Pricing power discussion
KAREN GIBBS: We are a nation obsessed with finding bargains. Good for shoppers, but what about companies trying to increase profits when they can't raise prices? In this tough economic environment, companies that can stay profitable and lower prices are scoring big on Wall Street.
Think discount airlines. Those are the kinds of companies Lisa Rapuano searches for. She's a value player, hitting home runs alongside star investor, Legg Mason's Bill Miller. Her fund, Special Investment, is up almost 36 percent this year. Sherry Cooper sees the low price environment as a great story for the consumer, but painful for labor. She is the chief global economist for BMO Nesbitt Burns.
Sherry, let's start with you. We saw job gains pretty much across the board, save for manufacturing. Is it sustainable?
SHERRY COOPER: I think it is sustainable, Karen. I'm very optimistic about the outlook. I think that businesses are finally becoming convinced that this rebound in corporate revenues is for real. The economy is growing again. In the third quarter we've probably seen 5 percent growth, maybe even stronger than that. Consumers are still spending, and the global economy is rebounding. We see commodity prices rising. This is the first synchronized economic recovery we've seen in years. So, with any luck at all, businesses will stop hiring just temporary workers and start to put permanent workers back onto the payrolls. And that's going to boost consumer confidence that much further and sustain what is going to be a self-reinforcing economic recovery next year.
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Rising prices?
Alan Greenspan may fret over deflation, but economist Sherry Cooper, of BMO Nesbitt Burns, found a few companies able to charge more, even in a tough economy:
Comcast, the U.S.'s largest cable company, raised their cable TV rates earlier this year.
General Mills raised the wholesale price of its cold cereals such as Cheerios, Wheaties and Chex in early 2003.
General Motors raised prices on most cars six times since the start of the 2003 model year last fall. And, Ford and Chrysler have increased prices eight times. Interesting since these carmakers are also offering zero-rate incentive buying programs, which play into customer psychology.
Microsoft, whose MSN Internet service is losing money and customers, will sell subscriptions to use a new version of its software (MSN Premium) in a bid to attract clients (the software uses email, calendar, sharing photos with other users, etc.)
Mandalay Resort Group is raising room rates at its 5 resorts in Las Vegas this fall by 10 percent.
Roughly 1/3 of the hotels in New York, Chicago and Atlanta have already raised rates.
Verizon raised long-distance rates, dial-tone rates, non-published listings, and directory assistance.
MCI and AT&T, the two largest long-distance providers, hiked rates earlier this year.
Dow Chemical raised prices for plastics and basic chemicals.
Kemira Chemicals, a global supplier of pulp and paper, water treatment and industrial chemicals for industry, announced it will raise prices for solvent-based cleaners, oil-based defoamers, etc.
Monsanto Co. raised prices on its popular biotech corn and soybean seeds.
UPS and FedEx raised their shipping rates earlier this year.
A general trend to higher air fares, but they might be a reflection of higher energy costs. The 6-month annualized trend in CPI for airline fares rose at a double-digit rate for three months straight.
More airlines are raising the cost of taking passengers from other airlines to thwart competitors. For example, Delta Air Lines is boosting the fee, by hundreds of dollars, for taking AirTran Airways' passengers.
Higher fees on college savings plans, also referred to as 529 plans. Americans poured around $35 billion into these plans this year, so fund companies such as Fidelity Investments and One Group raised commissions on their adviser-sold 529s.
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GIBBS: Well, what does that do to the productivity argument? Productivity is so high that companies didn't need to hire.
COOPER: Productivity growth is a good thing, not a bad thing. The surge in productivity growth meant that businesses were able to cut costs and still maintain huge production gains. Profits, therefore, increased sharply. We saw upside surprises in corporate profitability in the last several quarters, and more is likely to come.
Now, in the future, I believe businesses have tapped the gains in productivity. In fact, what they're doing is using their existing labor forces more intensively, so much more intensively that people are going to be burning out if they don't get some help. So in order to avoid missing sales this Christmas season, businesses have to restock their shelves, take inventory to sales ratios up from what have been record lows. That means stepped up orders, stepped up production, and that ultimately is going to mean more workers, more jobs, more hiring.
