Category: economy

Why Dick Smith is wrong about overseas buyers

Foreign investors are desperately needed in Australian retail

Last week’s announcement that Woolworths will sell their Dick Smith chain of electronics stores wasn’t surprising and neither was the reaction of the chain’s founder to the idea of the business being sold to a foreign buyer.

For all his legitimate concerns about Woolworth’s growth model, Dick Smith is wrong about the sale of the stores. It’s almost essential for Australian consumers and business that the chain is sold to a foreign retailer.

When Dick sold his business to Woolworths in the early 1980s it was the beginning of a long consolidation process across Australian industry that now sees most business sectors dominated by duopolies or – at best – three or four incumbents.

In retail, the Coles and Woolworths duopoly dominates groceries, liquor and petrol. The power of these companies was illustrated yesterday with Coles’ announcement of price cuts to various greengrocery lines.

Having a new player enter the market is always an improvement; in neighbourhoods where foreign retailers like Costco and Aldi operate or where a keen, smaller operator decides to compete with the big boys the response is always better prices and service.

More importantly bringing in overseas owners will bring in fresh thinking and new ideas. New blood in the retail sector may even stem the brain drain where many young, innovative future business leaders are forced overseas because of the limited opportunities in the incumbent duopolies.

Where Dick is right is that the electronics retail business is dying as fat profits in the sector are a distant memory in what is now a tight margin, fast moving consumer goods industry. To make things worse, consumer electronics aren’t even fast moving in the post GFC economy.

Adding to the retailer’s pain the collapse in margins has happened at the same time commercial rents have risen dramatically with Sydney now being cited alongside Hong Kong, London and New York as the world’s costliest shopping strips.

While suburban shopping centres don’t have the same rents as the Pitt or Bourke Street Malls, they still have risen dramatically in the last decade, catching all retailers in a vice between rising costs and falling margins.

In order to maintain profits, training and staff development have been slashed. Once up a time, a customer would go to a Dick Smith or Harvey Norman store to get informed advice on the best gadget, those days are also long gone as poorly trained staff fight to sell the products with the best commissions.

Owners of the stores have made it harder to recruit and train motivated staff when employer consider hospitality and retail jobs to be temporary, low esteem positions with few prospects.

This deskilling isn’t just an issue for the retail industry – it’s something we’ve seen across the Australian economy in the last thirty years. As training and skills development has been seen as an unnecessary business cost.

Tourism Australia chairman Geoff Dixon’s recent comments about the Australian tourist industry having to accept being a high cost destination is a symptom of this disconnect. The local tourism industry has no chance of moving up the value chain when there is no service culture among staff and no long term management vision to develop one.

It would be unfair to just pick on any one individual or business for these problems. We have a structural problem in the Australian economy that’s fuelled by entrenched beliefs and habits of a stagnant senior managerial class.

We desperately need new people and ideas in Australian management to shake up the staid duopolies and oligopolies we’ve allowed to develop in the last three decades, that’s why Dick Smith is wrong to say a foreign owner for the electronics chain he founded would be bad for the country.

Image courtesy of Icelandit on SXC.hu

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Book review: Endgame by John Mauldin

Life after the debt supercycle.

“There are no good choices – only bad ones” could sum up John Mauldin and Jonathan Tepper’s Endgame which looks at how our economies will evolve the end of the late 20th Century debt “supercycle” that has driven the world economy for the last fifty years.

Endgame examines the choices that confront governments, societies, businesses and investors as the world economy adapts to the realities of the West’s aging populations and excessive debt levels.

Much of Endgame relies on This Time Is Different by Carmen Reinhart and Kenneth Rogoff which the examined eight centuries of financial crises. While Reinhart’s and Rogoff’s conclusions are that speculative bubbles driven by debt almost always result in a banking crisis and painful economic restructure, each episode does have unique characteristics.

In each case governments have three basic choices; reforming spending which is rare and maybe impossible given the debt levels in many nations, inflating debts away as Western governments have done since WWII or through outright defaults which have been associated with less developed nations.

As we see with the convulsions the European Union is currently going through and the massive support given to banks around the world since the 2008 banking crisis, the default option is the one which governments will avoid at all costs.

While the bulk of the book concentrates on the US, John does dedicate several chapters to the how the debt endgame will play out in other nations including Japan –“a bug in search of a windshield” – the UK, Eastern Europe and Australia, where he finds a massive property bubble that he believes could be the most spectacular endgame scenario of all.

