Monday, September 29, 2014

FMCG market: India picks up but Bharat lags


Household consumption of fast-moving consumer goods (FMCG) appears to have recovered from a deep slump seen last year - at least in urban areas. Data from market research firm IMRB show that consumption in urban India, in volume terms, rose seven per cent in the May-July period this year, compared with a decline of 12 per cent in the same period last year. In value terms, consumption was up eight per cent during the period, against a decline of four per cent seen in the year-ago period.

The situation in rural parts of the country, though, was not as good. While urban areas were in the green in May-July, rural continued to be in the red, notably on the volume front. Rural volume declined seven per cent from May to July, against a fall of one per cent in the year-ago period. In value terms, consumption rose just one per cent, compared with two per cent last year.

Varun Sinha, group business director, IMRB Kantar Worldwide, said: "The uptick in urban sentiment led to better stocking of products across staples, as well as impulse categories. This resulted in household consumption recovering. By comparison, the positive sentiment appeared to be missing in rural areas."

Among FMCG segments, in urban areas, volumes for personal care inched up three per cent, compared with a two per cent increase last year. Value growth was sharper, at six per cent, against three per cent a year ago. Household care products saw steady volume growth of two per cent, while consumption increase in value terms was nine per cent (against seven per cent last year). Food & beverage consumption, on the other hand, grew eight per cent in May-July this year - the sharpest annual rate of rise for a segment. Last year, it had fallen 14 per cent, according to IMRB. In value terms, food & beverage consumption grew eight per cent in the period this year, against a decline of seven per cent seen in 2013.



Rural areas presented a mixed picture in FMCG categories. While personal care and household care saw marginal growth in the period when compared with last year, food & beverage slipped even further. Personal care volumes rose three per cent, compared with last year's two per cent, while value growth was steady at six per cent. For the household care segment, growth in volume terms was five per cent (against four per cent last year), while value growth was 13 per cent, versus nine per cent last year. The food & beverage volumes, in contrast, declined nine per cent in May-July this year, against a decline of two per cent last year. Consumption in value terms, on the other hand, slid three per cent in this FMCG category.

India Chief Executive Sunil Duggal said: "While pain exists in both urban and rural areas, the challenges of late have been greater in the hinterland. The rainfall has been patchy in the north and central parts of the country, coupled with a stagnancy in minimum support price of crops and a drawing down of rural welfare schemes. This has resulted in a shrinkage of income in the hands of rural consumers, affecting overall household consumption."

"As far as growth in personal care and household care in rural areas is concerned, that is more of an exception than norm, because the broad trend clearly points to a slowdown. Our talks with trade channels show consumers in rural areas have not been substantial spenders in recent months. This has been exacerbated by inflationary pressures on everyday items affecting both urban and rural areas. The moot point is that urban consumers seem optimistic, so the consumption is increasing," Duggal said.

Chairman Harsh Mariwala said: "A new government in power pushes sentiment notably in urban areas. The increase in household consumption in May-July in these parts is a result of this improvement in sentiment. This will get better as we go forward. Rural areas are a laggard in this respect and will follow urban areas in terms of a pick-up in sentiment. For that, there also has to be an improvement in economic growth, because people begin to spend only when they feel secure about the environment around them, about their jobs and incomes. While an element of optimism helps consumption to an extent, people feel more confident to spend if they begin to see real growth and development on the ground. Rural areas will respond with a lag, while the urban areas will see a quicker recovery."

The consensus is that the tide should notably turn for FMCG in urban areas by the fourth quarter of this financial year. The government has been working in this direction. Earlier this month, it raised the dearness allowance of its employees by seven per cent - a move that will benefit nearly three million workers.

Two months before that, in Union Budget, it announced a slew of measures to boost domestic consumption, besides increasing tax exemption for the salaried class. Both of these steps, analysts said, favoured people residing in cities more.

Innovation pays off for Cummins



Padarwadi is a village of rice growers, located 110km from Pune in Maharashtra. A key step in processing raw rice is dehusking—for many decades an arduous task for the farmers, who, without electricity to power a dehusking machine, had to trek to another village that had power supply to perform the task. That’s until Cummins Inc. stepped in, in 2011. Working together with the Indian Institute of Technology, Bombay, and non-profit Maharashtra Arogya Mandal, the company’s unit Cummins Power Generation developed a generator— one that runs on oil extracted from local pongamia seeds for fuel. The generator was used to power the village’s own electric dehusker—a small innovation that has made life a lot easier for the rice farmers of Padarwadi. “If you have to understand how Indian this company is and how specifically we tailor our products to the needs of our customers, this is it,” said Anant J. Talaulicar, chairman and managing director of Cummins India Ltd. “This is our product for the rural areas of India and I can tell you we don’t have any product like this in any other part of the world. And we developed it because we felt there is a need,” Talaulicar added. That anecdote, perhaps, explains why the maker of fuel systems and power generation equipment (among other products) has emerged as a rare example of a successful manufacturer in India, making products for both domestic and overseas markets. Many foreign manufacturers have been too daunted by India’s reputation for bureaucratic inertia, the rigidity of its labour laws and its infrastructural deficiencies to venture into the country. As India, under Prime Minister Narenda Modi, sets out to become a manufacturing hub to create jobs by attracting foreign investors to “Come, make in India”, Cummins’ experience makes for an interesting case study. The numbers tell part of the story. In 2013, the Cummins group posted Rs.9,834 crore in revenue. It employs more than 9,000 people. At its 20 manufacturing facilities in the country, Cummins makes diesel engines and natural gas engines—for trucks, buses, locomotives and ships—as well as mining equipment and drilling equipment. In its power business, Cummins makes generator sets for power backup systems used by banks, restaurants and factories; in its component business the company makes turbochargers, fuel systems and filtration systems. “Wherever there is a need to build infrastructure in India—roads, ports, airports, or backup factories with electricity—we provide our engines,” said Talaulicar. “You know India has had a deficit of electricity traditionally,” says Talaulicar. “We have approximately a grid of 200 gigawatts of gird power in India that is backed up by almost 100 gigawatts of generators—almost 50% of the grid capacity is backed up by the generator sets.” There are four boxes that a company must tick to demonstrate whether it has been successful in an overseas destination. First, has the company been able to use the country as a market for its products? Second, has it been able to use the country as a production base, to manufacture for the market and the rest of the world? Third, has it been able to use it as a sourcing base? And fourth, has the company used the country as an engineering base, to design and develop products? Cummins checks all the boxes. Take, for instance, Cummins Research and Technology India Ltd, a division set up in 2003. The unit does analysis-led design work that reduces cycle time for new product development and minimizes time involved in physical prototype testing. While most multinational corporations get hand-me-downs in terms of technology from their parent, Cummins does a significant part of its research and development (R&D) work in India. “Almost the tables have turned,” says Talaulicar. “A number of our engineers sitting in India are helping in global development work.” In fact, Cummins is setting up an advanced technical centre in Pune that will house about 2,000 engineers and is expected to come up by September 2015. “Only about 15% of that work will be targeted for the domestic economy. The rest will be for global purposes,” said Talaulicar. “Today we have significant engineering skills in the country and we are completely integrated into Cummins global engineering network in terms of the reporting relationships. Information system is seamless. We don’t simply take global technology and force-fit them for India. We significantly customize products and localize heavily,” he says. Localizing sourcing and making products according to the specific needs of customers is a complex business. Talaulicar though believes that it is inevitable because the nature of the Indian market is very different compared with other parts of the world. Be it in road conditions or nature of power supply or even emission norms. When India moved from Bharat Stage II to Bharat Stage III fuel norms, several vehicle manufacturers started using electronically controlled engines. “But Cummins saw that one could get by using a mechanical solution,” said Talaulicar. “It was also a lower-cost one. So we changed the rules of the game and came out with it, which Tata Motors has used very, very successfully all through Bharat Stage III.” Kumar Kandaswami, senior director at consulting firm Deloitte Touche Tohmatsu (India) Pvt. Ltd, says that since their inception in India, some small multinational companies have tended to treat India not as a discreet market but as part of a larger continuum. “The fact that they (Cummins) haven’t carried their global proposition to serve the Indian market, but have developed technologies and products that fit the local needs, have helped them succeed,” he said. Cummins clearly is one of those firms. It is another matter altogether that when Cummins started out in India, it was mostly a story of technology transfer. More importantly, a story of serendipity. This was way back in 1962, at a time when few foreign companies were willing to take a punt on doing business in India. Of course, with the specific exception of the East India Company, which by then had been there, done that. In 1960, with the idea of growing operations of Cummins outside of its home market in America, Robert Hutchsteiner, president of Cummins Inc., had embarked on a journey of over 40,000 miles— through Japan, Australia, India and the European Common Market. In their book, The Engine That Could, authors Jeffrey L. Cruikshank and David B. Sicilia recount how Hutchsteiner had kept in touch with a classmate and friend from Massachusetts Institute of Technology. He was S.L. Kirloskar. Back then, Kirloskar was the head of Kirloskar Oil Engines, a manufacturer of slow-speed, 2-40 HP diesel engines. In January 1960, the duo paired up and met with the then Indian minister of finance, Manubhai Shah, with the idea of setting up a jointly owned manufacturing facility. The authors write, “Shah was receptive, in part because the timing was right. India was preparing to launch the third of its ambitious Five-year Plans. The Third Plan was scheduled to begin in 1962 and would emphasize on heavy industry. The Cummins-Kirloskar proposal would coincide neatly with this proposal.” After much discussion on the ownership structure, on 17 February 1962, Kirloskar-Cummins was incorporated with Cummins taking a 50% stake, Kirloskar 25.5% and the Indian public 24.5%. Listed on the Bombay Stock Exchange, the sale attracted demand for 55 times the number of shares available (36,750). For decades, the operation remained a small, not very profitable, technology transfer unit. In 1987, there was a falling-out between partners. Cummins then became the controlling partner. While Cummins has grown, doing business in India has been anything but smooth. For 2013-2014, Cummins India, the only listed entity of the group, saw its net sales drop 13.4% to Rs.3,976.67 crore. Its net profit also declined 21.5% to Rs.600.02 crore. For the June 2014 quarter, net sales rose 0.4% to Rs.1,032.71 crore and net profit gained 27.6% to Rs.211.99 crore. The downturn in the past two years forced the company to clamp down on its investments. The strong intent demonstrated by the new government to accelerate economic revival and encourage foreign investment has, however, made it optimistic of the road ahead. Cummins’ Indian operations expect to increase their share in Cummins Inc.’s global business from 5-10% to 10--15% over the next five years. Analysts share the optimism. The revival of infrastructure projects bodes well for Cummins, and will help the firm, which has been running at half its capacity, to improve its operating leverage, said Kunal Seth, analyst at Prabhudas Lilladher Pvt. Ltd. Moreover, an ambitious export plan will also shield the group. “A pick-up in demand in the domestic business and robust exports will help them fire on all cylinders,” said Seth. Since the beginning of the current fiscal year, Cummins India shares have been outperforming the broader market. The stock has gained 39.67% while the BSE 100 index has risen 27.28% and the benchmark Sensex has advanced 26.31% in the same period. “We continue to like Cummins given its technology and distribution intensive business model, strong cash generation quality. Cummins has relatively strong balance sheet and return ratios (+30%)—amongst the best in the capital goods universe. We retain positive bias with ‘accumulate rating’ and a price target of Rs.600 per share,” wrote John Perinchery, an analyst at Emkay Global Financial Services Ltd, in a recent research report on the firm.

