Can Best Buy Be Fixed? Reply To @vitaliyk

A value investor by the name of Vitaliy Katsenelson, whose blog I subscribe to, just posted his ideas on How to Fix Best Buy:

Best Buy cannot have lower prices than its online competitors, and its stores lack the breadth of selection of Amazon.com, putting it at a permanent competitive cost disadvantage.

The new strategy Dunn announced a few weeks before his resignation — of closing big stores and opening a lot of smaller stores — made little sense. It was basically turning Best Buy into RadioShack Corp. It would have been great if this approach had worked for RadioShack, but it hadn’t.

Katsenelson is correct. Best Buy’s business model is cooked. It provides a service that is increasingly out of touch with how consumers of its products shop, and it does it within a cost structure that is not price competitive with the other participants in its market.

So, Katsenelson proposes a solution for Best Buy:

Best Buy’s strategy for the brave new world requires thinking that cannot be delivered by somebody who spent 28 years in the Best Buy box. It requires the strategy of an Amazon or Netflix, where management was willing to bring forward and execute a disruptive new approach that undermined its current cash-cow business. Amazon did this by bringing electronic readers to the masses. Netflix did it by streaming movies and TV shows.

The rest of Katsenelson’s proposal, while creative and worth pondering on its own from a strategic value point of view, is unimportant for the purposes of our present discussion, which is actually to highlight the role of innovation.

According to our reading of The Innovator’s Dilemma, Katsenelson is suffering from two confusions in his analysis:

  1. He is confused about the difference between sustaining and disruptive technologies
  2. He is confused about the likelihood of success in a firm disrupting its own business model

Let’s tackle each confusion separately before reaching a new conclusion.

Confusion #1 – sustaining vs. disruptive technology

In building his analysis of Best Buy’s current predicament, Katsenelson cites the examples of Amazon’s Kindle and Netflix’s digital streaming technologies as examples of “disruptive” technology.

It might be useful at this point to revisit the definition of sustaining versus disruptive technology provided to us by The Innovator’s Dilemma before proceeding:

  • sustaining, which are new technologies that improve a product or service in a way that is valuable to existing customers or markets
  • disruptive, which are new technologies that are uncompetitive along traditional performance metrics, which are unusable or undesirable to existing customers or markets but which nonetheless can eventually come to replace the traditional market over time

(A disclosure here, as well– I have not studied Amazon nor Netflix in depth, so I am making some conjectures here about margins and pricing which may be incorrect, and I realize they are central to the point I am making so it could weaken my argument slightly if I am speaking out of turn here.)

Now, judging by the definitions above, I’d say both Amazon’s Kindle and Netflix’s digital streaming service are actually sustaining technologies, not disruptive. A good clue to the truth of this might come in the fact that these technologies each were developed and implemented from within the firms in question, rather than being produced by an entrant, competitor firm.

But even if that is not the give away, sure both of these technologies improved their existing products and services (books and movie rentals, respectively) and both were appealing to existing customers. It is not my understanding that there were a bunch of people who were not buying books and not renting movies until Amazon and Netflix released their new services, at which point they jumped on board. In fact, it is my understanding that many customers who now use the Kindle or digital streaming were previously physical book readers or mail-order movie renters.

Additionally, my understanding is that these new businesses are either similar margin or better margin businesses than what came before. I understand Netflix has had issues with the cost of acquiring distribution rights to film properties but that seems a separate issue from the actual question of the cost of distribution– digital streaming seems far more cost effective than sending things through the mail. Same with e-readership; the question of acquiring separate rights for digital distribution is a different one than the cost of distribution, of which digital book distribution seems to be a far higher margin business than the one involving costs of inventorying and mailing physical copies of books.

This is another aspect of the sustaining vs. disruptive technology debate– firms on sustaining technological pathways look for higher margin business that satisfies their existing customers and provides them with improved, but similar service to what they had before. Disruptive technological pathways involve different (usually lower) cost structures and different products or services which are competitive on metrics or feature sets that were previously not an issue in the pre-existing competitive paradigm.

Best Buy was, in its heyday, an electronics and appliance retailer where customers not only shopped but transacted. Nobody wants to transact with Best Buy anymore. That truly is a disruption as now people just want to shop. Any proposal that involves Best Buy no longer being a retailer (shopping AND buying) is a proposal for disruptive innovation within Best Buy’s existing business model, and a change in cost structure that would go along with it.

Confusion #2 – the likelihood of success in self-disruption

The other thing that’s clear from reading The Innovator’s Dilemma is that responding to a disruptive threat from an entrant firm is hard enough, but successfully disrupting one’s own business model is nearly impossible.

There are myriad reasons why this is so but what it essentially boils down to is that, as Geoff Gannon says, businesses have DNA and part of their DNA is their cost structure. Asking a business to change its cost structure is like asking it to change its DNA; it’s akin to expecting a megalodon to transform itself into a tick.

Another part of a business’s DNA is its management culture and accumulated experience. Just as certain animal species seem to have integrated various memory experiences into their DNA which are expressed as subconscious, instinctive behavior that comes naturally and effortlessly to the animal, a business develops a management culture (tightly interwoven with and often times predicated on the business’s cost and incentive structures) that possesses a kind of collective memory, or instinct. Management culture is “evolutionary”– it’s highly specialized and adaptive, designed to excel in the conditions unique to that business’s industry but which may prove maladaptive in conditions dominating outside of the industry.

Expecting a company’s management to successfully adapt its culture, its DNA, to new competitive circumstances is like expecting a polar bear to hunt successfully after air dropping it into the African savannah, or a jungle on the Indian subcontinent.

Getting rid of the top executive is not enough. CEO Brian Dunn might be gone, but all his lieutenants remain. They’re like mini-Brian Dunns, the children of Brian Dunn, they might not be exact replicas but they’ve undoubtedly learned a lot and probably “grown up” believing in his authority and vision the way children have trouble question their parents. They bring all that along with them. (David Merkel discussed this phenomenon in his bond manager series where he talked about the way a corporate debt team will come to be subtlety but surely influenced by the PM, and it applies in other business organizations outside the world of corporate bond management.)

Everyone who works at Best Buy is used to succeeding (and failing) a particular way. It is unlikely they’ll find themselves succeeding in a new paradigm that’s completely foreign to them when they are failing to sustain their business in a paradigm they’re intimately familiar with and once dominated.

A third way? Dissolution, sub-disruption, liquidation?

Katsenelson’s two examples don’t shed much light on what Best Buy should do because they’re examples of successful adoption of sustaining, not disruptive technologies. Best Buy is facing disruptive competition, it is beyond the point where its business could be improved by a sustaining technology.

And self-disruption doesn’t appear to be a viable strategy because Best Buy has built-in business DNA which can not be easily mutated, if it can be changed at all.

So, what should Best Buy do?

One perfectly reasonable strategy could be dissolution (aka liquidation by change in ownership)– Best Buy could sell itself to a strategic buyer who values Best Buy more as a sum-of-parts than as its currently operating whole. The new owner could salvage and re-orient what it can and then re-sell the rest as “scrap”. Just because the Pinto explodes when it gets rear-ended doesn’t mean the metal and upholstery in the vehicle couldn’t be used elsewhere. This is an option.

Another strategy is for the company to liquidate itself– managed, slow-motion suicide. The company could cut cap-ex to zero, start winding down its inventory buying and other business activities in line with the maturation of its existing facilities leases and then close out the stores one by one (selling property, plant and equipment when possible as this process continues). The proceeds could be distributed as periodic dividends to shareholders or be distributed as a lump-sum cash payment in exchange for shares at the end of the process several years from now.

But there is a third way and it actually does involve self-disruption: Best Buy could set in motion the slow-motion suicide or not, and at the same time use some of its capital to set up a small subsidiary to either compete in the world of Amazon, or work at discovering another disruptive technology which could re-jigger the industry even more and prove a disruptive threat to Amazon. This subsidiary would have completely separate managementcompletely separate capital and a completely separate cost structure which would be appropriate to the new market it is attempting to compete in.

That’s one way Best Buy could successfully respond to innovation in its industry. But it’s most likely far too late for that.

Which is why I think it’s pretty clear Best Buy is a value trap outside a strategic buyer coming into the picture (Schulze might be a little slow to the draw, but at least he’s got the good sense to go for his revolver before his opponent six-shoots him into a shallow grave), or the current management dedicating itself to a program of self-liquidation over the next several years.

Would You Buy This Business? A Bargain In The Videogame Industry

The Nintendo investment thesis in one paragraph

At Y9020/share (June 1, 2012), you are buying a strong global entertainment franchise for Y1278T which has earned Y126B on average over the last ten years and generated Y120B in average FCF, with Y1191B in book value, Y958B in cash and investments and no debt. Global financial market pessimism coupled with hyperventilating technology futurist forecasting and a recent misstep by management that is now behind the company can be used to your advantage to buy this good business at a fair price.

The Nintendo investment thesis in several paragraphs, with links and charts

Nintendo ($NTDOY – ADR, JP:7974), the cherished childhood video game icon and global IP behemoth behind such hit game franchises and characters as Super Mario Bros., Pokemon, The Legend of Zelda and more, has stumbled recently. The company rolled out its new 3D handheld video game system, the Nintendo 3DS, around the world in the spring of 2011 at a price point that proved out of reach to many consumers.

To sale initial sales were disappointing would be an understatement– the system was a flop and with little software support from Nintendo out the gate, gamers had even less reasons to purchase this pricey new system. Realizing their mistake, the company quickly slashed the retail price of the system and offered retroactive credits and concessions to select customers who had purchased the system prior to the price drop.

