Soaring on Ridgelift

Why plan B should be your new plan A

I wrote the original draft of this post over a month ago… and decided to sit on it and see how the first quarter finished off. While there are some signs that the economy is no longer plummeting downwards like an elevator with a broken cable, there is still plenty of cause for concern.

We're heading into the reporting period for Q1 – already you can feel the storm clouds gathering. Remember that many companies chose to give no guidance at all for this quarter so there's no warning flurry of pre-announcements to provide a harbinger of things to come. I don't believe it's going to be an out and out disaster but I don't expect many to outperform.

With that comforting thought in mind, I offer you the following – if you haven't already done what I suggest below, you might want to give it some serious thought. The road out of the current economic wreck is going to be long and slow – a slog if you will.

 

Many companies have two plans…

Plan A – the plan of record (POR) that defines how the company will execute over the next year or so to achieve its goals. The POR acknowledges the assumptions, risks and future capital requirements for the company to continue to expand.

Plan B – the contingency plan that says what the company will do if plan A falls apart due to external factors (the economy? Duh!) or failures in execution, customer demand, external vendor screw ups etc.

 

This is the time to make that plan B your plan A.

Invert the psychology – instead of having a set of assumption that IF NOT MET cause you to take corrective actions (often with not so happy consequences like layoffs, a down round, going into hibernation…), do the opposite.

Put in a base case and then factor in what you would do when you have met or achieved the base case. Meet milestones that give you confidence on the business – spend more money to expand. Remove product or sales risk – move aggressively to the next phase.

In a nutshell, plan based on achieving confidence not having to sweep up the broken glass.

Apart for giving you more stability in your company, it will expand your cash runway and give your investors more confidence to boot.

Take out plan B, put it into action and use the original plan A to expand as your progress.

No plan B? Time to go back and read about Darwin…

SEC new guidance on FAS 157

The SEC aren't waiting for Congress to approve the "bailout" in order to start addressing the issues created by FAS 157.  There's an article in today's WSJ – Regulators Ease Securities-Valuation Rules that give some background.

You can also see the tension between easing this regulation and completely suspending it – the clarification allows:

"…executives to use their own financial models and judgment if no market exists or if assets are being sold only at fire-sale prices."

Judgment doesn't necessarily translate into transparency – exactly the issue that FASB was attempting to address with FAS 157 in the first place.

As I said in my last post:

"FAS 157 works fine until you have to contend with an illiquid asset such as a private company stock or (as in the current crisis) mortgage backed securities when the credit market dries up."

It's a challenge to see how to balance this tension – even a full set of disclosures are going to be difficult to investors to interpret.  I suspect we'll see such disclosures in future 10-Qs providing an explanation of the "judgment" that has been applied in valuing such assets.

Perfect storm of unintended consequences?

As I write this the NYSE is off almost 300 points - the market fretting about spreading "contagion" and the wait for Congress to pass the "Emergency Economic Stabilization Act of 2008" – formerly known as the "Bailout".

While the current Black Swan event continues to unfold I, like many others, struggle to try and understand how this happened – consistent with Nicholas Taleb's definition of a Black Swan event where human nature compels us to ascribe rationale and predictability to unforeseen events.

I suspect that when the dust settles we will find ourselves in the aftermath of a perfect storm of unintended consequences:

• A desire to extend home ownership
• Declining interest rates as 9/11 and the dot com collapse wrought prior havoc on the economy
• Changes in the accounting standards (FAS 157) to provide "better transparency" into asset valuations

Late Friday afternoon, Michael Arrington of TechCrunch offered "How the US Government Engineered the Current Economic Crisis" as he highlighted an article in the NY Times from 1999 where Fannie Mae was under pressure to extend loans to "borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans".

From the graph in the TechCrunch article you can see how US Residential debt grew rapidly, fanned by declining interest rates.

The masked villain in this plot begins to look like FAS 157 – today's newspapers are full of analysis of the "bailout" but there's little mention of sections 132 (Authority to Suspend mark-to-market accounting) or 133 (Study on mark-to-market accounting) – both buried in the 110 page draft of the bailout bill – you can find the full text here.

