Read Will Price's post on Large Companies - New Equation of Big Company Behavior. I generally agree with all of the points Will makes in his post but that is not the entire truth. My two bit, obvious as it may be, is that Will's entrepreneur friend certainly appears to be prone to making sweeping generalizations about large company behavior.
Startups ultimately succeed because they fit into the big company ecosystem--most of the exits these days are acquisitions by big companies, not IPOs. Big companies have unique advantages like economies of scale, supplier relationships etc, which enable them to profitably innovate in certain areas. Therefore, it boils down to what you want to do; P&G is the place to be if you care about developing, and marketing to the masses. On the other hand, Justin.TV is certainly a startup ;-) My point is that they encourage completely different risk profiles.
Large American tech companies have had a rich culture of innovation. The two most popular devices to have reached the hands of millions-ipod and RAZR-were both innovations from large corporations. Based on all accounts I have heard from my friends at Google, they are doing every bit they can to nurture the entrepreneurial spirit among their employees. It is therefore simplistic on Will's entrepreneur friend's part to associate smart people exclusively with startups. I would also argue that big companies have picked up the pace recently, when it comes to innovation and other go-to-market efforts.
Entrepreneurship certainly has made people rich (and added real value to the world) but I like to see that balanced out with other opportunities. See the FT article: "Smart companies take on 'intrapreneurial' spirit" from July 2005. Search link here.
Sunday, April 29, 2007
Friday, April 27, 2007
Fama or French - Matters of Credit
The three factor model extends CAPM with two factors size (small vs big) and value (market price relative to book value) in addition to the market risk premium. Basically, that leaves you with three betas. You can read more about it elsewhere, but what's hilarious is the article from Tuck School of Business (Dartmouth) that uncovers the real relationship between Fama and French, especially the real dope on who did all the work! Follow the link Fama Factors out French to read the article.
Thursday, April 26, 2007
Matters of Guidance
In a recent discussion about public versus private companies, a couple of us were wondering about the exact pros and cons of earnings guidance (earnings forecasts or estimates) and what is the impact of not providing any quarterly guidance.
Why give guidance at all? Basically the market trades on expectations (expected earnings). The catch with not giving guidance is analysts drop coverage or make up their own forecasts. This could potentially shoo away institutional investors and create unnecessary volatility. The argument for company executives giving earnings guidance is that they are likely in a better position than analysts and hence they could predict more reliably what the quarterly earnings report is going to look like.
The argument against giving guidance is that it fosters market myopia, which in turn causes companies to adopt a short-term "earnings management approach", rather than take a longer-term strategic view, one that includes making rational capital investments.
In "To Guide or Not to Guide? Causes and Consequences of Stopping Quarterly Earnings Guidance," the authors find no evidence that firms that stop giving guidance, offer better visibility on longer-term strategy including any additional capital investments. On the contrary, they point to issues with management and more earnings volatility (including losses).
Similarly, in "Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance" the authors suggest that firms couch poor performance and low external demand for guidance in altruistic terms, when they decide to stop guidance. Furthermore, stopping guidance causes the market to reduce its expectation.
From an operating perspective, my own dilemma is how do you reliably forecast earnings? I can see the value in making an attempt, just so you get a feel for all drivers of earnings, but sharing it with the investors is just likely to force managers to do their best to meet their guidance. For instance, not dispose off sunk investments, play tricks with non-cash generating activities like depreciation etc.
Some interesting bits on this on the web....
Google, the darling of the Wall St condemns the practice of giving guidance:
NY Times article on The Rational Mr Buffet points out that:
In an attempt to keep America's capital markets competitive, the chamber of commerce appears to have raised an issue with earnings guidance, among other things like Sarbox. Some of these are additional factors that may feed into the private equity, buyout binge.
WSJ reports:
Why give guidance at all? Basically the market trades on expectations (expected earnings). The catch with not giving guidance is analysts drop coverage or make up their own forecasts. This could potentially shoo away institutional investors and create unnecessary volatility. The argument for company executives giving earnings guidance is that they are likely in a better position than analysts and hence they could predict more reliably what the quarterly earnings report is going to look like.
