When Success Leads To Failure...

A handful of firms are having a larger and larger impact on the U.S. economy. Nowhere is this more evident than in the stock market where top tech titans Apple, Microsoft, Amazon, Facebook and Google alone represent almost 15% of the S&P 500’s overall market capitalization. Market observers, and Value investors in particular, are scratching their heads wondering how long this dominance can last.

A close examination of recent history provides some clues. Consider the case of Sears. In the early part of the last century, the firm grew to dominate retailing by capitalizing on two compelling trends; consumers’ desire for thriftiness and a new distribution channel – in this case not the internet but the introduction and expansion of the U.S. Postal Service.

It has been reported that by the 1960s, one out of every 200 U.S. workers was employed by Sears and the firm’s sales of everything from appliances to kit homes had grown to total just less than 1% of the nation’s GDP. By the 1980s, with sales growth slowing, the firm began expanding into financial services (Dean Witter, the Discover Card, Coldwell Bank) and other businesses. Distracted by these diversification efforts, management failed to notice emerging competition in the form of discount retailers such as Walmart and Target. Sales and earnings had been on the downswing for years when in 2005 current CEO Edward Lambert stepped in, merging the firm with rival Kmart. Unfortunately, this move was both too little and too late. Sales and employee headcount have fallen precipitously since then. Divisions including Craftsman have been sold or spun off and store count has been dramatically reduced (see below). Further liquidations are possible as Sears faces approximately $1 billion in loans next year.

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While the lesson from Sears sad tale now seem obvious (don’t stray from your core competency), it is not the only threat to today’s leading firms. Both IBM and Microsoft faced regulatory scrutiny as they grew in size. In 1969, IBM was sued by the Justice Department for monopolizing the market for mainframe disk drives. Microsoft faced similar regulatory challenges in 1998. In this case, antitrust claims focused on the company’s efforts to tie its Windows operating system to its Internet Explorer browser.   

Both companies ultimately successfully defended themselves against these anti-trust claims but the related distraction prevented them from fully addressing key competitive threats. In IBM’s case, the shift from mainframes to PCs and in Microsoft’s case, the move to mobile technology now dominated by Google and Apple.

Two points come to mind when considering the history of these earlier giants. First, regulatory or competitive challenges alone do not spell demise. Sears is indeed struggling for survival. But Microsoft has fared better. The company has successfully reinvented itself as a leading provider of software and cloud storage. The jury is still out on IBM which is working hard to monetize impressive artificial intelligence and data analytics technology.

While seemingly new, Google and Amazon are each more than 20 years old and Apple, the grand-daddy of the group, is over 40. It took years to build these giants and they will not be easy to unseat. Each benefits from a strong network effect (the more people use them, the more that want to) and have impressive financial war chests they can use to invest in new growth initiatives. But success is never guaranteed and shareholders expect a great deal from these firms. Continuing to flawlessly deliver on those elevated expectations will be no easy task.