free_LUNCH

I recently read about what a “bullet graph” is all about and I really liked what it conveys in a concise graphical manner. This type of graph is slowly finding its way onto corporate dashboards as a replacement of infamous gauges. Gauge takes up a lot of space, provides very little information, and guess what, takes practice to read. Shouldn’t graphs be intuitive to read and interpret. Bullet graphs help to do just that. Take a look at the graph that I have created below and try to understand what it is trying to convey. Remember, it is for dashboard purposes.

You can download the excel file here to play around with the chart and make your own variations. Another website to get a much better detailed version of the template here.

Number of articles have been written on Amazon and Wal-Mart’s war on book prices this holiday season. Let’s take a different look at the same story and how it can possibly help the economy and the consumers by – increasing the pie.

First, the story. Wal-Mart recently decided to start its own price war, taking on Amazon in the online book market. Wal-Mart began by marking down the prices of ten best-sellers—including the new Stephen King and the upcoming Sarah Palin—to ten bucks. When Amazon, predictably, matched that price, Wal-Mart went to nine dollars, and, when Amazon matched again, Wal-Mart went to $8.99, at which point Amazon rested…From a game-theory perspective, price wars are usually negative-sum games: everyone loses. A recent study found that, if competitors do match price cuts, industry profits can get cut almost in half. (Read more: here)

So the final prices were $9.00 (Amazon) and $8.99 (Wal-Mart). Where is the pie here?

I did some research to find out what exactly is the price elasticity of demand for books. Its a difficult number to calculate and I wasn’t very hopeful until I found this research article. This research intended to determine demand for books and was conducted in Norway. The research took into account number of demographic parameters into consideration. One of the numerous conclusion of the article was:

For our calculations, lets assume that demand is fairly elastic and it is –1.5.

So if the prices fell from $10.00 to $9.00 (say) then prices fell by 10%. Which means the books expected to be sold will increase by 15%. Which in turn means that the revenues will grow from 10X to 10.35X (9 x 1.15X). A value creation of 0.35X or 3.5%. While this number may look small in percentage terms, it is substantially big when we can find the real value of X (in 2006 3.13B books were sold) and substitute.

What Amazon and Wal-Mart have unintentionally done is to increase the total pie (the total revenues that can be earned by them). Yes, the margins may have taken a hit, but don’t we know that NPV is a better measure than IRR.

Do you think this research if conducted and analyzed in the US can change prices in the longer run? Thoughts?

A good analysis on this price war has also been done here.

Yes, problem solving is an art! An art that can be mastered through sheer discipline and rigor. The secret lies in being able to dissect the problem at hand into manageable, logical pieces and then working on them independently. At the end,  fit the pieces into a coherent whole that is nothing but one of the many practical solutions. There is no doubt that you need hard technical skills to work on the pieces, but there is no dearth of information and skills for that requirement. What really differentiates a good problem solver from bad is the beginning and the end.

Last year and most recently, I had the opportunity of attending a workshop organized by Prof. Patrick Noonan on ‘The Art of Problem Solving’. He reiterates the point of breaking down a problem (many times very ambiguous and convoluted) into smaller pieces. Say you are a part of a team asked to devise a long term strategy for a company. There are many ways to approach this problem – some good, some bad. One way is to assign team members to individually evaluate the company performance to date, industry performance, competitor analysis, and so on…Bad. Another way is to properly understand the main drivers of business, strategy of the company so far and its return on investments, awareness of macro/micro economic trends that can affect the business, forecasting outlook for the industry, reviewing current innovations and consumer behavior, and so on…much better. If you carefully compare the first approach to the second, you will see that in the former, each aspect does not contribute to the final solution. Whereas in the latter, each aspect has something to contribute. Understand that frameworks (the former method is a classic application of a classic framework) as taught in classes serve as guides, not as processes.  There is a big difference.

The last step is collating information gathered in a coherent logical way. This is where creativity, gut feeling, and experience plays a big role. Every strategy developed should be tested in such a way so as to suggest some tactical approach that can be quantified and justified. And then there should be another question – what if? Risks associated with each approach should be outlined in as much detail as possible. How you present your solution to the client is yet another step that needs no exaggeration.

