Contestable Markets...Follow up

Yesterday WSJ featured the most expensive city in the US to leave and that made me feel vindicated. The article can be found here. Back in September, I had published a post about CVG not being airline passenger friendly. I have chosen to fly to Dayton on occasions that I have had to fly to OH. I guess it is CVG’s loss but I am not sure when they will wake up to this fact.

Shareholder Education in Light of Triangular Mergers….

Today’s WSJ talked about Citi’s subsidiary taking over Nikko. This would be Japan's first major triangular merger, in which a foreign company uses a local subsidiary to buy a Japanese firm using the parent company's shares as payment. In answer to a concerned shareholder’s questioning of Citi’s business strategy and it’s understanding of cultural differences between Japan and US, Douglas Peterson, Citigroup Japan Holdings, Chief Executive cited as evidence of success Citi’s presence in Japan for 100 years and a nine year partnership with Nikko.

Is long term presence in a foreign country enough evidence of success? On the surface, the answer might be yes. However, there are quite a few issues to be considered. Transaction with affiliates, transfer pricing, subsidies extended by the parent company, long term business strategy are all valid considerations. Douglas Peterson could not have shared all of this information with the concerned shareholder at the meeting.

Is this an area of investor activism that needs attention? If someone is going to ask slightly more than cursory questions, then maybe there should be a forum to address these questions with suitable data. Or, is this an example of owners meddling with management who are assumed to work for the purposes of increasing shareholder wealth until proven guilty? Where do we draw the fine line? And, how do we educate shareholders about significant strategy details. Please bear with me while I work on the answers to these questions.

CEOs and musical chairs…

In light of Stan O’ Neal’s departure from Merrill, Class Action lawsuits against Countrywide CEO and WellCare Health Plans, a private equity veteran was interviewed on what makes a good CEO from a PE perspective. Two things stuck out.

They look for people who can add value quickly (cost cutting, low hanging fruit, no Friday bagels, etc.). He also mentioned people who can think clearly and act quickly and report information in a concise manner. Now that’s a requirement, I would imagine a lot of folks would meet right off the bat. For that matter, this is a requirement for pretty much every job, except if you’re a story teller, in which case, the more loquacious you are, the better it is.

I was pretty amused and a little surprised that there was no mention of leadership skills, understanding of the industry and most importantly personal integrity as basic requirements. I love the corporate world for all of it follies because that is yet another place to make a difference.

Value Migration and Business Design

A business design could be in one of three phases. Value could be flowing in, staying stable or flowing out. A business design can be altered to attract and retain value by focusing on the end customer. Sounds simple, right? It is meant to be.

I like the airlines industry so I am going to focus on that to expand on this concept. The airline industry encountered an external event in 1978 that changed it. It was deregulation. Long story short, the legacy airlines focused on profits, forgot about the customer and almost three decades later, here we are. Meanwhile, several Low Cast Carriers (LCCs) emerged. A few of them survived, the most beloved example being that of Southwest.

Recently, we have Virgin Air plying on the coveted LAX – JFK route. This is the cherry on the cake amongst the airline routes. The customer base is movie moguls, I am told. Virgin Air is going to try it’s very best to please these folks. JetBlue and Southwest will do their part to woo these folks as well because this would be the profitable tranche of the customer base.

So, getting back to that elusive thing, ‘value’ in terms of business design. LCC provide value at low prices. The customer base on this route is not looking for value at the best price. These folks might travel via Virgin for the ‘novelty factor’ and the VS PJ party but they would just as well take a United flight for $2,500.

How do these airlines intend to retain value? And, more importantly how do they define value for the different tranches of the customer base? Is there one formula that would satisfy all? Because it is one airline and more importantly, the plane is a whole, although they might be able to divide the service components between the areas of the airplane.

For the humor factor, let’s imagine, we have a passenger who paid $139 to fly from LAX to JFK and we have another passenger who paid $439. Let’s say they are sitting in the Economy section of the plane. How will the service differ for these passengers? Will the $139 passenger not get the soda drink he requested? Similarly, the add-on services are no longer at this point (air borne) a factor of their ticket prices. It is a factor of how good they feel as customers receiving the default service and their financial comfort level.

So, again, what is value and how do you retain it? You look at the business model and align it with where you can capture the most of it.

Broadband Access on Planes

Should we be rejoicing? Or, should we worry about things like privacy, etiquettes and intrusive conversations. I think there’s a happy middle ground. I had recently gone to Yosemite National Park with a few friends. I wanted to get in touch with the outside world via cell phone. The argument that I got was that it was better we didn’t have cell phone access and that we were cut off from the rest of the world. Why does it have to be a forced seclusion? If I wanted to be out of touch with the rest of the world while I was there, couldn’t I just switch off my cell phone?

