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Hollywood’s New Hit Factory p44
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The U.S. Energy Information Administration projects that sales of trucks that run on natural gas will increase to 275,000 in 2035, up from just 860 in 2010.
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“The kids who are watching our content on the Awesomeness channel are the same kids who are uploading content to YouTube. So why not try and make them part of the Awesomeness community for real?” p44
YOUTUBE
3
“I may have married into a slum, but my daughter won’t go back to one”
“A lot of these businesses around here are mom and pop. We’re not corporate. We don’t have deep pockets. If we lose our customer base, we’ll have to close our doors”
“This is the spawn of Moneyball. It’s the most pure, numbersdriven experiment baseball has ever seen”
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p50
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Cover Trail September 1 — September 7, 2014
Opening Remarks Islamic State’s vulnerable spot lies in how it’s financed Bloomberg View Fighting Ebola with rap • Afghanistan isn’t another Iraq
How the cover gets made
8 10
Global Economics Russians love Putin’s dustup with the West. But they’ve stopped spending money
12
An Indian developer coaxes families out of the slums and into high rises
13
Low popularity, cabinet firings, a party revolt—Hollande may be French toast
15
Shop class is more than an easy A
16
① “The cover story reports on how Hollywood, which used to just sue YouTube, is now investing in and acquiring YouTube networks.” “You mean investing in things like cats playing piano?” “Well, there’s still that, but it’s developed a lot since then.” “So what’s popular now?” “I would ask the writer.”
Companies/Industries Women are making their way into higher corporate offices. Just not the corner one
19
Broken barrels in Napa Valley
20
Eating more paiche will help the endangered fish survive, says Whole Foods
22
As Dollar General and Dollar Tree duke it out for Family Dollar, cheap never looked so valuable
23
Briefs: Kia joins carmakers’ race to Mexico; U.S. gun sales aren’t blazing
24
Politics/Policy
4
“I’m still reporting. Let me get back to you.” [Two days later] “The Cimorelli sisters are popular.” “Never heard of them. Who else?” “PewDiePie is huge.”
The secret code politicians use to talk to super PACs
27
Some federal agencies still refuse to recognize same-sex marriages
29
Alaska tries to lure Big Oil back
30
How California aims to clamp down on health-care costs
31
Technology
“Not ringing a bell. What’s that?” “He’s a 24-year-old Swedish guy who reviews video games.” “So he’s like the Swedish Roger Ebert of video games?” “Sort of. He plays video games and then talks about it as he’s playing.”
Daniel Graf’s dicey task: Making Twitter more user-friendly without offending hard-core fans
33
One of the hottest apps around, Remind gets parents, teachers, and students on the same page
34
Retailers aren’t enthralled with Apple’s iBeacon tracking system
35
How do you defend against a quantum computer?
36
“He has 30 million subscribers.”
Innovation: To minimize flood chaos, turn the hospital upside down
37
“My God. That’s about 29 million more subscribers than Businessweek.”
Markets/Finance
“Interesting. And this gets a lot of views?”
Yale’s Robert Shiller warns of overvalued stocks. Don’t panic
39
“Well, different medium, but technically yes.”
Whisky business: Top-tier single malts go through the roof
40
“I’m so scared.”
Joe Tsai, the dealmaker behind Alibaba’s IPO
41
The apartment-building boom in Washington brings lower rents
42
Bid/Ask: Burger King’s Canadian bellyful; Amazon acquires a Twitch
43
Features COVER: ILLUSTRATION BY KYLE PLATTS
[To writer] “So what’s popular now?”
Teenage Tasteland To reach younger audiences, Hollywood goes YouTube
44
Ferguson’s Future Post-protests, post-lootings, local businesses face enormous challenges
50
Hey, Data Data Data Jeff Luhnow remakes the Houston Astros the McKinsey way
56
Etc. Fall fashion: Dressing up is back in vogue. Here are 50 tips to show you the way
63
How Did I Get Here? HSNi’s Mindy Grossman thrives in the menswear boys’ club—wearing animal prints every day
76
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Index People/Companies
Accel Partners 33 Aiken, Brady 58 Al-Baghdadi, Abu Bakr 8 Alibaba Group Holding 41 Amazon.com (AMZN) 19, 43 American Airlines (AAL) 24 AOL (AOL) 19 Appflare 35 Apple (AAPL) 19, 33, 34, 35 ArtisanFish 22 AT&T (T) 46
DreamWorks Animation (DWA) Dreiling, Richard Drugstore.com Duke Energy (DUK) Duncan, David
46 23 19 19 20
E Earl, Duncan EBay (EBAY) Edmodo Edward Jones Ellis Energy Investments EMarketer Epicurious Equilar ESPN (DIS) Estimote
36 19 34 23 36 33 35 19 46 35
F
19
Mary Barra
B
6
Baidu (BIDU) Bain Capital Bannister, Barry Barclays (BCS) Barra, Mary Beane, Billy Beauchamp, Katia Berkshire Hathaway (BRK/A) Berlin Packaging Berry Bros. & Rudd Biggins, J. Veronica Birchbox Blackboard BlackRock (BLK) BMW of North America (BMW:GR) Bowmore BP (BP) Brown, Jerry Brown, Michael Buffett, Warren Burger King (BKW) Burstein, Adrian Byredo ByteLight
41 58 39 58 19 58 69 39 43 40 19 69 34 39 16 40 30 31 52 39 43 22 71 35
C Calpine (CPN) Cameron, Susan Campbell Soup (CPB) Castille, Chip Charles Schwab (SCHW) Chernin Group Chicago Cubs Christie’s Chrysler (F:IM) CNN (TWX) Collective Digital Studio ConocoPhillips (COP) Content & Co Cooper, Mark Cose Dulci Costolo, Dick Coupons.com (COUP) Crane, Jim Crocs (CROX)
43 19 19 39 19 46 58 65 52 46 46 30 46 75 52 33 19 58 19
D D-Wave Systems Dalmore Davis, Charles DeLong, Brad Deshmukh, Nirmal DeWitt Jr., Bill Diversified Search Dollar General (DG) Dollar Tree (DLTR) Dorsey, Jack Draghi, Mario Draper Richards
36 40 52 39 13 58 19 23 23 33 15 33
Facebook (FB) 19, 33, 52 Family Dollar Stores (FDO) 23 Ferguson Burger Bar & More 52 Fidelity Investments 39 First Round Capital 34 Ford Motor (F) 16, 24 Forrester Research (FORR) 35 Fujian Sunner Development (002299:CH) 43 Fullscreen 46
G Gardner, Cory 27 Gartner (IT) 35 Geddes, Owen 35 General Dynamics (GD) 19 General Electric (GE) 19 General Motors (GM) 19 GE Lighting (GE) 35 Glenfiddich 40 Good, Lynn 19 Google (GOOG) 19, 33, 34, 35, 36 GoPro (GPRO) 24 Graf, Daniel 33 Grossman, Mindy 76
H Hagan, Kay Hagel, Chuck Hearst Heidrick & Struggles Hess Collection Hewson, Marillyn Hillshire Brands (HSH) Holder, Eric Hollande, François Houston Astros HSNi (HSNI)
27 8 46 19 20 19 35 29 15 58 76
François Hollande
Kantar Media (WPP:LN) 27 Kaplan, Roberta 29 Karuizawa 40 Katzenberg, Jeffrey 46 Khosla Ventures 33 Kia Motors (000270:KS) 24 Kinetic Analysis 20 Kinniry, Fran 39 Kishnani, Rickesh 40 KKR (KKR) 43 Kleiner Perkins Caufield & Byers 34 Koch, Charles 27 Koch, David 27 Kopf, Brett 34 Korn Ferry (KFY ) 19 Kreiz, Ynon 46 Kroger (KR) 24
76 16, 36 23 30 8 43 30 46
J 68 41 76 58
20
Napa earthquake
L Lands’ End (LE) 58 Langmead, Jeremy 65 Lepore, Dawn 19 Levi Strauss 58 Levine, Howard 23 Lionsgate 46 Lockheed Martin (LMT) 16, 19 Lord & Taylor (HBC:CN) 35 Lorillard (LO) 19 Luhnow, Jeff 58 Lynch, Peter 39
M Ma, Jack 41 Macallan 40 Machinima 46 Macron, Emmanuel 15 Macy’s (M) 35 Madison Square Garden (MSG) 66 MagiQ Technologies 36 Manhattan International 76 Mayer, Marissa McConnell, Mitch 27 McDonald’s (MCD) 52 McHugh, Collin 58 McKinsey 58 McLean, Stuart 46 MEC 46 Mejdal, Sig 58 Mercedes-Benz USA (DAI:GR) 16 Merryvale Vineyards 20 Microsoft (MSFT) 36 Montebourg, Arnaud 15 MTV (VIA) 46 Murdoch, Rupert 46
N 19 37 58 24, 76 52 19 19 16
O
I
J.Hilburn JD.com Jeff Banks Jocketty, Walt
20 31
K
Nabisco (MDLZ) NBBJ New York Yankees Nike (NKE) Nixon, Jay Nooyi, Indra Novakovic, Phebe Novo Nordisk (NVO)
15
IAC Retailing (IACI) IBM (IBM) Icahn, Carl IHS (IHS) Inhofe, James InterMune (ITMN) ISI Group Izad, Reza
John Sutak Risk Services Jones, Dave
Oak Hill Capital Partners Oakland Athletics Obama, Barack Offerpop Olch, Alexander Olney, Buster Omkar Realtors & Developers Opus Research Orbitz Worldwide (OWW) OWN Oxford Industries (OXM)
43 58 29 75 74 58 13 35 24 46 76
P Palin, Sarah Parnell, Sean
30 30
Parris, Doug Patel, Roopal Patrick, Deval Peltz, Nelson PepsiCo (PEP) Platinum Wines PricewaterhouseCoopers ProSiebenSat.1 Media (PSM:GR) Putin, Vladimir Putnam Investments (GWO:CN)
37 73 31 23 19 40 31 46 12 39
QR Qubitekk 36 Ralph Lauren (RL) 76 Reagan, Joe 52 RealNetworks (RNWK) 19 Remind 34 Rentler, Barbara 19 Reynolds American (RAI) 19 Robbins, Brian 46 Roche Holding (ROG:VX) 43 Rocket Jump 46 Rometty, Ginni 19 Romney, Mitt 27, 58 Ron Chereskin 76 Ross Stores (ROST) 19 Rove, Karl 27 Rowghani, Ali 33 Ryan, Nolan 58
S Samling Group 43 Sandberg, Sheryl 19 Schlatter, René 20 Scripps Networks Interactive (SNI) 46 Shaheen, Jeanne 27 Shiller, Robert 39 Shopkick 35 Shumlin, Peter 31 Siemens (SIE:GR) 16 Silver Oak Napa Valley Winery 20 Simon Miller 72 Smith & Wesson (SWHC) 24 SnipSnap 35 Social+Capital Partnership 34 SoftBank (9984:JP) 41 Sommer, Susan 29 Sotheby’s (BID) 40 Southwest Airlines (LUV) 19 Spencer Stuart 19 St. Louis Cardinals 58 Starmont Wines 20 Starwood Hotels & Resorts (HOT) 35 Stearns, David 58 Stifel 39 Strompolos, George 46 StyleHaul 46 Subway 46
T
Vanguard Varma, Babulal
Tanaka, Masahiro 58 Target (TGT) 23 Tastemade 46 Thompson, Beth 52 3G Capital 43 Tim Hortons (THI) 43 Tommy Hilfiger (PVH) 76 Toner, Michael 27 Toyota Motor (TM) 16 Trademark 75 Trefethen Family Vineyards 20 Trian Fund Management 23 Tsai, Joseph 41 21st Century Fox (FOX) 46 Twitch Interactive 43 Twitter (TWTR) 20, 33
UV Udall, Mark Under Armour (UA) Valls, Manuel
27 24 15
39 13
W Wal-Mart Stores (WMT) 19, 23 Walt Disney (DIS) 46 Warner Bros. (TWX) 46 Wedbush Securities 23 Weibo 41 WellPoint (WLP) 31 WhiskyCast 40 Whole Foods Market (WFM) 22 Winfrey, Oprah 46 Wright, Doreen 19
YZ Yahoo! (YHOO) 41 Yamazaki 40 Yanukovych, Viktor 12 YouTube (GOOG) 27, 33, 46 Zarate, Ricardo 22
How to Contact Bloomberg Businessweek Editorial 212-617-8120 Ad Sales 212-617-2900 Subscriptions 800-635-1200 Address 731 Lexington Ave., New York, NY 10022 E-mail bwreader@bloomberg.net Fax 212-617-9065 Subscription Service PO Box 37528, Boone, IA 50037-0528 E-mail bwkcustserv@cdsfulfillment.com Reprints/Permissions 800-290-5460 x100 or businessweekreprints@theygsgroup.com Letters to the Editor can be sent by e-mail, fax, or regular mail. They should include address, phone number(s), and e-mail address if available. Connections with the subject of the letter should be disclosed, and we reserve the right to edit for sense, style, and space. Corrections & Clarifications “Building It Was Hard, Selling It to the Pentagon Will Be Harder” (Features, Aug. 25-Aug. 31, 2014) misidentified Cliff Byrd as a former Navy SEAL. He was a special warfare combatant-craft crewman. In “Wasted” (Features, Aug.11-Aug. 24), our story on post-Qaddafi Libya, we incorrectly asserted that Goldman Sachs made a payment to Palladyne International Asset Management. A Goldman Sachs spokesman says no such payment was made, despite Palladyne’s requests for one.
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Islamic State’s Risky Business By Brian Michael Jenkins
U.S. Secretary of Defense Chuck Hagel spoke of “an imminent threat to every interest we have.” Senator James Inhofe asserted that “we are in the most dangerous position we’ve ever been in as a nation.” Former Marine four-star General John Allen went further, saying “World War III is at hand.” The cause of these alarms is Islamic State, a swarm of murderers led by Abu Bakr al-Baghdadi. Little is known of him. The name isn’t his real one. He spent the past eight years rising through the ranks of Iraq’s jihadist underground to become its commander and most recently the self-proclaimed leader of Islamic State. He’s both a product and a creator of the region’s chaos. Practically overnight, al-Baghdadi’s group has become the U.S. military’s chief
State and its internal dynamics. Contrary to the rhetoric, Islamic State does not surpass every threat the U.S. has seen. According to intelligence analysts, al-Baghdadi’s arsenal includes old Soviet tanks, new U.S. Humvees, some artillery, and lots of machine guns and rocket-propelled grenades captured during recent conquests in Iraq. His most powerful weapon, however, is social media, which enable Islamic State to launch volleys of threats on the Internet, barrages on YouTube, and salvos on Twitter. Gruesome images of beheadings and mass executions are professionally recorded and posted. The atrocities serve a purpose. Like Genghis Khan’s massacres, they terrify adversaries, such as the Iraqi soldiers who threw down their weapons, running away as al-Baghdadi’s
foe and, following the Aug. 19 beheading of journalist James Foley, a source of revulsion to Americans. The threat al-Baghdadi poses shouldn’t be dismissed, of course. But before the U.S. engages in what could be another messy military intervention in Iraq, one that may well extend into Syria, it’s worth taking a closer look at Islamic
forces approached Mosul in June. The tactics reflect the man and his intentions. Al-Baghdadi’s public persona is a carefully crafted myth that’s enabled him to attract like-minded fanatics, troubled young men, and violence-seeking sociopaths from around the world, turning a jihadist gang into a fearsome force. The
Its leader may be attracting murderous support, but he has a vulnerability: the predatory financing of his caliphate
AFP PHOTO/HO/ISIL
8
group’s name outlines territorial ambitions under al-Baghdadi. Before taking its current form, it went from the Islamic State of Iraq to the Islamic State in Iraq and the Levant, or, in Arabic, al Sham, meaning the “north,” This is an area that encompasses Iraq, Syria, Lebanon, Palestine, Israel, and a slice of Turkey. It was the “north” to the first Muslim warriors who in the 7th century rode out of the Arabian Peninsula to conquer the Middle East, North Africa, and southern Spain. Al-Baghdadi’s personal ambitions transcend terrestrial boundaries. In a rare appearance in Mosul, he delivered a sermon that was also a kind of inaugural address. Wearing a black turban and robes—the visible assertion that he’s a direct descendant of Muhammad—he pronounced the restoration of the caliphate
The group’s arsenal includes old Russian tanks, new Humvees, and social media
with himself as the Caliph Ibrahim, successor to the Prophet and the supreme religious authority and absolute political leader of the world’s 1.5 billion Muslims. Al-Baghdadi obeys only God, so all Muslims must obey al-Baghdadi. Traditional Muslim scholars consider that declaration presumptuous and a violation
of Islamic law. Even Osama bin Laden never contemplated such a step. A lucrative criminal empire supports Islamic State’s operations. According to a recent RAND report, its diverse criminal operations bring in $1 million a day. Operating on a spoils-of-war principle, it lives mainly off plunder, emptying the banks of towns it captures, confiscating and stealing goods—mainly machinery, construction equipment, automobiles— which the group sells at a discount to buyers in Iraq and elsewhere, and seizing the property of those who have been forced to flee. Its videotaped demolitions of Shia mosques and Christian religious sites conceal a profitable trade in antiquities. Recently captured records of its financial transactions show that in one region of Syria alone, the group netted $36 million from smuggling plundered archeological artifacts. Ransom from kidnappings, protection money and other extortion, and taxes levied on the population it controls—even truck drivers pay road taxes—augment the group’s income. It’s also taken control of several small oil fields in Iraq and a refinery in Syria, enabling it to sell smuggled oil, adding millions to its coffers. Contributions from sympathetic supporters abroad appear to account for only a small portion of Islamic State’s income. This self-sufficiency gives the group greater autonomy but also creates a different kind of vulnerability. Its funding is predatory, which is why it must keep expanding. Otherwise, once the banks are emptied, the businesses looted, and the bulldozers and generators sold off, confiscation and extortion from the remaining inhabitants must increase, and that provokes opposition. The foes of Islamic State can accelerate this process by going after the obvious and vulnerable sources of cash flow—oil smuggling, for one. The presence of foreign jihadists in growing numbers, including zealots from the West, will also affect Islamic State’s trajectory. Al-Baghdadi can direct these violent impulses, but he cannot easily rein them in. To stay in charge—to be the most terrifying of terrorists—he may have to go along with violence that even he may regard as excessive. These tensions affect all such groups. Al-Baghdadi himself was a firebrand whose own thirst for violence al-Qaeda couldn’t contain. Among his commanders today are even more extreme copies of al-Baghdadi. The violence will inevitably alienate some of the Baathist commanders and Sunni tribes who support al-Baghdadi in Iraq. As Islamic State expands, it will be unstable both on the edges and inside. Al-Baghdadi has shown skills in creating
The ambitions of al-Baghdadi transcend terrestrial boundaries and extend to assuming the role of caliph alliances, but he’s also rapidly accumulated enemies. Islamic State forces remain at war with other jihadist groups in Syria, whose enclaves it will likely attack. Not one of al-Qaeda’s affiliates or any of the other jihadist movements has declared allegiance to Islamic State. And though the Syrian government may have allowed the group a degree of immunity because it tarnished the entire rebel movement, Syria won’t abandon the defense of its own enclaves. In Iraq, Islamic State faces an ineffectual Iraqi army, but sectarian demographics will impede the group’s advance to the north and east. To the north, it’s battling the more effective Kurds. As has been evident since the start of the Obama administration’s bombing campaign against Islamic State, al-Baghdadi’s handful of captured tanks and guns provide little defense against U.S. airstrikes. That doesn’t mean Islamic State will be a pushover. Its destruction, however, isn’t the sole responsibility of the U.S. President Obama should demand more of the regional powers most directly threatened by the jihadists. That begins with the Iraqi army: If Iraq, with almost 300,000 men under arms, can’t defend itself against 7,000 jihadists, how can the U.S. protect it? Saudi Arabia, with a quarter million under arms and 500 advanced combat aircraft, worries about the danger posed by Islamic State, but it won’t attack Sunnis to assist Iraq’s Shia or Syria’s Alawite regimes. Turkey and Jordan, which face the extremists directly across their borders, must contribute to the fight as well. And if Europe worries about the terrorist threat posed by Islamic State, it can also do more. Until his Mosul sermon, few of al-Baghdadi’s devoted followers had seen or heard him. For security reasons, he communicates with only a small group of lieutenants, who carry out his instructions. Some observers argue that the man who spoke in Mosul wasn’t al-Baghdadi at all but a stand-in. Islamic State’s cohesion depends heavily on the survival of its hunted leader. Al-Baghdadi’s three predecessors were all killed by U.S. military operations. The caliph may be the group’s charismatic center, but he’s also its weakest link. Jenkins is senior adviser to RAND’s president and author of The Dynamics of Syria’s Civil War.