There are various resources available throughout the internet for you to read about different approaches and tools to help you practice the art of problem solving. Six Thinking Hats by Edward de Bono, The McKinsey Way, and an upcoming book by Prof. Noonan will serve as good starting resources in case you are interested in fine tuning your skills.

Law of diminishing returns in a classic economic concept. Though it is really easy to visualize (or feel), it has proven very difficult for economists to really prove.

Lets first discuss what this law is all about. Lets say you want to start a business of selling milkshakes. You purchase all the necessary equipments and raw materials and are ready. A few days later you realize that it takes you about 10 minutes to serve a customer all by yourself. You hire a person to help you. He manages the cleaning of blender and you take care of serving the customers. You see that it takes only 7 minutes for you to serve the customers now. You get creative and hire another person. He takes care of all billing activities and you are free to just take orders and prepare the milkshake. The time to serve the customer reduces to 4 minutes. You are happy. But then you get more creative and hire another person just to take orders. Suddenly the time to serve a customer increases to 5 minutes. You realize that if you now end up adding one more person to the group the serving time will increase to 7 minutes. This is law of diminishing returns.

Law of diminishing returns state that as you add an incremental unit of a certain variable input, there will come a time when adding further units of the variable input (with all other inputs constant) will actually start decreasing the marginal output.

Why does this happen? That is a difficult question to answer but easy to understand. Conflict may be an appropriate word to describe the situation. Because all other inputs are constant, increasing of one particular input creates a conflict and hampers proper interaction between them. In the earlier example it is possible that the space in your shop is limited and continuous movement by 4 people is resulting in a loss of productivity. If you keep adding seeds to a pot, the number of flowering plants that actually grow will increase. But throw a large number of seeds, and there is a conflict and only a few plants actually survive. Over-utilization could be another reason. Taking the same example from above, if the blender keeps running for a long time, it may breakdown occasionally thus bringing down your marginal output. We can see this phenomenon occurring around us as well. Study for an hour, you learn, study for another hour, you learn more. But keep studying long hours and there comes a time, due to fatigue, that your learning comes to a standstill or becomes marginal.

So what is in it for us business folks. If it hasn’t become obvious yet, a LOT.  Every manager, in every capacity, should keep a close tab on this relationship and monitor the productivity of his/her resources. It should be on his dashboard for easy access. With experience, not only will he be able to isolate areas of conflict, overutilization, and fatigue but will also be able to mitigate the problem by either increasing other resources or controlling the increasing resource.

The law is widely used in a number of studies in various disciplines. Search the internet for numerous stories that correlate happenings with this law.

To understand what a 10-K is and what aspects should be read, I will refer to Home Depot’s 10-k document filed on 4/2/2009. As with all filings, 10-K document can be downloaded from the company’s website – in this case, here, or from secinfo.com – for Home Depot here.

A preliminary guide to the report can be found on Wikipedia. We will not cover the basics in this document.

The article on Wikipedia also covers the various sections within a 10-K report. We will delve a little deeper into most of the sections in this guide.

A 10-K document should always be read by a serious investor if he/she wishes to determine the current state of a company. A 10-K will help to gauge the health of a company, its operations, and its various other initiatives. Without a doubt, a single 10-K report is not enough for anyone to come to any conclusions. Typically, one should compare consecutive year 10-K reports so that a definite direction in which the company is going can be determined. At the same time, comparisons should be made with a competitor’s results, industry averages, so as to peg a company in relation to other players in the industry.

Similarly, a 10-K report does not provide any indication of how a company is going to perform in the future. The report only provides information of what has been, not what will be. An investor has to derive intuitive conclusions, based on economic, market, political, and other trends to gauge the performance in the future. Even if the conclusion is well supported by facts, it is impossible to accurately predict anything about the future.

But, with experience, good judgment, and detailed analysis an investor is expected to be right more than wrong most times.

So let’s see what Home Depot’s 10-K report tells us about the company.

