Forget Derivatives – Hedge Risks with Innovation and Integrated Data

To protect against wild currency swings or volatile commodity costs, one surefire strategy employed by senior managers is hedging risk with derivative contracts. However, some companies are discovering alternative methods to guard against uncertainty via two strategies—product innovation and integrated data.

In a recent Fortune article, author Becky Quick cites methods for dealing with tumultuous changes in our global economy. In addition to “natural” risk hedges against currency storms such as bringing production of goods back to home markets, Quick mentions that companies look to hedge risks against commodity price fluctuations by purchasing futures, options, or similar financial products.

And while companies from soda manufacturers to global airlines use such structured products to protect themselves from perfect storms, derivatives aren’t a complete panacea, especially for un-sophisticated players. “Companies enter into transactions that are rarely understood,” says derivatives expert Satyajit Das. In addition, he says, “(These) complicated (derivative) structures make it hard for clients to price (them).”

Instead of trying to “out-think” markets, Quick gives an example of Proctor and Gamble relying on “good old fashioned engineering and science” to innovate its way out of commodity price risks. She says Proctor and Gamble doesn’t bother buying derivatives.  Instead, the company looks at alternative packaging options and sometimes substitutes for price sensitive ingredients. For example in one hair care product, biodegradable cornstarch was substituted for pricey petrochemical resins, saving millions in costs.

In addition to innovation, another risk management avenue is merging disparate data sources from sales, marketing, inventory, finance etc into an integrated foundation. With integrated data, company managers can peer deeply into various departments or divisions and perform cross functional analysis. Integrated data means that senior managers gain a 360 degree view of business conditions. Managers can now see how one decision impacts other aspects of the organization. And with everyone in the company marching to the same drum-beat—making decisions from a “single source of truth”—it’s much easier to produce coordinated and flexible responses when extreme events such as supply chain disruptions or other “once in a century events” occur.

Derivatives – a $60 trillion dollar business – aren’t going away any time soon. But innovation and integrated data provide much more than simple risk management.

Innovation provides an opportunity for cost take-out and game changing products or services. And maintaining integrated data across multiple functional areas (finance, operations, customers, suppliers etc) allows for increasing risk management sophistication as a business can be managed as “as a whole”.  Armed with a more complete picture of business conditions, executives can steer their company through chaotic economic conditions and find safe harbors in explosive market storms.

Marketing Lessons Learned: Riding Bubbles at Lehman Brothers

When “the next big thing” is identified—whether it is tulip bulbs, internet technologies, real estate or financial derivatives, market mania is not far behind. And while riding and making a mint from a bubble of “irrational exuberance” is possible, it’s also beneficial to know when to exit the moving train before it explodes. Just ask the former executives of Lehman Brothers.

It’s been said the phrase, “this time is different” is one of the most dangerous sentences in business. That’s because executives keep making the same mistakes again and again say economists Carmen Reinhart and Kenneth Rogoff; “We gullible humans (believe) that the laws of financial physics have been repealed for us.”

Why do humans keep making the same mistakes? Perhaps it’s because over optimism—and resulting speculation—is very much a part of the human psyche. We like to believe those who have previously failed just didn’t have the right information, or that a new paradigm has emerged. And sometimes changes are so fundamental and drastic that they do create new markets. But more often than not, we’ve exchanged our money, time and hope for worthless swamp land.

Now what does any of this have to do with marketing?

An important role for marketing executives is to provide direction to our business leaders regarding trends, white space, and best areas in which to compete or avoid. We do this via a thorough understanding of competitive, social, governmental, and economic forces within a market.

In adding a potential new product or service to our portfolios, we need to ask ourselves, is this market sustainable —or does it depend on unstable factors? How long will this market exist? At what stage of the lifecycle is the market? Does my company have the capabilities to compete? Can my company make a profitable impact?

And this is where diagnosis of a market bubble comes into place.

Now let’s be clear. Not everyone believes in economic market bubbles. Some economists are convinced that people have all the information they need and therefore always make rational decisions. Efficient and rational market theorists from the Chicago School of Business, in particular Eugene Fama, don’t believe in unstable and wild market inflations. “I don’t know what a bubble means,” Fama recently declared to writer John Cassidy.

However, since there’s an abundance of evidence for market euphoria, let’s assume economic bubbles do in fact exist. The next step is identifying whether the market in which you plan to participate is in fact prone to speculative behavior (even mania), and if so, should your company compete or walk away from the opportunity?

These are a few questions that could have been asked by senior management at Lehman Brothers as they jumped headfirst into frenzied markets.

