WHAT DOES A COMPANY DO WHEN ITS
INDUSTRY IS DYING?
CFO MAGAZINE has published a thought provoking piece
looking at how leading companies in dying industries are responding to its
turning point. Industries profiled include the typewriter industry
dealing with PCs, the DVD rental industry dealing with Video on Demand,
and the check publishing industry dealing with debit cards.
In some of these cases, shareholders became obstacles to
effective corporate adaptation because the price of survival involved
risky diversification and short-term reduction of shareholder value. It
is under these circumstances that CEOs and Boards need to have the leadership
skills to shape shareholder opinion rather than to comply with it.
A fascinating piece about this article is the enchantment
leaders develop with "laggard":customers. Is it a viable
strategy to have a business model that says a bedrock of customers will
always want to use typewriters, always want to rent their DVDs in a retail environment,
and always want to write checks?
When the strategy revolves around serving laggard
customers, it may be time to bail out.
STYBEL PEABODY / BOARDOPTIONS
The Turning Point
What options do companies have when their industries are dying?
Kris Frieswick, CFO Magazine
April 01, 2005
Corp. has looked at life from both sides now. When it leaped out of the gate
in 1985, it quickly swallowed its mom-and-pop competitors to become the
dominant player in the fast-growing video-store industry. Today, it faces the
grimmer side of the corporate life cycle as emerging technologies and
delivery systems threaten the demise of video stores altogether.
have been dying at least since the Middle Ages, and often because a new
technology (cars, in the case of buggy whips) or product (petroleum, in the
case of whaling) made the old industry obsolete.
Blockbuster, it is video on demand and digital downloading that threaten to
make its business proposition obsolete. PCs put Smith Corona on the critical
list. Electronic banking may spell the end of check printer Deluxe Corp.,
based in St. Paul, Minnesota. As different as these companies are, each is
facing or has faced the same conundrum: in a mature industry, should a
company aggressively pursue transforming technologies or simply ride out its
current business model? The choice is far from clear-cut. History shows, for
example, that it is easy to get entrenched in existing technologyeven when change
is bearing down. "A lot of times, the train doesn't look like it's
coming at you that fast, and sometimes that's because you're looking at it
head-on," says Bert Ely, a banking industry consultant with Ely
&Co., in Alexandria, Virginia.
is also a hindrance, since "people in a legacy business want to hang in
there," adds Ely. Moreover, the cost to move to an industry-changing
technology can be prohibitive to the companyand to its shareholders. As
Deluxe CFO Doug Treff points out, sometimes "shareholder value is the
ultimate driver of decisionsmore important than survival of the
has every intention of surviving. Yet, while chief competitor Netflix is
investing aggressively in pay video-on-demand (VOD) delivery, Dallas-based
Blockbuster is mostly focusing on extracting every cent from the home
DVD-rental marketseeking acquisitions, boosting its online DVD-rental
services, launching a subscription program similar to Netflix, and creating a
DVD trade-in program. And why shouldn't it? In its most recent quarter, the
world's largest video-rental chain posted more than a 6 percent increase in
revenue over the previous year. Sure, there have been rough spots:
Blockbuster's planned acquisition of Hollywood Video was still under intense
scrutiny by the Federal Trade Commission at press time, for example, and it
is being sued by the state of New Jersey over its new "no late
fees" policy. But publicly, executives say critics are just trying to
throw cold water on a profitable business proposition.
been hearing about the ultimate demise of Blockbuster for years," says
Blockbuster CFO Larry Zine. "All we've heard about is the threat of
video on demand and how that is going to put us out of business. What happened
in the interim is something that gives us a lot of comfort in the
future." What happened in late 1999 was Blockbuster's introduction of
DVDs, which were cheaper to store, ship, and save than VHS tapes. More
important, says Zine, people still love the "experience of the
Blockbuster store," a habit that he says will keep Blockbuster's
DVD-rental model viable for some time.
