Business

Costco’s Underinvestment in Technology Leaves it Vulnerable to Disruption

Introduction

The conventional wisdom with respect to Costco is that its business model forms a “defensive moat” against the conquering retail army of “House Bezos”. Costco offers its loyal shoppers a reason to visit its warehouses replete with low cost bulk items, pharmacies and food courts. This sentiment has held, but nothing drains a moat faster than when Amazon expands its physical retail presence into your market with a splashy $13.7 billion acquisition (see Whole Foods). We don’t quite know what Amazon is up to in the grocery sector (and meal kit delivery space), but given its track record of disruption, Costco better start taking up a stronger defensive position to enable long term success. At a minimum, we can expect Whole Foods to adopt best practices and leverage world-class data mining capabilities from the Amazonian fiefdom. The prevailing thought is that Amazon will revolutionize how groceries are purchased.

Unfortunately, Costco is a laggard in the technology investment arms race as compared to B2C heavyweights Amazon and Walmart; even as e-commerce has captured a larger share of sales industry wide. Costco’s main competitors are devoted to having formidable omni-channel presences which will drive future revenues. In the second quarter of 2017, Walmart’s e-commerce revenue grew 63%; even Target saw a 22% increase as compared to Costco’s 11% [1].

Amazingly, Costco consciously chooses to underinvest in its e-commerce capabilities, which I believe is a disservice to an otherwise strong business model (and the continuing availability of $4.99 rotisserie chickens). In an industry where market share is being gobbled up by a noted technology disruptor, it’s as if Costco has subscribed to the “IT Doesn’t Matter” philosophy. Costco is not only on the defensive technology wise, it’s in catch-up mode. 

On June 15th, 2017 the day before Amazon’s Whole Foods acquisition was announced, Costco stock opened at $180.39. One day later the stock dropped 8.5% to close at $165. As of August 4th, 2017 the stock trades at $156.44 representing a 13.2% drop from June 15th. A more competitive grocery sector combined with Costco’s underwhelming investments in e-commerce technology have not inspired investors as of late.

In this post I’ll touch upon Costco’s advantages with respect to its competitors in the consumer staples and grocery sector, as well as offer some recommendations for its burgeoning digital strategy.

What Costco Does Well (Its Defensive Moat Against Competitors):

The “Treasure Hunt”

Let me be clear, Costco is not going anywhere in the medium run. Its revenues in 2016 totaled $119 billion as compared to $136 billion by Amazon. Costco’s value proposition relies upon attracting customers to its bricks and mortar warehouses, which are infused with “treasure hunt” and impulse purchase appeal. Shoppers explore the vast warehouses and stumble upon unexpected items, bargains and free samples that they didn’t know they wanted in the first place. The company believes that in-store customers will purchase many more items than they would otherwise purchase via an online channel.

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“We still are a bricks-and-mortar entity and we want to get you into the store because you’re going to buy more in the warehouse. You’re going to buy more when that happens, and we’ve got a lot of reasons for you to do that. We also recognize we don’t want to lose the sale to somebody else because they only buy online.” [2] – Costco CFO Richard Galanti

Because Costco sells many items in bulk, it is rightfully apprehensive of the freight costs associated with e-commerce. However, it needs to make progress in shoring up delivery capabilities if it wants to keep pace with Amazon and Walmart; potentially through investments in additional fulfillment centers. Walmart offers many bulk items online through Samsclub.com. Walmart is even experimenting with online order pickup at Sam’s Club locations.

“About a year ago, Costco CFO Richard Galanti said the only thing keeping him up at night is ‘everybody in the world never wanting to leave their house and only typing stuff to order and get it at the front door.’” [3]

Low Prices

In-store customers load up their baskets with groceries and other items in bulk with minimal price markups. Low prices are a strong competitive differentiator for Costco in that it has some of the lowest gross margins in its industry.

“Wal-Mart and Whole-Foods price their goods up higher. Wal-Mart posted 25.65% gross and 2.81% net margins in 2016. Whole Foods, known for its pricey merchandise, had 34.41% gross and 3.22% net.” [4]

Consider that Costco’s numbers are razor thin gross margins of 13.32% and net margins of 1.98%. The bottom line is that Costco shoppers obtain industry leading pricing from the company’s warehouses. Costco appeals to a wide variety of shoppers and it even attracts business customers looking to buy in bulk. In contrast, Whole Foods (derisively known as Whole Paycheck) appeals to a higher income demographic in search of artisanal offerings; thus there is minimal overlap with Costco’s broader range of shoppers. However, Amazon Prime members and Costco members overlap as both customer bases are in search of low prices.

Further enabling Costco’s low price scheme is its strategic use of vertical integration for enhancing product quality and increasing profitability. “Such integration includes Costco working with farmers to help them buy land and equipment to grow organics, building its own poultry farm, owning and operating its own beef plant and hot dog factory, and having its own optical grinding factory.” [5]

Memberships

Costco makes most of its money from selling memberships. The company is able to offer such low pricing and still make a profit because of its successful membership model. Costco charges $60 for its standard memberships and $120 for its executive memberships which pay-out a 2% redeemable award on pre-tax purchase amounts.

“Our membership format is an integral part of our business model and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase penetration of our Executive members, and sustain high renewal rates, materially influences our profitability.” [6] – Costco 2016 10K Filing

In other words, it’s easy to match or beat competitor pricing when your business model is buoyed by piles of membership cash. Costco’s 88 million memberships worldwide represent a healthy revenue stream for the company, accounting for an astounding 72% of pretax profits [7]. Furthermore, Costco shoppers renew their memberships at a high rate (roughly 91% in the U.S. and Canada and 88% on a worldwide basis). However, Costco would be wise to note that its “membership revenue growth has decelerated to around 5.5% from around 7%” [8].

Kirkland Signature: The Private Label Brand Everyone Loves

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Whether you are a Costco member or not, you are most likely familiar with its “Kirkland Signature” in-house brand which was started in 1992. The successful brand sells everything from dress shirts to luggage to vodka (i.e. the consultant staples). Costco has done a first-rate job of making Kirkland Signature a strong value play alternative to national brands.

“‘Costco’s Kirkland Signature is the best store brand there ever was,’ said one writer at foodie bible Bon Appetit in August, the same month Wal-Mart paid $3.3 billion for Jet. ‘You wouldn’t expect a brand that makes cashmere sweaters, batteries, and 900-count packs of baby wipes to also produce some top-notch food products’” [8]

Sales of individual Kirkland items have been reported to exceed $1 billion and the brand itself constitutes roughly 25% of Costco’s revenue. Although Amazon’s Whole Foods carries a “365” private label brand and Walmart carries “Sam’s Choice” and “Member’s Mark” (amongst others), both competitors offer Costco’s Kirkland Signature brand through their e-commerce properties.

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According to research from 1010data Market Insights, 69.5% of Kirkland online spend [9] is generated on Amazon! This unofficial cross-platform selling indicates a mashup between strong brand preference and the number one retail e-commerce portal. Since the current selection of Kirkland Signature branded products available on Amazon is offered by third parties, there is an opportunity to capture a portion of that online demand through the official Costo.com channel. Jet.com (recently purchased by Walmart for $3.3 billion) has indicated a phase out of Costco products in order to boost the popularity of the Sam’s Club “Member’s Mark” private label.

Recommendations for Costco:

I’ll open this section with Costco’s own words from its 2016 Annual Statement:

“If we do not successfully develop and maintain a relevant multichannel experience for our members, our results of operations could be adversely impacted. Multichannel retailing is rapidly evolving and we must keep pace with changing member expectations and new developments by our competitors.” [6]

Costco’s relative lack of ambition in e-commerce capabilities leaves the company vulnerable to disruption. Its online sales are currently $4 billion or barely 3% of sales; this figure is far less than smaller revenue retail players like Best Buy and Macy’s [10]. Walmart has poured billions of dollars into its digital and e-commerce capabilities in order to keep pace with Amazon. Costco would do well to leverage some items from the Walmart playbook.

    • Invest in an e-commerce research division to help bolster the organization’s base expertise in this space. Acquire the necessary pool of data scientists, software engineers and PhDs to inject new life into a digital and technology focused strategy. 
      • This approach will allow the company to increase its capabilities in e-commerce basics such as search functionality, order tracking and predictive analytics. Costco is already located in the technology rich talent pool known as greater Seattle.
    • Offer more items online at Costco.com. Focus on re-capturing some of the demand for Kirkland branded Costco products from Amazon. It bears repeating that 69.5% of Kirkland online spend is generated on Amazon!
    • Acquire startups to gain access to digitally focused management teams and their respective technology and insights (a la Walmart’s purchase of Jet.com and Marc Lore). Internal disruptors help cross-pollinate successful ideas that are not considered by the core legacy business.
      • In this sense Costco should acquire Chieh Huang’s e-commerce warehouse startup “Boxed”. Boxed was started in 2013 out of the founder’s garage and is currently known as the “warehouse in your pocket” by millennials. Boxed enables bulk goods to be ordered directly from a mobile app without the need for membership fees.
      • Currently Boxed offers free deliveries on orders of $49 or more. Although Boxed delivers non food items in bulk, it currently purchases its food items from Costco and marks up the price for delivery! [11] Costco has an opportunity to acquire a startup rival in order to gain access to its e-commerce talent.
    • Install drive through stations where customers can pick up online orders at either Costco warehouses or dedicated “click and collect” facilities. Walmart’s Sam’s Club currently offers this service at about 65 of its 660 US stores [12]. The company should be aware that members will not want to pay the markup associated with delivery specialists Instacart and Google Express; especially Costco members who have shelled out for a yearly membership.
    • Increase investments in fulfillment centers that will help temper the expenses associated with shipping bulk products ordered online.
    • Get better at the basics with respect to information technology infrastructure. Granted, core IT infrastructure is not necessarily a strategic resource but it is the cost of doing business. Consider this quote from Costco CEO Richard Galanti:
      • “You know, about three-and-a-half years ago, when we embarked on this dark journey, [we recognised that] we probably had the lowest-cost IT out there. I always joke we were in the greatest MASH unit. It was always up and running, but band-aided to death.” [2]

Costco needs to realize that its “treasure hunt” appeal to customers needs to be paired with a more robust omni-channel approach. This means Costco must ramp up its capital expenditures in e-commerce and mobile just to keep from losing pace with industry competitors who have a substantial head start. Costco will be fine in the medium run for all the reasons I’ve highlighted earlier. But how long until continued e-commerce disruption crosses the organization’s defensive moat and treats Costco like one of its mouthwatering rotisserie chickens?

For more retail related technology coverage check out:

 

References:

[1] Sozzi, B. Jul 19, 2017. Here Is What Costco Should Do to Keep Amazon From Being the Largest Company on Earth. https://www.thestreet.com/story/14233036/1/here-are-the-big-things-costco-could-do-to-keep-amazon-from-being-the-largest-company-on-earth.html

[2] Lauchlan, S. March 8 2017. Costco – an e-commerce tortoise takes on the omni-channel hares. http://diginomica.com/2017/03/08/costco-e-commerce-tortoise-takes-omni-channel-hares/

[3] Levy, A. March 12, 2017. Not Even Costco Is Safe From Amazon. https://www.fool.com/investing/2017/03/12/not-even-costco-is-safe-from-amazon.aspx

[4] GuruFocus. June 22, 2017. After Amazon’s Whole Foods Acquisition, Investors Are Looking At Costco. https://www.forbes.com/sites/gurufocus/2017/06/22/after-amazons-whole-foods-acquisition-investors-are-looking-at-costco/#18b01a50271d

[5] Tu, J. June 19, 2017. Amazon’s move into groceries could squeeze Costco. http://www.seattletimes.com/business/retail/amazons-move-into-groceries-could-squeeze-costco/

[6] Costco Wholesale Corp. 10K/A Annual Report for the Fiscal Year Ending Sunday August 28, 2016. https://www.last10k.com/sec-filings/cost/0000909832-16-000034.htm#

[7] Fonda, D. July 2017. Costco Is Surviving in the Age of Amazon. Warehouse giant Costco continues to prosper despite the growth of internet retailing. http://www.kiplinger.com/article/investing/T052-C008-S002-costco-is-surviving-in-the-age-of-amazon.html

[8] Boyle, M. June 12, 2017. Jet.com Will Phase Out Costco Products After Wal-Mart Acquisition. https://www.bloomberg.com/news/articles/2017-06-12/wal-mart-s-jet-com-carries-costco-products-but-not-for-long

[9] Wilson, T. September 13, 2016. Kirkland’s Online Enterprise. https://1010data.com/company/blog/kirkland-s-online-enterprise/

[10] Wahba, P. December 8,2016. Costco’s Battle Plan for the E-Commerce Wars. http://fortune.com/2016/12/08/costco-ecommerce/

[11] Fickenscher, L. August 4, 2017. Boxed buys from rival Costco before hiking prices for delivery. http://nypost.com/2017/08/04/boxed-buys-from-rival-costco-before-hiking-prices-for-delivery/

[12] Young, J. April 5, 2017. Why Costco Loves Store Sales: You Try Shipping a Tub of Mayo http://www.foxbusiness.com/features/2017/04/05/why-costco-loves-store-sales-try-shipping-tub-mayo.html

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The Definitive Walmart E-Commerce and Digital Strategy Post

Introduction:

Walmart has long been a dominant player in the traditional “bricks & mortar” retail space. The retailing giant has about 4,600 stores in the United States and about 6,000 stores worldwide that helped it generate fiscal year 2017 revenues of $485.9 billion. However, this retailing “Death Star” has a weakness as technological changes and innovations in its industry represent both an opportunity and a threat. The biggest threat to Walmart is the consumer preference shift from traditional in-store purchases to on-line digital channels. E-commerce is a small piece of the retail pie currently (roughly 10.4% of all retail sales in 2015), but it is growing at a pace that is much faster than growth at bricks and mortar locations. If Walmart does not evolve to defend its dominant market position, the company will erode (see Montgomery Ward, Woolworths, K-Mart, Sears) allowing other industry competitors to capitalize.

