Shifting Paradigms

Paradigms are a set of assumptions, concepts, values, and practices that constitutes a way of viewing reality for the community that shares them. (From a definition found at www.thefreedictionary.com/paradigm.)

When a paradigm in an industry changes, the business “winners” after the change most often are not the old-line companies who were the winners before the change. They are fresh new entities with new ideas for satisfying the market. The winners have no entrenched personal empires, no buildings and factories to amortize, no rigid ways of doing business – all of which prevent the old companies from changing.

What the new companies do have is a large dose of outside-the-box thinking, a willingness to take risks, the energy to get things done quickly, few layers of management….

Old, classic examples of paradigm changes include the railroaders who hauled passengers but thought of themselves as railroaders, and who were overwhelmed by the airlines who entered the business of hauling passengers in airplanes instead of trains. How would our landscape look now if the railroads, instead of scoffing at the airlines, had become the movers of passengers by airplane as well as trains?

Consider the Swiss, whose paradigm of a watch included a spring, escapement, gears, hands and a dial face. Enter the Japanese, whose paradigm for a watch includes a battery, a chip and a digital readout. The watch making business all but disappeared from Switzerland in its rush to Japan. The Swiss, who were offered the digital watch designs but passed on them, had a capital and emotional attachment to the old paradigm. Later, of course, the Swiss adopted many of the features of electronic timekeeping and do continue to make many fine watches. The volume market, though, theirs for many years, is now owned by companies in the Far East.

Almost every day paradigm shifts are taking place.

Consider the impact of NetFlix, with a new paradigm for distributing movies for the home market, had on the video store of the old paradigm. How many video stores remain, and how big a share does NetFlix have of the market? In watching the postal worker put mail in the boxes near my home, and seeing NetFlix envelopes in almost half the boxes, the question is answered.

Another recent shift is the advent of Craig’s List, the Internet classified advertising giant. From a small beginning in San Francisco, Craig’s List now has free nationwide classified advertising. It is very effective. Newspaper owners are crying about the demise of their classified advertising revenue, lost to Craig’s free list. Why did the newspapers not start the free lists? Did their thinking not go out of the box? What would be the situation if they had been the ones to start the free list, and receive advertising revenue for display ads on their pages? Would they be in such dire straights as they are now?

Now we see several paradigm shifts in the auto industry. Fuel prices will soon rise again, creating greater and greater demand for fuel efficient vehicles. Electric cars, and hybrid-electric cars will eventually dominate. Lithium ion batteries will replace older technology. Are the old-line battery companies leading the charge to lithium ion? It does not seem so – the bulk of the companies manufacturing them are in the Far East.

There will be many paradigm shifts resulting from the deep economic recession. The next posts to this blog will explore ideas about them.

Sign of the Times

As sometimes I do, today I looked in the Daily Camera, the Boulder (Colorado) daily newspaper, at the “Hot Jobs” listings. It was startling. As little as two months ago the number of jobs listed for Boulder and surrounding towns was over 500. Today it was just slightly over 300.

That is a 40% reduction of job availability in slightly over two months. Probably the end of season has some effect on the numbers, but not 40%.

The shortage of jobs is a grim reminder of the depth of the recession. It portends a long and slow recovery of consumer spending, the primary driver of our economy, and thus a long and slow recovery in the economy.

Bailout or Failure?

It is Wednesday evening and so far, there is no bailout program for the auto industry. Although a bailout is not the greatest idea, compared to certain other options, it is by far the lesser of two evils when considering the consequences of the failure of at least two of the three American auto makers.

Without an immediate bailout, GM and Chrysler will no doubt file for bankruptcy in the next sixty days. Executives of the companies have said bankruptcy would be q disaster because customers would not buy their cars. That does not make complete sense, though. If the manufacturers maintained their warranty programs throughout bankruptcy, and dealer service departments continued to operate, it seems people would buy the vehicles. The bigger problem of revenue generation is the lack of the right vehicles for the market, not a bankruptcy.

