Break Up the Washington Post Corporation

If I told you that a company had the following business units, what would you say? 

• an education and test preparation business
• a set of local television stations
• an internet company that helps churches engage in outreach and raise money
• a company that makes components for industrial furnaces
• a home healthcare and hospice provider

Most analysts would say that this company has a scattered strategy.   The company: the Washington Post Co. - or whatever it will be called now that Jeff Bezos has bought the flagship newspaper for $250 million.   With the newspaper gone, the Washington Post Co. will soon face pressure for more strategic change.  Investors will argue that this unrelated diversification strategy makes no sense.  Investors can diversify risk much more effectively and less expensively on their own.  They don't need the executives at the Washington Post Co. to do that diversification for them.  

Most people are focused on the Bezos' acquisition right now.  They are examining the future of the newspaper.  Can Bezos transform it?  Soon, though, many eyes will turn to the company that remains.  Expect investors to push for more change.   They will, rightfully, demand a clear strategy moving forward.  The key question: What does the Washington Post Co. want to be moving forward?

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Is the Sum of the Parts Worth More Than the Whole at Sony?

In May, hedge fund investor Dan Loeb proposed a break-up of Sony, the Japanese electronics and entertainment giant that has struggled over the past decade.   Actually, he's not proposing a complete break-up, but rather an initial public offering whereby Sony would sell a 20% stake in its music and movies business to outside investors.  Loeb argues that the sum of the parts is greater than the whole.  Sony has an entertainment division that produces movies (Skyfall, Spiderman) and represents recording artists (Adele, Springsteen).  The entertainment division has been more profitable than the electronics division in recent years.  Investors recognize that Sony has been subsidizing losses in areas such as its television business with profits from its entertainment division.   Sony also still owns a majority stake in a firm called Sony Financial Holdings, which operates in the banking and insurance business.  Here's an excerpt from a Bloomberg article about Loeb's push for a partial break-up at Sony:

The value of Sony’s entertainment division -- which makes the “Spider-Man” movies through its Culver City, California-based Sony Pictures and also represents music artists including Grammy winner Adele -- isn’t being realized in the company’s current structure, said Michael Souers, an equity analyst at Standard & Poor’s.  “It’s totally being weighed down by the struggling consumer electronics unit and the fact that it’s had to subsidize that unit,” Souers said in a phone interview from New York. A partial spinoff “would make sense for them. And from a managerial perspective, they could focus a little bit more on turning around the electronics business.” A sum-of-the-parts analysis by Christian Dinwoodie, a Tokyo-based analyst at CLSA, values Sony at 2,400 yen a share, 28 percent higher than its price May 14, before Loeb’s proposal lifted the stock. Spinning off part of the entertainment business would give Sony an infusion of capital and allow it to transfer some debt to the new entity, Dinwoodie wrote in a May 14 report. 

In late June, Sony CEO Kazuo Hirai announced the board of directors would be conducting a thorough review of the Loeb proposal.   The board has yet to make a decision on the Loeb proposal, to my knowledge.  Will Loeb succeed in his efforts?   It will be a tough slog, given that activist investors from foreign countries have not fared well historically in Japan.  Having said that, Sony did sell a stake in its financial services business several years ago; there is precedent for a refocusing of the company's strategy.  

Sony should consider Loeb's proposal seriously.   Years ago, many firms pursued strategies that combined media content with hardware/electronics businesses.  Most of those companies failed to realize the purported synergies.   Focused firms outperformed many of the integrated players (think Apple outmaneuvering Sony, not by owning media content, but by negotiating to secure access to content for iTunes).   One of the problems with integration in the entertainment business is the conflicts of interest that arise.  If you tailor content to your devices or vice versa, you run the risk of losing certain customers and partners. CEO Kazuo Hirai will have to explain clearly how he will make synergies materialize between the two arms of Sony, if he wishes to allay the concerns of investors.   If he holds onto both businesses, he has to explain why the entertainment business isn't going to continue subsidizing unprofitable elements of the electronics business. 