Previous disruptions in the retail space have not been kind to dominant players. Sears was able to overtake dominant retailing incumbent Montgomery Ward in the 1950’s by aggressively investing into suburbs (which was a new phenomenon for the time), while Montgomery Ward skittishly hoarded cash in anticipation of another great depression [1].

Walmart is not willing to be a Montgomery Ward in this scenario as the company became aware of the risks of e-commerce underinvestment and complacency. However, e-commerce giant Amazon is more than willing to be Sears in this example by over-investing in the more recent retail business model (e-commerce). Furthermore, Amazon recently encroached into Walmart’s home turf (i.e. physical locations) by purchasing Whole Foods for $13.7 billion. This high profile acquisition signaled to Walmart and the rest of the retail industry that Amazon is willing to take unanticipated bets to develop a competitive advantage across multiple channels.

Walmart certainly has a challenging road ahead if it wishes to catch Amazon in overall e-commerce sales but it is finally competing effectively. Although the company does not break out specific e-commerce dollars, it stated that its e-commerce sales had increased 64% domestically in the first quarter of 2017. Consider that Amazon generated $136 billion in annual sales during 2016, which accounted for half of all online shopping in the United States [2].

“With approximately 160 million items for sale, Amazon has become the go-to outlet for anything. In comparison, Walmart.com sells “only” 15 million items — and just 2 million of them are available for the free two-day shipping. It’s no wonder 52% of online shoppers start their search on Amazon, according IHL Group.” [3]

Walmart will not be able to overtake Amazon’s position as the dominant e-commerce player in the near future, but the company is positioning itself to remain competitive.

Walmart’s Main Strategic Risks in E-Commerce

Walmart’s annual 2017 10-K filing (a comprehensive summary of financial performance) details the strategic risks that the company faces. As mentioned previously, Walmart is aware of the risks of e-commerce underinvestment and complacency. Consumer preferences are shifting to shopping online and mobile platforms.

Failure to grow our e-commerce business through the integration of physical and digital retail or otherwise, and the cost of our increasing e-commerce investments, may materially adversely affect our market position, net sales and financial performance [4].

Many companies fail to adequately capitalize on the shift in consumer preferences (e.g. Smith Corona, Blockbuster, Kodak), while other firms are able to successfully capitalize (e.g. Intel, Apple). Unsuccessful companies either refuse to risk capital, lack the vision, or lack the execution competency to produce the new products and/or technologies necessary to maintain success. With that being said, Walmart plans to increase its investments in e-commerce and technology, while moderating the number of new store openings.

Screen Shot 2017-06-11 at 5.52.14 PM.pngFigure 1. [4]

Walmart’s capital expenditures back up its strategy. Observe that a $1.023 billion reduction in new stores and clubs dove-tails with a $199 million dollar increase in already impressive expenditures related to information systems, distribution and digital retail ($4.162 billion line item).

Walmart recently divested itself of its Walmart Express brand which contributed to the reduction in new store capital expenditures. These convenience store sized locations were originally conceived in 2011 to compete in the price conscious dollar store segment. Dollar General (a digitally un-savvy competitor) purchased 41 Walmart Express stores and plans to rebrand them under the Dollar General moniker. In an age of stalled wage growth, Walmart is experiencing pricing pressure from both Dollar General and Family Dollar for the most price conscious consumers.

The bottom line is that Walmart has to walk a fine line in the implementation of its e-commerce strategy. On the one-hand, the company may not be successful in implementing and integrating its physical and digital retail channels. As of late the company has been criticized for “overpaying” for growth in regards to its acquisitions. If its e-commerce acquisitions underperform or sustain large losses, this can harm Walmart’s market position and financial performance.

On the other hand, if the company is “too successful” with their e-commerce strategy, the company runs the risk of lowering physical store traffic which could also adversely impact in-store economics. The company seems to be facing a “dammed if you don’t, damned if you do” conundrum.

“The challenge for Walmart, and for all other retailers in the e-commerce era, is to protect both sales and profits. But these goals nay be mutually exclusive. Retailers face pressure to offer both free shipping and competitive prices, which generally makes selling a product online less profitable than doing so in existing stores. To expand sales online, retailers must spend on technology, which squeezes margins further. Making matters even worse, retailers are often not gaining new customers but simply selling the same item to the same person online for less profit. ‘You pour from one bucket into a less profitable bucket,’ explains Simeon Gutman of Morgan Stanley.” [5]

Backend E-Commerce Acquisitions

Walmart’s initial e-commerce forays focused on acquiring companies that helped bolster its prowess in backend technologies. This approach was a departure from the company’s traditional “build rather than buy” philosophy which helped it obtain and retain technological competitive advantages in its supply chain processes. Its research division @WalmartLabs, augmented its e-commerce war chest by making multiple purchases in the first half of the decade. “Between 2011 and 2014, Walmart acquired 15 small companies tied in some way to e-commerce. The other thing most of them had in common was that they were selling for a bargain after failing to attract a new round of venture funding.” [6]

For example, in 2013 @WalmartLabs purchased a company named Inkiru for its predictive analytics technology to target customers in marketing campaigns. The company purchased Kosmix in 2011 to revamp its Walmart.com search capabilities; a project known as Polaris. Site optimization start-up Torbit was purchased in 2013 to optimize page loading of its e-commerce sites. The acquired technology compresses files to an optimum size based upon display by phones, tablets or desktops. The company also purchased Adchemy for its strong pool of data scientists and PhDs who have specialized knowledge in the areas of ad technology and search engine optimization (SEO).

As an aside, “CEO Murthy Nukala and four top executives all got payouts of between $1.5 million and $2 million in the deal” while employees who held common stock saw their holdings become worthless [7]. 

The point of these acquisitions along with others of similar characteristics, was an attempt to grow e-commerce sales organically.

The Acquisition of Marc Lore and Jet.com

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Walmart learned that it is both difficult and time consuming for a firm to obtain organic growth intrinsically. When asked of his biggest regret at the helm of the company, former CEO Mike Duke who held the position from 2009 to 2013 said that the company should have moved faster to expand in e-commerce. One could draw the conclusion that Walmart either believed that growth in e-commerce would shift too much volume from bread and butter physical stores or that Amazon’s rise to e-tail prominence was not a significant threat to its dominant market position.

“When I look back, I wish we had moved faster. We’ve proven ourselves to be successful in many areas, and I simply wonder why we didn’t move more quickly. This is especially true for e-commerce. Right now we’re making tremendous progress, and the business is moving, but we should have moved faster to expand this area.” – Former Walmart CEO Mike Duke [8]

As Walmart’s sales growth continued its trend downward, new CEO Doug McMillon was tapped in 2014 to implement a new e-commerce, digital and technology focused strategy. In fact, for the first time since Walmart became a publicly traded company in 1970, annual sales shrank for the first time in 2015. McMillon was asked why did it take so long for Walmart to get into e-commerce and if the profitability of their original model affected its urgency to change. McMillon responded.

“We wish we had been more aggressive early on, no doubt. In some ways we experienced what Clay Christensen calls the ‘innovator’s dilemma.’ We hired talent, invested, and just kind of meandered along rather than hammering down, being aggressive, and making it a must-win aspect of our business. That’s partly because we had a bird in hand. We knew that if we continued to open Walmart Supercenters, they would do well.” – Walmart CEO Doug McMillon [9]

McMillion, true to his mandate, made a splash by acquiring online retailer Jet.com for 3.3 billion in cash and stock. The deal is reported to be the largest ever purchase of a U.S. e-commerce startup [10]. There were multiple reasons stated by the company for making a splashy purchase of this nature. However, the crown jewel of the acquisition was the procurement of e-commerce wunderkind Marc Lore who was immediately tapped to head both Jet.com and Walmart.com.

Marc Lore established his digital retailing bona fides by founding Quidisi. The start up was known for its diapers.com and soap.com sites amongst others. Quidisi was sold to Amazon in 2010 for $550 million. The purchase of Quidisi at the time was an attempt by Amazon to stifle competition.

“Amazon was slashing the price on diapers on its own site, putting pressure on Quidsi’s margins and making outside investors hesitant to put in more money. Furthermore, Amazon promised to keep dropping prices if Quidsi sold to Wal-Mart.” [15]

Lore stayed at Amazon for two years and then left to ponder his next move. Subsequently, in 2014 Lore founded Jet.com based upon the premise of charging members a yearly fee, encouraging consumers to buy in bulk and incentivizing consumers to purchase items from the same distribution center to lower product prices. On the strength of his name and new business model, Lore was able to raise $500 million in investment capital on this venture. Lore earned $243.9 million in 2016 making him the highest compensated CEO in the United States after the sale. Expect Lore to be at Walmart for at least five years, as he will lose substantial compensation if he exits beforehand.

Walmart previously missed out on buying Quidisi in 2010 as both Walgreens and Amazon were in a bidding war for Lore’s e-commerce property. Walmart decided with the Jet.com acquisition that they were not going to lose an opportunity to buy Marc Lore’s services again.

How Will Walmart Benefit from Jet.com?

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In just one year of operation, Jet.com scaled up to 12 million different products and reached a run-rate of $1 billion in gross merchandise value [11]. With this acquisition, Walmart is buying additional diversity of online product offerings. The brands that Jet.com offers are those that appeal to consumers that reside outside of Walmart’s more suburban, rural, older cost conscious demographic. Jet.com’s brand positioning is targeted to younger, “urban”, millennials who constitute a faster growing demographic than the demographic that Walmart has traditionally attracted. Walmart plans to keep the Jet.com brand identity separate from Walmart.com. Jet.com has relationships with more upscale brands that may not want to sell their products on Walmart.com. Additionally, this brand separation helps maintain Jet’s appeal to higher income consumers.

According to CNBC, Jet.com shoppers are more likely to have $150,000 and up incomes. Additionally, only 20% of Jet.com buyers also purchased from Walmart.com in the past six months (as of August 8th, 2016) [12]. There was little overlap between the customer bases of both companies making the acquisition by Walmart highly attractive. Furthermore Jet.com’s innovative supply chain business model and focus on low prices dovetailed with Walmart’s penchant for supply chain innovation and focus on low prices. Here is how Marc Lore described the company’s novel “smart cart” business process:

“Here’s how it works: If you have two items in your cart which are both located in the same distribution center and can both fit into a single box, then you will pay one low price. If you add a third item that is located at a different distribution center and cannot be shipped in a single shot with the other two items, you will pay more. As you shop on the site, additional items that can be bundled most efficiently with your existing order are flagged as ‘smart items’ and an icon shows how much more you’ll save on your total order by buying them.”

It should be noted that Jet was experiencing a high cash burn rate prior to being acquired by Walmart. Jet.com dropped its annual $50 membership fee which caused it to lose money on every shipment. The advantage of Jet.com being acquired by a deep pocketed industry player like Walmart was to help alleviate the stress of private fund-raising for an unprofitable company [13].

Walmart has to allow Jet.com to maintain its startup, entrepreneurial culture or risk losing talent. For instance, Walmart’s conservative, southern influenced culture clashed with the office drinking, happy hour culture of Hoboken New Jersey based Jet.com. Walmart eventually reversed course and did not impose this “in-office prohibition” rule on subsequent startup acquisitions. However, the more conservative Walmart did ask Jet employees to be mindful of swearing in the office [14].

Jet.com has the potential to infuse Walmart with much needed digital innovation. This fresh perspective has the potential to add tremendous value to the organization as a whole. The “old guard” rooted in Walmart’s core business model needs to allow acquisitions to thrive instead of imposing the more conservative legacy culture. According to CEO McMillon, the core business itself must learn to become more digital.

“The people who run the older parts of our business must also become digital. We can’t have some people live in yesterday while others live in tomorrow. And given the effects of inertia, we need people to lean into the future even more than other companies might. We’re trying to move large numbers of people to change their established habits.” [9]

E-Commerce Executive Shakeup

There was an immediate shakeup in the executive ranks once the Jet.com acquisition materialized. Neil Ashe, Walmart’s global e-commerce head previously ran CBS Interactive and had been named head of technology shortly before the acquisition, was transitioned out to make room for Marc Lore. Lore will assume the title of president and CEO of e-commerce at Walmart. Lore will head not only Jet.com but also all of Walmart’s e-commerce functions. Also leaving is Michael Bender, Walmart’s global e-commerce COO.

Fernando Madiera who previously headed Walmart.com and was previously CEO of Walmart’s Latin American e-commerce business was transitioned. Mr. Madiera had just taken the Walmart.com post in 2014. Other high level executives that transitioned were Dianne Mills, senior vice president of global e-commerce human resources; and Brent Beabout, senior vice president of e-commerce supply chain. Not even Wal-Mart’s chief information officer Karenann Terrell was spared, as she left the company late February of 2017.

Key executives from Jet.com that will join Marc Lore’s new team include Scott Hilton who was previously chief revenue officer at Jet.com. Jet.com co-founder Nate Faust will become the senior vice president for U.S. eCommerce and supply chain for Walmart’s domestic operations.

The point of this game of executive musical chairs is to provide Marc Lore with the executive team he deems necessary to launch an effective attack on Amazon’s e-commerce dominance. Walmart has 3.3 billion reasons to make sure Lore feels he has the necessary team in place to win.