The Federal Accounting Standards Board (FASB) issues a series of statements that define the framework for GAAP (generally accepted accounting principles) – these in turn are used by accountants and auditors in preparing financial statements. Statement 157 defines how to establish the value of certain assets using so called "mark-to-market" valuations.

Here's a critical element of FAS 157:

"This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price)."

I highlight the issue that may be the masked villain. FAS 157 works fine until you have to contend with an illiquid asset such as a private company stock or (as in the current crisis) mortgage backed securities when the credit market dries up.

Pricing assets under these conditions is a lot like trying to catch a falling knife – you have to keep reducing the price to fire sale valuations. The underlying asset may not be impaired but FAS 157 requires you to reduce the valuation to the price you would hypothetically receive in an open market transaction.

If you read the article on briefing.com that I linked to in my last post, FAS 157 is the reason why these assets are being held at heavily discounted values – the institutions holding these assets have had to report an accounting loss as a result. The knife started to fall as the credit market dried up and buyers became concerned (panicked!) about the risk of massive mortgage defaults thus driving prices down.

It's interesting that the proposed bill gives the SEC the power to suspend FAS 157 and also calls for a study to examine the role FAS 157 may have played in the meltdown.

When the dust settles, will anyone have the courage to call the crisis a result of unintended consequences of otherwise good intentions? Somehow I doubt it – Main Street, so poorly informed by the media about the issues behind this crisis is howling for blood… and in an election year, they will surely get it.

Time to pick up the phone…

The crisis facing our economy is unprecedented. As former President Bill Clinton said in his interview with Larry King (aired on CNN last night after President Bush's address on the crisis), this is a time for humility – where the true roots of the crisis lie will be hotly debated for years to come. After all, as a true Black Swan event, human nature condemns us to seek a rational explanation… and of course to pin the blame on someone else.

Regardless of how we got here, the crisis has frozen the credit markets – the implications of this illiquidity are dire and need prompt action. Meanwhile our elected officials have turned this into "Wall Street versus Main Street" – a cute moniker but one that ignores the realities that most American's have sizeable exposure to the equities markets.

An opinion poll in today's Wall Street Journal shows that voters expressing an opinion on the "bailout" are divided (33% against, 31% for), not surprising given the complexities of the issues.

Why "bailout" in quotes? To me this is not an issue of saving "Wall Street" by purchasing "bad" assets but instead of restoring liquidity to a frozen market. There have been several articles that do a great job explaining the underlying problem and of pointing out that the Government stands to make a good return for its assumption of the risks. For example, Briefing.com has a great article – "Why the rescue plan can work" and today's Wall Street Journal has an op-ed piece by Andy Kessler – "The Paulson Plan will make money for the Taxpayer" that makes the same point.

President Clinton pointed out to Larry King that the US made money when it "bailed out" Mexico and Chrysler in the past. There's a lot of smart money (including Warren Buffet) that I believe think the same way.

It's appropriate for our representatives to investigate and debate how to structure the plan proposed by the Treasury and Federal Reserve – but that debate can't go on nor get split by partisan politics. So please, get current on the issues, realize that the plan (with safe guards) can be a solid move to unfreeze the credit markets and then pick up the phone and call your representative to tell them you support the plan.

I made my call yesterday.

An Oil Bubble?

What role do analysts play in driving a speculative bubble and how do you determine a true bubble from market fundamentals?

Both of these questions came to my mind as I read this morning's New York Times and their coverage ("An Oracle of Oil Predicts $200-a-Barrel Crude") of Goldman-Sachs' analyst Arjun Murti and his prediction of oil at $200 a barrel.

Mr. Murti has a successful track record in predicting oil prices going back to 2004 so many traders are likely to pay serious attention to his latest projections as this quote from NYT suggests:

""Even if you disagree with their views, the problem is that Goldman does carry so much credibility," said Nauman Barakat, senior vice president for global energy futures at Macquarie Futures USA. "There are a lot of traders who are going to buy based on their reports."

