Monday, June 06, 2005

After Fiorina left HP, what’s next?

For almost two decades, the printer business of Hewlett-Packard has sailed along on a river of ink-cartridge profits, dominating rivals with a market share of more than 50%. The $24 billion-a-year division accounted for 76% of HP’s $4.2 billion in earnings for fiscal 2004. It has remained blissfully detached from the problems at HP’s computer units, created by the high profile, $19 billion acquisition of Compaq in 2002. But with overall growth in printer demand slowing and margins tightening in the face of an assault from Dell and others, HP has realized there is no room for complacence. After a recent reorganization that merged Imaging and Printing Group and Personal Systems Group to form the HP Imaging and Personal System Group, chief Vyomesh Joshi, who has been executive vice president of the imaging and printing unit for past three years, is planning a knee-deep “transformation” to ensure HP’s dominance in printing and imaging. Joshi is to refocus on the biggest opportunities while lowering costs to maintain profit and margins amid falling printer prices. The plan will involve 10% or more head count reduction and streamlining the cluttered portfolio of businesses in the division.
Hewlett-Packard was reinvented by Carleton S Fiorina via her “big-is-better” strategy since she took the helm in 1999. HP has doubled its sales in the past five years and become a competitor in an unrivaled number of markets, from $100 digital cameras to billion-dollar tech-services deals. Yet in too many of the businesses, HP is losing stream. Except for the printing division, the crown jewel, the rest of HP is an underachiever. Investors are not impressed, they want a far simpler solution: break the company up. Fiorina insisted that HP needs the broadest reach possible to capitalize on her vision of technology’s future and believed that spinning off printer business would destroy shareholder value. However, when shareholders are asked, they have different opinions about the spin-off. "I would like them to spin off the printer business," says Kenneth A. Smith, senior portfolio manager at Munder Capital Management, which owns about 2.9 million HP shares. After the ouster of Fiorina in February 2005, observers say HP could be edging closer to spinning off its cash-cow printer business from the rest of the sprawling company. The shares of HP surged $1.40, or 7 percent, after Fiorina’s announcement. Although HP declined this idea, investors believe that Fiorina’s departure makes such a move more likely. But they were disappointed again when the new CEO Mark Hurd said at a press conference on March 30 that it is too early to consider spinning off HP’s printer business.
HP says that combining the groups internally will foster greater efficiency and help the company to bring products out more quickly. The synergies between the two groups are believed to help HP drive its consumer electronic effort. This is supported by some HP’s customers who like to have access to PCs, printers, servers, storage and networking devices all from one company. "Our commitment has increased. We've purchased a full server infrastructure through HP, and desktops, they should not spin off any part of the business" said Paul Cullen, Macquarie Textiles IT manager. Others think that the cash flow of printer business put HP in a much better shape than those that have to rely on the computer business for cash flow. One of the oddities of modern business is that companies often seem to feel compelled to spin off their best performing businesses on the idea that in selling it out, they can get a better return on the standalone business than when it's saddled with other businesses that are dragging it down. That's why AT&T spun off AT&T Wireless a few years back, despite how obvious it was that having a wireless component was going to be a necessity in the future.
We believe that the key question here is what is the benefit and cost of synergy. To some extent economies of scale exist between the printer and PC businesses due to the similarity in the manufacturing process. A single sales force can sell bundled products to end customer and brings economies of scope. But will these two business lines reinforce each other? Will any consumer buy a HP PC because he prefers a HP printer, or vice versa? Not necessarily in a commoditized market where cost often plays bigger role. First, in the PC business, the direct-sale, build-to-order model is crucial for HP to compete with Dell. At the same time HP has to keep thousands of traditional retailers and resellers, who help HP sell its printers and ink, happy. These two systems often operate at odds with each other and operating in both worlds leaves HP doubly exposed. HP failed to match Dell’s scale and efficiency in the direct system. As a result, HP PC slipped to No. 2 with 15.7% share, behind Dell and operating margins in 2004 were a meager 0.9%, miles behind Dell’s 8.8% margins. A break-up would help resolve this dilemma, freeing the computer division to adopt the Dell approach. Second, most of printer business’ profit comes from selling high-margin consumable – ink cartridges and installed base is the key in this business. The printer business could expand its market and partner with HP’s computing rivals, including IBM and Dell – once it was unhitched from the computer company. Analyst Steven Milunovich of Merrill Lynch & Co. estimated that the total value of HP’s businesses could increase by 25% to 45% if it were split into printing and nonprinting operations. Lastly, HP’s push for synergies has gotten in the way, say insiders. To pull off a big sales deal at HP these days often requires delicate diplomacy. Putting together a package involving servers, printers, and software, a sales rep has to hammer out an agreement with each division. If one unit is concerned about financial targets and unwilling to bend its price, the whole deal can fall through. The company lacks an effective process to resolve conflict and motivate cooperation.
With all above, is it the right time to spin off the printer now? We don’t think so. It is hard to see how a separate HP PC business would be any stronger or more profitable on its own. HP should work on getting the computer business profitable without spinning of the printing operation. This would mean that HP must get its own business settled down. There has been enough wrenching of the culture at HP/Compaq that time still needs to be taken for a new cultural equilibrium to congeal. Furthermore, the market is still unsettled and unclear so it may not be the best time to spin-off. They should maybe explore and experiment with its current configuration along the lines of a 3M “make a little, sell a little” model, rather than lurching around in search of a radically different structure, or seeking to imitate IBM or Dell too closely.

Evrim Erdem
Kathy Liao
George Maurice

Saturday, June 04, 2005

…With IPod Woes, Will Apple Rot?

Being an early adopter of the iPod, I can speak first-hand about Apple’s digital audio player. The iPod can be used to travel, in vehicles, and also as a backup to store pictures and other files. Apple got many things right, most notably the user interface. The UI is easy to learn, simple, and has fairly robust implementation. The Mini’s design is ideal for running and exercising. Apple has sold more than 15 million since late 2001. Although the iPod is a good product, it’s nowhere near perfect.

The most prominent issue is the batteries. The constant charging/discharging of an iPod eventually leads to poorer battery longevity and eventually failure. The batteries were not designed to be replaceable. Initially, Apple told consumers they would have to buy new iPods. In November 2003, Apple began offering a battery replacement service for $99. Class action lawsuits were filed in December, 2003. A proposed settlement, valued at $100 million, will apply to as many as 2 million iPods sold before May 2004. Apple had agreed to replace some iPods and give other consumers up to $50 in cash or credit on Apple purchases. The non-removable battery is a major flaw. If batteries fail, consumers weigh the hassle and cost of replacing the battery versus buying a new generation MP3 player.