Walmart & Jet.com E-Commerce Timeline

  • February 2016: Jet.com purchases online furniture retailer Hayneedle.com for $90 million. The move is seen as way for Jet.com to acquire revenue growth. Of note, the Hayneedle CEO (John Barker) received a parachute package worth $3.4 million while other employees saw their investment stakes effectively wiped out.
  • August 2016: Walmart purchases Jet.com for $3.3 billion. The deal is reported to be the largest ever purchase of a U.S. e-commerce startup.
  • January 2017: Jet.com purchases Boston based ShoeBuy for $70 million. The purchase increases Jet’s online catalogue of items substantially and will allow the same items to be sold across Walmart.com, Jet.com and Shoes.com.
  • February 2017: Walmart purchases hip Michigan based outdoor retailer Moosejaw for $51 million. Moosejaw sells brands like Patagonia and North Face online and in its 10 brick and mortar stores. Moosejaw has expertise in online sales and social marketing that Walmart wishes to tap. Moosejaw and Its 350 employees will continue to exist as a standalone subsidiary.
  • March 2017: Jet.com purchases women’s online clothing retailer Modcloth for $75 million. The site caters to size diversity and body positivity. The acquisition represents an attempt to appeal to a younger, hipper demographic than Walmart currently courts.
  • March 2017: Walmart launches a Silicon Valley based tech incubator called Store No. 8. The initiative is named after a store where Sam Walton was known to experiment. Walmart plans to invest in businesses like a venture capitalist firm would and then grow this group of startups as a portfolio. “The incubator will partner with startups, venture capitalists and academics to promote innovation in robotics, virtual and augmented reality, machine learning and artificial intelligence, according to Wal-Mart. The goal is to have a fast-moving, separate entity to identify emerging technologies that can be developed and used across Wal-Mart.” [18]
  • June 2017: Walmart purchases NYC based men’s clothing retailer Bonobos for $310 million. The brand started modestly by selling chino pants and expanded its line of offerings for sale in its own stores and in Nordstroms. “Its co-founder and chief executive, Andy Dunn, will oversee Walmart’s digital brands, which also include the independent women’s brand ModCloth.” [16] Passionate Bonobos fans have mocked the acquisition on social media snarkily asking if the popular chinos will be refitted for the average Walmart customer.  Bonobos has a vertically integrated supply chain as it designs and manufactures all products in-house, which allows it to cut out middlemen costs [17]. Walmart is eager to tap founder Andy Dunn for his expertise in this area.

Peddling upscale merchandise will allow Walmart to expand its reach from low and middle income consumers to a more affluent base. As middle income consumers slowly shrink, Walmart is diversifying its customer base.

“Between 2000 and 2014, middle-class populations decreased in 203 of the 229 metropolitan areas reviewed in a Pew Research Center study. In an economically divided America, Walmart has tried to sell not only to shoppers looking for extreme discounts, but also to shoppers with higher incomes seeking higher-quality items. Walmart has been working to increase its sales to more affluent customers for years, especially in e-commerce.” [19]

Conclusion

Walmart’s e-commerce strategy appears to be reaping dividends as of the writing of this post. As mentioned earlier, Walmart stated that its e-commerce sales had increased 64% domestically in the first quarter of 2017.

For years, Walmart has dominated the retail space with its low cost/low price strategy (see my Micheal Porter post). In today’s e-commerce environment, the key is to compete on low prices and convenience, as well as appeal to diversified income groups. Only time will reveal if Walmart has the innovative capacity and leadership to overtake Amazon. The company is making bold bets in the e-commerce space and is aware of the shift in consumer preferences.

Walmart’s core business must be willing to be disrupted by its internal innovators. The current retail landscape is one of declining profits and closing stores. The organization as a whole must not be ideologically wedded to its massive assortment of physical stores while ignoring threats from outside competitors (namely Amazon).

Additionally, Walmart cannot ignore fresh retail ideas emanating from internal disrupters like Marc Lore, Andy Dunn or successful Store No. 8 startups if they materialize. The company must cross-pollinate successful ideas and quickly post-mortem and move on from unsuccessful ones. If Walmart continues to buy online growth at the expense of organic growth, then it must ensure that it does not continually overpay for growth and assets. If its e-commerce acquisitions underperform or sustain large losses, this can harm Walmart’s market position and financial performance.

For more Walmart coverage please check out Part 1Part 2 and Part 3 of my series on Walmart’s overall technology strategy, where I address areas such as:

  • Strategy for Technology Infrastructure
  • Strategy for IT Capability & Staffing
  • Strategy for Information Risk & Security
  • Strategy for Stakeholder Requirements, Testing & Training/Support
  • Project ROI and Key Success Measures
  • Strategy for Data Acquisition and Impact on Business Processes
  • Strategy for Social Media/Web Presence
  • Strategy for Organizational Change Management, Project Strategy and Complexity

If you’re interested in Business Intelligence & Tableau check out my videos here: Anthony B. Smoak

References:

[1] Kaufman L. & Deutsch, C. Dec 29, 2000. Montgomery Ward to Close Its Doors. New York Times. http://www.nytimes.com/2000/12/29/business/montgomery-ward-to-close-its-doors.html

[2] Abrams, R., May 18 2017. Walmart, With Amazon in Its Cross Hairs, Posts E-Commerce Gains. New York Times. https://www.nytimes.com/2017/05/18/business/walmart-online-sales-jump-63-percent.html?mcubz=0

[3] Yohn, D., March 21, 2017. Walmart Won’t Stay on Top If Its Strategy Is “Copy Amazon”. Harvard Business Review. https://hbr.org/2017/03/walmart-wont-stay-on-top-if-its-strategy-is-copy-amazon

[4] Walmart STORES, INC., ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JANUARY 31, 2017. http://d18rn0p25nwr6d.cloudfront.net/CIK-0000104169/c3013d40-212d-409e-bf30-5e5fd482fc2f.pdf

[5] The Economist. June 2, 2016. Walmart: Thinking outside the box. As American shoppers move online, Walmart fights to defend its dominance. http://www.economist.com/news/business/21699961-american-shoppers-move-online-walmart-fights-defend-its-dominance-thinking-outside

[6] Levy, A. April 24, 2017. Is Wal-Mart’s New E-Commerce Acquisition Strategy Any Better Than Its Old One? https://www.fool.com/investing/2017/04/24/is-wal-marts-new-e-commerce-acquisition-strategy-a.aspx

[7] Edwards, J. May 27, 2014. Some Employees Are Furious At Management Payouts In Walmart’s Big Adtech Acquisition. http://www.businessinsider.com/adchemy-stock-payouts-in-walmartlabs-acquisition-2014-5

[8] Lutz. A. Dec 12, 2012. Walmart CEO Mike Duke Shares His Biggest Regret. Business Insider. http://www.businessinsider.com/walmart-ceo-shares-his-biggest-regret-2012-12

[9] Ignatius, A. March 2017. “We Need People to Lean into the Future”. Harvard Business Review. https://hbr.org/2017/03/we-need-people-to-lean-into-the-future

[10] Nassauer, S. Nov 1, 2016. Wal-Mart E-commerce Executives Depart in Wake of Jet.com Purchase. Wall Street Journal. https://www.wsj.com/articles/wal-mart-e-commerce-executives-depart-in-wake-of-jet-com-purchase-1478038997

[11] Gustafson, K. August 8, 2016. Wal-Mart: This is why Jet.com is worth $3.3 billion. CNBC. http://www.cnbc.com/2016/08/08/wal-mart-this-is-why-jetcom-is-worth-33-billion.html?view=story

[12] CNBC Interview with Marc Lore. Aug, 9. 2016. https://www.nytimes.com/2016/08/09/business/dealbook/walmart-jet-com.html?mcubz=0

[13] Abramsaug, R. & Picker, L. August 8, 2016. Walmart Rewrites Its E-Commerce Strategy With $3.3 Billion Deal for Jet.com. New York Times. https://www.nytimes.com/2016/08/09/business/dealbook/walmart-jet-com.html?mcubz=0

[14] Baskin, B. & Nassauer, S. June 25, 2017. It’s 5 O’Clock Somewhere—Unless You’ve Been Acquired by Wal-Mart. The retailing giant bought Jet.com for $3.3 billion, then had to cope with its weekly happy hour. Wall Street Journal. https://www.wsj.com/articles/its-5-oclock-somewhereunless-youve-been-acquired-by-wal-mart-1498410840lipi=urn%3Ali%3Apage%3Ad_flagship3_feed%3Bu3d9V%2FcPTBqo%2BB0cP7nSZQ%3D%3D

[15] Levy, A. August 9, 2016. Why Wal-Mart couldn’t let Jet.com’s founder get away…again. CNBC. http://www.cnbc.com/2016/08/09/why-wal-mart-couldnt-let-jetcoms-founder-get-away-again.html

[16] de la Merced, M. June 16, 2017. Walmart to Buy Bonobos, Men’s Wear Company, for $310 Million. https://www.nytimes.com/2017/06/16/business/walmart-bonobos-merger.html?smid=li-share

[17] Sergan, E. June 19, 2017. Bonobos Founder Andy Dunn Knows You Might Be Mad At Him For Joining Walmart. Fast Company. https://www.fastcompany.com/40432313/bonobos-founder-andy-dunn-knows-you-might-be-mad-at-him-for-joining-walmart

[18] Soper, S. March 20, 2017. Wal-Mart Unveils ‘Store No. 8’ Tech Incubator in Silicon Valley Bloomberg. https://www.bloomberg.com/news/articles/2017-03-20/wal-mart-unveils-store-no-8-tech-incubator-in-silicon-valley

[19] Taylor, K. March 24, 2017. Walmart’s latest move confirms the death of the American middle class as we know it. Business Insider. http://www.businessinsider.com/walmart-invests-as-american-middle-class-shrinks-2017-3

Photo Copyright: moovstock / 123RF Stock Photo

More Than You Want to Know About State Street Bank’s Technology Strategy Part 3

This article is a continuation of my earlier analyses (Part 1, Part 2 here) where I waded into State Street’s strategy for Technology Infrastructure, IT Capability and Staffing, Information Risk & Security, Stakeholder Requirements, and Project ROI. In this final part of my three part series I will broach the company’s strategy for Data Acquisition, Social Media, Organizational Change Management and Project Strategy. State Street’s cloud implementation and virtualization initiative is a worthy example of business strategy/need influencing the firm’s information technology strategy.

State Street: Strategy for Data Acquisition and Impact on Business Processes:

The nature of State Street’s business as a custodian bank with trillions of dollars under custody management and multiple clients distributed worldwide means that the organization houses and processes a tremendous amount of data (internally generated and externally collected). The sheer volume and complexity of this data presents challenges as the bank looks to file regulatory reports and provide data back to its clients. The company receives an untenable 50,000 faxes a month from its client base (Garber, 2016). According to consulting firm Accenture, “(State Street) was unable to adequately track trades through each step in the trading lifecycle because there were multiple reconciliation systems, some reconciliation work was still being done manually and there was no system of record. To maintain industry leadership and comply with regulations, the company’s IT platform had to advance” (Alter, Daugherty, Harris, & Modruson, 2016).

The bank’s cloud initiative helped facilitate and speed up the burdensome process of transferring data back and forth between its clients. In addition, (as of 2016) a new digital initiative (code named State Street Beacon) will potentially help drive more cost savings. The cloud architecture project was a boon to data analysis capabilities as it enabled clients to access their data in the State Street cloud and subsequently enrich the data from multiple sources to support forecasting (Camhi, 2014). In this case, the bank’s infrastructure as a service (IaaS) enabled platform as a service (PaaS) capabilities.

The bank has embarked upon the development of 70 mobile apps and services that support its PaaS strategy. In one case, the bank developed a tablet and mobile accessible app for its client base named State Street Springboard. This application put investment portfolio data in the hands of its client base. Additionally, “Since State Street’s core competency is transaction processing, its Gold Copy app is one of the most important new tools it offers: The app lets a manager follow a single ‘gold’ version of a transaction as it moves through all of the company’s many departments and office locations — say, as it makes it way through trading, accounting, and reporting offices globally” (Hogan, 2012). This capability of the Gold Copy app enables more effective management of counterparty risk as an asset moves through the trading process.

State Street’s new infrastructure and massive data collection provides the bank with new big data capabilities that can better inform business units in the area of risk management. Data insights can potentially fortify stress testing, “What-If” and “Black Swan” scenario modeling. As we’ve seen in the recent 2016 case of Britain’s pending withdrawal from the European Union (i.e. “Brexit”), uncertainty in global financial markets is a certainty.

State Street: Strategy for Social Media/Web Presence:

State Street has traditional Facebook, LinkedIn and Twitter social presences but it has also used other social platforms to support various aims such as employee interaction and brand awareness. The bank was named a “Social Business Leader for 2013” by Information Week. As part of a “social IT” strategy (in which technology supports a collaboration initiative), the company held an “Innovation Rally” on its eight internal online forums to gather employee ideas on how best to improve its business. From 12,000 total submitted postings, employees could attempt to build a business case around the best ideas for executive management to implement (Carr, 2013). The company also launched an internal “State Street Collaborate” platform with the aim of crowdsourcing employee knowledge to help people find an appropriate in-house expert regarding diverse work related topics of interest.

Additional social initiatives include a partnership with TED to provide employees the opportunity to give a “Ted Talk” in front of their peers; the aim is to promote knowledge sharing within the organization. The bank also experiments with a presence on the (almost defunct) video sharing platform “Vine” where it can showcase the organization in quick six second sound bites. This approach caters to clients and the future millennial talent base.

State Street: Strategy for Organizational Change Management, Project Strategy and Complexity:

As stated earlier in this series, State Street started migrating its new cloud applications to production by selecting those with low volume and low complexity and then gradually ramped up to migrating the more complex applications (McKendrick, 2013). The standardization and virtualization aspects of cloud infrastructure that the bank implemented is conducive to agile development. Standardization and a reusable code approach reduces complexity by limiting development choices, simplifying maintenance and enabling new technology staff to get up to speed on fewer systems. Developers are placed in agile teams with business subject matter experts to provide guidance and to increase stakeholder buy-in. Per Perretta, “We circle the agile approach with additional governance to ensure that the investments are paying off in the appropriate timeframe” (High, 2016).