With a new slate of software titles by Nintendo and premium 3rd party developers released in the 2011 Holiday season and thereafter, and the new price point, the system has finally caught momentum and software and hardware sales are both impressive. As of March 2012, worldwide sales of the Nintendo 3DS reached 17 million units and sales of related software amounted to over 45 million units. Consider this in comparison to the 151 million hardware units and 900 million software units sold over the last 7 years with the predecessor system Nintendo DS and its generations, and the 95 million hardware units and 818 million software units sold over the last 5 years with the smash hit Wii home game console (data source PDF).

Game console hardware and software sales tend to grow and then peak 3-4 years after release (software especially, as its dependent upon a hardware install base for growth, while hardware is in turn dependent on hit software releases to coax gamers to purchase the system to play their favorite games). Even with the poor initial release, the Nintendo 3DS has already outsold the wildly popular Nintendo DS over a comparable time period.

The world’s biggest game expo, E3, starts the first week of June and Nintendo will make a new announcement about their 2nd generation Wii system, currently named Wii U. Sales of the predecessor, revolutionary motion-controlled system have continued to show strength as the company has strategically discounted the system over its lifecycle to maintain sales and the hardware install base, thus driving software transactions as well, although they are slowing as any game system will after long enough after its introduction into the market.

The pessimism about the initial 3DS rollout and the uncertainty about the potential success of the new Wii U system mean that the market is not looking forward to anything good for Nintendo. The stock has been left for dead as the company trades near book value of Y1,191B with a current market cap of Y1,278B.

The fear and pessimism about this company is not just related to the hardware issues (which appear to be solved). Nintendo’s fortunes have been swept up in the whirlwind Tech Bubble 2.0, where everyone insists that all old things will be torn down and ruined and new, cloud-based (and primarily Apple owned and operated) variants will rise in their place. Analyst opinions, professional and amateur alike, have revolved around an obsession with the idea of Nintendo giving up its hardware business completely and selling itself to Apple and focusing on its software franchises. The company’s stated disinterest in following any course resembling this option has left many to conclude it is an absurd dinosaur, cluelessly waiting for the asteroid apocalypse to arrive and destroy its once powerful and profitable franchise in a massive thermonuclear explosion.

That’s what’s being imputed into the stock price, which has continued to plummet like a rock. But, the reality is quite different. Nintendo’s hardware is not being abandoned en masse by former fans. Nor is the world moving to a permanent, entrenched and exclusive model of casual gaming via cell phone apps. The value of the “casual gamer” is likely severely overblown to begin with (which, by the way, calls into question the value of Nintendo’s strategy of “games for everybody” and expansion of the gaming population, as noble as it may be and as successful as it may appear with the blockbuster sales numbers of the Wii). And Nintendo, while initially hesitant and reluctant to jump into the online transaction and gaming space, is by now doing much more than just dipping a toe in.

A few choice quotes from the latest President’s address by Nintendo head honcho Satoru Iwata are below.

On digital downloads and digital game delivery:

it is true that downloading software with 10 gigabytes of memory cannot be done in an instant today, even with broadband connections. So, compared with the situation of portable gaming devices, where comparatively compact-sized software can be downloaded, we have to ask our consumers to wait for a longer time before the download process is completed. However, consumers will be able to use the Wii U effectively by finding convenient times to download software such as when they are sleeping at night. Some consumers prefer to download digital software so that they can play with them on their system anytime without the need to exchange the games’ storage media. Some other consumers find it easier to purchase the medium at a retailer and play it as soon as they insert it into the game hardware. These consumers think it advantageous that they can exchange games with their friends. In order to offer consumers options to choose from, it is important for the company to first make the situation (where digital downloads of packaged software are offered to our consumers in addition to the existing packaged software sales) a reality, and we are ready to offer these options now.

Nintendo is taking a flexible approach, trying to allow gamers a variety of options for receiving games and game content ranging from traditional retail distribution to digital distribution, all with respect for the current limitations of average broadband connections.

On digital versus retail pricing:

we are proposing the two formats of sales mechanisms from which our consumers can make their own choices. The needs of society shall be determined by the choices to be made by the consumers. We do not hold such a premise that digitally distributed software has less value. In fact, as we have discussed this with a number of software publishers around the world, we have found that their opinions are completely divided on the topic of the price points of the digital distribution of packaged software. Some publishers believe that the digital versions should be cheaper while others insist that both versions must be set at exactly the same price. So, it is not only Nintendo’s idea. Each publisher has various ideas on this point and, among them, Nintendo is now offering both versions at the same price point (the same suggested retail price).

Again, the focus is on flexibility– not wedding the company to one model but taking a wait-and-see approach that alienates neither consumers nor distribution partners and allows the market consensus to finally guide the company to the best process over time.

On management’s responsibility for the flop:

with the financial results that we have announced, it is natural that I am being criticized. I do not feel that I have been experiencing something unreasonable. I am making efforts so that the situation can change as soon as possible.

How often do you see the president of a public company accept responsibility for a problem, and, better yet, still feel like there’s hope for a resolution?

On the lessons learned from the failed 3DS launch that will be applied to the Wii U launch:

As we look back, when we launched the Nintendo 3DS, we failed to prepare a software lineup which could satisfy our consumers in addition to other factors, and the Nintendo 3DS could not initially increase the sales as we had originally expected. This is why the company needed to carry out such a drastic markdown measure by sacrificing the profitability. As a result, and supported by a strong software lineup, the Nintendo 3DS was able to regain momentum during the year-end sales season of 2011. We laid out such a drastic measure by understanding that regaining the momentum which had been once lost, is much harder than trying to create momentum from scratch. Without it, the Nintendo 3DS could not have realized positive results at the end of last year or the current sales pace in Japan. It did hurt our financial results, but it was a necessary measure. So, how will we be able to use this lesson for the Wii U? There is always a limit to our internal resources. The company now has to develop software for the Nintendo 3DS, has to prepare for the Wii U launch and has to finalize the hardware functionalities. With these circumstances in mind, if I said that an overwhelmingly rich software lineup would be prepared from day one, it would be too much of a promise to make. On the other hand, we are making efforts so that we will be able to make several proposals even from the launch period that can eventually become evergreen titles for the Wii U. We have learned the lesson that we have to make that kind of preparation for the Wii U, or the Wii U will not gain enough momentum to expand its sales.

On the role of their 3rd party software publishing partners in the success of their systems:

It is imperative for Nintendo that our new hardware offers new proposals and potentially new play experiences so that developers will be interested in this hardware and be motivated to make attractive software. At the E3 show this June, you will be able to experience not only Nintendo’s Wii U software but also the titles being prepared by the third-party publishers. As a result, I think you will be able to notice that a number of developers are creating software (for the Wii U) even today. As for the Nintendo 3DS, there may appear to be fewer commitments from the U.S. and the European software publishers than those of their Japanese counterparts. This is due to the different timing (between Japan and overseas) when they noticed that the Nintendo 3DS would surely expand widely into their markets and, thus, the different timing when they started the actual development of the Nintendo 3DS software. You will also notice a change in this situation when a richer Nintendo 3DS software lineup in the overseas markets is announced around the time of the E3 show.

The first bold part is critical– this is one of Nintendo’s competitive advantages. The company has a purposeful policy of creating new play experiences that will provide incentive for software publishers to publish for their hardware and not others.

The second part is an explanation for why it appears that non-Japanese publishers have not been excited to produce software for the 3DS after the failed launch. They were last to see the sales momentum for the system turn in their markets so they’re behind on the development schedule as a result.

On the “gaming population expansion” philosophy:

Without making efforts to increase the number of new consumers and make video games accepted positively by society, we cannot expect a brighter future than now, so we will continue to make these efforts.

Once consumers have a notion that “this system is not for us,” we have learned that it is extremely difficult to change their perceptions later. Therefore, in promoting the Nintendo 3DS and the Wii U, we have announced that we would like “width” and “depth” to coexist. With the Nintendo DS and the Wii, the approach of “width” was well accepted by many people; however, what we did in terms of “depth” was not satisfactory for some consumers. This time, we would like consumers to be satisfied in both aspects. In order to do so, we started to work on the “depth” aspect first, and the current and existing software you can see for the Nintendo 3DS is based on that idea. In the future, the approach will evolve. By exploring the development both from width and depth standpoints, it is our intention to satisfy a wider audience with one gaming platform. Our approach for the Wii U is basically the same. By doing so continuously, we are expecting that the number of game users per household will increase and as the gaming population increases, we believe we can create a sustainable video game market.

Nintendo is not going away. It’s not a clueless dinosaur. It made some mistakes with the 3DS launch that it has learned from. The industry may have some challenges, headwinds and uncertainties as the distribution model transitions to digital over time, but none of this changes the integral value of this business drastically, which is that it is a premium provider of desired game IP on innovative 1st party hardware platforms that a growing audience of gamers enjoy using.

It might be a different story if Nintendo were in a different financial position than the one it actually occupies but the reality is as of Q4 FY2012 (Mar 2012), the company had Y958B of cash and short-term investments against TOTAL LIABILITIES of Y177B. The company has no debt. According to this link on the Nintendo IR website, at a current share price of Y9020 the company actually is selling below book (NAV) of Y9313/share.

If you’re not yet getting an idea of how cheap this company is, consider the following table:

Nintendo Trading Multiples
10yr 5yr Pre-Wii
Market cap 1277863 (millions Yen)
EV 319541 (millions Yen)
P/S 1.3 1.0 2.5
EV/EBIT 1.5 1.2 2.7
P/E 10.2 8.0 17.9

I created three periods to consider– 10 year average (full system cycle from 2003-2012), 5 year average (since the global recession started, 2007-2012) and the pre-Wii era (these are average earnings generated by the company prior to release of the hit Wii console, 2003-2006).

