The US government’s takeover of mortgage giants Freddie Mac and Fannie Mae is a defining, but not the closing chapter in the credit crisis. New legislation is already on the table and wise men and women in Washington and all around the world are talking about greater government influence in what once was the number one free market in most of the Western world.
Commercial real estate in the US exploded after the housing prices went in an upward spiral in 1995. The markets in New York, Florida, California, and Greater Washington, D.C knew record increases. In Washington, D.C. proper, in 1999, the average price of a home was $264,668. In 2002 it had jumped to $367,676, a compounded annual rate of increase of 16%. (During this time, the median home price increased at a compounded annual rate of 15%.) Anyone who still rented was dubbed an idiot. During 2001, home prices for the entire states of California, Florida, and Massachusetts, rose by more than 10%, and in portions of New York, by more than 15%. Freddie and Fannie were at the hub of the frenzy. Between 1995 and 2001, Fannie and Freddie acquired almost three-quarters of the $2.25 trillion in new mortgage loans that combined banks in the US had made. Upon getting cash from Fannie and Freddie, the banks made new housing loans. Since 1995, Fannie and Freddie accounted for almost three-quarters of all housing mortgages.
To gain even more profits, Fannie and Freddie started to pool the mortgage loans together in Mortgage-Backed Securities (MBS). They put a guarantee on it; and sold it to third parties—such as mutual funds, pension funds, or insurance companies. The cash from the pension funds, or mutual funds went into the housing market. That cash was drawn into that market by Fannie Mae and Freddie Mac in the first place because they issued securities that provided cash to primary lending institutions like Lehman and Bear Stearns.
What is ironic is that the internet bubble is repeating itself. The keywords are “intrinsic value”. During the dotcom craze, companies that only existed for months could rake in billions in cash without any proven business plan or even a suggestion how to repay all those investors. It didn’t matter; as long as it was on the net, you had to get a piece of it. The same will happen if you build houses without looking at quality (who said that only the Chinese build bad housing?)
With real estate prices going through the roof, contractors were put under pressure to build as fast as possible for as low a price as possible. This resulted in inferior houses that were worth far less then the asking price. The real value didn’t go up but went down as any item that is used and can’t withstand the wear and tear. It didn’t bother the mortgage providers at all. The idea was to live in your own house for a year or two, then sell it to “the next guy” who would pay substantially more. The problems started when the banks let people borrow against the fictitious market value of their house instead of the real intrinsic value. These home equity loans had a temporary beneficial effect on the economy. People could spend all that extra cash on cars, television sets and other luxury items.
They forgot that even good houses need maintenance and that the extra dollars were better spent on paint then on an extra stereo. In the long term this decision turned out to be disastrous. As oil prices rose and the dollar weakened more and more people discovered that they simply couldn’t afford their mortgage anymore. What was worse, there appeared to be no “next guy” anymore. With more houses for sale and demand declining, the only way housing prices could go was down. The result is the by now well known mortgage crisis. The demise of Northern Rock in the UK, Bear Stearns in the US and many smaller financial institutions was only the tip of the iceberg. Much further down, we now find Freddie and Fannie, who have been trying to keep the failing mortgage market afloat and almost collapsed under the weight.
The US government had little choice but to nationalize the two Frankensteins it had created. The alternative would be to seek outside finance but that would leave the door open for the previously discussed Sovereign Wealth Funds and other venture capitalist. I doubt if Washington wants the domestic housing market controlled by Abu Dhabi, the UAE or Russian billionaires.
Wednesday, September 10, 2008
Tuesday, August 19, 2008
Enjoying our holiday in Europe
As I'm currently enjoying my graduation holiday in Europe, I haven't posted in a while. Just some good advice for anyone renting a car in Austria: don't rent it from Buchbinder rent-a-car. They might be the largest local rental company but they tried to rip us off yesterday. A very old trick; when you get the car they casually go around it,note some existing dents and scratches and let you sign a paper (I wasn't there at that moment, my wife did the honors). Yesterday they suddenly examined the car very carefully and off course found a scratch that wasn't noted on the rental agreement. So they tried to get us to pay EUR450 ($900) for the "damage". We had to come into "the office" where they tried to bully us into signing a damage declaration form. When I suggested to get a damage expert in they suddenly retracted their statement and said that it was probably caused by washing the car. I also noted that two Korean gentlemen were quoted a price that was about 3 times as much as what we paid (my wife is from Vienna). Not very professional and potential very damaging to a budding Herz, Avis or Sixt competitor.
Wednesday, July 16, 2008
From Corporate Chief to Corporate Thief, an analysis of the Tyco scandal.
Background
Tyco International Ltd. (NYSE: TYC) is a diversified manufacturing conglomerate incorporated in Bermuda, with United States operational headquarters in Princeton, New Jersey (Tyco International (US) Inc.). Tyco International is composed of five major business segments:
- ADT Worldwide,
- Fire Protection Services,
- Safety Products,
- Flow Control and Electrical
- Metal Products.
The Kozlowski era.
Dennis Kozlowski joined Tyco in 1975 and succeeded John F. Fort as CEO in 1992. In 1993 Tyco changed its name to Tyco International Ltd. The 1993 fiscal year saw the company post net income of a mere $1 million. After 1993 the business picked up dramatically and from 1994 to 2002, Kozlowksi built Tyco into a global conglomerate with $36 billion in revenue from the sale of everything from diapers to fire alarms.
Through acquisitions and mergers Tyco spent over $60 billion and acquired 200 major corporations and hundreds of smaller companies. Kozlowksi was notorious for being a very fast paced acquisitor, earning him the nickname "Deal-a-Day Dennis . Targets had to be complementary to an existing Tyco operation, however subtle that synergy might be. Tyco’s management was completely decentralized. Provided that they met their ambitious profit goals, Kozlowski’s executives could run their divisions as entrepreneurs. The strictly-by-the-numbers management--tended to antagonize the top executives of acquired companies, most of which Tyco radically shrank to boost cash flow immediately.
Kozlowski became notorious for his extravagant lifestyle, supported by the booming stock market of the late 1990s and early 2000s. Allegedly, he had Tyco pay for his $30 million New York City apartment which included $6,000 shower curtains. Kozlowski also purchased several acres in the private gated community, "The Sanctuary", in Boca Raton, Florida.
The collapse of Enron Corporation in 2001 was a wakeup call for investors. Like Enron, Tyco had a complex accounting structure due to its myriad of acquisitions. In January 2002, Kozlowski announced a temporary stop to acquisitions and presented a radical plan to boost shareholder value. Tyco was to be split into four separate publicly traded companies. This would make the corporate structure more transparent and would boost shareholder value. Investors reacted with skepticism. Three months later, Kozlowski shifted course again claiming that he would only sell off one subsidiary, CIT Group, through an IPO.
CIT Group had been bought in 2001 after a suggestion of Tyco board member Frank E. Walsh Jr., who was friendly with Albert R. Gamper Jr., CIT's CEO. Kozlowski had paid Walsh, fellow Seton Hall alum, a $20 million reward “fee” for the deal. The divestment of CIT ultimately brought Tyco a $7 billion loss.
By May 2002, Tyco's stock was trading at less than $20 per share, down 66 percent since the beginning of the year. The firm's market capitalization, which in December 2001 had been higher than that of General Motors Corporation, Ford Motor Company, and DaimlerChrysler AG combined, had plummeted by about $80 billion.
The accusations.
As far back as December, 1999, the SEC had investigated Tyco's handling of some 120 acquisitions. The following summer, however the agency had sent a letter informing Tyco that it was not taking action. It wouldn’t be accounting fraud that brought Tyco’s glamorous CEO down. In June 2002, Manhattan District Attorney Robert M. Morgenthau brought charges against Kozlowski on two accounts. It was evasion of New York sales tax on the purchase of expensive artwork, not his manipulations at Tyco that forced him to resign as CEO of Tyco International. One day after his resignation, Kozlowski was indicted. On November 27, 2002, the State of New Jersey took separate action in the scandal, filing a federal suit against Tyco and former personnel, with charges in part of violating the New Jersey RICO statute. As a result of the scandal, Tyco and some former directors and officers were named as defendants in more than two dozen securities class-action lawsuits. That March 31, Tyco made a motion to dismiss, which was granted in part over a year later, on October 14, 2004. At the end of 2002, U.S. News & World Report picked Kozlowski as its corporate rogue of the year, choosing him over Enron and WorldCom executives involved in much more extensive corruption. On September 19, 2004 Kozlowski and Tyco’s former CFO Mark Swartz were finally sentenced to eight and one-third to 25 years in prison .
Executive behavior.
What could have made a man who wanted to be a combination of Jack Welch and Warren Buffet turn into a greedy defrauding manipulator? Like any crime, the reason was a combination of reward, opportunity and a slim chance to be caught.
Kozlowksi was never one of the handsome fast boys like the traders and executives at Enron. He has frequently described himself as the son of a Newark cop turned police detective. Kozlowski was so keen to advance at Tyco that he started taking night classes at Rivier College, a Catholic college in Nashua. He completed only three classes, though he claimed to have earned an MBA from Rivier in a questionnaire submitted for the 1988-89 edition of Who's Who in America . For most of the 27 years that Kozlowski worked at Tyco, he was an exceptionally enterprising and effective manager.
In the early 1990, the success of the stock market had created the notorious “Bubble Era” that would end with the great dot com crash of 2001 . Not to be outdone by the upcoming “new world” companies, the traditional industry started a merger and acquisition spree of unprecedented scale. The phrase "Get large or get lost" was the wisdom of the day. Companies that knew how to grow where awarded with large boosts in share price. The CEO’s that brought about this new wealth were lavishly awarded. The growth caused ever higher shareholder expectations which in turn put the pressure on companies to produce ever higher results. The lack of corporate governance combined with their status as superstars caused many CEO’s to actually behave like superstars. Delusions of grandeur had previously been reserved for heads of state but in the corporate kingdoms of the late 20th century, the CEO’s felt increasingly above the law. According to Tyco, Kozlowski misappropriated $43 million in corporate funds to make philanthropic contributions in his own name, including $5 million to Seton Hall, which named its new business-school building Kozlowski Hall. This is behavior is not unlike that of a Roman emperor or an African dictator.
According to the indictment, Kozlowski's thievery escalated after Tyco shifted 40 more employees from Exeter to Boca Raton, where ADT had a luxurious office. Like Enron, Tyco had cultivated a corporate culture where executives felt entitled to the company’s assets. This attitude is further demonstrated by statements made during the Tyco trial where Kozlowski and Swartz testified that they had no intention of deceiving anyone and that they were entitled to the payments as bonuses under the company's board-approved compensation formulas.
Kozlowki’s apparent success, his status and ambition caused increasingly erratic behavior. Apart from his private spendings, financed by the firm, he allowed himself to become influenced by flamboyant men, like Lord Michael Ashcroft. Ashcroft was founder and CEO of ADT, a security and motoring auctions group. As drab as Kozlowski’s pre-CEO life had been, so exciting was Lord Ashcroft’s lifestyle. ADT was set up in Bermuda and Ashcroft used his yacht, the Atlantic Goose as a floating office. The acquisition of ADT was structured as a reverse takeover, allowing Tyco to move its statutory headquarters to the tax haven. Ashcroft joined the board of Tyco as one of the few executives of acquired companies. This was the first step in creating a network of offshore subsidiaries to shelter foreign earnings from U.S. taxes. It would be financial constructions like this that would ultimately bring down Enron.
Board oversight.
As long as Tyco’s profits soared, the investors couldn’t get enough of “Dennis the Menace”. The board of directors, normally installed to oversee the behavior and results of the executives on behalf of the shareholders, let Kozlowski do whatever he pleased. This wasn’t very different from the situation at Enron, Worldcom and other high rolling companies. Tyco’s SEC filings show no significant challenges to Kozlowksy’s reign in that period.
From 1997 through 2001, Tyco's revenues rose by 48.7% a year, five times faster than General Electric's, while its pretax operating margins improved to 22.1%, easily topping GE's 16.4%. It was easy for Kozlowksi to argue that he deserved a higher salary then Jack Welch, the CEO of GE, who was the best paid executive at that time.
The board of directors was only sparsely informed about Tyco’s executive decisions. The acquisition of CIT Group, which cost the company $9.2 billion wasn’t relayed to the board until 6 months later when Swartz mentioned it in a rough draft of a proxy statement. The $20 million fee that Walsh had received for the deal stunned the board members. When the board challenged him, Kozlowski claimed that he had made an innocent mistake--but at least had talked Walsh down from the $40 million he had initially wanted. Walsh refused to give the money back and left the board. Tyco sued Walsh and brought in the lawyer David Boies and his firm to start turning over every rock. Walsh declined to comment.
During the Tyco trial, prosecutors showed that Kozlowski and Swartz used company tax and relocation loan programs to make personal investments, buy jewelry and art and live ``like royalty.'' They were accused of awarding themselves and others $137 million in unauthorized payments in the form of cash, Tyco stock and company loan forgiveness.
The executives forgave their own debts without getting proper approval from the compensation committee of Tyco's board. Tyco’s executives were also charged with misleading investors about the company's financial condition while selling $575 million in Tyco shares and options. All of which the board of directors apparently never knew about. According to the other board members, Director Philip Hampton, who died in 2001, was aware of some of the payments. This statement drew comments from Assistant District Attorney Ann Donnelly who said it was “despicable to use a dead man's testimony as a defense”.
In the pre-SOX era, the independence of outside board members was questionable. Relationships with accounting firms were so tight that, in case of the Enron scandal, the auditors where often in on the scheme or at least closed their eyes to any irregularities. The increasingly complicated structure made it very difficult for board members who weren’t accountants to know exactly what was going on.
Why did the board disregard reporting rules?
In the Bubble Era, shareholder value was the most important factor. As long as companies provided growth, other stakeholder priorities were effectively bypassed. Unlike Enron, there was no whistleblower that brought the case to light. The lack of compliance to reporting rules wasn’t confined to Tyco. Former Chairman of the SEC Arthur Levitt pointed out, “the spate of (…) corporate failures and scandals of the past few years could not have occurred without the widespread breakdown in the oversight system of American corporate markets . Too many corporate professionals, including officers, directors, analysts, investment bankers, and most notably the accountants and attorneys, appeared to have forgotten that their fiduciary duties require them to represent the interests of the corporation and the shareholders first, above all other interests, including their own”. The culture of 'what can we get away with' eroded public confidence in American financial markets.
Until the passage of the Sarbanes-Oxley Act of 2002 both the accounting and the legal professions were allowed to set their own ethics rules with little or no oversight by the government. Official oversight results by professional auditors were therefore often kept confidential. This caused a “see no evil, hear no evil” attitude in many boards, because no board member wanted to be accused of being a “spoil sport” when the going was good.
How to regain trust?
In 2002, Tyco agreed to replace all board members who served with Kozlowksy, notably one of them being Michael Ashcroft. The move came after investors and a New Hampshire regulator objected to a bid to keep two of the board members . It was a good step in the direction of regaining investor confidence. Sarbanes-Oxley establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The act contains a minimum standard which Tyco needs to improve upon. There are several points that Tyco can take into consideration.
Direct measures:
1. Transparent corporate structure.
The complex acquisition schemes of the late 20th century caused a great many board members to lose oversight. Only a professional accountant or lawyer would be able to make sense of the great many links, special purpose vehicles and other specialized structures. Board members are often chosen because of their standing and past expertise, not for their current knowledge. The simpler the company structure, the easier it is to follow for board members and shareholders.
2. Truly independent board members.
Sarbanes-Oxley requires a greater number of outside board members. Individual board members should be able to acquire outside advice and be accountable for any decisions they make. Board members should be able to challenge executive decisions before they are made.
3. More influence of stakeholders.
Financial stakeholders should be engaged in (potential) management issues. Even in the SOX era, stakeholders are often informed after a decision has been made. A good example of this is ABN AMRO’s sale of LaSalle to Bank of America. This deal was made over the weekend without informing the shareholders. The decision was held up in court but only because ABN AMRO was to be sold anyway.
4. Direct influence on reward structure.
SOX requires executive compensation to be published. This doesn’t guarantee any influence over the board’s executive compensation policy. Fortis Bank’s CEO, Jean-Paul Votron has been ousted because his salary was raised 73% while at the same time Fortis chose not to pay dividend and to issue emergency stock. This was done after the decision and only because shareholders revolted. It will undoubtedly result in a golden parachute for the former CEO.
In the long term, Tyco should create and stimulate a corporate culture where the interest of all stakeholders comes first. A workers council, like that required by law in The Netherlands should be able to challenge management decisions. Shareholders need to get more direct influence on important company decisions and long term strategy. Other stakeholder groups should be engaged in the dialogue.
