Well...this is going to be a stock-picker's paradise as well as needing to rethink investment strategies in light of ongoing major structural shifts. Neither the top-down macroperspective nor the bottom-up value perspective can be entirely neglected but must be integrated. A lot of that machinery has been laid out here. The remaining key question is how do you actually go about linking the headlines to readily available financial data to business performance analysis. But before we dive into our central focus let's revisit the case for active value investing with a hattip to Barry Ritholz. It seems Vanguard, one of the better outfits around period, made it's case for a Buy-N-Hold strategy with an interactive tool that showed the market outperforming an active investor following simple mechanical rules. Unfortunately for them Barry and Paul Kedrowsky proceeded to demonstrate that if you tuned the parameters slightly it went the other way. We spent some more time playing with and got the results collected in this composite graphic. Barry's post and charts are excerpted in the readings while our multiple fiddlings are here, and if you click on the chart you'll go to the Vanguard's tool to play with yourself.

What you see at top is two alternative rules that do better than simple buy-n-hold, in case with less risk and the other with slightly better returns. In some ways case closed.But if there's any economy - markets - investing link we've been pounding on it's that economic turning points are visible a long way away and that economic performance drives markets in the long-run. So in addition to sensible asset allocation plus active value investing plus excellent company performance analysis it seems to us that the first, fundamental key is playing the turning points. Which we sorta mimicked by breaking up the time periods. Within the limits of Vanguard's tool, not designed for this purpose, we're in effective suggesting that you make the big turning point In/Out decision and then adapt/adopt an appropriate rule appropriate to the macro regime. Right now and for the rest of the 10's we think that regime is a rangebound trading market, just to remind you.

Business Performance, ROIC and Investment

Of course some of the other recent investment news is the annual Berkshire meeting which produced a flurry of stories and articles. Some of which are excerpted below along with our selections from Warren's annual letter, as usual a great must-read. One of the more interesting is the Marketwatch story pointing out that BRK beat all mutual funds for the last 45 years. By this time we basically know roughly how he does it (NB: the recent stories on how and why he took a pass on LEH reinforce it - a day with the 10K, some hours interviewing Dick Fuld, a complete lack of confidence in management and voila!) which is to pick good companies with aggressively defensible market positions and value-creating products run by management he trusts. Now we've spent a lot of time digging thru a bunch of different companies here to break that down in much more detail but we want to point to a way to screen and analyze companies for deeper analysis.

One key way to do it, with a number not commonly looked at but rather widely available, is ROIC, or Return On Invested Capital (sometimes ROC).  And the guy who surfaced it and was cited by a bunch of major bloggers was our old buddy Jim Jubak in this column: The one must-have number for successful long-term investing. It strikes a theme and approach he's been using in several by-the-way. But basically ROIC tells you how a company is doing with the resources it has available. We'll note in passing that our recent dive into Home Depot that they link business and operational strategy to key performance metrics to ROIC and capital discipline in a closed-loop management process that is a beauty to behold.

 We put together this sampling of some key bellweather companies, headline names and/or ones we've written about and make good comparisons, using the stats readily available on MSN Money's stock profile pages.One of the things we like is that it shows you ROE, ROA and ROC all side-by-side. ROE is the one most commonly followed but that's dangerous since it's simply ROA leveraged up, and subject as to management folly and accounting whimsies.

The top row is all Tech firms, the middle row exemplars of sorts we've discussed and the bottom row some representative samples. For example MickeyD's (MCD) vs. Burger King (BKC) - both are showing decent ROC, more importantly it's improving compared to the 5 year and tells us there may be a couple of winners. Since we used MCD as our working case for long-term valuation that's good to know. Exxon - the best run by far of the oil major- is interesting since current ROC is so much lower than historical. We know that's not for internal performance reasons but we also know that the world energy ecology is under-going a major structural shift that severely limits the long-term profitability of the Majors. The HD vs. WMT numbers are interesting - HD clearly has a ways to go. Also really interesting are the trends apparent in the Tech row. Dell for example has a decent current ROC but has fallen a long way, Apple seems to be maintaining its exemplary performance and Intel and Cisco are getting good returns with slight drops below historical performance yet, as we've discussed, are going thru major transformations. In other words we may be seeing Red Queen Syndrome in a relatively mature industry where only Apple has found a new value proposition, CSCO/INTC are extremely well run but aren't delivering breakthrus and Dell is struggling. IBM on the other hand is a different story.

ROC, ROA and the DuPont Method

A related number that's often easier to get, understand and analyze is Return on Assets. Especially since breaking it down and linking it to details of company performance has a long...long history having been invented by Pierre du Pont to help run DuPont rationally in the early 1900s but being more fully developed in his takeover, salvation and transformation of GM. (Strategy and Structure: Chapters in the History of the American Industrial Enterprise by Alfred Dupont Chandler). In the readings there are pointers to more educational resources on Dupont Analysis, somewhat related Enterprise Value/FCF and ROC or ROIC. Let's take a look at the relationships in DuPont's framework and what it says about business performance. A couple of notes - ROI here is also ROA, DuPont's critical metric. ROE is related to ROA by ROE = ROA* Equity Multiplier, where  the EM is a measure of leverage and is given by (1+Debt/Equity). You can and should break down ROA into its major components.

Operating Efficiency = Profit Margin = Net Profit/Sales tells us how efficiently a company is running today within existing resources. The trends over time and the value of various tactical and strategic initiatives, when analyzed thru the filter of their impacts on Revenue, Profit and operating costs, tells us where it's been and where it's going.

Capital Asset Effectiveness = Asset Turnover = Sales/Assets tells us how effectively a company has been and is being run. And, again, what the future holds by working the initiatives you read in the press and in the analyst and annual reports thru these filters, how it's likely to do in the future.

Capital Structure = Leverage Multiplier = Assets/Equity tells us whether or not the sources of performance are operational, business or financial engineering. Over the last couple of decades too much attention has been paid to short-term ROE which means too much credence has been given to financial engineering and leverage and not enough to business fundamentals.

Return vs. Performance: the final implicit equation is ROE = ROA X Leverage = Profit Margin X Asset Turnover X Leverage. It's the first two you want to know are improving and are likely to keep improving, or not.

Business Think vs Financial Think

All too often the press and analysts get numbers confused with running the business when actually it's the other way around. The numbers should result from business decisions, not drive them. But in a quarter-to-quarter world where headline earnings are all that matters for compensation plans just the opposite happens. Let us try and illustrate some ways of thinking the way a business person thinks, or tries to, or should (if they're not Dick Fuld and the management of Lehman).

Suppose a medium-sized manufacturer is facing an over-capacity market with lots of competitors and no clear differentiation. And they decide that the way to create a major value engine is to improve total operational service from ordering to delivery and installation to after-market and life-time service. As we know from our whole enterprise investigations that's not just beating up the troops to smile on the phone but involves deep operational changes in order process, fulfillment and distribution, perhaps the creation of a whole new service support organization with its own capabilities plus tight linkages to manufacturing and product development. Over time, say in a phased approach, you're likely to see the impacts on the P&L and the Balance Sheet work themselves out something like we've illustrated.

Beyond that "simple" change that creates a sustainable and appreciating advantage lies a whole host of other possibilities one could envision. Changes in fulfillment and speeding up the order-to-delivery and order-to-cash cycle might lead to and fund major changes in manufacturing operations, say to a leaner operation. With a more cell based operation and less emphasis on long production runs. That kind of flexability means the company could go after smaller markets more profitably, be more responsive to customers and have a broader product line. Which then would support a whole new approach to Product Development and Marketing and so forth...one thing leads to another.

We've covered a lot of ground and tried to do it at some depth, from alternative approaches to Investment Strategy to deep value screening and analysis of companies to deeper methods of business analysis linked to business performance. If there's a final argument to be made here it's that in this market and with this economic outlook the companies doing and demonstrating this kind of thinking are the ones you need to be looking into. Otherwise you'll be lucky to get your 4% return over the next decade.

READINGS

Investing for Performance

Lessons Not Learned From Bursting Bubbles Why have U.S. equities "stunk" since March 2000? And how has the trade-off between stocks and fixed-income investments turned on its head compared to ten years ago? BNN speaks to Pat Dorsey, director of equity research, Morningstar.

Advice to a Young Market Participant  I cannot restore your faith or improve your morale (Only you can do that). What I can do is share with you what I have learned over two decades, and perhaps in these words you might find some small comfort. Yes, there is an insanity to the markets that can make you mad if you let it. Instead, learn to see the delightful absurdity of it all. Revel in the stupidity, learn to read when the ‘wisdom of the crowd’ turns into an angry mob. Find some Zen in the foolishness of others. Step back and look for the variant perception . . . then wait for it to become a money maker. Consider this was an issue from 1996 or 97 until the collapse in 2000, and from 2005 to the collapse in 2008-09. It is a 3 or 4 or even 5 year time lag between the earliest inklings of recognition of mass stupidity/insanity, to any eventual collapse. Time is always on the side of the patient. Study, learn, absorb all you can. You are waiting for the next opportunity to make your bones, your fortune, your reputation. It will come along eventually — if you wait for it and are in a position to take advantage when the moment arrives. As Pasteur said, “Chance favors the prepared mind.” You must learn patience, young grasshopper. You must have faith that EVENTUALLY, the sorta kinda, almost efficient market will figure it out. That is when money returns to its rightful owners. There will be long periods of time when the blowhards, the jackasses, the arrogant, the ignorant will be eating better than you. During the dot com bubble, the dumber you were, the more money you made. Many of those who understood how silly things were missed out on the boom. But this state of affairs is temporary. Eventually, the knaves starve to death under the oppressive force of their own ignorance. Be patient. The day of reckoning is often surprisingly late in its arrival, but it will not be denied. The beast must be fed.

Market forecast - confusing "WE HAVE REACHED THE MAXIMUM POINT of indecision with regards to market direction." Finally, an honest assessment of the stock market outlook, and for this we should thank Christian Bendixen, director of technical research at Bay Crest Partners. Of course, that violates the first rule of Wall Street gurus -- you can be right or wrong but never in doubt. That assessment corresponds to what Lee Quaintance and Paul Brodsky, the principals of QB Asset Management, observe. Few investors have much conviction about economic trends and asset values, so most are reluctant to position themselves strategically beyond the short term. Professionals, they continue, have split into two camps: the smaller cohort either is hunkering down and sticking close to the indexes or aggressively trading in and out of "risk assets" and cash. "Such meaningless trading is providing the marginal pressure each day that forces prices of stocks and commodities higher or lower, and (inversely) dollar-denominated bonds and currencies lower or higher. "The other camp, primarily non-professionals, seems to have chosen simply not to participate in any major way in stocks and commodity markets for fear of volatility," the QB principals write. Even Wall Street's sell side is having trouble mustering more than middling enthusiasm for pushing stocks. According to the equity strategists at Bank of America Merrill Lynch led by David Bianco, their barometer of sell-side bullishness -- the recommended allocation to equities by Wall Street strategists -- stands at 58.9%, a hair above the neutral average of 57.6%.

• The Obama stock market is one year old

Vanguard’s Broken Discipline: The Buy & Hold Model  Yesterday, my buddy Paul showed this Vanguard interactive chart. Vanguard was trying to show the superiority of Buy & Hold versus “emotional investing.”  I have many issue with their argument. First, I have to challenge the use of that term — emotional investing — to describe what is a fixed mathematical exit and entry strategy. In fact, that is the exact OPPOSITE of emotional investing: Using predetermined risk management system that operates without any human intervention — a quant black box — is not emotional investing. Paul used the default settings — something guaranteed to never beat the market. That approach makes Buy & Hold look like the superior strategy. Vanguard shows B&H performance of $63,791 versus in/out performance of $33,628:… Vanguard did not count on clever market participants engaging in na little clever slide play . . . just a tweak here, down 20% to get you out, up 23% to get you back in — voila! Massive out performance form-fitted to recent history:  B&H performance of $63,791 versus risk managed performance of $88,095: And, you have not only out-performed over the past decade, you are actually up since 10 years ago — versus still negative for Vanguard. Vanguard’s Interactive Tool, Vanguard Chart, Barry’s Chart

There’s money in stockpicking hills The emphasis on asset allocation is also good news for investment advisers and brokers, because it gives them something to do. An analyst can charge a lot for recommending an allocation between different funds, if that is really what accounts for 90 per cent of returns. It is harder to justify a fee if performance has more to do with the decisions by fund managers when they pick stocks. Now, it seems that that conventional wisdom is changing. Another article in the Financial Analysts Journal suggests the earlier finding has been misinterpreted. Instead, Roger Ibbotson suggests the components of return should be divided into three: asset allocation and stock selection, plus market movement. Once this third factor is taken into account, the other two factors turn out to be about equal – and moves in the overall market are far more important than either.

How to maximize what your cash pays even when nothing is paying much of anything now Got cash? Maybe you’d love to invest it, but where? The stock market seems pricy after a 70% rally from the March 2009 lows. And it’s been so up and down lately that it doesn’t inspire much confidence. So maybe stocks are just too risky for you. Or you’re close to retirement or those college tuition payments and can’t take a risk. Maybe you’d just like to wait. Or maybe you just need more income than most stocks pay these days. Bonds are, well, no bargain. A three month Treasury bill pays just 0.12%. A two-year note pays just 0.79%. Inflation may not be very high at an annual rate of 2.6% for headline inflation (and 1.6% minus volatile energy and food prices) but it’s enough to eat up all the interest from those investments and more. (TIPS, Treasury Inflation-Protected Securities will protect you from inflation but the yields are really low (1.43% for a 10-year TIPS at recent auction) and they only protect you from inflation and not rising interest rates. For the short term you need to put your cash into something that’s as safe as possible but that offers you as much income as possible—and that doesn’t lock up your money for very long. My choice dividend paying stocks—if they pay a high dividend, are extremely liquid, and are battle tested. Let me use chemical maker E.I. du Pont de Nemours (DD) to show you why. Here’s a stock that’s paying a dividend of 4.86%. That’s more than you’ll get from even a 30-year Treasury at the moment. The shares are very liquid so you should have no trouble trading in and out when you need to. Average daily volume is more than 7 million shares traded and the company has issued 904 million shares. And the dividend has been battle tested in the Great Recession. The annual dividend was $1.46 in 2005, $1.48 in 2006, $1.52 in 2007, $1.64 in 2008, and, most impressively, $1.64 in 2009. If du Pont didn’t cut its dividend in 2009, I think it’s pretty safe unless the economy is hit by something worse than the great depression

The Master's Lessons

Warren Buffett's Letters to Berkshire Shareholders Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes. We see a “social compact” existing between the public and our railroad business, just as is the case with our utilities. If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should – and we believe will – understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems. We will do our part to see that they exist. I have been in dozens of board meetings in which acquisitions have been deliberated, often with the directors being instructed by high-priced investment bankers (are there any other kind?). Invariably, the bankers give the board a detailed assessment of the value of the company being purchased, with emphasis on why it is worth far more than its market price. In more than fifty years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given. When a deal involved the issuance of the acquirer’s stock, they simply used market value to measure the cost. They did this even though they would have argued that the acquirer’s stock price was woefully inadequate – absolutely no indicator of its real value – had a takeover bid for the acquirer instead been the subject up for discussion.

• Annual & Interim Reports

The Oracle Speaks One of the best annual reads on Wall St. — Warren Buffett’s letter to shareholders — has been posted [PDF]. Barry discussed his take on Sunday; Here are my views: Of course, the entire letter is worth reading. Here are two of what are, to me, the more notable points — one excoriating the financial press, the other excoriating some of the horrible mismanagement we’ve seen over the past few years. Amen to both (all emphasis in original). “It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascos of the last two years. To say these owners have been “bailed-out” is to make a mockery of the term. The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance.

• ”Stock $ense: Frances Horodelski discusses the difference between 'book' values and 'intrinsic' values.
• When CEOs Have Warren Buffett in Their Boardroom

The Oracle's Tips For the Rest of Us Buy when everyone else is selling. "We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend....Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble." Don't buy when everyone else is buying. "Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance," Mr. Buffett wrote. The obvious corollary is to be patient. You can only buy when everyone else is selling if you have held your fire when everyone was buying. Value, value, value. "In the end, what counts in investing is what you pay for a business—through the purchase of a small piece of it in the stock market—and what that business earns in the succeeding decade or two." Understand what you own. "Investors who buy and sell based upon media or analyst commentary are not for us," Mr. Buffett wrote. Defense beats offense. "Though we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results. In other words, our defense has been better than our offense, and that's likely to continue." All timely advice from Mr. Buffett for turbulent times.

