On March 1, a prestigious MIT research center published a Research Brief on a study of rideshare driver compensation, led by a respected Stanford University researcher. The MIT report asserted that half of Uber and Lyft drivers earn no more than $3.37 per hour, after accounting for vehicle ownership and operating costs. The study further concluded that 74% of rideshare drivers earn less than the minimum wage in their state, 30% are actually losing money and 74% of whatever driver profits there are could go untaxed, if drivers claim the standard IRS deduction for vehicle operating costs.

After MIT published its Research Brief, the press was quick to pounce, with brutal, indignation-laden headlines:

• MIT study shows how much driving for Uber or Lyft sucks – TechCrunch
• Uber's New CEO Faces New PR Disaster: MIT Study Reveals Drivers Make Less Than $3.37 an Hour – Inc.com
• Seriously, how are Uber and Lyft drivers surviving? – MIT Technology Review
  
  

Uber quickly published a thoughtful response, rebutting the MIT Research Brief by identifying a key error in its underlying methodology. In response, the MIT team leader, Stephen Zoepf, tweeted a mea culpa, blaming his error on confusing wording in the survey provided by a third party, and on the absence of more complete and transparent data from Uber and Lyft. After recalculating driver earnings using two revised methods, the MIT study author found rideshare driver hourly earnings to be in the range of $8.55 - $10 per hour (similar to many prior published studies), with “only” 41% - 54% of drivers making less than minimum wage in their state.
Ordinarily, this story would end here, with little additional fanfare. Stephen Zoepf isn’t the first university researcher to make an error in publishing preliminary sponsored research findings, and to his credit, Zoepf promptly issued a retraction, if not an apology, after being advised of his mistake.

But this story shouldn’t end here as it provides a useful parable on the powerful forces that promote the creation and viral dissemination of inaccurate information, aka fake news. The insidious dynamics behind this saga need to be told in three parts.

1. The root cause of the errors in the original MIT report was not simply a case of misinterpreting a confusing survey question as its author avers, but reflects a preventable lapse in research integrity, which ignored several red flags that should have signaled errors in the newsworthy but flawed findings before they were published.
2. The press was extremely eager to not only report, but to editorialize on the moral and societal implications of the MIT Research Brief before taking the time to review and vet the full study report or to elicit dissenting views.
3. Uber’s already fragile reputation took a serious hit, and has continued to be harmed even after the original version of the MIT report was retracted.
   
   

MIT’s Epic Fail
The mistake in the MIT Research Brief can be traced to how MIT researchers improperly interpreted responses from 1,121 Uber and Lyft drivers surveyed in January, 2017. In explaining his faux pas, the MIT team lead  benignly states, “I can see how the question on revenue might have been interpreted differently by respondents.” But when over 1,000 respondents interpret a survey question one way, and an experienced MIT research team sees the survey responses in an entirely different light, there has to be a reason.

It’s fair to assume that Uber and Lyft respondents answered the critical survey question driving MIT’s analysis of driver earnings as it was originally posed:“How much money do you make in the average month? Combine the income from all your on-demand activities.”

But the MIT study team inexplicably changed the wording and hence the meaning of this key survey question in their analysis. In their full study report, the MIT researchers state: “Responses to Question 14 ‘How much money do you make in the average month?’ determined monthly revenue for each driver.” By dropping the second part of Question 14, clarifying its reference to only earnings from on-demand activities, the MIT researchers erroneously were led to reduce driver earnings for the 83% of respondents who reported having other sources of income. As a result, MIT’s calculations of gross and net driver earnings were understated by more than a factor of two.

In response to my email to the lead study author, which mirrored Uber’s critique of MIT's study methodology, Stephen Zoepf told me “I’m re-running the analysis this weekend using Uber’s more optimistic assumptions.” But I don’t see this as a case of being more or less optimistic, but simply being accurate, consistent and applying common sense in conducting research to high academic standards.