Tyco International Ltd. (NYSE: TYC) is a diversified manufacturing conglomerate incorporated in Bermuda, with United States operational headquarters in Princeton, New Jersey (Tyco International (US) Inc.). Tyco International is composed of five major business segments:
- ADT Worldwide,
- Fire Protection Services,
- Safety Products,
- Flow Control and Electrical
- Metal Products.
The Kozlowski era.
Dennis Kozlowski joined Tyco in 1975 and succeeded John F. Fort as CEO in 1992. In 1993 Tyco changed its name to Tyco International Ltd. The 1993 fiscal year saw the company post net income of a mere $1 million. After 1993 the business picked up dramatically and from 1994 to 2002, Kozlowksi built Tyco into a global conglomerate with $36 billion in revenue from the sale of everything from diapers to fire alarms.
Through acquisitions and mergers Tyco spent over $60 billion and acquired 200 major corporations and hundreds of smaller companies. Kozlowksi was notorious for being a very fast paced acquisitor, earning him the nickname "Deal-a-Day Dennis . Targets had to be complementary to an existing Tyco operation, however subtle that synergy might be. Tyco’s management was completely decentralized. Provided that they met their ambitious profit goals, Kozlowski’s executives could run their divisions as entrepreneurs. The strictly-by-the-numbers management--tended to antagonize the top executives of acquired companies, most of which Tyco radically shrank to boost cash flow immediately.
Kozlowski became notorious for his extravagant lifestyle, supported by the booming stock market of the late 1990s and early 2000s. Allegedly, he had Tyco pay for his $30 million New York City apartment which included $6,000 shower curtains. Kozlowski also purchased several acres in the private gated community, "The Sanctuary", in Boca Raton, Florida.
The collapse of Enron Corporation in 2001 was a wakeup call for investors. Like Enron, Tyco had a complex accounting structure due to its myriad of acquisitions. In January 2002, Kozlowski announced a temporary stop to acquisitions and presented a radical plan to boost shareholder value. Tyco was to be split into four separate publicly traded companies. This would make the corporate structure more transparent and would boost shareholder value. Investors reacted with skepticism. Three months later, Kozlowski shifted course again claiming that he would only sell off one subsidiary, CIT Group, through an IPO.
CIT Group had been bought in 2001 after a suggestion of Tyco board member Frank E. Walsh Jr., who was friendly with Albert R. Gamper Jr., CIT's CEO. Kozlowski had paid Walsh, fellow Seton Hall alum, a $20 million reward “fee” for the deal. The divestment of CIT ultimately brought Tyco a $7 billion loss.
By May 2002, Tyco's stock was trading at less than $20 per share, down 66 percent since the beginning of the year. The firm's market capitalization, which in December 2001 had been higher than that of General Motors Corporation, Ford Motor Company, and DaimlerChrysler AG combined, had plummeted by about $80 billion.
The accusations.
As far back as December, 1999, the SEC had investigated Tyco's handling of some 120 acquisitions. The following summer, however the agency had sent a letter informing Tyco that it was not taking action. It wouldn’t be accounting fraud that brought Tyco’s glamorous CEO down. In June 2002, Manhattan District Attorney Robert M. Morgenthau brought charges against Kozlowski on two accounts. It was evasion of New York sales tax on the purchase of expensive artwork, not his manipulations at Tyco that forced him to resign as CEO of Tyco International. One day after his resignation, Kozlowski was indicted. On November 27, 2002, the State of New Jersey took separate action in the scandal, filing a federal suit against Tyco and former personnel, with charges in part of violating the New Jersey RICO statute. As a result of the scandal, Tyco and some former directors and officers were named as defendants in more than two dozen securities class-action lawsuits. That March 31, Tyco made a motion to dismiss, which was granted in part over a year later, on October 14, 2004. At the end of 2002, U.S. News & World Report picked Kozlowski as its corporate rogue of the year, choosing him over Enron and WorldCom executives involved in much more extensive corruption. On September 19, 2004 Kozlowski and Tyco’s former CFO Mark Swartz were finally sentenced to eight and one-third to 25 years in prison .
Executive behavior.
What could have made a man who wanted to be a combination of Jack Welch and Warren Buffet turn into a greedy defrauding manipulator? Like any crime, the reason was a combination of reward, opportunity and a slim chance to be caught.
Kozlowksi was never one of the handsome fast boys like the traders and executives at Enron. He has frequently described himself as the son of a Newark cop turned police detective. Kozlowski was so keen to advance at Tyco that he started taking night classes at Rivier College, a Catholic college in Nashua. He completed only three classes, though he claimed to have earned an MBA from Rivier in a questionnaire submitted for the 1988-89 edition of Who's Who in America . For most of the 27 years that Kozlowski worked at Tyco, he was an exceptionally enterprising and effective manager.
In the early 1990, the success of the stock market had created the notorious “Bubble Era” that would end with the great dot com crash of 2001 . Not to be outdone by the upcoming “new world” companies, the traditional industry started a merger and acquisition spree of unprecedented scale. The phrase "Get large or get lost" was the wisdom of the day. Companies that knew how to grow where awarded with large boosts in share price. The CEO’s that brought about this new wealth were lavishly awarded. The growth caused ever higher shareholder expectations which in turn put the pressure on companies to produce ever higher results. The lack of corporate governance combined with their status as superstars caused many CEO’s to actually behave like superstars. Delusions of grandeur had previously been reserved for heads of state but in the corporate kingdoms of the late 20th century, the CEO’s felt increasingly above the law. According to Tyco, Kozlowski misappropriated $43 million in corporate funds to make philanthropic contributions in his own name, including $5 million to Seton Hall, which named its new business-school building Kozlowski Hall. This is behavior is not unlike that of a Roman emperor or an African dictator.
According to the indictment, Kozlowski's thievery escalated after Tyco shifted 40 more employees from Exeter to Boca Raton, where ADT had a luxurious office. Like Enron, Tyco had cultivated a corporate culture where executives felt entitled to the company’s assets. This attitude is further demonstrated by statements made during the Tyco trial where Kozlowski and Swartz testified that they had no intention of deceiving anyone and that they were entitled to the payments as bonuses under the company's board-approved compensation formulas.
Kozlowki’s apparent success, his status and ambition caused increasingly erratic behavior. Apart from his private spendings, financed by the firm, he allowed himself to become influenced by flamboyant men, like Lord Michael Ashcroft. Ashcroft was founder and CEO of ADT, a security and motoring auctions group. As drab as Kozlowski’s pre-CEO life had been, so exciting was Lord Ashcroft’s lifestyle. ADT was set up in Bermuda and Ashcroft used his yacht, the Atlantic Goose as a floating office. The acquisition of ADT was structured as a reverse takeover, allowing Tyco to move its statutory headquarters to the tax haven. Ashcroft joined the board of Tyco as one of the few executives of acquired companies. This was the first step in creating a network of offshore subsidiaries to shelter foreign earnings from U.S. taxes. It would be financial constructions like this that would ultimately bring down Enron.
Board oversight.
As long as Tyco’s profits soared, the investors couldn’t get enough of “Dennis the Menace”. The board of directors, normally installed to oversee the behavior and results of the executives on behalf of the shareholders, let Kozlowski do whatever he pleased. This wasn’t very different from the situation at Enron, Worldcom and other high rolling companies. Tyco’s SEC filings show no significant challenges to Kozlowksy’s reign in that period.
From 1997 through 2001, Tyco's revenues rose by 48.7% a year, five times faster than General Electric's, while its pretax operating margins improved to 22.1%, easily topping GE's 16.4%. It was easy for Kozlowksi to argue that he deserved a higher salary then Jack Welch, the CEO of GE, who was the best paid executive at that time.
The board of directors was only sparsely informed about Tyco’s executive decisions. The acquisition of CIT Group, which cost the company $9.2 billion wasn’t relayed to the board until 6 months later when Swartz mentioned it in a rough draft of a proxy statement. The $20 million fee that Walsh had received for the deal stunned the board members. When the board challenged him, Kozlowski claimed that he had made an innocent mistake--but at least had talked Walsh down from the $40 million he had initially wanted. Walsh refused to give the money back and left the board. Tyco sued Walsh and brought in the lawyer David Boies and his firm to start turning over every rock. Walsh declined to comment.
During the Tyco trial, prosecutors showed that Kozlowski and Swartz used company tax and relocation loan programs to make personal investments, buy jewelry and art and live ``like royalty.'' They were accused of awarding themselves and others $137 million in unauthorized payments in the form of cash, Tyco stock and company loan forgiveness.
The executives forgave their own debts without getting proper approval from the compensation committee of Tyco's board. Tyco’s executives were also charged with misleading investors about the company's financial condition while selling $575 million in Tyco shares and options. All of which the board of directors apparently never knew about. According to the other board members, Director Philip Hampton, who died in 2001, was aware of some of the payments. This statement drew comments from Assistant District Attorney Ann Donnelly who said it was “despicable to use a dead man's testimony as a defense”.
In the pre-SOX era, the independence of outside board members was questionable. Relationships with accounting firms were so tight that, in case of the Enron scandal, the auditors where often in on the scheme or at least closed their eyes to any irregularities. The increasingly complicated structure made it very difficult for board members who weren’t accountants to know exactly what was going on.
Why did the board disregard reporting rules?
In the Bubble Era, shareholder value was the most important factor. As long as companies provided growth, other stakeholder priorities were effectively bypassed. Unlike Enron, there was no whistleblower that brought the case to light. The lack of compliance to reporting rules wasn’t confined to Tyco. Former Chairman of the SEC Arthur Levitt pointed out, “the spate of (…) corporate failures and scandals of the past few years could not have occurred without the widespread breakdown in the oversight system of American corporate markets . Too many corporate professionals, including officers, directors, analysts, investment bankers, and most notably the accountants and attorneys, appeared to have forgotten that their fiduciary duties require them to represent the interests of the corporation and the shareholders first, above all other interests, including their own”. The culture of 'what can we get away with' eroded public confidence in American financial markets.
Until the passage of the Sarbanes-Oxley Act of 2002 both the accounting and the legal professions were allowed to set their own ethics rules with little or no oversight by the government. Official oversight results by professional auditors were therefore often kept confidential. This caused a “see no evil, hear no evil” attitude in many boards, because no board member wanted to be accused of being a “spoil sport” when the going was good.
How to regain trust?
In 2002, Tyco agreed to replace all board members who served with Kozlowksy, notably one of them being Michael Ashcroft. The move came after investors and a New Hampshire regulator objected to a bid to keep two of the board members . It was a good step in the direction of regaining investor confidence. Sarbanes-Oxley establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The act contains a minimum standard which Tyco needs to improve upon. There are several points that Tyco can take into consideration.
Direct measures:
1. Transparent corporate structure.
The complex acquisition schemes of the late 20th century caused a great many board members to lose oversight. Only a professional accountant or lawyer would be able to make sense of the great many links, special purpose vehicles and other specialized structures. Board members are often chosen because of their standing and past expertise, not for their current knowledge. The simpler the company structure, the easier it is to follow for board members and shareholders.
2. Truly independent board members.
Sarbanes-Oxley requires a greater number of outside board members. Individual board members should be able to acquire outside advice and be accountable for any decisions they make. Board members should be able to challenge executive decisions before they are made.
3. More influence of stakeholders.
Financial stakeholders should be engaged in (potential) management issues. Even in the SOX era, stakeholders are often informed after a decision has been made. A good example of this is ABN AMRO’s sale of LaSalle to Bank of America. This deal was made over the weekend without informing the shareholders. The decision was held up in court but only because ABN AMRO was to be sold anyway.
4. Direct influence on reward structure.
SOX requires executive compensation to be published. This doesn’t guarantee any influence over the board’s executive compensation policy. Fortis Bank’s CEO, Jean-Paul Votron has been ousted because his salary was raised 73% while at the same time Fortis chose not to pay dividend and to issue emergency stock. This was done after the decision and only because shareholders revolted. It will undoubtedly result in a golden parachute for the former CEO.
In the long term, Tyco should create and stimulate a corporate culture where the interest of all stakeholders comes first. A workers council, like that required by law in The Netherlands should be able to challenge management decisions. Shareholders need to get more direct influence on important company decisions and long term strategy. Other stakeholder groups should be engaged in the dialogue.
Periodical reporting could be replaced by a balanced scorecard or dashboard structure. In the information age it’s much easier to provide up to date information to stakeholders without losing a competitive edge.
Resources.
To enhance a company’s reputation there are principles to adhere to:
- Publish what you preach. The internet is a good medium to tell the world what your company is up to.
- Practice what you preach. Show in actions what the board tends to do about stakeholder issues. The media are an important source to show and tell.
- Be accountable. Board members and executives should be held accountable for their actions. This doesn’t mean blamestorming but each decision should be defendable. If not, the board member or executive needs to go.
- Training. One of the most important resources to get a good reputation is training of staff and board. If you know about SOX requirements it becomes a lot harder to say that you weren’t aware when there are issues to deal with.
Tuesday, July 8, 2008
Is PC sports gaming dead?
Peter Moore, head honcho at EA Sports, has confirmed that the latest sports sim, Madden NFL ’09 will not be brought out on the PC. I’ve never really played EA sports games but the reasons that Moore gave for staying away from what used to be a premier gaming platform intrigue me. I can understand that the decline in demand for PC sports games makes development not viable. The piracy issue is a bit more difficult to grasp, since piracy on the Xbox 360 and Wii is just as rampant. Only Sony has managed to keep the door shut on its flagship PS3 although the PSP is a lost cause. Moore argues that “The business model for PC games is evolving from packaged goods to a download model. The on-line experience is paramount, and hundreds of companies in this space are experimenting with direct-to-consumer revenue models, incorporating premium downloadable content, sponsored downloads, micro-transactions, subscriptions and massive tournament play.” It sounds like EA wants to have nothing to do with them modern shenanigans. Isn't EA in danger of losing its market leadership with conservative thinking like that? Just like Apple brought music online so will other companies bring gaming online.
Lately I’ve been playing a little game called Top Speed. This cute, cartoonish racing game will be published by IAH games and is now in open beta. As the name suggests you have to drive your kart as fast as possible round a fantasy track. For those familiar with Mario Kart, it’s exactly like that. The big difference is the business model behind it. Instead of buying an expensive disk in a fancy package, bringing it home and hopefully find out that you didn’t buy 15 minutes of boredom, the game is free to download and free to play. Once you install the (moderately sized) client, you can literally design your driver. Sex, hairstyle, clothes, everything is customizable. There’s one basic kart to start with. Once you’re finished designing, off you go to race other gamers online. A race lasts up to 10 minutes and you get immediate results in the form of gold , experience, bonus items and a place on the scoreboard. With earned gold you can upgrade your kart or buy a new wardrobe for your driver, the experience points allow you to buy better karts, more powerful engines better wheels etc. Even if you have all the gold in the world, you still need to win races and gain experience to be able to drive your new cow mobile (I kid you not, there’s a cow mobile in there). Though the game is aimed at a younger crowd, I found myself in that zone that makes any game addictive; the “just one more time” zone. Have I mentioned that you can buy bombs and missiles to get rid of pesky competition in the race?
The brilliance behind Top Speeds business model is that it doesn’t cost anything to find out if you like the game. If you do, you can make it as expensive as you want. The big difference with MMORPG’s that have been free to play, as well as subscription based, is speed, competitiveness and continuity. World of Warcraft, the premier pay-to-play game has millions of players, but you need to spend at least a few weeks to get anywhere in the game and even more to gain levels. They don’t call it “grinding” for nothing.
Top Speed is very easy to learn, immediately fun to play but lasts as long as you want. You do get “quests” to gain extra items but the focus is to race, master drifting and generally have a good time with other players all over the world. Once you shut down your PC, your achievements will still be online. You can gain a name for yourself or just play for fun.
Free to play games need to generate revenue off course. Once you truly get into the game, you need to buy points with real money so you can have the best equipment to win the next race. Your competition will do the same so you’ll have yourself a nice little arms race going on. I’ve been on that road before, when internet was still in the hand of universities and the military. When I was in high school, a little play-by-mail game called “It’s a crime” sucked away my wage as a helper in the local supermarket as fast as I could earn it. With instant internet purchases, the money is bound to go even faster.
Top Speed shows that there is a future for PC sports games and I’m surprised that EA doesn’t jump into that niche. EA owns the rights to several franchises that beg for a model like Top Speed. FIFA, Nascar, NFL, PGA are just a few of the big ones. There are other (mostly Asian) free to play sports games, like Shot Online, but wouldn’t it be great to compete in an adult non cartoonish sports league where even the biggest couch potato can score a hole in one or win the World Cup?
