Monday, July 30, 2012

JAL’s Recovery: Philosophy or Practice?

There is mounting excitement over how well Japan Airlines (JAL) is emerging from bankruptcy to now have good profit margins (17 percent last year) and the confidence to start adding routes again after a period of cutting. As always when there is excitement about a firm, there will also be a great deal of hype. Can we separate the parts of the recovery that are genuinely interesting for observers (and worrying for competitors) from the hype? I don't have a crystal ball, but I can make a few suggestions.

First, the government gave them money. They are getting current and future tax exemptions. Second, the banks forgave them loans to the tune of $6 billion. Third, they cut their pension liabilities radically, reducing the pensions paid out to current retirees by 30 percent, and those to current employees to half. There is nothing special about these approaches to recovery except that they are tools given to firms in bankruptcy (in the US, this would be Chapter 11 bankruptcy; JAL is using a similar Japanese code). As many US firms and workers have discovered, bankruptcy law is a quick way to reduce or eliminate pension obligations in addition to bank loans.

The fourth part is a set of changes in internal management that are focused on operational efficiency, including such details as mechanics carrying small airport bags in used lunch bags instead of in special-purpose bags. This part has yielded impressive results, but we should probably not see it as a unique or very impressive. As a company known for its free-spending ways in earlier days, JAL had plenty of room to cut, and the cost-cutting tactic ("strategy" is too generous a term) is so often used in the airline industry that it is not a display of originality.

JAL’s CEO Kazuo Inamori has issued a booklet espousing its "JAL Philosophy." It is hard to make sense of this, because such booklets range all the way from empty self-promotion to profound changes of organizational culture and operations. Some of the elements in the booklet, such as the emphasis on open dialogue and independent decision making, are clear breaks with the hierarchical culture that JAL had before. However, they are hard to jibe with the centralized control and oversight issued by Mr. Inamori during his tenure. Although something important could be going on there, I tend to be skeptical.

JAL has rearranged its routes to make its domestic routes less political (no longer going to airports favored by local politicians) and its international routes more US-centered. Not only that, they are using the new generation of long-distance jets (Boeing 787) to fly directly to second-tier US cities rather than to the major hubs. To me, this is the more interesting part of their strategy. They are using a new technology to rearrange how passengers are moving between cities, and by being early in doing so they are avoiding direct competition. There is still substantial uncertainty on whether this is the right direction for the airline industry, as seen by all the airlines investing in Airbus A380. This jet is the largest in the world and a deeper commitment to intensive exploitation of hubs, so it is a reflection of the exact opposite strategy of favoring hubs.

It will take a while to know which strategy is the right one; the second-tier strategy or the hub strategy. That is an advantage for JAL and any firm that goes for the second-tier strategy, because the uncertainty keeps the competitors from investing in the assets needed to execute the second-tier strategy, if they should want to. In my research, I have found that the advantages from investing in a new technology that is coupled with a new successful strategy can be substantial and long-lasting: as long as a decade. JAL is placing a big bet, and it will be interesting to follow it in the future.

Delaney, K. J. 1992. Strategic Bankruptcy: How Corporations and Creditors use Chapter 11 to Their Advantage. Berkeley: University of California Press.
Greve, H. R. 2009. Bigger and safer: The diffusion of competitive advantage. Strategic Management Journal, 30(1): 1-23.
Maxwell, K. and Takahashi, Y. 2012. Japan Airlines Roars Back With an Eye on U.S. Market. Wall Street Journal, July 30 2012. 

Sunday, July 22, 2012

Golden Parachutes under the Microscope: The Xstrata and Glencore Merger

A merger between mining company Xstrata and commodities-trader Glencore would seem like a great opportunity for the two companies to gain market power through the control of both mining and trading, as well as the ability to use subtle trading signals to control mining operations in ways that non-trading miners would not be able to. Whether for power or efficiency reasons, the merger must look attractive to the two firms. It is large and complicated too. In total it involves a market value of around $58 billion for the two companies; Xstrata employs 70,000 people, Glencore 58,000 people.

The merger has faced resistance from shareholders for a number of reasons, including an interesting one that involves a number that is either really large or really small, depending on your perspective. Xstrata has an executive-retention package (also known as a golden parachute) valued at $268.5 million, which is a pretty big number even if it divided over many executives. But it is actually a small number compared to the potential gains or losses that the merger itself could generate for shareholders, depending on whether it succeeds or fails. Still, shareholders were sufficiently upset that the package is being modified to make a successful vote for the merger more likely.