That we have the ability to send/receive e-mails and phone calls, surf the Net, possibly make important financial decisions via our online brokerage accounts is such a conservation of time. If I wanted to talk to my fellow passenger on the plane, I’d do so even if I did have broadband access. Now if I didn’t have broadband access, does it necessarily imply I’d be having a conversation? I could meditate w/ or w/o broadband access. I could read a book w/ or w/o broadband access. I could get a shuteye w/ or w/o broadband access.

Hell and then some deals..

A book titled Deals from Hell by Robert Bruner assigns one or more of these as reasons for a deal to earn the title of a deal from hell: Destruction of market value; financial instability, impaired strategic position, organizational weakness, damaged reputation, or violation of ethical norms and laws. So, looking at these parameters, we would have the highly publicized deals that we know have gone bad and it would be a no-brainer.

What about the deals that have worked well at the start and then faltered along the way? Since the global business environment is constantly changing, will a deal that looks good today also continue to look good in the near or far future? That raises the questions of the time horizon that we would have to look at before rendering our decision. Another question would be the change in management. If a senior executive, who was championing the deal leaves after a few months, would we call it a deal from hell or would we classify it as a leadership issue?

I like the idea of standardization and the classification of aspects that would help us declare a deal a collosal failure. I am just not sure though if it would be a measured objectively if a deal works but circumstances have changed and it’s clearly an issue of mismanagement regardless of the prior deal.

Contestable Markets

A key characteristic of a contestable market is low barriers to entry and exit. These markets with only a few competitors maybe more competitive than they appear to be. An example would be starting an airline route from one city to another. If the route is not profitable, the airline has the option to delete the route.

In trying to understand this concept, I did a little research on the airline route from Cincinnati, OH to Los Angeles, CA. There are very few flights that serve this route and the prices always seem to be way higher than the rest of the country. It has a few competitors and seems to be profitable. If it is truly contestable, other airlines besides Delta should claim stake. If it is not, then it is an oligarchy, in which case the airline regulators should do something.

Either ways, CVG does not seem to be a very airline friendly airport and I for one would like to see that rectified.

Healthcare + Financial

Business + Strategy had an article that made a case for closer interaction between the healthcare and the financial industries. In trying to connect some dots, here are my quick thoughts on the same.

- Both these industries have to get competitive.
- Both of these industries have to wake up to the concept of RFID.
- Both of these industries have enormous paper trails that should be made electronic, which of course there are genuine impediments that they face in the form of legal regulations, county requirements, etc.
- Both of these industries have to necessarily have systems that are integrated in nature.
- Both of these industries have enormous impact on people’s lives. One impacts how well a person lives and the other impacts if a person lives.

Inefficiency at it's Best

Some things never cease to amaze me. A perfect example is Estonia’s efforts at selecting a national fish. Never mind if people eat it, never mind if fishermen fish for it. This is the perfect example of a callous waste of resources. The fact that this issue was marked by an emotional debate, online poll, charges of voter fraud and parliamentary debate astounds and worries me at the same time.

I would understand if for establishing an identity, they built the next wonder of the world, if they built the most modern hospital or school. But if a fish is supposed to bring identity to nation, wouldn’t you wonder what kind of an identity that would be?

Inviting Companies…

For years now, states have been inviting companies to set up shop in their states. The obvious reason is to invigorate the economy by creating jobs. But lately, the states have been providing incentives to companies with a clawback provision.

What this means in simple language is that of a company is bought over or has a change in the market geography, there would have to be a payback from the company to the states to the tune of the exact incentives the companies received to make the move more attractive.

Did cities such as NYC, SFO, and the other commercial capitals of the world become so by offering incentives to the companies to do business there and now with every other state offering some incentives, are we going to see a growth of such cities? And, if for some reason, a company has to move, it would have to do so at the peril of angering state officials and paying huge amounts that they received before? Well, if it means that states will dictate where a company does business, which is most definitely bad business, it is the complete antithesis of pure capitalism and free market economy. If businesses are bound by state incentives, are we making these businesses more inefficient? If this is such a big consideration, it is the eternal cost arbitrage chase.

Acquisitions

You know how they encourage businesses about sticking to their core strengths. It is also referred to the hedgehog concept from Jim Collins’ Good to Great. So, when I read about Lehman Brother’s acquiring Archstone-Smith Trust and now Morgan Stanley’s recent acquisition of Investa Property Group of Australia, I start to question the hedgehog concept.

Are we seeing some kind of vertical acquisitions? Are banks looking at all the money that an individual spends over a lifetime and if that part of the value chain offers significant profit margins, they want to capture it? Or, are we seeing an attempt at diversification? Are banks getting into the real estate industry? Or, the type of business/industry does not really matter as long as the profit margins justify the transactions. So, then what makes a good acquisition target for a bank? That’s the topic for another time.

On a side note, it would seem that anytime I said I wanted to work in a specific industry was all for naught. I might as well have worked in any industry and probably would have ended up working for a bank.