Buffett and Berkshire outperform all mutual funds Many investors can only look on with envy when Warren Buffett says his shareholders have seen 20% annualized gains over the past 45 years -- even the best mutual funds pale by comparison. Only two funds are even on the horizon: Fidelity Magellan Fund, which has returned 16.3% a year during Buffett's chairmanship of Berkshire Hathaway Inc., and Templeton Growth Fund, up 13.4% a year on average, according to investment researcher Morningstar Inc. Berkshire's Class-A shares have delivered returns of 22% a year since 1965, based on market price, though Buffett prefers to judge gains according to book value, which stand at 20.3%. Buffett has more structural freedom than mutual-fund mangers, so comparing their performance isn't apples-to-apples. But the differences also highlight the limits of mutual funds, particularly the short-term pressures that most managers face. Templeton Growth Fund uses a value deep value strategy, buying stocks when they're cheap, and keeps its portfolio turnover low, at just over 10%, according to Morningstar. In fact the fund shares many similarities with Buffett, owing its good performance mostly to consistent, if not overwhelming, gains in good markets and holding up well in down markets, said Kevin McDevitt, senior mutual fund analyst at Morningstar, who covers the fund

Returns, Performance & Analysis

After lost decade, it’s still tough to find returns AFTER THE JUST-ENDED LOST DECADE of making nothing from equities, you'd think investors ought to be entitled to count on high returns from the next 10 years. Just as buying high at the peak ensures punk future gains, the opposite ought to follow after a long period of weak returns. Don't count on it, say some insightful investment pros. Investors can't expect much more than 2%-3% in excess of inflation over the next 10 years from balanced portfolios. And fixed-income, which helped cushion the negative returns from stocks in the past decade, may be a loser in the coming decade. In the 10 years ended last Dec. 31, the Standard & Poor's 500 index lost 0.95% a year. The taxable bond benchmark, the Barclays Capital (formerly Lehman) Aggregate Index, returned 6.33% per year. But even with that fixed-income shock absorber, the traditional 60%/40% mix of stocks and bonds utilized by institutional investors such as pension funds and endowments, produced negative real returns for the decade (that is, less than the rate of inflation.) That's something that's never happened, writes Rob Arnott, the head of Research Affiliates, Newport Beach, Calif., consultants, in his recent missive to clients. Actually, Arnott observes, it wasn't a Lost Decade for those who eschewed these conventional approaches. For instance, simply avoiding the capitalization weighting of the S&P 500 would have returned 5.38% per annum in the past decade, or nearly 6.5 percentage points more than the cap-weighted measure as dictated by S&P. Future returns, by Arnott's reckoning, consist of three basic components: current yield, growth in income and changes in valuation. With yields on these asset classes relatively low, "the fat pitch of diversification in risk premiums beyond mainstream stocks and bonds is largely gone." As for conventional stocks and bonds (as represented by the S&P 500 and the Barclays Aggregate), Arnott doesn't see the new decade being much better than the last. Even assuming no change in yields, Arnott figures a reasonable expectation for returns from the standard 60/40 stock-bond portfolio for the next decade is about 2%-3% over inflation per year. "The Lost Decade has most assuredly not paved the way for easy times in the years ahead," he observes. In a yield-starved, risky world where nothing's cheap, yield wins. Finding it is another matter. Even after suffering through 10 lean years, investors can't expect lush returns to come back.

The one must-have number for successful long-term investing If I’m looking for a long-term investment, though, I don’t start with any of that stuff of with any of the usual measures such as price-to-earnings ratios, earnings growth rates, PEG ratios, or price to book or price to sales. I start with ROIC—return on invested capital. I don’t think there’s a single number that tells investors more about whether they want to buy and hold a stock.  It’s also a good basis for lots of other investment decisions such as whether an acquisition is a good deal for shareholders or not. Return on invested capital tells investors how good a job a company is doing at investing their money in profitable opportunities. It tells investors how good the company is at finding those opportunities. And—this is crucial for long-term investors—it indicates how good a job a company is doing at compounding investors’ money be re-investing profits at a high or low rate of return. (ROIC isn’t the most common of financial measures but you can find it on the Internet at sites like that of my partner MSN Money and AOL Daily Finance.) One of the reason that stocks are such a great long-term investment—if you pick the right stocks—is that companies throw off cash from their operations that then gets re-invested by the company in those operations. Today’s profits compound over time to produce even more profits in the future. You want to own shares of a company with a high ROIC for the same reason that you want to put your cash in a savings account that pays a high rate of compound interest. Let me explain how this works and show you how powerful it is by looking at one of the best ROIC stories in Jubak’s Picks, MacDonald’s (MCD).

• Get your portfolio ready for the profitless global economic recovery So what should investors do about it? What’s “it”? The global crisis in profits caused by excess supply over demand.
• Can CEOs destroy shareholder value in an acquisition? Just watch them I call it destruction by acquisition. Forget the synergies, the cost-savings, the cross-selling that CEOs tout when they announce one of these deals. Too many of the huge merger and acquisition (M&A) deals struck in the second half of 2009 and that are still being struck will take money out of shareholder pockets this year and for years to come.

Do the new Coke and the new PepsiCo both fail the taste test? It’s a signal of how the market for soft drinks has changed that both PepsiCo and Coke see the advantages of having more control over their distribution as now outweighing the cost to their profit margins from owning these distributors. In the case of Coke, for example, after the deal about half of its revenue will come from the lower margin bottling and distribution business. All of Coke’s very impressive financial numbers such as operating margin and return on invested capital will compress. The company won’t be nearly as profitable. Think about what that says about how the management of Coke and of Pepsi see their business. They’re willing to savage their margins because unless they can get more control of their distribution system the long term consequences are reduced market share and slower growth.

Performance Analysis: Dupont, EVA/FCF and ROIC

Decoding DuPont Analysis Return on equity (ROE) is a closely watched number among knowledgeable investors. It is a strong measure of how well the management of a company creates value for its shareholders. The number can be misleading, however, as it is vulnerable to measures that increase its value while also making the stock more risky. Without a way of breaking down the components of ROE investors could be duped into believing a company is a good investment when it's not. Read on to learn how to use DuPont analysis to break apart ROE and get a much better understanding about where movements in ROE are coming from. To avoid mistaken assumptions, a more in-depth knowledge of ROE is needed. In the 1920s the DuPont corporation created a method of analysis that fills this need by breaking down ROE into a more complex equation. DuPont analysis shows the causes of shifts in the number. There are two variants of DuPont analysis, the original three-step equation, and an extended five-step equation. The five-step, or extended, DuPont equation breaks down net profit margin further. From the three-step equation we saw that, in general, rises in the net profit margin, asset turnover, and leverage will increase ROE. The five-step equation shows that increases in leverage don't always indicate an increase in ROE.

• DuPont analysis

Stop using P/E ratios! Use EV / Unlevered FCF. The problem with using P/E is that it is a totally incomplete way to measure the value of an entire company.  The method alluded to by the hedgie in the video is what I will spend the rest of this post explaining. The “P” in P/E is just the stock price, which is the value of one share of the company’s equity.  Equity and nothing else.  What about the rest of the balance sheet? (unless you’re totally familiar with the concept of a company’s equity value, please read the prior 2 parts of this tutorial series before moving on.) So if the “P” in P/E ratios is an incomplete, is there a better way to measure company valuation?  Yes, it’s called “Enterprise Value,” or “EV” for short.  Again, the problem with “P” is that it measures equity value only.  When you buy a company, you aren’t just buying it’s equity.  You’re buying the whole balance sheet.  And that includes the company’s obligations.  And its assets…. EV = Market Value of Shareholder’s Equity + Company Obligations – Cash – Long-Term Investments.  The more cash and investments on the balance sheet, the lower my cost to buy the company, which is a good thing. But if I own the whole company, I also own its obligations, which means I may have some control over the mix of equity and debt used to finance operations.  If readers will pardon the use of a technical term, what I need to replace the “E” in the denominator is a measure of earnings that is capital-structure neutral.  In other words, what is the cash being generated by the business before I have to pay things like interest on my debt? That’s easy, it’s the company’s unlevered free cash flow. We want a “capital-structure neutral” measure of cash flow because we’re valuing the business BEFORE determining whether to fund our acquisition with debt. That’s easy.  Just add back interest expense to FCF.  Don’t forget to adjust for taxes.  Because interest is tax deductible, if we stop paying interest, we stop saving money on our taxes.  The formula is now complete: Unlevered FCF = Cash Flow from Operations – CapEx + [Interest Expense * (1 - company's tax rate)]

The Best Way to Measure Company Performance Most Wall Street analysts and investors tend to focus on return on equity as their primary measure of company performance. Many executives focus heavily on this metric as well, recognizing that it is the one that seems to get the most attention from the investor community. But is it the best metric? Even though more sophisticated valuation techniques like IRR, CFROI, and DCF modeling have come along, ROE has proven enduring. At one level, this makes sense. ROE focuses on return to the shareholders of the company. If you are a shareholder, this gives you a quick and easy to understand metric.But ROE can obscure a lot of potential problems. These issues with ROE led us to pick a different bottom-line metric for corporate financial performance when we constructed our Shift Index last year. We focused on a metric that receives far less attention from executives and investors alike — return on assets (ROA) — to analyze long-term profitability trends across all public companies in the US. Return on assets avoids the potential distortions created by financial strategies like those mentioned above. Long-term ROA trends highlight the importance of capability leverage options. Our Shift Index revealed that since 1965 all US public companies experienced sustained and significant erosion in ROA — dropping by 75%. Mounting economic pressures are largely obscured by the metrics and time frames we use. This doesn't just reflect the current economic downturn. These longer-term trends suggest our traditional approaches to business are fundamentally broken. This decline is occurring in spite of a movement to more asset-light business activities and the absence of a crucial asset from the balance sheet — the talent of the workforce.

Return On Invested Capital - ROIC Return on invested capital, or ROIC, is arguably one of the most reliable performance metrics for spotting quality investments. But in spite of its importance, the metric just doesn't get the same level of interest and exposure as, say, the P/E or ROE ratios. Admittedly, investors can't just pull ROIC straight off a financial document like they can with better known performance ratios; calculating ROIC requires a bit more work. But ROIC is well worth the effort for those eager to learn just how much profit and, hence, true value a company is producing. Important mainly for assessing companies in industries that invest a large amount of capital - such as oil and gas players, semiconductor chip companies, and even food giants - ROIC is a telling gauge for comparing the relative profitability levels of companies. For many industrial sectors, ROIC is the preferred benchmark for comparing performance. In fact, if investors were forced to rely on a sole ratio (not a good idea, mind you), they would be best off choosing ROIC. Defined as the cash rate of return on capital that a company has invested, ROIC shows how much cash is going out of a business in relation to how much is coming in. In an nutshell, ROIC is the measure of cash-on-cash yield and the effectiveness of the company's employment of capital. At first glance, the formula looks fairly simple. But in the complex financial statements published by companies, generating an accurate number from the formula can be trickier than it appears. To keep things simple, start with invested capital, the formula's denominator. Representing all the cash that investors have put into the company, invested capital is derived from the assets and liabilities portions of the balance sheet as follows: If the final ROIC figure, which is expressed as a percentage, is greater than the company's working asset cost of capital, or WACC, the company is creating value for investors. Moreover, ROIC helps explain why companies trade at different P/E ratios. The market demonstrates this well. From 1999 to 2003, the S&P 500 average P/E ratio fell roughly from 25 to 15, so the S&P 500 was trading at a discount to its historical multiple - does that mean the S&P 500 was oversold? Some market watchers thought so, but ROIC-based analysis suggested otherwise. Although the P/E ratio diminished, there was also a proportional reduction in the market's ROIC. This makes a lot of sense: since 1999 companies had had a much harder time allocating capital to worthwhile projects.

• Spot Quality With ROIC
• Measuring Management Moxie

Business Performance in the New Normal

Daimler Analysis: FT reporters introducing their interview with Dieter Zeitsche of Daimler Benz. Zeitsche’s Interview, Long/Short

Lessons from Lincoln Electric While factories across North America have shut their doors since the start of the recession, Cleveland-based manufacturer Lincoln Electric has thrived for more than a century without laying off one single employee. How did they do it? BNN speaks to Frank Koller, author of "Spark: How old-fashioned values Drive a Twenty-first Century Corporation." Part Two.

Companies’ Net Worth Falls Again The Federal Reserve’s latest flow of funds report offers a clue for those trying to understand why banks often don’t want to lend to businesses: By some measures, businesses’ finances are still deteriorating. In the fourth quarter of 2009, nonfinancial corporate businesses’ net worth — what they have minus what they owe — declined 1.9%, notching its ninth straight quarter of contraction. The main driver of the drop is companies’ real-estate holdings, which tend to include things like land, warehouses and offices that have kept falling in value even as residential real estate has rebounded a bit. One problem with the fall in net worth is that it can drive a wedge between the interests of a company’s owners and its creditors. With less to lose, the owners might be willing to take on more risk in the hopes of making big gains. The creditors, by contrast, are more likely to take a bigger loss if the owners’ bets go wrong. Consider, for example, a guy who bets $11 on a horse that pays double if it wins, $1 of his own money and $10 borrowed at 10% interest. In the best case, he makes $10; in the worst, he loses $1, with the creditors taking the rest of the hit.Those odds can make bankers wary of lending to anyone, a problem noted long ago by economists Ben Bernanke and Mark Gertler, who developed a concept known as the “financial accelerator” to describe how such lending problems can aggravate economic downturns. If the latest data on bank lending are any indication, the accelerator could still be engaged: As of the end of 2009, total bank lending to businesses — known as commercial and industrial lending — was down 18% from a year earlier.

Leadership Trends for 2010 Two results from this year's Best Companies for Leadership survey, conducted by Bloomberg BusinessWeek and Hay Group, stood out. First, the Top 20 companies this year are significantly more likely to be primarily focused on "positioning for the future" than other companies. The behavior of these companies indicates they believe the recession is over. Their focus is on seizing the initiative as the recovery begins to gather momentum. These companies are innovating new strategies, tactics, and execution and are already working to gain a competitive advantage. Secondly, there is a revealing shift in what the top companies value in leaders. In last year's program, the quality that the Top 20 companies valued most in their leaders was execution—the ability of leaders to achieve results through others. This year, the most valued quality is strategic thinking. Last year's focus on execution was a clear reflection of the turmoil that virtually every business had to deal with. In the teeth of the recession, with workforce reductions and limitations in resources commonplace, forward-looking companies recognized the importance and value of simply maintaining focus and performance with some kind of consistency.

How Companies Develop Great Leaders At first glance, Zappos.com, the online retailer, appears to have little in common with General Electric (GE), the multinational conglomerate. Hit hard by the recession, GE is in the throes of scaling down its financial services subsidiary, GE Capital, by an estimated 40%. Zappos, on the other hand, is tapping into changing consumer habits and ramping up for 30% growth over the next 12 months. Yet surprisingly, these two organizations with their rapidly shifting environments face similar challenges in motivating and engaging their employees. For Zappos, it's about creating and maintaining passion in a call-center culture. For GE, it's about keeping people engaged in a changing climate. Named among the 20 Best Companies for Leadership in a recent BusinessWeek.com/Hay Group survey, both GE and Zappos put a premium on selecting, developing, and retaining strong leaders at every level. What sets them and the other companies on the list apart, however, is not just their emphasis on good leadership, but also how they approach it. They carefully tailor their developing leaders to fit their unique business strategies and organizational cultures.

• Best-Led Companies: Global management consulting firm Hay Group has identified the 20 best-led companies and the traits they have in common. BNN speaks to Rick Lash, Canadian practice leader for leadership and talent at Hay Group.
• Best Companies for Leadership Study, Selected Results From Best Companies for Leadership Survey,
• Life Sciences: A Tough Transformation, Retailers in the Top 20: Pathfinders for an Industry

Firms Map Routes to Recovery  Corporate America is emerging from the worst downturn since the Great Depression smaller and thriftier. To survive, companies have laid off millions of workers, closed hundreds of factories and vacated acres of office space. Like those who grew up in the Depression and still reuse sheets of aluminum foil, the experience has left them financially conservative and wary of risk. The road to recovery will likely be marked by slow and steady acceleration, rather than speed. Some companies will see opportunities to amass undervalued assets or steal customers. But it is unclear if their efforts will create enough new jobs to spark broader economic growth. More than 60% of the 1,000 chief executives surveyed by YPO Global, a network of 17,000 executives, expect their work forces to be the same a year from now. About 30% see an increase and 7% a decrease. Rather than hiring or adding capacity, some companies hope to use their accumulated cash to make bargain-priced acquisitions. Eaton, which has been on the sidelines for the past year, is looking for opportunities, says Mr. Cutler, its CEO. Other companies are positioning themselves in different ways. Heavy-equipment maker Caterpillar is preparing for the recovery by making sure its supply chain is ready to pick up pace quickly and smoothly.

