What Kind Of Products Are You Really Selling?

Is your business selling a niche, fad or mass market consumer discretionary product? The answer makes a big difference in how to best market and manage growth for new product launches. To explore these product distinctions – and see the consequences of making the wrong bet — consider what a well-known company making action video cameras and another selling home carbonated soft drink machines have in common.

Both GoPro and Sodastream priced their IPOs in the low-$20’s, both more than tripled their market value within 9 months, both ran eye-catching Super Bowl ads in 2014 when optimism ran high, but both are now trading at less than 20% of their ephemeral market peaks. It is tempting to add one other obvious similarity: both GoPro and Sodastream sell consumer discretionary products (CDPs), which intrinsically run the risk of falling out of favor. But such a broad-brush categorization is overly simplistic, and warrants further exploration. After all, few CDP companies experience such an exhilarating surge of popularity followed so soon by such a terrifying fall from grace. So it’s important to understand what makes GoPro and Sodastream different from most CDP companies, and what one can learn to avoid their roller coaster ride in the marketplace.

What are consumer discretionary products?
Consumer discretionary products cater to consumer “wants” rather than staple “needs.” Companies in this sector encompass retailers of non-essential goods and services, media and entertainment, consumer durables, high-end apparel and automobiles, which typically exhibit cyclical performance tied to the health of the broader national economy. After all, by their nature consumer discretionary purchases can be deferred or simply ignored when times get tough.

But in fact, CDP businesses have performed extremely well of late. For example, the largest CDP stock index fund in the U.S. doubled in value over the past 5 years (2011-2015), outpacing growth in the overall S&P 500 by more than 2X.[1] So clearly, there have been other circumstances at play affecting the performance of GoPro and Sodastream.

A fad perhaps?
One popular view, embraced by short-sellers who have owned close to half of GoPro’s and Sodastream’s float, is that both companies sell fad products that were bound to run out of steam as consumers jumped ship in search of the ‘next new thing.’ It turns out that the shorts were right in betting against these stocks, but not because GoPro and Sodastream are fads.

Fad products stimulate an unexpected and viral explosion of consumer enthusiasm, leading to skyrocketing sales, followed by an abrupt and equally rapid decline in market interest. We’ve all seen (and probably owned) many fad products over the years. Perhaps the quintessential example was the Pet Rock – a product of mockingly limited value – which wound up selling 1.5 million units during a six-month silly season in 1975 before disappearing from sight. But there have been hundreds of other fad products over the years as well, some of which created immense wealth for their inventors. Take for example the now often forgotten, but once gotta-have fads for kids: Silly Bandz, Koosh Balls and Beanie Babies. Grownups too have had their flings with fad products such as Snuggies, Cronuts and Grumpy Cat merchandise.

The common characteristic underlying all fad products is that their basis of mass market appeal is almost strictly emotive (as opposed to functional), and therefore highly subject to the vicissitudes of consumer whim. What’s hip today is decidedly old-school tomorrow. So if you’re lucky enough to launch a successful fad product, enjoy the ride, because it likely won’t last.

Niche products
How does this apply to GoPro and Sodastream? Neither of these company’s products exhibit the intrinsic attributes of a fad, because they actually deliver tangible functional value to an identifiable niche segment of consumers, rather than temporary emotive appeal to the mass market. In fact, Sodastream has been selling home carbonated drink machines for well over one-hundred years during which its underlying consumer value proposition has hardly fundamentally changed.


What did change was that for a brief period following its 2010 IPO, Sodastream misguidedly over-hyped its product and over-expanded its distribution, which created the conditions for the inevitable business crash that followed.

Here’s the scenario. Buoyed by access to public capital, Sodastream believed it could dramatically expand its US addressable market by touting its home carbonated soft drink machines as a virtuous alternative to the soda category giants. The marketing team ramped up its advertising and promotion spend, pitching Sodastream home brews as more convenient, sustainable, healthy, cost-effective and personalized than popping open a can of Coke or Pepsi. As sales began to pick up – albeit from a very low base — the company aggressively recruited new retail partners, expanding beyond its initially limited distribution through Williams-Sonoma, to Macy’s, Bed, Bath & Beyond, JCP, Target, Best Buy and Walmart. By 2013, Sodastream’s US retail footprint peaked at nearly 17,000 stores.

The company was betting heavily that it could increase its US household penetration at least tenfold from an installed base of around 1%. Sodastream reasoned that its expanded marketing and distribution initiatives could generate mass market appeal, mirroring household penetration rates across Europe that ran as high as 25%.

Super Bowl ads soon followed, but starting in 2014, Sodastream’s US sales virtually fell off a cliff. Why did Sodastream fail to fulfill the growth potential envisioned by its CEO? And more puzzlingly, why did Sodastream’s sales trend resemble a fad product rather than the more typical product life cycle where the transition from high growth to maturity to eventual decline often takes many years?

The simple answer is that Sodastream (and its retail partners) fundamentally misread the market. They dramatically expanded national distribution as if the challenge was to keep up with explosive mass-market growth, whereas actual consumer demand was limited to a relatively small environmentally-and health-conscious niche of the US market. Much of Sodastream’s reported sales growth in 2012 and 2013 merely reflected the sell-in to stock new retailers’ shelves. When consumer demand failed to materialize, many overstocked retailers simply stopped ordering any new product, which explains Sodastream’s precipitous revenue decline over the past two years.

Sodastream revenues

In response, Sodastream has pushed reset on its misguided strategy, significantly scaling back its retail footprint and repositioning its consumer value proposition. As CEO Daniel Birnbaum explains:

We’ve completely shifted our strategy from a different way to do soda at home to Water Made Exciting! Americans want to drink more water; that’s what they really want to drink. It’s where the future of beverage is.

It’s in a space that doesn’t quite exist today. It’s very small… It’s the space between soda as we know it — sweet or chemical — and still water as we know it. There’s a space there in the middle.[2]

One of the mistakes that we made… was that because we address a mass market category, I thought early on that I can go ahead and access the mass market out of the gate and that we can go very quickly to places like Sears, Kmart, Wal-Mart, but really that doesn’t work that way. When you’re building a disruptive category, OK, that has a very unique appeal and it requires a behavior change, one needs to take a more staged approach to the consumer and focus initially on opinion leaders, evangelists, people who are courageous and bold and willing to make decisions that entail some sort of an investment in time and habit change maybe and money and that’s a realization that we have now after we’re already in Wal-Mart.[3]

In retrospect, Sodastream would have been far better served if it built its brand, customer base and distribution network at a more measured pace, consistent with the actual niche appeal of its customer value proposition, rather than chasing the misguided dream of mass-market demand.

The same lessons learned are now playing out at GoPro, which racked up impressive triple-digit annual growth rates prior to its late-June 2014 IPO. From its inception, GoPro enjoyed extraordinarily high global brand awareness, fueled by hundreds of millions of page views of its breathtaking action videos posted on YouTube and other social media channels. GoPro’s brand name quickly became synonymous with the category it created. As such, investors saw much cause for optimism, propelling GoPro’s stock to nearly $95 within 3 months of its IPO at $24 per share.

But alas, while a broad base of consumers undoubtedly enjoyed gawking at GoPro’s exhilarating online videos, far fewer had the lifestyle, budget or need to actually buy and use the pricey video cameras. In fact, GoPro’s sales growth rates had already been steeply declining prior to its IPO. [4]

GoPro Revenue Growth

Despite mounting evidence that GoPro was approaching the limits of its niche market appeal, the company continued to launch expensive new models and to rapidly expand its global distribution footprint. By the end of 2015, GoPro hit the wall, announcing that Q4 sales were expected to be nearly 50% below the same period in the prior year (in part reflecting the 50% price cuts it had been forced to make on its newest model), and that the company would be laying off 7% of its work force.[5]

As with Sodastream, GoPro drunk its own Kool-Aid and tried to extend its brand, price realization and distribution far beyond the limits of its actual niche market appeal. The company now faces a costly retrenchment that will undoubtedly harm its brand image, retailer relations and investor confidence for years to come.