Home Depot’s 10-K

Part 1 – Item 1 – BUSINESS

This section of 10-K gives a brief introduction to the company and the industry within which it operates. A very important item, it will help you to know what the company does, where is it located, what are its different product offerings, and who are its customers. This section will also list out different sources of revenue for the company and the various strategies it employs to stay ahead of its competitors. An investor should keep an open eye towards the risks mentioned in this item. Sometimes common sense, it is important to understand the risks because only then will an investor identify the impact of external forces such as market, political, and economic conditions.

Excerpts from Home Depot’s 10-K – Note that this list is not exhaustive. A complete reading of the report is needed to gather all necessary information.

“The Home Depot, Inc. is the world’s largest home improvement retailer based on Net Sales for the fiscal year ended February 1, 2009 (“fiscal 2008”).” – So we know it is the largest home improvement retailer.

“As of the end of fiscal 2008, we had 2,233 The Home Depot stores located throughout the United States…Commonwealth of Puerto Rico…U.S. Virgin Islands and Guam (“U.S.”), Canada, China and Mexico.” – They are present in different countries, mostly around the US. They have entered the China market, one of the fastest growing economies.

“We shifted our focus from new square footage growth to maximizing the productivity of our existing store base… to make them simpler, more consistent and more customer-focused… associate hours to be more customer facing and refocused our efforts…” – This tells us that they had been expanding quite rapidly earlier but have slowed down the process in exchange of increasing productivity at existing stores.

Their customers predominantly include home owners, and professionals in the building industry. We may infer that Home Depot’s business is highly dependent on the housing industry. In the face of any other kinds of products, any downfall in the housing industry cannot be mitigated by any of their other services very easily.

They have 4 categories of products:

· Plumbing, electrical and kitchen

· Hardware and seasonal

· Building materials, lumber and millwork

· Paint and flooring

It should also be observes that all categories contribute almost equally to sales even though plumbing, electrical, and kitchen contributes the largest.

“In fiscal 2008, we reduced our inventory while maintaining a favorable in-stock rate.” – They are in the right direction as they implement better forecasting and inventory management tools.

“We also reduced a number of one-time discount promotions…continued to introduce innovative and distinctive products… we have formed strategic alliances and exclusive relationships with selected suppliers” – If you remember the discussion we had on the retail industry earlier, Home Depot is following certain best practices that will help it differentiate from its competitors and stay ahead of the game. These are – reducing intermittent promotions to avoid stock piling and sell through, introducing store brands to maintain exclusivity, and forming strategic alliances to get better terms and reduced costs.

“…we have three sourcing offices located in the Chinese cities of Shanghai, Shenzhen and Dalian, and offices in …India…Italy…Mexico and Canada.” – Their products are made all over, not exclusively USA or China.

“we continued to make information technology investments…in our supply chain and merchandising tools to improve inventory management capabilities and streamline our operations.” – An analyzed above…

“Our business is highly competitive, based in part on price, store location, customer service and assortment of merchandise.” – Rightly said. We also see the impact of the 4 important characteristics of a retail company on Home Depot’s competitiveness.

Risk Factors

All companies are required to list the various risk factors that could adversely or materially affect its business. Investors should make a close note of all the risks and match them up with their knowledge of the current market conditions. It will help him/her make valuable judgment on a company’s operation in current times. Some of the risks noted in Home Depot’s 10-K include:

“state of the housing, construction and home improvement markets, rising costs, a reduction in the availability of financing,” – We all know what is going on these days. But if numbers have their say, we can probably say that markets are improving and home sales are increasing. This can positively affect Home Depot’s performance in the coming year.

“fail to identify and develop relationships with a sufficient number of qualified suppliers” – Though this is mentioned, unless we see any strained vendor relations in the past, we can say that the management is competent enough to maintain its supplier relationship. Research pertaining to exclusive relationship and its survival rate in the past can be a good indicator of the seriousness of this risk.

“ability to obtain additional financing on favorable terms” – Financing should be available in today’s market as government tries to fuel the economy by providing low lending rates.

