Business Performance II: Moving Toward Crisis, Managing By Hubris

8/14/2019 Business Performance II: Moving Toward Crisis, Managing By Hubris

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Business Performance II - Moving Toward Crisis, Managing By Hubris:

Earnings, Financial Engineering, Non-Performance, and Malfeasance

By Dave Livingston, Managing Principal, Llinlithgow Associates (www.llinlithgow.com )

Dave is a management consultant primarily focused on improving enterprise performance by coupling strategy with execution thru the design and implementation of workable, integrated management systems.He blogs on this and related issues in Economics, Markets & Investments and specific industries and companies at www.llinlithwo.com/bizzx , his BizzXceleration blog.

Introduction

This collection of blog essays look at business performance in 2008 and focuses on several inter-relatedquestions. First, with the slowmotion slowdown quickly turning into something much more serious, how well werebusiness prepared and preparing for the upcoming storm? Next, two key, critical and highly co-dependent

questions – what should a business be doing? That is what are the strategic and operating principles by which itshould be judged and analyzed? And how, in fact, do you conduct such an analysis? What are the perfomers andnon-performers doing, what are the data sources, how do you collect you own data. Finally, what were companiesdoing instead of what they should have been?

The short answers are that a business should be focused on creating value for its customers. That means that itneeds to have a workable, executable strategy where the strategy reflects the realities of the world around it aswell as operational capabilities. It also includes balancing short-term decision-making with long-term developmentand investment requirements. You can imagine if you like a matrix defined by columns of Current and Future androws defined by Strategic and Operational.

The essays use numerous case examples to illustrate the approach and test it’s usefulness as well as appealingto great gurus, such as Warren Buffett, as sources of insight and inspiration.

The bottomline is anything but good. But the machinery, case studies and principles developed and discussedhere are as applicable today as they were when first published. In fact they underpin a lot of what we see goingon around us every day.

Instead of focusing on creating value, on evolving sensible strategies and developing the operational capabilitiesrequired to be effective it seems that many of the problems that showed throughout our 2007 assessments werecontinued into 2008. Business focused on the short-term at the expense of the long-term, didn’t update or refreshstrategies or develop new ones and certainly didn’t focus on developing the operating capacities required. Worsethey largely ignored the warning signs surrounding them and instead focused on short-term stock performanceand the use of financial engineering to boost apparent stock performance. All the long-term damage of thecompany and resulting in poor positioning when the crisis arrived for real.

In short the focus was on financial returns not value creation or business performance. It can only be

characterized as a combination of hubris, short-sightedness and self-interest bordering on malfeasance.

There are of course many exceptions and we discuss a few. In the process we hope we provide a toolkit thatallows you to evaluate the health of a business and its prospects, whether you’re an employee, business partner,customer or investor. These are approaches, techniques and data sources intended to be used and they havebeen accurate and timely.



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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.

Table of Contents

1. Ganesh Filters III: Analyzing Businesses Blueprints 3

2. WRFest(Business): Business Shock 4

3. Truth, Justice and the NDX Way: More Tech Outlook Reflections 5

4. Brave New Worlds, Painful Old Ones 6

5. Winners & Losers: Rubble Sorting 7

6. Principles, Paradigms and Potzers 9

7. WRFest(Tech Bizz): Times They are Changing 10

8. Buybacks, Bounces and Splats: Buying High, Selling Low 119. Masterclass: Buffett on Investing and Business Analysis 12

10. Earnings, Valuations & Business Analysis (I): Readings 14

11. Earnings, Valuations & Business Analysis (II): Resources and Approaches 15

12. Naive Questions: Taking the Next Step 18

13. Business Strategy: What the Future May Hold? 19

14. Strategy, Context and Awareness: Sub-prime Lessons 20

15. Performance Assessment Basics: Five Fundamental Factors 22

16. Business Performance II (Readings): Performance, Pain and Prospects 25

17. Business Performance III (Readings): Sad Stories, Good Stories & "Fixes" 26

18. Sailing Into the Storm: From Execution to Innovation 28

19. General Business: Perspectives, Issues & Companies 31

20. About Llinlithgow Associates 32



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January 03, 2008

Ganesh Filters III: Analyzing Businesses Blueprints

http://llinlithgow.com/bizzX/2008/01/ganesh_filters_iii_analyzing_b.html

The prior posts surveyed the general economicand market situation and the investmentperformance situation. Here we'd like to continuethat theme and fortunately ran across severalinteresting sources and stories that reinforce theargument. Links and excerpts are continued belowthe line. A fascinating WSJ article finally extendsthe enterprise value argument by looking at currentresults vs future performance expectations.

The graphic example points at MickeyD's butplease take note that it was strategic re-thinking

and operational improvements that led to changesin future value, current valuations and stockimprovements.

In other words the way to translate our model ofenterprise performance assessment is nowexplicitly linked to stock performance. But, we'dstrongly emphasize, the key is the performanceimprovements, not pandering to short-term streetexpectations.

Below are some equally fascinating links to analystexpectations which seem, in this light to be wildly

misjudged, to the likelihood of very large increasesin corporate bankruptcies and, fresh today, two financial columns that outline strategies that coincide exactly withour overall outlook, sector analysis and individual performance analysis. We also provide linkages to applicableprior posts.

Just to explore this whole topic we ran aninteresting experiment on LinkedIn by posting a

question on expectations on enterpriseperformance. So far the response has been rathersmall - which may be a sampling problem. We'dalso suggest that it's serious awareness problem.And, as today's headlines illustrates, earlywarnings are easy to ignore. The "surprise"downturn in Employment has been visible formonths yet everyone is shocked, simply shocked:). Anyway if you can get to linked in check out thequestion for yourselves. Better yet leave yourcomments on your expectations here!

For another perspective we'll point to theperformance of the SP500 over the last severalyears, especially PE Ratios (for why they'reexcellent indicators of eventual long-term



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performance try here or here. Anyway if you'll pop up the chart at left you'll a "stunning" climb in EPS coupled witha more than stunning compression of PE rations. Now you ask why might that be - could the market have figuredout that earnings and profits are in fact not organic, are held up by buybacks and buyouts and not likely to besustainable? We'd argue that's a fair assessment and, willy-nilly, that any investment you're considering should besubject to the same value questions. How are they doing now and why? And what are the likelihood of futureimprovements?

Those are the questions that put you on the path to finding value investments that'll provide strong returns. Andthe heart of the discipline is seeing clearly what's coming, how performance is related and evaluating currentstrategic position and operational capabilities as well as future ones. Suitably adapted of course for sectors orother asset classes :).

Good luck and good hunting!

January 06, 2008

WRFest(Business): Business Shock

http://llinlithgow.com/bizzX/2008/01/wrfest_6jan08business_business.html

Now that we're moving beyond the holidays it's time to ask how businesses will react to the acceleratingdeterioration in the macro-environment. And the decline in the markets where implicit valuations are likely to takea big hit as a result. Rather sad in light of the amounts that have gone into buybacks and the damage to balancesheets that result from increased borrowing to support those buybacks. As things beging to work out it's likely thatthese mounting pressures will increase the level of bankruptcies, pressure profit margins and in general makethings more difficult.

Earlier this week, just to test the waters, I posted a question on LinkedIn to see if there's any shared widespreadconcern with these issues. If you're on LI you can take a look over there though it's early days as yet. We'll seehow the response go. But the gist of my inquiry was this:

As the economy continues to deteriorate what do you think the impacts on corporate performancewill be? And how well positioned do you think major companies and industries are?

Later amplified by suggesting that a) most companies have weakened balance sheets and aretherefore more fragile and b) haven't taken the opportunity of the last several years to revamptheir strategies, improve their operations or otherwise better position themselves.

If you have any opinions please feel free to chime in, either in the comments or on LI. On the topic, and to helpset the background up some more, we'd refer you to our prior posts on the macro-environment (& the balancesheet situation) as well as the approaches and prior readings on business performance evaluation. After thecontinuation we provide our usual list of decent industry and business links to help contribute to your thinking :).In our 'umble opinions enterprise performance will be an increasingly critical challenge in the next few years,though it always is. Now it could become critical. And, as we hope we've made clear, things don't look any toorosy!



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January 7, 2008

Truth, Justice and the NDX Way: More Tech Outlook Reflections

http://llinlithgow.com/bizzX/2008/01/truth_justice_and_the_ndx_way.html

And perhaps, to be both fair and honest, we should addSchadenfreude. If you look at the chart it shows therelative six- and three-month performances of the NDX,AAPL, GOOG, and RIMM. Now we've been warning forsome time that that the markets have "fluffed" or "bubbled"up over their long-term trends, irrespective of theunderlying economic fundamentals. Most recently here.

And that techs in particular and the big techs mostespecially had exaggerated that fluffing processconsiderably. Well those chickens came home to roost bigtime last week with a drop in the NDX since last Mon. of

about -8%, along with similar drops in AAPL and GOOGcoupled with an -18% drop in RIMM. Whee....are wehaving fun now or what?

Our argument has been basically the logic that a slowingeconomy meant slowing capex spending which meantlower tech demand and investment. A thesis which isbeginning to be reflected on a worldwide basis with lastweek's downgrade, for example, of INTC as well. To thatwe should have added another - which is that there's beena dramatic shift in some tech dynamics as companies likeApple make major efforts to enter what amounts to theConsumer Electronics industry. Which falls under the

sector heading of Consumer Discretionary - a sector evenmore hardhit than any but Financials.

Now we need to be a little careful here. All three companies are genuinely excellent operational performers withsome distinct differences. RIM appears to be still a dominant player in smart-phones for the business sector andalso to have gotten a major halo uplift from the iPhone, which opened up the "smart phone" appeal to a muchwider audience. Google continues to be a great company which continues to achieve superb results in its' corebusiness. Please note though that in terms of long-run value that it hasn't had any, that we can find, major newinnovations that have driven increased penetration of new markets. Though it continues to introduce and testflymany new inventions none have established new markets. Apple on the other hand continues to demonstrate arelatively rare combination of strategic innovation - defined as delivery new products and solutions to markets thatactually solve customer problems and provide new value as opposed to just introducing new technology per se.And to couple that with continued operational performance and delivery.

Nonetheless the bloom is indeed off of these roses for reasons we've waxed poetic about, repeatedly in fact,before. Barry Ritholz posted a delightful and insightful assessment of the gap between fundamentals and marketperceptions today that compared much of the thinking going on by Mr. Market as fitting Kubler-Ross's well-knownstages of denial (an analogy we've also used before).

