Coyote Blog

Here are Coyote's first three rules of business strategy:

1. If people are entering the business for personal, passionate, non-monetary reasons then the business is likely going to suck.  When I say "suck", I mean there may be revenues and customers and even some profits, but that the returns on investment are going to be bad**.  Typically, the supply of products and services and the competitive intensity in an industry will equilibrate over time -- if profits are bad, some competitors exit and the supply glut eases.  But if people really love the industry and do not want to work anywhere else and get emotional benefits from working there, there always tends to be an oversupply problem.  For decades, maybe its whole history, the airline industry was like this.  The restaurant industry is this way as well.  The brew pub industry is really, really like this -- go to any city and check the list of small businesses for sale, and an absurd number will be brew pubs.
2. If the business is frequently featured in the media as the up and coming place to be and the hot place to work, stay away.  Having the media advertising for new entrants is only going to increase the competitive intensity and exacerbate the oversupply problem that every fast-growing industry inevitably faces as it matures.
3. Beware the lottery effect -- One or two people who made fortunes in the business mask the thousands who lost money (Freakonics had an article on the drug trade positing that it works just this way -- while many of us assume the illegal drug trade makes everyone in it rich, in fact only a few really do so and the vast majority are and always will be grinders making little money for high risk).  Even those people who made tons of money in hot businesses sometimes just had good timing to get out at the right time before the reckoning came.  Mark Cuban is famous as an internet billionaire, but in fact Broadcast.com, which he sold for over $5 billion to Yahoo, only had revenues in its last independent quarter of about $14 million and was losing money (that's barely four times larger than my small company).

When I was at Harvard Business School, the first two cases in the first week of strategy class were a really cool high-tech semiconductor fab and a company that makes brass water meters that are sold to utilities.  After we had read the cases but before we discussed them, the professor asked us which company we would like to work for.  Everyone wanted the tech firm.  But as we worked through the cases, it became clear that the semiconductor firm had an almost impossible profitability problem, while Rockwell water meters minted money.  I never forgot that lesson - seemingly boring industries could be quite attractive, and this lesson was later hammered home for me as I later was VP of corporate strategy for Emerson Electric, a company that was built around making money from boring but profitable industrial products businesses.

Of course there are exceptions, but almost every one of these have built some sort of competitive advantage that allowed them to rise above the rivalry.  Google and Facebook are sexy and make money, but they have built scale and network effect advantages that make them hard now to challenge.   Apple makes money now because it has created switching costs (try switching from an iPhone to an Android and ever being able to text again with iPhone users) and a powerful brand.  The NFL owners have enormously sexy businesses but have created a brand and other competitive restrictions that protect their positions (not to mention have perfected the art of sucking money out of taxpayers for stadiums).  But even looking at these examples, the world is littered with folks who tried to be in the same business and failed.  Remember Nokia, Blackberry, Motorola, Lycos, Yahoo, AOL, Netscape, USFL, XFL, Myspace, etc.  I don't really know how strategy is being taught today, but I was schooled at HBS in Michael Porter's five forces.  I still find this framework useful, and probably about as much as any layman needs to know about business strategy.

But what about marijuana?  There are a lot of people very passionate about marijuana.  It is easy to grow (I remember an ex-girlfriend way back in the eighties whose mom grew it in the attic) and easy to sell (there is plenty of retail space nowadays going begging, or there is always the internet).  Every time there is some expansion opportunity in the business (e.g. a new state legalizing) the fact is advertised all over the media.  Overall, most folks are going to fail and most investment is not going to have very good returns for all the reasons listed above.   For most entrants, marijuana is gong to suck as a business for years to come.   And, some states seem to be developing onerous licensing regimes, and this may allow a few folks with the coveted licenses to make pretty good money.  Some day there could well be someone who consolidates the business and builds a powerful consumer brand and drives down costs and increases scale that makes money in marijuana.  But that is years away and typically the person who leads this is not among the initial entrants.  Remember, the vast vast majority of folks who traveled to California in the 1849 gold rush never made a cent.

You can already see this in California (my emphasis added). 

California's marijuana growers are producing far more pot than is consumed in-state — and will be forced to reduce crops under new regulations that ban exports, the Los Angeles Times reported.

"We are producing too much," Allen told the Sacramento Press Club during a panel discussion, the Times reported; he added that state-licensed growers "are going to have to scale back. We are on a painful downsizing curve."

Estimates vary for just how much surplus California produces — anywhere from five times to 12 times what is consumed in-state, the Times reported.