Another key approach that State Street uses to gauge project complexity is that of predictive analytics. The bank can help its internal business teams better understand the project costs and delivery timetables by analyzing historical data on all of the projects implemented over the years. The predictive analytics model uses inputs such as “…scope, team sizes, capability of the team, the amount of hours each team member spent, and ultimately, how well it delivered on these programs” (Merrett, 2015). As the business teams list their project requirements, the predictive model is created in real time which provides all parties with additional clarity.

Finally, it would be remiss to mention banking and transformation in the same breath without mentioning the requisite layoffs and outsourcing activities. For all the benefits of the bank’s cloud computing initiatives, technology workers who do not fit in with the new paradigm find themselves subjected to domestic and non-domestic outsourcing initiatives. A standardized infrastructure platform leads to fewer distinct systems in the technology ecosystem, an emphasis on code reuse and increased automation. This perfect storm of efficiency gains has lead to roughly 850 IT employees shuffled out of the organization to either IBM, India based Wipro or outright unemployment. Staffing cuts occurred amongst the employees who maintained and monitored mainframes and worked with other non-cloud based infrastructure systems. The bank was interested in shifting fixed costs for variable costs by unloading IT staff who were perceived as not working on innovative cutting edge technologies. The layoffs amount to “21% of State Street’s 4,000 IT employees worldwide” (Tucci, 2011b).

Revisit earlier analyses here:

References:

Alter, A., Daugherty, R., Harris, J., & Modruson, F., (2016). A Fresh Start for Enterprise IT. Accenture. Retrieved from https://www.accenture.com/us-en/insight-outlook-journal-fresh-start-enterprise-it

Camhi, J. (2014). Chris Perretta Builds Non-Stop Change Into State Street’s DNA. Bank Systems & technology. Retrieved from http://www.banktech.com/infrastructure/chris-perretta-builds-non-stop-change-into-state-streets-dna/d/d-id/1317880

Carr, D. (May 30, 2013). State Street: Social Business Leader Of 2013. Retrieved 6/25/16 from http://www.informationweek.com/enterprise/state-street-social-business-leader-of-2013/d/d-id/1110179?

Garber, K. (February 29, 2016). State Street doubles down on digital. SNL Bank and Thrift Daily. Retrieved from Factiva 6/20/16.

High, P. (February 8, 2016). State Street Emphasizes Importance Of Data Analytics And Digital Innovation In New Role. Retrieved from http://www.forbes.com/sites/peterhigh/2016/02/08/state-street-emphasizes-importance-of-data-analytics-and-digital-innovation-in-new-role/#a211b1320481

Hogan, M. (September 3, 2012). State Street’s Trip to the Cloud. Barron’s. Retrieved from Factiva 6/20/16

McKendrick, J. (January 7, 2013). State Street’s Transformation Unfolds, Driven by Cloud Computing. Forbes. Retrieved from http://www.forbes.com/sites/joemckendrick/2013/01/07/state-streets-transformation-unfolds-driven-by-cloud-computing/#408e1acf64cf

Merrett, R. (April 2, 2015). How predictive analytics helped State Street avoid additional IT project costs. CIO. Retrieved from http://www.cio.com.au/article/571826/how-predictive-analytics-helped-state-street-avoid-additional-it-project-costs/

Tucci. L. (July, 20, 2011). State Street tech layoffs: IT transformation’s dark side. Retrieved from http://searchcio.techtarget.com/blog/TotalCIO/State-Street-tech-layoffs-IT-transformations-dark-side

More Than You Want to Know About State Street Bank’s Technology Strategy Part 2

This article is a continuation of my earlier analysis (Part 1 here) where I waded into State Street’s strategy for Technology Infrastructure and IT Capability and Staffing. In this second part of my three part series I will broach the company’s strategy for information risk and security, stakeholder requirements and project return on investment. State Street’s cloud implementation and virtualization initiative is a good example of business strategy/need influencing the firm’s information technology strategy.

State Street: Strategy for Information Risk & Security:

State Street has acquired a substantial client base and houses sensitive financial data that is subjected to regulatory scrutiny. Given the sensitive nature of its data and operations, the cloud infrastructure that the bank chose to implement was that of a virtualized private cloud. Former Chief Innovation Officer Madge Meyer stated, “We’re totally virtualized, our network is a virtual private IP network. Our servers are 72 percent virtualized and our storage is all virtualized for structured/unstructured data” (Burger, 2011). For State Street, a private cloud offers the benefits of a public cloud with the added benefit of being owned and operated by the bank (i.e. exclusive dedication). While no architecture is 100% secure, the risk of an information breach is mitigated as the controlling organization’s data can be completely isolated from the data of another organization.

Additionally, the cloud implementation and virtualization initiative gave rise to shared services that are centrally managed but enforced across the enterprise. This single security framework can be applied across all of the application touch points precluding the need for multiple security frameworks across disparate systems.

State Street: Strategy for Stakeholder Requirements, Testing & Training/Support:

The architecture group within State Street works together with the business to tie together strategic objectives. The idea to embrace cloud implementation (and the additional data functionality it enabled for the bank’s clients) emanated in the architecture group. Thus, the business and the board of directors were key stakeholders in the initiative. The board of directors has a special dedicated technology committee that receives “a complete rundown of the technology strategy and the work that we (IT group) are doing in terms of digitizing the business” (High, 2016). According to Perretta, “They (architecture group) created a proof of concept with an eye toward: Here are the capabilities that our entire organization is going to need, here are the technologies that we can deploy, and here’s how to make them operational” (Camhi, 2014).

State Street started migrating its new cloud applications to production by selecting those with low volume and low complexity and then gradually ramped up to migrating the more complex applications (McKendrick, 2013). Dual pilots of the cloud architecture were conducted using roughly 100 machines. Once favorable results were achieved, a larger pilot consisting of 500 machines was stood up. Approximately 120 use cases were tested in the pilot in order to let the development team understand the failure points of the system (Tucci, 2011a).

The standardization and virtualization aspects of the cloud infrastructure the bank implemented was conducive to agile development. Virtual machines on the cloud allowed development teams to spin up multiple server instances as opposed to physically installing a new box in the legacy non-virtualized environment. Contention between teams waiting for server use is virtually eliminated. “When adding cloud computing to agile development, builds are faster and less painful, which encourages experimentation” (Kannan, 2012). The relative ease at which development and testing servers can be instantiated promotes “spur of the moment” experimental builds that could yield additional innovative features and capabilities.

State Street: Project ROI and Key Success Measures:

Prior to State Street’s cloud infrastructure upgrade initiatives, potential operating cost savings were projected to be $575 million to $625 million by the end of 2014; which State Street is on track to achieve. “The bank had pretax run-rate expense savings from the initiative of $86 million in 2011, $112 million in 2012, and $220 million in 2013” (Camhi, 2014).

When the IT group makes a budget request for substantial investments, they must lay out the potential benefits to the business. Some of the benefits are timely payback, regulatory compliance, data quality improvement and faster development cycle times (providing features and functionality with re-use and less coding). The ultimate aim is to connect the IT strategy to business results in a way that yields advantage for the organization.

In 2011, State Street published a matrix on the advantages of cloud computing vs. traditional IT. The following figure provides insight into State Street’s IT and business unit considerations with respect to making an investment in a fixed or variable cost infrastructure (Pryor, 2011).

Traditional IT Cloud Computing
Cash Flow Hardware / software purchased upfront Costs incurred on a pay-as-you-go basis
Risk Entire risk taken upfront with uncertain return Financial risk is taken incrementally and matched to return
Income Statement Impact Maintenance and depreciated capital expense Maintenance costs only
Balance Sheet Impact Hardware / software carried as a long-term asset Cost incurred on a pay-as-you-go basis

From a funding perspective, State Street employs the chargeback funding method for its private cloud initiative. Architectural capabilities empower end-users to automatically provision virtualized servers for usage. There are policies in place that determine how long a virtual server may remain instantiated and how much load balancing is performed across the infrastructure. Server usage is monitored, measured and chargeback is calculated based upon end-user processing time. Subsequently, the usage is billed back to the end-user’s respective business unit. “In short, it puts a management layer of software over the virtualized servers and operates them in a highly automated, low touch, fashion” (Babcock, 2011).

Don’t miss part 3 of the analysis:
More Than You Want to Know About State Street Bank’s Technology Strategy Part 3

References:

Babcock, C. (November 9, 2011). 6 big questions for private cloud projects. Information Week. Retrieved from Factiva.

Burger, K. (October, 1, 2011). Riding The Innovation Wave; Technology innovation has been key to State Street Corp.’s success, according to chief innovation officer Madge Meyer — and she’s been willing to take some risks to prove it. Bank Systems + Technology. Retrieved from Factiva

Camhi, J. (2014). Chris Perretta Builds Non-Stop Change Into State Street’s DNA. Bank Systems & technology. Retrieved from http://www.banktech.com/infrastructure/chris-perretta-builds-non-stop-change-into-state-streets-dna/d/d-id/1317880

High, P. (February 8, 2016). State Street Emphasizes Importance Of Data Analytics And Digital Innovation In New Role. Retrieved from http://www.forbes.com/sites/peterhigh/2016/02/08/state-street-emphasizes-importance-of-data-analytics-and-digital-innovation-in-new-role/#a211b1320481

Kannan, N. (August 20, 2012). 6 Ways the Cloud Enhances Agile Software Development. CIO. Retrieved from http://www.cio.com/article/2393022/enterprise-architecture/6-ways-the-cloud-enhances-agile-software-development.html

McKendrick, J. (January 7, 2013). State Street’s Transformation Unfolds, Driven by Cloud Computing. Forbes. Retrieved from http://www.forbes.com/sites/joemckendrick/2013/01/07/state-streets-transformation-unfolds-driven-by-cloud-computing/#408e1acf64cf

Tucci. L. (July, 2011a). In search of speed, State Street’s CIO builds a private cloud. Retrieved from http://searchcio.techtarget.com/podcast/In-search-of-speed-State-Streets-CIO-builds-a-private-cloud

Michael Porter’s Generic Differentiation Strategy Explained

I previously touched upon Michael Porter’s generic cost leadership strategy here. Porter asserts that a business model can’t offer the best product or service at the lowest price and maintain a sustainable competitive advantage. An organization employing a strategy that attempts to be “all things to all people” will become stranded in mediocrity (i.e. earn less than industry average profitability).

A differentiation strategy advocates that a business must offer products or services that are valuable and unique to buyers above and beyond a low price. The ability for a company to offer a premium price for their products or services hinges upon how valuable and unique these offerings are in the marketplace. A differentiator invests its resources to gain a competitive advantage from superior innovation, excellent quality and responsiveness to customer needs. [1]

“It should be stressed that the differentiation strategy does not allow the firm to ignore costs, but rather they are not the primary strategic target.” [2]

If you could boil the differentiation strategy down to a manageable sound-bite, it would look something like this; differentiation enables a firm to command a higher price.

Starbucks coffee doesn’t taste materially better than offerings from rival Dunkin’ Donuts, but Starbucks has crafted the “Starbucks Experience” complete with intimate environments, sustainable sourcing and mobile ordering to differentiate itself with a cult-like following (i.e. command higher than industry average prices for a commodity item).

Advantages:

Differentiation allows a firm to build brand loyalty, obtain customers who exhibit less price sensitivity and increase its profit margins. As opposed to cost leaders, differentiators are not as concerned with supplier price increases. Differentiators can more easily pass on price increases to their customers because customers are more willing to pay the increases.

Differentiators are protected from powerful buyers since only they can supply the distinct product or service offering. Differentiators are also protected against the threat of substitute products in that a new competitor must invest substantial resources to both match the capabilities of the differentiator and break customer loyalty.

“Differentiation is different from segmentation. Differentiation is concerned with how a firm competes—the ways in which it can offer uniqueness to customers. Such uniqueness might relate to consistency (McDonald’s), reliability (Federal Express), status (American Express), quality (BMW), and innovation (Apple). Segmentation is concerned with where a firm competes in terms of customer groups, localities and product types.”[1]

Risks:

Porter assets that there are risks to the differentiation strategy.

  • “The cost differential between low-cost competitors and the differentiated firm becomes too great for differentiation to hold brand loyalty. Buyers thus sacrifice some of the features, services, or image possessed by the differentiated firm for large cost savings;
  • Buyers’ need for the differentiating factor falls. This can occur as buyers become more sophisticated;
  • Imitation narrows perceived differentiation, a common occurrence as industries mature.”

All differentiators should be on guard for firms that seek to imitate their distinct offerings while never charging a higher price than the market will bear [1].

The differentiation strategy should not be mistaken for providing unique products simply for the sake of being unique; rather the differentiation should be tied to customer demand or willingness to pay.

References:

[1] Hill, Charles. W. L., & Jones, Gareth. R. (2007). Strategic Management Theory. Houghton Mifflin Company

[2] Porter, M. E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press, 1980.

Picture Copyright:  urubank / 123RF Stock

 

Strategic Analysis of ADP

To my surprise, one of the more popular blog posts on this site has been my excerpt from an MBA group paper drafted for a strategic management class (MGT 6125) taken back in the Spring of 2007 at the Georgia Institute of Technology.

The class was taught by the esteemed professor of strategy, Dr. Frank Rothaermel who literally wrote the book on strategic management. As part of the class our project group interviewed an executive from ADP (Mr. Greg Secord who went on to become President of ADP Canada), wrote a strategic analysis of the company and then presented our findings to the company (complete with Q&A).

Due to the aforementioned popularity of the excerpt that I authored, I have decided to post the paper in its entirety as written by me and other project members. Please keep in mind that this work was originally submitted on April 23, 2007 so please peruse the information with the proper context in mind. I must give credit where credit is due as this paper was put together by Brent Dutton, John Frazer, Jay Hornback, Kyungrok Jung, Chris Nygren, Anthony Smoak, Tom Whittingham, et.al.