GIBBS: Lisa, do you agree that this is a seminal shift now? Does it change the way corporate America is going to do business?
LISA RAPUANO: The seminal shift in terms of what happens with pricing?
GIBBS: And unemployment and productivity.
RAPUANO: I believe that there's something going on here with productivity that has allowed companies that are able to benefit from a productivity loop. So you have certain companies that have been able to have lower cost structures that allow them to put out more product, lower prices to consumers, brings consumers back to bringing in more volume, and therefore creates this loop that allows them to continue offering more value to their customers over and over again.
GIBBS: But isn't that kind of counterintuitive? Businesses want to buy low and sell high just like we do, so why would they benefit from passing on lower costs?
RAPUANO: Well, what we learn in business school is that you need to have a brand so that you can charge a higher price, to somehow extract more value from your customer, and I think that that's still valid in a lot of industries.
But there are also some businesses where the value is created by passing more of the price savings back to the customer. So take, for example, what happens at Amazon.com or at Wal-Mart or at JetBlue or at 99¢ stores or a number of retailers that provide discounts to customers. By providing the discounts, they create intense loyalty from their customers. They provide a value proposition to their customers that keeps them coming back. That, in turn, brings volume through the door, and that elasticity of the customer wanting to spend more at the company makes that company all that more profitable and productive.
GIBBS: Well, from the consumer point of view, all these productivity gains are a blessing. The price of a plasma flat panel plunged by about $3,800. Owning a digital camera has become downright affordable. And buying a pair of jeans went down a size or two for some of us. And in this era of guns and butter, butter is even cheaper.
Lisa, are there companies out there that you like because of this new environment?
RAPUANO: I think that there are a few companies that I mentioned previously, so let's talk a little bit about JetBlue, for example. The airline industry is notoriously a low economic return industry. A lot of it has had to do with the readjustment of the business after deregulation. But there's companies like JetBlue and Southwest that have come out and said, well, we're going to create a business that is much more effective, that operates under the pricing umbrella of the incumbent operators. And by doing that and by looking at the structure of the industry and basing the business model on providing more value to their customer, they have opened up air travel in a great deal of markets that we couldn't get to before, and they've made it much more effective for customers to get from point to point in a convenient, non-complex pricing environment. And that I think is what has accounted for so much of their growth, this explosive growth that we've seen with the discount airlines.
You see it also at the discount retailers. Just because Wal-Mart has the lowest price doesn't mean they're the least profitable. They have focused on keeping their cost structures down and returning that in the form of everyday low pricing. Amazon.com is another company that a couple, 18 months ago or so Jeff Bezos announced he was going to start slashing prices. And I still recall on the conference calls different analysts saying, "Well, isn't the point to raise price? Why would you be lowering price?" And his point back was, "If we can delight our customers, they will come and buy more from our service. The more that runs through, the volume that runs through our platform, the more profitable we will be and the better we will return to shareholders."
GIBBS: Sherry, do you see a difference between the goods sector and the service sector in terms of pricing power?
COOPER: Well, there definitely is a difference. But you see, even in the goods sector and all these companies we're talking about, there's still the potential for job creation. You see, I see this as a win-win. It's great for the households from the consumer side. It's also great for the households from a job creation side going forward.
Now in the service industry, we never really did get the big deflation, especially in health care and housing related prices. And all of those new homes sold meant that there was a tremendous demand for all of the goods and services that go into replenishing these homes. And in addition, of course, education has been a big cost increase sector, so university tuitions are going up.
And given all of this, we don't have outright deflation in the economy, even though Alan Greenspan at the Federal Reserve wanted us to believe that there was a meaningful risk of deflation earlier this year.
GIBBS: All right, Sherry, that's got to be the last word on it. Sherry, Lisa, thank you very much for joining us.
Schiffer interview
KAREN GIBBS: Well, one of the hottest trends in retail right now are selling things under a buck. 75 percent of all consumers shop at dollar stores now. And look at these returns -- the four major players are all up over 25 percent.