9
View
To read Mohamed El-Erian on Europe’s challenge and Margaret Carlson on Rick Perry’s troubles, go to Bloombergview.com
The Rap Against Ebola Music can be a powerful tool against a killer disease
families to see and understand how their loved ones are being treated, even after death. In Guinea, for example, 60 percent of Ebola cases have been linked to traditional burials. Where people are being forcibly quarantined, public health officials have a special obligation to ensure that everyone inside has access to health care and counseling—not to mention food, water, and services—and protection from exposure to the virus. They are trying. The United Nations World Food Program is preparing to feed 1 million people in restricted areas of Guinea, Sierra Leone, and Liberia. Containing Ebola will take months. But the virus can be brought to heel if communication can be improved. Any effort that helps the cause—including a rap song—is worthwhile.
Afghanistan Is Not Iraq
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In an effort to control the outbreak of Ebola in Africa, public officials are turning into music producers. The Ebola Rap is performed by famous Liberian hip-hop singers and underwritten by the country’s health ministry, along with Unicef and other groups. Although the situation may be desperate, the strategy is not. One of the greatest challenges in fighting the worst outbreak on record of one of the world’s deadliest diseases is communication—with patients, their families, and the public at large. In this context the Ebola Rap is a brilliant stroke. The song contains the gritty details about how Ebola is spread (“in direct contact with the blood, saliva, urine, stool, sweat, semen of an infected person, or infected animal”) and how to respond to symptoms (“go to the hospital”). It’s one of a handful of songs filling a great need: to communicate to the public that “Ebola is real” (a line from the song) and how to prevent and treat it. While Americans and Europeans fret over the unlikely possibility that Ebola will invade their shores, medical workers in Africa see all too clearly how it spreads. In Liberia, Guinea, and Sierra Leone, weak health-care systems are struggling not only to treat thousands of patients but also to deal with a general population understandably wary of outside medical practices. In areas with only one or two doctors for every 100,000 people, it’s been impossible to keep track of all who’ve come in contact with every Ebola patient. (In an ideal world, they would be monitored for 21 days.) People have become frightened of both the disease and its treatment, which entails several weeks in isolation wards. People with symptoms flee care centers or hide in their communities, and many residents of quarantined neighborhoods try to escape. Getting Ebola under control will require working with, rather than against, local customs and ways of thinking about medical care. The Ebola Rap is part of a smart overall strategy of using anthropology to contain the outbreak. “Call in the anthropologists” may sound like a weak response to a powerful killer. Yet it’s crucial that non-native health officials understand local resistance. In the case of this outbreak, it means allowing victims’
Afghanistan’s political impasse has renewed calls that the U.S. revisit plans to pull its soldiers out of the country by the end of 2016. Look at Iraq, these critics say, arguing that a precipitous U.S. withdrawal that started in 2009 vaporized U.S. influence, opened the door to insurgents, and plunged Iraq into chaos. There’s no denying that Afghanistan now teeters between civil war and its first peaceful political transition. Credible allegations of massive fraud have tainted the June election. An internationally supervised audit of the results is behind schedule and mired in controversy. President Hamid Karzai has threatened to leave office by Sept. 2, regardless of whether the audit is done. Yet it’s simplistic to say that as went Iraq, so goes Afghanistan. Afghanistan doesn’t face the same Sunni and Shia Muslim fissure. Instead, power struggles have played out among seven ethnic groups; Pashtuns are a plurality, but each of the others constitute a majority in different regions. Afghanistan’s population is more dispersed; it doesn’t have oil to spark conflicts. It isn’t clear that the number of U.S. boots on the ground translates into meaningful leverage or is necessarily conducive to an enduring, much less healthy, stability. That doesn’t mean the U.S. shouldn’t push the rivals for the presidency to compromise, and continue to provide economic support. A stable government that supports the aspirations of the Afghan people is more likely to advance U.S. interests. The case for keeping U.S. troops in Afghanistan should rest not on their utility in midwifing democracy. It should be based on their effectiveness in preventing the reemergence of a direct threat to the U.S. and its allies. Critics of the pullout have seen that prospect in the Taliban onslaught during the summer fighting season. But Afghan security forces seem to be holding their own. If that changes, and if the Taliban show signs of devolving into international terrorists or of welcoming foreign fighters who are, then the U.S. and its allies may want to revisit their withdrawal timetable. Any decision to do so, however, should depend on the facts on the ground in Afghanistan, not in Iraq.
ILLUSTRATION BY BLOOMBERG VIEW; PHOTOS: GETTY IMAGES (2)
Critics say U.S. withdrawal will be catastrophic. They’re wrong
September 1 — September 7, 2014
Putin’s Paradox As patriotic fervor flourishes, Russian consumers cut spending “It’s as if Russians were handed a cookie and they are happy”
PHOTO ILLUSTRATION BY 731; PUTIN: COURTESY PRESIDENTIAL PRESS AND INFORMATION OFFICE
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The Russian economy is rapidly weakening. Inflation is high; the ruble, weak. Interest rates are heading up, and disposable incomes have dropped. None of this affects the popularity of President Vladimir Putin, however; it’s shot up ever since he defied the West over Ukraine, triggering some of the economy’s woes by weakening the currency and goading the West into imposing sanctions. For now, Russians are backing Putin all the way and not blaming him for faulty economic stewardship. At the same time, they are cutting their own spending dramatically. This situation pits two powerful forces against each other: patriotism vs. economic reality. For now, patriotism has the upper hand; but if the economy continues its slide, Russians may change their mind. “Pride and patriotism have awakened in Russians, as was the case in the USSR, and that’s why they are willing to sacrifice some part of their well-being,” says Dilyara Ibragimova, a lecturer on economic sociology at the Higher School of Economics in Moscow. “I think that’s temporary, because the continued growth of prices will hit their pocketbooks and affect their attitude.” Putin’s approval ratings took off on the back of his actions in Ukraine, first by bailing out then-President Viktor Yanukovych in December, and then in March by seizing Crimea after months of deadly protests toppled Yanukovych. Putin managed to increase his popularity to 84 percent by early August, up from 61 percent in November, his lowest ranking since June 2000. He’s now only four percentage points short of a record reached in September 2008, after Russia’s five-day war with Georgia, according to pollsters at the Levada Center in Moscow. Putin would win an election by 64 percentage points
if a vote were held now, according to a survey by the Public Opinion Foundation in Moscow. “Political comfort is a substitute for economic comfort,” says Sergey Tsybizov, the head of IT projects in the Moscow region at Russian automaker Sollers. “Essentially it’s as if Russians were handed a cookie and they are happy, but almost all of them forget they need bread or soup.” The takeover of Crimea “brought a patriotic surge,” Putin said on Aug. 14, urging Russians to draw together and work for the good of the country. The conflict has allowed Putin to put behind him the antigovernment protests that started in December 2011 in the wake of allegations of vote rigging in parliamentary elections. The number of Russians who own a national flag rose to 38 percent in July, from 29 percent a year earlier, according to a Levada poll published on Aug. 21. “Russians love strong leaders, and Putin is certainly perceived to be a strong leader as he stands up to the West,” says Ivan Tchakarov, chief economist at Citigroup in Moscow. After Russia endured months of increasingly onerous sanctions by the U.S. and Europe, Putin struck back with bans on food imports from countries that had penalized Russia. Tsybizov, the IT manager, says his parents in Volgograd “clapped their hands” when they heard the news of Putin’s move. A Russian consumer-confidence index had its biggest jump in more than four years last quarter, and a gauge of “social comfort” has been at a record high since June. According to pollsters at state-run VTsIOM, an index that tracks Russians’ economic outlook hit a record 69 points in July, almost triple its readings in 2009 and 2010.
Hollande faces a party revolt 15
Why business loves shop class 16
Yet in malls, showrooms, and supermarkets, Russians are not acting very confident. Car sales, which grew by monthly leaps of as much as 88 percent in 2007, dropped an average of 20 percent in June and July. Sales of laptops dropped 33 percent from a year earlier last quarter. At least five tour operators have gone bankrupt, as Russians cut back on foreign travel for the first time since 2009: The ruble doesn’t buy what it used to abroad. In March, when Russia annexed Crimea from Ukraine, disposable incomes had their biggest drop since 2009. Investors dumped the ruble, which made imports of food and goods cost more and drove inflation upward, cutting purchasing power. The government estimates gross domestic product will grow 0.5 percent this year, the slowest since a 2009 contraction. “Russians are treating the situation very positively but are behaving very cautiously,” Mikhail Dmitriev, a deputy economy minister from 2000 to 2004, said in an interview with radio station Echo of Moscow. “The broader implications of this are related to the ambiguous perception by the Russian population of everything that’s going on.” The weakness of the ruble, one of the worst-performing currencies of the year, has fueled inflation of 7.5 percent; so have the Kremlin’s various bans on food from abroad in reaction to Western sanctions. Some bans, such as the one on pork from the European Union, have been in place for most of the year, and others were imposed this summer. According to the July inflation report by the Federal Service of State Statistics, prices of meat and poultry rose 11 percent in July from a year earlier. Milk and dairy were up 20 percent, although sanctions on dairy products are too recent to account for that spike. A jump in food prices for any reason is painful, as a third of ordinary Russians’ income goes to food. Faced with inflation well above its target, the central bank has had to increase its key rate three times this year, to
8 percent, further hampering Russians’ ability to afford a mortgage or car loan. The drop in demand hurts, in a country where consumer spending accounts for half of the $2 trillion economy. Before he asserted himself in foreign affairs, Putin was known as the president who restored the economy after its collapse in the 1990s. Putin made Russia’s rising prosperity and stable public finances the cornerstone of his appeal. Helped by exports of oil, the country’s biggest foreign-revenue earner, he presided over budget surpluses during his two terms as president, between 2000 and 2008. Growth averaged about 7 percent a year during the period, and real wages increased an average of 15 percent annually, according to data compiled by Bloomberg. The deflating of the patriotic bubble may be a risk for Putin, according to Alexei Levinson, head of the social and cultural studies department at the Levada Center. Even so, he says the country has a long road to travel before distrust of the government replaces love of country and deprivation leads to upheaval. That happened in the Russian Revolution, but it took three hard years of war before Russians embraced radical change. Putin is not facing a revolution. But a poor economy can turn the staunchest of supporters into opponents. —Olga Tanas The bottom line Putin’s muscular foreign policy is winning him support at home, while pushing Russia toward a recession.
Real Estate
In India, Slum Dwellers Move Into High Rises The catch: Developers also get to build luxury housing “There is all-round social upliftment as people move”
Indian developer Babulal Varma’s job requires the human touch. The company he co-founded, Omkar Realtors & Developers, specializes in coaxing Mumbai’s slum dwellers from their hovels, then bulldozing
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the slum and erecting a mix of luxury condominium towers and free new homes for the slum dwellers on the cleared land. Omkar has completed 12 projects, rehousing 40,000, with 12 more in the works, making it the most successful business in this niche. Mumbai’s slums still house 6.5 million people. In one slum several years ago, an old woman wouldn’t leave her home. Omkar was keen to develop the site into a $1 billion complex of six luxury high rises and modern housing nearby for the slum dwellers. As Varma recounts it, he visited her and learned that the woman wanted two Top 5 Slums free apartments, by Population not one. The woman lived Neza-Chalco-Itza, with her two sons Mexico City 4 million and their wives Orangi Town, in a 90-squareKarachi foot shack. The 1 million wives argued conDharavi, Mumbai stantly. Yet the law 1 million regulating slum Kibera, Nairobi 1 million redevelopment Khayelitsha, says a family that Cape Town proves residency 400,000 since 2000 can get only one new, 269-square-foot home on the same land. Varma came back with a piece of paper showing a line drawn through the unit they’d be moving into, with a second door cut into the hallway. The wives could live separately, he explained. Agreement came in 45 minutes. “If you can understand their problem, if you can understand their issues, all the issues are very small, like a peanut, but to them this is the biggest thing,” says Varma, who cites karma as his operating philosophy as he sits beside an incense-burning Hindu altar. By law, Omkar and other developers must secure the consent of 70 percent of a slum’s inhabitants before a project can go forward. Slum dwellers who have lived in the same spot since 2000 hold rights to the land but can sign them over to developers. Omkar (the long form of the Hindu mantra “om”) contributes to the city’s efforts to get its slum dwellers into the middle class. “There is all-round social upliftment as people move from slums into proper apartments,” says Nirmal Deshmukh, chief executive officer of the Slum Rehabilitation Authority (SRA), which selects the
developers for the slum projects. Since her marriage to a postal worker 13 years ago, Swarangi Pingle had lived in a 90-square-foot bilevel hut with her in-laws, her husband’s two siblings, and her daughter, now 11. On May 1 she and her family became homeowners in the development where Varma persuaded the old woman to go along. Pingle’s home on the top floor of a 23-story building has plenty of ventilation and sunlight. In the slum, Pingle would wait an hour to fill water jugs at the communal tap and for her turn at the common toilet. “This is much better,” she says as she shows off the private bathroom, kitchen sink, and aqua-painted living room. The new homes allow space for children to study, she says: “I may have married into a slum, but my daughter won’t go back to one.” Omkar, which is closely held, had
A slum in central Mumbai’s Parel neighborhood
14 billion rupees ($232 million) in revenue in the 12 months ended March 2014, a 40 percent increase from a year earlier, according to spokesman Suresh Rathod. Profit margins are about 20 percent, Varma says. Slum redevelopment can involve years of negotiations with interest groups—gangsters, slumlords, or residents—often divided along political lines. Typically, 5 percent of families in Omkar developments haven’t lived in one spot long enough to qualify for a new home, Rathod says. The families who get the free apartments own them and can sell them after 10 years. The approach has its critics. The promise of eventual free housing lures more immigrants to cities, “while the public transport, water, and electricity supplies are not geared to” handle the population increase, says Uday Athavankar, a professor at the
DHIRAJ SINGH/BLOOMBERG; DATA: THE BORGEN PROJECT, KIBERA LAW CENTRE, INTERNATIONAL BUSINESS TIMES
One of Omkar’s luxury high rises, under construction
Global Economics
Global Economics Industrial Design Centre at the Indian Institute of Technology in Mumbai. Developers create cramped “vertical slums,” Athavankar says, to devote as much of the lot as possible to luxury towers. A 2012 report by the comptroller and auditor general of India, the government watchdog, found the SRA failed to create proper lists of slum residents eligible for free homes. “There was no evaluation of developers, and the quality of the construction was left to their discretion,” it said. Deshmukh, CEO since late 2012, says he has taken steps to ensure that only qualified developers get projects and only eligible slum dwellers get homes. Omkar employs at least 250 “relationship managers” to persuade residents to move out and help them settle into their new homes. The new residents, who mostly never lived in a high rise, learn how to operate
elevators and fire extinguishers and care for stairs and hallways: No spitting; no littering. Slum dwellers gradually become respectable homeowners, Deshmukh says. “Their kids start going to school. The hygiene improves, and people fall sick less often. Crime reduces as the next generation gets on in life with better education and jobs. And all this happens without government putting in a single rupee,” he says. —Bhuma Shrivastava and Sheridan Prasso The bottom line Mumbai developers want slum dwellers to let luxury towers be built on their land in exchange for a free apartment.