Microsoft and Sony have a variation on the model, where you buy the game and can play online for free. A big reason Moore doesn’t mention in his blog but which must have played a big role, is development cost. On a closed platform like the Xbox 360 you don’t have to take hundreds of different hardware configurations into account. PC’s are still evolving fast and high level programming doesn’t allow getting the most out of the hardware. EA Sports games are struggling to re-invent themselves every year and are leaning heavily on eye candy and a lot less on originality. On a close platform, programmers can just take different elements from EA’s library and build games like a LEGO project. If you don’t need specialized programmers, you can keep cost down. If you don’t need to develop special routines, you can keep cost down. If you don’t need to update your games to keep your players you can use your resources for next years game and keep cost down. EA’s sports games will always be “same-same but different”.
With a free to play model you run the risk that if your game doesn’t meet expectations, players won’t pay. With the EA model you can try better next year. There will always be a place for subscription based games like World of Warcraft but in my opinion, the free to play or more accurately pay-as-you-play games have the future. Sports games have the advantage of speed, ease of play and you can pay as much as you like. Mature players with little time can play a quick round of golf or race a few laps on their notebook while waiting at the airport. Try doing that with your PS3! Capturing the interest and wallets of this group sounds like good business to me, but I guess EA knows what its doing when they leave the PC behind.
A few weeks ago I talked about taking free to play games mobile at a mobile banking conference. If done right, this will be the next big step. Mark my words.
Lately I’ve been playing a little game called Top Speed. This cute, cartoonish racing game will be published by IAH games and is now in open beta. As the name suggests you have to drive your kart as fast as possible round a fantasy track. For those familiar with Mario Kart, it’s exactly like that. The big difference is the business model behind it. Instead of buying an expensive disk in a fancy package, bringing it home and hopefully find out that you didn’t buy 15 minutes of boredom, the game is free to download and free to play. Once you install the (moderately sized) client, you can literally design your driver. Sex, hairstyle, clothes, everything is customizable. There’s one basic kart to start with. Once you’re finished designing, off you go to race other gamers online. A race lasts up to 10 minutes and you get immediate results in the form of gold , experience, bonus items and a place on the scoreboard. With earned gold you can upgrade your kart or buy a new wardrobe for your driver, the experience points allow you to buy better karts, more powerful engines better wheels etc. Even if you have all the gold in the world, you still need to win races and gain experience to be able to drive your new cow mobile (I kid you not, there’s a cow mobile in there). Though the game is aimed at a younger crowd, I found myself in that zone that makes any game addictive; the “just one more time” zone. Have I mentioned that you can buy bombs and missiles to get rid of pesky competition in the race?
The brilliance behind Top Speeds business model is that it doesn’t cost anything to find out if you like the game. If you do, you can make it as expensive as you want. The big difference with MMORPG’s that have been free to play, as well as subscription based, is speed, competitiveness and continuity. World of Warcraft, the premier pay-to-play game has millions of players, but you need to spend at least a few weeks to get anywhere in the game and even more to gain levels. They don’t call it “grinding” for nothing.
Top Speed is very easy to learn, immediately fun to play but lasts as long as you want. You do get “quests” to gain extra items but the focus is to race, master drifting and generally have a good time with other players all over the world. Once you shut down your PC, your achievements will still be online. You can gain a name for yourself or just play for fun.
Free to play games need to generate revenue off course. Once you truly get into the game, you need to buy points with real money so you can have the best equipment to win the next race. Your competition will do the same so you’ll have yourself a nice little arms race going on. I’ve been on that road before, when internet was still in the hand of universities and the military. When I was in high school, a little play-by-mail game called “It’s a crime” sucked away my wage as a helper in the local supermarket as fast as I could earn it. With instant internet purchases, the money is bound to go even faster.
Top Speed shows that there is a future for PC sports games and I’m surprised that EA doesn’t jump into that niche. EA owns the rights to several franchises that beg for a model like Top Speed. FIFA, Nascar, NFL, PGA are just a few of the big ones. There are other (mostly Asian) free to play sports games, like Shot Online, but wouldn’t it be great to compete in an adult non cartoonish sports league where even the biggest couch potato can score a hole in one or win the World Cup?
Microsoft and Sony have a variation on the model, where you buy the game and can play online for free. A big reason Moore doesn’t mention in his blog but which must have played a big role, is development cost. On a closed platform like the Xbox 360 you don’t have to take hundreds of different hardware configurations into account. PC’s are still evolving fast and high level programming doesn’t allow getting the most out of the hardware. EA Sports games are struggling to re-invent themselves every year and are leaning heavily on eye candy and a lot less on originality. On a close platform, programmers can just take different elements from EA’s library and build games like a LEGO project. If you don’t need specialized programmers, you can keep cost down. If you don’t need to develop special routines, you can keep cost down. If you don’t need to update your games to keep your players you can use your resources for next years game and keep cost down. EA’s sports games will always be “same-same but different”.
With a free to play model you run the risk that if your game doesn’t meet expectations, players won’t pay. With the EA model you can try better next year. There will always be a place for subscription based games like World of Warcraft but in my opinion, the free to play or more accurately pay-as-you-play games have the future. Sports games have the advantage of speed, ease of play and you can pay as much as you like. Mature players with little time can play a quick round of golf or race a few laps on their notebook while waiting at the airport. Try doing that with your PS3! Capturing the interest and wallets of this group sounds like good business to me, but I guess EA knows what its doing when they leave the PC behind.
A few weeks ago I talked about taking free to play games mobile at a mobile banking conference. If done right, this will be the next big step. Mark my words.
Friday, July 4, 2008
Energy and Power.
A friend of mine, who is in the risk consultancy business, pointed me towards a blog posting on the New York Times website. The accompanying chart shows how Sovereign Wealth Funds (SWF’s) are related and how the money streams flow. They look uncannily like weather patterns and, like I mentioned before, the clouds are mainly packing on the financial shores of the US and European banks. I was a bit surprised that the writer of this excellent piece mentioned “…sovereign funds have also learned the downside of deal-making: some of their blockbuster transactions have been big money losers so far”. This is truly thinking like an investment banker. If it doesn’t make money, it’s not worth it.
The reality is a lot more complicated though. The enormous sums of money that have been flowing into the oil exporting countries have created massive pools of liquidity. There are only so many houses, Rolls Royces and Ferraris you can buy with cash and if you pump too much in an economy, the US one included, the result will be overheating, inflation, misery and sorrow. You don’t want your customer’s economy to get unhealthy, especially if that customer has the tendency to invade your country if he doesn’t like you.
So the resident sheiks, presidents and assorted other rulers have been looking for ways to spent their money on other things. In contrary to the NYT blog, I think that a lot of SWF’s are not created to invest money but to buy something that’s of much more value: power.
Henry Liu wrote already in 2002 in the Asian Times:” Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. “
The US have always used their vast consumer economy as a weapon of deterrence and influence. It’s not the US military that keep the country on top, but the dependence on the US dollar as the world’s currency. Like a father threatening to withhold pocket money, most countries will do what the US tells them to or risk loosing the privilege to trade in US currency. With oil trade exclusively in dollars, countries need to maintain good amount of U.S. currency in their reserves to buy oil. At the end of 2000, the Bank for International Settlements estimated world dollar reserves of $1.45 trillion, or 76% of the total world reserves of $1.09 trillion.
Banks and other companies trading in US currency (and which bank doesn’t?) have to comply with the regulations set up by the Office of Foreign Asset Control (OFAC) and US Treasury Department's Financial Crimes Enforcement Network (FinCEN) or risk ending up on one of the sanction lists, which basically ends the ability to function on the world market. On the other hand, countries that have the favor of the US have access to the largest consumer market in the world to sell their goods. It’s by using this carrot and stick method that the US is the dominant power in the world.
When Iraq, in September 2000, switched to the Euro to settle oil contracts, it set a very dangerous precedence. If the other OPEC countries would follow, the end of the US dollar as dominant currency and with it the end of the US as dominant power would be in sight. After the Euro increased in value against the dollar, the conversion to petro Euros became a clear and present danger to the US. As a nation addicted to oil, the US would have to buy Euros to pay for its habit, where it could have used dollars before. Furthermore, the US borrow $665 billion annually from foreign lenders to finance the gap between payments to and receipts from the rest of the world. With no improvement in the current account deficit, the external debt of the United States will rise from 24% of total U.S. gross domestic product (GDP) at the end of 2003 to 64% by 2014.
The Chinese and Japanese, who have accumulated enormous dollar reserves, could finally drain this pool by converting to the Euro and hedge against the depreciation of the dollar. The Russians see Europe as an important trading partner and would have no objection to switching either. This creates new blocks that will shift most power from the US.
After the invasion of Iraq, the country quietly switched back to dollars, putting a temporary halt to the threat. It became clear to other countries in the region that there was a heavy price to pay for disobedience. 9/11 not only underlined the contrast between the Eastern “Islamic” world and the Western “Christian” world but made it increasingly more difficult for Middle Eastern countries to spend their petro dollars. When Dubai made a bid for several US ports, the domestic political resistance made it impossible to get the deal done.
So what to do with all those dollars? The US mortgage crisis and the subsequent liquidity crisis was a heaven sent for the dollar swollen SWF’s. Here was an opportunity, not only to get rid of the excess amounts of US currency but to quietly build up a position of power inside the financial bastions of the US and Europe. For funds like Temasek and CIC it may just be good investments. For the Middle Eastern funds there’s much more at stake then good returns.
The urgent need for liquidity made most banks less picky about who invested in them. As I wrote before, this may come back to haunt them. On the top, the posturing of Iran makes it appear that the struggle is about physical domination of the region. Under the surface though, there are much more complicated and bigger things going on. As the Chinese proverb says “may you live in interesting times”.
The reality is a lot more complicated though. The enormous sums of money that have been flowing into the oil exporting countries have created massive pools of liquidity. There are only so many houses, Rolls Royces and Ferraris you can buy with cash and if you pump too much in an economy, the US one included, the result will be overheating, inflation, misery and sorrow. You don’t want your customer’s economy to get unhealthy, especially if that customer has the tendency to invade your country if he doesn’t like you.
So the resident sheiks, presidents and assorted other rulers have been looking for ways to spent their money on other things. In contrary to the NYT blog, I think that a lot of SWF’s are not created to invest money but to buy something that’s of much more value: power.
Henry Liu wrote already in 2002 in the Asian Times:” Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. “
The US have always used their vast consumer economy as a weapon of deterrence and influence. It’s not the US military that keep the country on top, but the dependence on the US dollar as the world’s currency. Like a father threatening to withhold pocket money, most countries will do what the US tells them to or risk loosing the privilege to trade in US currency. With oil trade exclusively in dollars, countries need to maintain good amount of U.S. currency in their reserves to buy oil. At the end of 2000, the Bank for International Settlements estimated world dollar reserves of $1.45 trillion, or 76% of the total world reserves of $1.09 trillion.
Banks and other companies trading in US currency (and which bank doesn’t?) have to comply with the regulations set up by the Office of Foreign Asset Control (OFAC) and US Treasury Department's Financial Crimes Enforcement Network (FinCEN) or risk ending up on one of the sanction lists, which basically ends the ability to function on the world market. On the other hand, countries that have the favor of the US have access to the largest consumer market in the world to sell their goods. It’s by using this carrot and stick method that the US is the dominant power in the world.
When Iraq, in September 2000, switched to the Euro to settle oil contracts, it set a very dangerous precedence. If the other OPEC countries would follow, the end of the US dollar as dominant currency and with it the end of the US as dominant power would be in sight. After the Euro increased in value against the dollar, the conversion to petro Euros became a clear and present danger to the US. As a nation addicted to oil, the US would have to buy Euros to pay for its habit, where it could have used dollars before. Furthermore, the US borrow $665 billion annually from foreign lenders to finance the gap between payments to and receipts from the rest of the world. With no improvement in the current account deficit, the external debt of the United States will rise from 24% of total U.S. gross domestic product (GDP) at the end of 2003 to 64% by 2014.
The Chinese and Japanese, who have accumulated enormous dollar reserves, could finally drain this pool by converting to the Euro and hedge against the depreciation of the dollar. The Russians see Europe as an important trading partner and would have no objection to switching either. This creates new blocks that will shift most power from the US.
After the invasion of Iraq, the country quietly switched back to dollars, putting a temporary halt to the threat. It became clear to other countries in the region that there was a heavy price to pay for disobedience. 9/11 not only underlined the contrast between the Eastern “Islamic” world and the Western “Christian” world but made it increasingly more difficult for Middle Eastern countries to spend their petro dollars. When Dubai made a bid for several US ports, the domestic political resistance made it impossible to get the deal done.
So what to do with all those dollars? The US mortgage crisis and the subsequent liquidity crisis was a heaven sent for the dollar swollen SWF’s. Here was an opportunity, not only to get rid of the excess amounts of US currency but to quietly build up a position of power inside the financial bastions of the US and Europe. For funds like Temasek and CIC it may just be good investments. For the Middle Eastern funds there’s much more at stake then good returns.
The urgent need for liquidity made most banks less picky about who invested in them. As I wrote before, this may come back to haunt them. On the top, the posturing of Iran makes it appear that the struggle is about physical domination of the region. Under the surface though, there are much more complicated and bigger things going on. As the Chinese proverb says “may you live in interesting times”.
Monday, June 30, 2008
Boeing and Airbus, Flight of the Titans part 2.
For the last five years both Boeing and Airbus have been in a head-to-head battle to market their new airplanes; the midsize, efficient 787 “Dreamliner” and the super large and comfortable Airbus A380. Despite their differences both planes can be seen as substitutes as not many airlines will buy both models.
2004 was a tense year for Seattle. Once again, the company’s leaders’ forecasts — 200 B787 Dreamliners to be sold by the end of the year— failed to come true. As the company scrambled to restore its reputation from a defense procurement scandal, CEO Harry Stonecipher started a trade war with Europe — and was then forced out in disgrace over sexual indiscretions. Toby Bright became the latest of a line of Boeing commercial directors to be cast out . The strategies of Boeing, the long standing industry leader and that of its European rival Airbus are quite different. While they share a view of market size, there is one big difference in the two companies’ market forecasts. Airbus sees a very large 20-year market for widebody aircraft, accounting for 10 percent of deliveries and 22 per cent of revenues: 1,250 passenger aircraft and almost 400 freighters. Boeing latest market forecasts suggest that airlines will need barely more than 300 passenger aircraft larger than the B747, and around 400 aircraft in the B747 bracket. In fact, Boeing expects that the average size of commercial aircraft will decline as airlines turn to intermediate and large twin engine aircraft for long-haul routes, bypassing hubs. That view has in turn driven the companies’ major investments. Airbus has pumped more than $12bn into the A380 program, including overruns. Boeing never reveals development costs (much less overruns), but the company has spent a large budget on the development of the new Boeing 787 as can be derived from the new factories and production tools that were developed to support production of the new airplane.
The 787 is a modest successor to the iconic 747-400 and the 767. It’s smaller and more fuel efficient. The Airbus bets on the trend that airlines will carry more passengers in fewer flights. The Airbus A330 on the other hand is a very large super jumbo that can carry 555 seats in a three class and 853 in a single class configuration. This is 35% more than the Boeing 747. Singapore Airlines, the first that received an A380 even has super first class “cabins” on board that have their own beds.
Boeings outsourcing strategy versus Airbus in-house production.
For Boeing one of the major challenges to overcome was the unprecedented outsourcing of production. To keep cost down, third party contractors were used to design and build a large amount of the tens of thousands of parts, a majority of which would be made out of carbon fiber instead of the more traditional aluminum alloys. Direct fixed costs would be larger than those of Airbus because of the specialized new machinery needed to work with carbon fiber but variable and labor cost were expected to be much lower because of the outsourcing and off shoring of production. Boeing set up an internet based “world community” to design the then unnamed 7E7 that later would be renamed 787. Top level design however was done in Everett as Boeing holds closely to it’s store secrets. In this Boeing is moving from an airplane manufacturer to a designer and system integrator like Apple Inc. Applying a lean manufacturing process could help expand margins like it did for Toyota which uses a similar process for its cars.
The wings are manufactured by Japanese companies in Nagoya, e.g. Mitsubishi Heavy Industries; the horizontal stabilizers are manufactured by Alenia Aeronautica in Italy; and the fuselage sections by Vought in Charleston, South Carolina, (USA), Alenia in Italy, Kawasaki Heavy Industries in Japan and Spirit AeroSystems, in Wichita, Kansas, (USA).Final assembly employs just 800 to 1,200 people to join completed subassemblies and integrate systems. Despite cost savings the long supply line proved vulnerable, causing delays in production. The 787-8, which previously was listed at $148-$157.5 million was re-priced tot $157-$167 million after re-evaluation of cost and materials. The production delays not only cause penalties to be paid to the airlines but devaluation makes payment in dollars less attractive for the Seattle Company. In economic terms: every dollar not in the Boeing account makes production more expensive. Production abroad is becoming more expensive as well because local wages and fees have to be paid in higher value local currency.