My bigger concern with this research project – its epic fail – was the failure to recognize obvious red flags or to vet the results with knowledgeable professionals who could have quickly identified methodological errors, prior to publication. But instead, the project team charged ahead to publish its preliminary research findings, ignoring:

• MIT's reported findings on driver earnings were more than 50% lower than the comparable figures reported directly in the very survey used to drive their analysis.
• The MIT team actually used a second methodology to calculate hourly earnings for the small number of respondents that did not respond to the the monthly income question on the survey. Had MIT compared results from their two methodologies for the majority of respondents who did answer all driver income questions, they would have discovered major internal inconsistencies in their published results.
• The same survey that was used to drive MIT’s estimates of punitive driver earnings also reported that only 36% of Uber drivers somewhat or strongly disagreed with the statement: “I am satisfied with my experience driving for Uber.” If driver earnings were really as low as MIT calculated, the team should have expected to find lower driver satisfaction.
• MIT’s reported findings were starkly inconsistent with multiple prior published studies on rideshare driver earnings, all of which reported gross and/or net earnings at least twice as high.
• The researchers did not vet their surprising research findings with Harry Campbell – author of therideshareguy.com, a widely read blog on the rideshare sector – who provided the underlying survey data for the MIT analysis. Campbell told me shortly after seeing widespread press reports, that it was a shame that he wasn’t given a chance to preview MIT's findings prior to publication, because he would have immediately raised a red flag with the reported results.
  
  

Why would an experienced research team fail to detect an error that was so glaringly obvious to others who operate in or follow the rideshare business closely? Perhaps it was caused by a dose of self-serving bias, confirmation bias, ideology, or the excitement of racing to publication with a study that promised to be highly newsworthy. Anyone can make an honest error in conducting research on complex business issues, but failing to do even nominal stress testing or vetting of results is a grave mistake.


The Role of the Press
There are immense pressures on news organizations to avoid getting left behind in reporting breaking news, and this story offered the promise of immense “eye candy” appeal. After all, the study came from a highly trusted source, and presented alarmingly negative findings on a widely known and frequently maligned company.

Shortly after the MIT Center for Energy and Environmental Research (CEEPR) published its Research Brief, the story went viral, precipitating a newsroom arms race to get the shockingly low estimates of rideshare driver earnings out to the public.
When I last checked, a Google search on “MIT study Uber driver earnings” generated over 700,000 search results, undoubtedly exposing the bogus study results to tens of millions of viewers.

It was naïve for the study authors and its sponsor to not recognize the dangers of publishing such a potentially explosive and unvetted study as a working draft to solicit feedback on the approach and findings. The press predictably treated the results as gospel (without the benefit of reading the full report), and broadly condemned Uber’s (and Lyft’s) perceived abusive business practices.

Some news organizations did publish a brief follow-up on Uber’s rebuttal and the MIT team leader’s ensuing retraction, but with far lower impact and reader interest. The damage was done.


Uber’ Public Relations Hell
The public relations harm to Uber as a result of MIT’s initial study release is self evident. But even with Uber’s prompt rebuttal and the study author’s retraction, Uber’s reputation is bound to suffer in the weeks ahead.

One widely read business publication jumped on the initial release of the MIT study findings by headlining: “Uber’s New CEO Faces New PR Disaster.” But when Uber CEO Dara Khosrowshahi tweeted a testy rejection of the flawed MIT study results, the same publication followed with the story: “With a Single, Insulting Tweet, Uber's CEO Just Destroyed Months of Hard Work.” Opprobrium throughout the news cycle on this story has fallen mostly on Uber, rather than  on the instigators of this bogus news firestorm.

Stephen Zoepf’s revised study results are continuing to create negative press for Uber. For example, NPR recently reported that “in each new calculation method a significant percentage of drivers are still earning less than minimum wage in their state — 54 percent in the first case or 41 percent in the second case, according to Zoepf.”

While this statement is factually accurate, it fails to characterize MIT's research findings in proper context. Gig economy jobs provide considerable flexibility that is highly valued by drivers. Comparing Uber and Lyft driver compensation to minimum wage rates is mixing apples and oranges: part time/flexible work vs. full time/inflexible employment.

The MIT study correctly observed that fewer than 20% of drivers  rely exclusively on ridesharing services for their earned income. For most drivers, ridesharing is hard work that doesn't pay particularly well, resulting in extremely high turnover rates.  On the other hand, for many drivers, ridesharing provides a valued supplement to household income with considerable scheduling flexibility and frictionless entry/exit.  The value drivers associate with flexible, part time scheduling helps explain why less than one-third of rideshare drivers are dissatisfied with their work experience with Uber and Lyft, despite seemingly low hourly pay. 