At 3M, Innovation Comes in Tweaks In corporate research and development labs, staffers dream of creating sexy products. But at 3M Co., Chief Executive George Buckley is rallying his team to make cheaper respirator masks. It's part of a strategy for innovating in a weak economy at the maker of Scotch Tape, Post-it Notes and sandpaper. In addition, the CEO is under pressure to cut costs. So rather than push a few grandiose inventions, Mr. Buckley is asking staffers to improve products with tweaks and snips. Find innovations "at the bottom of the pyramid," he says. Many people "ask, 'What can I add?' Sometimes you have to ask, 'What can I take away?'" WSJ: You trimmed R&D spending but didn't slash it. Why? Mr. Buckley: If you don't invest in the future, there isn't going to be one. A lot of the stuff we spend on may not deliver a product for two or three years. There may be no return. But the alternative—not doing—is worse. WSJ: Where else did you scale back in order to shelter R&D? Mr. Buckley: Salespeople, and in some cases advertising and merchandising. WSJ: How do you get your R&D team excited about this? Mr. Buckley: When we first talked about going after this stuff at the bottom of the pyramid, a lot of them felt what was interesting was what was at the top. These people are turned on by things that are intellectually challenging. [We had to] convince them the intellectual challenge is making a real innovation that costs next to nothing. Initially it was hard for them to buy into. But once they bought into it they said, "You know what? We like it. You get volume, we get expansion. What's not to like?"

• Industrial Design - Part 1: To what extent does good design influence the success of a product? Headline looks at the importance of industrial design with Don Norman, co-founder, Nielsen Norman Group and former VP, Apple and author, "The Design of Everyday Things". Part 2, Part 3

Toyoda Rues Excessive Profit Focus Akio Toyoda said a key reason for Toyota Motor Corp.'s quality problems was an excessive focus on market share and profits among "some people" in the company, some of his bluntest words yet in assessing the flaws that led to widespread safety recalls. The Toyota president made the comments at a news briefing in Beijing, the last stop on a tour of apology and explanation over the company's quality woes that started in the U.S. last week. Mr. Toyoda, who returns to Japan Tuesday, used the briefing to reassure customers in China about the company's commitment to safety, a message he also delivered earlier in the day in a meeting with Chinese Minister of Commerce Chen Deming. Mr. Toyoda in his recent statements has repeatedly blamed excessive focus on growth for Toyota's woes, but his comments Monday were more pointed. Toyota's rapid expansion in recent years "attracted much praise from outside the company, and some people just got too big-headed and focused too excessively on profit," said the 53-year-old executive, a grandson of Toyota's founder. In Beijing, Mr. Toyoda said the company's misguided strategic focus warped what he called the "order of Toyota's traditional priorities" in car making: a stress on product safety and quality first, sales volume and cost second. That order changed when Toyota began expanding rapidly a decade ago. "There was a period we became too profit oriented," he said. Mr. Toyoda said he plans to ensure that Toyota restores the company's "traditional focus" under his watch—indicating he doesn't intend to step down over the quality problems.

• The Toyota Way Toyota's current crisis expands today from the technical...to the political. The automaker's top executive begins testifying before the U.S. Congress. Jeffrey Liker, co-author, "Toyota Culture: The Heart and Soul of the Toyota Way" takes a look at what we can expect on Capitol Hill.

Sears and the Role of Denial Sears convinced itself that its market was "saturated." The way to grow, therefore, was to enter whole new lines of business. The company bought the real estate franchise Coldwell Banker and the financial broker Dean Witter. Why the company's CEOs thought they would do better managing businesses in industries they did not understand than they would in general merchandise retailing remains one of life's mysteries. In fact, there was a fortune to be made in the very classes of trade in which Sears made its name. We know this—and everyone at Sears should have known it at the time—because Wal-Mart's spectacular success was no secret. Sam Walton had become the richest man in the world. He dressed in a grass skirt and did the hula on Wall Street itself in 1984 because Wal-Mart's stock had so outperformed what he had bet it would be. You had to be wallowing pretty deeply in denial to miss this. Sears executives should have been focused on nothing else. Instead, they were playing around with the "store of the future" and telling themselves they would succeed selling "socks and stocks."

Too Good to Fail Since its founding in 1868, Tata has operated on the premise that a company thrives on social capital (the value created from investing in good community and human relationships) in the same way that it relies on hard assets for sustainable growth. With every generation, Tata’s executives and managers say, they have nurtured and improved their capability for “stakeholder management”: basing investments and operating decisions on the needs and interests of all who will be affected. For Tata, this means shareholders, employees, customers, and the people of the countries where Tata operates — historically India, but potentially anywhere.“We may be among the few companies around the world who think and act first as a citizen,” says R. Gopalakrishnan, an executive director of Tata Sons Ltd., the privately held holding company of Tata, and a director of several Tata companies. Indeed, the primacy of citizenship — a philosophy associated historically with J.N. Tata — continues to be used as a corporate credo: “In a free enterprise, the community is not just another stakeholder in business, but is in fact, the very purpose of its existence.” If social benefits are one major goal of Tata’s strategies, another is rapid and continuing growth, in as many industries and venues as possible, on behalf of both philanthropic and fiduciary commitments. “We are hard-nosed business guys,” says Gopalakrishnan, “who like to earn an extra buck as much as the next guy, because we know that extra buck will go back to wipe away a tear somewhere.”

In fact while Radio and Television were, in their own rights, major innovations they were only locally disruptive. That is they displaced players and patterns but did NOT cause the entire ecology to be jump-shifted. Perhaps that's the source of the complacency but much of what's going on today was foreshadowed by work done at IBM in 1994-1996 when they came up with the whole e-Business schtick. In fact somewhere in my garage is the file of proposed new businesses that look a lot like everything you see around you! The catches are that IBM was, as usual, way to early and the rest of the world ignored the warning signs until the last 18 months or so. And is now scrambling to play catch up. The graphic is a composite of a vidclip the WaPo did at the WSJ's All Things D conference which has turned into one of the single best places to find out what's going on, what the players are thinking and doing and, especially in this context, how they are or are not adapting to the pressures for change.

It's All About the Value: Content and Delivery

There are three things that any Mediatainment company will have to do to survive and thrive. First, they have to have superb content that some customer set and marketspace wants. Second, they have to make it appealing, easy-to-use and powerful. By that we mean that it ties a lot of stuff together in an intuitive interface but links things into structured and coherent wholes. In the last 18 months or so you've watched everybody from Amazon to Hulu to the WSJ to Bloomberg rethink themselves.

Some have been more or less successful. For example some of the sliding icon dashboards that Amazon pioneered have been widely adopted, e.g. Business Week or the WSJ. But it reminds me of the early days of fungible fonts and laser printers - too complex, too much information, too hard to navigate, clutter for the sake of appearing to have stuff. That settled down after a while but most of the thinking has yet to be done. One example of a reasonable first pass, just to pick one, is PBS's Newshour. It still looks a bit like old school but is moving in the right direction, is unclutterred (somewhat anyway), easy to learn and takes you to some of the most powerful content around anytime you want it (and since it's dloadable, almost anyway). En passant we'll point out that when the online Journal looked like the print edition it was MUCH easier to use because there was a clear, consistent and in-depth Information Architecture with a 100+ years of history. The new version has yet to reach that level IOHO.

It's Really All About the Value: NextGen User Interfaces

Let's consider another example, this time from PBS's Video site which uses the sliding iconographics to take you to many of the subsidiary programs, many of which have their own well designed web sites as well as major sub-sections underneath the mothership. This is moving a tad beyond the Newshour's re-development, even though it preceded it but takes you to some of the most astounding content around. We use the example of Ken Burn's most recent special on the National Parks. Now Burns is Burns and everything he does is powerful, well done and set in context. In effect he's writing a history of America by finding and telling THE iconic set of issues, e.g. the Civil War, Baseball or Jazz, that allow him to explore things as a whole. He does the same thing with the National Parks program. We could go on but the real point for our purposes here is that this unparalleled content is readily available online anytime, anyplace (in fact we watch it over a wireless network remote from our network hookup). You could probably watch it on your iPad or iPhone having a latte' at Starbucks if you liked. We're not sure how downloadable it is though.

Now think about the contrast between the days when your only options were to catch it when it first ran, on a re-run or during fund raising or buy the VHS/DVD. And over time you can go back and catch what you missed or re-watch key programs that had information you want to be refreshed on. Properly architected a good new mediatainment resource creates an appreciating asset!

 Value Takes an Ecology: iTablet, Old/New Media, Content and Monetization?

Of course you might not want to watch a major, and spectacularly well photographed program on your tiny little iPhone screen. So, voila', we have the new iTablet. Ironically almost all the tecnorati punidotracy dismissed. On the other hand almost all the commentariat who have more of a design and users view of value think it's a game-changer. We happen to lean more in the latter direction because it satisfies the 4A criteria, it embodies a complete ecological solution from device to network to interface to content and it presents it all in an intuitive, powerful and easy-to-use way that will appeal to a lot of folks. The biggest barrier Apple and St. Steve will face here is that with the iPad (music), iTouch (video) and iPhone (phone) there was a completely predefined ecology including value propositions. What he did was put together a new and very disruptive solution in each case that was and is systematic and systemic.

Now they are tackling the definition and creation of a whole new ecology and that will be more challenging, risky and volatile. But this marketspace may in fact be at the point where it's past the early experiments with Tablets and e-Readers. So the real challenge will be to find, organize, structure and present content that people really want. And then, and this is the third major requirement, find a way to make it profitable. Needless to say the expectations are more than high but a repeat while be more problematic, take more time, will follow a "wavering" path and take serious resources. All of which Apple has, except for the content of course. Which explains why all the old media sees the iTablet as its savior.

The Life-cycle of Innovation and the Strategic Outlook

My buddies down at Gartner have been using some they call the Hype-cycle for years because of the tendency of the Technology Industry to over-sell the latest whizzbang and under-deliver. Many things that were oversold initially though eventually come thru and deliver big time. Remember relational databases? IBM came up with the concepts in the 60s but didn't deliver a viable commercial product until the early 90s. Meanwhile Oracle got to be Oracle by being the first to delivery a commercially effective RDMS. Now they run every major enterprise and organization on that planet - though it still took ten years after crossing the viability cusp point for almost everybody to figure out to do it right.

Anyway Gartner has been wrestling with the phenomenon for so long that they've come up with a standard architecture for analyzing it, evaluating each new technology and judging its strategic outlook. And on the whole, they've been pretty accurate. Whether they get it exactly right though is not as critically important as understanding how to understand, think thru and adopt the framework because it's very powerful. Take a careful look at this chart which shows the Hype-cycle status and the years to mainstream adoption of any given Technology. Consider Service Oriented Architectures, which are they under-pinnings to network-hosted business applications which are in turn the sine qua non of Cloud Computing. We've been talking about SOA for this entire decade and the roots go back ten more (almost) to e-Business and B2B inter-enterprise computing.

Whether you're a potential customer, an investor, a supplier, an employee or a potential user you really need to use this to evaluate things. Consider another example, Cisco's strategic plan envisions online video as a major driver yet Gartner thinks Telepresence is very early in the cycle. Or consider Social Networks - just passing the cusp of the downturn, which explains MySpace's problems and near-death as well as Facebook's mounting challenges. Now for our purposes here notice that Tablet Computing is not yet at the point of maturity required for true value creation yet for the iTablet to deliver on its promises is not just about the tablet per se but all the other pieces of the ecology.

Understand now why we see there are more challenges ahead than behind and why over-coming them is problematic? Yet as Old Media tries to re-tool itself, having ignored the problem until it couldn't anymore (in the readings you'll find some more stories, including the one about ABC News laying off most of its staff), it faces at least a decade or more of struggle to create content, deliver it and make money. And with lots of downside risks.

Content Wars: the New Campaigns

Welcome to Web 3.0 As excerpts from the annual conference show, we’re seeing the beginning of a new era in technology. Before the seventh D: All Things Digital conference, which took place last week in Carlsbad, Calif., we declared—with our tongues firmly planted in our cheeks—that Web 2.0 was over and Web 3.0 had begun. While we were poking fun at Silicon Valley’s incessant need to stick a hyped-up catchphrase on each and every development, the use of such jargon was actually important, because we think that the digital sector is now moving full bore into an entirely new cycle of profound change. As we wrote in our opening essay for the conference: ”So what’s the seminal development that’s ushering in the era of Web 3.0? It’s the real arrival, after years of false predictions, of the thin client, running clean, simple software, against cloud-based data and services.” The Apple iPhone and iPod Touch are the tip of this spear. It’s more than just those two products, of course, but it’s what they represent: the complete integration of computing into every part of our lives in a way that is seamless, ubiquitous and, ideally, dead simple. From using easy gestures to grab any piece of information from the Web to having powerful computers in the palm of your hand to being able to quickly dip into complex social networks to getting real-time information from across the globe as it happens, this is an era when computing could become as integrated and invisible as electricity and just as important. So what’s the seminal development that’s ushering in the era of Web 3.0? It’s the real arrival, after years of false predictions, of the thin client, running clean, simple software, against cloud-based data and services. The poster children for this new era have been the Apple iPhone and iPod Touch, which have sold 37 million units in less than two years and attracted 35,000 apps and one billion app downloads in just nine months. The excitement and energy around the iPhone and the Touch — and the software and services being written for them — remind us of the formative years of the PC and PC software, in the early 1980s, or the early days of the Web in the mid-1990s. It’s a big deal. But this is not just about one company, one platform or even one form factor. No, this new phenomenon is about handheld computers from many companies, with software platforms and distribution mechanisms tightly tied to cloud-based services, whether they are multi-player games, e-commerce offerings or corporate databases. Already Palm, Research in Motion, Nokia, Microsoft and others are hot on Apple’s tail. You will hear from them here at D. And a profusion of new devices, software development kits, app stores and cloud-based services has been announced in the teeth of the economic downturn. Some of these handheld computers will make phone calls, but others won’t. Some will fit in a pocket, but others will be tablets or even laptop-type clamshells. But, like the iPhone, all will be fusions of clever new hardware, innovative client software and powerful server-based components. And Media companies are on the case, too. You can already read The Wall Street Journal and other news sources, complete with photos and videos, on the iPhone, the BlackBerry and the Kindle, and new handheld devices are coming that are tailored to news. Our own AllThingsD iPhone app will be out by the time you read this. And consumers can stream radio and TV, and even follow live sports events, on pocket devices.

