Transformations: Wrapping an Old Fish in a Piece of Paper Called Change

Written by guest author Carlos Castelán with Andrew Murphy. Carlos is Managing Director of The Navio Group.

Note: size of bubble represents FY 2017 company revenue

In recent years, companies in the retail and consumer goods space have touted “business transformations” – a cue to analysts and Wall Street that they were launching innovative products and services or becoming more digital, to name a few themes. To understand the success rate of transformations in the retail and consumer good markets, The Navio Group partnered with Loup Ventures to identify a basket of companies and analyze key performance metrics over the last five years.

The results were surprising: companies that frequently touted a transformation on their earnings calls were less likely to succeed in driving long-term revenue lifts and generating growth.

More often, companies with executives that were eager to publicize transformation efforts were either a) unsuccessful driving top-line and bottom-line improvements or b) only succeeded in cost-cutting to improve margins, despite stagnant or declining revenue. In effect, transformations touted by executives at these companies resulted in operational restructuring.

One notable exception stood out amongst the list of companies: Domino’s. Between 2013 and 2017, its executives never mentioned a transformation and instead took a workmanlike approach to change their company to drive outsized results. Domino’s drove a staggering 30% revenue growth and increased its operating income by more than 40% over the five-year period.

We believe the genesis can be traced back to the CEO, Patrick Doyle’s, early declaration on Jim Cramer’s show that “Our pizza tastes worse than the box…I’m gonna tell people.” Rather than dust off the traditional turnaround playbook, the management team came out and exposed the underlying, widely known issue– the product. As Doyle told CBS, “We went on air on a Monday, and by Wednesday, our sales were up double-digit. And we hadn’t even told them how we’d fixed it.” The leadership team and organization focused on fixing the product and, in doing so, reinvigorated the brand. It then focused on enhancing customer experience through the facilitation of convenience by turning itself into a technology-focused company. The results speak for themselves as the company’s stock outperformed traditional high-achievers Amazon, Apple, and Facebook over a seven-year period.

So, what can we conclude from the data and from Domino’s success?  Three themes stick out:

  • Leadership and courage make all the difference. It doesn’t show up in any of the numbers but leadership and the courage to fundamentally address and then fix underlying issues separates companies like Domino’s. It’s hard to publicly acknowledge to both customers and Wall Street – particularly when executives’ compensation is tied to stock price – that your company has problems, but leadership is about making difficult decisions. As Doug Stephens writes in the Business of Fashion:

It requires significant organizational introspection, courage, honesty, design thinking and research. There is no off-the-shelf solution, no app and no magic to it – just the willingness to reinvent, reimagine and risk the occasional screw up. Think of it this way; if it’s not risky, it’s probably not innovative.

  • Understanding what a company sells and then reinventing the product is core to a successful transformation. Identifying the customer value proposition in terms of both product and experience– not how the company maximizes profit – is how a company reinvents itself. Domino’s went about fixing its product (pizza) and then creating a seamless customer experience through digital and mobile. It did this even though the legacy business and its processes relied on physical locations. Nordstrom is experimenting with service-only locations because it believes this to be a resonant experience for its customers. As Mr. Stephens writes, “Customer experience is…the future of how physical retailers will generate revenue. Experiences won’t just sell products. Experiences will be the products.”
  • Rethinking the talent strategy – both internal and external – is critical. To reinvent a business, leadership needs to also rethink its talent strategy. According to Rob Biederman, CEO of technology platform Catalant, 53% of individuals in the C-Suite are now thinking about a more agile workforce as a top priority. Domino’s now has 50% of its headquarters employees in software and analytics. The transformation of the organization is key to reinventing the customer experience and building an exponential mindset in the organization as the industry continues to evolve.

As change becomes the norm in the retail and consumer goods industry – as well as most others – executives and leaders will need to re-think what it means to transform their businesses rather than, as Barack Obama once said of his opposition, “wrapping an old fish in a piece of paper called change.” Leaders should ask themselves: what are the underlying issues? And how do we take a non-linear approach or exponential mindset to transforming the business, even if it disrupts our current model?

