"Philip Morris International: Profits & Ethics"

July 28, 2011

Philip Morris International: Profits & Ethics.

Browsing through the list of Fortune 500 companies, I was searching for a suitable subject for today's thoughts. I came across Philip Morris and was intrigued. One does not read about Philip Morris in the news much and smoking is increasingly frowned upon in the U.S. Yet, Philip Morris continues to reign the tobacco industry with force. Benefitting obviously from a "loyal" customer base, as any drug supplier does, the company prevails changing legislations and is ranked 94^th on Fortune's list of the largest 500 companies... Philip Morris International (PMI) that is. PMI generates over $27 billion in sales annually with profitability at 27% of sales (ranked at 24). The history of the company is interesting and provides evidence of acquisitions and international expansion, leading to the spin-off of Philip Morris International from the Altria Group in 2008. Interestingly, the Altria Group maintained ownership of Philip Morris U.S. and separately generated $21.6 billion in cigarette sales in 2010.

During my limited research, I was hoping to find clues and insights into what strategies were employed to be that successful in an industry that is as labeled as the tobacco industry. Do any of the normal business rules apply, or if it is a completely different ball game considering tobacco is a highly regulated product? And most of all: How does an individual such as Louis C. Camilleri, CEO and Chairman of the Board of PMI, deal with the scrutiny of his organization and civil attacks, negative press and associations? He surely has a strong backbone … and a cushioned pocket. I guess >$30 million in total annual compensation can thicken the skin.

Unique is probably the right descriptor for the company and its operations as well as for the industry overall. News coming out of PMI seem to be primarily related to announcements regarding its financial performance or decisions pertaining to some kind of litigation. Clearly needed is a team that works with regulators/government in different countries to fully grasp and stay on top of changes in legislation relating to the sale, marketing, and use of tobacco in the various countries. Volume growth stemmed only from the merger with Fortune Tobacco Company in the Philippines. Pro-forma sales volume declined 2.5% in 2010 compared to the prior year. The total market in units did take a hit based on the difficult economic climate as well as higher excise tax in several countries. 

In his latest address, L. Camilleri points out that PMI has worked aggressively with legislatures to adhere to and even support some of the new regulations. Additional regulations are pending, which include product display bans, bans on the use of ingredients, as well as further regulation pertaining to packaging to which the CEO clearly objects. He points out that the Australian government "has released an exposure draft of its plain packaging bill", which would mandate plain packaging in 2012.

It truly is like swimming upstream; imagine being a marketer in this environment. Imagine having to constantly battle government regulations across the globe. Particularly as health care cost escalate across the globe, the impact of smoking will continue to be scrutinized. The CDC states that 1 of every 5 deaths in the U.S. each year is caused by cigarette smoking leading to a total of 443K deaths annually (including deaths from secondhand smoke). Tobacco companies will clearly continue to be a target.

But financially, there still seem to be enough $$ to go around. Let's think about it: Is there much investment in R&D? Probably not, we are not talking about  advances in new product technology that need to be explored. According to PMI's 2010 Annual Report, total marketing, administration and research costs accounted for roughly 9% of sales. I cannot think of another industry where that is the case. I am used to operating expenditures in the 40% range!!! Interestingly, PMI does highlight its strength in innovation and development.  I would imagine that in terms of head count, the legal team must be unusually large and account for a significant portion of salary expense.

COGS were cited as <15% of sales. So how do we get to the previously mentioned 27% of sales net profits? Excise tax! Excise taxes account for almost a whopping 60% of sales. But as highlighted by Fortune, PMI remains the most profitable Tobacco company in the world. Brand image is fundamental to the success of its products in the various countries, understanding cultural differences and perception of smoking are key. Unique to this space are the fact that the top countries are not the top countries for most other industries: Russia, Indonesia, and Japan.

So, in terms of strategy: Strong investments in legal and regulatory teams to stay abreast of ever changing regulation and the litigation/lawsuits. Without question, tobacco companies have strong political ties that prove crucial in delaying (derailing?) certain legislation. Brand image is critical along with local marketing power and influence. Clearly, there is no global marketing approach given the vast differences in perception, image, and cultural influences in this space.

