Wednesday, December 28, 2011

Jeff Bezos wins again

After Christmas, I wanted to do a meeting with one of my LinkedIn friends, Sasha Cole, an economics PhD student who (like me) was home to visit family during the Christmas break (but unlike me is Jewish and not observing Christmas).

We met at the Pannikin, the well-known local chain of gourmet coffee shops started by Bob Sinclair in 1968 (before Starbucks). In addition to running coffee shops, as a coffee roaster he supplied hundreds of local restaurants and cafés. Both my friend and I recalled hanging out at the Pannikin in high school (long before Starbucks came to California), because it was one of the few places you could spend a small amount of money and sit around and talk for several hours (e.g. at the end of a Friday night date).

Long before every Barnes & Noble had a built-in Starbucks, Sinclair found a natural complementarity with independent booksellers who colocated with his coffee shops. (I had always assumed that they were under the same ownership, but instead the two businesses were independent). The two Pannikins I have visited most — the original in La Jolla and the nearby Del Mar location — eventually added funky bookstores next door where you could buy a book to read while sipping your coffee.

The La Jolla venue still has DG Wills, a used bookshop that proudly proclaims past appearances by leftist literary luminaries like Norman Mailer, Maureen Dowd, Christopher Hitchens and Oliver Stone. For Del Mar, it was the Book Works, located in the Flower Hill mall. However, when we met Monday in Del Mar, the Book Works was gone, having closed over the summer after 35 years in business.

Both locations serve students and faculty at UCSD, and local tech workers at Qualcomm and other firms. The nearest Barnes & Nobles are 7 and 9.5 miles away, where they have been for 15+ years. So it was clear that if anything killed the Book Works, it was Amazon.

In noting the bookstore’s passing, we recognized our own complicity (as Amazon patrons) in its death. Even yesterday, when browsing through a couple of bookstores with my family, I realized I was unlikely to buy any books in the store, because the two books I wanted were a) a novel I’d download for my e-reader and b) music books for my biggest Christmas gift (a handmade ukelele) that were not going to be found in a bookstore inventory.

Next to Steve Jobs, Jeff Bezos is the most brilliant and transformative tech executive of the past two decades (even if two Stanford grad students stumbled into better margins). He effectively created e-commerce, then leveraged that to become an online seller of everything, and now is leading the shift of cultural content from atoms to bits.

However — like Google and Apple and Microsoft and others — Amazon aspires to be a monopolist by forestalling rival entrants and growing (in the case of entertainment downloads) or maintaining (for books) his marketshare. Much like patrons of Walmart (or Target), in our search for convenience and low cost we customers of Amazon are reducing our options for the future: not just quirky (and often badly run) independent bookstores, but also physical bookstores of all sorts.

This seems to go unremarked in the US — at least in tech circles. A rare exception comes from a New York-based correspondent for Britain’s Financial Times, John Gapper. Earlier this month he wrote a scathing column about Amazon’s two-faced attitude towards antitrust as it uses price (and its superior scale economies) to squeeze out its competitors.

On the one hand, Amazon developed a plan to crowdsource spying on its competitors pricing, using a $5 bribe for customers to use a special price-check smartphone app to report prices of competitors. (To its credit, the NYT quickly covered the literary backlash.)

Beyond this, however, Gapper decried Amazon’s efforts to seize pricing power for ebooks — rather than allow publishers to set the same price for all ebook downloads — and then use that to push out all rivals:

While Amazon is blithely using its rivals’ property as a storefront, it wants antitrust authorities in Europe and the US to help it control the ebook market. The European Commission and the Department of Justice have launched twin probes, provoked by deals under which publishers set prices for their ebooks rather than letting Amazon, Apple and Barnes & Noble do so.

Amazon is eager to discount ebooks on the Kindle in the same way that it discounts everything else but has been stymied by publishers who fear it will eliminate all ereader competition. As Mike Shatzkin, a publishing industry analyst, says: “It is an incredible irony that antitrust law is being used to protect the biggest monopolist.”

Other things being equal, lower prices are good for consumers, but I fear a world in which Amazon squeezes out the Nook; pushes B&N into the same fate as Borders, which was forced to liquidate in July; marginalises all independent stores; and dominates the industry from publishing to printing to distribution. That would be a dystopia for both readers and authors.

Minimum prices deals helped to erode Amazon’s initial dominance in ereaders by encouraging competition from B&N and others. Even so, the Kindle still accounts for 60 per cent of ebook sales. It is not the job of antitrust officials to hand Amazon back its monopoly.
In physical retailing, Target has created a different shopping experience and higher quality brand to provide meaningful alternative to Walmart — much as the quirky independent bookstores next to the Pannikin gave booklovers a chance to browse when they were relaxing with their coffee.