Companies launching a consumer discretionary product should honestly assess whether their new venture is realistically likely to appeal to the mass market or a niche segment. Sodastream and GoPro belatedly discovered that their product was solving a problem that most consumers simply didn’t have. Trying to promote an inherently niche consumer discretionary product to the mass market can be a painfully costly mistake.

[1] http://etfdb.com/etfdb-category/consumer-discretionary-equities/

[2] Fortune Magazine interview with CEO Daniel Birnbaum, February 6, 2015; https://www.youtube.com/watch?v=C8WYa1J2G7E

[3] “5 Things Sodastream’s Management Wants You to Know,” Investopedia, May 19, 2015; http://www.investopedia.com/stock-analysis/051915/5-things-sodastreams-management-wants-you-know-soda.aspx

[4] Richter, Jason, “GoPro Has Trouble Sustaining Its Growth,” Statista, January 14, 2016

[5] Cipriani, Jason, “GoPro’s Shares Suffer Huge Wipeout on Weak Sales, Layoffs,” Fortune Magazine, January 13, 2016

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What Shakespeare Thinks About Brian Williams

I was chatting with William Shakespeare the other day about Brian Williams when he shared what seemed to be a keen insight: “the fault dear Len is not in our stars but in ourselves.”


Willy often drops these bewildering aphorisms, leaving me to ponder the hidden meaning. But just this morning, it hit me. Willy understood the real lessons learned from l’affaire Williams.

In his effete apology last month, Brian Williams claimed he conflated two separate helicopter missions in his reporting on the Iraq war. Subsequent investigations raised additional concerns with the veracity of his alleged encounters with Seal Team 6, Hurricane Katrina and, sacré bleu, even the Pope.

In my view, the ensuing tsunami of moral outrage has been misplaced. We should not blame Brian Williams, the star. The fault is mostly our own.

In granting Brian Williams star status, viewers and media pundits have conflated acting with journalism for years. We should never have revered Brian Williams as a serious journalist whose nightly reports could be taken as gospel.

Brian Williams is an actor. So is Bill O’Reilly (provocateur) and Jon Stewart (comedian). Each has a shtick that has served them and their TV ratings well. The reason why The Daily Show is so beloved and Williams is now scorned is that Jon Stewart never pretended to be a serious political commentator (although in many ways he was). Stewart is a talented comedian who delivers an irreverent perspective on the news, as often directed towards newscasters as newsmakers.

Brian Williams’ shtick was gravitas. His act portrayed him as a serious and inquisitive on-air journalist to be trusted to tell it like it is. But of course, Brian Williams’ on-air persona was just an act, not the work of a serious investigative journalist.

In playing his role, Williams felt obliged to create photo-ops at the scene of major stories – Katrina, Iraq, Vatican City – as if his very presence confirmed the importance of the event. After all, if Brian Williams told us he got dysentery after accidentally ingesting tainted water in New Orleans, we just knew Katrina was a serious hurricane, 1,833 fatalities notwithstanding

In retrospect, it was ludicrous for viewers to expect Brian Williams to deliver remarkable scoops during his 36-hour whirlwind tours through New Orleans or Middle East war zones that were somehow missed by other serious journalists.

You can’t blame Williams for wanting to share sightings of dead bodies floating down flooded streets in New Orleans or hanging out with Seal Team 6 or chatting with the Pope. Nightly News viewers would expect no less from a man of such gravitas. We wanted to believe that Williams could bring gripping stories to our TV screens nightly.

So we put Williams in an impossible spot; to be something he wasn’t and couldn’t be. Sure Brian Williams is an egotist who ultimately drunk his own Kool-Aid. But we were enablers every step of the way. Our anger now is probably rooted in recognizing our own foolishness.

The Brian Williams show is over. Going forward, I hope his replacement neither aspires to be a superstar, nor conflates his or her flyby photo-ops with real reporting.

I think Sergeant Joe Friday got it right when I recently asked him what he hoped to get from NBC Nightly News going forward. “Just the facts, Len; just the facts.”

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Are Customer-Friendly CEO’s Bad for Business?

Being the CEO of a publicly traded enterprise requires a delicate balancing act to keep multiple stakeholders happy, namely shareholders, customers and employees.  Dave Barger has been walking this tightrope for seven years as CEO of jetBlue, doing an admirable job building a profitable, growing airline that customers love to fly. This year, jetBlue earned the J.D. Power award for highest customer satisfaction among Low Cost Carriers in North America for the 10th straight year, reflecting the airline’s numerous customer-friendly perks:

  • Most economy legroom of any U.S. airline
  • No fee for first checked bag
  • Free satellite TV and wifi
  • Free premium snacks
  • Consistently friendly cabin service
  • Modern fleet

While jetBlue’s loyal customers are generally happy, some members of the Wall Street community decidedly are not.  jetBlue’s weather-plagued operating income in the first half of 2014 significantly lagged key competitors in the resurgent airline industry, a contributing factor for several industry analysts to downgrade the stock.

Airline OI

According to Bloomberg BusinessWeek, “several analysts have consistently suggested the shares are depressed because of Barger’s focus on passenger-friendly initiatives that leave shareholders at a disadvantage.”

Fortune Magazine echoed these sentiments, reporting “above all, {analysts} hate that JetBlue provides the most leg room of any domestic U.S. carrier in coach, with a seat pitch of 33 inches standard. By comparison, the legacy carriers have cut their seat pitch in coach down to 30 inches, which has allowed them to stuff more seats on their planes… {Analysts} view Dave Barger, JetBlue’s chief executive, as being “overly concerned” with passengers and their comfort, which they feel, has come at the expense of shareholders.”

Wolfe Research chimed in with additional advice to management: “JetBlue has ample opportunities to unlock value including a first checked bag fee, increasing seat density, cutting capex, dropping hedging, simplifying the fleet, and overbooking… to name a few.”

Some analysts such as Helane Becker of the Cowan Group have gone even farther,  openly calling for Barger’s head:  “We believe a management change would lead to a change in philosophy and likely morph the model similar to one of Spirit Airlines although not as extreme.”

This week, Wall Street naysayers got their wish, as jetBlue announced that Barger’s contract would not be renewed.  In February, Robin Hayes, jetBlue’s COO will succeed Barger as CEO, perhaps presaging a concerted pruning of jetBlue’s signature passenger-friendly perks.

This melodrama is reminiscent of Wall Street angst towards Amazon, where many analysts also feel that CEO Jeff Bezos has also been putting the welfare of customers ahead of shareholders.  For example, Slate columnist Matthew Yglesias has called Amazon ”a charitable organization being run by elements of the investment community for the benefit of consumers.”

Since when has superior customer service become viewed as a management liability?

CEO’s like Dave Barger and Jeff Bezos have managed their companies with a decided bias towards long-term value creation, brand distinctiveness and customer loyalty, rather than short-term profit maximization.

In this regard, Barger’s track record is actually considerably better than assessed by jetBlue’s critics.  In May, 2007, Barger inherited a seriously over-extended airline that was reeling from an existential crisis of mortifying customer service meltdowns.  Barger had to engineer a turnaround during a severe depression that wreaked havoc on airline balance sheets and income statements for at least three years, ultimately driving American, Frontier, Aloha and others into bankruptcy.  But by 2011, the results of Barger’s transformation of jetBlue were clearly evident.

The figure below compares jetBlue’s stock price appreciation  vs. the North American airline industry as a whole during Barger’s tenure.  As shown, stockholders who invested in JBLU on or after January 3, 2011 have enjoyed returns at or mostly above the industry as a whole through September, 2014.

JBLU vs. XAL Stock Prices

Nonetheless,  many on Wall Street have appeared to lose patience with Barger’s inability to convert industry leading levels of customer satisfaction into even higher growth in revenue and profits.

Dave Barger is not alone in struggling with this challenge.

One would like to believe that superior customer satisfaction is a competitive advantage that can help drive higher customer loyalty, word-of-mouth referrals, increased new customer acquisition, all at higher prices and profit margins.  In reality though, demonstrating this linkage has proven difficult for many companies, and at best requires a long timeframe to make the case.