In terms of leadership: Without question, it takes someone stubborn, confident, and with thick skin to lead such an organization. Personally, my ethical believes would be stretched if I had to attempt to drive adoption of tobacco products. The negative impact of tobacco products is unrefutable and stretches far beyond basic health issues. To quote the WHO: "Tobacco and poverty are inextricably linked. Many studies have shown that in the poorest households in some low-income countries as much as 10% of total household expenditure is on tobacco [and therefore] less money to spend on basic items such as food, education and health care. In addition to its direct health effects, tobacco leads to malnutrition, increased health care costs and premature death. It also contributes to a higher illiteracy rate, since money that could have been used for education is spent on tobacco instead. Tobacco’s role in exacerbating poverty has been largely ignored by researchers in both fields."

NO THANKS, Mr. Camilleri, it is all yours!!!!

Make Way for Dunkin!

July 27, 2011

Make way for Dunkin!

Yesterday, on July 26^th, Dunkin Brands Group, Inc. had its IPO. With an initial offering price of $19 per share, the company raised in excess of $420 million. Out of the various IPOs we have seen in 2011, this one appears to be more on the conservative side and maybe even historical. The company itself has been around for more than 60 years. That is certainly not the case for Pandora, LinkedIn, GroupOn, and some of the other technology, Internet-based rising stars that raised money this year by offering common stock.

I am a big Dunkin Donuts (DD) fan myself and believe that they have been rather clever in their marketing and advertising. The company has proven to be innovative in its thinking by introducing new drinks, new food items, integrating their stores in select gas stations and supermarkets. The concept of temporarily introducing new products and measure their acceptance before committing significant resources to them seems smart.

Surprising to me was that the company has only penetrated half the U.S. market. I can recall having an impossible time finding a DD outlet in Florida a few years ago. Nigel Travis, current CEO, says himself that 65% of the U.S. market is still unchartered territory (geographically).

The middle or the country also appears to have much lower coffee consumption than the coastal areas. Different pace of life...

The WSJ article on the IPO today focuses much on the future competition between DD, Starbucks, and McDonalds. Do I believe that my coffee will become much cheaper because of future price wars? Not really. Though certainly during economic hardship you risk losing less of your customer base. I also do recall DD running an ad campaign in its stores highlighting the fact that there have not been any price increases in x number of years. As I mentioned, I really do believe their marketing team and marketing partners have their fingers on the pulse of what is going on. Brand once again seems to be the key notion here. And the more I explore the various consumer markets through these commentaries, the more the value of branding becomes evident.

Without extensive further research what I find interesting here is the growth potential this roughly $580 million company still seems to have. International expansion is the key objective going forward. In October 2010, the company opened its 20^th DD store in Mainland China, which according to the CEO is a major focus for the company. [Who does not look at BRIC for future growth these days?] Information I found online seems to indicate that DD now has 8,835 stores worldwide, of which 6,800 are located in the U.S.

If growth in the industry, which appears to be in the low-single digits, comes from taking over customers, it looks to me as if McDonalds has the most to lose. [On a side note, since, yes I am a proud Mom, my 6-year old still refers to the giant fast food provider as "Old Mac Donald"…as in the farm song. I simply can't get myself to correct him. Maybe when he is 7.] While held back by the economic challenges, times for DD seem to look relatively rosy. Nigel Travis appears to have a good track record with a success story at Papa John's on his resume before joining Dunkin Brands in January 2009. Mildly disturbing was a comment I read online indicating that on top of the already existing debt load, owners took out an additional loan in November 2010 to borrow money in order to pay themselves $500 million in dividends. Oh boy – should we open that can of worms and go there? I did not do further research to verify whether this is true or not. If it is, well, that is one side of Corporate America… I am sure sooner or later I will write some commentary on the always-so-highly-debated-topic of unjust compensation for senior executives.

Until the IPO, ownership of Dunkin Brands Group lay in the hands of several private equity firms that continue to hold a stake now: Bain Capital Partners, Carlyle Corporation and Thomas H Lee Partners. They reportedly acquired the company for $2.4 billion in 2006. It is interesting to me that private equity firms keep buying these large organizations, really across all industries and segments. They tend to run them nice and lean.

Anyway, for today my point is "Go DD". Growth awaits if pursued with continued clever marketing, an eye on geographic expansion and diversification, and the right amount of humbleness!

My suggestion for creative diversification: Copy the idea of an ice cream truck and hit the spray parks and playgrounds and beaches with a DD truck/van to deliver iced-coffee during the summer. I would give anything for an iced latte during those moments….

