Top 10 Predictions for 2017

Conceptualization of giant robot fight.
Conceptualization of giant robot fight.

When I was on Wall Street I became very boring by having the same three strong buy recommendations for many years until I downgraded Compaq in 1998 (it was about 30X the original price at that point). The other two, Microsoft and Dell, remained strong recommendations until I left in 2000. At the time, they were each well over 100X the price of my original recommendation. I mention this because my favorite stocks for this blog include Facebook and Tesla for the 4th year in a row. They are both over 5X what I paid for them in 2013 (23 and 45, respectively) and I continue to own both. Will they get to 100X or more? This is not likely, as companies like them have had much higher valuations when going public compared with Microsoft or Dell, but I believe they continue to offer strong upside, as explained below.

In each of my stock picks, I’m expecting the stocks to outperform the market. I don’t have a forecast of how the market will perform, so in a steeply declining market, out-performance might occur with the stock itself being down (but less than the market). Given the recent rise in the market subsequent to the election of Donald Trump, on top of several years of a substantial bull market, this risk is real. While I have had solid success at predicting certain individual stocks’ performance, I do not pride myself in being able to predict the market itself. So, consider yourself forewarned regarding potential market volatility.

This top ten is unusual in having three picks that are negative forecasts as last year there were no negatives and in 2015 only one.

We’ll start with the stock picks (with prices of stocks valid as of writing this post, January 10, all higher than the beginning of the year) and then move on to the remainder of my 10 predictions.

  1. Tesla stock appreciation will continue to outpace the market (it is currently at $229/share). Tesla expected to ship 50,000 vehicles in the second half of 2016 and Q3 revenue came in at $2.3 billion. This equates to 100,000 vehicles and a $9.2 billion annualized run rate. The model 3 has over 400,000 units on back order and Tesla is ramping capacity to produce 500,000 vehicles in total in 2018. If the company stays on track, from a production point of view, this amounts to 5X the vehicle unit sales rate and about 3X the revenue run rate. While the model 3 is unlikely to have the same gross margins as the current products, tripling revenue should still lead to substantially more than tripling profits. Tesla remains the clear leader in electric vehicles and fully integrated automated features in an automobile. While others are looking towards 2020/2021 to deliver automated cars, Tesla is already delivering most of the functionality required. Between now and 2020 Tesla is likely to install numerous improvements and should remain the leader. Tesla also continues to have the strongest business model as it sells directly to the consumer, eliminating dealers. I also believe that the Solar City acquisition will prove more favorable than anticipated. Given these factors, I expect Tesla stock to have solid outperformance in 2017. The biggest risk is product delay and/or delivering a faulty product, but competitors are trailing by quite a bit so there is some headroom if this happens.

2. Facebook stock appreciation will continue to outpace the market (it is currently at $123/share). While the core Facebook user base growth has slowed considerably, Facebook has a product portfolio that also includes Instagram, WhatsApp and Oculus. This gives Facebook multiple opportunities for revenue growth: Improve the revenue per DAU (daily active user) on Facebook itself; begin to monetize Instagram and WhatsApp in more meaningful ways; and build the install base of Oculus. We have seen Facebook advertising rates increase steadily as more and more mainstream companies shift budget from traditional advertising to Facebook. This, combined with modest growth in DAUs, should lead to continued strong revenue growth from the Facebook platform itself. The opportunity to increase monetization on its other platforms should become more real during 2017, providing Facebook with additional revenue streams. And while the Oculus did not get out of the gate as fast as expected, it is still viewed as the premier product in VR. We believe the company will need to produce a lower priced version to drive sales into the millions of units annually. The wild card here is the “killer app”; if a product becomes a must have and is only available on the Oculus, sales would jump substantially in a short time.

3. Amazon stock appreciation will outpace the market (it is currently at $795/share). I had Amazon as a recommended stock in 2015 but omitted it in 2016 after the stock appreciated 137% in 2015 while revenue grew less than 20%. That meant my 2015 recommendation worked extremely well. But while I still believed in Amazon fundamentals at the beginning of 2016, I felt the stock might have reached a level that needed to be absorbed for a year or so. In fact, 2016 Amazon fundamentals continued to be quite strong with revenue growth accelerating to 26% (to get to this number, I assumed it would have its usual seasonally strong Q4). At the same time, the stock was only up 10% for the year. While it has already appreciated a bit since year end, it seems to be more fairly valued than a year ago, and I am putting it back on our recommended list as we expect it to continue to gain share in retail, have continued success with its cloud offering (strong growth and increased margin), leverage their best in class AI and voice recognition with Echo (see pick 10), and add more physical outlets that drive increased adoption.

4. Both Online and Offline Retailers will increasingly use an Omnichannel Approach. The line between online and offline retailers will become blurred over the next five years. But despite the continued increase in online’s share of the total, physical stores will be the majority of sales for many years. This means that many online retailers will decide to have some form of physical outlets. The most common will be “guide stores” like those from Warby Parker, Bonobos and Tesla where samples of product are in the store but the order is still placed online for subsequent delivery. We believe Amazon may begin to create several such physical locations over the next year or two. I expect brick and mortar retailers to up their game online as they struggle to maintain share. But currently, they continue to struggle to optimize their online presence, so much so that Walmart paid what I believe to be an extremely overpriced valuation for Jet to access better technology and skills. Others may follow suit. One retailer that appears to have done a reasonable job online is William Sonoma.

5. A giant piloted robot will be demo’d as the next form of Entertainment. Since the company producing it, MegaBots, is an Azure portfolio company, this is one of my easier predictions, assuming good execution. The robot will be 16 feet high, weigh 20,000 pounds and be able to lift a car in one hand (a link to the proto-type was in my last post). It will be able to shoot a paint ball at a speed that pierces armor. If all goes well, we will also be able to experience the first combat between two such robots in 2017. Actual giant robots as a new form of entertainment will emerge as a new category over the next few years.