The market will ultimately decide whether rideshare driver earnings are adequate to fuel Uber and Lyft's profit and growth aspirations. Time will tell. In the meantime, when MIT releases its revised full study report, it would be helpful for the authors to present a balanced, context-sensitive view on driver earnings that hopefully can be accurately reported by the press.

​
Lessons Learned
There are no singular villains or heroes in this story. The creators, disseminators and avid news readers drawn to the flawed MIT study each had reasons to behave as they did. Guarding against the epidemic of fake news that surrounds us will require all stakeholders to exercise better judgment in avoiding the fool’s race to spread and consume news with more shock value than validity.
​

• Outstanding academic institutions like MIT and Stanford carry an extra burden for integrity and professionalism, given the deep trust accorded to their published research.
• News organizations should avoid blindly accepting and editorializing on unverified press releases until the results can be vetted and verified. It is particularly dismaying that some news organizations that levied the harshest criticism of Uber and Lyft in their initial rush to judgment, have yet to publish the retraction by the MIT study author.
• News consumers need to be vigilant in recognizing their own confirmation biases. We’re stuck in a world of information overload, so individuals ultimately need to exercise their own editorial judgment in deciding how much and how soon to believe what we read.

_________________________________________
Disclaimers:

1. I have three degrees from MIT, and hold the institution in the highest regard
2. I have no connection with Uber or Lyft, and have no reason or desire to promote or defend their business practices

As 2017 drew to a close, Uber secured another round of investment to shore up its dwindling balance sheet. Softbank’s tender offer injected $1.25 billion of fresh capital into the company, while giving seed investors who chose to cash out a whopping 360,000% return on their investment. Softbank’s CEO, Masayoshi Son has made a fortune from his prior big bets on Yahoo, Vodafone, Alibaba, Sprint, Nvidia and others. What is Son seeing in Uber (or, for that matter in other ride sharing companies Didi Chuxing, Ola, Grab and 99, in which Softbank has also heavily invested) that overlooks the company’s dismal financial performance to date?

My Forbes article last month, “Why Can’t Uber Make Money?,” identified fundamental weaknesses in Uber’s business model that has led the company to lose more money, faster than any startup enterprise in history. In the year just ended—Uber’s seventh—the company’s projected loss of $5 billion is unprecedented and clearly unsustainable. And there is little reason to believe that on its current course, Uber can stop the bleeding any time soon for one simple reason: a fundamentally broken business model.
The taxi industry that Uber is seeking to disrupt was never particularly profitable when allowed to expand in unregulated markets, reflecting the industry’s low barriers to entry, high variable costs, low economies of scale and intense price competition—and Uber’s current business model doesn’t fundamentally change these structural industry characteristics.

While Uber’s business model has created enormous value for consumers, propelling the company’s rapid growth, its extremely aggressive pricing simply doesn’t generate enough revenue to deliver attractive compensation to drivers and sizable profits to shareholders. By pricing its services roughly 30% below comparable taxi fares and then retaining 25% or more of gross bookings for itself, Uber has squeezed the revenues available to compensate drivers, who are ultimately responsible for providing the labor, equipment, maintenance, insurance and fuel to serve consumers. There is little in Uber’s current business model that promises to reduce the factor costs of its ridesharing service, nor are there inherent economies of scale that would lower unit operating costs with continued growth. Thus, in attempting to disrupt the taxi industry, Uber has shifted, but not significantly reduced the costs of delivering an inherently low profit service.
The same value trap–low consumer willingness to pay, high unit costs and low economies of scale—also saps the profit potential from “last-mile” delivery services like uberEATS and uber RUSH who compete against a host of money-losing competitors like Postmates, Doordash and Instacart. Investors poured more than $9 billion into 125 on-demand delivery companies over the past decade in search of the next “Uber for X” unicorn, but new capital is drying up, as many venture capitalists are losing money and faith in a sector with bankruptcies and fire sales piling up. For example, within the last two years, Doordash was forced to accept a 16% valuation down round (with harsh terms to boot) while other urban delivery players like SpoonRocket, Sprig and Maple shuttered operations.