Note: Picture was accessed on July 27, 2011, at http://www.dunkinfranchising.com/

U.S. Politics - The Game of "Chicken"

July 19, 2011

U.S. Politics: The Game of "Chicken"

It's amazing to me, how daily routines continue and people are either too paralyzed or too naive to think of the consequences associated with  the world's largest economy possibly defaulting on its debt. Maybe I am exaggerating and overestimating the impact of a potential default. Maybe, and so many seem to think, "they" will never let it happen - it is all a political game of "chicken". Matt King, Head of Credit Strategy at Citi, was quoted in the FT WEEKEND saying "Given the likelihood of a downgrade, we are surprised that markets have not reacted more sharply already." Quite frankly, I am shocked. The world must be convinced that the U.S. would never allow the default. I certainly hope so, but convinced…I am not. Too much pride, too many egos involved. Cutbacks of $4,000 billion in ten years. If anybody admitted to being able to accomplish that, why was there such waste to begin with? Reminds me of the 1993 movie Dave with Kevin Kline in which he portrays a U.S. President double and in a brave notion attempts to cut back wasted budget allocations. How daring and exciting to think that someone without any political agenda and ties could come in and make some bold moves!

I don't have that many hot buttons that will lead me to go off in a tangent and become irrational, but politics is certainly one of them. A good reason for me to keep my focus and commentary directed toward the business side, rather than the political arena. To be frank, I try to follow politics as little as possible without being ignorant. The current inability of our U.S. leadership to come to a consensus with respect to the budget, however, warrants attention.

Can anyone possibly foresee the consequences of the U.S. defaulting on its debt? Europe appears to be panicking about the potential global impact. Yet in the U.S., many standup citizens still seem to be unaware of the current deadline and circumstance.

It is also amazing to me that considering the U.S.' involvement in establishing government's in so many different countries over the course of history including Germany after World War II, it is possible for only two parties to exist. Each party loyal to its partisanship rather than to great ideas and the concept of improving conditions for the country's citizens. Individual thinking and creativity appear to be punished; outliers typically have their careers ruined. So, how can you believe in politicians? How can you believe you are electing the best government if you only essentially have an option between two individuals?.... Am I digressing?

This morning as I drove to drop off my 6-year old at summer camp, he is praying for a chipmunk that got hit by a car and was rolling around in pain on the road (by the car in front of us I might add), while I am thinking whether or not I should do some currency hedging before the August 2^nd deadline with his savings. Should I invest in the Euro? Though how stable is the Euro going to be with one country after another going bankrupt?

Seriously, I am clearly not a financial expert neither am I someone who consistently proclaims doom and gloom, but isn't the current state of the world's economy concerning? How do you prepare, what do you invest in? Real-estate seems safe, but then again prices will crash and are they going back up in my lifetime…who knows.

As a so-called business woman, I probably should know how to prepare for a severe global financial crisis. I should probably know, how to deal with my cash, savings, and investments, to minimize any losses. In reality, I don't. In reality, I am worried and am hoping the government will put its egos and wrong loyalties aside and think of its people. In reality, I hope that our leadership will turn into warriors with guts, ideals, and integrity. No political games, please.

Ethics and Integrity or the "Rupert Murdoch Story"

July 19, 2011:

Ethics and Integrity or the "Rupert Murdoch Story"

I recall a particular wave and emphasis on integrity and ethics when I attended Business School. Seemingly a new trend, co-curricular speakers were brought in to emphasize the importance of these values in "tomorrow's leaders". This was likely directly related to the Enron and WorldCom scandals of 2001/2002. Other scandals have broken since, we have seen the banking industry turned upside down over the past years, and yet in many areas the saying still prevails "Good guys finish last".

The current scandal surrounding News Corporation and Rupert Murdoch is interesting and once again turns the attention to ethics and integrity of today's leaders. Since the 1950s, Rupert Murdoch has built a global media empire with key media including the Wall Street Journal, the Times, FOX, Dow Jones Newswire, along with a growing stakes in media outlets in emerging markets such as India. Just last year, he increased News Corps stake in a venture with Asianet TV to 75% after investing a total of $345 million to control four TV channels in India.  The man has been on a shopping spree to build his empire and in 2010 his personal net worth was estimated at $6.3 billion according to Forbes: The World's Billionaires, published in 2010 (He ranked #117 by the way. Bill Gates and Warren Buffet still topped the charts with $53 and $47 billion, respectively… ranks 2 and 3. Interestingly, out of the top 20 billionaires, 7 have their residence in the United States, the land of the free, living the American Dream.)

