King of the World, Again

This week Ronald Grover, Tom Lowry and Michael White of BusinessWeek report on Avatar, the phenomenon which is not just a movie, it’s a game-changer for the entertainment industry. By now we all know that Avatar has broken box office records: it’s the highest grossing movie of all time. The movie to hold this title before was Titanic, another James Cameron film.

BusinessWeek says “Cameron is the most important commercial force in modern film, and his vision for the future of the movie business is rapidly demolishing anything that gets in its way”. Sounds like quite a vision. But Cameron is the guy who brought us Aliens, The Terminator and The Abyss, so don’t underestimate him.

Not only is the sheer magnitude of revenue impressive, but how that bucket of cash was achieved is unprecedented. The movie business will never be the same. BW points out that Titanic hit $1 billion after a few months, and it took Avatar only 17 days to reach the same milestone. And no, inflation was not the cause. What did help is ticket prices 30% higher for 3D. Cameron said, “I decided, let’s make a movie they can’t ignore”.

In spite of Cameron’s past success with so many films, Twentieth Century Fox was not about to put all its eggs into Cameron’s basket. Not when Cameron was asking so much to begin with. James Cameron has been called not just a director, but also an entrepreneur. He developed the camera that would be indispensable to the film, using his own funds. Now with other movie makers lining up to use his technology – for a fee, of course – that was his first big success with Avatar.

3D technology existed before, but not quite at the scale of Avatar. This movie proved that people will pay more to see something great, and I predict we will be seeing more. Cameron started to develop the script back in the mid 1990’s, before Titanic hit the theaters. But in the 1990s, the technology did not exist, so the six-legged creatures and blue princess had to wait.

Cameron paid $12 million of his own money to hire Vincent Pace to work on the 3D technology. BW says that Hollywood wisdom is to “never sink your own money into a movie”. But, Cameron proved conventional wisdom wrong, and came out ahead. Fox would not foot the bill for Avatar even though Cameron had proved himself to be a sure thing. Not to be deterred, Cameron went to the private equity industry (see my previous post on Private Equity 101) and persuaded two firms to invest in his gargantuan project.

Cameron worked with Jeffrey Katzenberg of DreamWorks Animation. They created an animated world and put real human characters into the dream world. BW says that rivals in the entertainment world often root against each other, but Katzenberg was a big supporter of the project.

Cameron had to agree to cut his fee in half, cut other expenses and he took a lower percentage of the film’s revenues. Given the blockbuster success, I’m sure Cameron has made up for any financial considerations he had to give up in negotiations.

Production started at Cameron’s hangar in Playa Vista, CA and word soon got out. Other directors began visiting, to see the possibilities of 3D. It is important to note that not all movies benefit from 3D. BW uses the example of a Woody Allen film not being appropriate for 3D. Yikes – Woody Allen up close on the big screen? No thanks. Some things are best in 2D.

BW points out the risk of incurring the extra cost for 3D can pay off. Vincent Pace, Cameron’s technology guy, has a “steady stream of inquiries since Avatar was released”. If you want to make a 3D movie, he’s the guy. There has been interest expressed in 3D commercials and 3D TV sports broadcasts. Now that sounds worthwhile – your favorite sport, truly happening live in your living room.

Pace and Cameron hold the patents on the 3D technology. Of course, anyone smart enough to do what they did, would know to claim a piece of future revenues. Now theater owners are investing in the capability to show 3D movies. They want a piece of the pie, too.

In short, what Cameron has done has completely changed the nature of the business. He has showed that big budget films can pay off, developed the 3D technology that will be the “in thing” for a while, and has made sure that he will be at the top of Hollywood’s A list for years to come.

The Disposable Worker

Remember the movie “The Temp”? It came out in the 90s, when the economy was booming, which seems like eons ago. This week Peter Coy, Michelle Conlin and Maria Herbst of BusinessWeek report on “how companies are making the era of the temp less than temporary”.

