GDP and economic statistics

his morning, the BEA released the preliminary estimates of 3rd quarter Gross Domestic Product. Last month’s advanced estimate was a paltry 1.6%, a number low enough to make many economists worry about a slowdown. But today, we find that the real number is 2.2%. A big difference. The revision was due to fewer imports than expected and a greater accumulation of inventories (neither of which good news in and of themselves but are positive in that they increase the total GDP).
The size of the revision should prompt a moment of reflection about our economic statistics. We often complain that our current statistics don’t give us an accurate picture of the I-Cubed Economy. But even long-accepted statistics are not infallible — as is shown by this revision to a number which we all feel is a pretty good indicator. As we move forward with revamping our economic statistics, let us keep in mind the fallibility of the numbers. As the old saying goes, there are lies, damned lies and statistics.

Thriving by not winning

The mantra of the new economy has been “be first” — first-mover advantages, be first in market share, be first-to-market. But that isn’t how the I-Cubed Economy necessarily works. Servicing customer needs, rather than beating the brains out of the competition, is the real key to success — as James Surowiecki points out in his latest New Yorker column, In Praise of Third Place:

Fifteen years ago, the video-game industry was ruled by one player, Nintendo. The company had machines in a third of American homes, and it was Japan’s most profitable electronics company. The title of a 1993 book summed up the situation: “Game Over: How Nintendo Conquered the World.” Then the Sony PlayStation arrived, and everything changed. Today, Sony is the dominant force, and its chief rival is not Nintendo but Microsoft, which makes the Xbox. Two weeks ago, the début of Sony’s PlayStation 3 was greeted by crowds of hysterical consumers anxious to get their hands on the new console, billed as the most powerful gaming machine ever. When Nintendo’s new console, the oddly named Wii, appeared, a few days later, there were excellent reviews and expectations of good sales, but no more talk about world conquest. If Sony and Microsoft are the major-party nominees, Nintendo is more like a cool third-party candidate.

As Sony and Microsoft battle over who will own the home entertainment market (“control the living room”), Nintendo took a different tack.

Nintendo has dropped out of this race. The Wii has few bells and whistles and much less processing power than its “competitors,” and it features less impressive graphics. It’s really well suited for just one thing: playing games. But this turns out to be an asset. The Wii’s simplicity means that Nintendo can make money selling consoles, while Sony is reportedly losing more than two hundred and forty dollars on each PlayStation 3 it sells—even though they are selling for almost six hundred dollars. Similarly, because Nintendo is not trying to rule the entire industry, it’s been able to focus on its core competence, which is making entertaining, innovative games. For instance, the Wii features a motion sensor that allows you to, say, hit a tennis ball onscreen by swinging the controller like a tennis racquet. Nintendo’s handheld device, the DS, became astoundingly popular because of simple but brilliant games like Nintendogs, in which users raise virtual puppies. And because Nintendo sells many more of its own games than Sony and Microsoft do, its profit margins are higher, too. Arguably, Nintendo has thrived not despite its fall from the top but because of it.

Strategy is all about thinking through what you are doing – not necessarily following the latest management fad. The same is true for national or local economic strategies. I would venture to say that there are a lot of Nintendo’s out there – national and regions how are doing very well by following an older management fad of “sticking to your knitting.” That is not to say that they aren’t innovative. Today’s knitting is nothing like yesterday’s. But building on your strengths and shoring up your weaknesses has always a good strategy. And while others fight over who has a larger market share, making sure that you are providing value to your customer will always be a winning strategy.

Wall Street Journal on patent cases

FYI – this insight from the Wall Street Journal – As Patents Grow More Contentious, Battleground Shifts to High Court:

With the economy increasingly dependent on technological innovation, the Supreme Court is scrutinizing more patent rulings made by a special court that critics say has tilted too far in favor of intellectual-property rights and could be stifling competition.
The high court, which today hears arguments in one of three patent cases on this term’s docket, has ruled in recent cases on the side of more flexibility in enforcing such rights. If that trend continues, it could translate into weaker protections for patent holders and promote greater access to inventions.
The Supreme Court’s newfound assertiveness on core issues of patent law — after hearing only a handful of cases in the field over 20-plus years — comes amid a sharp debate over how to maintain American industry’s competitive edge while upholding the protections that reward the risk-taking behind cutting-edge inventions.
In today’s economy, for instance, many innovations — such as software programs, drugs or advanced electronics — are built on myriad smaller inventions. That has led to disputes between owners of component patents and those who incorporate those pieces into more complex products, leaving federal courts to delineate who owns what.