6. Virtual and Augmented reality products will escalate. If 2016 was the big launch year for VR (with every major platform launching), 2017 will be the year where these platforms are more broadly evaluated by millions of consumers. The race to supplement them with a plethora of software applications, follow on devices, VR enabled laptops and 360 degree cameras will escalate the number of VR enabled products on the market. For every high-tech, expensive VR technology platform release, there will be a handful of apps that will expand VR’s reach outside of gaming (and into viewing homes, room design, travel, education etc.), allowing anyone with simple VR glasses connected to a smartphone to experience VR in a variety of settings.  For AR, we see 2017 as the year where AR applicability to retail, healthcare, agriculture and manufacturing will start to be tested, and initial use cases will emerge.

7. Magic Leap will disappoint in 2017. Magic Leap has been one of the “aha” stories in technology for the past few years as it promised to build its technology into a pair of glasses that will create virtual objects and blend them with the real world. At the Fortune Brainstorm conference in 2016, I heard CEO Rony Abovitz speak about the technology. I was struck by the fact that there was no demo shown despite the fact that the company had raised about $1.4 billion starting in early 2014 (with a last post-money at $4.5 billion). The problem for this company is that while it may have been conceptually ahead in 2014, others, like Microsoft, now appear further along and it remains unclear when Magic Leap will actually deliver a marketable product.

8. Cable companies will see slide in adoption. Despite many thinking to the contrary, the number of US cable subscribers has barely changed over the past two years, going down from 49.9 million in Q2 2014 to 48.9 million in Q2 2016 (a 2% loss). During the same period, Broadband services subscribers (video on demand for Netflix, Hulu and others) increased about 12% to 57.0 million. Given the extremely high price of cable, more people (especially millennials) are shifting to paying for what they want at considerably less cost so that the rate of erosion of the subscriber base should continue and may even accelerate over the next few years. I expect to see further erosion of traditional TV usage as well, despite the fact that overall media usage per day is rising. The reason for lower TV usage is the shift people are making to consuming media on their smart phones. This shift is much broader than millennials as every age group is increasing their media consumption through their phones.

9. Spotify will either postpone its IPO or have a disappointing one. In theory, valuation of a company should be calculated based on future earnings flows. The problem for evaluating companies that are losing money is that we can only use proxies for such flows and often wind up using them to determine a multiple of revenue that appears appropriate. To do this I first consider gross margin, cost of customer acquisition and operating cost to determine a “theoretic potential operating profit percentage” that a company can reach when it matures. I believe the higher this is, the higher the multiple and similarly the higher the revenue growth rate, the higher the multiple. When I look at Spotify numbers for 2015 (2016 financials won’t be released for several months) it strikes me (and many others) that this is a difficult business to make profitable as gross margins were a thin 16% based on hosting and royalty cost. Sales and marketing (both of which are variable costs that ramp with revenue) was an additional 12.6% leaving only 3.4% before G&A and R&D (which in 2015 were over 13% of revenue). This combination has meant that scaling revenue has not improved earnings. In fact, the 80% increase in revenue over the prior year still led to higher dollars in operating loss (about 9.5% of revenue). Unless the record labels agree to lower royalties substantially (which seems unlikely) its appears that even strong growth would not result in positive operating margins. If I give them the benefit of the doubt and assume they somehow get to 2% positive operating margin, the company’s value ($8 billion post) would still be over 175X this percent of 2015 revenue. If Spotify grew another 50% in 2016, the same calculation would bring the multiple of theoretical 2016 operating margin to about 120X. I believe it will be tough for them to get an IPO valuation as high as their last post if they went public in Q2 of this year as has been rumored.

10. Amazon’s Echo will gain considerable traction in 2017. The Echo is Amazon’s voice-enabled device that has built-in artificial intelligence and voice recognition. It has a variety of functions like controlling smart devices, answering questions, telling jokes, playing music through Sonos and other smart devices and more. Essentially an app for it is called a “skill”. There are now over 3,000 of these apps and this is growing at a rapid rate. In the first 12 months of sales, a consulting firm, Activate, estimated that about 4.4 million were sold. If we assume an average price of about $150, this would amount to over $650 million to Amazon. The chart below shows the adoption curve for five popular devices launched in the past. Year 1 unit sales for each is set at 1.0 and subsequent years show the multiple of year 1 volume that occurred in that year. As can be seen from the chart, the second year ranged from 2x to over 8X the first year’s volume and in the third year every one of them was at least 5 times the first year’s volume. Should the Echo continue to ramp in a similar way to these devices, its unit sales could increase by 2-3X in 2017 placing the device sales at $1.5-2.0 billion. But the device itself is only one part of the equation for Amazon as the Echo also facilitates ordering products, and while skills are free today, some future skills could entail payments with Amazon taking a cut.

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Re-cap of 2016 Predictions

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Samsung FamilyHub Fridge: manage groceries, family scheduling, display photos and play music through a wifi enabled touchscreen

In my post for top 10 predictions for 2016 I noted how lucky I had been for 3 years running as all my picks seemed to work. I pointed out that all winning streaks eventually come to an end. I’m not sure if this constitutes an end to my streak but in my forecasts for 2016 I was wrong with one of the three stock picks (GoPro) and also missed on one of my seven forecasts of industry trends (that the 2016 political spend would reach record levels). My other 2 stock picks and other 6 trend forecasts did prove accurate.

I’ve listed in bold the 2016 stock picks and trend forecasts below and give a personal evaluation of how I fared on each. For context, the S&P was up 7.5% and the Nasdaq 10.0% in 2016.

1. Facebook stock appreciation will continue to outpace the market (it is currently at $97/share). One year later (January 3) Facebook opened at $117.50, a year over year gain of 21.1% from the time of my blog post. While this was short of the 40% gain in 2015, it still easily outpaced the market.

2. Tesla stock appreciation will continue to outpace the market (it is currently at $193/share). One year later, Tesla shares opened at $219.25 (January 3), a 13.5% gain from the time of my blog post. It might have been higher but the acquisition of Solar City created headwinds for the stock as revenue grew well over 100%, gross profit improved and in Q3 (last reported quarter) EBITDA was positive. Still, it outperformed the market.