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JetBlue: Does Adding Business Class Seats Make Sense?

According to Businessweek, JetBlue will be rolling out a 16-seat business-class cabin on certain transcontinental routes aboard new Airbus 321 planes in the near future.   JetBlue VP Scott Laurence told Businessweek,  “I think the incumbent pricing at $2,500-plus, each way, is something we think doesn’t make a lot of sense.  It doesn’t stimulate an already existing market. We think we can stimulate demand there and really have an impact on that market.”  In other words, look out legacy carriers!  Your first class service is about to be challenged by a less expensive, high quality service from JetBlue.  

Is this a good idea?   It strikes me that an opportunity does exist in the market.  A significant gap exists between the price (and associated service) of a first class seat on one of those transcontinental flights and the price and service associated with an economy seat.   JetBlue may be able to come in with an attractive offering at a price point that induces some economy customers to upgrade, while stealing some first class customers from other airlines. 

What's the downside?   JetBlue has succeeded in part because it made good tradeoffs.  It chose NOT to do many of the things legacy carriers do (no first class, no bulky cart used to deliver drinks, no hub and spoke system, etc.).  Those tradeoffs made JetBlue unique and hard to imitate.  Now the company is relaxing one of those key tradeoffs.   Companies often find that they violate key tradeoffs when they strive to grow.  Sometimes, abandoning key tradeoffs damages the power of a unique business model.  JetBlue will face some questions: Will it slow down the boarding process when you add a business class cabin?  Will stocking the cabin require more time, and thus slow down turnarounds?   Will providing service to the business class cabin cause flight attendants to sacrifice the quality of service to the rest of the passengers?  Given these questions, it's a good idea that JetBlue is launching this new model as an experiment.  The key will be to learn and adapt quickly as challenges arise.  The deeper question will be:  Are we sacrificing key elements of our competitive advantage by pursuing this opportunity, or are we enhancing our competitive advantage by further differentiating from the competition? 

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What Should Lafley Do Now?

Yesterday, we learned the shocking news that embattled P&G CEO Bob McDonald had resigned abruptly, and that former CEO A.G. Lafley had been hired to replace him.  P&G's performance had lagged investor expectations during much of McDonald's tenure.   Activist investor Bill Ackman had been pressuring the company to make significant changes.  

What should Lafley do as he resumes command of the company he led successfully for many years?

First, he has to streamline his other professional commitments, accumulated since he left P&G.  Why?  Ackman criticized McDonald heavily for holding many board seats at other organizations.  Ackman claimed that McDonald held more than 20 board positions at other institutions!  P&G claimed that Ackman was incorrect.  Yet, the company admitted that McDonald held 7 other board positions. Yikes! Even 7 board positions sounds very, very high to me, particularly for a CEO whose company is not performing as well as expected.   Lafley has to show his people and outside investors that he is giving P&G his undivided attention.  

Second, Lafley should consider streamlining the P&G portfolio.  During his tenure, he divested a number of brands that he considered non-core products or businesses.   More work needs to be done.  I believe two strong candidates for divestment are IAMS (pet food business) and Duracell (battery business).  Why?  P&G has divested nearly all of its food brands over the past decade or so.   IAMS is an anomaly.   In fact, if you go to the company website, IAMS falls under the category of "household brands" - along with the company's large stable of soaps, detergents, and household cleaners.  How does dog food fit in that category?   The US pet food industry is less consolidated than the European market.  It could consolidate further.  Lafley ought to seek a buyer for the business.    He also ought to consider divesting the Duracell business.   It also seems like an outlier amidst the company's other household care brands.  Duracell is a leading brand in its category and surely would fit better at a company selling other similar products.  Having divested these brands, Lafley can reinvest in innovation efforts to ignite more top line growth in P&G's core categories. 