If you have a traditional, old-fashioned job, thank your lucky stars. What am I talking about? The sort of job where the worker is classified as an employee, with full benefits such as health insurance and a 401k, promotion opportunities, paid vacation and just maybe, an employment contract. Those jobs seem to be going the way of the Dodo bird and the 8-track tape. (Remember those? The CD and the DVD are on their way out also).

The temp is here to stay, and it just may be you some day. That job you are not enamored of may be one you miss – at least you’ll miss the 401k and paid vacation.

I’ve read plenty of reports, and most seem to predict a rebound of employment to 2005 levels sometime in 2015, 2018 or even 2019. That’s a long time, folks. If you have a newborn baby now, that child may be in the fifth grade before this country is happy about employment again. Jobs are going overseas, processes are being automated, management techniques are changing, and good ol’regulation may be to blame. BW gave the scary example that because managers are now responsible for more people, and in a more detached way, it is easier for them to conduct layoffs because they have less of a connection to the people they supervise.

Even if you are an executive, you might find yourself as a “C-level to go” after a few years. What’s that? A C-level temp, willing to take skills and services wherever needed. The CEO of Kelly Services, a staffing firm, said “We’re all temps now”. Barry Asin of Staffing Industry Analysts also says that “The idea that any job is permanent has been well proven not to be true.”

Payroll used to be a fixed cost and it is becoming more and more a variable cost. We’ve all heard of just-in-time inventory, now there is just-in-time employment. The business risk is being transferred from the employer to the employee. When bad times come, the employer doesn’t worry; the brunt will be borne by the employee.

Chronic underemployment and unemployment have a lot of victims. Older people go into early retirement and younger people have a bad start to their career. Even 15 years out of school, that head start has a lasting impact. BW reports that people who graduated in a recession earn 2.5% less than if they had graduated in prosperous times.

Yikes. What’s a salaryman or woman to do? Have highly sought-after skills, that’s what. Get educated. Be in the right industry. The poorly educated and low-skilled fare the worst in this type of system.

Are there any consequences for employers? Do they just get off scot-free? Indeed, they are stuck with an “alienated, dispirited workforce”. That can’t be good for productivity. BW says “poor morale can devastate performance”. No kidding. UBS, Credit Suisse and American Express have all hired a Harvard psychology lecturer to train employees in positive thinking. How about a little decent treatment by the employer? That could work wonders for positive thinking in any organization. Used to work in the old days. And it seems to work for companies like Google and Zappos.

But, corporate profits have been good with a lower payroll. And most of us still hold stocks of some companies.

BW talks about a “trend toward a perma-temp world”. Companies that made big changes in the recession are sticking with those changes. It’s called “taking advantage of flexibility”. Microsoft, whose stock you might not mind holding, is a champ at using temporary teams. In spite of the bad things said about Steve Ballmer (some by me) they’re doing pretty well. The quality and pay of temps is no longer limited to “the girl from the agency” who comes in to file.

BW profiles a “temp exec” who does very well inside the C-level suite, albeit on a temporary basis. BW also mentions a lawyer with an MBA who is now on his own. More fancy degrees don’t necessarily translate into “sought-after skills” which would help the employer to justify hanging onto an employee.

At the bottom of the ladder, workers get the short end of the stick – nothing much they can do. Not surprisingly, depression and other mental health problems are on the rise. I think we would all agree with that. Career problems can be a prime source of stress and anxiety, as we all know. Better buy stock in pharmaceutical companies which sell sleep aids and anti-depressant medications.

Young people are losing out in the new world, unless they want to work as an unpaid intern. Even IBM, which seems like such a stalwart, old-economy company, had 71% of its workforce outside the U.S. in 2008. In 2009, it continued to reduce its workforce in the U.S., eliminating approximately 10,000 jobs.