 

Thursday, September 25, 2014

Falling commodity prices flash warning on widening global divergences



Global gloom-mongers have something new to worry about – falling commodity prices. The closely watched Bloomberg Commodity index, which tracks 20 commodity prices, has dropped this week to a fresh four-year low.
Tumbling prices for metals, oil and agricultural products fit with a narrative of a slowing China and of growth spluttering in advanced economies, despite exceptional levels of central bank support. It is hard, however, to find anyone in equity, bond or currency markets getting seriously concerned – yet. If anything, the opposite is the case.

Of course, falling commodity prices should feed through into higher real incomes and thus boost economic growth prospects. What matters as much, however, is the effect on inflation gauges watched by central banks. Falling commodity prices have this week helped push lower expectations about inflation rates priced into bond and swap markets.
That increases the chances of central bank interest rates remaining at historic lows for even longer – in turn, supporting elevated bond and equity prices. As one analyst puts it: “Asset reflation is here to stay.” (Readers are forgiven for feeling confused at this point: it was not so long ago that central banks were criticised for driving commodity prices higher.)
Another reason suggested for ignoring the most recent falls in commodity prices is that they result from an exceptional confluence of unrelated factors that is unlikely to last. Grain prices have fallen on bumper harvests – which are entirely unrelated to worries about credit bubbles in China which have hit metals. Oil prices fell as tensions in the Middle East and over Ukraine failed to hit production, as well as on demand concerns.
But the general price falls are flashing warning signs. They highlight widening faultlines between the world’s biggest economic regions. Such divergences are already driving currency and bond markets – and could become a bigger feature as quantitative easing by the US Federal Reserve ends next month.
Falling commodity prices reveal mounting concern about China and Beijing’s attempts to curb unsustainably high rates of credit creation, perhaps without fresh stimulus measures to counter weaker growth. Metal prices reflect investors’ assessment of just how voracious China’s appetite for raw materials will remain. “Ten years ago copper prices were a barometer of the global economic cycle – now they are all about China,” says Robert Farago, an investment strategy consultant.
In the US . . . rather than a sign of weakness, commodity price falls largely reflect the dollar’s appreciation on the back of a recovering economy
Across emerging markets – at least those dependent on commodity exports, for instance in Latin America – price falls fit with the story of a decade in ascendancy that is drawing to a close. But continental Europe is not becoming an alternative growth driver. Here, the prospect of falling energy and food prices boosting real incomes offers scant relief. With inflation already dangerously weak and the eurozone facing the risk of a deflationary slump, the last thing the European Central Bank wanted was something that risked further upsetting inflation expectations.
The disinflationary impact in the eurozone of commodity price falls has been offset by the weaker euro – but only partly. In euro terms, the Bloomberg index is still down more than 10 per cent since April. “There remains clear pressure for the ECB to do more to weaken the single currency,” says Richard McGuire, bond strategist at Rabobank. Expectations are rising that the ECB will be forced into full-blown “quantitative easing” with large scale purchases of government bonds.
In the US, the fall in commodity prices is seen differently. Rather than a sign of weakness, commodity price falls largely reflect the dollar’s appreciation on the back of a recovering economy. The experience a decade ago, when metal and oil prices rose sharply, suggests the likely pass through into consumer price inflation is anyway likely to be modest, argues Benjamin Mandel, Citigroup economist in New York. “If you’re the Fed and see the stronger dollar leading to commodity price falls, you might just see that as a side effect of the recovery and still be perfectly comfortable raising interest rates next year.”
If falling commodity prices mark the waning of emerging market fortunes, they show the US’s waxing. Stronger US growth will help alleviate the gloom elsewhere – but not investors’ concerns about the global divergences those price declines are revealing.

Is smart money on smartphone banking?


Could a passion for mobile banking be about to sweep the western world? Mobile phone services have proved popular for paying bills, receiving salaries and checking balances on basic phones using text messaging in Africa, India and Latin Amercia. But smartphone users in Europe and the US have been slower to use their devices for banking transactions.
However, Matt Krogstad, head of mobile banking for California’s Bank of the West, thinks that could be about to change.

