In my previous roles as program manager for sustainability at ABN AMRO Bank I often had skeptical managers trying to argue that sustainability was a fad and contrary to sound economical behavior. I have since moved on but sustainability has trancended from a activist “use both sides of the toiletpaper” oddity to a permanent item on the board agenda.
Last Friday there was an interesting article on mises.org, the website of the Ludwig von Mises institute. For those of you unfamiliar with Ludwig von Mises; he was one of the forerunners of the Austrian school of economic thought. The main premise of the Austrian school is that human behavior is too complex to develop mathematical models of evolving markets. It is often seen as an extreme libertarian stream because Austrian economists largely reject government interventions but believe that the power of pricing organizes the market.
Although I am a long time follower of the Austrian economic school of thought, I refuse to let myself be swept away by “Austrianism”. Like socialism, it is a very tempting idea that works best if everyone follows the rules. Unlike socialism, Austrian economics stops working whenever politics come into play. Off course in practice politicians seldom stay out when money and electoral power are at stake.
Tyler A. Watts, a PhD candidate in economics at George Mason University takes a shot at what he calls “the sustainability movement”. Like any proponent of an idea he doesn’t fully understand but is against anyway, he starts out with labeling sustainability as an “-ism”. The same technique is used by religious zealots when they talk about the ideas of Darwin. It makes the attack easier because you can dismiss any rational argument with the counter-argument “it’s a belief, not a fact”. It also makes any attack more personal because you can group the “believers” into a homogenous category which makes for a larger target. Watch out! The sustainists are out to control us!
As Watts tries to make his readers believe, sustainability is all about control of the market. “(Sustainists) are damning in their fervor, poise, and rhetoric. Their ideology is pregnant with an accusation that the way things currently are is somehow unsustainable.”
The rant gets even more polarizing when Watts argues that: “The sustainability movement is an assault on economics. It claims at its core that prices don't operate through time to direct consumption and production decisions in a sustainable way. A lesson in basic economics should suffice to defend against the sustainists' attack.”
Apparently Wattsists know exactly what sustainability is all about and companies that operate in a sustainable way are a threat to the free market. Unfortunately for the not-ye- existing Wattsist movement, practice has shown that sustainable behavior in the market has nothing to do with intervention but everything with supply and demand.
One of the arguments that Watts brings to the table is that “prices arise in the market economy as a concomitant of mutually beneficial exchange. People want things that improve their lives — we call this value. (…)The price of any good reflects this combination of value and scarcity.”
Apart from the fact that diamonds are expensive not because of scarcity but because their price is tightly controlled, what is ignored or forgotten here is that “value” is not only determined by price and scarcity but by (perceived) quality as well. Apple products are more expensive, not because they are scarcer than comparable products but because they have a (perceived) higher quality.
High quality commodities can become so expensive that few can afford them. According to Watts, water is abundant and therefore sustainists (which my MS Word spellchecker suspiciously wants to change to “Satanists”) needlessly worry about depletion. If water becomes scarcer, prices will go up, consumers will use less and entrepreneurial scientists will invent substitutes. The market will control itself. What Watts is basically advising is to use resources as much as possible until they become too expensive and then find a substitute.
What will happen if we were to follow the Wattsist behavior? Empirical evidence can be found in countries like Ethiopia and Sudan. Clean water is scarce there and people are poor. The ratio of water price vs. average income is extremely high. The result is that people drink whatever is available. One out of three children dies of diarrhea.
Watts’ solution to the price dilemma is simple: “if the price of a good trends strongly upwards over time (indicating it has become scarcer and/or more valuable), they rush to find cheaper substitutes”. I wonder what substitute for clean water is being researched in the labs of George Mason University.
Watts argues that “prices reliably guide individuals, both consumers and producers, toward a rational use of resources.” Theoretically this is true. In practice however, humans tend to have an economical horizon, both in fore- and in hindsight. Managers rarely think more than 5 years ahead. An earned profit now is often better than a possible profit in the future. This is especially true if you expect to be promoted away from your responsibility anyway. Unsustainable use of resources may sound very attractive. It keeps prices down and margins and profits are higher. Who cares about the time when resources become expensive? Let my successor worry about that!
Free markets are a crucial part of a world where prosperity is divided in a fair and equal way. This doesn’t mean that one should blindly follow every idea that comes out of the Austrian camp. The most attractive and in my humble opinion most valid argument for Austrian economics, is Mises’ premise that every conscious action is intended to improve a person's satisfaction.