5 Stages of Market Grief One of the most intriguing things I find about the market is how thecollective psyche sometimes resembles a singular entity. In particular, I have been fascinated bythe commentary we have heard from some quarters regarding deep and obvious flaws in thepresent macro environment. I spent a lot of time over the holidays (skeptically) reading



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commentary from various pundits. There was something strangely familiar in the absurdlyerroneous observations, but I couldn't place my finger on what it was. Until Friday. I don't knowwho or what actually triggered my memory, but it finally dawned on me what the parallel was: TheKübler-Ross model of 5 stages of grief. For those of you who never took any psych in college,that is the process by which Humans deal with grief and tragedy. It was introduced by ElisabethKübler-Ross in her 1969 book "On Death and Dying". This has become well-known as the "Five Stages of Grief ". Reviewing recent market commentary, it appears that the investors, traders andpundits alike have been working their way through each of these 5 stages.

As the recent unpleasantness, as they say, continues to work its' way forward that's a worthwhile model to keep inmind. And not just for tech but for all the other sectors, industries and firms. On the continuation you'll find anotherinteresting excerpt on the overall outlook for tech spending that resonates with these points.

January 12,2008

WRFest(Business): Brave New Worlds, Painful Old Ones

http://llinlithgow.com/bizzX/2008/01/wrfest_12jan08business_brave_n.html

As part two of the week's interesting stories we'll focus on the business outlook. Just to continue with our story ofattending a panel on the LBO industry outlook, with a mid-market emphasis, we'll mention that the panelconcluded with a live case study. This was a small manufacturer and distributor of a branded set of healthcarecleaning supplies with about $80 of annual revenue and $11M of profits. Quite a tidy little business with low capexrequirements, some reputation, low debt and some real adjacent market opportunities. It also helps to know thatthe founders were in their late 60s and most management was in the 55-65 range.

In other words we have a small company with an excellent track record, superb financials and some interestingopportunities. The three panelists were sr. execs from a finance company, a PE buyout firm and a private hedge-like fund focused on alternative investments. The question is what would you pay and how much debt and, mostespecially, what key questions would you ask. Without reviewing them in detail the questions were very sound interms of overall EBITDA multiples and debt ratios.

There were two interesting things. First off the panelists, while fairly aggressive, were much more conservativethan the winner LBO firm's bid which in turn was very aggressive on the debt side for the financing. The secondnobody asked the key operational questions:

1) What drives the financials in terms of market, customers and operating capabilities,

2) What happens in a slowdown, how well will those numbers hold up in other words,

3) If you buy it and leverage it up how much does that increase the risk factors and

4) What are the capital requirements to go after the growth opportunities presented to justify the

multiples suggested, let alone on offer from the actual acquirer.

Now these guys are a lot better at their jobs than I'll ever learn to be. They quickly and efficiently analyzed (it was

a short case study after all) the financials as presented. But nobody, and I repeat nobody, asked the fundamentalstrategic and operating questions. Which, for readers following along at home with this blog, will now know makesus extremely nervous in general and, given the fragilities we've discussed, more so in this case.

There's an interesting WSJ column in today's In the Lead which summarizes the 'run the company aspects' in away:

Moving Ahead of a Slowdown A look how some companies prepared for an economicslowdown. As U.S. jobless claims rise, manufacturing activity declines and consumer spendingskids, many executives are beginning to acknowledge that the economy is slowing. But others,like Mr. Zollars, caught cooling signs early and have already trimmed labor costs and inventory



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levels and made other adjustments. "The best-performing companies plan in advance -- or atleast ahead of many of their rivals -- for slowdowns," says Michael Mankins, a partner andconsultant at Bain, which has studied which companies best weathered the last downturn in 2001and why. "They take a bet early on which way the economy is going and quickly identify whichcosts they can manage aggressively and where they should use cost savings to fund newgrowth," he says.

As we mentioned the mid-markets have done better thru '07, which to put it in perspective was a great yearoverall, than the large buyout firms. But are they a lagging indicator? There doesn't seem to be much awarenessof nor commitment to the mantra of economy - industry - firm analysis we support. The real question here is howwidespread is that attitude? As opposed to the examples in the WSJ story. We suspect, so far, that it stillrepresents the dominant thinking

January 16,2008

Winners & Losers: Rubble Sorting

http://llinlithgow.com/bizzX/2008/01/winners_loosers_rubble_sorting.html

A friend and I were discussing the currentsituation, or "mess" as he calls it and heasked a very pertinent and simple question.Also a very difficult one yet as crucial as it ishard. While I'm not sure an easy answer willroll forward here there are someapproaches. Here's the original question:

"Now, I have an interesting and difficultquestion for you to work around. Canyou propose what kind of scenarios wemight see in the resolution of all themess? Who will wind up being thebiggest losers? the biggest winners?"

Take a look at the chart on the right whichshows the monthly stock prices of Boeing(BA), Citigroup (C), GE, Pfeizer (PFE) andWal-Mart (WMT) from Jan95 to now. That'sbasically the situation we're faced with going forward - how to seperate the winners from the losers. What criteriado we use, what timeframes are relevent and where do we find the information ? Now some of those answerswere reviewed/previewed in earlier posts that are worth looking back at. And in fact the most recent WRFest onBusiness provides all those links, plus some interesting stories and a little context: WRFest 12Jan08(Business):

Brave New Worlds, Painful Old Ones.

But take a look at the chart and what do you see? Because here's a pretty good starting place.

The first thing that seems to leap out is C'sdominance of the chart, at least until it fell off thecliff recently. But take a little closer look - it reallyhasn't gone anywhere since '00 after the bubble-run of Weill's buyout spree. On the other hand just looking at this chart Boeing wouldn't seem tohave done well at all, at least at this scale.

What we need to do now is both change thescale to break performance up into timechunksand then apply a little business analysis to see



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what's what. Be we'll give you a hint and it's contained in an earlier post which pointed to a great WSJ article on long-term vsshort-term performance (Ganesh Filters III: Analyzing Businesses Blueprints).

First, let's change the scale and take a couple of different looks at enterprise performance and then ask somequestions. Now all of a sudden an entirely different picture emerges where BA is far and away the bestperformer, on both sub-charts. Despite it's recent dip due to B787 Dreamliner delays.

At the same time, if you look at the top sub-chart, the only one of these bellweathers that has come even close tomatching the performance of the SP500 is GE. As noted C has dropped big time, ~ 60% so far. And neither PFEnor WMT has done well with declines since '04 of -30% and -15% respectively. So what's going on here?Well we have several mantras we like to apply and hope to persuade you to, if not adopt, at least think-thru andbe aware of. And which we'll use as our template for further discussions. The three (& there are likely more butlet's stick with three for now) are:

1. Economy to Industry to Firm analysis: no firm is entirely immune from general trends and the more it's one ofthe pack the more that's true. Conversely a true innovator, e.g. Fedex in its' heyday, can defy the overall trends ifit's establishing a new business model, industry or solution.

2.Timeframe: back in my days in corporate planning one of the great puzzlements was how major initiatives thathad huge payoffs failed to move the market. And conversely how irrelevent short-term data caused it to jump all

over. Businesses move in three timeframes.

• Short-term where the run what they have with who they are, say over 12-18 months.

• Intermediate-term where major shifts, investments and adaptations take place, say over 18-36+ months. So, for

example, a decision by Frito-Lay to go to Europe is a major strategic effort. Whether it pays off or not depends on

how well suited the fundamental DNA of the company aligns with the new market. As WMT found out to its' great

chagrin its' model wasn't well-adapted to Europe or Japan but seems to be working better in China and Latin

America.

• Long-term where major innovations in product, markets, business model and/or strategy take place. Apple's recent

"firing on all cylinders" success is based on executing well on all fronts but becoming the champion at sustained

product innovation that adds value. BA is another good example because its' great success if based on major

innovations in design, manufacturing, go-to-market and operations that date back years, if not decades.

3. Enterprise Characteristics: when youget to looking at an individual firm thenyou have to ask three fundamentalquestions. First, what's the BusinessModel and Strategy. Next, what are theoperational capabilities, in all timeframes,and are they aligned with the BM etc. Andthird, what's the Management System -that is can they ensure that we they think

they want to do is what they actually dodo. GE seems to be as good as anybodyin the world at this while Citi appears togive new meaning to the words miserablefailure. For each of these example firmswe lay out a partially filled in table of themajor question areas to investigate.

Here's a couple of things to think about.How much of this sort of thing do the



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Street analysts do? Or do they just extrapolate this quarter off into infinity? And, since we start with the BM andStrategy - for each of these companies how well is it working now? We'd argue that BA's model has shownsuperlative returns and will do so again in the future while Citi, as many have argued, has never managed toconvert it's story (it only gets to be called a business model when it's working at least partially) into operationaldelivery. Yet, GE which is in most ways much more complicated, seems to have mastered the art of making ahuge, multi-group, many-division conglomerate enterprise function. And the distance between medical equipmentand aircraft engines is a lot farther than that between investment banking and consumer banking, vast as thosedifferences might be to "inside baseball" cognoscenti.

So there's the first two+ questions you can ask for any company - how well is their model working ? And can theymake it work? And where's the information? On that latter question, look around you. MickeyD's recovery basedon changing its' model was headline news several years back and any casual skim would tell you something isgoing on. In the same industry when Howard Shulz broad-sided Starback back last winter it told you that their BMwas on the verge of breaking. Lo and behold here we are. And you could have made money going both ways onboth companies but a relatively quick investigating of these questions.

January 23,2008

WRFest(Business): Principles, Paradigms and Potzershttp://llinlithgow.com/bizzX/2008/01/wrfest_20jan08business_princip.html

This should be the last post for last week's stories and links. The primary focus is on traditional industries andcompanies. Continuing our theme of digging into enterprise performance are several key readings. Let's kick it offwith a great story that, IMHO, encapsulates a lot of our notion of speak softly, run a good business, execute wellnow and lay the groundwork for the future at the same time.

Green Bay's Quiet Football Mastermind Before this season, fans were calling for Mr.Thompson's head. While the Packers had won just 12 of their last 32 games, he did not seem tocare. No matter how loudly the fans complained, Mr. Thompson, who avoids publicity and rarelyexplains himself, continued sending away popular veterans and replacing them with untested

college players, some of whom weren't highly regarded by other NFL teams. This year, led by acore of players that helped make Mr. Thompson a pariah, the Packers won 13 games and madethe playoffs. What's more, the players he's brought into the league during his career are havingan exceptional year -- as the playoffs resume Saturday, nearly 10% of the active players on theremaining eight teams were signed out of college by Mr. Thompson. While pro football is thenation's most popular sport, the brutal economic structure of the league -- where all 32 teams areeffectively given the same resources -- has made winning and losing largely a function ofmanagement. Winning not only requires ruthless cost control, but it also seems to reward peoplewho are able to make decisions in a hermetically sealed chamber without worrying about whatthe fans, the media or their own players will think. "I try to keep my eye on the ball, so to speak,"Mr. Thompson says.