Another issue is multiple computers and multiple iPods. What if you want to move music from one computer to another? Once CDs are recorded onto a hard drive it’s very cumbersome to transfer iTunes files to another computer. Third party products that facilitate the process have been blocked by updated versions of iTunes and iPod software. Users can’t copy from the iPod to a computer for Apple’s fear of copyright issues. Apple is not allowing customers to do things with the music that they have fair use rights to. This will eventually hurt Apple in the long-term.

The ultimate problem with iPods is that Apple appears to be executing an isolated strategy, which will erode market share when competitors release new generation products. They have not established any logical licensing agreements. If you want a hardware device to be standard, the software has to be in play. Apple probably realizes that the iPod isn’t unique beyond its design and thus can’t be protected as a standard. Apple has great innovations, but has no idea how to give them long-term legs. This weakness will become more apparent as firms begin releasing comparable products.

Apple is behaving just like they did with the Macintosh. Initial product and iterations are consumer friendly and enticing. Price hasn’t decreased, performance hasn’t increased, quality issues remain, users’ demands haven’t been met, the system has been kept closed and unlicensed and eventually Apple will be left with little market share and just a small, loyal following.

Competitors will soon be selling hard drive-based portable devices. Will any of them have the right combination of usability, style, and compact size to lure consumers away from the iPod? Apple has had a free ride because making a great music player is no secret. Vendors attempting to emulate the iPod say the best choices in 1.8-inch hard drives are from Toshiba (Apple’s orginal supplier) and Hitachi. To gain leverage in negotiating hard drive prices, some iPod competitors will size their cases to fit both. The difference is only a few tenths of an inch in each direction, but this could add up to a 20% increase in volume. Some manufacturers use 2.5-inch hard drives, making the players up to twice as big as the iPod. As hard drive MP3 player prices move down toward $200, the desirability of flash memory players may decrease, too. If you could get 350 hours of music for $200, would you pay $125 for 2 hours (128MB) of music?

Analysts have dismissed most of the issues related to the iPod. IPods now account for nearly one-third of Apple’s revenue, generating $1.01 billion in sales in the quarter ending Mar. 31. Piper Jaffray has maintained an “outperform” rating and $52 target price on Apple Computer, expecting the fiscal third quarter to outperform the second. The research firm raised the fiscal 2005 and 2006 EPS estimates on Apple to $1.32 and $1.48, respectively, from $1.27 and $1.38, citing indications of a strong launch for OS X Tiger.

Analysts believe in Apple’s stock performance in the long-run because Apple is a survivor. Even as its personal computer business lost market share, the company found a way to be relevant as a niche player. Even though its computer business is booming again thanks to iPod users migrating back to the Mac platform, that’s not the primary catalyst for faith in Apple. Apple is a company that personifies innovation. MP3 players and computers are commodities, for the most part, yet Apple has been able to make its products distinctive. While that also implies that Apple sometimes rests on its laurels when things are going well, it’s still an amazing company that will likely find future niches that are worth differentiating.

Jua Mitchell

Friday, June 03, 2005

The Reinvention of the Infomercial

The “long-form” format of commercials otherwise known as infomercials has been plagued by a past reputation of cheap production and a mass peddling of junk products. The key word is past; now infomercials are creating a medium for mass appeal products that could give commodity products a decisive competitive advantage in an increasingly crowded market.

In the past infomercials were seen as a way to peddle junk products that were traditionally marked up ten times or more over their direct price. Most of the products were not available in retail outlets and were housed in warehouses ready to ship. The number of infomercials that were pulled by the FCC and/or charged with deceptive advertising was many. Many of the infomercials were aired late at night to prey upon unsuspecting insomniacs. The primary products advertised were fitness and diet, health and beauty, home convenience appliances and get rich quick schemes.

There are now a number of successes from the infomercial sector. The George Foreman Grill has earned $1 billion in sales; ironically good infomercials also drive traditional in-store sales because the retail revenue from the hit infomercial by Foreman was many times higher than actual infomercial sales. Ron Popeil has sold $1billion worth of Ronco rotisserie ovens. Endorsements for Proactiv acne products ($2.1 billion is sales) from such mega-stars as Jessica Simpson, Alicia Keys, and Sean (P. Diddy) Combs have encouraged us to do a double-take. Infomercials are well-suited for introducing new products, high-ticket items and complex products within the specified time format by varying between entertainment, information, and a hard pitch that includes multiple calls to action and purchase incentives. Interactive television technologies such as digital cable, satellite TV, TIVO, and video-on-demand are creating new infomercial sales opportunities.

The products that have been successful as mentioned have mass market appeal and solve a common denominator problem. The products must seem like a bargain. Quick, easy, greed, new, fun, and vanity must be reiterated many times over to appeal to the masses. Only one in sixty infomercials turns a profit. The products traditionally have been easy to demonstrate and all have been pitched as a story to tell. Approximately thirty percent of viewers will buy anything from the TV. However as aforementioned good infomercials boost brand awareness and motivate shoppers to seek products in retail stores. In light of this it seems appropriate to build a two-channel sales strategy.

Fortune 1000 companies are seriously integrating infomercials into their brand differentiation strategy. Apple Computer, Braun, Nissan Motors, and AOL Time Warner have started using the infomercial medium to combine rigorous product development, exhaustive consumer targeting, and daily scrutiny of advertising rates to create pitches that can be altered to maximize sales. Joined with the opportunity to boost margins by selling directly to consumer infomercials can be a powerful tool to create brand recognition and translate it into sales. Land Rover and Disney are creating their own infomercials. The brand recognition power comes from viewer recall which can be three times higher than for traditional 30-second spot commercials. Approximately ninety two percent of consumers have heard of the Nautilus Bowflex home fitness system (featured in infomercials), about the same number of people that recognize the Nike brand.

Experienced infomercial producers have begun to take a “soup to nuts” approach when marketing its marketers by changing product packages, collecting customers’ cash and purchase data and building customer loyalty. Warren Direct, the direct marketing firm for the SCOOTER Store, identified the target market, repositioned the product and designed complementary messages that created synergies which reinforced the SCOOTER Store brand name. Warren Direct also asserts that there are 14 steps to infomercial success including “The Art of The Sale”, “The Art of Delivering the Brand Relationship”, and The Science of Analytics.