Moreover, contrary examples abound.  For example, companies with strong monopoly/oligopoly positions often exploit their market power to achieve high margins, despite horrific customer service.  Take Time Warner Cable (TWC) for example, a perennial rock-bottom loser in customer satisfaction studies.  Despite widespread customer abuse, TWC’s share price has grown >250% over the past five years.

More broadly, the American Customer Satisfaction Institute conducts annual surveys of customer satisfaction across multiple industries using a common battery of metrics.  Comparing company-specific customer satisfaction measures for 146 companies in 2013 with their stock price appreciation during the year yields the following discouraging results.

There is virtually no relation between a company’s measured ability to satisfy customers and its stock price appreciation.  In fact, a regression between these two variables yields a slightly negative relationship.

As noted at the outset, managing a complex enterprise requires a delicate balancing act to serve the often-competing interests of customers, shareholders and employees.[1]  jetBlue undoubtedly can and will find additional mechanisms to raise revenues in the months ahead, but hopefully will do so in a manner consistent with its customer-friendly brand persona that has distinguished the airline since its founding.

Calls for jetBlue to jam more seats into their aircraft and to mimic standard industry practice of charging fees for every conceivable service would render jetBlue no different from its peers, whose track record in delivering satisfactory customer service is quite poor.  As shown below, jetBlue is currently a US industry leader in airline customer satisfaction.

jetBlue has invested heavily in creating an exceptionally strong customer franchise, built on a solid foundation of valued service.  The challenge now is to determine how to extract more value from this strong position, without losing jetBlue’s brand essence or corporate soul.

Some sage advice from Michael O’Leary, CEO of low cost airline Ryanair is apropos here: “If you don’t approach air travel with a radical point of view, then you get in the same bloody mindset as all the other morons in this industry.  This is the way it has always been and this is the way it has to be.”

Maintaining meaningful differentiation is essential for jetBlue to build on its distinctive brand character.  Finding the right tradeoffs between increased revenue realization and valued customer service offerings will continue to be a delicate balancing act for jetBlue’s new CEO.


[1] In April, jetBlue’s pilots voted to join the ALPA union, highlighting another conflict in balancing the objectives of management and the company’s stakeholders.

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Uncharted Waters: What to Make Of Amazon’s Chronic Lack of Profits

Amazon’s Q2 2014 earnings report brought a triple whammy of disappointment to impatient investors:

  1. A loss of $126 million on revenues of $19.34 billion, more than doubling analyst consensus estimates of expected losses for the quarter
  2. Q3 guidance that losses could exceed $800 million, reflecting accelerating investments in AWS infrastructure, content acquisitions and other unspecified technology outlays
  3. Amazon CFO Tom Szkutak remained decidedly unremorseful and characteristically opaque in discussing the company’s financial performance

The market reaction was swift and harsh: Amazon shares tumbled by almost 10% the day after its Q2 report, wiping out nearly $16 billion of market capitalization, and a growing chorus of analysts blasted the company’s business policies.

Three chronic concerns underscore growing investor unease with Amazon’s management priorities:

  1. The time is long overdue for the company to deliver profits, not just growth
  2. In its relentless pursuit of growth, Amazon has become over-extended
  3. The company’s obsessive secrecy manifests a blatant disregard for shareholders, which stands in frustrating contrast to its attentiveness to customers

While there is some validity to each of these concerns, in historical context, there was nothing unexpected in the results or message Amazon delivered in its Q2 2014 earnings report. The paradox and enigma surrounding Amazon is that Jeff Bezos has been both extraordinarily forthright and secretive about the company since its inception.

Jeff Bezos’ Guiding Principles
Bezos built Amazon on the foundation of being stubborn on vision, but flexible on details. And no CEO has ever been so clear in articulating his corporate vision as Jeff Bezos, who laid out the company’s guiding principles in his first letter to shareholders in 1997. In that document (which Amazon has included in its Annual Report every year since), Bezos signaled his intent to build a company focused on long-term growth, bold action, market leadership and customer satisfaction. As if anticipating the current criticism, in 1997, Bezos cautioned: “Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than some companies.” He has been admirably, and to some, frustratingly true to that vision ever since.

In this context, let’s examine each of the sources of investor angst in turn.

The time is long overdue for the company to deliver profits
Echoing the concerns of many analysts, Michael Yoshikami, CEO of Destination Wealth Management (which sold its stake in Amazon last year) recently noted: “Most companies with the kind of gross revenue Amazon has are not posting these kind of losses.”

Well that’s an understatement!

To put Amazon’s recent financial performance in perspective, consider the figure below, which displays revenue and net income since the company’s inception. There should be little doubt that Amazon has been reinvesting operating profits to fuel future growth. And its growth rate has been extraordinary. From 1995 through 2013, Amazon has grown its topline at a compound annual growth rate of 94%.

Rev and NI

Granted, growth rates have slowed as the company has bulked up, but Amazon is on track to be the fastest company in history to reach $100 billion in sales. With current revenues of >$75 billion, Amazon reported 23% topline growth on a year-on-year basis in its Q2 results. As noted below, comparing Amazon to companies that are within +/-10% of its current revenues, Amazon’s topline growth rate is in a class by itself – as is its lack of profitability!

Comparative Growth_Profit

In its relentless pursuit of growth, Amazon has become over-extended
Amazon’s profitability has undoubtedly been dragged down by its frenetic pace of investment in new businesses. As Jeff Bezos noted in his official statement accompanying the company’s Q2 earnings report:

We’ve recently introduced Sunday delivery coverage to 25% of the U.S. population, launched European cross-border Two-Day Delivery for Prime, launched Prime Music with over one million songs, created three original kids TV series, added world-class parental controls to Fire TV with FreeTime, and launched Kindle Unlimited, an eBook subscription service. For our AWS customers we launched Amazon Zocalo, T2 instances, an SSD-backed EBS volume, Amazon Cognito, Amazon Mobile Analytics, and the AWS Mobile SDK, and we substantially reduced prices. And today customers all over the U.S. will begin receiving their new Fire phones — including Firefly, Dynamic Perspective, and one full year of Prime — we can’t wait to get them in customers’ hands.

Each of these ventures requires startup capital that may take years (if ever) to recoup. As Amazon’s cash from operations has grown over time, it has accelerated its investment in new business development, venturing further afield from core ecommerce retailing to compete in the markets for tablets, smartphones, cloud computing, streaming media and original television content.

S&P Capital IQ analyst Tuna Amobi (who has a sell rating on Amazon) summed up the sentiment of many in noting: “There’s a lot of stuff they’re doing that’s questionable. There’s nothing wrong with spending to diversify your business, but it has to be in a focused manner as opposed to throwing spaghetti on the wall and seeing what sticks.”

The company’s obsessive secrecy manifests a blatant disregard for shareholders, which stands in stark contrast to its customer attentiveness
From the company’s founding, Jeff Bezos has been unwilling to divulge financial performance at the business unit level. This has set up a cat-and-mouse game between Amazon executives and industry analysts striving to learn more about company operations. For example, analysts have struggled for years to gain more insight into how many Prime customers Amazon has enrolled, or how many Kindles, Fires, hardcovers or ebooks it has sold, or how much AWS revenue it has booked or how much investment it has made in streaming video.

But Jeff Bezos doesn’t like to get specific with numbers.

For example, When Bezos took the stage in June to announce the launch of the Amazon Fire smartphone, during his 90-minute presentation, he took the opportunity to drop hints about the company’s broad-based business impact using the deliberately vague terminology: “tens of millions.”

Here’s a sampling from his presentation:

  • “Today we have tens of millions of Kindle owners”
  • “And today we have tens of millions of tablet owners as well”
  • “We’ve got tens of millions of songs you can buy”
  • “We very quickly had tens of millions of Prime members”
  • “That’s how you get tens of millions of members”

Tens of Millions

Bezos’ catchphrase is reminiscent of astrophysicist Carl Sagan, who popularized public awareness of astronomy with his frequent reference to the “billions and billions” of stars in the intergalactic universe. The difference of course is that the phenomenon Sagan was referring to is truly unknowable, whereas Jeff Bezos knows precisely how individual components of his business are doing. But that’s for Bezos to know and others to guess.