As you can clearly see, the company is trading for abnormally low multiples of sales, operating and net earnings. The future for Nintendo will probably be better than the pre-Wii era (it is a larger company with an even more expansive market and fan base than then) but may not be as successful as it was with the Wii. That remains to be seen.

Here is the company’s historical margins over the last 10 years:

  • Gross – 40%
  • Operating – 22%
  • Net – 13%
  • FCF – 12%

I think these margins demonstrate Nintendo is a good business with stable earnings power and strong ability to generate FCF from sales.

Relative to its average earnings power and franchise potential, the company seems to be unreasonably priced. Businesses like Nintendo do not deserve to trade below book or anywhere close to 1.5-2x sales. The stumble on the 3DS was temporary and the company is moving on. It’d be nice if the company was even cheaper, and with all the pessimism in global financial markets it might still be. But at these prices, it’s “cheap enough” for a business like this.

The True Principle Of Modern Education Exposed: To Make Us A Means To Others’ Ends

What is the true purpose of public education?

According to a new research study reported in the WSJ, it appears to be all about career-prep:

Can finger-painting, cup-stacking and learning to share set you up for a stellar career?

Research says yes, according to Dr. Celia Ayala, chief executive officer of Los Angeles Universal Preschool, a nonprofit that funds 325 schools in Los Angeles County, Calif., using money from tobacco taxes.

“When they enter kindergarten ready to thrive with all the social, emotional and cognitive skills, they perform at grade level or above,” she said. “When they don’t, that’s where that achievement gap starts.”

Note: don’t ask why money from tobacco taxes is being used to fund preschool research nonprofits.

There’s a lot at stake here– not only does pre-school appear to grant an advantage, but NOT doing appears to confer disadvantages such as increasing the likelihood of becoming a “special needs” student:

Kids without that early boost have been shown to be more likely to get special-needs services, be held back a grade or two, get in trouble with the law and become teen parents. Preschool alumni have a better chance, she said.

Today, a child’s life ends before it even begins:

“Those who go to preschool will go on to university, will have a graduate education, and their income level will radically improve,” she said.

Implication: don’t go to preschool, don’t go to university, don’t get a graduate education, watch your income level stagnate or decline, eventually you’ll probably kill yourself through obesity or suicide in a depressed state of lifetime unaccomplishment.

The article goes on the explain that preschool could hold “the key to job success in adult life” and warns of the sorrows of children who don’t receive an education in preschool because they’re spending time with “parents or caregivers.” Yes, there is nothing being learned there, apparently. Nothing valuable, at least.

But valuable to whom? And for what?

Why, valuable to society, for the purpose of making the child a good little worker! The definition of success is one who works productively for others. The purpose of education is not to develop a society of individuals, but a society of workers.

Or, as one French director of an “ecole maternelle” put it, the object is to give them social skills “to be students and citizens,” a “citizen” being one who obediently does what others ask of him.

Meanwhile, policymakers in the US are big on preschool:

Policymakers in the U.S. are most concerned about eliminating the gap between kids who do well in school, going on to college and successful careers, and those who fall behind. Preschool, say policymakers, offers educators the best shot for getting children of varying backgrounds on equal footing.

There’s a codeword in there– “equal”. Equal means same. Same means, “not different.” But wait, individuals ARE different. They have different likes and dislikes, different skills and aptitudes. How can beings who are inherently different, ever be equal? And why would policymakers care? How does being “equal” help one succeed at living ONE’S OWN life?

Answer– it doesn’t. It isn’t about living one’s life. Sameness, equality, is being sought to create an army of interchangeable cogs to go on society’s wheel. Then, the elites spin the wheel. And round go all the equal people, never asking why.

Don’t worry, though. Policymakers at Department of Education won’t let anyone fail to be equal. They’re “equal” to the task:

“We’re really focusing on the cradle-to-career continuum,” said Steven Hicks, special assistant for early learning at the federal Department of Education, where there has been a recent shift as officials realize “we need to start earlier.”

Once people are in the work force, the Social Security Administration is responsible for the “career-to-grave continuum”. Which means no matter what point in the continuum you’re at during your life, the State is there to help you out, with kid gloves, of course.

Although most education funding happens at the state level, the federal government has been trying to fuel a preschool wave with a half-billion dollars in challenge grants funded in January. The next five states in line will share $133 million in preschool money this year. Call it a pre-job-training program.

Are you starting to get the picture here? You’re being trained from the moment you develop the mental, emotional and conceptual faculties to see yourself as a differentiated “other” in the world, to prepare to work for someone else. This is scary stuff. And it’s all coming in the innocuous guise of “equality” for all.

Most teachers and parents would agree that early-childhood education matters to a child’s trajectory in life. But with budgets stretched around the country, a lack of money is forcing some states to make choices about scarce education dollars. Too bad, the DoE thinks.

“Secretary Duncan says there are smart investments and some things you can do that are not so smart, and one of those is cutting early childhood education,” Hicks said.

To calculating socialists running short on Other People’s Money, future worker bees are like hot dogs from the corner stand– “Get ’em while they’re young!”

This article, intentionally or not, is coincidentally the most timely and blatantly obvious confirmation of Stirner’s false principle of education. Nobody in this article is aiming at an educational system which produces “self-developed” individuals. The name of the game is forming human clay into pre-determined molds appropriate to other people’s ends.

It is distinctly anti-individual. It’s a quiet and brutal form of slavery-as-virtue.

Notes – Dying Of Money

Dying of Money

by Jens O. Parsson, published 1974, 2011

The collapse of a monetary regime

The following note outline was rescued from my personal document archive. The outline consists of a summary of Jen O. Parsson’s classic tale of monetary woe, Dying Of Money. Parrson catalogued two mass inflation events in modern Western history– the German post-war hyperinflation and the US monetary boom of the 1960s and 70s which culminated in the abrogation of the gold-exchange mechanism by Nixon in 1971; both are instructive for different reasons.