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Adrenaline Shots for Apple AI

  • Apple has been criticized for not doing enough in AI. Two recent announcements show the company is closing the gap.
  • In the past two weeks, the company has announced the hiring of Google’s AI head, and an AI partnership with IBM.
  • Google’s AI head (John Giannandrea) brings credibility to Apple AI, critical in recruiting, and is likely work on AI-powered interfaces and Apple’s self-driving car program.
  • IBM partnership allows iOS developers access to IBM Watson’s enterprise machine learning, and use it to make smarter AI apps.

Core ML 101. At WWDC 2017 Apple unveiled Core ML, a platform that allows developers to integrate machine learning into an app. The AI model runs locally on iOS and does not need the cloud. At the time of the announcement, Apple outlined 15 domains for which they have created ML models, such as face detection, text summarization, and image captioning.

IBM Watson and Apple announcement. Two weeks ago Apple and IBM announced they will integrate IBM Watson with Apple Core ML. Previously, developers could convert AI models built on other third-party platforms, like TensorFlow (Google) or Azure ML (Microsoft) into Core ML, and then insert that model into an iOS app. Now developers will be able to use Watson to build the machine learning model, convert it to Core ML, and then feed the data back to Watson’s cloud. The reason why this is important is it allows iOS developers to leverage Watson’s capabilities and ultimately improve the AI in iOS apps.

Watson works locally on iOS and improves apps. What’s unique about Core ML is it runs locally on mobile devices, meaning it doesn’t have to send data back to a server. This is different than other mobile AI approaches. Running locally is an advantage when the speed of AI is important, like image recognition in AR or natural language processing. What’s new is Watson will be able to “teach” Core ML to run the AI model built with Watson. Basically, Watson does the hard work of getting a usable AI model built and then teaches it to Core ML, who can then run the model locally on its own. The app can then send data on the model’s performance back to Watson, at any time, to be analyzed for available improvements.

Recent history of Apple and IBM. In July 2014, Apple and IBM partnered to create enterprise applications on iOS devices, leveraging IBM’s big data and analytics and Apple’s hardware-software integration. IBM started selling iPhones and iPads to clients that came with software and applications for enterprise designed with Apple’s help.

Summary of big tech’s machine learning services. 

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

How To Think About Recent Volatility in Tech

Market decline does not change the mega growth opportunities. The heart rate of the market increased the past week because of fears of a trade war, Facebook data privacy, and broken market technicals, but the health of the market is unchanged and the health is good. Core underlying tech trends including artificial intelligence, robotics, big data, and autonomous transportation, will support continued growth.

Hold tech for the long-term. We believe that tech is essentially taking over the rest of the economy; therefore, investors should hold tech long term. Just as every company is now an internet company to some degree, we believe that eventually every company will be an AI company.

Market undervalued. From a valuation perspective, our view is undervalued. The market has rallied back to the old highs, but the S&P is up only 3% per year over the past 17 years, compared to the previous 17 years (1983-2000) when it was up 17% per year.

Putting the size of tech into perspective. The tech sector’s growing clout is not just a U.S. story. Tech stocks have become so dominant in emerging markets that for the first time since 2004, the industry last year overtook finance as the biggest sector in the MSCI Emerging Markets Index. Tech had a 28% weighting near the end of 2017, more than double its level six years ago, according to data provided by MSCI. Facebook, Amazon, Netflix Inc. and Alphabet together account for a 7.8% weighting in the S&P 500, more than double from five years ago.

Company Updates:

Tesla. We remain positive on TSLA. Shares are down 20% in the past month mostly due to fears of another miss in Model 3 production. The recent stock dive is due to a combination of a Model X accident that is being investigated, Waymo’s partnership with Jaguar, which legitimizes a key competitor (the I-Pace electric SUV), growing concern among all companies testing self-driving vehicles amid the Uber fatality, and news that Moody’s has downgraded Tesla’s bonds to B3 from B2, citing significant shortfall in the Model 3 production rate and a tight financial situation. We continue to believe the Tesla story has the best risk-reward among tech companies over the next 5 years.

