Richard Price

I'm the founder of Academia.edu. The goal of Academia.edu is to get every science PDF ever written on the internet, accessible for free. We want to make science faster and more open. We're hiring engineers!

Jul 6, 2014

Forking Consciousness

Often it would be nice to be in two places at once. There is a conference you want to go to, but there is also work to do at the office. There are Christmas vacations on different sides of the family, and you want to be at all of them.

Suppose that in the future you can duplicate your consciousness and imprint it onto a synthetic robot that is sitting inside your closet. You activate the robot, duplicate your consciousness onto it, and then send the robot off to the conference to attend on your behalf.

When the robot returns, you look at the experiences it has had, and decide whether you want to merge its experiences back in with yours. If you merge, you would then remember the event from a first-person’s perspective. If there are any conflicts in the merge, e.g. new beliefs that the robot has acquired while being away, you would resolve the conflict to keep the beliefs that you wanted to keep.

You then wipe the consciousness from the robot, turn it off, and put it back in the closet. Over time you can imagine the robots getting more and more life-like, until they look like humans, and do a good job representing you.

Ethical challenges

Even if this technology was possible, there would be an ethical challenge to its going mainstream. Once you put a duplicate conscious state into the robot, the robot is now a conscious agent, and as deserving of moral consideration as you are. If you turned the robot off while it was protesting and saying it wanted to live longer, it seems that this would satisfy a reasonable criterion of murder. It would be natural for robot rights groups to form that protested against the treatment of conscious robots, pointing out that if an agent is conscious, it shouldn’t matter whether the agent is made of skin and bone, or something else.

Is there a way to get around this ethical roadblock? One tactic would be to include in the copy your conscious states in robot the desire to be terminated.

There would be two problems with this. One is that robots rights group would meet these robots at conferences or wherever they are and point that they are effectively brain-washed, and offer to delete that self-terminating desire from their conscious state. When you sent your robot off to act on your behalf, you wouldn’t know whether they would come back and still have that self-termination desire.

The second problem is that it is not clear whether it’s ethical to include a self-terminating desire in the robot’s consciousness. Suppose we could tweak DNA and someone created a child that wanted to self-terminate after 5 years. I imagine there would be an ethical reaction to that.

When I was chatting with John Hawthorne, he came up with an interesting idea. What if the robot was just streaming consciousness to you via the cellphone networks, and the actual physical seat of consciousness was in your brain? In this scenario your brain is the seat of consciousness, and the robot is a far-away input to your conscious system, and it’s not itself conscious.

Let’s suppose that the physical seat of consciousness was a chip in your brain: this chip did the thinking and experiencing and had the conscious states. Then there will be ethical implications of switching off this chip when you want to turn the robot off. The chip is a conscious agent with its own desires, and it has a right to life in the same way that you do.

What if you never switched it off, and you just activated the robot when you wanted? In this scenario, the physical chip is always conscious. Sometimes it is connected to an external robot, and sometimes it is disconnected, and it has to make do with its own thoughts.

One issue is that if the chip never turned off, and was left to wander with its own thoughts, it would develop its own personality, distinct from the personality of your brain. Then it would no longer be as effective, if the idea is that the robot can represent you at conferences and other places. Wiping the consciousness of the chip every time you wanted to activate the robot would be considered unethical, just as unethical as it would be to wipe the consciousness of a human agent without their consent.

There may also be ethical implications about activating and de-activating the robot, which is the chip’s access to the world. It would be equivalent to periodically inducing in a human a state of not being able to experience the world or touch things, and then periodically re-activating that access.

What if you could do this forking of consciousness without any new hardware in your brain, no special chip? What if you could spin up a kind of sub-routine in your brain that was a separate conscious process, and that could act as the basis of streaming for the robot?

I don’t think the hardware is the main issue here. The complication emerges when we consider whether the conscious sub-routine can form separate desires from the master conscious process. Suppose it can, and that the sub-routine forms the desire not to be shut down at the end of the conference. Against this desire, the master conscious process shuts it down. It seems that this is analogous to the conscious chip situation. The sub-routine has as much right to survive as the master process, as they are both conscious processes.

Could you create a conscious sub-routine that couldn’t form its own desires? This seems hard to imagine. You want the sub-routine to be able to form desires such as “I want to catch this plane”, “I want to talk to that person”. The sub-routine could be set up so that it consults the master conscious process to formulate desires, but then the master conscious process would be bombarded with desire requests every second or two about what desire the sub-routine should formulate next, and this would remove the benefit of forking your consciousness in the first place.

In short, even if we do manage to figure out how to fork consciousness and imprint it onto duplicates, it seems that once you spawn a conscious agent or process, you have spawned something that deserves moral consideration as much as you do, and so switching the conscious processes off is not ethically permissible.

Comments

May 11, 2014

Ambient Screens and Reducing the Friction of Initiating Calls

I think it would be cool if we could create ambient screens and have them all over one’s house. 

Then, if you are on a Skype call with someone, instead of being rooted to your screen, you can wander about, make dinner and so on, and your friend can follow you.

This would get communication a little closer to what it’s like when the person is in the same room as you.

The other thought I have is that there is friction involved in initiating a call and the other person accepting it. You wouldn’t normally call someone as you are leaving your house in the morning and say ‘Just wanted to say Hi and have a fun day - bye’. Whereas when you live with someone or have a neighbor, a lot of the relationship is based on on these little pieces of regular communication. 

To remove the friction of initiating calls, and accepting calls, I was thinking that you might turn on your ambient screens with a friend or a family member for a period of time like a weekend, or a week. E.g. if you have kids and their grandparents are far away, you may want to turn on the ambient screens for a weekend, and the grandparents would do that also. This would mean that, during that weekend, instead of having one catch-up call on Skype for an hour, instead both households would be streaming their houses to each other. The households would come and go, and when they overlap they can chat for a bit, or just hang out together and read in each other’s presence.

I can imagine that in most cases people would only turn on their ambient screens for specific periods of time, like a weekend, a few hours in the evening, or a Sunday afternoon. Perhaps if you were in a long-distance relationship with someone, you would have the ambient screens on all the time. 

When your ambient screens aren’t streaming friends or family members, you could perhaps have them stream a webcam on a beach on the Caribbean, watching the waves roll in. 

The technology for these kinds of floor to ceiling high definition screens are some way off. Also, the internet bandwidth required to support high definition images in your house is significant. 

Before that point, I can imagine smaller screens working. You still want quite a lot of them to capture the natural movement of people as they walk about their respective houses and chat. These screens would need to be quite beautiful if you were going to decorate your house with them. 

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May 4, 2014

A Scenario In Which It Would Be Tempting to Believe That The Universe Has A Creator

Imagine that in 200 years science has developed so much that people can create their own universes, universes that are spatio-temporally disconnected from our own.

I am picturing people tinkering in their backyard, designing how they want their universe to be, and then initiating the creation process. People would fork each other’s universes. Some people would be better at designing universes than others, and there would be various kinds of bugs in most universes.

Suppose that intelligent life began to form in these created universes. You can imagine that the intelligent inhabitants evolving to the point where they figure out how to create their own universes.

The cycle might continue: the second-order created universes might develop intelligent life that learns how to develop third-order universes. A tree of universes would form. Inhabitants of one universe would beget other universes. Inhabitants of the begotten universes beget others. The tree may continue indefinitely.

At this point people in our own universe who are creating universes will wonder “Where is my universe in the tree of universes? Either it is the root universe in the tree, or it is somewhere embedded in the tree, and it was created by an inhabitant of a universe earlier in the tree.”

People will reason that the majority of universes are created. And therefore, given that they live in a universe, it’s more likely that it’s a created universe than the root universe.

After thinking through this argument, I realized that it has some similarities with Nick Bostrom’s simulation argument. Bostrom’s simulation argument goes like this. Computing power is increasing continually. There is a chance we will get to a point where computers are conscious. Furthermore, there is a chance that we can get to a point where computers create games with agents in, and those agents may be individually conscious.

When we think about AI, we normally picture the computer itself being conscious, but Bostrom is encouraging us to imagine that computers will generate game-like simulations, and the agents in the game are individually conscious.

Bostrom’s thought is that in the distant future, our descendants will want to use this AI simulation technology to run detailed simulations on their ancestors. If this were to happen, we would end up with two classes of conscious life: the original race of people who built the computers, and the conscious agents in the games simulated by the computers. It may turn out that there would be more conscious agents in simulations than there are conscious beings in the original race. 

If the majority of conscious life is simulated, then what conclusions should one draw about the origins of one’s own conscious life? If the majority of conscious life is simulated, we will reason that it’s more likely that our own conscious life is simulated. Conscious life belonging to the small realm of original people who built the computers would be rare.

One difference between my universe argument and Bostrom’s simulation argument is that in the universe argument, the conscious beings are living inside real universes. Whereas in the simulation argument, the conscious beings are living inside artificial computer simulations.

Despite this, there is a similar pattern of argument. The general question is: assuming that natural selection and evolution are correct for our world, what is the most likely way in which technology will evolve, and what implications does this have for how many universes there are, and the kinds of conscious beings that will exist?

Once we have a sense of that, we then have to figure out where our own universe falls in the hypothesized distribution of universes, and where our conscious life falls in the hypothesized distribution of conscious life.

Many root universes?

One question that one might ask about the universe argument is: what if there are many root universes? If there is one root universe, perhaps there are many. If there are many root universes, then the fact that our universe spawns a tree of descendant universes doesn’t get us the majoritarian point alluded to above: it doesn’t get us the point that the majority of universes are created ones, rather than root ones.

Let’s suppose that when we create universes, and intelligent life takes hold in a universe, we observe that the intelligent inhabitants tend to figure out eventually how to create their own universes, and that trees of descendant universes form. Suppose we observe this with multiple different kinds of intelligent life, and multiple different kinds of starting conditions for the universe.

If this was something we observed, we would be tempted to believe that if other root universes exist, and contain intelligent life, that they will spawn descendant universes. If root universes containing intelligent life do indeed tend to spawn trees of descendant universes, and some of those descendant universes contain intelligent life, it follows that the majority of universes containing intelligent life would be created ones rather than root ones. It would follow that our universe, which contains intelligent life, is more likely to be a created one than a root one.