Many industries could leverage the power of infomercials to give them a strategic advantage in the ever increasingly competitive commodity markets. Automobile manufacturers such as Nissan and Land Rover have already begun implementing infomercials into their brand awareness strategy. The automobile is essentially a commodity which has an increasing number of new manufacturing entrants. To distinguish themselves automobile manufacturers such as Ford Motor Company spend roughly $30 billion for commercials per year. At the same time audiences are scattering as television fragments into hundreds of cable channels and the Web, video-games, DVDs, MP3 players, and satellite radio compete for consumer attention. The infomercial segment could allow this same company to target its products directly at consumers. Jac Nasser former CEO of Ford Motor Company actually envisioned the two-source strategy during his tenor at the automaker; Nasser felt automobiles should be made to order and available through e-commerce (website) and through traditional automobile dealerships. Recall that effective infomercials use a two-source strategy that requires products to be available for purchase directly through infomercial and retail outlets. Product differentiation could be further realized through the infomercials and reach consumers on a more cost effective basis than what would have been otherwise possible.

Infomercials are just beginning to be realized as a powerful medium for building strong brand recognition, cost effective advertising, and product development strategy. We believe this type of medium should not be overlooked in increasingly competitive commodity markets where company’s struggle to differentiate themselves.

Submitted by:

Sachin Kelkar
Riahna Phillips
Bryant Houston

Thursday, June 02, 2005

An Invasion of American Capitalism or of American Socialism?

Malcolm Glazer, the billionaire-owner of the NFL’s Tampa Bay Buccaneers, recently completed his 2-year quest to gain control over the world’s most valuable sports franchise, Manchester United, a publicly-traded firm. On the surface, one could easily group this purchase with the many recent acquisitions by US-based private equity shops of European firms. In classic LBO style, the acquisition will be considerably funded by debt, the firm will become private at the completion of the transaction, and the new owner will try to realize significant operational synergies. However, the uniqueness of the situation is clearly demonstrated by the reaction not only of the team’s vast legion of fans, but also by the British government.

Oftentimes, when LBO’s occur, employees of the target firm vigorously protest the transaction, fearing the loss of their jobs if the transaction were to go through. Typically, the new equity owner wants to ensure good labor relations, but they can also go out and find replacement workers if the workers are becoming too problematic. Manchester United’s potential problem is not in alienating its employees (i.e. the players don’t really care who the team owner is as long as they’re collecting their $100K per week), but rather with alienating what is arguably their most valuable asset, an extremely loyal fan base.

We believe the recent uproar of Manchester United’s fans over their beloved club being taken over by an American capitalist is not only highly ironic, but likely short-lived. Man U, unlike virtually all American sports franchises, is a publicly-traded entity that is directly responsible for delivering returns to its shareholders. Man U has delivered tremendous on-field performance since the early 1990s. This was initially largely driven by the club’s ability to develop great local players (i.e. David Beckham, Paul Scholes, Ryan Giggs, etc…) via its youth system, but its biggest stars today (i.e. Ruud Van Nistlerooy, Wayne Rooney, Christiano Ronaldo) have arrived via purchase from other clubs. If Man U fans believe their team’s on-field success today comes from the superior ability to train local boys, they are simply mistaken.

According to analysis presented in The Business of Sports: Text and Cases on Strategy and Management, there was an extremely strong correlation between payroll and on-field performance from 1999-2003 in the English Premier League, Man U’s domestic soccer league. This correlation greatly exceeded the correlation in any of the major US sports leagues, suggesting that Man U was ‘buying performance’ more than any other major sports team, including the NY Yankees. The capital need to purchase this success did not come from some benevolent team owner, as one might describe Chelsea’s owner Roman Abramovich, but rather from the merchandise marketing machine that is Man U. We would suggest that before a Man U fan starts protesting, he should notice the huge corporate logo on the front of his replica jersey and ask himself whether he’d rather have on-field success or a logo-free jersey. We believe that virtually all fans would choose on-field success and that as long as Glazer delivers on-field performance, the current uproar will rapidly subside.

Ironically enough, we believe that Malcolm Glazer potentially biggest value-add to British soccer is not his experience as an American capitalist, but his experience in the socialist world of American professional sports. Compared to the EPL, the major sports leagues in the U.S. have actively worked to ensure competitive balance between teams. Nowhere are these efforts more prominent than in the most financially successful of leagues and the one where Malcolm Glazer has deep experience, the NFL. We believe the NFL’s financial success is a direct result of its ability to ensure competitive balance via mechanisms like a salary cap, particularly one that all teams can afford with revenue sharing in place, and a reverse-order collegiate draft.

Should Glazer try to introduce similar collectivist features to the EPL? While modeling the EPL on the NFL would like greatly enhance total revenue and profits of EPL-teams, we believe that Man U’s financial performance could decline significantly as it wouldn’t be able to internalize most of the value of these changes (however, we note that these changes might be more economically rational for Man U to push for in the Champions League competition or in a future European ‘Super-League’). In the short run, we believe Man U should try to deliver the best on-field EPL performance and squeeze as much incremental operating profit as possible out of opportunities like marketing pushes into the US and China, selling off home stadium naming rights, raising ticket prices and negotiating an independent TV deal. This will allow Glazer to de-lever the firm. However, Glazer must ensure that in the long-run, fans don’t abandon Man U and the EPL because they are bored by the same team winning every year. If any hint of that alienation begins to occur, Glazer could push for more redistribution of the wealth within the EPL so that poorer clubs can become more competitive and indirectly benefit Man U.

In reality, we would expect Man U’s fans to remain interested as long as at least one viable domestic competitor exists. That is certainly the current case given the strong squads of Chelsea and Arsenal. If all three of these entities were rationally-driven, profit-maximizing entities, they would likely try to implicitly collude to limit investments in new players. Unfortunately for Man U, Chelsea’s owner currently appears to be committed to winning, independent of the economic ramifications of his actions. Glazer may succeed in talking Abramovich out of this philosophy, but assuming he can’t, should Man U try to play an arms war with Chelsea or resign itself to aiming for 2nd place in the EPL? We believe that they can’t profitably play the arms game with Chelsea in the long-run. In fact, their best action would likely be to try re-positioning as a lovable underdog. This re-positioning would likely prove quite difficult, so Malcolm Glazer better hope that either he can talk some economic sense into Roman or that Roman finds a new hobby (possibly in a jail cell courtesy of Vladimir Putin) if Glazer’s investment in Man U is to provide a handsome return.

-Vlad Bystricky, Tim Ligue, Justin Segool

Morgan Stanley: Hunted or Hunter

During the past month, the roles of the game seem to have been reversed for the Wall Street powerhouse Morgan Stanley. Well regarded as a dealmaker, the focus is on Morgan Stanley again, but this time the storied firm is in the uncomfortable and unimaginable position of acquisition target. The apparent cause of this change in fortune lies in internal disagreements, related to the company’s management performance, between its Chief Executive Officer Philip Purcell and old-line Morgan Stanley investment bankers. The firm’s turmoil has encouraged outsiders to bet on the likelihood of spin-offs or even a complete sale of the firm, in which players such as Bank of America and HSBC Holdings top the buyer’s list. If the rumors turn into reality, this will have been the first attempt of merger with another investment bank since Credit Suisse First Boston’s disastrous $13 billion deal with Donaldson, Lufkin & Jenrette Inc. in 2000.