Care to speculate how many Kindles Amazon has actually sold? From Bezos’ opaque tease, the answer may be 20 million and growing or 220 million but declining. Granted, the SEC doesn’t require public companies to divulge such details to the investment community, but for a company whose market cap has been buoyed by shareholder trust, Amazon’s opacity has been testing investor patience.

Every quarter, buy- and sell-side analysts join in a conference call with Tom Szkutak, Amazon’s CFO, and pepper him with questions about company operations. But Szkutak doggedly dodges each query; as exemplified by his replies during Amazon’s Q4 2013 analyst call:

“I am sorry I can’t help you … you have to wait on that … In terms of the details, I can’t really give you a lot of color … you will have to stay tuned on that one … I can’t talk to the specifics of that … there is not a lot I can help you with there … I wouldn’t speculate what we would do or not do going forward … I wouldn’t speculate. We might or might not do in the future … if you look back at what we have done, you can’t expect that we might do [it] going forward … I wouldn’t want to speculate what they would or wouldn’t do related to pricing … it’s hard to tell, honestly. It’s hard to know … it’s very early … that’s really all I can say … I can’t comment.”

At Amazon, every obfuscating quarterly conference call feels like Groundhog Day.

What’s Next for Amazon?
So Amazon is arguably guilty as charged of disappointing earnings, worrisome increases in business complexity and investment, compounded by a stubborn unwillingness to share more information about business operations. The market has clearly lost confidence; Amazon is currently trading 25% off its 2014 peak.

Does the current market sentiment signal the need for a fundamental shift in Amazon’s overarching business vision, strategy or priorities? I don’t think so.

Taking the long view, it is somewhat puzzling that investors have seemingly become so unnerved by Amazon’s recent business performance. There is nothing particularly new or different in Amazon’s business priorities, or in its operating results through the first half of 2014. Jeff Bezos is managing Amazon today exactly as he said he would 17 years ago, making good on his longstanding commitment to prioritize long-term growth and market leadership over short-term financial returns. As such, it shouldn’t be surprising that Amazon has only beat quarterly earnings estimates half the time over the past 20 reporting quarters. So why have investors suddenly become impatient?

AMZN Price_Misses

Admittedly, there are some headwinds of concern. To begin with, Amazon’s recent EPS misses have come in bunches – viz. 4 out of the last 5 quarters. Then too, some of Amazon’s current business development priorities – cloud computing and original video content development — have particularly high investment thresholds with inherently long paybacks.   More generally, the law of large numbers is catching up with Amazon, making the required size of its investment bets and risks higher. Finally, as Amazon has moved farther afield into new business ventures, it has attracted new and stronger competitors. For example, AWS, Amazon’s industry-leading cloud computing business, is encountering fierce price competition from deep pocketed, committed players such as IBM, Microsoft and Google. So it shouldn’t be surprising that Amazon’s historically thin profit margins are under additional pressure.

But strategic, growth-oriented companies who are able and willing to sustain new business development activity through cyclical business swings are often rewarded over the long term. As a case in point, Amazon’s relentless focus on new business development and market leadership has propelled its unprecedented long-term growth.

Lest there be any doubt that Jeff Bezos is continuing to manage for long-term growth, consider the comparative business performance between Amazon and two of its major competitors: Walmart, the largest global retailer and IBM, a technology leader and fast follower in cloud computing.

Where Do The Profits Go?
As illustrated below, Amazon performed reasonably well in generating cash from business operations in 2013: 7.4% of revenues compared to 4.9% and 17.5% for Walmart and IBM respectively. What really distinguishes these three large enterprises is how each chooses to deploy their capital. Amazon spends far more of its cash from operations on R&D and Capex – the engines of growth – than Walmart or IBM. The payoff is in topline growth: 23% for Amazon vs. low single digit or negative for its competitors. In contrast, Walmart and IBM reward their shareholders with near term gratification in the form of dividends and stock buybacks (29% and 73% of cash from operations in 2013 for Walmart and IBM respectively).

Comparative Biz Perf

To understand the reason for these stark differences, it is worth repeating Jeff Bezos’ prescient comments in his 1997 letter to shareholders:

“We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions…

Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than some companies…

We aren’t so bold as to claim that [we have] the “right” investment philosophy, but it’s ours, and we would be remiss if we weren’t clear in the approach we have taken and will continue to take.”

Virtually every month, Amazon seems to announce yet another major new business venture. Recent examples include Amazon Fresh (groceries), Amazon Local (local services), Get It Now (same day delivery), Amazon Payments (online payments), streaming video and audio services, original content, Fire Smartphone, aggressive expansion in India, etc.

Critics who have grown impatient with Amazon’s lack of profits may be underestimating the long gestation period required for new-to-world ventures to yield attractive returns. This was certainly the case with Amazon’s initial ecommerce business, and subsequent third party marketplaces and Kindle platform, which took as long as a decade to go from concept to profitable returns.

This is not to suggest that Amazon hasn’t experienced its share of abject failures, including the following initiatives, which either were abandoned, written off or salvaged only via pricey, face-saving acquisitions:

  • Amazon Auctions, an ambitious attempt to compete head-to-head with eBay was abandoned after seven years of dismal performance
  • Living Social, a Groupon competitor, garnered a $175 million investment from Amazon in 2010, 97% of which was written off 18 months later
  • Zappos and Diapers.com both were acquired by Amazon for a significant premium, after the company abandoned its attempts to penetrate these categories on its own

In essence, Amazon has been operating as a corporate VC, using retained earnings to continuously fund investments in new business ventures. In this regard, while periodic failures are to be expected, by most measures, Amazon’s success rate has been remarkable, and its growth rate unprecedented.

It is also important to recognize that Amazon’s preference for long-term growth over short-term profits is a matter of strategic choice. Amazon could easily boost its EPS by throttling back Capex and R&D investments (at the expense of growth), whereas, it is unclear whether Walmart or IBM are capable of turbocharging their topline growth.

Investors who expect Amazon to deliberately scale back its growth initiatives and/or raise prices to achieve short-term profits either don’t understand the company or lack the appetite for Jeff Bezos’ long-term vision. Amazon is positioning itself at the epicenter of multiple businesses with exceptionally strong growth potential – global ecommerce, streaming media, electronic payments, cloud computing, same-day delivery services, the South-Asian continent etc. It is neither in Amazon’s DNA or long-term interest to slow its pursuit of these opportunities.

What could go wrong?
Is Amazon an indomitable force, bound for world domination? Of course not.

There are a number of factors that could sidetrack Amazon’s prodigious appetite for growth and market leadership.

The biggest challenge is management risk associated with the growing complexity of Amazon’s global business endeavors. As noted earlier, Amazon chooses to operate with razor thin margins across its business portfolio, and as such, will have to execute flawlessly to maintain torrid growth without jeopardizing their balance sheet. This will require a deep bench of committed executive talent across the enterprise.

As their Q3 2014 guidance perhaps presages, Amazon may hit a bad patch if a few of its strategic growth initiatives take longer to materialize, attract more vigorous competition and/or require considerably higher investment than anticipated. Such outcomes, as noted below, could set in motion a downward spiral in business performance that might require significant retrenchment. Amazon relies heavily on options-based compensation in its senior executive ranks, making the company vulnerable to prolonged softness in the stock market.

Given its dependence on public markets to fuel aggressive organic growth and acquisitions, Amazon’s reticence and repeated opacity in dealing with the investment community is another risk factor. A growing chorus of analysts and shareholders has lost patience with what they view as the company’s arrogant disregard of shareholders. True, the company can point to its unusual candor in initially articulating its management philosophy and to the shareholder-friendly returns achieved over the past decade (~500% stock price appreciation from mid-2004 to mid-2014). But the public has short a memory span, and Amazon risks needlessly squandering shareholder trust by doggedly refusing to respond to questions regarding business line results or to provide a credible case for the company’s path to profitability.