The hypothesis about creating universes is far-fetched, so one can’t use the argument today to argue that there is a high likelihood that our universe is created. But if we do end up creating this technology to develop universes, and we watch a tree of universes unfold, then there are scenarios in which we would consider it’s more likely that our universe is a created one than a root one. 

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Apr 26, 2014

An IM presence-like app but for signaling when you are at home

I thought it would be good for there to be an app that would let your friends know when you are at home. Then they can drop by and say Hi. 

It would be a bit like the “online” presence status on IM clients but for when you are at home and would like friends to drop by. 

I was chatting about this idea with Arianne Ransom-Hodges and she came up with a good name for the app - “Porch Light”.

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Mar 30, 2014

An App For Auctioning Off Your Bart Seat

I would like an app where you could auction off your Bart seat to someone who would be happy to buy your seat.

The reason I was thinking about this is that I can work effectively when sitting down on the Bart but not when standing up. For 30 mins of work on my commute I would be happy to spend $25 to get a seat.

I envisage the app would work like this. You create a profile in the app with your photo on. When you get on the Bart and get a seat you say what you are prepared to sell your seat for.

If you want a seat but don’t have one, you open up the app, and find the lowest price that someone is prepared to sell their seat for. You see their photo and then navigate to where the person is in the carriage, click “buy” and they sell their seat to you.

Normally offering someone $25 to buy their seat would be awkward. This app is designed to accomplish that goal in a non-awkward way.

One effect of this app is that people may travel the Bart just to sell seats and make money. That is one of the objections that the taxi commissions have made about Uber and Lyft - more cars on the road looking for passengers means more congestion. But the convenience of having more supply of taxis has generally been thought to outweigh the cost of any increase in congestion.

Another issue with this is whether the location on the phone is precise enough to find people in the same carriage as you. When the Bart is on an outdoor track, location may be accurate enough. When the Bart is in a tunnel, even if there is a cellphone signal, which there often is, I don’t know if location works.

Another locating idea would be for the person who is happy to sell their seat to “check in” to the carriage, and select which seat they are in from an airline-style seat selector. Then you could walk to their seat and find them.

It would also be good if the app worked for trains generally, so you could use it to buy seats on trains you were on in other cities and countries.

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Mar 29, 2014

Review of Ted Turner’s autobiography, “Call Me Ted”

Ted Turner is the founder of CNN, and a number of other TV channels. He took over his Dad’s small billboard business just as TV was emerging as a new technology. He sold off the billboard assets and started buying TV assets. He spotted an opportunity for a 24 hour news channel, which other channels thought was a bad idea. He built it into a huge business, and had other channels too, all as part of Turner Broadcasting Services.

He sold his company to Time Warner, and then had a ring-side seat as the internet took off in the 1990s. There was a sense of urgency within Time Warner that something digital had to be done: an internet strategy was required. There was a decision to sell Time Warner to AOL, which had a huge market cap at the time. Then the web 1.0 bubble burst, and the share price of AOL Time Warner tumbled.

Alongside his media career, Ted Turner was also a world champion sailor. Somehow he managed to find time, at the same time as founding CNN, to win the America’s Cup, and a number of other international sailing trophies.

His autobiography is also about his family. The pressures of work and sailing meant that he didn’t spend as much time with his children as he would have liked. His children provide their viewpoints during the book in excerpts.

Other people from Ted Turner’s business career have cameo roles in the book too, and they share their perspectives on Ted in excerpts. It’s good to see these alternative points of view, because sometimes their points of view differ from Ted’s. It’s an unusual technique in an autobiography to provide these candid excerpts from other people, especially when they disagree with you about something. It gives you the sense that you are a getting a better understanding of the situation.

Some themes about Ted Turner that struck me as I was reading the book were:

  • Turner is skillful at presenting his point of view in a dispute. He provides some examples where customers or governments have objections to what he is doing. His responses to their arguments are compelling. 
  • Frequent and effective use of lawsuits. He seems to use bring lawsuits reasonably often against companies that he feels are overstepping a boundary, and the threat of the lawsuit brought the company’s behavior back into line.
  • An ability to get things done. Turner fizzes with energy for doing things, and it sounds like he is also good at walking through walls.

Sales and negotiation

When he was getting one of his first local TV channels off the ground, the revenue came from advertising. Ted writes “We were also aggressive and creative when it came to ad sales and I personally went on a lot of calls. When potential advertisers criticized us for running old black and white shows when color TV was all the rage, we’d tell them that our black and white programming would help their color commercials pop out of the clutter. Others would say that since our shows were older and old-fashioned that our viewers were probably that way, too - not as smart and wealthy as the people watching our competition. I’d tell them they had it backward - our viewers were actually much smarter than our competitors’ because you had to be a genius to figure out how to pull down a UHF signal!”

Initially TV was broadcast over the air, and then people started developing cable technology. Turner writes “I saw that people were signing up for a new service to get local stations they were unable to tune in with their antenna and/or a better picture for stations they were already receiving.”

Turner decided to use cable to deliver his local programming to a wider geographical audience. Local TV operators didn’t like the idea of Ted Turner streaming his content into their territory. He writes “Back then, broadcasters saw cable operators as the enemy. For many years, local TV stations had a monopoly and they viewed cable operators with fear and suspicion. It was one thing when cable helped them improve their signals and get full penetration of their home markets, but quite another when they started importing distant stations. One time, the manager of a Florida station got angry when Channel 17 started coming into his area. He asked me to stay out of his territory and I replied, “What do you mean, ‘your territory’? If we can get our signal there, it’s our territory, too!” As far as I was concerned, our territory was the United States, and later the world!”

This happened again when Turner attempted to get national distribution for a local TV station he had. There were various kinds of licensing issues he had to deal with, about whether the licenses he had bought for his content allowed him to go national. Sports leagues didn’t like the idea for various reasons. Local broadcasters didn’t like the idea. About these negotiations, Turner writes “Washington became a primary battlefront and I started spending a lot of time there….When those testifying against me said that I was “stealing” their programming or encroaching on their territory, rather than defend my own position I would go on the attack. “If there are any real thieves here it’s ABC, NBC, and CBS!” I argued “They’re the ones who convinced the government to hand over incredibly valuable VHF licenses all over the country completely free of charge! They’ve used the public airwaves to make a fortune and never paid a dime for that right!” I’d go on to argue that no one would ever dream of letting a paper company cut timber on federal land or an oil company drill offshore without putting those rights up for bid. So why should TV companies get these rights for nothing? A free license might have made sense in the beginning when the business was just getting started but what about now, when these broadcasters were making millions? “When these licenses come up for renewal every three years, why not put them up for bid?” I asked. “These companies would probably fork over enough money to pay off the national debt!”

"When it came to the sports leagues I painted a picture that the owners basically sat around a table a long time ago and said "Okay, I’ll take New York, you get St. Louis, and the guy over there gets Chicago." They colluded to create local monopolies, I said "And I thought one of the roles of government was to regulate monopolies!" I asked legislators to imagine a world where the heads of Ford, GM and Chrysler sat down and the Ford guy says "I get everything east of the Mississippi. General Motors, you get west of the Mississipi, and Chrysler, you can have the state of Michigan. If we agree to this, we can eliminate competition and we can charge $10,000 for a car instead of $2,000, and we’ll make a lot more money!"

"Baseball’s commissioner, Bowie Kuhn, tried to counter by saying that the importation of games into other markets would disrupt things to the point where the league’s viability might even be threatened. "How is that possible?" I asked. "The owners are all millionaires, we’re paying millions to the players, and guess who gets left holding the bag - our fans!"… My overall theme in Washington was consistent. I was the underdog - an entrepreneur trying to compete in a world dominated by oligopolists."

The “don’t innovate in this industry because it will break everything and the whole system will stop working” card is probably a favorite of the incumbent. It has been used by lobbyists for the scientific journal publishers to try to persuade the US government to stop pushing open access. The argument is ‘don’t mess with the industry, because peer review is incredible, and if you interfere, the viability of peer review and the whole system is at stake.”

Lawsuits

Nielsen

Turner also had trouble with Nielsen. He writes “Nielsen, the company that measures viewership of television stations, refused to document our audience outside Atlanta. They claimed it was prohibitively expensive for them to measure a channel whose distribution was so spotty across the country, but I was suspicious that their real motivation was to avoid upsetting their customer base - the broadcast networks and local stations that were our competition.” This made it hard to sell advertising, because advertisers used Nielsen for metrics about audience size.

Turner writes “Our lack of Nielsen ratings continued to hold us back, so I kept after them to add us to their service. It becomes increasingly clear that the only reason they were freezing us out was because of pressure from ABC, NBC, and CBS and I decided that my only option was to threaten a lawsuit. My argument was that Nielsen’s refusal to measure our networks amounted to anti-competitive behavior by them and the networks. Estimating that they were costing us $10 million a year in lost revenues, I said I would seek treble damages in the amount of $30 million. This got their attention and it wasn’t long before they came back and said they would work on a rating plan for us.”

RCA

The initial way that Ted Turner thought about getting national distribution for a TV network was via relaying signals from one transfer tower to another. Cable companies would take the signal from the transfer tower into the subscriber’s home. However, the transfer towers had to be no more than 25 miles apart, and they required a direct line of sight. It ended up being very expensive to build out infrastructure to send a signal just a few hundred miles.

Then Turner read about satellite technology in a magazine, and he discovered “that instead of using an antenna in Atlanta and hopping across microwave points through the Southeast, I could use one satellite “antenna” that’s 22,000 miles up in space and cover all of North America.” This was how he got his first TV station to go national - the “Superstation”.

When he was launching CNN, it was also going to be broadcast from satellite, direct to the cable operators. Cable operators had receiving equipment that could take the signal from the satellite, and then route it into people’s homes. The satellite company that Turner was working with for his first national station, Superstation, was RCA. RCA was going to put a new satellite in space, and Turner booked a slot in it for CNN. The advantage of this new satellite was that the cable operators could get the CNN signal without buying any new receiving hardware.

RCA then calls Turner up to say that the satellite launch had gone wrong. They had lost the satellite. They offered CNN a slot one of their other satellites, but this would involve cable operators buying a second receiver, at a cost of $100,000 apiece, and Turner believed they wouldn’t do that. He had already invested a lot of money in getting CNN off the ground, and he believed CNN was dead in the water if they couldn’t get a cost-effective satellite connection.