Austerity
France’s Hollande Takes a Big Gamble The president’s late decision to cut spending antagonizes his party The government “tried to postpone the day of reckoning”
During his 27 months in office, French President François Hollande has consistently disappointed his countrymen with predictions of economic recovery that haven’t materialized. Now the beleaguered Hollande is trying to quell a revolt within his own Socialist Party. On Aug. 26, he named a new cabinet, ousting ministers from the party’s left wing who attacked his plans to curb government spending and ease taxes on business. In an interview with Le Monde on Aug. 23, Economy Minister Arnaud Montebourg said it was “absurd” for Hollande to propose spending cuts when the economy has barely grown in three years and unemployment exceeds 10 percent. Three days later, Montebourg was out of a job, replaced by a 36-yearold supply-side reformer named Emmanuel Macron. For Hollande, the shake-up increases the risk that the Socialist majority in Parliament will balk at approving his economic plan. “Implementation of any further reform is actually going to be more difficult,” with as many as 100 of roughly 270 Socialist lawmakers leaning toward Montebourg’s views, says Gilles Moec, chief European economist at Deutsche Bank in London.
Such infighting could further dent business and consumer confidence, inflicting even more economic harm. Underscoring that risk, data released on Aug. 27 showed manufacturers’ sentiment at a 13-month low. Montebourg, who’s eyeing a presidential run in 2017, is likely to keep up his attacks on Hollande. The sagging economy, along with revelations this year that the president was cheating on his longtime partner with a muchyounger actress, have sent his popularity plunging to a record-low 17 percent, according to a late-August poll by the Ipsos survey group. The anti-austerity message is likely to resonate across Europe, where growth has stalled after painful belt-tightening. Even European Central Bank President Mario Draghi, who’s helped enforce euro zone budget discipline, called for a “more growthfriendly composition of fiscal policies” in the region, in a speech on Aug. 22. France hasn’t demanded much fiscal sacrifice from its citizens so far. It has repeatedly failed to meet budget deficit targets agreed upon by European leaders. In France, government spending equals 56 percent of gross domestic 15 product, the highest proportion of any euro zone country—a figure that hasn’t budged since Hollande took office in 2012. In neighboring Spain, which enacted draconian budget cuts and probusiness reforms, government spending has fallen from almost 47 percent of GDP, to 43 percent, since 2012. Soon after taking office, Hollande started raising tens of billions in new taxes, mainly on businesses and highincome households. Social benefits and other government spending were left largely untouched, along with rigid labor rules that crimp French companies’ ‘‘We have to be competitiveness. The frank. We need government “tried to tighten our belts and stop to postpone the day living beyond of reckoning, hoping our means.” that there would be a —Jean-François European recovery” that Moes would lift the economy enough to avoid difficult reforms, says Bruno Cavalier, chief economist at Oddo Securities in Paris. Instead, France Inc. slashed investment and hiring, forestalling a rebound. Earlier this year, Hollande made a policy U-turn. He named a new marketoriented prime minister, Manuel Valls, and promised some €50 billion
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($66 billion) in budget savings over the next three years to help offset lower payroll taxes on business. The plan is “exactly what Mr. Draghi would call growth-friendly,” Cavalier says. Hollande and Valls have some tools at their disposal to win Parliament’s approval. Under the French constitution, some legislation can be enacted without a parliamentary vote, a tactic frequently employed by Socialist President François Mitterrand. Hollande could even threaten to dissolve Parliament, a move that would trigger new elections in which many Socialists would risk losing their seats. Some ordinary French citizens seem ready to give Hollande and Valls’s plan a chance. “We have to be frank,” says Jean-François Moes, a sales manager in a real estate finance firm who was lunching on a baguette sandwich outside the Printemps department store in central Paris. “We need to tighten our belts and stop living beyond our means. We have to free up companies and release the constraints to hire and fire.” —Carol Matlack, with Ania Nussbaum The bottom line Hollande’s proposed $66 billion in spending cuts has stoked rebellion within the government’s ranks.
Education
Shop Class Makes a Comeback Choosing a vocational path can still lead to a solid job “I’m not rich, but I’m not hurting either”
Two years out of high school, Evan Fischbach is earning $40,000 a year. His secret: shop class. Fischbach, 19, wanted to work on cars ever since he took an automotive class in his junior year of high school in Saline, Mich. His college- educated parents wondered if he was aiming too low. When Fischbach was still a junior, a local auto dealer desperate for mechanics hired him as an apprentice in the service bay. Now he’s earning about three times as much as the average 19-year-old high school grad and slightly more than the national median for all working
adults, according to the Bureau of Labor Statistics. “Friends weren’t interested in auto shop when I suggested it, and now I think they wished they had tried it,” says Fischbach, who works at the LaFontaine Chrysler-Dodge-Jeep-Ram dealership. “I’m not rich, but I’m not hurting either.” With schools focused on preparing kids for college, shop class has gone the way of stenography courses in much of the U.S. Yet now companies as diverse as Toyota Motor, Siemens, and IBM are pushing high schools to turn out students with the practical skills businesses need. The message is getting through. This year, for the first time in a decade, the U.S. government boosted funding for high school and college vocational education to $1.1 billion. That’s still $188 million below the 2004 budget to help schools teach hands-on skills. Proponents say spending on vocational training will help reverse the hollowing out of America’s middle class and combat rising inequality. U.S. wage growth since 2009 has been the weakest since World War II. There are 29 million “middleeducation” jobs that pay more than $35,000 a year, considered a threshold to the middle class, according to Georgetown University research. Of those, 22.9 million require only high school or some post-high school training. Fischbach’s job pays enough to launch him on a once-familiar trajectory: Start a family; buy a home; pay taxes. Fifty years ago most American boys in middle and high school attended shop class, where they learned to make ashtrays, rebuild engines, and weld metal. As the space race gave way to the hightech era, policymakers decided such skills were unnecessary. College prep classes gradually supplanted shop, which by then was perceived as a “dumping ground for kids the regular school couldn’t figure out what to do with,” says James Stone, director of the National Research Center for Career & Technical Education in Louisville. From 1999 to 2009 the average number of high school credits earned in career/technical education fell 15 percent, according to the U.S. Department of Education. The other reason shop classes lost their appeal was the steep drop in factory jobs. The U.S. lost 6.1 million such jobs from 1997 to 2009. Only
ROBERTO E. ROSALES/ALBUQUERQUE JOURNAL/ZUMA PRESS
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Global Economics 644,000 have been added since, according to the Bureau of Labor Statistics. No wonder parents can be dubious about shop class for their kids. Area Tool & Manufacturing in Meadville, Pa., tries to recruit from local high schools. It’s hard. “How do you walk into a classroom and talk to a 16- or 17-year-old, when he has a parent who used to work there but was laid off 10 years ago?” asks Ashleigh Smith, Area Tool’s office manager. Although many parents now agree that more students should have vocational training, the prevailing attitude is still: Not my kid. “For a lot of parents, and policymakers, it’s easier to say we need to send more kids to college,” Stone says. “Parents go, ‘Yes, that’s what I want to do. My kid will be successful.’ Then after four or five years they come back with a lot of bills and they’re sleeping on the couch.” Businesses meanwhile can’t find enough people to fix cars or work in factories. Mike Hughes, the service manager who hired Fischbach, competes with rivals to recruit kids right out of high school. If he can’t find candidates there, he has to train them from scratch. “Nobody wants their kid to be a mechanic,” says Hughes, who figures Fischbach will make $60,000 a year some day. “They just don’t know how good of a living it is.” Advocates of vocational education are pushing high schools to identify students’ career interests earlier. Then the students can be guided to both vocational and other classes to support that career, whether the goal is college or not. Progress is patchy, and many of the newer programs require students to travel to Quoted
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The number of “middle-education” jobs that require only a high school degree
$1.1b Federal funding for high school and college vocational education
shop class or leave their neighborhood schools altogether. Rather than incur the expense of technical training classrooms in each school, New Jersey operates 60 public magnet schools in 21 counties where students can take classes in culinary arts, cosmetology, engineering, computers, landscape design, auto body repair, and more. Eleven companies including Mercedes-Benz USA, BMW of North America, Lockheed Martin, and Novo Nordisk are forging partnerships with the magnet schools. Last year, 32,254 kids enrolled, up 30 percent from 2000. Many applicants had to be turned away. Three years ago, New York City started the Pathways in Technology Early College High School with IBM, the New York City College of
“If Britain were to somehow leave the European Union and become the 51st state of America, we would actually be one of the poor states.” Fraser Nelson, editor of the Spectator, writing in the Telegraph
Technology, and the City University of New York. The six-year high school was designed to help students apply classroom work and real-world skills toward an associate degree in computers or engineering at graduation. IBM provides internships. Even colleges are starting to see the benefits of vocational courses. Seth Bates, who teaches applied engineering at San José State University, started a remedial shop class for aspiring engineers who can’t use a power drill properly. “By 1995, a student who came to us who had actually worked with tools was exceedingly rare,” he says, adding that now the situation is even worse. “Maybe it’s one out of 50 today. Most of them come in without a clue.” Kyle Jennings, an advanced placement student at Saline High School, Fischbach’s alma mater, is determined to know his way around a machine shop by the time he starts an engineering degree. His dad, a Ford Motor engineer, persuaded him to take shop. His friends mostly think it’s an “easy A” with zero career value, he says. “These classes really will help,” Jennings says, as he ferrets out a pressure leak in a Jeep Liberty one day in auto class. “You need to know how to work with machines.” —Jeff Green and John Irwin The bottom line Funding for shop classes has increased, but many parents still have a “Not my kid” attitude about vocational training. Edited by Christopher Power Businessweek.com/global-economics
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Crying over spilt wine in Napa 20
The multibillion dollar battle to be king of the dollar stores 23
Whole Foods’ plan to save the paiche is no fish tale 22
Briefs: Kia heads for the border; Smith & Wesson misfires 24
September 1 — September 7, 2014
This Is Not a Trend More women are in top corporate jobs—just not ones that lead to the corner office
ILLUSTRATION BY JACI KESSLER
“It’s very hard to move from a functional job to a CEO job” Mary Barra made corporate history careers. Young women lack female seven months ago when she became role models who have flourished the first female chief executive officer within operations, so they tend to start of a major global carmaker. Yet for all in functional or support positions such the gains women at the highest levels as human resources. Later, boards— of U.S. companies have made, most are which remain predominantly male— still in the wrong jobs if they want to often fail to identify promising female follow Barra’s career path. executives who can be moved into That’s because unlike Barra, who’d operational slots. been in charge of General Motors’ Dawn Lepore, now a product development for two director at multiple years before her appointment, a companies, says majority of top-ranked women she probably at companies in the Standard & wouldn’t have Poor’s 500-stock index aren’t in been hired the kinds of operational jobs—think as CEO of division heads or senior managers Drugstore .com in 2004 in charge of key product lines— if she that usually lead to the corner office. Rather, 55 percent of them are in functional roles—top lawyers, finance chiefs, and heads of human resources—according to data compiled by Bloomberg. About 94 percent Mary Barra, GM of the S&P 500 CEOs held senior operations positions immediately before ascending to the top job, and the relative scarcity of women overseeing product lines or entire businesses has slowed their advance to the pinnacle. The data suggest that the next generation of female executives is not positioned to capitalize on the growing recognition by many companies, including Google and Apple, of the lack of diversity within their executive ranks. Recruiters say women are left off the CEO track at numerous points during their corporate Ginni Rometty, IBM
hadn’t first run a Charles Schwab unit. “It’s very hard to move from a functional role to a CEO job,” she says. “You usually can’t just go from CFO or head of marketing to CEO. More women need to get into these operating jobs. The fact that I’d run a revenue unit with revenue of $1 billion made a huge difference.” Women make up about half of the total U.S. workforce. The 24 female chief executives in the S&P 500 today, although a record, is still less than 5 percent of the total. In the layers just beneath the top job, women account for about 8 percent of the five highest-paid executives at each S&P 500 company, according to 2013 proxy filings. About 70 of those topranked non-CEO women were in operating jobs, based on data compiled by Bloomberg. To produce female CEOs, more corporations must make a conscious effort to spot future leaders early in their careers and push them toward operational jobs, according to management experts. Boards also need to actively groom more female presidents, chief operating officers, and heads of units who will become role models for the next generation. In other words, more Mary Barras. An Marissa Mayer, Yahoo! engineer by training, the 52-year-old spent more than 30 years at GM, where she gained increasing responsibilities, including as
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Companies/Industries
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a plant manager and vice president rarely pick heads of HR to be directors, for manufacturing engineering. says Julie Daum, who leads the North Another example is Susan American board practice “The question is, Cameron, who returned from at executive-recruiting firm do women opt into a three-year retirement to Spencer Stuart. those jobs or is that where people retake the top job at Reynolds “People have been allow them to American in May. From 2001 talking about it for a long succeed because to 2004 she was CEO of tobacco time, and clearly nothing it’s OK to have company Brown & Williamson has changed,” says Daum, an HR person who before it combined its U.S. who has recruited directors is a woman?” businesses with Reynolds, where —Julie Daum for major corporations she was CEO from 2004 to 2011. including General She’ll remain the Reynolds Electric, Amazon.com, chief after it completes its $25 billion and Wal-Mart. “The question is, do purchase of rival Lorillard. women opt into those jobs or is that Other recent appointments to where people allow them to succeed CEO include two female former because it’s OK to have an HR person COOs: Lockheed Martin’s Marillyn who is a woman?” Hewson and General Dynamics’ Facebook COO Sheryl Sandberg’s Phebe Novakovic. “Women need to book Lean In is resonating with get into these line roles, demand it, women precisely because not and focus on it as their career path,” enough of them are taking the risk says Lepore, who is now a director at and getting to operational jobs, says AOL, RealNetworks, and Coupons. Jane Stevenson, who leads the global com, and a past director at Wal-Mart succession practice at recruiter Korn Stores and EBay. Ferry. “Generally speaking, when a Many companies fail to think man gets into a new job, he’s already far enough in advance about future thinking about the next job and CEO candidates, says John Wood, what he needs to get the next job,” vice chairman at executive recruiter Stevenson says. “Women, on the other Heidrick & Struggles. Doreen Wright, hand, when they are appointed to big former chief information officer of jobs, are out to prove they deserve to Campbell Soup and Nabisco and be in the job they’re already in. That a board member at Crocs, says not presents a different way of looking for enough is being done to get women career progression.” promoted up the specific operational There are signs of change. At the rungs of the career ladder. “It’s not turn of the century, the S&P 500 had the step of the president to CEO; it’s six female CEOs, and the total didn’t the step before that,” says Wright, who rise above 10 until 2006, according wasn’t personally interested in the to Spencer Stuart. The female ranks top job. “There’s plenty of women, reached 24 after Barbara Rentler’s so why aren’t they making it to the promotion at discount retailer Ross business [unit] president role? That’s Stores in June. Eleven of those CEOs the problem.” took their jobs after 2011. Women often become head of Two notable female exceptions to nonoperational business functions the prescribed operational career because they started in those areas. path to the CEO office: PepsiCo’s “I don’t think there is a bias. A lot of Indra Nooyi was chief financial officer companies are specifically looking before taking the top job, as was Lynn for women to put into these jobs,” Good at Duke Energy. They are says Wood, who has helped place more than 200 CEOs and directors. “If you haven’t been thoughtful about Number evolving and developing your talent, of female you may find that you narrow your CEOs at choices beyond what you should if you S&P 500 companies had more actively managed people getting new assignments.” The lack of operational experience is also hurting women’s chances to sit on boards in the S&P 500, where female directors account for 18 percent of the total. Companies
24
among the 6 percent of S&P 500 chief executives—men and women—who had a nonoperational job immediately before their accession to the top spot, according to data from executive compensation consultant Equilar. Women need all the role models they can get to succeed, says J. Veronica Biggins, managing director at Philadelphia-based Diversified Search and a director at Southwest Airlines: “Only recently have women been able to see other women in roles where they could say, ‘Wow, I could be the CEO of this company.’ ” —Jeff Green The bottom line Women make up almost half of employees at S&P 500 companies but only 5 percent of CEOs.