Cultural clash or merely a conspiracy? The eight former executives waging the campaign against Mr. Purcell are veteran bankers from the firm before its merge with the retail brokerage house Dean Witter. They are claiming weak performances by businesses in the latter division drag down the performance of the whole company. They are also accusing Mr. Purcell – a former McKinsey & Co. consultant credited with making Dean Witter into a consumer powerhouse – of favoring executives from his old firm. Indeed, the recent nomination of two co-presidents (Stephen Crawford and Zoe Cruz) triggered the departure of several bankers (including the “rainmaker” Joseph Perella) feeding a growing culture clash between the white-shoe Wall Street firm and the retail division, including its Discover card unit.

HSBC: The White Knight? Lately, London-based HSBC Holdings plc. has been making a push in the global merger and acquisition advisory business, but it is still far away from the top position in the famous (or infamous) league tables, especially in the US market. Measured by market value, HSBC is the largest banking company in the UK and second largest in the world. In addition to commercial banking services, the firm provides asset management, leasing services and, primarily through HSBC Investment Bank, investment banking services.

During the last few weeks, rumors intensified that HSBC was weighing a possible $75 billion bid for Morgan Stanley. However, sources say the British bank would not make such an aggressive move, and would consider an offer only with the full agreement and support of the US bank’s board.

Morgan Stanley under fire. Amid efforts to quell the firm’s turmoil, the US investment bank announced its intention to spin off its Discover credit card unit (a business built by Purcell). As the seventh largest issuer of general-purpose credit cards in the United States, Discover would be an attractive target in the credit card industry. In addition, its spin off would pre-empt calls by shareholders to break up the company, while making the remainder of the firm less appealing as a takeover target. However, the strategy seems more of an attempt of the firm’s CEO to remain in power than addition to shareholder value. Indeed, one could argue that the investment bank will decrease market value for the following reasons:

Through divestiture of its Dean Witter retail brokerage or Discover credit card businesses, Morgan Stanley would lose the benefit of having diversified businesses that keep its revenue stable through downturns;

Divestitures would likely unleash ratings downgrades from important rating agencies such as S&P and Moody’s. In this regard, Standard & Poor’s analyst Tom Foley said, “We would consider downgrading Morgan Stanley if they were to spin off one of their divisions”.

The firm could be too small to be able to compete against its rivals who are all expanding instead of shrinking. Examples are Lehman Brother’s acquisition of asset management Neuberger Berman, Merrill Lynch’s decision to keep its own asset management division, and Bank of America and JP Morgan’s huge mergers.

On the other hand, one could argue that by divesting, Morgan Stanley could return to its roots: a pure investment bank focusing all its efforts in revenue growth and profitability margins.

Is Morgan Stanley worthy? Absolutely. Under all conditions, the US investment bank would foster HSBC’s ambitions in the US market. With a market value of $177.8 billion, HSBC could easily swallow Morgan Stanley whole, and finally consolidate a top position in investment banking. Despite prior history of investment banking acquisitions resulting in a massive departure of talent, firms like Morgan Stanley could absorb such large-scale departures by rapidly replacing old talent with new stars.

Considering solely the Discover credit card unit spin-off, which the market prices at around $14 billion, HSBC could be considered a strong buyer, due to its expansion strategy in US market. This strategy is evident in the firm’s $14.2 billion acquisition of Household International, a major provider of consumer finance and a top 10 issuer of credit cards in the United States.

Finally, Morgan Stanley’s current situation could not be better from an acquirer’s perspective: it is the worst performing stock among the five largest independent securities companies (shares were down 27% in the past four years, plunging 50% since its peak in September 2000) and the series of internal conflicts make the venerable investment bank not only a vulnerable prey but also attractive at a discounted price.

Marcelo Hanan
Gabrielle Lambert
Valentin Pitarque

Eight Men Out….Take Your Balls and Go Home!

Recently, eight former directors of Morgan Stanley staged an attempt to overthrow current CEO Phil Purcell and insert themselves, along with several recently departed senior executives, in leadership positions. The plan was simple: leverage their one percent equity stake in Morgan Stanley and exploit their prestige as retired and/ or recently fired Morgan Stanley directors to promote their idea of how Morgan Stanley should be run.

No one can deny that Morgan Stanley under Phil Purcell has lately stumbled on hard times. In the past year, Morgan Stanley stock price has lagged behind its financial competition, numerous top level executives have exited the firm, and it has faced two highly-publicized lawsuits. One of those lawsuits ended with a jury awarding Ron Perelman $1.4 billion in damages for Morgan Stanley’s perceived mismanaging of the sale of Mr. Perelman’s Coleman Company.

Soon after the Group of Eight made their case public, Morgan Stanley announced a plan to spin off its Discover Card unit, a move that was seen as a reversal of strategy for Mr. Purcell. Purcell had always toted Discover as part of Morgan Stanley’s strategy to remain diversified and help smooth earnings when the market took a downturn. Most critics and analysts viewed the spin-off of Discover as a strategy chosen by the Board of Directors’ and/or Mr. Purcell’s attempt to throw the group of eight a bone, hopefully ending their public attacks.

Despite recent difficulties, Morgan Stanley still sits atop the vaunted league tables in most of the major investment banking categories: M&A, Debt underwriting, and Equities. Morgan Stanley recently jumped 16 spots from number 25 to number 9 in a recent Fortune Magazine poll asking MBA grads to rank their most desirable employer. Morgan Stanley placed ahead of Lehman Brothers, Bear Sterns and Merrill Lynch, trailing only Goldman Sachs amongst investment banks.

If the group of eight were serious about effectively reforming their former firm, they should have brushed up on their history first. Teddy Roosevelt once said ‘walk softly and carry a big stick’. The group of eight, with their one percent equity stake, instead decided to run like a bull in a china stop and wear a bell around their neck. The group of eight could have used their Wall Street connections to obtain some institutional backing and maybe even set a goal for a double digit equity stake in favor of ousting Phil Purcell. Everyone thought Michael Eisner was in trouble at Disney in the early 2000’s due to a struggling stock price and poor growth, but it was not until some of the big institutional players like CalPers got involved that the Disney board decided to act.

In terms of strategy, the group of eight would have been much better off not going directly for the throat of Mr. Purcell. In taking such harsh actions, they left Mr. Purcell no choice but to staunchly defend himself. The group of eight also placed current employees and shareholders in a sticky situation, having to choose between the current CEO and the former directors. Their approach backfired, and although they were able to drum up plenty of media attention, they never really acquired enough shareholders’ or board of directors’ votes, the items that mattered most.