The clear lesson from Endgame is the post World War II social compact of working taxpayers supporting the aged, the sick and unemployed is over and was only propped up the illusion of wealth generated by loose credit and financial engineering throughout the 1980s, 90s and early 2000s.

Some are hoping the Chinese economy can provide the global demand that was provided by US consumers. While Endgame doesn’t specifically look at this aspect, it’s unlikely China’s economy can do this.

With consumers and governments now exhausted by debt and at the limits of what they can spend, the assumptions that have driven the economy along with our investment and consumption patterns of the last fifty years no hold true.

Endgame is primarily a book for investors and John Mauldin’s emphasis is on where the safest investments will be in at the end of the debt supercycle. His view is it depends on whether governments choose to eliminate their national debts through deflation or inflation.

For business owners, wage earners and retirees this is an important question too and Endgame describes what the consequences for everyone are under either scenario.

The message of Endgame isn’t overwhelming negative; John Mauldin also looks at where the opportunities will lie after the credit endgame plays out. “We don’t know where the jobs will come from, but they will come” is another theme of the book.

Whether you’re an investor or a business affected by the changing economy or building those businesses of the future, this is an important book for understanding the changing economic world in which we live.

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The evolving business

How a fading electronics chain illustrates an evoluting industry

This story originally appeared in Smart Company on February 2, 2012

Woolworths’ announcement earlier this week they are exiting the Dick Smith Electronics business ends an interesting study in how a business can evolve as their industry changes.

In the thirty years since Dick Smith sold a stake in his business to Woolworths – a few years later they bought out the rest of Dick’s equity – the electronics retail business has changed immensely.

At the beginning of the 1980s, the CB radio boom that had fuelled the growth of stores like Dick Smith Electronics was coming to an end, as was the hobbyist industry which supplied those building their own computers and other electronic devices.

In the US, the hobbyist industry included people like Paul Allen and Bill Gates – who founded Microsoft – along with Steve Wozniak and Steve Jobs, the founders of Apple Computers. Both of these companies had a lot to do with the growth of the DSE business later.

While those two industries were fading at the time Woolies bought the chain, the availability of consumer electronics was taking off as Video Cassette Recorders, car hi-fi and, later, CD players started entering the market.

At the time these were high margin items so the transition from a hobbyist store to consumer electronics chain was a lucrative move for Woolworths – something helped by Dick Smith’s penchant for publicity even though he was no longer with the store.

Eventually the steam ran out of the early wave of consumer electronics but in the mid 1990s the PC revolution took off which allowed Dick Smith Electronics to diversify again.

As personal computers were taking off, so too did the next wave of consumer technology, particularly in mobile phones, games and big screen TVs which initially had big, fat margins.

Over time, these margins began to fade as prices dropped but for Woolworths this wasn’t a problem as the beginning of the 2000s saw an explosion of easy consumer credit, allowing stores to move more products to willing consumers.

Very quickly, the consumer electronics industry became more like the low margin, high volume FMCG – Fast Moving Consumer Goods – sector that is Woolworths’ core business.

The global financial crisis heralded the end of the credit boom and now cautious, credit shy householders meant consumer electronics were no longer fast moving.

Dick Smith Electronics aren’t the only chain affected by this, Harvey Norman are suffering the same way and in the United States Best Buy and Radio Shack are in desperate straits for the same reasons.

Making things tougher for Australian retailers are store rents that are among the highest in the world. Woolworths’ decision to shut down a third of the Dick Smith outlets is a wise move as many of those stores probably have lease renewals pending.

Woolworths has done well from Dick Smith Electronics over a quarter century as the consumer electronics industry has evolved. Their story is a great example of how a business can adapt in a changing sector.

Hopefully Woolies will find a motivated buyer – one hopes not one of the clueless private equity asset strippers that have destroyed so many other retail icons in recent years.

Perhaps we’ll see a buyer who can steer the business well into the phase of consumer electronics retailing with some innovative and fresh thinking that the Australian retail sector needs right now.

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The battle between the old and the new

What side of history do we want to be on?