Today, Rupert Murdoch finds himself front and center in a scandal feared to damage the reputation and brand of the News Corp empire, which reportedly has $66 billion in assets. Two senior executives resigned last week. The business' News of the World outlet, which for years has been accused and legally pursued for phone hacking, supposedly bears responsibility for hacking into the phone of a 13-year old girl who ended up being murdered. The hacker reportedly deleted messages giving false hope to the parents of the teenager. The news on television and the papers have been full of stories of individuals who felt victimized by the paper and its unethical tactics as Rupert Murdoch is hibernating with its team of advisors before heading to a committee meeting this week.

Can Rupert Murdoch claim total ignorance of the tactics employed by his employees to obtain information and stories? Clearly not if you believe all the stories and reports that have appeared in the news in relation to the scandal. Should we blame society, which has become increasingly hungry for insights into drama and detriment of others as evidenced by the plethora of "reality TV" shows in existence?

In either case, leadership and ignorance … not a likely pair. You cannot claim ignorance and refute responsibility when at the helm of an organization. Rupert Murdoch was reportedly planning to retire shortly and make way for succession by current COO Chase Carey. Retiring in the midst of the scandal, whether planned or not, is a tough option for a man of Murdoch's stature considering the brand and public perception. But in all honesty, considering the size of the empire, will this scandal bring the company to bankruptcy, I doubt it. Some additional branches and news arms will likely have to be closed, staff will continue to turn over, and yes, Rupert Murdoch will retire. Will select individuals go to jail for (supporting/encouraging) criminal activity? Possible and ideally it would send a message. I assume this will turn into a long, long, long investigation with a lot of finger pointing and … how much evidence?

Maybe in the business world we should change our thinking from "good guys finish last" to "without integrity and ethics, what goes up, must come down!" Without question, the story of News Corp will make for an interesting case study in business school five years from now. Topic: Ethics and Integrity.

"Borders & Barnes" – The importance of spotting emerging Megatrends!

July 21, 2011

"Borders & Barnes" – The importance of spotting emerging Megatrends!

If you read the WSJ over the past couple of days, you saw several articles on the "demise" of the Borders Group, Inc. This one hits me hard. I personally have some sort of illness as part of which I seem to be unable to enter a bookstore without leaving with at least four or five new books. Not that I ever get a chance to read them all… they are piled high on my nightstand (ask my husband)… but what if I did…

On February 16, 2011, Borders filed for Chapter 11. At the end of fiscal year 2011 (ending January 29, 2011) the company still maintained 642 retail stores (FYI: the four states with the most stores at the time were CA (81), IL (41), PA (41), and NY (36)). Since then, Borders has already begun closing stores and according to the WSJ is down to 399 U.S. retail stores today.  The company hopes to begin liquidating this Friday, July 22^nd. In its Annual Report Borders stated that it employed 5,700 FTEs and 10,700 part-time employees who will now have to search for new opportunities. Sales have slowed consistently over the past fiscal years from 3.4 billion in 2007 to 2.3 billion in 2011. Net losses on the other hand increased to $299 million this past year. Leadership attributes the demise to missing the boat on developing a presence in the e-book/e-reader space, an area that Barnes & Nobles on the other hand has invested in quite heavily over the past years.

According to the WSJ, Barnes & Noble (B&N) reported growth of +0.7% for fiscal year ending April 30, 2011. Growth in the e-book segment offset declining sales of physical books and now Liberty Media Corporation is interested in acquiring Barnes & Noble for $1 billion. I was unable to quickly identify fiscal 2011 sales, but prior year B&N sales reached $5.8 billion; net profits were roughly $73 million. This valuation is very interesting. I would love to know the math behind it. Valuations in the industry I work in are typically multiples of sales, not fractions, but clearly, this is an eroding market and different rules apply. 0.7% growth is after all <1%. [Now there is a quote to remember!!] The WSJ referenced a net loss for fiscal year 2011.

What I think is impressive is B&N's ability to recognize the importance of the technology evolution and predict critical changes in its industry. Isn't this what we are all attempting? To identify emerging trends and assess their relevance and potential impact so that we can make appropriate investments and build competitive advantages? Good for B&N to keep an eye on emerging megatrends and incorporating them into their corporate strategy, which resulted in being among the first to launch an e-reader (the Nook) back in 2009. But… competition is tough and CEO of B&N.com William Lynch will have to be bold and creative. B&N has committed substantial investments to its digital strategy, which will heavily impact its bottom line. Liberty Media Corp seems to believe something can be gained from the acquisition. Liberty Media Corp owns interests in select TV and radio channels (i.e., QVC) along with ownership stakes in evite, Expedia, AOL, and Starz. I wonder what they will do with the physical retail outlets?