Dying Of Money

  1. Prologue: The German Inflation of 1914-1923
    1. The Ascent
      1. “Disastrous prosperity”
        1. old mark had been worth 23 US cents; written off at 1T old marks to one new mark at end of inflation
        2. all the marks in the world in summer of 1922 (190 billion) were not enough to buy a newspaper or tram ticket in November 1923
        3. first 90% of Reichsmark’s real value had been lost before the middle of 1922
        4. inflation cycle: gestation of 8 years, collapse of 1 year
      2. The beginning
        1. summer of 1914, Germany leaves gold standard, runs up debt, prints money in anticipation of WWI
        2. war financed through issuance of new debt (war loans) paid for with newly printed currency
        3. domestic prices slightly more than doubled by the end of the war in 1918, even though money supply increased more than 9x
        4. 1919, Germany sees violent price increases of 17x prewar level
        5. other nations, including WWI victors, stop spending and suffer recession 1920-1921; Germany continues printing and experiences a boom while prices stabilize for fifteen months between 1920 and 1921, money supply doubles again
      3. Benefits of the inflationary boom
        1. Exports thriving
        2. Hordes of foreign tourists
        3. New fortunes minted overnight
        4. Berlin becomes one of the brightest capitals in the world
        5. Great mansions of the new rich in abundance
        6. City life took on a wanton, careless manner
        7. Frugality absent as no one took time to search for real value
      4. Losers of the inflationary boom
        1. Crime rate soared
        2. Unionized workers kept up with inflation while non-unionized fell behind
        3. Salaried and white-color workers lose purchasing power even as unemployment virtually disappears
        4. Total production rose
      5. Paradoxical wealth and poverty
        1. much employment in “spurious and unproductive” pursuits
        2. paperwork and paperworkers abounded
        3. government employment grew, heavy restraints against layoffs and discharges kept redundant employees on payroll
        4. incessant labor disputes and collective bargaining consumed time and effort
        5. business failures and bankruptcies were few
        6. almost any kind of business could make money
      6. Speculative fever
        1. speculation became one of the largest activities
        2. fever to buy and sell paper titles to wealth was enormous
        3. volumes on Berlin Bourse were so high that, even with bloated back-office staff, Bourse was closed several days a week to work off the backlog
        4. capital goods and industrial construction industry experience a boom, many new factories built all while neighboring countries continued using old equipment
        5. M&A, takeovers and proxy fights in vogue
        6. massive conglomerations of non-integrated businesses took place; these businesses and the “kings of inflation” disappeared after the collapse
    2. The Descent
      1. Price increases catch-up with money printing
        1. From July 1921, prices double in next four months and increase 10x through summer of 1922
        2. consumers put on “buyer’s strikes” that are fruitless
        3. interest rates soar as lenders attempt to anticipate inflation
        4. businessmen transact in gold or constant-value clauses or foreign currency
        5. government’s budget deficits close to balance; nonetheless, government is only able to refinance existing debt through money printing
      2. Final moments
        1. July 1922, prices rise 10x in four months, 200x in 11 months
        2. near end in 1923, prices nearly quadrupling each week
        3. prices raced so far ahead of printing that the total real value of all Reichsmarks in the world was smaller than ever
      3. The end of the inflation
        1. August 1923, government of Wilhelm Cuno falls; October 1923, Gustav Streseman made chancellor, given dictatorial powers, hires Dr. Hjalmar Schacht as commissioner of new Rentenmark (“investment mark”)
        2. Rentenmark placed in circulation beside mark with the avowal that Rentenmark’s would not be inflated
        3. Germans believed it, and Rentenmarks supply was held constant
        4. November 15, 1923: final exchange rate, 1T mark: 1 Rentenmark
        5. Government budget balanced by finance minister Dr. Hans Luther
      4. The fallout of the collapse
        1. Schacht orders end of credit from Reichsbank April 7, 1924; credit squeeze ensues; price increases halt
        2. Savings destroyed
        3. Inflationary boom businesses go bankrupt
        4. Credit nearly impossible to get
        5. Unemployment temporarily skyrockets
        6. Govt spending slashed, govt workers dismissed, taxes raised
        7. Working hours increase, wages cut
        8. Millions of voters join Communist and Nazi parties in the “inflation Reichstag” of May 1924
      5. Economic recovery
        1. New elections in December 1924 erase extremist party gains
        2. business recovery based upon foreign loans due to German credit tightening; world depression of 1929 knocks debtor Germany down
    3. Gains and Losses
      1. Debtors: winners
        1. every contract or debt fixed in marks was paid off in worthless marks
        2. Germany’s total prewar mortgage indebtedness, equal to 40 billion marks or 1/6th of total German wealth, worth less than one American cent after the inflation
        3. Savers and owners of mark wealth (bank accounts, savings, insurance, bonds, notes) lose out big
        4. those who borrowed up until the last minute to buy assets turned out to be winners
      2. German Govt: winner
        1. Largest debtor
        2. Entirely relieved of crushing war debt, representing cost of war, reconstruction, reparations and deficit-financed boom
        3. beware being a creditor when the government is a huge debtor
      3. Farmers: winners
        1. always had food
        2. farms were constant values
        3. mortgages were forgiven outright
      4. Foreign owners of marks and other losers
        1. Germany made a profit of 15 billion gold marks, or 40% of annual national product, on sale of paper marks to foreigners, after deduction of reparation payments
        2. Trustees, forced by law to own fixed obligations, lost
        3. Wealthy Germans invested in marks lost
        4. Great charitable institutions wiped out
        5. Banks and insurance companies were weakened but not destroyed (they are both lenders and borrowers)
        6. Sound business survived, but in a weakened state, boom businesses wiped out
      5. Industrial stocks
        1. height of the boom, astronomical P/E ratios
        2. dividends cancelled
        3. stock prices increase 4x from February 1920-November 1921
        4. Stock market crash of December 1, 1921, in the middle of inflation
          1. prices fell by 25% and hovered for 6 mos while other prices were soaring
        5. real value of stocks decline because their prices lagged behind the price of tangible goods
          1. Entire stock of Mercedes-Benz valued at price of 327 cars
        6. near end of 1923, stocks skyrocket again as investors realize that stocks have value even when bonds do not and have a claim to underlying real value
    4. Roots of the inflation
      1. Prices contained by faith
        1. Germans and foreign investors, until 1922 and the brink of collapse, absorbed the Reichsmark
        2. faith was in the idea that an economic giant like Germany could not fail
        3. willingness to save marks kept them from being dumped immediately back into the markets
        4. realization that Germany would not back the money was the moment the dam let loose
      2. Balance of payments
        1. More cheap Reichs flowed out than hard money came in
        2. This despite constantly rising exports and constantly falling imports
        3. payment deficit actually muted price increases by keeping Reichs outside of German markets
        4. Reversal of payments deficits marked the proximity of the end
        5. in collapsing stages, Germany ran a huge payments surplus
      3. Foreign exchange rate
        1. unlike era after WWII, free and uncontrolled “float” of forex
        2. German mark almost always falling and almost always had a lower forex value than its purchasing power within Germany
        3. Thus, forex rate proved a quicker and more sensitive measure of inflation than internal prices
        4. German exports were abnormally competitive on world markets due to forex vs. internal purchasing power discrepancies
        5. Germany lost 10 billion gold marks, or 25% of a year’s national product, on underpriced exports due to inflation
    5. The Great Prosperity of 1920-1921
      1. March 1920-December 1921
        1. prices stable
        2. businesses and stock market booming
        3. exchange rate of mark against $ and other currencies rose for a time, was momentarily strongest in the world
        4. ROW enduring severe recession; Germany envy of the world
      2. Reign of finance minister Matthias Erzberger, June 1919
        1. Raised taxes on capital; real tax yield of 1920 highest of any year from beginning of war to end of inflation
        2. tight money induced for an extended period in late 1919; only time money supply stopped rising for more than a month or so
        3. March 1920, price level was 17x prices of 1914, roughly equal to increases in money supply, new equilibrium reached
        4. Price increases halted for nearly a year, real burden of war debt had been cut by 5/6ths as a result of price increases of 1919
        5. March 12, 1920, Erzeberger exits govt, disgraced after a libel suit, and his pro-inflationary rivals take over
        6. March 1920 is the month prices stop rising, but with Erzeberger’s exit, the boom prosperity begins
          1. prices remain passive
          2. exchange value of Reichsmark rises
          3. stock market rises 3x before crashing in December 1921
          4. Reichsbank doubles over next year into summer of 1921 when price increases catch up
    6. The Lessons
      1. Unrealized depreciation
        1. built upon faith in the German economy to recover
        2. built upon faith in German government to make good on debts
      2. Booms
        1. built upon increasing rates of inflation
      3. Hitler and extremists thrive in wild, inflationary conditions
        1. Hitler’s putsch was in the last and worst month of the inflation
        2. totally eclipsed when economic conditions improved
        3. took power through elections during another economic period of trouble
        4. middle class voters wiped out in the inflation moved to the extremes in polling, bolstering Hitler and others
  2. ACT ONE: The Rise of the great American Inflation
    1. The War
      1. Dollar lost 70% of its value from 1939-1973, prices rose 3.5x
      2. Seven years of WWII, Federal debt increased to $269B
        1. 1/4th greater than the annual gross product of the country at that time
        2. money supply grew by 3.5x between 1939 and 1947
        3. June of 1946, prices had increased by less than half from 1939
          1. price controls
          2. new money was absorbed by the issuance of war debt rather than bidding for consumer goods
          3. many saved money during the war for “safety” rather than spent it
          4. low money velocity resulted
        4. real value of dollar at the end of the war was 2/3rd what it had been at start of war
        5. government stopped inflating, allowed price increases to reach new equilibrium
      3. Prices controls end 1946
        1. prices double from levels in 1939 in two years
      4. Money supply held stable 1947-1950; prices remain stable as well
        1. economic recession 1949
      5. Comparisons: German war inflation vs. US war inflation
        1. American war debt of $269B, about 1.25x annual national product; Germany 153B marks, about 1.5x annual national product
        2. American monetary inflation, 3.5x; German 25x
        3. American price inflation 2x; German 17x
        4. Ratio of monetary to price increases about the same, 60%
    2. Grappling with Stability
      1. Korean War, 1950
        1. Federal budget did not run a deficit fighting the war
        2. money supply increases by 16%; prices increased 13%
      2. Eisenhower administration
        1. money supply increased 1% per year on average from 1953-1962; wholesale prices never varied +/-1% from 1958-1964
        2. “monetary oscillations”
          1. 1953-1954, money growth <1%, recession
          2. 1954-1956, money growth 3.9%pa, boom and price inflation
          3. 1957, money supply contracts, followed by recession
          4. 1958-1959, inflation
          5. 1959-1960, contraction
          6. 1961, inflation
          7. 1962, contraction
    3. The Great Prosperity of 1962-1968
      1. intense monetary inflation beginning 1962
        1. 4.6% per annum for 43 months (through April 1966)
        2. 7.2% per annum for 27 months (January 1967-April 1969)
        3. total inflation over seven years was 38%, interrupted only by the 9month period of no expansion in 1966, accompanied by stock market collapse and economic recession by no effect on prices
        4. combined with an investment tax credit of 7% for businesses to spend on new capital assets, leading to exaggerated investment boom
        5. prices did not keep up, leading to “unrealized price inflation”, despite rising at nearly 5% per annum for the seven year period
    4. The Inflationary Syndrome
      1. economic effects from 1962-1968
        1. gross national product increased $360B, or 7% per annum, compared to 4.8% per annum during Eisenhower years of 1955-1960
        2. unemployment continually decreased
        3. stock market was almost constantly rising for more than 6 years
      2. speculative effects
        1. high stock market volumes, huge capital gains appreciation, large paper profit generation
        2. conglomeration and merger of big business
        3. most wage growth in the speculative class of paper-pushers
        4. overinvestment in capital goods
        5. IBM, Xerox (back-office service/goods companies) were the investment darlings of the era
        6. overproduction and stimulation of the growth of educational and legal industries
      3. foreign exchange and the balance of international payments
        1. current account deficits are a symptom of inflation
          1. when there is excess money in one country it flows out to other countries
          2. the currency in the inflationary country is overpriced relative to world markets, so it goes out and buys imports
        2. current account deficits reduce price inflation in the inflationary country because the currency bids up prices in foreign rather than domestic markets
        3. dollars held by foreigners returning to the US at the point that the current account turns to a surplus, would result in price inflation in the US
  3. INTERLUDE: The General Theory of Inflation
    1. Prices
      1. prices in aggregate are determined by total amount of money availble for spending in a given period of time, in relation to total supply of all values available for purchase with money in that period of time
      2. money supply defined as that which people use to buy things of value with, but which is not a thing of value itself (dollars, coins, checking account deposits)
      3. money available per unit of time, aka money velocity, also a factor, but it is hard to measure or determine
      4. price level = money quantity x money velocity / supply of all real values
      5. this is the quantity theory of money
    2. Real Values
      1. in an inflation, there are many “spurious values” which disguise and conceal the inflation of prices of real values
      2. real wealth consists of land, resources, productive plant, durable goods and people
      3. paper wealth is not real wealth; money wealth is debt, including money contracts such as bonds, mortgages, debentures, notes, loans, deposits, life insurance and pension obligations
      4. debt does not represent the direct ownership of any real assets but rather subdivision of interests in real assets with the direct owners of the assets
        1. for ex, a man is not part of the total supply of real capital as he can not be bought and sold
        2. however, if this man borrows money, he subdivides ownership of his future productive power and adds himself to the supply of capital assets
        3. if he borrowed from a bank which borrowed from a depositor, further subdivision has occurred
        4. government debt represents a “lien” on the part of the productivity of all citizens
      5. this multiplication and stratification of paper wealth can be increased to many times the size of the real existing wealth
      6. paper wealth structure is all built on faith– issuance of new paper wealth does not result in an increase in real values by itself
    3. Government Debt
      1. issuance of government debt increases supply of paper wealth, meaning it is price deflationary
      2. when Fed wants to tighten money, sells govt debt into market, reducing prices
      3. large issues of government debt could not be marketed without a large increase in the supply of money because they’d drive interest rates upward– precisely what govts don’t want; therefore, they’re almost always accompanied by money printing
      4. government surplus is price inflationary; if it is used to pay down debt, it reduces the supply of outstanding values and raises prices
      5. when faith in government debt fails, price inflationary effects will be amplified
    4. Interest
      1. lenders accepted negative real rates only because they didn’t realize what they were doing
      2. “the announced intention of Keynesian economics was to effect [the holder of money’s] extinction”
      3. the rich tend to be net debtors in an inflation
      4. inflation is paid for by the lower classes and the creditors
      5. an attack on interest results in a flight from debt to equity, from money wealth to equity/real values
    5. The Economics of Disaster
      1. occurs when the holders of money wealth revolt
      2. duller the holders of money are, the longer price inflation can be kept at bay by govt, though the greater will be the eventual breaking of the price dam
      3. desertion of money resembles a panic, sudden and unexpected
      4. people’s ability to discern real and spurious values suddenly becomes acute
      5. people flee paper assets and goods and services for known value like food and land
      6. no government causes collapse, “when at least it sees the choice, it has no choice”
  4. THE LAST ACTS: The American Prognosis
    1. Act Two, Scene One: President Nixon Begins
  1. Treasury reduces expenditures and attempts to balance budget, July 1969- June 1970
  2. Fed drops inflation rate in May of 1969 from 8%, 1yr later approx 3.8%
  3. Stock market prices fall by 14% within two months of May 1969, another year later down 31 percent; interest rates rise into spring 1970 credit crunch
  4. Approaching two year mark to next election, government begins pumping money again
    1. August 1970, budget deficit plunges to new peacetime lows
    2. money inflation of 6.5%
    3. interest rates plunge, stock market soars
  • Act Two, Scene Two: Price Controls and Other Follies
    1. worst inflation since the end of WW2 and before 1967
    2. economic boom into Nixon’s re-election in 1972
    3. boom quickly wears off
      1. stock market falls
      2. interest rates rise to surpass peaks of 1970
      3. price inflation worse than ever, around 4%
      4. cheap dollar floods world markets
    4. Nixon announces Phase I of price controls, August 15, 1971
      1. detaches dollar from gold
      2. 10% import surcharge
      3. excise taxes on automobiles removed
      4. wage and price controls
  • Self-Defense
    1. No sure safety, safety will change fluidly through an inflation
    2. Best hope is to lose as little as possible
    3. fixed money wealth/debt is the absolute worst investment in an inflation
    4. foreign money can be safe refuge only if the foreign government inflates less wildly than the domestic government
    5. the author shits on gold, but with no reason other than an arbitrary one because he is a Keynesian– gold may be overvalued during and even before and inflation but so long as people continue to think it is money, it can hold some value
    6. real estate provides a shelter for REAL value (usability/livability/productivity of land) but could be harmed in terms of investment value in an inflation
      1. real estate held in high esteem by inflationary prosperity (luxury dwellings, overblown commercial developments) may lose more real value than other investments as they started out overpriced in the inflation
    7. farmland is a special category of real estate
      1. produces what people must have, inflation or no
      2. farmers thrive and farmland excels in dying throes of every inflation
      3. less prosperous in early stages of an inflation
    8. hoarding of useful goods is a possibility, but has large storage, distribution and opportunity costs prior to an inflation
  • Self-Defense Continued: The Stock Market
    1. stock shares are pieces of paper, but they are claims on real assets and real wealth
    2. stock market is incredibly liquid
    3. common stocks provide returns in first madness of an inflation, then fall into disrepute in middle stages of an inflation
    4. a booming stock market is not necessarily part of an economically healthy nation
      1. the opposite is truer: booming stock market is a signal of inflation
      2. falling stock market is a sign of returning to reality
    5. the stock market as a whole rises due to inflation and nothing more
    6. the stock market declines on a weakening of inflation
    7. general business conditions and price inflation operate on a lag; when money is first printed it has nowhere to “work” and goes into investment markets
      1. markets rise while business is still bad
      2. later, as money moves out of the market and into businesses, the market falls
      3. when business is worst, stock markets rise; when business is best, stock markets fall
      4. rising stock market signals nothing but fresh money inflation– it is the earliest and most sensitive signal
    8. stocks bought at any price above their real-value bottom are not a hedge against loss but a guaranteed loss
    9. conversely, stocks bought at real-value bottoms have a good chance of holding their values through an inflation
    10. American stock market’s deflated bottom in 1970 was 43% higher than deflated bottom in 1962, just as money supply in 1970 was about 43% higher than in 1962
    11. as other prices outpace stock market rises (or even stock market decreases), fear can take over that the businesses will not be worth anything; but faith will pay off with real value nearly the same at the end of an inflation
    12. stock markets can enjoy inflated gains if there are laws in place forbidding the inflationary money to bid up prices elsewhere or in foreign markets
    13. the stock market represents real value, but not every stock does
    14. inflationary times tend to reward the most valueless stocks; use a “post-inflationary eye” to have a look around at what might actually survive the inflation in terms of real value
    15. “Attempting to make profits from the stock market, or even to make sense of it, without completely understanding the universal determinant of inflation was like being at sea among uncharted rocks and shoals without so much as a tide table.”
  • A World of Nations
    1. Virtually all of the entire growth of Federal debt after 1967, $55B, was involuntarily financed and acquired by foreigners
    2. by 1973, foreigners’ holdings of liquid dollar debt had risen to $90B from $31B in 1966
    3. America exported inflation; other nations imported it– this is the balance of payments deficit
    4. natural consequence of an inflation, surplus money must flow outward looking for “cheap” items to buy abroad
    5. 100% beneficial to the deficit country
      1. import real value from abroad while exporting worthless paper
      2. price inflation domestically is partially contained
    6. central bankers began a game of printing up new local currency to exchange with the inflowing dollars, sending the dollars back to the US where they would be recycled and re-exported
    7. exchange rates operate on a time lag
      1. first, the internal price level is too low, so the new currency flows out to the rest of the world
      2. then, the internal price level rises, drawing in currency from the rest of the world
    8. the best defense against another country’s inflation, is inflation