Company Background

Automated Data Processing, Inc. is a company that many people have heard of but may not be fully aware of its value proposition. ADP processes payroll for 1 in 6 Americans [1]. While payroll processing is its core competency, it is not the organization’s only line of business worth highlighting. Tax filing, benefits administration and labor management are just a few of the company’s other services. The purpose of this analysis is to offer a better understanding of ADP as a company. We will offer insight into the functions that the organization performs, how they have maintained success and where they are headed as an organization.

ADP’s corporate culture and structure bolster its internal strengths and contribute to the company’s competitive advantage. In addition, expansion and integration have contributed to ADP’s unmatched growth in the industry. ADP’s business level strategies and unique competencies have also been a contributing factor in its growth. This strategic analysis offers a detailed inspection of each of these growth factors and as well as recommendations that should help foster future growth and success.

Before diving into the current state of the business and its strategy, it is important to understand the company’s past. In 1949, Henry Taub became the sole owner of what would become ADP at the age of 21 [2]. This humble beginning, managing one client’s payroll, would slowly snowball through the 1950s as more companies saw the value from payroll outsourcing. ADP expanded by absorbing “Mom and Pop” payroll processors in major U.S. cities and expanding their local clientele.

In the 1960s, ADP became a publicly traded company and continued its expansion strategy. It developed a Brokerage Services division which provided services for stock brokerages on Wall Street. The 1970s saw further domestic expansion as well as ADP’s first international office in The Netherlands. A new Dealer Services division was created to cater to the inventory and accounting needs of automobile dealers. The decade wrapped up with the creation of Claims Services, another valuable division positioned to automate insurance estimates for insurers.

The growing PC industry of the 1980s posed a serious threat to ADP as many companies could more feasibly perform ADP’s services in-house. However, ADP proved up to the challenge by turning that threat into a strength as they absorbed this new technology into their operations. The company crossed the $1 billion revenue mark in the mid-80s and found themselves in the perfect strategic position as outsourcing became trendy in the 1990s. Into the 2000s, ADP boasts 570,000+ clients, 42,000+ employees and $7 billion+ revenue as they continue to be a leader in the HR outsourcing industry.[3]

Industry Analysis

In order to analyze the industry in which ADP competes, Porter’s Five-Forces Model was applied. In the context of this model the competitive makeup of the employee services industry becomes clear.

Threat of Potential Entrants

The threat of potential entrants is relatively low as the result of significant barriers to entry. These include high switching costs for customers and large upfront capital investment for potential competitors. There is little upside to performing payroll processing correctly and significant consequences for performing it incorrectly. As a result, companies are leery of switching payroll providers, giving new entrants little chance of stealing customers from existing payroll firms and thereby limiting the size of the market for new entrants. A large initial capital investment is also needed to establish the hardware and software infrastructure needed to process high volumes of transactions efficiently and effectively. In addition, an extensive sales force needs to be in place to combat the industries largest substitute.

Substitutes

The threat of substitutes is high, and primarily revolves around the mindset of businesses wanting to process payroll themselves [4]. Some plausible reasons include not wanting to lose control of the financial books or being unaware of the cost savings associated with outsourcing functions like payroll [5]. Other substitutes include ERP software like Oracle and SAP.

On the larger scale there are two Macro-environmental forces that have an affect on the industry as a whole; the Technological and Macroeconomic environments. Technology has not only helped the industry to increase the speed in which it can process transactions, but it has also increased the reach of individual companies. For example, ADP began operations using paper and pen to process payrolls. Later they moved onto calculators, punch cards, and mainframes. The processing power of mainframes increased the number of daily transactions they could process and in turn helped to grow the business.[6]

Lastly, the Macroeconomic Environment can affect the potential of companies to attract new clients and maintain current revenue streams. During an economic downturn companies are less likely to spend capital on nonessential projects resulting in fewer new clients. Also, a reduction in a client’s workforce has a direct relationship to the amount of steady revenue received[7] because a smaller workforce equals fewer payroll transactions processed.

Strength of Buyers

The strength of the buyers in the payroll industry is proportionate to the size of the buyer, or more specifically, the number of employees the buyer has.  Recently, many of ADP’s clients in the fragmented financial services industry have begun to merge and consolidate. In fact, there are 770 fewer such institutions in 2007 than there were in 2000[8]. While this consolidation has not happened yet on a large enough scale to severely impact ADP’s margins, it may do so in the near future if the trend continues.

Intensity of Rivalry

For the first forty years that ADP was in business it enjoyed very little competition in its industry. This was due mainly to the fact that ADP had developed a series of in-house competencies using complex technology such as punch card computers and later mainframes to process their customers’ transactions.  Not many other companies had the expertise to handle this difficult technology efficiently and effectively.  However, the advent of the personal computer and user friendly software such as PeopleSoft greatly lowered technical barriers to entry into the industry. This resulted in the advent of numerous new competitors such as Paychex, Ceridian, and Administaff. Although the payroll industry is still dominated by a few players (ADP and Paychex primarily), the PEO and BPO industries that ADP operates in feature many competitors and intense competition. This has already led to price competition and if it continues will hurt ADP’s profit margins.

SWOT Analysis: Strengths

ADP recorded a robust financial performance for the time period 2004 – 2006. Revenue has increased over the past year at the rate of 10%, operating profits 10%, net profit 29%, and cash flow 14% respectively [9]. This financial strength is the foundation for ADP’s future growth. For this industry with small margins and a high cost of acquiring new business, client retention rate is very important. ADP’s average client tenure is estimated at ten plus years, which exceeds the industry’s average [10]. This has allowed ADP to enjoy very predictable recurring revenue streams. ADP’s broad range of offerings is also a strength. These include computerized payroll, transaction processing, data communications, and IT-based business solutions [11]. ADP can offer substantial scale advantage across all its product offerings, which enables it to cater to a larger customer base. As a main player in the industry, ADP consistently processes difficult, mundane, and high-volume transactions very efficiently at a comparatively low cost. Additionally, ADP has established effective and robust business channels through a highly trained and competent sales force of more than 4000 associates; something that is very difficult for competitors to imitate. On top of that, top management succession has been extremely smooth and has caused very little disruption since the 1950s [12]. Lastly, decentralized organization makes for smoother transitions during M&A periods.

SWOT Analysis: Weaknesses

Increasing consolidation in the financial services industry has resulted in the creation of larger entities with more bargaining power. These larger players have adversely affected the margins of the company. First, for the period of 2004 – 2006, ADP’s return on average assets, investments and average equity were 4.6%, 5.1% and 18.8%respectively. This is significantly lower than corresponding industry averages of 8.4%, 10.2% and 21.6% over the same period. Weak returns indicate the inability of the management to deploy assets profitably and can adversely affect investor confidence[13].

Another weakness is their very high dependence on the U.S. market. ADP earned nearly 83.7% of its revenues from the U.S. market in 2006 [14]. The company has a presence in Europe and Canada, but the comparative revenue is smaller. A domestic concentration of revenues makes ADP vulnerable to adverse market conditions in the U.S. Further, ADP doesn’t have a scale advantage in its international market. Having a relatively small presence in international market makes ADP vulnerable to certain foreign risks – dealing with legal systems, establishing distribution channels, finding trained people for the right position, etc. Lastly, ADP has lost much of its tradition of innovation. ADP had been successful in adopting new technology and in turning technological threats into opportunities. ADP was the first to introduce early computer machines into payroll systems. With the threat of mini-computers and PCs in the 1980s, ADP saw this new technology’s potential for company growth and integrated it successfully [15].  But, as the company grew, it became understandably more conservative in its pursuit of new technologies. As a result, ADP will now typically wait for a new technology to be commercially proven before it will consider adoption. Because the most likely disruptive force in ADP’s industry will come in the form of a new technology, ADP’s lack of product innovation and conservative approach to new technology could prove to be a weakness.

SWOT Analysis: Opportunities

ADP still has room for growth in the Domestic Markets. Current estimates place the small business sector at 10 million companies and of that, ADP only does business with 9% of this set [16].  Similar opportunities exist in the large business sector where ADP services 26% of employees [17]. ADP should also look to up-sale current customers who do not outsource their entire HR department. Finally, ADP needs to continue to evaluate foreign markets like India. As India’s citizens grow their annual salaries, so do the opportunities for ADP to offer their outsourcing products.

SWOT Analysis: Threats

The two primary threats that ADP faces are disruptive technology and both potential and current competitors. Up to this point, ADP has been able to adapt to changes in the technological environment. This includes adapting to the introduction of PCs by offering software solutions that resided at clients’ sites [18]. Potential competitors include companies like IBM, who have large amounts of capital and come from industries with lower expected ROI. Within ADP’s own industry, competitors like Paychex are growing rapidly. Today, Paychex focuses mainly on small size businesses [19].  However, as they continue to grow so does the potential that they will bleed into ADP’s market and become more direct competitors.

Competitive Position

Throughout its corporate history ADP has managed to positively differentiate itself relative to its competitors and achieve and maintain superior profitability compared to the industry average [20]. This is indicative of a sustained competitive advantage. In order to understand how ADP has differentiated itself through its competitive advantage, it is necessary to examine the sources of their advantage and understand how they continually reinforce each other. Though there are certainly numerous factors that have contributed to ADP’s success, probably the three key attributes that fuel its competitive advantage are the firm’s brand equity and reputation, its powerful sales force, and its ability to retain clients.

ADP was founded over fifty years ago and is the longest running payroll/HR company in its industry. This is actually quite a feat considering their industry and the types of services that they provide to their clients. By managing such highly visible, though mundane functions such as payroll, benefits and retirement services, ADP is put in an uncompromising position. If the company performs its job well, no one notices. But if it errs in its performance, many will notice and will likely exhibit a highly (negative) emotional response toward ADP. Therefore, in order to prosper in this “no fail” environment, ADP must continually prove to its clients and potential customers that it is extremely reliable and consistently good. Based on the fact that they have been steadily growing over the past fifty years, clearly ADP has managed to remain reliable. In doing so, ADP has built up major brand equity and is highly regarded in the industry. This solid reputation for consistent performance is the first source of their competitive advantage. The result of ADP’s strong brand and reputation come is its high revenues and solid profits. This puts ADP in a healthy financial position, and ultimately allows them to support a large sales force of over 4000 sales associates [21]. ADP’s large sales force is their second source of competitive advantage.

It is their sales force that allows ADP to have a personal presence in every single deal that they pursue [22] (uncommon in today’s world of web and phone based sales). This results in new business growth beyond that of their competitors and a greater brand equity, reinforcing their first source of competitive advantage. Further, in order to effectively compete with ADP, competitors must be able to finance a large sales force of their own. Not many firms have the capital to do this, which provides a high barrier to entry in ADP’s industry. Additionally, ADP uses its sales force to continually serve the clients that it already has. This ensures that there is always someone to personally handle any issues or meet any requirements that a client may have. Due to this highly responsive and effective service provided to its clients, ADP has enjoyed an average client tenure of over ten years [23]. It is this high client retention level that is their third source of competitive advantage.

Keeping the clients that it earns for ten years or more provides a number of benefits to ADP beyond simple client familiarity. First, it prevents market share erosion – once a client goes with ADP, they are very unlikely to leave for a competing firm. Second, it provides an industry barrier to entry because with fewer potential companies to target (since ADP has walled off a large number of clients already), competitors are less likely to enter the industry. Third, and probably most important, ADP’s lengthy client tenure translates into over 90% of its revenues being recurring. This puts ADP in an extremely healthy position financially because not only does it have guaranteed revenue streams, but it also allows the company to plan financial moves years in advance with an extremely high degree of accuracy. ADP can then use its revenue streams to fund its sales force, which in turn strengthens its brand equity, which in turn helps gain and retain clients.

ADP’s reinforcing sources of competitive advantage are very powerful and continue to build upon themselves. These competitive advantages are very difficult to imitate.  This has ultimately allowed ADP to differentiate itself in the industry (See Appendix A). As a result of this differentiation, ADP can charge a premium on its services. This premium is very important in terms of profitability since ADP operates in a relatively low margin industry.

Market Segmentation

ADP has divided their offerings into two main divisions. The primary division is their Employer Services Division that covers all HR offerings as well as the corporate tax services. Employer Services is broken down by company size into three segments for sales purposes. The smallest segment (Small Business Servies) includes all companies with 50 employees or less and represents $0.9 billion in annual revenue [24]. The middle segment (Major Account Services) includes companies that range from 50 employees to less than 1000 employees and represents $1.7 billion in annual revenue [25].

The final segment (National Account Services) is the large employer segment, made up of companies with more than 1000 employees. The National Account Services segment represents $1.6 billion in annual revenue. ADP has strong market penetration in the Major and National Account segments but is currently dealing with slowed growth within these segments. ADP must look to expand into the Small Business segment to grow their market share. This may prove difficult because smaller companies are very price conscious and ADP charges a premium rate for their services. To expand into this price competitive market ADP will have to demonstrate to these companies that it is less costly to outsource payroll and other functions to ADP than it is to do those functions in-house.

Additional revenues in the Employer Services division are gained through ADP’s total source PEO service and product oriented business units. The product oriented business units are comprised of tax, retirement, and pre-employment services. While the PEO service represents only $0.7 billion in annual revenue we feel that this is another growth segment that ADP can focus on. The entire employer services division provided ADP with $5.7 billion in annual revenue in FY 2006.

ADP’s second division is the Dealer Services division which provides multi-purpose software packages for auto dealers. The Dealer Services market is also split into three market segments. The largest segment of the dealer services market is the Domestic Auto Dealers. The second segment represents International Auto Dealers. Finally, ADP’s third segment is the Recreational Vehicle and Commercial Truck Segment. Altogether, Dealer services has 25,500 customers representing $1.6 billion in annual revenues.