For online purchases of digital goods, ambience isn’t going to be a differentiating factor. Much as I love price competition, I agree with Gapper that this is one choice we don’t want to have — a short-term price war that lads to a long term monopoly.

Jeff Bezos will still get richer, as his shareholders have doubled their money in the past three years. However, as with Steve Jobs competition will force him to continually innovate, while (limited) antitrust regulation will maintain consumer choices of technology and vendors.

Sunday, December 18, 2011

Gambling with OPM

From the San Jose Mercury News, Sunday December 18:

If state Treasurer Bill Lockyer, union leaders and the state's largest government employee retirement funds have their way, they'll continue betting against the odds. It's not surprising. It's not their money at risk. They won't have to cover the losses. Taxpayers will.

Last week, a study led by Joe Nation, a Stanford public policy professor and former Democratic assemblyman from Marin County, made explicitly clear the magnitude of the risk. He found that there's a better-than-even chance we're going to lose the wager.

The assumption about the investment returns is critical. The higher the expected return, the less money must be contributed now. But here's the kicker: If investments don't meet expectations, the employer -- the taxpayer -- must make up the entire shortfall. The employee has no risk.

So labor groups typically push for high return-rate assumptions. That means less pressure on workers and employers to kick in more now, and that frees up government funds to hire workers and pay for salaries and benefits. But unrealistically high assumptions mean we're shortchanging the system, creating a debt for future taxpayers.

Currently, the UC system uses an annual assumed rate of return of 7.5 percent, while CalPERS and CalSTRS use 7.75 percent. Defenders say those rates are based on past performance. Nation, like many academics, thinks they're irresponsible. Investment guru Warren Buffett has called them "crazy."

Nation, using CalPERS' own data going back as far as it would provide, 1982, ran statistical simulations to forecast the odds of meeting several investment targets. He found there was only a 42 percent chance of meeting or exceeding our current wager on the 7.75 percent rate.

Here's another way of thinking about it: Assuming future annual returns of 7.75 percent, the three pension systems combined were short $143 billion, or $11,703 for each California household. At a more realistic 6.2 percent investment assumption, they're short $291 billion, or $23,852 per household. Thus, the higher assumptions hide the magnitude of the problem.
The temptation to spend Other People’s Money is irresistible, especially when you can legally bind others to spend the money in the future.

Our system is supposed to provide checks and balances to prevent such problems. But public employees pay more attention to (and contribute more money to) state and local elections than do the average voter. An additional problem in California is that with 8 year term limits, many politicians don’t worry about tomorrow because they expect to be long gone (in Congress, a local mayorship, lobbying or private practice).

Thursday, December 15, 2011

Best-run companies are not the best to work for

The Merc did a Silicon Valley take on the November 2011 “Best Places to Work” list prepared by Glassdoor.

Here are the top 5 overall:

  1. Bain (of Mitt Romney fame)
  2. McKinsey (the high end strategy consultants)
  3. Facebook with a 4.3 out of 5.0
  4. MITRE (alongside RAND, the elite DoD consultant)
  5. Google - 4.0/5.0
This is yet more evidence proving my career maxim to my undergraduate students: all things being equal, you’ll be much happier at a high gross margin company than a low gross margin company.

Other Bay Area companies listed
  • Apple (10) - 3.9/5.0
  • (13) - 3.9
  • Chevron (16)
  • NetApp (30) - 3.7
  • Intel (32) - 3.6
  • Groupon (40) - 3.6
  • Intuit (42) - 3.6
  • Nvidia (49) - 3.5
But what was really interesting was the losers in the beauty contest:
  • Yahoo,eBay,Oracle: 3.2
  • HP: 2.5 (Note: HP Pavillion, the ice hockey arena, rates 3.4)
(The Merc said Netflix ranked below Yahoo, but the numbers are not on the Glassdoor site.)