Review – The Pixar Touch

The Pixar Touch

by David A. Price, published 2008

It starts with Disney

The story of Pixar is interesting because it starts and ends with Disney, but under very different circumstances in each case. The two primary characters in the company’s founding and subsequent rise to glory, Ed Catmull and John Lasseter, were both Disney aficionados and aspiring animators from the get-go. At the time each was coming of age and establishing their careers, Disney was not only the premiere animation studio to work for, it was essentially the ONLY major animation studio to work for. But Catmull almost missed playing a pivotal role in the development of computer-animation when he decided, in high school, that he was not artistically cut out to be an animator. Lasseter, by contrast, found his high school experience to be an affirming one and it was during this period of his life that he knew for sure that an animator was what he wanted to become.

The two luminaries: Ed Catmull and John Lasseter

Though they had similar aspirations (with Catmull’s muted initially), Catmull and Lasseter took quite different paths to their eventual rendezvous at LucasFilm where they would come to create a Pixar Animation-in-the-womb.

Catmull went from the computer science department at the University of Utah, which was not only the scene of huge amounts of R&D spending by the Department of Defense’s ARPA project, but was also the unwitting locus of a number of individuals who would come to be highly influential innovators in the space of computer graphic design. It was here at the university where Catmull had a second awakening and decided that while he may not have a future as a traditional animator, he might become one yet by pioneering animation in the computer-generated space.

He eventually was scooped up by an “eccentric millionaire”, Alexander Schure, who drafted Catmull as well as a number of his computer science comrades from the University of Utah computer science department to come to his mansion-turned-technical institute (the nascent New York Institute of Technology on Long Island) and essentially tinker away at computer graphic design on his dollar. Catmull and company obligingly did so until personal and family pressures drove him to seek other employment, eventually finding his way to George Lucas’s design outfit in northern California where he and a number of other defectors worked on various technology-related odd jobs for Lucas’s studio.

Meanwhile, John Lasseter graduated from high school and went into the animation program at CalArts, an art school that was partially meant to be a recruiting ground for future Disney animation talent. He was subsequently hired into Disney’s animation studios only to be later fired in a political scuffle. He, too, wound up at Lucasfilm, where he teamed up with Catmull and the other NYIT veterans to develop the proprietary Pixar Image Computer. On the side, the ambitious would-be animators continued teaching themselves the craft of computer-generated animation, a technology they were largely innovating into existence on their own. Each year they attended the SIGGRAPH convention and showed off their latest minutes-long computer-animated film clips to an awe-struck and excited audience.