The only way forward was for CNN to get a slot on the same satellite that the Superstation was beaming from - SATCOM I. The problem was that there were many people who had been promised slots on the new satellite launch, SATCOM III, that had failed. And now they all wanted slots on SATCOM I.

Turner didn’t have much leverage with RCA, because Turner Broadcasting was a small company compared with RCA, which was a large conglomerate. Turner’s lawyers dug around in their legal agreements with RCA, and they eventually found something that gave them leverage. They had done a deal a few years before selling an “uplink facility” in Atlanta to RCA - a facility where you transmit the TV signal from the ground to the satellite. In that agreement RCA had agreed to offer Turner a right of first refusal whenever RCA allocated new satellite transponders. In the years since they had signed the agreement, RCA had overlooked this provision. While Turner would not have used the offers had they been made, technically RCA was in breach.

Turner went to RCA and said that he was going to sue them for the $30 million he had invested in starting CNN, and that he would take the case to the FCA, unless they got him a spot on the SATCOM I. He said “I also made the point that it probably wouldn’t look good to the regulators that RCA also happened to own NBC.”

Turner writes “We got their attention and left that meeting with the sense that the RCA people almost wanted us to sue them. Turns out that they were in a bind because we weren’t the only programmer with a SATCOM III slot who now wanted space on SATCOM I. Since they only had two openings available there, if they granted a transponder to CNN, they would have no logical or legal explanation as to why Turner was taken care of while the others were not. Of course, if a lawsuit from us would actually do them a favor, we were more than happy to oblige. Our legal team worked around the clock, and by the end of February, Turner Broadcasting sued for breach of contract. Within a week the court ordered an injunction. We were granted access to SATCOM I for the next six months, taking us beyond our June 1 1980 launch date. Then in April, the FCC weighed in and ordered this access period to be extended through December. While this didn’t give us all the security we would have liked we could move forward with our plans and we were confident that between April and December we would come up with a long-term solution.” Turner doesn’t mention the satellite issue again, so one assumes that the issue got resolved within this extra 12 month window they were granted.

White House

CNN faced pushback from incumbents. He writes that they had some successes, but “despite these successes, we continued to confront institutional and competitive barriers that made our work difficult. In these early days, our crews were denied access to the White House pressroom and any other press pools organized to cover the president. We were told that only “the networks” (meaning ABC, NBC, and CBS) were allowed. When we responded, “But we are a network”, it fell on deaf ears. The broadcast networks had no interest in CNN joining their exclusive club and the White House press people had no incentive to change policy, either.

"CNN could not cover Washington politics adequately without access to the White House pressroom so we were forced to sue, and we went all the way to the top. In addition to ABC, NBC and CBS, we also named in our lawsuit President Ronald Reagan, White House press chief Larry Speakes, and Reagan’s chief of staff, James Baker. Our claim that CNN was unfairly being denied access placed the White House in a no-win situation. There was no way they could defend shutting out our journalists and once our case was made public, the issue was resolved in our favor."

ABC

CNN was gaining attention, and a rival network, ABC, announced plans launch two competing news channels, one modeled directly on CNN, and another would be slightly different: an 18 minute “wheel” of news stories that would update and repeat throughout the day. The competitive threat was that these services would be offered for free. CNN at this point was monetized via the cable operators paying a license fee for CNN, which they would then recoup from their subscribers. ABC’s idea was that their scale would mean that they could cover their costs with advertising, and they wouldn’t need to charge license fees.

Turner’s response was to create CNN2, which was modeled on this new wheel concept of updating headlines throughout the day. Furthermore, CNN2 would be offered for free to cable operators who subscribed to CNN. He didn’t like the idea of dropping the price for CNN, as they had invested $100 million in CNN and still weren’t breaking even. They decided to launch CNN2 six months before ABC’s news channels were going to launch, to steal some of ABC’s thunder.

Turner also had a lawsuit strategy to fend off the competitive threat. He writes “Another welcome opportunity presented itself in the form of a boast from an ABC executive shortly after their launch announcement. He told a newspaper reporter that this was going to be like General Motors going after Studebaker, and was quoted saying something to the effect of “we have deep pockets and Turner doesn’t.” This comment, coupled with the fact that they were coming after us with well below-market prices, gave us a great case to accuse them of predatory behavior in violation of anti-trust laws. This would be no small deal - in anti-trust cases the aggrieved party can sue for treble damages, and since our CNN investment to date was upward of $100 million, we could sue for $300 million. Their executives claimed publicly that this threat didn’t concern them, but privately we knew they were worried.

The fact that CNN2 had launched meant that ABC’s competing channel now had to split the market for a headline service, and they hadn’t anticipated this in their business plan. A few months after CNN2 launched, ABC decided to delay the launch of of their channel, and Turner heard that they might be willing to settle the anti-trust claim. ABC met with Turner and said that they would be willing to exit the news business if Turner paid them $25 million. Turner decided that the fight with ABC was costing them $4 million a month, but Turner decided that it made sense to pay the $25 million. Turner said that it was thirteen years before they faced another twenty four hour news channel.

Getting Things Done

Charity telethon

Turner would do whatever it takes to solve the problem at hand. Just as he was getting into the TV business, he bought a station that looked good on the surface, but turned out after the acquisition to be in poor financial shape. It got to the point where they were struggling to pay their suppliers.

Turner writes “When we were beginning to get desperate, Sid Pike, who was running station operations in Atlanta, came to me with an idea. He suggested we go on the air with a telethon but instead of raising money for a charity we’d ask for viewers’ pledges to save our station. I thought it was worth trying and since we didn’t have any better ideas we gave it a shot. All weekend we ran movies but instead of putting ads on during the breaks, I’d come on and tell people that if they wanted us to stay on the air, we needed their help in the form of a direct cash loan. I’d say things like ‘By the rules of business, we’re failing, but before we go off the air we’re asking for your support. We air about three thousand movies a year, so it’s probably worth a few of your dollars to keep us afloat.” Well, the money started rolling in. Little kids brought in their piggy banks and we had policemen and firemen come on the air and tell us why they felt the need to give. It was a lot of fun and when all was said and done, we raised about $25,000 and generated tremendous goodwill in the community. (By the way, we kept receipts for every donor for whom we had a record and we we turned the corner three years later we paid every single one back with interest - $4 for every $3 borrowed - about a 10 percent annual return.)

Uplink station

When Turner was looking into getting the Superstation launched, his first satellite-powered national channel, he went to RCA with his idea. RCA told him that there was a major problem with his idea: any broadcaster would need an uplink station, to beam the signal to the satellite, and the uplink stations only existed in New York, Chicago and Los Angeles - not down in Atlanta where Turner was based. Moreover, RCA said that no-one was planning to build an uplink station in Atlanta for several years. Turner writes “I thought that one over and said ‘Well, what would prevent us from building one?’ They had never considered this option but could see no obstacle other than the expense: about $750,000. I asked them if there was anyone in Georgia who could build one for me and they suggested I contact a company named Scientific Atlanta.” Turner used this company to build an uplink station in Atlanta and he solved this particular problem.

Direct response ads

Before Turner had national reach, he had a regional station: bigger than local, thanks to cable, but not yet national. Turner writes “Adding new viewers via microwave and cable did not help us generate much incremental advertising revenue. When we spoke to media buyers outside Atlanta, all they wanted was ABC, NBC and CBS. They were used to making two different buys - local and national - and a regional outlet like ours didn’t fit into their plans. We quickly concluded that the only way to generate revenue from our expanded audience was through direct response ads - the ones that sell the latest record compilation or steak knives and end with a phone number to call to purchase the products.

"…The best products to sell via direct response are unique little gadgets and gizmos whose producers have trouble getting retail distribution. This allows you to call them "Exclusive TV Offers!" and say things like "Not Available in Stores!" We managed to find all kinds: super glue, steak knives, and vinyl repair kits, among others. Since most of these companies couldn’t afford it, we often produced the TV commercials ourselves, and in some cases the products and the ad were pretty amateurish…. The ads and the products may have been silly but we did manage to sell a lot of merchandise. Direct response revenue would prove to be vital for us while we worked to convince traditional advertisers that we were worth considering."

When Turner was starting his regional and national stations, he bumped up against a number of barriers: legal, regulatory, technological. In one of the excerpts in the book, John Malone, a major cable operator, writes “Ted doesn’t care about the obstacles in his way, and that was classic Ted. Ted asks himself the question, “If a rule doesn’t let me do something that’s so logical, it must be a bad rule. And if it’s a bad rule I ought to be able to change it or it should just go away.” He’s always had that kind of basic, almost childish, logic about him that refuses to accept artificial impediments. I think one of his big secrets of success over the years is that the things that most of us would sit there and ponder - all these regulatory and legal reasons why it might not be something you could do - Ted would just say, “Oh, hell, you can overcome those kinds of things,” and he’d just go do it.”

Discrimination lawsuit

In order to fund the launch of CNN, Turner decided to sell one of his existing TV stations, WRET. He found a buyer and a del was reached to buy WRET for $20 million. Just after he had successfully sued RCA to solve the satellite issue, the WRET deal got held up, meaning Turner didn’t have the cash he needed for CNN. Turner writes “our station manager in Charlotte and gotten into a dispute with representatives of a local African American group called the Charlotte Coalition. They had been lobbying the station for more minority employment and the airing of more minority-related programming. And instead of being respectful and listening to their concerns, our manager got into a fight with them and ordered them out of his office. Following this shabby treatment, they filed a lawsuit against the station. The FCC was very attentive to potential issues of discrimination, and this claim was sure to hold up our license transfer.

"Without this sale and the $20 million in proceeds, we were in big trouble. As this dispute dragged on we were forced to take out a $20 million loan at 25 percent interest, requiring us to make $400,000 interest payments every month.

"…In difficult situations like this, I try to be as straightforward as possible. I made it clear that I agreed that our manager had been in the wrong and as president of the company I took responsibility for his lousy judgement.

"…At one point in the negotiations I actually got down on the floor on my hands and knees and begged for forgiveness. I clasped my hands together and said "You gotta let me sell this station or I’m a goner! Somehow, between Hank Aaron’s support [a friend of Turner who was well respected in the black community] and my demonstration of genuine contrition, we got the negotiations back on track and worked out a deal. They would drop the lawsuit if I agreed to make a certain level of donations to the United Negro College Fund and some other worthy causes they supported. With the lawsuit resolved, our license transfer was approved, and we completed our $20 million sale of WRET."

