Creative Destruction Revisited

 

Joseph Alois Schumpeter was an economist from Austria who settled at Harvard University in the last two decades of his life. He was colorful and controversial. One of his lasting legacies is that he was perhaps the first major economist who focused frequently on the role and importance of entrepreneurs in a free market economy.

 

From this interest in entrepreneurs in a capitalistic model came a concept that he popularized if not invented. It has become known as Creative Destruction. Simply put, it states that innovation constantly destroys the existing old structure and creates a new one in an industry or even an entire economy.

 

Entrepreneurs bursting with ideas created significant increases in productivity and this leads to the demise of older, less established players or industries.

 

I have always loved this concept and we can see both historically and recently how it rings true in many situations. The industrial age took over from the agrarian economy and then electricity and automobiles changed the face of the world and how we lived. Yes, buggy whip manufacturers went broke in the early 20^th century but the automotive industry opened up millions of jobs throughout the western world and triggered the growth of suburban life.

 

With the word “destruction” as part of the term, clearly, everyone is not a winner when the winds of change roar through an industry. Yet, over the years, when one door closes due to creative destruction a few new ones open up which creates jobs and prosperity for many. Certainly, some people lose out as their skills are no longer needed. Politicians always promise job re-training plans but they never seem to live up to expectations.

Pressure groups are a different story. Affected industries lobby their congressmen and ask for protective tariffs or tax breaks if foreign players are upsetting their pot of gold. Sometimes they succeed and the consumer suffers.

 

Why do I say revisit Creative Destruction? Well, to me this time it is different as a result of globalization. When jobs are eliminated increasingly new ones are not created that are equal or higher paying. Shoe manufacturers went abroad years ago and those jobs were not replaced. Consumers may grouse about wishing to buy American made but do they really want to pay $220 for a pair of athletic shoes? That would be a reasonable price if many more were made in the United States. So, once a job leaves the West these days, it almost never returns due to outsourcing (producing overseas for lower cost of labor, land, capital or energy).

 

Creative Destruction is not limited to heavy industry. Amazon has killed thousands of retail jobs and small retailers and robots are a bigger presence in their distribution centers. Newspapers got hurt by the 24 news cycle in cable and then by social media as did many magazine titles. Streaming video has taken a huge bite out of advertiser supported TV and cable channels.

 

“Experts” say that the solution to lost jobs is simple—education and retraining. Well, some people resist it and others cannot move from their locations. Also, does this still work when we are in a global economy where high skill levels are readily available via an internet connection for an often tiny fraction of the salary required in the U.S., Canada, or parts of Western Europe.

 

Creative Destruction has always tied into my sunny view of the future. Advances in technology and medicine will make life better for most of us and in tech areas will also help fight climate change perhaps faster than legislation.

 

Yet, in a global economy will the level of displaced people working in dying or soon to be obsolete jobs be out of luck as no door will open for them within a few thousand miles?

 

The major media have rarely addressed this topic meaningfully. It is not a simple issue and cannot be addressed in a 30 second sound bite.

 

If you would like to contact Don Cole directly you may reach him at doncolemedia@gmail.com or leave a message on the blog.

Netflix and Advertising

 

Over the last few weeks, the media world has been buzzing about Netflix discussing their plans to accept advertising on their service. For years, management has said that they would NEVER have advertising on their programming. Well, I suppose that even the brilliant Reed Hastings has learned never to say never. Other services such as Warner Brothers/Discovery and Paramount may be changing their models as well as debt service will hit them hard in 18-24 months.

 

The Netflix announcement was greeted positively by some in the media/advertising world and even a few Wall Street analysts. The logic flow is that Netflix has perhaps up to 800 million possible viewers as many subscribing households have 4-5 users. That is quite a platform for advertisers and by careful matching of advertising with content there could be a nice fit. A very well-known media executive who pledged me to secrecy weighed in as follows (expletives deleted):

 

“Don, we are really excited about advertising on Netflix and other streaming services. Remember how 30 years ago, we talked about narrow-casting on minor cable networks. Well, this is narrow-casting on steroids. Think of the products that we can sell to young adults who love horror films or sci-fi. That may be garbage to you and me but many enjoy it. Or, how about the arcane British and Australian mysteries that you are always recommending to me? The audience has to be aged 60+, well-educated and affluent and we can target them beautifully”.

