thenextwave

Main Street versus Wall Street

Posted in business, digital, retail by thenextwavefutures on 24 September, 2017

The abrupt decision by Toys R Us—the biggest toy retailer in N. America and Europe—to file for financial protection for its north American stores under America’s Chapter 11 provisions needs a second look. It sounds technical, but there’s more going on here than meets the eye.

Chapter 11 allows companies a breathing space in which they get some protection from creditors while they restructure their finances. It’s usually about sorting out debt.

Christmas cashflow

For retailers, this is exactly the wrong time of year to have a credit crunch: most of your sales and almost all of your profits come in the last 60 days of the year, but that means that you have to push the boat out to pay for stock at the beginning of the final quarter. Most retail businesses know the day or the week of the year that their cashflow hits its worst point, because it’s a similar pattern every year. It wouldn’t surprise me if the company’s CFO has been forecasting this issue for most of the year.

Commentators were quick to point to the difficulties of competing with Amazon and Walmart—who increasingly start to look like mirrors of each other as Amazon moves into the world of physical stores and Walmart sharpens up its digital operations. Others saw it as further evidence for the continuing decline of the American mall.

“Trading profitably”

But the CEO and Chairman, Dave Brandon, didn’t mention these in his statement. What he actually said was that “the vast majority” of the stores were trading profitably.

British journalists who asked were told that the company was proceeding with new store openings in the UK and refurbishment of some existing stores. Toys R Us’ international businesses are not part of the Chapter 11 move.

I was once a financial journalist, and when you see apparently contradictory statements in the same place, it is an invitation for more research. If most of the stores are trading profitably, where had the $5 billion of debt come from?

Ah: someone at Bloomberg had the same question.

The bankruptcy filing in Richmond, Virginia, estimated the company has more than $5 billion in debt, which it pays around $400 million a year to service. Much of that is the legacy of a $7.5 billion leveraged buyout in 2005 in which Bain Capital, KKR & Co. and Vornado Realty Trust loaded the company with debt to take it private. Since then, the Wayne, New Jersey-based chain has struggled to dig itself out.

Vampire capitalism

So this is actually vampire capitalism at work. It doesn’t make anything itself, it simply attaches itself to productive businesses and sucks the profits and the value out of them.

Since this takes us into the slightly arcane world of investment finance and the murkier world of mergers and acquisitions, it is worth spending a paragraph or so on the world of the leveraged buyout. It is a classic example of the locust and the bee.    

What happens in a leveraged buyout like this is that as soon as the deal is completed, the guys (yes, they mostly are) who have done the deal then finance it by borrowing the money from the company they have just bought.

You might want to read that again: the guys who have done the deal then finance it by borrowing the money from the company they have just bought.

Financial engineering

It is pure financial engineering. What it means for the business that’s just been acquired is that as well as paying its staff, for its premises, for its overheads, and so on, it also has to find a whole lot more money to pay the interest costs on the debt the new owners have used to buy the business. In the case of Toys R Us this ran at $400 million dollars a year.

Often, the cost-cutting that has to be done to service such loans wrecks the financial and operational health of the business, as the Telegraph noted. 

Its stores have been in desperate need of modernisation, the chain has been woefully unprepared for the rampant rise of online shopping, and it has failed to meet a growing demand for subscription services for baby items, which the supermarkets and other rivals now deliver.

The investment guys don’t mind so much; they still have control of the underlying assets—property, brands etc—whether the business sinks or swims.

It may sound complicated, but it happens all the time, though less so post crisis. The Glazer family used exactly the same method to gain control of Manchester United, which is why many United fans have no time for the Glazers, or for the former chairman, Martin Edwards, who agreed to the deal.

Of course, it’s also true that it’s tough competing with Amazon and Walmart, and that there are new retail models out there that more traditional retailers such as Toys R Us need to evolve towards. Yes, these things are true. It’s just that when most of your stores are trading profitably, those aren’t the elephant in the room.  

Pointing the finger

In fact, when you read Brandon’s statement, he more or less points the finger at the way the debt is crippling the business. The company, it says, plans

to restructure its outstanding debt and establish a sustainable capital structure that will enable it to invest in long-term growth and fuel its aspirations to bring play to kids everywhere.