** You can tell I have classical training in business strategy because my goal is return on investment.  One can argue, perhaps snarkily but also somewhat accurately, that there is a new school of thought that does not care about profitability, revenues, or return on investment but on getting larger and larger valuations from private investors based on either user counts or just general buzz.  I am entirely unschooled in this modern form of strategy.  However, the general strategy of getting someone to overpay for something from you is as old as time.  I mentioned Mark Cuban but there are many other examples.  Donald Trump seems to have made a lot of money from a related strategy of fleecing his debt holders.

AOL is still apparently worth over $4 billion.  Next someone will be buying The Source.

I wrote the other day about how Kevin Drum was confused at why broadband stocks might be rising in the wake of news that the government would regulate broadband companies as utilities.  I argued the reason was likely because investors know that such regulation blocks most innovation-based competition and tends to guarantee companies a minimum profit -- nothing to sneeze at in the Internet world where previous giants like AOL, Earthlink, and Mindspring are mostly toast.

James Taranto pointed today to an interesting Richard Eptstein quote along the same lines (though he was referring to hospitals under Obamacare):

Traditional public utility regulation applies to such services as gas, electric and water, which were supplied by natural monopolists. Left unregulated, they could charge excessive or discriminatory prices. The constitutional art of rate regulation sought to keep monopolists at competitive rates of return.

To control against the risk of confiscatory rates, the Supreme Court also required the state regulator to allow each firm to obtain a market rate of return on its invested capital, taking into account the inherent riskiness of the venture.

Kevin Drum simply does not understand why Wall Street might be piling into broadband stocks despite proposed "tough new regulations."  He posits a number of hypotheses -- that Wall Street expected the rules to be worse than they turned out to be.  But this can't be it because the hundreds of pages of rules are still a secret.  He also hypothesizes there might be some nefarious secret loophole buried in the rules Wall Street knows about but we don't.

This is crazy!  How can a reasonably bright person like Drum who writes about the political economy not understand the issue of regulatory capture?  Seriously, I have always figured that the Left, which has a seemingly infinite appetite for regulation, must favor regulation because they find the benefits to out-weight the crony-ist downsides.  Is it really possible Drum is unfamiliar with the downsides altogether, or is he just being coy?

Here is what regulation, particularly utility-style regulation, tends to do -- it locks in current business models and competitors.  It makes it really hard for new entrants to challenge incumbents with innovative new business models or approaches, because regulations have been written based on the old business model and did not take the new one in account.  So a new entrant must begin business by getting regulators to allow their new model, which never happens because by this time incumbents have buildings full of lobbyists aimed at the regulatory process.  Go ask Tesla and Uber and Lyft about how easy it is to enter a heavily regulated business even with a superior new business model.

This is particularly true in the technology world.  The biggest threat to incumbency is someone with a new technology or approach to the technology.  Don't believe me?  I suggest you go to the offices of Netscape or AOL or Lycos or Borders or Circuit City or Radio Shack and interview them about the security of their multi-billion dollar businesses in the face of new online technologies.  At best, regulators put a huge speed bump in the way of competitors, costing them time and money to get their alternative business model approved.  At worst, regulators block new competitors altogether.

I will give you a thought experiment.  Let's say these exact same rules were adopted in the year 2000, when AOL and Earthlink dial-up ruled the internet access world.  Would cable and satellite and DSL have grown as quickly?  I can see the regulators now -- "hey, all the rules specify phone dial up.  There's nothing here about cable TV.  Sorry [Cox, Comcast, whoever] you are going to have to wait until we can write new rules.

The other thing that happens with utility-style regulation is that companies in the business tend to get their returns guaranteed.  Made a bad investment in a competitive market?  Well good luck getting customers to pay extra to bail you out from your bad decision when they have other options.  But what happens when your local power company wastes $10 billion on a nuclear plant that never opens -- it gets built into your rate base!

In the cast of broadband, they are locked in what business school students would see as a classic supply chain battle.  Upstream companies like Netflix supply content via downstream broadband companies.  Consumers are only willing to pay a certain amount for this content, so the upstream and downstream fight a lot over who gets what share of that consumer $.    This happens everywhere in the business world, from Cable TV to oil refining to selling TV's at Wal-Mart.  There is a real danger that broadband will lose this fight in the future -- but not now.  Regulated industries never die, they appeal to their regulators for help.

As of yesterday, Wall Street is looking at broadband companies and realizing that they are now largely immune from competition and some level of minimum returns are likely now gauranteed forever.  Consumers should hate this, but what's not to love for Wall Street?