Downward Spiral

Another risk factor of course is Jeff Bezos himself. Few companies are as personified by their CEO as Amazon. Bezos’s eventual successor will obviously have some very big shoes to fill, with outsized management transition risk.

But for the foreseeable future, with respect to Jeff Bezos’ guiding vision, don’t expect new news from Amazon. If you’re looking for hints on Amazon’s strategic blueprint for the years ahead, look no further than Bezos’ 1997 letter to shareholders excerpted below.

Shareholder Letter








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What Happens When David Becomes Goliath…Are Large Corporations Destined To Fail?

We’ve all been inspired by stories of brilliant entrepreneurs whose game-changing ideas sparked in humble settings — e.g. a garage (Steve Jobs), dorm room (Mark Zuckerberg) or Milanese coffee bar (Howard Schultz) — blossomed into market-leading global enterprises.  A new generation of entrepreneurs is now building companies that reached $10 billion in market value in record time (Uber, Airbnb, WhatsApp), posing grave threats to established industries.  It would appear that the traditional bases of competitive advantage that used to protect incumbent market leaders – scale, operational experience, brand image, customer base, distribution, and financial depth –- can no longer withstand the onslaught of upstart entrepreneurs.

This was the theme of Malcolm Gladwell’s recent book, David and Goliath: Underdogs, Misfits and the Art of Battling Giants.  In his retelling of the biblical tale of David and Goliath, Gladwell portrays David as a fearless, agile and resourceful fighter who defeats the dim-witted, over-confident and ponderous oaf, Goliath. Gladwell rebuts the common belief that David was an underdog.  In this mismatch – and in a surprisingly large number of others – Gladwell asserts that leaders have liabilities that make them particularly vulnerable to brash upstarts.

This should come as no surprise to students of business.  History is replete with examples of profitable, market-leading corporations who were felled by smaller but more nimble and effective competitors. For example, when AT&T — the largest company in the US for much of the 20th century– failed to adapt to deregulation and the emergence of wireless technologies, it was forced to sell its dwindling assets for a fraction of its historical peak value to one of its former regional divisions. AT&T’s vulnerability as a ponderous, customer-abusing monopoly was bitingly captured in one of Lily Tomlin’s signature parodies, with the tagline: “We don’t care. We don’t have to. We’re the phone company!”

GM, which also held the distinction of being the largest US corporation for decades declared bankruptcy in 2009, and only lives on today (in shrunken form) as the beneficiary of a taxpayer bailout.  But GM’s management shortcomings are no laughing matter, as details of its willful disregard of fatal vehicle design flaws have recently come to light.

Kodak serves as yet another example of how the mighty have fallen.  The firm, which enjoyed photographic film industry leadership for over a century, peaking at a 90+% market share in the mid-1970’s, declared bankruptcy in 2012.   Kodak is a poster child of Clayton Christensen’s disruptive technology theory, which explains why large enterprises struggle to adopt innovations such as digital imaging.

Are these isolated examples of bad management bringing down venerable institutions, or are market-leading corporations destined to be felled by disruptive upstarts, by aggressive attacks from traditional competitors, or by a combination of both?  Conventional wisdom has increasingly tilted toward the latter:  market leaders cannot sustain global competitive advantage over the long term.

Take Apple as a case in point.  A gloomy outlook has been predicted for the post-Steve Jobs enterprise by no less than a Nobel Prize-winning economist (Paul Krugman), one of the most influential business theorists of the last 50 years[i] (Clayton Christensen), a Wall Street Journal reporter and best-selling author (Yukari Kane), an SAP board member writing for Der Spiegel (Stefan Schulz) and 71% of respondents to a recent Bloomberg global survey who say that Apple has lost its cachet as an industry innovator.  The reasoning behind these arguments that the mighty must fall is not limited to Apple, but stem from a broader belief that large enterprises inevitably lose their competitive advantages over time.

But this viewpoint is not only flawed, but perversely could become a self-fulfilling prophecy of corporate failure. If management truly believes that long-term above-market profitable growth is impossible, the logical response is to protect and harvest current assets and customers for as long as possible.  But such an approach — playing not to lose, as opposed to playing to win –  only serves to hasten the decline of incumbent market leaders.

The biblical Goliath may have been a ponderous oaf, but large enterprise CEO’s don’t have to be.  Business Goliaths can continue to prosper if they maintain the same entrepreneurial spirit and adaptability that led to their success in the first place.

Let’s explore the case of Apple as a case in point.

On September 29, 2012, Apple reported record earnings, capping a remarkable three-year run during which the company grew revenues by 266%, profits by 406% and market capitalization by 280%.  Already the most highly valued company in the world, few expected that Apple could continue its torrid growth rate forever.

But as Apple’s margins and growth rate did begin to abate over the ensuing 18 months, many pundits declared  this was a broader sign of the company’s expected erosion of competitive advantage, dooming Apple to average financial performance – or worse – going forward.

For example, one of my esteemed colleagues at Columbia Business School shared this provocative point of view with MBA students:

It’s very hard to dominate big global markets. Nobody has ever dominated electronic devices. Trust me, we’ve seen it in related industries for Sony, for Motorola and for Nokia.  They’ve had nothing like the margins of Apple, and the margins of Apple have gone down by at least a third in the last 16 to 18 months. You can’t dominate a big market…  Apple is going straight down the tubes!  — Bruce Greenwald, Columbia Business School

Why would a company that has repeatedly demonstrated extraordinary customer insight, innovation, design expertise, marketing prowess, high quality manufacturing and retailing excellence be headed “straight down the tubes?”

I believe there are three fallacious arguments that underscore the belief that Apple, and indeed all market leaders, eventually must lose their competitive advantage and above-market financial performance over time:

  1. The law of large numbers
  2. The law of competition
  3. The law of competitive advantage

The law of large numbers
This law posits the obvious mathematical property that as a company grows, the incremental revenue required to maintain above market growth becomes ever larger.  For Apple, whose revenue is currently $175 billion, the challenge is indeed daunting.

For example, consider what would be required for Apple to grow it’s topline by 10% over the coming year, which while still above market average, is still only one-third of the compound annual growth rate the company achieved over the past five years.  Growth of this magnitude would require the equivalent of adding the total revenue from companies such as Southwest Airlines or General Mills or US Steel to Apple’s current topline.  No mean feat!

Or think of it another way.  Apple-watchers have been keenly anticipating the launch of the iWatch, in the intriguing “wearable technology” category.  Characteristically, Apple has not been the first-mover in this emerging technology (nor was it in portable music players, smartphones or tablets), as smartwatches from Samsung, Pebble and more recently Google have been on the market for a year or more.

But let’s give Apple the benefit of the doubt based on past success and assume that it achieves 10 times the industry sales of smartwatches achieved in 2013 ($712 million).  At an assumed iWatch price of $299, this translates into annual sales of 24 million devices, generating just over $7 billion in revenue.  As long as we’re being generous, let’s assume that each consumer also buys an average of $50 in apps each year for their slick new iWatch, of which Apple would claim a 30% revenue share.  That would add a paltry $360 million in additional revenue (albeit at high margins).  But the point here is that if Apple’s ability to continue to outgrow the market requires upwards of $17 billion of new revenue (and even more in the years ahead), it will take more than the vaunted iWatch to get the job done.[ii]

It will undoubtedly be difficult for Apple to outgrow the market over the long term.  But is it impossible?  Absolutely not!

The most definitive study on this issue was undertaken by the Corporate Executive Board in their landmark study of long-term growth rates.  The CEB examined the performance of over 400 US companies that have been on the Fortune 100 list over the past 50 years, along with 90 non-US companies of a similar size.  The authors concluded that approximately 13% of the nearly 500 large companies studied have been able to outgrow the market average for up to 50 years.  So while outperforming the market over the long-term is a notably uncommon achievement, it is far from a mathematical impossibility.