Of course, he could have gone further than this. He could have said:

Unfortunately the big bet made on our business by the leeches who acquired our business in 2007 hasn’t worked out so well, and now we’re creaking under a mountain of debt that isn’t in our employees’ interests, our suppliers’ interests, or our customers’ interests. But it suited the financial guys just fine. The good news: some of those investors are going to have to take some losses, and about time too.

I don’t have any inside knowledge here, but analysts were surprised by the timing of the announcement. Reading between the lines, it’s possible to believe that in timing the announcement for when they did, the management of Toys R Us were playing a high stakes game of poker with the holders of the debt. If the restructuring goes wrong at this moment in the retail cycle, the losses they’ll take will be at their highest. Main Street sees Wall Street—and raises?

The image at the top of the post is via Wikimedia Commons. It was taken by Raysonho and is published here, with thanks, under a Creative Commons licence. 
 
 

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Chaos in the Valley

Posted in advertising, business, digital, Uncategorized by thenextwavefutures on 20 September, 2017


On the strength of a long review of several recent tech books by John Lanchester in the London Review of Books, I read Antonio Garcia Martinez book Chaos Monkeys, which is mostly about his time as a willing hand in Silicon Valley, first in a startup and then as a product manager in Facebook’s ad department. 

Chaos Monkeys takes us from Goldman Sachs to Facebook, and out the other side, via a digital ad business called Adchemy,  the start-up ‘school’ Y Combinator, and the startup, AdGrok. Mostly Martinez is a good guide; especially to the world of venture capital and startups. Martinez persuades a couple of engineer colleagues at Adchemy, which is clearly struggling, to pitch to Y Combinator, the start-up hothouse then run by Paul Graham. Going in, they have a product concept that probably isn’t going to work, but that doesn’t matter because Y Combinator, like much of the rest of Silicon Valley, is as interested in teams as it is in products. 

Miracles

Why isn’t their product going to work? This is a flash of innovation insight that’s worth the price of the book and quite a lot more.

When confronted with any startup idea, ask yourself one simple question: How many miracles have to happen for it to succeed? 

If the answer is zero, you’re not looking at a startup, you’re just dealing with a regular business… To be a startup, miracles need to happen. But a precise number of miracles.

Most successful startups depend on one miracle only. For Airbnb, it was getting people to let stragers into their spare bedrooms and weekend cottages. This was a user behavior miracle. For Google it was creating an exponentially better search sevice than anything that had existed to date. This was atechnical miracle. For Uber or Instacart, it was getting people to book and pay for real-world services via wesites or phones. This was a consumer-workflow miracle… 

The classic sign of a shitty startup is that it requires at least two (or more!) miracles to succeed. (P50-51)

Y Combinator is particularly good at getting its progeny in front of investors, but even allowing for that the commitment, rat-like cunning and persistence needed to get it across the line with investors and an eventual acquisition is more or less complete. As he says when he has the chance to pitch to a potential buyer and has a computer glitch, rule #1 of the start-up is “Always be closing”. 

VCs at work

The history of AdGrok, and its eventual acquisition following some initial investment, is almost a case study in VCs at work, and Martinez is pretty good at explaining the mechanics of how the VC business works (and the different and sometimes conflicting things that different types of VCs want from the eventual deal), even if you sometimes have to go back and check on some of the technicalities. This focus on the mechanics of the start-up reminded me of Jerry Kaplan’s 1990s classic Startup.

I hadn’t realised before I read the book of the extent to which the big Silicon Valley companies use startup acquisitions as a way of acquiring talent rather than software or patents. The rationale is that acquiring good product managers and engineers is difficult, and they come expensive, so using discussions about their product is a good way of assessing cultural fit. And bringing in people who have been through the startup mix, rather than looking first for a long-run career at a big company, injects some energy into the culture, and that energy is worth paying a premium for.  

Breakfast, lunch and dinner

In the end (spoiler!) Martinez has the chance to go to Twitter or Facebook. He chooses Facebook because of the full-on nature of the demands that the business makes of its staff, compared to Twitter, and this was partly learned from a casual remark from a Twitter engineer, when Martinez asked him what he liked most about Twitter.

