Don’t Fear the Fad

As an investor, can you ever know for certain if that newfangled gizmo come to market is the real deal or a fad?

Let’s try it a different way—perhaps everything is a fad, until it’s proven otherwise.

Bread, most likely not a fad. But organic fair-market nine-grain soft crust, probably a fad.

Cars, probably not a fad. But eight-cylinder 130 mph muscle mobiles with no back seats could be a fad.

AM radio, possibly a fad, but one that has enjoyed a long shelf life—and now with news and sports retransmitted over the internet to mobile devices, probably a decent bit of runway left in the broadcast machine.

Farmville, Mafia Wars, and their brethren? You tell me.

Our attention spans are surely fickle, but just because something is a fad does not necessarily make it a bad investment. I am not certain internet keyword search will last forever, but the last decade and a half have proven pretty rewarding, at least for one company that currently commands better than 70% market share. Games? That’s where they come and go in a coughing breath—if you are going to bet at that crap table, come with a lot of chips and a jug of Pepto-Bismol.

The question of whether it makes sense to bet on a fad in a commercial, accelerated, low-loyalty, short-attention-span, vastly diverse, market-driven global economy seems moot. People have bet against railroads, phones, airlines, television, personal computers, and even guitar bands as fads—and that was before they had customers! Even after these “fads” had momentum, there were endless naysayers who said they were on their way out as fast as they’d found their way in. With that kind of outlook, eventually you have to be right, but you may be staring up at daisy roots when you finally win your bet.

There is tremendous Monday morning quarterbacking now about the dive in Web 2.0 companies, from Facebook to Zynga to Groupon to Pandora. Maybe they are all fads, but let’s separate the fad of stock market performance from the fad of consumer adoption as two separate issues. The shine may be off the stock, or the shine may be off the company’s products, but those are very different things. High-growth speculative stocks like these are most often valued on future earnings potential, not current performance, so if the stock is out of favor, that does not de facto mean the product or service has gone out of favor. Plenty of people are enjoying these consumables at the moment, though it is safe to say that they won’t all be in vogue for eternity. Styles change, tastes change, brand loyalties change. We know that to be Creative Destruction, an ever-present cycle, so when we criticize either an equity or a product as being a fad, let’s be careful to make the distinction, and even more careful not to level broad sweeping judgment that could lead to missed opportunity.

Can a company make money riding the wave of a fad? Seems to me that is more norm than anomaly. Can an investor make money owning the stock of a company that rides the wave of a fad without volatile exposure to market timing? Again this seems perfectly reasonable, depending on the window. Think Intel with micro-processing chips during the PC revolution, Electronic Arts with the rise of sports-based video games led by Madden NFL, and today’s True King of All Media, Apple. Equity markets in the long run reward smart risk and punish reckless risk, just as commercial markets reward desirable consumer offerings and reject cynical ones. There has to be risk for there to be reward or no one would invest, so the question is not whether something is a fad, but whether that fad represents some potential form of continuity recognized by visionary management as one in a string of ventures that together comprise opportunity.

Intel’s legendary former CEO Andy Grove clearly taught us, “Only the Paranoid Survive.” He knew at any strategic inflection point the difference between a fad and a trend was largely the expanse of the product life cycle. More importantly, he worried about management culture as the path to product culture, where innovation means never-ending creativity, not tossing the dice and getting lucky on a good roll. I don’t worry whether a company is profiting from a fad, I expect companies to be opportunistic. I worry whether the company is a one-trick pony, whether it has created a learning culture where success and failure are both studied. A company that has learned to learn, that can read data and understand how fads are perpetuated as trends that constitute periodically sustained disruptions—that is a company that can extract true shareholder value from a fad, foremost by surprising and delighting customers repeatedly with that which they never expected was possible.