Contrast these challenging economics with other startup enterprises that are creating and capturing value by disrupting industries with historically high margins andhigh costs. In such cases—eyewear, fashion apparel, mattresses and enterprise business systems—companies like Warby Parker, Rent The Runway, Casper and Amazon AWS have developed innovative business models delivering better service at considerably lower cost across the value chain, which fundamentally alters industry economics. For example, Warby Parker and Casper disintermediated inefficient industry value chains with as high as a 10-fold markup from manufacturing cost to retail price in their respective industries, to deliver superior customer experiences at vastly lower prices than traditional competitors, while still leaving room for sustainable operating margins.
Such is not the case with Uber.  Since the dawn of the internet, we’ve witnessed many sobering cases of companies with intriguing value propositions but unproven business models who flamed out in their mad dash to scale fast, profit later. Kozmo and Urbanfetch were early casualties in the urban last-mile delivery business, burning through more than $300 million of venture capital before declaring bankruptcy in 2001.
That same year also claimed another epic business model meltdown–Webvan, the company that pioneered the online grocery delivery category. Flush with $800 million in venture and IPO capital raised during the height of the eCommerce bubble, Webvan raced to establish first mover advantage, building highly automated pick-and-pack warehouses in 26 cities across the US. But Webvan never got a chance to master the executional discipline required to operate profitably in the low-margin grocery category, and each new launch city merely deepened their negative cash flow. As a result, Webvan went from IPO to bankruptcy in only 18 months, one of the fastest public company flameouts in history.
The Webvan saga presents a cautionary tale for any company engaged in a mad dash to scale fast and profit later, particularly in categories with challenging underlying economics. To be sure, Uber has several benefits that its predecessors lacked at the turn of the new Millennium, including low cost computing, bandwidth, GPS, mapping and software tools, widespread consumer acceptance of mobile and online transactions, and deeper (albeit dwindling) capital reserves. Nonetheless, like Webvan, Uber has yet to prove it can consistently operate profitably in major metro markets, despite seven years of effort, yielding more than $9 billion of negative cash flow.
Against this backdrop, what does Masayoshi Son see in Uber that warrants its recently completed $7.7 billion investment for a 15% stake in the company? The answer likely lies in Son’s expectation for improved financial performance over two distinct time horizons.
In the short- to medium-term, while Uber can no longer realistically expect to become the “last man standing” in major metro markets around the world, it can still hope that a reduced set of large ridesharing competitors will become more disciplined in avoiding financially ruinous fare wars, much as US airlines did in reversing thirty years of shareholder value destruction by undertaking industry-consolidating acquisitions over the past decade. If and when competition in the ridesharing and last-mile delivery sectors does thin out (despite relatively low barriers to entry), remaining players could enjoy somewhat greater pricing power and decreased driver recruiting costs. Softbank also has invested heavily in other major ridesharing companies, which should promote more favorable coopetition between Uber and Didi Chuxing, Ola, Grab and 99 in global markets. Nonetheless, the ridesharing industry has dug itself into a deep hole, and underlying business model weaknesses are unlikely to radically improve the industry’s profit outlook.
Over the longer term, Uber has always pinned its potential for improved financial performance on autonomous vehicles (cars and air taxi drones), taking expensive and unreliable drivers out of the equation. In theory, driverless vehicles should allow ridesharing providers to increase productivity and service quality while sharply reducing operating cost -- subject to three critical caveats.
First, the economics of autonomous vehicle technology have yet to be proven, and we don’t yet fully understand the tradeoffs associated with substituting capital for labor in transforming the industry. Under any circumstances, widespread adoption of autonomous vehicles will eventually require billions of dollars of new investment, which Uber may not be in a position to fund.