In the book, “A Colossal Failure of Common Sense; the Inside Story of the Collapse of Lehman Brothers,” former Lehman Brothers vice president, Larry McDonald cites how then CEO Dick Fuld and his second in command Joe Gregory made bet after bet, first in derivatives such as collateralized debt obligations (CDOs) and credit default swaps (CDS) and then grandiose real estate purchases.

These purchases—with borrowed money—were made with the following inherent assumptions:

  1. the market would keep rising indefinitely,
  2. there would always be a market for securitized debt, and
  3. what’s profitable for competitors must also be the same for Lehman Brothers.

Sadly, we know how the story ends. McDonald relates, “When a high rolling market goes wrong, history tells us that it happens with lightning speed, as everyone stampedes for the door at the same time.”

Indeed, as the market for derivatives self destructed, Lehman was stuck with a bag full of product than nobody wanted, to the tune of sixty billion dollars. Senior management failed to ask themselves, “how long can this market sustain itself?” or even “what’s our current position and what happens if this bubble pops?”

It seems that it’s quite easy to get caught up in the euphoria of a new market, especially when everyone appears to be making boatloads of money. An ebullient market looks like it will never end.

However, it’s very possible to enter at the very top of the market and not know it, effectively joining the party just as the host removes the punchbowl. And this is where very careful analysis from the marketing function can come into play.

While a frothy market may be pretty easy to identify, it’s difficult to know when it’s going to end. Participating in a market bubble is a risky proposition and timing (getting in and out) is everything. And for those analytical types, even if deep market analysis is performed, it’s possible your timing may be off by just a bit, leaving you short or long. After all, as John Maynard Keynes once said, “The market can stay irrational longer than you can stay solvent.”

One thing is for certain, history repeats, or as others have said, it rhymes. Lehman Brothers stood for 158 years but participation in one of the largest asset bubbles in history brought this noteworthy firm to the steps of bankruptcy court. Lehman rode the bubble and didn’t “get out”. The musical chairs stopped with nary a seat.

It really wasn’t different this time.

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Marketers, do bubbles exist? Is it possible to discern a bubble? How can one discern when to “get out” of a frothy market before it implodes?

Marketing Lessons Learned from Collapse of Lehman Brothers

For one hundred and fifty eight years, the investment bank Lehman Brothers survived multiple business cycles and even the Great Depression. However, critical miscalculations in its last few years of life ultimately proved catastrophic for not only Lehman Brothers, but the global economy as well.  A post-mortem examination of mistakes made by Lehman executives provides ample lessons for marketing executives of all stripes.

Started in the 1850s by three German immigrant brothers (Henry, Emanuel and Mayer) the Lehman’s founded the New York Cotton Exchange and eventually became huge players in the trading of equities and debt instruments.  At the time, the Lehman Brothers probably could not have imagined the firm would become one of the largest investment banks in the world, with over $46B of revenues in 2008.  Also inconceivable was mistakes the company made that ultimately led to its destruction.

In the book, “A Colossal Failure of Common Sense; the Inside Story of the Collapse of Lehman Brothers,” former Lehman Brothers vice president, Larry McDonald, chronicles the rise and fall of his company. Taking readers from the nascent beginnings of Lehman Brothers to the eventual bankruptcy of the firm, McDonald weaves a tale of good advice ignored, political snubs, and gross mismanagement of the world’s fourth largest investment bank.

This bestseller has abundant lessons learned for those seeking to understand best and worst practices in corporate governance and politics, financial management and business strategy. There are also cautionary tales for marketing professionals. Let’s start with the first:

Sometimes innovation isn’t a good thing

Innovation, for the simple sake of producing something new sometimes doesn’t increase value, and in fact may end up destroying value. A compelling example in the financial services sphere is the exotic (and sometimes toxic) derivative products produced and sold by Wall Street in the past decade.

Simply stated, derivatives are securities whose value is “derived” from an underlying asset or security. A polluted medley of derivatives during McDonald’s tenure at Lehman Brothers came to be known by names such as credit default swaps (CDS), collateralized debt obligations (CDOs) and derivatives of derivatives (CDOs squared) among others.

Instead of selling corporate or government bonds, equities and other financial instruments that customers could readily understand, companies like Lehman Brothers pushed complex financial products to hedge funds, pension funds, and institutional investors that often had higher margins.

Now, to be fair, derivatives on the whole, aren’t a bad idea, regardless if Warren Buffett labels them “financial weapons of mass destruction” or “weeds priced as flowers.” They can serve a purpose for savvy investors as a method to transfer, insure or hedge against risk. And used correctly, they can offer significant returns.

Yet, many of these derivatives sold by Lehman Brothers and other investment banks were so complex in nature; they could only be valued and priced by PhDs in physics and mathematics. Regulators and traders often didn’t understand derivatives, much less the customers buying them.

