A Warning About Forecasting

Just this week I had the privilege of discussing my economic outlook for the industry in a special WhatTheyThink.com webinar sponsored by Printcafe. In the process of developing that forecast I kept thinking about my pre-WTT newsletter of June 2002, where I asked the question: "Is survivor bias distorting industry research and economic data?"

It seemed to be the appropriate time to revisit this issue, but first let me summarize what "survivor bias" is: mistaking the characteristics of a part as being fully representative of a whole and ignoring how things got that way. Basically, it's the sin of ignoring history. Here's the example I used last year.

Assume that there are three printing companies in a geographic area, all with the same sales volume, but one is healthy, one is okay, and one is very sick.

Healthy printer's sales volume: 100
Okay printer's sales volume: 100
Sick printer's sales volume: 100
Total market: 300

Next, assume that there is a decline in total market volume and that sales in the market drop to 250 from the original 300. What happens?

Healthy printer's sales volume: 100
Okay printer's sales volume: 90
Sick printer's sales volume: 60
Total market: 250

Because the market changed, the sick printer can't cover costs and goes out of business. The market is reallocated between the two remaining printers.

Healthy printer's sales volume: 130
Okay printer's sales volume: 120
Sick printer's sales volume: 0
Total market: 250

This is "survivor bias" in action. The healthy printer's sales volume is up 30%, and the okay printer's volume is up 20%. Yet the market decreased in size by about 17%. So if one were researching the market, it might very well be concluded that business is great up, 20-30%. By assuming a growing market, they might start to gear up to sell to more establishments, add more products, etc., blind to the trends that are really shaping the market.

This is why it is very important to always be skeptical of press releases, pronouncements and survey-based economic data that lack both a "top-down" and "bottom-up" context. If you don't, you miss the subtleties of a marketplace that allow you to identify opportunities and allocate resources efficiently.

This is particularly critical in the current economic situation. The economy is growing and the printing business is not, but there are signs that the decline is slowing. I believe, as I said in the webinar, that we are in for a short-term upturn. But to hear some industry pundits, one would start to think that the business was in for a massive explosion in print volume and capital investment. Well, it is, if the only ones you talk to are survivor firms. The industry will still be investing in amounts in its historical ranges, between about 3.5%-4.5% of shipments. And if the total shipments are lower, wellyou can do the math as well as I can.

Just remember this: the healthy companies are the ones who drive the business, buy new technologies, and deliver innovative services. And they will be in a smaller industry without weak competitors who were not slayed by economic forces, but by their own inability to navigate them effectively. The surviving companies' investments and operations will be quite different than they would be if industry was structured as it was in 1995 and 1985, and so on. It's a vastly different business, and you can only understand how different with the context of history.

Forecasting is tough right now when you have to decide if you're at an inflection point or just will be getting more of the same. And unless you do the top-down, bottom-up analysis, you can't get a sense of that, nor can you understand the magnitude of the directional shift, if there is one.

As managers, make sure you are not operating on the gut feel of the last thing you heard. That creates the kinds of strategies that reflect a gnat's attention span. Be judicious and be deliberative. Make sure you have the whole story as best as it can be gotten. And then act.

Creo's Plate Foray

I have been asked what I thought about Creo's recent announcement relative to plate manufacturing by a number of people. Rather than discuss Creo's news directly, I wanted to make a general comment about the strategy of capital equipment suppliers and of consumables businesses.

It should be noted that the copier business ended up being built in the opposite direction, and we see the effect of that today, even in desktop ink jet printers. Because of lack of interest in copiers when they first came to market, manufacturers shifted the margins to the supplies. One of the reasons they could do that was that most of their supplies had to be optimized for the peculiarities of individual machines, thus leading to their ability to retain control of the consumables, at least until a given product reached maturity, and sometimes throughout the life of the product.

A very big problem in strategy is the lack of recognition of the different natures of management required in high-uncertainty businesses as compared to those with low uncertainty. The capital equipment business has a high degree of risk, is more subject to economic fluctuation, and is subject to many forces beyond managerial control (such as financial markets, interest rates, etc.). It is a high uncertainty business (except for its parts and maintenance revenues in most cases). The supplies business is viewed as one with greater certainty, less subject to severe ups and downs, and much easier to predict and manage than a capital investment business.