The silver lining of this Wall Street soap opera is that it has brought attention to the fact that Morgan Stanley stock has been lagging and that Mr. Purcell does need to come up with some answers or seriously consider handing over the reins to someone else. More importantly, it brings attention to the importance of an independent board of directors and the significant roll the board should play in corporate America. Morgan Stanley’s board, largely consisting of Purcell’s ex-McKinsey buddies, certainly does not fit the ideal of a truly independent board. Morgan Stanley shareholders cannot blindly assume that the board is acting in their best interest, but instead must actively consider not re-electing some of the existing directors at re-election time.

We feel that one of the problems with the group of eight is that they still are upset about the 1997 merger between the two financial behemoths Dean Witter Discover and Morgan Stanley. The often overlooked fact is that Dean Witter Discover bought Morgan Stanley and eventually dropped the Dean Witter name in favor of the Morgan Stanley name. It is no secret that the executives at the white shoe Morgan Stanley never liked the idea of being taken over by the gym shoes of Dean Witter. However, that takeover is the past and they must focus their attention on Purcell’s current strategic vision and the opportunities and challenges facing Morgan Stanley going forward.

In conclusion, the group of eight is like the kid who had the basketball at the park and would let others use it only as long as he was playing. Well, as in every playground around the world, the kid with the ball ends up getting beaten up, and like most kids with the ball he does not like it, so he clearly states for everyone in the park to hear, “if I can’t play I’m going to take my ball and go home.” Our advice to the kid and the group of eight are you got beat fair and square and now its time to take your ball and go home or sit down, shut-up, and watch to see how the game unfolds. Maybe you will play in the next game (particularly if you can get some big institutional investors on your side), maybe you won’t, but you had your chance, you lost…so deal with it and deal with it privately.

-Vlad Bystricky, Tim Ligue, Justin Segool

Wednesday, June 01, 2005

India to the Rescue?

Is it possible for the two largest automakers, Ford Motor and General Motors, to maintain its market strength within the automotive industry via the previously ignored India market? The two are currently facing financial and competitive challenges around the globe which are depressing recent earnings and sales, and one of their strategies is to put the full court press on the rapidly growing India market. You can be sure that there are plenty of doubters of their strategies, as evidenced with the recent downgrade of their debt by Moody’s and S&P to below investment grade status…and from what we can tell there is good reason for worry if either Ford or GM are counting on the Indian market to contribute significantly to profits anytime soon.

To date, Ford and GM have been unable to keep up with their competitors in the Asian markets (both have a measly 3% market share even though they have been in the market for more than seven years) which is led by Maruti (50%), Tata-Motors (16%) and Hyundai (15%). The infamous SUV and light truck vehicles that have led the US automakers to large market share and profits in the US do not apply in India and both have struggled to come up with viable solutions. Up until recently both companies have relied on the same old pricey mid-sized cars they sold elsewhere, gambling that middle-class incomes would rise and the consumers would be in the market for larger cars. Unfortunately for them, they were only half right. Incomes did rise, but consumers didn’t upgrade nearly as fast as expected. Just as importantly, the ones that did upgrade, upgraded to newer Asian models with more style and better technology. A quote from a Ford representative says it best: “We saw a car like the Escort as being at the heart of the Indian market. If you took a standard emerging-market template, it seemed like a logical conclusion…what we found was is that in India, unlike in some of the other emerging markets, the segment shift happened much more gradually”. They missed, plain and simple. A new strategy was needed.

The new strategy was not to abandon India. India is the third largest growing market in the world – and the third-biggest market in Asia in terms of unit sales after China and Japan. Over the last 18 months, India’s economy grew at a 6-8% clip. According to the International Organisation of Motor Vehicle Manufacturers, OCIA, India’s car production in 2004 grew 30%, while the next closest economy, Brazil grew at only 17%. The new strategy was to go to market with products that the customers were demanding. In order to crack the India market GM and Ford would need to come to market with more affordable cars tailored to local tastes and needs (re: cheap and small). And that is exactly what Ford did with its introduction of the Ikon. It promoted the car as having enough head room for a turban and only costing 450,000 rupees (only 50,000 rupees more than most mini cars). This led to an uptick in sales, leading them to expand the line to more than six models covering the entire mid-size car range. Last year alone they sold 40,000 Ikon, compared to 2,300 Escorts in 1999.

Problem solved right? Wrong, they only have 3% market share and the market is competitive as ever. Automotive market analysts in India say that “Ford and GM could have been market leaders if they had introduced their latest models, priced competitively, five or seven years ago, however, now they are just behind the ball as the market has become a lot more competitive”. With competition comes falling prices, combine that with a regulation change that lowered excise duty taxes (which increase competition) and now we have even tighter margins and fewer opportunities for profit.

So the conclusion seems obvious, there is no way that India is going to save GM or Ford anytime soon. So why haven’t Ford and GM given up? Because neither Ford nor GM are in this market for its short-run potential. The Indian market currently only represents about $6 billion in revenue. If Ford had 100% market share it would only increase its total revenue by 3.5%. So, while winning 20% of the market would be a huge success, it wouldn’t even dent their top line growth. The bottom-line then, this is a long-term play…according to a source at Toyota "Toyota believes that India will be one of the biggest markets in the world in this century”. That’s right folks, this CENTURY. By the time it does happen, Ford and GM want to be established players not late entrants (as they are already perceived) in order to take advantage when the market does move to larger more profitable cars that are right in these US manufacturers wheel house. Any money spent by Ford or GM in this space should be chalked up to R&D.

Baruah McGrath and Shelly

Monday, May 30, 2005

How to Save a Sinking Ship

Long suffering Time Warner may finally be pulling itself up from market whipping boy and pre-market bust joke back to a stable firm. Ever since the “visionaries” of the mega-merger between AOL and Time Warner, Steve Case and Jerry Levin, raised their hands in victory and promised to build the most valuable company in the world, Dick Parsons, the current CEO of Time Warner, has led the company from being known as the “worst merger in business history” back to a prominent player in the cable and media industry. Since then, Parsons has accomplished most all of what he promised when coming into the company as Chairman and CEO in 2002- he has reduced corporate debt by half, stabilized America Online, settled two federal investigations, and is now set to take control of Adelphia’s cable assets. Due to all of Parson’s success, Time Warner has been reaping the fruits of success, posting a profit of $3.3 billion on revenues of $42 billion… but will the company be achieve similar success long term while winning back the hearts and minds of a skeptical market?

