Can’t Win for Losing

It sounds like one of those riddles you hear from professors who aren’t quite as funny as they think they are: “When is a $700 million savings really a $2.3 billion loss?” Usually it’s the set-up for a problem in sunk costs, hidden costs, or multi-year depreciation that the accountants in your class love – and that remind the rest of us just how critical a good accountant is to any successful business venture. Yes, non-profits too. For a strategist, though, it’s usually an indication that there has been an unexpected consequence of what appeared to be a straightforward action. In the case of a publicly-traded company, it might not even have anything to do with the action itself, or even with anything your company did…

Consider, if you will, the case of Walgreens, CVS, Rite-Aid, Wal-Mart, Amazon, and an on-line pharmacy company called Pill Pack. If you’re not familiar with it, and I wasn’t until I read the CNBC story about this situation, Pill Pack is licensed to sell prescription drugs in 49 of the States, and booked about $100 million in sales last year. Wal-Mart has been in negotiations to buy Pill Pack for several months, but negotiations broke down when Wal-Mart balked at going over $700 million, at which point Amazon stepped in and offered $1 billion. Wal-Mart probably could have matched the offer, but they didn’t want to get into a bidding war with one of the only retailers their own size, and they didn’t believe Pill Pack was worth that much anyway…

This would probably be a non-story – Amazon has bought a lot of smaller companies, some of which panned out and some of which didn’t – if it hadn’t been for the stock market fallout. Within 24 hours after the transaction was announced Wal-Mart’s stock price dropped by $1.03, which doesn’t sound like much, until you realize that the company has almost 3 billion outstanding shares of stock, each of which is now worth a dollar less than the day before…

Not making the purchase saved Wal-Mart $700 million, but it ended up costing them $3.04 billion in market value, or a net loss of $2.3 billion. That might not seem fair, but consider what also happened to the three big drugstore chains mentioned above. According to a second CNBC story, Walgreens lost 9.9% of their stock price, Rite-Aid lost 11.1 % of theirs, and CVS lost 6.1%, for a combined loss of around $11 billion on the same day (June 28, 2018). Meanwhile, Amazon’s stock gained 2.5% on the same news, resulting in a gain of just under $20 billion…

Now, I’m not saying that we should blame the drugstore chains, or their leadership teams, for the losses in question – although I will be very surprised if at least some of their stockholders don’t start asking a few rather pointed questions at the company’s next General Meeting. I’ve got nothing to suggest that any of these companies, or even all three of them together, could expect to out-bid Amazon without bankrupting themselves, or that they would be able to recover the $1 billion if they did. I can’t even tell you for sure if Wal-Mart could do that and live. What I am saying is that the leadership of every company needs to be watching the competition, and potential competitors as well, exactly so they don’t get surprised by something like this…

Because, to paraphrase a very old joke, a few billion here, and a few hundred million there, and eventually it adds up to real money. And while I imagine Wal-Mart will survive this mistake without much difficulty, there is a limit to how many more times they can ignore the consequences of their actions…

Would You Buy That?

At first glance, the owners of a major company looking for buyers is nothing special. Most people thing of acquisitions as starting from the buyer’s side – somebody finds a company that they think can create synergy with their existing assets and puts in an offer to buy it – but it isn’t at all unusual for an ownership group to decide that one or more business units are not going to become profitable in the future and look to sell them off. It is somewhat more uncommon for such an offering not to get a single bid, even one that dramatically lowballs the value of the company being offered and is extended just to see if the seller is serious. What makes the story from earlier this week so remarkable is that the seller in question is a national government – and the company being offered for sale is their national carrier…

If you missed it, the Times of India article is available here. Why exactly the offer hasn’t drawn any bids isn’t entirely clear – it can be very difficult to explain things that didn’t happen – but a few parts of the deal seem a bit unworkable. Assuming the debt owed by the company being acquired isn’t unusual in this sort of transaction, but when there’s a lot of it (as in this case) it can serious impede efforts to recoup the cost of the purchase. Taking responsibility for an inappropriately large work force can also be problematic, given the costs in both severance pay and public relations that will be involved in cutting down the number of employees to a manageable level. But what really sounds like the deal-breaker to me is that the Indian government is only looking to unload 76% ownership of the company…

Now, let me stress that I don’t have anything against public-private partnership arrangements in general. In this case, however, the national elections in India are apparently less than a year off, and there is no guarantee that the government will continue to cooperate with an acquiring company if the party currently in power does not retain control following the election. In fact, if I’m reading this article correctly, there’s no telling what a new government might choose to do regarding the sale. There is always some degree of uncertainty in an acquisition project, but it’s hard to blame any potential buyer from being skittish about having to work with a minority partner whose identity, let alone policy, could change at any moment…