• Welcome to Lucky D7: Still Gambling on the Digital Future
• Off to D7: The More Things Change, the More They, Well, Are A-Changin’
• Twitter Guys: We’ll Still Be Running This Company in 5 Years
• AT&T CEO Randall Stephenson: “Wireless Is the Priority of This Business”
• Ticketmaster CEO Irving Azoff: How to Make Money While Music Becomes “Demonetized”
• D7 Tech Demo: Pure Digital
• Yahoo CEO Carol Bartz: We’re a Different Company Than Google
• Liberty Media’s John Malone: Video Will Be Everywhere, but Someone’s Got to Pay for It
• D7 Interview: RIM CEO Mike Lazaridis Says It’s Not a One-Size-Fits-All Business
• Interview: Olli-Pekka Kallasvuo and the Nokia N97
• Interview: Jon Miller and Owen Van Natta Say MySpace Needs to Innovate
• Interview: Mark Cuban
• Microsoft CEO Steve Ballmer: Bing!
• NBC CEO Jeff Zucker: Hulu Will Start Breaking Even “Soon”
• Washington Post Exec Katharine Weymouth: I Wish Our Headlines Were as Good as Huffpo’s
• Mozilla: In the Shadow of the “Don’t-Be-Evil Bulldozer”
• D: All Things Digital

Network News at a Crossroads ABC News is making no secret about what is behind the sweeping staff cuts it now faces: raw survival instinct. “I just looked out at the next five years and was concerned that we could not sustain doing what we were doing,” said David Westin, the president of ABC News, as he explained the decision last week to jettison up to 400 staff members, a quarter of the news staff, in the coming months. The same compelling motive already instigated strategic retrenchment at ABC’s broadcast competitors. NBC, the one network with a cable news channel, MSNBC — and, not coincidentally, the only network in a sound position of profitability — has drastically pared down its operations over the last few years. So has CBS, which is losing money already and has cut about 70 jobs this year. But with news available more places than ever, on cable channels and Internet sites, and with revenue challenged by heavy dependence on shrinking advertising dollars, the future for the news divisions at ABC and CBS remains deeply insecure.  “Long term, it’s going to get harder for these guys to exist as they are currently constructed, with the exception of NBC because it can offload the costs on MSNBC,” Michael Nathanson, an industry analyst for Sanford C. Bernstein & Company, said. The economic problems facing ABC News and CBS News in many ways mirror those faced by newspapers, which have been similarly afflicted by a drop in advertising revenue. The reaction — severe cuts in personnel and other costs — also looks to be the same. But can you shrink your way to prosperity? Andrew Heyward, the former president of CBS News who is now a news media consultant (NBC News is one client), said of the ABC cuts: “The real issue after this is what is going to drive growth? How do you generate more profit? And this doesn’t address that.” The easy answer would seem to lie in NBC’s structure, because in contrast to its competitors, that news organization is flush, making an estimated $400 million in profit a year. “We actually think we have a completely different model,” Steve Capus, the president of NBC News, said. That model: win every significant ratings competition on the broadcast side and rely on MSNBC’s revenue stream of advertising plus cable subscriber fees to subsidize the high costs of news gathering. The effectiveness of that formula inevitably resurrects predictions that a marriage with a cable news organization is imperative for CBS and ABC. The obvious partner is CNN, and both those networks have been in courtships with it before. To date, the cultural challenges have been insurmountable. CNN, which says last year was its most profitable since its founding in 1980, would seem to have little incentive to rush to the aid of a network. And neither network wants to cede editorial control to CNN.

• Deal Will Put Times Content on 850 Screens
• Condé Nast Is Preparing iPad Versions of Some of Its Top Magazines
• Survey Finds Slack Editing on Magazine Web Sites
• Math of Publishing Meets the E-Book

TV Apps Take a Cue From iPhone A longtime quest to bring the Internet to the living room has entered a new phase, borrowing a page from Apple Inc. and its iPhone. Companies are now racing to build marketplaces for TV programs that act much like iPhone apps, able to interact with social-networking services, play games, call up movies and other Web content—all using a remote control, rather than a computer equipped with browsers. The TV applications are designed to exploit new consumer electronics devices with Internet connections that are beginning to appear in homes in significant numbers. Exhibitors at this week's Consumer Electronics Show are promoting rival technologies for creating such software and helping users manage their many options on TV screens. Big players from the computer industry also are playing a role. Yahoo Inc., for example, was an early contender with a technology for TV applications it calls widgets. Vizio Inc., a U.S. TV maker that has been pushing Internet-connected sets, was among the first to use the term apps for TV software. Besides using Yahoo's widgets, the company worked with Adobe Systems Inc. to adapt the popular Flash format to offer a second ways for developers to write TV apps. Matthew McRae, vice president of Vizio's product group, says buyers of its TVs currently can choose from among 25 to 30 applications. "We will exit the year in the hundreds of applications," he says. Such efforts have been evolving for more than a decade. Microsoft Corp., for example, in 1997 purchased WebTV Networks Inc., which sold a set-top box with a browser that allowed users to call up Web sites. That model didn't catch on. TVs at the time weren't good at handling text-heavy sites, which were also designed to be called up using keyboards—an option in few living rooms. Web browsers also were seen to be too much like computer software and not enough like TV-style entertainment. Things changed, gradually. Internet video services began drawing large audiences of PC users. Home users signed up for broadband data services and snapped up high-definition TVs that handle digital content well. Most recently, a new generation of TVs, gaming machines and devices that play Blu-ray disks began appearing that have Internet connections. What is still missing is the equivalent of Microsoft Windows for the living room, a widely accepted way to write programs that appear and act the same on most TVs. But many companies are trying. Yahoo in August 2008 announced its plans for widgets—a format for simple programs that appear on a strip at the bottom of a TV screen while traditional programming plays above. It lined up four initial TV makers and tested the widgets to make sure they don't cause technical problems with TVs.

Yahoo Widgets Lend Brains to Boob Tube  Your television set may be the most expensive, eye-catching piece of electronic equipment in your home, but compared to a computer with Internet access, it's just a dumb box. With their low-tech IQs, TVs encourage a lot of family-room multitasking: While watching the big screen TV, lots of people are looking away to surf the Web with the computer on their lap or the mobile device in their hand.I've been testing the Yahoo Widget Engine on a 46-inch Samsung TV, and I found it to be a lot of fun to use. It's easy to navigate, thanks to special color-coded shortcuts on the TV's remote control, and I didn't have to abandon the show I was watching to look up a few things online. Widgets, which are small, easily downloadable computer applications, typically expand to a semitranslucent, overlaying panel on the left, or your program can be resized so you don't lose any of the picture. If you're reading this and thinking that Internet on the TV has been tried before with limited success, you're right. For years, companies have designed external boxes that bring some form of the Web to your TV. These include Microsoft Corp.'s Xbox, Apple Inc.'s Apple TV and some features of TiVo. But the Yahoo Widget Engine differs from these boxes in two ways. First, Yahoo's widget system works simultaneously with your TV programming, so you don't have to turn off the college basketball game to pull up a news story about a star player. Second, it will include widgets with video content that directly compete with live programming. This second point is noteworthy because television manufacturers in the past have quashed applications with Web video content for fear of these programs competing with live shows. Yahoo says it won't block widgets from its Widget Engine, so you could, say, run a Showtime widget that plays an episode of "The Tudors" instead of watching a live show. The Yahoo Widget Engine follows a model that encourages developers -- even Yahoo's competitors -- to make widgets for its store-like Widget Gallery, where they will be available to download free directly on the TV. The system is similar to Apple's highly successful App Store for the iPhone, and, like iPhone apps, these widgets will take seconds to download and are fun to try. The Yahoo widgets will work across all enabled televisions, regardless of manufacturer.

Hadoop, a Free Software Program, Finds Uses Beyond Search In the span of just a couple of years, Hadoop, a free software program named after a toy elephant, has taken over some of the world’s biggest Web sites. It controls the top search engines and determines the ads displayed next to the results. It decides what people see on Yahoo’s homepage and finds long-lost friends on Facebook. It has achieved this by making it easier and cheaper than ever to analyze and access the unprecedented volumes of data churned out by the Internet. By mapping information spread across thousands of cheap computers and by creating an easier means for writing analytical queries, engineers no longer have to solve a grand computer science challenge every time they want to dig into data. Instead, they simply ask a question. “It’s a breakthrough,” said Mark Seager, head of advanced computing at the Lawrence Livermore National Laboratory. “I think this type of technology will solve a whole new class of problems and open new services.” The MapReduce technology makes it possible to break large sets of data into little chunks, spread that information across thousands of computers, ask the computers questions and receive cohesive answers. Google rewrote its entire search index system to take advantage of MapReduce’s ability to analyze all of this information and its ability to keep complex jobs working even when lots of computers die. MapReduce represented a couple of breakthroughs. The technology has allowed Google’s search software to run faster on cheaper, less-reliable computers, which means lower capital costs. In addition, it makes manipulating the data Google collects so much easier that more engineers can hunt for secrets about how people use the company’s technology instead of worrying about keeping computers up and running.

Social Networking Sites Extend Reach Social-networking sites like Facebook and MySpace are popular services on high-end cellphones like the iPhone and the BlackBerry. But extending their reach to the broader wireless market has been challenging, because most basic phones tend to have clunky Web browsers and can't support fancy software. Now, handset makers and wireless carriers are ramping up efforts to tap the mass market. Manufacturers such as INQ Mobile Ltd. and Samsung Electronics Co. are rolling out midrange cellphones tailored to social-networking software, with some features of smart phones but lower prices. Carriers including AT&T Inc. and Sprint Nextel Corp. are trying to improve access to the services by upgrading browsers on regular cellphones and integrating Web-based applications made by companies such as Intercasting Corp., whose Anthem service lets users monitor and update several networking and messaging services at once. Mobile email provider Good Technology Inc. said Wednesday it was acquiring Intercasting for an undisclosed sum. About 15% of the 25 million U.S. smart-phone users access social-networking Web sites "almost every day," compared with about 3.6% of users of more basic "feature phones," according to comScore M:Metrics Inc. Many smart-phone users download slick software that make it simple to upload Facebook photos or send updates by Twitter, the microblogging service. Lower-end phones don't have the memory or processing power to run such software. Developing new phones that can be priced for the mass market but include features of smart phones isn't easy. Hutchison Whampoa's INQ Mobile device comes loaded with Facebook software that ties into users' address books, but to keep the cost down it lacks smart-phone features like a full keyboard and large high-resolution screen.

Yet we can look back well over a 100 years to Joseph Pulitzer and his creation of a new media empire as the benchmark for how technology and media companies will have to adopt and adapt to this ecology. The fulcrum of his efforts was the widespread emergence of two disruptive technologies that changed the fundamental structure of the world's economy, more than at any time in human history, and more (relatively speaking) than now. Those technologies? The railroad and the telegraph. But the lever that created the world's first media empire was value - he focused on delivering news the way the new audiences wanted to see it, written in ways that were appealing and that gave value for money. Pulitzer's innovations defined and shaped how we view media ever since and offer us lessons for resilience that are still relevant today. This recent Newshour interview of a recent biographer is a clear summary of the man's ideas and impacts and is, IOHO, well worth the time of anybody concerned about the outlook for these industries.

Where's the Beef(Value): Old Media Mal-adaptations & Sclerosis

We've been saving this Doonsebury cartoon for a while just for this discussion. Take a good look at it and ask yourself what it's telling you. We find it funny, wry and sad. After all an emotional appeal for you to collect the family by texting them to get together to read the hardcopy has more than a certain edginess to it. But where's the value? The appeal is not to you the reader for what value you get for your time and effort. It's for the nostalgic preservation of something that's evolving away because new distribution technologies have disrupted the old ways of delivering newspapers.

Yet it's not just the newspapers that are struggling. In the readings section we've collected representative stories on newspapers, movie making, and TV in both the old and some new forms. For example the struggles studios are having with digital piracy and the sudden death of DVD profits as digital 4A access plays out. Given that over the last decade DVDs suddenly surged, completely displaced VHS and then nose-dived even more rapidly we'd have to say the new models have yet to emerge in sustainable forms.

The perfect bad example though of sacrificing new value for old shibboleths is NBC's handling of the new Leno show. Now at this point, in our gossipy media-centered world, everybody probably knows NBC decided to create a new show for Jay, gave Conan his old slot (otherwise his contract was up and he was gone), then canceled the new show because ratings were poor, moved Jay back to his old slot (because Conan's were worse) and had to pay Conan a serious separation payment. What you may not know is that one of the few bright lights was a new NBC cop show called "Southland" that was edgy, real, had good writing and was rapidly building an audience got abruptly put on hold to make room for Jay's new show. Coming full circle you could watch Southland on Hulu or now directly (all the old episodes) on TNT.

This is a perfect example of executive decision-making based on the old rules of the game that they grew up with and sacrificing new sources of value without even apparently thinking it thru because the simple rules told them to. What we all knew as a fiasco was actually a bigger fiasco and more revealing about deep structural problems than anybody has mentioned so far. Yet in the last decade a lot of the best new TV has been on HBO (Earth to Moon, Band of Brothers, Sopranos, Deadwood) and other cable networks (the Wire) where they made money thru a subscription model, targeting an audience that was willing to pay. Media companies make money either thru subscription or advertising (back to Pulitzer) and nobody's come up with anything new. Right now a lot of good writing is migrating to places where the business model works and is created something of a virtuous cycle. Good products create good value and people are willing to pay for good value.

Where's the Beef(Value): New Media Nextgen Edition

But least you think all of this is strictly limited to the old dinosaurs it turns out that Darwin's forces are working even faster in the new media. The graphic is taken from a Business Week cover story from several years ago that provided the same sort of breathless coverage and analysis of the new social media opportunities we used to see at the height of the Tech Boom. While discussing a real phenomenon it also is extraordinarily revealing and ironic, perfectly illustrating a major part of the problem.

As you all probably know by now after Fox vastly overpaid for MySpace they were never able to turn it into a sustainable and profitable business. The founders were shown the door after spending to much time on sex, drugs and rock-n-roll (literally) and too little time on actually building the business. Their replacements, recruited from Yahoo and other places, changed the business model by narrowing it down to a focus on music and related entertainment and trying to wrap it with a social media envelope. A value proposition and business model we saw absolutely no sense in. It was recently announced that they too are leaving. So in the meantime that leaves Facebook as the remaining "champion", right? Well guess what - they're having their own problems as well, have yet to make money and may even be for sale.

If Technology was the fulcrum for Pulitzer and value the lever then the Force that created an empire was business judgment and leadership. All of which seems to be sadly missing. If you go back and audit the last 20 years of the Tech business or the emerging Technotainment business you find the fulcrums are changing but no so much that the principles of good business do. What you also find is that value creation and business models, the levers, keep crumbling away because they aren't well built and that the Force (leadership and judgment) seem to be sadly lacking.

It's a Real Opportunity

Yet, as several firms like Apple or Google have shown us (and perhaps Yahoo again?), if you create something that has real value you can in fact make money. The part that BW did get write (and how ironic is it they almost went out of business and were bought out by Bloomberg, themselves an exemplar of how to leverage technology to create value, keep adopting and innovating and make money!) was the size of the opportunity. From a theoretical market analysis point of view thar's gold in them thar hills boys. But how to get it out?

Value Creation, the "Engine"  and the Technotainment Stack

The simple answer is that you have to create something that some markets are willing to pay more for than it costs you to make plus a return for re-investment. The complex answer is that that's hard to do. But again Apple seems to be a serial value innovator by focusing on just that point and driving it thru the entire stack of a total solution. That happens when the right device uses the right application to put the right content in the right place. And, of course, make sure that all the other pieces are in place efficiently and cost-effectively.

At the end of the day each of these major industries is betting on that value creation engine to drive them thru the next 10-20 years. After a decade of struggling to create a value engine IBM for example may have found it in the Smarter Planet initiative which exactly fits this model. The idea is to embed smart sensors in everything from streets to powerlines, collect the data, assemble and filter, use sophisticated applications to analyze and interpret it and present it in easy to understand and use ways for the users and consumers. Cisco thinks it's found three 4A engines to pull it into the future: Video, Collaboration and Virtualization. It may even be right, at least partially. But M&E and Consumer Electronics are struggling and the Technotainment sector is embryonic.

You can use this stack picture to analyze trends, players and opportunities. Each "cell", e.g. data communications for Tecnotaiment defines an opportunity. The question is who will go after it? Plenty of room for lots of key players but the health of any particular stack depends, ultimately, on whether somebody creates the value. Consider for example the Telecom Industry. Landlines are dying, Wireless is maturing and it's mobile applications and data services that will define their futures. Yet they don't create the equipment that runs their networks, the devices that run on them or the applications and content that are what their users are paying for. Take another example - Comcast bought NBC Universal - how does that work in this model? Well they have a network but is it suited to the delivery of 4A content? Not really. So how are they going to extend their capabilities and what investments will be required? And what content will they get from a network that creates value in the 4A world? NBC management having just created a double-backed fiasco. On the other hand they were also progenitors of HULU. And how are these people going to make money?

READINGS

Evolution of every medium

1.       Technicians who invented it, run it

2.       Technicians with taste, leverage it

3.       Artists take over from the technicians

4.       MBAs take over from the artists

5.       Bureaucrats drive the medium to banality

TV used to be driven by the guys who knew how to run cameras and transmitters. Then it got handed off to the Ernie Kovacs/Rod Serling types. Then the financial operators like ITT and Gulf + Western milked it. And finally it's just a job.Same thing happened to oil painting and it'll happen to your favorite slice of the web as well.