Natural Disasters
Crushed Glass and Broken Barrels in Napa A major quake reminds wine producers of California’s faults “ ‘Am I insured? Am I insured?’ And the answer is: ‘No’ ”
The earthquake that struck Napa Valley at 3:20 a.m. on Aug. 24 produced the expected disaster photographs of piles of broken bottles and wine bleeding into the street. David Duncan, chief executive officer of Silver Oak winery, posted just that image on Twitter two hours after the 6.0 tremor, getting 5,000 retweets. However, the more significant damage wrought on the wine producing area by the quake—the worst in the area in 25 years—didn’t involve crushed glass. Wineries hold on to relatively few bottles. Most are immediately shrink-wrapped after they’re filled and labeled, then sent off to warehouses and on to distributors. The trouble was the barrels. In many wineries, they’re stacked six high; and if a few of the top ones rock back and forth enough, they fall like Jenga pieces, crushing the ones below in an avalanche. The quake shook René Schlatter, CEO of Starmont Wines and Merryvale Vineyards, awake. “I was out of bed in three seconds, and I had quite a bit of wine that night,” he says. Schlatter immediately headed over to Merryvale, the older of his two
Companies/Industries Post-quake
Inside Starmont Wines, a mess of fallen barrels
PHOTOGRAPHS BY PETER EARL MCCOLLOUGH FOR BLOOMBERG BUSINESSWEEK
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wineries. It was the first to produce wine after Prohibition ended and has a building dating from 1933. Once he saw Merryvale was fine, he went back home, figuring the Starmont facility, which is just eight years old, wouldn’t have been affected. Then, the next morning, he says, “Our team started sending us pictures, and I was like, ‘Holy s---.’ ” Schlatter, a calm man who started working at his dad’s wineries in 1995, shoved a flatbed truck against the outside of a building buckling from the weight of the fallen barrels pressing against the wall inside. The building’s three enormous storage rooms were piled with a mess of 8,000 barrels, most of them broken. Fortunately, only 3,000 of them were full; the others had been emptied to prepare for grapes from this year’s early harvest. “We’ll be fine,” says Schlatter, as hard-hatted Pacific Gas & Electric workers walk by to Schlatter
inspect the damage. “We’re not talking about $10 million of damage. But it’s more than $100,000. It’s not going to shut down our business,” he says. Unless the federal government designates Napa a disaster, Schlatter and other winemakers will not be eligible for special loans. He will have to pay for a new air-conditioning system, barrels, and tank repair himself. Starmont has no quake insurance. The damage to the area—including fractured roads, broken water lines, and crumbled facades like that of the 113-year-old Goodman Library in the town of Napa—may come to $4 billion, according to Kinetic Analysis, which assesses the cost of natural hazards. Insurance companies are likely to cover $2.1 billion of that amount. In California, however, earthquake risk isn’t part of standard homeowners’ policies. Only about 12 percent
of state residents have that protection, Robert Hartwig, president of the Insurance Information Institute, told Bloomberg News. That statistic falls to about 6 percent in Napa. “It’s been text, call, text, call, text, call. ‘Am I insured? Am I insured?’ And the answer is: ‘No,’ ” says Nick Svetcoff, a broker at John Sutak Risk Services, which has been a risk manager to much of Napa’s wine industry for 30 years. Of its 500 clients, none have earthquake insurance. “In the few instances when someone asks us to run the numbers, they say it’s too expensive,” he says. Earthquake insurance for wineries costs about three times as much as property insurance and has a high deductible: typically 15 percent of the total value of the property and all its contents. Napa has 789 licensed wineries, which had combined sales of $5.5 billion in 2011. The damage in some places was dramatic. The tasting room at Trefethen Family Vineyards, built in 1886, looks like it’s in a funhouse mirror; the
Companies/Industries Hess Collection said Ugly Is Only 15,000 cases of cabernet Fin Deep sauvignon poured into its garden. Still, the earthquake won’t cause a disruption of supply or a spike in prices for the industry. “The 2012 and 2013 were record vintages. The crops were super abundant both those years,” says Patsy McGaughy of the Napa Valley Vintners trade group. Arson at a Vallejo wine warehouse in 2005 b that destroyed 4.5 million bottles worth as much as $100 million had a Sales of Napa’s Grouper Lumpfish far greater effect. 789 licensed Tourists are still wineries in 2011 coming. Two days after the quake, visitors walked the streets of Napa. Some took selfies next to a Nissan Sentra crumpled with bricks, festooned with a “For This fish’s scary looks Where the poor man’s belie its mild flavor caviar comes from Sale” sign reading “As is. Runs great.” The producers know they’re in an earthquake zone, but winemaking has briefly considered putting out a limited always been about tradition—and their edition called “Earthquake Blend.” model is France, which doesn’t have a “I was talking about it with my wife. major fault line running through it. They But it’s a bit of a gimmick. It’s not us.” might consider the experience of Silver Besides, he says, “somebody probably Oak. The damage at the 42-year-old already has that name.” —Joel Stein winery was almost entirely documented in the photo tweeted by its CEO, Duncan. The bottom line Of the 500 clients of a Other than so-called library bottles, Napa Valley wine risk manager, none have which winemakers keep to compare past earthquake insurance. lots with new, the winery is intact. That’s because Silver Oak was rebuilt as an earthquake-proof fortress after a 2006 fire. Duncan even got earthquake insurance with a $1 million deductible, in case Food of a catastrophe. “I was driving up here thinking, ‘God, I wonder if it worked,’ ” says Duncan of all his earthquake preparedness. After reading a University of California Greater demand for paiche could at Davis study, he got rid of the stanattract commercial fish farmers dard two-barrel pallets and replaced them with heavy, stainless-steel four If only Peruvians ate farmed paiche, barrel pallets that help absorb the “it would not cover the fixed costs” shock of earthquakes better. Those Many Americans have their first required bigger forklifts. “It was a really encounter with the giant Amazonian expensive decision,” he says. “It’s a lot fish paiche while watching extremecheaper now.” fishing shows such as cable network At Starmont, Schlatter is considering Animal Planet’s River Monsters. The how he’d store his barrels differently: thrashing, carnivorous fish has a bony Maybe buy those four-barrel pallets; head and sometimes requires several maybe pack them more tightly; maybe men to lift it out of the water since it build a retractable fence around the can weigh up to 400 pounds—making stacks or not stack them as high. More it the largest fish in the Amazon River likely, he’ll keep things as they are. Living with risk, he says, is just part of basin. But the next time some U.S. shoppers run into paiche could be at the California wine business. He says he
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Saving an Endangered Fish by Eating More of It
297 lbs. of delicious
John Dory
The eye spot on its side doesn’t scare off diners
Monkfish
Think lobster, without the cute or the claws
their local Whole Foods Market. For more than a year, the high-end supermarket chain has been promoting farm-raised paiche (pronounced pie-chay and also called arapaima) from Peru as a cheaper option to halibut or Chilean sea bass. The grocer’s goal: to combat the overfishing of wild paiche in South America by generating demand for the farm-raised version in the U.S., where barely anyone knows how to pronounce it, let alone cook it. If you want to save the paiche, the theory goes, you first have to eat it. The Convention on International Trade in Endangered Species of Wild Fauna and Flora (Cites) categorizes paiche among species that are “not necessarily threatened with extinction,” which allows it to be sold commercially, though “trade must be controlled in order to avoid utilization incompatible with their survival.” Although few Americans eat paiche today, its advocates say that could change. Demand for Chilean sea bass, once known as Patagonian toothfish, was minimal in the U.S. until the 1990s. Still, from a sustainability standpoint, creating more demand for the vulnerable fish seems counterintuitive. Adrian Burstein, founder of Whole Foods’ paiche supplier ArtisanFish, says its commercial farm needs to export paiche to the U.S. to generate enough revenue to offset the cost
FROM TOP LEFT: DAVID SILVA; ALAMY (2); ANIMALSANIMALS (2); SEAFOOD INTERNATIONAL; DATA: COMPILED BY BLOOMBERG; *MOST RECENT REPORTED EMPLOYEE COUNT
Companies/Industries of raising the fish. That can’t be done based on the current demand for it in Peru. “If we had to operate only for the Peruvian market, it would not cover the fixed costs of the project,” Burstein says. In 2012, 82 percent of Peru’s paiche exports went to the U.S., says the state news agency, citing the Peruvian Association of Exporters. If paiche farms close, overfishing in the wild will resume, Burstein argues. Meanwhile, the arapaima population continues to dwindle. In a recent survey of 81 communities in Amazonas state in neighboring Brazil, 19 percent said the paiche have already vanished from their waterways. The fish have fared better in communities with fishing rules, such as a minimum capture size. “We’re giving consumers the opportunity to buy that fish, and it’s not coming from an endangered source, and we’re helping to rebuild that stock,” says Jeremy St. Gelais, Whole Foods’ seafood-product procurement team leader. Whole Foods is selling paiche for roughly $13.99 per pound, about 40 percent cheaper than other whitefish at its stores. The effort also tracks with Whole Foods’ recent efforts to offer customers lower-priced seafood, including cheaper salmon at $10.99 a pound, while still meeting the company’s no-antibiotic, no-hormone, no-pesticides standards. There’s a risk here, says Paul Greenberg, author of Four Fish: The Future of the Last Wild Food. “The Whole Foods consumer is looking for something new and exotic,” he says, but if paiche becomes popular Whole Foods is enough in the trying to make U.S., supermarpaiche popular kets without Whole Foods’ mission could buy from fishermen with lesssustainable practices. Whether the farms help restore the paiche population “rests on the ability of each country to manage their fisheries,” Greenberg says. So far, paiche has made its way onto such culinary TV shows as Iron Chef and into some high-end restaurants, including chef Ricardo Zarate’s California restaurant Paiche. In fact, ArtisanFish sells most of its paiche to restaurants, rather than grocers. According to St. Gelais, paiche has the
mild flavor of whitefish but is denser and less flaky than cod. A spokesman for the Monterey Bay Aquarium Seafood Watch program says it will add paiche to its 2015 list of species to be assessed for sustainability because there is now enough U.S. market demand for the fish. —Venessa Wong The bottom line About 82 percent of Peru’s exports of paiche went to the U.S in 2012. That demand supports sustainable fish farms.
Retailing
The High-Stakes Battle For a Low-Price Retailer Why rival discounters are vying for control of Family Dollar Stores Pursuing “markets that can’t support a giant Target or Wal-Mart”
In a season marked by heavy mergerand-acquisition activity, few takeover contests have matched the intensity of the bidding for Family Dollar Stores. While it’s not quite Game of Thrones, the battle between Dollar General and Dollar Tree for control of the North Carolina-based discounter has the kind of intrigue and promise of riches that have turned the saga of the warring houses of the Seven Kingdoms into must-see television. At issue is who will dominate lowerincome and small-town discount retailing in the U.S. now that Wal-Mart Stores has moved more upscale. “It’s one of the best opportunities in retail,” says Edward Jones analyst Brian Yarbrough. “There are a lot of small, rural markets that can’t support a giant Target or WalMart,” whose largest stores can exceed 170,000 square feet, “but can support a 7,500-square-foot dollar store.” To snare the low-end discounting crown, Dollar Tree in late July struck a deal to buy Family Dollar for $9.2 billion. By combining Family Dollar’s 8,200 locations with its own roughly 5,000 stores,
Battle of the Bucks
Dollar Tree would have the largest number of discount outlets in the U.S. The tieup also would help Dollar Tree, the only one of the three that actually sells all its merchandise for a buck or less, to quickly become a major retailer offering goods at all price points. Dollar General, which had been negotiating its own buyout offer for Family Dollar when Dollar Tree’s surprise takeover was announced, refuses to walk away quietly. Instead, the 11,300-store retailer on Aug. 18 tried to scuttle the deal by making a $9.7 billion counterbid for Family Dollar. The spoiler also says it’ll pay the $305 million breakup fee that would be due Dollar Tree if Family Dollar accepts the higher offer. Family Dollar is a surprising target. The No. 2 U.S. discounter by number of stores (behind Dollar General) with revenue of $10.4 billion in the past 12 months, the chain has struggled with declining sales at stores open for more than 13 months because its prices have become too high for many cashpinched customers. To counter that, Family Dollar lowered prices on about 1,000 items this year. Still, there’s potential to turn things around in a merger, says Yarbrough. Neither Dollar Tree nor Dollar General would be eager to compete against whichever of them does manage to bag Family Dollar, since the resulting behemoth would have more buying clout with suppliers. That would help the winner keep prices low, a key selling point for this type of retailer. “Dollar stores have a valid place, especially after the recession,” says Wedbush Securities analyst Joan Storms. “People that traded down, they aren’t trading back up.” Representatives for Family Dollar, Dollar Tree, and Dollar General declined to comment for this story. Most analysts say a Dollar GeneralFamily Dollar merger makes the most sense, as both stock similar goods—housewares, apparel, and food and other consumables—and sell them at a wide range of prices. Yet there’s concern that combining two such similar discounters into a
Less money, but Family Dollar CEO Howard Levine wouldn’t be out of a job
Purchase bid
$9.2b
Revenue
Employees*
Stores
Family + Dollar
Dollar Family + General Dollar
$9.7b
$28.2b
134,600
19,584
Dollar Tree
$18.4b
51,600
13,326
23
Companies/Industries 19,584-outlet chain would raise antitrust questions. Dollar General says it’s prepared to sell as many as 700 stores By Kyle Stock to appease regulators. “We don’t believe the antitrust is the matter of concern,” Chief Executive Officer Richard Dreiling told investors on Aug. 18. But on Aug. 21, Family Dollar rejected Dollar General’s bid # ○ ○ Kia Motors said it will build a $1 billion assem“on the basis of antitrust regulatory considerations” and bly plant in Mexico near the U.S. border, joining a reaffirmed its commitment host of rivals seeking low-cost labor close to Ameri- The price of GoPro’s to the deal with Dollar Tree. Fetch, a harness can dealers. Plans for $9 billion worth of car plants in designed to strap video Activist investor Carl Icahn, cameras to dogs. The who holds a 3.6 percent stake Mexico have been announced in the past 20 months. company is trying hard in Family Dollar and helped to stretch its consumer Thanks to new foreign-owned factories, the country base beyond extreme pressure the retailer to put athletes. itself on the block this summer, is expected to produce 3 million vehicles this year, isn’t backing off. He suggested passing Brazil in car manufacturing. ○ ○ The U.S. gun market on his blog that Family Dollar CEO Howard Levine may have been cool continues to cool off after a record 2013. In its most recent quarto striking a deal with anyone other ter, Smith & Wesson sales plummeted 23 percent to $132 mil- than Dollar Tree because that retailer said he would have a management lion. The company blamed the slump on a production glut had role in the merged company. “It seems and stores stocked with unwanted models. It said its fortunes obvious that, in a Dollar General/ Family Dollar merger, Levine would should rebound with stronger demand during this fall’s hunting not have any future role,” Icahn said. season and more manufacturing discipline. ○e○ American However, Nelson Peltz’s Trian Fund 24 which has a 7.3 percent Airlines stopped selling tickets on Orbitz Worldwide websites Management, stake in Family Dollar, has defended as it pressed for lower booking fees. The airline said it would the Dollar Tree matchup based on antitrust concerns. take a similar step with its US Airways brand, as it struggles to Family Dollar might still be willing compete with discount carto reconsider Dollar General’s higher The Standard & Poor’s 2k 500-stock index finally offer if the suitor commits in advance riers that skip distributors closed above the 2,000 to completing its deal even if federal barrier on Aug. 26. like Orbitz entirely. ○ q ○ antitrust regulators require that far stores be divested, people familVolvo unveiled the XC90 SUV, more iar with the matter who were not 1k which it hopes will reverse a authorized to comment publicly told 8/2009 8/2014 News. decade-long swoon in U.S. Bloomberg Given the strategic advantages for sales. The vehicle will go on sale next year for about $49,000. both suitors, many on Wall Street think the courtship is far from settled. It’s the automaker’s first model in 15 years that doesn’t Edward Jones’s Yarbrough says CEO include parts from Ford Motor, which sold the com- Wisdom both bidders have solid management teams and can be successful, pany in 2010 to China’s Zhejiang Geely. but “the deal will be more beneficial to Dollar General’s earnings,” ○ ○ Under Armour is trying to get its basketwhich should enjoy greater savings ball shoes on Kevin Durant, as the NBA MVP’s because of its similar business model. long-term contract with Nike comes to a close. And if Family Dollar is looking for more money, “Dollar General has more dry The Baltimore-based apparel giant is offering “That even seems powder.” But you can bet it won’t be in a 10-year deal valued at up to $285 million. ludicrous to me.” dollar bills. —Venessa Wong
Briefs Run for the Border
Durant-endorsed footwear accounts for about 5 percent of basketball shoe sales, a market still dominated by Michael Jordan gear.
—David Dillon discussing the $13 million he made in his last year as CEO at supermarket chain Kroger
The bottom line Dollar General thinks it has something to scuttle the $9.2 billion marriage of Dollar Tree and Family Dollar: more dollars. Edited by James E. Ellis Businessweek.com/companies-and-industries
DILLON: AP PHOTO; DATA: COMPILED BY BLOOMBERG
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Marriage equality remains elusive for gay vets 29
Alaska tries to get its oil flowing again 30
California dreaming— of lower health-care costs 31 September 1 — September 7, 2014
How Candidates Speak to Super PACs …
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The law says campaigns and interest groups can’t coordinate, but that doesn’t stop them
PHOTO ILLUSTRATION BY 731; GETTY IMAGES (2)
“People have just become more sophisticated on how to do it” When Republican Representative Cory Gardner of Colorado announced in March that he would run for the U.S. Senate, he knew he could count on backing from national Republican groups, including so-called super PACs. But he wasn’t allowed to talk to them directly. Federal election law prohibits campaigns from having contact with the super PACs and advocacy organizations that have come to dominate political spending since the U.S. Supreme Court’s 2010 Citizens United v. Federal Election Commission decision. Those rules were intended to put a wall between candidates, whose fundraising is constrained by federal limits, and special interest groups allowed to spend unlimited amounts of money promoting candidates and issues. In practice, campaigns have found ways to
talk to super PACs while staying on the right side of the law. Gardner’s race illustrates how the system works. Within weeks of his declaring his Senate run, Americans for Prosperity, backed by billionaire brothers Charles and David Koch, told the Washington Post it would spend $970,000 on three weeks of television, radio, and online ads attacking incumbent Democratic Senator Mark Udall. That news was a signal that Gardner, who was unopposed in the primary, could hang back and focus on raising money—even as Democratic groups began running their own ads attacking him. Then, the day after the Americans for Prosperity ads ended, another Kochbacked group, Freedom Partners, stepped in with three more weeks of commercials. In the first week of May,
the political spending arm of the U.S. Chamber of Commerce announced it would put up another $1.1 million for a third wave of pro-Gardner ads, including some in Spanish. On May 19 the Associated Press reported that American Crossroads, the super PAC co-founded by Karl Rove, and its issue advocacy arm, Crossroads GPS, planned to spend $2.3 million in Colorado. That flagged the ad buy to Gardner and outside groups aligned with his campaign, along with everyone else. Two days later, as required by law, filings showed up on the Federal Communications Commission website listing the times and stations where those ads would run, making it clear that there was a period leading up to the June 24 primary when there would be no outside ads. During that
Politics/Policy The Subtle Art of Collaboration
On May 19, the AP reported when Crossroads GPS would buy ads in June and July—a signal for Gardner
Two key Senate races illustrate how closely outside groups work together to support candidates—and how their actions guide campaigns Outside group ads February
Colorado Senate Race
Candidate ads March
April
May
June
July
August
Americans for Prosperity Freedom Partners Outside groups bought U.S. Chamber of Commerce ads early, giving the Republican Rep. Cory Gardner candidate more time Crossroads GPS to raise money
Senate Majority PAC North Carolina Senate Race
Democratic Sen. Kay Hagan Women Vote! Patriot Majority
The largest outside Democratic group spent millions on ads to weaken the leading candidate in the Republican primary
After the primary, Hagan launched ads focused on her record in Congress …
… while outside groups ran ads on issues
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window, the Gardner campaign— which declined to comment for this story—ran its own ads. “This election cycle, we’re seeing super PACs fully installed in virtually every competitive Senate race, and are now seeing them migrate down into competitive House races,” says Michael Toner, former chairman of the Federal Election Commission and a partner at law firm Wiley Rein. Figuring out how to work the system allows candidates to avoid wasting hard-won dollars when money from better-financed national groups is available. Outside groups look to candidates for cues about which issues they should highlight. “People have just become more sophisticated on how to do it,” Toner says. “How much information to put out, what kind of information to put out there.” Earlier this year, the campaign of Senate Minority Leader Mitch McConnell of Kentucky posted footage on YouTube of the candidate grinning blankly into the ether. What looked like
Cut …
J
On March 11, McConnell’s campaign uploads video of the Senate minority leader to YouTube
a hamfisted effort at going viral—one skewered by the Daily Show With Jon Stewart—was a legal way for the campaign to provide footage to outside groups to use in ads. In April aides for the Democratic Senatorial Campaign Committee, which can talk directly to candidates but not to outside groups, tweeted a link from the website of New Hampshire Senator Jeanne Shaheen, the state’s Democratic incumbent, with what appeared to be an anti-Koch ad message. Two days later, Senate Majority PAC, the largest outside Democratic group, launched ads mirroring the same themes. Groups have also found ways to share opposition research, the centerpiece of most political ad campaigns. In 2012 a single outside group, American Bridge, became the hub for feeding information to liberal super PACs to use in ads against Republican presidential candidate Mitt Romney—but couldn’t pass it directly to Democratic candidates. Last year, former Romney operatives
… And Paste A week later the Kentucky Opportunity Coalition used the footage in its “Deserve” ad
founded a new group, America Rising, which incorporated a for-profit arm. That allows candidates to buy information collected by outside researchers that would otherwise be off-limits. According to FEC filings, McConnell’s campaign is among its customers; so is American Crossroads, which helps fund America Rising’s super PAC operations. As they send signals to candidates, outside groups are also working together more closely to avoid duplicating their efforts. Top aides for the Chamber of Commerce, Crossroads, and other GOP groups speak at least weekly. That coordination goes back to 2010, when Republican operatives gathered at Rove’s house in Northwest Washington. In the years since, those links have “evolved and gotten tighter,” says Steven Law, president and chief executive officer of Crossroads. In the runup to North Carolina’s Republican primary in May, American Crossroads and the Chamber agreed to split five weeks of Senate campaign ads on behalf of state legislator Thom Tillis, who was fending off a Tea Party challenge. Crossroads paid $1.6 million for the first four weeks. The day those ads went off the air, the Chamber came in with $900,000 for a week of ads in the same markets, according to data from Kantar Media’s CMAG, which tracks campaign ad spending. Tillis won decisively, avoiding an expensive runoff. “It was joint polling, joint communication,” says Carl Forti, political director for American Crossroads and Crossroads GPS.