3. GoPro stock appreciation should outpace the market in 2016 (shares are currently at $10.86). This pick was a clear miss as the stock declined 17.1% from the time of the blog post to January 3. In my defense, I had it partly right as the stock peaked at $17/share at the time of the drone and new camera announcements. In retrospect, given GoPro’s history of poor execution, I would have been smarter to recommend selling at the time these were announced. Instead, I mistakenly viewed execution as pretty easy and failed to suggest this. Since the company, once again, had an execution misstep, I was proven wrong and the stock subsequently declined.

The remaining predictions were about industry trends rather than stocks.

4. UAV/Drones will continue to increase in popularity. Drones continued to increase in popularity at the end of 2015 and into the first half of 2016. According to Market Watch, drone sales were up over 200% in April of 2016 as compared with April of 2015. Starting in December of 2015, the government began requiring drone operators to register on a federal database and by December 2016 had registered over 600,000 drones and users.

5. Political spend will reach record levels in 2016 and have a positive impact on advertising revenue. This forecast proved incorrect. Donald Trump won the presidency despite raising less money than any major party presidential candidate since 2008. Hillary Clinton, raised nearly twice as much as Trump, but still fell short of what President Obama raised in 2012. In the case of President-Elect Trump, more than half of his small raise consisted of $66 million he personally donated to his campaign and $280 million from donors giving $200 or less. Mrs. Clinton, despite depicting Trump as the candidate of the rich, received a substantial portion of her donations from wealthy individuals. The two candidates raising less money meant that the size of the boost in advertising from political ads fell short of my prediction.

6. Virtual/Augmented Reality will have a big year in 2016. As expected, 2016 was the big launch year for VR and AR. Highly anticipated VR product launches (the Facebook Oculus Rift in March, the HTC Vive in April and the PlayStation VR in October) showed strong consumer interest with sales of over 1.5M units. Pokemon Go’s 500M + downloads and the initial release of Microsoft’s Hololense generated intense interest in AR, creating a flurry of application development across a variety of industries including healthcare, agriculture, manufacturing and retail. Unsurprisingly, this excitement is mirrored in VC investment dollars, with a 140% growth in funding over 2015, bringing the total amount invested this past year to $1.8 Bn. This shows a strong trajectory for more development across gaming and commercial applications in AR / VR as we move into 2017.

7. Robotic market will expand to new areas in 2016. From chatbots being introduced by many companies for interacting with customers, to a giant fighting robot (16 foot tall, 20,000 pounds) that can lift and throw a car, to robots for making pizzas, to robots that help educate kids, 2016 was a year of enormous expansion in the robotics market.

8. A new generation of automated functionality will begin to be added to cars. In 2016 autonomous cars moved from concept to closer to reality. To date, the technology leaders appeared to be Tesla and Google, the former building a fully integrated product, the latter a set of components that can be integrated into many different vehicles. Tesla, who appears to be furthest along in putting a fully autonomous car on the road in volume, added more components (software and sensors) to its autonomous technology but suffered a setback when a driver ignored Tesla requirements to “supervise” the autonomous driving and suffered a fatal accident. Autonomous cars took many steps forward in 2016 as additional companies entered the fray. Uber, a company that has much to gain from driverless cars (like eliminating the need for its over 1 million drivers), began an experiment in Pittsburg to offer driverless cars (supervised by an actual person in the driver’s seat) as part of its service. These cars are being manufactured in a partnership with Volvo using technology created by Carnegie Robotics (who’s founder was one of the creators of the Google technology). Uber also acquired Otto, a startup focused on driverless trucks, to gain further technology. In August, Ford announced its intent to bring an autonomous car to market by 2021. Audi just announced a partnership with Nvidia to bring an autonomous car to the road by 2020-21. Toyota, Chrysler and others have also announced intent to create such a vehicle. While I believe that the actual mass usage of driverless cars will be further out then 2021, we seem to be close to a breakout of “supervised automated vehicles”.

9. The Internet of Things will expand further into kitchen appliances and will start being adopted by the average consumer. In the past 12 months Samsung, LG, GE and others have launched numerous smart refrigerators. These can now be thought of as devices that can connect to a smart phone through an app. The user can receive alerts like ‘a water filter needs replacing’ or ‘the door was left open’. Some have digital bulletin boards on the fridges, other features can let you know when various items stored in the fridge are running low, and still more features can be deployed to control functionality (change temperature, etc). The adoption of these devices has reached sufficient levels for them to be carried in mainstream stores like Best Buy.

10. Amazon will move to profitability on their book subscription service and improve cloud capex. Amazon did indeed make three major shifts in its book subscription strategy. First, it significantly reduced payouts to publishers for their books that were downloaded; second, it reduced the proportion of third party published books offered to subscribers to the service and third it reduced the amount it pays their own authors. While Amazon does not report these numbers, I believe this combination has reduced the cost to Amazon by over 50% and has made the service profitable. The gross margin before stock based compensation for Amazon’s cloud service increased year over year in Q3 (last reported quarter) from 27.1% in 2015 to 31.6% in 2016.

 

While it wasn’t in my Top 10 post for 2016, I did predict that Kevin Durant would sign with the Warriors as he would fit right in and improve his chances of winning championships. He has signed, seems to fit in well, but we’ll have to wait to see if the championships follow.

I’ll be making my 2017 picks within the next week.

Trump’s Carrier deal a positive step for workers

It saves at least 800 jobs at a 14x return to government

Let me start this post by saying I did not vote for Donald Trump and consider myself an independent. But, as my readers know, I can’t help analyzing everything including company business models (both public and private), basketball performance, football, and of course, economics. I have, to date, resisted opining on the election, as it appears to be a polarizing event and therefore a no-win for those who comment. However, I care deeply about the future of our country and the welfare of workers of all levels. Being in Venture Capital allows me to believe (perhaps naively) that I contribute to adding jobs to our country. All this brings me to the recent agreement reached between Trump and Carrier, as it may mark a shift in economic policy.

