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5by5 | The Critical Path #51: Product Portfolio Theory

We cover three topics:

  1. Safety and air travel: the bases of performance that don’t get rewarded
  2. The unintended consequences of litigation: US v. Microsoft and lessons learned for Apple v. Samsung
  3. Product Portfolio theory: is focus impossible for everyone but Apple?

5by5 | The Critical Path #51: Product Portfolio Theory.

  • DesDizzy

    Hi Horace
    Just listened to latest CP. I sympathise with you getting beat up over portfolio theory. I actually have worked within financial services for over 30 years and believe portfolio theory is rubbish. Both from a risk diversification (I am a risk manager) and portfolio performance perspective. It is one of those theories beloved of academics, which bears no relationship to the real world. Historic evidence suggests that diversified portfolio’s do not beat the benchmark, so why bother, and that they are just as correlated during times of stress.

    My hero’s are Warren Buffet and Ian Posgate. You’ve probably never heard of the latter,which ages me! However he was a famous underwriter at Lloyds of London, nicknamed Goldfinger. His operating theory was that you got to know a risk well and you put everything on the money. He was hated by the marked/establishment and made lots of money, this was 25 years go.

    I agree that it would make an interesting PHD study topic. Why do companies, especially asian companies, make so many products. As an example, I like Canon products and have used Canon cameras for years. Their camera range is utterly confusing in the number of compact and professional cameras (Panasonic TV’s are another example). Why do they have such confusing/bloated product ranges?

    On another matter, re Samsung v Apple, Samsung tablets are doing so well in the UK that there are endless advertisements offering a free tablet when you buy a Samsung TV.

    • Ian Ollmann

      > Why do companies … make so many products?

      It is a basis for modular competition. I, as a consumer, initially favor one-size-fits-all device A but it has only a 50 MP camera. One of competitor’s devices, B, has all of A’s features except some I don’t care about and has a 200 MP camera, which I want. So I try device B, and competitor makes the sale. Deploy hundreds of such variants and you may capture some share. They aren’t trying to make a better product, just compete on featuritis. The strategy is a hallmark of the modular model.

      You either beat that as an integrated vendor by making a much better product, if the market standard isn’t good enough. If it is good enough, you make a much cheaper product in a new competing category that needs to be integrated because the sum of the parts (available at that price point) is not good enough to itself satisfy the job to be done when tossed together with minimal effort.

      I was a little disappointed by the podcast because I think Horace hasn’t yet explained how Apple’s distinctive focus is a contributing factor of its success. Perhaps he was just being conservative, but so far, we can’t be sure whether it is the basis for success or an unrelated corporate quirk. I suspect the answer lies in the difference between what you must do to be a modular vs. integrated designer.

    • Andrew Condon

      I think some of the SKU bloat is channel strategy – enables every retailer to honestly say “lowest price guaranteed” because every retailer in each market has unique product.

      So it was initially a feature rather than a bug, however, I think that direct selling in the Apple mode makes this a liability once again.

    • Relentlessfocus

      Regarding what you said about getting to know risk very well, I was heavily influenced by Jim Rogers in some interview many years ago when talking about portfolio theory he said that brokers loved portfolio theory because they would always be telling their clients what they had to do to balance their portfolio of stocks to best advantage picking up commissions every time they gave their sage advice.

      Rogers went on to say that rich people who got rich on equities put all their eggs in one basket and watched that basket very very closely.

      My basket has been AAPL. great management team with long experience working together and proven track record for success, great logistics, great products, plenty of room to grow in each of its main product categories except perhaps iPods which are being replaced by phones, great consumer demand with high user satisfaction, clever lock in techniques, strong international distribution network and in most areas of competition their competitors can’t figure out a response to APPL products.

    • Bruce_Mc

      > Why do companies, especially asian companies, make so many products.

      Because those companies are not committed to what they sell. Apple is committed to what they sell in a way that few large companies are.

      > As an example, I like Canon products and have used Canon cameras for years. Their camera range is utterly confusing…

      Canon makes cameras for their customers, Apple makes products for themselves. When I read quotes from people at Canon or Nikon, I see a lot of talk about market segments and what segment a particular camera is made for.
      If you want to make a lot of money but aren’t particularly committed to your products, then serving the market is the way to go. If you are afraid of failure, spread the risk around by making a lot of products. I think most big companies are much more afraid of failure than they are attracted to greater success. Their products are made to preserve what success they have, not to achieve greater success.

  • http://twitter.com/demigoose Tim Sweetman

    Regarding climate change, risks of industry adding extra CO2 to the atmosphere have been known since about 1950: http://www.ted.com/talks/david_keith_s_surprising_ideas_on_climate_change.html. I don’t have figures to hand, but, if anything, (I get the impression that CO2 emissions grew less rapidly through the 70s and 80s than expected (due to, for example, 70s oil price shocks, and the discovery of additional reserves of natural gas)).

    Rocky Mountain Institute’s work – one of the possible “opinion Z”s in the climate change debate – seems very much focussed on disruptive innovation. Examples: http://www.smallisprofitable.org/ExecutiveSummary.html, http://www.ted.com/talks/amory_lovins_a_50_year_plan_for_energy.html

    • http://twitter.com/asymco Horace Dediu

      I would guess that climate change reversal will come from a re-framing of incentives not quotas or penalties or taxes. Markets respond efficiently, even violently, to prices.

      • Oliver Bruce

        Right, which is at the core of carbon pricing.

        Only trouble is that there are significant entrenched players with vested interests in maintaining the status quo. The challenge will be whether technologies can be developed and scaled fast enough to reduce the value of the assets and disrupt the entrenched players.