FROM LEFT: YOUTUBE (2); WALLY SKALIJ/LOS ANGELES TIMES
DATA: KANTAR MEDIA/CMAG, FEDERAL COMMUNICATIONS COMMISSION
Politics/Policy Republican fundraising has “forced us to be more efficient and more effective,” says Ty Matsdorf, a spokesman for Senate Majority PAC. Women Vote!, the advocacy arm of the group Emily’s List, and Patriot Majority USA, a nonprofit allied with the Senate Majority PAC, have lined up their plans to minimize overlaps in spending. In North Carolina, where incumbent Senator Kay Hagan is defending her seat against Tillis, the Democratic groups—which have put more than $9 million into the race— began buying ads on March 27, allowing Hagan to hold on to her own cash until June 10, when her first TV ads aired. The pattern is repeating itself in the runup to the November midterm elections. In May the National Republican Senatorial Committee began buying ads for the fall; its filings on the FCC’s website provided a road map for outside groups. “You’re seeing all of the other groups start to layer in,” Forti says. “That’s a coordinated effort.” That helps candidates keep up with the national groups’ plans. On July 1, the Hill newspaper reported that American Crossroads and Crossroads GPS had reserved $20 million in fall advertising time. The buy tracked the NRSC schedule. American Crossroads reserved $5.5 million in Alaska and $3 million in Iowa, while Crossroads GPS staked out $5.1 million in North Carolina, $2.5 million in Arkansas, and
Couples getting married in California in 2013
$2.1 million in Louisiana. Candidates, including Gardner, know where to find the gaps. “It’s not quite like ordering sandwiches,” says Scott Reed, the chief political strategist for the Chamber of Commerce. “But it’s close.” —Phil Mattingly The bottom line Candidates and outside groups have developed ways to get around rules prohibiting direct communication.
Marriage
Washington Struggles To Get Gay Rights Right The ruling that overturned DOMA did nothing about older laws “You should examine whether you think this statute … is constitutional”
After the U.S. Supreme Court repealed key parts of the Defense of Marriage Act last year, most federal agencies adopted “place of celebration” policies under which any marriage that was legally recognized in the state where it took place would also be recognized by federal authorities. The Internal Revenue Service allows gay couples to file joint tax returns, the Department of Defense extends spousal benefits
to same-sex couples, and the Federal Bureau of Prisons grants equal visitation rights. Yet there are a few federal agencies that still won’t recognize some samesex marriages. They include the Department of Veterans Affairs, the Social Security Administration, and the Railroad Retirement Board. Each is bound by statutory language dating back decades requiring them to defer to state laws in determining who counts as married. In June, Attorney General Eric Holder wrote in a memo that congressional action is required to address the gap, but Democratic proposals to do so have stalled. Now a group representing same-sex couples is suing the VA for its decision to continue denying spousal benefits to gay veterans unless the state where they lived when they wed or applied for benefits recognizes their marriages. The federal government should not be “giving the force of a federal prohibition [to] these state laws that are unconstitutional,” says Susan Sommer, who directs constitutional litigation for Lambda Legal and brought the lawsuit on Aug. 18 on behalf of the American Military Partner Association. Those benefits include pensions, governmentbacked loans, and disability pay. A 1958 statute determines who counts as a veteran’s spouse according to “where the parties resided at the time of the marriage or the law of the place where the parties resided when the right to benefits accrued.” In a June memo, the VA’s general counsel, Will Gunn, noted that this has been the standard for veterans’ benefits since 1882, when similar wording was written into a Civil War widows’ pension statute. The Obama administration has already taken steps to address another problematic provision. A 1975 amendment to the 1958 law replaced genderspecific language such as “widow” and “woman” with “surviving spouse” and “person of the opposite sex.” In 2013, after the Supreme Court ruling, a district court judge in California enjoined the federal government, including the VA, from using that “opposite-sex” definition to deny benefits to samesex couples in the state. Holder subsequently announced he would cease enforcement nationally. Sommer also cites the Social Security Administration’s decision to stop automatically denying benefits to the
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Politics/Policy
The bottom line The federal government recognizes same-sex marriage, but the VA and other agencies still defer to state laws.
Energy
Alaska Lures Back Big Oil With Big Tax Breaks The state squeezes the last dollars from a lucrative, dwindling industry “We didn’t have a recession in Alaska. We had a slowdown”
Alaska’s oil boom times, which have propped up the state for decades, are coming to an end. In the late 1980s the state produced as much as a quarter of all U.S. crude, about 2 million barrels a day. Over the last 15 years, its daily oil production has been cut in half, to just more than 500,000 barrels. And the fracking boom has unlocked shale oil beneath Texas and North Dakota that is more profitable to extract. Rising oil prices have so far made up for Alaska’s declining production, but for a state
Alaska’s Oil Boom—and Bust
Production peaks in March 1988 at 2 billion barrels a day
Billions of barrels per day
2
Lawmakers hope lower taxes will reverse the slide
1 The Prudhoe Bay oil field comes online in 1977 0 1970
2014 GRAPHIC BY BLOOMBERG BUSINESSWEEK; DATA: COMPILED BY BLOOMBERG
whose budget relies on oil profits for 90 percent of its revenue, the picture is starting to look troublesome. Last year, Alaska’s Republican-led legislature voted to cut taxes on oil and gas companies, reversing higher tax rates Sarah Palin put in place as governor in 2007. The lawmakers are betting that lower taxes, which budget hawks claim will wind up costing about $2 billion in fiscal 2014, will coax companies to invest in the state and ultimately start producing more oil. An August ballot measure to repeal the tax cuts, which were decried by opponents as a wasteful giveaway to Big Oil, failed by about 5,000 votes. Republican Governor Sean Parnell urged the oil companies to “move those billions of dollars” in tax savings “into work for Alaskans.” They appear to be doing just that. BP is upping its capital budget in Alaska by 25 percent in 2014, to $1.2 billion. ConocoPhillips, the state’s largest producer, is spending $1.7 billion, 50 percent more than in 2013. The company has already raised production in Alaska by 6,000 barrels per day this year and plans to add as many as 40,000 barrels a day by 2018. “The oil companies clearly signaled they’d spend more if their taxes were lowered, and so far that’s what they’re doing,” says David McCaleb, an analyst at energy research firm IHS. McCaleb expects Alaska’s lower taxes will boost total investment from the industry by 10 percent to 15 percent over the next several years. The question is whether all that investment can reverse Alaska’s slide. Oil production in the state was declining decades before Palin’s higher taxes went into effect. First discovered in the late 1960s, the state’s Prudhoe Bay oil field
turned out to be a gusher. From 1976 to 1980, with production growing almost tenfold, from 173,000 barrels a day to 1.6 million, Alaska briefly edged past Texas as the country’s top oil-producing state. By the mid-2000s, oil revenue had generated about $50 billion in taxes for Alaska. Some of that money is invested in the state’s beloved Permanent Fund, established in 1976, which pays citizens a yearly oil dividend. The fund’s balance is currently about $50 billion. Last year everyone got a check for $900. While that windfall raised the state’s standard of living, it also left Alaska dependent on the oil industry, which for years enjoyed low tax rates and little regulation. In 2007, FBI wiretaps caught state officials accepting bribes from oil companies, exposing what many had long suspected: Some of Alaska’s most prominent politicians were doing the industry’s bidding. Then-Governor Palin cooperated with Democrats to pass a law raising the tax rate on oil and gas profits to 25 percent or higher, depending on oil prices. (This was back when Palin was making her name as a populist reformer, before her transformation into an antitax Tea Partier.) The timing couldn’t have been better. By the summer of 2008, oil prices had jumped almost 50 percent, to $146 a barrel, kicking billions of dollars into the state’s coffers. By the time the recession hit and most states were slashing budgets and laying off workers, Alaska was sitting on a $12 billion surplus. “We didn’t have a recession in Alaska. We had a slowdown,” says Gunnar Knapp, an economist at the University of Alaska at Anchorage. Yet to avoid the taxes, oil companies eventually cut their operations
PHOTO ILLUSTRATION BY 731; GETTY IMAGES (2)
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children of unwed parents on the basis of state laws as precedent for the VA to disregard discriminatory language. “Courts started saying, ‘You don’t have to do that,’ ” Sommer says. “You should examine whether you think this statute, this underlying state statute, is constitutional or not.” The VA isn’t commenting on the suit. “Generally speaking, you wouldn’t expect administrative agencies to get out in front of the courts in terms of saying, ‘This state law is unconstitutional, we’re going to disregard it,’ ” says Kermit Roosevelt, a professor of constitutional law at the University of Pennsylvania. Some believe the White House would likely welcome a court ruling allowing the federal government to disregard state bans on same-sex marriage. “I suspect that the Obama administration would not be in any way disappointed if they lose this lawsuit,” says attorney Roberta Kaplan, who argued against DOMA before the Supreme Court. Sommer says she’s looking at bringing a similar case against the Social Security Administration. “I think the tides have turned,” she says. “We’re not going back to where we once were.” —Josh Eidelson
Politics/Policy in the state, hastening the decline in production. By 2011, ConocoPhillips was spending just $774 million in Alaska, half its 2008 investment. The higher taxes also coincided with the shale boom in Texas and North Dakota. All of a sudden, Alaska had to compete with less-remote states awash in oil. “The choice was obvious for a lot of these companies to move money out of Alaska,” says Doug Terreson, an oil analyst for ISI Group, a New York-based investment firm. Short of a large discovery, Alaska is looking at a slow, if profitable, fadeout for its No. 1 industry. Politicians aren’t panicking just yet. The TransAlaska Pipeline is still flowing, and the Permanent Fund is still flush, meaning there hasn’t been much soul-searching about what, if anything, could ultimately take oil’s place. “We have not looked in the mirror and said, ‘OK, we’re gonna be the Silicon Valley of the North,’ ” says Knapp, the economist. “Even if we don’t get back to the glory days, a lot of people think it’s still worth it to attract whatever investment we can.” —Matthew Philips The bottom line Alaska’s new low taxes on oil profits are spurring production—but may not be enough to reverse a decades-long decline.
Obamacare
States Step In to Put A Lid on Health Costs
California asks voters for the power to reject insurance price hikes “It’s really the missing piece” of the Affordable Care Act
As a California state lawmaker, Dave Jones sponsored four bills that would have given insurance regulators authority to reject health-plan rate hikes, as they can in 35 other states. None became law. Now that he’s California’s state insurance commissioner, and
running for a second term, Jones wants California voters to grant him that power directly. He’s urging passage of Proposition 45, a November ballot measure that would let him deny proposed insurance rate increases if his office deems them too high. This power would apply to individual and small-business healthinsurance markets, which cover about 6 million Californians. Jones argues that states need the ability to keep a lid on premiums as health providers and insurance companies absorb new Obamacare customers. “There’s nothing in the Affordable Care Act or state law that reins in excessive health insurance and HMO rate hikes,” he says. “It’s really the missing piece” of the law. It’s not the first time state officials have tried to tame health costs. In the 1970s and ’80s, states including Connecticut, Massachusetts, Maryland, New Jersey, and New York began setting hospital prices, similar to the way governments oversee electric utilities. “States have long been on the front lines of health-care innovation, especially when it comes to cost,” says Ceci Connolly, managing director of the PricewaterhouseCoopers Health Research Institute. Most hospital price controls were undone in the 1990s, when the healthcare industry embraced managed care in an attempt to contain costs. In Maryland the rate-setting commission lived on, and this year the state expanded its authority. In addition to determining how much hospitals can charge for individual services, Maryland regulators will attempt to prevent total hospital spending from growing faster than the state’s economy. Deval Patrick, the Democratic governor of Massachusetts, signed a similar law in 2012. A state commission will audit health-care providers and can require “corrective action” if spending increases too much. An even more radical experiment is under way in Vermont, where a 2011 law authorized the state to build a single-payer health-care system by 2017. So far, it’s gone nowhere. Governor Peter Shumlin, a Democrat who campaigned on the idea in 2010, has yet to say how the system will be financed. Jones’s proposal in California is mild by comparison. Democratic and Republican voters support the ballot measure, with 69 percent in favor, according to a poll published on Aug. 20 by Field Research. Not so
thrilled about it: the insurance industry and health-care providers, which are lining up to fight the measure. A No on Proposition 45 committee has raised $37 million, with 98 percent of its funding coming from three of the state’s largest health plans: Kaiser Permanente, WellPoint (also known as Anthem), and Blue Shield of California. The insurers directed questions to Robin Swanson, a spokeswoman for No on Proposition 45. “It gives one politician too much power,” she says. Swanson points out that the California measure goes further than laws in other states in one important way: It would enable third-party consumer groups, including the one pushing the ballot measure, to challenge insurance rates in court. Such challenges could leave proposed premium increases mired for months in hearings and legal challenges, says Jon Kingsdale, the former head % of Massachusetts’ health insurance exchange, who was Share of California’s hired by opponents voters who favor of Prop 45 to draft a letting the insurance commissioner police report on its possiprice increases ble consequences. If challenges keep rates from being decided in time for Obamacare’s open-enrollment period each fall, “I can’t even tell you what happens,” Kingsdale says. “There’s absolutely no imagination within the ACA for such a development.” That’s one reason leaders of Covered California, the state’s Obamacare exchange, have been cool to the idea of expanding Jones’s power. Governor Jerry Brown has not weighed in on the issue. The size of Affordable Care Act subsidies is pegged to the premiums in the marketplace, so even Californians buying policies that have been approved wouldn’t know how much they’d ultimately have to pay until every other plan’s rates have been settled. Obamacare’s political opponents might welcome such a scenario. Kingsdale says: “There are lots and lots of people who want nothing more than to gum up the works.” —John Tozzi
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The bottom line If passed in November, a ballot measure in California will give the state authority to reject health-insurance price hikes. Edited by Weston Kosova and Allison Hoffman Businessweek.com/politics-and-policy
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Pencils, notebooks, glue … and the Remind app 34
Helping computers block a threat from the future 36
Apple’s iBeacon runs into a wall 35
Innovation: A hospital designed to withstand rising waters 37
September 1 — September 7, 2014
ILLUSTRATION BY 731
Operation Twitter The company struggles to woo casual users “If someone’s gotten divorced five times, there may be a pattern”
The summer has been good for Twitter. Starting with the World Cup, the season has been packed with the kind of news that drives people to read and write tweets. Twitter also announced at the end of July that its ad revenue last quarter more than doubled, to $312 million, from the same period a year earlier, thanks largely to a boost from mobile phones. Its share price closed at just over $48 on Aug. 27, up about 50 percent since the beginning of June. That success only underscores the woes that sent Twitter shares falling from a December high of more than $73 to a low of about $30 in late May. Its monthly user count, 271 million, grew 6 percent last quarter, on par with its results since November’s initial public offering. Most of those sign-ups are overseas tweeters, however, worth onefifth the ad rates of U.S. users. American tweeters are less engaged with Twitter than they were a year ago, spending 7.2 minutes a day browsing its mobile app in June, compared with 9.2 minutes the year before. Grim world news of the last few weeks has made Twitter more indispensable to hard-core users and more impenetrable to casual ones. “The mundane day-to-day is where Twitter still has challenges,” says Debra Aho Williamson, an analyst with EMarketer. “A lot of people consider Twitter hard to understand, hard to figure out, hard to follow, and they don’t know what to do with it.” The trouble may have its roots in Twitter’s own interface, which has awaited a serious overhaul for years. There’s a reason dedicated users read their Twitter feeds on programs such as TweetDeck and scoff at twitter.com. It remains difficult for casual or prospective users to browse the site or learn to tweet. Its private-messaging tool is anemic, as is Discover, a barely used news tab. Perhaps most important, Twitter’s real-time flurry makes it tough for less-than-constant users to check their feeds quickly or efficiently. Top managers have debated changes to basic elements of Twitter’s user interface since at least 2011, when cofounder Jack Dorsey was still in charge of the service’s look and feel. A slew of executives have spun through the company’s revolving door after failing to fix these problems.