I can't help thinking that we're seeing the precursor of another Black Swan event – if that's true, two more questions come to mind… who's going to lose their shirts this time and will it be another massive hit to the financial markets? I can't see the Fed stepping in to bail out the oil speculators if indeed this is a bubble!

The price of oil impacts a business model

One of my favorite bike rides in the Bay Area is the Portola Valley loop – nice wide bike lanes and great scenery. Riding the "Loop" takes me past Valley Fuel, an independent gas station almost at the intersection of Portola and Alpine.

As long as I can remember, Valley Fuel was always "full serve" only – the price of gas was always higher than alternative fuel stops around the area but the staff are very friendly and the station saw good patronage.

For the last couple of weeks my daily ride had allowed me to check out the impact of rising oil prices at Valley Fuel. Slowly the price rose… $4.59, $4.69 then $4.79 for premium gasoline. I looked forward to my daily ride with renewed enthusiasm – when would Valley Fuel pass $5 a gallon as a posted price?

But last week saw the end of an era – an era where Valley Fuel was a throwback – hanging on as a "full-serve" fuel station while all their competitors had long since gone "self-serve" only.

Last week, Valley Fuel introduced "self-serve" as a purchasing option for their customers.

My guess is that "friendly good service" had a limit to its price – at $4.79 a gallon, Valley Fuel was 50-60 cents/gallon higher than the competition and, after all…

It isn't hard to pump your own gas!

Vista = DOS?

Is Vista* a "Dead Operating System"? This question came to mind over the last couple of weeks as more and more entrepreneurs pull out Macs to give their pitches to me and everyone else is still running Windows XP.

The percentage of Macs has really spiked over the last 6 months – ok – anecdotal observation with no scientific method or basis to back up the claim – but the increase has been significant enough that as we waited for a entrepreneur to hook up to the projector (only to find that the projector didn't have a DVI cable) one of my friends remarked, "we need to get a couple of MAC adaptors and keep them in the conference room".

Ok, this is the Best West Coast and the sun is shining, everything is green (for a couple more weeks) and what happens in Palo Alto/Menlo Park isn't a proxy for what happens in New York or D.C – but the (re) adoption rate of Macs is remarkable.

With the ability to run XP (through Parallels), get the benefits of OS X (Mac and Unix under one cover) plus have all the great Apple industrial design, it's tempting…

If it wasn't for my investment in software for digital photography (much of which I'd have to purchase the MAC versions), I'd give some serious thought to switching...

So that brings me back to Vista…

There is no compelling reason or attractive feature in Vista to make me want to upgrade – moreover, the experiences of my friends with Vista has made me stick to XP for the foreseeable future. The lack of sizzle in Vista and the rising penetration of Macs caused the "dead operating system" thought to pop into my head.

With Apple now a serious Intel customer, Intel has become neutral in the OS wars – Linux, Mac, Windows – doesn't matter to Intel – they collect the dollars for the CPU every time.

Absent a new release of Windows that adds significant new (and useful) functionality, I'll stick with XP… or keep thinking about a switch to the Mac**.

*All trademarks are the property of their respective owners

**I'm sure I'll get a lot of email from my Mac friends who have been telling me to buy a Mac for the last 2 years!

Food for thought – a sobering thought

It was a little over a year ago when I wrote "First oil, next food?" wondering how long it would be before food suffered the pricing pressures we'd seen in oil.

Sadly I didn't have to wait very long as an article on CNN this evening describes rioting over food prices in several countries around the world – "Riots, instability spread as food prices skyrocket".

The last 6 months have seen incredible increases in the prices of commodities as investors poured money into futures. I suspect this speculation is more the cause for rising food prices than the demand for corn to make Ethanol but surely that's also an underlying cause.

As I re-read my original post, this paragraph stuck in my mind…

"But as any investor will tell you, if there isn't a return to be made in one sector, money will flow into a sector that offers the promise (hope?) of a better return."

We've seen the impact of huge capital inflows into specific sectors – the sub-debt mortgage fiasco, the (continued) growth of LBO funds and now the commodities market. The promise of a superior return attracts more and more capital which eventually kills the returns that attracted the investment in the first place.

I wonder where all the capital will go next? I shudder to think!