In addition there are some general business readings: one of those "smart" companies that moved ahead of theslowdown and are well positioned to ride it out and take advantage of the recovery if/when it comes. How manycan say that ? Not many. A good example is what's going on in Retail specifically and the broader function ofCustomer Service - a major source of competitive differentiation that's little developed, invested in or exploited.The MSN article points to some earlier customer service stories you ought to backtrack, particularly since theypoint to Comcast, Sprint, ATT, et.al. as being terrible at it. Both for its' own sake but also because it's exemplary isthe story further dissecting the mis-steps at Sears which are based on wrong-headed views of how to run aretailer.

We also point to our own earlier posts on the SEE changes coming in the Innovation(Tech) and Financeindustries. Complemented by more readings on the Auto industry, Energy, and Airlines.



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WRFest(Tech Bizz): Times They are Changing

http://llinlithgow.com/bizzX/2008/01/wrfest_20jan08tech_bizz_times.html

Now that our little side detour to look at the emerging bear is "over" - btw just kidding, from the futures today it's just really beginning - it's time to put up the interesting links and excerpts for the business stories of the week.There are enough we're going to split them into two. This one will focus on Innovation based industries and thenext on general business issues and more traditional industries. In fact judging from today's open this is prettytimely :).

A constant theme we've been playing is the need to understand the drivers and characteristics of enterpriseperformance, which argument has been mightily reinforced these last few weeks. Not to mention these last fewdays. While all this sturm und drang is going on there are some major deep changes happening in the innovation-based industries. Which notion is itself a major one. Notice we didn't just say technology industries ! Innovation issomething that all firms should be doing, most don't and will become increasingly important as a foundation forsurvival. But the innovation-based industries are the ones where product development in fact drives the wholerest of the firm.

As Josh Limon pointed out the first pill costs $10B while the 2nd costs $1 in the pharmaceutical industry. Similarlyin the aerospace business Boeing and Airbus should really have a split P&L. One for the research, developmentand production behind the first new model. The second for the continued manufacturing, sales and support of thenext 1,000. In comparison R&D and innovation do not, as a matter of fact, take up as much of the budget andaren't as critical to the traditional tech industries. Though it is still critically important. So we've collected readingson tech, telecomm, pharma, aerospace and alternative energy under this heading.

But let's set the table with - why do you care? Well if this carnage ends in six months as the standard expectationhas it who'll you pick to get back in with? If it keeps going same question, different dates? On the other hand ifyou'd read Truth, Justic and the NDX Way and agreed with the conclusions you might have been out of Tech intime to save or short and make money. Consider this post a continuing part of our efforts to dive deeper intobusiness evaluation and rubble sorting (Winners & Loosers: Rubble Sorting). Since we've a little space, and each

link deserves it's own post - if not a series, let's try and expand on the context a bit.

1. Telecomm - on it's 3rd or 4th Perfect Storm. The story below on the iPhone will help explain why the decade+business model of the big telcos got blown up last year. Another major disruption is the "fat pipe to premise" warbetween the telcos and cable companies. The result of which is already upending the media & entertainmentindustries more than they've been since they were shaped at the end of the 19th C (hyperbole ?). Part of the nextbig storm is the growth of Unified Communications which should be a major innovation for the Telcos but whichthey're having trouble grasping. Meanwhile MSFT and IBM are going after it big time. Interesting. And then there'sthe GOOG vs YHOO war where the first's model may be aging while the latter let complacency and lack ofinnovation and adaptation depreciate its' user base value so severely. And who doesn't seem to be generatingany new breakthru thinking either !

2. Technology - meanwhile IBM reported a 12% jump in EPS but when you look at the detailed investorpresentation that was 24% YoY but 10% was in revenue growth and buybacks, each. But revenue growth wouldhave been 4% without currancy benefits. And they told me that you buyback shares when they're under-valuednot to catch a falling knife in a down market. Me, I'd rather have that cash as a dividend rather than see it go intobuybacks and be depreciated completely. Similarly ORCL bought BEA (finally) but BEA has almost completelylost its' clout to IBM in the last few years in the Java arena and ORCL's not done well with its' own middlewarestrategies (FUSION). Can't say there are many indicators of organic revenue and profit growth let alone long-terminnovation here.

3. Pharma - it's finally dawning on investors that the R&D model which drives Big Pharma is broke as broke canbe and no substitute is on the horizon for a long....long time. Which is why you hear a lot of analysts beginning to



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talk about major downsizings and further consolidations. Drug pipelines are 7-15 years long. Today's problemswere laid down in the late 90s and the stock prices have increasingly reflected that.

4. Aerospace - Boeing's been taking it in the neck recently over continued delays in the B787 Dreamlinerbecause of supply problems. That's in addition to market pressures of course. Yet the 787 represents majordesign and construction innovations that date back almost a decade, based on design innovations in CAD/CAMthat go back to the mid-90s. For this plane they've undertaken a huge new operational innovation by outsourcingwhole assemblies around the world. That's turning out to be a major headache but I'm pretty confident that they'llsolve it. Meanwhile Airbus's big new thing is the A380 which is so big only a few airport can handle it and which isreally only profitable on very long-haul int'l routes. Yet as technology advances it becomes more feasible to startflying more and more point-to-point city pairs. Which is perfect for the B787. When this is over, like Apple with its'string of sustained innovation, BA looks like a great investment for the future.

5. Energy - alternative energy is going great guns but the fact of the matter is that it takes 20-30 years to migratean energy infrastructure to a new foundation. All this does is nibble around the edges. And that's as long as youdon't make silly mistakes like subsidizing ethanol production from corn thereby driving up food prices, notproducting fuel at any cheaper prices and neglecting your real alternatives over the next several decades of coaland nuclear. Meanwhile of course these might still be good speculative investments.All in all there are going to be real winners and loosers in these industries. Sorting them out takes a bit of work butyou'd probably spend that much time reading charts and financials. Why not invest a little in exploring the

structure and fundamentals as well. We'll do our best to help.

January 24, 2008

Buybacks, Bounces and Splats: Buying High, Selling Low

http://llinlithgow.com/bizzX/2008/01/buybacks_bounces_and_splats_bu.html

Rather than wait for the weekend Readfest posting there are a couple of sets of interesting stories you ought tobe reading now and thinking about heading into the weekend, next week and for the duration. The duration of

what you may ask ? Well that's the question - the duration of the current unpleasantness of course. It's apparantlyreally beginning to dawn on the MSM though not widely that all the pressures for stock buybacks have resulted inattempting to prop up company stock prices have resulted in paying top prices and now, re-financing and re-capitalizing, at lower prices. Though some, including us have been beating that drum for quite a while now.

• UPDATE: The WSJ chimes in (bigger excerpt below): Investors can usually count on share buybacks to helpstabilize a stumbling market, but it's not happening this time around.

Below are seveal readings we've either recently collected and/or gone back and put here on the role of buybacks.Three things greatly.......many g's puzzle us:

1. This has largely resulted, aside from the minor detail of perverse executive incentive programs that cause them to

prop up the price while damaging the company, from hedge fund and buyout firm activism. Yet the capital that, for

example, the banks squandered over the last several years is now desperately needed to offset what's likely to be

continuing massive writedowns. In other words given their supposed financial acumen they put all these pressures on

management to do a stupid thing if they understood how the deep structures were playing out. They're going to get

hurt as badly as anyone because the cash they could have had in dividends or protecting their investments is

gone...gone...gone. So instead of re-deploying it, or putting it under the mattress, it'll never be seen again.

2. As part of this buyback effort not only has "excess" free cash flow been used but many companies have re-leveraged

their balance sheets and are much more exposed to the pressures and perils of a downturn than they would be



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normally. In other words businesses are a lot more fragile than they should be, AND nobody is anticipating this in

their outlooks as yet.

3. Denial - while some commentary is appearing the necessary simple analysis combined with the facing of the facts

hasn't really started. We've used the Kubler-Ross "Stages of "Denial" analogy several times but this looks like yet

another case. The lesson for you is that whatever you read reflects only partial reality, so far.

So take a good gander at this morning's links plus the prior posts from the blog that provide deeper dives and backup. Thelatter provide some useful, we hope and think, context for evaluating this meme as it begins percolating around. And oh yeah,or BtW, the two immediate prior posts(WRFest 20Jan08(Tech Bizz): Times They are Changing, WRFest20Jan08(Business): Principles, Paradigms and Potzers )on the secular and cyclical risks and outlooks for many industriesand companies ought to be added in the mix.

Our analysis is telling us things are going to get a little dicey/interesting, as the climber said to his partner as the avalanchestarted down the gully they we’re in. Anybody see the Eiger Sanction ? :)

January 30, 2008

Masterclass: Buffett on Investing and Business Analysis

http://llinlithgow.com/bizzX/2008/01/masterclass_buffett_on_investi.html

At the end of the lost post we laid down a, perhaps the, challenge for these interesting times:

"As this sorting goes on the real winners will be the firms and industries who have an effective business model or who re-invent one. Finding them will be the interesting challenge. "

So how does one go about sorting things out. Well there's ourinteresting little mantra of economy - industry - firm but we thought,beyond that, we'd appeal to the words of the Master. Mr. Warren Buffett

himself. Now there's several ways to do that from reading any of theseveral books that've come out, to reading Warren's annualstockholders letters. Which are online at the Berkshire web site andentirely worth your time. And he's made several invaluable and wisdomfilled visits to the Charlie Rose program. Two other interesting sourcesare another of our favorite blog sites and the AAII.

• NotMakingThatUp (Jeff Matthews): this is the last of a ten part serieson Jeff's attendence at the annual BRK meeting. Also if you'll searchJeff's site there are several other interesting posts that are well worthyour time and attention:Pilgrimage, Part X: On The Cheap

• Another is this introduction to the AAII's Buffett Screen

http://youtube.com/results?search_query=warren+buffett+mba&search=Search

We strongly suggest follow-up on those but fortunately modern technology has given us an even better startingpoint. Back around 1998 Warren made a major appearance at the founding of the Graham-Buffett school ofSecurity Analysis, the speech/Q&A was recorded and now it's posted on YouTube as a 10-part vidclip set. Eachof the parts is well worth watching, pondering, taking notes and re-watching. In fact as part of our prep work,obviously in addition to reading the previously mentioned materials, we watched the set twice. Being slow it tookus a while to catch on to the "take notes" part as well as the little gems and insights that we've heard no whereelse.