As earlier written on this blog, it still seems that bankruptcy of GM, with post petition financing guaranteed by the government; a line of credit for Ford guaranteed by the government; and the breakup of Chrysler makes the most sense.

If in bankruptcy, GM can quickly deal with the problems of high labor costs, high legacy costs, too many dealers and debt overload. They can shed models and factories and dealers, and renegotiate their debt, and in two years exit bankruptcy as a smoothly operating company with the beginning of a competitive model lineup. Many thousand dealers will be out of business, with great dislocation to customers and employees – unfortunately that is the consequence of the Big 3’s poor management through the years.

Although Ford is stronger than GM, they also may need to go through a Chapter 11 proceeding in order to achieve all their goals in the time available. Union reaction will have great importance in determining the issue.

The next few days will decide the fate of the companies, their employees, their customers and the many other stakeholders. Too bad I will not be the “Car Czar.”

GM and Bankruptcy

Executives of General Motors Corporation are saying GM cannot survive a bankruptcy, and needs government money to continue operation.

The second part of their statement is certainly true. In the latest report, GM is asking for $4 billion to keep operating through December and another $4 billion for January. With more to come.

The first part of the statement, about not surviving a bankruptcy, seems wrong. There are many, many cases of companies going into bankruptcy, emerging and regaining successful operations. Two come to mind – the Dana Corporation, and automotive and truck parts and accessories manufacturer; and Harnischfeger Corporation, a mining and heavy equipment manufacturer. Both now are successful, generally thriving companies.

Think about the airlines – most have been, are in, or are going into bankruptcy. People still fly on them. Usually there is an interruption for a few days, and then service is as normal as airline service is.

Then there are the the retailers. Kmart and Winn Dixie stores have been through bankruptcy, along with many others. Each is better off after the event than before. Customers continue to do business with them.

GM executives say people will not buy GM vehicles if the company is in bankruptcy. What is new about people not buying GM cars? People are not buying GM cars now because they are the wrong ones, and of lower than desirable quality.

Bankruptcy will give GM the tools to deal with the killer problems they face as they go forward. It will allow reworking legacy costs, labor costs and an unwieldy dealer organization. Yes, enormous problems are involved in restructuring those items. They can be overcome.

Car buyers would no doubt rather buy cars from a revitalized, restructured GM that from the one that exists now, propped up by massive infusions of our (taxpayers’) money.

Let the government infuse the money into GM after bankruptcy. Everyone except some GM executives will get more bang for the buck.

Bailout Anyone? Get in Line

Whoee!

The homebuilders want a bailout, with the government offering to guarantee low interest mortgages and a $22,000 tax reduction incentive for homebuyers. Outrageous.

Next ought to be a bailout for underemployed management consultants.

It makes just as much sense.

Who is on your "top ten" list of bailout targets.

Practical Suggestions for the Auto Industry

A monolith is a geological feature, such as a mountain, consisting of a single massive stone or rock

In some respects, the US auto industry is monolithic. The three major US vehicle manufactures, GM, Ford and Chrysler all face: a difficult credit crunch – both from the lack of credit available to its customers and to the companies; high fuel costs that have almost destroyed the market for expensive, profitable large vehicles; and the impact of the economic recession, low consumer confidence, and low consumer spending. Additionally, the companies have very similar business models.

However, that is where the monolith ends. When considering rescue (or bailout) of the industry –each company’s situation is quite different.

GM, for example, has an approximately 22% share of the US market, is using cash at a very rapid rate; is almost bankrupt; has an impossibly limited lineup of vehicles consumers want; has high labor costs and high legacy costs. Already obtained autoworkers union concessions will allow savings in long term, but the kproblem is not long term, it is now. GM quality is low compared to most imported vehicles and to Ford. From an outside perspective, Rick Wagoner, its CEO, seems almost detached from the reality of current conditions.