“We will build an America where ‘hope’ is a new job with a paycheck, not a faded word on an old bumper sticker” – Mitt Romney, US Republican Presidential candidate

“What immediate measures can be taken to protect jobs?” – French President Nicolas Sarkozy

“We want to be countries that made cars” – Kim Carr, Australian Minister for Manufacturing

Around the world the forces of protectionism are stirring to shield fading industries, businesses and fortunes from economic reality.

The most immediate target in this battle are the new industries that threaten the old.

It’s no coincidence US lawmakers want to introduce laws that will cripple the Internet in order to favour music distributors, that the US and New Zealand governments work together to shut down a cloud sharing service or that failing Australian retailers call on their government to change tax rules in order to prop up their fading sales.

The old industries appear to have the advantage; they are rich, they have political power and – most importantly for politicians – they employ lots of voters.

We shouldn’t under estimate just how far the managers and owners of the challenged industries will go to protect their failing business models, unwanted product lines and outdated work methods, which isn’t surprising as their wealth and status is built upon them.

Eventually they will lose, just as the luddites fighting the loom mills and the lords fighting the railway lines did.

The question for society and individuals is do we want to be part of yesterday’s fading industries or part of tomorrow’s economy.

We need to let our political leaders know where we’d our societies to go before they make the wrong choices.

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Misunderstanding Chinese growth

It’s best we get developing economies into perspective.

When I first visited China in the late 1980s, I was amused at all the adverts for Rolex watches and Luis Vuitton handbags lining Shanghai’s Bund and the streets of Guanzhou; “how many Chinese can afford these goods?” I asked.

The response was usually along the lines of there are a billion Chinese and if only one percent can afford these products then that’s a huge market.

Over the years since we’ve seen consumer brands pour into China only to find the markets for Western style consumer goods aren’t what they expected. Many have left with their tails between their legs.

The New York Times looked at this in their weekend story “Come On China, Buy our Stuff.”

What many misunderstand is that while there are some millions of well heeled Chinese who can afford a Rolex, the vast majority simply cannot afford a Western style consumer lifestyle.

The average Chinese income in 2010 was $4,270 per person according to the World Bank. For the United States, average income was over ten times China’s at $47,000. The average across the Europe Union is just over $32,000. India’s was only $1,330.

So any business selling into the PRC expecting to find a consumer society like those of Northern Europe, Japan, the United States or Australia’s is in for a disappointing experience. Chinese households have neither the income or access to the credit lines that drove the Western consumerist societies over the last thirty years.

For economists hoping that Chinese and Indian workers can pick up the world economy’s slack by becoming consumers on a level similar to European and US workers, they are deluded; this is at least a generation away.

According to the Nation Master web site, the US had a similar average income to what China’s current levels in 1900. While there are clearly some differences in measures, we can say today’s Chinese workers are – in wealth terms – around a century behind their US colleagues.

It may take a century for Chinese workers to catch up with Europe and North America, but it won’t happen as quickly as businesses and economists hope.

Those hoping China will take up the slack left from the excesses of the 20th Century credit boom are going to have to look for a plan B. It may be up to the rest of us to find what’s going to drive the world economy for the next twenty years.

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Losing the supply chain

When an entire industry moves offshore it isn’t just a few jobs that are lost

The New York Times’ weekend feature on Why Apple Manufacture iPhones in China focused on the underlying reasons why manufacturing has become concentrated in the PRC.

While much of the commentary on the article has – correctly – focused on how US manufacturing move to China is destroying the economic bases of the American working and middle classes, there’s also another serious consequence of the story; the destruction of the US supply chain.

The story itself emphasised this;

In part, Asia was attractive because the semiskilled workers there were cheaper. But that wasn’t driving Apple. For technology companies, the cost of labor is minimal compared with the expense of buying parts and managing supply chains that bring together components and services from hundreds of companies.

While wage costs are important, far more critical are the surrounding supply chains. Without those, even if you want to manufacture in the US or anywhere else you’ll struggle to find suppliers and skilled labour.

The amazing thing with the United States is the world’s most powerful economy has managed to dismantle most of their supply chains that took a century to develop inside twenty years whil China has built up most of theirs since they joined the World Trade Organisation in 2001.

For the United States economy, the effects are more subtle and dramatic than they first appear. The accompanying video to their story illustrates how the multiplier effect, the number of jobs created in the wider economy for each industry worker is as much 4.7 for a manufacturing job, while a service sector worker is less than 1.