A key assumption in interpreting the value of the deal is how many jobs were already slated by Carrier to leave the country and which of these were saved. President-Elect Trump has claimed he saved 1,150 jobs. Trump’s opponents say 350 were never slated to leave the country. I’m not going to try to figure out which camp is right. My analysis will only assume 800 manufacturing jobs that were slated to leave the country now will remain in Indiana. This does not seem to be disputed by anyone and was confirmed by a Carrier spokesperson. My observations for this analysis are:

  1. Had those jobs left, 800 fewer people would be employed (which might be different ones than these but less jobs mean less employment).
  2. The average worker at these jobs would make $20 an hour plus overtime (some reports have put this as high as $30 per hour fully loaded cost to Carrier). The average worker at these jobs would make about $45,000 annually, assuming modest overtime.
  3. On average, assuming working spouses in many cases, family income would be an average of $65,000.

Given what we know, here’s why I think Trump’s Carrier deal is a good one for the U.S., and actually results in revenue to the government that far exceeds the tax credits:

Social security taxes are currently 6.2% of each worker’s wages. The employer matches that, resulting in about $5,600 in FICA tax income to the government per worker from social security. Medicare is 1.45% and is also matched, resulting in about $1,300 in Medicare taxes paid to the government.

The federal income tax increment between a $20,000 family income (for spouse) and $65,000 family income is about $4,000 (but depends on a number of factors). Indiana state taxes of 3.3% on adjusted gross income comes out to nearly $1,400.

To make the total relatively conservative, I’ve omitted county taxes, payroll taxes and other payments that various other governmental entities might receive. This should mean the total financial income to various governmental entities from these jobs remaining probably exceeds those calculated in Table 1 below even if some of my rough assumptions are not exact.

Table 1. Governmental Income per Worker

Table

So, the economic question of whether the subsidy Trump agreed to was worth it partly depends on how much additional income was derived by the government versus the tax credits of $700,000 per year granted to Carrier in exchange for keeping the jobs here.

Of course, there is also a multiplier effect of families having higher income available for spending. And if 800 additional people are unemployed, there are numerous costs paid by the government. We’ll leave these out of the analysis, but they are all real benefits to our society of more people being employed. It is important to realize how expensive it is for the government to subsidize unemployed workers as opposed to realizing multiple sources of tax revenues when these workers have good jobs.

If we take the total from Table 1, which we believe underestimates the income to governmental entities, and multiply it by the 800 workers, the annual benefit adds up to about $9.8 million. Since Carrier is getting a $700,000 annual subsidy, the governmental revenue derived is over 14 times the cost. And that is without including a number of other benefits, some of which we mentioned above. As an investor, I’d take a 14 times return every day of the year. Wouldn’t you? Shouldn’t the government?

This is not a sweetheart deal for Carrier

I won’t go into all the math, but it indicates that Carrier will spend tens of millions of dollars more by keeping workers in the U.S. rather than moving them to Mexico. Comments that the $700,000 yearly benefit they have been given is a sweetheart deal does not appear to be the case.

Why the Democrats lost the election

Trump campaigned on the promise that he would create policies and heavily negotiate to increase employment in America. While this is a small victory in the scheme of things and certainly falls short of retaining all the jobs Carrier wanted to move, the analysis demonstrates that spending some money in tax breaks to increase employment has a large payback to government. It also means a lot to 800 people who greatly prefer being paid for working rather than receiving unemployment benefits.

Is this approach scalable?

The other question is whether this is scalable as a way of keeping jobs in America. Clearly Trump would not be able to negotiate individually with every company planning on moving jobs out of the U.S. Some infrastructure would need to be created – the question would be at what cost? If this became policy, would it encourage more companies to consider moving jobs as a way of attracting tax benefits? Any approach would need to prevent that. My guess is that getting a few companies known to be moving jobs to reconsider is only an interim step. If Trump is to fulfill his promise, an ongoing solution will be needed. But it is important to properly evaluate any steps from an impartial financial viewpoint as the United States needs to increase employment.

Employment is the right way of measuring the economy’s health

My post of March 2015 discussed the health of the economy and pointed out that looking at the Unemployment Rate as the key indicator was deceptive as much of the improvement was from people dropping out of the workforce. Instead, I advocated using the “Employment Rate” (the percent of the eligible population employed) as a better indicator. I noted that in 2007, pre-downturn, 63.0% of the population had a job. By 2010 this had declined to 58.5%, a 450 basis point drop due to the recession. Four years later the “Recovery” drove that number up to 59.0% which meant only 1/9 of the drop in those working returned to the workforce. Since then the workforce has recovered further but still stands at 325 basis points below the pre-recession level. That is why the rust belt switched from voting Democrat to President-Elect Trump.

The real culprit is loss of better quality job opportunities

In an article in the New York Times on December 7, “stagnant wages” since 1980 were blamed for lack of income growth experienced by the lower half on the economic scale. I believe that the real culprit is loss of better quality job opportunities. Since 1980 production and non-supervisory hourly wages have increased 214% but at the same time manufacturing workers as a percent of the workforce has shrunk from 18.9% to 8.1% and there has been no recovery of these jobs subsequent to the 2007-2010 recession. Many of these displaced workers have been forced to take lower paying jobs in the leisure, health care or other sectors, part-time jobs or dropped out of the workforce entirely (triggering substantial government spending to help them). This loss of available work in manufacturing is staggering and presents a challenge to our society. It also is the button Donald Trump pushed to get elected. I am hoping he can change the trend but it is a difficult task for anyone, Republican or Democrat.

A condensed version of of this post is featured on Fortune.com 

The Importance of Lifelong Relationships

At my son’s convocation at Wharton, the incoming MBA class was asked to write the names of their five best friends on the left side of a page and then the five people with whom they would most want to start a business on the right side of a page. The lesson was that the key to success in business was to develop relationships so that the future version of that piece of paper would have as many overlapping names as possible on both sides of the page.

Earlier this summer, I was invited to speak to Brooklyn College’s 2016 graduating class. I wanted to emphasize the importance of lifelong relationships for personal and business success. For me, Brooklyn College was foundational to so many of my most important relationships. It is where I met my beautiful, brilliant wife Michelle as well as eight couples who all attended my son’s wedding late last year. As we wrapped up our 10th Annual Azure CEO Summit, I was humbled to see so many familiar faces that may have started as business acquaintances but have now become close friends. As I reflect on the importance of these lifelong relationships, I wanted to share my speech to the Brooklyn College’s Class of 2016.