 

I confess to being a bit skeptical of my friend’s enthusiasm. We have gotten spoiled by the streamers. After years of viewing a huge portion of our video time commercial free, do people want to go back to an advertiser supported model even if they save several dollars/month? Think about it for a moment. When you go to You Tube, do you dutifully watch the 15 second spots before a video? Advertising avoidance continues to march and why should we be so accepting of it on a platform that up to now has been commercial free?

 

 

Churn

 

Young adults were way ahead of the curve on this. They think nothing of subscribing to a service for a few months. Then, they proceed to binge watch a few series that are very popular and then cancel. A year or so later, they bounce back. After a dozen years plus, I just cancelled Netflix as I found most of my viewing was on Apple TV Plus, Amazon Prime Video and British based Acorn. Will I come back to Netflix? Absolutely, at some point for sure. Yet, I am certain that I will not linger for years this time around. So, if an old geezer such as I and his ever-youthful wife will cut the services back and forth in a manner similar to millennials, that has to hurt some streaming services. Amazon Prime Video will largely be immune to churn as it comes with an Amazon Prime subscription which most consumers would not wish to lose.

 

Consolidation

 

Since 1900, there have been about 3,000 auto manufacturers begun in the U.S. By the end of the 1920’s, The Big Three (General Motors, Ford and Chrysler) had a combined market share of over 90%. The same thing will happen in video streaming with some players going under but many getting swallowed up by the solvent giants. Five to seven years from now, I posit that we will be down to 4-5 meaningful players tops.

 

Conclusion

 

The next few years will be make or break for some players in the streaming space. Some must go the advertising route as they cannot make it on subscriptions alone and continue to produce world class programming. As always, stay tuned!

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a message on the blog.

The Greatest Business Model

 

Over the years, I have received a great deal of mail about my Media Realism (MR) posts. Some 99% of the response comes from readers who do not post on the blog but maintain their privacy by e-mailing me directly at doncolemedia@gmail.com

 

One thing has stood out—every month or so, someone asks me what company or companies out there has a perfect business model. The simple answer, of course, is that the perfect model does not exist. Many do not accept that and ask which company has the best? Most people who write to me feel that Amazon is the best and, until recently, a number felt that Netflix was #1.

 

Here is my answer. No one has a complete handle on all the businesses across the globe of any size that could be analyzed but my “vote” goes for Costco.

 

While Amazon gets high marks who their stunning array of products, lightning-fast delivery times and customer-centric nature, I give Costco the nod when you look at all metrics (Full disclosure—I am not nor have ever been a Costco shareholder. That could change someday  ).

 

In brief, Costco Wholesale is a membership warehouse retailer that has been around since 1983. Founded in Seattle, Washington, it now operates 832 locations in 14 countries and continues to grow regardless of the state of the economy. In terms of volume, it is the 3rd largest retailer in the world.

 

Why do I admire them so? They, as is certainly true of Amazon, are laser focused on being customer-centric.  And, they resemble Amazon in that they think long term, in fact, very long term. As Costco has grown, so have the benefits to members. Costco basically caps profits of 15% on every item while most retailers go for up to 30% or more in many categories. The firm operates on a slim profit margin of 2% and makes the majority of their operating income on membership fees. You get a 5% discount on all  warehouse sales if you use the Costco Visa card. They treat employees quite well and pay better than other retailers. Shareholders benefit nicely with increasing dividends and somewhat recession resistant share prices over the years. I have tried to time visits to my nearest warehouse to avoid crowds but the parking lot is generally full.

 

Costco critics do not like that you often have to buy in bulk. This is because they can get better deals on merchandise by having a limited number of SKU’s (stock keeping units). You do not find 45 different toothpaste SKU’s at Costco, for sure. What they do have is great value. So, Costco may not be great for a single person living in a Manhattan studio apartment. I did suggest to one that he go long a few cases of tuna fish and store them under his bed. For homeowners for kids, Costco makes great sense.

 

A spectacular bargain is their ¼ pound hot dog and 20-ounce soda (plus a refill) that weighs in at $1.50 as it has been for decades. Not a healthy snack but long term customers love it.

 

These are attributes that have given Costco what Warren Buffett calls a durable competitive advantage. They are in the game for the long pull and have built loyalty among customers, employees and shareholders even though short term earnings may be suffered.