Family

Ted Turner rushed into his first marriage. He didn’t think that much about who he was marrying, and they quickly fell out of love, if they were ever in love. They did have two children before getting divorced. The children went to live with their mother, but her new husband, who was an alcoholic, started physically beating them, so the children moved in with their father, who by this time had a second wife, and some more children.

It was a complicated situation. Ted Turner was never at home because he was working and sailing all the time. His second wife suddenly had to bring up two children from the first marriage as well as her own three children. She didn’t like the situation and the children from the first marriage ended up eating dinner in the basement, separate from the rest of the family.

One of the children from the first marriage writes in the book about Janie, Ted’s second wife “Janie really was not happy. First of all, my father was off sailing and he’d come home with his dirty laundry and as soon as things were clean he was off again. She was pregnant and now his kids from a former marriage were being shoved on her. Janie was trying but this was more than she bargained for and she couldn’t stand the situation. After all these years Janie and I have not become best of friends but back then she really couldn’t stand us. My brother Teddy and I spent a lot of time down in the basement with Jimmy Brown and with my dad being away so much, he became like a surrogate father for us.”

It must be difficult to transition from being treated badly as a child by your stepmother, to now being ‘best of friends’.

Ted Turner writes “Janie did her best to manage a household of five young kids but it was a struggle. She never embraced the idea of caring for Teddy and Laura and their unequal treatment continued. As the stepchildren, they would often spend mealtimes down in the basement with Jimmy Brown, eating different food than their half siblings enjoyed upstairs.”

The other child from the first marriage, writes “Dad was gone a good bit between sailing and work but I don’t really think anybody holds it against him because ultimately he was very successful in both. It’s not like he wasn’t around because he didn’t want to be there - as a kid that would really upset you - that wasn’t what he grew up with and he was away doing big things. We were proud of him doing it and were very happy when he was around…. Dad makes the most of every moment… With Dad, when it was a weekend or vacation the term was “maximum fun”. His view was that if you didn’t get it all in you’ve wasted time and haven’t had your maximum fun.”

Turner writes “One of the reasons I liked military schools was I wanted my boys to be tough and self-sufficient. I also tried to set a personal example for all my children when it came to hard work and appreciating the value of hard-earned money. My kids obviously saw the hours I put in at the office and at the height of my wealth I still drove around Atlanta in a Ford Taurus and bought my clothes off the rack. In fact, I was so thrifty that someone at the company once said “Ted Turner could squeeze Lincoln off a penny.”

One of Ted’s sons writes “I remember we would go duck hunting in South Carolina in December and January and my dad would drive us out in his Jeep. It had a cover and heating, but instead of using either of those Dad kept the top off and the windshield straight down. We had our jackets and warm clothes on but it was still really cold and he’s up there shivering while he’s driving the car and Beau and I are sitting there freezing, thinking, “Jeez, can’t he at least put the windshield up?” I never understood why he did this until finally, several years ago, I asked him. I said ‘Dad, when we were down at Hope Plantation I don’t understand why you drove that Jeep with the top and the windshield down. Remember? You’d be freezing, with snot going down your mustache and gloves; you could hardly hold onto the steering wheel.’ He said ‘Son, I didn’t do that for me. I did that for you guys. I was working on making you tough.”

Another of Ted’s sons writes “Dad was always very plain with all of us: “After your graduation you have two weeks and your stuff better be out of my house.” He was never into handouts. When I was in college I had a $25 allowance and I was traveling all over the country with The Citadel sailing team on an annual budget of less than $1,500. I learned how to live very frugally, thanks to Dad.”

Onset of new technology

Ted Turner describes his first exposure to the nascent TV industry “I noticed an ad on one of our billboards for a UHF TV station called WJRJ, Channel 17. I wasn’t following the television business back then - to be honest, I didn’t even watch much TV. I remember having to ask someone what UHF stood for. (“Ultra High Frequency” was the answer). Still, this business intrigued me.”

Turner describes his first exposure to the internet. By this time he had sold his company to Time Warner, and he was working there, reporting to the CEO, Jerry Levin. He writes “Jerry Levin didn’t just want Time Warner to be big, he wanted it to be great, and in the late 1990s, it seemed like the great new businesses were being created on the Internet. I first started paying attention to the Internet when I heard references to “dot-coms” in sales reports from our cable networks. CNN and our entertainment channels were enjoying tremendous growth in ad sales during the mid- to late 1990s and an increasing percentage of that money came from dot-coms. Some of these new startups raised large amounts of capital at high valuations and then spent a lot of that money on traditional media outlets like television, radio and print. As investors poured their resources into online companies they turned their noses up at the older conglomerates like Time Warner. It was a strange time. I’d had to work hard for years to build Turner Broadcasting into a company that investors would value, and now these online entrepreneurs were raising millions of dollars almost out of thin air. After years of blazing trails, it felt odd to find myself at a company that was considered to be “old media”.

"…In the late 1990s, if you didn’t think that most of your future was going online, it was hard to get anyone’s attention, including Jerry’s. He was obsessed with formulating an Internet strategy for Time Warner that would be, as he described it, "transformational".

At a recent TED talk, Larry Page said something interesting “I looked at lots of companies and why I thought they don’t succeed over time…And I said, what did they fundamentally do wrong? What did those companies all do wrong? And usually it’s just that they missed the future.”

One of the reasons Blockbuster failed was that it missed the future. So Jerry Levin was thinking along the right lines when he was obsessed about formulating an internet strategy.

The Time Warner AOL merger

Turner writes “By 1999, Time Warner was taking flak from investors and the press for not being more successful on the Internet - for neither making any bold acquisitions nor creating any successful online businesses of our own. After a run-up in Time Warner stock for the first few years after the Turner merger, our shares were no longer in favor.”

The AOL deal was rapidly put together. Turner writes “January 3, 2000, was a Monday. The world was discovering that Y2k had come and gone without a major disaster, and I was in Big Sur, California, trying to relax. Unbeknownst to me, back in New York and Virginia, conversations had resumed between Jerry Levin and Steve Case of AOL. Apparently, over the holidays, Jerry had decided that this was the deal he wanted to do. They agreed to terms on Thursday night over dinner at Case’s house and on Friday, January 7, Jerry called me to tell me that we had a deal. We were merging with AOL… This would be a $160 billion transaction - the biggest corporate merger ever.”

Turner describes the board meeting where the deal was ratified “The board session lasted almost seven hours. With big deals like this one, it’s customary for the board to listen to lengthy presentations and hear recommendations from investment bankers, and this case, the people from Morgan Stanley made a forceful case for why this was a great deal for Time Warner shareholders. According to the transaction’s supporters, this would be the ultimate combination. They said that Time Warner, with all its valuable “old media” assets, would be “turbo-charged” by this merger with AOL, one of the fastest growing and most well-respected “new media” companies.

"…Everyone agreed that this would put AOL Time Warner out in front of our competitors. We’d be the biggest, most diversified, and most formidable company in the media industry. So when we voted, we were unanimous and I signed the document voting my shares irrevocably."

The news of the merger sent the share price up, and Turner’s net worth increased from $2 to $10 billion. Then the web 1.0 bubble crashed, and the stock price of AOL Time Warner fell. Turner is now worth $2 billion. There is a rather amusing video where Turner talks about the difference between someone like Buffett and someone like him ‘who is only worth a billion or so”

Rupert Murdoch

Turner writes “Murdoch was not someone with whom I wanted to do business. Seeing the way he used his newspapers to advance his personal political agenda really bothered me. I certainly encouraged our networks to air programming about issues I considered important, like the environment and overpopulation, but Murdoch specifically supported or tore down individual political candidates through his publications, particularly in Europe. We had worked very hard to establish CNN as an impartial outlet with the highest journalistic standards.”

I admire Murdoch’s business acumen and prowess, but this objection seems absolutely right to me. It does seem amazing that the market has allowed one unelected person to have such disproportionate influence on the politics of a country.

Wisdom

Ted Turner’s father grew up poor and then built up a billboard business that allowed him to be comfortable. Achieving wealth had been a goal of Turner’s father, and after he achieved a level of comfort, he struggled to come up with a plan for the rest of his life.

Turner writes “He told me something that I have never forgotten. He said “Son, you be sure to set your goals so high that you can’t possibly accomplish them in one lifetime. That way you’ll always have something ahead of you. I made the mistake of setting my goals too low and now I’m having a hard time coming up with new ones.”

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Mar 22, 2014

Review of “Netflixed: The Epic Battle for America’s Eyeballs” by Gina Keating

Blockbuster went from having 9,000 stores in 2003, and $6 billion in revenue, to going bankrupt in 2010. The company was disrupted primarily by Netflix’s DVD-by-mail business.

There were two issues that led to Blockbuster’s disruption:

  • delay in launching a competitor to Netflix
  • dysfunction in the Blockbuster Board, and at the store manager level

Netflix launched in 1997, and Blockbuster’s initial view was that Netflix’s DVD business was a niche business that would appeal only to a small number of customers. The view of Netflix by the video rental industry was summed up by Joe Malugen, who ran the second largest video rental store in the US “The online delivery model requires patience and days of planning and waiting. We know that the online model does not meet the needs of most of our customers, because for most, renting a movie is not a carefully planned activity. I continue to believe that online rentals are a niche business that will appeal to only about 5 percent of the market.”

By 2004, Netflix had grown a lot, and Blockbuster realized that they had misjudged Netflix. Customers liked the fact that Netflix had a lot of choice, that there were no late fees, and that the cost per DVD was less than at Blockbuster. Blockbuster launched a competitor, Blockbuster Online. Reed Hastings, CEO of Netflix, believes that the delay factor was critical in Blockbuster’s demise. He said later “If they had launched two years earlier, they would have killed us.”

