Friday, November 16, 2012

Ding dong, Hostess is dead

Perhaps the big news of the day is that Hostess Brands is closing its doors after 82 years. Hostess has been attempting a reorganization since its January filing for Chapter 11 bankruptcy, but after a weeklong union strike Hostess said Friday it asked for court permission to close its doors and will lay off most of its 18,500 workers.

The TV news was filed with consumers rushing to buy up what's left of Twinkies and Ding Dongs, some of them hoping to make a quick buck on eBay.

My teenager was sorry to see Twinkies disappear and argued that we should stock up on the sponge cake — because they would store well at least until I'm a grandfather. (Wikipedia says this is an urban legend that may be attributed to a brief Twinkie cameo in the movie WALL-E although the Clinton White House put one in a 100 year time capsule.)

But even the consumers interviewed on TV realize that the brands will be sold to another company. Bloomberg identified at least two possible bidders, Flower Foods and the private equity firm than owns Pabst Brewing.

What went wrong? An Aug. 13 story in Fortune magazine said there’s enough blame to go around, with a mismanaged company, falling demand and high debt since an earlier 2004 bankruptcy filing

But in truth there are no black hats or white knights in this tale. It's about shades of gray, where obstinacy, miscalculation, and lousy luck connived to create corporate catastrophe. Almost none of the parties involved would speak on the record. Still, it's clear from court documents and background interviews with a range of sources that practically nobody involved can shoot straight: The Teamsters remain stuck in a time warp, unwilling to sufficiently adapt in a competitive marketplace. The PE[private equity] firm failed to turn Hostess around after taking it over. The hedges can't see beyond their internal rates of return. Et cetera, et cetera, et cetera.

The critical issue in the bankruptcy is legacy pensions. Hostess has roughly $2 billion in unfunded pension liabilities to its various unions' workers -- the Teamsters but also the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union (which has largely chosen not to contest what Hostess wants to do -- that is, to get out of much of that obligation). If the bankruptcy court lets Hostess off the pension hook -- which often happens in these cases -- it only moves the struggle outside the courthouse, and the ante goes up. For the Teamsters can then call a strike -- which its Hostess employees have already ratified by a 9-to-1 margin.
Hostess settled in September with the Teamsters but not with the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union, who called the fatal strike. The NY Times reported that union decided to play hardball:
Frank Hurt, the union’s president, seemed to lose patience with Hostess’s management, upset that it was in bankruptcy for the second time despite $100 million in labor concessions. He saw little promise that management would turn things around.

“Our members decided they were not going to take any more abuse from a company they have given so much to for so many years,” said Mr. Hurt. “They decided that they were not going to agree to another round of outrageous wage and benefit cuts and give up their pension only to see yet another management team fail and Wall Street vulture capitalists and ‘restructuring specialists’ walk away with untold millions of dollars.”

About a month ago, [CEO Greg] Rayburn said, the bakers union stopped returning the company’s phone calls altogether.
The union workers are gambling they’ll get their jobs back at the same factories under a new owner, but instead the failure looks like the classic lose-lose proposition. It’s clear that they won’t be getting defined benefit pensions or the same salary levels under the new owners, and it’s hard to see how all 18,500 will get their jobs from a new owner seeking to buy only the most profitable assets and to dramatically cut costs.

I think there’s more than just the pressure on high-wage, semi-skilled labor and the public health war on excess sugar. Society has moved to (as Geoff Moore put it) more fractalization of consumer demand, with increasingly specialized products reaching a broad range of tastes. A teenager who might have eaten a Twinkie every day now eats ones once or twice a week, with pretzels, a Larabar or Trader Joe’s fruit wrap the other days. Meanwhile, the Hostess donuts face increased competition from branded donuts, generic store donuts, chain donut stores and a proliferation of bagels everywhere.

Fame is not fortune — in part because the brand is the butt of nonstop jokes (including a tongue-in-cheek TV tribute by longterm union supporter and junk food addict Bob Beckel.) In some ways, the Twinkie (and other aspects of the) brand has become like “spam” — high brand recognition but not high brand equity. Oldtimers even remember the infamous “twinkie defense”, in which Dan White got off with a five year prison term after killing two people (vaulting Diane Feinstein to fame).

So what is the brand worth? Given the company lost $341m on sales of $2.5b (for its last reported fiscal year) with accumulated debts of $800+m, it’s hard to see how the remaining brands will go for even $200m, and more likely much less. By comparison, Zynga is 7 years old, with its main line of business in trouble, lost $404m on sales of $1.1b last year — and still has a $1.7b market cap. (It also has no unions and a 71% gross margin, suggesting a potential upside if it can ever regain scale).

Even when they went into bankruptcy, troubled airlines had a reason for existence, marketable assets, market share and (thanks to frequent flyer programs) switching costs. Hostess has little to recommend it, other than nostalgia (which failed to save Pan Am, TWA, Mercury, Pontiac or Oldsmobile, among others).

Is it worth saving? Two CSU Fullerton professors offer their guidelines as to when brands are worth saving:
While we feel that most brands can be revived, some brands may just not be worth the effort. This is particularly true for brands that suffer from lack of relevant differentiation, low awareness, and a negative image. In such a case, it may be better to kill the brand, than to invest in it.

Sunday, November 11, 2012

Remembrance Day

In Flanders Fields the poppies blow
Between the crosses row on row,
That mark our place; and in the sky
The larks, still bravely singing, fly
Scarce heard amid the guns below.

We are the Dead. Short days ago
We lived, felt dawn, saw sunset glow,
Loved and were loved, and now we lie
In Flanders fields.