He has been working in the financial sector for about three years and was previously employed in the technology industry. There, his career was devoted to giving consumers a reason to conduct business using their smartphones.
Bank of the West has embraced mobile banking, and one of its most popular smartphone services, Quick Balance, is a rapid way to find out how much money customers have in their accounts that bypasses conventional online security checks. Customers only have to download and authenticate the bank’s Quick Balance app once. After that, whenever they want to check their account, all they have to do is use the app.
But while Mr Krogstad has great enthusiasm for mobile banking’s, not everyone is convinced. Lu Zurawski, a consumer banking expert with payment systems company ACI Worldwide, thinks banks should ask themselves some tough questions. “I genuinely don’t think that checking a bank balance is a compelling enough reason to introduce a mobile portal,” he says.
Mr Zurawski also remains sceptical about claims of a breakthrough in the adoption of mobile banking services and argues that, unless banks link mobile services to promotions and deals, consumers will lack incentives to adopt smartphone banking.
He adds that putting the detail and scope of PC-based services on to a smartphone is not easy. “There is a genuine technical problem here. To provide a true mobile banking experience requires lots of really tedious integration with existing banking systems. This work is not the top priority for in-house IT staff.”
This technical challenge means many mobile banking services on offer simply cannot reflect the PC-based online banking experience, says Bernd Richter, a Frankfurt-based partner with consulting group Capco.
“The classical web interface has more functions than do apps, where the service is similar to a self-service banking machine. Almost no bank I know has integrated the one experience across all its online channels.”
Certainly, simplicity is crucial if a mobile banking application is to succeed. Mr Krogstad’s past career in mobile commerce software has left him wary of foisting technically impressive products on customers. “People don’t want to fill out forms,” says Mr Krogstad. “The user experience has to be carefully designed.”
The Quick Balance app aims to meet the criterion of being designed to fulfil a definite customer need, as checking accounts is something most of us do on a regular basis. Bank of the West says mobile banking sign-ons have grown 400 per cent in the 18 months since Quick Balance was launched, with active users turning to the app 21 times a month on average.
As a result of this success, Mr Krogstad thinks the perception of mobile banking is changing fast. “More than 50 per cent of our active online customers use the mobile banking app. I’d say that a huge amount of transactions happen on phones.”
He also points to the rise of cheque deposits being made using smartphone cameras as “a fundamental shift” in the conduct of customers in a US economy where paper cheques still feature prominently.

Tuesday, September 23, 2014

Car rentals: Hire purpose


BOOTLEGGERS and bank-robbers were among the first to use car-hire firms when they got going in the 1920s. Nowadays their customers are more likely to be tired and irritable travellers, picking up the keys at an airport hire desk, lacking the energy to quibble with all those optional extras being loaded on to the bill. It is a big business—worldwide turnover last year was about $37 billion. But a wave of consolidation in recent years has left just three firms—Hertz, Avis Budget and Enterprise—with 95% of the market in America and a sizeable share elsewhere. So it ought to be a cosy oligopoly, with the dominant firms feeling no need to compete vigorously.
However, Hertz’s boss, Mark Frissora, does not see it that way. An investor backlash against his undercutting of rivals may be one of the reasons why he quit—officially for “personal reasons”—this week.
Hertz and Avis Budget still do over two-thirds of their business at airport counters. Enterprise, the largest firm, with about 40% of the world market, mainly rents out cars in city centres, and in America it has the lion’s share of the market for the cars that insurers lend to policyholders after crashes. Enterprise bought National and Alamo in 2007, a year after Avis and Budget joined forces. In 2012 Hertz bought Dollar Thrifty. But instead of being satisfied with its lot, Hertz has since expanded vigorously in the city-centre and insurance-replacement businesses, and refused to follow rounds of price increases by its two rivals.Mr Frissora has been under pressure because of accounting errors discovered at the firm, going back to 2011. But analysts at Morgan Stanley, an investment bank, say Hertz shareholders have also expressed annoyance at the way Mr Frissora was being “too disruptive” and failing to “behave” on price-setting. The analysts think he was right: the rising use of smartphone apps to book cars, the emergence of new business models for car-sharing and a renewed interest in the hire business by carmakers together mean that the industry is going to be disrupted anyway, and any oligopoly will not last long.
There are two reasons why it may make sense for Hertz to sacrifice short-term profits for market share. Smartphone apps for car rentals are killing the hire counter, even at airports, so Hertz (and Avis Budget) will need to replace the easy profits those counters generate. And becoming even bigger may be the best defence against a rising wave of competition from car-sharing schemes of various types, some backed by carmakers. This week Renault said it would join a new electric-car-sharing venture, for which it will make the vehicles. Daimler’s Car2Go service operates in about 30 cities in Europe and America.
Avis Budget, recognising the emerging threat, spent $500m last year buying Zipcar, the world’s largest example of a “car club”, a form of sharing in which vehicles are parked on the streets and users can rent them, using a swipe-card, by the hour. In theory, the giant hire firms are well-placed to operate the car-club model: conventional rentals peak during the week, whereas club-car use peaks at weekends, so they can achieve high utilisation rates by shifting cars between the two services.
Car clubs and other forms of sharing are proving especially attractive to young drivers. That is encouraging the carmakers to return to a business they have dabbled in before (Hertz has been owned by both Ford and GM; and GM once part-owned Avis). Their theory is that when the time comes for young motorists to buy their first set of wheels, they will choose ones that they got used to driving when they were impecunious sharers.
(Source: The Economist)