The book “Netflixed” chronicles the Netflix-Blockbuster wars. It highlights dysfunction at the Blockbuster board level and store manager level in responding to Netflix:

  • Around 20% of Blockbuster stores were owned by franchisees. These franchisees threatened to sue Blockbuster to stop the company from building Blockbuster Online, which they felt would threaten the stores. Other store managers, worried about the threat that the internet posed to their jobs, did various things to slow the adoption of Blockbuster Online, such as hiding the laptops where customers were supposed to be able to sign up to the service within the stores, and telling customers that it was a bad service when they inquired about it. 
  • There was an ongoing feud at the board level between John Antioco, the CEO, and Carl Icahn, who owned a large chunk of Blockbuster. This feuding was a distraction to the CEO, and it affected his ability to focus on developing Blockbuster Online.
  • Eventually this feuding led to John Antioco being replaced by a new CEO, Jim Keyes, in 2007. Keyes didn’t believe the internet was the right strategy for Blockbuster. Instead he decided to pursue a store-focused strategy. He canceled funding for Blockbuster Online, and said that the plan was for “Blockbuster stores to become ‘great’ again, as entertainment destinations that would sell a new mix of prepared foods, such as pizza and fountain sodas, as well as electronics, such as iPods and DVD players.”

Carl Icahn is a fairly major figure in the Blockbuster story. He is presented in the book as an antagonistic figure on the Blockbuster board, pressuring the board to consider courses of action that don’t make sense, and generally getting in the way of the CEO executing a vision for the company. It’s hard to know where the exact truth lies, since the CEO, John Antioco, was interviewed extensively for the book, and Icahn wasn’t at all, so it’s natural that the account is going to be one-sided.

In a Harvard Business Review article in 2011, Icahn shares his thoughts on why Blockbuster failed. He writes “Blockbuster turned out to be the worst investment I ever made. It failed because of too much debt and changes in the industry. It had too many stores, Netflix created a better business model, and then Redbox kiosks and the whole digital phenomenon eliminated the need for consumers to go to a separate DVD store.” The real question is why Blockbuster was unable to adapt to these industry changes.

Icahn does acknowledge that hiring Jim Keyes, which would have basically been Icahn’s call, was a mistake: “Maybe the board did make a mistake in picking Jim Keyes as Antioco’s successor — Keyes knows retailing and did an excellent job with the stores, but he isn’t a digital guy….To this day I don’t know what would have happened if we’d avoided the big blowup over Antioco’s bonus and he’d continued growing Total Access. Things might have turned out differently.”

With regard to Jim Keyes, Gina Keating, the author of Netflixed, writes “More shocking - because it displayed a lack of understanding of digital video technology - was Keyes’s contention that someday consumers would make it a habit to drop by Blockbuster stores to load movies and games onto flash drives or video-enabled devices at in-store kiosks, instead of simply using their home broadband lines.”

When Keyes outlined his new strategy for Blockbuster, “a number of senior-level executives phoned in sell orders on most or all of their Blockbuster shares during the next ‘open’ period when they could legally do so.” It is mystifying how Icahn hired Keyes, and gave Keyes’s anti-internet strategy his blessing.

Before reading this book, I wondered whether the shift to internet streaming of videos played a role in the disruption of Blockbuster - streaming products from Netflix and iTunes. But those streaming products were released in early 2008, and by that stage Blockbuster was on the road to bankruptcy. From 2003 to 2005 Blockbuster’s market cap dropped from $5 billion to $700 million. The main disrupting shift was Netflix’s DVD by mail business. According to Icahn, Redbox’s kiosk model, where you could rent DVDs from vending machines, played a role too.

Founding of Netflix

The book tells a good story about the founding of Netflix. Reed Hastings and his co-founder Marc Randolph looked at bringing the video rental market online. Keating writes “Marc Randolph said ‘Operationally, I bet we could do rental. You ship it there and then someone ships it back.’ They ultimately rejected the idea because of VHS inventory costs of sixty five dollars to eighty dollars per tape, and because the bulky tapes cost too much to mail back and forth.

"In his research, Randolph learned about an optical media storage format called DVD that movie studios and electronics manufacturers were testing in a few markets and planning to launch later that year. The five inch disks looked exactly like compact disks. Then they test-mailed one to Hastings house and it arrived unscathed a day or two later."

History of video rental

Keating tells an interesting story about the history of video rental, and particularly how the movie studios didn’t like the idea of video rental. Movie studios tried to sue video rental companies to curtail their operations.

Keating writes “The studios had long resented the video retailers as interlopers that took no risks yet siphoned off profits from movie-making through the burgeoning home entertainment category. Home video sales and rental started in 1977, when Magnetic Video founder Andre Blay convinced 20th Century Fox to license fifty titles to him to sell directly to consumers…. Mom-and-pop retailers bought copies of the pricey videos from Blay and started their own home video rental businesses. As the prices of players dropped, video clubs sprang up across the country.

"…The studios threatened lawsuits to curtail the rental operations, leading the merchants to form the Video Software Dealers Association in 1981, to lobby against attempts to force them to pay a royalty on each video sale or rental. The U.S. Supreme Court ruled that a 1908 U.S. copyright law, known as the First Sale Doctrine, protected the merchants’ right to sell or rent the videos they owned.

"By 1988, annual video rental revenue had surpassed box office receipts for the first time - $5.15 billion to $4.46 billion. Home video rental was here to stay."

Netflix’s early days

Netflix’s initial business model was a la carte rental, just like a video store. Customers would pay $4 to rent a DVD, and $2 for shipping to get the DVD to them. Customers were able to keep the DVD for 7 days, and then return it in a pre-paid “mailer” - the special Netflix envelope.

Keating writes “The title count in late 1997 was an underwhelming five hundred DVDs of mostly older movies. Only Warner Home Video had risked releasing new titles onto DVD, and strictly because its home video chief, Warren Lieberfarb, was pushing the format.”

"…The team argued over whether to leave the company’s name off the packaging to discourage theft of the DVDs, and they fussed over minute details in the placement of the crucial bar code that let the mailer bypass the high-speed drum sorters that frequently ripped open envelopes and crushed disks. San Jose post office officials even allowed Jim Cook, head of Netflix operations, to dump trays of DVDs into its sorters, day after day, to watch what happened.

"Slowly, after dozens of iterations, the elements of a viable fulfillment operation took shape. Randolph discovered "skip shipping", a way to bypass all automation by sorting mail into twenty-seven bags by zone and delivering them straight to the post office freight docks."

Keating describes scaling up server operations in the pre-AWS days. “The servers reached capacity about ninety minutes after the website launched - and crashed. Meyer sent Boris Droutman to a nearby Fry’s Electronics, in company controller’s Greg Julian’s battered Toyota pickup truck, to buy ten new computers to boost capacity while he worked on a fix to bring the site back up.”

Netflix came up with an interesting growth tactic to acquire customers. They approached DVD manufacturers offering to put a Netflix coupon in DVD player boxes. Keating writes “Manufacturers quickly discovered that Netflix offered a way out of a dilemma that was holding down sales: consumers did not want to buy DVD players because DVDs were not widely available at stores. Retailers did not want to stock DVDs because no-one had DVD players. By including a Netflix coupon in the box a DVD manufacturer could promise consumers access to a library of more than one thousand titles.”

Netflix had originally been founded by Marc Randolph and Reed Hastings, with Randolph as the CEO and Hastings as the investor. Hastings had sold a previous company, Pure Atria, and had made a lot of money. He’d gone to Stanford to pursue a Masters in education, but found the growth of Netflix attracting his interest. In a move reminiscent of Tony Hsieh at Zappos, he decided to come into the company as co-CEO, alongside Randolph. Hastings used his reputation in the venture capital world to raise $100 million for Netflix over the next 18 months. The co-CEO experiment didn’t last long, and soon Hastings became sole CEO.

In 1999 Netflix switched to the subscription business model: 4 movies for $15.95 a month. Keating writes “The costs of buying enough DVDs to satisfy the growing subscriber base would eventually crush the company unless Lowe could persuade studios to drop DVD prices drastically in exchange for a share of rental revenues.” The studios agreed, and “The deals cut Netflix’s cost of buying DVDs to between three dollars and eight dollars per disk and put two to three times more product in the company’s warehouse just as DVD player penetration levels soared to thirteen million US households.”

Blockbuster Online

Blockbuster Online launched in 2004. The person running it was Shane Evangelist. Keating writes “Evangelist tried, over a six or seven month period in 2003, to get each Blockbuster department - store operations, marketing, merchandising, product, and franchise - to come up with specifications for participating in the online plan. The project hit roadblock after bureaucratic roadblock. Every department wanted to put its spin on it, or held it up with deal-breaking conditions.

"Part of the problem centered on the CEO’s demand for store tests of several other nationwide initiatives at the same time. Manpower was stretched in every department, as Blockbuster rushed to meet to-market deadlines on retail, gaming, and trading programs that their CEO wanted to test."

Keating writes about an attitude of benign neglect that Blockbuster took towards Blockbuster Online. The Blockbuster CEO, John Antioco, had decided that Blockbuster Online should be set up as a separate venture, which “meant that the stores’ customer mailing lists were totally off-limits to the online marketing department, and that any online activities couldn’t steal the spotlight from the stores.”

Another interesting point is that Blockbuster Online didn’t charge late fees, but it wasn’t allowed to mention that in its advertising, because “the comparison could cast a negative light on Blockbuster stores.” A key part of Netflix’s advertising strategy was mentioning the lack of late fees.

Keating writes “when it became clear that corporate headquarters’ benign neglect would not kill the online business, Blockbuster’s franchisees threatened to sue to stop it from going live.”

Feuding with Carl Icahn

Carl Icahn had bought up a number of Blockbuster shares and he started to try to influence Blockbuster management. The first tussle was over acquiring another video rental chain, Hollywood Video. The Blockbuster CEO had put in a low offer, and were significantly outbid by another chain, Movie Gallery. Keating writes “Icahn insisted in almost daily phone calls that Antioco raise Blockbuster’s bid. The calls became acrimonious, as Antioco insisted that the chain wasn’t worth what Movie Gallery had bid.”

In the end Blockbuster, under pressure from Icahn, did raise its bid, but still lost the deal, because Hollywood Video thought a merger with Blockbuster may not be accepted by the regulators. Keating writes “Icahn filed a letter with the Securities and Exchange Commission ten days later, criticizing Blockbuster’s management in blistering terms for failing to close the deal.”

Antioco replied with his own letter filed with the SEC “The turmoil and uncertainty you have created threatens to destroy the organization, jeopardize our success and could prove damaging to shareholder value.”

