The Benefit of the Crisis: A German View

From our colleagues at Schmid Preissler Strategy Consultants:

Due to current events, we are publishing this very special BriefLetter written by Dr. Thomas Schürrle. Dr. Schürrle is an attorney consulting globally operating businesses. It is due to this occupational activity that his point of view of the current situation is of particular value and interest.  Dr. Thomas Schürrle The Benefit of the Crisis A few years ago, the former president of the Federal Constitutional Court and Federal President Roman Herzog suggested suspending a percentage of all rules and regulations across-the-board with the reasonable expectation that the absence of numerous regulations would remain undetected. The criticism that this process has not been implemented quickly and noticeably enough has not yet faded away and the call for extended regulations and increasing legislative efforts already becomes loud again - to bring the financial market under control and to prevent systemic catastrophes within the global economic and fiscal system - which are currently dampening the future prospects.  Only at first glance there hides a paradox within the inconsistencies of both approaches. This is not a question of quality and quantity of regulation, but rather of market regulation as a whole. Apparently, the freedom of competition and management is, from experience, a better guarantee of the supply with economic goods and services than the administered planning via a centralized government. That both exponents view each other as opposites of the integrated whole without ever representing competing alternatives we know since the heuristic discussions about the viability of the particular economic system. The position of the pendulum of regulatory measures between both exponents generally reflects ex-post-facto reaction according to the requirements of the control of markets. Within a regular framework, public administration can and should impact the markets through control to a very limited degree.  However, it would have to do so to a much more considerable degree in order to keep the markets from reaching their target functions. If you examine the existing regulation of the financial markets under aforesaid premise, you will discover that the market for the supply with debt – with some regional distinctions – has been strictly regulated for the past few decades. Where as the market for the supply with equity is regulated only rudimentarily, either through private equity or hedge funds. Regulation of share derivatives and their trade, especially of those utilizing the leverage effect, is virtually non-existent.  Considering this background, it is fair to conclude that the markets and their instruments tend to develop into the area where they are subjected to the least limitations. Thus, the private equity / hedge fund business has grown considerably in the past two decades. The business with financial derivatives has exploded. Since the new development of products in unregulated segments was only profit-oriented and not controlled and it also was not subject to any self-regulating market conditions, fundamental principles were disregarded. One of these principles is that money cannot proliferate on its own. Appreciation of value which has a profit increasing affect on financial transactions based on derivatives must be generated by the underlying market economy. Furthermore, the extension of the derivative-chain does not simply increase the profit expectations but also the loss expectations and it simply defines the gradient of success or failure.  The increased dependence of the successful finance business on financial derivates does not square at all with the fact that banks, insurances and suppliers of proprietary capital have to primarily ensure the supply of external or proprietary capital. Trading with financial derivatives remains a secondary business, even if it speculates on the basis of short positions, unless strictly for hedging purposes only. If the financial leverage contingent on derivative trade typically leads to short term profits, it is at the same time inevitable that a market expanding in this direction will make out a draft on the future. Such drafts have been drawn in the past years and now it is time for payment: Since the market for financial derivatives inflated explosively, the bill is proportionately large.  This asks for more than drastic corrections. Trailing the runaway derivative market development with corrected touch-ups is doing too little. In view of the potency of this crisis and the magnitude of the dissipated finances, the main function of the money market to supply money has been jeopardized. In such a crisis, bans simply curtailing derivative trade or controlling managerial salaries do not work. In fact, approaches must be methodical and need to be all-encompassing. This is exactly what the crisis provides space for: Legislature can and should, during a free-enterprise regulation, conceptually make the markets more expensive where limits need to be imposed, especially in secondary and tertiary derivative markets, which do not primarily serve the goal of supplying the population with economic assets, services and capital. In return, legislature will prevent economic main and primary functions – namely the supply of the population with economic assets, services and capital within the intergovernmental or domestic segment – from being curtailed. Internal and external barriers to trade need to be avoided at all costs. They were the main amplification factor in 1929. Any form of accelerators, which neither serve supply nor its basic principles, need to be strictly avoided. This includes not only derivatives from the financial sector but also other disruptive factors that could unduly amplify cyclical value fluctuations of products, services and businesses through leverage. Even a short term duty to supply information and reporting requirement should be taken out of the market to allow for long-term planning, where since such reporting requirements are verifiably not useful or used correctly. Long-term orientation has to be the basis for the entire market regulations to effect adequate self-regulation. The awareness of what needs to be done is now forming in the crisis. Only the enormous pressure of a global economic crisis generates the necessity for clarity, thoroughness and strategy that is inherent to every great reform and creates the ability to get things done without endless debate. The industry has shown us the correct and successful path from a crisis jeopardizing ones existence in many cases, e.g. in the case of Siemens. Within a timeframe of just two years, the company was able to utilize a severe crisis in connection with dubious business practices and exchanged the entire top management and restructured nearly all internal control systems. Those familiar with Siemens before know that this equals the gutting of a building, and such a drastic restructuring would not have been possible without such a threat to the existence from the outside.  It is primarily the crisis that allows us to throw overboard pointless restrictions and enables the creation and installation of new and reasonable self-regulating market structures with a long term perspective. What proved to be imperative for the largest German industrial enterprise should also apply to the “site management” by political and administrative bodies, both on a Federal and a State level.