Business Level Strategy

ADP has three main business level strategies. The most important strategy focuses on using “solid time tested operating principles”[26]. By utilizing proven operational methods and products for all services ADP is able to provide solid, consistent performance in all market segments. This reliable consistency is especially critical given the nature of ADP’s services. Mistakes in processes such as payroll are highly visible to employees and employers. If ADP were not able to deliver this consistent service their clients would leave in droves. Thanks to ADP’s reliable operations and core knowledge of the transaction services business they can boast over a 90% client retention rate.

The second main business strategy stems from ADP’s decentralized corporate structure. By making decisions at the lower levels of management, ADP is able to deliver superior service to their clients. The flat corporate structure allows for flexibility and incremental improvements in services that are unhindered by bureaucratic obstacles. Because of this, ADP is able to quickly respond to and fill customer needs faster than their competitors. This strategy will become more important as ADP begins to expand into the Small Business segment where customers will have more specialized demands.

The final business level strategy is the direct sales force employed at ADP. By maintaining a sales force of over 4,000 dedicated field representatives ADP is able to include a personal touch on almost every business transaction. As mentioned earlier in the paper ADP’s sales force is seen as a competitive advantage by itself. By saturating the marketplace with well trained, capable sales personnel ADP is able to nurture and capitalize on personal relationships. While this is a competitive advantage it is also extremely costly. The high costs associated with the sales force could be ADP’s greatest weakness in targeting the lower margin Small Business market. Because of this higher cost, ADP has begun to experiment with telephone and web-based sales pitches to target the Small Business market. Using these less expensive marketing channels will allow ADP to quickly and inexpensively contact a greater number of small businesses and hopefully increase their client base within this market.

Mergers and Acquisitions

ADP has become highly successful in its strategy of pursuing growth via horizontal integration. Although current CEO Gary Butler has maintained that ADP has no interest in “large, dilutive, multiyear acquisitions” [27], the company actively acquires smaller industry competitors. Acquisitions give ADP the opportunity to grow inorganically, increase its product offerings, acquire technology and reduce the level of rivalry in its industry.

A perfect execution of this strategy can be seen in its January 2003 acquisition of Probusiness. Probusiness was a much smaller California based provider of payroll and human resources services. Before the acquisition, Probusiness cited eight large competitors who had an interest in acquiring them. An acquisition of Probusiness would give a larger company an opportunity to expand its share of the payroll business [28]. Amongst those eight competitors were notable companies such as International Business Machines Inc. (IBM), Microsoft Corp. and Electronic Data Systems Corp. (EDS) [13]. True to form, ADP decided to react and proceeded to acquire Probusiness. The acquisition effectively prevented large competitors from acquiring approximately 600 new payroll clients in the larger employer space and reduced future competition.

The Probusiness acquisition was also a boon to the company in the fact that it offered ADP advanced payroll processing technology. Probusiness utilized PC based payroll processing as opposed to ADP’s more mainframe based technology [13].

A key acquisition for ADP in terms of increasing its global footprint was the December 2005 acquisition of U.K. based Kerridge Computer. This particular acquisition was significant in the fact that it increased ADP’s Dealer Management Services (DMS) presence from fourteen countries to over forty one [29].

ADP along with its main DMS competitors in the European market, Reynolds & Reynolds and SAP, began to realize the significant growth opportunities for the region. The European market for DMS, unlike the United States market, is much more fragmented which means there are more opportunities for a larger player to standardize product offerings [30]. In 2003 the European Union lifted rules that had previously banned franchised car dealers from selling rival brands [15]. Demand for pan-European systems to help multi-brand dealers manage their stores, sometimes in multiple countries and in various languages increased dramatically [15]. ADP shrewdly realized that many smaller DMS providers would not be able to meet this demand and acquired Kerridge to bolster its position.

Strategically, the Kerridge acquisition has allowed ADP to have first mover advantage over its main competitors with respect to China. New vehicle sales growth in Asia is expected to be at 25.3% by the year 2011 [31]. By becoming a first mover in the region, ADP will have the opportunity to lock customers into its technology since it currently has a 96% client retention rate16. ADP will also have the opportunity to create high switching costs for its customers and make it difficult for rivals to take its customers.

Other recent acquisitions by ADP include Taxware, which brings tax-content and compliance solutions to the table; VirtualEdge, which offers tools for recruiting; Employease, which develops Web-based HR and benefits applications; and Mintax, which provides tools for corporate tax incentives [32].” All of these acquisitions represent small fast growing companies with complimentary products and services. These products and services can be incorporated in ADP’s vast distribution network and provide potential bundling, cross-selling, or up-selling  opportunities with ADP’s current offerings.

Culture, Structure, and Control Systems

Top management at ADP plays an important role in maintaining and advancing the culture created by its founders. The promotion of the core values by top managers sets the tone for the entire organization. ADP stresses the following three core values: 1.) treat everyone with honesty, fairness, and respect; 2.) conduct business with the highest level of integrity; 3.) open, informal communications, hard work, and prudent financial management [33]. Adhering to these values has created a culture of prudent risk taking, continuous improvement, and promotion from within based on ability. As a company that built its core business around delivering first class applications to its client base, maintaining an environment where employees advance their careers based on their ability to improve services is essential because better services lead to higher client satisfaction.  Client satisfaction is the most important metric for client retention, and retention is imperative for a mature company with 46,000 employees and 570,000 clients [34].

Creating incentives for employees to adopt and adapt new technologies will be paramount as ADP begins to embrace the software-as-a-service platform. Collaboration and incremental innovation occur naturally at ADP as a byproduct of its relatively flat, multidivisional organizational structure. As a result managing change during a paradigm shift should be relatively painless for the company. ADP’s flat corporate structure meshes well with its core values and business objectives. ADP avoids excess management layers in favor of decentralized authority and empowered product teams. These empowered associates respond well to this structure as it gives them a better sense of their mission, their accomplishments, and their accountability. Ultimately this leads to happier employees and better service levels [35]. Better service levels lead to longer relationships with ADP, expanded service offerings and more references to other companies who use ADP’s products and services [36].

As mentioned above, ADP advocates incremental innovation and relies heavily on outsiders to produce new products or platforms. Once the benefits of the technology are well known, ADP leverages the new technology to enhance its product offerings. This strategy has fewer risks and lower costs as opposed to investing directly in R&D and innovating internally. Streamlined implementations with aggressive timelines – most are completed in less than one year [37] – allow ADP to catch up quickly and capitalize on the advances along with the first movers. Dedicated cross-functional product teams “live with” the product implementation from its initial project management stages to the final testing and quality assurance phase. These experienced and focused teams deliver new products in half the time of most competitors. ADP also has strategic control systems in place to ensure products continue to meet their high quality standards. The Product Marketing Council and Product Steering Committee meet regularly to evaluate the quality of their products and services in terms of how effectively they meet the client’s business needs and how reliably the applications actually perform. Managers at these meetings also examine industry trends and external product innovations and assess the need to change platforms or introduce new products to ADP.

Recommendations

Over the past fifty years, ADP has a history of planned long-term growth. In the past twelve months, ADP divested their Claims and Brokerage Service businesses. ADP has made a clear strategic focus on the Employer and Dealer Service businesses, part of the new “Fit and Focused” ADP brand. Below are two strategic recommendations for ADP that mesh well with its strengths and the opportunities present in the industry.

Inorganic Growth in Employer Services

ADP has been very successful in matching organic growth with inorganic growth through mergers and acquisitions. Currently, the Professional Employer Organization, or PEO segment of the Employer Services business, is highly fragmented with solid expected growth. In some domestic PEO markets, ADP will be able to grow their presence with their existing ADP Total Source package. New regulations make California a prime market to expand with PEO services [38].

However, the PEO market as a whole is highly fragmented. Currently, over 700 firms provide PEO services to small businesses throughout the US. The overall market penetration of PEO services is about 2.5% with annual growth of about 20%. ADP is in a unique position to grow in this segment because ADP has the largest capital structure (see Appendix B) [39]. ADP could greatly accelerate their growth in this promising market through continued mergers and acquisitions.

Dealer Services in the Booming Chinese Auto Market

As mentioned in latter portion of the Mergers and Acquisitions section, ADP acquired Kerridge Computer which expanded the Dealer Services business internationally. The Dealer Management Service, or DMS, industry will continue to have steady growth in North America and Western Europe. The largest, long-term growth potential, however, is in the Chinese automotive market. The growing economy and shift from institutional vehicle purchases to individual purchases are the primary reasons for a need to increase ADP’s DMS presence in China.

“China’s auto demand is expected to rise to 10 million in 2010, second only to North America,” says Zhang Xiaoqiang, Vice Minister of the State Development and Reform Commission [40].

Currently, the automotive market in China is around 2 million vehicles per year. Thus the projections of the Chinese government equate to 20-30% growth over the next several years [41].

The automotive growth in China also lends to growth in the DMS industry because the Chinese auto market is switching from an institutional sellers market to an individual consumer buyers market [42]. The switch in customer base will put an increased need for dealerships to provide more personalized and generally better customer service. DMS systems can help dealerships manage their business more effectively while focusing more time on building their customer base and nurturing customer relationships. ADP clearly has a focus on the growing Chinese automotive market with its recent announcement with BMW of China [43]. Building on that, ADP needs to continue to focus resources and energy on the great opportunity China’s automotive market provides.

Endnotes

[1] http://www.adp.com/employer_services_overview.asp?iid=EFI0483

[2] Kanarkowski, Edward J., ADP 50th Anniversary Book, Automatic Data Processing, Inc., 1999.

[3] http://www.adp.com/employer_services_overview.asp?iid=EFI0483

[4] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[5] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[6] ADP, 50th Anniversary : 1949 – 1999, p.5. p. 14

[7] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[8] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 8.

[9] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 5.

[10] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[11] ADP, Focus on growth : 2006 summary annual report, 2006. http://www.investquest.com/iq/a/adp/fin/annual/index.htm

[12] ADP, 50th Anniversary : 1949 – 1999, http://www.investquest.com/iq/a/adp/main/archives/anniversary.htm

[13] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 6.

[14] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 6

[15] ADP, 50th Anniversary : 1949 – 1999, p.5. p. 30., http://www.investquest.com/iq/a/adp/main/archives/anniversary.htm

[16] Rubel, Brian, Sales Executive, ADP NAS, 25 February 2007 (verbal conversation)

[17] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[18] ADP, 50th Anniversary : 1949 – 1999, p.5. p. 30

[19] Paychex 2006 10k report……………………………..

[20]ADP, 50th Anniversary : 1949 – 1999, p.43 http://www.investquest.com/iq/a/adp/main/archives/anniversary.htm

[21] Rubel, Brian, Sales Executive, ADP NAS, 25 February 2007 (verbal conversation)

[22] Secord, Greg, VP of Marketing, ADP NAS, 30 March 2007 (verbal conversation)

[23] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 6

[24] http://www.investquest.com/iq/a/adp/main/archives/adp031406analyst.pdf

[25] http://www.investquest.com/iq/a/adp/main/archives/adp031406analyst.pdf

[26] http://www.adp.com/about_philosophy.asp#strengths

[27] Simon, Ellen “ADP chief looks at expansion, not acquisition” ASSOCIATED PRESS (7 March 2007)

[28] Gelfand, Andrew “ADP Seen Holding Off Competition With ProBusiness Buy” Dow Jones News Service (6  January 2003) :Factiva

[29] Kisiel, Ralph “Reynolds, ADP aim for European growth” Automotive News Europe Volume 11; Nbr 3 (6 February 2006) :Factiva

[30] Jackson, Kathy “Dealer software market is booming; Multibranding boosts demand for dealership management programs” Automotive News Europe, Volume 11; Number 21 (16 October 2006) :Factiva

[31] ADP Annual Financial Analyst Conference Call Presentation. March 22, 2007

[32] Taulli ,Tom “ADP Tries Getting Even Better” Motley Fool  (November 2, 2006) Accessed 4/14/07 <http://www.fool.com/investing/general/2006/11/02/adp-tries-getting-even-better.aspx.

[33] http://www.adp.com/about_philosophy.asp, “OUR BUSINESS CULTURE”

[34] Automatic Data Processing, Inc. Company Profile, DataMonitor, p. 6

[35] http://www.adp.com/about_philosophy.asp, “ORGANIZATIONAL STRUCTURE”

[36] Automatic Data Processing, Inc. Annual Financial Analyst Conference, “Strategic Growth Program”, Slide 16, March 22, 2007

[37] Notes from meeting with ADP executive on 3/30/07

[38] ADP. (2007). 2006 Annual Report. Retrieved March 24th, 2007 from http://www.investquest.com/iq/a/adp/fin/annual/index.htm

[39] Gordon, Benjamin and Gordon, Matt, “The PEO Industry in Transition,” HRO Today, June 2006.

[40] Gluckman, Ron, “Shifting into High Gear,” The Silk Road, April 2004

[41] Lienert, Dan. “The Rising Chinese Auto Market,’Forbes.com, December 2003.

[42] Hemerling, Jim, Jin, David, and Chen, Forrest, “Winning in Today’s Chinese Automotive Market,” The Boston Consulting Group, June 2005

[43] ADP. (2007). ADP Press Release. “ADP Announces Major Contract With BMW China Automotive,” February 2007.

Michael Porter’s Generic Cost Leadership Strategy Explained

Preface:

Back when I was a heads down developer analyst working at General Motors, my mindset was completely focused on being a data expert and techie. At the time I did not have a broader understanding of business concepts and business strategies. Thus, I considered myself a “one dimensional” resource (a very competent one dimensional resource but one dimensional nonetheless). I set out to remedy my blind spots by acquiring business knowledge so I would have an understanding of broader concepts, become less myopic, and position myself favorably in the marketplace against other one dimensional techies (like myself at that time).

Subsequently, it was in business school where I first learned of American academic Dr. Michael E. Porter of Harvard Business School fame. Mr. Porter is regarded as the preeminent thought leader in the area of business strategy and competitiveness.