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Parts 1 and 10 have a lot to say about personal values, integrity, doing work that you love and the kind of worldwe live in. Odd that the world's most successful investor does a pretty good job as a downhome, country-storephilosopher, isn't it? :). The middle parts are particularly interesting for getting Warren's take on understandingand analyzing businesses and making investment decisions. But we'd especially point to Parts 3-5 if you listen tono others.

Now at some point you've probably seen Warren's basic principle's in some business article or heard him on Roseor someplace else. Certainly the AAII article does a superb job of translating those principles into a screening set,within the limits. We'd summarize/paraphrase them roughly as: 1) Understand the business and be absolutelyconfident in it as a business for the long-haul, 2) view investments as buying a piece of the business and becomfortable not trading them for 10 years, 3) look for companies with sustainable competitive advantages thatprotect the core value proposition and 4) pick companies with good management. Listening to Warren takes thosesimple-sounding principles and fleshes them out with examples and discussions that makes them meaningfullyoperational. Beyond that though we got several surprises that, as long we thought we'd been following Buffett,were eye-openers:

1. Understand the business - everybody's heard the make a decision in 5-10 mins. What's new news to us isthat a) he adds develop a circle of competency, say 30+ companies, you really understand and follow and b) ittakes a lot of digging and research. It turns out the Warren spent a long...long time and a lot of effort learning howbusinesses really work, i.e. what their business models are. Since this is our central mantra we were extremely

gratified to hear it.

2. Focus - you don't have that many good ideas, one good one will get you to where you need to go, don'tdiversify if you're really willing to work at it but instead focus on 6-8 companies, or investment ideas, that yournurse for a long time. If you're just investing in general without the time or interest then diversify, in fact focus onstock index funds. Otherwise if you are looking for above average returns they are the result of work, lots of it,good ideas and focus.

3. Moats - a key strategic principle is for companies to keep growing their moats, that is their abilities to defendtheir businesses and maintain above average returns. The re-emphasis on this was interesting but what wasanother major eye-opener were the definitions by example. A moat could be service, cost advantages & price,distribution, patents, etc. All the traditional operating functions that we here think are so important, that are almostentirely ignored by the business & financial press and constitute the sustainble operating advantages of a firm. In

other words the Moat.

4. Breakdowns and Bad Examples - Warren constantly used examples of companies with good businesses andbig moats. In passing he mentioned MSFT and technology and why he doesn't invest, the utility/power industry,why he's a member of Airlinoholics Anonymous, P&G, MickeyD's, Gillette and Coke, Coke, Coke and Coke. Nowin our books Coke became the perfect counter-example to some of his thinking. They thought they had a never-break business model where all they had to do was sustain in the states and extend it worldwide. In fact aftermajor efforts and a huge bad patch since about '00 they're now recovering.

It turns out that you can indeed put a major business model & moat at risk of destruction. Consider anotherinadvertent bad example used - Kodak. Coke has dug itself out from under its' own arrogance by re-thinking it'sapproach to product development and innovation, by realizing that one could indeed saturate the core market andrenewing the basic strengths of its' culture and sanding off, painfully, a lot of the arrogance and learning to adopt

and adapt. One could say the same thing for MickeyD's as well.Now are these exceptions to Warren's model or confirmations?

We'll let you answer that as a take-home quiz but the hint is this. If you pick a good business with a strong cultureit's likely to renew itself. :)

Another "little" thing that struck us that hadn't been obvious before but seems clear and simple is how closelyWarren's approach, one you get under the covers of the last ten years of press coverage, lines up with the one weoutlined earlier: Think Like a Private Equity Guy ? No, Think Like An Owner !



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Here's a side by side comparison:

Buffet Principles BizzXceleration PrinciplesFind and invest in good businesses as ifyou were an owner Understand the Business Model &

Strategy and make sure it’s good for thelong-haul. And what value you’re buying

into.Make sure those businesses have widemoats Make sure that the operational

capabilities to execute the strategy arein place, excellent and improving

And doubly sure that management ishonest, competent and trustworthy;with high integrity

Make sure the management systemestablishes clear goals, holds peopleaccountable and compensatesaccordingly.

For a collection of prior posts and readings that pursue these themes try browsing the archive on Enterprise

Performance for a collection. Including examples and more tools.

February 7, 2008

Earnings, Valuations & Business Analysis(I): Readings

http://llinlithgow.com/bizzX/2008/02/earnings_valuations_business_a.html

The immediate prior post was a collection of recentstories about how credit problems are Metastasizinginto tighter lending standards, lower demand,lowered ability to sell corporate debt and theincreased liklihood of accelerating defaults. All ofwhich increase the stresses on an already fragile

general business condition. As the chart at rightmakes clear(er) the prices for corporate debt areheaded into the tank. And corporate default ratesare headed the other way!

Yet, judging by the market action so far this week,the increasing likelihood of a recession and the associated impacts on earnings are NOT priced into the market. Acritical part of this is the very optimistic outlook for second half earnings on the part of sell-side analysts, who arelooking for amazing up-bumps in Q3/Q4 earnings. None of which is consistent with a slowing economy. When youfactor in the likelihood’s of increased pressure due to decelerating consumer spending as Housing worsens and agenerally tight credit market will be worsened. When you factor in the fragilities of excess leverage &buybacks/buyouts, margin and revenue pressures, etc. etc. indicate, at least in our 'humble opinions, that theStreet's analysts are too focused on bottom-up views of their individual companies. And not enough on their abilityto survive in this rapidly evolving environment. Put another way - what are they thinking? Or smoking as the casemay be!



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The heart of the conundrum(s) is analyst'sestimates of earnings, the P/E multiples beingplaced on those earnings estimates byinvestors and the amazing gap betweengrounded business analysis and more realisticearnings estimates. Repeating an earlier point- while there are some very good analysts byand large they're finance guy's who're good atnumbers courtesy of their MBA's. But they lackan understanding of how business works. Apoint which is reinforced by two charts we'veborrowed from Schwab's most recent outlookwhich a) show the failure of analysts to catchturning points. And b) relate earnings as finallyreported to businss cycle turning points suchas we're now at. Take a careful...careful look atthese charts and ask youself which analysts doyou believe? And why? How can you check itout?

And why should you care? Other than theobvious impacts on the market and theeconomy we mean :). For a couple or three major reasons. First off the analysts track record for calling turningpoints is abysmal. Secondly, and perhaps the most important, however this all sorts out, there are going to besome wonderful opportunities to pick up good companies that pass the Buffet filters very cheaply. Inother words you can turn this all to your advantage. But not without doing some homework.

We'll remind you of some more of Warren's advice - learn to understand business, narrow your "circle ofcompetence" to 30 +/- companies or so and then really dig into them. You only need to be making 5-6 goodinvestments in a focused strategy to do well.

The readings below should be helpful background for how to go about that. First up are two stories about topics that mightappear to be far afield. The first is how the Patriots built up a long-term strategy for an effective organization and the second is

on Mitt Romney's failure to follow his own prescriptions for doing the same; that is establishing and executing against arealistic vision. Translated - find those companies with Business Models and Strategies that are sound. Then filter them againby finding those that can execute well against the vision. And have the right culture, leadership and controls. The rest of thereadings, including a listing of some of the most pertinent prior posts, are more specific guides to business analysis.

February 8, 2008

Earnings, Valuations & Business Analysis (II): Resources and Approaches

http://llinlithgow.com/bizzX/2008/02/earnings_valuations_business_a_1.html

A constant them here is having to dig into the actual structural nature of an investment, particularly business. On

that topic we've put up some posts on approaches, valuations, and Warren Buffett's thinking (btw - if you haven'tfollow that post to the YouTube videos we repeat it's well worth your time). The question we haven't addressed asyet is how. Which we propose to make a bit of a start on here. Below the line you'll find a listing of web resourcesthat we've found useful. Now these aren't the resources of course that somebody in the business has access to -in fact we rather hope they have much better and deeper ones. Nonetheless there's more and more informationsufficient for you get into investment and business analysis. Along with the links we'll also wrap a shortexplanation of the stepwise process.

As part of the approach let's repeat our fundamental mantra: Economy, Industry, Company. In other wordsunderstand how the overall Economy (& therefore Markets are headed), then understand how particular industries



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will play in this context. And finally how particular companies will play. Now Warren is found of saying he pays noattention to big picture, macro stuff which is all well and good, especially when you've got his resources andtimeframe. But the mantra is not just top-down, as it might appear. One could as readily start on the other end byfinding interesting companies, however you do it, and then understanding their bigger picture context. So themantra works both topdown and bottom-up.

So below the line please find our suggested links, resources and (implicit) approach to business analysis. Wehope you find it useful and productive.

Let's start with Warren's materials, though we've already pointed you at the videos. In our post on comparing hisapproach to ours we also pointed to an article by the AAII on their interpretation of his approach which resulted intheir "Buffett Screen". That's a start of another sort as well, too. If you haven't already join the AAII unless you'realready in the Finance industry and have access to alternative resources. Regular reading of their Journal will goa long way toward laying down a solid foundation.

Buffett

Buffett Screen: http://www.aaii.com/stockscreens/screendata/overview.cfm?screen=BuffHags

NotMakingThisUp: Pilgrimage, Part X: On The Cheap

BRK Web Site: http://www.berkshirehathaway.com/

The link to the screen is repeated above. One of our favorite bloggers is Jeff Matthews and he's also a fan of Warren's andmade a Pilgrimage to the last BRK annual meeting. His resulting multi-part trip report is very much worth your time. Finally,there's no better resource than Warren's annual stockholders letters - if for no other reason than they're fun to read as well asbeing informative, folksy and wise. Besides those resources we'd also recommend Graham's "Intelligent Investor" and either ofPeter Lynch's books. A related resource is the annual meeting of the Value Investor's Congress which has a LOT of verygood information on it.

AAII: http://www.aaii.com/

StockScreens: http://www.aaii.com/stockscreens/

Clearly we think well of the AAII. Either bottom-up or topdown their site has a wealth of stock screens that arevery good starting points for building up an initial list of candidate stock invesmtments. Now if you choose not togo the level of the individual company but instead focus on broader economic and industry trends, as well as keythemes, then you might not have to dig this deep but in the long -run it 'll still pay to understand key players tounderstand an industry, e.g. IBM's investor presentations will serve as a fine educational tool on the structure anddynamics of part of the tech industry.

Finance Web Sites

Two other very good web resources that provide a broade wealth of tools and information on stocks, variousassets, e.g. ETFs or Mutual Funds are Yahoo Finance and MSN Money Central. Both of which we've found to be

very useful.

