Blogging About Business versus Doing Business
Both Matt Yglesias and Karl Smith have blog pieces that claim businesspeople are doing pretty dumb things. The claims are in some ways mirror images. Yglesias claims that Barnes & Noble is foolishly spending money developing and selling Nook, when instead it should just return the cash to shareholders. Smith is claiming (as far as I can tell) that Apple investors haven’t figured out that Apple can’t really return much of its immense pile of cash to shareholders, because this money is required to run the business.
Yglesias says that it is an obviously bad use of shareholder funds for Barnes & Noble to invest in Nook, because their expertise is in running brick-and-mortar stores. But by this kind if logic, why would movie company Disney invest shareholder funds opening theme parks, why would brick-and-mortar retailers Walmart, Target and Macy’s invest shareholder funds developing web businesses, and why would computer company Apple invest shareholder funds developing phones?
Core competencies and intangible assets are notoriously tricky to define and quantify for a real company, but for Barnes & Noble they almost certainly include the power of their brand name as a place to look for book-related merchandise, their expertise in developing and managing relationships with publishers, and their existing back catalog of titles. I don’t know enough about the specific situation to know whether Barnes & Noble should have developed and sold an e-reader, but based on what is in the piece, Yglesias doesn’t either.
Karl Smith is a very smart guy, but keeps digging himself in deeper and deeper on his criticism of Apple’s shareholders as foolish, in direct contradiction to the fact that Apple shareholders seem to have done very, very well for some time.
Smith argued in an earlier post that because Apple has not paid real cash dividends to shareholders, that it is more valuable to put money in a trash can and burn it than to invest it in Apple shares. I did a long post pointing why I don’t think this is true. Smith has subsequently done several posts on this same topic, amplifying and clarifying his point.
His most recent post on this subject develops an analogy between the workforce of a tech company and the particles in a sub-critical fission reactor. This is meant to be literally (as far as I can tell) a sketch of a mathematical model for why Apple requires a huge amount of cash on hand to retain its employees. At best, it is pure speculation. And based on any practical experience in a tech company, it’s also extremely implausible that Apple would start to shed important engineers, or be at a disadvantage in recruiting, if it had built up, say, $40 billion on the balance sheet instead of $80 billion.
Smith is arguing that Apple shareholders are suckers who depend on greater fools coming along, because there are hidden requirements for cash in the business that mean the true free cash flow available for distribution to shareholders is less than it seems to investors based on accounting statements. This is not a crazy idea (though his argument that specific hidden requirement is that this amount cash is needed to retain employees does strike me as very implausible). It is also not a new question to ask, and in my experience is one that is debated by professional equity investors in relation to many stocks, ranging from technology companies to convenience store chains.
I have no idea whether Apple stock should be a buy, sell or hold, but if Smith is right that the current shareholder base of Apple massively misunderstands the true capital requirements of the business, then he has a huge moneymaking opportunity. If he really believes in his investment thesis, he should borrow a lot of money and short Apple’s stock.
Don’t guys like Yglesias and Smith see the creepiness of telling investors in Apple—who’ve made millions of dollars investing their own money, and maybe other people’s money—that they don’t know what they’re doing?
I don’t know exactly what epistemic humility means, but I’m pretty sure Yglesias and Smith represent the opposite.
As you said, Jim, if Smith really believes in his investment thesis, he should borrow a lot of money and short Apple’s stock.
Or, as a little cube on my Dad’s desk used to say: If you’re so smart, why ain’t you rich?
— jd · Jan 10, 06:02 PM · #
An almost infinite number of similar posts could be made with the titles “Blogging about politics versus doing politics, “Blogging about coaching football versus coaching football”, “Blogging about books versus writing books”, etc.
I think it’s become clear that there’s a certain Ivory Tower aspect to being an internet big mouth.
Mike
— MBunge · Jan 10, 08:15 PM · #
Blogging about blogging instead of blogging . . . no, wait . . .
Commenting on a blog instead of blogging?
— Noah Millman · Jan 10, 08:58 PM · #
We lowly commentors are less in the Ivory Tower and more in the balcony with Statler and Waldorf.
Mike
— MBunge · Jan 10, 09:16 PM · #
You’re badly mischaracterizing what I wrote about Barnes & Noble. I didn’t allege the existence of a single businessman there doing any “dumb things.” What I said is that the management team at Barnes & Noble is acting as if its main goal is to perpetuate the existence of the firm. Is that a “dumb thing” thing to be doing? It seems very normal.