Ford, on the other hand, with market share of approximately 16%, has reported cash reserves to last it for six months to a year. although Ford may face bankruptcy, its situation is not as dire as that of GM. Ford has introduced small, fuel efficient, cars (Focus and Fiesta) that consumers seem to like. Ford quality is almost to the level of imports. Ford CEO Alan Mulally joined the company from a career outside the automotive industry, and appears willing to, and is changing, the business model. Were it not for the credit crunch and the recession, Ford could have reached profitability in the near future.

Chrysler (10% to 11% market share) is the anomaly in the industry. Ownership of the corporation is private, unlike public companies Ford and GM. Available analyses indicate Chrysler has no cutting-edge designs or potential big sellers in its Chrysler, Dodge or Jeep brands. There will be no company rescue from vehicle sales – what models they will sell in the future remains a mystery. Chrysler quality is low. The situation at Chrysler is grim.

So, what are the solutions?

Bankruptcy with management change seems the only reasonable solution for GM. Bankruptcy will allow relief from high labor cost, legacy costs and other contractual situations (dealerships.) The government can provide post-petition financing, allowing time for the reorganization. The cost to the government will be far lower than if it provided funds to rescue GM with its present management and business model. As to the problem of the lack of small, fuel-efficient cars, perhaps GM can buy basic models from other manufactures, create its own trim packages, and have something to sell during the time it will take to bring GM small cars onto the market. Some ideas from the two previous postings on this blog could help too.

For Ford, the government’s rescue makes sense. The company is poised for profitability. If credit becomes more available, Ford will sell vehicles. They will continue to revise their business model for greater profitability. All the government will need to do is keep Ford supported for the interim. Loans or loan guarantees seem best.

Chrysler is a lost cause. Reducing the size of the company to a much smaller one, with limited vehicle models and market share, could work. Breaking up the company by selling brands and the factories to build them is another thought. The private owners of Chrysler took an enormous risk when the bought the company. Had the economy not sagged (collapsed) they might have won the bet. Now it looks like they lost. Government intervention with Chrysler makes no sense.

Let me know what you think by sending your comments.

Note: The last two articles meant to elicit comments from readers, and succeeded in doing so. Some comments were serious, some in jest. For example, one email asked, “Do you really want your auto industry run by the same people who run Medicare and the Post Office?” Another said, “First priority will be to entice Steve Jobs to take on GM. Would you please ask him to reserve one of the first iCars for me?”

What do you think?

HAVE A GREAT THANKSGIVING!

More on A Different Thought about the Auto Industry Bailout

Response to yesterday’s post was quick, and plenty. Most comments came to my email address, but one was posted to the blog.

This follow-up article is a reply to the question asked, “How can we do it?”

As to the other part of the comment about political courage; among current leaders there is not enough to take action such as suggested here. Perhaps Barack Obama will have it….

Your comments are encouraged and all are welcome – pro and con.

To bailout, or not bailout, that is the question.

On the one hand, some say the loss of jobs in the industry and related fields would cripple an already weakened economy. The ripple effect would be enormous: auto parts makers and auto dealers are the obvious; the trickle down effect is not so obvious, but towns, families, retailers, etc. would suffer.

On the other hand, some say the foreign auto producers will step into the gap left by the demise of the American auto companies, and the effect of the demise will not be such a disaster. In addition, with millions of US cars on the market, parts and service requirements will continue for many years. All we would really lose, in the long term, are the profits that the car companies might generate and keep in this country. That may all be true, but no one mentions the timing. It will take years for auto production in this country to rebound, regardless of who is making the cars.

Lastly, is $25 billion dollars enough or will the car people come back for more? At the rate they are burning cash, probably the latter.

Therefore, here is a more complete new thought.