Good Morning, President Gould, distinguished faculty, parents, and especially – the fabulous graduating class of 2016! It’s a great pleasure to be back in Brooklyn to greet you all today, as I now live in what’s known as Silicon Valley, California.

I want to focus on three things:

  1. Make sure your friends from Brooklyn College become friends for life.
  2. College is only the beginning of your education, post-college you must continue to learn or you will be left behind.
  3. Never forget that Brooklyn College helps people move up in society.

My beautiful, brilliant wife, who I met at Brooklyn College, is also here today. We recently celebrated our son’s wedding. One of the highlights was there were 8 couples attending where the origin of the relationship stemmed from our school days. And make no mistake about it; there is a difference in the depth of the relationship when you know someone from that early in life. So my first advice is: “Make sure you stay in touch with those you really care about from college”

Brooklyn College is for people who work hard, are smart and typically couldn’t have afforded to go to college were CUNY not available

It helps people move up in society

The close friends I met here all had parents with modest incomes. Yet, we are all very successful financially –but more importantly –in life.

In my case, my father was an immigrant who came through Ellis Island. He had to go to work and couldn’t even attend high school. My mother, the daughter of an immigrant, did have the opportunity to finish high school.

Brooklyn College allowed me to be part of the first generation from my family that could afford college. And it provided as good an education as any school in the country!

I became the CEO of a successful startup and then went to Wall Street where I became the Number 1 Analyst following the PC space, and after 10 years left Wall Street to co-found a Venture Capital firm. 

The trick for you to replicate what my friends from College and I have achieved is to leverage this great education and your superior intelligence beyond college. Senator Schumer mentioned the advantage you have because you know today’s technology. This advantage is ephemeral. Whether you’re going to grad school or straight to a job my second bit of advice is:

Never take anything for granted, the world is changing at an increasingly rapid pace. Within 5 years all that you know regarding technology will likely be obsolete. To keep up you must always continue to learn. That coupled with working hard is the way you will succeed beyond college.

Many of you may have noticed that governmental support for CUNY is diminishing and could impact the school. “So, once you do succeed, as I know you will, remember to give back to Brooklyn College so the next generation that wants to move up in society has the same opportunity as you

Thank you and congratulations.

Soundbytes

  • Speaking of long term relationships, I am both happy and sad to note that Dan Park, my editor and collaborator for SoundBytes is leaving his full-time position at Azure to take a senior operating role at Uber Canada. I’m happy for him but sad not to have him continue full-time at Azure. Fortunately, he has agreed to remain as an Azure Venture partner and to continue to work with me on this blog.

An Analysis of Kevin Durant’s Free Agency Decision

There is much controversy over whether Kevin Durant should leave OKC and if so, what team he best fits with. In evaluating what makes the most sense for him I’d like to cut through emotional clutter and start with objectives:

  • To be rated among the best ever, a basketball player needs to win championships – which is why LeBron James left Cleveland originally and why Bill Russell (8 championships) usually gets rated above Wilt Chamberlain (2 championships) despite the fact that Wilt was clearly a much more complete player and why you don’t typically see the great Patrick Ewing, Allen Iverson or Elgin Baylor (all 0 championships) getting ranked that high among the greatest players of the century .
  • When you win championships, people soon forget how stacked your team may or may not have been – LeBron is sometimes referred to as a failure in his first Cleveland stint despite taking the worst team in the league to the NBA finals and few talk about how good Michael Jordan’s supporting cast was in making the playoffs even when he was playing baseball instead of basketball.
  • I believe Durant understands that and his primary objective is to win championships so that he can rank higher among the greats.

How can he best accomplish that?

  • Kevin Durant could stay in OKC because of the emotional concept that it’s “his team” and he should not abandon them. The idea being that helping them win is somehow better than helping someone else win. If he does, his chance of winning a championship would be less than 12.5% (1 in 8) since they would probably need to beat San Antonio, Golden State and Cleveland and it’s hard to rate them as favorites in any of those matchups.
  • If Durant went to Golden State they would likely win the Western Conference again and have an easier schedule than a Durant led OKC could have in the playoffs. They are already the favorite to win the title even without Durant and the odds of them winning would increase significantly should they land him. Golden State is also a perfect fit for him as it plays a team game that would improve the quality of his shot opportunities. How does a team simultaneously double team Durant, Curry and Thompson? So not only would this increase his chance of winning, it also would likely increase his shooting percent and his assists.
  • The other team that he could pick with the best opportunity to win would be Cleveland but there is no cap space there and it’s unlikely that this would be a fit.
  • The third strong opportunity is San Antonio. While this would be a fit, the path to a title would not be as likely as Golden State or Cleveland because several key players are aging. However, adding Durant would create a strong trio that could challenge Golden State and possibly would be favored over them. But not the overwhelmingly favorites that the Warriors would be with Durant. Also going from one small market to another would not add the media draw that would lead to maximizing endorsement income.
  • Although there are rumors of Boston, Los Angeles, New York, Washington, Houston and Miami also courting Durant, none of these teams would solve any of his objectives. None would give him a high probability of winning a championship and would solve even less for the emotional component of the decision.
  • The question that was rattling around all year was “Why would the Warriors want Durant.” The answer is obvious and even more obvious after their game 7 loss – he will make them better. Adding one of the 5 best players in basketball, who shoots for a high percentage, plays defense well and is team oriented makes any team better.
  • What about the argument that adding Durant would use up so much cap space that the Warriors would need to shed other key players? I agree that they would not be able to keep Harrison Barnes and Festus Ezeli. But the reality is that Ezeli is not a key player and they should not match the high price he is likely to get in the free market, regardless of whether or not they get Durant. By Durant (and in the future Curry) taking less than a max salary, the Warriors could make sure that they kept Iguodala and Livingston plus all starters (including Andrew Bogut) other than Barnes. The rest of the team could be filled in and I would predict the Warriors could attract others who are willing to take lower salaries in order to be on a championship team. So, I suspect the remainder of the supporting cast will be as good as this year. If Durant is willing to take a salary that enables keeping the 6 key players mentioned, then he will maximize his chance of winning a title. When the cap goes up next year, he and Curry could take higher, but not maximum, salaries so that the team around them could continue to include Iguodala and Livingston.
  • What about the argument that Durant should maximize his compensation? My answer is that he will maximize his compensation by taking a lower salary and going to the Warriors because his endorsement money will increase by far more than any salary he forgoes since he would be playing on the highest profile team in a major market and winning championships. To quantify the opportunity, Michael Jordan made more in 2015 from endorsements (12 years after his last retirement) than he did in all 15 years in NBA earnings. Curry is already proving that and can easily take a lower than max salary when his contract expires in another year as his endorsements will dwarf his salary. And winning more championships will only increase all the key players’ outside revenue dramatically.