 

Speaking of Warren Buffett of Berkshire Hathaway, his long- term financial partner, Charles T. “Charlie” Munger joined the Costco board of directors in 1997. Many Costco policies to me look to have Charlie’s fingerprints of ethical treatment of all stakeholders all over them.

 

Companies of all stripes could learn a great deal by studying Costco. They move steadily but patiently forward quarter after quarter. The company has focus and the macroeconomic environment be damned.

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com

 

 

America's Feudal Future?

 

In recent weeks, I have received several messages from acquaintances who are frustrated with their lack of financial progress in today’s world. To a person, they appear to be on a treadmill of very busy activity but are feeling very insecure and used at the same time. They describe themselves as peasants, or wage slaves relative to their corporate CEO’s. Yesterday, someone whom I have never met in person but reads MR wrote, “You know what I am. I am nothing but a serf reporting to the lord of the manor.” He said that he was a student of history and that America was far along on a passage to a Neo-Feudal society.

 

It sounded  a bit dramatic to me but I had heard similar frustrations from others. As people like to say these days, let’s “unpack” this issue a bit.

 

Feudalism was a reciprocal agreement that was prominent in Western Europe from the 9^th-15^th centuries. It was an economic, military, legal and, to a large degree cultural system in which a lord (Baron, Earl or Duke) offered protection to people living near his castle. The serfs had to scramble for a living and part of their meager earnings/production went to the lord of the manor in exchange for personal protection in case of foreign invasion or neighboring groups attacking. The serfs could actually hide in the relative safety of the castle were the area invaded.  There was little chance for upward mobility as you were born, lived and died at your station in life that was largely determined at birth. The system died out as cities developed and artisans formed guilds and free markets began to emerge. A middle class began to emerge and serfdom diminished significantly.

 

When doing some research for this post, I was surprised to see how a small but vocal group are referring to what they see as our emerging feudal society. Interestingly, some are left wing and some are right wing. Their argument seems to hinge on the growing income and wealth inequality in the U.S. So, why do they feel they are trapped peasants or serfs?

 

Let us look at a few facts. Virtually everyone realizes that the top 10% of people in the U.S. control 80% of the assets. Yet that is true in many nations across the world.

 

Here are a few more stunning factoids that I confirmed from multiple sources:

 

1)  Since 1978, CEO compensation has grown by 940% while employee compensation has grown by 12% (both adjusted for inflation).

 

2)  In 1965, when Lyndon Johnson unveiled his war on poverty, the average ratio of CEO to median employee compensation was 21 to 1. Today, it is slightly over 320 to 1.  Read FORBES OR FORTUNE regularly and you will see that some CEO’s go way over 320 to 1. Should CEO’s be rewarded for good performance? Absolutely, in my opinion yet looking at these data gives me pause. Things do appear to be out of whack.

 

There is no question that wealth is getting concentrated into fewer and fewer hands. And, the middle class is shrinking for sure. So, are these sad or angry people writing to me far wrong when they refer to themselves as peasants or serfs? It is hard to say. Increasingly, upward mobility is getting more and more difficult in the U.S. What zip code you lived in as a child and what you parents did for a living have a great impact on where one can wind up thirty years later.

 

One wrote to me saying that the approximately three million among the 1% rule over the remaining 99% (340 million plus Americans) quietly but firmly.

 

The new billionaires from Silicon Valley are remarkably similar  in some ways to the Rockefellers, Vanderbilts, Carnegies and Morgans of the gilded age of the late 19^th and early 20^th centuries. The difference is that there was no income tax for the “robber barons” of the gilded age. Today, the 21^st century oligarchs benefit from special tax breaks and overseas corporate tax dodges. They have good lobbyists and have the ear of politicians from both major parties.

 

So, it is likely true that many people are simply jealous of the amazing success the daring tech entrepreneurs have had. Yet, it is not merely envy. Games are being played. During the height of the pandemic, politicians gave out cash to virtually all citizens. Yet, who benefitted the most? Clearly, the top 10% and especially the top 1% who own the real estate and stocks that soared to dizzying levels. Some 49% of US citizens have no stocks and about 40% do not own their dwellings.