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From: Schmid-Preissler Strategy Consultants

Crisis, Recession or What?

Readers of BriefLetter or recipients of our Synesis have known our assessment for a long time already. What we mean is that what we are experiencing today is neither a crisis nor a recession. We characterize this situation as a break. A break with the past. We wrote about it in the essay “The last 50 years have passed”. 

It is not about pondering how to cope with the crisis, about how to get out of a recession. It is now time to define in every business, in society and politics, the future primary values and along with them to necessarily develop new strategies for the future. 

It is essential to take stock in all areas, to filter out the substantially valuable and to put it together to a new performance indicator. Less has to be more in the future. The “every year increasing turnover” can no longer be in the center of strategic thoughts. The goal has to be to achieve a substantial profit. Only with such a profit can new goals be reached. 

It is imperative to procure certainty in regard to availableness of knowledge and expertise of employees, because with too few or even no employees with enough knowledge and lots of experience a future cannot be shaped. 

It is essential to rigorously verify products and services in regard to their superiority as compared to the offer of the competition. In the best sense, distance has to be created and expanded. 

It is it is necessary to be prepared for consumers keeping a close watch on the price/performance ratio during purchases for products meeting needs. For purchases taking place in the big field of satisfaction of wants, more attention is going to be paid that the intrinsic value of immaterial values emanating from Premium and Luxury brands is going to be expressed and as such dreams and wishes of the buyer are going to be fulfilled. The latter is very important, especially in times where money is spent cautiously and prudently. Surely, it is going to be easier for people to extricate themselves from bad times, if they can strike a balance between reality and beautiful experiences. Wise and sensitive marketing are in demand here. 

We suggest to look less to the left or right, but to be self-concentrated and to concentrate on the relationship to the customer. The livelihood of a business and its success actually depend on ones performance ability and on ones attitude towards the customer.

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Re: WSJ: Milan Woos the New Frugal Luxury Shopper

Re: Today's Wall Street Journal. 

Touting runway designer clothing as an "investment" is a bad idea. If branding teaches us anything, it is that your brand is your promise to your consumer, it's your contract, your bond. So, why make a promise that you know you will disavow a year or two from now? Does anyone really envision next year's ad pitch to be " you don't have to buy much this year because you bought well last year? Is this what we'll be saying next year? I don't think so.

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Starbucks: Grinding The Numbers, Losing its Soul

Re: Cold Coffee, NY Times, August 2, 2008

Bravo, The New York Times.

But Starbucks, What have you been drinking. lately?

When you're a 5000 store chain, boasting outlets all over the world,  and a national newspaper begs you to keep open one, 1000 square foot location, one would think this might get the attention of the cost cutters. 

Has everyone in charge of the Starbucks brand been fired, already? 

"Maybe cutting these particular costs might be more expensive than we calculated" they might ask. 

"Are there some "off-financial-statement costs here that we haven't accounted for?" 

"Maybe our customers thought we stood for something more than just the opportunity to buy an expensive latte?" 

"We used to talk about building our reputation, did that ever matter?"

"Has anyone checked what we told the community planning board when we were lobbying to open the store and the neighborhood was concerned that the shop, previously there for 25 years, might be forced to close?" 

"Do you they will remember this closing when times turn and we are again wanting to expand into their neighborhood?"

 "I know it's a longshot, but do you think any of the locals travel out of the neighborhood and might actually tell people what we're doing?"

Just some non-financial-analyst metrics that Starbucks might add to sharpen its grinder.