“inflation or deflation of commodity prices could affect our prices, demand for our products, sales and profit margins.” – O yes! Gas prices have been fluctuating recently and so are the commodity prices. This can very well affect the transportation, procurement, and maintenance costs and can have a big impact on the business. Investors should pay close attention to this risk.

“ability to attract, train and retain highly qualified associates.” – At least for the near future, this shouldn’t be a problem if Home Depot plays its cards right. There are many talented folks looking for job these days.

“Increased competition could adversely affect prices and demand for our products and services and could decrease our market share.” – Because of high entry cost, Home Depot can be safe from new players. But needs to closely monitor existing competitors and be proactive in implementing it’s own strategies.

“If we cannot successfully manage the unique challenges presented by international markets, we may not be successful in expanding our international operations.” – Home Depot operates only in China apart from nearby countries. It does not have a lot of experience managing expansion internationally. So if it tries to open in other countries, close watch needs to be maintained on its performance, market share, and sustainability. Even a company like Wal-Mart had to leave Korea. It’s not easy.

No. This is not a feature by feature comparison of iPhone and iPod touch. But these are my views pertaining to a discussion I was having yesterday whether iPod touch is in a declining stage of its lifecycle. I say not.

First the facts: I have been an avid user of iPod touch and love the device. Though it is restricted in its use of wifi to connect to internet (data), I find it quite satisfactory as all places I frequent – home, office, hotels, most fast food restaurants (yes!) and school, have free wifi connection. The only time I am unable to check my emails is when I am commuting to and fro these places. I am completely fine with that as I do not need to do that anyways (and it may be dangerous). Most apps that work on the iPhone also work on the iPod touch. I have an RSS reader that helps me read various blogs and news sites I frequently visit. There are music applications, even an NPR application for radio. There are various applications for Facebook, Twitter, and other social networking sites. It also doubles as a mobile gaming platform. I don’t mind carrying a phone with me as my pants mostly have four pockets and there are enough slots in the dashboard and my bag to accommodate both these devices. What are absent is a phone and a GPS. The lack of GPS is compensated by an excellent maps application in iPod touch. I just download the directions one way and use that if necessary and voice direction is provided by my wife. Needless to say, a lot of innovation is still left in this product (adding a camera, GPS, office applications, etcetera) for a long time to come. Total cost of ownership for an iPod touch is $229, $299, or $399 depending on the memory one desires.

On the other side, iPhone has all of the above including what’s lacking in iPod touch. Will I prefer one over the other. If I have a choice, yes!!! I will go for an iPhone. But the cost of ownership of the device is prohibitive, for now. It comes to around $120 per month. I will go on to say that unless a corporate is sponsoring my data plan, I may never buy an iPhone and be happy and content with my iPod touch.

Coming back to the original argument – Broadly speaking, there are two categories of people – one who can afford and one who cannot afford an iPhone. In my opinion there are more in the latter than in the former. And I also believe that there are many more people in the latter category who haven’t yet switched to iPod touch from their current mp3 player. This is a huge market segment that will show itself in the years to come and buy the product. With Apple providing free iPod touch to Mac buyers as part of back to school program, this device will continue to have users and will get continuous traction among the 15 – 27 age group.

What can also point us in coming to the right conclusion are the sales figures of these devices. Per last announcement by Apple, sales of iPod touch doubled over the last year. Almost 3.21 million devices were sold last quarter, in line with 3.79 million iPhones. More here.

In the end, I would still place iPod touch in the growth stage. iPhone is going to be the choice of device for corporate users and those who can afford it.

For a while I have been thinking of writing a Cow guide on ‘How to read a 10-k document’. For that document I wanted to analyze a real 10-k of a retailer as a reference. But I realized that it is not a good idea to read a 10-k document without knowing about the industry itself.

So as first step, I have written very, very broadly (in bullet points) some of the characteristics of the retail industry. I am assuming the readers are a bit knowledgeable about the industry and can extrapolate my short blurbs for their better understanding. Also note that this document is not intended to be read expecting to learn about great new innovations in the industry.

The pdf version of this document is available here.