That means less employment and less wealth.

For the US, and most the Western world, we were able to avoid the effects of becoming less wealthy over the last decade by spending big on credit cards. Homes that would have been out of reach to the average American – or Australian, Brit or Irishman – were kept accessible by easy, cheap credit.

As that credit dries up with the end of the Twentieth Century debt supercycle, the economic basis of this model is eroding.

For most of us in the Western, developed world it means we are going to become poorer. Chinese and Indian workers might catch up with our living standards, but that standard will be at a lower level that we anticipated a decade or two ago.

The most interesting consequence of the New York Times’ story is what happens to the managerial classes?

Right now they appear to be riding high as their companies’ profits increase and they award themselves trips to the Paris Ritz and receive 50 million dollar payouts when caught cheating on their expenses.

Over time though this cannot continue as the senior managers themselves have become major cost centres which will eventually have to be reduced.

Indeed Apple, the leader in the outsourcing trend, is unique among US companies in that it had a driven, visionary leader and doesn’t have a bloated, self indulgent cohort of bureaucrats managing the business.

With every stage of the deskilling of America and the offshoring of supply chains, there’s been the belief that “it could happen to me” to various groups of workers – we’re now seeing the same process happen in white collar professions like the law are subcontracted to Indian and Philipino service providers.

Senior managers should have no illusions the same will happen to them as the search for cost savings runs out of targets in the rest of organisations.

The biggest problem though is that loss of supply chains and industry knowledge. The question is, can you rebuild that capacity in decade in the way China did?

Supply company image courtesy of Stock Xchange and Andy McMillan.

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The pay day

How does a local news agent exit their business?

Last Sunday Mark Fletcher celebrated his 10,000th post at the Australian Newsagency Blog. In seven years of posting that’s an impressive achievement for someone running both a retail store and a software company.

In his landmark post, Mark looked at the major issues he’s covered on his blog over the last few year and one stands out as the biggest – the payoff for newsagency owners when they sell their businesses.

The failure of many newsagents to manage their businesses for day to day profit. Too many newsagents expect their pay day when they sell and do not realise that their pay day is today, tomorrow and next week … and that this determines what they will receive when they sell.

For Australian newsagencies the news is bad; their established industry is struggling in the face of technological change and regulatory changes – both of which are other points Mark raises – but more importantly the buying and selling businesses in all sectors is undergoing a fundamental economic shift.

Lifestyle Businesses

The underlying idea is that these businesses are what Steve Blank calls “lifestyle businesses”; proprietors buy them to provide an income for their families.

For these “lifestyle businesses” to have a resale value another family is has to raise the funds to purchase the enterprise.

Therein lies the problem, most purchases of businesses are financed by bank loans secured against property.

Late baby boomers and Generation Xers – those born between 1955 and 1970 – are the obvious buyers of these businesses and they don’t have access to the same equity as their parents.

The situation is even worse for those generations following whose high education debts mean an even later entry into the property market and even less equity available should they want to buy these businesses.

For sellers, this means is buyers can’t pay the prices retiring business owners need as their nest egg to support them through twenty or thirty years of bowling or travelling in their later years.

This inter generational mismatch isn’t just restricted to Australian newsagents; it’s a problem around the Western world for business owners whose exit strategy involves selling the business as a going concern for a substantial amount.

Cash poor buyers

As we reach the end of the late 20th Century credit boom, the money isn’t there for people to pay the sort of sums required by existing local business owners to retire in comfort. Even if the banks were prepared to lend the sum required, the buyer’s underlying assets can’t secure the loans and, most importantly, the cashflows aren’t there.

In an Australian newsagent context much of the cashflow has changed because of deregulation and new competition but on the bigger scale changing consumption patterns at the end of the 20th Century debt binge coupled with aging populations and restricted credit are changing the economics of family owned, small local businesses.

For the current owners of these small businesses, it means the pay day has to be today as it won’t be there tomorrow.

The danger is how many will follow the example of the large corporations who find themselves in a similar situation and respond by excessively cutting costs or chronically under-investing which is what has crippled big store retailing across the US, Australia and the UK.

Mark’s constantly pointed out that Australian newsagents have to reinvent themselves, as he celebrates seven years of blogging and 10,000th blog post it’s probably worthwhile considering how many, like the rest of us, will be working in our businesses far longer than we originally expected.

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