for much less cost―will offer us a once-in-a-generation chance to establish powerful, profitable, branded positions.To take advantage of this great opportunity, we need forward-looking, global strategies that are brandable, break cleanly with the cellular past, and are unencumbered by the priorities of today’s industry participants.In the near future, every person, literally, will be a TV station. With YouTube and Facebook, we are well on the way. We want to play a dominant role in this new market.We will, therefore, have to look well beyond Google’s text-based advertising and find new, innovative business models for mobile video entertainment. Content providers, similarly will have to monetize the “lost generation,” those young viewers who will never own a TV, just as they will never own a landline phone. To prosper, carriers too must understand these needs and learn to profit from them. CIP will have participants from these areas so we have friends from whom we can learn a lot and leverage a lot.Capturing this fast shifting global market means recognizing that:

• Wireless is on a price-performance curve. Forget the word “cellular.” This is a term for a mobile technology whose time on the price-performance curve is already in the past.

• Our North River Third Law of Information is that value always flows to the least regulated. This means that the most open and least proprietary architecture for maximum user value creation always wins.

Apple’s iPhone is so successful because it is part of a complete entertainment management ecosystem, iLife. Apple positions iLife―a three dimensional package that includes hardware (iPhones, iPods, and Macintosh computers), services (iTunes, iMovie, iDVD), and content (the movies, videos, TV and music files of others)―to extract premium value from the markets of others.We know that we should not―and cannot―simply copy Apple. But we can learn from Apple’s strategy.

• Apple focuses internal investment on key areas of differentiation, leveraging the innovation potential of its suppliers to an extraordinary degree.

• Apple targets segments where competitors are highly profitable, but careless about financial management. These are companies in North River’s “Risk Zone.”

Apple’s greatest strength with iPhone is also its greatest weakness: its ecosystem is largely proprietary. Furthermore, carriers and content suppliers view Apple as a threat to their own proprietary ecosytems. Google has correctly identified the appeal of open source software for wireless Internet devices.To gain a large role in wireless, we must foster an ecosystem where others can fill in the dimensions we cannot. CIP will play a key role here, allowing us to do what we do best and leverage the strength of others to participate profitably in one of the most rapidly inflating realms of cyberspace at minimal investment.CIP will also help us set our go/no go decision criteria.The North River Velocity Model also tells us that the sine qua non of market entry is cash and capital velocities high enough to maximize operating free cash flow, giving us the above industry OFCF-to-R&D and OFCF-to-SG&A ratios that will provide the Customer Information Premium we need to maintain a leading position.To get these velocities, our sales almost certainly have to be direct, without intermediaries, because we cannot generate competitive high cash velocities otherwise.The gating factor for market entry, therefore, is not technology or alliances, but whether or not we can establish an effective, brandable, direct sales operation. So, to design our market entry strategy, regardless of whatever we do and whatever partnerships we enter, we have to start here.Thus, CIP allows us to see what it will take to benefit from Motorola’s misery and to do it quickly, reducing costs and preventing us from wasting R&D on something that will not work if we cannot build a direct sales operation.The first piece is in place.

08:38 am | 0 recommendations | 1 comment

The Automotive Industry Crisis

The collapse of the U.S. automotive industry is, without question, one of the greatest tragedies of the age. Hundreds of thousands have lost jobs already and hundreds of thousands more will follow them in the coming years.

What makes the story so compelling is the homes that will be lost, the college educations that will go unfunded, and how easy all this was to foresee and therefore to forestall.

To read the entire report on the Auto Industry, published in 2006, download the PDF here

http://www.northriver.com/AutoIndustry2006.pdf

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Good News from China

New York — It may seem tasteless to say there is good news from China,
given all its suffering from last week’s catastrophic earthquake, but
there is good news. Wal-Mart, which gets my North River Management Grade A,
will respond to quality problems on Chinese goods by demanding
“traceabality information” from Chinese suppliers. This should drive
cash velocity improvements across large sections of Chinese industry,
good news for everyone.

You can see from these data that Wal-Mart is well ahead of competitor Target, which gets my North River Management Grade C+, down from B in FY 2007, taking its stock down 17%. Wal-Mart’s North River Velocity of Cash Index
is 41 points better. But, Wal-mart has struggled with inventory
management in recent years — its signature strategy is putting more on
the shelves with fewer stockouts and less inventory than anyone else —
and its stock price has languished as a result.

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Is EDS another Compaq?

New York — The real question in the acquisition of EDS by Hewlett-Packard is, can a NORTH RIVER MANAGEMENT GRADE B company make the acquisition of a Grade D company accretive? Experience says it cannot. At an operational level, the mechanics of the two will be tough to integrate.

Hewlett-Packard has struggled mightily to get to where it is today and I have given CEO Mark Hurd much credit.

You can see large scale implementation of the data used to make these assessments in the Goldman Sachs report based on my system, PICKING CASH VELOCITY WINNERS.

Hurd’s management team may reason that applying H-P’s operational skills to EDS will improve its fundamentals — EDS’ North River Velocity of Cash Index shows that H-P’s sales operations, for example, are clearly superior — to leverage the differential sales multiples and make the deal accretive quickly. It may also reason that EDS operating margins have improved every year for the last five and that sales have finally begun to grow too.

Still, this deal is going against history, not with it, and will be hard to do. The last time H-P acquired a low grade company — Compaq — the CEO lost her job.