Eating your own dog food

One of the quickest ways to improve your product or service is to use it yourself. Not just try it out, but live your life with it – make use of it in your own business to the point where you are critically dependent on your own stuff.

Why? Because if you do, your engineers and marketing people will be the first ones exposed to mistakes or fiascos that could be devastating to your customers.

I've been a firm believer in the mantra of "Eat your own dog food before offering it to your customers" for years. At Cisco, the engineers and associated marketing folks sat behind alpha level software – new releases of the Cisco IOS were tested internally long before they saw the light of (public) day. Not surprisingly, the features that we depended on for our day to day business were always in the best shape and seldom caused problems. The features we used least (or didn't have internally) were always the problem children as they saw extensive lab testing, not real world exposure.

I was reminded of this manta over the weekend as I grappled with the failure of iTunes to sync my iPhone with my Outlook calendar. This problem dawned on me late last week as I was trying to schedule a meeting with a friend and realized that there were serious numbers of missing appointments on my calendar.

A search session over the weekend revealed that I wasn't the only one having the problem – I tried all the "fixes" that were described on the Apple support notes and those on numerous blogs. Then the penny dropped… iTunes had upgraded itself (yes, I know I had to click the button to do it – I'm culpable too) a couple of weeks ago from 7.5 to 7.6.

Regressing back to 7.5 (including restoring my old iTunes library from January 18^th – the day of the "upgrade") fixed my problem and now I'm happily syncing again – not only that but the sync takes a couple of minutes instead of half an hour!

I have to believe that Apple's engineers are good ones and that they both care and test their product… But I'll bet there are few folks over at Apple that live behind a PC running Windows where their life depends on Outlook AND have an iPhone. If they did, my experience with non-syncing iPhone calendars would have been caught before 7.6 made it out into the wild.

So, the morale of the story is clear – make sure you eat your own dog food. Your customers will thank you and you will be amazed at what you find (and fix!) first!

MSFT + YHOO = Gift for GOOG?

As expected, the papers and blogs are full of speculation about the impact of Microsoft acquiring Yahoo!

Two articles caught my attention in today's NY Times. The first – "Yahoo Deal Is Big, but Is It the Next Big Thing?" makes the point that perhaps Microsoft is still focused on yesterday's war rather than looking to the next. The second article – "Yahoo Sale Could be Bad for Minnows" speculates about the impact on startup companies as two prospective acquirers merge into one.

What surprises me is how little discussion there is about the impact and potential opportunity this creates for Google!

Acquisitions are hard – even the small ones. I've had a lot of experience with M&A over the years and I'm left with several observations:

• Only 1 in 3 acquisitions work out and give you the results anticipated when you made the acquisition offer.
• The bigger the acquisition, the harder it becomes (and it's not a linear function of size – it gets exponentially harder).
• Strategy and culture synergies are critical. Without them, merging two companies is like mixing oil and water.
• M&A distracts the management teams of both companies. The bigger the merger, the more the distraction.

Merging Microsoft and Yahoo will be a very difficult process and will totally consume the senior management attention of both companies.

What an opportunity this creates for Google! Think of it – your two major competitors are suddenly consumed with each other. Their management teams are focused inward on making the merger successful and have to contend with what to keep and what to let go. All you have to do is focus on winning in the market! Just what you were doing before but now your two major competitors are sitting on the sidelines trying to get their act together.

I saw the impact that this can have when I was at Cisco; Wellfleet and Synoptics announced their merger to create Bay Networks. That merger gave Cisco a golden opportunity to go out and win in the market while our two competitors were distracted. With John Chambers' guidance, we did just that.

Will we look back in a couple of years and say that this merger helped Microsoft win or that it helped Google rise to an even more dominant position in the market?

Time will tell.

While the merger reduces the number of potential acquirers by one and so might impact M&A valuations, it could spur an acquisition fest by Google and other companies impacted by the MSFT/YHOO merger.

It's a lot easier to go out and acquire a large number of smaller companies than it is to merge with one big giant. Google has an opportunity to go and cherry pick the smaller (but growing) startups while the two elephants dance.

This is going to be very interesting to watch!!!!