Joseph Pulitzer: Biography Tracks Rise of Media Empire Pulitzer was the central man who reshaped the American media. Others were involved in that, Hearst, his great imitator. But Pulitzer changed journalism entirely, in a way that all of our news consumption habits today, the very idea of purchasing news, the way it's written, the style it's written, the basis of a story being part of news are all gifts that Pulitzer gave to us and changed America and politics. And Pulitzer saw journalism as a means to reform -- it was an extension of politics -- by -- in a sense, shining the light on the dark recesses of government and exposing what was going on was a means of reform. Some of his greatest journalistic coups were, much like I.F. Stone in the 1950s, all he was doing was publishing publicly available information. For instance, he published the tax returns, which were then public information, of the richest people in Saint Louis, revealing that they claimed they had no money. And that's very much the kind of thing that Pulitzer would do, create a journalism that was talked about, instigate reform, and then cover the reform. The -- the Pulitzer magic was to begin to write about the urban world, particularly its lower class and its middle class, in a way that represented the interests. Before his time, newspapers were boring. You had to read the entire letter from London to find out the Crimean War was over. And the thing he kept telling his reporters was to pay attention to content. The -- the medium is not the message. It's what's in it. And if you read the journalism he inspired, it -- it never lost track of the fact that at its basis is a story. Much like the Dickens of his world, he -- everything had to have that narrative drive, that kind of colorful adjectives that drove people to read it. And I think that, in some ways, was the magic. He kept getting back to the story. And I think, in some ways, with the cacophony of sound we now have in multimedia presentations, we're losing that narrative thread that is what drives us to listen and read stories.

Millennials Study Captures Snapshot of Young America They are 18 to 29 years old. There are some 50 million of them, and they're often called the millennial generation. Today, they were the subject of a conference at the Newseum in Washington, D.C. The event, for which I served as moderator, coincided with the release of a comprehensive national study conducted by the Pew Research Center. Among its findings: Millennials are the most diverse generation in U.S. history. Only 61 percent are white, 19 percent Hispanic, 14 percent black, and 5 percent Asian. That contrasts with those 30 and older, a group that is 70 percent white. The study also found that millennials are voracious users of new technologies, from smartphones to social networking sites. When respondents were asked if they sleep with their cell phone nearby, 83 percent of millennials said they did, far more than their parents or grandparents. PAUL TAYLOR, executive vice president, Pew Research Center: Well, why this generation? Arguably, this is the most consequential generation of young adults, perhaps since the baby boomers, who famously made a lot of noise in the '60s and were part of a counterculture movement. This generation is also making a lot of noise. It made a tremendous amount of noise politically in 2008, when it voted more differently from older voters than at any time since the 18-to-20-year-olds have had a vote. And they turned out in very big numbers. Now, politically, they may be in a slightly different place 15 months later than they were then, but they have sent a message: We -- we intend to be involved in the political process. We have very strong views. They are more liberal than their elders. They are more Democratic -- capital-D Democratic -- than their elders. But, as your setup piece points out, they are very different in other ways as well: technology use. They are the edge of the sword, if you will. We're all going through a digital revolution. These young adults are getting there faster than the rest of us, and they're doing more -- more different things. And then they are -- they're tolerant. They're tolerant of new arrangements. They're tolerant of immigrants. They're tolerant of new family arrangements, gay couples raising children, interracial marriage. It -- it all seems natural to them. And, finally, just in terms of how distinctive they are, they are a very expressive generation. The new technology gives them the ability to go on a digital platform and say to their friends or the people they care about, here's what I'm doing right now. Here's a video of what I did yesterday.

Iron-Horse Stampede The railroad was born in Britain in the early 1800s as a means of transporting coal from mines to market. But proprietors of the early railways, such as the Liverpool & Manchester in Britain and the Baltimore & Ohio in the U.S., quickly discovered that people could also be profitably transported over great distances. The result was a revolution. The emergence of this new form of transport "enabled the migration of wide swaths of the population from land-based employment or subsistence farming to paid work for capitalist businesses," Mr. Wolmar says. This newly mobile labor force ranged far afield, supplying manpower for a host of new industries. The transforming effect of railroads ranged into the world of finance as well. Vast amounts of capital were required to build locomotives and freight and passenger cars, to lay down track, to acquire land, to build stations, to buy fuel, to pay wages. Railroad barons like Cornelius Vanderbilt became major players on Wall Street, while financiers like Jay Gould, J.P. Morgan and E.H. Harriman found themselves drawn into the railroad business. By the end of the 19th century, railroads were ubiquitous. Railway managers scoffed at the notion that the newfangled horseless carriage might cut into their business. Mr. Wolmar quotes one particularly clueless executive on the subject: "The fad of automobile riding will gradually wear off and time will soon be here when a very large part of the people cease to think of automobile rides." That comment was made in 1916. Four years later, railroad traffic in the U.S. peaked at 1.2 billion passengers. By the 1930s the Iron Horse was in serious decline, thanks to the internal combustion engine. The railroads shifted from steam power to electricity and diesel engines, but it was too late: Competition from cars, trucks, buses and airplanes cut deeply into their business. More recently, passenger service has mounted a comeback in much of the world, thanks in part to the popularity of high-speed rail

Content Wars: the Old Disruptions

Can Computer Nerds Save Journalism? A cadre of newly minted media whiz kids, who mix high-tech savvy with hard-nosed reporting skills, are taking a closer look at ways in which 21st century code-crunching and old-fashioned reporting can not only coexist but also thrive. And the first batch of them has just emerged from Northwestern University's Medill School of Journalism. Programmers and journalists may seem like strange bedfellows; many criticize the Internet for the layoffs, buyouts and bleeding bottom lines that characterize the news business today. But, as emphasized by a report released last month by PricewaterhouseCoopers and the World Association of Newspapers, traditional news outlets must "cross the digital abyss" if they wish to survive. The problem, of course, is scraping together the capital to invest in new technologies. "While the core skills of journalism will always be solid reporting and clear writing, it's not just about storytelling anymore," says Berkeley's director of new media Paul Grabowicz. He adds that although some old-school media companies may be "slow" or "hesitant" — or too broke — to hire techies, they will be forced to do so in order to compete with more entrepreneurial ventures. Boyer, the original hacker journalist, prefers to put it differently, likening the paradigm shift to the old adage that if you can't beat 'em, join 'em. "If the source of the tumult in the news business is technology," he says, "then journalism needs more nerds."

A Reporter Faces the Naked Truth  A couple of years back, around the time he was turning 50, Michael Precker was in his prime as a journalist. He'd never imagined himself doing anything else: "I knew in seventh grade I wanted to be a newspaperman." A graduate of Columbia Journalism School, he was a foreign correspondent for 11 years in the Middle East and wrote feature articles on countless subjects for the Dallas Morning News. One year, the paper nominated him for a Pulitzer Prize. Now he has a new job: running a strip club. "I feel lucky," he says. Mr. Precker's career adjustment reflects the recent chaos of the newspaper business. It happened in 2006. Back then the industry was already pretty far along in its path to today's never-ending reports of bankruptcies and layoffs. His decision to take the buyout and join the strip club surprised some at the Morning News. "He's probably the last guy anyone would have expected to become the manager of a topless joint," says columnist Steve Blow, a 30-year veteran of the Morning News. "He was a family man, a truth seeker, a serious journalist who covered the Middle East for us and then came back and wrote lifestyle stories about every subject imaginable." Now he's serving as an all-purpose manager of the 12-year-old establishment, called the Lodge. Mr. Precker's new employer offers upscale food in a plush setting replete with a business center. Last year it won "Best Overall Club" at the Gentlemen's Club Owners Expo in Las Vegas. "If you disapprove of the entire genre, then they all seem the same," says Mr. Precker. "But at the Lodge, class and elegance and integrity are very important to us." With a laugh, he adds, "Obviously, I have drunk the Kool-Aid."At the Lodge, Mr. Precker writes speeches for Ms. Rizos as well as advertising copy. He has given the club a new slogan: "For the finer things in life." The old one: "Where a man can be a man." Ms. Rizos says Mr. Precker combines "great intelligence and writing ability" with a willingness to handle operational duties. This week, for instance, he wrote a press release about the guest appearance of a burlesque star named Tiny Tina. Then he drove to the airport to pick up the 3-foot-9-inch entertainer. For his part, Mr. Precker takes pride in how the club treats its dancers. He says Ms. Rizos encourages them to go to college, even pays tuition in some cases, and lectures them that, like professional athletes, they need to prepare for a second career.

The MySpace Generation You have just entered the world of what you might call Generation @. Being online, being a Buzzer, is a way of life for Adams and 3,000-odd Dallas-area youth, just as it is for millions of young Americans across the country. And increasingly, social networks are their medium. As the first cohort to grow up fully wired and technologically fluent, today's teens and twentysomethings are flocking to Web sites like Buzz-Oven as a way to establish their social identities. Here you can get a fast pass to the hip music scene, which carries a hefty amount of social currency offline. It's where you go when you need a friend to nurse you through a breakup, a mentor to tutor you on your calculus homework, an address for the party everyone is going to. For a giant brand like Coke, these networks also offer a direct pipeline to the thirsty but fickle youth market. Preeminent among these virtual hangouts is MySpace.com, whose membership has nearly quadrupled since January alone, to 40 million members. Youngsters log on so obsessively that MySpace ranked No. 15 on the entire U.S. Internet in terms of page hits in October, according to Nielsen//NetRatings. Millions also hang out at other up-and-coming networks such as Facebook.com, which connects college students, and Xanga.com, an agglomeration of shared blogs. A second tier of some 300 smaller sites, such as Buzz-Oven, Classface.com, and Photobucket.com, operate under -- and often inside or next to -- the larger ones. Although networks are still in their infancy, experts think they're already creating new forms of social behavior that blur the distinctions between online and real-world interactions. In fact, today's young generation largely ignores the difference. Most adults see the Web as a supplement to their daily lives. They tap into information, buy books or send flowers, exchange apartments, or link up with others who share passions for dogs, say, or opera. But for the most part, their social lives remain rooted in the traditional phone call and face-to-face interaction. The MySpace generation, by contrast, lives comfortably in both worlds at once. Increasingly, America's middle- and upper-class youth use social networks as virtual community centers, a place to go and sit for a while (sometimes hours). While older folks come and go for a task, Adams and her social circle are just as likely to socialize online as off. This is partly a function of how much more comfortable young people are on the Web: Fully 87% of 12- to 17-year-olds use the Internet, vs. two-thirds of adults, according to the Pew Internet & American Life Project.

Digital Pirates Winning Battle With Studios On the day last July when “The Dark Knight” arrived in theaters, Warner Brothers was ready with an ambitious antipiracy campaign that involved months of planning and steps to monitor each physical copy of the film. The campaign failed miserably. By the end of the year, illegal copies of the Batman movie had been downloaded more than seven million times around the world, according to the media measurement firm BigChampagne, turning it into a visible symbol of Hollywood’s helplessness against the growing problem of online video piracy. The culprits, in this case, are the anonymous pirates who put the film online and enabled millions of Internet users to view it. Because of widely available broadband access and a new wave of streaming sites, it has become surprisingly easy to watch pirated video online — a troubling development for entertainment executives and copyright lawyers. Hollywood may at last be having its Napster moment — struggling against the video version of the digital looting that capsized the music business. Media companies say that piracy — some prefer to call it “digital theft” to emphasize the criminal nature of the act — is an increasingly mainstream pursuit. At the same time, DVD sales, a huge source of revenue for film studios, are sagging. In 2008, DVD shipments dropped to their lowest levels in five years. Executives worry that the economic downturn will persuade more users to watch stolen shows and movies. “Young people, in particular, conclude that if it’s so easy, it can’t be wrong,” said Richard Cotton, the general counsel for NBC Universal. People have swapped illegal copies of songs, television shows and movies on the Internet for years. The slow download process, often using a peer-to-peer technology called BitTorrent, required patience and a modicum of sophistication by users. Now, users do not even have to download. Using a search engine, anyone can find free copies of movies, still in theaters, in a matter of minutes. Classic TV, like every “Seinfeld” episode ever produced, is also free for the streaming. Some of these digital copies are derived from bootlegs, while others are replicas of the advance review videos that studios send out before a release.

Who Threw the DVD From the Train? DESPITE the feverish attention on box-office results each weekend, the truth is that Hollywood stopped relying on the multiplexes to make money a long time ago. For over a decade, a motion picture’s caboose — DVD sales — has been the driver of its profitability. The DVD money has been so big that studio decisions about whether to green-light a movie have sometimes gone like this: Is this film going to draw interest at the box office? We’re not sure? Well, if it’s only a modest success, that’s O.K. We can count on consumers to toss the DVD into their shopping carts and make us whole. Who’s up for martinis at the Hotel Bel-Air? Now that train is reversing. Business at the multiplex is going gangbusters. Ticket sales are up 14 percent this year over the same period in 2008, according to the tracking firm Media by Numbers. Attendance is up 12 percent after falling the last two years. But according to studios, sales for some new-release DVDs are down a jaw-dropping 40 percent, hammered by the recession, a saturated market (on sale now: the complete ninth season of “Murder, She Wrote”) and a shift to Internet downloads. At least for the moment, Hollywood is heading back to the days when the theatrical run of a film was actually important for more reasons than serving as a marketing platform for home video. When executed correctly, Hollywood genre films — inexpensive movies that honor cinematic rules instead of defying them and stick to carefully defined categories — have tended to snag more than enough viewers to justify their modest cost. And lately they have been on fire. Hollywood insiders recoiled at the Sony film “Paul Blart: Mall Cop” until it started printing money at the multiplex. So far, this screwball comedy, made for $26 million, has sold $138 million in tickets and is still playing.But the movie that has studios the most jealous is “Taken,” a genre film from 20th Century Fox about a former C.I.A. agent on a quest to save his kidnapped daughter. It was produced for about $33 million and has sold $127 million in tickets (and counting) since its release on Jan. 30. This middle ground once represented the meat of the movie business but receded over the last decade as the industry pursued the fringes of the market — tiny specialty films and blockbusters — because of the huge DVD upside, among other things. Generally speaking, the middle just wasn’t where the smartest people wanted to play. The pendulum shift back to the big screen is changing that.

Do Studios Need Help Finding Audiences? Hollywood has a long and tortured history with marketers trying to break into the club. Every few years, a market research firm — usually a star in its primary field — sashays into the movie capital with big promises about building a better mousetrap and little understanding of the industry’s culture and process. Cut to fangs from filmmakers. ARSgroup’s fate could be very different, of course, and not only because it has so much experience. The company has something else going for it: timing. The six big movie studios, all suffering from a sharp decline in DVD sales, are scrambling to cut costs. Marketing is seen as the most bloated part of moviemaking. A summer blockbuster can easily carry a worldwide marketing budget of $150 million. ARSgroup executives talk about offering studios a “holistic testing package” — how well do stars, the script, the marketing plan and other creative elements stack up? “Do you spend that last $10 million of the marketing budget as insurance or do you save it to optimize profitability? That’s the kind of thing we answer,” Mr. Cox said. Still, is it smart to bring on pricey consultants when corporate overlords are demanding cost cuts? And what of the parade of failed attempts by consumer research firms to break into Hollywood? Few people in the industry can forget Tremor, the research firm that was owned by Procter & Gamble. It came to Hollywood in 2002, signed up with Creative Artists Agency and roped clients like DreamWorks — though its ideas often proved prohibitively expensive. “One of the biggest differences between movie marketers and consumer brand marketers involves timing,” said Richard Ingber, president of marketing at Alcon Entertainment. “Films have a very narrow window in which to succeed,” he said. “Products are designed to gain momentum while they live on the shelf.”

Broadcasters' woes could spell trouble for free TV For more than 60 years, TV stations have broadcast news, sports and entertainment for free and made their money by showing commercials. That might not work much longer. The business model is unraveling at ABC, CBS, NBC and Fox and the local stations that carry the networks' programming. Cable TV and the Web have fractured the audience for free TV and siphoned its ad dollars. The recession has squeezed advertising further, forcing broadcasters to accelerate their push for new revenue to pay for programming. That will play out in living rooms across the country. The changes could mean higher cable or satellite TV bills, as the networks and local stations squeeze more fees from pay-TV providers such as Comcast and DirecTV for the right to show broadcast TV channels in their lineups. The networks might even ditch free broadcast signals in the next few years. Instead, they could operate as cable channels — a move that could spell the end of free TV as Americans have known it since the 1940s. "Good programing is expensive," Rupert Murdoch, whose News Corp. owns Fox, told a shareholder meeting this fall. "It can no longer be supported solely by advertising revenues." Fox is pursuing its strategy in public, warning that its broadcasts — including college football bowl games — could go dark Friday for subscribers of Time Warner Cable, unless the pay-TV operator gives Fox higher fees. For its part, Time Warner Cable is asking customers whether it should "roll over" or "get tough" in negotiations. The future of free TV also could be altered as the biggest pay-TV provider, Comcast Corp., prepares to take control of NBC. Comcast has not signaled plans to end NBC's free broadcasts. But Jeff Zucker, who runs NBC and its sister cable channels such as CNBC and Bravo, told investors this month that "the cable model is just superior to the broadcast model."