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Cutting Its Costs, Starbucks Brand Begins to Bleed

Re: To Starbucks, a Closing; To Newark, a Trauma, NYTimes, July 23, 2008

Starbucks explains the planned closing of its Broad Street, Newark store very candidly: ““We used several criteria to determine stores for closure, including identifying locations that were not profitable at a store level and not believed to provide acceptable returns in the foreseeable future.” Where's the assessment of the impact of a store closing on the company's reputation, on the Starbucks brand? 

Clearly, financial criteria are important to the consideration. Surprisingly, for a business that is so brand driven and profits so much from its investment in its brand,   there is no indication that a brand strategy is playing any role in planning the Starbucks retrenchment. To be sure, Mr. Schulz, clothed his comeback in the language of “brand values” and “return to the brand’s roots”.  But, where's the meat? In fact, no brand planning has surfaced as of today. Instead, Starbucks is cannibalizing its brand and sacrificing it on the altar of satisfying the financial goals imposed by Wall Street.

Some very smart person once said, “it’s not whether you fail but how you deal with your failure that reveals who you are.” And that’s true of brands as well. These times will reveal much about Starbucks and will set the foundation for its future success or failure.

Starbucks sold itself as a “different” type of coffee company. It was the American adaptation of the European coffee house, the neighborhood coffee house. People friendly, the café’s were stocked with newspapers and periodicals and invited customers to linger while enjoying their quality coffee time. It was also a company that was good to its people: good salaries, advancement possibilities, good ingredients in its foods, good coffee purchased from the right parts of the world. Starbucks was a trend-setter which “proved” during its rise that you can be a good corporate citizen as well as a highly successfully company. These were some of its hard earned brand equities.

People felt good when they sipped their Starbucks; they were part of a good thing. Who can measure how much of the premium they knowingly paid for their Starbucks was for the better roast, or coffee bean and how much for the privilege of participating in this "good", "positive" feeling.

It’s now clear that in its giddy days, the Company embraced some ridiculous expansion policies. It played to its financial analyst audience and has paid the price in hits to its profits caused by foolishly chosen, duplicative locations and other wasteful expenditures.

But while claiming to be focused squarely on the protection of its base, its core, its brand, its current tactics reveal a serious misunderstanding of what the Starbucks brand is all about. Ignore the people on Newark’s Broad Street, if you like; what are the rest of Starbucks followers going to think when their “different” kind of company turns its back on the community development it once prided itself as being part of? What is the next local zoning board going to think when Starbucks needs a variance to successfully replace the old, local coffee shop with a brand new Starbucks café? How much of a premium will coffee drinkers pay for a cup of coffee from a regular corporate coffee shop?

How much is a company’s credibility worth? Well if you leave it exclusively to the numbers crunchers tasked with reducing costs by a target percentage within a specified time frame, “not much”. There may not be a line item in the company’s financial statement for “brand equity” but intelligent, forward looking leaders of brand driven companies surely understand its value.

How about you, Mr. Schulz?

 

 

 

 

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The High Price of Opacity

Re: Why No Outrage? Wall Street Journal, July 19, 2008

Great question, but that’s where it stops. James Grant’s answer: blame the victims, bad answer. 

In this illuminating chronicle of financial misdeeds, Grant presents a long list of reasons why the American public should be outraged at the state of the economy, at the condition of the vast majority of Americans, and at the seemingly near unanimous willingness of those in power to do nothing to correct the situation. He asks, given that this is an election year and these problems are well publicized why don’t we see any signs of public outrage. He answers: Americans don’t care.

This article is only one of a growing number of inquiries into why, at a time when we Americans are awash in information, various groups within our society consistently behave against their self-interests. In your spare time, read What's the Matter with Kansas by Thomas Frank.

“Things have become too complicated.” “It’s harder to connect the dots.” “The US and global economies have become so inter connected that it’s difficult to discern cause and effect relationships.” We are regularly showered with lists of reasons why not to understand a situation.  Add to this our penchant for the sound-bite and 100 word news analysis and it’s clear why many will tell you that any concept which can’t be explained within these parameters is probably not a concept worth understanding.

But there’s more. This is not an entirely benign situation. It didn’t just happen.

We have developed an unsettling pattern in our national culture: We provide government assistance to the poor and middle sectors of society through direct assistance programs and we provide government assistance to the affluent and corporate sectors indirectly through opaque systems of credits, tax incentives and indirect benefits. There may be nothing sinister here, it may just have developed this way for historical reasons, but the costs of this opacity have become enormous.