        As a side note, aren’t quotas/penalties/taxes themselves simply disincentives?

      • r.d

        As long as people are willing to go back to pre-industrial economy,
        otherwise war is only answer that people power will come up with.

        http://www.theoildrum.com/node/7095

        really horace, oil has 100:1 ratio EROEI. nothing your economic model can do to change that. if you believe it can be reversed then I have no hope for you.

      • http://www.asymco.com Horace Dediu

        100:1? Not according to this http://en.m.wikipedia.org/wiki/Energy_returned_on_energy_invested#section_3
        Oil imports in 2007 were at 12. Contrast with Wind at 18

  • http://twitter.com/demigoose Tim Sweetman

    Regarding Freedom’s Forge, World War Two, and the speed of revolutions, a Freeman Dyson quote from “Infinite in All Directions”:

    “People of my generation who lived through World War II have vivid memories of monumental confusion and incompetence—after all, the word “snafu” is of World War II vintage—and in spite of all that, we remember that in the end things got done. When Winston Churchill became prime minister in 1940, England was desperately short of ships, airplanes, tanks, guns, everything that we needed to fight a war. I saw how bad things were when the little old 22-caliber rifles that the boys in my school at Winchester used for target practice were taken away from us and given to the army. Those rifles probably last saw active service in the Crimea in 1856. In 1940 Winston Churchill spoke on the radio and said, “I am sorry I cannot do anything for you in less than three years. I give an order to build a factory today, and in two years you have nothing, in three years you have a little, in four years you have a lot, in five years you have all you want.” He was right. In five years we had all we wanted and in five years the war was over.

    • http://twitter.com/asymco Horace Dediu

      The amazing part was that Churchill was off in his timing. The US was able to ramp in less than three years (to a level exceeding demand). They key was that there were no “orders to build factories”. The building came about through incentives not orders.

      • oases

        The U.S. had been gradually ramping up by accident before it officially joined the war because it was getting huge munitions orders from the U.K. and was also involved in the war of the Atlantic.

      • GeorgeS

        1. Most of the “incentives” were orders from the government.
        2. The US wasn’t under direct attack–no bombs fell on Detroit.
        3. The US population was several times that of Britain.
        4. The US had native resources, including oil, and no significant food shortages. It wasn’t dependent upon ships running the gauntlet of U-boats.

        Thus, it’s not all that comparable.

      • SHG

        It’s amazing what production can be achieved when you’re the only Western industrialized nation whose factories aren’t having high explosive dropped on them from the sky.

  • Relentlessfocus

    On a small topic Horace referred to books about revolutions in Science but struggled to name one; the most famous possibly being The Structure Of Scientific Revolutions by Thomas Kuhn

    • http://www.asymco.com Horace Dediu

      That’s the one I had in mind.

  • jpzip

    Horace. I think you are chasing the right hypothesis (and hence the
    right conclusions), but I’d say the logic of decisions in daily corporate life can
    be more complex than what can be captured by any one theory focusing only on one
    dimension of business.

    I suspect many companies end up diversifying their
    portfolio, because they are stretched too thin with their revenue expectations against
    their cost base. This is because – and what I say is not PhD work conclusions,
    but just rules of thumbs I’ve derived from my related work experience – for any
    product investment the probability of the R&D budget being spent is close
    to 100% (or sometimes a little above) whereas the probability of the
    corresponding projected revenue coming in is in anywhere between 50-100%
    (excluding the sleeper hit outliers).

    So the portfolio planners end up diversifying more than what is
    natural (male/female skew etc) in order to ensure there is enough of cash flow
    to pay the quarterly bills and have a story to the capital markets. Product
    after all is only one of the four 4 P’s, and a lot of things can be done e.g.
    with pricing of one product line to compensate for non-performance of others
    against any given quarter.

    Now, the irony is – as your references to the theories well
    point out – that these very actions of reducing investment affordability risk by
    creating more options for short-term sales & marketing create another set
    of execution risks. These range from more complexity in channel and less clarity
    in marketing to the difficulties in using matrix-ed resources efficiently and hidden
    cultural issues such as the impact of ‘lack
    of unconditional love from mgmt.’ (product teams are a sensitive bunch of
    people). All this ties the company deeper to the vicious circle of mediocrity, which can be lethal in markets where the best products take home unproportional share of the money.

    I can’t help but to think/agree that the true wisdom of Apple’s kitchen
    table is not the products on it, but the fact that only a clearly
    pre-determined number of people fit around it.
    I would argue it all starts with a tightly controlled cost base combined
    with some healthy expectation management against the Wall Street is fundamental
    to give companies enough of breathing space to be able to fund the focused
    portfolio.

    Of course, having an existing portfolio of high gross-margin
    proven products in so many different segments (handhelds, computers, phones)
    gives a lot of ammunition to “business manage” that revenue/R&D cost base
    ratio, even on quarterly basis, but the question is that can you ever get to that
    position without focus. And how do you keep the kitchen table from getting
    crowded when hunger is replaced with gluttony.

  • DanFrett

    Horace. You might want to read some of Nassim Taleb’s work; Fooled by Randomness or The Black Swan. I think that although there are practitioners of Portfolio Theory, it has been largely discredited.

  • DanFrett

    Horace. I recommend reading Nassim Taleb with regards to Portfolio Theory. In both ‘Fooled by Randomness’ and ‘The Black Swan’ I think he successfully debunks Portfolio Theory as as its underlying assumptions (primarily the concept of Normal Distribution) are erroneous.

  • nash

    Thinking about companies that do very few products very well, Blizzard pops to mind.