I have a lot of criticism about this year’s poor performing new entries in the NASDAQ, but that criticism has nothing to do with whether those companies were beneficiaries of identified fads now assessed by pundits to be in decline. My own career has been the beneficiary of any number of fads that came and went—computer games that sold millions and now barely qualify as second round questions on Jeopardy, once immensely cool websites that scored millions of visits that no longer can be found, virtual communities that ranked with the best in loyalty and now would be lucky to make the card draw on Trivial Pursuit. Does that mean they weren’t good businesses that added significant value to their owners? To the contrary, in their useful lives they added exceptional shareholder value in earnings and lifetime contribution. We worked the brand promises as long as we could, but when their time was done, we moved on.

That’s why a sweeping statement like “don’t invest in fads” makes little sense, because if virtually everything is a fad with varying sustainability, there is no choice but to invest in fads. What I worry about is management vision, how the brand stewards of a company are migrating from one fad to the next, how maneuvering through Creative Destruction is an art and science unto itself. Edison did it over a very long period of time. So did Steve Jobs. The folks who run television networks have to do it, because no show lasts forever and formats are cyclical; yesterday’s Variety Shows are today’s Reality Shows, half-hour comedy goes in and out of style, so does one-hour drama. Walt Disney famously bet the ranch on 2D feature animation, clearly a fad, although one he created and that lasted more than 50 years—but that wasn’t the only trick he had in the magic shop, not even close. To invest wisely in the likelihood that originators can capitalize on a string of fads through creativity and experimentation is very different from investing in one hot rocket that goes straight up with full knowledge that gravity will send it back down with equal and opposite thrust.

As the contemplative George Harrison reminds us, All Things Must Pass. That doesn’t mean windows of opportunity aren’t always in abundance. Watch the fad-makers, not the fads themselves, and the game changes significantly. While even the best fad-makers can’t call winners forever, those longer windows leave plenty of room for upside, especially when you bet the full spectrum of an index rather than trying to call the hits in isolation. If you bet on a one-trick pony and lose your bait, that was most likely your mistake, not that you bet on a fad.


Innovation Finds a Way

If there is one thing the history of evolution has taught us, it’s that life will not be contained. Life breaks free, expands to new territory, and crashes through barriers, painfully, maybe even dangerously.  — Dr. Ian Malcolm (Jeff Goldblum), Jurassic Park, 1993

When not engaging in polite conversation over the past few weeks that involved either unsound journalistic ethics at News Corporation or the pending apocalypse of the U.S. debt ceiling, the most popular question I tended to encounter was, “Do you think we’re in a stock bubble?”  Truth be told, that has been a raging topic all year.  The cover story in the current issue of Fortune is “Tech Bubble 2.0” with a reasonably balanced assessment of Is It or Isn’t It.   My assessment?  Got me.

Here’s what I know.

It’s sure not 2000.  The internet is real now and so are an incredible number of businesses being launched of late.  This new wave of entrepreneurial enterprises sits upon real business models either with real revenues and real profits or real revenues and reasonably predictable profits at scale.  The business models are new, unexpected, but sound.  Some are working wildly well and bringing buckets of cash to their corporate bank accounts with pleased and well served customers, employees, and shareholders.  Others hold promise to do the same, aren’t quite there yet, but don’t take a lot of imagination to understand how they will scale to profitability because their models make sense.

Corporate earnings appear for the most part to be sound, albeit with heavy cost controls in place that aren’t doing much for the unemployed.  If you are buying the major indices across the board — domestic and international, large and small, growth and value — fully diversified along with fixed income to your own level of acceptable risk, you probably aren’t having trouble sleeping at night (except, of course, when you think about resolution to the debt ceiling).  Are the markets volatile?  They are, but they always are.  Are the fundamentals and multiples reasonable?  Well, I’m not an economist or a trader, but the Dow looks pretty understandable to me.

So how about that bubble?  Major players in venture capital have issued their opinions and are easy to search on other blogs, I am hardly qualified to comment.  Is it likely that some valuations are products of hope, optimism, or hyperbole?  Tell me anytime when that’s not the case.  Have you ever heard a Realtor tell you it’s not a good time to buy a house?  It’s always a good time, if it’s the right house at the right price.  My sense is, same with equities, preferred and common, private and public.  Bubble is a broad and complicated idea, always easy to assess in hindsight, virtually impossible in the crystal ball.