By way of illustration, we have school lunch programs through which the federal and local governments provide direct assistance to schools to provide healthful lunches to our students. If someone were interested, one could compute the amount of money that the government provides through this program. If one day, it were discovered that some local officials were misappropriating the food intended for the students and instead selling it, in addition to the deserved outrage, we could take remedial action. We understand the flow of the money through the program, how much money is involved, who should handle it etc. We could fix this problem.

Now take the example of how hedge fund managers are compensated. Generally, they receive most of their compensation through a construct called a carried interest. The reason for this is that their tax advisors have advised that a carried interest qualifies them for capital gains treatment for the money they are paid for their work and it is therefore subject to a maximum tax rate of 15%.  One day, someone writes an article in the Wall Street Journal noting that while hedge fund managers typically make in the tens of millions of dollars per year, unlike the rest of the American public, they are taxed at a maximum rate of only 15%.  There is the expected outrage and the public says: “fix this”. But the fix is no longer direct, it’s no longer easy. Why, because the fix involves changing the tax provisions which in this case were used to incentivize people to take investment risks. The argument from their lobbyists: if you tax these poor hedge fund managers on the same basis as we do the rest of us, they will not take the risks (what risks) and they might even move to the Cayman Islands where they have set up their funds.  The argument essentially is: we can’t afford to lose these guys.

Imagine if we had paid some ordinary person $50,000,000 and his contribution was to burden our business with billions of dollars of worthless debt that we now have to reckon with. Would anyone be screaming, “don’t cancel his bonus, he might leave?”

T. Boone Pickens is now publicizing his alternative energy plan to end the US dependency on foreign oil. The plan will entail tens of billions of dollars of government assistance.  Mr. Pickens is lobbying for government assistance. It might very well be a good plan; he might deserve the government assistance.  But if I were going to help, I would want to know how much I’m giving, how it’s being spent and what can I expect in return.

But under our current system, the assistance will come through very indirect and hard to measure programs like energy credits, research and development tax credits, the use of government eminent domain powers and numerous other incentives. In the end noone will know how much public money was spent. Noone will know how much was given to Mr. Pickens.  No one will be able to calculate what we, the public, have gotten in return. 

There is no accountability for public money given to the affluent and to corporate America. Many don’t even acknowledge the subsidies exist; many don’t assume any responsibility for providing the public with a return on its investment.

There is no appreciable public debate on the subject because the welfare and other assistance programs for the affluent have been kept out of the public’s view. The price for keeping them out of public view is that they are not measurable, it is difficult to tell if they are accomplishing the goals for which they were created, and there is no accountability. Our leaders preach the benefits of free market capitalism, of transparency and of accountability. It's time that we insist that these principles be applied to all of the members of our society.  

 

 

 

 

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Brand Repair: Fresh Views Breathe New Life Into Inbred Brands

Re: Nelson Peltz, Activist Marketer, Fortune Magazine, July 10,2008

Brand strategy is shrouded in secrecy by most brand driven companies. And the more successful the brand is, the more likely it is that the group responsible for its creation remains around for a long time, each successful year growing more confident, and frequently less open to opinions from outsiders. We see this phenomenon in our politics and we see it in our businesses. Insularity and smugness kill brands.

When businesses falter, how frequently do they go back to the business's founder or early leaders seeking to be rescued by those who had the "original formula" down right? Sometimes, I think the reason why this strategy works at times is because the founder has been disassociated with the business long enough to have seen it from the outside, not because he possess the deep, hidden secrets on which he built his original success.   Steve Jobs is certainly credited with turning Apple around and Howard Schultz was brought back to Starbucks with great fanfare. The jury is still out to determine what Schultz learned while away from his creation.

So, this little article about activist investor, Nelson Pelz, has an important message. But it's not that Mr. Pelz is or is not a wonderful marketer. The message is how valuable it can be to bring some fresh air into the insular brand strategy and marketing thinking of established brand driven companies . In Pelz's case, he has bought his own ticket to the party by owning more than 5% of the company's with whom he shares his advice. Management could hardly afford to ignore his views. 

But one would hope that enlightened brand managers would seek the views of those who are sometimes outside of their inner circle. Someone has to tell us when the emperor is wearing no clothes!

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