I have never been in a capital equipment business that did not view supplies manufacturers with great envy. I have never been in a supplies business that did not look at capital equipment manufacturers with that same level of envy. It often seemed that they wanted to trade places. The capital equipment business drooled at the thought of a more consistent revenue stream. The consumables business was jealous of the capital equipment business' high profit margin potential of each transaction.

As a result, inside every graphic arts capital equipment company there always seems to be a financial or accounting executive who utters something like the following every single day of their career:

"...blah blah blah... smooth out cash flow ...blah blah blah... reduce risk ...blah blah blah... get the supplies annuity ...blah blah blah... sell the razor ...blah blah blah... sell the blades ...blah blah blah..."

(The film and plate consumables business usually had someone of the same ilk muttering things like higher margins and sell direct and the like, in between the blah blah blah stuff.)

This is completely understandable. There is nothing worse than being in a capital equipment business when that business is bad. It can wear you down, and bad morale can, unfortunately, be contagious. But the opposite is certainly true; when the capital equipment business is good, it's usually incredibly stupendous.

Over the years, I have come to see that the requisite managerial skill in capital equipment companies is vastly different than the skills one would need in a supplies business, and vice versa. I have rarely seen an executive who can be successful in both arenas; the temperament needed is not the same . Most mergers and acquisitions do not work out and rarely, if ever, deliver promised ROIs, and this dichotomy is one reason why. The other reason is the diverting of management attention from working with current business problems to transition and integration issues, often leaving current business problems to fester. Stuff that was really important one day suddenly is trumped by an unforeseen crisis in an unfamiliar place.

In the 1980s, Tom Peters' and Robert Waterman's legendary In Search of Excellence book, based on their experiences at McKinsey, identified corporate characteristics that made companies great. "Stick to your knitting" was one of them. This was intended as a warning to companies to be very careful about what new ventures they got themselves into.

So what does this mean with respect to the market for plates? Another supplier. Increased supply. Lower prices. More giveaways. More customer spiffs. More dealer rebate schemes. More free processors. More delayed financing. Economics 101 all over again. Supply goes up, prices go down (and it's worse if demand goes down, too). You think the printing business has overcapacity? Then you haven't looked at the supplies business! Sounds great if you're a printer-more suppliers willing to aggressively negotiate for your business.

The industry has a long history of successful lucrative and mutually profitable OEM private label arrangements, and I was surprised to see that fail here. Obviously Creo feels the strategic need to own it and make it, rather than to just sell it.

I don't know what the future holds for Creo or for this acquisition. But I hope for their sake that this was an eyes-wide-open decision.

This is one of the often misunderstood directives of Peters and Waterman. You should stick to your knitting only if you still have yarn left, of course. I have seen companies purposely gloss over market opportunities that just present themselves, fortuitously falling in their laps, yet still turning them down.

There's a joke (that I've shortened considerably) about a husband and wife caught in a flood, ending up on the roof of their house. A rowboat comes by, and they turn down its aid. A motorboat comes by, and they do the same. A helicopter sees them and they refuse that as well. Each time, they told the rescuer that God would save them. They die and go to heaven, and upon seeing God, they ask, "How come you didn't help us?" And God says, "I sent you a rowboat, a motor boat, and a helicopter..."

Very often companies have unexpected discoveries in R&D or find themselves in fortuitous business situations that offer a nontraditional opportunity. Peters and Waterman did not say to dismiss them out of hand. What you need to do is, as Peters writes in later books, develop skunk works separate from the corporate culture, to allow new potential ventures to be developed without excessive distraction to the existing business. Or alternatively, joint venturing with an outside company or funding a new company may be a better idea.

In the case of some industry suppliers, the ball of yarn that made them great is running out. Yet they have the urge to divest themselves of new technologies that may present significant opportunities elsewhere. Be careful with your knitting. If the wool is getting low, you may have to look elsewhere. A good example is Kodak Polychrome's sale of DI presses and Xerox high-end equipment. There is a risk to doing that and there is a cultural shift that can be difficult, and I'm sure they know it. But sometimes you need to pick up a new ball of yarn when the old one is running out. That's true no matter what business you're in. Don't give away the new ball of yarn without checking the supply of old yarn first.