Given that the investments will have to be high in order to compete in this space with intense players such as Amazon and Apple, the offer may not be that unattractive to B&N. On the other hand, the company could decide to stay independent and focus on expanding its educational business. This is an area that could probably allow B&N to expand its share. I would assume additional notable changes in this arena are imminent and an area for growth. Amazon is potentially too diversified to build a leadership position in this segment. But these are only my personal thoughts without any further insights into either of those companies' visions. I met a software engineer at a conference earlier this year who used to work for Apple. He claimed that Apple, aka Steve Jobs has no interest in pursuing the professional business; it is all about consumer products. Some kind of involvement on the education side, however, is expected given the potential.

Apple - The Happy Brand

July 25, 2011

Apple: The Happy Brand!

Talking about Apple these days is hip. Writing anything about Apple will almost always guarantee readership. In fact, you probably will not be able to open a newspaper without finding at least one article on Apple or the man himself, Steve Jobs. [Is he really being paid $1 in total compensation?] I will agree, the company and the man are equally fascinating. The 10-K reads like a mystery novel, with interesting detail on units sold, cash on hand. The company is bold, creative, and seemingly full of financial wizards. So Jobs himself gets paid an annual salary of $1. In January, it was reported that he held 5.5 million shares of Apple stock, which right this minute is valued at $398.63 (up +1.36% today). Ergo, his stake is worth over $2 billion (according to the calculator on my iPhone). An article in the Associated Press from January 2011, claimed that Tim Cook's compensation, who currently serves as COO received $59.1 million in total compensation (including bonuses, etc.). Fascinating has also been to watch the insider trading activity at Apple. Senior Vice President of Operations, Jeffrey E. Williams, stands out with more than 7 transactions since the beginning of April as part of which he exercised stock options and sold stock worth over $8 million. According to Form 4, the stock option exercise price was roughly $46 versus the current share price of over $300. Happy times at Apple.

Company sales have increased  $19 billion in fiscal 2006 to $65 billion in fiscal 2010. 44% of net sales stem from the U.S. 39% of total sales are generated by iPhone related products and services, which equaled $25 billion in fiscal 2010. According to the 10-K, Apple sold roughly 40 million iPhones in fiscal 2010 and 7.5 million iPads. As of late September 2010, the company maintained a total of 317 retail stores of which 233 are located in the U.S. and 84 internationally. On a side note, I have seen the Apple store in London…it is almost intimidating. Much like one of the seven world wonders. It is very evident that Apple places a lot of emphasis on the buying experience in its stores. The Annual Report states that it is key to attracting and retaining customers… "genius".

But is there a worm in the apple? Without a doubt, when you grow as fast as Apple has, sustainability of that momentum is in question, and should the momentum slow, Wall Street will be ruthless. We have seen it before!!

Steve Jobs has been on and off on medical leave, smartphone adoption is outpacing adoption of Apple iPhones, and according to the WSJ today, Apple appears ill-equipped to address the low to mid level tier of cell phones. Analysts are expecting this market segment to be the future growth drivers in the space. If true, so the article, Apple's share of the smartphone market may have reached its peak.

Apple invested roughly $1.8 billion in R&D in fiscal 2010. One can only imagine what the engineers are dreaming up. But from my perspective this is a real dilemma. The Apple iPhone brand has developed into something elite, high-end, so have the companies computers (at least from my perspective). And quite frankly, the brand here has become a huge sales driver at this point, without a doubt. How do you bring that to the mid or low cost level without losing the brand equity that the iPhone has established for the Apple name? I wonder what the Apple brand is worth?  I am sure a business school case has been written on this topic. [Let's call HBS and find out.] Clearly, Steve Jobs gets it and does not allow any tarnishing of the Apple brand. An article published in Fortune earlier this year in May, clearly highlights the unforgiving and ruthless culture and importance of public image to the CEO and co-founder or the organization. [Love the org chart that was published as part of the article.]

Maybe the solution would be to develop a separate business unit and brand for lower-cost products that remains disassociated from the corporate Apple brand. Pharma companies have done so in order to develop and sell generic drugs without negatively impacting the image of its branded products.

The Apple brand is still strong despite its share of negative associations. Articles appeared on child labor employed at supplier companies as well as the poisoning of workers by n-hexane in factories in China. Yet the brand stays strong. Today, news surfaced that both Kobo, Inc. and the WSJ halted direct sales on Apple applications in rebellion against Apple's seemingly ever tightening rules regarding the sale of digital content. Let's just hope that Apple can withstand the current glory without developing a "God-complex" and remain creative and bold enough to protect its brand. Happy times at Apple.