When will it all stop? BW says that American workers will have to “swallow hard and accept lower pay”. The not-cheery statistic is that pay for 80% of the private workforce is 9% lower than it was in 1973, adjusted for inflation. So your paycheck may be larger in nominal terms (that’s the number on your paycheck) but the real term is lower (what you can buy with it is less). Consider the fact that GM was the largest employer in 1953, and today the largest employer in the U.S. is Wal-Mart. Something tells me the current Wal-Mart hourly wages and benefits don’t quite match up to what GM workers had in 1953.

BW proposes “rapid economic growth sustained over a long period” will fix the situation. Sounds great, but don’t hold your breath waiting. Clearly we could all use an economic stimulus – where will it come from? I wouldn’t bet on buying power from China – I’ve read enough reports that claim the Chinese economy is another bubble waiting to burst. India? Brazil – maybe they are building for the Olympics? Hmm. If anyone sees growth in a sector other than bankruptcy lawyers, let me know.

As usual, the political parties are sharply divided on what to do. Conservatives think the problem is too much government spending and involvement in the economy. Liberals, led by Paul Krugman, think there hasn’t been enough spending and job programs. At this point, I’m happy to see anything that works, regardless of the political affiliation.

BW points out in Europe, traditional jobs are much harder to come by and there is much greater use of temporary and contract employees. However, the big difference is that the temps and contractors receive full benefits, courtesy of the semi-socialist governments there.

One faint hope long in the future – if you are not a baby boomer – is that yes, the baby boomers will eventually retire, and someone needs to take those jobs. And take care of the baby boomers. So if you are starting medical school now, better specialize in geriatric medicine. In the nearer future, once the economy picks up all the employees who do not feel valued by their employers(that’s a lot!) will fly the coop when a better offer comes along. In the meantime, better keep that resume fresh, save for a rainy day and improve those skills.

Why Dubai Matters

What’s going on in Dubai? The week BusinessWeek put Dubai on its cover, and subtitled, "Why It's No Mirage". On December 14, Dubai received a lifeline from its neighbor, Abu Dhabi. How did it get to the point where it needed a lifeline? In late November Dubai hit its limit: it had to reschedule payments on $26 billion of debt. BusinessWeek describes Dubai as “the most dynamic business hub in the Gulf” and “a model for its neighbors”.

Dubai is unusual in the region because it is not dependent on the energy economy and has a more open economy than its fellow emirates. It is true that Dubai must be more innovative than its neighbors; it does not have the oil and gas reserves and must find other ways to be an important economic player.

Dubai experienced a real estate boom not unlike the one in the United States. Rules were looser, prices went up and the cycle fed on itself. Dubai first let foreigners buy real estate in 2003 and the buyers streamed in.

Nakheel, a subsidiary of Dubai World, suffered the most in the economic downturn. It created the iconic palm island development seen in so many photos. Nakheel currently has approximately $21 billion in debt.

The problems in Dubai have been simmering under the surface for a while. The ruler of Dubai is Sheikh Mohammed bin Rashid Al Maktoum. Sheikh Mohammed likes to protect the image that everything is okay. But Dubai is still tightly ruled. Finances are not transparent. Apparently, no one really knew the debt picture.

In spite of this, Dubai is still tolerant of foreigners, does not tax income and has some fun amenities. Many multi-national companies have located in Dubai because of the “open culture, top-notch infrastructure and hassle-free business climate”.

Dubai is home to the Dubai International Financial Center, just a few years old. Why have the investment banks chosen to locate here? The emerging market for Islamic Financial Services, now about $1 trillion worldwide.

Companies native to Dubai are doing well also. There are real estate companies, ports and airlines. The leading private equity firm is Abraaj capital. Qatar also has a financial center. Abu Dhabi has a joint venture with GE and Saudi Arabia is trying to get into the game.

BusinessWeek says that the Emirates region has provided wealth but few jobs. This is an issue of concern because it is important to employ young people. BW reports that young people “risk being drawn toward Islamist extremism if they don’t get it (a better life)”. 