Second, Uber is far from alone in the race to perfect driverless vehicles, and it is yet unclear whether Google (Waymo), the car industry or rideshare companies will be best positioned to extract value from deploying driverless vehicles to ridesharing services. If the key to sustainable profitability in the urban transport sector is driven primarily by access to superior autonomous vehicle technology (with high barriers to entry), and not in operating a metro-by-metro ridesharing platforms (with relatively low barriers to entry), driverless vehicles may not prove to be the salvation to Uber’s elusive quest for profitability.
Finally, under the best of circumstances, the time framefor widespread deployment of “Level 5” autonomous vehicles in dense urban areas is likely to be measured in decades, not years. This is not a bet that any investor looking for a quick return on investment is likely to make. And this reality may ultimately explain Masayoshi Son’s big bet on Uber et al, to become the kingmaker of the ridesharing industry.
Son has consistently proven himself to be an exceptionally patient visionary, willing to make large investments in nascent technologies that have yielded outsized returns over time. Son has been an early and big player and ultimate winner in the explosive growth of Internet 1.0 (Yahoo), eCommerce (Alibaba), telecommunications (Vodafone, Sprint), microprocessing (ARM, Nvidia), robotics (iRobot, Boston Dynamics), the sharing economy (WeWork), and solar energy (SBG Cleantech). Time will tell if Son’s bet on ridesharing will also pay off.
But in order to survive until the hoped for transition to a more profitable driverless vehicle future, Uber will need to take aggressive near-term actions to improve operating performance. Two imperatives should be high on Uber CEO Dara Khosrowshahi’s priority list:
1. Fix driver relations. In Uber’s two-sided market, it is critical to effectively balance the economics and participant experience of both riders and drivers.  Uber has consistently put rider satisfaction ahead of its treatment and compensation of drivers. This bias has led to low driver satisfaction and growing turnover, both in absolute terms and relative to its main US competitor, Lyft. Recent corrective efforts have been a step in the right direction, but still gallingly inadequate, as exemplified by the (deliberately?) poor execution of long-overdue in-app tipping, and the company’s strategically sound, but poorly communicated upfront pricing initiative. Trying to run a service business with competitively disadvantaged satisfaction of mission critical de facto employees is an expensive and losing hand. Khosrowshahi would be well advised to add an additional item to his recently promulgated statement of Uber Cultural Norms that commits the company to ensuring and delivering the most rewarding and supportive driver experience in the industry. This will undoubtedly be a costly transition, which only reaffirms the strategic imperative of focusing on selected markets where Uber can sustain competitively advantaged pricing power and operational efficiency.
2. Shrink to grow. From its inception, Uber made a calculated bet that it could achieve global domination, wiping out both incumbent taxi companies and competing shared ride providers, to enable the company to exercise monopoly pricing power. But it is now apparent that Uber has lost this bet in its headlong rush into an industry with historically low profit potential and low barriers to entry. There are undoubtedly defensible geographic markets and user segments in the global ridesharing market that can currently sustain profitable operations. Khosrowshahi will need some serious soul-searching to rethink Uber’s soaring ambition and penchant to win-at-all-costs in all markets. This will require abandoning current operations showing little potential for near-term profitability, while continuing to explore opportunities to exploit industry-leading scale in selected markets that promote competitively advantaged operations (e.g. uberPOOL and Express POOL which can yield lower costs, higher asset productivity and greater returns, particularly for market share leaders).
There are numerous inspiring case studies of overextended companies that retrenched to a defensible core, only to reemerge down the road, stronger than ever. Given Uber’s current burn rate, Uber clearly needs to zero base budget its sprawling current operations to decide where to defend the core at all costs, and where the company should temporarily retreat to live to fight another day.
Softbank has given Uber additional runway to get its operations and finances under control. But the company will have to make some hard choices to ensure that unlike Webvan, its soaring ambitions don’t result in a mad dash to oblivion.