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Technology
900
Average number of times per month an active user checks Twitter
U.S. Worldwide International
800 700 600 500 Q2 2012
Q2 2014 DATA: TWITTER
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The job now falls to Daniel Graf, Twitter’s fourth head of product in five years. Swiss-born Graf, 39, previously ran Google Maps after some up and down years in the startup world. His charge is to make the daily experience of using Twitter more intuitive and inviting without alienating core fans. Since arriving in April, he’s restructured the product team around an inner circle of recent hires, according to two people familiar with the matter who aren’t authorized to comment on it. To reinforce the focus on adding and addicting new users, he’s killed a series of side projects, the people say. Graf declined to comment for this story; a Twitter spokeswoman says Graf wants to have something to show for his tenure before he talks. Graf demonstrated interest in a product like Twitter as far back as 2005, when he started a mobile videoblogging company called Kyte.tv. The service was too far ahead of its time in a pre-iPhone world, when smartphones couldn’t really load apps or reliably record video. By the time that was possible, Kyte was no match for YouTube, and a belated effort to remake it as a service for businesses flopped. In 2011, Graf and his directors unloaded Kyte on Dubai-based video hub KitDigital, which filed for bankruptcy last year. Although most investors lost money, many still have kind words for Graf. “The product was very slick, and it was positively easy to use,” says Howard Hartenbaum, a venture capitalist who was at Draper Richards when it backed Kyte. “Like many consumer products, we just couldn’t get the level of usage and engagement we were looking for.” After the sale, Graf joined Google and helped redesign Google Maps, which has remained the industry standard since Apple’s disastrous launch
of its own mapping program. “Daniel was the biggest agent of change the Google Maps team saw in years,” says Hugo Barra, a former vice president of Google’s Android division. Ben Ling, who hired Graf at Google and is now a partner at Khosla Ventures, says Google would have lost the mapping fight without Graf: “He really was the guy who pushed it forward, staffed it, built it, and got into the marketplace.” At Twitter, one of Graf ’s biggest obstacles may be his boss. Chief Executive Officer Dick Costolo hired Graf in April, toward the end of a C-suite drama that led to the exits of Twitter’s chief financial officer, its head of engineering, and its chief operating officer, Ali Rowghani, who clashed with Costolo over product decisions. “If someone’s gotten divorced once, you really don’t know who’s to blame,” says Brian O’Malley, a partner at venture firm Accel Partners, which owns Twitter shares. “But if someone’s gotten divorced five times, there may be a pattern there.” Costolo hasn’t been shy about scrapping projects he dislikes, including a redesign that Graf ’s predecessor tested last year. “I think it’s important when you’re thinking about strategy to set direction from the top, and I have some very clear things that I think about and want to see us deliver on,” Costolo said after the company’s earnings announcement at the end of July. About the turnover, he said, “There’s always a trade-off for serving the needs of the company as it evolves and grows. Hopefully this will be the team we have in place for a long time.” Although ads on Twitter are getting more sophisticated, the service hasn’t changed, remaining principally a moment-to-moment stream of 140- characters-or-less messages in reverse chronological order. The pop cultural elements most identified with Twitter, including @ replies, retweets, and hashtags, were all created and pioneered by users before Twitter’s engineers baked them into the system. As it tries to refresh its look, it may take some Graf is Twitter’s inspiration from fourth head of Facebook, which product in uses algorithms to five years present posts in roughly the order
it thinks users will want to read them. On Aug. 20, Twitter confirmed that it’s begun to tweak user feeds to predict users’ interests better than they might on their own, though it won’t say how it’s deciding what to add or move. Graf, for better or worse, approaches these problems with the perspective of an outsider: He rarely tweets. —Sarah Frier and Brad Stone The bottom line Twitter is relying on a Google Maps veteran to keep users coming back while making the service friendlier for newbies.
Software
The Teaching App at The Head of the Class Remind pushes smartphone messages to students and parents Tech “walked into the classroom in the pockets of all the kids”
As kids head back to school, a relatively unknown mobile app is rocketing toward the top of the most-downloaded lists for both Apple’s and Google’s app stores. Remind isn’t a game or social network— it’s a texting tool used in many parts of the U.S. to establish stronger lines of communication between teachers, students, and their parents. About 1 million teachers and 17 million parents and students have downloaded Remind, a free app developed by a San Francisco startup of the same name. In states including Texas, Alabama, and Georgia, 40 percent to 50 percent of teachers use the software, the company says. Educators can update homework assignments, solicit volunteers for field trips, and send photos from the classroom without having to count on paper handouts making their way into and out of backpacks or on parents regularly checking their e-mail. Remind says it will roll out app features on Aug. 28 that let teachers transmit short surveys (“Was today’s homework too tough?”) and record voice messages. “If we can find a way to engage parents in the classroom two to three times a week, vs. one to two times a year, and if we can make teachers better by making them more efficient, we can have an enormous impact,” says Brett Kopf, Remind’s 27-year-old chief executive officer.
GRAF: BRYAN BEDDER/GETTY IMAGES; KOPF BROS: PHOTOGRAPH BY TIMOTHY O’CONNELL FOR BLOOMBERG BUSINESSWEEK
Canary in the TweetDeck
Technology Kopf founded the company in 2009 while finishing his bachelor’s degree in agricultural economics at Michigan State University. For the first few years, it went nowhere. He grew up with dyslexia and other learning disabilities and initially designed Remind to help people facing similar challenges, alerting students to quizzes and other deadlines once they uploaded their lists of assignments. Kids didn’t respond, and soon Kopf, who started the company with his older brother, David, was $10,000 in debt. The Kopfs had better luck after moving to the Bay Area in 2011 and joining an education-minded startup incubator, Imagine K12. They decided to focus more on communication and asked 200 teachers what they’d want from a classroom app. The consistent answer: simple ways to get parents more involved. Remind now has the kind of support most Silicon Valley startups covet. Venture capital firms First Round Capital, Kleiner Perkins Caufield & Byers, and Social+Capital Partnership have invested $20 million. KPCB’s John Doerr, who sits on Remind’s board, says that given the challenge of breaking into education technology, Remind’s success proves the value of tailoring a service to
smartphones. “For decades we fought to try to get technology adopted in classrooms,” says Doerr. “While no one was looking, it walked into the classroom in the pockets of all the kids.” Industry mainstays Blackboard and Edmodo, which offer a broader set of teaching and communication tools, declined to comment on the rise of Remind. Protecting student privacy and security is the biggest challenge for Remind and its rivals. The company conceals phone numbers; parents connect with teachers’ accounts by entering a unique classroom code. To guard against predators, the service only lets teachers text their students collectively, not individually, and the app saves every message. Kopf says he has no plans to sell ads based on user data. Instead, he says he hopes to make money by charging fees to parents and school districts for added features, such as mobile payments for field trips or sports equipment. Jessica Deon, a fifth-grade teacher in west-central Louisiana, says many of her students come from poor families without reliable Internet access at home—but they all have phones. Remind is Deon’s go-to means of alerting parents to snow days (there were eight last year)
Brett Kopf
David Kopf
18
m
Number of downloads for the Remind app
and other unexpected schedule changes. More important, she uses it daily to brief parents on whether their children did well in class and what their homework is for the night. She says the app has led more students to complete their homework and even credits it with improving scores on standardized tests. “The word I use is ‘transform,’ ” she says. “It transformed my classroom. And I think it made me a better teacher.” —Brad Stone The bottom line Remind, an educationalmessaging tool, is among the hottest apps in Apple’s App Store and Google Play.
Mobile
Why Apple’s iBeacon Hasn’t Taken Off—Yet The indoor tracking equipment is in less than 1 percent of U.S. stores “The retailers haven’t yet deciphered what customers want”
Hillshire Brands sees the promise of Apple’s iBeacon, software that’s been embedded in iOS 7 for a year. With iBeacon, Hillshire can track a shopper wheeling through a grocery store and send his iPhone a coupon or an ad for sausages just as he approaches the right cooler. Hillshire says consumers in 10 U.S. test cities who received iBeacon messages via apps such as recipe service Epicurious have been 20 times likelier to buy its American Craft sausages. Last year, iBeacon promised Apple a new wave of consumer data and looked like a boon to retailers and advertisers trying to reverse a decline in impulse buys. Using a low-energy Bluetooth signal, the software makes an iPhone’s proximity to certain items easier to track with the help of $10 signaling devices—beacons—mounted on shelves and ceilings, each no bigger than a hockey puck. For the most part, however, stores have yet to embrace Apple’s technology. “Retailers are just putting their toes in,” says Owen Geddes, chief executive officer of startup Appflare, which sets up iBeacon networks for merchants. He says there have been a lot of announcements by retailers that they are trying out iBeacon networks in a handful of locations, “but the reality is, very few of them have
35
Technology ByteLight to develop lightbulbs that can also help track shoppers via iBeacon, which would eliminate the need for retailers to buy separate hardware. More companies are curious. “We have half of Fortune 500 developing with us,” says Steve Cheney, a senior vice president at startup Estimote, which designs hardware and software to work with iBeacon. There is just one major group of holdouts to persuade: shoppers. —Olga Kharif The bottom line Apple’s year-old indoortracking technology hasn’t broken out from its pack of rivals.
Security
Defending Against Hackers of the Future
Cryptographers are working on ways to thwart quantum computers “It’s a niche application for the most paranoid customers”
Fully functioning quantum computers don’t exist yet, but a lot of really smart scientists think they soon will. A twoyear-old startup’s 12 employees spend their days trying to figure out what to do if the bad guys get there first. And now, a quick physics lesson. A guiding principle of quantum mechanics, the study of the universe’s subatomic building blocks, has been that matter
and light, at their most basic levels, exist in multiple states at once. An electron in a hydrogen atom doesn’t have a welldefined position, but rather it exists as a fuzzy cloud around the proton, simultaneously existing everywhere in the cloud. Quantum computing applies that principle to bits (binary digits), the computer’s units of information, which are either in a state of 1 (on, alive) or 0 (off, dead). Your PC performs calculations using 1’s and 0’s, which can be combined to represent other numbers and letters, including those that make up passwords. A quantum computer uses quantum bits (qubits), which are simultaneously positioned as 1’s, 0’s, or a series of muddled states in between, making number crunching—and blasting through passwords—a whole lot easier. A quantum computer could perform some mindnumbingly complex calculations in no time at all. And that would mean that most cybersecurity as we know it could be as permeable as tissue paper. Qubitekk, based 45 minutes north of San Diego, is trying to deal with that problem. Cybercriminals looking to unlock a PC login, bank account, or the occasional nuclear launch codes tend to quit when they run up against top-of-theline encryption software or supersecure passwords. “All of our communications security is ultimately based on that,” says Duncan Earl, a Qubitekk co-founder. He and his 11 co-workers, including a couple veterans of the U.S. Department of Energy’s cyberwarfare division, are trying to head off the threat of technology that hasn’t quite arrived yet. They keep their solution in a 15-by-20-foot laboratory, entered through a kitchen. It’s a two-pound metal box filled with a $5,000 crystal inside, essentially a fragment of a quantum computer. The device creates qubits by using a crystal to split a light beam into pairs of red photons, the smallest known amounts of light. The pairs move in tandem; if an intruding
Quantum Headache Your PC performs calculations using bits, tiny units of information that exist in either the off (0) or on (1) state.
0 Off
or
A qubit, or quantum bit, also exists in positions between the off and on states. Think yes, no, and a bunch of maybes.
1
0
On
Off
or
1
or
On And any state in between
Both
A classic computer uses its 1’s and 0’s to perform linear computations in series.
Quantum computers can perform many computations in parallel all at once.
Classic Computer
Quantum Computer
ILLUSTRATION BY SHAWN HASTO; RENDERINGS COURTESY NBBJ
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been deployed.” Less than 1 percent of the 3.6 million retail stores in the U.S. make use of iBeacon, says Mark Hung, an analyst at market researcher Gartner. Apple declined to comment for this story. The main obstacle for retailers is that iBeacon doesn’t quite do everything by itself. Shoppers need to have apps such as Epicurious or discount service Shopkick that have incorporated the tracking technology. Many consumers don’t consult shopping aids while they’re in the store, and, says Adam Silverman, an analyst at Forrester Research, “Those apps are gimmicky.” He adds, “The retailers haven’t yet deciphered what customers want.” Another factor: Apple’s design wasn’t the first indoor location-tracking system available. Many businesses are experimenting with other technologies, including Motorola Solutions and Datzing beacons that use both Bluetooth and Wi-Fi signals. “I wouldn’t say it’s a clear winner at all,” Derek Top, an analyst at Opus Research, says of iBeacon. Shopkick is among the startups that combine Apple’s system with their own ultrasound technology to increase its accuracy. Although Apple has a lot of big names using iBeacon, most, like Hillshire, are just testing it. Macy’s has set up beacons in two stores that push product recommendations and discounts to Shopkick users; Lord & Taylor is doing the same in 10 stores with coupon app SnipSnap. Starwood Hotels & Resorts is trying out iBeacon in 30 hotels to help concierges greet arrivals by name. Clay Cowan, a vice president at Starwood, says the service may also help accelerate check-in for frequent guests or inform housekeeping when a room is occupied. IBeacon’s biggest convert so far is Major League Baseball, which put beacons in 28 of 30 ballparks. Bill Schlough, the chief information officer for the San Francisco Giants, says check-ins by fans using the MLB’s ballpark app more than doubled this season after the app began using iBeacon to help push merchandise coupons and seat upgrades. “For us, that’s a success,” he says. The MLB app is now adding short, location-specific videos on the history of stadiums. Some barriers to iBeacon adoption are falling away. Google has built more iBeacon functionality into the latest versions of Android. GE Lighting has formed a partnership with startup
Technology computer tries to read the pattern in the photons, it throws them out of sync, rendering the information unreadable. The device’s first use may be as an educational tool. “If you’re a professor and you teach quantum mechanics, you can tell your students about it, and that’s pretty much it,” says Earl. “With our kit, you can show them.” Qubitekk has seen interest in the kits from what Earl calls “hard-core science types” at universities but hasn’t sold any. The company has received $2 million in funding from Ellis Energy Investments, a seed investor looking to protect the grid. While the handful of quantum computers that now exist are mostly used for research, there’s plenty of interest in them. A Google system housed at NASA’s Ames Research Center uses quantum-computing equipment from Canadian company D-Wave Systems that generates about 512 qubits of processing power. Peter McMahon, a Stanford University researcher in quantum cryptography, says the magic number of qubits needed to achieve superfast calculations is between 10 million and 100 million, and that’s likely years or even decades away. The funding flowing to academic research on quantum computing runs into the billions, from companies such as Microsoft, Google, and IBM, as well as governments including the U.S., U.K., Canada, Singapore, and China. “The Chinese are being very aggressive in this,” says Andrew Hammond, the head of business development for MagiQ Technologies, a Qubitekk competitor in Somerville, Mass. MagiQ, a research and development lab founded in 1999, sells a system that can use quantum technology to transmit encryption keys—sophisticated passwords—mostly to government agencies, banks, and a few telecommunications companies. “It’s a niche application for the most paranoid customers,” says Hammond, whose clients include the U.S. Navy and Defense Advanced Research Projects Agency. He wouldn’t discuss what those customers are using his equipment for but says he wouldn’t be surprised to see full-fledged quantum computers in the next few years. —Ian King and Dune Lawrence The bottom line Startups are selling solutions to quantum hacking, a problem that hasn’t yet been shown to exist. Edited by Jeff Muskus Businessweek.com/technology
Innovation Inverted Hospital Form and function
Innovator Doug Parris
Project Legacy is a U.S. Department of Veterans Affairs hospital slated to open in 2016 that’s designed to withstand disasters like Hurricane Katrina. The design elevates patients and essential features above a 20-foot flood line.
Age 62
Background During Katrina, dozens of patients died at New Orleans’s 16 hospitals, seven of which were out of commission for more than two years. A VA hospital was among those beyond repair.
1.
Title Partner at architecture firm NBBJ and lead designer on Project Legacy in downtown New Orleans
①
Layout The 1.6 millionsquare-foot hospital’s patient rooms, power plant, and food and water supplies are all on the fourth floor or above, with administrative offices below.
37
Other Concerns To meet VA antiterrorism guidelines, the shatter-resistant glass facade has to be able to diffuse the impact of an explosion as well as 130-mph winds.
2.
②
Extras Project Legacy will have a boat dock set 20 feet off the ground to receive patients and supplies in case of flood. Cost The budget for the new VA campus is $995 million.
Care Each of the 200 private rooms is packed with power outlets and medical supplies to accommodate extra patients in an emergency. There’s enough backup power and potable water to serve 1,000 people for five days.
Next Steps Parris says elements of the Project Legacy design could also be used to retrofit older hospitals with more efficient electrical systems and a layout that moves patients and critical equipment above the flood line. “Any hospital should be able to take steps toward making a more resilient facility,” he says. —Belinda Lanks
“I helped to start CECP with the belief that corporations could be a force for good in society.” PAUL NEWMAN (1925–2008), FOUNDING CO-CHAIR, CECP
CECP is pleased to welcome 13 new CEOs to date in 2014:
Inge Thulin
Adam Silver
3M
James M. Cracchiolo
National Basketball Association
Ameriprise Financial, Inc.
Indra K. Nooyi
Michele Scannavini
PepsiCo*
Coty Inc.