True sustainability isn’t about “going green” or intervention in healthy market behavior. It’s about long term true value that is not only determined by price and income but by our satisfaction with the way we live. Even from Watts’ own somewhat cynical point of view, sustainability makes sense. It has created a huge, multi billion dollar industry and isn’t that what free market is all about?
Monday, December 7, 2009
Monday, November 30, 2009
Dubai goes pop
It’s been an incredibly long time since I wrote anything, which I blame squarely on my workload instead of my laziness off course. However the events of last week in Dubai have renewed my interest in writing at least a little bit even if it’s just so I understand it myself clearly.
Dubai’s state owned investment company, Dubai World had to postpone repayment of part of its crushing $59 billion debt, including $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. The Dubai World announcement came less than two hours after Abu Dhabi, the capital and wealthiest emirate in the U.A.E., bought $5 billion of Dubai bonds as part of a $20 billion support fund to help reorganize state companies.
Investors, journalist and the whole financial industry held its collective breath and braced for impact. Off course Dubai’s oil rich sister state Abu Dhabi and the rest of the UAE will not allow Dubai to fail. It’s just a matter of how many pounds of flesh the ruling house has to shed to make sure that their dream of a thousand and one nights will stay alive.
However, will this work in the long term? Whenever I’m in Dubai I’m always amazed by the scale of the real estate projects. There seem to be more shopping malls than people and at one time the largest part of the world supply of construction cranes could be found in Dubai.
The problem with shopping malls though is that you need shops and that means shoppers. The thing is that there doesn’t seem to be a lot of incentives for locals or tourists to shop in the cavernous Mall of the Emirates or the gigantic Dubai Mall. The local population is so rich that they rather fly to Paris or London to do some real shopping which leave the tourists. The price of electronic goods and clothing, two things tourists shop most for, isn’t much lower than in any comparable Western shop. D&B, Gucci and friends can be bought for less in Amsterdam. Sony, Samsung et all can be had for less in the malls of Hong Kong or even Singapore.
So if it isn't the shopping, what will attract tourists? Culture? Unlike Abu Dhabi, which agreed to pay France $1.3 billion to borrow the Louvre's name and hundreds of its artworks, as well as treasures from the Picasso Museum, Pompidou Center, Chateau de Versailles and other French museums, Dubai borrowed even more money to build Dubailand amusement park. Apart from the small but interesting local museum, there’s not much else to do. Dubai is notorious when it comes to nightlife but I doubt that the authorities really want that kind of image for their Islamic state.
A lot of people think that Dubai is oil rich, just because it lies in the Middle East. This is not so. Abu Dhabi has enough oil to guarantee revenue in years to come but Dubai saw the need to diversify years ago and borrowed heavily against its real estate assets. Doesn’t it sound familiar? Someone who borrows money against his house to afford a lavish lifestyle? It’s the mortgage crisis on a country wide scale!
Let’s have a look at Dubai’s current financial position. It has always been a well kept secret but the debt crisis forced the Dubai Executive Council to give a little insight:
Sovereign debt: $10.000.000.000
State-affiliated debt: $70.000.000.000
Sovereign assets: $90.000.000.000
State-affiliated companies assets: $260.000.000.000
This means that the total debt of 80 billion is covered by 1.3 trillion in assets. How many of these assets need to be written down to more realistic values if the Dubai real estate market continues like it is? Most of Dubai’s prestigious projects were conceived on the basis of making a quick buck. When stripped from all their glamorous hype, the Palm and World islands are just sandbanks with buildings on them. Sure it’s nice to have Brangelina as your neighbors but who would want to live on a sandbank?
Now that foreigners are fleeing the country to avoid debtors prison (yes there is such a thing in Dubai), the glitterati must really consider if they want to be associated with this less than glamorous reality. No celebs means no wannabes that are willing to pay the big bucks and that means re-evaluating real estate (yet again).
Again, this should sound eerily familiar. If Dubai can’t refinance, it will have to sell and if the assets values are going down, friendly uncle Abu won’t be around forever for the bail out.
That leaves the regular options that any sovereign state has at its disposal. Argentina and Russia, two states that hovered at the same brink of financial destruction restructured and raised their taxes. Both countries have a sizable domestic workforce and enough GDP based on tangible production. The issue with Dubai is that it has neither. The local workforce is largely comprised of imported construction workers, domestic personnel and white collar expats. Tax is negligible and for the domestic population, most public amenities are free. The real estate boom ground to a halt even before the Dubai debacle hit. Dubai’s best bet for the future would be modest spending habits combined with leverage of its central position between the East, the West and Africa. Expanding Dubai’s role as importer/exporter with excellent port and airport facilities could start the revenue engine again. Financial and political transparency is crucial if the image of the desert state as an overspending family owned business is to be changed. Time to sell the Ferrari and pawn the bling bling. If not, Dubai World will be only the beginning of the bursting bubble.