Rather than loan or invest billions in Ford, GM and Chrysler, why not quickly nationalize them, removing management, installing new people, new energy, new thinking, a new model for doing business, and possibly even new pay rates and health insurance and retirement plans, and get on with the job. Bring in a Bill Gates or Steve Jobs, or one of hundreds more innovative thinkers to lead the charge. Use the $25 billion to create new, trim, companies rather than propping up old stale ones. Along that line, fire the entire core of lobbyist, especially those who fight against higher fuel efficiency standards.

That sounds very easy. Obviously, it is not. Here is a blueprint that might work if given a chance.

Consider the GM situation. GM stock is hovering slightly above $3.00 a share, and the capitalization of GM is somewhere near $3 billion. For the plan, have the company create a new class of voting stock and let the government buy $5 billion to $10 billion worth. The funds go to GM for immediate use. At the same time, voting the new shares, completely replace the GM Board of Directors. Get new people; with no auto industry experience; with creative minds; not willing to work the old, failed model; and let them go to work. Replace the current executive staff without bonuses. Let the lawyers begin!

Bring the best and the brightest to the Board and the executive ranks to lead the company. Develop a new model for doing business. Perhaps the DELL model of building to order, having dealers only to provide a few demo cars, take orders, and supply parts and service. Without saying, “It won’t work,” say, “It is a good idea, let’s make it work.” If not that though, what others ideas are there? Remember, the old model failed.

Here is another thought: Rather than manufacturing so much of the vehicle let others do so. Become a design and marketing organization. Buy engines from someone else – Honda, for example. Transmissions from another source. Fit the cars together in less than a year rather than taking two or three years to bring a new model to market. Alternatively, buy immediately salable cars from other manufacturers, customized to be the GM model. That is certainly not a new idea. Think about the Isuzu Rodeo and the Honda Passport of a few years ago. Honda sold Passports by the thousands. It was not a Honda vehicle though; Isuzu built a Rodeo, changed the trim and interior, sold it to Honda and then Honda sold it as a Passport. There are other examples.

Get vehicles with fuel-efficient engines on the market in a hurry. Give GM and/or its dealers something to sell.

Fuel-efficient small cars, and hybrids, have proven themselves as sellers in the market. There are more than a million of Toyota’s Prius on our roads. Rather than taking two or more years to do the research, design and testing, buy the technology. Now is the time for action – not development and design.

Get vehicles selling and cash flowing. Then, when operations are stable, start investing in research, development and design. At this moment, what difference does it make who manufactures the major assemblies? Later build a goliath of an industry and be a technological leader. There is no time now.

With no lobbyist fighting to keep fuel efficiency requirements low, the government can move forward with stringent regulation to reduce carbon emissions. In spite of what the auto companies and the oil companies have said, global warming is real. Let the bailed out auto industry be the leader in reducing carbon emissions, not the fighter against reduction.

There are many creative geniuses in our country. Let them “have at” the auto industry. Forget the words, “We have never done it that way,” or “We tried it once and it did not work,” or, even worse, “It can’t be done.” A long time ago, people said that about landing on the moon.

Adopt the cry, “We know it will work and we can do it.”

How many years will it take to move the inertia of the auto industry to make it into something new, different, and PROFITABLE and FLOWING CASH?

Probably close to three years. On the other, without the bailout suggested here, the existing companies, working the old auto industry model, will take at least five years IF they can do it at all.

It is exciting to think about. It would be exciting to participate.

Your comments are invited.

A Different Thought about the Auto Industry Bailout

Shakespeare might have said, "To bailout, or not to bailout, that is the question."

On the one hand, many say the loss of jobs would cripple an already weakened economy. The ripple effect would be enormous: auto parts makers and auto dealers are the obvious; the trickle down effect is not so obvious, but towns, families, retailers, etc. would suffer.

On the other hand, many say the foreign auto producers will step into the gap left by the demise of the American auto companies, and the effect will not be such a disaster. In addition, with millions of US cars on the market, parts and service requirements will continue for many years. All we would really lose, in the long term, are the profits that the car companies might generate and keep in this country. Of course, the dislocation and relocation of factories and thousands of people would be harsh.