Airbus took a different approach by keeping development largely in house. By keeping supply lines relatively short and designers closer together it was able to develop faster. Major structural sections of the A380 are built in France, Germany, Spain, and the United Kingdom. Due to their size, they are brought to the assembly hall in Toulouse in France by surface transportation. Since all EU countries except the UK settle accounts in Euro’s there was much less currency risk. Airbus is still acting like a traditional manufacturer that keeps everything in house. Even so, the multinational roots of the company make it difficult to work as a team. The French and German engineers often misunderstood each other. The delays in manufacturing were more caused by extra demands from the airlines and hold ups in the design process then from the production process itself. A big difference with the Boeing approach is that by manufacturing in house, labor cost is more a fixed part of the total cost then a variable part. Boeing can pick and choose whom to hire for its production, Airbus doesn’t have that luxury. Meanwhile, the two competitors continue to sell head-to-head in every market segment. In single-aisle aircraft, Airbus has no plans for any major changes to the A320 family.
The aircraft market is in fact a duopoly with very high barriers to entry. So far, Boeing’s success with the B787 has not changed the fact that the two rivals’ market shares are close to 50:50; and both, recently, have stated that profits matter more than market share. Both companies, also, share an optimistic overview of the market — projecting well over 800 new aircraft deliveries a year for the next 20 years, a market that Airbus values at $1.9 trillion.
As an American company, Boeing has a big competitive advantage; the military. There is no threat that the US government will negotiate away Boeing’s access to Washington state tax breaks or to any of the foreign markets that are depended on US military aid. Airbus simply can’t compete to replace the USAF’s tanker planes. Airbus has to compete in each European country separately if it wants to sell its aircraft for military purposes.
Conclusion
Offloading part production is a sound method for producing complicated products like aircraft. Boeings outsourcing has become more flexible because production can be switched to other factories or countries if bottlenecks occur. Asia is a large target market for Boeing and as such the availability of production and maintenance facilities close to the customer are a good sales argument. There are drawbacks however. Airbus can invest in improving processes — for example, using lasers rather than physical gauges to inspect composite skins — test it on one product (the A320, for instance) and then apply it immediately to the rest of the line and thereby amortize its costs. Boeing can’t do that because their sub-contractors are more or less independent, outside the company. Boeing’s aircraft have no parts in common while Airbus strives at inter-operability of parts.
Airbus decision to develop an airplane in an entirely different segment of the market was both risky and necessary. Boeing sought to take advantage of a truly globalized world while Airbus wanted shorter production lines and more control. Off course nationalistic factors should also be taken into account. As a crown jewel of the American industry, the US government is bound to support Boeing as much as possible. Japan has been a close ally of the US since WO2 and could be used as a safe outsourcing destination. Airbus on the other hand has EU politics to contend with. Its decision to spread out production between EU member states is as much a political as a strategic decision. At the launch of the A380, French president Chirac, Prime Minister Blair from the UK, The German Chancellor Schroeder, and Prime Minister Zapatero from Spain were all present, underlining the political commitment to make Airbus a successful business. This was much to the dismay of the US officials who (officially) oppose any kind of government intervention in the marketplace.
For Boeing to be proved correct the A380 must not attract substantial new business and existing customers must cease buying the aircraft beyond their initial orders. This does not seem likely. The duopoly will continue until a third player enters the field. This player might well be of Chinese origin .
2004 was a tense year for Seattle. Once again, the company’s leaders’ forecasts — 200 B787 Dreamliners to be sold by the end of the year— failed to come true. As the company scrambled to restore its reputation from a defense procurement scandal, CEO Harry Stonecipher started a trade war with Europe — and was then forced out in disgrace over sexual indiscretions. Toby Bright became the latest of a line of Boeing commercial directors to be cast out . The strategies of Boeing, the long standing industry leader and that of its European rival Airbus are quite different. While they share a view of market size, there is one big difference in the two companies’ market forecasts. Airbus sees a very large 20-year market for widebody aircraft, accounting for 10 percent of deliveries and 22 per cent of revenues: 1,250 passenger aircraft and almost 400 freighters. Boeing latest market forecasts suggest that airlines will need barely more than 300 passenger aircraft larger than the B747, and around 400 aircraft in the B747 bracket. In fact, Boeing expects that the average size of commercial aircraft will decline as airlines turn to intermediate and large twin engine aircraft for long-haul routes, bypassing hubs. That view has in turn driven the companies’ major investments. Airbus has pumped more than $12bn into the A380 program, including overruns. Boeing never reveals development costs (much less overruns), but the company has spent a large budget on the development of the new Boeing 787 as can be derived from the new factories and production tools that were developed to support production of the new airplane.
The 787 is a modest successor to the iconic 747-400 and the 767. It’s smaller and more fuel efficient. The Airbus bets on the trend that airlines will carry more passengers in fewer flights. The Airbus A330 on the other hand is a very large super jumbo that can carry 555 seats in a three class and 853 in a single class configuration. This is 35% more than the Boeing 747. Singapore Airlines, the first that received an A380 even has super first class “cabins” on board that have their own beds.
Boeings outsourcing strategy versus Airbus in-house production.
For Boeing one of the major challenges to overcome was the unprecedented outsourcing of production. To keep cost down, third party contractors were used to design and build a large amount of the tens of thousands of parts, a majority of which would be made out of carbon fiber instead of the more traditional aluminum alloys. Direct fixed costs would be larger than those of Airbus because of the specialized new machinery needed to work with carbon fiber but variable and labor cost were expected to be much lower because of the outsourcing and off shoring of production. Boeing set up an internet based “world community” to design the then unnamed 7E7 that later would be renamed 787. Top level design however was done in Everett as Boeing holds closely to it’s store secrets. In this Boeing is moving from an airplane manufacturer to a designer and system integrator like Apple Inc. Applying a lean manufacturing process could help expand margins like it did for Toyota which uses a similar process for its cars.
The wings are manufactured by Japanese companies in Nagoya, e.g. Mitsubishi Heavy Industries; the horizontal stabilizers are manufactured by Alenia Aeronautica in Italy; and the fuselage sections by Vought in Charleston, South Carolina, (USA), Alenia in Italy, Kawasaki Heavy Industries in Japan and Spirit AeroSystems, in Wichita, Kansas, (USA).Final assembly employs just 800 to 1,200 people to join completed subassemblies and integrate systems. Despite cost savings the long supply line proved vulnerable, causing delays in production. The 787-8, which previously was listed at $148-$157.5 million was re-priced tot $157-$167 million after re-evaluation of cost and materials. The production delays not only cause penalties to be paid to the airlines but devaluation makes payment in dollars less attractive for the Seattle Company. In economic terms: every dollar not in the Boeing account makes production more expensive. Production abroad is becoming more expensive as well because local wages and fees have to be paid in higher value local currency.
Airbus took a different approach by keeping development largely in house. By keeping supply lines relatively short and designers closer together it was able to develop faster. Major structural sections of the A380 are built in France, Germany, Spain, and the United Kingdom. Due to their size, they are brought to the assembly hall in Toulouse in France by surface transportation. Since all EU countries except the UK settle accounts in Euro’s there was much less currency risk. Airbus is still acting like a traditional manufacturer that keeps everything in house. Even so, the multinational roots of the company make it difficult to work as a team. The French and German engineers often misunderstood each other. The delays in manufacturing were more caused by extra demands from the airlines and hold ups in the design process then from the production process itself. A big difference with the Boeing approach is that by manufacturing in house, labor cost is more a fixed part of the total cost then a variable part. Boeing can pick and choose whom to hire for its production, Airbus doesn’t have that luxury. Meanwhile, the two competitors continue to sell head-to-head in every market segment. In single-aisle aircraft, Airbus has no plans for any major changes to the A320 family.
The aircraft market is in fact a duopoly with very high barriers to entry. So far, Boeing’s success with the B787 has not changed the fact that the two rivals’ market shares are close to 50:50; and both, recently, have stated that profits matter more than market share. Both companies, also, share an optimistic overview of the market — projecting well over 800 new aircraft deliveries a year for the next 20 years, a market that Airbus values at $1.9 trillion.
As an American company, Boeing has a big competitive advantage; the military. There is no threat that the US government will negotiate away Boeing’s access to Washington state tax breaks or to any of the foreign markets that are depended on US military aid. Airbus simply can’t compete to replace the USAF’s tanker planes. Airbus has to compete in each European country separately if it wants to sell its aircraft for military purposes.
Conclusion
Offloading part production is a sound method for producing complicated products like aircraft. Boeings outsourcing has become more flexible because production can be switched to other factories or countries if bottlenecks occur. Asia is a large target market for Boeing and as such the availability of production and maintenance facilities close to the customer are a good sales argument. There are drawbacks however. Airbus can invest in improving processes — for example, using lasers rather than physical gauges to inspect composite skins — test it on one product (the A320, for instance) and then apply it immediately to the rest of the line and thereby amortize its costs. Boeing can’t do that because their sub-contractors are more or less independent, outside the company. Boeing’s aircraft have no parts in common while Airbus strives at inter-operability of parts.
Airbus decision to develop an airplane in an entirely different segment of the market was both risky and necessary. Boeing sought to take advantage of a truly globalized world while Airbus wanted shorter production lines and more control. Off course nationalistic factors should also be taken into account. As a crown jewel of the American industry, the US government is bound to support Boeing as much as possible. Japan has been a close ally of the US since WO2 and could be used as a safe outsourcing destination. Airbus on the other hand has EU politics to contend with. Its decision to spread out production between EU member states is as much a political as a strategic decision. At the launch of the A380, French president Chirac, Prime Minister Blair from the UK, The German Chancellor Schroeder, and Prime Minister Zapatero from Spain were all present, underlining the political commitment to make Airbus a successful business. This was much to the dismay of the US officials who (officially) oppose any kind of government intervention in the marketplace.
For Boeing to be proved correct the A380 must not attract substantial new business and existing customers must cease buying the aircraft beyond their initial orders. This does not seem likely. The duopoly will continue until a third player enters the field. This player might well be of Chinese origin .
Monday, June 23, 2008
Stakeholders and Wal-Mart, an analysis
1. Wal-Mart, a history of success.
In 1962, Sam Walton expanded his retail career by opening the first Wal-Mart Discount City Store in Arkansas. Walton had had significant success with a discount shop he called “Walton’s Five and Dime Store” in Bentonville by putting sales volume before prices. Accepting a slightly lower margin, he had managed to drive out the competition and achieve an image of low prices without compromising quality. Walton continued the growth of his Bentonville store at accelerated pace and soon expanded to 24 stores across Arkansas, reaching $12.6 million in sales.
The company was incorporated as Wal-Mart Stores, Inc. on October 31, 1969. In 1970, it opened a home office and first distribution center in Bentonville. It had 38 stores operating with 1,500 employees and sales of $44.2 million. It began trading stock as a publicly-held company on October 1, 1972, and was soon listed on the New York Stock Exchange. The first stock split occurred in May 1971 at a market price of $47. By this time, Wal-Mart was operating in five states: Arkansas, Kansas, Louisiana, Missouri, and Oklahoma; it entered Tennessee in 1973 and Kentucky and Mississippi in 1974. As it moved into Texas in 1975, there were 125 stores with 7,500 employees and total sales of $340.3 million.
The growth continued, indicating that Wal-Mart’s strategy was solid. In 1987 there were 1,198 stores with sales of $15.9 billion and 200,000 associates. In 2006, Wal-Mart was 67th most profitable corporation (profits divided by total revenue), behind retailers Home Depot, Dell, and Target, and ahead of Costco and Kroger. Today Wal-Mart employs more than 2 million associates worldwide, including more than 1.4 million in the United States with over $374 billion in sales worldwide for the fiscal year ending Jan. 31, 2008
With success often come concerns over the way this is achieved. Labor unions, religious organizations and environmental groups have criticized Wal-Mart for its policies and business practices. Other areas of criticism include the corporation's foreign product sourcing, treatment of product suppliers, environmental practices, the use of public subsidies, and the company's security policies . Wal-Mart has also been criticized for some of the products that it carries. Diverse groups have accused Wal-Mart of selling anti-Semitic, anti-black, anti-Christian or other objectionable materials or of not selling products like “The Daily Show's America (The Book)” that depicted a US Supreme Court judge nude, calling it censorship.
Despite the criticism, Wal-Mart seems to stick to the core strategies that carry its success.
2. Wal-Mart strategies and their impact.
The way that Wal-Mart Stores Inc. creates growth is summarized by the company’s new slogan:
“Save money, Live better”
When Sam Walton created Wal-Mart, he declared that three policy goals would define his business: respect for the individual, service to customers, and striving for excellence. By choosing clearly identifiable strategies and sticking with them, Wal-Mart has achieved de-facto cost leadership and sustainable value for the company’s shareholders.
Wal-Mart achieves Cost Leadership by four main strategic goals .
1. Dominate the Retail Market wherever Wal-Mart has a presence.
2. Growth by expansion in the US and Internationally.
3. Create widespread name recognition and customer satisfaction with the Wal-Mart brand, and associate the retailer with the reputation of offering the best prices.
4. Branching out into new sectors of retailing such as pharmacies, automotive repair, and grocery sales.
Wal-Mart management strategy emphasizes its workforce and its corporate culture. It wants to create an image of a morally conservative, religious, and family-oriented business. Wal-Mart emphasizes how it listens to the needs of its workforce as stated in the “factsheets” on the corporate website. Store employees are called “associates” and are treated part of the Wal-Mart family. Wal-Mart states that “Unlike the employees of many of our retail competitors, Wal-Mart associates – both full and part-time – can become eligible for health benefits”. However; the bulk of Wal-Mart's employee base that work at Wal-Mart stores are part time workers who are paid the local minimum wage. Most employees are not entitled to any benefits, as it takes a part-time employee over five years to become eligible for benefits, profit-sharing, or other such compensation . On April 17, 2006, Wal-Mart announced it was making a health care plan available to part-time workers after 1 year of service, instead of the prior 2 year requirement.
Wal-Mart's corporate management strategy involves selling high quality and brand name products at the lowest price. To keep costs low, Wal-Mart negotiates deals for merchandise directly from manufacturers, eliminating the middleman. This often leads to accusation that Wal-Mart misuses its market power to deliberately underpay its suppliers. In Walton’s philosophy, the essence of successful discount retailing is to cut the price on an item as much as possible, lowering the markup, and earn profit on the increased volume of sales. However, when the markup is as low as the company can bear, the burden is often transferred to the supplier, who is depended on Wal-Mart to sell his products. In a modern globalized society, Wal-Mart no longer buys its products on the domestic market but in low-wage countries with often questionable labor practices. More than 70% of the goods sold in Wal-Mart are manufactured in China .
3. What are the stake holder groups and what are their expectations?
A large company like Wal-Mart has a diversity of stake holders, each with their own agenda. Like any commercial entity, the first group is most important for the company’s survival. Stakeholder groups can be divided into internal and external stakeholders:
1. Internal stakeholder interests:
1.1 Shareholders.
As a listed company, Wal-Mart is accountable to its shareholders. Despite growing revenue, share price development has been trailing over the years, only recently picking up. Shareholders are most interested in profit generation and dividend, although in recent times there have been calls for more transparency. Wal-Mart donates generously to political causes without detailing exactly who they are donating to, or how much. Wal-Mart says that full disclosure is already required in many states, but the proponents for this resolution would prefer a centralized source for determining Wal-Mart's state-based political contribution levels. However, as long as the share price of Wal-Mart has a positive trend, shareholders remain upbeat.
1.2 Employees
Wal-Mart’s strategy in keeping prices low translates into an effective “low as possible” wage strategy. Associates at Wal-Mart have often little education, work part-time and have little or no alternative job perspective. Labor conditions and wage are for most an important factor. Recently Wal-Mart has faced issues on both which has led to criticism by labor unions and other external stakeholder group. By the end of 2005, Wal-Mart had launched the website Working Families for Wal-Mart to counter criticisms. Additional efforts to counter criticism include launching a public relations campaign. In reality, the core issues haven’t been addressed yet since they can impact Wal-Marts bottom line severely. Wal-Mart claims to listen to its employees but doesn’t seem to engage their staff.