McDonald called these types of derivatives, “Wall Street’s neutron bomb.” And that’s exactly what happened in the collapse of Lehman Brothers.  Lehman’s role in CDOs was to take bundles of mortgages and “slice, dice, package and ship (these mortgage backed securities) to investors all over the world.” And it all worked out swimmingly until the market for CDOs imploded, leaving Lehman holding a bag of several billion in risky mortgages and CDOs that were un-saleable at almost any price.

Marketers understand the push for innovation all too well. Our products and services must always ‘one up’ last year’s model/edition and deliver more value for the same (or more money).  Even if there’s really nothing new to announce, the next product/service cycle often demands new features that customers may not have even asked for.

Marketers must understand and articulate the value that our products and services bring to customers. However, sometimes products and services are so complex they defy comprehension.  Ask yourself; is the “innovation” proffered really innovative? Will my customer see it this way? Can the value proposition be simplified? Can the marketing messages be recited by the everyman on the street? If not, perhaps it’s back to the drawing board.

All eggs in one basket is a recipe for disaster

Mark Twain is to have said, “Put all your eggs in one basket, and watch that basket.” And while this is a potentially sound strategy, there are times when a singular focus, a concentration on a “sure thing” can lead to disaster.

Under then CEO, Dick Fuld, Lehman Brothers became one of the largest players in the mortgage backed securities business. According to McDonald, Lehman borrowed thirty two times their worth, mostly to cover purchases of mortgages from mortgage brokers or “body shops”.  In fact, at the end of 2006, Lehman Bros was in the subprime securities market to the tune of over fifty billion dollars.

Now $50B is a lot of eggs in one basket! And sadly, this money was leveraged –or borrowed. Thus, when the CDO market slowed down, McDonald relays that, “(Lehman) had a growing mountain of these things piling up, not yet sold…potential liabilities.” Stuck with securities Lehman could not sell, any financial losses would crush their capital cushion.  Lehman went neck deep into the subprime market and when this market caught fire, Lehman was running for the theatre exits and getting trampled along the way.

A key responsibility of a well-rounded marketing executive—whether in industry, product, market communications, or the like—is to provide direction to business leaders regarding trends, white space, and best areas in which to compete or avoid. Marketers need to constantly examine the landscape and have a keen understanding of the competitive, social, governmental, and economic forces that drive new market entrants or exits.

The goal for a marketer, then, is to anticipate key obstacles to achieving a company’s objectives and identify means to circumvent them.  Don’t make the mistake of Lehman Brothers. Take a look at your overall product portfolio. How are your revenues weighted? Where have you placed your bets today and tomorrow? Are all your eggs in one basket?

Going For Growth…In China

shanghaiCharged with finding new markets for growth, many Western marketers are eyeing China’s rising middle class and terrific GDP numbers. And while getting Western products and services into the Chinese market is hard enough, the ability to compete and thrive in China takes mastery of specific skills and processes. Success also involves a drastic change in mindset.

As one of the few countries in the world showing positive economic growth, the future of China sure looks promising. And to take advantage of a very large marketplace, Western companies like Pfizer, Astra Zeneca, Goodyear and others have established beachheads in Chinese markets. However, an Economist article titled, “Impenetrable” reminds readers how truly difficult it is to sell foreign goods in China.

To be sure, some companies are thriving in China. The Economist article cites luxury good makers, airplane manufacturers, and commodity producers as successfully penetrating China. Yet, for every success story, there are a dozen works in progress especially in fields such as pharmaceuticals, banking and insurance and telecommunications. In fact, Ronald Schramm, a professor at the Chinese European International Business School says that the impact of Western firms’ total sales in China are little more than a rounding error.

Why all the difficulty? Western firms must deal with the fact that for all the excitement of capitalistic economic zones in China, most of the enterprises in China are state owned. That means Western companies must deal with plenty of costly and unending red tape from protective Chinese authorities. And while China joined the World Trade Organization in 2001, there is much work to be done to level the playing field for Western companies to effectively compete.

Yet, all hope is not lost. Digging a bit deeper for strategies to penetrate and prosper in Chinese markets, I interviewed Globe Trade founder, Laurel Delaney. Ms. Delaney argues that companies doing business in China need to change their mindset and think of China as an investment that will pay off over the long run. She says, “It takes tremendous time, incredible patience and phenomenal preparation to do business in China. Many companies just don’t have the stamina, perseverance or dollars to last — yet, if they hang on and keep working on it, they will eventually find success.”

The path to successfully navigating Chinese markets also involves avoiding the biggest blunders. To that point, Ms. Delaney mentions the number one mistake a Western marketer can make when looking to China for growth is attempting to go it alone. “You need a strong and effective team and good “Guangxi” (relationship) when doing business in China,” she says. “The stronger the team you assemble breaking out of the gate — the greater your likelihood of success in developing business in China.”