Finally, Lafley has to make a decision about the competitive positioning of the company's portfolio of brands.  During his first tenure as CEO, Lafley divested many low cost brands and focused heavily on products with a differentiated, premium position in the market (think Gillette, Braun, and many high-end fragrances, for instance).   During the recession, the company found itself struggling in some categories, as customers opted for lower price alternatives.   Pressure built to offer lower-priced options.  Meanwhile, Ackman pressured the firm to cut costs.  There's danger in this situation.  Is P&G determined to be a differentiated player in many markets or a low cost player?  Or, is it stuck in the middle, muddling along with an unclear position between the high and low ends of many markets?  Lafley needs to make some tough decisions about the firm's competitive positioning.  

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Clorox vs. P&G: How an Incumbent Deters Potential Entrants

Columbia Professor Rita McGrath recently tweeted a link to this interview of former P&G CEO A.G. Lafley, and she noted that it is a terrific example of competitive gamesmanship.  It sure is!  Here's what Lafley said, when asked to describe one of his failures at P&G:


"In the 1980s P&G tried to get into the bleach business. We had a differentiated and superior product—a color-safe low-temperature bleach. We created a brand called Vibrant. We went to test-market in Portland, Maine.  We thought the test market was so far from Oakland, California, where Clorox was headquartered, that maybe we could fly under the radar there. So we went in with what we thought was a winning launch plan: full retail distribution, heavy sampling and couponing, and major TV advertising. All designed to drive high consumer awareness and trial of a new bleach brand and a better bleach product.  Do you know what Clorox did? They gave every household in Portland, Maine, a free gallon of Clorox bleach—delivered to the front door. Game, set, match to Clorox. We’d already bought all the advertising. We’d spent most of the launch money on sampling and couponing. And nobody in Portland, Maine, was going to need bleach for several months. I think they even gave consumers a $1 off coupon for the next gallon. They basically sent us a message that said, “Don’t ever think about entering the bleach category.”

When teaching strategy, I talk to students about how incumbents can use various techniques to deter potential entrants.  In some cases, though, those moves to aggressively fight entrants can be very costly.  To cut prices substantially, for instance, can be very expensive.  If you are a large incumbent, and the entrant is quite small, a large price cut can be a costly way to try to keep a start-up out of your market.  Here, though, Clorox found a way to send a powerful SIGNAL that they were READY to fight aggressively, and that was enough to make P&G rethink their move into the bleach business.  The beauty of an effective signal, such as this one, is that it is far less expensive than ACTUALLY HAVING TO FIGHT THE WAR.   The neat thing about this story, of course, is also that Clorox was so good at scanning its environment that it was able to detect this move by P&G even at such an embryonic stage.  Great firms pay close attention to possible future entrants, and they have thought in advance about who might attack their position.  Clorox seems to have done so in this case.

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Whose Needs Are You Serving? WEEI vs. The Sports Hub

Regular readers of the blog know that I have commented several times on the fascinating competition that has unfolded in sports talk radio in Boston.   For many years, WEEI had a dominant position in the Boston market.  Entrants came and went, unable to topple the station or even to survive in the market.  Then, the Sports Hub (98.5) came along and knocked off the powerful incumbent.  It took a substantial ratings lead in many key time slots.   In the past, I've commented on how 98.5 did things a bit differently, while also focusing on a few important customer segments, so as to be successful.  

I've noticed one other lesson from this interesting competition.  In the mornings, the Toucher and Rich show on 98.5 has overtaken the once-popular Dennis and Callahan show on WEEI.   They became successful for many reasons.  However, one key thing that they have done is bring on guests in a different manner.  On the WEEI show, most of their prominent guests come on the show between 8am and 10am.  On the Toucher and Rich show, many key guests actually come on the show prior to 8am.   Why is this important?  Well, I've noticed that I miss many of the WEEI guests as I'm at work by 8:00am or shortly thereafter.  Why does WEEI have its guests on after many audience members are already at work?  I think, in part, it's because the guests prefer the later interviews.   They don't want to get up that early, or they aren't yet prepared to be interviewed on radio at that early hour.  WEEI is serving the needs of its guests, but at the expense of its audience members!   The audience wants those early interviews.   The Sports Hub has delivered on that previously unmet customer need.