Why, exactly, the government wants to retain a 24% interest in the airline isn’t clear in the story, although I’d expect it has something to do with this having been the national carrier up until now. Also unclear in this reporting is the question of why the government believes that Air India would have been an attractive takeover target in the first place. The industry isn’t quite as volatile outside of the US, where only one major airline (Southwest) has consistently made money over the last 30 years, but neither jet fuel, landing rights, or airliners are getting any cheaper, while the world of international travel is becoming increasingly dangerous. And the fact that all of the relevant unions have been opposing the sale definitely doesn’t this offering any more attractive…

Operating an airline that hasn’t made a profit in years would be difficult enough without adding a significant debt load and an unpredictable minority partner to the mix, let alone all of the other issues that appear to be in effect. Unless the government can identify some other selling point for Air India, it seems likely that they’re going to be stuck running the airline as a public entity for some time to come. Maybe things will improve after the elections, or perhaps they can bring some intangible factors (National pride? Love of air travel?) into the mix. But unless they can find some way to make the acquisition more attractive, they may eventually just have to shut down the company, sell off the remaining assets, and hope that the hit to national pride won’t be any worse than having to deal with the fact that no one seems to consider their national carrier worth buying in the first place…

Figures Don’t Lie…

Normally I wouldn’t be paying much attention to an Internet pay-site acquiring the rights to a free site, or to anything that has been taken off of the free site since its acquisition, but in this case the acquiring site is one of the big dating sites (Match.com) and the deleted material was a blog post explaining a why you should never pay for a dating site that used to appear on the “OK Cupid” free site. Since this type of Internet business has come up on the blog a few times in the past month, I decided to take a look at the argument that the founder of the free site was making. It turns out that there are some interesting numbers here…

To begin with, consider the claim that these sites have tens of millions of customers. In one case, one of the big companies claims they have 20 million of them, but if you divide their gross income for the last year by the amount they charge per customer and take into account their own figures for turnover every 6.5 months, they can’t have more than about 750,000 paying customers at any one time – or about 1/30th of the total. You read that correctly; 96.25% of their accounts are going to be inactive (and therefore unable to respond to your attempts to contact them) at any give time. Even worse, if you’re a man sending messages to an active account, you have about a 30% chance of getting a response (which is huge, compared with most advertising, for example). If only one out of every thirty messages you send actually goes to a live account, that means that you can expect to get 1 response for every 100 messages you send. Which, in turn, means that to get any significant number of responses you need to send hundreds or even thousands of messages, which means you’re going to have to make them impersonal form letters which are even less likely to get a response…

But even worse, according to the author, is that according to census figures and one of the dating sites’ own success claims, you are more than 12 times more likely to get married if you don’t belong to this site than if you do. Which is to say that the group of single people in the US who don’t belong to this online dating site account for a percentage of all marriages that is 12 plus times larger (relative to their numbers) than the percentage that belong to this one site and get married. It’s not a true correlation, since those figures don’t account for all of the competing dating sites, old-fashioned services that don’t work over the Internet, professional matchmakers, and so on. Still, it is kind of a disturbing thought – and it’s rather unpleasant to think that one of the biggest pay-sites just bought one of their free competitors and took these warnings about pay-sites down…

Now, I’m not saying there is anything wrong with Internet dating sites as such; I’m not even saying there’s anything wrong with ones you pay for. The two biggest sites claim to be responsible for about 5,000 marriages and about 86,000 marriages a year, respectively, and it would be difficult to say that those 91,000 people didn’t get value for their money. If we assume that at least twice that many people at least got dates or other enjoyable experiences out of their investment, that would mean as many as 300,000 happy customers, which isn’t bad – unless you happen to be one of the 39,700,000 people who paid their $600 and got absolutely nothing because all of the people they tried to connect with were “ghosts,” as the inactive accounts are called...

Twenty years ago in Los Angeles I worked with some people who belonged to one of the pre-Internet dating services, paying $3,000 a year for public mixers and the occasional “personal” introduction – and back then, that was a lot of money. No one I knew ever got a date using the service, but it hardly mattered; even though they knew the odds, there was always the chance that they might end up being one of the 3.75% and not one of the 96.25%, and that was enough to keep them coming back month after month. Modern dating sites can claim that they are selling something other than hope (and a rather forlorn hope, at that) if they want to, but just remember the old saying: “Figures don’t lie, but liars figure…”

Elephant Walk

A while back in this space I was writing about some of the measures that Starbucks is using to attempt to recover the market share it is losing to other coffee providers, notably including McDonald’s highly successful “McCafe” product line. I said at the time that I didn’t believe that the Starbuck’s breakfast sandwich program would be enough to turn the tide, since most of the people who want a breakfast-on-a-bun product already eat at McDonald’s (or one of their competitors) and it’s hard to differentiate one badly-made breakfast product from another. Subsequent sales seem to have borne out that contention, and the chain has continued to tinker with their product mix, adding new beverages and experimenting with new food items. Including products from the Cheesecake Factory…