Even early on, Lasseter was showing a knack for story-telling beyond his years and experience.

Exit Lucasfilm, enter Steve Jobs

Having tired of losing money on the Pixar Image Computer and the Pixar company itself for long enough, Lucas looked for a buyer at an asking price of $15M plus an additional $15M to capitalize the spun-off business. Initially, there were no takers. At one point, an executive at Disney considered purchasing the entire company at $15M to subsume it into Disney’s animation facilities, but a young Jeffrey Katzenberg felt pursuing it was a waste of time.

Another series of failed deals followed (including one in which GM almost acquired the company before board member Ross Perot shot the idea down) when Steve Jobs’s offer of $5M for the company was finally accepted.

For the next several years, Jobs stuck $5M at a time into Pixar to keep in afloat, but he, too, had trouble finding anything to do with it. Initially imagined as a hardware design company, everyone ended up being frustrated as Catmull, Lasseter and their team were truly animators at heart (and certainly not businessmen) and Jobs was impatient and still reeling from the ego-blow of being booted out of his own company at Apple. He was looking for vengeance.

Jobs almost abandoned Pixar but at the last minute he decided to hold on to the company, realizing what he controlled was an outstanding group of talented individuals, not a failing hardware business. Soon after, Pixar inked its first deal with Disney animation (under Katzenberg, who had come to see the error of his earlier ways) to create what would become the smash, breakout computer-animation genre hit, Toy Story.

Jobs, always the savvy financier just as much as he was an outstanding technologist and businessman, took the company public on November 29, 1995, one week after the premiere of Toy Story. Still hot off the success of the film, Jobs brilliantly managed to hype the IPO by placing it so close to the release of their first major film even though he was technically supposed to be observing an SEC-enforced quiet period leading up to the IPO event. Jobs 80% stake in the company was valued at around $1.1B.

The story ends with Disney

Just over a decade after going public, Disney, the long-time partner of Pixar (and the long-time dependent, as Pixar’s computer-animated films essentially had become Disney animation, not the mention a substantial part of Disney’s total film and company-wide earnings) announced its offer to acquire Pixar on January 24, 2006, for 287.5M shares of Disney valued at about $7.4B.

Pixar’s fortunes, and the fortunes of its two central figures, Catmull and Lasseter, had now come full circle. What started with inspiration, dreams and ambitions based on the world of Disney had ended as a massive payoff from that very same studio. And along the way, these gentlemen and their co-creators not only revolutionized the world of animation, they created and popularized a genre, all while maintaining a nearly uninterrupted stream of critically-acclaimed, highly profitable film franchise hits.

The moral of the story

The Pixar story carries with it many morals: Always have the courage to follow your dreams; Don’t let the absence of something stand as proof of its impossibility; A lot of life’s magic and human progress is due to lucky happenstance.

But the most enduring lesson of all from the Pixar story is most likely the fact that greatness is hard to forecast, and the future is always full of uncertainty. Before Pixar was sold to Disney for $7.4B in stock, it was first nearly kicked to the curb by Lucasfilm for a song ($5M on the original asking price of $15M) and thought to be hopeless. And this was the view of it from a highly successful film studio whose chief architect was a successful technological innovator himself! From there, the group went on to suck millions of dollars out of Steve Jobs nearly to the point of exasperation before it finally had its first major breakthrough. How many failed deals came and went before Pixar turned out to be a multi-billion dollar enterprise?

Would the Pixar we know today even have existed if no one had ever thought to drop the frustrating hardware side of the business and let these technological entrepreneurs follow their true passion in story-telling and computer-animation?

The world could always be a different place than it is. It’s easy to see how obvious everything looks when you’re at the end of the story and not the beginning.

What kind of value would you have put on Pixar in the early 1980s?

Review – The Innovator’s Dilemma

The Innovator’s Dilemma: The Revolutionary Book That Will Change the Way You Do Business

by Clayton M. Christensen, published 1997

Technological innovation always means change, but which kind?

In the world of business technology, innovation can be thought of as coming in two distinct flavors:

  • sustaining, which are new technologies that improve a product or service in a way that is valuable to existing customers or markets
  • disruptive, which are new technologies that are uncompetitive along traditional performance metrics, which are unusable or undesirable to existing customers or markets but which nonetheless can eventually come to replace the traditional market over time

Throughout history, it is the best-in-class businesses which have the most difficult time with disruptive technologies to the point that disruptive technologies are usually the death knell for the leading businesses at the time. But this raises a question: if they’re such good businesses and they’re so well-managed, how come they can’t manage their way around disruptive technology in their industry?

The answer lies at the heart of what the author refers to as the “innovator’s dilemma”:

the logical, competent decisions of management that are critical to the success of their companies are also the reasons why they lose their positions of leadership

Why do good management teams and competent decision-making processes miss disruptive technologies? Disruptive technologies:

  1. are normally simpler and cheaper, promising lower margins, not greater profits
  2. typically are first commercialized in emerging or insignificant markets
  3. are usually unwanted and unusable to leading firms’ most profitable customers

But good management teams with excellent decision-making processes are fine-tuned to search out:

  1. higher margin opportunities at best, and opportunities with minimum margin requirements based upon their existing cost structure
  2. opportunities that market research and querying of leading customers show there is a present demand for
  3. markets and growth opportunities which can have a significant impact on their business relative to their current scale

In short, every successful firm has a unique “value network” DNA that allows them to be especially dominant within a certain set of competitive circumstances.

the value network — the context within which a firm identifies and responds to customers’ needs, solves problems, procures inputs, reacts to competitors, and strives for profit

But disruptive technologies present a paradigm shift of a market into a completely different “value network” that the firm has not been evolved to survive in which results in, similar to biology, an extinction event for firms with the wrong type of value network DNA.

Crafting a response to disruptive technology

But the reality of disruptive technology is not entirely depressing for successful firms, and they can develop successful strategies for coping with disruptive technologies if they first make themselves aware of the five principles of disruptive innovation:

  1. Companies depend on customers and investors for resources
  2. Small markets don’t solve the growth needs of large companies
  3. Markets that don’t exist can’t be analyzed
  4. An organizations capabilities define its disabilities
  5. Technology supply may not equal market demand

Each of these principles holds within it a potential misstep for successful firms within their traditional value networks trying to respond to a disruptive technology. Because firms depend on their customers (primarily their leading, most profitable customers) and investors for their resources, they are often incentivized to ignore the low margin disruptive technology because their customers initially don’t want it. And because disruptive technologies start in emerging or insignificant markets, successful firms often ignore them in favor of better growth opportunities. Meanwhile, firms that DO try to take disruptive technologies seriously often commit themselves to particular investment and marketing patterns based off of market research for a market that is dynamic and prone to sudden and rapid change. At the same time, that which makes a company excellent at doing A simultaneously makes the company horrible at doing B (where B is the opposite of A), and often disruptive technologies require B responses when successful firms are honed to operate at A. The final frustration for these successful firms occurs when they attempt to enter a disruptive market with a solution that technologically exceeds the needs of its current users, causing them to withdraw in defeat only to watch the market then take off anyway!

An ironic twist

As hinted at above, it is ironic that the very strengths of leading firms in adapting their business to sustaining technologies (improvements in performance in relevant metrics that their best customers demand) are the exact things that cause them to fail to respond to disruptive technologies in a profitable, dominant way. And to make a bad story worse, it is these strengths-as-weaknesses that allow entrants in disruptive technological markets to capture important first-mover advantages for themselves, constructing barriers to entry which are later often insurmountable for established firms.

To a dominant firm, disruptive technology looks like low-margin, small market business that neither their customers nor anyone else seems to be interested in. But for entrants in the disruptive market, with radically different cost structures than dominant firms and with organizational sizes and resources better matched to the opportunities presented, disruptive markets are a wild playground full of unchallenged opportunity.

And while the dominant firms look down at lower-margin, smaller market business and shake their heads dismissively, entrant firms look up above at higher-margin, huge market opportunity and lick their chops. Every business ultimately looks upstream for higher-margin opportunities than the ones they have at present.

Is it any wonder why dominant firms are continually defeated by surprise attacks from below?

How dominant firms can successfully respond to disruptive technology

The position of the dominant firm in the face of disruptive emerging technology is not hopeless. For every yin, there is a yang. By inverting the five principles of disruptive innovation outlined earlier, dominant firms can find five guidelines for successfully responding to disruptive technology:

  1. Give responsibility for disruptive technologies to organizations whose customers need them
  2. Match the size of the organization to the size of the market
  3. Discover new and emerging markets through a flexible commitment to “plans for learning” rather than plans for implementation
  4. Create organizational capabilities and strengths which are complementary to the unique demands of the disruptive market place
  5. Resist the temptation to approach the disruptive technology with the goal of turning it into something existing customers can use, rather than serving the customers unique to the market and searching out new markets entirely

Conclusion

This book was published 15 years ago. The subtitle is, “The revolutionary book that will change the way you do business.” I don’t know if 15 years is long enough in the business world for the ideas of a book like this to be fully adapted into the mainstream but I would guess it is not. I am no business expert but this material was completely uncharted territory for me.

Frankly, I never thought I’d enjoy reading something written by a Harvard business school professor as much as I did with this book. Whereas case studies, quirky charts and statistical evidence usually bore me to the point that I often skip over them, this book was something of a page-turner for me and I found myself eager to find out “what happens next” in each subsequent chapter.

As faddish as it has become as of late to hype the increasingly rapid change of markets and business practices in general, the reality is that most markets don’t change that quickly and most business practices are timeless themselves. But for those unlucky enough to find themselves, suddenly or otherwise, in a market or business that is changing due to disruptive technology, this book could be a lifesaver at a minimum and a handbook for profiting immensely from that change at best.