1.2 Management
Although management is part of a company’s employee corps they can have different interests and priorities. In 2007 when Wal-Marts growth seemed to come to a halt, the company re-organized its top management layers rigorously. It is this groups responsibility to turn the core strategies into practice while at the same time balancing stakeholder interests.
1.3 Suppliers
Suppliers are often seen as external stakeholders. In the case of Wal-Mart, the connection between suppliers and the company is so close that they can be considered internal. Wal-Mart’s cost leadership strategy means that the company will offer only a minimal margin to its suppliers. For a lot of suppliers, Wal-Mart is their major, if not only, customer. As mentioned before, Wal-Mart buys the majority of its products in China. The US labor market just can’t compete with the low wages and large workforce available. Suppliers often use questionable local labor practices to be able to offer the lowest possible price to Wal-Mart. Wal-Mart has been accused of using market power to force its suppliers into self-defeating practices. For example, it is argued that Wal-Mart's constant demand for lower prices caused Kraft Foods to "shut down thirty-nine plants, to let go [of] 13,500 workers, and to eliminate a quarter of its products ”.
2. External stakeholders.
2.1 Customers and the community
Suppliers and customers are both defined as product market stakeholders. In Sam Walton’s eyes, the customer is the most important stakeholder for the company. The demands and priorities of Wal-Marts customers are conflicting creating the largest and potentially most important issues. In an economic downturn, the results of Wal-Mart improve showing that customers shop at Wal-Mart because of the low prices. To maintain low prices, Wal-Mart needs scale, which means opening large stores in small places. This results in a perceived negative impact on communities. Additional, Wal-Mart is often seen as an unfair competitor because local stores can’t compete against the company’s low prices. The recent media attention has focused on the negative aspects although a recent study has shown that the impact of Wal-Mart on small local stores is less than is assumed. It is suggested that Wal-Mart even has a positive impact on small business. A study conducted in 2006 argued that while Wal-Mart's low prices caused some existing businesses to close, the chain also created new opportunities for other small business, and so "the process of creative destruction unleashed by Wal-Mart has no statistically significant impact on the overall size of the small business sector in the United States. "
2.2 Unions and NGO’s
Wal-Mart has been criticized for its policies against labor unions. Other nongovernmental organizations have accused Wal-Mart of using sweatshops and child labor in low wage countries. Wal-Mart's anti-union policies also extend beyond the United States. The documentary Wal-Mart: The High Cost of Low Price, shows one successful unionization of a Wal-Mart store in Jonquière, Quebec (Canada) in 2004. Wal-Mart closed the store five months later because the store had become unprofitable due to the costs of union demands. The priorities of unions are sometimes conflicting. If Wal-Mart fires employees and closes a store it will result in un-employment and loss of benefits. However if they insist on higher wages and better benefits, the result will be unprofitability, causing the store to close.
4. How does Wal-Mart manage stakeholder issues and expectations?
After Wal-Mart’s labor and supplier issues became publicized the company hired public relations firm Edelman to interact with the press and respond to negative or biased media reports. It has used TV commercials emphasizing the health benefits of Wal-Mart associates. Wal-Marts efforts are mainly focused on the positive affect the company can have. In October 2005, Wal-Mart announced it would implement several environmental measures to increase energy efficiency. After Hurricane Katrina struck, Wal-Mart gave $20 million in cash donations, 1,500 truckloads of free merchandise, food for 100,000 meals and the promise of a job for every one of its displaced workers.
The real issue however is that Wal-Mart’s cost leadership strategy doesn’t leave room for higher than minimal wages or excellent labor conditions. Wal-Mart argues that it provides millions with jobs and passes on the saving to millions more.
5. What can Wal-Mart do to improve?
Like many large and not-so-large companies, Wal-Mart has been caught by its own success. As employer and supplier of millions it is open to criticism and needs to be aware of that. By engaging stake holders early and by being transparent in its actions many issues can be prevented. Modern consumers and other stakeholders need to be taken seriously. This doesn’t mean cater to every whim but major problems can’t be covered up anymore in the internet age. Customers on the other hand need to be aware that higher wages, better benefits and labor conditions mean higher prices because Wal-Mart’s margin is already minimal. So far, there hasn’t been a competitor that leveraged on an ethical way of business and cost leadership. Wal-Mart can leverage its market advantage to divert a fraction of the savings it now passes on to the consumer to improve the outstanding issues as long as it can explain to the customer why it is doing so.
Wednesday, June 11, 2008
Is the PVV similar to the NSB?
Since the death of Pim Fortuijn, politicians in The Netherlands have been scrambling to fill the lucrative void that opened up at the far right of the political spectrum. Central to the themes of most wannabes is the (perceived or not) threat formed by immigrants, especially those with Islamic backgrounds. Emphasizing every negative aspect of Islam they can find, the two main contestants vying for right wing votes are Geert Wilders with his PVV and Rita Verdonk with Trots op Nederland (Proud of The Netherlands).
Wilders founded his Party for Freedom (PVV) in February 2006. The PVV started out as a one man fraction when Geert Wilders decided to leave the People Party for Freedom and Democracy (VVD) in September 2004. Wilders could not reconcile himself with the VVD positive stance towards Turkey's possible accession to the European Union, and left the party disgruntled. Wilders decided to go on as “Group Wilders” even though the fraction consisted of only one person. Later, when more people joined his cause, the Group Wilders was renamed PVV even when the party is still revolving around Wilders and his ideas.
Wilders' party is committed to "freedom of the individual"; Wilders believes that the Netherlands has been held hostage by elitist (mostly social democrat and left-wing liberal) politicians for decades. In this his views differ from the “nation above self” doctrine of national socialism. The Party for Freedom combines economic liberalism with a conservative programme towards immigration and culture. The party seeks tax cuts (€16 billion in the 2006 election programme), de-centralization, abolition of the minimum wage, and limiting child benefits and government subsidies. Towards immigration and culture, the party believes that the Judeo-Christian and humanist traditions should be treated as the dominant culture in the Netherlands, and that immigrants should adapt accordingly. The party wants a halt to immigration from non-western countries. It is skeptical towards the EU project, is against future EU enlargement with countries like Turkey and opposes the presence of Islam in the Netherlands. The party is also opposed to dual citizenship.
Wilders has been called a crypto neo-nazi and his party similar to the national socialist movement (NSB) that became symbol of German oppression during the second World War. But is this comparison valid? The NSB, founded in 1931 by Anton Mussert and Cornelis van Geelkerken, started out as an ultra nationalist party with a program based on Italian fascism and German National Socialism. It didn’t target any group in particular until after the German invasion and even had Jewish party members.
Wilders has presented himself as anti-Islamic from the start. After the murder of Dutch cineast and polemist Theo van Gogh by an islamic extremist, Wilder’s references to what he calls “The book (..that..) incites hatred and killing and therefore has no place in our legal order” became more pronounced, culminating in a movie he dubbed “Fitna” or "Strive" that was meant to prove that Islam had no place in Western society. It was more the press coverage and hype that incited worries about reprisals from extremists than the actual movie. Fitna was no more than a compilation of 9/11 clips and beheadings of hostages by terrorists.
Like the German NSDAP, the NSB followed a political ideology concerned with notions of cultural decline remedied by placing the nation or race above the individual. Wilders' views are different in some aspects. Individual freedom is of great importance in the PVV programme. However; in Wilders' eyes, Islam is an authoritarian religion that is not compatible with the "Western" definition of freedom. The selective use of 'freedom' for different groups was also done by the NSB after 1936. Jews where seen as a thread and must therefore be eliminated from society. The PVV doesn't go as far as to propagate extermination but in demanding Muslims to abandon their faith and the Koran to be declared illegal, the party goes at least for a cultural equivalent.
There are more differences than similarities between the PVV and the NSB. In fact, the PVV has stronger views against a named group than the NSB had before 1936. It's not difficult to see however that the PVV uses rethoric and symbols that are eerily similar to that of the (post 1936) NSB. In “Historisch Nieuwsblad” of June 2008, political historian Gjalt Zondergeld posed the question why the PVV had chosen the seagull as its symbol. This symbol was also chosen by the NSB in the 30’s and 40’s as a symbol of freedom. Wilders furiously denied the allegation but wouldn’t explain the motives behind the obvious similar choice.
The reaction of Wilders resembles that of Eugene Terre’Blanche, leader of the racist South African Resistance Movement (Afrikaner Weerstandsbeweging) during the apartheid era. Terre'Blanche viewed the end of apartheid as a surrender to communism just as Wilders views modern day politics in The Netherlands as a surrender to Islam. Symbol for the AWB were 3 black 7’s in a white circle on a red background. When it was mentioned that the symbol strongly resembled the German swastika, Terre’Blanche was furious and denied any similarity. The explanation he gave can be read here.
The PVV does not call itself National Socialist and ideologically there are more differences than similarities. But the words and actions of Wilders and company push the party ever further to the right and with it, the whole tolerant, pragmatic climate of The Netherlands. In this may lie the real threat, because in today's modern world the influence of other cultures and religions can't be ignored anymore.
Wilders founded his Party for Freedom (PVV) in February 2006. The PVV started out as a one man fraction when Geert Wilders decided to leave the People Party for Freedom and Democracy (VVD) in September 2004. Wilders could not reconcile himself with the VVD positive stance towards Turkey's possible accession to the European Union, and left the party disgruntled. Wilders decided to go on as “Group Wilders” even though the fraction consisted of only one person. Later, when more people joined his cause, the Group Wilders was renamed PVV even when the party is still revolving around Wilders and his ideas.
Wilders' party is committed to "freedom of the individual"; Wilders believes that the Netherlands has been held hostage by elitist (mostly social democrat and left-wing liberal) politicians for decades. In this his views differ from the “nation above self” doctrine of national socialism. The Party for Freedom combines economic liberalism with a conservative programme towards immigration and culture. The party seeks tax cuts (€16 billion in the 2006 election programme), de-centralization, abolition of the minimum wage, and limiting child benefits and government subsidies. Towards immigration and culture, the party believes that the Judeo-Christian and humanist traditions should be treated as the dominant culture in the Netherlands, and that immigrants should adapt accordingly. The party wants a halt to immigration from non-western countries. It is skeptical towards the EU project, is against future EU enlargement with countries like Turkey and opposes the presence of Islam in the Netherlands. The party is also opposed to dual citizenship.
Wilders has been called a crypto neo-nazi and his party similar to the national socialist movement (NSB) that became symbol of German oppression during the second World War. But is this comparison valid? The NSB, founded in 1931 by Anton Mussert and Cornelis van Geelkerken, started out as an ultra nationalist party with a program based on Italian fascism and German National Socialism. It didn’t target any group in particular until after the German invasion and even had Jewish party members.
Wilders has presented himself as anti-Islamic from the start. After the murder of Dutch cineast and polemist Theo van Gogh by an islamic extremist, Wilder’s references to what he calls “The book (..that..) incites hatred and killing and therefore has no place in our legal order” became more pronounced, culminating in a movie he dubbed “Fitna” or "Strive" that was meant to prove that Islam had no place in Western society. It was more the press coverage and hype that incited worries about reprisals from extremists than the actual movie. Fitna was no more than a compilation of 9/11 clips and beheadings of hostages by terrorists.
Like the German NSDAP, the NSB followed a political ideology concerned with notions of cultural decline remedied by placing the nation or race above the individual. Wilders' views are different in some aspects. Individual freedom is of great importance in the PVV programme. However; in Wilders' eyes, Islam is an authoritarian religion that is not compatible with the "Western" definition of freedom. The selective use of 'freedom' for different groups was also done by the NSB after 1936. Jews where seen as a thread and must therefore be eliminated from society. The PVV doesn't go as far as to propagate extermination but in demanding Muslims to abandon their faith and the Koran to be declared illegal, the party goes at least for a cultural equivalent.
There are more differences than similarities between the PVV and the NSB. In fact, the PVV has stronger views against a named group than the NSB had before 1936. It's not difficult to see however that the PVV uses rethoric and symbols that are eerily similar to that of the (post 1936) NSB. In “Historisch Nieuwsblad” of June 2008, political historian Gjalt Zondergeld posed the question why the PVV had chosen the seagull as its symbol. This symbol was also chosen by the NSB in the 30’s and 40’s as a symbol of freedom. Wilders furiously denied the allegation but wouldn’t explain the motives behind the obvious similar choice.
The reaction of Wilders resembles that of Eugene Terre’Blanche, leader of the racist South African Resistance Movement (Afrikaner Weerstandsbeweging) during the apartheid era. Terre'Blanche viewed the end of apartheid as a surrender to communism just as Wilders views modern day politics in The Netherlands as a surrender to Islam. Symbol for the AWB were 3 black 7’s in a white circle on a red background. When it was mentioned that the symbol strongly resembled the German swastika, Terre’Blanche was furious and denied any similarity. The explanation he gave can be read here.
The PVV does not call itself National Socialist and ideologically there are more differences than similarities. But the words and actions of Wilders and company push the party ever further to the right and with it, the whole tolerant, pragmatic climate of The Netherlands. In this may lie the real threat, because in today's modern world the influence of other cultures and religions can't be ignored anymore.
Tuesday, June 10, 2008
What goes around…
As the media are predicting the end of the credit crunch, governments and central bankers are becoming increasingly worried. Especially the US, hardest hit by the mortgage crisis and weary of the efforts to keep the backbone in their banks must see the circular motion of a tornado approaching their financial shore. Oil has hit $139 a barrel and is rising without an end in sight. The dollar on the other hand is still slipping down the slopes of inflation making it even more expensive for the oil addicted Americans to pay for their habit. So what is keeping the bureaucrats in Washington and the bosses on Wall street awake at night? This:
(Click for a bigger picture)
Now let’s assume that the Fed had all this cash in store. What would a sudden influx of money do to the value of the good old greenback? Like any good, whenever the total amount goes up, the value goes down.
The total cost of the credit crisis is around $ 1 trillion, according to the IMF. Who’s going to pay for all that? American tax payers? Seeing the allergy most Americans have for paying tax (and who hasn’t..) and seeing it’s almost election year, I can’t see anyone committing political suicide by proposing sharp and painful tax increases.
According to Wim Bischoff, Chairman of Citigroup, the amount of money available from Sovereign Wealth Funds will be $12 trillion by 2015. Already the funds hold over $2,75 trillion, which is more than all the hedge funds and private equity in the world together. Just realize that SWF’s don’t have to comply with even the minimal standards that hedge funds are held to. Also realize that the entities behind these funds are some of the most undemocratic regimes in the world. Even if they don’t have a seat on the board of the banks and institutions they own what will happen to sustainable business? Can a bank afford not to give a loan to a weapons’ manufacturer that happens to sell to Abu Dhabi, when this same country is controlling the fund that owns most of the bank? The same dollars that were paid to regimes in Saudi Arabia and Kuwait, countries with atrocious records when it comes to the rights of women and countries that throw dissidents in jail without trial are now used to buy large shares in American and European financial institutions. And what will happen with the oil dollars of Iran? The current sanctions against this country prohibit it from outright investing it's US currency. But money is like water and will find a way. Bankers, keep your eyes open and your compliance officers sharp.
(Click for a bigger picture)
(Click for a bigger picture)Now let’s assume that the Fed had all this cash in store. What would a sudden influx of money do to the value of the good old greenback? Like any good, whenever the total amount goes up, the value goes down.
The total cost of the credit crisis is around $ 1 trillion, according to the IMF. Who’s going to pay for all that? American tax payers? Seeing the allergy most Americans have for paying tax (and who hasn’t..) and seeing it’s almost election year, I can’t see anyone committing political suicide by proposing sharp and painful tax increases.
According to Wim Bischoff, Chairman of Citigroup, the amount of money available from Sovereign Wealth Funds will be $12 trillion by 2015. Already the funds hold over $2,75 trillion, which is more than all the hedge funds and private equity in the world together. Just realize that SWF’s don’t have to comply with even the minimal standards that hedge funds are held to. Also realize that the entities behind these funds are some of the most undemocratic regimes in the world. Even if they don’t have a seat on the board of the banks and institutions they own what will happen to sustainable business? Can a bank afford not to give a loan to a weapons’ manufacturer that happens to sell to Abu Dhabi, when this same country is controlling the fund that owns most of the bank? The same dollars that were paid to regimes in Saudi Arabia and Kuwait, countries with atrocious records when it comes to the rights of women and countries that throw dissidents in jail without trial are now used to buy large shares in American and European financial institutions. And what will happen with the oil dollars of Iran? The current sanctions against this country prohibit it from outright investing it's US currency. But money is like water and will find a way. Bankers, keep your eyes open and your compliance officers sharp.
Wednesday, June 4, 2008
Malaysia's brilliant way to deal with high oil prices.