Before jumping into the analysis of Parson and team’s strategies for long-term success, a quick walk through the company’s operating units would be valuable at this juncture. The following data was provided by Standard & Poors. AOL, the global leader in online services, had about 31.6 million subscribers worldwide, while the Film entertainment business unit, mainly Warner Bros., consists of both film and television properties. According to Deutsche Bank equity analysts, the AOL business unit, together with the film unit, was both bright spots in Q1 of this year. Another large business unit of Time Warner, the Cable segment, is the second largest U.S. cable operator, serving about 10.9 million subscribers. It offers high speed data and other interactive digital services. Analysts were also encouraged by the cable business unit’s solid results, meeting their estimates. Although Time Warner has additional business units within its control, these are the three primary foci for future growth of Time Warner.

Although equity analysts are coming around on the short term prospects of the stock, investors still seem confused. As stated in the article in Fortune Magazine titled, “Will Wall Street Ever Trust Time Warner,” the author believes that growth investors like the prospects of cable and AOL, but find the publishing and broadcasting businesses a major drag- and would rather put their money in pure plays such as Comcast and Yahoo. Value investors, on the other hand, are averse to the risks in the cable and online properties. Finally, investors who believe in the value of content would put their money in Disney even though Time Warner owns some of the most valuable entertainment and media properties.

Based on the Fortune article references above, Parsons understands that the past failures to capitalize on synergies and complementarities between the diversified business units (the core of the value proposal from the AOL and Time Warner merger) is the key source of confusion with investors which has caused the company to trade at the same value as over a year ago and nine times 2005 earnings (below other diversified media companies). At the same time, though, we believe that Parsons has the correct strategies in mind to drive strong earnings from all business units with the backup plan to spin off those business units that under perform, which should begin to re-build investor confidence.

At the business unit level, he and his management team have refocused the underperforming business units into more profitable units. For example, in the AOL business line, while subscriptions continue to drop over time, Parsons and team have taken a page out of the Yahoo business model and plan to release a free portal with content and other value added features with the sole purpose of capturing a larger piece of the online advertising market. Analysts have taken this as a very favorable strategy, and this is one of the key points driving the bullish outlook of the company. With the same desire to strengthen the cable business line, Parsons also made a strong investment by purchasing the cable lines from Adelphia’s cable properties, providing Time Warner’s networks with access to approximately three million cable viewers. The deal also calls for the company to create a separate cable stock that would have its own equity, although Time Warner would still have controlling interest. This is a very positive move for Time Warner since it will allow them to make moves in the cable and wireless area without further confusing shareholders and market investors. Both of these moves to strengthen two of their core business units, if successful, should allow Parsons to begin to capitalize on synergies and complementaries between the business units.

A primary step before doing this, however, is for Parsons to focus his energies to truly break down the fiefdoms between the various business units, a key factor in driving synergies between the business units. The architects of the original AOL and Time Warner deal had the correct idea in mind, but they clearly did not consider the internal culture clash that was to come that would torpedo the success of the deal. However, thanks to Parsons, the focus from the top down is to focus on Human Resources to promote information sharing and harmony between the units.

If Parsons is truly successful in building the AOL and cable businesses into consistently profitable business lines while building strong lines of communication between all business lines within the enterprise, only then will the company begin to capitalize on the synergies and complementarities that they have only been able to speak about in the past without any tangible success. If Time Warner is successful, the company will own a suite of complementary products and services that will saturate the market producing significant barriers to entry to other diversified media companies. This is a tantalizing vision for the business units, the management team and shareholders alike. On the flip side, the backup plan to spin off the AOL and cable units depending on success or failure of these initiatives will provide some solace and clarity to investors that AOL’s chairman and CEO still has the shareholder’s best interest in mind. Based on Parson’s success to-date turning around one of the biggest corporate disasters in history, even the most risk averse investor should think twice when deciding on whether or not to pass on investing in Time Warner and its chairman.

-- Bryant Houston, Sachin Kelkar, Riahna Phillips

Friday, May 27, 2005

Collusion Behind the Ivy Walls? Harvard, Wharton, and the Business School Rankings

Business School rankings are a source of pride for students and alumni, a guide for applicants and corporate recruiters, and cash cows for the publications producing them. On the surface, rankings are a win-win situation for all participants, but two of the “industry” leaders, Harvard Business School and University of Pennsylvania’s Wharton School, don’t appear to agree.

Over the past year, Harvard and Wharton have taken steps that some in the business school community perceive as taking a stand against the proliferation of business school rankings. A year ago, both schools took the unprecedented step of refusing to provide journalists with access to the graduating class of 2004 and alumni. More recently, both schools refused to provide the Financial Times with statistical data involving their executive education programs, making it very difficult for the publication to rank the schools.

Are these actions intended to send a signal to such publications about business schools’ participation in other, more comprehensive rankings? In the past, the business school ranking issues have been top sellers for the major business and financial publications. These publications have everything to gain by conducting the rankings, but it is arguable as to whether these rankings provide actual service and value to readers. Most of the rankings are written by journalists who don’t have intimate “knowledge” of a business school’s program, relying instead on subjective opinions and data provided by the very schools they are ranking.

In the game of business education versus ranking publications, Harvard and Wharton are suppliers. By limiting the publications’ access to information, Harvard and Wharton are increasing the price of producing a legitimate ranking by forcing publications to compile the information they need through alternate channels. Rather than being supplied with this information “pro bono” from the schools, as was done in the past, publications will have to spend more resources contacting students and alumni on their own. Publications who are considering starting their own rankings may think twice, now that two of the more highly regarded institutions in the world have increased the input costs.

Or, could Harvard and Wharton’s actions be simply indicative of perceived slights by the publications? The jilted publications (Business Week and the Financial Times) cite hypocrisy on the part of the business schools, claiming that they should be held to the same transparency as public companies. Prior to the decisions made by Harvard and Wharton, neither school finished in the top two spots of the 2002 Business Week rankings, and finished out of the top ten in student satisfaction.

Whether Harvard and Wharton’s defections are merely finger-shaking at the double-standard cited by the publications or a premeditated effort to collude in order to shift the market so that business schools have more supplier power isn’t clear. In either case, though, other top-tier business schools may be incentivized to no longer cooperate with publications, collectively falling to an un-spoken “focal point.” This focal point would create an “elitist” group of business school programs with increased supplier power.
Should other top schools take this route, the responsibility falls on the members of this new group to develop a more organic marketing strategy for presenting their program to the public and sustaining their brand differentiation. Alternatively, should other top-tier schools remain in the ranking game, they may now have more power to negotiate with the publications, insisting upon a different approach to the ranking.