Yahoo Finance: http://finance.yahoo.com/ Industry Browser: http://biz.yahoo.com/p/s_conameu.html

Stock Screener: http://screener.finance.yahoo.com/newscreener.html



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When you're beginning your explorations at the Industry level Yahoo is a great place to start. It also has a decentJava based stock screener. You might consider converting the AAII stock screen criteria, as far as possible, intotheir tool.MSN Money: http://moneycentral.msn.com/investor/home.asp

Research Wizard: http://moneycentral.msn.com/investor/research/wizards/SRW.asp

StockScouter: http://moneycentral.msn.com/investor/StockRating/srsmain.asp

StockScreener: http://moneycentral.msn.com/investor/finder/customstocksdl.asp

Jim Jubak: http://articles.moneycentral.msn.com/Commentary/Experts/Jubak/Jim_Jubak.aspx

The MSN site is rich with resources and we're only touching the surface here. News coverage, explanatoryarticles, guides and columnists are all particularly good. The tools listed above are about as good as it gets forinvestment research (and can be used whether you're an investor, employee, customer or supplier. In factthese days whomever you work for it's becoming more and more obvious that understanding how well yourcompany is or isn't doing is definitely in your own best interests !). MSN's StockScouter is a particularlyinteresting tool and uses a muti-factor scale to rate and evaluate companies. Highly recommended. The stable of MSN columnists is also very good but we'll especially call out Jim Jubak. His columns cover the reach and rangeof the economy, markets, industry trends and particularly companies and he's as close to our approach as anything out there.He also nicely balances technical with fundamental analysis - which in these markets is a necessary technique. We areespecially fond of and impressed with his ability to id macro-trends and themes and then translate that into investmentstrategies and company evaluations. In fact his columns are actually a better starting point for selecting targets than anystandard screen might be and should be part of your regular reading.

Other Resources

Hoover’s Research: http://hoovers.com/free/.

Hoover's provides a fair amount of research on individual companies for free but reserves the more in-depth stuff for fee. You'llhave to decide whether it's worthwhile though with regard to what it provides it's relatively inexpensive - though the free sitesmay take you far enough.

FusionIQ: http://fusioniqrank.com/ Another for fee site is the one put up by Barry Ritholz's new company FusionIQ which brings a rich set ofproprietary tools to the table, though for a fee. That fee however is very affordable and the tools seem to coverboth technical and fundamentals analysis very well indeed.

Schwab: Schwab has completely transformed itself and become perhaps the goto resources for the mid-sizeinvestor. Of course you'll need to be a client to access their tool kits but having been a customer for many yearswe've always been reasonably happy and in recent years the asset classes and instruments available as well astools for analyzing them have gotten very good. For example their ETF screening tools are as good as anythingwe've seen and they've introduced a stock analyzer with a proprietary multi-factor rating and screening tool that isvery good. In addition their commentary on the Economy, Markets, outlooks and companies is as close to ours asanybody out there. In the classic test of the intelligent person when they agree with you AFTER in-depth analysisthen you've got something.

CAVEATS and Additions

A couple of things we didn't mention but are readily accessible thru the sites mentioned above and where therubber really begins to meet the road.



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1. SEC Filings - all the investment sites provide access in their company profiles to SEC filings. You should, ifyou believe anything of what we're telling you, make it a constant habit to read the 10-K and 10-Q filings on everymajor company you're interested in (the now famous 30+ Buffett "Circle of Competence")

2. Company Investor Presentations - many of the larger companies put their presentations to investors up ontheir web sites, which can also be reache thru the sites listed above. You should be reading these regularly aswell. And, as we mentioned, if you're beginning to be pursuaded about the notion of business analysis thesepresentations are must reads. And again - not just for the individual companies but also for the insights into theirindustries and general conditions. For example the IBM pitches from last Spring on Emerging Markets focus ofcourse on IBM but tell you a lot about those situations. For another example the GE presentation by Jeff Immelton the strategic framework for GE's future is an exemplar of how it should be done. A comparison and contrastbetween GE and Citigroup is highly informative. One is clear, consise and well-structured. The other is atechnician's dream and tells you how disorganized their thinking is.

3. Financials - all of the web sites have some company financial reports and you should always look at these.And learn how to read and interpret them if you don't know already. However there's not enough data to get anappropriate baseline. For that you may want to look into something like the AAII's "Stock Investory Pro" whichprovides multiple years of market and fundamentl information.

4. Operating Information - unfortunately none of these sights carries much in the way of business specific

discussion or analysis. That is information on how a company really works though some of the available researchreports, e.g. on Schwab, will get you started. For that you need to follow the business and financial press, e.g.Bloomberg, Financial Times, CNN/Money/Fortune, Marketwatch or WSJ etc.

If you've been following along on this blog you'll notice that we periodically collect and comment on this sort ofreporting. Over time as you build up a comptency with an industry and company and accumulate your backlog ofstories you'll find youself accumulating something even more valuable. An appreciating asset of business domainknowledge. Here again we'll go with Peter Lynch-like advice. Start with the things you know and build up yourknowledge. We'll have more to say on that topic - in fact it's central to our whole argument.

And hopefully the point is clear that as we walk thru these sources and resources we're also outling what we thinkis the stepwise approach to business analysis. At least we hope it's clear and that you find it a useful and valuableapproach to understanding business analysis and performance evaluation.

February 8, 2008

Naive Questions: Taking the Next Step

http://llinlithgow.com/bizzX/2008/02/naive_questions_taking_the_nex.html

Following two of our long traditions we're going to a) post several links together rather than sepertately, unliketypical blog practice (a several months tradition now with our Readfests :) ) because these stories are valuableindividually but more so IMHO taken all together, as William James puts it. And b) post them en passant duringthe week (a many weeks old tradition).

As you may have noticed the markets roared ahead today and it was all because of the outstanding Retail Salesnumbers, not to mention momentum from yesterday when Buffett's offer to the bond insurers plus GM's earningssurprise got this 2nd Bear Bounce kicked off (and oh yeah, leave us not forget yesterday's look at earnings andthe talking heads also: Grading the Takehome: Bottoms, Earnings & Outlooks).Setting the table here wasMarketwatch's take on things:U.S. STOCKS RIDE HIGHER ON RETAIL SALES AND STIMULUS; NASDAQ CLOSES UPMORE THAN 2%

Tim Walker over at Hoover's Business started an interesting line of discussion with a post on asking simplequestions about apparantly complex problems - btw, the comments are worthwhile, ahem.



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The power of naive questions. One of the basic beliefs behind this blog is that the same basicpsychological issues confront us both as individuals and in our organizational lives. In otherwords, the same hangups that drag down one person can drag down an organization. We seethis all the time in the way, for example, that fear undermines the confidence of both individualsand companies. For a person, we call it a “mindset”; for a company, it’s a “culture”; but theoutcome is the same — paralysis. With that in mind, I’d like to kick off a discussion of one of myfavorite hangup-busting tools: the naive question.

Now Tim's bottomline is that you can dig beneath the surface so let's do that by asking what's beneath thesurface. Well:

1. Buffett's offer was actually to gurantee the municipal bonds covered by the insurers leaving them with the screwball

stuff and taking away their only income source. Which would mean their deaths as viable companies.

2. It turns out that GM's earnings surprise of +$.08/share was closer to -$.58/share when you take away the $1.5B North

American loss that was offset by claiming a $1.6B tax credit. BTW it was Phil Le Beau of CNBC who reported this

(vidclips below) and it wasn't picked up by any other news source we can find ! Earned his pay on this one, he did.

3. Retail sales rise was in autos and energy related stuff - in other words when you take out the inflation factor real sales

are, again, likely to have gone down. But, also again, everybody looked at the headline even though it was clearly

based on nominal numbers.

February 23, 2008

Business Strategy: What the Future May Hold?

http://llinlithgow.com/bizzX/2008/02/wrfest_23feb08business_strateg.html

Have you ever stopped to really thinkabout what makes a business work?Obviously it's a central question here but

have you really wondered?

Well it's intellectually fascinating - reallyfew things are that complex, with so manymoving parts and challenges. A mix ofchess, poker and rock climbing because ittakes brains, thought, discipline, skills,people judgment and ability to managestress and risk. More clearly it really...reallymatters to people where things are goingbadly or poorly...just ask all those autoworkers laid off, the Yhooites about toloose their jobs because of executive

short-comings or all those folks in NYCabout to suffer even worse.

For every millionaire IBanker laid off there's likely to be hundreds who feel the effects. But it's even more than that- big business has been the engine that's driven our economy and society since the late 19thC. Small businessescreate more jobs but the repositories of big change, for good or ill, or are when innovations are turned into USSteels, the Pennsylvania RR, Ford or GM, GE, Pfeizer, Intel, IBM, Microsoft,..., etc. etc. [If you're interested inexploring this more and understand how much the rise and fall of big business shapes the world around you weHIGHLY recommend two book:Big Business and the Wealth of Nations, Inventing the Electronic Century: The



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Epic Story of the Consumer Electronics and Computer Science Industries ]. Just as an analyst, investor,employee or other participant you'll learn a lot.

Recently a lot of executives have been complaining though about the headwinds surrounding them and making ithard to do their jobs. Well as my old sailing instructor said, "you've got to sail where you can to get to where youwant to go". Think about it - it's both eminently practical and more Zen than it first seems. Headwinds are part ofthe game, it's what you do with them that makes or breaks you. A point we've tried to capture in the chart above.Headwinds are the things going on in the world - the changes and trends in the Economy, how the markets effectthat and so forth. But even more broadly how Technology impacts your company and how Social and Politicalchanges and events define your environment. The ecology in which you must survive. You can be a predator or arabbit - but you can't choose the ecology. You can choose just how fast, tough, mean and agile a rabbitt you arethough. And be a lazy, mangy and decrepit predator not long for the world. What can't be done is NOT choose !We mention all of this by way of introducing the following excerpts - the first of which is a survey of key strategicissues from Booz, Allen.

While we don't necessarily agree with them all, especially their resolution, the point is that this is a checklist that'snot bad to start with. Or if you like, how you play the chess game is up to you but the board and the rules are whatyou have to work with. And this begins to sketch them out. That big picture piece is complemented by twostrategic pieces on things companies can manage - Product Quality and Innovation. Both of which are vital tosurvival, let alone prosperity. Yet both of which have been complainably badly done for a long time.

Somebody who's literally writing the book on how to do it right by balancing Strategy, Execution and Leadership isMark Hurd at HP. There's great interview excerpt below though in our 'umble opinions the writer missed the keypoints. Fortunately one of our favorite business blogs had a really good series of posts fleshing it all out. Finallythere's a good example of $B are beginning to flow into Green Technology, beginning another major wave ofproduct and industry innovation though it's a long ways off. Maybe by the time those guys are turning into bigcompanies we'll have stopped burnng down the barn to catch the rats ? Any bets ? Ferris, Ferris, ... FerrisBuehler?