Apple's future: Reluctant reformation


APPLE prides itself on constantly re-imagining the future, but even the world’s leading gadget-maker likes to dwell on the past too. Thirty years ago Steve Jobs commanded the stage at the Flint Centre for the Performing Arts near Apple’s headquarters in Cupertino to show off the new Macintosh computer. On September 9th Mr Jobs’s successor, Tim Cook, held a similar performance in the same location to thunderous applause. Those invited were given a chance to play with the gadgets presented on stage: two new iPhones and a wearable device, called the Apple Watch. “This is the next chapter in Apple’s story,” he said, sounding much like the young Mr Jobs in 1984.
It may well be true—but not for the reasons most people might think. Consumers, analysts and investors have been howling for proof that Apple can still do the magic tricks of the Jobs era; iPad sales have weakened in recent quarters and the iPhone, launched a tech aeon ago in 2007, still generates more than half of the firm’s revenues. Yet lost in the maelstrom of snazzy new gadgets, applause and photos was an important shift: this week’s announcements showed that Apple’s future will be less about hardware and more about its “ecosystem”—a combination of software, services, data and a plethora of partners.
As with Apple’s existing products, much effort went into the watch’s design. Its backplate contains sensors that measure the user’s vital signs; and people can send their heartbeat to other watch-wearers—as a new sort of expressive message. But starting at $349, and only usable in conjunction with an iPhone, it looks unlikely to be a serious competitor to other expensive watches (see article).If Apple were simply a hardware-maker, there would be reason to worry. It is losing market share to rivals such as Samsung of South Korea and Xiaomi of China, which make cheaper devices, and to Google’s Android operating system, which runs on 71% of the world’s smartphones. Apple’s average selling price is $609, compared with $249 for smartphones worldwide, according to IDC, a market-research firm. That is good for profits, but it makes Apple increasingly a niche player, somewhat like a luxury-goods firm, says Colin Gillis of BGC, a stockbroker.
Still, many are likely to stick with their iPhones and even plunk down the money for an Apple Watch, because of the firm’s ecosystem. Apple is considered a laggard in online offerings, especially since it bungled the launch of its map service. Its services and apps can be maddening. But iTunes, Apple’s media store, now boasts more than 800m active users, three times as many as Amazon’s. Apple’s software and services category, which includes iTunes, its Apps Store, revenue from warranties and other businesses, brought in sales of more than $16 billion in 2013 and is growing steadily.
Apple’s watch is supposed to help the firm expand into new areas. One example is a mobile wallet. It aims to replace swiping credit cards with the tap of an Apple watch (or an iPhone) on a device connected to a retailer’s cash register. Apple’s new health and fitness applications help people monitor their workouts. The firm’s new operating systems, due out soon, will allow its devices to work together seamlessly: an e-mail started on an iPhone can be finished on an iMac.
For Ben Wood of CCS Insight, another market-research firm, Apple’s plan is to be even more like the Hotel California (as in the Eagles’ song), “where you can check out any time you like, but you can never leave”. The more Apple-gadget owners store their data in them, from photos to health information, the more they are locked in, and must stick with Apple.
At the same time, Apple is trying to become more open to partners—a big change for the firm. “There has always been a huge tension between keeping control and opening up” at Apple, explains Michael Cusumano of MIT’s Sloan School of Management. Mr Jobs saw Apple products as complete works of art and never wanted them unbundled. Only after the executive team rebelled, for instance, did he relent and in 2003 let iTunes become available on Windows—a move that dramatically increased sales of the iPod.
Three years after Mr Jobs’s death, Apple seems to be ready to go further, hoping to entice other firms to contribute to its ecosystem and make it more attractive. Earlier this year Apple announced a partnership with IBM, as well as changes that make it easier for outside developers to design apps for the iPhone. And Apple’s watch will have third-party apps from the start. The iPhone launched without the app store; it opened only a year later, after many outside developers had hacked the device, allowing them to write apps for it.
The new openness does not only apply to technology. Mr Cook has let outsiders join his inner circle, hiring executives from retail and other industries to expand Apple’s expertise. He has also overseen the largest acquisition in Apple’s history, the $3 billion purchase in May of Beats, a headphones and music-streaming company. For its new payment system it teamed up with big retailers, such as Whole Foods and Walgreens, and credit-card firms, including MasterCard and Visa.
This opening-up may need to go further, to keep up with Google’s ecosystem. The internet giant’s services still beat Apple’s. And it not only lets device-makers modify Android, but also gives it away (albeit with conditions, such as the requirement to carry Google’s services). “Apple v Android” could still end up a repeat of “Apple v Windows”: in personal computers Apple lost the battle against Microsoft because it refused to license its operating system to other hardware-makers.
Umberto Eco, an Italian novelist, once compared Apple’s platform to Catholicism and Microsoft’s to Protestantism. The Macintosh, he wrote, “tells the faithful how they must proceed, step by step”. By contrast, Windows “allows free interpretation of scripture...and takes for granted the idea that not all can achieve salvation.” This still rings true today, but Apple is clearly going through a Reformation.
(Source: The Economist)