What's the lesson for other businesses?   Think about whose needs you are actually fulfilling.  Yes, you have multiple constituents.  However, at the end of the day, the customer's needs must come first.  You never want to leave their needs and desires unmet because you are focused on other priorities. 

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A New Kind of Disney Princess

The Wall Street Journal reports today on Disney's development of a new type of princess for young girls.  Sofia the First is one of the new additions to Disney's family of characters.  She's "confident, resourceful and focused on being a good person. She should not be valued most of all for her beauty. Her royal family should include exactly zero evil stepmothers."    Nancy Kanter, a senior executive at Disney, explains: "We knew we didn't want it to be a young woman looking for a man."    The Sophia the First series debuted on Disney Junior on January 11th.   It has become the year's top-rated show among pre-school children.  Disney aimed to create a princess that would appeal to young girls, but that would provide an image and identity more acceptable to parents than some of the company's traditional princesses.   It appears that they have succeeded.

To me, this case provides another interesting development at Disney, besides the unique way that they are trying to reposition a key type of character.   Here we have a case of a key new animated character debuting on Disney's cable networks, rather than in an animated feature film.   The firm has begun to leverage the character in the theme parks and through its consumer products and retail divisions.  Historically, Disney launched key characters through animated feature films, and then leveraged them to other areas.  With Johnny Depp's Pirates of the Caribbean movies, we saw Disney take a theme park ride and build a popular series of feature films.  Now we have a character debuting on cable and then moving to the theme parks.  Could an animated feature film be next for Sophia the First?   Disney's ability to find different ways to originate content may be a key driver of growth for the future.  Relying only on feature films to launch a new franchise can be expensive and risky.  Having other ways of originating and leveraging characters could be key to the company's future... as important as some of the recent acquisitions have been in terms of adding to the stable of characters in the Disney family. 

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Backward Integration at Starbucks

Source: Wall Street Journal

The Wall Street Journal reports that Starbucks has acquired a 600 acre coffee farm in Costa Rica.  You might ask: Why is Starbucks backward integrating?  They probably do not think they can operate the supply chain more efficiently through vertical integration.   They certainly aren't going to obtain a significant amount of coffee beans through one 600 acre farm.  What are they doing?

They are learning, experimenting, and innovating.  It's a terrific reason to engage in partial/limited backward integration.   Starbucks CEO Howard Schultz explained, "We are talking about doing innovative things we would not be able to do without this farm."   Craig Russell, a Starbucks senior vice president, explained that the company would try to identify ways to address a fungus problem that is affecting coffee farm yields in Central America: "It's a dynamic situation and we will absolutely use this farm for testing different methodologies and ways to use new types of coffee trees we've developed that have become more disease- and rust-resistant."   Finally and most importantly, Starbucks intends to share what they learn about the fungus with other farmers, so that coffee bean production improves overall for the industry.   

This example demonstrates that a small bit of vertical integration (backward) can be very effective as a means of innovation and experimentation.  Many companies simply view vertical integration from the perspective of its immediate effect on the bottom line.   Ironically, many of those efforts actually decrease profits much to the chagrin of senior executives.   Of course, many of those efforts are not small experiments.  They are bold moves down without a good pilot to test the concept.  In this case, a small bit of experimentation could yield large improvements in profits over time.  

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Ron Johnson: The Heat is On

The pressure continues to escalate on J.C. Penney CEO Ron Johnson.   In this week's New Yorker, James Surowiecki writes about the struggling retailer (thank you, James, for the shout-out).   Meanwhile, on CNBC, former J.C. Penney CEO Allen Questrom speaks out about the situation.

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Planet Fitness: Making Money in a Tough Industry

I ran across this excellent article by Judith Ohikuare in Inc. magazine.  The article is titled, "The Secret to Planet Fitness's Success."  Here's a quote from the company's CEO in the article:

It's very, very difficult to make money in the fitness industry. In order to thrive, you really have to have a niche and sell it. You've either got to be at the high end or at the low end; otherwise, you're not in at all. We're at the very low end: Members have access to a great club for 10 bucks a month, and I don't see that changing. We keep it as simple as possible, so that there are as few areas to disappoint as possible. When we started out, we included perks that everyone else had, such as day care and yoga classes, but none of that made sense for us.