A few observations
  • Having a good boss helps, but isn’t enough. NetApp’s CEO got 100% rating from employees but his company is only 30th. Apple CEO Tim Cook is liked by 96% of Apple employees vs. 89% for Mark Zuckerberg, but Facebook is still preferred overall
  • Being a winner certainly helps, but again isn’t everything. Apple stock options from 2005 or 2008 are worth far more than those from Google, but Google wins out overall.
  • Being a loser certainly hurts. Then high-flying Netflix was #3 on the 2009 list, but this year employees seem demoralized by wave upon wave of bad news.
  • Some results are puzzling. Yahoo is perpetually up for sale, but does well compared to two companies that are in no danger of going away. It’s equal to Oracle, which has $26 billion in working capital — more than the GDP of half the world’s countries. Yahoo ranks well ahead of HP, the once great company whose total assets are 50% more than Oracle’s
Young high growth companies are exciting, but what happens when the growth (and stock returns) disappears? Groupon employee satisfaction will collapse when (as with Netflix) the high-flying stock comes crashing down to earth. Will a mature Facebook become another Google, more like Intuit (down 31 slots in 3 years), or end up like Adobe (which is no longer on the top 50 list).

It also confirms what I've observed since Steve Jobs took over at Apple in 1997. Apple is the Valley’s most valuable and (among Fortune 500) highest growth company, but it’s not a worker’s paradise. People work hard, and unlike at Google, it’s all about business. As long as their run continues, it will be a good place to work, but it remains very demanding.

Meanwhile, Google seems to me to be like IBM 40 years ago — a dream job living off monopoly profits. What will the working conditions be like when the rents from search dissipate the same way that they did from mainframe computers? Like IBM, I think the company will make a fair and ethical transition in how it handles its employees, but like IBM (and HP) it will be unable to treat them as generously as it did during its salad days.

Tuesday, December 13, 2011

Open source doesn't repeal laws of economics

After failing in its webOS strategy, HP has announced plans to use it to create an open source project. This is an example of what (in our 2006 paper) Scott Gallagher and I called a “spin-out” strategy by firms to find a home for a technology they no longer wish to control.

Some might hope this would be as successful as IBM was with Eclipse. Others compare it to Fedora, the Red Hat desktop variant of its core Linux server product. However, with more than a decade of open source research and consulting, I don’t think it will be successful.

I take HP at their word that they will work with the open source community to set up appropriate licensing and governance. Unlike other firm-sponsored communities, letting go is not likely to be a problem.

However, open source only works when you have enough contributors. WebOS is not desktop Linux. Before a project launches, the best proxies are developer interest and user demand (“scratching your own itch”), and it’s no secret that webOS — although technically sophisticated — was already an also-ran when HP bought it in spring 2010.

The fact that when software has failed as a proprietary technology, it nearly always fails as an open source technology. From my research, I’d say a major reason is timing: firms don’t let go until the technology has clearly failed on the market.

The other problem that the world really only wants (or needs) a single open source product in each category. Eclipse was the first open source tools platform, so that Sun’s subsequent efforts to let go were too late (see #1 above). The BSD variants of Unix predated Linux but were swamped and the Netscape server never caught on against Apache. It doesn’t have to be all that open, as the success of MySQL (and Android) has shown.

(Some would argue that Chrome and Mozilla are an exception to this rule. Perhaps — but the competition is not over yet.)

In fact, with webOS HP seems doomed to repeat history — in this case, Nokia’s failed efforts with open source Symbian. In addition to being late and competing against Android, Symbian began open source life with a raft of problems that caused it to lose its once-dominant market share in the category it created. The prospects for webOS seem similar — except that webOS never had 60% of the global smartphone market.

Does webOS have a chance? Over a decade ago, Shane Greenstein and Tim Bresnahan showed that the only way a new platform succeeded was by identifying an unserved niche (that hopefully became a big market). So if webOS is going to succeed, the answer is the same as a year or two ago: not by competing head-to-head with Android and the iPhone, but serving a market that they’ve ignored. Since HP hasn’t found this market in the past 18 months, I can’t see how open source will change things.

Sunday, December 11, 2011

Strategy is choosing what not to do

Strategy is making trade-offs in competing. The essence of strategy is choosing what not to do. Without trade-offs, there would be no need for choice and thus no need for strategy.
— Michael Porter, “What is Strategy?”
Harvard Business Review, 1996
As an entrepreneur — with limited resources and a finite period of time before we ran out of money — this is a lesson I had to learn the hard way. It is something I emphasize in my consulting, in my business analysis and my teaching.

I don’t recall seeing the original Porter quote, but the version I normally use in class is
Choosing what to do means choosing what not to do.
Thus, I was pleasantly surprised to read Dilbert this morning. For at least a decade, I didn’t care for Scott Adams emphasizing the cynical over the insightful. But in lampooning the foolish overconfidence of the pointy head boss, he makes the point in a way that will stick with students far better than anything I’ve ever said in class.