Share buybacks: The repurchase revolution


IN THE decade before America’s housing bubble burst, Home Depot, an American home-improvement chain, spent heavily on building new shops to meet rampant demand for everything from taps to timber. For every dollar of operating cashflow the firm generated, it ploughed back 65 cents into capital investment. The financial crisis hit hard, and demand for some products has yet to recover fully. Sales of kitchens are only 60% of their peak level. But Home Depot has evolved into a very different kind of beast. Its capital investment has fallen by two-thirds and it is investing heavily in something else: its own shares.
Since 2008 it has spent 28 cents of every dollar of cashflow on dividends and a further 52 cents on share repurchases. In June it took advantage of low interest rates to issue a $2 billion bond partly to pay for more buy-backs—a “great trade, these kind of opportunities don’t come often”, says Carol Tomé, the firm’s chief financial officer. She says that as more customers buy online, there is less need to invest in physical shops, and that using excess cashflow and cheap debt to repurchase stock creates value for investors. The stockmarket seems to agree: Home Depot’s shares have trebled since 2010 and are at an all-time high.
Even in Europe and Asia, where dividends tend to be venerated, buy-backs have become more common in the past decade. Tencent, a Chinese internet giant whose billionaire boss, Ma Huateng, has a seat in the National People’s Congress, now regularly repurchases its stock. The conservative champions of Japan, including Toyota, Mitsubishi and NTT DoCoMo, are buying their own shares at a record rate. Today no chief executive can ignore buy-backs. They are an idea that has conquered the world.That story, of sluggish investment despite low interest rates, and huge share repurchases, is broadly true of all of corporate America. The companies in the S&P 500 index bought $500 billion of their own shares in 2013, close to the high reached in the bubble year of 2007, and eating up 33 cents of every dollar of cashflow. The greatest of America’s 19th-century tycoons, John Rockefeller, once said his sole pleasure was “to see my dividends coming in”, but buy-backs have usurped dividends as the main way listed American firms give money back to their owners, accounting for 60% of cash returns last year.
In a way, this is a victory for shareholders. Firms cannot now hoard cash or invest it sloppily. Instead they face a contest for resources with their owners, particularly those that are activist investors, says Michael Mauboussin of Credit Suisse, a bank. Even the haughtiest firms must dance to the piper’s tune. Apple, with the largest cash pile of any firm in the world, has faced heat from two feisty fund managers, Carl Icahn and David Einhorn. It now plans to buy back $130 billion-worth of shares between 2012 and 2015.
Yet share repurchases also have many critics. They fall into two camps. Some view buy-backs as a form of financial sorcery, on a par with all those abstruse credit derivatives that helped cause the financial crisis. Others accept that buy-backs are a legitimate way to return cash to shareholders but worry about their extent. They fear they have become a kind of corporate cocaine that induces a temporary feeling of invincibility but masks weakness and vacuity. They worry the boom will damage firms and the economy. “You have to save shareholders from themselves,” says the finance chief of one of the world’s biggest multinationals, who thinks there may be a buy-back bubble. Jim Chanos, a short-seller who helped expose the Enron scandal, says the rate at which firms are repurchasing their shares is reckless.
Eye of newt and toe of frog
The “sorcery” gibe has rich antecedents. Repurchases by firms in the open market, the main type of buy-backs today, used to be banned. America loosened its rules in 1982, Japan in 1994 and Germany in 1998. But the criticism seems excessive, given how similar buy-backs are to dividends.
The theory goes like this. When it buys its shares or pays a dividend, a firm is transferring cash to its owners. In neither case does this alter the underlying value of the firm, which is determined by its expected cash flows and their riskiness. Instead all that happens is that the financial instruments with a claim on those cash flows are reshuffled: the value of the firm’s equity declines, its cash falls (or debt rises) and investors’ cash holdings rise, all by an identical sum. In both cases, owners’ wealth is also unaffected: those who sell shares in a buy-back end up with more cash and fewer shares; those who do not end up with a bigger slice of a smaller pie.
The real world varies from what the textbooks say. Since interest paid on debt is tax-deductible, whereas interest earned on cash is taxable, by increasing its net debt to finance buy-backs or dividends, a firm cuts its tax bill. And of course, increasing the firm’s indebtedness makes it riskier. Buy-backs and dividends can also boost perceptions of a firm’s value if, say, investors had feared it might otherwise blow its excess cash on corporate jets, lavish new headquarters, exotic takeovers or other monuments to executive vanity.
Where buy-backs differ from dividends in theory and practice is that they do not treat shareholders identically: some sell, some do not. But executives are alarmingly muddled about this: they imagine they are able to time their companies’ share purchases, buying them when they are cheap to “create value” for all. Even Warren Buffett alluded to this in his 1984 letter to shareholders: “When companies with outstanding businesses and comfortable financial positions find their shares selling far below their intrinsic value in the market place, no alternative action can benefit shareholders as surely as repurchases.”
Sadly, this is a delusion. If a firm buys its stock at a price that, with the benefit of hindsight, is low, it transfers wealth from the shareholders who sold too cheaply to its continuing owners. It does not enhance shareholder value overall. Managers’ duty is, of course, to all shareholders.
In any case, managers in aggregate are about as good at predicting share prices as dart-throwing simians. Admittedly, studies show a mild “signalling” benefit to share prices when firms buy—perhaps because investors believe executives know more than they do. Indeed, says Theo Vermaelen of INSEAD, a French business school, little-studied small companies and technology firms with opaque product pipelines can sometimes judge their share prices better than the outside world.
Overall, though, executives are hopeless. This is amply illustrated by the fact that buy-backs last peaked in 2007, just before the crash, whereas few firms bought in 2009 when shares were dirt-cheap. In the six months to May 2008, as Lehman Brothers faced a cash crunch that would end in its bankruptcy, it blew $1 billion on buying its shares. In all, America’s financial sector repurchased $207 billion of shares between 2006 and 2008. By 2009 taxpayers had had to inject $250 billion into the banks to save them.
Even if the most extravagant boast about buy-backs—that firms can use them to create value through market timing—is flaky, they can still be a flexible cash-management tool. Aswath Damodaran of the Stern School of Business at New York University explains that they let firms vary their cash returns to shareholders as their profits oscillate. He sees dividends as a throwback to the 19th century, when investors insisted on bond-like payments.
Most well-run firms nowadays opt for a compromise. First, they invest cash in any projects likely to produce positive returns. Then they pay out a steadily growing dividend, which pension funds and life insurance firms tend to like. If any cashflow is left over in a given year, they use this to buy shares. What could be more sensible?
Addicted to the “pop”
However, buy-backs have a flaw: they can create perverse incentives to pay out too much cash, damaging firms’ balance-sheets and their ability to invest. For a start, both investors and managers can become addicted to the temporary “pop” that a buy-back can give to a share price. In a half-hearted effort to discourage this, there are rules to limit the rate at which firms can buy their stock—25% of daily trading volumes in America and Britain, for example. Some firms undoubtedly attempt to prop up their share prices in the short term. Hewlett-Packard, a computer firm, bought back shares heavily in 2011 even as its profits and prospects sank.
Pay plans can corrupt managers’ motives. By buying existing shares they can offset the effect of new ones created for their personal stock-option plans. Cash leaves the firm for their pockets without being booked as a cost or reducing earnings per share (EPS). Buy-backs can also give a superficial boost to EPS: the number of shares falls more than the decline in profits from higher interest costs. If managers are paid on the basis of EPS targets—as up to half of American bosses are—they have a temptation to go buy-back bananas.
Bad incentives have not been enough to push corporate America as a whole into reckless behaviour. Take the non-financial firms in the S&P 500 index last year. Their books roughly balanced: buy-backs, dividends and capital investment ate up 101% of operating cashflow. Their net debt was modest and stable relative to gross operating profits. Most have taken advantage of low interest rates to extend the maturity of their debts, making them safer, notes Jeff Meli of Barclays Bank.
Yet beneath the placid surface are nasty undercurrents. The aggregate figures for America are skewed by a few giant technology and pharmaceutical firms. Two-fifths of S&P 500 firms are spending more than their entire cashflow on dividends, capital investment and buy-backs, thereby increasing their net debt.
Buy-backs are weakening the balance-sheets even of the most cash-rich firms because of an oddity in American tax laws. Companies have to pay tax on foreign profits at the difference between America’s rate of 35% and whatever they paid in the foreign country (often 20% or less)—but only if they bring the proceeds back to America. So, they hoard this cash offshore. Microsoft, General Electric, Google, Apple, Pfizer, Coca-Cola and Johnson & Johnson, among others, hold the majority of their cash overseas. Those firms in the S&P 500 that deign to disclose this have $650 billion of cash overseas, or two-thirds of their total, says David Zion of ISI, a research firm.
So, when such companies do buy-backs, their American operations bear the burden of borrowing to pay for them. The corporate accounts of listed American firms, which capture their global operations, suggest indebtedness is low. But the national accounts, which principally capture just the domestic operations of American firms, paint a much more alarming picture, says Andrew Smithers, an economist (see chart).
For strong companies the resultant behaviour is merely quirky. Last year Apple borrowed $12 billion at home to help fund buy-backs despite having $132 billion of cash sitting abroad. But weaker companies which habitually borrow at home to finance buy-backs may risk a liquidity crunch if debt markets dry up and they cannot rapidly get their paws on cash stashed abroad.
Some critics’ main beef about the buy-back boom is that it is leading firms to skimp on long-term investment. This has to be taken with a pinch of salt. Michael Porter, a celebrated management thinker, warned of America’s “failure” to invest in 1992, contrasting it with Japan, which shortly thereafter imploded thanks to its firms’ sloppy and excessive investment. Relative to sales, American firms’ investment has indeed been declining. But that could be because of a shift from manufacturing to services, and the rise of the digital and internet economy, which is inherently less capital-hungry.
Part of the frustration comes from policymakers, who had hoped ultra-low interest rates might stimulate corporate investment. But Jeremy Stein of Harvard University argues that buy-backs are not to blame: firms are unlikely to alter their long-term investment plans just because long term interest rates have been artificially pushed down. Mohamed El-Erian, an adviser to Allianz, an insurance firm, says firms are being sensible by restraining investment in the face of economic uncertainty, even as financial investors go wild, fuelled by central banks’ actions.
However, among fund managers and some executives, there is little doubt that the pressure to boost cash returns can contribute to low investment. Simon Henry, the finance chief of Shell, which invests more in absolute terms than any other European firm, says that investors like executives to feel a creative tension between the pull of capital investment, dividends and buy-backs. But that can spill into an irrational hunger for cash returns: “The longevity of the firm is what matters...executives need to hold their nerve against short-term pressure so that they can invest for the long run”.
In the end it will come down to what shareholders want. And here there are signs the buy-back boom is peaking. A survey of fund managers in July by Bank of America Merrill Lynch found an overwhelming majority thought firms were underinvesting—the strongest reading for at least a decade—and that few wanted even more cash returns.
There are even signs that investing may be back in fashion. Exxon, the biggest spender on buy-backs thus far, has recently tempered them in favour of long-term projects. Since 2012 Amazon has poured $3-4 billion a year into its distribution network. Its shares have soared. And on September 4th Tesla, a maker of electric cars, said it would build a $5 billion battery factory in Nevada. Its share price rose in response. It was a reminder that shareholder capitalism is still capable of moments when acts of creation, rather than changes to capital structures, induce euphoria.
(Source: The Economist)

Monday, September 22, 2014

Siemens to Buy Dresser-Rand for $7.6 Billion in Cash


Siemens AG (SIE) agreed to buy Dresser-Rand Group Inc. (DRC) for $7.6 billion including debt as Europe’s largest engineering company expands its business with oil-and-gas equipment in the U.S.
Siemens will pay $83 a share in cash, the Munich-based company said in a statement today. That’s a premium of about 37 percent to Dresser-Rand’s share price in July before reports about a potential bid boosted the stock.
Siemens has coveted Dresser-Rand, which makes compressors and turbines for the oil and gas industry, for at least three years. Siemens Chief Executive Officer Joe Kaeser is seeking more deals in that industry after saying that the German engineering company hadn’t made the most of the boom in shale gas extracted by hydraulic fracturing.
“The valuation is a stretch but strategically it makes sense,” said Volker Stoll, a Stuttgart-based analyst at Landesbank Baden-Wuerttemberg, who has a hold rating on the stock. “With the deal, the energy business will be strengthened, especially in the U.S. where Siemens hasn’t been as strong.”
Sulzer, which last week said it was in non-exclusive talks with Dresser-Rand, today said it terminated the negotiations to focus on other M&A opportunities. 
While Siemens said it expects to close the transaction by summer 2015, there is leeway for potential competing offers to be placed as the takeover must still be approved by Dresser-Rand shareholders.