Having read that quote, now check out the commercial below, a creative follow-up to the famous "I lift things up and put them down" ad which I featured on the blog awhile back. (Thank you to student Meredith Soper for pointing me to this commercial).   What you see is a company that is clearly trying to identify its niche... and clearly specifying what it is not (and who it does not seek to target).  In a very tough industry, leaders must pay particular attention to the clarity of their target market and the boundaries of their strategy.  Making clear choices becomes all the more important when you have fewer potential profits because of an unattractive industry structure (such as in the fitness center industry).  

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Is The End Drawing Near for Sears?

The Wall Street Journal reports today that Edward Lampert, whose hedge fund ESL Investments Inc. controls over 50% of Sears' shares, will be taking over as the CEO of the company.   Lampert merged Sears and K-Mart several years ago, and he has been Chairman of the company since that time.  He succeeds a former IBM executive who ran the company for the past two years.  Before that, Sears had an interim CEO for three years.   Hmmm... That's a pretty long period of instability at the top, and now we will be continuing with a person at the helm who lacks retail industry experience.   Can Lampert turn this ship around, or is it too late?

Same-store sales have decreased for six straight years.  Sear lost $441 million through the end of the third quarter, and it expects to lose roughly $300 million in this quarter. Concerns have been raised about liquidity at Sears.  The firm is clearly in rough shape.

What should they do now?   I think Sears really has to think long and hard about what assets it has that are truly valuable and distinctive.  It's future must rest on building around those assets.   What is valuable and distinctive?  Craftsman and Kenmore appear to fit the bill.  Perhaps Lands End does as well.  After that, it's not clear that the firm has a future.  So, if I were thinking about the future strategy, I would be thinking about those three brands, rather than trying to preserve the entire traditional department store business.  Maybe the future is in small stores and/or an online retail presence that just sell Craftsman, Kenmore, and related brands, with Lands End sold off to another clothing catalog retailer.  For certain, the future does not seem to bright for the traditional brick-and-mortar business that they have been trying to preserve for years, amidst a clear and tragic decline. 

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Being Clear vs. Being Right

Fast Company's Jessen O'Brien recently interviewed Ping Fu, the cofounder and CEO of 3-D software company Geomagic.   Ping Fu just wrote a new book titled Bend, Not Break: A Life in Two Worlds. Fu's story is quite remarkable.  She grew up during the Cultural Revolution in China.  She suffered brutal treatment at the hands of Mao's regime.  Fu survived those tortuous years and came to the United States to become Inc. magazine's Entrepreneur of the Year in 2005.  In this interview, she offers some leadership advice that I found to be quite thought-provoking:

I found in my career that it is better to be clear than to be right. A lot of times, I find leaders want to be right and they think being right is what gains respect. I find being clear is what gains respect--if you’re clearly wrong, people can correct you, and if you’re clearly right, people can follow you.

Here's why I think she makes a great point.  If someone isn't making a clear point, here is what you should be asking yourself:  Do they really have a sound strategy, vision, plan?  Lack of clarity may be a simple problem of  articulation and communication.  However, in many cases, a lack of clarity speaks to much deeper problems.  An inability to articulate a plan or strategy clearly means that someone actually has a muddled vision.  They haven't thought it through with the type of precision required to perform at a very high level.  In many cases, it means that they are trying to do too many things at once, or they are pursuing inconsistent objectives.     

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Beware of Shiny Objects!

Adam Bryant interviewed Sandra Kurtzig, CEO of software management firm Kenandy, in a recent Corner Office column for the New York Times.  Kenandy offers some great advice for leaders regarding the need to stay focused despite some dazzling and attractive distractions that sometimes appear.   Here's an excerpt:

I don’t run after “shiny objects.” That’s a mistake that a lot of people make in running a company, especially in starting one. They tend to get a lot of opportunities from people who want to partner with them. And these are just shiny objects, because there are very few partners that end up being right for your company. So I’m much more selective. If I hear something, I’m very quick to think, ‘Hey, that’s a shiny object; let’s get back to work.’ I think that’s what’s so distracting to a lot of companies — they see a big customer or some other distraction, and they spend too much time on it and they lose their way. 