That’s what I know.  Sorry if I disappointed.

Here’s one thing else I know: the innovation all around us is astounding.  I can’t remember a time when there was so much happening so quickly and so much of it actually looked like true value creation.  Here is small sampling of the mind-blowing advances all around us:

Apple — the iPhone was a game changer, the iPad is a life changer.  I think the iPad will change everything about media for a generation.

Netflix — another game changer, first movies by mail, then movies on demand, easy and affordable, changing entertainment distribution paradigms at every turn.

Zynga — will people buy virtual goods?  They will.  Can a tiny segment of your audience underwrite the ability for everyone else to play free and still create profits?  Indeed.

Pandora — here’s technology that lets you create your own radio station that not only plays the songs you already like, but introduces you to new music you probably will like.

LinkedIn — not long ago if you had your resume online you were job hunting, afraid of being caught by the boss; now you must have your resume online or you don’t exist.

Hulu — one new brand aggregator derives more advertising revenue from network created content than the total online revenue of all the suppliers combined; wow!

Groupon & Living Social — coupons used to be the least cool way in the world to shop; call them time sensitive Daily Deals and online drives consumers back to storefronts offline.

Twitter — people communicate in less than 140 characters and the world is connected through snippets of information that can alter public opinion and evangelize democracy.

Facebook — connect people with friends, redefine the verb like, open your platform, create the most display ad inventory imaginable, then enjoy the value of 750 million accounts.

Again, this is just a sample of very cool companies doing very interesting things, among them, creating jobs and creating wealth.  Each of these represents incredible creativity, brilliant execution, and deep levels of passion.  People are working hard, people are working smart, people are being rewarded.  With > 9% national unemployment still our challenge, it is inspiring to see there are paths out of the malaise.  There are lessons to be learned in the current Silicon Valley run-up, first among them, the key is innovation.

It is ironic this “Tale of Two Economies” comes at a time when so much of the nation’s economy is suffering, and so many job losses lead the gloomy headlines.  It’s also ironic that it comes just as we lose a much beloved company, Borders, which in its day reinvented our notion of what a bookstore could be.  When the first wave of internet companies changed the landscape, Borders leased their digital real estate to Amazon.  They never recovered.  I asked a former VP of mine her sense of this recently, to which she replied: “They just forget to keep innovating.”

Perhaps the former CEO of Intel, the incomparable Andy Grove, said it best and most succinctly in the title of his 1996 book: Only the Paranoid Survive.

While I will always be reticent to render an opinion on the fair market value of a company, I can give a resounding endorsement to so much outstanding work I see going on all around us, much of it disruptive, as it should be in an entrepreneurial landscape that favors creative destruction.

Given a choice to share an opinion on the bubble versus the landscape, I’ll take the landscape.  I like what I see.  I would like to see it spread.  The old jobs aren’t coming back, innovation and automation pretty much assure that, there is little point waiting.  Let’s hope the new business models work so that new jobs will replace them and all boats float with the rising tide.  Many companies will fail, but the direction seems right.

Creativity tempered by sound judgment is the currency of the new economy.  It remains largely an open playing field for anyone who wants to relearn on a daily basis everything they thought they knew.

In Honor of E3 – Drawing Lines

And now for something completely different…

E3 — a.k.a. the annual Electronic Entertainment Expo — was held again earlier this month in Los Angeles, where many hope that it will stay.  If you have never attended E3, it cannot be adequately described in words, it is an experience of the senses — loud, visual, politically incorrect, a descent into adolescent decadence as long as what you really want to do is see the latest in new video and computer games coming soon to a device near you, currently invented or otherwise. 

I didn’t get to the show floor this year, just to a nice dinner with former colleagues and some interesting meetings, but immediately prior to the show, I was asked by a college student studying for a degree (gasp!) in videogames for my opinion (horrors!) on issues of censorship in game land.  Here I provide my largely unedited memo to that fellow, to which he recently responded my material made the cut and he received an A on his presentation.  We’ll see if you agree…

College Student Question 1:

What is “the line” for videogame developers in regard to deciding what kind of content is not included?