GE Talks

General Electric Co. (GE) has also been in talks with Dresser-Rand and is weighing whether to make an offer, the Financial Times reported on Sept. 19., citing unidentified people with knowledge of the matter. GE’s representatives couldn’t immediately be reached for comment.
“This is a transaction that should create value for clients, as well as for both sets of shareholders, that would not have been achieved had Dresser-Rand not become part of the Siemens group,” Vincent Volpe Jr., Dresser-Rand’s chief executive officer, said in the joint statement.
As Kaeser is overhauling Siemens, he also agreed to sell its 50 percent stake in the BSH Bosch und Siemens Hausgeraete GmbH joint venture to Robert Bosch GmbH for 3 billion euros ($3.85 billion), the company said today in a separate statement. Siemens and Bosch will each receive from BSH an additional distribution of 250 million euros before the transaction is completed.

Loescher’s Defeat

Siemens dropped 0.4 percent to 96 euros in Frankfurt trading as of 11:00 a.m., valuing the company at 84 billion euros. Sulzer fell to 124.30 Swiss francs, a decline of 4.5 percent that gave it a market value of about 4.3 billion francs ($4.5 billion).
The agreement with Dresser-Rand allows Siemens to prevail against its former chief executive officer Peter Loescher, who is now chairman of Sulzer. Kaeser became CEO in August 2013 after predecessor Loescher slashed profit targets five times in his six-year tenure.
Siemens had first cultivated its interest in Dresser-Rand under Loescher’s leadership. The Austrian was appointed Sulzer chairman earlier this year after becoming chief executive of Renova Management AG, a holding company for Viktor Vekselberg, Sulzer’s biggest shareholder.
“Dresser-Rand is a perfect fit for the Siemens portfolio,” Kaeser said in the statement.

Shale Oil

Siemens has already spent $1.3 billion this year buying most of Rolls-Royce Holdings Plc (RR)’s energy business, which also makes gas turbines and compressors. Kaeser toldBloomberg News in a July interview he had “firepower” for takeovers, after he unsuccessfully tried to compete with GE for Alstom SA (ALO)’s gas turbines business.
As more facilities spring up across the U.S. to extract, transport and store shale oil and gas produced from hydraulic fracturing, or fracking, Siemens must expand its own offering, Kaeser said at the time. Supplying more equipment would give the company a lock on lucrative, long-term service contracts, he said.
Growing energy needs and a boom in unconventional oil make Dresser-Rand’s compressors and turbines -- which are used to extract, move and process oil and gas -- attractive to rivals and larger industrial conglomerates. Dresser-Rand, which has the largest installed base of compressors serving the energy industry, has been seen as a takeover candidate for more than year.
(Source: Bloomberg)

Sunday, September 21, 2014

Tim Cook Interview: The iPhone 6, the Apple Watch, and Remaking a Company's Culture



Steve Jobs’s office remains Steve Jobs’s office. After his death in 2011, Tim Cook, his friend and successor as Apple (AAPL) chief executive officer, decided to leave the sparsely decorated room on the fourth floor of 1 Infinite Loop untouched. It’s not a shrine or place of mourning, but just a space that Cook sensed no one could or should ever fill. “It felt right to leave it as it is,” he says. “That’s Steve’s office.”
Almost everything else on Apple’s campus in Cupertino, Calif., is different. The executive wing once radiated nervous energy, with handlers scurrying to anticipate the whims of Apple’s temperamental co-founder. Now there’s tranquility in the hallways, a reflection of the new boss’s calm Southern demeanor. Downstairs, the cafeterias are packed—the workforce has almost doubled. A mile away, behind a ring of fences, construction crews are building the massive foundation for the circular “spaceship” campus that will accommodate 12,000 workers when it’s completed in a few years.
Until Sept. 9, all the other changes at the world’s most valuable and scrutinized company were largely invisible to the public. Then Tim Cook took the stage at the Flint Center for the Performing Arts and laid out much of what Apple has been working on over the past three years. The immediate aftermath is that Apple is swamped by a record number of preorders for the new iPhone 6 and supersize 6 PlusBank of America (BAC)Capital One (COF)JPMorgan Chase (JPM), andWells Fargo (WFC), among other banks, plus the major credit card companies and a number of nationwide retailers, have embraced the new mobile payment system, Apple Pay. Even the Apple Watch, the company’s first attempt at launching an entirely new product category in the Cook era, has garnered an encouraging early response, though it will face the only test that matters when it hits stores sometime in 2015.  
Cook is eager to declare all this as a decisive victory. “Anybody coming out of there yesterday knows that innovation is alive and well in Cupertino,” he says, rocking back and forth in a conference-room chair next to his office, an Apple Watch on his wrist. “If there were any doubts, I think that they should be put to bed.”
Behind the product announcements is a different story. When Cook took over from Jobs three years ago, the chances he could continue Apple’s epic run appeared slim. The iPhone accounted for more than half of Apple’s revenue and the bulk of its gross profit. At the same time the rise of phones made by Samsung Electronics(005930:KS) and other companies that ran Google’s (GOOG) free Android operating system had left Apple with a shrinking stake of the smartphone market. A huge part of Apple’s business hinged on what seemed like a doomed strategy, evoking its defeat to Microsoft (MSFT) Windows in the PC battle of the 1980s and ’90s.
Cook’s professional background is in managing supply chains, not changing the character of sprawling, complicated, ego-filled organizations. Yet three years later, veteran Apple executives repeatedly and emphatically say they want the new boss to get credit for pulling off one of the more improbable high wire acts in business history. “I feel damn proud to be working as a part of Tim’s team,” says Eddy Cue, senior vice president for Internet software and services. “If he gets a little bit of recognition from the outside world, that is great. He deserves a lot more than he is going to get.”
 
 
Cook didn’t take control of Apple under anything like ideal circumstances. “Even though Tim accepted the responsibility of being CEO with all the enthusiasm you’d expect,” says Robert Iger, Walt Disney’s (DIS)CEO and a member of Apple’s board, “it was dampened by a very deep sense of mourning. It made the transition hard, not just for Tim but everybody initially. He had a lot to prove.”