Take up our quarrel with the foe:
To you from failing hands we throw
The torch; be yours to hold it high.
If ye break faith with us who die
We shall not sleep, though poppies grow
In Flanders fields.

“In Flanders Field,” May 3, 1915
by Lt. Col. John McCrae (1872-1918), Canadian Army Medical Corps

Sunday, November 4, 2012


… We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.--That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, --That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. …
Signed by John Hancock and 55 others, Philadelphia, Pennsylvania, July 4, 1776

Declaration Of Independence Stone 630
Reproduction courtesy of the National Archives

Friday, November 2, 2012

The living undead of storefront retail

I've been meaning to blog about the great cover on a recent Bloomberg Business Week. (Perhaps thanks to its spendthrift mayor, the magazine is now economically illiterate, but it still has good artwork.)

The cover story was about the travails of the quintessential “big box” retailer, Best Buy. (I’d hoped to post for Halloween but October was a hectic month).

Interestingly, in trying to find the cover story (with the magazine’s useless search engine), I found a 2007 story promoting the stock at a target price of $63. (It’s now at $15). I think this illustrates the point that the displacement of storefront retail by online (particularly Amazon) has been quicker and more severe than almost anyone anticipated.

The October story notes that the company has failed in its online strategy due to an excess of caution:
Best Buy’s response to Amazon and other online threats has been inadequate. The company set up as early as 2000, when Schulze was still CEO as well as chairman, but years later, as purchases of TVs, stereos, and microwave ovens shifted increasingly to the Web, the site still lacked such basic features as customer reviews. An Internet unit didn’t get much financial support and was kept walled off from store sales. While e-commerce now accounts for more than 20 percent of U.S. consumer-electronics sales, online is only 6 percent of Best Buy’s domestic revenue.
Cannibalism is a concern of most storefront retailers, but one that can be overcome. Of the top 10 US e-commerce sites listed in the story ( was #11), 5 are by companies with a storefront presence: Staples, Apple, Walmart, Office Depot and Sears. Clearly Apple is agnostic to whether it sells its products online or in stores, but Staples has been a great success in making the transition also.

(There is also a certain irony of reading about the death of physical retailers in a physical magazine, given what’s been happening to them recently. The Bloomberg Business Week website seems to violate all the precepts of best-in-class customer-friendly experience, as prescribed for Best Buy.)

So what is the answer? Founder Richard Schulze (now trying to buy back the company) wants to double-down on the in-store experience, a viewpoint supported in an August 6 BBW article about his takeover attempt:
According to Alex Goldfayn, chief executive officer of the marketing strategy consultancy Evangelist Marketing Institute and author of the book Evangelist Marketing, Best Buy needs to focus on improving its in-store shopping experience, rather than competing online. “They need to understand that if they make their business about competing with Amazon, they’re going to lose,” he says. “In fact, they’ve already lost, and they’ve lost painfully and publicly in a very sad and ugly way. Their one advantage in the world is their physical stores.”

Goldfayn, who outlined his Best Buy improvement plan for Mashable in February, suggests a quick and dramatic overhaul. “Rather than thousands of boxes on shelves, which are ugly and don’t do anybody any favors, they need to set up tables for people to interact with the technology,” he says. “There isn’t really a [store] that you can go to now to literally interact with technologies from multiple manufacturers, and Best Buy is in the unique position to let people walk into a store and experience not only the iPad but also the Samsung Galaxy and also another Android tablet.”
Both Goldfayn and Schulze seem to believe that first-rate service would create traffic and loyalty. (It also seems like it would further accelerate showrooming).

The same article also quotes a Morningstar analyst who says customers are driven by price, and the chances of turning around Best Buy are “a long shot.”

Whether Best Buy survives — as a big store, tiny store, discount warehouse or high-service emporium — begs the broader issue of whither storefront retail? The implications go far beyond one company: Books and CDs are gone, electronics is going (cf. Circuit City), and clothes seem to be slowly heading in that direction. Movie theaters are also disappearing in the face of Netflix and (again) Amazon downloads.

Meanwhile, what is the future of commercial real estate in such a scenario? Do strip malls just become restaurants, liquor stores and grocery stores? Does the suburban shopping mall die before it turns 100?

Thursday, November 1, 2012

California holds education hostage

From the WSJ, November 1:

[California Governor Jerry] Brown and his labor allies say Proposition 30 will fix the state's budget deficit and ward off education cuts. But the real choice before voters is whether to issue Sacramento's incorrigible spendthrifts another blank check.

Mr. Brown has threatened to "trigger" $5.9 billion in education cuts if his initiative fails, but he'd make less than $100 million in other trims. How's that for balance?

Such "trigger cuts" could easily be re-configured with a modicum of political will in Sacramento. Instead of slashing $500 million from higher education, Democrats could kill their quixotic bullet train, which will cost about $360 million this year alone in debt service, and chop $100 million in tax credits to their Hollywood friends (who are bankrolling the tax campaign).

Or they could restructure retirement benefits, which cost $6.5 billion this year—up from about $1.4 billion in 1999. There's millions more to be found in modifying current workers' pensions and retirees' cost-of-living adjustments as nearly a dozen states have done. In Rhode Island such reforms have cut the state's pension liability by half.

Barring such reforms, pension costs will continue to balloon and eat up all new revenues. The California State Teachers' Retirement System has projected that it will need between $3.5 billion to $10 billion annually over the next 30 years to stay solvent. So any money allocated to schools will merely backfill the teachers' pension fund.

The only way California can escape its recurring fiscal Frankenstorms is through reform and economic growth. The former would stimulate the latter while the Governor's tax initiative would squelch both. Raising taxes on small business owners when one in five Californians is out of work or employed part-time because he can't find a full-time job is the definition of insanity.