Joining us from New York to talk about this growing phenomenon is Eric Schiffer, president of 99¢ Only. Eric, it's a pleasure. Thanks for joining us.
ERIC SCHIFFER: Thank you for having me.
GIBBS: Well, a lot of people think of these 99¢ Only stores or the dollar stores as something akin to a garage sale with walls, but you've got actually stores in Beverly Hills. What's behind all that?
SCHIFFER: That's correct. Actually the company's best store out of 174 is located right next to Beverly Hills on Wilshire Boulevard in Los Angeles. Rich people love bargains, too.
GIBBS: What's behind the success? How can you sell wine for 99 cents a bottle?
SCHIFFER: Well, I'm glad you mentioned that. Actually there was a blind taste test done by the Los Angeles Times earlier this year for 22 wines bought in the Los Angeles County area that were under $5.00, and our wine that we sold for 99 cents came in first place with the highest rating. What we do is we buy in large quantity directly from the manufacturers. We cut out the middle man. And we pay them right away. We're easy to deal with and we're able to negotiate very good deals and pass the savings along to the customer.
GIBBS: Well, Eric, then what's the growth potential here?
SCHIFFER: Well, right now we've been growing at a square footage growth rate of 25 percent a year, which is among the highest in retail. And we only have 174 stores as of today. So our plans are to continue to expand. We're based in California. We're in four states now: California, Las Vegas, Nevada; Phoenix, Arizona, and we just entered the Houston, Texas market earlier on this summer in June. And the plans are to keep expanding continuously and eventually make it to the East Coast.
GIBBS: Well, of course with the level of success that you're seeing, you're bound to attract competitors. What do you think about competition?
SCHIFFER: We love competition, and it makes us better. We were the first to open up a store to sell everything for the single price point of either 99 cents or $1.00, and that was in 1982, 21 years ago. And since then we've seen many people try to copy us, so we always feel that we have to get better every year. For example, last year we introduced in all our stores gourmet fancy food sections and milk in the stores, so we just keep trying to get better and better.
GIBBS: And how do you get those products there so cheaply?
SCHIFFER: Again it's just, you know, buying right and we're just very good buyers. We buy in very large volume and we pay our bills very quickly, and we have great relationships with the name brand suppliers. About 40 percent of the merchandise we sell are closeouts or one-time special buys, and about 60 percent we can constantly reorder.
I think the beauty of our concept is we're able to get these reorderable merchandise at such great prices because we don't have to carry every single brand, every single package type and size like a regular market would carry. So we can go to the name brand suppliers and say we'd like to buy this big tube of toothpaste and sell it for 99. If they say no, we can go to the next one or the next brand, and so we can always carry one or two brands.
GIBBS: Well, being price sensitive, does that mean customers lose out on service?
SCHIFFER: We don't believe so. We try to tell our employees treat the customer and run the store like you'd run your own business. And it's easy for a boss to say that to their associates, and when the boss walks out the associates probably say, well, you know, it's that guy's business. But we put our money where our mouth is, and we grant stock options to every single employee in our company, including part-timers, every year, once a year. In fact, the only people that don't get stock options are myself, the president, our CEO, Dave Gold, and our executive vice presidents, and we prefer to get the options down to the lowest levels. And so when people are part owners, it's very easy for them to care a lot. So I think we have great service and we have great associates working in the stores.
GIBBS: Eric Schiffer, thank you very much for joining us.
SCHIFFER: Thank you for having me again.
Executive failure
GEOFF COLVIN: He's accused of looting Tyco when he was CEO; now the trial of Dennis Kozlowski is underway. Frank Quattrone, once the star investment banker of the tech stock bubble, is now spending his days in a courtroom. And plaintiffs demanded more documents from Ken Lay, Enron's former chief, this week. Suddenly these former high-fliers are deep in the justice system, and our next guest says the details of how they went wrong can help protect us from making bad investments.
Whenever a company or career turns up dead, Sydney Finkelstein performs the autopsy, and his fascinating findings are the largest research project ever devoted to leadership failure. He's a professor at the Tuck School of Business at Dartmouth.