Lastly, is $25 billion dollars enough or will the car people be back for more? At the rate they are burning cash, probably the latter.

So here is a new thought.

Rather than loan or invest these billions in Ford, GM and Chrysler, why not quickly nationalize them, removing management, installing new people, new energy, new thinking, a new model for doing business, and possibly even new pay rates and insurance and retirement plans, and get on with the job. Bring in a Bill Gates or Steve Jobs, or one of hundreds more innovative thinkers to lead the charge. Use the $25 billion to create new, trim, companies rather than propping up old stale ones. Along that line, fire the entire core of lobbyist, especially those who fight against higher fuel efficiency standards.

On that last line of thinking, could the car company disaster be similar to the financial disaster have been caused by deregulation (i.e. low fuel efficiency standards?)

Your comments are invited.

Investing or Gambling?

Years ago, when buying stocks, the pattern of many people was to carefully pick a target industry in which to invest, and then equally carefully pick companies within that industry that were growing or seemed poised to grow at rates faster than the general market. With this system, through the years, people made a few killings, and had a few losses, but overall created a steady and good return on their investments. Later, in managing a small 401k investment sthe process was the same, this time picking funds that were in target industries and that performed better than other funds in those industries. SGenerally the returns were better than double stock market indices growth rates. Buying in, and selling out of stocks, or more succinctly, TIMING was the key.

Some people pto them that this was not investing, it was gambling. Short selling seemed to be about the same thing; making a bet that a stock would go down, and making money when it did. It was also gambling. Sure, careful study preceded these investments, but because of the limited time period for them, it required selling on a schedule, not like longer term investments. Sometimes the timing was not favorable.

Day trading requires almost constant attention to the market, a luxury not available to most people.

Fortunately, most people did not become involved in the real estate bubble, although many did. In Phoenix, for example, there were plenty of opportunities. Property values in some areas increased 50%, or doubled, or in some cases even tripled in a year. The question was, “had the properties risen in value by the same amount as the increase in price?” It did not seem so. The great bulk of properties could earn only slightly greater rent because of higher property prices. It was apparent that properties were overvalued. (Some of this is 20/20 foresight, and some is 20/20 hindsight.)

For example, an investment group bought a nearby apartment complex with 270 units, and announced they would convert the units to condominiums. Tenants could buy their apartments at favorable prices, and a few did. After refurbishing the complex the new owners sold, in a little over two weeks, the remaining 200 or so units. Investors, not prospective tenants, bought the bulk of the condominiums. They gambled, and for the most part, they lost when the real estate bubble burst.

The same is so with most of the gamblers who expected great gains when they bought asset backed securities (derivatives), hedge funds, and other such paper instruments about which most people know nothing, or sold short, or bet on commodities, etc. In other words, they did not invest into value; they invested in paper assets. Underlying assumptions and the tacit assumptions behind them were either not investigated or ignored. Many of those paper assets disappeared, in many respects causing the mess our financial system, and our economy are in.

Here are some questions to consider. Readers say they appreciate your comments….

First, is there more benefit to the economy by investing in productive assets, such as operating companies, rather than investing into paper assets? Second, do the high-risk instruments and investments benefit our economy? Third, should we consider limiting or banning investments in paper assets and other high-risk methods of investing in the financial system?

Revision and more thoughts on the economy

It was only eight days ago that I posted a comment about the economy. In those eight days, worldwide financial and economic news was so bad, with massive employee layoffs, terrible earnings reports and steep stock market declines that, in my opinion, the comments in that post proved wrong. If there was an ethical way to remove those comments from the Internet, I would.

The better action, though, is to acknowledge an overreaction to the short-term developments that led to the opinion expressed. Following is a revised opinion.