KG Response:

There are two answers to this question, artistic and business. In terms of artistic, the question is no different from any other art form (literature, painting, film, etc): is it true or “felicitous” to the content? By felicitous the artist implies the necessary use of whatever element of free expression is necessary to make his or her point with the best tactic available to advance the project. Of course this is subjective, but that’s what separates an artist from an amateur, effective application of subjectivity. If as an artist you need to use violence in a certain way to make a point or advance the story, you do so in the most honest and appropriate manner for the effect you need to advance the work. The opposite of felicitous in creative endeavor is gratuitous, meaning the decision is made purely for commercial reason, shock value, impact, or audience effect, what is most often referred to as hack work. When you see a string of cool special effects and all you can say is, “wow, cool special effects” and there is no other point, that’s gratuitous and likely should be edited. An artist uses a filter of appropriateness based on vision, not implication.

On the business or practical side, it is really quite simple, just like the movie business. Someone else is financing your work, whatever rating the entity financing the work wants, you edit to achieve that rating. No question, the marketing reasons will always trump artistic expression when someone else is financing your work to get the best possible return on investment they can. If you don’t like that, finance it yourself, but you will have a very high risk of losing your money because with financing comes distribution.  Abundant marketing and promotion dollars are most often provided by those who have the most skin in the game in a double down strategy, and they are by no means free of hooks, quite the contrary, but with all the noise and competition for mindshare, a good publisher can add tremendous value when you are aligned.  With trust established, the editorial dialogue between publisher and developer can also be immensely satisfying.

College Student Question 2:

How do game developers decide on the level of sensitive, questionable, and possibly offensive content in their games?

KG Response:

To be honest, one of the reasons I took a hiatus from the business a few years ago is because the artistic sensibility was not advancing at the same level as the technology. The majority of auteurs in game development tend to push the technology and pay lip service to its meaning, if any. In most other art forms the artist’s desire to advance spiritually and intellectually tends to develop with the craft and with age. I don’t see that in games as much. It is a very young industry, most often with very short life cycles driving the creative process, which can be great for business because the craft means to sell peer-to-peer, but in terms of thoughtfulness about the greater art form and what goes in and what comes out, I don’t see enough introspection. There are a few, like Will Wright and Shigeru Miyamoto, whose scope has developed with their craft and their tools, but mostly it’s the next generation simply trying to “out cool” the competition.  Sequels and branding increasingly become overpowering forces over freeform imagination and exploration as capital requirements increase, just like movies. That’s just the way it is, not good or bad, just reality.

Zynga has changed some of that with a new paradigm for lightning fast development and iteration in social contexts that is much less demanding of production values, which makes them less dependent on eye candy.  The fast rise of relatively cheap mobile apps is also bringing back a level of independence that allows more experimentation and creative risk.  Yet it would be great to see a few gifted minds really explode the give-and-take storytelling platform (you can’t say “interactive” anymore without drawing sneers) taking a weed wacker to clichés and with subject matter beyond outer space creatures, monster machine guns, dungeon royalty, and various interpretations of the technocrat’s apocalypse.

College Student Question 3:

How seriously do game companies take the critics who claim that video games are terrible for children and the cause of societies problems?

KG response:

Game companies worry about customers and sales. When sales stop because of this or that element, they stop putting it in the game. This too de facto is neither good or bad, it just is. If PR makes a game sell, it’ good. If it makes a game stop selling, it’s bad. This is a business like any other business. If you are not fully responsive to customers you will go out of business. Do you think the people who make Oreos had a sudden revelation about trans fat? No, it made the headlines as a direct link to poor health, sales dipped, and now you have Oreos without trans fat. That is the way capitalism works, and whether it has a spiritual ground is irrelevant, it is the best way known for a business to work. Customer opinion is EVERYTHING because sales reflect customer opinion, especially in a world of social media and internet exchange of unedited public opinion. Noise will always be noise, but sales are not noise.

So what do you think, did we earn our A? Or do you think differently about the lines of censorship in gaming, how they are applied or how they should be applied? Please join the dialogue publicly or privately.  Game On!