February 23, 2008

Strategy, Context and Awareness: Sub-prime Lessonshttp://llinlithgow.com/bizzX/2008/02/strategy_context_and_awareness.html

Earlier we put up a readfest (WRFest 23FEb08(Business Strategy): What the Future May Hold ?) focused onbusiness strategy, including a view of our strategic concept/context chart. Judging from the performance of theFinance Industry as a whole most of the arguments we made were and will continue to be ignored. But asstakeholders (investor, employees, suppliers, customers) we don't think you. Eventually and ultimately. Now theWSJ has kindly joined us in our finger-wagging prescience with a fascinating story about strategic awarenessreally matters. Rather then wait to put up a shorter excerpt we're posting a longer one now. There are manylessons and examples cited here. The question for you becomes - as a stakeholder - do you know where yourstake is tonight ?

UPDATE:

More credit costs seen weighing on banks, brokers Analysts at Goldman Sachs cut estimates for the nation'stop banks and brokers Monday and said these major institutions would likely report write-downs of between $1billion and $12 billion for soured real-estate loans and related exposures. Goldman's estimates of new write-downs ranged from $1.4 billion it expects for Bear Stearns Cosall the way up to a whopping $12 billion projectedfor Citigroup Inc.

The Coming Leveraged Debt Write-Downs



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Subprime Lessons Hit Home for CEOs Executives far from Wall Street are finding lessons in the subprime-loan meltdown. Among the insights: Don't chase a boom without planning for the bust and ensure that incentivesystems don't encourage excessive risk. As mortgage lenders imploded and stock prices swooned last summer, alight bulb went off for Tim Houlne, chief executive of a Texas call-agent provider: "Bubbles always burst." Mr.Houlne's realization attests to how, far from Wall Street, executives in other industries and their advisers arefinding management lessons in the subprime-loan meltdown. Among the key insights: Don't chase a boom without planning for the bust. Make sure subordinates feel safe delivering bad news. Ensure that incentive systems don't encourage excessive risk. And don't gloss over complicated details.

"Every five to 10 years, there's a mess of this sort," says Richard Coughlan, a management professor at theUniversity of ichmond. "Leaders would do themselves a great service if they would study the failures of the pastand learn from them." By contrast, in the finance industry, many firms continued to pursue subprime-relatedbusiness long after the first signs of a housing slowdown.

That's a familiar pattern to veterans of the technology boom of the 1990s and the ensuing bust. During the boom,telecom companies rushed to install miles of fiber-optic lines based on predictions of an exponential need forcapacity… Instead, he suggests that executives plan new initiatives before the current wave crashes. ToyotaMotor Corp. did this well during the 1990s, Mr. Kanazawa says. While Toyota and its peers chased the then-hotsport-utility market, Toyota also developed its hybrid Prius. Its 2000 U.S. launch ran counter to conventionalwisdom at the time. But as gasoline prices rose, Toyota's move looked prescient.

Jim Bradford, dean of Vanderbilt University's Owen Graduate School of Management, sees another lesson in thesubprime woes: Make sure subordinates feel comfortable delivering bad news -- promptly. It's possible that earlier strong warnings of mounting subprime problems may have helped top bank executives react better. Mr. Bradford speaks from experience. Before entering academia, he was CEO of glassmaker AFGIndustries, a unit of Japan's Asahi Glass Co. He tried to foster a candid environment by also praising andpromoting people who disagreed with him or who brought him bad news. That candor helped thwart disaster atleast once.

Other management experts say the subprime mess underlines dangers of incentive systems' unintended consequences. Many finance-industry participants are rewarded for closing deals, with less regard for the deal'sultimate value. Critics say that encourages everyone from mortgage brokers to investment bankers to disregardlong-term risk. Sears auto centers learned this lesson about incentives in the early 1990s, recalls Mr. Coughlan,

the University of Richmond professor. State officials alleged that employees recommended unnecessary repairslargely to earn more commission payments. By 1994, Sears had paid $15 million in refunds and other costs tosettle charges in 41 states and 19 related class-action suits. It also pledged to change its compensation plan.

February 23, 2008

Performance Assessment Basics: Five Fundamental Factors

http://llinlithgow.com/bizzX/2008/04/performance_assessment_basics.html

We'd thought to put up the next readings collections focused on traditional businesses but with INTC's results andGE's from last week, along with the resulting market gyrations, it seemed like a good idea to set that up with adeeper dive into evaluating business performance beyond the headlines. And trying to couple that with someobservations on market behavior and investing.

The bottomlines are that GE is actually doing much better than its' hammering, deserved in the short-term but abuying opportunity in the long. INTC is also doing some wonderful things, though not as outstanding as theheadlines, and both are long-term investment opportunities. And for largely similar reasons. Both have undergonemassive transformations over the last several years, both have broadened and modernized their productportfolios to match the 21st C and both are running very tight, forward-looking but current-controlled enterprises.We'll pick on each one a little more detail in a follow-on post but we need some machinery first.



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We've talked before about our approach and Warren Buffett's to understanding a business, and it might beworthwhile to review that (Masterclass: Buffett on Investing and Business Analysis), but two guidelinesWarren came out with that motivate this whole exercise. Understand the business you're investing in - what hedoesn't mention is that he spent decades at it, not just sticking to ice cream. And focus - if you're going down thispath focus on 7-10 investments but constantly track and monitor a pool of selected targets of 20-30. GE and INTCare perfect examples because, among other reasons, if you get familiar with them you get a baseline forunderstanding a broad swath of industries. And when Warren says understand a business he means this kind ofin-depth investigation.

Understanding the business means digging into five major factors and their relationships with each other and thecompany as whole, laid out in the graphic and discussed in detail below. If you'd like some more discussion keepon....

Five Factors of Performance

1. Fundamental Value Proposition - the first thing youneed to understand is what does a company do. Oddlythat's a lot less trite than you think because the answer

leads to the business model and strategy, i.e. how theymake money now and in the future. A good example ofsomeone who lost sight of their business model was Dellwhere they stuck with their old model and can't find a newone. An example of a company who may have self-arrested in time is Starbuck's.

Which can be contrasted with both WMT and Home Depotboth of whom had mature, saturated and aged businessmodels that they're still struggling to adapt to the newworld. On the other side of the coin P&G and MickeyD'sare perfect examples of companies that self-arrested, re-thought their fundamentals and re-built their companies in flight. Which shows you good strategy is one thing but

execution another.

2. Marketing, Sales and Service - a good place to start is what anyone can see by inspection which is how docompanies treat their customers. Oddly enough we've known for over 20 years, and by known we mean had dataand profit figures to prove it, not just good business judgment and intuition, that good service is not just a cost. Ithelps grow revenues and profits. Whether your someone involved in investing or running a company this is a testpoint, for one thing it's an area where some of the fastest short-term benefits show up. It's also where problemswith the business model and execution do as well. If you go into a retail store and the displays are sloppy, theprices terrible and the floors are dirty you've found out a lot about that company.

One of the first signs that Dell was in deep trouble was when they cut service costs, cut corners and outsource toIndia. Nothing against Indian outsourcers per se but the company was built on a value proposition that said we'lltake care of the customer. When service started going down, extras got charged for you had a 2-3 year heads-upon looming major problems. A more recent example - the Ritz-Carlton is running a series of on-line ads

suggesting a bridegroom has one last chance to cheat on his girlfriend. That's just wrong in so many ways letalone for a company supposedly based on service, customer-focus and value. That it got out the door is appallingon multiple levels.

3. Operations (Logistics, Procurement, Manufacturing, Product Development etc.) - in some ways this is thebeating heart of the company. For auto companies at the end of the day they can run all the great ads they wantbut what kind of a car did they build. Two perfect examples of the same kind of execution breakdown are Chryslerand AMD. AMD came up with some great new chips while INTC took it's eye off fundamental changes in the



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market so AMD was able to kick butt and take names for a couple of years. But it turned out they couldn't sustainit.

Similarly Chrysler culture for decades has lurched from hit-to-hit but had poor manufacturing and operations.Another perfect example is Motorola which rode the Razr high but didn't have either the manufacturing executionor product development processes necessary to create sustained performance. One can envision applying this tothe entire Finance Industry - great strategic concepts combined with terrible risk management and operationalexecution. Oops and ouch. Bright ideas don't count if you can't deliver them.

4. Management Systems (Budgets, Operating Plans, Controls, HR, Leadership ) - this is kinda of a catchall butit's the skeleton and sinew that everything else is hung around to form the body of the enterprise. I can't tell youhow many companies don't have any budgeting systems let alone effective ones. Years ago I sat thru apresentation on SOX the first 3rd of which was common business sense and the last 2/3 of which was legislativeand regulatory rules for enforcing what should have been common business practice. The story goes that eachCiti manager has so many conflicting institutional goals, measures and conflicting instructions that they just ignore80% of them.

If you wonder why Citi blew off both feet at the knees infront of our eye and has never made the supermarketfunction there you go. If you really want to know

whether a company can hang all together and makethe parts integrate and serve the whole this is whereyou can test. And there's actually a pretty good forwardlooking indicator. Look at the Investor Relations pitches- Intel and GE's are particularly good. For clarity andstructure IBM's is superb except that it's focused onfinancial engineering and not on growing the business.

5. Pauschian Head Fake - did you notice in the chartthat there are only four boxes and we talked about FiveFactors? Well if we didn't get too clever and youclicked thru on the repeated graphic it took you to aPPT slideshow version that filled in the middle with the

head fake. At the end of the day this is all aboutmaking the pieces work together. And especially on realizing in this brave new world that just maintaining historywon't cut it.



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April 16, 2008

Business Performance II (Readings): Performance, Pain and Prospects

http://llinlithgow.com/bizzX/2008/04/business_performance_ii_readin.html

We've seen some really interesting gyrations in earnings reports so far but we'll remind you that it's early days yet.Not just for this quarter but if/when the economy continues to weaken earnings will too. A lot more severely thananalysts are currently anticipating due to inherent weaknesses in the process that we and others see (Readings(Earnings): The Real Earnings Realities that Ain't...YET).

Now our mantra here is Economy/Industry/Company/Job meaning that you need to understand the generaleconomic situation, the impact on an industry as well as that industry's innate characteristics and where aparticular company fits, or not, in that big picture. By and large these factors are the climate and weather ofdoing business. Where a company performs or not in the circumstances it is given though is up to it. Andperformance really....really matters, as thecollection of readings excerpts shows.

Earlier we put up a post (PerformanceAssessment Basics: Five Fundamental Factors) ona way of thinking about and analyzing the keyfactors that will determine performance andearnings. That was probably a tad abstract, notto mention business wonkish, but it nonethelesswas and is the things that tell you how the wholeenterprise will perform. Here we're going to fleshout the abstractions with some flesh, bone and,especially, blood.