You can get the essential points of the book entirely from reading my review, or skim-reading the introduction and final chapters of the book (which present a comprehensive summary of the ideas outlined above). But the case studies are invaluable in driving the point home and there are numerous nuances to Christensen’s argument that are worth savoring and considering on their own. Because of this, I unequivocally recommend that every interested reader purchase their own copy and read it in full, and thereby grant themselves an invaluable competitive advantage in the market place, whichever value network they might happen to be competing within.

Review – The 22 Immutable Laws Of Marketing

The 22 Immutable Laws Of Marketing: Violate Them At Your Own Risk

by Al Ries & Jack Trout, published 1993

The redundant and contradictory laws of marketing

The 22 Laws is a helpful quick-read book for those looking to dip their toe into the waters of marketing. It takes a high level approach to the strategy of marketing and is definitely a “how-to-do” not “what-to-do” title. As such, my goal in this write-up is to focus on the laws I found to be most reasonable and deserving of consideration, the combine several laws that seemed to be versions of one another or the same concept examined from different angles, and dropped a number of laws I thought were too crude to be of any use.

An abridged journal of immutable marketing laws

My abridged version of The 22 Laws is as follows:

  1. It’s better to be first than it is to be better
  2. If you can’t be first in an existing category, introduce a new one in which you can be first
  3. Target mindshare, not marketshare
  4. Perception is reality; focus on perception, not products
  5. Own an exclusive word or attribute; your product and a category keyword or attribute should be inseparable in people’s minds
  6. The only positions that count in the market are first and second, and second’s marketing strategy is dictated by first’s
  7. Marketing categories will continually bifurcate over time
  8. There is a temptation to extend brand equity to new product lines, which simply dilutes the brand and invites additional competition
  9. You must be willing to give up product line, target market or constant change in order to dominate a market
  10. Failure is to be expected and accepted
  11. Trends, not fads, are the key to long-term marketing success

Putting the 11 laws into practice

Hopefully each of the 11 abridged marketing laws above are self-explanatory. But even as simple as they are, each holds a wealth of additional implications.

Law 1 is related to the concept of competition and is tied to laws 3 and 4. If you are the first product into a market you will not only likely benefit from a first-mover advantage but, if done correctly, you will have positioned yourself to define the market. People form habits and tend to make up their mind once and then not change it. When you’re first into the market you have a fortress position within people’s minds that entrant firms must assault if they hope to dislodge you. People tend to remember those who did things first, not best. It is easier to entrench than dislodge.

This is why law 2 is important– you want to avoid being an entrant in the competitive landscape as much as you can. Much better to create a category where you are the only supplier at best, or force your competitors to be No. 2, 3, 4, etc. at worst. Once you’ve created a category you are first in, promote the category, not your brand.

Marketing is a deeply psychological enterprise, which is why laws 3-5 focus on the role perception and mental imagery play in good marketing practice. But the specific application of these psychological rules is once again strategic in nature– they are each about how you compete and limiting your competition. By owning a word or attribute, as law 5 suggests, you deny your competition the benefit of identifying their product with that word and you often get a halo effect as related words and benefits get associated with your product in the consumer’s mind as well. The most effective words are simple and benefit oriented.

Furthermore, your word should be exclusive and precise, and you should only have one. If you pick something like “quality” you haven’t said anything about your product, because everyone intends to create a product with quality. You haven’t differentiated. And if you try to pick “value and safety”, you’ll lose because you’re now competing with two opponents– the one which prides itself on value and the one which prides itself on safety. It’s harder to fight two people than one. And it should go without saying that, if available, you should always choose the most important word or attribute to focus on.

Law 6 is important to understanding the concept of relativity in marketing. Your marketing strategy should always take account of “which rung of the ladder” you’re on as certain claims and strategies won’t make sense or will sound inauthentic if given from the wrong place on the market share ladder. Further, it will never be appropriate to market as if you’re No. 1, when you’re No. 2. The advantage of No. 1 is telling everyone you’re the best. The advantage to No. 2 is telling people they have an alternative to No. 1.

Laws 7-9 deal with the concept of marketing focus, or concentrating your marketing strategy to a narrow band where you can actually be competitive. Category bifurcation is a natural process (eg., computers –> laptops vs. desktops; automobiles –> family sedans vs. economy compacts, etc.) in market evolution. Many firms make the mistake of trying to maintain leadership in all resulting markets as initial markets bifurcate, instead of sticking to the market they have an advantage in where their brand is trusted most.

Worse, they dilute their own brand by bifurcating their market themselves (eg., 7UP –> cherry 7UP vs. original 7UP). The market that 7UP made for itself as an “uncola” and the marketing strategy it followed to enable that success does not carry over to derivative products and it ends up just competing against itself. Sometimes, you simply expose yourself to more competition in the process as competitors mimic you and you further slice up a slice of the market.

This is why a successful marketing strategy entails “sacrifice”, either of product line, target market or the impetus to constantly change. Expanding product lines mean expanding competition. According to earlier marketing laws, a brand can’t mean everything or it means nothing. Expanding product lines under a brand means movement toward “meaning everything/nothing”.

Similarly, few products will appeal to everyone. Attempts to appeal to everyone usually result in appealing to no one. Focus on the target markets where your product has the strongest appeal and then dominate those markets. And when you have a marketing strategy that works and results in market dominance, leave it alone, don’t go out in search of a new market you might not dominate (while giving up your dominant position in the process!)

The eleventh law highlights the long-term nature of successful marketing strategies. Good marketing is about coming up with an angle or word that differentiates your product and then establishing a long-term marketing direction to maximize the idea or angle over time. This implies avoiding hype and the temptation to market your product as a fad and instead seek to create a trend, which is more enduring and has more competitive inertia making it harder for your opponents to fight.

The law of failure (10) is the one likely most forgotten and least appreciated. Failure will happen. Not every strategy will work out. In the event of a failure, it’s best to cut your losses early and change directions. At the same time, it’s critical to understand that the first several laws of marketing entail risk-taking (for example, being first at anything involves sticking your neck out) so occasional failure is part of the territory.

Notes – Distilled BuffettFAQ.com Investment Wisdom Of Warren Buffett

All quotes were originally collected and compiled at the outstanding BuffettFAQ.com

On Learning Businesses

Now I did a lot of work in the earlier years just getting familiar with businesses and the way I would do that is use what Phil Fisher would call, the “Scuttlebutt Approach.” I would go out and talk to customers, suppliers, and maybe ex-employees in some cases. Everybody. Everytime I was interested in an industry, say it was coal, I would go around and see every coal company. I would ask every CEO, “If you could only buy stock in one coal company that was not your own, which one would it be and why? You piece those things together, you learn about the business after awhile.

Funny, you get very similar answers as long as you ask about competitors. If you had a silver bullet and you could put it through the head of one competitor, which competitor and why? You will find who the best guy is in the industry.

On The Research Process

It’s important to read a lot, learn about the industries, get background information, etc. on the companies in those piles. Read a lot of 10Ks and Qs, etc. Read about the competitors. I don’t want to know the price of the stock prior to my analysis. I want to do the work and estimate a value for the stock and then compare that to the current offering price. If I know the price in advance it may influence my analysis.

Pick out five to ten companies in which you understand their products, get annual reports, get every news piece on it. Ask what do I not know that I need to know. Talk to competitors and employees. Essentially be a reporter, ask questions like: If you had a silver bullet and could put it into a competitor who would it be and why. In the end you want to write the story, XYZ is worth this much because…

Narrowing the Investment Universe

They ought to think about what he or she understands. Let’s just say they were going to put their whole family’s net worth in a single business. Would that be a business they would consider? Or would they say, “Gee, I don’t know enough about that business to go into it?” If so, they should go on to something else. It’s buying a piece of a business. If they were going to buy into a local service station or convenience store, what would they think about? They would think about the competition, the competitive position both of the industry and the specific location, the person they have running it and all that. There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do.

Q: So if they’re walking through the mall and they see a store they like, or if they happen to like Nike shoes for example, these would be great places to start? Instead of doing a computer screen and narrowing it down?

A computer screen doesn’t tell you anything. It might tell you about P/Es or something like that, but in the end you have to understand the business. If there are certain businesses in that mall they think they understand and they’re public companies, and they can learn more and more about them…. We used to talk to competitors. To understand Coca-Cola, I have to understand Pepsi, RC, Dr. Pepper.

The place to look when you’re young is the inefficient markets.

Investment Process

  • Read lots of K’s and Q’s – there are no good substitutes for these – Read every page
  • Ask business managers the following question: “If you could buy the stock of one of your competitors, which one would you buy? If you could short, which one would you short?”
  • Always read source (primary) data rather than secondary data
  • If you are interested in one company, get reports for competitors. “You must act like you are actually going into that business, and if you were, you’d want to know what your competitors were doing.”

Four Investment Filters

Filter #1 – Can we understand the business? What will it look like in 10-20 years? Take Intel vs. chewing gum or toilet paper. We invest within our circle of competence. Jacob’s Pharmacy created Coke in 1886. Coke has increased per capita consumption every year it has been in existence. It’s because there is no taste memory with soda. You don’t get sick of it. It’s just as good the 5th time of the day as it was the 1st time of the day.

Filter #2 – Does the business have a durable competitive advantage? This is why I won’t buy into a hula-hoop, pet rock, or a Rubik’s cube company. I will buy soft drinks and chewing gum. This is why I bought Gillette and Coke.

Filter #3 – Does it have management I can trust?