Generic Competitive Strategies:

I found value in studying and discussing Porter’s framework that defined generic competitive strategies. A generic competitive strategy is a business level strategy that companies adopt in order to obtain a competitive advantage. The strategies are termed generic because they can be pursued by any and every company across a range of industries. The three primary strategies employed in the framework are:

Cost Leadership (low cost structure, e.g. Wal-Mart, Dell, Southwest Airlines)
Differentiation (offering unique product and services for a premium, e.g. Apple, BMW, Starbucks)
Focus (limiting scope to narrow market segments, e.g. local restaurant or local service provider)

michael_porters_three_generic_strategies-svg

These three strategies help contextualize how businesses aim to obtain profits in their respective marketplaces; they also help businesses understand how they can seek new opportunities for advantage. Porter originally emphasized that a company should target only one of the strategies in the framework or risk paying a “straddling penalty” (a la the doomed airline offshoot Continental Lite). Porter later softened his stance in this regard recognizing the benefits of a hybrid approach in some cases.

Cost Leadership Strategy:

This post focuses on cost leadership because it’s the strategy that relates tangentially to IT and the concept of globalization. As IT workers are aware, the forces of globalization have no mercy in their enablement of companies to offshore work in an attempt to lower costs. This outsourcing of IT work to offshore firms is happening at organizations such as Disney, the University of California and [Insert Any Bank Name Here]. Obviously not all technology related offshoring is done in order to focus on a cost leadership strategy but the activity’s initial intent is to lower a firm’s IT cost structure (refer to my post on how IT has to do a better job communicating its value).

Returning to the main point, the cost leadership strategy is employed when a company aims to be the lowest cost producer in the market. Strategic managers in the organization make a concerted effort to lower business costs in order to achieve a competitive advantage. A lower cost structure enables a business to reap higher than average profitability.

Businesses attempting to implement this strategy may aim to increase inventory turnover, lower their wage expenses and/or manufacturing costs, gain bargaining power over suppliers, develop distinctive competencies in logistics, develop low cost distribution channels or any combination thereof. As an aside, I could prattle on ad-nauseam about Wal-Mart and how its technological capabilities provided the organization significant advantages (and I have here: Part 1, Part 2 and Part 3).

Advantages:

When the cost leader and another company decide to compete in the same price range for the same customers, the cost leader will have the inherent advantage because it will reap higher profits due to its lower cost structure. The cost leader will be able to weather the “price war” due to its lower cost structure advantage.

“The cost leader chooses a low to moderate level of product differentiation relative to its competitors. Differentiation is expensive; the more a company expends resources to make its products distinct, the more its costs rise. The cost leader aims for a level of differentiation obtainable at a low cost. Wal-Mart, for example does not spend hundreds of millions of dollars on store design to create an attractive shopping experience as chains like Macy’s, Dillard’s, or Saks Fifth Avenue have done.” [1]

The cost leader also positions its products to appeal to the “average customer”. The aim is to provide the least number of products desired by the highest number of customers. Although customers may not find exactly what they are seeking, they are attracted to the lower prices [1].

Disadvantages:

Since the strategy involves providing the lowest costs, companies must strive for a large market share when employing this strategy. The cost leadership strategy has been linked to lower customer brand loyalty which in turn means that customers can be swayed by lower priced substitutes from other competitors.

Additionally, as technological change enters the marketplace, new competitors can attack cost leaders through innovation thus nullifying the cost leader’s accumulated advantages. For example, Amazon has accumulated substantial knowledge and proficiencies in the online e-tail space and has placed Wal-Mart on the defensive in this arena as Wal-Mart’s expertise is tailored to its brick and mortar assets.

Or as foretold in Porter-speak back in his 1996 HBR article “What is Strategy”,

“A company may have to change its strategy if there are major structural changes in its industry. In fact, new strategic positions often arise because of industry changes and new entrants unencumbered by history often can exploit them more easily.” [2]

References:

[1] Hill, Charles. W. L., & Jones, Gareth. R. (2007). Strategic Management Theory. Houghton Mifflin Company

[2] Porter, M. E. “What Is Strategy?” Harvard Business Review 74, no. 6 (November–December 1996): 61–78.

Header Image Copyright: olivier26 / 123RF Stock Photo</a>

Diagram Image By Denis Fadeev – Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=32434551

More Than You Want to Know About State Street Bank’s Technology Strategy Part 1

Introduction:

In November of 2010, Investment Management firm State Street Bank publicly announced an overall transformation of its technology infrastructure. State Street is a massively sized transaction services provider to both mutual and pension fund managers. The custodian bank holds $23 trillion in investor accounts in 29 countries around the world. In an organization with a massive store of data (most of it subjected to regulatory oversight), enterprise wide data conformity and accessibility is a challenge.

In a case of business strategy/need influencing information technology strategy, State Street’s COO in 2009 (Jay Hooley) wanted to help an institutional client calculate its exposure to a particular market. The information request was highly urgent given the financial consequences of late reactions during the great recession. “Getting the numbers turned into a painful exercise as State Street’s middle- and front-office staffers reconciled disparate data sets housed in different client systems and in nine of State Street’s 29 global locations” (Fest 2013). This failure to deliver for the client in an instantaneous manner spurred Hooley to call upon his information technology leadership to present a strategy to address this business need. The result of the IT leadership planning effort was the idea to move the bank’s diverse legacy infrastructure to a more standardized and nimble cloud computing architecture.

State Street: Strategy for Technology Infrastructure:

Former State Street CIO Chris Perretta, who as of 2016 holds a similar position at MUFG America’s Holdings Corporation, spent a considerable amount of time evangelizing the benefits of cloud computing to both the business and the bank’s board members. In its early stages, the technology vision resulting from the COO’s planning request was to position an updated infrastructure as a competitive advantage for the business in terms of cost savings, automation, and future development efficiency. Furthermore, the updated infrastructure could be an enabler of new product revenue streams. It should be noted that a shift to the cloud for a financial organization the size of State Street was unusual. “Too Big to Fail” sized banks are not typically known for their innovative technology development. Derisively, the bank has been known as “Staid Street” for its conservative manner. Within financial services, innovation is usually the domain of smaller, nimbler “fintech” startups looking for scalability and speed to market.

From an infrastructure perspective, State Street embarked upon migrating from disparate legacy data centers running proprietary Unix servers to a standardized cloud architecture based upon commoditized x86 servers running Linux. The initial cloud service was built from a Massachusetts based disaster recovery center and the bank currently has six major data centers in the U.S., Europe and Asia along with three backup facilities (Brodkin, 2011). In addition to the rollout of virtualization capabilities and distributed database functionality, Perretta states, “New tools for provisioning, change control, load balancing, a common security framework and various types of instrumentation to enable multi-tenant infrastructures are all part of the mix” (Brodkin, 2011).

Traditionally State Street has relied upon the “build rather than buy” approach as it builds customized software (development traditionally accounting for ~20%-25% of annual IT budget) to meet its needs (CMP TechWeb, 2012). The standardized cloud platform now enables developers to reuse code for future development which can shorten project timeframes.

State Street: Strategy for IT Capability & Staffing:

State Street’s IT organizational structure can be characterized as federalism. With the federalist approach, the organization gains the benefit of having centralized leadership and vision at the “top of the house”, yet allows decentralized co-located IT groups to remain responsive to their respective divisions. As described by former CIO Perretta, “We line up delivery capacity with each unit, and each CIO is responsible for delivering business services to that unit” (MacSweeney, 2009). For example, The CIO has a direct report on the ground in China where the company operates a subsidiary (State Street Technology Zhejiang Co). Furthermore, the bank is tolerant of “skunk works” style projects that organically develop in different IT divisions throughout the enterprise (MacSweeny, 2009).

On the centralized side of the federalist equation, the bank operates a shared services group that is responsible for technical necessities distributed throughout the enterprise (i.e. security, information and communications). This federalized approach makes sense for a sprawling organization that is comprised of disparate business operations across its custodian bank, investment management, investment research and global divisions.

With the introduction of the cloud infrastructure at State Street, the technology staffing vision is to acquire individuals with architectural knowledge who can think “big picture” yet are able to wallow in the details as necessary. The bank employs a chief architect whose aim is to drive technology innovation that leads to strategies that will impact the business in an advantageous manner. Perretta states, “We don’t use him to manage projects; we use him to come up with the ideas that make sense for our business community. Now he does those pilots, and then we industrialize them for the rest of the organization” (Tucci, 2011).

To be continued in Part 2 and Part 3 where I address additional areas such as:

  • Strategy for Information Risk & Security
  • Strategy for Stakeholder Requirements, Testing & Training/Support
  • Project ROI and Key Success Measures
  • Strategy for Data Acquisition and Impact on Business Processes
  • Strategy for Social Media/Web Presence
  • Strategy for Organizational Change Management, Project Strategy and Complexity

References:

Brodken, J. (April, 14, 2011). State Street modernizing with cloud, Linux technologies; Virtualization, open source drive cloud project at State Street. Network World Fusion. Retrieved from Factiva 6/19/2016

CMP TechWeb. (June, 25, 2012). State Street Private Cloud: $600 Million Savings Goal. Retrieved from Factiva 6/19/2016

Fest, G. (January 1, 2013). State Street’s Dig (Data); Championed by CEO Jay Hooley, boston-based state street is remapping a huge technology infrastructure to reap the benefits of the cloud and big data. American Banker Magazine. Vol.123, No.1. Retrieved from Factiva

MacSweeney, G. (August, 1, 2009). Serious Innovation; CIO Christopher Perretta supports all of State Street’s IT needs by mixing new technologies and rapid development and even encouraging ‘skunk works’ experimentation when appropriate. Wall Street & Technology. Retrieved from Factiva

Tucci. L. (July, 2011). In search of speed, State Street’s CIO builds a private cloud. Retrieved from http://searchcio.techtarget.com/podcast/In-search-of-speed-State-Streets-CIO-builds-a-private-cloud

Photo courtesy of DAVID L. RYAN/GLOBE STAFF

Enterprise Risk Management at Microsoft

This is a brief writeup from an Enterprise Risk Management class that I took back in 2013. The case describes Microsoft from the mid to late 90’s and its efforts to implement an Enterprise Risk Management group. The case mentions former head of treasury Brent Callinicos, who went on to become a regional CFO at Microsoft and the CFO for Uber.

For those who are interested in the case details, check out “Making Enterprise Risk Management Pay Off: How Leading Companies Implement Risk Management” by Thomas L. Barton, William G. Shenkir & Paul L. Walker.

Introduction

Historically, the technology sector has always been subjected to swift, rapid changes. Microsoft has always tried to anticipate new threats and technology advances (i.e. dealing with both existing risks and unanticipated risks). Back in the late 1990’s, technological changes due to the rise of the internet provided Microsoft a different landscape from the historical era of the unconnected, standalone PC. In Microsoft’s 1999 annual report, the first item discussed under “issues and uncertainties” is “rapid technological change and competition”[1].

Additionally as the mid 90’s era Microsoft launched new products, it also ventured into new business models. The launch of Expedia in 1996 positioned Microsoft as a player in the travel agency business and its Home Advisor product made the company a licensed mortgage broker. These novel business models exposed the organization to a new set of risks, which in-turn exposed the risk management group to new challenges.

Moving to an Enterprise-wide Risk Management Approach

Microsoft has always competed in a very competitive landscape replete with technologically savvy competitors and condensing product life cycles. As a result, an enterprise wide commitment to risk management was a necessary and prudent choice to remain competitive in the company’s markets.

The momentum that triggered a more enterprise wide view of risks at the company was the establishment of the risk management group in 1997. Prior to 1997, there was no such group to start the process of implementing an ERM framework. Within the treasury group, the risk management group head Brent Callinicos (also notably the eventual CFO of Uber) set out to develop a consolidated risk identification, measurement and management approach.

The treasury group started with finance risk management changes by increasing the complexity and effectiveness of VAR analyses. Furthermore, treasury presented a paper to the finance committee of the board of directors that analyzed the derivative losses of several major companies. This report precipitated a more integrated approach to the various financial risks handled within treasury. The creation of Gibraltar (a treasury information system) allowed the company to view all of its risks “holistically rather than on a silo basis” [1].

From a business risk perspective, the risk management group worked closely with business unit managers in order to develop risk-financing plans and to aid business units with appropriate quantitative risk modeling. This evangelist approach was an effective method for gaining buy-in regarding the risk management group’s aims.

Microsoft’s Enterprise Risk Management Structure

Microsoft’s risk management group is nestled within the treasury function of the organization. The leader of the risk management group is the corporate treasurer who reports directly to the CFO. Treasury manages somewhere in the neighborhood of $80 billion for the software company [2]. Business risk is divided into worldwide products, worldwide sales & support and worldwide operations. The company does not have a CRO as it decided that a CRO would not be practical.

In my opinion, I believe that Microsoft housed their risk management under the treasury function because they viewed a standalone risk organization under a CRO as duplicative. Treasurers concentrate primarily on managing financial risks but by nature must also be generalists with respect to many types of risk. In a multinational technology company such as Microsoft, various market currency risks exist that require appropriate anticipation and response.

Microsoft is inherently technologically driven. The company has very smart, knowledgeable people naturally embedded into its lines of business. These smart people understand the risks of their technological products and desire to see these products succeed. To the benefit of the organization, the embedded personnel have an inherently risk minded mentality. Therefore the job of the risk management group is to partner with and support the lines of business and various operations groups by adding “incremental value”; i.e. information that the business units may not have considered.

“Microsoft is first run by the product group, then maybe by sales, and finance and risk management will come after that. The risk management group or treasury group will not run the company”[1].