But first consider the summary performancecharts which are slightly updated. We've been

tracking various headline performers for sometime and watched them evolve from category tocategory. Some of the stories are encouragingand some are sad and some are much worsethan that. If you're a bit of a baseball fan considerthe non-business examples of the A's, NYY andSox as well as the Red Raiders of Texas Tech.Purely as an illustration of course with no impliedcomments as to the merits of any particular team (please no hatemail or bombs).

Better yet consider the truly sad migrations of, for example, Dell or Citi. Dell for example started out in theSustainers column of high-performers who have found a way to maintain that performance. Alas not as it turns outthey were unable to see the changes in their environment, succumbed to internal sclerosis that then led to biggerand more public failures. Consider Citi which started in one of the worst places - in court due to the breakdown ofinternal controls and the management system. While they struggled with those terrible self-inflicted wounds theystill hadn't managed to figure out to make themselves work [Citi(2)] but finally seemed to be getting somesemblance of clean-up and control back together [Citi(3)]. Having reached a certain level of mediocrity they thenproceeded to loose their minds, insofar as business judgment and acumen was concerned and turned in adisastrous performance [Citi(4)].

How many other companies are on similar journey's? Or the opposite ones ? Because the answer really matterswhether you're worried about the economy, your investments, are a customer or supplier or perhaps anemployee.



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Let's repeat that:

Business Performance really matters and is critical to surviving the downturn andestablishing long-term returns.

Just to put a point on it the reading start with Goldman's take that "earnings are awful", one of thee first summary judgments and then walks thru excerpts from three Ram Charan columns on things business should do. Some ofit will read pretty basically but the fact of the matter is that the poor performers lost sight of what they needed todo now, environmental changes and required adaptations. Which leads us to the GE example - which despite theheadlines based on an earnings surprise is just the opposite of a bad example. We cite the GE story instead asan example where headline reporting that fails to dig into the massive changes and strengths of a companymisses its' long-term performance capabilities. An argument exposed to considerable dispute we admit but onewe're prepared to defend and will follow-up on.

There are more readings on long-term values and valuations and how they split between current and futureprospects as well as on the habits of thought that cause good executives to turn good companies intoperformance disasters. The long-term valuation excerpts are particularly interesting. One about Shiller's study ofPE ratios shows that valuations are still much too high compared to both historical norms and looking at realearnings instead of future fantasies. But the second reading makes a key point - companies operate in the nowbut invest and develop for the future. And what they find is that, over time, better than half the value of a company

is based on future performance. In other words all that chasing after short-term quarterly earnings isfundamentally dangerous to the long-term health of the company.

What we hope is that you'll walk away from this with the idea that performance is critical, that it's about long-termresilience, that it's possible to achieve sustained high-performance and possible to find the companies that arelikely candidates. Or at least get a start on it.

April 20, 2008

Business Performance III(Readings): Sad Stories, Good Stories & "Fixes"

http://llinlithgow.com/bizzX/2008/04/business_performance_iiireadin.html

We're continuing yesterday's thoughts on Business Performance with some sad stories and some happier storiesas well as some readings on thinking about performance and how to improve it in both the short and long-terms.The sad fact is that almost all of the companies who are in trouble, much of it life-threatening, got there thru theirown internal machinations, by loosing sight of the customer, failing to execute crisply and not planning for thefuture.

The sadder fact is that, as the first excerpt shows, that this is not just about under-estimated earnings anddownturns. Many of the mediocrities will have to deal with that and many good companies will as well. But manyof the poor performers who have been able to get by on leveraged funny money are facing a rising tidal wave ofbankruptcy. And the much sadder fact is that the world is changing around them and they are not only notprepared to adopt and adapt. They won't have the resources of money, skills or leadership.

But that's not the saddest fact. No, the saddest fact, aside from much of this being self-inflicted, is that there areways to address and fix these fundamental breakdowns. If they have the time, money and guts. And we're not justmaking that up as some of the good stories prove.



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The chart perfectly captures what can and needs to be done. It shows the evolution of Olympic High Jumpingthru four major "industry" innovations in fundamentals along with the on-going improvements along the newinnovation paths:

Innovation + Strategy + Execution = Performance.

BtW if you'd like to see the whole pitch onstrategic thinking here's the dloadable file.make all the pieces fit together. A greatvision, not a lot of real strategy and noexecution.

The sad stories start with Thompson, theFrench electronics manufacturer, who'sbeen pursuing a chaotic M&A strategywithout the operational changes to morechanges, minor compared to what he'll haveto do, but more than has happened sincebefore '98. He's settled on the supermarket

story - which actually makes sense to us -but the real question is can he tighten upoperations, put a good management systemin place and make each division performwell as a division (TWX are you listening?) and then get "whole > parts" synergies.

Of the sad stories the saddest is Ford partly because they're a great American icon, partly because they wereonce the world's leader in manufacturing. And partly because I've worked with them a small bit over two decades.And every time the same thing - big but not major changes and then falling back on the culture that got them introuble. Mulally's new team seems to be getting back to their roots and focusing on execution, good customerfocus, building products people want and tying it all together. Whether or not he has the time is another question.Right now we're talking about millions of people's jobs and lives for that matter. But keep on eye out - they'rereally talking the right talk in both C & F and beginning to walk it a bit. These might be serious very long-term

opportunities. For a view on how many times this has gone on try The Reckoning by David Halberstam or Taurus:The Making of the Car That Saved Ford by Eric Taub. The latter is particularly sad and scary because there's littledifference between that effort and current ones yet Ford walked away.

On the other hand are stories from HPQ and P&G which exactly prove our points. Hurd came in set highstandards, cleaned up operations, put better controls in place and, in spite of his reputation for being pureoperations, is nicely balancing strategy against execution. The real exemplar is A.G. Lafley at P&G who's done allthat but seems to have added the real deep structural change by completely changing the way they developproducts and go-to-market. If he can get it built into their DNA it's a fantastic story, a better job and maybe a long-term opportunity.

And if you'd like a great read on what can be done try this: The Silverlake Project: Transformation at IBM by RoyA. Bauer, Emilio Collar, Victor Tang, and Jerry Wind. It's the story of how IBM built the AS400 in spite of itself,

revamped a huge business completely and put DEC out of business in the process.There's also a great Drucker and baseball story and a teacher in Harleem story that provide some generalprinciples as well as being great reads.

We finish up the excerpts hopefully pointing to the future based on Business Week's recent survey of Innovativecompanies. We've managed to eke out our corporate survival but as we said yesterday it's getting down to thenut-cuttin'. It's almost like somebody's come along and introduced several "Fosbury Flops" all at once. First,there's the filter that'll sort the loosers out - execution. Then there's the replacement vs stars filter, Innovation. Andfinally the Stars will decide who gets into the Hall of Fame by who best adapts to the profound changes in the



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global economy. Oh wait, that's more Innovation. But the question is is it sustainable or a one-short ? A Chrysleror MOT vs a Toyota or Apple? Those differences are going to make all the differences.

April 20, 2008

Sailing Into the Storm: From Execution to Innovation

http://llinlithgow.com/bizzX/2008/04/sailing_into_the_storm_from_ex.html

Our normal sequence would call for taking up the market situation but that's not only too depressing, for severalreasons, but Sun. seems more suited to reflection on big issues. So we're going to focus on Innovation. Nowhopefully some previous posts have established the motivation for that, and they're listed below the break, but indiscussing sad, not so sad and good stores about business performance a couple of themes emerged. One ofcourse was good execution and another was balancing strategy with operations. But if you review some of thereadings sustainable long-term performance, by which we mean growth in revenue, profits and earnings, alsorequires adaptability and invention. Innovation in other words. And when you look at the examples from HPQ toP&G you can see where this is all born out. And conversely when you look at the sad stories where the counter-examples also support the argument.

But in case you need more convincing or, better yet, you'd like tosee it explained by somebody with a real track record of bothsustained performance and sustained change management we'llpoint you at the recent appearance of A.G. Lafley on Charlie Rose.IOHO this ought to be required listening in every MBA program andexecutive suite in the country. As well as by every analystmistaking this quarter for infinity and beyond.http://www.charlierose.com/shows/2008/04/23/2/a-conversation-with-a-g-lafley

Another interesting exercise is look over the recently published list

of the Fortune 1000 and see who ranks where by revenue, profit

and return. You'll have to do some eyeball work as the story behindthe ranking won't just jump out but a couple of themes emerge.One of course is energy and hot commodities. Another is folkswho've been franchises and moats, e.g. WMT and MSFT, whocontinue to enjoy the fruits of the legacy for now. But you'll also findsome of our exemplars moving up those ranks as well. The other thing you'll notice is that ten years it was allabout "technology" per se. Now it's about changing the way you do business, bring products to market and isbeginning to appear across leaders in all industries.

There's a lot of confusion about innovation, especially as distinct from invention and raw R&D. We defineInnovation as the ability to create new products, services and business models that deliver value to the customerprofitably. And sustain that over a period of time. Enterprises that can do this are rare but they are the ones who'lldo more than merely prosper in the coming storms. And notice some of the subtleties. Innovation is not number ofpatents, % of revenue spent on R&D or any of those similar metrics. Heck, by those measurements Ford is an

innovative company. But what has it to show for it? Or the Auto Industry in general.

We were happy to hear Mr. Lafley not only has a similar view but is very eloquent both on how hard it is and howimportant. But also on how becoming an innovative company requires a fundamental change in every aspect ofthe company. In other words this is NOT about what happens in the lab but the ability to look at the market,develop new products, make them and then delivery them. And then repeat.

After the break we'll share some of the conceptual framework we've developed over the last several years forwhat's required, what the typical problems are and what an integrated approach to innovation should look like. At



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the end of the day this matters to investors, stakeholders, employees and any other related party because thecloser a company gets to these "Should-Be" ideals the more likely it'll be on the list in another ten years, or 20...or30 or....well you pick your horizon. One warning note - right now US companies have something of an advantagein this business "software" but our friends in China, India and elsewhere know that and are taking steps toimprove their own capabilities.

Product Development As-Is

The problem with most organizations isthat innovation is viewed as an isolated,stove-piped process which occurs, to theextent it does, within the confines of theR&D organization. Which is itself isolatedfrom marketplace and customer realitiesand disconnected from the downstreamactivities that turn bright idea intoinvention into profitable innovation. Thepicture of things as they are lookssomething like the chart at right. All to

often the way products are improved or created starts with a "bright" idea (or just history for that matter), which isthrown over the wall to Design and Development.