Golden parachutes do get investors and others upset because they often seem to reward the wrong people. They are triggered when a change in control of a firm occurs, as in an acquisition or a merger. A change in control, in turn, happens if someone thinks that they can run the firm better than the current management, which is more likely to happen if the current management is doing poorly. So; do poorly, get paid for being taken over. Despite the resistance from shareholders, managers want golden parachutes very badly, and with boards of directors being mostly accepting of parachutes if other local firms have them (as I have shown in a study with Jerry Davis), the key issue is how to make golden parachutes so that they don’t raise anyone’s ire.

A recent study by Fiss, Kennedy and Davis has shown some interesting patterns in how this is done. To me the key variable is whether they seek to hide in the crowd by making the parachute similar to that of other firms. This happened more often when takeover activity was high, suggesting that vulnerability to a takeover makes it more important to make the parachute seem normal. This reminds me of the Costa Concordia captain preparing to leave the ship in a lifeboat while having the crew broadcast don’t-panic messages to the passengers, but maybe the comparison is inappropriate. More articles in the press on golden parachutes made them less similar, which makes me think that authors of such contracts probably think they have more freedom to draft them as they wish if “everyone does it.” But, as the Xstrata and Glencore situation suggests, the effect of press attention changes if it is directed toward the same firm. I guess some things don’t look as good in the spotlight as they do in the shade.

MacDonald, Alex. 2012. Glencore, Xstrata Set September Date for Merger Vote. Wall Street Journal, July 11 2012.

Monday, July 16, 2012

Microsoft in the Clouds: Can a Major Corporation Change?

Several news outlets have been reporting on the new Microsoft Office, which is due to be released in two versions. One is the traditional form of software that is on the disk of a PC and run from there (Office 2003). The other is a cloud version of Microsoft Office (Office 365), which means that it will be downloaded from the web and run through a web browser. There is no need to keep a local copy on the PC, and no need to wait for those annoying upgrades (the downloaded version is always the latest). In fact, there is no need for a PC because cloud software can be run on any device with a compatible web browser, though the performance may differ depending on how well it is programmed to take into account that it might be run from a tablet or a phone, for example.

Why is this change notable? Microsoft has long been successful using the traditional format of software, and Office still accounts for a sizable portion of their profits. They have also long voiced doubts about the various new computing devices based on the web, such as netbooks (light and inexpensive laptops that primarily get their software from the web). The argument has always been that there is so little to save from having lower-grade specifications that users are unlikely to settle for anything except full-featured computers that can be run both with and without web access.

The change to delivering Office over the cloud is significant because buyers will now be able to choose between the highly profitable normal Office and a subscription-based cloud Office. Although there are clear opportunities in having subscriptions instead of users who buy once and maybe never pay again, it is not clear that the pricing can be done so that this consumer choice can be turned into a benefit for Microsoft. This is especially true because Microsoft is behind competitors such as Google and Zoho in providing cloud-based computing.

Microsoft is a good example of a major firm facing uncertainty because of technological changes. This situation often results in a failure to launch innovations in response, even though the major firms often have greater capabilities to make innovations than their smaller competitors do. What holds them up is the will to do so. In my research, what keeps coming up is that the current success is a deterrent against making necessary changes, but past success can help because it sets the aspirations for future performance high. That looks like a good description of Microsoft now, because its performance is not quite what is used to be, which is exactly the situation that can drive innovations forward. So, I think we can expect Microsoft to launch more innovations that are adapted to the cloud, and perhaps also to the new generation of computing devices. Whether it is soon enough to maintain their competitive strength remains to be seen.

Greve, H. R. 1998. Performance, aspirations, and risky organizational change. Administrative Science Quarterly, 44(March): 58-86.
Greve, H. R. 2003. A behavioral theory of R&D expenditures and innovation: Evidence from shipbuilding. Academy of Management Journal, 46(6): 685-702.

Tuesday, July 10, 2012

Google's Privacy Breach: Abnormal Wrongdoing or Normal Wrongdoing?

Today there is news that Google is close to a settlement involving payment of $22.5 million related to its circumvention of the Apple Safari security settings, which let it monitor the web browsing of users who had blocked such monitoring. This very large payment was caused by a small piece of computer code that planted a "cookie" (a tracking file) on devices using Safari, including iPhones. The reason this computer code ended up involving the FTC (Federal Trade Commission) in the US is that privacy rights are regulated by law, so if a user sets the privacy settings on a browser to deny monitoring, it is illegal to ignore this and monitor anyway. (It ought to be difficult as well, but Safari was not programmed securely enough to stop Google.)

Google has stated that the monitoring has not harmed anyone and that it was not done intentionally. This statement will strike many as odd, because it sounds like the excuse of a driver caught speeding: "I didn’t look at my speedometer, and anyway nobody was harmed." Surely there must be a better (and more ominous, for the consumer) reason for the monitoring, because would they otherwise risk a fine of that size?