I agree wholeheartedly.  Leaders get approached all the time with interesting proposals both from potential external partners as well as from internal folks.   They see opportunities for new investments and initiatives emerging all the time.  Opportunities abound in many cases.  The question is how to screen those opportunities and put scarce resources to work on a few key priorities.  The scarcest resource often is not financial capital; it's management time and attention.   Top leaders simply can't focus on a laundry list of new initiatives.  Leaders also can't forget that execution on current initiatives will likely suffer if they turn their attention to new pastures too quickly.   Strong execution requires discipline not just from the troops, but from top leaders as well.    

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Struggles at Build-a-Bear

The Wall Street Journal reports that Build-A-Bear, the once high-growth retailer, has begun a search for a successor to founder and CEO Maxine Clark.  The company has struggled recently, even closing some locations.   What happened to this retailer, which had been growing rapidly and profitably several years ago?

Build-A-Bear offered a unique retail concept.  It truly provided an "experience" for the customer, not just a set of products.  In that sense, it should have been insulated a bit from the pressures that other children's toy retailers faced from internet retailers such as Amazon.  However, I think Build-A-Bear's growth strategy had some weaknesses that are not uncommon in retail.  First, it grew very rapidly, opening stores in malls throughout the nation.  However, the appeal of Build-A-Bear was, in part, because it was a destination.  You don't go to such a store on numerous repeat occasions.  You go rather infrequently - special occasions mostly, like birthdays and holidays.  When you have so many stores, it's hard to support them all given that you don't have customers coming back again and again each month.

Second, Build-A-Bear didn't innovate enough with regard to the store experience.  Children did not see or do unique things over the years; they were doing precisely what they had been doing on prior occasions.  That inability to innovate the experience meant that repeat visits were increasingly unlikely.

Third, the tie-ins to movies such as Smurfs are great; they produce a surge in sales.  However, you have to pay royalties on those products, and then you face the challenge of continuing to grow revenues after those movie promotions have ended. 

Finally, the company didn't generate enough of a powerful razor-and-blades business model to truly drive the type of profitability that they hoped to achieve. Compare them to American Girl.  In that case, young girls play with those dolls often, and they come back to the stores, catalog, or online store to buy new accessories, clothing, and other products that can be used with the dolls.   Build-A-Bear did not have that type of powerful razor-and-blades model.  Yes, kids bought outfits for the bears when they made the bear.  However, children didn't tend to come back often to buy other accessories.  Bears aren't like dolls, after all, in that they aren't played with repeatedly in the same way.  

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Retailers, Black Friday, & A Prisoner's Dilemma

We've certainly heard a great deal over the past few days about the controversy surrounding the decision by many retailers to open on Thanksgiving evening.   Regardless of where you stand on that issue, you should ask yourself:  Are these retailers actually generating incremental sales and profits by opening at 8pm on Thanksgiving or at midnight, as opposed to early on the morning of Black Friday?   Perhaps they are, but I suspect that they are simply shifting sales which otherwise would have occurred on Black Friday or thereafter.   People aren't buying more items overall this Christmas; they are simply buying them a bit sooner as a result of the Thanksgiving day openings. 

Why are firms pursuing these policies if they are unlikely to drive incremental sales and profit?  I think it's because the retailers are caught in a prisoner's dilemma.  If they all chose to wait and open on Black Friday at 6:00am, they would be better off as a whole.  However, each retailer is worried that it will lose out if it remains closed while rivals open on Thanksgiving night.  Therefore, each retailer opens up earlier and earlier, for fear of ceding sales to rivals. 