There are three major patent cases that the Supreme Court will decide before the end of this term in June 2007. These three will go along way to reshaping patent law. But ultimately the Congress needs to step up and pass patent reform legislation. Let us hope the new Congress is up to that task.

Collateralizing intangibles

Ford Motor Company wants to borrow money. Lots of money. $18 billion to be exact.
Normally, that would not be big news. It would be some news for the corporate bond market. But this is generally routine news.
What is newsworthy about this borrowing is how Ford plans to do it. Rather than sell normal corporate bonds (with a rating at junk bond levels), Ford is selling bonds backed by some of their assets. As the Wall Street Journal reported:

In arranging to borrow as much as $18 billion, Ford Motor Co. is making a massive bet that by pledging its assets as collateral, it can take advantage of buoyant debt markets to help pay for a difficult and costly restructuring.

This is not completely unusual. As the Journal goes on to say:

Ford isn’t alone in being forced to back its borrowing with hard assets. Earlier this month, General Motors Corp. pledged some equipment assets as collateral for a $1.5 billion loan and arranged earlier in the year for a $4.6 billion secured credit line, which, like a credit card, can be tapped when needed.

What is noteworthy is the mix of assets Ford is using. Its not just hard assets. According to the Washington Post:

Among the other assets Ford was using as collateral are its intellectual property, such as patents or significant trademarks; real estate; and its automotive financing unit, Ford Motor Credit.

It also apparently includes the Volvo brand, which Ford owns.
A few years ago, bankers would not touch intangibles as collateral. Now I hear from financial advisors and valuation specialist that they are getting more calls about using intangibles as part of a larger loan package (as Ford is doing). I suspect we will see more of the deals in the future. And as the market becomes more familiar and comfortable using intangibles as part of a package, we are likely to see stand-alone type of deals – where the intangible assets are the only collateral used. This is already happening in the securitization arena. Look for this type of financing to spread.


From Forbes and the Reputation Institute comes a listing of one of the most intangible of intangibles:The World’s Most Respected Companies.

“Reputation” has become a watchword in the corporate world, and safeguarding a company’s image is now a top priority for many CEOs. That’s one reason why the Reputation Institute, a New York consulting firm, decided to rate the reputations of the biggest companies in the world. The results may surprise you; only one American company, for example, made it into the top ten worldwide.

The only US company in the top worldwide 10 was Kraft. Other top US companies include Johnson & Johnson, Pepsi, Disney, Home Depot, 3M, Kroger, Target, P&G and Deere.

Proliferating VIOP patents

Patents, patents and even more patents. I came across the following in Business Week a couple of weeks ago – VoIP Patents: Innovation—and Lawsuits:

The Patent & Trademark Office is approving patents aplenty for Internet-based calling. On Nov. 14 alone, it handed out a patent on what IBM calls a “conversations computing system,” and granted chipmaker Intel a patent for a computer-based phone “eliminating the need for a telephone set.”
Those were among dozens of patents granted on two separate days in November to companies including Texas Instruments, Motorola, and Nokia. In October, the PTO gave an additional 76 patents to the likes of Qualcomm, Nortel, Broadcom, Time Warner’s AOL, and NTT DoCoMo of Japan.
In all, the U.S. has to date issued 2,049 patents related to Voice over Internet Protocol (VoIP), a technology that enables low-cost or free calling using the same method that zips e-mail around the Internet.

I think this illustrates the problems of patent thickets, especially in IT: over 2000 VoIP patents and counting. As the article goes on to say:

Chances are, many patent battles will be fought outside the courtroom. Patent holders are likely to use their intellectual property portfolio to extract concessions on cross-licensing deals, where one company may share its VoIP expertise in exchange for use of another company’s patented technology, says VoIP expert Jeff Pulver. “It’s certainly going to be something somebody could use against somebody.”

This also illustrates the differences in technologies. A new drug has a patent (or a few patents) on the chemical composition and on the process. IT has literally thousands of patents on one technology. How to deal with that difference is the major stumbling point for patent reform.
It is also the reason why we need patent reform. Does anyone really think that everyone in the VoIP business (equipment supplier to service supplier) has carefully researched all 2049 patents to make sure they aren’t infringing? And that there aren’t a bunch more patents out there that may not be called VoIP related, but really are?
It’s the Wild West out there — it really is folks. Time for the Congress to finally step up and deal with the problem.