Now oil prices have reached $130 a barrel, the problem starts to affect more than commuting car drivers and budget airlines. Countries like Malaysia, Indonesia and others that heavily subsidize their fuel start to run in trouble. A 2005 article in the Herald Tribune said that an oil price of $65 a barrel would spell big trouble for the Indonesian economy. After the price of gas was increased with 126%, riots broke out in Jakarta and elsewhere. The article never mentioned what $130 a barrel oil would do with the budget. Last month the price had to be revised again resulting in students taking to the streets in protest. I wonder where they get the money to buy a car in the first place?
Malaysia has found another way. Instead of raising the price of fuel, which would make the government undoubtedly unpopular, a wise committee thought long and hard about it and decided that the cause of inflation wasn’t domestic but had to lie with the foreign fuel smugglers. All those rich Singaporeans lining up at the Malaysian pumps were apparently stealing a significant portion of the 56 billion Ringit subsidized fuel. The first idea was to issue every Malaysian a pass to buy subsidized fuel. This turned out to be an expensive and fraud prone project because there are 24,821,286 people living in Malaysia that all would need a pass (or at least the ones old enough to drive). So they decided to outright ban foreigners from buying fuel at stations closer than 50km to the Thai and Singaporean borders.
The committee might have thought a bit longer about this. Singapore has a law that makes it illegal to pass the border with a tank that is less then 3/4 full. Let’s assume that an average fuel tank holds 70 liters. That means that the average Singaporean family can top up their tank with 17.5 liters of sweet subsidized fuel before returning to the land of Laksha and expensive fuel. At the same time this family will probably have lunch and even dinner in Johor Baru, fill the trunk with cheap fruit and vegetables and other groceries, have an ice cream or two or even spend some time at Genting, Malaysia’s version of Vegas. I know how these things go, whenever you’re abroad you always spend more then you intend to. Already the results are visible at the borders with Thailand, where tourism has died down to a trickle. The same will probably be true for Johor, because although the cheaper gas might not have been so cheap after all the extra spending; it’s still a major attraction for thrifty Singaporeans. I wonder how long it will take before the local Johorans will be lining up to buy just a bit of extra gas to sell to Singaporeans and other foreigners. That way the subsidy flows directly into the pockets of the needy. All outside the official gas stations off course…
Fortunately the measure will be effective against the many, many trucks of fuel that were smuggled into Singapore each day. They must have been camouflaged because I’ve never seen them cross the border….
Update. The Malaysian government must have thought a bit longer and decided that increasing the price of gas with 65% will help them a bit more than banning foreigners from buying gas. So far, the country remains quiet...
Update2. Demonstrations are planned this weekend in Kuala Lumpur. Off course this was to be expected.
Malaysia has found another way. Instead of raising the price of fuel, which would make the government undoubtedly unpopular, a wise committee thought long and hard about it and decided that the cause of inflation wasn’t domestic but had to lie with the foreign fuel smugglers. All those rich Singaporeans lining up at the Malaysian pumps were apparently stealing a significant portion of the 56 billion Ringit subsidized fuel. The first idea was to issue every Malaysian a pass to buy subsidized fuel. This turned out to be an expensive and fraud prone project because there are 24,821,286 people living in Malaysia that all would need a pass (or at least the ones old enough to drive). So they decided to outright ban foreigners from buying fuel at stations closer than 50km to the Thai and Singaporean borders.
The committee might have thought a bit longer about this. Singapore has a law that makes it illegal to pass the border with a tank that is less then 3/4 full. Let’s assume that an average fuel tank holds 70 liters. That means that the average Singaporean family can top up their tank with 17.5 liters of sweet subsidized fuel before returning to the land of Laksha and expensive fuel. At the same time this family will probably have lunch and even dinner in Johor Baru, fill the trunk with cheap fruit and vegetables and other groceries, have an ice cream or two or even spend some time at Genting, Malaysia’s version of Vegas. I know how these things go, whenever you’re abroad you always spend more then you intend to. Already the results are visible at the borders with Thailand, where tourism has died down to a trickle. The same will probably be true for Johor, because although the cheaper gas might not have been so cheap after all the extra spending; it’s still a major attraction for thrifty Singaporeans. I wonder how long it will take before the local Johorans will be lining up to buy just a bit of extra gas to sell to Singaporeans and other foreigners. That way the subsidy flows directly into the pockets of the needy. All outside the official gas stations off course…
Fortunately the measure will be effective against the many, many trucks of fuel that were smuggled into Singapore each day. They must have been camouflaged because I’ve never seen them cross the border….
Update. The Malaysian government must have thought a bit longer and decided that increasing the price of gas with 65% will help them a bit more than banning foreigners from buying gas. So far, the country remains quiet...
Update2. Demonstrations are planned this weekend in Kuala Lumpur. Off course this was to be expected.
Tuesday, June 3, 2008
Is it possible to find impartial information on internet?
As a professional anti-money laundering specialist it is my job to keep the bank that pays my salary free of “the bad guys” that want to clean their ill-gotten gains. This means that the millions of transactions that are processed every day have to be scrutinized by a team of highly trained analysts using sophisticated computer programs. It would seem that with the resources available today, it would be easy to determine if a payment going from A to B is just meant to facilitate the export of the latest trendy underwear and not to purchase explosives or weapons or to let Mr. Mafia buy another Ferrari. Unfortunately (or rather, fortunately) there is still no substitute for our human brain. It is this brain that helps us determine if a 14 year old boy named “Muhammad” is the same as the 60 year old terrorist of the same name. To make these decisions an analyst uses every resource he or she can get. The internet is a treasure trove of information and can shorten the research time of every case considerably. As long as professional and neutral organizations are used to provide the necessary information the result will be a professional and neutral conclusion that won’t touch any “innocent” lives and only helps to keep the “bad” and the “good” guys apart. To find these neutral and impartial sources however is much harder then it seems.
Take for instance ‘World Check”. Founded in Switzerland and used by financial institutions and law enforcement organizations world wide, it has become the leader of “bad guy” information business. Its database is both comprehensive and without question neutral. The database is only accessible for paying and screened customers who use it for professional purposes. At the same time the public World Check web site publishes articles that are far less unbiased and neutral.
Lawyer-turned-money launderer for the South American mafia-turned consultant Kenneth Rijock publishes daily about money laundering and terrorist financing concerns. Recently however his articles seem to focus on Venezuela in general and the evils of its president Chavez in particular. No doubt that the oil rich country is waging a socialist inspired war of words with the current Bush administration and no doubt that Venezuela is a country high on the financial crime concerns list,but is it the job of a seemingly neutral information provider to focus on one country? According to mr. Rijock, Chavez and his regime are guilty of everything from from election fraud (not true) to financing FARC (might be true) to bribing US Democrats (really?). The problem is that it is very difficult to find corroborating publicly available evidence for Rijock’s accusations. Even if its all true, where are the articles about Uzbekistan, Myanmar or other countries of concern? Or is it Iran, Chavez's alleged puppet master that is the source of all evil?
Another source of information I read frequently is the Terrorist Finance blog written by David Nordell and a group of contributing experts. Mr. Nordell, like mr. Rijock is an esteemed member of the AML/ATF community and his knowledge is no doubt beyond reproach, but even he can’t hide his preferences. Instead of Venezuela, the countries of choice here are the usual suspects in the Middle East. Again, there’s nothing wrong with campaigning against or for a cause but I always advice my colleagues that there is no issue with using the information of any source on or outside the internet as long as all sides of a story are told in the final analysis. So far, I’ve only encountered a few commercial sites that I consider impartial. Stratfor, ironically called “The shadow CIA” tries it’s best to show as many sides in an international issue as possible. The last few months they’ve become a bit more Readers Digest like in their marketing strategy but the analyses I’ve read are both comprehensive and sound. It might be because they use multiple analysts or it might be because providing information (or intelligence) is what they do best but it seems to help me in unraveling the complicated puzzle that today’s world has become.
Take for instance ‘World Check”. Founded in Switzerland and used by financial institutions and law enforcement organizations world wide, it has become the leader of “bad guy” information business. Its database is both comprehensive and without question neutral. The database is only accessible for paying and screened customers who use it for professional purposes. At the same time the public World Check web site publishes articles that are far less unbiased and neutral.
Lawyer-turned-money launderer for the South American mafia-turned consultant Kenneth Rijock publishes daily about money laundering and terrorist financing concerns. Recently however his articles seem to focus on Venezuela in general and the evils of its president Chavez in particular. No doubt that the oil rich country is waging a socialist inspired war of words with the current Bush administration and no doubt that Venezuela is a country high on the financial crime concerns list,but is it the job of a seemingly neutral information provider to focus on one country? According to mr. Rijock, Chavez and his regime are guilty of everything from from election fraud (not true) to financing FARC (might be true) to bribing US Democrats (really?). The problem is that it is very difficult to find corroborating publicly available evidence for Rijock’s accusations. Even if its all true, where are the articles about Uzbekistan, Myanmar or other countries of concern? Or is it Iran, Chavez's alleged puppet master that is the source of all evil?
Another source of information I read frequently is the Terrorist Finance blog written by David Nordell and a group of contributing experts. Mr. Nordell, like mr. Rijock is an esteemed member of the AML/ATF community and his knowledge is no doubt beyond reproach, but even he can’t hide his preferences. Instead of Venezuela, the countries of choice here are the usual suspects in the Middle East. Again, there’s nothing wrong with campaigning against or for a cause but I always advice my colleagues that there is no issue with using the information of any source on or outside the internet as long as all sides of a story are told in the final analysis. So far, I’ve only encountered a few commercial sites that I consider impartial. Stratfor, ironically called “The shadow CIA” tries it’s best to show as many sides in an international issue as possible. The last few months they’ve become a bit more Readers Digest like in their marketing strategy but the analyses I’ve read are both comprehensive and sound. It might be because they use multiple analysts or it might be because providing information (or intelligence) is what they do best but it seems to help me in unraveling the complicated puzzle that today’s world has become.
Wednesday, May 14, 2008
Nike and the third world.
This paper is based on the business case “Hitting the wall: Nike and International Labor Practices." It analyses the labor issues that Nike faced in the late 90’s and the companies’ response to accusations of child labor and inhumane working conditions in its factories. Was Nike’s response to widespread criticism sufficient? As an example, the Nike’s wage policy in Vietnam will be discussed.
History.
In 1964, Phil Knight, a track athlete founded a running shoe distributor named Blue Ribbon Sports . The company initially operated as a distributor for Japanese shoe maker Onitsuka Tiger, making most sales at track meets out of its founder’s car. In 1966 BRS opened its first retail shop in Oregon, when the relationship with Onitsuka Tiger neared to an end. To continue business, BRS designed the first line of footwear that would contain the soon-to-be-famous swoosh. The name of the shoe would be “Nike” after the Greek goddess of victory. In 1978, BRS, Inc. officially renamed itself to Nike, Inc .
By 1980, Nike had reached a 50% market share in the United States athletic shoe market, and the company went public in December of that year. Nike has been manufacturing throughout the Asian region for over twenty-five years, and there are over 500,000 people today directly engaged in the production of Nike products. The company utilizes an outsourcing strategy, using only subcontractors. Nike has more than 700 locations around the world and offices located in 45 countries outside the United States. Most of the factories are located in Asia, including Indonesia, China, Taiwan, India, Thailand, Vietnam, Pakistan, Philippines, Malaysia, and Republic of Korea. The factories are 100% owned by subcontractors, with the majority of output consisting solely of Nike products. Currently, Nike employs a team of four expatriates in China, Indonesia and Vietnam, focusing on both quality of product and quality of working conditions. Nike’s manufacturing model is based on a minimal cost strategy. This strategy takes direct, short term cost heavily into account when considering a manufacturing location. Nike’s practice of contracting third parties to manufacture the shoes and other apparel made the selection process less complicated because most of the whole supply and manufacturing chain would be managed out-of-house leaving Nike with the only decision to choose the lowest bidder.
It wasn’t until the early 1990 when an activist named Jeff Ballinger focused consumers attention on the conditions under which Nike let its products be manufactured. Ballinger’s argument was that by removing direct responsibility for manufacturing, Nike was encouraging local manufacturers to abuse and mistreat workers to maximize their own margins. Only by offering the lowest possible price could a contract from the Oregon company be obtained. This meant that laborers were paid below minimum wage, factory conditions were often below standard and working hours were long. Ballinger knew exactly how to use Nike’s fame and image against the company when campaigning for better working conditions in Indonesia. As a Country Program Director for the Asian-American Free Labor Institute (now the AFL-CIO's American Center for International Labor Solidarity) he wrote the first expose of Nike’s labor policies, coinciding with Indonesia’s political turmoil and sweeping strikes of the early 1990’s.
In 1992 Indonesia had increased the minimum wage in a response to pressure from the unions and other political factions. Local contractors however largely ignored the legislation or petitioned for exemptions, which would be easy to obtain due to Indonesia’s rampant corruption. Seeing the potential damage that an anti Nike campaign could cause, Nike drafted a series of regulations that each contractor had to adhere to. It refrained from taking any substantial action to directly address the labor issues, leaving responsibility with the local contractors.
Countering Jeff Ballinger’s arguments.
Despite the undeniable facts that Ballinger brought against Nike’s practices, there are a few counter arguments that Nike could have used. In countries where Nike products were made, the wages were earned not to sustain families but to supplement household income. The fact that workers were paid below minimum wage therefore should have led to a shortage of workers, as they left the company for better paying jobs. Comparisons with workers in the West that are paid many times the amount of the average Indonesian worker are often unfair, since local prices are much lower. Even the argument that children as young as 14 years work for Nike ignores the fact that these children would otherwise have to work on the land or in the family business to help sustain the family. This has been a practice for hundreds of years and can’t be changed by the practices of one company.
Nike’s response.
Nike’s response against Ballinger was less than convincing. First it ignored the wage issue. Later it stated that it couldn’t be held responsible because it didn’t control the factories. The workers weren’t on the Nike payroll but were paid by the subcontractors. For consumers and activists these arguments were largely semantic. The contractors for all intents and purposes acted as wholly owned subsidiaries and as such any blame on them would be blame on Nike Inc. To distance the company from the issues would prove to be impossible. With the large difference between the wages paid to make a Nike shoe and the price of the product it would be hard to convince the average Nike consumer that the company can’t influence the way it makes its products. Reports of physical and sexual abuse make the matter even worse.
Nike and the press.
When the issues in Indonesia hit the mainstream, Nike began to realize that a negative image could seriously damage its revenues. Nike had always seen itself foremost as a sports apparel manufacturer but in reality a large portion of Nike’s sales came from fashion conscious teenagers and students. The issues that plagued Nike in Indonesia now became apparent in other countries like Pakistan, Vietnam and China. In April 1997, 10,000 Indonesian workers went on strike over wage violation. In the same month, 1,300 workers in Vietnam went on strike demanding a one cent per hour raise and last year 3,000 workers in China went on strike to protest not only low wages, but hazardous working conditions .
Nike contracted Andrew Young to write a report on Nike’s labor practices. Young was largely positive but concluded that Nike could and should do better. The media however condemned the report for the fact that the writer had been paid by Nike and therefore couldn’t have been impartial. This gave rise to the word “Nike-writing ”
On May 12, 1998, Phillip Knight spoke at the National Press Club in Washington, DC and made what were, in his words, "some fairly significant announcements" regarding Nike's policies on working conditions in its supplier factories.
Knight made six commitments:
1. All Nike shoe factories will meet the U.S. Occupational Safety and Health Administration's (OSHA) standards in indoor air quality.
2. The minimum age for Nike factory workers will be raised to 18 for footwear factories and 16 for apparel factories.
3. Nike will include non-government organizations in its factory monitoring, with summaries of that monitoring released to the public.
4. Nike will expand its worker education program, making free high school equivalency courses available to all workers in Nike footwear factories.
5. Nike will expand its micro-enterprise loan program to benefit four thousand families in Vietnam, Indonesia, Pakistan, and Thailand.
6. Funding university research and open forums on responsible business practices, including programs at four universities in the 1998-99 academic year.
The commitments, although at face value impressive, still failed to appease the ever growing criticism that Nike treated the matter as a public relations rather than a human rights issue. “The promises made by Phillip Knight in his May 1998 speech were an attempt by the company to switch the media focus to issues it was willing to address while avoiding the key problems of subsistence wages, forced overtime and suppression of workers' right to freedom of association. ”
What does Nike do wrong?