— Matthew Yglesias · Jan 10, 09:21 PM · #
Okay, let me take this topic seriously for a moment.
For pretty much all organizations – government agencies, universities, armies, banks, corporations, NGOs, unions, political parties, churches, etc. – the first rule is the perpetuation of the existence of the organization. So yeah, that’s totally normal.
The feedback mechanism for business – that shareholders will fire management if it too obviously acts in its own interest rather than in the interest of the shareholders – is far from perfect, but it does exist.
I think all Jim was saying, really, was that Matt implied that it was obviously in the interest of shareholders for management not to do what it’s doing – perpetuate itself – but instead return the money to shareholders. His point is simply to say that this is far from obvious.
I don’t personally have a dog in this fight; I don’t own a Nook, or any other e-reader, and I don’t really have any idea myself of what the long-term prospects for the category are, much less the various competitors. It’s a very new product, still.
Nonetheless, some possible counter-arguments to your specific example:
- The Nook is competing primarily with the Kindle and the iPad. The Kindle was developed by Amazon. Amazon is not an electronics firm; it’s an on-line department store. They had no prior experience with developing a consumer electronics device. The iPad was developed by Apple, as an outgrowth of the iPhone. Before the iPhone, Apple had no experience in the phone market. Basically, all the firms in the e-reader market are competing for market share in a brand new market, where nobody knows exactly what will catch on. What B&N does know something about is books – what readers want in a book and how to market to readers. Those would seem to be highly relevant areas of expertise.
- B&N also has a valuable brand. Starting a new business that leverages that brand is very different from acquiring an unrelated business. If B&N bought a chemical manufacturing company, that would be pointless. If it bought a paper mill or a book publisher, that might make sense if there was some advantage to vertical integration in their market (I doubt it), but wouldn’t leverage the brand. But there is a very plausible case that the Nook does, in fact, leverage the B&N brand – that, basically, it is possible for the Nook to compete successfully with the Kindle and the iPad for market share in a way that it would not be possible for a true startup to compete. That may or may not be true, and it’s a hard argument to prove one way or another – but it’s not obviously untrue.
- Even if the Nook itself never makes money, it may give B&N a toehold in a new market. If that market turns out to be very large, there may be other businesses that B&N could get into that would not be accessible if it didn’t already have the Nook platform. Large businesses have the opportunity to acquire “real world options” of this sort in a way that startups do not, precisely because they have the spare resources from their legacy business – as well as the value of their existing brands – to deploy to acquire them. Again, these options are essentially impossible to value, but that’s not the same thing at all as saying they are valueless.
In theory, of course, all of the above could be achieved by a startup that was able to win an exclusive marketing deal through B&N. The startup would raise the capital to create the Nook, which would then be marketed under the B&N brand. The startup, being a startup, wouldn’t have any experience as an institution with anything – not with consumer electronics or anything else. The individuals involved, of course, would, but then again I’m sure the key individuals hired by B&N for their Nook unit have at least some relevant experience. And in both scenarios B&N would have to make some evaluation of whether it made sense to be involved in this business, either under some kind of marketing/licensing deal or, as currently, as the owner. So it doesn’t seem to me that the decision-making or the level of expertise brought to bear on that decision-making would be all that wildly different in either case.
In a sense, the whole debate is about which is a greater drag on returns: the transaction costs associated with having to reassemble human and financial capital under a new umbrella (which is what would have to happen if public corporations were required to return the bulk of their free cash flow to shareholders), or the incentives to management of public corporations to maximize their own returns at the expense of shareholders (which is what Yglesias is worrying about in our existing paradigm).
The traditional “conservative” position on dividends is that they should be as high as possible consistent with proper functioning of the existing business. High dividends are, in this view, the best check on management acting in its own self-interest rather than the interest of shareholders. The contrary view holds that managers of very successful businesses are likely to deploy capital more innovatively than are professional investors, and that therefore it’s actually bad for shareholders to give them back their money as quickly as possible. And then there’s Jim Manzi’s view that large corporations are big drivers of innovation because of their deep pockets, but that they don’t always – perhaps don’t often – actually derive the benefit of their innovations; that they are the “nurse logs” of the capitalist forest.