Icahn ended up winning some seats on the board at a proxy battle. Keating writes “With the proxy battle behind him, Antioco and his managers settled in to what would become a draining battle with an increasingly dysfunctional board of directors…. For the sake of the company, Antioco and Icahn papered over their differences, and in public at least appeared to be pulling in the same direction. The executive team at Netflix had remained mum in the press about the proxy battle, but they watched it delightedly as the mounting feud with Icahn distracted Antioco from his fight with Netflix.”

Blockbuster Online vs Netflix

When Blockbuster Online did go live, Wall St viewed it as a real threat to Netflix, and Netflix lost 60% of its market cap in a week. Blockbuster began a price war with Netflix, running the online business unprofitably to acquire market share against Netflix.

Netflix’s response to this was interesting. Keating writes “Blockbuster Online was essentially Netflix in a time warp and would experience the same growth and usage patterns. The CFO Barry McCarthy tasked Kirincich with modeling Blockbuster Online’s business and growth trajectory using subscriber metrics they had gathered from Netflix’s operations over the years - data that Evangelist had no way of knowing.

"… Since Blockbuster stores would have to fund the online business until it could break even - at about two million subscribers - it was critical to understand how many marketing dollars Antioco could put behind Blockbuster Online before he start to have budget problems."

Blockbuster was a public company, but a few years prior a large chunk of it was owned by Viacom, and Blockbuster bought back Viacom’s stake by taking on $1 billion of debt. Keating writes “The $1 billion debt that Blockbuster had taken on in the Viacom split-off put a time limit on how long they would have to wait out Blockbuster Online if it continued to spend on marketing and price cuts.” Based on the model, Netflix believed that at the rate Blockbuster was growing, Antioco would be forced to back off, or possibly suspend marketing activities, by the second quarter of 2005.

Netflix’s model nailed it: by the summer of 2005, financial difficulties at Blockbuster led the CEO to cut the marketing budget for Blockbuster Online in half. Keating writes “To compensate, Evangelist and Cooper stepped up pressure on the store staff to tout the online service to their customers aggressively

"….The sign-up rate at Blockbuster stores was so abysmal that the head of marketing decided to do some snooping around. They set up "secret shopper" expeditions to a sampling of stores across the country and found that some actively discouraging their customers from signing up, from using passive tactics like hiding the sign-up laptops, and even telling customers who inquired that the online service was no good."

New CEO at Blockbuster

In 2005, Blockbuster Online had hit certain targets, and that entitled the CEO John Antioco to a $7.6 million bonus. Carl Icahn, who was on the board, refused to pay the full bonus, saying it was too high, given what was going on in other areas of the business. Antioco said to Icahn “You approved it. You’re on the compensation committee.” Icahn replied “I didn’t know it was going to be this big” to which Antioco replied “Well, you should have done the math.”

The board offered to pay Antioco $2 million instead of $7.6 million, and Antioco decided to sue Blockbuster for the full bonus. Carl Icahn rang Antioco one night, after they had both had a few drinks, and they lost their tempers with each other. On that phone call, Antioco decided to quit Blockbuster.

The board hired Jim Keyes as CEO; Keyes had previously been CEO of 7 Eleven. Keyes started to execute his anti-internet, pro-store strategy: defunding Blockbuster Online, and turning stores into “entertainment destinations with pizza and fountain sodas”.

Keyes took over in July 2007, and Blockbuster filed for bankruptcy in September 2010.

Timing

There are stories in the changes to this industry of being too late, being too early, and being in just the right time window to seize a temporary opportunity.

Blockbuster was too late with its Blockbuster Online product. Hastings was conscious of that, and he didn’t want to be disrupted himself by the shift to streaming. So in 2011 he decided to hive off Netflix’s DVD business into a separate business, Qwikster.

After public outcry about the Qwikster split, Hastings reversed his decision. The self-disruption had happened too early. There was an impact on the brand: during the Qwikster episode, Netflix lost fourteen points in the American Customer Satisfaction Index, one of the largest-ever single year drops in the ACSI’s survey history.

Despite this, Netflix’s stock price has grown from a high of $286 in 2011 to $447 today.

A story of a company seizing a temporary opportunity was Redbox. Redbox created kiosks where people could rent and return DVDs automatically. Redbox started growing in 2005. It might have seemed strange to be betting on a physical rental model when internet streaming was coming in a few years. But Redbox was able to do pretty well, and by 2009, the company was worth around $300 million.

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Feb 17, 2014

Review of “Grinding it Out” by Ray Kroc, co-founder of McDonald’s

McDonald’s was the first national hamburger chain in the US, founded in the 1940s. Ray Kroc was the man who grew the brand across the country. His autobiography is a lot of fun: it’s amusingly written and it tells the story of McDonald’s well.

The success of McDonald’s came down to three factors:

  • Assembly-line production: making food quickly and cheaply 
  • Good French fries
  • Good franchise model

The first McDonald’s was founded in 1940 by the McDonald brothers in San Bernadino, which is near L.A. The McDonald brothers in fact closed down their first successful restaurant in order to transfer principles they had learned in the running of that restaurant into the foundation of a new restaurant.

Kroc writes “The San Bernadino restaurant was a typical drive-in. It developed a terrific business, especially among teenagers. But after World War II, the brothers realized that they were running hard just to stay in one place. They weren’t building volume even though their parking lot was always full. So they did a courageous thing. They closed that successful restaurant in 1948 and reopened it a short time later with a radically different kind of operation. It was a restaurant stripped down to the minimum in service and menu, the prototype for legions of fast-food units that later would spread across the land. Hamburgers, fries and beverages were prepared on an assembly line basis, and to the amazement of everyone, Mac and Dick McDonald included, the thing worked! Of course, the simplicity of the procedure allowed the McDonalds to concentrate on quality in every step, and that was the trick. When I saw it working that day in 1954, I felt like some latter-day Newton who’d just had an Idaho potato caromed off his skull.”

On French fries, Kroc writes “Now, to most people, a french-fried potato is a pretty uninspiring object. It’s fodder, something to kill time between chewing bites of hamburger and swallows of milk shake. That’s your ordinary french fry. The McDonald’s french fry was in an entirely different league. They lavished attention on it. I didn’t know it then, but one day I would, too. The french fry would become almost sacrosanct for me, its preparation a ritual to be followed religiously.”

Kroc writes “One of my suppliers told me ‘Ray, you know you aren’t in the hamburger business at all. You’re in the french-fry business. I don’t know how the livin’ hell you do it, but you’ve got the best french fries in town, and that’s what’s selling folks on your place.’”. Looking back, Kroc writes “The quality of our french fries was a large part of McDonald’s success.”

Robert Anderson, who helped Kroc write the book, writes about McDonald’s franchise model in an afterword “Kroc’s real contribution was not in standardizing American taste - it was in creating the McDonald’s franchising system. His greatest skill was as an instinctive leader who brought entrepreneurs into a structure that both forced them to conform to high standards of quality and service and freed them to operate as independent business people. These franchisees, teamed with corporate managers and the various suppliers of food and equipment, form a system that by 1987 represented more than 2,000 independent companies.”

One thing that is interesting about the franchise model is that Howard Schultz expressly avoided the franchising route for scaling Starbucks. He feared that he wouldn’t be able to control quality. Schultz was founding Starbucks in the early days of venture capital, and he was able to raise venture capital to fund growth. It’s interesting to see that Blue Bottle Coffee just raised $25 million in venture capital to grow. I wonder whether the idea of financing a national roll-out on a franchise system is on the decline.

Starting out aged 52

An interesting fact about Ray Kroc as an entrepreneur was the fact that he was 52 years old when he first started rolling out McDonald’s across the country. He spent the next 20+ years of his life expanding McDonald’s to 4,000 stores across the world. A bit like Sam Walton, Ray Kroc built a system that kept on growing, long after he retired: now McDonald’s has 34,000 stores around the world.

Before getting involved with McDonalds, Kroc was in the business of selling Multimixers for making milk-shakes. He’d heard about the San Bernadino McDonald’s restaurant buying a lot of Multimixers from him, and he flew out to meet the owners. He was taken with the operation straight away, and he writes “‘I’ve been in the kitchens of a lot of restaurants and drive-ins selling Multi-mixers around the country”, I told them, “and I have never seen anything to equal the potential of this place of yours. Why don’t you open a series of units like this? It would be a gold mine for you and for me, too, because every one would boost my Multimixer sales. What do you say?”

The McDonald brothers agreed to let Kroc be the one to start opening new stores. Kroc writes “When I flew back to Chicago that fateful day in 1954, I had a freshly signed contract with the McDonald brothers in my briefcase. I was a battle-scarred veteran of the business wars, but I was still eager to go into action. I was 52 years old. I had diabetes and incipient arthritis. I had lost my gall bladder and most of my thyroid gland in earlier campaigns. But I was convinced that the best was still ahead of me. I was still green and growing.”

Selling paper cups

Up to this point in his life, Kroc had been a successful salesman, and a hard worker. Before Multimixers, Kroc was in the business of selling paper cups, which he had selected because he “sensed from the outset that paper cups were part of the way America was headed”.

About his sales technique, Kroc wrote “My cup sales kept growing as I learned how to plan my work and work my plan. My confidence grew at the same rate. I found that my customers appreciated a straightforward approach. They would buy if I made my pitch and asked for their order without a lot of beating around the bush. Too many salesman, I found, would make a good presentation and convince the client, but they couldn’t recognize that critical moment when they should have stopped talking. If I ever noticed my prospect starting to fidget, glancing at his watch or looking out the window or shuffling the papers on his desk, I would stop talking right then and ask for his order.”

Kroc was a hard worker. Early on his career, he was working 19 hour days in two jobs: sales, and playing the piano on a radio show in the evening. He writes “I had to arrive at the station at 6pm and play for two hours. I was off from 8 to 10pm, and then I returned to work until 2am. A few hours later, 7 or 7:15am, I’d be off with my sample case in pursuit of paper cup orders. The only break in this routine was Sunday, my day off from paper cup selling. But we had afternoon hours at the radio station then.”