So where might Apple find its next growth wave, if not from the iWatch?  There are several  large opportunities that Apple may exploit that could fuel another round of dramatic growth.  Opportunities include:

  • Gaming
    The next generation of Apple’s iPad is reputed to have processing speeds and video refresh rates equivalent to or better than any high-end game console.  Combined with further inroads into the iTV market with streaming technologies, Apple can seriously disrupt the global gaming industry, which currently generates over $90 billion in revenue.
  • Home Entertainment
    Ever since Walter Isaacson’s 2011 autobiography quoted Steve Jobs saying “I finally cracked it” — the it being a uniquely easy-to-use television — Apple-watchers have expected a transformative technology that would put Apple in the forefront of home entertainment – a >$120 billion dollar global market.
  • Payments
    With an installed base of over 700 million global iTunes customers that have credit cards on file with Apple, and a market-leading share of mobile shopping on its iOS devices, Apple is ideally suited to transform the payment processing industry.  With over $4 trillion in credit card transactions in the US alone, an “iWallet” product can be a huge game-changer for Apple.
  • Retail Services
    Relatedly, Apple has been researching a range of in-store retail applications enabling brick-and-mortar retailers to offer personalized shopping services to customers.  Building on an in-store tracking technology called iBeacon, Apple could enable retailers to provide personalized shopping recommendations, cross-sell promotions, loyalty discounts and automated checkout – all generating fees for Apple of course.
  • Enterprise IT Solutions
    With its recently announced partnership with IBM, Apple is poised to significantly expand its presence in the mobile enterprise market.  Both partners have fully complementary objectives to sell integrated mobile business solutions to IT executives which include internal management processes (e.g. accounts receivable, time & expense reporting) and customer facing apps (e.g. CRM, order-to-fulfillment processes) — all in the iOS environment of course. To date, Apple’s inroads in the enterprise market has largely been confined to selling smartphones and tablets, sanctioned by the IT department, at corporate discount price levels.  But partnering to move up the value chain to enterprise solutions gives Apple (and IBM) the opportunity to deepen its enterprise penetration at higher price points.  Apple’s challenge will be to fully exploit its new IBM relationship  without closing the door on other strong players in the enterprise IT sector — HP, Accenture, Infosys.  Under any circumstances, enterprise IT solutions presents an attractive growth opportunity for Apple

What has distinguished Apple over the past 15 years is its ability to repeatedly launch market-expanding innovations, thereby avoiding the drag of declining sales on aging products.  In some cases, Apple has cannibalized its own sales in seeking new growth, as with the iPhone vs. the iPod and the iPad vs. the MacBook.  Looking forward, Apple’s greatest growth opportunities may now lie in exploiting ecosystem services, rather than new hardware wizardry.

Under any circumstances, the assertion that Apple cannot continue to outperform the market because of the “law” of large numbers is pure sophistry – a case of simple mathematics posing as strategic thinking.

The law of competition
A second argument for why Apple is destined to decline falls under the rubric, the law of competition. According to this “law,” Apple’s historically sky-high returns on invested capital (ROIC) must inevitably revert to average levels for the following reasons.

  • The higher its ROIC, the more competition a market leader attracts
  • New competitors will be attracted to attack the market leader even if their cash returns are slightly lower than the market leader.   That is, as long as the opportunity to generate above industry average returns by attacking the market leader is deemed higher than alternative uses of capital, the market leader will come under increasing attack
  • As more competitors enter, product differentiation will weaken, pricing pressures will mount and ROIC for all players will inevitably decline.
  • This process will continue until economic profit margins (ROIC net of the cost of capital) approach zero at which point a new industry equilibrium will be established with market leaders reduced to operating at or near industry average net returns.

This theory is elegant and the data supporting it would appear to be supportive. For example, Figure 1 below displays the distribution of return on capital employed vs. market cap for all publicly traded US companies in 2013.  Adherents of the law of competition see validation of their theory in the decline of Apple’s return on capital and market cap between 2012 and 2013 — presumably a first step towards Apple “going down the tubes.”

Many industry observers have also pointed to the loss of technological leadership in the smartphone/tablet market, and the four-year lag since the company introduced its last game-changing product (iPad) as further evidence of Apple’s inability to maintain the competitive advantage required to sustain high margins (see Exhibit 2).

But the inexorability of the law of competition applied to Apple and other highly profitable corporations is fundamentally flawed on two grounds:

  1. This “law” only applies if the market leader stands pat, opening opportunities for competitors to catch up with or surpass the technical merits of current product offerings.  But if the market leader continuously adapts its strategy, renewing the bases of its competitive advantages, competitors may be put in a position of perennially playing catch-up.  Take Amazon, for example.  Had Amazon been content to sit on and defend its market-leading ecommerce book business, it would be no more than a $3 billion, declining business today.  Instead, Amazon – now an $80 billion company growing at >20% per year –  chose to disrupt itself in the book market and dramatically expand the scale and scope of its enterprise, putting competitors on the run, rather than exposing itself to the law of competition.[iii]
  2. As applied to Apple per se, many critics of its current products apparently misunderstand the basis of the company’s competitive advantage.  Apple has never billed itself as a first mover, nor laid claim to leadership on technical specs –i.e. the “speeds and feeds” of its products.  Rather, Apple has created competitive advantage by consistently providing a superior customer experience across an expanding array of hardware devices and consumer services.  This source of competitive advantage has as much to do with Apple’s prowess as an integrated software developer as its hardware wizardry.  Apple’s  product design superiority is another intangible but highly significant differentiator. Lest one doubt that these sources of Apple’s competitive advantage can continue to nullify the “law of competition,” consider the latest consumer electronics battlefield: smartwatches.  Over three dozen manufacturers have rushed products to market in this space, led by Samsung, Pebble and Google.  But as New York Times fashion writer Vanessa Friedman recently noted in her On The Runway column:

Neither [Samsung smartwatch] does what the best design does, which is make you rethink all your old assumptions about the form (see: Chanel’s boucle jacket, which gave sartorial armor the ease of a cardigan; Armani’s deconstructed suit, which gave form to the idea of “soft power”; Prada’s black nylon backpack, which elevated the mundane, for example)…

In fact, the [current smartwatches] do the opposite: they re-enforce all our old assumptions about the form, which is that you take your phone screen, make it small and stick it on your wrist. All I can think when I see them is: “Beam me up, Scotty!” And where’s the joy — or the desire — in that?…

Admittedly, this has entirely to do with aesthetics, not functionality or engineering. But a smartwatch is an accessory, so aesthetics matters.

Tech writers have been largely negative as well, noting the lack of useful functionality and confusing user interface of the current genre[iv].  Given these reviews, it’s not surprising that early sales in the smartwatch category have been disappointing.  But if history repeats itself, Apple will once again set a new standard for style, form factor, capability, usability and market leadership when it launches its new iWatch, as rumored this fall.

Critics who bemoan Apple’s late entry in this category as proof that Apple has lost its innovative edge in the post-Jobs era should remember that Apple’s unprecedented success with the iPod, iPhone and iPad came at least a decade after competitors pioneered product launches in these categories, as noted in Figure 3.


The law of competitive advantage
At the heart of the widespread conviction that large companies cannot sustain global leadership (marked by above-market growth and margins) is the underlying belief that the basis of a company’s competitive advantage inevitably erodes over time.  A good starting point to examine the validity of this argument is to recall that all products and services experience a product life cycle.  The familiar bell shaped curve shown in Figure 4 traces the trajectory of a new product through early adoption, rapid growth, maturity and eventual decline, driven by competitive technology advances and shifts in customer preferences.  Schumpeter described this process as creative destruction over fifty years ago, and while the underlying dynamics are still compellingly true today, Downes and Nunes have argued that product life cycles have dramatically shortened due to a number of forces described in their recent book Big Bang Disruption[v].

Whatever one assumes about the duration of a product lifecycle – for example, in consumer electronics, successful products can come and go in less than a year – it is undeniably true that to sustain long-term market leadership, companies must consistently renew their product lineup with the “next new thing” in each of the categories in which they compete.  This does not mean simply adding incremental improvements, which Christensen has noted propels most companies into a sustaining technology feature-function arms race.  Rather, successful companies must rethink their consumer value proposition on an ongoing basis and be willing to consider entirely new product concepts aimed not only at current customers, but those poorly served by current offerings.