The company Cook inherited was broken up into specialized groups devoted to hardware, software design, marketing, and finance, all working separately and sharing little information with each other; they didn’t need to because the overarching vision resided in Jobs’s head. After Jobs died, say several people who were there at the time, it wasn’t clear such a decentralized structure could survive without a powerful guiding voice at the top. For the first few months, no one had a clear mandate to make big decisions, and teams were tussling for turf.
The decisive moment for Cook came at the end of his first year as CEO when he fired Scott Forstall, one of Jobs’s most trusted lieutenants. Forstall had led software development for the iPad and iPhone; he was also divisive and responsible for the poorly received Apple Maps and Siri voice recognition service. There was an audible gasp in Apple’s offices when the dismissal was announced, say people who were there. Cook immediately convened meetings with senior managers to explain how the new structure was going to work. Jonathan Ive, Apple’s head of design, was given control over the look and feel of iOS while development of the mobile operating system was consolidated with Mac software under Craig Federighi, the senior vice president for software engineering.
“The things we should be doing at Apple are things that others can’t”
It was a plan designed to break down walls and extinguish infighting, executed with precision. Cook says he has “nothing bad to say” about Forstall and “has no regrets.”
A decade ago, when he first became a public figure, Cook, now 53, was often caricatured as Jobs’s logical, icy sidekick—the Spock to his Kirk. In person, Cook defies those expectations. He bounds toward Apple employees, posing for on-campus selfies and answering every question regardless of the holes it eats into his schedule. He can also be quite emotional about a range of subjects close to his heart, from Auburn University football to social justice. It’s easy to project this unfailing politeness onto Apple and deduce that the CEO’s demeanor has trickled down to the corporate ethos. But this gives Cook too little credit.
Collaboration may be a virtue, but Cook insists it’s more of a strategic imperative. Aligning thousands of employees is crucial now that “the lines between hardware, software, and services are blurred or are disappearing,” he says. “The only way you can pull this off is when everyone is working together well. And not just working together well but almost blending together so that you can’t tell where people are working anymore, because they are so focused on a great experience that they are not taking functional views of things.”
The result is only now becoming apparent with services that work across different Apple devices. Embedded in the iPhone 6 and the new iOS 8 and Mac OS X Yosemite operating system is a feature called Continuity, which lets users start an e-mail or some other task on their Mac, pick it up on their iPhone, and then move it to their iPad or even the Apple Watch. “We would never have gotten there in the old model,” Cook says. These new products are reminders “of why we exist. The things we should be doing at Apple are things that others can’t.”
“I don’t consider the bloody ROI. If you want me to do things only for ROI reasons, you should get out of this stock”
With the Apple Pay service, users will be able to touch their finger to the Touch ID finger scanner on their iPhone, tap their handset against a credit card terminal, and make a payment without having to turn on their phone or open an app. It’s another illustration of Cook’s focus on products that combine hardware, software, and services—and it’s an important test for the company. Apple doesn’t have a stellar track record when it comes to making easy-to-use services. Products such as iCloud, iTunes, and Siri lack the intuitive polish of Apple’s devices, and customers aren’t likely to be as forgiving when the stakes are raised from organizing photos to ensuring the security of their financial transactions.
The new iPhones use a technology called near field communication that employs a short-range wireless signal to transmit data from the handset to a store’s payment terminal. Software keeps a person’s credit card information inside the phone and ensures it’s never shared directly with the merchant. Led by Jennifer Bailey, a vice president who had overseen Apple’s online store, the company started pitching this system early last year to banks, credit card companies, and retailers as more secure, more intuitive, and, unlike previous mobile payment systems, more likely to actually be used by tens of millions of iPhone owners. As a result, Apple signed up the largest banks, credit card companies, and national chains such as McDonald’s (MCD) andWalgreen (WAG). “They set out to do something from Day One with substantial scale,” says James Anderson, MasterCard’s (MA) senior vice president for mobile and emerging payments. “They had a vision for how it was going to work and a vision for how simple it had to be.”
Cook’s culture hasn’t suited everybody. To one former senior designer, accustomed to spitballing sessions with Jobs to go over details as minute as the look of screen icons, the company no longer has the same allure. He says he left because Apple grew too large and that products once created in small groups are now done in sprawling teams. Others chafe at Cook’s insistence on financial discipline; in meetings once devoted to the hallowed act of reviewing products, he asks managers pointed questions about spending and hiring projections, says a person involved. Staff from finance and operations now sit alongside engineers and designers in product road map sessions with key component partners.
Cook also continues to micromanage areas at Apple where he has the most expertise. He still holds Friday afternoon meetings with senior managers in charge of the company’s vast supply chain, much to the chagrin of some who’d hoped his attendance, and mercilessly detailed questions, would fall off after he became CEO.
 
 
“Excuse my September allergies,” says Jony Ive, rubbing his nose as he settles into a black leather seat in Apple’s executive offices. Ive has become a design legend over the past 15 years, having overseen the look and feel of the original iPod (2001), iPhone (2007), and iPad (2010). His very name—three syllables, no unnecessary letters—fits his minimalist aesthetic. He has the delicate voice and precise diction you’d expect, but he’s thickly built, and in suede chukka boots, loose-fitting blue-and-white-striped painter’s pants, and blue T-shirt with glasses hanging from his neck, the world’s most famous designer could easily be mistaken for the guy who fixes your sink.

“One of our competitors is on their fourth or fifth [watch], but nobody is wearing them”
With an Apple Watch wrapped around his hand brass-knuckle style, Ive reveals that the project was conceived in his lab three years ago, shortly after Jobs’s death and before “wearables” became a buzzword in Silicon Valley. “It’s probably one of the most difficult projects I have ever worked on,” he says. There are numerous reasons for this—the complexity of the engineering, the need for new physical interactions between the watch and the human body—but the one most pertinent to Ive is that the Apple Watch is the first Apple product that looks more like the past than the future. The company invited a series of watch historians to Cupertino to speak, including French author Dominique Fléchon, an expert in antique timepieces. Fléchon says only that the “discussion included the philosophy of instruments for measuring time” and notes that the Apple Watch may not be as timeless as some classic Swiss watches: “The evolution of the technologies will render very quickly the Apple Watch obsolete,” he says.
Ive, 47, immersed himself in horological history. Clocks first popped up on top of towers in the center of towns and over time were gradually miniaturized, appearing on belt buckles, as neck pendants, and inside trouser pockets. They eventually migrated to the wrist, first as a way for ship captains to tell time while keeping their hands firmly locked on the wheel. “What was interesting is that it took centuries to find the wrist and then it didn’t go anywhere else,” Ive says. “I would argue the wrist is the right place for the technology.”
Ive’s team first tried using the same pinch-to-zoom touchscreen they’d invented for the iPhone, but the screen was too small and their fingers obscured the display. A year into the project, the group started toying with what became the Apple Watch’s defining physical feature: “the digital crown,” a variation on the knob that’s used to wind and set the time on a traditional wristwatch. By pressing or rotating the crown, Apple Watch users can return to the home screen, zoom in or out, and scroll through apps.
Watches are as much about fashion as functionality. Ive and his colleagues indulged their obsession for detail and designed three collections of devices made of different materials and seven watchbands with their own features and flourishes. Ive handles each of the watches with the proud familiarity of a father, demonstrating, for example, how links can be plucked off a stainless steel band by pressing two buttons, no specialized jeweler’s tool required. In another bit of engineering cleverness, the watch’s packaging doubles as a charging stand; wearers nestle the watch against an inductive magnet inside the watch box to recharge it. (How often they’ll have to recharge remains unknown. Apple hasn’t yet announced specs on the watches’ battery life.)
For every $100, Apple takes nearly $38
By last summer, with Apple’s stock down by as much as 40 percent from a record high because of concerns about the lack of new products, Cook was ready to accelerate the project. (The stock, now at around $100, has recovered all that ground and then some.) Apple insiders say that while an executive named Dan Riccio, who leads hardware engineering, would have been the obvious choice to take over the Watch program, Cook assigned it to Jeff Williams, 51, senior vice president for operations. Williams is Cook’s go-to guy—he vets possible acquisitions, coordinates withFoxconn Technology (2354:TT) and other manufacturers, and oversees the logistics needed to get millions of devices from Asian factories to stores around the world. He’s an uncanny Cook clone: tall, soft-spoken, and an avid fitness buff with an inexhaustible memory for operational details. Both men have MBAs from Duke University and spent early parts of their careers at IBM (IBM). In the new Apple, he’s Tim Cook’s Tim Cook.
Williams took over a team that had little in common with the small groups that created the Macintosh and iPhone, which considered themselves renegades operating in secrecy from other colleagues. The watch team included hundreds of engineers, designers, and marketing people and was the kind of cross-company interdisciplinary team now common under Cook. Apple, which has more than 1,000 chip designers, built the new S1 processor that powers the watch. Metallurgists responsible for the casing for Macs and iPhones devised a stronger gold alloy for the premium model of the watch, and Apple’s algorithm scientists studied how to improve the accuracy of the watch’s heart rate sensor.
Williams is unapologetic about the Apple Watch missing the 2014 holiday season. “We want to make the best product in the world,” he says. “One of our competitors is on their fourth or fifth attempt, but nobody is wearing them.” Cook also preaches patience. “We could have done the watch much earlier, honestly, but not at the fit and finish and quality and integration of these products,” he says. “And so we are willing to wait.”
Critics of Apple—they do exist—say the watch’s user interface is confusing and that it’s not entirely clear whether there’s a “killer app” or what, if anything, the watch does better than a smartphone. Prices start at $349, which is more than most users will pay for an iPhone 6 with a two-year contract.