French fries

After getting the go-ahead from the McDonald brothers to roll McDonald’s out nationally, Kroc got to work on setting up the second store. Getting the french fries right proved challenging. “I had explained to Ed MacLuckie with great pride the McDonald’s secret for making french fries. I showed him how to peel potatoes, leaving just a bit of the skin to add flavor. Then I cut them into shoestring strips and dumped them into a sink of cold water. The ritual captivated me. I rolled my sleeves to the elbows and, after scrubbing down in proper hospital fashion, I immersed my arms and gently stirred the potatoes until the water went white with starch. Then I rinsed them thoroughly and put them into a basket for deep frying in fresh oil. The result was a perfectly fine looking, golden brown potato that snuggled up against the palate with a taste like… well, like mush. I was aghast. What the hell could I have done wrong? I went back over the steps in my mind, trying to determine whether I had left something out. I hadn’t. I had memorized the procedure when I watched the McDonald’s operation in San Bernadino, and I had done it exactly the same way. I went through the whole thing once more. The result was the same - bland, mushy french fries. They were as good, actually, as the french fries you could buy at other places. But that was not what I wanted. They were not the wonderful french fries I had discovered in California. I got on the telephone and talked it over with the McDonald brothers. They couldn’t figure it out either.

"This was a tremendously frustrating situation. My whole idea depended on carrying out the McDonald’s standard of taste and quality in hundreds of stores, and here I couldn’t even do it in the first one!"

In solving the problem, Kroc learned something about how potatoes improve in flavor as they dry out after being dug. ”I contacted the experts at the Potato and Onion Association, and explained my problem to them. They were baffled too, at first, but then one of their laboratory men asked me to describe the McDonald’s San Bernadino procedure step-by-step from the time they bought the potatoes from the grower up in Idaho. I detailed it all, and when I got to the point where they stored them in the shaded chicken-wire bins, he said ‘That’s it!’ He went on to explain that when potatoes are dug, they are mostly water. They improve in taste as they dry out and the sugars change to starch. The McDonald brothers had, without knowing it, a natural curing process in their open bins, which allowed the desert breeze to blow over the potatoes. With the help of the potato people, I devised a curing system of my own.”

Franchises

The majority of McDonald’s stores were franchised. This created a culture of small businessman, many of whom operated several McDonald’s at once and became very successful.

Kroc writes about the franchise culture “Nobody could argue with the success of menu additions such as the Filet-o-Fish, the Big Mac, Hot Apple Pie, and Egg McMuffin. The most interesting thing to me about these items is that each evolved from an idea of one of our operators. So the company has benefited from the ingenuity of its small businessmen while they were being helped by the system’s image and cooperative advertising muscle.”

Each franchisee pays a percentage of its gross sales to the McDonald’s corporation. The percentage was 1.9% when McDonald’s started, and by the time Kroc was writing his autobiography, which was 1977, it was 11.9%.

Kroc writes “Art Bender, my first franchisee, says he’s sometimes asked why he doesn’t just start his own restaurant instead of paying a percentage of his gross to McDonald’s. After all, he helped teach Ray Kroc the business; he could make it on his own easily.

“‘I might have a successful restaurant,’ Art says, ‘but I’d have to think what it would cost me as an individual to buy the services I get from the corporation. The name is worth a lot, of course. National advertising with Art’s Place? No way. Then there’s purchasing power, Hamburger U training for my managers, product development… how could I do all that alone?’”

Some issues in the franchise system arose. Kroc writes “Back then, of course, I couldn’t foresee an operator owning twenty-five of thirty stores. I couldn’t envision situations in which an operator claimed we were hurting his sales volume by locating another store too close to his….I wasn’t thinking about what would happen when a franchise expired. But my basic philosophy is as true today as it was then. We are an organization of small businessmen. As long as we give them a square deal and help them make money, we will be amply rewarded.”

It takes a while for someone to get a McDonald’s franchise. After applying, they first have to work in a McDonald’s store near their home. Kroc writes “He’s assigned to evening or weekend hours that won’t conflict with his present job, and he learns firsthand what’s involved in both crew work and management. If he’s really not suited for our kind of restaurant operation, this is the time to find that out.”

In 1977 Kroc says that it would usually take less than two years for a site to come up for the applicant. The applicant would then have to do another 500 hours working in a McDonald’s restaurant. Then they attend Hamburger University where “we award them a Bachelor of Hamburgerology degree with a minor in french fries.”

Learning from adversity

When Kroc was selling paper cups, he came up with the idea of selling Multimixers, and thought it was a terrific idea. He negotiated a contract with a Multimixer firm to sell Multimixers, and he tried to persuade his paper cup employer to go into the Multimixer business. They thought it was a bad idea, and Kroc decided to resign and pursue the Multimixer opportunity himself.

At this point his paper cup employer said that Kroc didn’t have the Multimixer contract: he’d signed it on behalf of his employer, meaning that they owned the contract. Kroc said to his employer “Well, since you aren’t going to use the contract, just give it up.” They refused to do this, and instead they negotiated to own 60% of Ray Kroc’s new company in return for relinquishing the contract. They also provided $6,000 of startup capital. Kroc knew this was a bad deal but he nonetheless accepted it. At one point Kroc states that this was a “Satanic deal”. I don’t quite understand why the Multimixer company wasn’t empowered to rip up the contract and sign a new one with Kroc, given that Kroc’s employer wasn’t going to pursue the Multimixer opportunity. But there we go.

Later on Kroc was doing fairly well at selling Multimixers, but as a 40% owner, his previous employer was still effectively his boss, with their 60% ownership. He offered to buy the 60% off them, and they demanded $68,000 for their share. Kroc writes “I was so benumbed by his outrageous demand that I couldn’t think straight.”

Kroc re-mortgaged his house and paid off the amount. He writes “For me, this was the first phase of grinding it out - building my personal monument to capitalism. I paid tribute, in the feudal sense, for many years later I was able to rise with McDonald’s on the foundation I had laid. Perhaps without that adversity I might not have been able to persevere later on when my financial burdens were redoubled.”

Howard Schultz talks about learning from adversity in his first book “Fear of failure drove me at first, but as I tackled each challenge, my anxiety was replaced with a growing sense of optimism. Once you overcome seemingly insurmountable obstacles, other hurdles become less daunting.”

Another echo, more on the legal wrangling side of things, is the bit in Sam Walton’s life where he had built his first store to tremendous sales, and suddenly the owner of the department store refused to renew his lease, preferring instead to reclaim ownership of the store, along with all the trade goodwill Walton had created. Walton was irate at himself for having let himself be caught out by a contractual oversight - not checking the renewal terms of the lease. I wrote about this in my review of Sam Walton’s autobiography.

Stress management

Kroc writes “I learned then how to keep problems from crushing me. I refused to worry about more than one thing at a time, and I would not let useless fretting about a problem, no matter how important, keep me from sleeping. This is easier said than done. I did it through my own brand of self-hypnosis. I may have read a book on the subject, I don’t remember, but in any case I worked out a system that allowed me to turn off nervous tension and shut out nagging questions when I went to bed. I knew that if I didn’t, I wouldn’t be bright and fresh and able to deal with customers in the morning. I would think of my mind as being a blackboard full of messages, most of them urgent, and I practised imagining a hand with an eraser wiping that blackboard clean. I made my mind completely blank. If a thought began to appear, zap! I’d wipe it out before it could form. Then I would relax my body, beginning at the back of my neck and continuing on down, shoulders, arms, torso, legs, to the tips of my toes. By this time, I would be asleep. I learned to do this procedure rather rapidly.”

Expanding the menu beyond hamburgers

In his books, Howard Schultz has written about the tensions between purism and growth for Starbucks. There were also differing views about whether to expand McDonald’s menu beyond hamburgers.

In the case of McDonald’s, the first proposal was to add a fish sandwich. Kroc writes “My reaction when Lou first broached the fish idea to me was, “Hell no! I don’t care if the Pope himself comes to Cincinnati. He can eat hamburgers like everybody else. We are not going to stink up our restaurants with any of your damned fish!

"But Lou went to work on Fred Turner and Nick Karos. He convinced them that was either going to have to sell fish, or sell the store. So they went through a lot of research, and finally made a presentation that convinced me."

Another addition was the Hot Apple Pie. Kroc writes “Our Hot Apple Pie came after a long search for a McDonald’s kind of dessert. I felt we had to have a dessert to round out our menu. But finding a dessert item that would fit readily into our production system and gain wide acceptance was a problem. I thought I had the answer in a strawberry shortcake. But it sold well for only a short time and then slowed to nothing. I had high hopes for pound cake, too, but it lacked glamor. I was ready to give up when Litton Cochran suggested we try fried pie, which he said is an old southern favorite. The rest, of course, is fast-food history. Hot Apple Pie, and later Hot Cherry Pie, has that special quality, that classiness in a finger food, that made it perfect for McDonald’s.”

Sparing with the company dime

Like Sam Walton, who flew economy class while being one of the richest people in the world, Ray Kroc was also sparing with the company dime. Kroc writes “I purchased a fleet of nineteen customized Greyhound buses, outfitted with kitchens, restrooms, telephones, color television, and lounge style seating, and I rent these to the corporation for one dollar a year….I also bought the company plane, a Grumman Gulfstream G2 jet. McDonald’s rents it from me for the same low price, one dollar a year.”

Brad Stone, in The Everything Store, mentions that Jeff Bezos always lets passengers in the company jet know that Bezos is personally paying for the jet, not the company. Apparently Larry Page and Sergey Brin personally paid for the Google jet too.

Writing style

Kroc has a humorous, sparky writing style. About San Bernadino, the site of the first McDonald’s, Kroc writes “Now San Bernadino is on the edge of the desert, remember, and you could probably put its average annual precipitation in a martini glass and still have room for an olive.”

About hamburgers, Kroc writes “Consider, for example, the hamburger bun. It requires a certain kind of mind to see beauty in a hamburger bun. Yet, is it any more unusual to find grace in the texture and softly curved silhouette of a bun than to reflect lovingly on the hackles of a favorite fishing fly? Or the arrangement of textures and colors in a butterfly’s wing? Not if you are a McDonald’s man. Not if you view the bun as an essential material in the art of serving a great many meals fast. Then this plump yeasty mass becomes an object worthy of sober study.”