Nike failed to realize that the consumers that buy Nike gear are mostly well educated, socially active and outspoken. Instead of immediately going to the heart of the matter, Nike played the issues down, thereby not only underestimating the issue but far worse, underestimating the intelligence of its customers. Reebok and adidas, which had similar issues have responded in force, mainly by improving wages and working conditions but also by taking its critics seriously, providing open and transparent communication. Nike on the other hand is still unwilling to disclose which contractors are responsible for its manufacturing process. Its code of conduct that is now distributed to every factory worker contains a statement that “full and fair compensation” will be paid but does not say how much this would be. Nike also refuses unannounced inspections from outside organizations.
Fair wage in Vietnam.
President Franklin D. Roosevelt declared in 1937, "All but the hopeless reactionary will agree that to conserve our primary resources of manpower, government must have some control over maximum hours, minimum wages, the evil of child labor, and the exploitation of unorganized labor."
History.
In 1964, Phil Knight, a track athlete founded a running shoe distributor named Blue Ribbon Sports . The company initially operated as a distributor for Japanese shoe maker Onitsuka Tiger, making most sales at track meets out of its founder’s car. In 1966 BRS opened its first retail shop in Oregon, when the relationship with Onitsuka Tiger neared to an end. To continue business, BRS designed the first line of footwear that would contain the soon-to-be-famous swoosh. The name of the shoe would be “Nike” after the Greek goddess of victory. In 1978, BRS, Inc. officially renamed itself to Nike, Inc .
By 1980, Nike had reached a 50% market share in the United States athletic shoe market, and the company went public in December of that year. Nike has been manufacturing throughout the Asian region for over twenty-five years, and there are over 500,000 people today directly engaged in the production of Nike products. The company utilizes an outsourcing strategy, using only subcontractors. Nike has more than 700 locations around the world and offices located in 45 countries outside the United States. Most of the factories are located in Asia, including Indonesia, China, Taiwan, India, Thailand, Vietnam, Pakistan, Philippines, Malaysia, and Republic of Korea. The factories are 100% owned by subcontractors, with the majority of output consisting solely of Nike products. Currently, Nike employs a team of four expatriates in China, Indonesia and Vietnam, focusing on both quality of product and quality of working conditions. Nike’s manufacturing model is based on a minimal cost strategy. This strategy takes direct, short term cost heavily into account when considering a manufacturing location. Nike’s practice of contracting third parties to manufacture the shoes and other apparel made the selection process less complicated because most of the whole supply and manufacturing chain would be managed out-of-house leaving Nike with the only decision to choose the lowest bidder.
It wasn’t until the early 1990 when an activist named Jeff Ballinger focused consumers attention on the conditions under which Nike let its products be manufactured. Ballinger’s argument was that by removing direct responsibility for manufacturing, Nike was encouraging local manufacturers to abuse and mistreat workers to maximize their own margins. Only by offering the lowest possible price could a contract from the Oregon company be obtained. This meant that laborers were paid below minimum wage, factory conditions were often below standard and working hours were long. Ballinger knew exactly how to use Nike’s fame and image against the company when campaigning for better working conditions in Indonesia. As a Country Program Director for the Asian-American Free Labor Institute (now the AFL-CIO's American Center for International Labor Solidarity) he wrote the first expose of Nike’s labor policies, coinciding with Indonesia’s political turmoil and sweeping strikes of the early 1990’s.
In 1992 Indonesia had increased the minimum wage in a response to pressure from the unions and other political factions. Local contractors however largely ignored the legislation or petitioned for exemptions, which would be easy to obtain due to Indonesia’s rampant corruption. Seeing the potential damage that an anti Nike campaign could cause, Nike drafted a series of regulations that each contractor had to adhere to. It refrained from taking any substantial action to directly address the labor issues, leaving responsibility with the local contractors.
Countering Jeff Ballinger’s arguments.
Despite the undeniable facts that Ballinger brought against Nike’s practices, there are a few counter arguments that Nike could have used. In countries where Nike products were made, the wages were earned not to sustain families but to supplement household income. The fact that workers were paid below minimum wage therefore should have led to a shortage of workers, as they left the company for better paying jobs. Comparisons with workers in the West that are paid many times the amount of the average Indonesian worker are often unfair, since local prices are much lower. Even the argument that children as young as 14 years work for Nike ignores the fact that these children would otherwise have to work on the land or in the family business to help sustain the family. This has been a practice for hundreds of years and can’t be changed by the practices of one company.
Nike’s response.
Nike’s response against Ballinger was less than convincing. First it ignored the wage issue. Later it stated that it couldn’t be held responsible because it didn’t control the factories. The workers weren’t on the Nike payroll but were paid by the subcontractors. For consumers and activists these arguments were largely semantic. The contractors for all intents and purposes acted as wholly owned subsidiaries and as such any blame on them would be blame on Nike Inc. To distance the company from the issues would prove to be impossible. With the large difference between the wages paid to make a Nike shoe and the price of the product it would be hard to convince the average Nike consumer that the company can’t influence the way it makes its products. Reports of physical and sexual abuse make the matter even worse.
Nike and the press.
When the issues in Indonesia hit the mainstream, Nike began to realize that a negative image could seriously damage its revenues. Nike had always seen itself foremost as a sports apparel manufacturer but in reality a large portion of Nike’s sales came from fashion conscious teenagers and students. The issues that plagued Nike in Indonesia now became apparent in other countries like Pakistan, Vietnam and China. In April 1997, 10,000 Indonesian workers went on strike over wage violation. In the same month, 1,300 workers in Vietnam went on strike demanding a one cent per hour raise and last year 3,000 workers in China went on strike to protest not only low wages, but hazardous working conditions .
Nike contracted Andrew Young to write a report on Nike’s labor practices. Young was largely positive but concluded that Nike could and should do better. The media however condemned the report for the fact that the writer had been paid by Nike and therefore couldn’t have been impartial. This gave rise to the word “Nike-writing ”
On May 12, 1998, Phillip Knight spoke at the National Press Club in Washington, DC and made what were, in his words, "some fairly significant announcements" regarding Nike's policies on working conditions in its supplier factories.
Knight made six commitments:
1. All Nike shoe factories will meet the U.S. Occupational Safety and Health Administration's (OSHA) standards in indoor air quality.
2. The minimum age for Nike factory workers will be raised to 18 for footwear factories and 16 for apparel factories.
3. Nike will include non-government organizations in its factory monitoring, with summaries of that monitoring released to the public.
4. Nike will expand its worker education program, making free high school equivalency courses available to all workers in Nike footwear factories.
5. Nike will expand its micro-enterprise loan program to benefit four thousand families in Vietnam, Indonesia, Pakistan, and Thailand.
6. Funding university research and open forums on responsible business practices, including programs at four universities in the 1998-99 academic year.
The commitments, although at face value impressive, still failed to appease the ever growing criticism that Nike treated the matter as a public relations rather than a human rights issue. “The promises made by Phillip Knight in his May 1998 speech were an attempt by the company to switch the media focus to issues it was willing to address while avoiding the key problems of subsistence wages, forced overtime and suppression of workers' right to freedom of association. ”
What does Nike do wrong?
Nike failed to realize that the consumers that buy Nike gear are mostly well educated, socially active and outspoken. Instead of immediately going to the heart of the matter, Nike played the issues down, thereby not only underestimating the issue but far worse, underestimating the intelligence of its customers. Reebok and adidas, which had similar issues have responded in force, mainly by improving wages and working conditions but also by taking its critics seriously, providing open and transparent communication. Nike on the other hand is still unwilling to disclose which contractors are responsible for its manufacturing process. Its code of conduct that is now distributed to every factory worker contains a statement that “full and fair compensation” will be paid but does not say how much this would be. Nike also refuses unannounced inspections from outside organizations.
Fair wage in Vietnam.
President Franklin D. Roosevelt declared in 1937, "All but the hopeless reactionary will agree that to conserve our primary resources of manpower, government must have some control over maximum hours, minimum wages, the evil of child labor, and the exploitation of unorganized labor."
In the US, the Fair Labor Standards Act of 1938 established a national minimum wage, guaranteed time and a half for overtime in certain jobs, and prohibited most employment of minors in "oppressive child labor," a term defined in the statute. When a worker puts in 40 hours per week, the worker should be able to pay the minimal bills to survive. That, and health benefits, are the definition of the "living wage."
At the end of 1994, Nike had shifted part of its production from South Korea and Taiwan to Vietnam in an effort to control cost. In Vietnam, minimum salaries for unskilled and manual laborers in FIEs in all three labor zones are $55 USD monthly in urban Hanoi and Ho Chi Minh City, $50 in suburbs of those cities and within many of Vietnam’s major cities and ports, and $45 in all other areas . From the moment contractors started producing; Nike has been accused of paying below minimum wage, thereby circumventing local labor laws. Workers at VN Nike shoe manufacturing plants make on average 20 cents per hour. Team Leaders at VN Nike plants make only $42 per month, below the Vietnam minimum wage. Regular workers make even less.
At the heart of Nike’s predicament lies the fact that workers that make Nike’s expensive running shoes according to consumers are not getting paid enough for the job. To justify spending $150 on a pair of sneakers, the average modern consumer needs to know that his money isn’t going to the pockets of greedy shareholders and overpaid executives but ends up, at least in part, to sustain the man or woman that made the product in the first place. The International Monetary Fund rates Vietnam at number 129 for Purchasing Power Parity per capita, only slightly higher than most African countries. The issue with PPP when considering “fair wage” however is that when workers get paid more, price inevitably go up, lowering PPP again.
Conclusion.
Nike should make its contractors accountable for their wage practices. Instead of a “lowest cost strategy” it should take the long term cost of image damage into account. With a transparent compensation policy the public can see for itself if a fair wage is paid. Most of all, an open dialogue with all stakeholders instead is crucial to understanding the issues. Without it, Nike is just guessing what the best policy would be and will lose out in the end.
Monday, May 5, 2008
Evolution of the Xbox supply chain.
History of computer gaming
Few industries have had such a meteoric and world-altering rise as the computer industry. From the number crunching military machines of the Second World War to the sophisticated miniature offices we keep in our pockets today, they all serve their purpose to make our lives safer and more convenient. Along with the design of serious applications came always the need of the mostly young engineers and programmers for relaxation and competition. In February 1951, Christopher Strachey tried to run a draughts program he had written for the NPL Pilot ACE. This became the first computer game ever written, even though the first version overloaded the computer’s memory banks.
Tennis for Two was the first computer action game. It was developed in 1958 by American physicist William Higinbotham and ran on an oscilloscope which simulated a game of tennis or ping pong.
The commercial success of video gaming came in the 1970. Although coin operated games were available as early as 1971 it wasn’t until Nolan Bushnell and Ted Dabney founded a company called Atari and released the VCS (later called 2600) system in 1977 that computer gaming entered the living room. The big names in the industry weren’t Microsoft or Sony but Intellivision and Colecovision. In 1977 the market had become over saturated, creating the first video game crash. Quality had become second to quantity which led to an overproduction of mediocre machines and questionable cartridges. Fairchild and RCA left the industry leaving Atari and Magnavox as the sole contenders.
The home computer market took off with the release of the Commodore 64, Sinclair ZX 81 and Spectrum and the late success of the Apple II computer. The driver behind the surging sales was the ability to play realistic games in color and with sound. Soon home computers had taken a big bite out of the console market, especially since adults now could buy a computer to “do work” on and play games besides. In 1984, the computer gaming market took over from the console market causing the second video game crash.
In 1985 one brand dared to enter the market with an 8-bit console. The Super Famicom, or NES as it was renamed in the US, was manufactured by the innovative Japanese company Nintendo. The Nintendo Entertainment System was one of the greatest successes in computer gaming history. The effective use of gaming icons like Mario made the games instantly recognizable and the Japanese sense of humor made a refreshing contrast to the often violent and serious games of its US counterparts. Nintendo is the only company from that era that is still active and successful in the computer gaming business. Atari has become all but extinct, the brand name changing hands frequently.
The PC industry has traditionally kept its focus on the professional market. Geared toward word processing power and number crunching, it never gained the popularity as a gaming device like the consoles did. In the 90’s however, dedicated graphics and sound chips meant that games could be played on PC’s as well. Microsoft was never very interested in the gaming market (although they made a very good Flight Simulator) but the release of third party software using Microsoft’s DOS operating system created a whole new genre of gaming. Three dimensional shooters like Castle Wolfenstein and Doom pulled the serious gamer away from “kiddy consoles” like the NES. The PC soon became the gaming platform of choice for immersive, time consuming games while the console was used for fast moving action gaming and Japanese style adventuring. Big names in the console industry were Sega, with their Master System and Megadrive and again Nintendo with the 16 bit Super NES, leveraging on the popularity of Mario, Zelda and other brand characters.
The fifth generation saw a new name emerging. Sony, the Japanese electronics giant, had an opportunity to conquer the gaming market with its PlayStation. The 16 bit system sported sophisticated 3D graphics and, more importantly, could also be used as a CD and Video CD player. The PlayStation was a huge success, committing Sony to the still expanding gaming market. In 2000 Sony had surpassed Nintendo as market leader and released the second incarnation of its gaming system, the PlayStation 2. Microsoft in the meantime had seen a whole industry grow on what was basically their business operating system and wanted to have a piece of the market. In 2001, the Xbox was launched.
Supply and demand.
The Xbox took off in a complicated and demanding market. In 2005 Sony was still the undisputed market leader with 5 PlayStations and 4 PlayStation 2s sold for every Xbox. Nintendo had lost much of its luster with much lower sales numbers for its 5th generation GameCube system. The Xbox was a first for Microsoft and many people thought that Gates and friends couldn’t pull it off. PC gaming had become very popular with gamers buying equipment that cost multiple times that of the Xbox. It was almost impossible to believe that a machine that was basically a PC in a different package with limited memory and no expansion slots could survive against a dedicated console like the PlayStation 2. Microsoft had delayed the launch of the Xbox to be able to provide the latest processor and graphics chips to directly compete with Sony’s flagship. To gain sufficient market share, Microsoft would almost certainly have to sell the Xbox console at a loss and try to make up with software licenses given out to third party game designers.
An additional challenge for Microsoft was that the manufacturing and distribution needed a completely different approach from the traditional software the company was used to. The machine was made out of hundreds of parts that needed to be supplied at just the right time to avoid bottlenecks at the manufacturing plants. Time to volume was the critical factor. There were only a few time windows, like the Holiday period, to successfully launch the machine.
Microsoft’s sought help in the supply chain management from Flextronics, a contract electronics maker which provides electronics manufacturing facilities to original equipment manufacturers (OEM). Together with Flextronics, Microsoft selected 40 major suppliers, negotiated continuity of supply agreements; ensured capacity was in place, established complex logistics channels, found software tools to automate some of its supply chain tasks. To keep transportation lines to the markets in the US and Europe short, the company decided to use “industrial parks” in Mexico and Hungary. Suppliers were invited to set up shop in the parks making supply both flexible and efficient. There was an average of 600 [engineering change orders] weekly across the supply chain in the early stages of the design so flexibility was very important.
Manufacturing in Asia would be cheaper but as Sony had experienced, long transportation lines can lead to shortages at critical moments. The higher cost meant that Microsoft’s entrance in the computer gaming market came at a price of $4.4 billion in operating losses in May 2005. The first generation of X-boxes were market driven and not cost driven since Microsoft could not afford supply shortages in stores. Later models had a less critical time to market factor, which led Flextronics to move manufacturing from Mexico to much less expensive Chinese factories. Microsoft is now sourcing components locally within different geographies, creating new logistics channels, and doubling supplier capacity to support manufacturing in new regions, like the Asian market .
The sixth generation of consoles was a culmination of everything the most demanding gamer could want from a console. At the same time, new market segments were being identified. The Sony Play Station 3 not only provided the power for next generation gaming but was also a weapon for expansion in the broader electronic entertainment market. The next generation of video content carriers was Blu-Ray and HD-DVD. Sony as one of the founders of the Blu-Ray standard saw an opportunity for leverage and included a Blu-Ray player in its next generation console. Microsoft had already made several attempts to distribute content online and decided not to include an expensive add-on, managing to keep the price of its next generation console, the Xbox 360 below its competitor.
Although Microsoft kept its main supply chain and manufacturing manager, Flextronics it decided to out-source some of the designs to cater to non-US markets. Instead of keeping production close to the end-user, the cost factor was a bigger issue this time. Xbox 360’s would be made in Chinese factories and shipped to the US and EU as readymade products. Sony’s delays in bringing out the competing PlayStation 3 meant that Microsoft had some time to build up a head start. The success of titles like Halo and Halo 2 meant that there was an established base of Xbox enthusiasts that almost certainly wouldn’t wait for the Sony product to come out. IBM designed and co-manufactured the custom microprocessor that powers the Xbox 360. The microprocessor is a triple-core PowerPC that runs at a frequency of 3.2GHz. At a cost of $106, this single part accounts for 20.2 percent of the total Bill-of-Materials cost for the Xbox 360. Factoring in costs for the hard disk, the DVD drive, enclosures, the Radio Frequency (RF) receiver board, power supply, wireless controller, cables, literature, and packaging – the total BOM cost for the Xbox 360 Premium reached $525, well above the retail price of $399 .