The argument against giving guidance is that it fosters market myopia, which in turn causes companies to adopt a short-term "earnings management approach", rather than take a longer-term strategic view, one that includes making rational capital investments.
In "To Guide or Not to Guide? Causes and Consequences of Stopping Quarterly Earnings Guidance," the authors find no evidence that firms that stop giving guidance, offer better visibility on longer-term strategy including any additional capital investments. On the contrary, they point to issues with management and more earnings volatility (including losses).
Similarly, in "Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance" the authors suggest that firms couch poor performance and low external demand for guidance in altruistic terms, when they decide to stop guidance. Furthermore, stopping guidance causes the market to reduce its expectation.
From an operating perspective, my own dilemma is how do you reliably forecast earnings? I can see the value in making an attempt, just so you get a feel for all drivers of earnings, but sharing it with the investors is just likely to force managers to do their best to meet their guidance. For instance, not dispose off sunk investments, play tricks with non-cash generating activities like depreciation etc.
Some interesting bits on this on the web....
Google, the darling of the Wall St condemns the practice of giving guidance:
Although we may discuss long term trends in our business, we do not plan to give earnings guidance in the traditional sense. We are not able to predict our business within a narrow range for each quarter. We recognize that our duty is to advance our shareholders' interests, and we believe that artificially creating short term target numbers serves our shareholders poorly. We would prefer not to be asked to make such predictions, and if asked we will respectfully decline. A management team distracted by a series of short term targets is as pointless as a dieter stepping on a scale every half hour.
NY Times article on The Rational Mr Buffet points out that:
Mr. Buffett is also against the practice of issuing quarterly earnings guidance, the self-imposed benchmarks that drive executives to sacrifice long-term strategy for a short-term payoff.On the brighter side, there seems to be some rationality creeping up amongst investors. WSJ reports:
As the stragglers report actual results for 2006, investors have been unusually forgiving toward companies that have reported profits below expectations.
In an attempt to keep America's capital markets competitive, the chamber of commerce appears to have raised an issue with earnings guidance, among other things like Sarbox. Some of these are additional factors that may feed into the private equity, buyout binge.
WSJ reports:
The report, commissioned by the nation's biggest business lobby, called for an end to quarterly earnings forecasts, an overhaul of the Securities and Exchange Commission, and an increase in retirement savings.The Economist appears to have a good article on this topic. I don't have access to it. If you are a premium subscriber you can access it here.
To start up or not...
Accelerating your career, awareness/expertise in all aspects of company building from the ground up, reaping bigger monetary payouts are all good reasons to be doing a startup.
A thought provoking article on if you should do a startup or not by Paul Graham, a programming languages researcher and LISP guy, now running Y Combinator, an early stage venture firm.
Its important to first acknowledge that to be uncertain is human:
Those of us trained to look for data, gather support and be deliberate before making a decision (could degenerate to analysis paralysis) may find it interesting that he offers some support for the blink theory:
A thought provoking article on if you should do a startup or not by Paul Graham, a programming languages researcher and LISP guy, now running Y Combinator, an early stage venture firm.
Its important to first acknowledge that to be uncertain is human:
There's nothing wrong with being unsure. If you're a hacker thinking about starting a startup and hesitating before taking the leap, you're part of a grand tradition. Larry and Sergey seem to have felt the same before they started Google, and so did Jerry and Filo before they started Yahoo. In fact, I'd guess the most successful startups are the ones started by uncertain hackers rather than gung-ho business guys.Unless you are looking at an industry that is crying for new business models, I do agree with Paul that an early stage tech startup probably needs kick ass engineers rather than "gung-ho business guys."
Those of us trained to look for data, gather support and be deliberate before making a decision (could degenerate to analysis paralysis) may find it interesting that he offers some support for the blink theory:
Several of the most successful startups we've funded told us later that they only decided to apply at the last moment. Some decided only hours before the deadline.He then cites a whole bunch of reasons for people's reluctance to start something up. Some interesting ones that may provoke interesting discussions...