Leno Wars: Flounder, Flail & Fail

Leno's New Slot Shows Changing TV Landscape Not even Jay Leno, NBC's new 10 p.m. star, is particularly enthusiastic about the network's prime-time prospects. Executives Tuesday confirmed reports that they have locked Mr. Leno into a new contract and a new prime-time slot, as host of "The Jay Leno Show," an hourlong program in the mold of "The Tonight Show," every weeknight, beginning in next fall. The move is likely to slow the flow of cash and viewers from the network's faltering night-time programming block. But it amounts to an admission that NBC faces long odds for developing new hit shows. That exchange, and the acrobatics NBC performed to secure aid -- in the form of Mr. Leno's talk show -- reflect a tectonic shift in evening television programming, at NBC and across the television landscape. Scripted fare has become increasingly expensive and risky for the broadcast networks, which are suffering as advertising craters and audiences scatter to cable, digital video recorders and the Web. The networks are turning to cheaper-to-produce reality fare and live programs, like Mr. Leno's, in hopes that topical content will discourage "time-shifting" -- watching programs recorded earlier on DVRs, a practice especially prevalent in the 10 p.m. hour. Others who were circling Mr. Leno, including competing broadcast networks Walt Disney Co.'s ABC and News Corp. 's Fox, began adjusting their strategies Monday night, when news of Mr. Leno's decision to stay with NBC leaked out. Executives placed a flurry of calls to agents and studio chiefs, trying to poach top NBC writing and producing talent, arguing the network, a unit of General Electric Co., was moving away from scripted fare. News Corp. owns Dow Jones & Co., publisher of The Wall Street Journal. Rare as they may be these days, traditional prime-time hits mean windfall profits for a network. Successful prime-time shows command the highest advertising rates on television and produce the most lucrative "back-end" revenue streams, from international distribution, DVD sales and syndication. But the risks involved in developing and producing such shows are high, and fewer shows are able to command mass audiences anymore.NBC Universal Chief Executive Jeff Zucker says the Leno deal will provide considerable cost savings to the network, but that what's really driving it is "the fact that we had to acknowledge that prime-time viewing habits are changing."

• NBC Re-Evaluates 'Leno' Show
• O'Brien Mulls Leaving NBC

NBC's prime-time tragedy: Its business model "30 Rock" is NBC's critically acclaimed prime-time comedy starring Tina Fey, who plays the head writer for a fictionalized NBC late-night comedy show, and Alec Baldwin, the vice president for East Coast television and microwave programming, sent in from corporate headquarters to boost ratings by pandering to viewers' worst instincts. At its heart, "30 Rock" is a satire on corporate culture and the conventions of American business. But as self-parody, it can't hold a candle to the tragicomedy now playing out at the real-life NBC. NBC's late-night farce is emblematic of just about everything that is wrong with American business these days. It starts with the mind-set that puts short-term profit over long-term value creation. Unable to come up with something new and fresh, NBC's fallback -- like so much of American business -- was simply to do more of what worked, until it didn't. Truly great companies see themselves as part of a business ecosystem. They understand that their long-term success depends on having financially healthy suppliers and distributors, and take pains not to share gains and avoid profiting excessively at their expense. But NBC forgot that wisdom when it decided to go for a strategy of low-budget offerings in prime time that would maintain profitability at the expense of program quality or ratings. It turned out that the new strategy posed an existential threat to the independent studios and production houses that networks still rely on to create their entertainment programming. And the smaller audiences that NBC was willing to accept for Leno's 10 p.m. show translated into shrunken audiences for 11 p.m. news shows that generate as much as 40 percent of the revenue for local affiliates that are already reeling from the recession and competition from Internet advertising. There are many other lessons to be drawn from NBC's late-night debacle -- on the shortcoming of industrial conglomerates (GE), on the difficulty of old dogs learning new tricks (Leno), and surely the one about sacrificing old products to launch new ones (O'Brien). You could probably construct an entire business school class around this case study in mismanagement.

Turned On by TV Again TNT's cop drama "Southland" is like a hot date on a Saturday night. Just waiting for another episode to begin each week is a thrill, and once the show gets going the rush is like nothing else on TV. The word most often used to describe this show, set on the mean streets of Los Angeles and revolving around various pairs of patrol cops and detectives, is "gritty." But if that's all it was, far fewer people would be counting down the hours as "Southland"'s long-delayed second season approaches. Gritty suggests bad language, bad smells, rogue cops and lots of blood and gore. There's some of that here, but it's not what drives the action or defines the main characters. Grit cannot explain the quivering fear we feel when cops in mortal danger creep through a crime-scene house, their pistols drawn, their shotguns racked and their breath coming fast and shallow. Or the heart-thumping tension as they wade into an angry, roiling mob to extract fellow officers before they are ripped apart. What makes us experience the adrenaline of an animal in danger, and the exhilaration of escape? This kind of excitement isn't just a product of intricate, often hand-held camera work. Although many of the effects, from photography to music, can lift "Southland" into the realm of the cinematic, they are not what give the show its visceral appeal. It is the characters themselves, the people who have been cast to play them. Talent no doubt plays a large part, and writing. How to explain the alchemy, though, that has turned so much of "Southland" to gold? The anticipation is all the sweeter as the new season officially begins this week because the six coming episodes were left twisting in the wind when NBC yanked "Southland" off the air last year—citing its "darkness," but all as part of a plan to grease the path for the soon-to-bomb Jay Leno show at 10 p.m. "I'm glad it failed" Mr. McKenzie recently said about the now-canceled Leno show. Sounds like something Officer Sherman and, indeed, any of the "Southland" cops would say, too.

• Southland on TNT

Even Bad Boys Turn Good in Vancouver On Sunday night, the Peacock marooned the U.S.-Canada hockey game—a stirring affair, as it turned out—on MSNBC in favor of showing ice dancing, a sport that remains illegal to show in a Canadian bar. But the universe isn't run by hockey fans, especially not in 2010. The universe these days is run by 14-year-old girls—free-spending, trend-setting, social media-izing girls—and 14-year-old girls would rather see Mr. Pattinson's head shaved bald than watch two-plus hours of preliminary hockey. They aren't totally wrong. But we can't let these Cute Olympics get too cute. We're OK with a friendly Bode Miller, and we have a feeling that Mr. Miller will be OK with his gold medal. But we're a little concerned about these 14-year-olds and their Facebook petition to replace Bob Costas with Justin Bieber, and Al Michaels with a really cute guinea pig named Snickers.

New Experiments: Meanings, Means & Money

Top Playwrights Migrate to TV  To catch the latest work of a hot American playwright, there's no need to go the theater—just turn on the TV. Keith Huff, who wrote last fall's Broadway hit "A Steady Rain," just started a new job as a writer for the AMC show "Mad Men." Seven of the nine people writing the next season of HBO's "Big Love" are playwrights. Of the 200 applicants for writing jobs for an upcoming FX drama, "Lights Out," about an aging former heavyweight boxing champion, one in three were playwrights. "Theater is now viewed as a way of getting a staff writing job on TV," says Warren Leight, the show runner and developer of "Lights Out" who won a 1999 Tony Award for the jazz-inspired play "Side Man." "For a lot of guys now, it's a means to an end. And the end is, 'How do I make a living as a writer?'" Many playwrights say television is a good fit for their talents, since it is often driven by dialogue rather than by the visual effects that dominate film. Recent TV writers include critically acclaimed playwrights—such as Marsha Norman, the Pulitzer Prize-winning writer of "'night, Mother" who wrote for last season's "In Treatment" on HBO—and current theater darlings such as Jon Robin Baitz, who created ABC's long-running "Brothers & Sisters" and will debut a new play on Broadway next season. Playwrights have found a second home on TV before: David Mamet created "The Unit" for CBS, and widely produced playwright Theresa Rebeck has written for TV since the 1990s with shows such as "NYPD Blue." But some in the TV world say that the traffic from stage to TV has never been heavier than it is now—a result, in part, of the rise of more cable shows with literary aspirations and a TV marketplace that puts a premium on writers with original voices.

• 'Modern Family' Revives a TV Genre

Hulu who? After much confusion, it is becoming clear what works in online video. Until recently, says Shahid Khan, a video analyst at IBB Consulting, there were only question-marks. Did a new service need user-generated content as well as professional videos? Was it better to aggregate the content of many media companies or to be an outlet for just one? Would people prefer to download films or television shows to their computers, then transfer them to their iPods, as Apple was betting? Or would they prefer “streaming” a video just once? If so, might they be persuaded to install a bespoke video application onto their computers, or would they insist on watching videos inside their web browsers? Would they pay to watch, or would advertising provide the revenues? Almost every permutation has been tried. From Amazon to Apple, from Netflix to Joost, from ABC to CBS’s TV.com, companies old and young started serving videos over the internet. Into this mess Mr Kilar tried to enter with the service that was to be Hulu. The bloggers at first scoffed: it turns out that Hulu can mean “cease and desist” in Swahili. But then they started paying attention. Today, even though advertising is destined for a depression, Hulu appears to have clarified much of the confusion. Mr Kilar will not say what revenue or profit Hulu is making. But it seems to be successful by any measure. Although Hulu is still far behind YouTube (see chart), users have been flocking to it, watching 216m videos in December. Just as importantly, Hulu’s inventory for advertisers appears to be sold out. So Hulu is in the rare position of being able to increase inventory (through new content and more views) and make money from it. Hulu now has more than 100 advertisers, including big brands such as McDonald’s, Bank of America and Best Buy. It therefore appears that Mr Kilar has, in effect, answered a lot of the questions. He contemplated user-generated content, then decided that “the world didn’t need yet another” YouTube; so Hulu has only professional content, and advertisers love it. He also talked with his bosses at NBC Universal and Fox and agreed that aggregating the content of many was “something potentially much larger” than piping out the videos of just two. Hulu now offers content from more than 110 partners.

• Disney Climbs Aboard Video Site Hulu

The Unlikely Mogul Even for Hollywood, where long odds and high stakes are staples of storytelling, the plotline is a doozy: A couple of old business rivals facing the threat of a lifetime agree to put aside their differences and join forces on a half-baked experiment that makes them laughingstocks. (We're thinking Jack Nicholson and Warren Beatty.) And who do they put in charge? A young guy, a newbie to the biz. He promptly cleans house and hires an even younger guy who's halfway around the globe. These renegades throw out the rule book -- and they pull it off. Their idea kills. The naysayers feast on crow. This pitch meeting would not end well. Cue Ari Gold: Nobody'll believe it, not in a million years. Are you nuts? Get the %*#$ out of my office! Yet this is the tale of Jason Kilar and a company called Hulu, costarring the heads of NBC and Fox, with guest appearances by Andy Samberg, Tina Fey, Jeff Bezos, and Walt Disney. But we're getting ahead of ourselves

• All-Time Top 10 TV Shows on Hulu
• The Wild World of Web TV
• Second Life

Rise of Web Video, Beyond 2-Minute Clips When motion pictures were invented at the end of the 19th century, most films were shorter than a minute, because of the limitations of technology. A little more than a hundred years later when Web videos were introduced, they were also cut short, but for social as well as technical reasons. Video creators, by and large, thought their audiences were impatient. A three-minute-long comedy skit? Shrink it to 90 seconds. Slow Internet connections made for tedious viewing, and there were few ads to cover high delivery costs. And so it became the first commandment of online video: Keep it short. New Web habits, aided by the screen-filling video that faster Internet access allows, are now debunking the rule. As the Internet becomes a jukebox for every imaginable type of video — from baby videos to “Masterpiece Theater” — producers and advertisers are discovering that users will watch for more than two minutes at a time. The viral videos of YouTube 1.0 — dog-on-skateboard and cat-on-keyboard — are being supplemented by a new, more vibrant generation of online video. Production companies are now creating 10- and 20-minute shows for the Internet and writing story arcs for their characters — essentially acting more like television producers, while operating far outside the boundaries of a network schedule. Some are specifically introducing new shows this month with the knowledge that TV networks generally show repeats and reality shows over the summer. Yet TV networks get much of the credit for the longer-length viewing behavior. In the past two TV seasons, nearly every broadcast show has been streamed free on the Internet, making users accustomed to watching TV online for 20-plus minutes at a time. By some estimates, one in four Internet customers now uses Hulu, an online home for NBC and Fox shows, every month. “Dancing With the Stars,” the popular ABC reality show, draws almost two million viewers on ABC.com, according to Nielsen.

Is Facebook the new Wal-Mart? Given the way social networking has exploded on the Web, it was inevitable that one player would soon emerge as the Wal-Mart of the space.  By many measures, that's now Facebook. It's a giant, like Wal-Mart Stores  And as a one-stop shop that lets users easily build networks of friends to share news and photos, join groups and search for school and work buddies, it has the potential to bury MySpace, Classmates.com and other competitors the way Wal-Mart has busted local retailers. In fact, even giants Google Yahoo and Microsoft's MSN might be getting nervous, because tools such as instant messaging and e-mail are built right in. Facebook has sacrificed cool to go decidedly mainstream. Consider: Its traffic. In December, 108 million people, or 30% of the world's Internet population, visited Facebook, compared with 81 million who visited MySpace, according to Nielsen Media Research. Its users. Facebook now reports more than 175 million active users, compared with 130 million for MySpace, its closest direct competitor. "Facebook is eating MySpace's lunch," says Bill Douglass, a social-media strategist with Brainerd Communicators. Its value. Two years ago, based on the sale of 1.6% of its business to Microsoft, Facebook might have been worth $15 billion. The idea of linking people with common interests into online communities is as old as the Internet. But lately, social networking has exploded. Ratings company Nielsen recently reported that time spent on social networks and blogging sites had grown by 63% last December compared with a year before. Three of four adults in the U.S. now participate. Sites range from small, special-interest sites such as CafeMom to giants like MySpace and Facebook. Facebook began its path to the top when it decided to lift "college only" restrictions in 2006. The cool fell away as more "old people" showed up, says Andrew Foote of Cohn & Wolfe, a marketing firm. But "Facebook had to lose its exclusivity to become a 'big box retailer.'" In fact, older people are the ones flocking to Facebook right now.

"At its simplest, value investing tells us to buy when assets are cheap and to avoid purchasing expensive assets. This simple statement seems so self-evident that it is hardly worth saying. Yet repeatedly I’ve come across investors willing to undergo mental contortions to avoid the valuation reality."

"In his book on value investing, Marty Whitman says, “Graham and Dodd view macrofactors … as crucial to the analysis of a corporate security. Value investors, however, believe that such macrofactors are irrelevant.” If this is the case, then I am very happy to say that I am a Graham and Dodd investor. Ignoring the top-down can be extraordinarily expensive. The credit bust has been a perfect example of why understanding the top-down can benefit and inform the bottom-up. "

The chart is taken from that same white paper which is well worth your time along with a discussion of Shiller's CAPE without the cycle (What is the Cyclically Adjusted S&P500 P/E Ratio ? ), which finds that stocks have been tremendously over-valued for a long-time. Which is, as are the other points, entirely consistent with things we've been saying for years. The basic points we want to focus on is that you need to understand the macro-environment AND business performance, along with the notion that at current valuation levels the chances of a decent return for the next ten years are nil. The critical questions are what do you do about that?

Once More Into the Confusion: the Real Macro-environment

So, especially given that today saw revised GDP numbers come out, plus Housing (abysmal) and the week saw Durable Good, et.al., let's take yet another pass at benchmarking where we're at in the business cycle. In this graphic we combine both the data (YoY changes in GDP, Consumption and Employment) along with conceptual models of where we're at in cycle and what we're looking at going forward.

First off it should be clear that we've crossed the cusp of a recovery but, as expected, Employment is lagging and will be weak for years. If you want this week's high-frequency data to confirm that the Durable Goods Orders chart gives it to you. Second off all we've done is arrest the collapse and begun to move into the early stages of growth. We're a very long way from self-sustaining growth and the chances of serious growth are poor to non-existent. Any questions? 