“Well, you know, in companies like Facebook and Google, they serve you breakfast, lunch and dinner. Here at Twitter, they only serve you breakfast and lunch.”

I cringed inwardly. So the big selling point was that nobody worked late into the night…? (P237)

And after two years (more spoilers) after his live adserving product FBX loses out in an internal power struggle, he’s gone again:

I could barely remember what my life was like before Facebook, and there was a trail of destruction I had caused by spending m entire life there: two children neglected, two different women whose worthy love I’d spurned, two boats rotting in neglect, and anything like an intellect or a life outside campus rotting in neglect due to indifference and my dedication to the Facebook cause. (P458)  

If he’d stayed with the rest of the AdGrok team and gone to Twitter, he’d also have been about $1m better off and would not have burned his bridges irrevocably with one of his investors.       

And no: nowhere in the book does he make the connection between these outcomes and his disdain for Twitter’s failure, at the time, to serve dinner.

If he were chocolate

There are things not to like about Chaos Monkeys. It’s readable, but it’s too long; a competent editor could have taken 80 pages out of it without blinking, and improved it a lot. For example, I didn’t need to know about an inconsequential fling with a Facebook colleague in a company stationery cupboard, nor his streetrace in a carshare Tesla; I already knew he was reckless and competitive by then. He tries not to be, but he’s too pleased with himself a lot of the time. The lawyer who bailed AdGrok out of a hole may have agreed to a terrible deal (he accepted equity in the startup with no risk premium) but I’m not sure why Martinez needs to rub his face in it. 

There are too many footnotes, all too long. He tips his hat in a look-at-me sort of way to Michael Lewis’ Liar’s Poker without really understanding what made that such a fine book (well written, aware of his own shortcomings as a bond salesman, telling anecdotes, watching the start of deep transformation in the way investment banks work.) Martinez is a good observer, but if he were chocolate he would eat himself.

Saving Facebook

The reason that the advertising market and its monetisation became so important to Facebook in that period was because of its IPO–its revenues were flat and it needed to show growth to its new shareholders. The solutions that were attempted were basically a develop of Facebook’s existing, but closed, ad platform, and FBX, Martinez’ project, which was an open platform. Facebook’s culture and model is about closed systems, and that approach commanded most of the resources. The FBX platform, with its small team and limited resources, was essentially an insurance policy, although Martinez, for all his smarts, never seems to realise this. 

But the thing that saved Facebook’s financial position was neither of these things. It was the rapid shift in 2013 towards mobile and device use. If the shift was expected, its timing and speed were not. This allowed Facebook to insert ads profitably into user feeds on mobile.

News Feed Ads rode to success atop a tsunami-esque wave nobody had predicted, or at least hadn’t predicted to arrive right then and so quickly. In this case, that wave was mobile, which in the space of a few months in 2013 suddenly constituted the majoriy of Facebook usage… [D]ata and high quality formats and placements, meant that Facebook dominated mobile like few oter incumbents had managed to. (P483, 487-8)

Carthage must be destroyed

Despite being fired by them, Martinez clearly remains a fan of Facebook. He defends its position on privacy vociferously (they’re not a threat to your privacy, he says) and he admires the focus that Zuckerberg has on avoiding complacency. When Facebook moves into Sun’s former buildings in Menlo Park, Zuckerberg left some of the old Sun signs up, as a reminder, as it were, that this too could pass. When Google launched Google Plus, a clear bid for Facebook’s market space, the phrase Carthage delenda est (“Carthage must be destroyed”) became a company catchphrase.

John Lanchester, on the other hand, is not such a fan. He sees Facebook as the exemplar of a new form of surveillance capitalism. More on that in the next blog post. 
  

Globalisation, nations, and cities

Posted in aviation, brands, economics, politics by thenextwavefutures on 8 September, 2017

Maersk_Container_Ships_In_Loch_Striven_-_geograph.org.uk_-_1917442

With my Kantar Futures hat on I was asked to write a short piece for WPP’s house magazine, The Wire, on whether globalisation was over. Here’s the article. 