— Noah Millman · Jan 10, 10:16 PM · #
Come on, Noah. That’s uncharacteristically stupid.
— Chet · Jan 10, 10:37 PM · #
Mr. Manzi:
I read Yglesias’ piece. I couldn’t find anything intelligent in there at all. Smith’s piece I couldn’t even finish. You are definitely doing the Lord’s work by engaging with those guys.
You have said they’re intelligent. They’re quoted here at TAS often. But those articles are written by people who don’t seem to have any connection with the business world or its purpose.
And I wonder if Yglesias could possibly write something without typos. Even his comment here is questionable.
Chet:
Amazon is not an electronics firm; it’s an on-line department store.
— jd · Jan 10, 11:48 PM · #
Matt:
Thanks for the comment. If you don’t like the word “dumb,” then fair enough. I guess just substitute the word “bad” or something,
I went back and read your post again, and I don’t think I mischaracterized your argument, which I summarized as:
But maybe I’m missing something,
Noah,
Thanks for the extended examples, which I found very helpful.
jd,
Thanks very much.
Mike,
Very well put.
Best,
Jim
— Jim Manzi · Jan 11, 12:00 AM · #
I enjoyed Smith’s response to this post and think it makes the point well; Manzi seems to be confusing Smith’s idea that something may be good for the firm but bad for shareholders, by assuming that those two interests are always the same — and although Noah makes a point Smith doesn’t address, that the shareholders really can in the long run come in and run the show, I still think Manzi is somehow failing to acknowledge that the firm’s management’s interest, and the shareholders’ interests, can diverge, and when the subject under question is that divergence (which, in Smith’s case, it has been) saying what is or isn’t good business for the firm is sort of tangential: what Manzi has to do is parse out, in which of those two groups interest is this thing? or, why is this a case where those interests don’t diverge? I suspect both cases can be made, but he hasn’t tried, that I am reading, to make either.
Amazon is, in fact, an online department store not an electronics firm.
I thought the deal with the Nook is actually at least a couple steps towards what Noah describes (another company could make it and enter into an agreement with B&N) and slightly removed from Yglesias’ model: I understood that they had basically opened up contracts with multiple manufacturers to make different “Nooks” and then basically licensed that product. But it’s not a thing I know much about so maybe B&N owns a Nook factory somewhere and a bunch of electrical engineers are working for B&N.
— Kieselguhr Kid · Jan 11, 01:05 AM · #
Chet, until the Kindle Amazon had never made an electronic device, and until the Fire conventional wisdom was they were going to lose to iPad. Before the iPad there was no mass-market tablet that had gained serious traction. All of this happened in just the last 2-3 years.
The Fire has gotten lukewarm reviews, so it’s certainly not madness to continue pursuing that market.
— Derek Scruggs · Jan 11, 01:23 AM · #
KK
I’m very aware of the distinction between management and shareholders.
— Jim Manzi · Jan 11, 03:38 AM · #
Well, from jd and Kid that’s entirely characteristically stupid. From Noah I expect better. The two of you morons? Not so much.
— Chet · Jan 11, 03:51 AM · #
Jim, I don’t mean to suggest that you don’t! Clearly you should be on as firm ground as anyone could be on this topic.
Which makes your responses to Smith, as I say, puzzling. His critique has been consistently that those interests diverge here, and your response has always been, “but hey, Apple’s actions may well be in its interest.” OK, but that doesn’t address the critique: whose interest, or are they both, in this case, aligned?
— Kieselguhr Kid · Jan 11, 12:16 PM · #
KK:
No problem. That hasn’t been the argument that I’ve been trying to make. I’ve been trying to make the argument that Apple’s shareholders might, or might not, be better off because of Apple holding so much cash on its balance sheet, and that Smith has not come close to making the case that he knows the answer to this. I have a post up right now responding to him that might clarify my points.
Best,
Jim
— Jim Manzi · Jan 11, 12:32 PM · #
It seems to me that what amazon is primarily is a internet interface company. It isn’t their selection (like a department store), or their sophisticated software (which they may have, but it’s invisible to the consumer); it’s that it’s so easy to find stuff and buy it on their site, compared to other online retailers.
They may also, from what I read in the business press, be a masterly state sales tax avoider. Unfortunately, their current strategy involves collecting taxes in New York as part of a pending litigation, so I’m not getting the benefit of that.
— y81 · Jan 13, 04:21 AM · #