To keep decreasing cost, Microsoft would continually have to redesign the components which made centralized manufacturing critical. To change the supply chain now required changing only the plant in China instead of changing several links in different parts of the world.
Global launch.
One of the characterizing features of the video game industry is that the end-users don’t want to wait for the product. In Japan, gamers are known to wait for days in front of a store to be the first to buy a new game or console. When Microsoft decided to launch the Xbox 360 globally it took a big risk. If supply wouldn’t be able to keep up with demand, the potential for damage to the brand name were great. For the first time ever, Microsoft plotted the near-simultaneous rollout of Xbox 360 on three continents: November 22, 2006 in the U.S., December 2, 2006 in Europe and December 10, 2006 in Japan.
Microsoft had already started planning the supply chain with its logistics partners more than a year before. The goods moved by barge from the factories to Hong Kong, at which point Microsoft took nominal ownership. The shipper had chartered Boeing 747 freighters for transit to its main distribution centers in Memphis, Tenn., and Duren, Germany, about 37 miles from Cologne. The booking of high-security trucks, both in the U.S. and Europe, was coordinated with customs clearance to keep product from sitting idle between its release and movement inland. Once again, flexibility was the hallmark of Microsoft’s distribution strategy. Most shipments went to the major distribution centers, where they were processed by one of the company’s “distribution turnkey vendors,” or DTVs. Rail played an important role in North America. Railroads have come under criticism in recent years for severe delays and capacity constraints, Microsoft sidestepped the problem by shipping on dedicated stack trains moving directly from Los Angeles to Memphis, via the Burlington Northern Santa Fe .
The risks of the global launch were evident. The longer the supply chain, the more issues could occur. If the product wasn’t ready at the factory, the ships couldn’t sail which made the smooth transition from manufactured product to sold product difficult. The sheer size of the operation made it difficult to manage. There was however a hidden opportunity in the unprecedented scale. The “buzz” created by the anticipated launch of the Xbox360 meant that many more potential customers were ware of the new console. The global launch also meant that coordination was central and potential issues could be dealt with simultaneously. Despite the changes in supply chain management, the Xbox 360 was in short supply at its launch date , a fact that might have actually benefitted sales in the long run.
Multiple suppliers.
Microsoft used three suppliers to make the Xbox 360 instead of only one. Because the company owns the rights to all the component designs, it can switch to the lowest bidder at any time. Flextronics and Wistron stayed on as assembling partners, later joined by Celestica. The supply contracts specify that Microsoft can discontinue working with a partner at any moment and can have other partners join whenever needed. In 2007, Wistron phased out production for the console, ending a six year cooperation. With Microsoft dropping its selling price of the Xbox 360 console earlier this year, it tried to push the profit pressure onto its three OEMs. Wistron, seeing it’s gross margin drop to 5.49% in the third quarter of 2007 couldn’t cope with a lower margin. In 2008 Asustek picked up production for the Xbox 360, showing advantages of flexibility .
Using multiple suppliers has its limitations. The coordination and quality assurance control is more complicated. Using multiple suppliers hasn’t made Microsoft impervious to lack of supply. Quality issues with the DVD drive, heat problems and the dreaded “Red Rings of Death” have led to problems with 3 out of 10 Xboxes, setting Microsoft back $1.05 to $1.15 billion in the second calendar quarter of 2007 . Because there is not one “owner” of an issue it is hard to look for the root cause. Only after pressure from end-users did Microsoft admit there were problems, offering to repair the affected consoles for free “This problem has caused frustration for some of our customers and for that, we sincerely apologize," Microsoft's entertainment chief Robbie Bach said. "We value our community tremendously and look at this as an investment in our customer base."
Conclusion.
As an avid gamer I have owned almost every gaming console in existence since 1980. During my law studies I worked in one of the first computer gaming stores in The Netherlands and I have experienced the anticipation that a new console or game can bring from close by. The issues that companies like Microsoft, Sony and Nintendo are facing are different from most other products because the gaming market is a very personal and emotional market. The video game industry crashes of the 70’s and 80’ were caused by the lack of quality and the emphasis on quantity. The distance make supply chain management crucial for today’s complex consoles. Sony, Microsoft and Nintendo have all had supply issues and survived. Companies like Samy (too expensive), Sega (quality and margin loss), Atari and even Philips have been less fortunate. To survive a company needs to take the market very seriously and keep informing the customer of expected issue.
Update:
There's an interesting article on the pricing policy for the hard disk upgrade that is available for the X Box 360. You can find it at http://kotaku.com/387864/why-360-hdds-are-so-ridiculously-expensive
Few industries have had such a meteoric and world-altering rise as the computer industry. From the number crunching military machines of the Second World War to the sophisticated miniature offices we keep in our pockets today, they all serve their purpose to make our lives safer and more convenient. Along with the design of serious applications came always the need of the mostly young engineers and programmers for relaxation and competition. In February 1951, Christopher Strachey tried to run a draughts program he had written for the NPL Pilot ACE. This became the first computer game ever written, even though the first version overloaded the computer’s memory banks.
Tennis for Two was the first computer action game. It was developed in 1958 by American physicist William Higinbotham and ran on an oscilloscope which simulated a game of tennis or ping pong.
The commercial success of video gaming came in the 1970. Although coin operated games were available as early as 1971 it wasn’t until Nolan Bushnell and Ted Dabney founded a company called Atari and released the VCS (later called 2600) system in 1977 that computer gaming entered the living room. The big names in the industry weren’t Microsoft or Sony but Intellivision and Colecovision. In 1977 the market had become over saturated, creating the first video game crash. Quality had become second to quantity which led to an overproduction of mediocre machines and questionable cartridges. Fairchild and RCA left the industry leaving Atari and Magnavox as the sole contenders.
The home computer market took off with the release of the Commodore 64, Sinclair ZX 81 and Spectrum and the late success of the Apple II computer. The driver behind the surging sales was the ability to play realistic games in color and with sound. Soon home computers had taken a big bite out of the console market, especially since adults now could buy a computer to “do work” on and play games besides. In 1984, the computer gaming market took over from the console market causing the second video game crash.
In 1985 one brand dared to enter the market with an 8-bit console. The Super Famicom, or NES as it was renamed in the US, was manufactured by the innovative Japanese company Nintendo. The Nintendo Entertainment System was one of the greatest successes in computer gaming history. The effective use of gaming icons like Mario made the games instantly recognizable and the Japanese sense of humor made a refreshing contrast to the often violent and serious games of its US counterparts. Nintendo is the only company from that era that is still active and successful in the computer gaming business. Atari has become all but extinct, the brand name changing hands frequently.
The PC industry has traditionally kept its focus on the professional market. Geared toward word processing power and number crunching, it never gained the popularity as a gaming device like the consoles did. In the 90’s however, dedicated graphics and sound chips meant that games could be played on PC’s as well. Microsoft was never very interested in the gaming market (although they made a very good Flight Simulator) but the release of third party software using Microsoft’s DOS operating system created a whole new genre of gaming. Three dimensional shooters like Castle Wolfenstein and Doom pulled the serious gamer away from “kiddy consoles” like the NES. The PC soon became the gaming platform of choice for immersive, time consuming games while the console was used for fast moving action gaming and Japanese style adventuring. Big names in the console industry were Sega, with their Master System and Megadrive and again Nintendo with the 16 bit Super NES, leveraging on the popularity of Mario, Zelda and other brand characters.
The fifth generation saw a new name emerging. Sony, the Japanese electronics giant, had an opportunity to conquer the gaming market with its PlayStation. The 16 bit system sported sophisticated 3D graphics and, more importantly, could also be used as a CD and Video CD player. The PlayStation was a huge success, committing Sony to the still expanding gaming market. In 2000 Sony had surpassed Nintendo as market leader and released the second incarnation of its gaming system, the PlayStation 2. Microsoft in the meantime had seen a whole industry grow on what was basically their business operating system and wanted to have a piece of the market. In 2001, the Xbox was launched.
Supply and demand.
The Xbox took off in a complicated and demanding market. In 2005 Sony was still the undisputed market leader with 5 PlayStations and 4 PlayStation 2s sold for every Xbox. Nintendo had lost much of its luster with much lower sales numbers for its 5th generation GameCube system. The Xbox was a first for Microsoft and many people thought that Gates and friends couldn’t pull it off. PC gaming had become very popular with gamers buying equipment that cost multiple times that of the Xbox. It was almost impossible to believe that a machine that was basically a PC in a different package with limited memory and no expansion slots could survive against a dedicated console like the PlayStation 2. Microsoft had delayed the launch of the Xbox to be able to provide the latest processor and graphics chips to directly compete with Sony’s flagship. To gain sufficient market share, Microsoft would almost certainly have to sell the Xbox console at a loss and try to make up with software licenses given out to third party game designers.
An additional challenge for Microsoft was that the manufacturing and distribution needed a completely different approach from the traditional software the company was used to. The machine was made out of hundreds of parts that needed to be supplied at just the right time to avoid bottlenecks at the manufacturing plants. Time to volume was the critical factor. There were only a few time windows, like the Holiday period, to successfully launch the machine.
Microsoft’s sought help in the supply chain management from Flextronics, a contract electronics maker which provides electronics manufacturing facilities to original equipment manufacturers (OEM). Together with Flextronics, Microsoft selected 40 major suppliers, negotiated continuity of supply agreements; ensured capacity was in place, established complex logistics channels, found software tools to automate some of its supply chain tasks. To keep transportation lines to the markets in the US and Europe short, the company decided to use “industrial parks” in Mexico and Hungary. Suppliers were invited to set up shop in the parks making supply both flexible and efficient. There was an average of 600 [engineering change orders] weekly across the supply chain in the early stages of the design so flexibility was very important.
Manufacturing in Asia would be cheaper but as Sony had experienced, long transportation lines can lead to shortages at critical moments. The higher cost meant that Microsoft’s entrance in the computer gaming market came at a price of $4.4 billion in operating losses in May 2005. The first generation of X-boxes were market driven and not cost driven since Microsoft could not afford supply shortages in stores. Later models had a less critical time to market factor, which led Flextronics to move manufacturing from Mexico to much less expensive Chinese factories. Microsoft is now sourcing components locally within different geographies, creating new logistics channels, and doubling supplier capacity to support manufacturing in new regions, like the Asian market .
The sixth generation of consoles was a culmination of everything the most demanding gamer could want from a console. At the same time, new market segments were being identified. The Sony Play Station 3 not only provided the power for next generation gaming but was also a weapon for expansion in the broader electronic entertainment market. The next generation of video content carriers was Blu-Ray and HD-DVD. Sony as one of the founders of the Blu-Ray standard saw an opportunity for leverage and included a Blu-Ray player in its next generation console. Microsoft had already made several attempts to distribute content online and decided not to include an expensive add-on, managing to keep the price of its next generation console, the Xbox 360 below its competitor.
Although Microsoft kept its main supply chain and manufacturing manager, Flextronics it decided to out-source some of the designs to cater to non-US markets. Instead of keeping production close to the end-user, the cost factor was a bigger issue this time. Xbox 360’s would be made in Chinese factories and shipped to the US and EU as readymade products. Sony’s delays in bringing out the competing PlayStation 3 meant that Microsoft had some time to build up a head start. The success of titles like Halo and Halo 2 meant that there was an established base of Xbox enthusiasts that almost certainly wouldn’t wait for the Sony product to come out. IBM designed and co-manufactured the custom microprocessor that powers the Xbox 360. The microprocessor is a triple-core PowerPC that runs at a frequency of 3.2GHz. At a cost of $106, this single part accounts for 20.2 percent of the total Bill-of-Materials cost for the Xbox 360. Factoring in costs for the hard disk, the DVD drive, enclosures, the Radio Frequency (RF) receiver board, power supply, wireless controller, cables, literature, and packaging – the total BOM cost for the Xbox 360 Premium reached $525, well above the retail price of $399 .
To keep decreasing cost, Microsoft would continually have to redesign the components which made centralized manufacturing critical. To change the supply chain now required changing only the plant in China instead of changing several links in different parts of the world.
Global launch.
One of the characterizing features of the video game industry is that the end-users don’t want to wait for the product. In Japan, gamers are known to wait for days in front of a store to be the first to buy a new game or console. When Microsoft decided to launch the Xbox 360 globally it took a big risk. If supply wouldn’t be able to keep up with demand, the potential for damage to the brand name were great. For the first time ever, Microsoft plotted the near-simultaneous rollout of Xbox 360 on three continents: November 22, 2006 in the U.S., December 2, 2006 in Europe and December 10, 2006 in Japan.
Microsoft had already started planning the supply chain with its logistics partners more than a year before. The goods moved by barge from the factories to Hong Kong, at which point Microsoft took nominal ownership. The shipper had chartered Boeing 747 freighters for transit to its main distribution centers in Memphis, Tenn., and Duren, Germany, about 37 miles from Cologne. The booking of high-security trucks, both in the U.S. and Europe, was coordinated with customs clearance to keep product from sitting idle between its release and movement inland. Once again, flexibility was the hallmark of Microsoft’s distribution strategy. Most shipments went to the major distribution centers, where they were processed by one of the company’s “distribution turnkey vendors,” or DTVs. Rail played an important role in North America. Railroads have come under criticism in recent years for severe delays and capacity constraints, Microsoft sidestepped the problem by shipping on dedicated stack trains moving directly from Los Angeles to Memphis, via the Burlington Northern Santa Fe .
The risks of the global launch were evident. The longer the supply chain, the more issues could occur. If the product wasn’t ready at the factory, the ships couldn’t sail which made the smooth transition from manufactured product to sold product difficult. The sheer size of the operation made it difficult to manage. There was however a hidden opportunity in the unprecedented scale. The “buzz” created by the anticipated launch of the Xbox360 meant that many more potential customers were ware of the new console. The global launch also meant that coordination was central and potential issues could be dealt with simultaneously. Despite the changes in supply chain management, the Xbox 360 was in short supply at its launch date , a fact that might have actually benefitted sales in the long run.
Multiple suppliers.
Microsoft used three suppliers to make the Xbox 360 instead of only one. Because the company owns the rights to all the component designs, it can switch to the lowest bidder at any time. Flextronics and Wistron stayed on as assembling partners, later joined by Celestica. The supply contracts specify that Microsoft can discontinue working with a partner at any moment and can have other partners join whenever needed. In 2007, Wistron phased out production for the console, ending a six year cooperation. With Microsoft dropping its selling price of the Xbox 360 console earlier this year, it tried to push the profit pressure onto its three OEMs. Wistron, seeing it’s gross margin drop to 5.49% in the third quarter of 2007 couldn’t cope with a lower margin. In 2008 Asustek picked up production for the Xbox 360, showing advantages of flexibility .
Using multiple suppliers has its limitations. The coordination and quality assurance control is more complicated. Using multiple suppliers hasn’t made Microsoft impervious to lack of supply. Quality issues with the DVD drive, heat problems and the dreaded “Red Rings of Death” have led to problems with 3 out of 10 Xboxes, setting Microsoft back $1.05 to $1.15 billion in the second calendar quarter of 2007 . Because there is not one “owner” of an issue it is hard to look for the root cause. Only after pressure from end-users did Microsoft admit there were problems, offering to repair the affected consoles for free “This problem has caused frustration for some of our customers and for that, we sincerely apologize," Microsoft's entertainment chief Robbie Bach said. "We value our community tremendously and look at this as an investment in our customer base."
Conclusion.
As an avid gamer I have owned almost every gaming console in existence since 1980. During my law studies I worked in one of the first computer gaming stores in The Netherlands and I have experienced the anticipation that a new console or game can bring from close by. The issues that companies like Microsoft, Sony and Nintendo are facing are different from most other products because the gaming market is a very personal and emotional market. The video game industry crashes of the 70’s and 80’ were caused by the lack of quality and the emphasis on quantity. The distance make supply chain management crucial for today’s complex consoles. Sony, Microsoft and Nintendo have all had supply issues and survived. Companies like Samy (too expensive), Sega (quality and margin loss), Atari and even Philips have been less fortunate. To survive a company needs to take the market very seriously and keep informing the customer of expected issue.
Update:
There's an interesting article on the pricing policy for the hard disk upgrade that is available for the X Box 360. You can find it at http://kotaku.com/387864/why-360-hdds-are-so-ridiculously-expensive
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