An article published last week suggests that Starbucks may be considering a corporate alliance or even a merger with the Cheesecake factory. There might be a case for doing something like this, in fact; Starbucks locations definitely sell food products that go well with coffee, including lots of cheesecakes and other desserts, and this would provide a huge number of retail channels for the Cheesecake Factory. At the same time, this would almost certainly provide a boost in business for Starbucks, particularly if they invest in enough stock (and equipment to take care of it) to sell whole cakes and pies from their existing locations. It’s debatable how many more people would go to Starbucks just to eat better cheesecake, but if the retail locations became an outlet where you could get a pie for the office party, or a cake for today’s conference, this would almost certainly draw additional business to locations in commercial areas…

What is known, and rather more unexpected, however, is the effect this speculation is having on the stock position of the Cheesecake Factory. Starbucks’ financial situation is a bit up in the air right now, as they attempt to find new growth areas (and possibly reposition themselves into a more “premium” segment of the market), but the Cheesecake Factory’s stock has risen more than 6% just on the speculation that they might be entering into a closer relationship with the giant coffee retailer. Even in a relatively stagnant time, Starbucks is so big (and an alliance with them would have so much impact) that even the rumors about a possible deal are influencing the stock price of another company, like the vibrations from an elephant’s footfalls knocking fruit off of a tree…

Of course, this is hardly a new phenomenon. Investors and investment firms spend a significant portion of their lives searching for news of events like these, and more than occasionally the price of a specific company’s stock will take a sudden increase on the rumor of some deal that never materializes. Even though the financial analysts quoted in the story all said upfront that they were only speculating, and no one has said anything about an actual deal, the rumor of a possible event is enough to send people scrambling to call their brokers…

What we can learn from all of this is that while some news stories carry more weight than they really ought to, and you can’t believe all of the wild speculation you will read in the paper (or see on the Internet), some companies can make waves just because of their behemoth size and the impact that even a minor deal with them would have on the rest of their industry. In the long run, Starbucks may not merge or ally themselves with the Cheesecake Factory, or the La Brea Bakery, or any other food-production company. But if your company is likely to be affected by such a deal, either because you’re a Starbucks competitor, a Cheesecake Factory competitor, or a supplier of anything to either firm, it probably wouldn’t hurt to pay attention to those vibrations you keep feeling underfoot…

Another Follow-up

It's a little bit eerie, when you write about a wave of potential failures in the Retail sector, and less than a month later one of the major companies you were reading about is going into the tank. But only a little bit, since I got that tip (for the post titled “Retail is Burning”) from online research in the first place, and this is what a business analyst does. No, we don't just walk in, look around for a few moments, and then tell the owner, "You are a business!" In this particular case, the company in question is Circuit City, and they have begun preparations to sell off the company, most likely to Blockbuster. What, exactly, Blockbuster will do with the stricken retail chain remains to be seen...

The biggest issue cited in the story is the downturn in the U.S. economy, which is making consumers skittish about purchasing non-essential items like home electronics in the first place, and definitely putting a damper on the sales of big-ticket items wide-screen televisions and home theater systems. Without these sales the company cannot sell lucrative extended warranty and service plans, delivery services or installation and set-up services, either, which is a major problem since that's where most electronics retailers make the majority of their money. However, the chain's large number of brick-and-mortar locations, including many in under-performing or declining communities, was also cited as a factor, as was the increasing competition from both industry leaders like Best Buy and warehouse store competitors like Costco and Wal-Mart. Blockbuster's management has a history of closing marginal stores and making the surviving ones more profitable, and they might be able to figure out how to compete with the warehouse stores. But it's really hard to imagine what they intend to do about the economy...

The thing is, Blockbuster has not done well itself, in recent years. Their new CEO has had some luck restructuring the company and returning the focus of their operations to sectors (e.g. real world locations) and advantages (e.g., convenience, speed, low price) where they can successfully compete with newer, more technology-dependant competitors like NetFlix and iTunes. Blockbuster is expected to become profitable again later this year, although it remains to be seen if they can stay ahead of the competition in the longer term -- and there's no way to tell if acquiring another problem company will actually help them.

From an outsider's point of view, it does seem as if there might be a niche left in the electronics business that Circuit City could take over, although it would take a major effort to move into it. The big issue with much of their competition is the lack of service; in a warehouse store there is literally none to speak of, and even big-box retailers like Best Buy and Wal-Mart are prone to either not having enough help on the sales floor or else trying to sell you whatever they have the most of in the store, whether that's what you needed or not. In theory, a retailer could add value for the customer by hiring good sales associates and training them to help customers of low and moderate technical ability to find what they need and get the support they require. They would also, of necessity, have to remedy the chain's supply problems, since finding the article you want and then not being able to purchase any is another major source of customer dissatisfaction.

If the concept sounds familiar, it should: it's the Nordstrom model, applied to electronics. If the new Circuit City operations can develop the reputation for being the place where you can go to get exactly what you need, whether you know what that is or not, every time, with people who can get you through the process quickly and efficiently... Yeah, they might make a go of it. But if they try to compete on price or convenience alone, they're going to be wrecked...