Microsoft previously looked at risk in separate silos. In order to look at risk holistically, the risk management group had to step back and take a strategic assessment, which is a much more challenging endeavor. With this holistic approach, the grouping or correlation of risks are considered as opposed to dealing with one specific risk at a time. For example, Microsoft considered property insurance as the legacy best way to manage the risk of building damage in an earthquake. With a new scenario analysis approach employed by the risk management group, additional risks must be considered that are correlated to property damage. This new correlation mentality required partnering with multiple areas of the company to incorporate additional risks for an appropriate risk assessment.

Use of Scenario Analysis

Scenario analysis is used to understand the risks with respect to situations where it is very hard to quantify or measure the precise impact to the organization. Sequences of events regarding severe earthquake damage or severe shocks to the stock market are risks that are difficult to quantitatively measure and thus scenario-based tactics are applicable to try and gauge the fallout. Additionally, Microsoft uses scenario analysis to conduct stress testing which consider hard to measure impacts of political and geographic circumstances. An order of magnitude approach is used in scenario analysis as opposed to an exact measurement approach. Microsoft uses qualitative language such as, “..the quantification of business risks is not exact…”  and , “Does this feel about right for this risk” in their scenario analyses.

Once the risk management group has identified the risks associated with each scenario, it then partners with other business units to understand impacts. The risk group will also investigate other external organizations that have experienced similar events in order to learn how these organizations weathered their experiences.

The Main Benefits of Enterprise Risk Management

One substantial benefit for Microsoft in moving to an ERM approach is that the company can view and assess its risks holistically as opposed to assessing risks in an independent/uncorrelated fashion. This is evident in initiatives such as the company’s Gibraltar treasury system which provides an aggregated view of market risks.

Another benefit is that the risk management group works across the organizational footprint and can provide input to various groups so that each group can “stay current on what is happening in the business” [1]. The risk management group can diffuse information across the organization by working closely with business unit managers. Face time with product and operations managers allows the risk group to understand risks across the enterprise which contributes to a holistic understanding.

This approach is mutually beneficial for both groups as the risk group gains understanding of new risks (continuous cataloging of risks) and the business units gain insight into risks they may not have previously considered.

“By having the business units educate us on the intricate details of their business, the risk management group can be aware of perhaps 90 percent of the risks facing Microsoft”[1].

Closing Thoughts

At Microsoft, the risk management group doesn’t necessarily have to posses the all-encompassing best risk solution for every line of business. Risk management considers the product managers and the respective lines of business as the most knowledgeable sources of risk within their own domains. The risk group is on hand to provide additional insight for incremental improvement and to enhance or build upon the risk knowledge already contained within the lines of business.

This approach makes sense for a technology company that is teeming with very risk aware and knowledgeable personnel at the operational levels who are designing or working with complex products.

In my work experience at a traditional bank, the risk group was assumed to have the best procedures, templates and analyses with respect to handling credit, market and operating risks.  From Microsoft I have learned that highly efficient and capable risk management can also be a synthesis of understandings from risk management proper and the lines of business.

References:

[1] Barton,T., Shenkir,W., Walker, P. (2002). Making Enterprise Risk Management Pay Off.

[2] Groenfeldt, T.  (Nov, 2013). Microsoft Treasury Wins Best Risk Management Award. Forbes. http://www.forbes.com/sites/tomgroenfeldt/2013/11/19/microsoft-treasury-wins-best-risk-management-award/#4fcade2124ed

Copyright: mrincredible / 123RF Stock Photo

More Than You Want to Know About Wal-Mart’s Technology Strategy Part 3

This article is the final piece and a continuation of my earlier analyses (Part 1, Part 2) where I waded into Wal-Mart’s strategy for information risk & security, stakeholder requirements and project ROI. Whether you love or hate Wal-Mart, no one can argue that historically the organization has been highly innovative, effective and efficient. In this third part of my three part series I will broach the company’s strategy for data acquisition, social media, and project execution.

Wal-Mart: Strategy for Data Acquisition and Impact on Business Processes:

Wal-Mart has always been on the forefront of how an organization acquires, handles and shares data with internal and external parties. The company’s information technology spans across their 11,500 stores operating under 63 banners in 28 countries and e-Commerce websites in 11 countries (Wal-Mart Stores, Inc, 2015). This diverse assortment of digital and traditional brick and mortar assets services 260 million customers. The company’s sprawling POS system must remain highly operable and robust enough to harvest daily sales data across its global footprint. In order to accommodate data from a substantial customer base of millions of shoppers, the company must have the requisite back end storage infrastructure. As of 2015, Wal-Mart is embarking on a plan to build a massive private cloud which is expected to make 40 petabytes of data available everyday (Buvat et al., 2015). From a strategic standpoint the in-house cloud build-out makes sense, as employing Amazon Web Services would be making the company reliant on a key competitor’s technology offering to house sensitive data.

The data acquired from its POS systems allows the company to better allocate its product mix in real time. For example, on “Black Friday”, which is typically the busiest shopping day of the year, the company’s buyers mine the day’s sales data as early as 6am on the East Coast in order to optimize the company’s product offerings for the day (Sullivan, 2004).

From a data acquisition perspective, Wal-Mart pioneered the use of bar code scanners. The usage of scanners and Universal Product Codes was not just to register the price and make the cashier’s job of processing customers faster (as its early competitors had used the technology); Wal-Mart realized that bar codes enabled the company to determine where and how sales were made. In order to link POS, inventory and supply chain management data together with headquarters, the company invested in its own personal satellite system in 1984 (Sherman, 2013). This investment impacted in-store business processes as analytics could be run against purchase data to determine customer market basket mix and product to product correlations. Being on the forefront of purchasing data analytics allowed the company to more effectively place products in-stores that customers demanded.

This information linkage enabled by Wal-Mart’s satellite investment also led to profound business practice impacts with respect to its supply chain management process. As mentioned earlier in this analysis, with the development of Retail Link, Wal-Mart led the industry by providing first P&G and then the rest of its supplier network with direct visibility to real time store-shelf data. This was a highly innovative move as suppliers and internal buyers could work together on “forecasting, planning, producing, and shipping products as needed” (Sherman 2013). Enabled by its new technology system, the data sharing of information between supplier partners allowed those suppliers to manage inventory at Wal-Mart stores with a more comprehensive understanding of product demand, while Wal-Mart benefited from lower inventory storage costs.

Wal-Mart: Strategy for Social Media/Web Presence:

Wal-Mart operates e-commerce web presences across 11 different countries. Although it is by far the biggest brick and mortar retailer in the world, it has struggled to compete with online “e-tail”, competitors such as Amazon and Target. Updating its digital know-how and refreshing its digital properties will be a requirement in order to keep pace in a shifting industry dynamic. To this end, Wal-Mart has embarked upon a number of strategies to keep itself relevant and enhance its digital capabilities. The company is leveraging its web properties to not only analyze purchasing behavior but also review customer search histories and customer social media interactions. The latter activities are aimed at boosting its online sales and predicting customer demand for its brick and mortar locations.

“Teams at WalmartLabs use visualization techniques to analyze social activity to capture insights that may indicate changes in product demand. Walmart can then use these insights to stock extra inventory at locations where it expects higher demand and reduce it from locations with lower demand” (Buvat et al., 2015).

Wal-Mart has also embarked upon a strategy of purchasing startup companies with the intention of adding to the retailer’s knowledge in the mobile, analytics and social media realm. The retailer purchased a company called Kosmix, whose founders had sold a digital company to Amazon in the late 1990’s. Kosmix is a social media data aggregator which analyzes data from Twitter and other social networks with the aim of helping the company understand the relationship between customers and products. Shortly after the Kosmix acquisition, a small team at @WalmartLabs prototyped a new search capability code-named “Polaris”. Polaris helps to determines customer intent when embedded within Walmart.com. “As a result, if a user types in the word ‘denim’, it returns results on ‘jeans’ while ‘chlorine tablets’ returns results related to pool equipment (Ribiero, 2012). Within 9 months the prototype was production ready as it replaced an Oracle based product (Endeca) whose search functionality was simply keyword based. The company claims that it sees a 10% – 15% boost in shoppers completing a purchase using the Polaris search algorithm.

One recent splashy acquisition in the e-tail space involved Wal-Mart’s purchase of Jet.com for 3 billion in cash. Wal-Mart realizes that customer preferences have shifted to the online retailer space while Wal-Mart has a substantial legacy footprint in brick and mortar locations. According to the Wall Street Journal, “The retailer gains access to a larger group of young, wealthy, urban shoppers through Jet” (Nassau, 2016). The company also gains access to a startup minded employee talent base, startup executive experience and Jet.com’s proprietary pricing software and customer data.

Additional social project activities employed by Wal-Mart include adding a ratings review capability to its products on Walmart.com and a partnership with Facebook to offer individual pages for each of the retailer’s 3,500 stores. The company has also used the hashtag #lovedata to appeal to potential technology hires.

From an employee social engagement perspective, Wal-Mart developed an internal web site called mywalmart.com with the aim of developing an employee social media community where employees are allowed to blog and answer questions related to the company. Roughly 75% of the company’s 1.4 million U.S. based associates log on to the site (Tuttle, 2010). This effort required integrating multiple disparate websites running on different web platforms (for example payroll and benefits sites).

It should be noted that although the company is taking positive steps in the social media space, its initial attempts in the early 2000’s were clumsily executed. “Its Walmarting Across America blog in 2006, about two Wal-Mart enthusiasts traveling around the U.S. in an RV, was revealed to be less than authentic when it was learned that Wal-Mart paid for the flights, the RV and the gas of the two protagonists. ‘The Hub,’ a MySpace-like clone, closed in October 2006, just 10 weeks after it launched, while a Wal-Mart sponsored Facebook group reportedly had lackluster results” (Edelson & Karr, 2011).

Wal-Mart: Strategy for Organizational Change Management, Project Strategy and Complexity:

Best practice project management principles for handling complexity include implementing risk management practices and analyzing project risk/rewards. This series has already addressed Wal-Mart’s heavy reliance on ROI as a measure of project success. But Wal-Mart also has the advantage of running a common information systems platform for its global operations. This has allowed the company to offset the higher costs of developing in-house systems by building a system once and then rolling it out along with the respective business processes enterprise wide.

The company also lowers IT project complexity by closely examining the current process that the system is supposed to improve. This activity has been described by former CIO Kevin Turner as “eliminate before we automate”.

“Eliminate steps, processes, reports, keystrokes; eliminate any activity that you possibly can for two reasons: One, you’ll end up building a whole lot better system that’s easier to support, and two, invariably you will have a better solution that’s more [user] friendly” (Lundberg, 2002).

Once the system is built, then a piloting phase occurs amongst the stores, distribution centers and customers that will present the most challenges. If the challenges are caught and addressed by pilot builds in the most trying situations, then installing at less challenging locations should experience minimal interruptions.

From an Enterprise Risk Management standpoint Wal-Mart uses a 5 step process that allows its ERM group to work with the business to mitigate many of the risks that the company faces. “The five-step ERM process involves: 1. risk identification, 2. risk mitigation, 3. action planning, 4. performance metrics, and 5. shareholder value” (Atkinson, 2003).

An additional project strategy is to funnel all IT projects through the central IT office with a single enterprise-wide portfolio overseen directly by the CIO. King (2014) asserts that objectively ranking projects by using an automated spreadsheet tool helps to eliminates politically-driven decisions. Resources are assigned to projects based upon criticality and available funds. When available employees and funds are exhausted for the quarter, remaining projects on the list do not make the cut. Technology resources are asked to remain flexible as they rotate to different jobs within the company to gain additional skills. The flexibility of IT resources is a boon to change management plans as resources can be swapped out without minimal interruption to the overall project plan.

In case you missed something, make sure to revisit Part 1 & Part 2 of the series.

If you’re interested in Business Intelligence & Tableau check out my videos here: Anthony B. Smoak

References:

Atkinson, W. (December, 1, 2003). Enterprise Risk Management at Wal-Mart. Risk Management. Retrieved from Factiva.

Buvat, J., Khadikar, A., KVJ, S. (2015). Walmart: Where Digital Meets Physical. Capgemini Consulting. Retrieved from https://www.capgemini-consulting.com/walmart-where-digital-meets-physical

Edelson, S., & Karr, A. (April, 19, 2011). Wal-Mart to Buy Kosmix. Retrieved from Factiva.

King, R. (October 2014). Wal-Mart Becomes Agile But Finds Some Limits. Dow Jones Institutional News. Retrieved from Factiva

Lundberg. A. (July 1, 2002). Wal-Mart: IT Inside the World’s Biggest Company. CIO magazine. Retrieved from http://www.cio.com/article/2440726/it-organization/wal-mart–it-inside-the-world-s-biggest-company.html?page=2

Nassau, Sarah (2016). Wal-Mart to Acquire Jet.com for $3.3 Billion in Cash, Stock. Wall Street Journal http://www.wsj.com/articles/wal-mart-to-acquire-jet-com-for-3-3-billion-in-cash-stock-1470659763

Sherman, Richard J.. ( © 2013). Supply chain transformation: practical roadmap to best practice results. [Books24x7 version] Available from http://common.books24x7.com.libezproxy2.syr.edu/toc.aspx?bookid=49746.

Ribeiro, J. (August 31, 2012). Walmart rolls out semantic search engine, sees business boost. Retrieved from http://www.computerworld.com/article/2491897/internet/walmart-rolls-out-semantic-search-engine–sees-business-boost.html

Sullivan, L. (September 24, 2004). Wal-Mart’s Way: Heavyweight retailer looks inward to stay innovative in business technology. Retrieved 6/17/16 from http://www.informationweek.com/wal-marts-way/d/d-id/1027448?

Tuttle, D. (February, 17, 2010). Wal-Mart’s social media community earns accolades. Retrieved 6/17/16 from Factiva

WAL-MART STORES, INC. (January 31, 2016). FORM 10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/104169/000010416915000011/wmtform10-kx13115.htm

Photo Copyright: dutourdumonde / 123RF Stock Photo