 

The Ultimate Marketing Framework

Combining a Top Marketing Specialist’s Framework with Our Thoughts

We just spent several hours speaking with Marc Schwartz, an Integrated Marketing Specialist.  Marc has been in marketing for 25 years in various high level positions with companies like Kraft/Gevalia, Publishers Clearing House, Starwood Hotels, Wyndham, Pfizer and Sanofi. His experience spans both online and offline. In this post we combine his concept of a marketing framework with our thoughts on specific topics within that framework.

Creating a Marketing Framework

Marc points out that it is important for every company to have a marketing framework that has three common threads throughout:

  • Consistently build your brand throughout every step in the process.
  • Measure everything – “If you can’t measure it, don’t do it!”
  • Be customer centric – always think about how the customer will feel about anything you choose to do

Marketing can be broken down into 4 important steps and companies will likely need different people with different skill sets to address each step:

  1. Acquisition
  2. Retention
  3. Upsell /Cross sell
  4. Winning Back Customers

1. Customer Acquisition – The 40/40/20 Rule

Marc’s experience has shown that in acquiring new customers 40% of success has to do with targeting the right people, 40% with the nature of the offer and 20% with creative.  Worth noting while creative and messaging is critical, in direct marketing the right offer delivered to the right audience is the most important factor. Targeting is not about mass marketing but rather about knowing your potential customers and finding the most efficient way to reach them.

Targeting

One important thing I have found is that it may make sense to spend more money per potential customer (referred to as Customer Acquisition Cost or CAC) if you reach individuals who will be greater spenders on your product (this is referred to as Life Time Revenue or LTR).  For example Facebook charges more to find closer matches to your target demographic but spending more initially has led several Azure portfolio companies to acquire a stronger customer set which in turn increases LTR and and makes the higher spending worthwhile. The key is to compare the CAC of each particular acquisition channel to the value of the customer (Lifetime profits on the customer or LTV). When LTV is higher than the CAC that means the customer is profitable. But we discourage our companies from going after marginally profitable customers so I would encourage you to think in terms of LTV being at least twice the CAC (I won’t invest in a startup unless I believe the ratio can exceed 3X). Each acquisition channel can become less effective when going beyond a certain scale but that scale will differ dramatically with the products being offered. The determination of where to cap spend should be decided by gradually increasing your commitment on a successful channel until you find that the incremental spend is not yielding good incremental results.  It is important to avoid being a one trick pony so using multiple channels helps scale customer acquisition without hitting diminishing returns for a much longer period. Any channel that tests well should be utilized with the total spend being apportioned based on effectiveness (the ratio of LTV/CAC) of each channel.

The Offer

Each campaign should lead with an offer that is a strong value proposition for the target customer. The offer must have a very clear call to action. Saying “try my product” would not usually be viewed as a compelling offer. At Gevalia Coffee, the company offered a free coffee maker if you began subscribing. At Publisher’s Clearing House the company entered you in a contest where you could win $1,000,000. More recently, Warren Buffet offered $1 billion to anyone who picked every game right in the NCAA tournament (his risk of paying out is low as the odds of there being a correct answer among 100 million unique entries is less than one in 10 billion!).  Marc points out that his experience indicates there is a direct correlation between the value of what you give away and retention. The more compelling the offer, the lower the retention as more “cherry pickers” sign up so starting with a free month of a physical product can potentially backfire.  In fact, these days, there are bloggers who tell their following, “Go to this site for a free month of some product”. It would be surprising if your company recovered it’s CAC on this set of potential customers as followers of such bloggers will rarely become paying customers.

Therefore it’s important to find the balance between your brand equity and the value of the premium used.  While a lower valued premium will probably lead to fewer customers being acquired, it is likely to also lead to higher LTV for those customers and stronger brand equity. The key with this, as with everything in this blog post, is a continuous A/B testing philosophy to see what works best.

One note of caution: From early November through late December, the cost of virtually every form of marketing goes up due to increased purchasing that takes place for Christmas gifts. If your product won’t benefit from this, your annual plan should have the lowest spend (if any) during this period.

Creative

Marc ranks creative at 20% of the formula for winning customers. This is half the importance of proper targeting and the nature of the offer because great creative can’t overcome a poor offer or going after the wrong customers. However, the creative is where you get to explain who you are (your brand statement), why the offer has value to the target customer and your call to action. If the call to action is not clear enough than you won’t get the desired action. The creative needs to be A/B/C tested for best language, fonts, colors, graphics, etc. Every element of the creative has an impact on how well the offer performs. You also need to decide if different offers and/or creative should be used for different subsets of the target customers. One of the best examples of this that I have seen was a campaign that targeted graduates of various schools and led with something like: “Your Harvard degree is worth even more if you …” The conversion rate of this highly targeted campaign was more than double the norm for this company.

2. Optimizing Customer Retention

On Boarding

I’m sure you have heard the expression: “You only get one chance to make a good first impression.”  Your best opportunity comes after the customer has placed their order (although the acquisition process was the first step). For this section I’m going to assume you are sending the customer physical goods. Marc calls this first experience “The Brand Moment”. If you think of how Apple packages its products, they have clearly enhanced their brand through the packaging with every element of the package as perfect as they can make it. Opening their box certainly enhances the Apple brand. So you need to balance the expense of better quality packaging against the degree to which it enhances your brand equity. The box itself should be branded and can contain a message that you want to relate to the customer. The nature of collateral material, how many items, what messaging on the materials and the order they are placed in the box needs to be researched. Have you included easy to find information on how to resolve a problem? Should there be a customer support phone number to call if something is amiss? Is your brand position re-emphasized in the materials?  A good impression can lead to higher LTV, recommendations for other customers and more.