 A new book by Donald Palmer offers an interesting answer to this question. He looks at different theories of wrongdoing by organizations, and classifies them by whether the wrongdoing is seen as abnormal actions -- done for some benefit and facilitated by slack rules and organizational cultures -- or whether the wrongdoing is seen as an outcome of normal organizational functioning. Of those two types of theories, we are familiar with the theories of abnormal wrongdoing, because it fits our ideas of individuals and organizations calculating the potential costs and benefits of wrongdoing and (if they lack a moral compass) choosing wrongdoing when it benefits them. We are less familiar with theories of wrongdoing as a result of normal organizational functioning, but these theories are interesting because they are likely to explain many kinds of wrongdoing. The idea is that under certain conditions, organizations are likely to commit wrongdoing thoughtlessly and without consideration of benefits – just because their systems lead to such actions.

A number of theories on normal organizational wrongdoing exist, and it would be hard for me to do justice to his excellent book in a short post. I can give an example, however: In an earlier post on the Costa Concordia shipwreck, I asked whether there might be a larger problem of safety routines in Costa shipping. The answer was not clear then and still isn't, but Costa ships have been involved in mishaps later, raising new questions about how they are managed. This would be an example of wrongdoing through faulty administrative systems. Organizations are not always organized (!) well enough to handle the technologies and activities that they operate, and in some cases the gaps in organization lead to wrongdoing through organized carelessness. Google may indeed have broken privacy laws simply because no one thought of checking, most likely because those writing the programs were too separated from those who knew the law. In this case (Google says) nobody was harmed, but the same process can produce much more dangerous results in other kinds of organizations.

Angwin, Julia. Google, FTC Near Settlement on Privacy. Wall Street Journal Asia, July 9.
Palmer, Donald. Normal Organizational Wrongdoing: A Critical Analysis of Misconduct in and by Organizations. Oxford University Press.

Sunday, July 1, 2012

Firms Chasing Profits, and Then Running Away from Them: Corporate Venture Capital

Venture capital firms provide early funding to startup firms, and for that they get an ownership portion and a say in their strategy. Many startup firms value both the funding and the strategic advice, because they often lack the managerial experience that venture capital firms have.  A quick look through news sources on venture capital is enough to give the impression that venture capital firms are backing some startup companies that are earning very high returns, and are likely to earn more. A recent (June 29) entry on the Wall Street Journal blog "Venture Capital Dispatch" showed a $50 million deal for advertisement optimizing company Rocket Fuel.  The same entry reported an $81 million deal for cancer-drug company Tesaro.  Tesaro sells hope for investors and (potentially) relief from side effects of chemotherapy for patients. Its most advanced drug helps against common and noxious side effects, but is not yet approved for use.

What these reports don’t show is that for every venture that succeeds there are many that fail. Most fail before they even get the kind of capital injections that are reported above, some fail afterwards. For example, discovery of any dangerous side effects of Tesaro's chemotherapy drug would be a major setback because they are only investigating one other drug at the time.  So venture capital firms are in a risky business. That is well known.

What is less well known is that many established firms in other industries have also been looking at venture capital returns and wondering if they can get them too. They also have funding that they can turn over to startup firms; they also have managerial expertise. As a result, Corporate Venture Capital departments have popped up in various firms from well-known ones like General Electric and BMW to firms that are less famous but still large enough to put substantial funding into startup firms. For the startup firms, this is promising because any kind of funding may be what they need to turn an innovation into a venture. For the established firms, this is a way to possibly increase growth and returns.

But then there is the risk. Relative to the size of these firms, a Corporate Venture Capital department is not a big risk on an absolute scale, but it is easily among the riskiest activities they can take on relative to the money invested. Established firms worry about risks, which means that they react in ways that are quite different from what venture capital firms do. As Vibha Gaba and Shantanu Bhattacharya have shown in a recent paper, they start imitating other firms: when other firms start corporate venture capital, they do too. When other firms close their corporate venture capital department, they do too. Somehow a risk that is acceptable when others take it isn’t when others are not.

Firms also look at their own research performance, and they seem to let the confidence decide what happens to corporate venture capital. If they do really poorly, then they are unlikely to start and very likely to stop doing venture capital. Such firms seem to lack confidence that they can do anything right. If they do really well, then they are unlikely to start and very likely to stop doing venture capital. Such firms seem to lack confidence that they can do anything right. Such firms act as if they don’t need venture capital to do well. It is the firms with in-between performance that are most likely to start and continue corporate venture capital. So an activity that is a haven for the really high risk-taking independent financiers is, ironically, also a favorite for the firms that are just OK in their research.