Professor Finkelstein, Ken Lay of Enron, Bernie Ebbers of WorldCom, Dennis Kozlowski of Tyco, all very smart guys. They worked very hard. They really wanted to succeed, and of course three of the most spectacular CEO failures in history. Besides all that, what did they have in common?
SYDNEY FINKELSTEIN: Well, they were tremendously talented, and that's very much one of the themes that I found all the way through in the research that I did: tremendous track records. In fact, you don't get to run a billion-dollar company unless a lot of people selected you in front of a lot of other people.
What they really had in common in addition to that type of track record was falling into a series of traps, you can call them, or habits of behavior that really turned them in the wrong direction.
 COLVIN: Well, in your book based on this research, which is called Why Smart Executives Fail you identify what you call the Seven Habits of Spectacularly Unsuccessful People. Now, what's interesting to me is that a lot of them sound like good things. For example, they identify so completely with the company that there is no clear boundary between their personal interests and corporate interests. Well, a lot of governance experts will say the problem comes when the CEO's interests are allowed to diverge from the corporate interests. So, say he can pay himself a huge bonus while the shareholders get poorer.
FINKELSTEIN: I think that's a perfect example of how in small doses a lot of these themes, a lot of these behaviors are really, they're really sensible. The problem comes up when they go out of control. And that's true, you mentioned Dennis Kozlowski. One of the habits that I talk about is the company is mine, the belief that you, that you own the company, the belief that the company is almost an appendage to yourself as opposed to you being an employee, an executive, or even the CEO of the company. And when that happens, it's really a slippery slope down to getting closer to some allegedly illegal activities.
COLVIN: Well, that was certainly the case in his case and many others. Since it's my place, in effect, anything I do is by definition okay.
FINKELSTEIN: I think that's ImClone, I think that's Martha Stewart, I think that's definitely Adelphia. There are a lot of companies that fall into that boat.
COLVIN: Another one of the habits of unsuccessful people, they seem to have all the answers, often dazzling people with the speed and decisiveness with which they can deal with challenging matters. But we praise people, we train them, we reward leaders for being fast and decisive. So what's the danger?
FINKELSTEIN: The danger is when you come up and say, "I've got all the answers." Number one, you shut out other people. You make it difficult to get the team that's around you to be able to contribute. And number two, who is it to say that you really do have all the answers? In fact, many of the executives that I interviewed and that I talk about in the book had answers, but they weren't the right answers at all. But there was no one there who was able to challenge and question them, because they have this mindset that said they have to have all the answers.
COLVIN: And so their attitude intimidates everybody else.
FINKELSTEIN: Absolutely.
COLVIN: Well, it's one thing to explain what went wrong after the fact. What we all really want is some way to forecast or foresee failures before they happen. And you have come up with exactly that, a list of warning signs. Unnecessary complexity is the first one, meaning what? Unnecessarily complex answers to simple questions?
FINKELSTEIN: Sometimes it's unnecessary to complex strategies, like Webvan when they created dozens of warehouses around the country to sell online groceries, and it cost them over a $1 billion, when we all know you can hire a kid after school to deliver groceries at a slightly lower price point than that.
COLVIN: Speeding out of control. What's that all about?
FINKELSTEIN: That's a warning sign that says you're moving so quickly that you're not able to really manage what's going on. You're getting ahead of yourself. A lot of startups of course fall into that trap.
COLVIN: Yeah, they did. The distracted CEO.
FINKELSTEIN: The CEO is more interested in seeing himself on television, who is interested in having stadiums named after him or her. That's someone who is distracted.
COLVIN: So when the CEO becomes a celebrity, that may in itself be a sign of trouble.
FINKELSTEIN: I think that's right.
COLVIN: Excessive hype.
FINKELSTEIN: You see excessive hype both about products and about actual companies. And I think there were several companies that I looked at were the hype was just going on and on and on. Whether it's Mattel with the Barbie brand, which became the core of the whole company, even though they ended up making a series of acquisitions that weren't quite so successful, or it's a startup company like a General Magic, which is the old Apple spin off where they hyped the product.
COLVIN: Right. Finally, a question of character.