Credit will slowly loosen making borrowing at all levels somewhat easier. The change will not be as fast as the Treasury and the Federal Reserve would like, but credit will slowly loosen. The Federal Reserve has started lending against commercial paper from banks and corporations, and some of the $250 billion used to capitalize banks by buying stock is deployed. Banks are slowly beginning to trust other banks – interbank loans are slowly rising. Yesterday’s news showed a rise in the rate of new home purchases, probably because cash rich buyers (there are some out there) see housing prices near the bottom of their decline. New home construction will not pick up for some time though because the inventory of unsold new homes is still high.

The Conference Board's index of consumer confidence index was just published. At 38.0, down from last month's 61.4, it is dismal. Consumer spending already is down. As consumer confidence declines, so does consumer spending. The present level of the index points to an extremely weak retail season. If gains in the stock market - up some 400 points today - continue, and gasoline prices stay down, confidence and spending will slowly return

Small business owners – hunker down. Reduce expenses as much as possible, and increase revenue if possible. Depending on the business, most of you can survive unless you are heavily in debt. If heavily in debt, have a contingency plan in mind or on paper so that if your line of credit is reduced or canceled you have a plan of action ready to go. Many options exist – take off the blinders and look at all.

I do not believe the US will suffer either the depth or the length of the worldwide recession that is at hand. However, it will be at least a year, and perhaps two years, before an upturn in the economy show up. Worldwide it will be deeper and longer.

In this country, we will have dodged a bullet. Barely.

Positive Signs 10/20/2008

Barring unforeseen surprises, of which there have been many, there seems to be light at the end of the tunnel of economic crisis. There are several signs of (the overused term) “cautious optimism” showing their heads long before Groundhog’s Day.

First, interbank lending rates are down today to the lowest level since September 30. That does not mean the credit crunch is over; in fact, it is long from ending. However, the lower rate does mean a larger number of banks are willing to lend to other banks – a statement of rising confidence in the viability of the banking industry. Confidence needs to increase even more before the credit crisis ends, but a glimmer of hope is showing.

Second, and quite a surprise, the Conference Board reported today a slight increase in leading indicators. Caution: this does not mean business will be booming soon. Nor, with a one-month increase, does it mean the economy is turning around. Having expected a decrease in the indicators, though, the very slight increase is welcome news. There is little question that the economy will continue to fall for some time; perhaps the slight rise means the fall will not be as severe as some expect. If there is continued rise in the indicators, a turn in the economy could be expected in less than a year.

Third, there is less and less doubt that the government will create another economic stimulus package. The style of the package will depend on the creators: either the current administration or a newly elected one (of either party.) Certainly, the infrastructure needs investment, and along with encouragement to the housing industry, a stimulus package can in short order return thousands of unemployed workers to newly created jobs.

Before dancing in the streets in celebration of an economic recovery, temper all the above with the size of the deficits that will follow, and the enormity of the national debt. The United States will be financially weakened for many years to come. We have put ourselves into a large hole and now face the perhaps impossible task of digging out.

Musings on the Economy

In the spring of this year, it seemed certain the economy was entering a recession. Oddly enough, based on the definition of a recession as two consecutive calendar quarters with shrinking GNP, we still are not in a recession.

Another definition sees a recession as a reduction in the amount of business activity in the economy, based on measures like employment, industrial production, real income and wholesale-retail sales. A recession starts as business activity reaches a peak and starts to fall and ends when business activity bottoms out and begins to rise. Using this definition, recessions last on average about a year.

Now, in the current economic drama, recession seems sure – using either definition. Employment is down; unemployment is up. Industrial production is down; wholesale and retail sales are down. Food and fuel prices have risen sharply, driving down real income.

There are some interesting good signs, though, even during the drama. The dollar is stronger. It has risen some 17% over the last two and a half months. Looking at the economy, that is a surprise. It seems it should have fallen further during that time. Apparently, compared to national economies around the world though, ours is better than most, giving strength to the dollar. If other economies are worse than ours are, they must be very bad. With the weak dollar, exports rose. As the dollar strengthens, they will fall. With a stronger dollar, the real cost of a barrel of petroleum is lower. Fuel costs are lower and may go down even more.