Ms. Delaney also mentions the types of local talent, needed “on the ground” to propel success. First, she says, Western companies should set up a peer-to-peer advisory board consisting of legal talent, an individual with M&A knowledge, a transportation and logistics “superstar”, a banker and a governmental contact. It’s these people that can help a Western marketer iron out issues and challenges they’ll likely face.

In addition, outside of setting up a joint venture with a company, consider hiring local talent to help market to Chinese consumers. According to Ms. Delaney, someone on your marketing team, “(needs to know) native tongue languages of China, is smart and masterful at communicating which includes marketing/advertising, has experience with your product or service offering, and has a history of proven success.”

China is an economic giant and is poised—eventually—to be the number one economy in the world. For Western marketers, finding ways to get your products and services into China is definitely worth strong consideration. Success in Chinese markets won’t come easy, and it won’t be cheap. China’s markets hold great promise, but also peril for companies that lack determination and endurance for the long-run.

Questions:

  • A Business Week article notes that in many instances the Chinese government has of late, “strengthened its grip on the economy.” Is there any hope for Western companies to sell their wares against state owned companies?
  • Green industries are often cited by futurists as an area where the United States and other Western nations can create competitive advantage. And yet, currently, 35% of the world’s solar cells are made in China. Will the next Green revolution take place in China?
  • Beijing University professor Michael Pettis says, “There is little real innovation or branding ability in China.” Does this provocative sentence scream “opportunity” for Western marketers and their associated products/services?

Craigslist: One Place CRM Isn’t Welcome

craigslistWith no recommendation engine, graphical improvements, or image search, Craigslist is a website stuck in the past. And while business best practices often include heavy investment in sales, marketing, and customer service, Craigslist eschews these functions–yet continues to grow its revenues. What makes Craigslist a “classifieds killer” and how is it able grow its business with little attention to the customer experience?

Craigslist seems to defy the odds. As an online classifieds website, it doesn’t accept payment for most advertising (with the exception of some job posts, and apartment listings in large cities). And recently the site begrudgingly charged for listings in categories frequented by prostitution services–and only then in order to assist law enforcement. Yet estimated revenues for the website top out at $100 million per year!

How can a company that cares little about maximizing profit, stay in business much less be termed wildly successful? A Wired magazine article, “The Tragedy of Craigslist” (September 2009), may provide some answers.

Gary Wolf, author of the article, noticed that Craigslist founder Craig Newmark and CEO Jim Buckmaster break just about every rule in business.

First, customer service is almost nonexistent. While founder Craig Newmark makes a diligent effort to respond to customer service requests and complaints about spam, there are many queries that never receive a response. Also, if you happen to do something on Craigslist that the community considers a “no-no,” such as starting too many conversations in user forums, your posts might be met with a haiku similar to:

Frogs croak and gulls cry
Silently a river floods
A red leaf floats by

Moreover, users complain that posts sometimes don’t show up, or are deleted by Craigslist staff without notification. And if your posts are too often “flagged” for inappropriateness by the Craigslist user community, you may find yourself completely locked out of future listings.

The Wired article notes that Craigslist has no marketing staff or sales teams. Business development is unnecessary because at Craigslist, postings are–for the most part–no cost.

And that’s exactly how Craig Newmark would have it. Newmark believes that the best way to run a business is to provide customers a basic foundation/infrastructure to interact and transact and then step aside.

Could Craigslist improve its user interface, design a recommendation engine, or allow third-party advertising on the site? Sure, but so far Newmark and Buckmaster have shown little interest in innovation. And with 47 million unique users every month, Craigslist figures, Why tinker with success?

Newmark has long believed that Craigslist is a community service, much to the dismay of its for profit competitors–those dying periodicals formerly known as daily newspapers. In fact, according to the article, revenue from newspaper classifieds is off nearly 50 percent in the past decade.

It’s hard enough to compete in today’s challenging economic environment, much less compete with free, as newspapers such as The New York Times, or San Francisco Chronicle have discovered.

However, where there is indifference and customer dissatisfaction, perhaps there’s also opportunity for competition. And while market momentum is currently with Craigslist, technological innovation coupled with a focus on customer value may leave a crack in the door–and a fighting chance for someone to dethrone the giant.

Should Marketing Report to the CFO?

bag of cashMarketing professionals around the world lament pitiful budgets, poor executive visibility, and lack of a central role in helping drive corporate strategy.

And while we’ve made progress with tracking the right metrics and aligning more closely with the executive suite, would marketing – as a function –be better served reporting to the office of the chief financial officer (CFO)?

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