I get a fair amount of flak for telling founders just to make something great and not worry too much about making money. And yet all the empirical evidence points that way: pretty much 100% of startups that make something popular manage to make money from it. And acquirers tell me privately that revenue is not what they buy startups for, but their strategic value. Which means, because they made something people want. Acquirers know the rule holds for them too: if users love you, you can always make money from that somehow, and if they don't, the cleverest business model in the world won't save you.This is certainly true about YouTube and all those other Web2.0-ish companies like MySpace, Flickr etc that offer up a strategic value simply because of number of eyeballs. We all know venture investments are a high-risk "asset class" but Paul seems to rationalize that in a very odd way. I am not sure I buy the comparison between a startup (i.e something like Justin.TV) and a value stock:
The most valuable truths are the ones most people don't believe. They're like undervalued stocks. If you start with them, you'll have the whole field to yourself. So when you find an idea you know is good but most people disagree with, you should not merely ignore their objections, but push aggressively in that direction. In this case, that means you should seek out ideas that would be popular but seem hard to make money from.No idea? No problem!
In fact, we're so sure the founders are more important than the initial idea that we're going to try something new this funding cycle. We're going to let people apply with no idea at all. If you want, you can answer the question on the application form that asks what you're going to do with "We have no idea." If you seem really good we'll accept you anyway. We're confident we can sit down with you and cook up some promising project.Or follow some practical advice.
So here's the brief recipe for getting startup ideas. Find something that's missing in your own life, and supply that need—no matter how specific to you it seems. Steve Wozniak built himself a computer; who knew so many other people would want them? A need that's narrow but genuine is a better starting point than one that's broad but hypothetical.For those of us not in our 20s, I found he addresses three other relevant misgivings: need for structure, not ready for commitment and family to support.
Tuesday, April 24, 2007
MBA @ Wharton: Recap of Term 3
[Almost About to Finish Term 4, I figured I'd clear out my backlog on the recap of Term 3!]
If there is only one thing I could say about Term 3, that would be "Whew! Its done." With about 3.25 credits--that's 4 1/2 credit courses, one 1/4 credit course and a 1 credit course--it was a lot of awkward context switching. Add to the mix your day job that pays the bills and occasional family considerations ;-), it got real messy.
My classmate Chairman P has a few posts on Term 3. Here's a funny poem and one on how you age faster at Wharton, especially during Term 3.
My take on the courses this past term:
Corporate finance (the 1 credit course) was an absolute delight. Prof Percival was great at de-quantifying finance; in other words, a good deal of time was spent in class trying to use financial analysis to drive strategy, product mix, cost structure etc. In contrast were the exams, which were mostly quantitative. Calculating NPV's by hand sure seemed like a lot of drudgery... The case write-ups were lesser binary in approach - we had the opportunity to understand a business problem, take our time, use Excel to analyze the data and then finally present a nuanced view point - not just numbers.
Marketing Management was like an introduction to marketing - basic frameworks (5Cs - 4Ps, Segmentation Targeting Positioning - STP etc), basic marketing math - describing the economic value to the customer (EVC), using EVC to set prices, figuring out break-even volumes, sizing up markets (for both volume and profitability) etc. While many of the concepts were tribal knowledge for many of us in the industry, it helps to have frameworks and a strong quantitative bias (only to be expected at Wharton) towards marketing initiatives. I particularly enjoyed Prof Bell's classes and especially his liberal references to marketing literature during his lectures.
For a 0.5 credit course, Marketing Strategy was a ton of work. Most lectures were case based. In addition to preparing for the cases, we had to work out the marketing math (like ad budget, price, market sizes etc) and enter the data into an online system. We spent a great deal of time messing with a market simulation system (called Sabre), which had algorithms that simulated typical market dynamics. In the later part of this course we looked into life-cycle of markets/industries; I think that may be a nice segue into Competitive Strategy - something we'll be looking in Term 4.