Cook says he wishes he could make the device more affordable, particularly since the company boasts of its potential to help customers manage their health and wellness (“that’s the humanitarian coming out”), but he won’t compromise Apple’s large profit margins to make it happen. (Cook theorizes that employers eager to see their workers become healthier may subsidize the device.) Then there are fashion considerations. “Some men will find it to be a little too feminine and some women will find it too bulky and possibly too masculine,” says Gadi Amit, president of the San Francisco firm NewDealDesign.

Cook sees the watch as a way for customers to manage their fitness and improve their daily lives and as an ever-present remote control for their televisions, home appliances, and online relationships. “I think it’s the beginning of a very long run,” he says.
 
 
At Apple’s March shareholder meeting, a representative from the conservative National Center for Public Policy Research questioned Cook on Apple’s commitment to making its factories carbon neutral and removing harmful chemicals from its products. What was the return on investment? Cook showed an uncharacteristic flash of real anger. “I don’t consider the bloody ROI,” he said. “If you want me to do things only for ROI reasons, you should get out of this stock.” The crowd erupted into raucous applause.

Team Tim
Last year Cook hired Lisa Jackson, the former director of the Environmental Protection Agency, to lead Apple’s environmental initiatives. And he hasn’t met an in-house environmental impact video he hasn’t lovingly embraced, narrating them personally in his Alabama baritone. Jobs sometimes gestured toward caring about stuff like Apple’s climate impact, too—when he wasn’t dismissing it as “bulls-‍-‍-,” as he did in 2005 in response to criticism that the company didn’t do enough to limit the chemicals in its products or make them more recyclable.
One of Cook’s mantras is that Apple should “default to open” on issues of corporate responsibility and engage on causes that are important to customers. In the old Apple, “it was the ‘just be quiet, just say nothing, only talk about things that are completed,’” Cook says. “My view is that that doesn’t work in things involving social responsibility. … I’m going to be 100 percent transparent.” (Alas, that transparency stops at Apple’s product plans. On those, he’d “like to find a way to be more secretive, but unfortunately the rumor mill goes a little beyond me.”)

In August, Apple released its internal diversity report. Its employment numbers were lopsided toward white and Asian men. “There was a view we shouldn’t” release the report, Cook says. “I didn’t agree. … It clearly says we’re not a perfect company, and we have work to do. And that’s fine.” The company continues to struggle with conditions at its factories in China, with an internal audit this year documenting use of underage laborers and abuse of migrant workers.
There’s another kind of openness at Apple as well. Cook is more willing to acknowledge weaknesses in its business and, when necessary, seek outside partnerships to boost demand for products. In July the company linked up with IBM, its original arch nemesis, to sell iPads and iPhones to large companies and develop industry-specific productivity apps. The deal was an acknowledgment that Apple needs to find new ways to sell its devices, particularly the iPad, which accounted for 20 percent of its sales last year and has hit a surprising slump in recent quarters. Ginni Rometty, IBM’s chief executive, calls Cook the “hallmark of a modern-day CEO. It’s all about clarity of vision and knowing what to do and what not to do.”
Cook had decided that Apple needed more corporate customers but didn’t want to add the requisite army of buttoned-up salespeople. So he found a partner. Cook says the IBM venture is the perfect deal, because it plays to both companies’ strengths and there’s little competitive overlap. “I don’t want 100,000 people that do consulting,” he says. And an IBM smartwatch? “You wouldn’t want to see it. It would be awful,” Cook says. “I think [Rometty] would admit that.”
Apple learned to play well with others the hard way—from working with hundreds of wireless carriers such as AT&T over the last few years. Apple’s carrier partners are a little like younger brothers: congenitally put upon, thoroughly dominated, but ultimately along for a tremendous ride. The carriers say Apple under Cook can still be imposing and secretive, though now there’s more of a personal touch. “Tim’s a tough negotiator,” says Glenn Lurie, CEO of AT&T Mobility, who’s been working with Cook since before the release of the iPhone in 2007. “He’s a very consistent guy, and that makes it a lot easier to do business with him.”
Apple is also more willing to seek another kind of outside help. Over the last few months, the company’s gone on a hiring spree, vacuuming up accomplished tastemakers such as Patrick Pruniaux, the chief salesman at watchmaker Tag Heuer; Paul Deneve, the former CEO of couture house Yves Saint Laurent; and Angela Ahrendts, Burberry’s (BRBY:LN) former chief executive, who joined Apple to run its stores.
The recruitment spree isn’t only about finding people who know how to sell watches at extravagant markups, but also about adding a diversity of views inside the company. Cook “is very focused on finding a very wide range of people,” says Susan Wagner, founding partner and director of asset-management firm BlackRock(BLK), Apple’s largest shareholder, who joined the company’s board earlier this summer. “It’s not automatically the way you think about diversity. It’s about bringing in experience, skill set, and perspective.”

Cook “is comfortable enough to say ‘we need help here,’ and then he goes out and gets it,” says Jimmy Iovine, who became a part of the talent wave, along with Dr. Dre, the hip-hop impresario, when Apple acquired their company, Beats Electronics, in May for $3 billion, the biggest acquisition in the company’s history.
In Beats, Apple got a business in fashionable (some might say overpriced) headphones and wireless speakers that brought in more than a billion dollars in revenue last year. Yet Cook says he bought the company for another reason—to enlist its brokers of cool to help Apple reestablish its core franchise in digital music amid the decline of single track downloads on iTunes and the rise of streaming music services such as Pandora (P). “The recording industry desperately needs a delivery system that is as compelling as the music,” says Iovine, nestled among celebrities and journalists after Apple’s product introduction in the blindingly white demo hall that the company constructed next to the Flint Center.
As he speaks, Gwen Stefani is trying to get his attention, but Iovine doesn’t notice. He’s engrossed in describing his new colleagues’ quest to sell high-fashion, high-tech merchandise. “These guys don’t want to just hire it,” he says. “They want to understand it. They want our input. They’ve been all over us for input.”
Cook concedes that consumers will issue the ultimate verdict on the Apple Watch, his biggest bet so far as chief executive. “You don’t really know on that first day or first weekend,” he says. “With things that are new, it’s not like a movie, where you can look at that first weekend and draw the line.” If consumers are befuddled or ambivalent, the questions about his product chops, and Apple’s ability to innovate, will return with a new ferocity.
He’s also likely to face challenges retaining Apple’s top talent. Longtime execs such as Philip Schiller, the marketing chief, and Eddy Cue, who runs iTunes and the App Store, are worth hundreds of millions and could easily retire to spend more time with their car collections. Ive owns Jobs’s 15-seat Gulfstream jet, which he bought from Jobs’s widow at a significant discount, according to a person with knowledge of the transaction. As Ive, who helped Jobs decorate the interior, joked to a friend, “At least I don’t have to redesign anything.”
Some former Apple executives think Ive could be inching toward the door and interpret the recent hiring of celebrity designer Marc Newson, Ive’s friend, as evidence he may be staying put for now. An Apple spokeswoman declines to comment on Ive’s plans, and Schiller says the team is staying together. “A lot of us at Apple are here because we love the products,” he says. “We think we are making the best products we have ever made as a company.”
For now Cook is just trying to capitalize on the attention and enjoy the moment he worked the past three years for. Backstage at the Flint Center before the Sept. 9 event, he could be found with his white earbuds on, psyching himself up by listening to the OneRepublic song I Lived on his iPhone. “Hope when you take that jump, you don’t fear the fall … / Hope when the crowd screams out, they’re screaming your name.
(Source: Bloomberg BusinessWeek)
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