How can firms extricate themselves from this losing proposition?  Well, the retailers cannot legally collude to shift openings back to Black Friday morning.  However, they can try to achieve some form of tacit collusion, or they can try to influence and signal to one another in a way that leads to cooperative behavior for the greater good.  Typically, such cooperation emerges if you have a strong market leader who can influence the behavior of smaller rivals.  Could Wal-Mart serve that function?   It seems unlikely, because even though they are enormous, rivals would probably jump at the opportunity to steal sales from them.  That's why we probably will see this trend of early openings continue, though it may not be enlarging retailer profits by much at all. 

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What is Strategy? A Very Helpful Reminder

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JC Penney vs. Zara: How to Reduce Markdowns

Frequent markdowns can eat into a retailer's margins quite substantially.  No wonder, then, that Ron Johnson - the CEO of JC Penney has tried to wean the department store off of its reliance on discounts and sales.  We all know, however, that he has had limited success to date.  In fact, sales have plummeted as customers have revolted at the dramatic reduction in sales and markdowns. 

Let's compare JC Penney to Zara for a moment.  Zara is a Spanish apparel retailer that has done remarkably well over the past decade or so.   Zara manages to offer fewer markdowns than many rivals, and when it does discount its clothing, they price reductions are smaller than those offered by competitors.  How does Zara do it?  They pursue a "fast fashion" strategy, whereby they make smaller batches of fashion items - a substantial percentage of which they make in their own factories.  They change their product mix often, and they react quickly to changing trends and consumer tastes.  Customers know that many lines of clothing will have limited numbers of items, and that those items may not be on the shelf one month later.  As a result of this nimble strategy, Zara minimizes the downside of "fashion misses" in their product line.  Because they don't produce huge runs of some of these items, they have much less inventory left over if a new product is not a hit with consumers.  Therefore, they have less of a need to mark down those clothes.  

In short, Zara has reduced its dependency on markdowns, but they have not done it simply by declaring that there will be less discounts.  They have built an entire strategy that makes it much less likely that they will need to discount items.  JC Penney hasn't yet built that comprehensive strategy to support its  new pricing policy.  As a result, JC Penney has struggled. 

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Are Network Effects Over-rated?

Nir Eyal and Sangeet Paul Choudary have written an absolutely terrific column for TechCrunch about network effects.  The essay is titled, "The Network Effect Isn't Good Enough."  Network effects, of course, exist when the value per user rises as the number of users of a particular good or service rises.  When network effects are strong, one firm can become the standard in a market - think eBay in auctions, for instance.  In these situations, firms tend to try to "get big fast" so as to move up the curve and achieve a high value per user.  Then they hope that switching costs will lock users into their good or service.    Eyal and Choudary point out that many startups in Silicon Valley bank heavily on the notion of network effects.  They willingly run up huge losses in the early years, hoping to cover those losses with venture money.  Then they hope to reap the rewards when they have become the dominant player in their particular market. 

The authors point out, however, that network effects may not be the elixir that many startups believe they will be.  Why?  The authors make several key points.  Here is an excerpt from their argument:

For one, in the old days, consumers paid to access the network through their upfront investment in hardware. These upfront costs locked users into the network and once they were in, they were in for good, thus erecting barriers to entry for would-be competitors. However, the cost of providing access to the network has fallen precipitously. The days of customers buying expensive hardware to use a network are gone as is the correlating lock-in effect. In addition to access costs falling to zero, another key component of what once kept users locked into a network has vanished. Once, porting contacts onto a new network, like switching instant messaging services from Yahoo! to AIM, was a non-trivial task. Today however, customers use their Facebook, Twitter or Google profiles to join a new service in seconds. A burgeoning network, take Instagram or Pinterest, can leverage the single sign-on enabled by the social graph to reach critical mass faster than ever before.

In other words, switching costs may not be nearly as high as many startups believe them to be.  Thus, the lock-in effect doesn't materialize as hoped.  Consumers flock to a platform, but then they may just as quickly move on to a different product or service.   Think MySpace relative to Facebook.   This limitation on switching costs may explain why many startups have a hard time "monetizing" their eyeballs.  If they try to extract more value from their consumer, they face the startling possibility that people will simply switch to another product or service. 