The Answer Ain't 42: What's the Question Again?

As many of us know the answer to the ultimate question was 42, at least in Douglas Adams' world. In our world the question is what should we be looking for - and our answer is those businesses that can creat sustainble value over the long-term (and that we have opportunities to buy into at less than a full price). Since we're facing at least another decade of a volatile and fragile market that means there will be buying opportunities, as long as you don't get in when the PEs are over the top of course. It also means that you need to be building up a target list of potential candidates with good long term potential. That potential will not come from growth because this decade will ALSO see most industries facing worldwide excess capacity. Instead it'll come from those businesses that create value for their customers, establish and maintain a clear market position (call it branding if you like), build hard-to-duplicate operational capabilities (especially in supply chain management, customer service and core operations) and leverage technology in business-driven ways. 

Now we've put up several examples of very deep dives on various enterprises (Citi, Dell, WMT, Cisco, et.al.) to illustrate how to go about it but we want to revist one of our early favorites and on-going targets, Home Depot. In fact our strategic assessment for things to work on is in this graphic., first suggest in April07, re-visited in Oct07 and then again in Sep08. In that last post we found that HD was not only moving in the right direction, perfectly in line with our earlier suggestions, but had made substantial progress for as early in the game as it was. It seems like time to briefly re-visit them because they are "walking the talk" in multiple ways. In fact we're thrilled at the level of execution and operationality being shown and carried thru. They're strategically focused on customer value and carrying that down to the key operating areas of Merchandising and Store Operations, which is where a Retailer realizes that value in tangible form.

Value Focus, Store Operations and Customer Service

Under Nardelli's regime HD destroyed a decade's worth of accumulated good will and developed a terrible reputation for service, in contrast to the outstanding one they had. To get it back takes changes in the way they treat their employees, in floor operations, in the way they stock their stores, the way they replenish them and the IT support they provide. All of which seems to be in train and well along - and they are reporting honestly on their status as well as telling a darn good story.

In fact one of the most impressive things we see is that each major operating function tells the same story but taken down from the corporate level to the specific concerns of each key function. Now that's progress. In particular they seem to be changing from an inside-out, financial engineering approach (Nardelli) to an outside-in value delivery focus driven by enabling the store clerks to take care of the customers. And backing it up with training, process re-engineering and policy and procedure changes. Outstanding!

Integrated Measurement and Performance

What's even more, or equally, impressive, is that they developed their strategy based on value, translated that into effective capital investment decisions and are putting ROIC at the center of the enterprise results. But not at the center of their metrics. Instead each operating function is building it's own bottom-up metrics based on the things they need to do.

What we really like about this chart is two things. First, it starts with the overall enterprise guidelines, emphasizing discipline on an integrated set of value measures. Second, each function has its own metrics based on what they need to do to be in line. Here, reading clockwise, you see how process improvement in store operations puts more emphasis on time spent with customers, how transforming the Merchanising operations with regard to product strategy, mix and marketing impacts gross margin (a critical retail metric) and then how SCM operations contributes constructively. All based on metrics derived from the nature of each function. That is CRITICALLY important because the two biggest problems facing all businesses in this environment are short-termism and the tendency for each function to be run in isolation. These metrics tell us that "local" decisions are being made that integrate and balance short- vs. long-term and function vs. enterprise issues. NB: though not quite yet - a historical stock price composite,with PEs and earnings, chart is in the readings and HD is fully valued just now. But if we get the kind of correction we should get then...

Ultimate Question

The ultimate question is who will perform in this environment and it'll be folks who make these kinds of long-lasting strategic improvements and execute them. In other words as investor, stakeholder or other involved party what you need to be doing is finding those enterprises who can in fact not succumb to sclerosis but actually adapt to the "New Normal" and adopt the innovations they need to more than survive. We're going to suggest that HD appears to be one of those and somebody that goes on your long-term watch list.

In some alternate Universe the Earth was designed and built by a race of superior multi-dimensional beings as the most amazing super-computer designed to answer the Ultimate Question. The final piece, once those beings had the answer but having lost the question, was contained in one of the organic components - Arthur Dent's brain. All they had to do was remove and bring to a close almost 15 million years of research.

Well the conditions of the New Normal are going to go looking for the Ultimate Answer to the question of business performance in every nook and cranny. When the brains of the company are opened up what will be found? We've got even less choice than Arthur about all this - that saw is coming (actually it's here) and so far not many are turning out to have the right answers. (Complacency, Hubris and Sclerosis: Beyond GS to Real Performance). Herein lies you "ultimate answer"!

READINGS

Market Lessons, Economy & Policy

Montier: Was it all just a bad dream? Or, ten lessons not learnt James Montier, a member of GMO’s Asset Allocation Team, examines whether we learned anything from the market declines of 2008 and early 2009. In this paper - his first since joining GMO from Société Générale - he outlines ten of the lessons he believes not to have been learned. Here is the opening paragraph: “It appears as if the market declines of 2008 and early 2009 are being treated as nothing more than a bad dream, as if the investment industry has gone right back to business as usual. This extreme brevity of financial memory is breathtaking. Surely, we should attempt to look back and learn something from the mistakes that gave rise to the worst period in markets since the Great Depression. In an effort to engage in exactly this kind of learning experience, I have put together my list of the top ten lessons we seem to have failed to learn. So let’s dive in!” Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt (the GMO Whitepaper).

• What is the Cyclically Adjusted S&P500 P/E Ratio ? 

  Chris Turner took a look at Yale’s Bob Shiller “cyclically adjusted price to earnings ratio” (CAPE). Shiller uses an inflation adjusted S&P 500 Index (using simple monthly CPI data). The professor then divides that a 10 year average of trailing earnings (similarly CPI adjusted) earnings.Chris wanted to know what happens if we pull the Cycle out of the CAPE? (Chris’ paper is here).Short answer: You end up with a long term chart of inflation adjusted SPX valuation that implies the market, by Shiller’s metrics, has been overvalued (i.e, “Not Cheap”) for a long time.

  • CAPE Removed
• Technical talk: Expect more volatility for equities

Brisk 5.9 Percent Growth in Q4 Will Likely Fade The economy rocketed ahead at a 5.9 percent pace in the final quarter of 2009, stronger than initially estimated. But the growth spurt isn't expected to carry over into this year. The fresh reading on the nation's economic standing, released by the Commerce Department on Friday, was better than the government's initial estimate a month ago of 5.7 percent growth. It would mark the strongest showing in six years. Even so, it didn't change the expectation of much slower economic activity in the current January-to-March quarter. Roughly two-thirds of last quarter's growth came from a burst of manufacturing -- but not because consumer demand was especially strong. In fact, consumer spending weakened at the end of the year, even more than the government first thought. Instead, factories were churning out goods for businesses that had let their stockpiles dwindle to save cash. If consumer spending remains lackluster as expected, that burst of manufacturing -- and its contribution to economic activity -- will fade. The signs aren't hopeful. Consumer confidence took an unexpected dive in February. Unemployment stands at 9.7 percent. Home foreclosures are at record highs. And many Americans are still having trouble getting loans. Forecasters at the National Association for Business Economics predict the economy will expand at only a 3 percent pace in the first quarter of this year. The next two quarters should log similar growth, they predict.Unlike past rebounds driven by the spending of shoppers, this one is hinging more on spending by businesses and foreigners.

• 'Average GDP' in 2009 Worst Since 1946, Q4 GDP Revised to 5.9%
  

Housing Recovery Is Looking a Lot Shakier These Days The recent slump in housing is making some analysts uneasy about a recovery that many thought sustainable just a couple months ago and comes at a time when the Federal Reserve is nearing the end of a critical, year-long program to support the mortgage market."Housing is at a pivotal, ambiguous point," says Ted Gayer, co-director of Economic Studies at the Brookings Institution.A spate of recent reports from home sales to mortgage activity has been starkly negative. And, even if some of it can be written off to seasonal patterns, namely weather, the weakness is not what what people expected with the extension and expansion of the government's homebuyer tax credit that jacked sales for several months last summer and fall.New homes sales fell to a record low in January, extending a two-month slide; pending and existing home sales were down in December; homebuilder sentiment in January fell back to where it was last June, and mortgage applications have fallen three of the past four weeks. Even the optimists never expected a traditional housing recovery with unemployment stubbornly high, the consumer balance sheet still in repair mode and credit conditions stingy, but right now there's palpable worry about momentum-especially given a string of solid months in mid- to late-2009.

• Existing Home Sales... "Uh Oh" Edition,Existing Home Sales Decline Sharply in January, More on Existing Home Sales, Existing Home Sales losing the little mo it had
•  Freddie Mac: Delinquencies Increase Sharply in January, FDIC to Test Principal Reduction ,Underwater Home-Owers: Demand Principal Reductions

Govt. Interference Makes It "Almost Impossible" to Forecast Stocks, Strategist Admits There's no shortage of hubris and declarative statements on Wall Street, especially among the pundits and strategist types. Thus, it was refreshing to hear Miller Tabak equity strategist Peter Boockvar say "it's almost impossible to say where the market is going to go" in the short term. There's a very specific reason for Boockvar's apparent modesty: The overwhelming influence of policymakers worldwide, which he says has forced market players to become political scientists. "If I came into work every day focused on fundamentals, return on equity, economic data...company behavior, then I'd be able to tell you where I think the market is going to go," he says. "But we're all sitting around waiting to see how the market responds to...what the governments are trying to do to supposedly make things better."

China is misread by bulls and bears alike China specialists have known for a long time what the world suddenly seems to be discovering: that China’s national balance sheet contains much more debt, especially in the way of unstable contingent liabilities, than had been assumed. The first reaction is to conclude that China is on the verge of collapse. But this is based on only a partial understanding of the balance sheet. Yes, there is a lot more debt than many supposed, much of it collateralised by non-viable, illiquid assets, but liabilities are also a lot less liquid than we might think. Capital controls, a high savings rate and limited alternative investments will allow China to defend the domestic balance sheet while it works through the adjustment. Will China collapse? No. It may have a painful financial contraction, but this will not necessarily lead to a collapse in growth. Instead it will grind away at its overinvestment and excess capacity, which, with a reversal of the favourable demographics enjoyed since the mid-1970s, will slow growth sharply, but this will coincide with three more favourable circumstances.First, China will continue to urbanise rapidly, which will raise household income and create new sources of growth. Second, even as the workforce declines, increased education and infrastructure spending will raise worker productivity. Third, a sharp contraction will force Beijing finally to liberalise the financial system and transfer resources from the inefficient state sector to small and medium enterprises, increasing productivity. Chinese growth will almost certainly slow dramatically, but the country will nonetheless continue to grow faster than the rest of the world. Its share of global GDP will rise.

• The myth of China’s blithe consensus
• Never short a country with $2 trillion in reserves?
• Rising wages in China are a good thing

What the PBoC cannot do with its reserves If China runs a current account surplus, it must accumulate net foreign claims by exactly that amount, and the entity against which it accumulates those claims (adjusting for actions by other players within the balance of payments) ultimately must run the corresponding current account deficit.  And as long as China ran the largest current account surplus ever recorded as a share of global GDP, and the US the largest current account deficit ever recorded, and especially since China also ran an additional capital account surplus (i.e. other non-PBoC agents ran a net capital inflow), it was almost impossible for the PBoC to do anything but buy US dollar assets.  Given the sheer amounts, a substantial portion of these assets had inevitably to be USG bonds.This was not a discretionary lending decision.  It is the automatic consequence of China’s currency regime, in which it pegs the RMB to a foreign currency, in this case the dollar.  Why?  Because when the PBoC decides on the level of the RMB against the dollar, it does not do so by passing a law, and making it a capital crime for anyone to trade at a different price.  What it does is far simpler.  It offers to buy or sell unlimited amounts of RMB against the dollar at the desired price. China’s reserves are often thought of as if they were a treasure trove available for spending.  They are not.  They are simply the asset side of the mismatched balance sheet.  If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100.  To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes.  Reserves are effectively borrowed money.

If you believe that the RMB is undervalued then you must accept that China takes a “real” loss every single time it exchanges a locally produced good or asset for a foreign one.  It does not “realize” the loss, however, until it revalues the RMB to its “correct” value. In other words, the PBoC, as the representative of China’s net creditor status, will immediately realize a loss when the RMB revalues, but this loss did not occur because of the revaluation.  It occurred the very day the trade took place.  When a Chinese producer sold goods to the US and took payment in US dollars, there was an unrealized economic loss equal to the undervaluation of the RMB.  This unrealized loss was passed onto the PBoC when it bought the dollars from the exporter and paid RMB. This loss, however, will not actually show up until the RMB is revalued, which forces the real loss to be realized (i.e. recognized as an accounting matter).  Postponing the revaluation, then, is not the way to avoid the loss – it is too late for that.  The only way to avoid future additional loss is to stop making the exchange, which means, ironically, that the longer the PBoC postpones the revaluation of the RMB, the greater the real loss it will take. Revaluing the RMB, in other words, is important and significant because it represents a shift of wealth largely from the PBoC, exporters, and Chinese residents who have stashed away a lot of wealth in a foreign bank, in favor of the rest of the country.  Since much of this shift of wealth benefits households at the expense of the state and manufacturers, one of the automatic consequence of a revaluation will be an increase in household wealth and, with it, household consumption.  This is why revaluation is part of the rebalancing strategy – it shifts income to households and so increases household consumption.

Value & Business Performance

Get your portfolio ready for the profitless global economic recovery So what should investors do about it? What’s “it”? The global crisis in profits caused by excess supply over demand. Take a look at how “it” is at work across the global economy. The aluminum industry—awash in excess global capacity with more scheduled to come on line.The auto industry—awash in excess global capacity with more scheduled to come on line. The steel industry—awash in excess global capacity with more scheduled to come on line.The memory chip industry—awash in excess global capacity with more scheduled to come on line. As I’ve written about repeatedly in the last week or two, because the world hasn’t begun to address the problems of excess capital and the excess production capacity that it creates under current economic rules, the global economic recovery is going to turn out to be extraordinarily profitless in industry after industry as producers with excess capacity cut prices in an effort to buy market share. This isn’t a short term problem. With the short-term success of the Chinese economy in recovering more quickly from the depths of the downturn than any other global economy, China’s “solution” of flooding the economy with cash, building new plants, and then exporting the excess has become a model to emulate. The mis-match between global supply and demand in many areas of the global economy will go on for years, and in some sectors the excess of supply over demand will get worse before it gets better. To avoid the trap of excess capacity killing even modest profits I think you have to look for sectors that have barriers that prevent excess capacity from driving down all prices as companies slit each other’s throats to acquire profitless market share. I can think of three big barriers like that. First, brands. In markets and for products where consumers are willing to pay for a brand, the brand provides protection from excess capacity running prices so low that the producer can’t make a profit. Second, distribution and service networks. Building new production capacity is relatively fast and easy these days. But distribution and service? That’s tough.

• Ford’s dilemma: It has to sell more cars in places like India to survive but can it make a profit there?
• Alcoa delivers bad news for global profits

Can CEOs destroy shareholder value in an acquisition? Just watch them I call it destruction by acquisition. Forget the synergies, the cost-savings, the cross-selling that CEOs tout when they announce one of these deals. Too many of the huge merger and acquisition (M&A) deals struck in the second half of 2009 and that are still being struck will take money out of shareholder pockets this year and for years to come. But some CEOs are so desperate for growth and so pessimistic that their company can produce growth internally–you know by doing things like developing new drugs, marketing new products in new markets or finding new reserves of oil or natural gas, for example—that they’re willing to mortgage the future for a deal that makes them look good now. Or that allows them to disguise how bad things actually are with accounting tricks for long enough to walk out door and cash out those options. Not every deal in 2009 and 2010 will destroy shareholder value. I’d give you a few at the end of this post that might actually work out well for shareholders and discuss how to tell the difference between the good and the bad. But a high percentage of the deals that have earned the headlines and moved the stock market in the last year or so need to be seen for what they are: admissions of weakness in sectors desperate for growth. ExxonMobil (XOM) buys XTO Energy (XTO) for $41 billion. Kraft Foods (KFT) buys Cadbury (CBY) for $20 billion. Xerox (XRX) buys Affiliated Computer Services for $5.6 billion. Comcast ($37 billion) buys NBC Universal for $37 billion. Merck (MRK) buys Schering-Plough for $41 billion.What’s striking about each one of these deals? They’re in sectors that are desperately seeking growth.Let’s just take the most obvious growth problem child, the biotech and pharmaceuticals sector. 2009 started off with Pfizer (PFE) buying Wyeth in January. And it culminated in the fourth quarter of 2009 with 78 deals.