Steve Mollenkopf
John Richels
Qualcomm Incorporated*
Devon Energy Corporation
Gregory Lee
Mary T. Barra General Motors Company
Samsung Electronics America, Inc.*
Dinesh C. Paliwal
Stuart Thorn
HARMAN
Southwire Company
R. Milton Johnson
C. Douglas McMillon
HCA Inc.*
Wal-Mart Stores, Inc.
CECP is pleased to welcome 8 new corporations to date in 2014 at the company level: BAE Systems, Inc. Land O’Lakes, Inc. Broadridge Financial PIMCO Solutions, Inc. Visa Inc. CenterPoint Energy, Inc. Votorantim Group Honeywell International Inc. Pictured top to bottom: Richard Edelman, Edelman (CECP CEO since 2009); Barry Salzberg, Deloitte Touche Tohmatsu Limited (CECP CEO since 2008)
*CEOs are new to CECP, but their companies have existing affiliations with CECP.
Find the full list of CECP CEOs at cecp.co/CEOs. Leading CEOs are united in the belief that societal improvement is an essential measure of business performance. These CEOs belong to CECP, a coalition of 150 CEOs that commits $19 billion annually through their companies to solving pressing societal challenges, understanding that close community ties are a direct line to employee engagement, innovation, customers, new markets, brand, and sustainability, as well as mitigating risk and building trust.
CEOs: Join us CECP’s 10th Annual Board of Boards February 23, 2015 New York, NY cecp.co/BoB THE CEO FORCE FOR GOOD cecp.co
Investors guzzle singlemalt whisky 40
Renters have the edge in Washington 42
The mastermind behind Alibaba’s IPO 41
Bid/Ask: Burger King’s $11.4 billion taste for breakfast 43
September 1 — September 7, 2014
Stocks Overvalued? Who Cares? Shiller is sending up warning flares. It may be best to ignore him “People are getting jobs, getting paid, becoming solvent”
The milestone came at 10:10 a.m. on Aug. 25: The Standard & Poor’s 500stock index edged above 2,000 for the first time, helping to push the value of equities worldwide to a record $66 trillion. The benchmark has tripled since March 2009, climbing at a blistering pace that has seen 65 calendar months elapse without a 10 percent loss in any of them. For the average investor, it’s a dizzying peak from which to contemplate the eternal question: buy or sell? Arguing for the bulls on Aug. 19, Barry Bannister, the chief equity strategist at Stifel, dramatically raised his prediction of where the S&P will end the year. He had been forecasting a modest loss. Now he envisions a 15 percent climb to 2,300 as the economy picks up steam. “People are getting jobs, getting paid, becoming solvent,” Bannister says. On the bearish side, no less an authority than Yale University professor Robert Shiller, one of the few economists to have warned about the housing bubble, said in an Aug. 16 New York Times piece that his influential Shiller price-earnings ratio has reached a “worrisome level,” one not seen since 1929, 1999, and 2007—years that are synonymous with bursting bubbles. Just because there are two compelling sides to the argument doesn’t mean investors have to choose one. Decades of market history make a persuasive case that the best course of action may be to take no action at all. As Peter Lynch, the renowned stockpicker for Fidelity Investments’ Magellan Fund until 1990, once put it, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Brad DeLong, a professor of economics at the University of California at Berkeley, came to much the same conclusion in an Aug. 17 response to Shiller on his blog. Investors who were walloped by the 1929 crash, he calculated, would have seen their losses improve to an annual gain of 3.3 percent, on average, if they’d simply stood pat for at least a decade. Investors who held the S&P 500 from the 1999 peak until today have seen a 2.7 percent average annual return; for the past seven years, a period starting with the 2007 market top, the figure is 5.2 percent.
39
Markets/Finance
40
$774
“Not too shabby,” DeLong writes. The point is not just that rallies tend to follow crashes. It’s that getting caught in an especially bad downturn—the thing so many investors worry about today—really isn’t so bad if you’re in the game for the long term, with a time horizon of a decade or more. Almost every 10-year period, DeLong finds, has produced gains. Stocks are inherently risky—the S&P has lost more than 5 percent in a calendar month 33 times during the past 30 years. But buy-and-hold advocates have long pointed out the risk of missing rallies while trying to avoid drops. Putnam Investments published a report in January showing that investors who missed out on the market’s 10 best days over the last 15 years would have had annualized gains of only 2.1 percent, compared with almost 6.5 percent for a portfolio that stayed fully invested. That’s a difference of $11,911 for a starting stake of $10,000. The report also notes that “seven of the Dow’s 10 best days since 1996 occurred within a year of the financial crisis triggered by the Lehman Brothers collapse.” Shiller, who shared the Nobel prize in economics in 2013 for his study of asset prices, has cautioned that his ratio is a general barometer and not a precise signal for when to buy and sell. Also known as CAPE, for cyclically adjusted price-earnings, it measures profits over a 10-year period, typically spanning one or more business cycles, to give a better picture of corporate health than any one-year snapshot. The historical CAPE average is 16.6; at its current 26.4, the metric suggests that returns from stocks will be lower in the coming years than investors have enjoyed since the crisis. Even if that’s true, a portfolio with a large exposure to equities remains essentially the only option for people with a 10-year or longer horizon, such as those planning for retirement, says Fran Kinniry, a principal in Vanguard’s investment strategy group. Alternatives such as high-quality bonds and CDs will not offer sufficient growth to produce enough income for a retiree to live on.
k
Stayed fully invested, 6.46% annualized return
$13
k
Missed 10 best days, 2.1%
The bottom line Investors who put money in at the 2007 market top earned a 5.2 percent average annual return in the past seven years.
Auctions
A Bull Market in Single Malts Sought-after Scotch whiskies can fetch seven-figure prices “I am a believer of buying two of everything”
$10k invested in the Dow Jones industrial average (12/98-12/13)
$25
“Bonds might have a 10-year return of 2.5 or 3 percent,” Kinniry says. “Even judging from CAPE today, stocks would be around 6, 7, 8 percent—significantly more than bonds, significantly more than inflation.” Vanguard recently became the world’s second-largest money manager, overseeing $2.93 trillion, behind BlackRock with $4.59 trillion. Both asset managers have been propelled by the growth of target-date funds, which automatically change investors’ exposure to equities and fixed income as they age. In his annual letter to Berkshire Hathaway shareholders this year, Chairman Warren Buffett said it’s not a bad idea for investors to put 10 percent of their holdings into short-term government bonds and 90 percent in an S&P index fund and “never to sell when the news is bad.” “There’s a fair amount of research that indicates that most retirement investors do not have the ability to time the market,” says Chip Castille, head of the U.S. retirement group at BlackRock. “And missing the runs, missing those important days or weeks, can meaningfully affect the long-term outcome.” “I think people misuse quantitative or statistical information,” Vanguard’s Kinniry says. “A lot of investors are all in or all out. I’d caution investors, if they want to take a little bit on or off their allocation to make them feel better, that’s fine, but don’t make major deviations because of these statistical measures.” —Nick Summers
Two years ago, when Aaron Chan heard that a liquor store in Athens might have a rare Hanyu Ichiro Malt Japanese whisky, he phoned the shop from Hong Kong. Unable to make himself understood, he e-mailed photos of the distillery’s
distinctive playing-card labels to the shop. The owner replied with a picture of his bottle—the label was the Ace of Spades. “That was my eureka moment,” says Chan, who paid about HK$6,000 ($774) for the whisky. “The Ace of Spades was very, very rare already.” Another bottle of Ace of Spades went for HK$85,750 at a Bonhams auction on Aug. 15 in Hong Kong—14 times what Chan paid and slightly more than the price of an entire case of 1982 Château Margaux wine from Bordeaux that Sotheby’s sold in New York in June. Investors are bidding up prices of rare single-malt Scotches from distillers such as Macallan, Bowmore, and Dalmore, and Japan’s Karuizawa and Yamazaki. In January, Sotheby’s sold a 6-liter Lalique decanter of Macallan “M” single malt—one of only four made—for a record HK$4.9 million. “I’m not really an advocate of buying whisky and flipping it,” says Heather Greene, director of whisky education at the Flatiron Room in Manhattan, a bar for spirit lovers that offers tasting classes to aspiring connoisseurs. “But I’m getting questions from people asking if they should buy a couple of cases and sell them for double.” According to the Investment Grade Scotch index, published by consulting firm Whisky Highland in Tain, Scotland, prices for the top 100 single malts rose an average 440 percent from the start of 2008 through the end of July this year. That compares with a 2 percent drop in the Liv-ex 100 Benchmark Fine Wine Index and a 31 percent gain in the Standard & Poor’s 500-stock index. Mahesh Patel, a real estate developer in Atlanta, has amassed more than 5,000 bottles over the past 25 years. His cache is insured for almost $6 million. “Everything I have is appreciating,” Patel says. “I am a believer of buying two of everything. One to open and enjoy, the other you put away if it’s rare.” One exception to his rule is a Dalmore Trinitas 64 Year Old, which he bought in 2010 for £100,000 ($166,455). Only three were ever made, and he’s not touching the one he owns. Distillers are finding it hard to keep up with the increase in demand, given
FROM LEFT: COURTESY BONHAMS; GETTY IMAGES; COURTESY ALIBABA GROUP; DATA COMPILED BY BLOOMBERG.
Markets/Finance offering, including the design of the how long it takes for whisky to age. A hit the button, sending the 340-page company’s corporate structure and standard bottle of Glenfiddich spends document that began a process that’s the choice of investment banks to 12 years in the cask and investment likely to culminate soon in what may underwrite the deal. Tsai will be well grade Scotches many more. The 1962 be the largest initial public offering rewarded if the IPO is successful. His Macallan seen in the James Bond movie ever in the U.S. stake of 2.9 percent could be worth as Skyfall aged for half a century. Alibaba Chairman Jack Ma is the much as $4.5 billion, based on analyst Rising demand for rare malts visionary. Vice Chairman Tsai is the estimates of the company’s value. prompted Rickesh Kishnani, the chief guy who stays up until 4:30 a.m. to get Through a spokesman, Alibaba, Tsai, executive officer of Platinum Wines things done. As the company’s chief and Ma declined to comment. People in Hong Kong, to launch the world’s dealmaker, he helped who have direct knowledge of the first whisky fund, in June, after transform Alibaba into ‘‘Joe always did events, who asked not to be named, raising $4 million. “There will be a a global powerhouse, what he thought provided information for this story. gap in the market for 10 to 15 years leading negotiations was right. And he In a corporate structure Tsai helped between the supply of rare old for most of the early was a steadying presence for all devise, Alibaba will be governed by a single malts and growing demand, outside investments in of us.” group of 27 managers who will have the particularly in Asia,” he says. the company, includ—Jeff Gordon ing $20 million from exclusive right to nominate a majority Whisky’s popularity is spawning counterfeits, says Luigi Barzini, SoftBank. He’s also of the board of directors. Alibaba’s spirits specialist at merchant overseen dozens of biggest shareholders, SoftBank and Berry Bros. & Rudd in London. acquisitions—including Yahoo!, support the arrangement, “There are a lot of fakes across more than $4.6 billion even though they will not have representatives in the management group. Asia and some in Italy,” he says. “It’s a worth so far this year, according to big problem for all of us.” There also is data compiled by Bloomberg—that have After two years of discussions with the company, Hong Kong’s Securities a growing number of speculators who expanded Alibaba’s business into new & Futures Commission rejected the may be pushing prices too high too territories: online mapping, department stores, and TV content. proposal, ruling that it gave too much fast. “The needle is getting closer to the The company posted a profit of power to a small group of shareholdbubble,” says Mark Gillespie, who runs ers. That decision led the company $1.99 billion in the three months the website WhiskyCast. to move its IPO to the New York Stock through June. Sales rose to about That doesn’t bother Patel. “I don’t Exchange; the SEC has not objected. $2.5 billion. “Alibaba wouldn’t be see this as a paper investment,” he says. China prohibits foreign investors where it is today without Joe Tsai,” “It has inherent value. At the end of the from owning shares of companies says Porter Erisman, who worked in day, you can still open the bottle and in certain industries, including the marketing and communications at enjoy it.” —Frederik Balfour Internet. Chinese companies Alibaba in the The bottom line Prices for the top 100 single get around the restrictions by early days and malts have risen an average 440 percent since 2014 Acquisitions and the start of 2008. using variable interest entijust released a Investment Highlights ties, or VIEs, which give overdocumentary on Citic 21CN seas investors the economic the company’s Jan. 23 $158.3m gains and losses of the Chinabeginnings. Alibaba Pictures Group based parts of the business Tsai’s top priMarch 11 $783.6m ority now is to Stocks through contracts rather Intime Retail Group persuade investhan direct ownership. All of March 31 $692m tors to buy the the major Chinese Internet AutoNavi Holdings April 11 $486.6m company’s stock. companies that list on U.S. Singapore Post He’s been involved exchanges use the structure, May 28 $248.9m in shaping every including search firm Baidu, Tsai helped build the company— Tianhong Asset Management aspect of the online retailer JD.com, and May 29 $42m now he has to sell it to investors
The Dealmaker Driving Alibaba’s IPO
“Alibaba wouldn’t be where it is today without” him
At 4:30 on a May morning, Joseph Tsai and three other executives of Alibaba Group Holding Ltd. gathered at a Hong Kong office. With the U.S. stock market just closed, it was time to submit the Chinese e-commerce giant’s prospectus for its initial public offering to the U.S. Securities and Exchange Commission. With bottles of Champagne at the ready, each executive typed a word of the company’s name on a computer. All four then
Guangzhou Evergrande Football Club June 5 $191.8m Kabam July 31 $120m
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Markets/Finance Nice Digs
5%
4%
Alexandria’s Virginia Square Towers hopes to lure tenants with amenities like a game room
3% 2008
2014
Midyear
The apartment inventory has increased
86
percent since 2013
significant contributor to the world’s economy in some way, shape, or form? Of course. It’s how hard he worked, how smart he was, his ability to see differences in others and become their brother.” —Leslie Picker and Zijing Wu The bottom line Tsai’s 2.9 percent stake in Alibaba could be worth as much as $4.5 billion after an IPO.
Real Estate
It’s a Renter’s Market In Washington A glut of luxury apartments benefits young professionals “If you’re a good renter … you can finagle a little bit”
Mandy Johnson and her roommate thought they were priced out of Virginia Square Towers, a new luxury apartment building across the Potomac River from Washington, where for about $3,000 a month they would enjoy amenities such as a pool, a game room with a pool table, video game consoles, and a golf simulator. Less than 24 hours after declining to sign a lease in June, Johnson got an e-mail from a leasing manager offering two months’ free rent on a 14-month contract. The $450-a-month discount clinched the deal for Johnson, 28, who works at a nonprofit that gives scholarships to military families. “We are able to
have this brand-new apartment for the same price as one in older buildings, so we went for the shiny object,” she says. An oversupply of construction in and around the nation’s capital is giving young professionals such as Johnson the upper hand in negotiations with landlords. Haendel St. Juste, a Morgan Stanley analyst, calls Washington “the weakest apartment market in the country right now.” About three years ago the metro area had one of the lowest vacancy rates in the nation, at 3.4 percent for Class A, or high-end, apartments; the rate stood at 4.1 percent at midyear. Rents in the D.C. metro area, which includes the Maryland and Virginia suburbs, fell 0.1 percent in the second quarter of 2014, compared with an average increase of 3.3 percent nationwide, according to apartment research company Axiometrics. That follows a big jump in inventory, with 14,840 newly built apartments coming to market this year, an 86 percent increase from 2013, data from the Dallas-based firm show. The Washington building boom got under way in 2010. Developers began work on 5,186 apartments that year, according to Axiometrics, confident that the area’s strong job growth would help fill them. The metro area sprouted residential towers featuring sun decks with grill stations, communal TV lounges, and free breakfasts and fitness classes. The rapid increase in supply wasn’t mirrored at the low end of the housing market: From 2000 to 2010, Washington lost half
KEVIN LOCK, DATA: DELTA ASSOCIATES
42
Weibo, a microblogging service. Still, VIEs are in a legal gray area because China has no official rules governing their use, so Tsai took extra precautions to protect investors. Unlike earlier Chinese companies, which went public with as much as 99 percent of their revenue assigned to the VIE, less than 12 percent of Alibaba’s revenue and 8 percent of its assets are allocated to its VIE. “Alibaba Group is one of the best in terms of minimizing the amount of business conducted in the VIE,” says Paul Gillis, a professor at Peking’s Guanghua School of Management. Born into a family of prominent lawyers in Taiwan in 1964, Tsai came to the U.S. when he was 13. He spoke little English when he enrolled in the Lawrenceville School, an elite boarding school in New Jersey. By the time he graduated, he had no accent and was playing lacrosse. He went on to play the sport at Yale, where he defied conventional jock protocol by wearing a pink triangle on his chest in support of gay rights. When members of the team teased him, he replied that it was just the right thing to do. “Joe always did what he thought was right,” says Jeff Gordon, a teammate. “And he was a steadying presence for all of us.” An Alibaba spokesman says Tsai now prefers to avoid commenting on political and social issues. After graduating from Yale Law School in 1990, Tsai worked as a tax attorney at Sullivan & Cromwell in New York. Three years later he went to work at a small buyout firm, doing deals, then moved to Hong Kong for the Swedish holding company Investor. It was in this role that he first met Ma in 1999 in Hangzhou, China, after being introduced by a friend. He was so impressed with Ma’s energy and drive that he quit his $700,000-a-year job at Investor to help launch Alibaba. Tsai, the only Western-educated member of the management team, served as the company’s chief financial officer for more than a decade before becoming vice chairman in 2013. In mid-July, Tsai juggled his IPO responsibilities while watching the World Lacrosse Championship in Denver, where the Hong Kong and Chinese teams that he helped build were playing. Gordon, who stays in touch with Tsai through his Facebook account, attended the games with him. “He hasn’t changed one iota,” Gordon says. “Did I expect him to be a very
Vacancy rate in metro D.C.