I learned a great deal of new concepts in the other two 1/2 credit courses: Matching Supply with Demand, and Managerial (or Cost) Accounting. I have never worked in manufacturing; I enjoyed learning about the type of issues one needs to be aware of with inventory management, use of different supply chain topologies, distribution strategies etc. I would say the workload was medium. Managerial Accounting was the last 1/2 credit course and it whizzed past most of us! Excellent professor and very pertinent material on inventory valuation, internal performance measurement, assigning costs to products etc. Especially in this day and age of corporate cost cutting, managerial accounting certainly teaches you what to focus on when you are looking to cut costs, and the right questions to ask when someone claims s/he cut costs.
Finally, a quick word about the course on communication. The intent is to get you comfortable with various forms of corporate communication - addressing employees, the press, managing crises etc. If you are not a good speaker already, I guess the course could help. But I have to say that its certainly not a conducive environment to prepare and practice a speech, especially when your communications class starts at 630pm or 7pm and goes on till 9. It makes even lesser sense given that you probably had two or three deliverables on that very day and have been sitting in class since 9am!
If there is only one thing I could say about Term 3, that would be "Whew! Its done." With about 3.25 credits--that's 4 1/2 credit courses, one 1/4 credit course and a 1 credit course--it was a lot of awkward context switching. Add to the mix your day job that pays the bills and occasional family considerations ;-), it got real messy.
My classmate Chairman P has a few posts on Term 3. Here's a funny poem and one on how you age faster at Wharton, especially during Term 3.
My take on the courses this past term:
Corporate finance (the 1 credit course) was an absolute delight. Prof Percival was great at de-quantifying finance; in other words, a good deal of time was spent in class trying to use financial analysis to drive strategy, product mix, cost structure etc. In contrast were the exams, which were mostly quantitative. Calculating NPV's by hand sure seemed like a lot of drudgery... The case write-ups were lesser binary in approach - we had the opportunity to understand a business problem, take our time, use Excel to analyze the data and then finally present a nuanced view point - not just numbers.
Marketing Management was like an introduction to marketing - basic frameworks (5Cs - 4Ps, Segmentation Targeting Positioning - STP etc), basic marketing math - describing the economic value to the customer (EVC), using EVC to set prices, figuring out break-even volumes, sizing up markets (for both volume and profitability) etc. While many of the concepts were tribal knowledge for many of us in the industry, it helps to have frameworks and a strong quantitative bias (only to be expected at Wharton) towards marketing initiatives. I particularly enjoyed Prof Bell's classes and especially his liberal references to marketing literature during his lectures.
For a 0.5 credit course, Marketing Strategy was a ton of work. Most lectures were case based. In addition to preparing for the cases, we had to work out the marketing math (like ad budget, price, market sizes etc) and enter the data into an online system. We spent a great deal of time messing with a market simulation system (called Sabre), which had algorithms that simulated typical market dynamics. In the later part of this course we looked into life-cycle of markets/industries; I think that may be a nice segue into Competitive Strategy - something we'll be looking in Term 4.
I learned a great deal of new concepts in the other two 1/2 credit courses: Matching Supply with Demand, and Managerial (or Cost) Accounting. I have never worked in manufacturing; I enjoyed learning about the type of issues one needs to be aware of with inventory management, use of different supply chain topologies, distribution strategies etc. I would say the workload was medium. Managerial Accounting was the last 1/2 credit course and it whizzed past most of us! Excellent professor and very pertinent material on inventory valuation, internal performance measurement, assigning costs to products etc. Especially in this day and age of corporate cost cutting, managerial accounting certainly teaches you what to focus on when you are looking to cut costs, and the right questions to ask when someone claims s/he cut costs.
Finally, a quick word about the course on communication. The intent is to get you comfortable with various forms of corporate communication - addressing employees, the press, managing crises etc. If you are not a good speaker already, I guess the course could help. But I have to say that its certainly not a conducive environment to prepare and practice a speech, especially when your communications class starts at 630pm or 7pm and goes on till 9. It makes even lesser sense given that you probably had two or three deliverables on that very day and have been sitting in class since 9am!
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