Once in a lifetime This is perhaps the greatest marketing strategy struggle of our time:Should your product or service be very good, meet spec and be beyond reproach or...    should it be a remarkable, memorable, over the top, a tell-your-friends event?The answer isn't obvious, and many organizations are really conflicted about this.Delta Airlines isn't trying to make your day. They're trying to get you from Atlanta to Salt Lake City, close to on time, less expensive the other guy and hopefully without hassle. That's a win for them.Most of the consumer businesses (restaurants, services, etc.) and virtually all of the business to business ventures I encounter shoot for the first (meeting spec). They define spec and they work to achieve it. A few, from event organizers to investment advisors, work every single day to create over-the-top remarkable experiences. It's a lot of work, and it requires passion. If you ran a spa at a ski resort, which would you shoot for? Most of the people who come aren't regulars, and most of them just want a massage, a good one, one that makes the trip a little special. I don't think most people coming by expect anything more than that.On the other hand, you could invest in staff and training and services that would be so connected to each other and the guests, so willing to engage and to change people that it might become the sort of transcendent experience that people talk about for months.

• It's easier to teach compliance than initiativeCompliance is simple to measure, simple to test for and simple to teach. Punish non-compliance, reward obedience and repeat.Initiative is very difficult to teach to 28 students in a quiet classroom. It's difficult to brag about in a school board meeting. And it's a huge pain in the neck to do reliably.Schools like teaching compliance. They're pretty good at it.To top it off, until recently the customers of a school or training program (the companies that hire workers) were buying compliance by the bushel. Initiative was a red flag, not an asset.Of course, now that's all changed. The economy has rewritten the rules, and smart organizations seek out intelligent problem solvers. Everything is different now. Except the part about how much easier it is to teach compliance. 

Home Depot

Cheap at the Price: Nardelli, Home Depot and Performance This has been an interesting year so far for major corporate announcements with the number of name-brand enterprises making suprising changes from Home Depot to Dell, not to mention MSFT's Vista launch. Not to pile on too much but there are several lessons and mysteries worth exploring in Mr. Nadelli's departure. The obvious one is the severence package valued at $210M which has predictably created outrage in many quarters. Not to mention the widespread comments in the business press and the blogosphere - including the well-founded reports of spontaneous celebrations in the halls of corporate offices and stores alike that were all over the news.Despite the outrage let me suggest that his departure was cheap at the price. And that the real question was why it took the Board so long to reach the necessary conclusions. Perhaps the short-term lesson is that dissing the Board, as he did by not inviting them to last year's annual meeting, is not in any CEO's interest. On the other hand after six years he walks away with at least $20M in cash and the rest of the package.

Home Depot: a Little History Well let me try and get back to discussing Home Depot and the lessons therein for corporate performance. While my primary purpose and focus here is on enterprise performance I keep letting economic and market events seduce my attention away - largely because it's hard to sail the boat well if you don't know where the wind and the currents will take you. That said I'm liable to succumb in the future somewhat often to build up my collection of tools and observations. In the prior HD post we talked about Nardelli's short-term focus doing tremendous damage to the soft-assets of customer value and employee morale; and that enormous asset depreciation being reflected in a long-term decline of PE Ratios and the associated drop in enterprise value. With a couple of toolkit posts on PE trends and valuations in the market we can turn around and dig a little deeper now into HD's history. Unfortunately the Nardelli experiment in excessive cost control for apparent short-term earnings not only spent soft-assets but squandered a major market opportunity. Now that housing is slowing dramatically the new management must not only re-build the company that was but face severe down-pressures in demand. It won't be easy but perhaps a look back may help.

 Picking on HD Some More After some sidetrips to explore performance vs. valuation and the impacts of sacrificing employee morale on long-term performance it's time to revist our friends at Home Depot. Not that we're above just plain old picking on HD, probably the sign of jilted expectations for us as well as the many folks who innundated message boards around the Net and the Blogosphere expressing their deepest disappointments with value and customer service at HD. But it's also more than that - and we hope - much...much more. HD was, perhaps is and certainly can be a great company again but it faces many challenges.

• Six Steps to Prosperity: HD Initiatives to Consider So here's our preliminary shopping list - things to focus on now and things to do to set the table for the future. In other words while emergency repair and recovery needs to be pusued with all due haste and effort those short-term focused efforts need to seque into longer-term and deeper changes or they will be unsupportable.

 Performance Re-visited: Another Trip to HD's Woodshed For some time now it's been the intention to revisit prior dissections of HD - where we ran a nice little series but also with the intent of using HD as an example of we outsiders taking a look at company performance. It seems like it might be time to re-visit that and for several very good reasons. As the set of postings on profits and earnings show company performance is a critical factor in many things. And, the point in yesterday's post on the Weekly Reader, there's a lot of examples of folks who deserve poking at. Just to review the bidding the last HD posting id'd six major factors in digging into HD's performance and then worked thru them in some detail. The six are: 1) Economic environment and whether or not it was going to be worse, 2) Employee Morale and it's linkages to HD performance (an analysis thread we dug into in several postings, and here), 3) Customer Service - a major area of old competitive advantage, current major breakage and bad image and one requiring major investments but not too major, 4) Operations - major changes in procurement, logistics and store operations to improve service and lower long-term operating costs, 5) Product Development - continue and expand the development of new products with higher value propositions and new services to support them ala Target and 6) revisions and extensions of the historical Business Model because the US market is pretty well saturated and new market niches will need to be developed to restore growth.So the key questions are how're they doing, what's likely to happen and what can we do about it ? Below we present a summary table of the six factor

 Value Delivered: Revisting HD as Retail Exemplar The last post (Value at Risk: Business Performance, Issues, News) laid out the high level concerns with understanding and improving general business performance. Here we're going to both build on that and take it down to a specific enterprise by re-visiting our prior posts on Home Depot. (Performance Re-visited: Another Trip to HD's Woodshed) As well as try to kill several birds with one boulder, so bear with us. And there are several things that thread thru here perfectly illustrated by the past posts on Citigroup and Dell Computer. In all three cases careful attention to the details of what the companies are doing indicates that they are all well along with putting in place the kind of re-engineering transformation required to turn poor performers into good ones. And in each case there are macro-considerations that also need to be weighed, as Dell's recent results and the resultant analyst outcry about non-delivery indicate. The bottomline here is that HD is putting in place all the right kinds of carefully crafted strategic initiatives that promise to turn it into a high performer once we all come out the other side of the worsening economic downturn and the Housing crisis. Now is the time to learn about, follow and monitor that performance. Not, if you believe our economic analysis and earnings/valuations outlooks put money into a bet on an immediate return.So before we dive deeply into the thing we've been looking forward to for months, a analysis of HD's turn-around, let's set the stage.

Mobility, the 4A's and Cisco's Strategic Environment

With all that in mind it may seem a little strange to start (above) with a clip pointing to NBC's Olympics coverage home page but there's a method to our madness triggered by a recent TechTicker on how upset everyone was with their coverage (NBC's Olympics Coverage Infuriates Sports Fans From Coast To Coast). Now we gave up TV years ago and see everything online and the one thing we still missed was some sports but especially the Olympics and it turns out if you actually navigate your way over there there's plenty of stories, photos and slideshows. And, lo and behold, an immense inventory of online video clips, full event coverage and live streaming broadcasts. And it's all pretty well done. Which made someone who's resurrected their career by hoping on the new media outlet using that venue to harshly criticize NBC for tape-delays disingenuous at best and appallingly ignorant at worst. We'll admit NBC has a long ways to go to better market and integrate their new stuff, cross-leverage with the old and make money but they've done a find job. In fact we've lost way too much time, including being able to watch the entirety of the complete opening ceremonies online. Which makes NBC on the bleeding edge of the 4A's - Anywhere, Anytime, Anything, Any Device. It is this brave new world that Cisco sees as being a major driver of the Tech world going forward (as does IBM, HPQ, Dell, Intal, TI, etc. etc.). The real question is who's got it right, who can develop the right capabilities and who can deliver? Now those are really interesting indeed. And to attack them and understand what making the 4A's real you need to know a bit about how all the pieces play, or not as the case more often is.

The graphic captures most of the relationships and capabilities required, at a certain conceptual level. It probably deserves a long and detailed dissection of each level plus examples and case studies. Rather than do that here as it happens we've already published something that might serve online (Technomediatainment Futures: Evolution, Barriers, Structure and Opportunities of a New Industry) you should probably take a look at if this is at all interesting. But just to take a perfect example of synergy requirements and breakdowns ATT is getting knocked because it's network won't support the applications demand of the iPhone, where nobody anticipated the demand for online data and applications. Now what happens if the iPad takes off - will the networks invest the next multiple $B to make the 4A world a reality? Can they afford to? At an reasonable price? There are all sorts of those complex questions running all the way thru the biggest shakeup in the Tech world we've seen in a long time and Cisco is sitting, one way or another, at ground center. What's the CEP - the circular error probability though?

Cisco in Context: Stock Price History

And even if they manage to preserve and extend their legacy businesses, position for the new ones and grow by huge rates what will that mean for them as a business? And as an investment? BtW - it's important to remember these questions apply to everybody and that much of Cisco's analysis and planning, really superb as it is, is shared by almost every other player in some form or another. So when we walk thru their stuff we're also walking thru almost every other major player in the game with a similar perspective and strategy.

The context is defined by looking back a decade - Cisco has never recovered their bubble value and has in fact, despite everything they've done, been going sideways like any mature value company for the rest of the decade. More component of the market than driver or leader. And if you look at the last five years (UR corner) they've got a very rich valuation, that's held up thru the crisis and very good but not growing earnings. From an investment perspective we have to start by saying that superb performance is already more than priced in. In fact at PEs of 20-25 they're going to have to grow at 10-15% forever. That's not just Red Queen Syndrome it's a requirement for sustained Olympic performance to collect the medals you've already got!

Strategic Encapsulation: V/S/E to New Markets and Solutions

The kernel of truth behind the Tech Bubble was a major transition in data communications technology from the old disparate networks (numerous acronyms we won't list 'cause we forgot) to TCP/IP, otherwise known as the Internet. And the subsequent discovery that not only could computers talk to computers but so could people and, more recently, that people could talk to people. And they could/now can do it with more than alphanumerics, say with pictures, video and music.

The heart of Cisco's business was and remains the networking business but the real questions are: can they keep improving it, what new transitions will be built on top of it and what new market niches will open up? This chart is kind of their strategic visions (built from sampling all the presentations at their last major analyst briefing btw, which you can find here).We actually recommend taking a looksee/listen to all of it. But basically they see three major new "lobe" transitions - virtualization out of the data center, the growth of teams and workgroup collaboration and the integration and online access of video. NB: Cisco is betting BIG TIME on the 4A Ecology emerging and its rapid development as well as being dependent on the other major players from the device makers to the application developers to the service providers to the network providers getting their stuff right. At the same time they also understand that a correct interpretation of the new emerging ecology places more burdens on them for strategy, execution and management. Plus finding and creating new sources of value - which they appear to see in the many market adjacencies where they envision creating integrated composite solutions. Whether or not that all comes to pass and in what time frame is wide open. The fact that they see it, are probably right and are bending every effort to position for it while continuing to develop their base tells us that they're already way ahead of most of the companies we know about - a true 5 on our scale.

Cisco's Performance History & Outlook

 If you start in the UL corner and work around this start with us you can see that financial performance has been exemplary - revenue, operating income and earnings have all grown very well indeed. Below that you can see that they have a very strong pipeline and backlog, a strong balance sheet, and need to work on operating efficiency quite a bit more. You can also see the hallmark of a mature business in that buybacks are a major item though.

In the UR corner you get a shorthand view of their worldwide strategic outlook, which is reasonable but optimistic. Our work tells us that their worldwide growth outlook is too sanguine while their guestimates on IT spending are optimistic and underestimate the damage that IT spending will have taken. At the same time it also tells us that they see offshore markets, at least in their traditional marketspaces (largely enterprise datacomm) as critical to their future.

The LR corner tells us that they know their traditional routing and switching markets will remain their bread and butter but they expect new technologies to vastly expand the number and size of marketspaces they can go after. In fact they are anticipating huge growth in those adjacent markets. The LL corner tells us what kind of operational strategies they are pursuing - which is basically to combine continued product development with services combined with vertical solutions. It also tells us that they understand how difficult the transitions to these new markets will be, both in general and on paper (hence the "Chasm" barrier!). Whether their guts know and they are prepared to do what it takes and have the capabilities are another question. But again this type of work puts them far ahead of most companies we're aware of AND is a VERY good assessment of the nature and structure of the 4A Revolution. Cisco gets it, in other words!

 Execution, Execution, Execution?

It's one thing to talk the talk and another to walk it of course. A few months back Cisco announced a radical new organizational structure that was going to be built up out of collaboration councils strategically designed and located throut the Company. Most of the reaction was, "say what?". The rest was duh? But in actual fact it's Cisco attempting to wrestle with the organosclerosis problems inherent in the complexity of their organization as is and where they want to go. So they end up with a council for products and another for services, each btw focused on a specific one, and yet another for end-market solutions. All at various levels from the operational to the executive. It might be the mother of all multi-dimensional matrix organizations gone mad (the last time somebody had to really try this it was NASA in the early days of the Space Program). At the same time it's both an honest attempt to face up the organizational and management system architectural issues innate in what they're trying to do. It is ALSO an attempt to walk the talk on what they think the brave new world of Collaboration will look like - and how new technologies can address it. In other words it is Cisco very much eating their own cooking - so much so that they're betting the Company on it. Now that's serious.

All of which you can see in these chart sets. In fact they had us with the UL where they paired Innovation with Execution (& Collins) but when the took it down the several layers we know to be necessary we started applauding. This is the only organization we're aware of that's thinking about this stuff, let alone with this much depth and detail, clearly for a long time and also clearly translating it into specific solution concerns. They, in effect, become their own laboratory and testimonial. Take a careful looksee - this is what a lot of large, complex and multinational organizations are going to have to do. And almost none are doing; in fact most aren't even aware of the problem (that is they haven't taken the first step on a 1,000 mile journey and Cisco would seem to be a couple of hundred miles down a tough road). You might compare and contrast them to our previous deconstruction of SAP or our dissection of Dell (Dell Computer: It Ain't Your Grandfather's Beige Box), a company who had some good but not well-thought ideas and is struggling mightily with execution.

Brave New World: Services and Solutions

Let's tunnel down a little farther on their articulation of Strategy - from the Enterprise conceptual to the specific and operational (as Gen. Schwarzkopf calls it the "Operational Art").  Which leads us to this next composite chart which illustrates how they intend to go after Services and Vertical Solutions, what role they play in chasm crossing and what they might look like. One of the things we emphasized repeatedly was the need to balance functional island with whole enterprise concerns in both the short- and long-terms.

Here the middle two charts tells us how Cisco is going to pursue enhancements of its existing business in the near-term while building services in the intermediate and and then solutions in the long-term. They're intending to grow the business by 12-17%, which is impressive, but know that 9-11% of that comes from their core while the rest from creating and growing new businesses. Even more impressive. The top two charts more explicitly lay out examples of the kinds of things they are talking about, at each layer of their implicit total solutions architecture and against a time-phased structure, where one thing builds on another. The bottom two charts show two particular examples. Which perhaps perfectly illustrate the critical challenge they'll face.

The creation of vertical solutions for the sports entertainment world will NOT require deep understanding of the business and will therefore more readily lend itself to a technician's approach. Healthcare on the other hand is the most complex marketspace we've ever tried to analyze. To get embedded their on the solutions side you'll have to know it about as well as the practitioners do, be able to design and develop solutions, convince and sell them and help a whole industry work it's way thru innate cultural and organizational barriers. That's one tough challenge.

And is probably endemic to the whole notion of complex business solutions at the top layers of the 4A Ecology Stack. Something Cisco will struggle with because it doesn't have the cultural background or domain knowledge - nor does anyone else. But if they can crack the code they'll be good for a long...long time to come. And everything else they're trying means they'll be good for a long time as well. It's the solutions spaces that will determine whether they can create a breakthru to new sources of significant growth - or just continue to be a very good, even excellent, company.

We'll pick up on Cisco with a second major pass, hopefully not to far in the future but this is enough to digest for now. However if you'd like to access a downloadable PPT show that has all these chart sets collected together you can find it here.