Elite schools having power over publications would be a first for the rankings industry. Currently, publications exert buyer power by establishing a structure for the rankings wherein much of the weight is derived from peer reviews - surveys that are filled out by the deans of other schools measuring various programs, concentrations, and specialties for each school (25% of the U.S. News rankings are based on peer review.) This forces schools to compete against one another in a “tit-for-tat” environment, where schools literally market themselves to one another by mail, often just days in advance of peer reviews. This creates a second game, where the publications are forcing business schools to compete against one another in tit-for-tat fashion.

These days, schools have plenty of reasons not to play this game. For example, in 1991, a top-tier business school only had to respond to two surveys. Today a full time employee at this same school spends approximately three-quarters of their time filling out surveys submitted by the publications for rankings and information guides. Harvard and Wharton argue that this has been an incredible time sink, pulling away valuable resources from more lucrative endeavors. Additionally, top-tier business schools already have considerable brand equity. The economic value added by participating in the rankings is highly suspect considering the opportunity cost of completing the surveys. Even after all this effort, schools are not guaranteed good “shelf space” in the rankings.

So what is the true value of these rankings? First, there are certain barriers to entry in the business school and education. Schools with low brand equity, new programs, and even new programs at established schools need the rankings to spread the word about their program and measure incremental successes in recruiting and placement. Second, even top schools’ “line extension” programs – executive education, part-time programs, and non-degree professional programs – can benefit from the recognition of the rankings. Finally, education and brand equity alone may not be enough to differentiate top schools from one another. Arguably, the strength of a school is in its network. Denying publications access to alumni and students diminishes the legitimacy of relevant information about the network power of a school. This can be incredibly damaging as schools increasingly promote its alumni network as a key differentiating characteristic.

To gain a better understanding of why some in the business school community are concerned with the rankings, one should ask who is compiling this data and doing the initial analysis. Is it seasoned industry professionals, or is the bulk of the information being compiled by journalists who are short in the tooth and lack the perspective or experience to understand what attributes truly differentiate one school from another and what is just marketing blather. Publication staff compiling the data may not know enough about a particular program to rank its merit, and may base judgments on biased actions or qualities.

We think Harvard and Wharton seek to change the way the ranking game is played. When two of the top programs are dropped from a ranking, the new ranking results can be deemed artificial and may lose relevance. This new game has a potential for new rules, where schools stop competing on rankings, and start competing on the quality of the education and culture.

By: Edward Connolly, Deborah Battat, and T.K. MacKay

This Ain’t Cola (the DVD rental wars)

Following its Deal with Wal-Mart, Netflix Hopes to Set the Rules for the Online DVD Rental

Last week Wal-Mart, the juggernaut of the retailing world, announced that it was conceding defeat and giving up its DVD rental business. Well known for dominating every market segment in which it operates, Wal-Mart seems to have been pummeled into submission and has agreed to transfer its DVD rental business to its upstart competitor, Netflix. In the deal announced last week, Wal-Mart’s subscribers will be referred to Netflix’s web site and offered to continue their membership with Netflix, while Netflix will promote Wal-Mart’s DVD sales to its three million customers. With this deal, Netflix hopes to finally achieve a level of pricing power that will allow it to stop the flow of red ink.
Netflix entered the DVD rental market in 1997 and offered an innovative model that eliminated the despised late fees, increased selection and offered the convenience of on-line ordering, mail delivery and low price. Blockbuster, the long-established market leader in brick and mortar DVD rentals, entered the online rental market last fall offering a service similar to Netflix’s at a lower price. Although the competitive war between the companies extends to the fronts of selection, availability of titles and service, the main competitive weapon remained price. This led to rapid and heavy price cutting that sent both companies into the red. Most industry analysts have pointed to this lack of industry profitability, caused by the Netflix – Blockbuster price war, as the main reason for Wal-Mart’s sudden exit.
The impact of the exit on the online DVD rental industry and the end result of the partnership with Netflix are contentious. Will this partnership change the dynamics of the battle? Some think that the partnership will radically change the competitive landscape by establishing a clear market leader who can set the rules of the game. Others argue that, in reality, Wal-Mart’s exit doesn’t change the fundamental dynamics of the competition, since Blockbuster will continue to challenge the dominance of Netflix. This week Blockbuster has already fired a responsive shot, and begun offering special deals to those subscribers who defect from Wal-Mart and Netflix. Indeed, Blockbuster seems to be showing signs that it will not quietly accept the number two position in this market.
Traditionally, Wal-Mart is known for flexing its muscle in extracting value from all parts of the value chain. Wal-Mart has built on its strengths in low cost distribution and procurement to provide value to customers. Wal-Mart has some power over suppliers and has experience dealing with DVD distributors thanks to its DVD sales business, but we believe that these are not significant enough to support Wal-Mart’s low-cost model. Wal-Mart may have some room to bargain, but pushing hard on suppliers may not be possible due to the numerous and fragmented channels through which movies are distributed.
Both Netflix and Blockbuster are likely to have comparable DVD distributor relationships. Blockbuster also has greater synergies in the rental marketplace, already a core part of its business model. Netflix is supplied by 67 studios and distributors. Although exact costs are not published, we assume that the three competitors had similar costs per movie in the rental business and therefore, Wal-Mart did not have a long-term sustainable competitive advantage in this market and were not able to gain significant market share (analysts estimate their number of subscribers by anywhere between 100,000 and 250,000). After seeing nothing but losses, Wal-Mart finally decided to cut its losses and leave the battlefield to the Netflix/Blockbuster duopoly.
In the DVD online rental market, we would expect customers to have low switching costs due to lack of long-term subscriber contracts. In addition, Consumers now have a plethora of options for obtaining DVDs, both through the rental and purchase markets. However, Netflix states in its annual report that new subscribers are more likely to switch than old subscribers, meaning that Netflix benefits from its first-mover advantage. “Despite is size and merchandising savvy… Wal-Mart couldn’t overcome Netflix’s headstart in the rapidly expanding niche of online DVD rentals.” This could be explained by customer loyalty, or low customers’ sensitivity to price.
Analysts seem to disagree on what signal the deal sends to other potential market entrants. As a result of Wal-Mart’s exit, Amazon, which has already started a DVD rental program in England and had been planning to enter the US market, may now be less likely to do so due to Netflix’s now dominant position. Others point to Amazon’s recent talks with Blockbuster and Netflix as indication that Amazon may still enter, although they may now do so in cooperation with another existing market player.
Wal-Mart may have decided that it has more to gain from cooperation than from further competing. By agreeing to remove itself from the industry, Wal-Mart has immediately reduced the competition that has been driving down prices in the DVD rentals market and potentially cannibalized its DVD sales. Additionally, the exit sends a signal to Amazon and other potential entrants that the industry is not profitable, even for a power like Wal-Mart. This strengthens the positions of the remaining players (i.e. Netflix and Blockbuster), possibly allowing them to raise prices. Wal-Mart hopes that this will drive customers back to Wal-Mart stores to buy DVD’s that will be comparatively cheaper to renting. Furthermore, by engaging in cross-promotion, the deal may help both Wal-Mart and Netflix to grow both the rental and sale market pies.
As mentioned above, Blockbuster has already responded to the deal and offered subscription discounts to those defecting from Wal-Mart and Netflix. However, there are some indications that this may be a sign of desperation and a one shot, short-term reaction to take advantage of a fleeting change in the marketplace. This strategy is clearly not sustainable by Blockbuster. Price reductions affect their online and store business. Blockbuster’s online DVD rental business has been bleeding cash since inception and has also been suffering from internal management problems. Carl Icahn, who recently joined Blockbuster’s board, has publicly criticized Blockbuster for its loss making businesses. Carl and other board members are expected to push for higher prices sooner rather than later.
The market for on-line DVD rentals is expected to continue to grow at 60% over the next few years. With a market potential of 70 Million potential households, the current DVD rental market is far from mature. However, to show short term profits, Blockbuster may be forced to concede to Netflix the number one position, and be content to remain the follower in this market. While this will be a new and unfamiliar spot for Blockbuster after dominating the bricks and mortar video rental market for so long, it will probably come to realize that the pie will be large enough for it to sustain a large customer base and finally start to realize future earnings.
Both Wal-Mart and Netflix hope that their deal will lead to higher rental subscription costs. This would bring Netflix back into the black, and might also help Wal-Mart to sell more DVD’s as they become comparatively cheaper. Wal-Mart may also be getting a cut of future Netflix profits, allowing them to have something to show for their failed foray into the online DVD rental market. The only holdout remains Blockbuster, which tested higher rental fees last week and matched Netflix’s price.
Stability in price may decrease competition and allow both players earn hefty profits. However, studios, who earn more than half of their income from DVD sales and rentals may object to price increases, and support new players or other channels. In the short term however, it seems that customers are likely to see fewer price promotions and should prepare to increase their entertainment budget.