The result is then forced thru a manufacturing (make) and packaging process and then Marketing puts lipstick onthe pig while Sales is handed the fun task of forcing it down the throats of the customers. In those few sentenceswe've just summarized, for example, the typical process in the Auto Industry. Which, sadly as some of the earlierreadings,e.g. the story of the Taurus, show that they in fact know better. But don't do it on a sustainable basis.

The Capabilities vs Knowledge Gap

The primary reason is that companies tend tofocus on what they've done, if for no otherreason than it's what they know, have the

current capabilities (here labeled technology)that've built up over years and decades, it's whatthey've always done and, worst, have interestsinside the company who're invested incontinuing to do things as they've always beendone. Most of the bad performers on ourprevious lists suffer from this CustomerRequirements vs Inherited Capabilities Gap.

Whether it's software companies building applications that don't meet customer needs, auto companies buildingcars that no one wants to buy or pharmaceutical companies making yet one more variation on old, tired drugs theinability to match marketspace value to capacities is the most fundamental barrier to Innovation. We'd even go sofar as to argue that this describes the content generation processes (WRFest (Telemediatainment): The Content

Who Would Be King) of the media and entertainment industries. Compare Disney and Pixar for example to the lastbunch of multi-$M bombs :)!



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The Three Gaps

That fundamental gap is composed ofthree major breakdowns. The first and

most fundamental breakdown usually liesin a lack of understanding of howcustomers actually function. That is a lackof understanding of how their businesseswork in commercial and industrial sector orhow customers live their lives in consumersectors.

So the first thing to repair is the focus oninternally generated ideas with learningthose things. In other words replacing "not-invented-here" with "how it works really".

Related to that is the Marketing gap where most enterprises go to market with the story they want to tell ratherthan the story that explains how they'll benefit their customers. This btw is a great index that any outside observercan use to judge how truly customer focused any company that claims to be innovative is. Do they trulyunderstand and talk to their customers the way those customers would like to be talked to?

The twin of the breakdown in Marketing is a parallel breakdown in Sales where yet another salesman shows up totalk about the latest brochureware. As a friend of mine said, "no matter how busy I am any salesman who's thereto talk about solving my problems will get time. But most of them are there to sell me another pig in the pokewhere I have to figure out what it's worth". Successfully innovative companies sell (and service and support) totheir customers value propositions.

How It Should/Could Work

The chart at right shows how Innovationshould work if it's done right. Here what yousee is an integrated, closed-loop and end-to-end view on Innovation. Which strangelylooks more than a bit like what Mr. Lafleydiscusses in his interview. It starts withanalyzing the markets and customers,translating that into a deep description of thereal needs and characteristics of thosecustomers and then turning those into highlevel product designs.

That's then passed on to operations in an

integrated, not throw it over the wall fashion,where manufacturing and deliveryrequirements are incorporated at the earliestdesign stages. Not as after-thoughts.

In other words innovation involves putting all the relevant disciplines onto the same team and operating concurrently , with feedback and feed forward. Not as one isolated stovepipe after the other. Again somethingLafley emphasizes strongly.



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Finally, with this deep understanding of the customer, the entire Go-to-Market and Service/Support operationsinherit a basic of customer value propositions. The other thing that happens is that each stage is used as aninformation gathering and feedback mechanism to make sure that innovation is continuous and adaptive. Finally,as Lafley continuously emphasizes, you have to organize around these sorts of processes.

Companies that put these sorts of innovation capabilities in place, invest in them and maintain them will be theones who will establish long-term survivability and prosperity. These are the ones you want to invest in or work foror work with. Good luck.

May 4, 2008

General Business: Perspectives, Issues & Companies

http://llinlithgow.com/bizzX/2008/05/general_business_perspectives.html

Time for a little Su. reflection as well as a rather large collection of readings with regard to business performance.Now over the last few weeks we've put up some posts on analyzing business performance and associtedreadings to illustrate some key points. Ranging from understanding the necessary balances between strategy and

execution (Business Performance III(Readings): Sad Stories, Good Stories & "Fixes") to the critical role ofinnovation(WRFest 27Apr08(Tech Ind): Innovators, Survivors & Also-rans). These readings extend those argumentsand provide in the company stories specific examples of many of these themes, along with several of our priordissections of particular industries, e.g. Airlines or Technotainatronics [:)]. By this time we hope enoughmachinery has been provided to enable and encourage you to wrap each story with the big picture of Economy-Industry-Company mantra.

We've divided the excerpts into three sections. Long-term Perspective, Key Issues and Companies. And while thestories weren't deliberately selected to support the themes we've been striking it's nonetheless true that they do infact align extremely well. Which suggests perhaps that the machinery might be relatively powerful.If you think back over the last several years the investments that have done well have done so as the result ofanomalies. That is as the result of some sort of deep, sometimes, structural change in the economy, industry orcompany. Think of real estate, commodities or energy all of which went or are going thru major structural shifts.

Or think of Emerging Markets which are well beyond their emergence into relatively full, sophisticated and soundparticipation in the world economy. Albeit with some major risk factors still remaining as the last two posts on theWorld Economy show.

In the LT Perspectives, with articles on earnings quality, PE valuation and Buffet's accelerating shopping spreeyou find what we think is a fundamental theme now and for the future. How good are earnings, what are theylikely to do and what'll they be worth. After several years of passing by stocks Buffett is putting big money to workbecause he's finally seeing opportunities in a combination of performance improvement and lowered prices. Thesection starts with one of the great financial analysts assessment - which boils down to "worst credit crisis sincethe '30s" and "very low earnings quality". We'd strongly suggest keeping those two signposts in mind.In the Issues section we see several major strategic concerns from the impacts on morale and performance of thepay gap between worker bees and executives (Aholes, Shirkers and Performance: a Draft People Principles Policy)to major challenges and shifts in the emerging markets - the combination of rising labor costs and skills shortageswith an effort/need to move up the value stack. And then two excerpts on the critical role of Innovation which israpidly becoming a required core competency...only it's not.

In the Company section everything from Retailing to Airlines to Big Oil and Steel to Disney and Kodak arecovered. Each story representing more than just the company in question. Many of the best Big Box retailers arehoping to seize the opportunity created by this downturn to continue entering new markets and expansion. We'llhave to see how that holds up if the economy, as we expect, turns down farther and longer than many areanticipating. Nonetheless this is a bold strategic move, which suggests these are candidates to put on your Buffettlist. As a retailing counter-example Starbucks got badly scalded but is still looking for int'l expansion. The questionis going to be can SBUX do for itself what MickeyD's did several years ago - self-arrest, recover and transform?



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On that fundamental question hangs it's future value, as for so many others.In complete contrast there's AMR, losing $3M/day, as proxy for an industry which is direst need of the mostfundamental reexamination of business models, strategies and, most especially, network structure. An initiativewhich does NOT appear to be even being considered by any players. Instead they're moving ahead to re-arrangethe deck chairs as the soles of their shoes are getting soaked.

As examples of another sort consider Oil and Steel (On Being a Boiled Frog: the Strategic Outlook for US

Industries). The latter is our poster child for an old-line industry who's been reborn thru long, hard, painful anddisciplined effort. Who'd have thought. Yet many of their troubles were self-inflicted by avoiding and delayingnecessary changes for decades. Lessons that many other industries are having to learn the hard way. ObviouslyAirlines but also Autos. Big Oil is facing some similar challenges, strangely enough. Not because they'reincompetently run. Just the opposite in fact. The problem is that their environment is changing where new oildiscoveries are lagging, they aren't replacing reserves as fast as they're using them, national oil companies andpolitics are controlling the agenda and are doing so for short-term political goals and their exploration andproduction costs are escalating rapidly. Whee....talk about changes....and differences from the headlines.

Finally there are two stories of Renewal. One from Disney which we consider a poster child of both the innovativenew mediatainment company and a superb example of what self-arrest and transformation should look like. Theother is Kodak which continues to change but also to struggle. Disney had to re-discover itself. Kodak has to

create a new self - a much...much harder problem. Made harder by, again, denial and willful ignorance. In the lastfew years they seem to have worked thru that after a decade of avoidance but now it's a race between creatingthe new Kodak and getting enough speed down the runway to get in the air. Remember V1 - the speed whereyou're moving fast enough to rotate the nose wheel ? You'd better hope there's enough runway left, especially ifyou're still too heavy with historical baggage. (Auto Industry: Pressures, Changes & Outlook - Finding V1)



About Llinlithgow Associates

Llinlithgow Assoc. is a management consultancy

focused on evaluating businesses to reduce risk,leverage under-developed opportunities inoperations and increase overall enterpriseperformance to improve investment return.

Our approach is based on BizzXceleration, aproprietary framework with 25 years ofdevelopment, to review and analyze BusinessModels and Strategy, key operating functions andsupporting infrastructure and managementsystems. From there we develop comprehensive,integrated operating plans that tie all thecomponents of the business into a high-

performance enterprise.

Several years ago Michael Lewis published aninteresting book on how the Oakland A’s took a systematic look at how the game really works, and whatinvestments in players, strategies and tactics were most likely to result in the most wins for the lowest cost. Ourapproaches are similar in taking a systematic look at the whole business, each of the major components and thebest way to tie everything together into a high-performance system.

We start by looking at the basic core value proposition and it’s translation into the Business Model and Strategy.Typically we next examine Marketing and Sales operations, where it is possible to reduce operating costs by30%, shorten the sales cycle by 30% and increase the closure rate by 30%. This is primarily the result ofestablishing good processes and discipline.

BizzXceleration is comprehensive but integrated across the total reach and range of business activities andissues. And emphasizes a pragmatic, workable approach that results in a stepwise path to performanceimprovement. We believe that our approach mitigates business risks, improves operational performance and canlay the groundwork for 10-30% EBITDA improvements in post-deal execution.

If you would be interested in further discussions, more detailed descriptions or the review and testing of specificopportunities we would enjoy hearing from you. We can be reached at [email protected] .

Customer Problem

• Value Proposition

• Business Model

• Strategy

Core Operating

Functions

• Functional Efficiency

• Inter-function

Integration

•Value Alignment

Marketing, Sales &

Service

• Customer value focus

• Process Discipline

• Business-driven

Management System

•Budgeting system

•Management Controls

•Operating Plans

•Resource Development

Customer Problem

• Value Proposition

• Business Model

• Strategy

Core Operating

Functions

• Functional Efficiency

• Inter-function

Integration

•Value Alignment

Marketing, Sales &

Service

• Customer value focus

• Process Discipline

• Business-driven

Management System

•Budgeting system

•Management Controls

•Operating Plans

•Resource Development

Business Performance II: Moving Toward Crisis, Managing By Hubris

Documents

Transcript of Business Performance II: Moving Toward Crisis, Managing By Hubris