On real estate “Finding locations for McDonald’s is the most creatively fulfilling thing I can imagine. I go out and check out a piece of property. It’s nothing but bare ground, not producing a damned thing for anybody. I put a building on it, and the operator gets into business there employing fifty or a hundred people, and there is new business for the garbage man, the landscape man, and the people who sell the meat and buns and potatoes and other things. So out of that bare piece of ground comes a store that does, say, a million dollars a year in business. Let me tell you, it’s a great satisfaction to see that happen.”

On the foundation that his scientist brother runs “My brother Bob talks the language of science. He’s pedantic and painstaking; he’s willing to get fewer things done in order to make fewer mistakes. I’m impatient. I’m willing to make a few mistakes in order to get things done. So our thinking is miles apart on the handling of money for the foundation. I never realized it could be so damned difficult to give away money. Our grants seem to take endless study and deliberation. Yet I must say that Bob has managed to fund some important research. We have had many highly esteemed scientists and physicians attend our conferences, and the results of their sessions have been published as books and as supplements to the most prestigious medical journals.”

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Feb 2, 2014

Review of Howard Schultz’s first book “Pour Your Heart Into It”

This book is about how Howard Schultz came up with the idea for Starbucks, developed it into a national chain, and took it public.

Schultz grew up in the projects in Brooklyn. He writes “The odds on my coming out of the environment in which I was raised and getting to where I am today are impossible to imagine. How did it happen?… Fear of failure drove me at first, but as I tackled each challenge, my anxiety was replaced with a growing sense of optimism. Once you overcome seemingly insurmountable obstacles, other hurdles become less daunting.”

That last sentence contains an interesting principle for life, I think.

Another piece of wisdom from Schultz is about the role of an entrepreneur. “I didn’t realize it at the time, but I’m now convinced that one of the greatest responsibilities of an entrepreneur is to imprint his or her values on the organization. It’s like raising children. You start with love and empathy, and if you’ve imprinted the right values on them, you can trust them to make reasonable decisions when they become teenagers and young adults. Sometimes they will disappoint you, and sometimes they will make mistakes. But if they have absorbed good values, they will have a center line to return to.”

The romance of coffee

One theme in the book is how, in Schultz’s words, he intended to ‘re-invent a commodity’. He was reminded by investors early on that coffee is the second most traded commodity in the world, after oil. Schultz wanted to invest a sense of romance into coffee.

A second theme is how to balance a purist philosophy around coffee with the need to grow and innovate. Does it cheapen the Starbucks brand to put it on things like coffee-flavored ice-cream, bottled drinks, and airline coffee?

In 1983 Schultz went on a business trip to Milan. He found a culture where there were espresso bars on every corner. There was a sense of theater about how the owners of the espresso bars would make an espresso for customers. Schultz had the idea that he should bring espresso-based drinks to the US in a mass-market kind of way.

Mass-market espresso-based drinks was a fairly unique idea. Schultz writes “Nobody believed that espresso would jump out of its narrow niche and become so popular and widely accepted a drink. Nobody foresaw that coffee bars and espresso carts would appear on street corners and in office lobbies all across America, with more opening each month. Nobody imagined that even fast-food places and gas station convenience stores would hang big “espresso” signs in their windows to lure in customers.

There are some new high quality coffee chains currently emerging in San Francisco like Sightglass and Blue Bottle. Blue Bottle recently raised $25 million, and the CEO said “We all owe the chains like Starbucks a debt of gratitude, because — were it not for them — the concept of coffee as more than a side thing never would have happened.”

At the time of his 1983 Milan trip, Schultz was director of marketing for Starbucks, which at the time didn’t sell drinks. It just sold coffee beans. Schultz tried to persuade Jerry Baldwin, the CEO of Starbucks, to start offering espresso-based drinks in addition to coffee beans. Jerry Baldwin disagreed with Schultz’s vision, saying “We’re coffee roasters. I don’t want to be in the restaurant business. It’s just not the right thing to do. If we focus too much on serving coffee, we’ll become just another restaurant or cafeteria. It may seem reasonable, each step of the way, but in the end, we’ll lose our coffee roots.”

Schultz decided to leave Starbucks and form his own coffee company, Il Giornale. He spoke to 242 investors in the first year to raise money, and 217 people said No. Schultz writes “What we proposed to do at Il Giornale, I told investors, was to reinvent a commodity. We would take something old and tired and common - coffee - and weave a sense of romance and community around it. We would rediscover the mystique and charm that had swirled around coffee throughout the centuries. We would enchant customers with at atmosphere of sophistication and style and knowledge.”

"… Nike is the only other company I know that did something comparable. Sneakers were certainly a commodity - cheap and standard and practical and generally not very good. Nike’s strategy was first to design world-class running shoes and then to create an atmosphere to top-flight athletic performance and witty irreverence around them."

Growth

Starbucks grew quickly. The idea of espresso-based drinks took off across America. Initially there was not much competition, but competition started to come. Schultz writes “If you want to know what Starbucks did right, you have to look at our competition and find out what they did wrong. Clearly, Starbucks isn’t perfect. But among our competitors in the specialty coffee business, you’ll see examples of all the mistakes we didn’t make: companies that didn’t raise enough money to finance growth; companies that franchised too early and too widely; companies that lost control of quality; companies that didn’t invest in systems and processes; companies that hired inexperienced people, or the wrong people; companies that were so eager to grow that they picked the wrong real estate locations; companies that didn’t have the discipline to walk away from a site if they couldn’t make the economics work.”

Purism vs growth

As the company grew, there were debates about whether Starbucks’ role was to educate customers about coffee, or give them what they want. One debate was about whether to offer non-fat milk in addition to normal milk. Coffee purists in Starbucks, including Howard Schultz, were against the idea, even though many customers wanted it. Coffee purists felt that coffee made with nonfat milk didn’t taste right.

The guy pushing nonfat milk was Howard Behar. One of the coffee purists confronted Howard Behar once and said “Nonfat milk is not in keeping with the quality of our coffee. That is bastardizing it. It’s getting to the point that we’ll do anything the customer wants us to.”

Howard replied “Are you nuts? Of course we’ll do want they want us to!”

Howard Schultz writes “Believe it or not, the issue of nonfat milk led to one of the biggest debates in Starbucks’ history. I fought it. Dave Olsen (one of the early employees) fought it. Howard Behar was adamant that they at least test the idea.

Howard Schultz writes about what led him to change his mind. “One morning I woke up early, still wrestling with the idea after a restless night. I got dressed and drove to one of our Starbucks stores in a residential neighborhood of Seattle. I paid for a double espresso and took a seat at the table. Even though it was early, there was already a long line. I was reading the newspaper but also keeping my ears alert to hear what people ordered. The atmosphere felt good, with a smooth, steady coordination between the two baristas, one taking orders, the other making drinks. I noticed one customers, a young woman in her late twenties, dressed in sweats and sneakers and slowly nodding her head to the music on her Walkman. It looked as if she had just finished her morning run. When she got to the counter, I could hear her say the words I’d been waiting for:

"I’ll have a double tall latte, with nonfat milk."
"Sorry, we don’t have nonfat,", the barista replied politely but firmly. "We only have whole milk."
I could hear her sigh in frustration and then ask “Why not? I always get it at the place down the street.”
The barista apologized, but she strode out of the store, apparently headed for a competitor.
A lost customer is the most powerful argument you can make to a retailer.
I went in to the office that morning and told Howard Behar to go ahead with his test, and to make sure we include that store…. Within 6 months, all our stores offered it. Today, almost half of the lattes and cappuccinos we sell are made with nonfat milk.”

Schultz points to two paradigm shifts in Starbucks’ history. “The first was adding the beverage to the bean sales, beginning in 1984. After that we weren’t selling just coffee but also the coffee experience. The second shift came when we moved outside the four walls of our stores and invented new ways to enjoy the flavor of coffee, in bottled beverages, ice cream, and other innovative products.”

A risky expansion was doing a deal in 1996 with United to offer Starbucks coffee on United flights. The benefit was that they would expose the Starbucks brand to 20 million new customers a year. The risk was that coffee couldn’t be prepared as well on an airplane, so these customers would form a sub-optimal impression of Starbucks coffee. Schultz writes “At both United and Starbucks, we think the risk has paid off. And 20 million people, on 2,200 flights a day to destinations on every continent around the globe, are drinking Starbucks coffee, at 35,000 feet.”

Starbucks IPO’d in 1992 with 140 outlets and $73 million in revenue. Today it has 21,000 outlets and $13 billion in revenue. Pretty amazing! It experienced a blip in 2008 after standards started slipping. Schultz had left the CEO position in 2000, but he came back in 2008 and started turning things around. He wrote a book about that experience, and I reviewed it here.

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Feb 1, 2014

An API for cellphone data plans

Jeff Bezos innovated in the data plan market when he sold the Kindle with a lifetime data plan built into the cost of the device. The new Google Nexus tablet now offers a similar deal: 200 MB a month from T-mobile for the lifetime of the device as part of the cost of the device.

These are each custom biz dev deals. It’s hard for developers to access the personnel in the relevant cellphone companies to pull off these kinds of deals. It would be preferable if there was an AWS-style API for cellphone data plans, so a developer who wanted to sell a device with a data plan could buy different data packages from cellphone companies from the command line: buying data from cellphone companies as easily as one can buy compute time from AWS.

I’ve recently come across a few use-cases for this. I was looking for a location transmitter that I could stick on arbitrary objects like a car, and it would transmit the location of the device. You’d need a data plan for this so the device could send its location to the internet over the cellphone networks. It turns out that BikeSpike is about to start selling a product like this, with a custom $5 a month data plan.

Tesla offers free data with its Model S, so the whole car is internet-connected on the go. There is someone inside Tesla whose job it is to tailor the data plans for different Model S owners depending on their data usage - e.g. depending on how much music they are streaming etc. Instead of the cost of the data automatically tracking usage, there is a human being manually switching the plans for certain cars to optimize the rates.

Another example is digital photo frames. These frames don’t work very well because you have to configure them with your wifi network when you get them, and at least part of the use-case for digital photo frames is being able to send photos to grandparents who may not have wifi at home. It would be better if the photo frame owners could put a 3G/LTE chip in the device, so the device is already internet-connected, and let the device-maker choose how to finance the data plan.

If a device-maker was able to buy cellphone data from multiple providers, and not be locked into one, they could optimize for coverage in certain areas - e.g. customers in SF get Verizon, and customers in New York get whatever has the best coverage there.

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