Leann Tchaikovsky, Ohad Reshef, John Rhoads

The future is… now?!

In a recent Forbes article, GM restated its goal of producing a hydrogen-based car at the same price point as today’s average car by the end of the decade. George Jetson, here we come! But before we reach into our pocketbook and start saving the environment one mile after another, we need to evaluate the reality of this initiative. Is this technology for real? If so, will we drive these cars and where will we fill them up?

First, we need to realize that fuels cells are not something new. Identified back in the 1800’s, they were considered an improbable device until the 1960’s when NASA began using them in the space program. But unlike so many computer related technologies, fuel cells have not progressed much over the last 20 years. GM says this is all changing.

GM first announced their intentions back in October of 2002 when a Wired article revealed to the world their billion-dollar gamble. Since that time, DOW Chemical announced their involvement in using a GM fuel cell to generate a portion of the electricity requirements for one of DOW’s Texas operations. Encouraging to be sure, this is a far cry from the complete overhaul of the century old petroleum based auto industry. But let’s say for the sake of argument that GM can overcome the technical issues of storing hydrogen, fuel cell life and the costs of production. How does GM’s strategy stand up to other auto manufacturers?

All of the other auto manufacturers are spending some R&D on hydrogen vehicles. But they do not see potential for 20-30 years. In the meantime, hybrids and alternate fuel systems are their focus. GM will be the only buyer in the market for purely hydrogen vehicles components for upwards of 10 years. The positive side of this story is that GM will have strong bargaining power with the suppliers once they have invested in hydrogen vehicles technology. The negative side is that many suppliers will have no incentives to start investing in developing components for an uncertain market with only one costumer. Going alone GM could capture huge profits if successful, but they will have to bear the risk of most of the required investments in any step of the Supply Chain.

Another factor in the success of this strategy will be the complimentary products and services needed to support a hydrogen-based vehicle. First and foremost is the production of hydrogen as well as the distribution. Current hydrogen production is nowhere near the volume needed to support the transportation needs of the American economy. In the case of DOW Chemical above, DOW produces and stores hydrogen as a part of their business. It is unlikely that many of GM’s customers will have the same capability to leverage. Service industries will also have to change to support an entirely new vehicle platform. What incentives are there for these industries to develop and / or change?

That brings in the role of government. Today there are state and federal tax incentives to get buyers to purchase hybrid cars. This may help on the purchase side, but what about infrastructure? If the market demand is composed of even 1 million autos in 2010, will any of the large petroleum distributors be interested in developing a nationwide network for hydrogen distribution? A recent study estimated the cost of building such a network throughout Europe could cost as little as $4.6 billion. Clearly the costs to develop the United States will be more. How much will the ruling party in 2010 be willing to spend to make this a reality? Politically, they would be helping to save the environment. On the other hand, they’re using public funds to subsidize large corporations and the few elite who are able to purchase these cars.

But, let’s say a distribution system is developed. What would be the adoption in 2nd and 3rd world countries? At a time when rivals in the industry are looking for ways to sell their cars abroad to growing markets, this car would most likely only be viable in the US, Europe and a few other small 1st world markets for at least a decade. Fortunately, GM is continuing to invest in their current lines of business through continued introduction of new models across their collection of brands. Will there be any complimentary technologies from the hydrogen effort that can enhance future conventional models? Only time will tell.

Is this a worthwhile endeavor? Will GM’s investment ever return a profit? The risks against success seem huge. There’s the development of the technology to cost efficiently power a car; the ability to store an effective quantity of hydrogen onboard; hydrogen production and distribution capabilities and ultimately consumer adoption. History is littered with technologies that were superior to the competition, and yet were never embraced by the market. A first mover advantage is rarely the sole key to success, yet this is what GM appears to be betting on. Is a hydrogen only based car really the best option? What about hybrids? Imagine driving your company down a curvy road vs. speeding through a hairpin turn. With a gamble this big, one really needs to expect a large payoff. But in this case, the payoff could be decades away. That gives the competition plenty of time to develop their response and build on the work GM has done.

To be true, we would love to see the vision of a hydrogen economy become a reality. Cleaner fuels for transportation (remember, the production of hydrogen is not without its dirty side) would help relieve the issue of smog and could reduce the consumption of fossil fuels. But at what cost? A billion here and a billion there? GM is already fighting for market share along with its survival. Let’s hope GM will be successful and that they will be able to gain some of the profits generated by their efforts to help the world. But for right now, we’re not betting on it.

Rafael Calderon, Jay Geiger, Joan Gelpi