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Iger's Long Term Strategy at Disney

As you know by now, Disney acquired Lucas Films last week. With that, Disney now owns the Star Wars and Indiana Jones franchises. I'm not surprised by the move. In fact, you can see a pattern emerging to Bob Iger's strategy at Disney, which is quite in contrast to the strategy during the second half of Eisner's tenure at the company. In Eisner's later years, he moved away from simply focusing on the characters as the central driver of synergy among Disney's businesses. He acquired ABC and Miramax, and he owned a baseball and hockey team for some time - among other moves. Now we see Iger refocusing on characters as the heart of Disney's corporate strategy. We see three major moves (Pixar, Marvel, and now Lucas) during his tenure that all involve expanding the universe of characters which Disney can leverage across its many businesses. I think the focus on characters makes a great deal of sense. Here's why...

When thinking about the characters at Disney, we should note those resources are quite valuable because they are highly durable and inimitable. Moreover, Disney can appropriate the value associated with those resources (as Buffett says, "the mouse has no agent"). How then can one think about leveraging such a valuable resource across multiple businesses? A strategist needs to think about how specialized vs. fungible/general the resource is. A highly fungible resource/capability would be something like “brand management expertise” or “innovation” or “risk management.” A highly specialized capability might be patented product formulas or engineering expertise in a very narrow discipline. Fungible capabilities can be easily transferred across lines of business. However, they are often too general/not unique enough to convey a substantial competitive advantage. On the other hand, highly specialized capabilities tend to provide powerful competitive advantage in a particular business, but they lose value very quickly when a firm tries to transfer them to a wide array of businesses. In other words, there are only so many areas in which you can grow based on a highly specialized set of capabilities.

In the 1980s, Disney’s core capabilities revolved around animated character development and deployment. Those tended to be highly specialized capabilities; Disney was able to leverage those capabilities to enter the hotel and cable television business, but ultimately, growth was constrained by the specialized nature of that capability. To move into even more diverse businesses, Disney had to be able to make the case that it had a broader/more general/more fungible capability such as “managing creativity.” That's the argument that Eisner used to move into a variety of businesses that did not have to do with characters (ABC, Miramax, etc.) There are two challenges associated with defining a firm’s capabilities so broadly. First, it is more difficult to make the case that the firm is truly unique and superior to all rivals in that set of capabilities. Second, it becomes rather difficult to discriminate among various options for diversification, i.e., how many businesses have something to do with managing creativity vs. developing and deploying unique characters?

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The Launch of the New Wii U Gaming Console

In November, Nintendo will launch its new Wii U gaming console.  The company hopes to revive lackluster gaming revenues that have resulted from the maturation of the original Wii product line, as well  as the shift to mobile gaming that has hurt the console business overall.  Kyle Orland writes in this article about Nintendo's pricing strategy.  The firm will be pricing at below cost at launch.   In some ways, we should not find that fact surprising; after all, most gaming companies price below cost at launch. However, Orland notes that Nintendo did not have to do that when it launched the original Wii.  It actually turned a profit at the start.  That proved rather unusual though, running contrary to most product launches in the gaming industry's history.

Source: Nintendo

Why do most gaming consoles sell below cost at launch?  Three major reasons exist. First, companies hope to capitalize on network effects.  They want to build the installed base quickly.  As they do so, the value to each customer grows, and the attractiveness of the console to software developers increases as well. Second, the companies hope to use a "razor and blades" model to make money.   A higher installed base of consoles brings with it higher software sales, which can be very profitable.   Third, the cost of producing a console decreases significantly over time.  Those cost decreases occur for two reasons:  economies of scale and learning curve effects.  

For these reasons, Nintendo rightfully can expect to improve console profitability over time.   Still, they will need strong launch sales to kick off this virtuous cycle.  With the explosing of mobile gaming, the question remains:  Can consoles bounce back?  Have their struggles in recent years simply been due to the usual cyclical downturn in the later years of a technological generation, or are they experiencing a permanent disruption to their business due to the emergence of attractive substitutes?

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