Communications

Marc believes the first step in communications should be to welcome the new customer. This would usually be through an email (or snail mail). Marc finds an actual phone call is highly effective but costly.  Obviously your business model will determine the appropriate action to welcome the new customer. The welcome email (or call) is an opportunity to re-emphasize your brand and its value to the customer. It’s important to communicate regularly with every customer. He actually found that placing a phone call can often improve customer retention even more than giving something for free.  To the degree that it makes sense, customers should be segmented and each segment should get their own drip campaign of emails.  Don’t over communicate!  This can be even more negative than under communicating and can cause churn. Of course if you can offer real value to the customer in greater frequency than do so – for example, customers that sign up to a “daily deal” product probably expect daily emails. There are some email platforms that automatically adjust frequency based on open rates (very low open rates are a good indicator of over communication with that customer).

Retention Offers

Various types of premiums can be used for retention. Much like those used in acquisition there should be careful testing of cost vs expanded LTV. For any offer, tests should be constructed that track how paired groups perform who haven’t received the offer vs those that have.  If the LTV of the group receiving the offer doesn’t exceed the LTV of the paired group by more than the cost of the offer than the offer should not be rolled out. Marc found in the past (in a subscription model) that if an offer is too valuable the company may see a large churn of customers in the month subsequent to the offer being received.

3. Cross Sell/Upsell

There are multiple ways to think about increasing a customer’s LTR:

  1. Keep them as customers longer
  2. Get them to buy more frequently
  3. Get their average invoice value to be higher, i.e. cross sell/upsell

The strategies I spoke about for retention actually focus on the first two of these. The third is an extremely valuable part of a marketing arsenal and I am surprised on how underutilized this tactic is among many companies. To begin, you need to have things in your product set to upsell or cross sell. The items should be relevant to your brand and to your customers. If you are already shipping a box to your customer as their base order, adding another item or shifting to a more expensive version of the base item typically makes the order not only higher in revenue but also can increase the Gross Margin on the order as shipping and fulfillment are unlikely to increase much, if at all (and these days shipping is usually absorbed by the seller). Every company needs to think about brand positive ways to make such offers.

When I was the primary analyst on Dell it was the early days of selling online. Dell quickly created a script that included several upsells like “add another x bytes of storage at 75% of the normal price” (and huge GM to Dell), “financing available for your computer”, etc.  Several phone manufacturers started to offer the ability to insure your screen against breakage (usually from a drop). What is interesting there is insurance sometimes covers things the company would have done anyway but is now being paid extra.

For clothing companies, saying “this blouse would go very well with the skirt you’re buying” or “for the suit you bought which of these three ties would you like to buy”, can substantially increase cart size and increase margin.  One company I’ve dealt with has an increasing discount on the entire order based on the total dollars you spend (net of the discount). Since it sells T-shirts, socks, underwear, etc., it’s easy to add to your order to get to the next discount level and given my personality I always wind up buying enough to qualify for the maximum 20% off.

4. Winning Back Customers

Cancel/Save Tactics

Customer service is usually the first line of defense for preventing customer cancellations. The key to saving a customer is to listen to his or her issue that is causing the cancellation and to be able to adjust your relationship in order to solve that issue. Most companies match each cancellation reason with a particular offer. A simple example is if a customer thinks the product/service is too expensive, a company may offer a discount.

Creating rebuttals and scripts

Your company should create a list of reasons why a customer might cancel. If a new reason why a customer cancels arises, add it to the list. For each reason they might cancel, you must prepare a rebuttal that addresses that issue. If she is receiving too many offers you can agree to cut the frequency to what she prefers, if she is unhappy with something you sent her you can agree to take it back or give a coupon towards the next purchase, etc.  Marc says the key is creating scripts and emails that address every reason for cancellation with a counter that you believe will make the customer happy (without too much cost burden on you). Once you have this in place, anyone who will be dealing with the unhappy customer needs to be trained on how to use the script and what escalation (to a supervisor) procedure should be used.

Winning back Customers

The least expensive customer to acquire is a previous customer. You know quite a bit about them: what they prefer, how profitable they were and more.  Given what you know, churned customers can be segregated into groups as you are probably willing to spend more to win back the high value group than a lower value one. For each group you need to go through the process of original acquisition, but with a lot more specific knowledge. So an offer needs to be determined for each group and creative needs to be created. The methodology should parallel that of customer acquisition with the difference being a defined target.

5. Summary

The steps of the framework have been outlined in detail. But there are a few more points to be made.

  1. SEO should be utilized by all companies as it’s the lowest cost of access to target customers.
  2. Work with a very strong agency partner who understands the fundamentals of marketing.
  3. Have a solid set of vendors for things like email, campaign management, etc.
  4. Data is crucial. Make sure you track as much as you can regarding every potential and actual customer.
  5. If you can’t measure it don’t do it!

SoundBytes

  • There has been much chatter this season about Curry becoming the 8th player with 50/40/90 stats – 50% field goal shooting, 40% 3-point shooting and 90% from the foul line. My partner Paul Ferris noted that if we raise this to 50/45/90 Curry is only the third. And the surprise is that the other two are Steve Nash (not a surprise) and Steve Kerr! Data for this observation was gleaned from BasketballReference.com.

Challenging the Argument for Homogeneous Classrooms

In our November post, Transforming Education”, we discussed several issues associated with the U.S. education system. Two respondents (both former teachers) to the post had some very interesting comments (I’ve included them below followed by my observations). The first respondent, Seth Leslie said:

I’ve always been a proponent of heterogeneous groupings in classrooms, but I’d be the first to admit that pulling it off in a way that benefits all learners is a huge challenge.  It takes a very skilled teacher, excellent curriculum and the right materials to make this work well.  But when it does work well, it’s awesome, and the relational/socio-emotional learning that occurs alongside of the content learning is super important in an increasingly collaborative and interconnected workplace.  It’s just so hard to do this well!