More on financial competitiveness

The man whom some on Wall Street blame for their competitiveness woes is speaking out on financial regulation and competitiveness – Spitzer slams threat to corporate reforms:

In an interview with the Financial Times, the outgoing state attorney-general, who won fame for tackling corruption in the financial services industry, said diluting such reforms would be “counterproductive” and would fail to tackle the reasons US businesses are falling behind.
“The argument that we are failing in competitiveness because of regulations is incomplete,” Mr. Spitzer said. “We’re failing in competitiveness because of failed business models and the lack of smart investment in technology. General Motors is not failing because of regulations but because it hasn’t produced good products.
. . .
Mr. Spitzer said critics who warned that aggressive enforcement hurts competitiveness were ignoring recent history. “The sectors that bore the brunt of my cases are performing extremely well,” he said. “They are more competitive because they understand the importance of ethics.”
Many of the top investment banks and the insurance companies that settled with Mr. Spitzer over allegations of biased stock research, accounting fraud and bid-rigging are having extremely profitable years.

Spitzer’s remarks in the Financial Times come on the heels of Secretary Paulson’s remarks (see earlier posting) and a special report (and cover story) in the Economist. That report, America’s capital markets: Down on the street, gives a précis of the “roll-it-back reformers” objections:

The advocates of reform see plenty of scope for improvement. The problem is not only Sarbanes-Oxley, they argue. Aggressive investigations by Eliot Spitzer forced the financial industry into settlements that curbed innovation as well as sharp practice. Federal regulators, desperate to keep up with the New York attorney-general (and now governor-elect), ran amok. Class-action lawyers have been allowed to wield too much power, and shareholders too little. on

From the tone of the article (and the accompanying opinion piece What’s wrong with Wall Street), the Economist isn’t buying this as the sole problem:

The bad news for America is in part the result of good news elsewhere. Thanks to financial liberalisation (which America encouraged), New York faces a lot more competition than it used to. Developing countries are getting richer, and their companies and financial markets better governed. Firms that might once have rushed to American exchanges to privatise themselves are instead doing so at home, or at least nearby. London is seen as a natural home for companies from Russia. Chinese firms are turning more to Hong Kong, which is gaining a reputation for capital-raising as well as trading: witness the gargantuan offering by ICBC, a bank, last month. As Asian markets mature, more of the capital there will surely never leave the region: there is little point in Asian companies going to New York to raise cash from Asian savers. Other markets are growing up, making Wall Street less exceptional.

This echoes their earlier comments on how London became a financial center (the subject of an earlier posting). A large part of the story is flow of funds and financial innovation.
Yet, almost everyone (including Governor-elect Spitzer) that some regulatory overhaul is needed. Steps are already being taken to fine-tune Sarbanes-Oxley. As the Economist says:

With regulators soon expected to announce rule changes that will lighten the burden, the battle against Sarbanes-Oxley’s excesses looks well on the way to being won. This should mean efforts can be directed elsewhere.

They suggest two areas of reform. The first is shareholder rights:

On the one hand, they have too few rights in their dealings with company boards; they have less power than their British equivalents when it comes to electing directors, for instance. On the other, American shareholders (or rather the lawyers who purport to represent them) wield too much power in securities litigation. Lawsuits brought because of falling share prices make a mockery of both the principle of caveat emptor and the honourable New York tradition of never giving a sucker an even break.

The second is the regulatory structure:

Regulators could also do with an overhaul. Here there are two problems, both serious. First, the Securities and Exchange Commission (SEC) is good at the tough stuff, bringing plenty of “enforcement actions”. But in its zeal to keep pace with crusading state attorneys, who exploit high-profile campaigns to win votes, it has lost sight of its other supposed goal—ensuring that markets run smoothly and efficiently. One way to address this imbalance would be to replace some of the SEC’s vast army of lawyers with economists. That would also lead to better cost-benefit analysis of new regulations—an area where the SEC trails behind Britain’s Financial Services Authority.
Second, the regulatory structure is too atomised. Too many agencies monitor the markets. There are four separate banking regulators. State and federal regulators tread on each other’s toes. The SEC’s duties overlap with those of the Federal Reserve, the Commodity Futures Trading Commission (CFTC) and others. Since it no longer makes sense for the increasingly entwined cash and derivatives markets to be policed by separate regulators, a sensible first step towards streamlining would be to merge the CFTC and the SEC.

These sound to me to be good starting points. As Mayor Bloomberg and Senator Schumer have said, To Save New York, Learn From London.
Let’s see if the financial community can rally behind these lessons from London. It will be a good test of their newly merged lobbying association – Securities Industry and Financial Markets Association.