The critical issue in the current economic drama is credit. No one wants to lend money, especially banks to other banks. Without bank-to-bank short-term loans, credit availability dries up. The Fed yesterday intervened by buying commercial paper, never before done. Then the Fed, joined by the larger industrialized nations in the world, reduced interest rates. In the US, the federal funds rate dropped half a point. Mr. Bernake and friends are creative geniuses – he seems to have something new every day. The result, along with interest rate cuts worldwide, may stem the tide of the drama. If only (and how many times have you heard,”if only”) we get a few days of calming, these and other measures will begin to defuse the drama. I personally believe that the many measures and rescues of the Federal Reserve and the US Treasury will keep the economy from falling into a depression - defined as a severe economic downturn lasting several years.

Speaking of depressions, the Great Depression of 1929 lasted ten years, ending only when the outbreak in Europe of World War II began demanding greater output from our mines and factories. We certainly do not want that. Overburdened with a national debt far into the trillions, surviving a depression would become problematic.

Thoughts on Consistency in Business

I recently posted two pieces on consistency on another blog site I maintain. One piece has tips for achieving consistency, and the other is an example of the results of consistent operations. Rather than post the same content on this page I invite you to read them www.sixpillarsresearch.blogspot.com.

I believe consistency is one of the overlooked features of good business practice. We all know how important consistency is, and yet many companies completely fail at achieving it. Some stay in business, but many do not. Think about it. Would you do business with a firm that meets your needs only inconsistently? I doubt it. There doesn’t seem to be a reason to.

Some companies don’t care about repeat customers. They advertise and promote heavily to get new customers, but don’t consistently serve them. Their philosophy seems to be, “It is a big market with many, many prospective customers. Keep up the advertising and promotion to keep them coming in and all will be well.” Personally, I like the philosophy that says our customer are the most important asset we have so we take good care of them and keep them coming back again and again. What do you think? I would appreciate having your thoughts as a comment part to this blog.

Charles R. Schaul, Partner of SixPillars Research Group, focuses on increasing business profits by resolving the problem of customer attrition. Aligning companies with their customers; generating and implementing strategic initiatives; and promoting employees’ customer focus through commitment, responsibility and accountability combine to achieve the result.
Copyright 2008 by Charles R. Schaul, Boulder, Colorado. All rights reserved.

The Appearance of Impropriety

The appearance of impropriety is often as damaging to all concerned as is the impropriety itself.

With that in mind I bring to your attention a fascinating front page article in the March 27, 2008 New York Times. It can be read at
http://www.nytimes.com/2008/03/27/world/asia/27ammo.html?_r=1&th&emc=th&oref=slogin.

It is an amazing story of a munitions supplier to Afghanistan. I make no judgment on the article except to say that it is an extraordinary example of the appearance of impropriety among a number of people.

Here is the story of a young man, Efraim E. Diveroli, who in 2003 became president of an apparently inactive corporation, AEY Inc., and immediately began bidding on US government contracts. In January, 2007, AEY won a contract from the US Army that could amount to as much as $300 million to supply ammunition to the Afghan army and other Afghan fighters. According to the story, the ammunition eventually supplied was aged, poorly packaged and boxed. Some of the ammunition was manufactured in China in 1966 (42 years ago) and was acquired from Albania for shipment to Afghanistan. Much of it seems to have been declared obsolete by NATO and the US State Department.

There appear to be multiple intermediaries involved in the transactions, including one company of unclear ownership that was organized to participate as a middleman. Additionally, according the Times article, the contract with the US Army also has the appearance of impropriety in its vague language and limited restrictions.