It's Just Not Happening
As Zine's comments illustrate, finance executives in challenged industries
are in a precarious position. Publicly, they must tout their companies'
commitment to innovation and long-term goals. Yet instead of investing in new
technology, they can become enamored of their current business modelespecially
if it is successful. And their unrelenting focus on shareholder value can
blind them to the fact that they may be facing a Waterloo moment.
partly what happened to Smith Corona. The company had been making typewriters
for more than a century as it sank into the sunsetkicking the whole way.
Despite tough times in the early 1980s due to overseas competition, Smith
Corona was soaring late in the decade after it was acquired by Hanson Trust
Plc, posting its best year in 1989. That same year, though, Hanson
(apparently recognizing what Smith Corona's executives would not) spun off
the typewriter division as a separate entity. Shortly thereafter, the company
was run over by the personal-computer revolution.
that Smith Corona didn't see the PC coming. In 1991, the company actually
partnered with Acer, a Taiwanese manufacturer, to make what was lauded as one
of the most user-friendly PCs yet built. But the market was already filled
with Johnny-come-latelies when Smith Corona got in. The venture faced severe
price competition, and most tellingthe Smith Corona board killed it after a
year because the product line wasn't growing fast enough. In November 1992,
the company's CEO, G. Lee Thompson, told the Wall Street Transcript,
"Many people believe that the typewriter and word-processor business is
a buggy-whip industry, which is far from true. There is still a strong market
for our products in the United States and the world." When asked what
new products and services the company planned to introduce, he replied,
"Nothing right now. They're still in the formative stages."
grossly misjudged the public's preference for PCs, contends one former
company executive. "It was a decision made without a lot of vision as to
what the computer was going to be," says Mike Chernago, former vice
president of operations, who believes the Acer machine could have saved the
company. "People screamed like crazy when they killed that deal. But at
the time, the executives thought that Smith Corona was never going to be put
out of business. It was hard to imagine that the typewriter would be
annihilated in just 10 years."
Remington Rand acted on the next big thing. The company, which produced the
first commercially available typewriter in 1873, also made the first business
computer, the 409 (sold as the Univac), in 1949. After merging with Sperry
Corp. to form Sperry Rand in 1955, the company sold off the Remington Rand
typewriter division in 1975, years before the PC was a threat. It was a
fortuitous move: Remington Rand Corp. went bankrupt in 1981. Meanwhile,
Sperry Rand thrives in its latest incarnationas computer-services giant
A Checkered Approach
Smith Corona illustrates that insight into a changing industry is useless unless
it is followed by preemptive, definitive actioneven if shareholders seem
typewriters, the paper-check industry has been under fire for decades, as
consumers turn to electronic banking. But only in recent years have the biggest
players begun to react. In fact, industry leader Deluxe made 90 percent of
its revenues from checks up until fiscal-year 2003, and continues to unveil
mid-1990s, the company made a Smith Corona--like stab at acquiring companies
in the electronic-payments field. But Deluxe CFO Doug Treff, who was not with
the company at the time, says that shareholders were not enamored of the
strategy. "Our shareholders are value-oriented, and the electronic
companies were more growth-oriented," says Treff. Lack of sell-side
coverage made it hard to get the word out that the acquisitions were part of
a long-term strategy, he adds. So, instead of tolerating short-term stock
pressure in order to diversify, the company consolidated the acquisitions and
spun some of them off as a tax-free distribution to shareholders (called
printing was such a large contributor to profitability and cash flow,"
says Treff, that the company was ultimately unwilling to contribute to the
demise of the sector by embracing electronic-fund technology. But, he admits,
"the spin offs left us with a company focused on the paper check."