 

Look, if you know me it is clear that I have always been an ardent capitalist and will die one. But is it crony capitalism that is causing the gulf between the top 10% and the bottom 90% to grow wider? America has been “the land of opportunity” for every generation from 1789 up until recently. Now, some young people are choosing not to have children as they say that they cannot afford them. Others are drowning in college loan debt (yes, they signed the papers but are paying it off over 15-20 years).

 

Reading and listening to these bitter young people remind me of the Andrew Yang political campaigns. He ran briefly for president in 2020 and more recently for mayor of New York City touting Universal Basic Income (UBI) as his major policy plank. All Americans would receive a guaranteed minimal income in his American utopia. I read his book THE WAR ON NORMAL PEOPLE a few times. It was a breezy read but, to me, it encourages a cycle of dependence that went far beyond what the feudal lords had over the serfs.

 

These 21^st century self-proclaimed “serfs” have my attention and sympathy. I do not see a new feudalism on the horizon as some of them do but I do see a bumpy road ahead and the possibility of social upheaval unless the ship can be righted a bit.

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a comment on the blog.

 

 

 

A Disturbing Headline

 

Throughout my life, I have always been and remain something of a business news junkie. I follow markets, marketing trends, the media (natch) and consumer behavior quite closely.

 

A few days ago, I the following headline: “Subprime Car Loan Defaults Hit An All Time High in February.” I thought it might be an exaggeration, so I read it and then searched elsewhere. A second source put it as the highest level since 2007. A half hour later, I found a CNBC interview replayed on You Tube that confirmed the 2007 date.

 

Okay, why does this strike me as a big deal? Let us back just a bit. For much of my adult life, many mainstream economists would say that the economy was essentially stable. One outlier whom I loved to read was Hyman Minsky who argued forcefully that the economy was inherently unstable. He was suspicious of expanding credit too widely. Prior to his death in 1996, he developed his Financial Instability Hypothesis. To Minsky, there were, in broad strokes, three types of borrowers:

 

1)  Hedge—These people have no problem making payments of both interest and principal (99% of the readers of this blog, I would presume). They dutifully pay off their mortgages or car loans and credit card balances and sometimes add a bit of principal to a payment to save interest expenses.

2)  Speculative—these folks are stretched and can only handle the interest payments. I met more than a few in 2006-2008 who had interest-only mortgages.

3)  Ponzi—name in honor of 1920’s Boston area conman Charles Ponzi, these dreamers are betting on rapid increase in asset value to bail them out. If you think they are imaginary, remember the sub-prime mortgage holders in 2007-2008, many of whom did not even have jobs or income but bought homes based on hope. Perhaps more amazingly, institutions gave them loans in a frothy real estate market.

 

Okay. So now we have the current issue of sub-prime car loans. They have always been part of the auto sales mix but it appears with the relief checks sent out during the early part of the Covid crisis plus the tax breaks for parents with young children, a number of rather poor credit risks were more flush than they had ever been. To their credit, many paid down their credit card balances and also saved part of the windfall.

 

Others, however, were able to buy new cars in 2021 and many were purchasing vehicles far more expensive than they have ever owned before. Now, these sub-prime borrowers are getting whipsawed by sharp increases in gasoline costs and rising food prices. So, some are behind on their car loans. The latest data say that 8.8% of sub-prime car loans are more than 60 days behind.  If you have a long commute to work, you are really stuck—you need a vehicle and gasoline costs are soaring.

 

More ominous is that many had not paid off their existing car loan when they traded up last year and took out 84-month loans (seven years!) on their new vehicles plus what they owed on their existing car.

 

Most media headlines talk about low unemployment and how flush consumers are. There is no question people who were struggling prior to the pandemic got some real breathing room with the stimulus payments plus the tax credits. Now, with inflation hitting fuel and food, the sub-prime borrowers are in trouble again.

 

Whenever the next recession hits (2023 perhaps), more people are likely to slip out of the middle class than we have seen in some time. Dig beneath the headlines, I say. Things may not be so rosy as they appear.

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a comment on the blog.

 

 

The Future of Streaming Video

 

Back on February 28^th of this year, I put up a post entitled “Should Netflix Still Be a FAANG? The response was quite strong with many people saying that I was commenting way above my pay grade and should stay out of securities analysis (which I did not think that I was doing). Since then, with the collapse of Netflix from $700 per share to a recent low of $162.71 a few people have contacted me and asked how I knew what was going to happen. One called me a seer.