And herein lies the challenge.  In most cases, established market leaders struggle to disrupt themselves and eventually get overtaken by newcomers who bring radically different approaches to market that are often better and cheaper than existing products.  The list of disruptive technology examples stretches back centuries and cuts across every industry sector.  For example, as noted in Figure 5, Western Union’s telegraph business was decimated by Bell Telephone, which in turn gave way to Motorola/Nokia’s leadership in mobile handsets, which in turn got toppled by Apple/Samsung’s dominance of the smartphone market.  Figure 5 lists numerous other cases where incumbent market leaders got toppled by newcomers who attacked with better product technology and/or superior business models.

Christensen’s Innovator’s Dilemma explains that the reason why incumbents usually fail to disrupt themselves boils down to the  strong tendency of large companies to:

  • Focus on their biggest, most demanding customers who typically push for incremental improvements in current products
  • Focus on traditional competitors, who behave similarly
  • Dismiss non-traditional entrants, whose initial product entries may be relatively crude and unsophisticated
  • Lack interest in nascent or underserved segments that seem to offer limited short-term revenue opportunities
  • Lack internal processes and management mindsets that promote corporate entrepreneurship
  • Establish incentives that reinforce short term profit-taking while disincentivizing risky or long-term business development

Is it possible to overcome these barriers to innovation, allowing a company to renew its basis of competitive advantage, which in turn can drive sustained market leadership?

This is precisely what Apple and Amazon have done over the past 15 years.  For example, Apple has continuously created new growth opportunities through breakthrough product innovation, sometimes at the expense of cannibalizing its existing products. This is illustrated in Figure 6 below, where the top line reflects the sum of sales from each of Apple’s main product lines over time.

Similarly, Amazon’s exceptionally strong sustained topline growth (if not profitability) has been driven by relentless scope expansion and product innovation, often on initiatives with long-term payoffs and/or that have cannibalized existing product lines.


Summing It Up
The belief that business Goliaths will eventually lose their basis of competitive advantage stems from an implicit assumption that large enterprises suffer from strategic inertia.  It is true that if a company (small or large) focuses more on defending current market positions than on renewing its basis of competitive advantage through meaningfully differentiated innovative new products and services, it will fail for all the reasons noted above:

  • The law of large numbers will catch up with the company as its products saturate maturing markets.  We’ve already begun to see some evidence of this in Apple’s current product lineup (Figure 6)
  • Competitors will relentlessly attack current products with comparable (or better) features and benefits, often at lower cost, eroding margins and enterprise value (Figure 5)
  • The historical basis of a company’s competitive advantage will weaken or possibly be destroyed by emerging disruptive technologies (as was the case for Kodak, travel agencies, newspapers, Nokia and many others).

But these negative outcomes are not inescapable.

Unlike scientific laws[vi], which describe intrinsic characteristics of our physical world, the business “laws” of large numbers, competition and competitive advantage can be broken by strong leadership.

As Rita McGrath notes in her insightful book, Transient Advantage, winning companies can (and indeed must) repeatedly renew their basis of competitive advantage to sustain long-term profitable growth. It is admittedly not easy, and there are often strong headwinds that challenge corporate entrepreneurship.

But exceptional CEO’s such as Jeff Bezos (Amazon), Howard Schultz (Starbucks), Marc Benioff (salesforce.com) and Fred Smith (FedEx) demonstrate that companies can continuously renew their bases of competitive advantage and achieve sustained profitable growth, notwithstanding the growing chorus of naysayers who assert that the mighty must fall.

Whither Apple in the years ahead?   Tim Cook’s leadership rather than immutable laws of large numbers, competition or competitive advantage will determine Apple’s business performance going forward.

Time will tell.


[i] Forbes Magazine; http://www.forbes.com/forbes/2011/0314/features-clayton-christensen-health-care-cancer-survivor.html

[ii] Some industry analysts are quite bullish on the business outlook for iWatch sales, suggesting that the combined effect of iWatch pull-through iPhone sales will be quite dramatic.  In this case, the iWatch alone would refute the “law of large numbers.”

[iii] One can point to Amazon’s miniscule profit margins as a sign of weakness, but this reflects Amazon’s predominant emphasis on growth over profits rather than a consequence of the laws of competition.

[iv] For example, CNET’s bottom line on the Samsung Gear smartwatch is: “Samsung’s take on the smartwatch has some potential, and it does get some things right, but its inability to perform truly “smart” functions means it falls far short of expectations.”

[v] Compressed product life cycles are due in part to dramatic reductions in the time and cost to develop new products.  Moreover, viral marketing through social media can allow startup companies to instantly reach a global consumer marketplace at little cost.

[vi] For example, the laws of gravity and thermodynamics

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Advice to Publishers: Don’t Fight For Your Honor, Fight For Your Lives!

Intense media coverage of the standoff between Amazon and French publisher Hachette over ebook pricing has called into question who will control the future of the book industry.  This debate has historical precedent.  The invention that enabled the creation of the modern book publishing industry – the Gutenberg printing press – was ridiculed at its inception by the prior gatekeepers of the printed word.  Monks who transcribed scriptures and religious writings by hand once controlled both the editorial and distribution functions in what was the parchment, if not the book industry.  As with Hachette today, it is understandable that artisanal monks felt threatened by a new technology, which allowed laypersons to print and distribute any document at far lower cost.


We have seen similar cases of technological disruption throughout history, be it combine harvesters and threshers that accelerated the agricultural revolution at the expense of family farmers, or Sam Walton’s big box retailing innovations that dislodged thousands of mom-and-pop retailers, or Internet news aggregators that are posing grave threats to today’s metro and national newspapers.  In each of these transitions, critics – either businesses directly disrupted by new technologies or citizens wedded to traditional mores — have rightfully called attention to what is being lost in exchange for supposed progress.  For example, some critics of inaugural telephone services feared that families would become asocial, no longer needing personal visits to communicate with friends and neighbors.  One can only imagine how such luddites would feel today about text messaging and social networking!

It is ultimately up to the consumer marketplace, moderated as necessary by regulators and the courts, to decide on the pace and direction of technological progress. Under any circumstances however, new technologies that undermine historical bases of competitive advantage are highly disruptive not only to the incumbents’ business economics, but to their emotional well-being as well.  If one has spent an entire career mastering complex skills and business relationships only to find these assets diminishing in value, the impacts are viscerally disorienting and threatening.

These dynamics are once again at play in the negotiations between Amazon and Hachette. But the roots of this dispute go much deeper than ebook pricing terms, and the stakes pose an existential threat for book publishers.  The question is, what can publishers learn from history to guide the way forward?

To understand this high stakes game, it’s important to start with the historical context underscoring the publishing industry’s dilemma and challenge.  For starters, the book publishing industry was caught in a broken business model of their own making, long before Amazon introduced its first Kindle in 2007.  Decades ago, publishers adopted an inherently costly business model whereby books were sold on consignment to bookstores.  With thousands of releases each year added to an even larger backlist, it has always been extremely difficult to predict the popularity of any given new title.  Either bookstores or publishers had to assume the risk of getting new titles on retailers’ shelves.  With production economics favoring large print runs, publishers bit the bullet, allowing free returns from bookstores, and have lived with the costly consequences ever since: return rates averaging 40% across the industry.

Facing chronic slow growth and anemic profitability, independent publishers were acquired by large media conglomerates (e.g. CBS, Bertelsmann, News Corporation), who by 2000 controlled over 80% of total book production.  Backed by stronger balance sheets, book publishers increasingly focused their efforts on blockbuster hits, funneling multi-million dollar advances to established authors.

But as competition drove up the bidding, publishers continued to struggle to earn attractive returns, typically losing money on over 70% of new releases. Moreover bigger bets on populist blockbusters meant fewer resources were available to support up-and-coming authors with advances, marketing, PR and promotions.   Thus the industry’s storied past of cultivating great literature has been under pressure for decades, quite apart from the threat of ebooks or Amazon.