In other words, back at square one with no long-term diversification plan.
made the traditional moves to boost earnings per share: it cut costs, closed
manufacturing facilities, and bought back shares. Finally, in June 2004,
Deluxe purchased New England Business Service (NEBS), a forms, office-supply,
and stationery manufacturer. As a result, in the third and fourth quarters of
2004, print-check revenues accounted for 75 percent of total 2004 revenues,
and the firm posted an 18.8 percent increase in its fourth-quarter profits.
percent amounts to a dangerously high portion of revenue dependent upon a
vanishing consumer activity. In 2003, according to the Federal Reserve Board,
Americans for the first time conducted more transactions using debit cards,
credit cards, and E-billing than they did using paper checks. Although NEBS
may prove a sound acquisition from a shareholder-value standpoint, it might
not ultimately guarantee Deluxe as a going concern.
seems, is OK with that. Yet, while he may hold shareholder value in the
highest regard, the CFO, who joined Deluxe in late 2000, maintains that it
"has to be looked at in the long term." And, he adds, "We do
make investments that don't pay off right away." Meanwhile, eFunds is
trading at 23, double its opening share price.
comparison, Deluxe's main competitor, Atlanta-based John H. Harland Co., has
spent the past few years acquiring electronic-funds and data-processing,
testing, and software companies, and reinventing itself as a software and
services provider. Its shareholders have supported the acquisitions, which
led to reduced earnings in 2004. Harland's stock has jumped 30 percent in the
past three years, compared with Deluxe's, which dropped about 15 percent over
the same period.
Ultimately, a Crapshoot
immediacy of the moment, no one can tell which choices are sound and which
fatal. In the DVD-rental market, this uncertainty is compounded by the fact
that the two category leaders, Blockbuster and Netflix, are betting on what a
feeder industryin this case, the movie studioswill do. Currently, those
studios make 50 percent of their gross profits on DVD sales and $2.5 billion
annually from DVD rentals, a revenue stream guaranteed by well-guarded
distribution channels. Once a movie has ended theatrical release, for
example, it is sold or rented via Wal-Mart, Blockbuster, Netflix, or similar
outlets for between 30 and 60 days or more. Only after that does the film go
to pay-per-view and pay VOD. The film moves into the cable film channels and
free VOD after that channel has gone cold, and finally ends up on regular TV.
"The studios are very good at adding distribution channels," says
Dennis McAlpine, an entertainment-industry analyst. "They don't
eliminate channels when something new comes along."
is staking its future on traditional DVD rentals in stores and online. To CFO
Zine, the threat posed by VOD will be thwarted in several ways. (Blockbuster,
which was spun off from Viacom Inc. last October, has not yet generated
annual earnings as a company, due to write-downs, accounting changes, and
other noncash adjustments.) He argues that Blockbuster receives new releases
before VOD services, it has a bigger library of titles than VOD, and its DVD
technology offers higher production values than VOD movies. Most important,
movie studios don't think VOD is a big revenue generator. "The studios
would have to hope for a fivefold increase in VOD rentals before VOD would
really become a viable channel for them," says Zine.
That may be
more likely than Zine predicts. According to Derek Baine, an analyst with
Kagan Research, several studios have begun to make some films available on
pay VOD simultaneously with home DVD rental. "They want to see what
happens to their DVD sales when they move up the window for pay VOD,"
says Baine. If DVD sales aren't affected, the home DVD-rental business could
face far more of a threat than it does at present.
DVD-rental companies could always counter this threat by getting into VOD
themselves. Netflix has already pounced. The company, which just hit 2.5
million subscribers and posted earnings of $4.8 million on revenues of $144
million for 2004, announced an alliance with TiVo, the digital video
recording service with 2.3 million subscribers, to create a "digital entertainment
product." Although Netflix won't say much more than that, the service
will reportedly allow customers to order a movie online at Netflix.com, which
will then be loaded onto their TiVo sets, providing DVD-quality movies on
demand. The combination of delivery channel, quality, and selection could
dramatically change the business proposition for Blockbuster.