Postscript:  Kevin Drum describes the new regulation this way:  "Basically, under Wheeler's proposal, cable companies would no longer be able to sign special deals to provide certain companies with faster service in return for higher payments."  This is a bit like describing the Patriot Act as a law to force people to take their shoes off at the airport.  Yes, it does that narrow thing, but it does a LOT else.  The proposal is hundreds of freaking pages long.  It does not take hundreds of pages to do the narrow little niche thing Drum (like most neutrality supporters) wants.

This Administration has cleverly taken this one tiny concern people have and have used it as an excuse to do a major regulatory takeover of the Internet.  This is a huge Trojan Horse. But I have already ranted about the details of that and you can read that here.

I have been playing around with this DVD, which is a collection of high resolution situation maps from the European theater of war after D-Day in WWII.  The maps are really interesting, though the interface is awful.  Like something from the AOL era.  I would play with this much more but it is just too kludgy.

This is probably my favorite map (click to enlarge)

Of course, on the very next day, the last great German attack on the Western Front came right out of that empty red circle.

In the software, one can zoom very deep into these maps, deeper than these images allow.  So it's a shame that the interface is so bad.

PS - The Bulge is deservedly a part of American military mythology but we should remember that in many ways it was a small battle compared to any number in the East.  This is one of those facts that always perplexes this libertarian, because there is no way the Western Democracies could have ever defeated Germany IMO.  Only Stalin's willingness to soak up astounding losses really defeated Germany.  German army casualties on the Eastern Front were nearly three times their combined casualties in Africa, Italy, France, and Benelux.

The flip side of this is that no one else other than the US could have defeated the Japanese, though again the Soviets would have given them real troubles in Manchuria.  That war was more about projecting power across great distances than pure numbers.  We did bravely soak up absurd casualties in short bursts.  But again, the Russians were soaking up Bettio-level casualties every few hours, and sustained it day in and day out for years.

One of the lessons we learned at business school is that there can still be money to be made in a declining business.  Today's case in point:  AOL.  The butt of much Internet-related humor, did you know that AOL still has 3.9 million US subscribers?  To give a sense of scale, that makes its subscriber base about as large as Charter Communications, a not insignificant 6th place player in the cable TV market.  Its income statements are a total mess, cluttered with enough special charges and unusual income items to scare me off from touching the stock, but it looks like it is still making about $50 million a quarter on about $500 million in sales.  Not what it once was, but not an awful business either.

A company like this run for cash flow could do well for quite a while for shareholders.  Of course, companies like that are seldom run for cash flow -- that is not how corporate management incentives work.  Corporate managers are going to want to take the cash flow from the declining business and try to build some new kind of empire on the corpse of the old one.  Shareholders can reasonably ask why they are not just dividended the cash to make their own reinvestment, but insiders benefit much more if the cash is reinvested within the company.  And sure enough, AOL seems to be buying a ton of small companies.

The Overlawyered blog is one of the blogs I read every day, and is one of the grand old blogs of the Internet, dating back to when AOL was relevant, Pets.com was still paying for Superbowl ads, and I was still using Netscape to browse.

The move to Cato is described here.

This sounds a lot like what AOL tried to do, back before anyone knew what the web was or how to navigate it.  Interesting how these things come back around

Facebook's long-term ambition has been twofold. First, to become the de facto front end for the web— to become a portal not just to the lives of your buddies, but to everything else that is on the web in the first place. (There is remarkably little discussion about Facebook eclipsing Google as a search engine, maybe because nobody thinks the subject is worth taking seriously; they need to reconsider.) The second step is to replace the web entirely— to take every piece of functionality that we've normally associated with the rest of the web, from picture storage to news aggregation to messaging— and reincarnate it inside Facebook's ad-driven walled garden.

Facebook Home is yet another way to do that. By giving people a low-entry-level device that's essentially a front end for Facebook— or a convenient all-in-one fullscreen app— they make it easier for people to dispense with dealing with any other part of the web that's not Facebook. They don't have to block anything explicitly; they just have to make the Home experience so immersive, and offer so much through it, that after a while you don't feel the need to touch anything else. And given that I have friends who barely know a web that exists outside of Facebook, that's really unnerving.

On UVA from Walter Russel Mead via Glenn Reynolds

As the NYT article points out, universities all over the country are facing a world of rapid change. This is going to be hard to face. Universities are structured to adapt slowly—if at all. Typically, university presidents have only limited controls, while faculties have a lot of power to resist. Management is usually decentralized, with different schools and departments governed under different rules and accountable to different constituencies. The fiscal arrangements of most universities are both byzantine and opaque; it can be very hard for administrators to understand or properly and fairly value the true cost and contributions of different parts of the institution.