There’s a lot to like about the U.S. economy.  Corporate profits are at their highest level in fifty years.  The Dow surged past 20,000, continuing the second longest bull market run in history.  And the unemployment rate is currently inching towards its lowest level in a decade.
 
But there are headwinds that have roiled the American electorate. The US economy grew only 1.6 percent in 2016, continuing a generally downward trend over the past 30 years. Real wage growth remains stubbornly elusive, income inequality is at its highest level since the Great Depression and customer satisfaction with the nation’s goods and services is just beginning to recover from a ten-year nadir reached in 2015.

These dichotomous results call into question our national and corporate priorities: why isn’t corporate prosperity translating into broader societal well-being? The answer lies partly in two pervasive management practices that have unwittingly compromised long-term national growth and tilted the scale towards corporate benefits at the expense of consumer and employee welfare:

• A binge in large M&A transactions, increasing industry consolidation across a wide range of industries
• Unprecedented levels of corporate stock buybacks at the expense of value creating investments in long-term growth

 
The Economist reports that a $10 trillion acquisition binge since 2008 has contributed to increasing concentration in two-thirds of the US economy’s roughly 900 industries, including cable television, railroads, pharmaceuticals, industrial chemicals, telecom, media, hotels, health insurance and hospitals. Not surprisingly, the resulting decrease in competition has conveyed greater pricing power to many bulked-up incumbents, helping to drive up corporate profits.  Take the airline sector for example, long considered an unattractive industry that failed to earn its cost of capital in the thirty years following industry deregulation. As Richard Branson once quipped, "if you want to be a millionaire, start with a billion dollars and launch a new airline." But a wave of mergers between 2008 and 2012 allowed the three remaining legacy airlines (American, Delta and United) to reduce capacity, raise fares, increase load factors and dramatically improve profitability, despite chronically abysmal customer satisfaction. Since 2012, a weighted index of U.S. airline industry stocks has grown three times faster than the S&P 500.  And last year, Branson’s Virgin America agreed to be acquired by Alaska Airlines, further thinning the ranks of U.S. air carriers.
 
Ordinarily, rising profitability would be a cause for celebration, but for two nagging concerns.  First, increasing the concentration of corporate profits in fewer oligopolistic hands can stifle innovation, limit consumer choice and increase prices. As a case in point, after AT&T’s proposal to acquire T-Mobile was blocked by the Justice Department in 2011, T-Mobile used its breakup fee windfall to upgrade its network, introduce a number of creative, customer-pleasing rate plans and cut prices.  As a result, T-Mobile has increased its market share by 60 percent over the past five years, at the expense of industry market leaders.  In pressing for the merger, AT&T had argued that it couldn’t justify investments to upgrade its own 4G-network without first spending $39 billion to acquire T-Mobile.  But in reality, intensifying competition, not greater concentration induced AT&T to upgrade its wireless infrastructure over the past five years.  And Verizon just announced it would offer unlimited data plans to match popular rate plans offered by T-Mobile and Sprint.  Given robust competition, US wireless rates have come down and customer satisfaction has gone up since the AT&T/T-Mobile acquisition was blocked.

Often, large horizontal mergers are defensive responses by companies mired in mature, low or negative growth industries.   In such cases, mergers are perceived to provide opportunities to “buy” growth, to exploit cost-reducing synergies, and to improve profits as a result of reduced competition and higher price realization. But the resulting corporate behemoths often become even more wedded to status quo business practices, preventing investments in disruptive new products and business models that might cannibalize current market leading positions.  
 
A related concern with growing industry concentration is that fewer firms are earning more cash flow than they are able or willing to invest in organic growth.  As a result, more capital has flowed to share buybacks of dubious value, and to executive compensation, exacerbating already high levels of income inequality. 
 
With growing profitability in the short- to medium-term, corporations have increasingly allocated corporate capital to value extraction activities – share buybacks and dividends – at the expense of value creating investments in R&D, growth-driving capital expenditures and worker training.  Over the years 2006-2015, the 459 companies in the S& P 500 Index publicly listed over this period expended nearly $4 trillion on stock buybacks, representing 54 percent of net income, plus another 37 percent of net income on dividends, raising legitimate concerns as to whether too many large enterprises have been under-investing in innovation and corporate capabilities to sustain long-term profitable growth.  
 
Many corporate executives have personal incentives to boost EPS and short-term stock price over investments in long-term growth. Recent research indicates that executive compensation currently yields an executive-to-average-worker pay ratio amongst the 500 highest paid U.S. executives of almost 1,000:1. At a time when worker pay has been stagnant for decades, when overall corporate revenue growth has been anemic, and when the rates of returns on assets of U.S. firms been declining for a half-century, this highly skewed distribution of benefits raises troubling questions about whether the U.S. has been enjoying profits without prosperity.
 
While big corporations have been getting bigger, the rate of new business formation in the U.S. has been steadily declining for decades.  This trend poses significant problems for the U.S. economy for two reasons.  First, startups have traditionally been a hotbed of innovation, increasing growth and productivity.  And second, young businesses have accounted for nearly all net new jobs created in the U.S in recent years. Older, larger businesses, by comparison, have been shedding almost as many workers as they’ve added, and this trend is likely to be exacerbated with increasing industry concentration. 
 