guarantee Netflix will succeed, either. Licensing hurdles could be a
deal-breaker. But standing still equals failure, eventually. And Netflix
seems willing to put long-term survival ahead of short-term shareholder
concerns: its stock was trading at $10 in early March, down precipitously
from its all-time high of 38 in April 2004. Despite the hits, Netflix CFO
Barry McCarthy is currently investing 1 to 2 percent of revenues into
digital-downloading technologies, which, coupled with a recent subscription
price cut, should lead to a loss for 2005. "But it's potentially
important for our future," says McCarthy. "The only way to have a
seat at the table is to test the proposition with consumers, figure out the
best model, then rapidly innovate as you learn more about the consumer
unsure how long it will be before digital downloading and VOD become a
"meaningful component of our revenue stream. It will come slower than
people think." He says this is partly due to the difficulty of licensing
digital content from studios loathe to mess with their precious DVD sales and
rental revenue, and partly to the challenges of the technology required to
download high-quality movies. Also at play is the price point for the
"boxes" that would store the downloaded movies. Still the TiVo
alliance goes a long way toward painting a picture of how home movie rental
may soon look.
Zine says that Blockbuster takes a more cautious approach to new
technologies, often buying smaller companies that are engaged in that
technology, and "learning lessons" from them that they eventually
incorporate into their own business model. For instance, two years before
getting into online rentals, it bought a small online company, Film Caddy,
and studied its operations. Only then did it unveil Blockbuster Online.
Blockbuster also purchased a small company specializing in movie trading
before introducing trading to its stores. And it launched VOD tests in the
United Kingdom and the United States before announcing during its annual
conference call in March that it plans to launch its own VOD service on
Blockbuster Online in 2006although it had no details about how it would work,
or what delivery mechanism would be used.
which is now appearing to embrace VOD as a potential new business line, was
far from enthusiastic about it just two weeks earlier when Zine said of VOD,
"we don't think the economics work well right now." Instead, the
CFO said, the company was focused on boosting revenue through its online and
in-store subscriptions program (a replica of Netflix's program), same store
rental revenue through elimination of late fees (a concept also pioneered by
Netflix), its DVD trading program, and the transformation of some of its
stores into "gaming" venues, which allow customers to rent video
games before buying them. It appears that someone at Blockbuster got the message
that VOD is a space in which, economics or not, Blockbuster must be.
Smoke and Mirrors?
nonchalance about impending technology may conceal aggressive
behind-the-scenes moves. Whether that is the case with Blockbuster, or if
there is simply a hesitance to embrace the next big thing, remains to be
seen. Without a significant shift in the studios' distribution strategy,
analysts predict, Blockbuster can continue to grow revenue by a couple of
percentage points a year for the foreseeable future. Ironically, analysts
said the same about Smith Corona, predicting that an established base of
typewriter customers would never move to PCs, including a large overseas
market. The company sold its assets for $6 million in 2000.
does appear to be doing a few things right, says Kathryn Rudie Harrigan,
Henry R. Kravis Professor of Business Leadership at Columbia University
Graduate School of Business. "You need to love your laggards," she
says. Customers who are laggards don't switch over to new technology right
away, she explains. Instead, "make it very convenient for them. Make it
so they are reluctant to switch to a new product. Eliminating late fees is a
great way to get people to go to video stores."
But the key
to survival in a contracting industry, says Harrigan, is "to become
diversified and to evolve as your customers evolve. Define yourself broadly
enough to develop other products, some of which may make your older products
obsolete." This means CFOs must put aside some of the cost-cutting and
EPS-boosting tools they use to pull companies through tough times in
more-robust industries. They must make the argument to shareholders and to
Wall Street that long-term investment in emerging opportunities is more
important than short-term stock price.
What CFOs can't do, she warns, is
ignore obvious signs of industry contraction. Believing in your company is
important, but CFOs must be active participants in learning all they can
about the industry-killer next door. "It's like a lot of things,"
she adds. "If you let yourself get stagnant, if you're not constantly
reinventing yourself, you're dead meat."