FINKELSTEIN: In the final analysis, I think that's the most important thing, and it's the hardest to get your hands around of course. I try to develop some ways in which the average investor, or employee of a company for that matter, can try to get a sense of what to do, and there are a few things that we can talk about along those lines.
COLVIN: So how can employees or shareholders figure out if there are character problems in a particular CEO or in a company?
FINKELSTEIN: The first place to look is the annual report and the letter to shareholders that the CEO writes. It is one of the most vetted of all documents that any company has. There are lawyers that go through it, other top managers. And if there are still some warning signs that you see there, where maybe the CEO is talking about "I" rather than "we" a little too much, talking about, or rather not acknowledging, any of the mistakes that the whole world knows happened, those are things to look out for.
I think another one is to spend some time listening to conference calls with research analysts. They're now always available on the Internet, often in real time. And listen carefully to how the CEO, and for that matter the CFO, respond to questions that probably they didn't expect or maybe didn't want. How open are they? What type of reaction are they giving you? And you can learn a lot I think from kind of having that type of insight.
COLVIN: Let me ask you, with that as background, about a couple of companies that have been in trouble lately. Sun Microsystems, very high profile CEO, Scott McNealy. Merrill Lynch analyst Steve Milunovich said just this week, "the company has gone from being pure in vision and predictable in financial performance to an underachieving, bloated, unfocussed reflection of its former self." In light of your research, how's it look?
FINKELSTEIN: I'll tell you something about Sun. There's a pattern that emerged over a year ago, which was -- and it's a classic warning sign -- of significant turnover of senior executives. And they were all in the same type of time period of two, three, four months apart, and every single one of them by themselves, they sound reasonable, whether there's other opportunities or some other reasons. But when you start to see that pattern begin to snowball, and now, I mean if you go up and down the ranks of Sun, you'd find that probably two dozen senior executives have left, and why is that?
COLVIN: Gateway, another high profile company with a high profile CEO, Ted Waitt. That was at $80 a share a couple of years ago. Now it's $6 a share. How's it look to you?
FINKELSTEIN: I think Gateway is a story of what I call desperation management. It's a company that keeps on changing their strategy, has no clear sense of how to win. For example, Ted Waitt was the founder of the company, steps to the side. He's back in. He changes his whole top management team. They decide that they can't beat Dell at PCs, so let's go and try to beat Samsung and Sony with plasma TVs. That constant change is really not the right thing to do, always looking for something to hang your hat on.
COLVIN: Well, if you look at the opposite of all these traits we're talking about, presumably you'd come up with a list of pretty good bets for the future. So with that in mind, who do you like?
FINKELSTEIN: Well, I think there are a few companies that I've seen where if you see the strategy, in particular what the leaders are doing, they're doing the opposite to what I describe in the book. Accenture, the consulting firm, is a good example. Joe Forehand is the CEO, and he had the incredibly challenging job of following George Shaheen, who as you may recall, left to go to Webvan.
COLVIN: To Webvan, right.
FINKELSTEIN: Kind of created a circle for us. And what he had to do is, number one, go through the IPO process. Number two, rebrand Accenture, which was the old Andersen Consulting. And we know the partner of Andersen Consulting was Arthur Andersen.
COLVIN: Arthur Andersen.
FINKELSTEIN: And he managed to go through all of those different stages and pretty challenging situations, expand the level of responsibility for people throughout the organization, and try to create a more open-minded organization.
COLVIN: One more.
FINKELSTEIN: I think I would take the New York Times Company as another example, and they're a particularly interesting one because of the Jayson Blair scandal and how they got so much bad press around that. In fact, if you go look at their corporate management, in particular the CEO, Russell Lewis, he in my mind is a standout for someone who is creating a very open-minded organization, a place where they are challenging and asking the tough questions. And the Jayson Blair story is a good one, because it was Russell Lewis and his top management team that were willing to take the rather challenging step of having the two top editors in the news division resign in response to the Jayson Blair scandal. And I think that was a tough call to make and the right call to make.
COLVIN: Sydney Finkelstein, this is a really fascinating perspective on things. Thanks for your views.
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