As an example of the limits of large acquisitions to drive profitable growth, consider the case of Pfizer.  Entering the new millennium, Pfizer recognized that its weak product pipeline left it vulnerable to the looming patent expirations on its blockbuster drugs.  In response, Pfizer went on an acquisition binge, spending $357 billion (all figures in 2016 dollars) between 2000 and 2016 to buy several large pharmaceutical competitors, including Warner Lambert, Pharmacia and Wyeth.  But Pfizer’s acquisitions also faced declining drug discovery productivity, which worsened under Pfizer management. A 2014 analysis of R&D productivity found that Pfizer was the only top ten pharmaceutical company to experience negative net income returns on R&D investment.


As a result, over the past five years, Pfizer’s real revenue and net income has declined by 25 percent and 33 percent respectively.  To offset weak earnings, Pfizer escalated its stock buybacks, allocating $42 billion to buy back shares since 2012.  Over the same period, Pfizer reduced its inflation-adjusted investments in organic growth: R&D spending by 11 percent and capital expenditures by 18 percent.[1]
 
Pfizer’s situation offers a cautionary tale of the limits of large acquisitions and stock buybacks to generate long-term profitable growth.  Despite its massive acquisitions and stock buybacks since 2000 at the expense of investments in organic growth Pfizer has emerged as a smaller, less profitable company whose market value has declined by $160 billion (-45 percent).
 
Is there is a better way to manage for long-term profitable growth?  This question has been hotly debated for years, with many observers asserting that too many companies have been managing for short-term results, emphasizing cost control and stock buybacks at the expense of investments future growth. New research, led by a team from the McKinsey Global Institute found that companies that operate with a true long-term mindset have considerably outperformed their industry peers since 2001 across almost important every financial measure.
 
The research team analyzed the operating metrics of 615 non-finance companies that reported continuous results from 2001 to 2015, and whose market capitalization exceeded $5 billion in at least one year.  To distinguish between companies that exhibited a short- and long-term management mindset, researchers analyzed five operational and business performance indicators.

• Investment. The ratio of capex to depreciation, indicating which companies invest more and more-consistently than other companies.
• Earnings quality. Accruals as a share of revenue, indicating which companies rely less on accounting decisions and more on underlying cash flow than other companies.
• Margin growth. Difference between earnings growth and revenue growth, assuming that long-term companies are less likely to grow their margins unsustainably in order to hit near-term targets.
• Earnings growth. Difference between earnings-per-share (EPS) growth and true earnings growth, highlighting actions such as share repurchases to boost short-term EPS
• Quarterly targeting. Incidence of beating or missing EPS targets by less than two cents, indicating long-term companies are more likely to miss earnings targets by small amounts when they easily could have taken action to hit them and less likely to hit earnings targets by small amounts where doing so would divert resources from other business needs.

 
The analysis concluded that 27 percent of the sample were managed for the long-term relative to their industry peers over the entire study horizon or clearly became more long-term oriented between the first and second half of the study horizon.  The remaining 73 percent of companies exhibited evidence of short-term management priorities.  The preponderance of management short-termism reflects growing pressure executives feel to hit near-term targets.  A recent executive survey reported that 87 percent of executives and directors feel most pressured to demonstrate strong financial performance within two years or less, 65 percent say short-term pressure has increased over the past five years, and 55 percent of executives and directors in companies lacking a long-term culture say they would delay a new project to hit quarterly targets, even if it sacrificed long-term value.
 
But this bias for short-term results is misguided.  The difference in financial performance between companies managed for short- and long-term growth is striking.  Among the firms identified as focused on the long term, average revenue and earnings growth between 2001 and 2014 were 47 percent and 36 percent higher, and market capitalization grew 58 percent faster as well.
 
The returns to society and the overall economy were equally impressive. Companies that were managed for the long term added nearly 12,000 more jobs on average than their peers over the study horizon. MGI calculated that U.S. GDP over the past decade might well have grown by an additional $1 trillion if the whole economy had performed at the level the long-term stalwarts delivered — and would have generated more than five million additional jobs.
 
Nearly 65 years ago, GMs CEO Charlie Wilson stated “what was good for the country was good for General Motors and vice versa.”  But Wilson’s equivalence between corporate and national welfare is only true if executives effectively manage their enterprises with a long-term mindset committed to continuous innovation, meaningful product differentiation and a corporate culture that promotes corporate agility and market responsiveness.


[1] Data for four year period, 2011-2015, latest full year for which capex data is available

​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.

​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

​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.