  • Model 3 production. We’re expecting another miss in Model 3 production in the March quarter but that does not change the story. There is more demand than supply for the Model 3 (about 400k preorders which is unheard of in automotive). It might take a year, but eventually, Tesla will get the Model 3 production right, and ramp output.
  • Model X accident. We see the recent Model X accident the same as accidents with gas cars. It is unlikely that the battery or Tesla’s advanced cruise control “autopilot” were to blame. Tesla disclosed that the autopilot feature properly functions 200 times a day on the same stretch of road where the accident happened.

Facebook. Limited upside to FB. Given the privacy issues, for the first-time advertisers have to think about Facebook as a liability. Separately, it’s unclear about how the recent privacy changes will impact Facebook’s ability to make money.

Nvidia. We remain positive on NVDA. Shares of NVDA dropped 11% in the past week following the announcement that they temporarily stopped autonomous testing, and in part because of the broader market sell off. While the company did not comment on timing, we expect testing to resume in the next 3 months. The big picture is the company is well positioned to capitalize on four mega trends, AI, autonomous cars, gaming, and blockchain through their dominance of GPU processors.

Apple. We remain positive on AAPL. Concern is emerging that iPhone demand in June will fall below Street expectations. We think iPhone demand over the next two quarters is not important to the story. What’s important is the share buyback, services, and the next iPhone.

  • Share buyback. Apple can add 4% per year to the stock price (assuming they use $40B of the $55B they generate in cash each year to buy back stock). Apple will give an update on the share buyback when they report the March quarter, likely late in April.
  • Bigger screen iPhone this fall. We expect Apple will announce a 25% bigger phone in the fall. This will be a positive for unit demand and average selling price.
  • Services. Services account for about 15% of revenue and are growing at 15-20% year over year. We believe this segment will continue to grow at a 15% or better rate over the next five years. This is important because the earnings multiple on shares of AAPL will likely increase as investors view the predictability of services are more attractive.

Google. We remain positive on GOOG. We expect the next six months to be rough for shares of GOOG as questions emerge about how the company uses data. Despite that negative potential, Google is too tightly woven into the fabric of the internet. The company is one of the best ways to invest in AI, given the company has a stated their intention to move from a mobile-first company to an AI-first company over the next several years. Lastly, the company has a stake in Waymo, the leading autonomous car company. We expect years of positive news to come from Waymo.

Amazon. We remain positive on AMZN. The company is best positioned for the future of retail. We see that future as a combination of both online and offline retail. Online sales account for about 15% of global retail, and in the future, we believe it will eventually reach 55% of sales. We also expect Amazon to do more with physical retail locations and we continue to believe the company will eventually acquire Target (TGT). The company’s AWS web hosting business is only 15% of revenue, but it is growing at greater than 30% for the next several years.

Twitter. Limited upside to TWTR. About 14% of Twitters 2017 revenue came from selling data, growing at 18% y/y, compared to Twitter’s ad business that declined by 6%. Selling private data is a toxic label, and this could limit the upside to shares over the next year.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make. 

Apple and Amazon are a Privacy Safe Haven

Apple and Amazon are relative safe havens.

  • We expect over the next year investors will look favorably on Apple given the company’s privacy-first ethos in an age where privacy is becoming a more prevalent topic.
  • Amazon will also likely benefit from the Facebook blowback given Amazon relies less on data to run its business than ad-focused companies.
  • The biggest risk to Facebook is attrition and, to a lesser, extent regulation.

Attrition. People are upset that FB abused their trust, although it doesn’t seem that users are upset about social media in aggregate. The trend is #deletefacebook not #deletesocialmedia. The risk to Facebook is that user growth slows or even declines. At the end of Dec-17 quarter, the company had 1.4B DAUs, up 15% y/y. For 2018, the Street expects about 10% DAU growth. If Facebook misses those numbers, shares will likely be negatively impacted. While it’s still early to tell how serious this bout of outrage against Facebook will ultimately be, Twitter and Snap may have an opportunity to benefit if users do leave Facebook.