 

Well, I do not think that I am an idiot as some hinted at and I know for sure that I am not a seer. The share price of Netflix was taken down sharply as in the last quarter their subscriber count actually dropped by two hundred thousand. Disney shares also have been halved over the last year going down with the general market in 2022 but also, likely due to fallout from the Netflix decline.

 

Here is my take on what is going on:

 

Streaming video is definitely not finished. This decline in share prices is merely a hiccup or slowdown that generally occurs in many dynamic industries. And, as mentioned in the February post, there is a great deal more competition in the streaming space these days vs. a few years ago when Netflix looked as if they had won the “war.”

 

Please keep a few things in mind. Netflix’ business model was based on continuous subscriber growth. Many of us loved their programming but they borrowed heavily to produce it and they were not a well- diversified entity.

 

Think about their competition. Disney + is, at best, one fourth of Disney revenue. They have the theme parks, cruise ships, movie studios, ESPN, Hulu, ABC and many other properties. Apple and Amazon are huge entities that can lose billions in streaming over the next decade and not really feel it. This fall, Thursday Night Football will be a digital only format on Amazon Prime Video. More sporting events are sure to follow on various streaming properties globally.

 

Yes, at some point soon, Netflix and perhaps Disney + will have a subscription tier with reduced costs if commercials are allowed. I do not think that this will put an end to cable cord-cutting. Netflix is planning to enforce the number of users on a single subscription more rigidly but again, I do not see that as death knell to the service.

 

There was a time when I thought that Apple or Disney should have purchased Netflix but then the share price put it out range in terms of value. Also, we all remember the time years ago when Netflix approached Blockbuster (remember them  ) about an equity arrangement and were rebuffed.

 

Younger adults across the world love streaming and they are the future of home entertainment. All of us are enjoying the commercial free aspects of most existing streaming services and the content is quite good as well.

 

Financially, one hindrance to growth may be the lower subscription rates offered in some developing countries, particularly India. Subscriber growth may look robust but revenue not so much.

 

Cable and over the air TV are in a steady decline. The recent stock market valuations of streaming services will not change that. Growth may be slower especially if Western countries have a recession over the next 24 months, but the future looks solid.

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com

 

My Final Entitlement Rant

Over the years, I have been an outspoken critic of how governments in the western world have never had the political courage to face the demographic disaster that marches relentlessly towards them. In person, I have often found that I need to check myself so as not to disrupt a pleasant gathering or dinner with my warning.

 

The media world ignores the inevitable. Yes, a few Cassandras arguing about imminent Wall Street collapse sometimes mention the issue as an aside. So, I promise, for the last time in Media Realism, I will in this post provide a less than gentle reminder of some future troubles.

 

Demographics drive the bus in society as I have often written. With all the side noise such as the horrors of Covid and the disaster in Ukraine, the demographic trends continue to move right along at many developed nations. The issue can be centered around one term—entitlements.

 

When Social Security and Medicare/Medicaid were instituted in the United States we were a much younger nation demographically. Sixty-five was considered a fair age to initiate benefits as not all that many lived longer than that in the 1930’s when Social Security entered the picture. Yet medicine improved and knowledge about heart disease and the dangers of smoking increased and people took better care of themselves and began living longer.

 

Today, people in Western societies have far fewer children than earlier generations. Part of that is a big positive—millions of talented women are no longer housebound and are contributing mightily to virtually every profession. The problem is that they have fewer children than earlier generations so the number of workers paying into safety net programs is less relative to what it used to be. At one time, some 7.5 people were paying into Social Security for every one person receiving it. Now that number is closer to 1.5. So, in the not-too-distant future, something has to give.

 

Solutions would be raising income taxes and/or cutting benefits or slashing Federal spending (not to be cynical but the last suggestion is NOT going to happen). The situation is far worse in Western Europe where you have a somewhat older population and a firmly entrenched “provider state” that covers virtually all citizens.

 

So, the tidal wave is coming. It may appear far off. I know that I may not live to see it play out fully. Reform of government programs and spending plus a simplified and truly fair tax system are needed to deal with this issue. If not now, when?

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a message on the blog.