Dubai’s state owned investment company, Dubai World had to postpone repayment of part of its crushing $59 billion debt, including $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. The Dubai World announcement came less than two hours after Abu Dhabi, the capital and wealthiest emirate in the U.A.E., bought $5 billion of Dubai bonds as part of a $20 billion support fund to help reorganize state companies.
Investors, journalist and the whole financial industry held its collective breath and braced for impact. Off course Dubai’s oil rich sister state Abu Dhabi and the rest of the UAE will not allow Dubai to fail. It’s just a matter of how many pounds of flesh the ruling house has to shed to make sure that their dream of a thousand and one nights will stay alive.
However, will this work in the long term? Whenever I’m in Dubai I’m always amazed by the scale of the real estate projects. There seem to be more shopping malls than people and at one time the largest part of the world supply of construction cranes could be found in Dubai.
The problem with shopping malls though is that you need shops and that means shoppers. The thing is that there doesn’t seem to be a lot of incentives for locals or tourists to shop in the cavernous Mall of the Emirates or the gigantic Dubai Mall. The local population is so rich that they rather fly to Paris or London to do some real shopping which leave the tourists. The price of electronic goods and clothing, two things tourists shop most for, isn’t much lower than in any comparable Western shop. D&B, Gucci and friends can be bought for less in Amsterdam. Sony, Samsung et all can be had for less in the malls of Hong Kong or even Singapore.
So if it isn't the shopping, what will attract tourists? Culture? Unlike Abu Dhabi, which agreed to pay France $1.3 billion to borrow the Louvre's name and hundreds of its artworks, as well as treasures from the Picasso Museum, Pompidou Center, Chateau de Versailles and other French museums, Dubai borrowed even more money to build Dubailand amusement park. Apart from the small but interesting local museum, there’s not much else to do. Dubai is notorious when it comes to nightlife but I doubt that the authorities really want that kind of image for their Islamic state.
A lot of people think that Dubai is oil rich, just because it lies in the Middle East. This is not so. Abu Dhabi has enough oil to guarantee revenue in years to come but Dubai saw the need to diversify years ago and borrowed heavily against its real estate assets. Doesn’t it sound familiar? Someone who borrows money against his house to afford a lavish lifestyle? It’s the mortgage crisis on a country wide scale!
Let’s have a look at Dubai’s current financial position. It has always been a well kept secret but the debt crisis forced the Dubai Executive Council to give a little insight:
Sovereign debt: $10.000.000.000
State-affiliated debt: $70.000.000.000
Sovereign assets: $90.000.000.000
State-affiliated companies assets: $260.000.000.000
This means that the total debt of 80 billion is covered by 1.3 trillion in assets. How many of these assets need to be written down to more realistic values if the Dubai real estate market continues like it is? Most of Dubai’s prestigious projects were conceived on the basis of making a quick buck. When stripped from all their glamorous hype, the Palm and World islands are just sandbanks with buildings on them. Sure it’s nice to have Brangelina as your neighbors but who would want to live on a sandbank?
Now that foreigners are fleeing the country to avoid debtors prison (yes there is such a thing in Dubai), the glitterati must really consider if they want to be associated with this less than glamorous reality. No celebs means no wannabes that are willing to pay the big bucks and that means re-evaluating real estate (yet again).
Again, this should sound eerily familiar. If Dubai can’t refinance, it will have to sell and if the assets values are going down, friendly uncle Abu won’t be around forever for the bail out.
That leaves the regular options that any sovereign state has at its disposal. Argentina and Russia, two states that hovered at the same brink of financial destruction restructured and raised their taxes. Both countries have a sizable domestic workforce and enough GDP based on tangible production. The issue with Dubai is that it has neither. The local workforce is largely comprised of imported construction workers, domestic personnel and white collar expats. Tax is negligible and for the domestic population, most public amenities are free. The real estate boom ground to a halt even before the Dubai debacle hit. Dubai’s best bet for the future would be modest spending habits combined with leverage of its central position between the East, the West and Africa. Expanding Dubai’s role as importer/exporter with excellent port and airport facilities could start the revenue engine again. Financial and political transparency is crucial if the image of the desert state as an overspending family owned business is to be changed. Time to sell the Ferrari and pawn the bling bling. If not, Dubai World will be only the beginning of the bursting bubble.
Wednesday, September 10, 2008
Blowing bubbles
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.
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.
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”.
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