Tax Benefits..Maybe

The Wall Street Journal today had an interesting article on the new regulation called FIN 48 that requires companies to disclose how much they set aside as reserves in case the transactions that have gotten the companies tax relief don’t pass muster.

Would it not logically then follow that the higher the amount any company reports as reserves, the higher the company might be at risk of transactions not passing the audit? I of course, mean this on a relative comparison level. And, then would this mean the more the amount of reserves, the higher the chances that the IRS or any other regulatory agency will be scrutinizing those companies and those transactions?

And, then the other question is, does the size of this reserve also able to quantify the relative risk the company has taken on. Are we incentivising the companies to have smaller reserves so as to not attract the attention of IRS? Or, are we preventing the companies from thinking creatively but within legal bounds of course?

Jumpstarting Economies

The other day the CEO of OPIC came to our school to speak about OPIC’s mission and how it makes a difference around the world. One thought struck me as important. He mentioned that housing is the single most important driver of economic growth in a region. The logic that follows is that once you can afford a house, there are primary and secondary mortgage markets that help in other entrepreneurial activities. I thought housing isn’t only important as a basic unit that spurs economic activity. It is also the single most important material possession that most human beings hope to have in a life time. It leads to peace of mind, psychological stability, incremental happiness, and the confidence to go out there and do something. Just for that, everyone should have a home. It will definitely make for a better society.

Branding TouchPoints

I was at Safeway the other day shopping for my weekly supply of a graduate student’s food (apples, milk and bread). I also went looking for a lotion there. I saw Johnson’s Baby lotion and Aveeno’s new line of baby lotions. There is something to be said abt. an MBA education - It lets you connect the dots. Back to the lotions – Aveeno promised softer skin, which my hands desperately were in need of, thanks to the Arizona sun. Trust me, there is a point to all this. The Aveeno lotion package looked attractive from a distance but when I picked it up, it was harsh to the touch – like a sandpaper. That’s where my mind (now armed with an MBA) started thinking about branding touchpoints. Seems like the company in this case missed the literal touch point – mine. Needless to say, I didn’t buy Aveeno. I plan to write to the company.

What's in a name?

A while ago, I was researching economic data on the 49 poorest countries on the globe. Why 49, you ask. Apparently, my professor thinks it’s the magic number. Anyway, it got me thinking if there was any relationship between the name of a country and its economic health or the lack thereof. Turned out that there were 7 Ms, 7 Ss and 6 Cs and 5 Bs. People in some parts of the world believe that there is a lot in a name. If that really were the case, maybe these countries ought to consider changing their names. If they don’t want to change their economic policies, that is.

Business and the new civil economy

I read a great book recently and wanted to share some thoughts on the same. The book is titled ‘The New Capitalists: How Citizen Investors are Reshaping the Corporate Agenda’ and written by Stephen Davis, Jon Lukomnik and David Pitt-Watson.

It is a progressive read in terms of explaining the rise of a new civil economy. It explains the Circle of Accountability to the new capitalists drawing parallels to a civil society. One thing is clear, that this book is published, that there are instances that have triggered this thinking, that there are rules, regulations, standards that are being rewritten, are all signs of progress.

That capital fuels reform is undeniable. Only now, the capital belongs to the working class as opposed to the individual rich. That corporate governance has a direct correlation to higher valuations of the company, other related benefits namely creation of more jobs is undeniable but what I found most interesting was that “momentum" of corporate governance reform at a company is a key influence on equity price performance.

I think the new civil economy affords new ways for investors to be engaged with a company but in the end it could come down to a matter of how many people can you actually have in the driver’s seat as opposed to it being a matter of fair and complete disclosure and even then it might be open to interpretation.

Since the society and shareholder are one and the same, it follows that companies should act in the interests of society at large. These universal owners expect companies to perform a certain way, which is no different from what we know as common sense. For example, creation of value is not a new principle. It still is the appropriate way to behave. That there are myriad of standards to follow is itself a huge deterrent for a company. A possible solution might be the Global Compact, which is but slowly emerging as a standard.

In essence, the individuals who own stock in the biggest corporations of the world have a majority over the individual rich. However, to simplify the concept, I am gong to use an example. An individual A owns 2% GE vs. individuals B through Z who combined own more than 30% of GE. For the B-Z group to make a difference they have to work together and the way they do that is through institutional investors, web collaborative tools such as, Wikis, rating services, investor advocacy tools, independent auditors, audit certifying agencies and the like. These collectively are the new information moguls. The recent fate of activist investor Carl Icahn, who failed to secure a seat on Motorola’s board belies the power of these new information moguls, what with one shareholder advisory firms siding with Carl Icahn and the other with the Motorola management.

The book nicely ends with a memo to the various players in the new economic ecosystem. Whether it is sustained, is to be seen in the future. For now, this book offers a lot of hope to someone who believes business does a lot of good for economies and societies.