Filter #4 – Does the price make sense?

Finding Bargains

The world isn’t going to tell you about great deals. You have to find them yourself. And that takes a fair amount of time. So if you are not going to do that, if you are just going to be a passive investor, then I just advise an index fund more consistently over a long period of time. The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Most of you don’t look like you are overburdened with cash anyway. Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it.

Don’t pass up something that’s attractive today because you think you will find something way more attractive tomorrow.

Defining Risk

We think first in terms of business risk. The key to Graham’s approach to investing is not thinking of stocks as stocks or part of the stock market. Stocks are part of a business. People in this room own a piece of a business. If the business does well, they’re going to do all right as long as long as they don’t pay way too much to join in to that business. So we’re thinking about business risk. Business risk can arise in various ways. It can arise from the capital structure. When somebody sticks a ton of debt into a business, if there’s a hiccup in the business, then the lenders foreclose. It can come about by their nature–there are just certain businesses that are very risky. Back when there were more commercial aircraft manufacturers, Charlie and I would think of making a commercial  airplane as a sort of bet-your-company risk because you would shell out hundreds and hundreds of millions of dollars before you really had customers, and then if you had a problem with the plane, the company could go. There are certain businesses that inherently, because of long lead time, because of heavy capital investment, basically have a lot of risk. Commodity businesses have a lot of risk unless you’re a low-cost producer, because the low-cost producer can put you out of business. Our textile business was not the low-cost producer. We had fine management, everybody worked hard, we had cooperative unions, all kinds of things. But we weren’t the low-cost producers so it was a risky business. The guy who could sell it cheaper than we could made it risky for us. We tend to go into businesses that are inherently low risk and are capitalized in a way that that low risk of the business is transformed into a low risk for the enterprise. The risk beyond that is that even though you identify such businesses, you pay too much for them. That risk is usually a risk of time rather than principal, unless you get into a really extravagant situation. Then the risk becomes the risk of you yourself–whether you can retain your belief in the real fundamentals of the business and not get too concerned about the stock market. The stock market is there to serve you and not to instruct you. That’s a key to owning a good business and getting rid of the risk that would otherwise exist in the market.

Valuation Metrics

The appropriate multiple for a business compared to the S&P 500 depends on its return on equity and return on incremental invested capital. I wouldn’t look at a single valuation metric like relative P/E ratio. I don’t think price-to-earnings, price-to-book or price-to-sales ratios tell you very much. People want a formula, but it’s not that easy. To value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate. All cash is equal. You just need to evaluate a business’s economic characteristics.

[Highly qualitative, descriptive and verbal, has little to do with the numbers in justifying an investment]

The Ideal Business

WB: The ideal business is one that generates very high returns on capital and can invest that capital back into the business at equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the next year earns 20% of $120 million and so forth. But there are very very few businesses like this. Coke has high returns on capital, but incremental capital doesn’t earn anything like its current returns. We love businesses that can earn high rates on even more capital than it earns. Most of our businesses generate lots of money, but can’t generate high returns on incremental capital — for example, See’s and Buffalo News. We look for them [areas to wisely reinvest capital], but they don’t exist.

So, what we do is take money and move it around into other businesses. The newspaper business earned great returns but not on incremental capital. But the people in the industry only knew how to reinvest it [so they squandered a lot of capital]. But our structure allows us to take excess capital and invest it elsewhere, wherever it makes the most sense. It’s an enormous advantage.

See’s has produced $1 billion pre-tax for us over time. If we’d deployed that in the candy business, the returns would have been terrible, but instead we took the money out of the business and redeployed it elsewhere. Look at the results!

CM: There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested — there’s never any cash. It reminds me of the guy who looks at all of his equipment and says, “There’s all of my profit.” We hate that kind of business.

Making Mistakes In Investments

We bought it because it was an attractive security. But it was not in an attractive industry. I did the same thing in Salomon. I bought an attractive security in a business I wouldn’t have bought the equity in. So you could say that is one form of mistake. Buying something because you like the terms, but you don’t like the business that well.

The Market and Its Price

The NYSE is one big supermarket of companies. And you are going to be buying stocks, what you want to have happen? You want to have those stocks go down, way down; you will make better buys then. Later on twenty or thirty years from now when you are in a period when you are dis-saving, or when your heirs dis-save for you, then you may care about higher prices. There is Chapter 8 in Graham’s Intelligent Investor about the attitude toward stock market fluctuations, that and Chapter 20 on the Margin of Safety are the two most important essays ever written on investing as far as I am concerned. Because when I read Chapter 8 when I was 19, I figured out what I just said but it is obvious, but I didn’t figure it out myself. It was explained to me. I probably would have gone another 100 years and still thought it was good when my stocks were going up. We want things to go down, but I have no idea what the stock market is going to do. I never do and I never will. It is not something I think about at all.

Forecasting

People have always had this craving to have someone tell them the future. Long ago, kings would hire people to read sheep guts. There’s always been a market for people who pretend to know the future. Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts. It happens over and over and over.

What’s going to happen tomorrow, huh? Let me give you an illustration. I bought my first stock in 1942. I was 11. I had been dillydallying up until then. I got serious. What do you think the best year for the market has been since 1942? Best calendar year from 1942 to the present time. Well, there’s no reason for you to know the answer. The answer is 1954. In 1954, the Dow … dividends was up 50%. Now if you look at 1954, we were in a recession a good bit of that time. The recession started in July of ’53. Unemployment peaked in September of ’54. So until November of ’54 you hadn’t seen an uptick in the employment figure. And the unemployment figure more than doubled during that period. It was the best year there was for the market. So it’s a terrible mistake to look at what’s going on in the economy today and then decide whether to buy or sell stocks based on it. You should decide whether to buy or sell stocks based on how much you’re getting for your money, long-term value you’re getting for your money at any given time. And next week doesn’t make any difference because next week, next week is going to be a week further away. And the important thing is to have the right long-term outlook, evaluate the businesses you are buying. And then a terrible market or a terrible economy is your friend. I don’t care, in making a purchase of the Burlington Northern, I don’t care whether next week, or next month or even next year there is a big revival in car loadings or any of that sort of thing. A period like this gives me a chance to do things. It’s silly to wait. I wrote an article. If you wait until you see the robin, spring will be over.

Managers Should Be Investors

Charlie makes a good point. Managers should learn about investing. I have friends who are CEOs and they outsource their investing to a financial advisor because they don’t feel comfortable analyzing Coke and Gillette and picking one stock vs. the other. Yet when an investment banker shows up with fancy slides and a slick presentation, an hour later the CEO is willing to do a $3 billion acquisition. It’s extraordinary the willingness of corporate CEOs to make decisions about buying companies for billions of dollars when they aren’t willing to make an investment for $10,000 in their personal account. It’s basically the same thing.

The Value of Accounting

I had a great experience at Nebraska. Probably the best teacher I had was Ray Dein in accounting. I think everybody in business school should really know accounting; it is the language of business. If you are not comfortable with the lan- guage, you can’ t be comfortable in the country. You just have to get it into your spinal cord. It is so valuable in business.

Staying Rational

One thing that could help would be to write down the reason you are buying a stock before your purchase. Write down “I am buying Microsoft @ $300B because…” Force yourself to write this down. It clarifies your mind and discipline. This exercise makes you more rational.

Do You Know What The NSA’s True Purpose Is?

A friend sent me a chilling article from Wired magazine about a new, gargantuan spy center being built by the NSA in Utah. The article started with this short background on the genesis, and current evolution, of the NSA:

For the NSA, overflowing with tens of billions of dollars in post-9/11 budget awards, the cryptanalysis breakthrough came at a time of explosive growth, in size as well as in power. Established as an arm of the Department of Defense following Pearl Harbor, with the primary purpose of preventing another surprise assault, the NSA suffered a series of humiliations in the post-Cold War years. Caught off guard by an escalating series of terrorist attacks—the first World Trade Center bombing, the blowing up of US embassies in East Africa, the attack on the USS Cole in Yemen, and finally the devastation of 9/11—some began questioning the agency’s very reason for being. In response, the NSA has quietly been reborn. And while there is little indication that its actual effectiveness has improved—after all, despite numerous pieces of evidence and intelligence-gathering opportunities, it missed the near-disastrous attempted attacks by the underwear bomber on a flight to Detroit in 2009 and by the car bomber in Times Square in 2010—there is no doubt that it has transformed itself into the largest, most covert, and potentially most intrusive intelligence agency ever created.

I want to channel G Edward Griffin a little bit here. Griffin is the author of The Creature From Jekyll Island, and in this book he put forth the notion that if the results of a policy consistently and widely diverge over time from the stated intentions, one has a sound basis upon which to question the stated intentions of the policy being observed.

In “Creature”, Griffin was discussing the Federal Reserve System and its “dual mandate”– to maintain stable prices and low unemployment. Of course, the Fed has never managed to achieve either one of its objectives since it was founded, leading a skeptical observer to wonder if the Fed was perpetually failing at its stated objective, or consistently succeeding on an unstated one.

Proponents of the NSA will argue that there are many successes we might never know about due to matters of secrecy. We can’t critically examine the veracity of these arguments because we’re not deemed worthy of the trust necessary to obtain the information required to evaluate these claims, so they must be ignored.

What we are sure of, as the paragraph above points out, is that there have been numerous “surprise assaults” that the NSA has done nothing to stop.

And yet, it only grows larger.

Maybe the NSA is succeeding wildly at its true purpose despite appearing to fail at its stated purpose. The construction of this massive, $2 billion facility in Utah is alarming.

But we should be even more alarmed that we do not know what is the true purpose of this multi-billion dollar agency.