 One other point – no mention of teacher quality in your article.  This is also a factor that contributes significantly to student outcomes – as much or more than class size and family circumstances.

Technology seems to offer some interesting opportunities to schools and learning, but my experience tells me that too much effort goes into selling goods to schools, and not enough effort goes into ensuring that teachers are well trained and well supported in utilizing the technology effectively.  I’d love to tell you about my personal experience with my son Zach, who is in the second year of the 1-to-1 iPad program at his school.  In short, I’m not a fan (and I love technology!)

 Very interesting read, though, and your points make a lot of sense.  It’s frustrating that we as Americans produce so much to be proud of, yet we can’t seem to solve education.”

Although he is a proponent of heterogeneous grouping, he does acknowledge how hard it is to make it work. I, on the other hand, am against it because I believe the obstacles to it working outweigh the small number of cases where a great teacher might be successful in making it work. He also points out that teacher quality can be an issue.  I believe that this stems from not budgeting enough dollars to education, including teacher salaries. Finally, he has had poor experience with the use of technology in the classroom. I agree that this issue has yet to be solved. Simply putting technology into a classroom without integrating it into the learning experience and providing the training necessary for teachers won’t lead to success.

The second teacher that responded, Tatum Omari, is now the lead for Education.com learning products, an Azure portfolio company. She is also a supporter of heterogeneous grouping. Her comments follow.

“Hetero vs. Homogeneous grouping is definitely a complex topic. It can be incredibly hard to do well. Those that are able to pull it off well are usually teachers who have years of experience under their belt. The problem with implementation involves many factors, including the high rate of teacher turnover, and the fact that they don’t quite have time to build the necessary experience to master approaching classroom instruction that facilitates heterogeneous grouping. This requires instruction that utilizes whole group tasks that have low floors and high ceilings. Being able to consistently provide your classroom with tasks that are this rich and promote deep understanding because of their ability to be extended so easily takes quite a bit of skill. That said, to abandon it completely is problematic as there is much research to support that it is not only a worthy endeavor, but one that will be critical to the U.S. elevating our educational system, and our students, back to a place that is competitive with that of the achievements of other countries and our students back to a place that is competitive with that of the achievements of other countries.

The most successful countries, in terms of academic achievement, including Finland, Japan, and Korea, all teach to heterogeneous classrooms and do not practice ability-based grouping. This is because they prize the development of cooperative group achievement over that of the individual. As a result, all of their students experience a far more elevated degree of achievement. There are also some key negative consequences to ability-based grouping which include:

  • Lower expectations from teachers regarding the abilities of students that are placed in groups believed to have lower abilities. Research has shown that randomly distributed students of varying levels scored higher when their teachers believed them to be a group with a higher level of ability. In contrast, another randomized group scored lower when the teacher was led to believe that the students had a lower level of academic ability.
  • Less masterful teaching practices. When teachers are given the ability to use ability-based tracking and teach their students in homogeneous groups, they are less likely to provide all of their students with the type of rich tasks that provide low floors and high ceilings. That means that while the high group may periodically gain access to higher level tasks, the teacher instruction overall is aimed at the middle of the class and there the high students actually miss out on encountering that type of deeper learning throughout the day. In some cases that higher group will only work with the teacher 1-2 times per week which means they are bored a fair bit during the rest of instruction.
  • There can be borderline casualty students, assessed just below the entry requirement for the more advanced groups. This means students who are assessed at one point below what is required to be included in the high group, could be excluded permanently from the opportunity for the rest of their educational career.
  • The development of a fixed mindset by both higher and lower achieving students. Surprisingly the adoption of a fixed mindset can be just as detrimental for a high achiever as that of a low achiever. If the high achiever sees themselves fixed at “smart” they can develop anxiety which leads them to ask fewer questions so as to never appear to not understand or “not smart”. This keeps them from developing a flexible mindset where it is ok to problem-solve out loud and in a group.
  • Missed resources in terms of what students can learn from working and problem-solving together in a group. Often times high achieving students who are offered instruction in mixed ability groups score much higher than those instructed in homogeneous groups because their thinking is stretched when working in groups and looking at problems through different perspectives. The act of observing a fellow students possible wrong assumption, and then helping them to clarify, can help them grasp the concept on a much deeper level, as they are forced to take abstract mathematical concepts, and translate them into oral language which can be very difficult.

While, like Seth, Tatum makes strong arguments (many drawn from the book by Jo Boaler: “What’s Math Got To Do With It?”) that heterogeneous grouping can be beneficial under the right circumstances, I continue to believe that it does not work well in the US for the reasons she points out at the beginning of her comments: inadequate training, teacher turnover, insufficient resources, etc. However, I believe it is worthwhile to provide readers with these alternate points of view (and a reference that expounds on it) from very thoughtful teachers who themselves I’m convinced could make it work to the benefit of students. It seems to me from an aspirational view, heterogeneous grouping is ideal but not from a practical point of view given current U.S. classroom conditions.

Soundbytes:

  • Recently, a number of former players have stated that the lack of adequate defense is the reason behind Curry’s success. Personally, I think defense is actually stronger today than in the past but regardless, the best way of judging any player is by comparing him to his peers. At Curry’s current pace he will score over 50% more 3s in a season than anyone besides him has ever done. The prior record holder before Curry, Ray Allen scored 41.2% of his 3s in his record setting year. Stephen Curry is hitting 46.8% of his 3s this year despite taking more shots per game (which for most would lower their shooting percentage). To put this in perspective, at Allen’s percentage made, he would have scored 34 fewer 3s on the same number of shots Curry has taken this season to date. This equates to 102 less points And Allen was widely considered the best 3 point shooter ever prior to Curry! If we compared Curry to the league average 3-point shooting percentage for the season to date of 35.7%, then the difference becomes about 67 extra 3s made on the 3 point shots he has taken through 56 games played or an extra 201 points vs the league average (which equates to 286 points for the full season). I believe there are few record holders in any era that have such a large discrepancy vs peers (today’s NY times sited Wayne Gretzky and Babe Ruth as similar in producing outsize increases in a major record).