To compound their woes, book publishers failed to anticipate and have been slow to effectively respond to the transformation of the publishing industry in the post-Kindle era.  In November 2007, Amazon CEO Jeff Bezos launched the original Kindle, surprising publishers with plans to price new ebook releases and best sellers at $9.99, well below the wholesale price publishers charged Amazon.  With its aggressive, loss-leader pricing, wide selection and heavy marketing, ebook sales skyrocketed and Amazon’s market share reached nearly 90% within two years, alarming publishers.

In response, in January, 2010, Hachette and four other publishers announced an agreement with Apple, whereby publishers would set retail prices for ebooks – typically 30% higher than Amazon’s prices at the time – giving retailers a fixed agency commission on each sale. But t he Department of Justice filed suit in April 2012, claiming Apple and the five publishers were guilty of collusive price-fixing. Hachette was one of three publishers that immediately chose to settle, restoring Amazon’s freedom to set ebook prices and agreeing to renewed negotiations after a two-year “cooling off” period, bringing us to today’s standoff between Amazon and Hachette.


As digital penetration of the overall trade book industry approaches 50%, publisher profits have actually been strengthening, reflecting lower paper, print and binding costs and fewer unsold returns.  But even if publishers temporarily succeed in maintaining their margins in the current round of negotiations, a far larger concern is the uncertain role legacy publishers will play, as printed books inevitably become an ancillary component to an ebook-dominated marketplace.

The publishers’ longstanding source of market dominance has been their editorial gatekeeping function that historically dictated which books would be published at a scale requiring capital-intensive printing plants, and their distribution network that could rapidly place printed books on thousands of bookstore shelves.  But with the advent of digital book production and distribution, these assets are no longer as valuable as they used to be, nor do they serve as effective barriers to competition.

Thus, despite the recent tsunami of negative press being directed towards Amazon, this dispute is ultimately not about whether Amazon is a monopolist or monopsonist.  Nor is it about whether Amazon is trying to use books as a loss leader to sell other merchandise or whether the company is treating Hachette, authors or its own customers fairly.  It is also not about whether book publishers as currently configured are an essential bedrock of our society.

It is about whether publishers can retool their business capabilities to maintain a vital role in adding value to all stakeholders in an industry where books will increasingly be produced, marketed, reviewed and sold in profoundly different ways.

What does this mean in practical terms?  Many authors who once would have been thrilled to be offered a legacy publisher contract are now asking: “what can you do for me that I can’t obtain elsewhere?”  Publishers are quick to point out their longstanding editorial excellence, which will undoubtedly continue to be important.  But to succeed in the post-digital era, publishers will also need to excel in customer relationship marketing, exploitation of social media, video production and promotion, multi-media web design and virtual book promotion as well as increasing the efficiency of their business operations and offering far more competitive digital book royalties.

Right now, digital publishing capabilities are being driven and refined by a wide range of new competitors – native epublishers, enterprising self-published authors and a host of specialists providing a la carte services, including cover design and graphics, editing/copyediting, fact checking, videography, digital marketing, business analytics and market trend analysis.

Publishers who continue to focus their attention and anger on Amazon rather than on the broader forces reshaping the book publishing industry are in grave danger of losing their battle for relevance and possibly survival.

The imperative now is to build new skills necessary to survive and prosper in this rapidly changing industry.  Publishers need to get beyond defending their nobility while demonizing Amazon, and start fighting more effectively on the new battlefield.

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In the fight over ebook pricing, why Amazon is not the bully

 May 30, 2014: 10:20 AM ET
{Reposted from Fortune.com}

Amazon should be viewed as a fierce competitor in its dispute with publisher Hachette.

By Len Sherman

Amazon.com CEO Jeff BezosAmazon.com CEO Jeff Bezos

FORTUNE – As a fight over ebook pricing intensifies between French book publisher Hachette and online retailer Amazon (AMZN), some are suggesting that Amazon customers are being left behind.

While details of the ongoing standoff are sketchy, it has become clear that Amazon is pressuring Hachette by making access to its books difficult on amazon.com. As an author whose recent book was published by Hachette, Fortune’s Adam Lashinsky  penned an article earlier this week that takes issue with Amazon’s behavior as contrary to the company’s ostensible obsession with customer service.

I would argue that he is confusing “anti-consumer” with “fierce competitor” in characterizing Amazon’s behavior.

By way of background, this dispute dates back to November, 2007, when Amazon CEO Jeff Bezos launched the original Kindle, surprising publishers with plans to price new ebook releases and best sellers at $9.99, well below the wholesale price publishers charged Amazon. At the time, publishers charged Amazon and other retailers the same wholesale price for e-books as for hardcovers, typically around $13.  With its aggressive, loss-leader pricing, wide selection and heavy marketing, ebook sales skyrocketed and Amazon’s market share reached nearly 90%, alarming publishers.

In response, in January, 2010, Hachette and four other publishers announced an agreement with Apple (AAPL), whereby publishers would set retail prices for ebooks – typically 30% higher than Amazon’s prices at the time – giving retailers a fixed agency commission on each sale. The Department of Justice filed suit in April, 2012, claiming Apple and the five publishers were guilty of collusive price-fixing. Hachette was one of three publishers that chose to settle, providing Amazon and other retailers immediate discretion in ebook pricing and agreeing to renewed negotiations after a two-year “cooling off” period, which brings us to today’s riff between Amazon and Hatchette.

In his piece, Lashinsky says:

“But let’s get back to the customer. Assume for a moment that Hachette is the bad guy here, that the smallest of the major book publishers is making unreasonable demands on Amazon. (This seems unlikely, but bear with me.) Even if Hachette were behaving badly, I’m scratching my head trying to figure out in what strange universe Amazon believes that making it difficult for its customers to buy Hachette’s products is consistent with “customer obsession.” I’m trying to understand how Amazon thinks this will help it “earn and keep customer trust.”

I would argue that it’s a mistake to assume there are good guys or bad guys here. I don’t begrudge either side for fighting hard for their own interests. So let’s just look at the impact on consumers if either side gets their way.

Hachette might prevail because they have a 100% monopoly on all their titles, and are pushing Amazon very hard with the threat of not selling any of their books at lower wholesale prices.  Essentially, Hacehtte’s position for now appears to be: “our way or nothing — if you want our books, here’s the price, period.”  If Amazon backs down, they will have to maintain high retail prices to cover high wholesale prices. Keep in mind of course that the publishers set high wholesale prices for ebooks from day one and then illegally colluded with Apple and other publishers to keep ebook retail prices high in 2010. Lashinksy seem to ignore these facts in brandishing Amazon as the anti-consumer player in this dispute.

Now if Amazon prevails – despite having the relatively weak bargaining position of controlling only 33% of total book sales – Hachette (and then presumably other publishers) will be forced to lower wholesale prices, which Amazon will likely pass along to consumers. Consumers would be the obvious beneficiaries here, as they are across every product category on amazon.com.

Turning Lashinsky’s argument around, I’m trying to understand what strange universe he lives in to believe that consumers won’t come out ahead if Amazon wins this fight. Lashinsky may be conflating author interest with consumer interest, and I can understand his disappointment in being collateral damage in this fight. But as he notes, consumers have alternative choices to buy his book (as I already have). After the dust settles, if Amazon wins, he will wind up selling morebooks at lower retail prices and probably earn higher royalty payments.

I think Lashinsky should redirect some of his wrath on Hachette, who, like other major publishers, pays only a 25% royalty rate on e=book sales, compared to 50% from native e-publishers like Open Road Media or 50%-70% from Amazon (depending on ebook price).

Right now, publishers are squeezing authors and consumers pretty hard. But it’s just business. I don’t waste a lot of energy worrying whether publishers are anti-consumer.  Having said that, I stick with my prediction that major publishers will not be able to win this fight.  Amazon has consumers on their side. That’s the universe I live in.

Len Sherman is an adjunct professor at Columbia Business School, where he teaches courses in business strategy and corporate entrepreneurship. Prior to becoming a converted academic, he spent over thirty years in management consulting with Booz, Allen & Hamilton, J. D. Power & Associates and Accenture, primarily in the automotive industry.

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