The long globalising wave of the later 20th century is over. Global trade is barely growing, compared to overall economic output. Cross-border bank lending is down, as are international capital flows. Hostility to migrants is one of the defining features of the present political moment. Everywhere, businesses, even transnational businesses, are thinking and acting less globally and more locally. National and regional champions are growing at the expense of multi-national competitors.

This should not be a surprise.

As Stein’s Law has it, something that can’t go on for ever won’t go on for ever. Globalisation created winners, but it also created losers. Twenty years ago Hirst and Thompson observed that the globalisation wave from 1870-1913—if anything more extensive than the more recent one—collapsed into nationalism after it had over-stretched itself. More than a decade ago, before the financial crisis, John Ralston Saul noted that globalisation was losing momentum and national ideas were reasserting themselves.

We have, in short, moved from the world of the 1990s in which credible politicians spoke only for those who supported globalisation, and the language of competitiveness and market reform that went with it, to a world where in many markets globalisation has no obvious advocates. One notable casualty, certainly in Europe, has been the parties of the social democratic left. Those which continued to talk the language of markets after the financial crisis have been outflanked and decimated.

But it is easy to see right-wing populist movements and think that this is the only political change that is happening. In fact that is just part of wider shift towards a place-based politics. The diagram, developed from some earlier work by Ian Christie, suggests that this politics of place still divides along the lines of “rights” versus “authority”, a traditional split since the French Revolution.

This, in turn, has implications for brands. Election results across a broad number of countries suggest that the markers of this left-right divide are younger vs older, better educated vs worse, and core cities vs towns and country. One of the paradoxes of the digital world is that just when it is possible to live and work anywhere, attachment to place has become stronger (opens pdf). If economics has produced a place-based political response, technology has produced an emotional response, in which values have re-surfaced.

And in a world which is more than 50% urbanised, the cities are where the money is. Part of the business response to the end of globalisation has to become more national. GE, for example, is focusing on regional centres in a response to protectionism. The head of the investment group, Blackrock, told staff earlier this year, “We need to be German in Germany, Japanese in Japan and Mexican in Mexico.”

But the other implication is more interesting. If cities are becoming centres of radicalism and diversity, and that’s where the money is, businesses have to follow. After a century in which business has been associated with conservative values, it is suddenly becoming imperative to be identified as progressive. This was seen, perhaps in extremis, in the way American corporations responded to the Muslim travel ban. And truth be told, many business leaders now hold beliefs that are closer to this more progressive, diverse, urban politics than to conservative populism.

The result: the purpose of business is suddenly central to reputation, among customers, suppliers, and staff. It is not surprising, therefore, that much of Kantar Futures‘ recent work has been about helping clients think through their brand and position in terms of developing a sharp and coherent view of brand purpose. This is a deep shift, driven by long-run fundamentals, that isn’t going to go away.

The image at the top of this post, of Maersk container ships parked up in Loch Striven, is by James T M Towill, and is published here under a Creative Commons licence.

Breaking up with Brexit

Posted in politics by thenextwavefutures on 2 September, 2017

London_Brexit_pro-EU_protest_March_25_2017_47.jpg

There are at least five reasons why Brexit is too complex to deliver. The most likely outcome is a transition period that continues until the political demographics have changed.

The news that Labour has resolved its policy on Brexit is welcome for short-term, medium-term, and long-term reasons. It is also smart politics, because it is becoming increasingly clear that Brexit is too complex to deliver. Richard Murphy made this suggestion on his blog recently. And when I say, “too complex to deliver”, I don’t mean “too complex to deliver in a two year window plus a transition period”. I mean too complex because Britain has become institutionally and economically interlocked with the rest of the European Union. It can check out but it can’t leave.

The first reason is that the relationship between Britain and the EU is fantastically intricate. Just after Article 50 was triggered Buzzfeed published a memorable list of the 30-odd things that Britain had to do resolve Brexit, and it was immediately clear, reading the list, that all of them were complicated and that the government didn’t have a clue what to do about well over half of them. Since then, these issues have kept on getting more complex. Euratom, for example: it’s both essential to Britain’s nuclear power industry, and it requires accepting the jurisdiction of the European Court of Justice.

(more…)