The structural problem our universities face is this: confronted with the need for sweeping, rapid changes, administrators and boards have two options — and they are both bad. One option is to press ahead to make rapid changes. This risks — and in many (perhaps most) cases will cause — enormous upheavals; star professors will flounce off. Alumni will be offended. Waves of horrible publicity will besmirch the university’s name.

Option two: you can try to make your reforms consensual — watering down, delaying, carefully respecting existing interests and pecking orders. If you do this, you will have a peaceful, happy campus . . . until the money runs out.

This kind of organizational change issue is NOT unique to public institutions.  I think if one were a fly on the wall at Sears, or RIM/Blackberry, or AOL, one could describe exactly the same dynamic: insider constituencies were and are successful under the old model, so consensus processes involving these same constituencies seldom lead to change since these changes are inherently threatening to these same constituencies.  A simpler way of saying this is that it is really hard to obsolete oneself.  Just go ask Blockbuster Video.

But there is one difference in the world of public institutions.  In the private world, new success models in the worlds of Sears and AOL and Blackberry are already out there and growing really fast, run by outsiders who have absolutely no stake in the success of the old model (in fact by folks who have a strong economic stake in killing the old models).  But there is no parallel to capital markets and entrepreneurship in the public space.  There is no venue for new-model proponents to get capital and support outside of the old-model institutions.  In fact, if anything, public institutions will rally their political clout, up to and including sponsoring new legislation, to make sure new models are strangled in the crib.

If I were in the VA legislature and really cared about education innovation in the future, I would give up on UVA driving it and instead take 20% of its funding and hand it off to a brand new parallel entity, say UVA 2.0, run by an entirely new team.

I am always fascinated by folks who fear private power but support continuing increases in public / government power.  For me there is no contest - public power is far more threatening.  This is not because I necesarily trust private corporations like Goldman Sachs or Exxon or Google more than I do public officials.  Its because I have much more avenues of redress to escape the clutches of private companies and/or to enforce accountability on them.  I trust the incentives faced by private actors and the accountability mechanisms in the marketplace far more than I trust those that apply to government.

Here is a good example.  First, Kevin Drum laments the end of privacy because Google has proposed a more intrusive privacy policy.  I am not particularly happy about the changes, but at the end of the day, I am comforted by two things.  One:  I can stop using Google services.  Sure, I use them a lot now, but I don't have to.  After all, I used to be a customer or user of AOL, Compuserve, the Source, Earthlink, and Netscape and managed to move on from those guys.  Second:  At the end of the day, the worst they are tying to do to me is sell me stuff.  You mean, instead of being bombarded by irrelevant ads I will be bombarded by slightly more relevant ads?  Short of attempts of outright fraud like identity theft, the legal uses of this data are limited.

Kevin Drum, who consistently has more faith in the state than in private actors, actually gets at the real problem in passing (my emphasis added)

And yet…I'm just not there yet. It's bad enough that Google can build up a massive and—if we're honest, slightly scary—profile of my activities, but it will be a lot worse when Google and Facebook and Procter & Gamble all get together to merge these profiles into a single uber-database and then sell it off for a fee to anyone with a product to hawk. Or any government agency that thinks this kind of information might be pretty handy.

The last part is key.  Because the worst P&G will do is try to sell you some Charmin.  The government, however, can throw you and jail and take all your property.  Time and again I see people complaining about private power, but at its core their argument really depends on the power of the state to inspire fear.  Michael Moore criticizes private enterprise in Capitalism:  A Love Story, but most of his vignettes actually boil down to private individuals manipulating state power.  In true free market capitalism, his negative examples couldn't occur.  Crony capitalism isn't a problem of private enterprise, its a problem of the increasingly powerful state.  Ditto with Google:  Sure I don't like having my data get sold to marketers, and at some point I may leave Google over it.  But the point is that I can leave Google .... try leaving your government-enforced monopoly utility provider.  Or go find an alternative to the DMV.

A great example of this contrast comes to us from Hawaii:

There may be some trouble brewing in paradise, thanks to a seemingly draconian law currently under consideration in Hawaii's state legislature. If passed, H.B. 2288 would require all ISPs within the state to track and store information on their customers, including details on every website they visit, as well as their own names and addresses. The measure, introduced on Friday, also calls for this information to be recorded on each customer's digital file and stored for a full two years. Perhaps most troubling is the fact that the bill includes virtually no restrictions on how ISPs can use (read: "sell") this information, nor does it specify whether law enforcement authorities would need a court order to obtain a user's dossier from an ISP. And, because it applies to any firm that "provides access to the Internet," the law could conceivably be expanded to include not just service providers, but internet cafes, hotels or other businesses.

Americans fed up with Google's nosiness can simply switch email providers.  But if they live in Hawaii, they will have no escape from the government's intrusiveness.