Abu Dhabi is apparently the financier of the Emirates region, but Dubai is the business center.  Dubai needs to strengthen its infrastructure and is having trouble lining up bank credit. Because of Dubai’s dependence on Abu Dhabi, it may become more conservative socially and politically and may not be so independent in its foreign policy.  If Abu Dhabi has the funds for a bailout that means the region will gravitate toward Abu Dhabi.

What does the future hold for Dubai?

Many think Dubai will land on its feet and do just fine. Many of the excesses will be tamed. Development will slow down. Dubai needs to “tighten up regulations” and “improve governance” according to BW.  A major part of Dubai’s role as a business leader is its openness to foreigners. Other countries in the region do not want foreigners. BW cites Singapore as an “inspiration” to Dubai. If that is the case, we’ll be seeing more of it in the future.

Wall Street vs. America

This week BusinessWeek reports on deals done between investment banks and local municipalities which, like so many other things in this economy, have gone bad, leaving the little guy in the lurch. The photo in the article is of an abandoned public school, indicative of the destruction these deals have wrought.

What happened? Cities, states and local municipalities have an ongoing need to raise capital to finance special projects and ongoing operations. To raise capital, they have historically issued municipal bonds, which are underwritten and sold by an investment bank. Investors like to buy these bonds because they are usually free of federal tax, are considered safe, and rated by a reputable agency. That system worked well in the past, and that’s how funds have materialized to build bridges, new roads, buildings and other large projects we need on a regular basis.

Like so many other things in the recent economy, this formerly working system changed in the past few years. Over time, investment banks have become more sophisticated about how to add fees, raise funds, and ensure something is still left for them if a deal should fall apart. The folks working in municipal governments haven’t experienced the same learning curve. During the boom, many municipalities signed on to deals which would protect the investment banks should things fall apart. The municipalities, not as sophisticated, thought good times would continue and did not think to build contingencies into their plans. BW reported on what has happened as a result of the economy going south.

Detroit as we know, is a city with more than just a few problems. Detroit last had a heyday in the sixties, and has never recovered. Recently, things have gotten even worse. Unemployment is 28%, home prices are down 39% since 2007, and they have a $300 million budget deficit, according to BW’s reporters. Not only that, they did some deals with investment banks during the boom which have returned to haunt them. When debt is issued, it is often customary for the issuer to include contingencies which require extra payments if the borrower(in this case, the city of Detroit) should have a fall in credit rating. Not surprisingly, Detroit’s credit rating dropped, and now they owe millions of dollars in extra payments to these financial firms.

Cities like Detroit are squeezed already – who isn’t? – so coming up with the extra funds would be difficult in good times, and next to impossible in bad times like this. Detroit has become a mere shadow of its former self, and basic services such as bus routes, education and even garbage pickup have been severely impacted.  Detroit has to make a $4.2 million payment to the investment banks each month, which it is paying for out of casino revenue. Consider what would happen if this shell-shocked city had those funds to spend on basic services!

How did this come to happen?

The GDP Mirage

This week Michael Mandel, chief economist at BusinessWeek, reports on “The GDP Mirage”.

What is it?

GDP is a measure of all the goods & services produced by the U.S. economy. We use it as a benchmark. The change in GDP is what we are referring to when we discuss the perennial question, “how’s the economy?”

On October 29, The Bureau of Economic Analysis reported that GDP rose 3.5% in the third quarter of 2009. That’s quite a number! Especially when you consider we haven’t seen any numbers like that since Q2 of 2007, over two years ago.

Most media outlets and pundits are reporting that the recession is over. Mandel disagrees. How dare he issue such a contrarian viewpoint when we are all looking for good news? Because he’s probably right. Mandel’s argument is that the GDP as it is currently measured fails to track intangibles which are a necessary ingredient of the economy in 2009.

The intangibles he mentions are R&D, product design and worker training. Certainly those sound important to me. We would never have gotten to this stage of development if companies hadn’t spent on these things in the past!

So, why are the companies cutting these important intangibles?