Through the appearance of impropriety the whole affair blemishes the US Army contracting officers involved, AEY, Inc. and Mr. Diveroli, as well as several others. The most confusing part of this is how it has lasted so long, and that the Army has said it will allow AEY, although now suspended from further government bidding, to complete the current contract. If the facts are as reported, why would the Army want to buy more ammunition from AEY?

One other comment – where is all the money going? Or, should I say, where does it appear all the money is going?

Your comments are invited.

Charles R. Schaul, Partner of SixPillars Research Group, focuses on increasing business profits by resolving the problem of customer attrition. Aligning companies with their customers; generating and implementing strategic initiatives; and promoting employees’ customer focus through commitment, responsibility and accountability combine to achieve the result.

My Take on the Economy

I have been watching the unfolding events in the economy and have formed an opinion on what to expect. Here’s the way I see it.

With the reduction in the discount rate last week and now the federal funds rate today, interest rates are down to 2005 levels. These moves by the Fed are meant to slow and then stop the recession we have fallen into. Slight additional rate cuts are possible too, even though there is not much room left in the rates.

Unfortunately, with the Fed pumping so much money into the system through the discount window, and our interest rates so low, the dollar will continue to decline in value over the next few months. (Of course, interventions by foreign banks may change this.) This means for us, higher fuel costs and a higher rate of inflation. Because of the high fuel costs, I believe this recession will be a steep one, and a long one. I hope I am wrong.

With cheap dollars US exports will increase because our goods are more competitive worldwide. That is good but the main driver of our economy is consumer spending (almost 70% of total GDP.) Because of high fuel costs, consumer spending will not rebound any time soon, no matter how low interest rates are. So the main driver of the economy will be weak, and the recession will continue. It is a vicious cycle, more interest rate cuts will drive the dollar down even further, fuel will become even more expensive, and consumer spending will not grow.

I believe we are in a bind and I don’t see a way out of it. You may have a different take on the situation – post a comment to let us know what your crystal ball says.

Charles R. Schaul, Partner of SixPillars Research Group, focuses on increasing business profits by resolving the problem of customer attrition. Aligning companies with their customers; generating and implementing strategic initiatives; and promoting employees’ customer focus through commitment, responsibility and accountability combine to achieve the result.

Economic Gloom

The Federal Reserve Bank’s usual treatment for a recession is to lower interest rates. In six months or so the effect of the rate cuts are felt throughout the economy and the recession eases or disappears. It seems to work well, and the Fed has been reasonably successful through the years in dealing with recessions. A few years ago, though, the Fed cut and cut and cut, and when all the cuts were felt we had superheated growth, and inflation jumped up. Inflation is manageable though by raising rates, so the Fed did that and took the heat out of inflation growth.

This time as we enter a recession, however, the process is not so simple. The massive deficits we have had the last few years have driven down the value of the dollar to an alarming extent. The Euro is worth more than $1.50, the British pound is over two dollars, and even the Canadian dollar is worth more than ours. To buy crude oil we now spend about half again what we spent in the past, and the high oil prices are causing us to have high production and transportation costs, leading to high food prices, and more inflation. Normally the Fed raises interest rates to combat inflation, but with the recession staring us in the face, they won’t do that. If the Fed cuts interest rates to fight the recession, the dollar slides down even further, and imported goods, like crude oil, cost even more, and inflation grows as the economy is in recession.

Add to these problems the sub-prime mortgage losses in the credit markets, the potential for more runs on financial institutions like the one on Bear Stearns last week, and the situation gets very precarious.

If you read the current editorials, or follow the financial news closely, you know our economic situation is becoming a nightmare. How we weather this is uncertain and for the astute among you, even terrifying.

I have no advice to give. Hang on and hope is the best I can say.

Charles R. Schaul, Partner of SixPillars Research Group, focuses on increasing business profits by resolving the problem of customer attrition. Aligning companies with their customers; generating and implementing strategic initiatives; and promoting employees’ customer focus through commitment, responsibility and accountability combine to achieve the result.