Regulation. The Cambridge Analytica news of the past week has extended the privacy topic beyond Facebook. Given the political nature of the scandal, it currently seems more likely than less likely that some sort of restrictions get placed on the use of online consumer data. Mark Zuckerberg’s comments yesterday on CNN suggested that Facebook will take additional steps to assure user privacy as well as being open to some level of government oversight. If the government does decide to regulate the use of online consumer data, it could negatively impact all companies that rely heavily on monetizing that data including Facebook, Google, Twitter, and Snap.

Apple’s privacy ethos.  Tim Cook has made privacy a religion at Apple. It impacts everything from secrecy around new products to Apple Pay‘s anonymous transaction framework. In fact, Apple has a section on its website that outlines all of the ways Apple protects user privacy across all of the ways one uses their devices. Some notable Apple privacy insights include:

  • Privacy is a fundamental human right
  • Apple doesn’t gather your personal information to sell to advertisers or other organizations
  • Every Apple product is designed from the ground up to protect personal information
  • If we use third-party vendors to store your information, we encrypt it and never give them the keys

Amazon is service-first. Amazon’s focus is on delighting the customer through the services they provide. While Amazon does sell targeted ad space on their website, the “Other” revenue segment, which mostly constitutes advertising revenue, was less than 3% of total revenue in the Dec-17 quarter ($1.7B out of $60.5B). Advertising has never been a focus of the company, and it’s inconceivable they would abandon their current core businesses to pivot to an ad-first model that leaves them exposed to the risks we’ve highlighted in this note. Amazon’s real use case for user data is on their own site, targeting users with product suggestions.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Target Taps into One Advantage Over Amazon

  • We tested Target’s Drive Up service with 10 separate orders.
  • The most important metric, park-to-depart, average time was an impressive 1:18 seconds.
  • This delightful service that will gain traction, and something that Amazon can’t offer today.
  • This does not change how we feel about a Target/Amazon combination long term.

Conclusion. We had a positive initial experience with Target’s Drive Up service, so we decided to put it to the test. We completed 10 total purchases at 2 different Minneapolis stores (5 at each store), paying attention to the overall experience as well as putting them on the clock. Target is leveraging its brick and mortar DNA to create an experience Amazon can’t today.

What does Drive Up mean for an Amazon + Target Combo? We are believers that Amazon will eventually buy Target, given Amazon’s interest in Target’s store count, and their shared customer demographic. Plus, long-term, brick and mortar will account for 45% of global retail sales – and Amazon knows it. Amazon is attacking traditional retail through Prime Now, Whole Foods, and Amazon Go (more on Amazon Go’s Trojan horse strategy in retail here). We believe those initiatives will yield market share gains in brick and mortar, but not get them a footprint that can only be achieved by acquiring an established retailer. Target’s Drive Up service – leveraging assets that only brick and mortar can offer – is a good example of the innovation necessary to compete in retail, which makes Target more appealing to Amazon.

A word on Shipt. In Dec. Target announced plans to acquire Shipt for $550m. We think it’s the right move for Target to try to compete with Amazon Prime Now; ultimately, though, Target will struggle to integrate Shipt. Why? Because Shipt is outside of Target’s sweet spot (both strategically and geographically). Counterintuitively, we see the Shipt acquisition as another reason why Amazon will eventually acquire Target.

What we learned about Drive Up. We were delighted with how fast and convenient the service was as a whole. There were some outliers, one order (body wash) took over an hour to be ready for pickup, while the ready for pick up average was 21 minutes and removing the one outlier dropped it to 16 minutes. On average it took 35 seconds from the time we parked to the employee reaching the car with the order. From there, it was an average of 43 seconds to scan the phone’s barcode and get the items into the car before being able to driveway. In total, for the most important metric, park-to-depart, the average time was 1:18. From the Loup team’s perspective, half of our future Target runs will use Drive Up. Detail below.

  • Ready for pickup: Time from order completion to items being available for pickup
  • Park-to-Departure: Total time from being parked to leaving the parking lot with the items

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.