ILLUSTRATIONS BY OSCAR BOLTON GREEN
Markets/Finance of its low-cost rental units, those with monthly rent and utility expenses of less than $750, according to a report from the DC Fiscal Policy Institute. There were 25,481 Class A apartments on the market or under construction midyear, according to Delta Associates. The average monthly rent in central Washington, with some of the city’s most expensive neighborhoods, was $2,847 at the end of June. Investors in real estate investment trusts that own Washington properties are bracing for a downturn that could stretch into 2016. Equity Residential, the country’s largest publicly traded apartment landlord, projects revenue for its properties in the area will fall 1 percent this year, Chief Operating Officer David Santee said in July on a call with investors. In contrast, the REIT’s holdings in cities including Seattle, San Francisco, and Denver, where there are strong job markets, are expected to produce more than 5 percent revenue growth, according to the Chicago-based company. Renters at the upper end have benefited, with landlords offering a free month’s rent and other concessions such as scrapping fees for parking or pets, says Rick Gersten, chief executive officer of Urban Igloo, an apartment finder service. The units will likely fill up eventually. U.S. household formation is expected to pick up again after falling to its lowest level after the recession since records started being kept after World War II. “We’re at the point of the recovery when young adults are starting to move out of their parents’ homes,” wrote Jed Kolko, chief economist at Trulia, in an e-mail. The majority will rent before buying, he added. Johnson, who moved into her twobedroom apartment in Alexandria in July, says she’ll probably have to move again if her rent is raised back to market rate at the end of her lease. Still, she’s wagering the flurry of development will give her room to negotiate. “I’ve heard if you’re a good renter and always pay on time, you can finagle a little bit and tell them, ‘We’ll stay here if you leave us at the same price,’ ” says Johnson. “I hate moving, but there’s so much being built around us.” —Heather Perlberg The bottom line An apartment glut has turned Washington into the nation’s worst rental market, at least for investors and landlords. Edited by Eric Gelman and Cristina Lindblad Businessweek.com/markets-and-finance
Bid/Ask
By Caroline Winter
$11.4b
Burger King buys Canada’s biggest coffee chain. The American burger giant is acquiring Tim Hortons to expand its breakfast business. The combined company would be the world’s No. 3 fast-food operation, with $23 billion in sales, including franchisees, and more than 18,000 restaurants in 100 countries. 3G Capital, the Brazilian private equity firm that controls Burger King, will keep a stake of about 51 percent.
$8.3b $1.4b $970m $530m $400m $360m $3.2m
Roche Holding acquires a California biotech. With the purchase of InterMune, Switzerland’s Roche will enlarge its portfolio of drugs for respiratory ailments. Oak Hill Capital Partners expands into packaging. The private equity firm agreed to purchase Chicago-based Berlin Packaging, a leading supplier founded in 1898. Amazon.com bets on a gamer website. Acquiring video game service Twitch Interactive will give the e-tailer an online forum with 55 million active monthly users. Calpine adds a Boston-area power plant. The Houstonbased power company will buy the Fore River Generating Station to expand in New England. KKR invests in Chinese chicken. The private equity firm will purchase 18 percent of Fujian Sunner Development, China’s No. 1 chicken breeder and processor. Samling Group bids for a luxury car distributor. The Malaysian conglomerate plans to buy Singapore’s Wearnes Automotive, say people with knowledge of the deal. Superman sets an auction record. Action Comics No. 1 from 1938 introduces the Man of Steel and is credited with launching the superhero industry.
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Gre Bethany Mota Subscribers: 7m Genre: Makeup and style tips
e
s g n ti
Zay Zay Fredericks Subscribers: 44k Genre: Comedy
The Cimorelli Sisters Subscribers: 2.8m Genre: Music
m o Fr
Epic Rap Battles of History Subscribers: 10m Genre: Comedy PewDiePie Subscribers: 30m Genre: Video games
Fred Subscribers: 2.3m Genre: Comedy
TeaLaxx2 Subscribers: 405k Genre: Beauty and fashion
RocketJump Subscribers: 6.9m Genre: Sci-fi comedy
45
Epic Meal Time Subscribers: 6.5m Genre: Food stunts
A few years ago, big media companies were filing copyright lawsuits against YouTube. Now they’re buying in. By Felix Gillette
46
hen Brian Robbins first told people he was going full time into the YouTube business, his colleagues in Ho l ly wo o d we re incredulous. “My agent, my lawyer, my dad—people thought I was crazy,” he says. For decades, Robbins had worked in the traditional entertainment industry, first as a teenage actor starring in the ABC sitcom Head of the Class, then as a producer of TV shows about teenagers, such as Smallville and One Tree Hill, and finally as a director of feature films catering to teenagers, including Good Burger, Varsity Blues, and Norbit, a comedy starring Eddie Murphy in multiple roles, among them an obese woman. It was steady and lucrative work, if not always the most prestigious. Watching the ways in which his two teenage sons consumed media, Robbins became convinced that the future of youth entertainment wasn’t in broadcast or cable TV but in short-form digital videos, particularly on YouTube. He thought big media companies had been slow to adapt, leaving a void that he could fill. And so, in 2012, the former teenage star set up a business to recruit, manage, and capitalize on the teenage stars of tomorrow. Robbins’s timing was good. After years of more or less passive support, YouTube was starting to take an active role in original programming, encouraging entrepreneurs, producers, and established TV stars to start channels, which on YouTube refers to a collection of videos hosted by an individual or by a creative team. It was even lending producers money and gave Robbins some. He set up an office and a production studio in West Los Angeles. In June 2012, Robbins launched his YouTube channel, which he named AwesomenessTV. The channel was geared to teenagers and preteens and featured lots of two- to fiveminute videos, which ranged from quickie talk shows about beauty tips to mini-reality shows about cheerleaders. Within months, AwesomenessTV was routinely ranking among the YouTube top channels. “It happened very fast,” says Robbins. What was also happening quickly, he noticed, is that several new media companies in Los Angeles were amassing billions of monthly video views on YouTube not only by creating material but also by bundling together existing channels into what the people were starting to call multichannel networks, or MCNs. Rather than create all the
programming themselves, the MCNs were recruiting tens of thousands of independent YouTube creators, from the semiprominent to the obscure. Each of the MCNs offered a slightly different slate of services, but they generally promised aspiring YouTube talent that, for a cut of gross revenue (typically 30 percent), the MCN would get them more attention and make them more money. Sign up with us, kid, we’ll make you a star. “Nothing beats when a kid makes a sketch for us and he does a great job, and you say to him, ‘We think you’re really talented. Why don’t you write a movie?’ ” says Robbins. The MCNs were attempting to solve a problem that had bedeviled YouTube throughout its short history—how to organize such a vast and chaotic programming environment in a way that makes sense for viewers, creators, and advertisers. In November 2012, six months or so after launching AwesomenessTV, Robbins and his colleagues posted an invitation on their channel. Anyone interested in becoming the next big YouTube phenom was encouraged to join AwesomenessTV as a member of what they dubbed the ATV Network. “I was sitting here thinking that the kids who are watching our content on the Awesomeness channel are the same kids who are uploading content to YouTube,” says Robbins. “So why not try and make them part of the Awesomeness community for real?” The following morning, Robbins and his colleagues arrived at work expecting to find a few hundred requests to join.
video views. Nobody is second-guessing Robbins’s career move any longer. On the heels of the DreamWorks acquisition, other media companies with backgrounds in storytelling and talent management have been piling into the YouTube ecosystem, hungry to devour everybody’s epic YouTube lunch. Robbins says his Hollywood experience will help him keep his edge. He knows how to spot young talent and how to navigate the many hazards of making entertainment. “Our big advantage is that everybody on our management side came from making content,” he says. “We didn’t come from tech.” . It’s perhaps inevitable that Hollywood eventu ally turned its tool kit to YouTube. The platform’s net global advertising revenue continues to grow, from $1.2 billion in 2012 to a projected $3.4 billion this year, according to estimates from EMarketer. Every month, 1 billion people around the planet go to YouTube, where they collectively consume some 6 billion hours of video. Every minute, 100 more hours of programming are added to the platform. With summer TV ratings falling, the domestic movie box office down sharply, and upfront sales of TV advertising surprisingly weak, a slew of mergers, acquisitions, and investment has shaken the YouTube cosmos. Big media companies, which a few years ago were furiously filing copyright lawsuits against YouTube, are jostling for a piece of the action.
“I always laugh when people say the economics don’t make sense. The economic part of the ecosystem is accelerating” They found 4,500 instead. In the months to come, the numbers kept growing. Almost overnight, Robbins had transformed AwesomenessTV from a boutique YouTube production house into a teen entertainment factory. Within a year, he had venture capitalists visiting each week looking to invest, and in May 2013, Robbins announced he was selling AwesomenessTV to DreamWorks Animation, the publicly traded Hollywood studio, for $33 million upfront, plus $84 million in potential payouts down the road. AwesomenessTV now has 88,000 channels with 54 million YouTube subscribers, collectively generating 1 billion monthly
“There’s a tremendous amount of activity,” says Gian LaVecchia, a managing partner at the global media-buying agency MEC. “At a macro level, it’s about these companies moving aggressively to reimagine how they connect with digital, mobile, and social audiences.” Says David Hallerman, an analyst with EMarketer: “It’s a real awakening.” In March, Walt Disney snapped up Maker Studios, one of the largest of the multichannel networks, for an initial $500 million, plus a potential $450 million, depending on future performance. Warner Bros. led an $18 million round of investment in Machinima, which focuses on
PHOTOGRAPH BY NATHANAEL TURNER FOR BLOOMBERG BUSINESSWEEK; YOUTUBE (1). PREVIOUS SPREAD: GETTY IMAGES (4); YOUTUBE (9)
Robbins with AwesomenessTV talents Cameron Dallas and Lia Marie Johnson
programming related to video game culture. Chernin Group and AT&T, according to multiple press accounts, are narrowing in on the purchase of a large multichannel network called Fullscreen. Scripps Networks Interactive, the owner of the Food Network, led a $25 million investment round in Tastemade, an MCN specializing in food. ProSiebenSat.1 Media, a German media conglomerate, bought 20 percent of Collective Digital Studio. And several media companies, including Hearst and 21st Century Fox, are now said to be kicking the tires on StyleHaul, an MCN oriented around beauty and fashion content. The rapid consolidation of YouTube programming has thrown the small players into a frenzy of excitement and apprehension. They’re concerned that the big companies will squash the community’s creative autonomy and turn its artists into creative serfs. The great hope, on the other hand, is that the newfound investment will free artists from the shaky economics of living video to video and allow them to focus on improving their craft. More premium programming will lead to more premium advertising, which will finally unlock YouTube’s full economic potential and make everybody embarrassingly rich. Optimists will tell you that YouTube in 2014 is like cable television in the 1980s, when a few entrepreneurs conquered a new and slightly baffling distribution landscape, giving rise to programming brands such as MTV, CNN, and ESPN, which decades later still throw off hefty annual profits for the companies with the foresight to acquire them. “If you look at the history of cable, it started as a rough-
and-tumble, entrepreneurial business,” says Reza Izad, the chief executive officer of Collective Digital Studio. “Cable took 10 to 15 years to mature. This is happening a lot faster.” “We are the paradigm, we believe, of what media companies will look like in the future,” says Ynon Kreiz, CEO of Maker Studios. Says George Strompolos, CEO and founder of Fullscreen: “We want to be the next Viacom, the next Disney, the next NBCUniversal. We feel like we’re on that path. We’re laying the foundation for what we believe will be a massively valuable and massively profitable media company.” G o o g l e p u rc h a s e d Yo u T u b e f o r $1.7 billion in 2006 and at first focused on improving the site’s technology and fending off litigation from media companies, which were apoplectic about people using the platform to share copyrighted TV shows, movies, and songs without consent. At the time, Google took a laissez-faire approach to the programming side of the business. That turned out to be fortuitous. In the absence of a gatekeeper, a decentralized culture of homegrown talent took root on YouTube. The early YouTube entertainers tended to be outsiders, opportunists, and jacksof-all-trades. They wrote, shot, edited, starred in, and marketed their own videos. Budgets were thin, and so were production values. A bedroom was a typical set, and often the show was one person with a big personality talking smack about sports, clothing, or video games into a laptop camera. Teenage audiences loved them. It was an intimate medium on which young fans and the creators they adored could easily socialize.
In 2007, YouTube made a revenue-sharing program available to the most popular video creators. Once a creator signed, Google would load up the channel with advertising, take a 45 percent cut of the resulting revenue, and hand over the rest. For many YouTube creators, the money was an incentive to keep going but wasn’t enough to live on. They still had to hustle. So they did. All the interaction with fans, it turned out, made it easy for the early stars to sell things on their channels directly to YouTube viewers, including T-shirts, mugs, music albums, and DVDs. Soon, creators realized they could also use their channels to promote other people’s products in exchange for flat fees, which were significantly more than what they were earning from Google. In this way, native advertising—Internetspeak for paid placement— was born on YouTube. Many of YouTube’s leading entertainers found juggling the growing business and creative demands to be overwhelming. In New York and Los Angeles, a handful of entrepreneurs—many of whom were former Hollywood agents or producers looking to go digital—rushed in. For a cut of a creator’s gross revenue, they took over the business side of the operations, setting up ad sales teams, marketing services, and merchandising divisions. “There are some larger media companies that look at companies like us and our contemporaries as pure farm systems,” says Fullscreen’s Strompolos. “I think that’s an oversimplification. You can’t just take someone who is working on YouTube and plop them into a 22-minute sitcom. That’s a disservice to a creator.” Often these early YouTube talent networks would also set up production studios in L.A. to help their clients improve the quality of videos and to foster more collaboration among their various artists. To take advantage of the soundstages, many YouTube creators who had previously worked out of their homes in, say, North Carolina or Idaho, packed up and moved to L.A.—pulling them closer into Hollywood’s orbit. By June 2012, when Robbins launched AwesomenessT V, a
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multichannel networks that include Maker Studios (55,000 channels, 8.5 billion monthly video views), Fullscreen (50,000 channels, 3.5 billion monthly views), and Machinima (12,000 channels, 3.1 billion monthly views). “It’s only been a few short years that the industry has been in play,” says Kreiz. “It’s obvious that the monetization and the economics have been lagging behind the size. But it’s definitely moving at a very fast pace.” The belief at MCNs is that as more brands understand how young people consume content, ad budgets will shift from TV to digital-video advertising. That migration has yet to take place. In 2013 the TV ad market in the U.S. hit $66.6 billion, according to EMarketer, vs. $4.2 billion in digital-video ads. Not only does TV remain a bigger market, but it also continues to add more dollars yearover-year. From 2011 to 2013, TV advertising grew by almost $6 billion, compared with a $2.2 billion increase in digital-video advertising, according to EMarketer estimates. “Digital video remains a supplement to TV,” says analyst Hallerman. “That part is not shifting.” Robbins says AwesomenessTV became profitable last year, though he won’t say how much it made. Advertising rates on YouTube, he concedes, have remained low. He says AwesomenessTV’s business model doesn’t rely heavily on preroll advertising, the TV-like spots supplied by Google that run before a video starts. Instead, the business makes the bulk of its money working directly with brands to create original programming and sponsorship opportunities and by extending its artists’ ideas beyond YouTube into venues such as live concerts, TV shows, and movies.
AwesomenessTV recently teamed up with Content & Co., an L.A. business that helps advertisers find and develop opportunities on YouTube, to make a show for Subway. They created an original Web series, Summer With Cimorelli. The show stars the six singing Cimorelli sisters, an a cappella act with a rabid teenage fan base. Behind the camera, Douglas Lieblein, a TV veteran who previously served as the co-executive producer for Disney Channel’s Hannah Montana, wrote and ran the series. The sisters dine on Subway subs during the program. And over the summer, Subway ran traditional TV ads starring the singers. “What we created with Summer With Cimorelli is a template that worked great for everybody involved,” says Content & Co. CEO Stuart McLean. “Our belief is that partnering YouTube talent with top Hollywood talent is the Holy Grail.” Just as traditional media figures like Donald Trump, Martha Stewart, and Paula Deen use their media exposure to create much more lucrative product licensing deals, YouTube entertainers are doing the same. Robbins says it won’t be long before AwesomenessTV’s nascent consumer-products division makes more money than any other part of the company. “Like any media business, it doesn’t work with one revenue stream,” he says. “If the movie business were only based on theatrical box-office [revenue], there would be no movies made. I always laugh when people say the economics don’t make sense. The economic part of the ecosystem is accelerating.” L ast year, YouTube opened a 41,000-square-foot studio in Los Angeles on the site of the former Howard Hughes airport. The facilities include soundstages, green rooms, editing suites, a coffee bar, postproduction equipment, a screening theater, and a set made to look like a neighborhood bar. Everything is sleek and immaculate—and totally free for YouTube creators no matter which MCN represents them. Members of the AwesomenessTV diaspora routinely drop in to use the facilities, which are much more extensive than anything at AwesomenessTV headquarters. The result is a warm, collegial setting in which YouTube talent is treated with reverence. They’re invited to attend regular musical performances, instructional
Maker Studios’ Kreiz (right) with rapper and videographer Timothy DeLaGhetto
PHOTOGRAPH BY NATHANAEL TURNER FOR BLOOMBERG BUSINESSWEEK
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handful of companies in and around Los Angeles were pioneering a business model in which they used automated systems on the Web to sign up and manage thousands of independent YouTube creators. The trend was similar to what Huffington Post and BuzzFeed do in digital news— combining small amounts of crafted premium content produced in-house with large volumes of unpolished content produced for minimal compensation by decentralized amateurs. Aggregated, the smaller channels can create a big audience, and the MCNs developed tools and services to help their video makers grow bigger. Kreiz of Maker Studios says his team has developed 40 “levers” it can pull on the YouTube platform to optimize an artist’s reach and value. For example, he says, Maker has a proprietary tool that looks at variables such as geography, target audience, and number of subscribers to a channel to determine the optimal time to upload a new video. “It can be vastly different if you’re in gaming vs. in fashion,” says Kreiz. “One could be Sunday morning, the other could be Wednesday afternoon. We can automate that and adapt it in real time based on all these various attributes.” As the MCNs pulled together the video makers, they formed programming clusters organized around certain topics such as video games and music, which they then sold to advertisers hoping to reach some subset of the young American populace no longer glued to TVs. The model has proven it can generate huge audiences, but not yet huge profits. AwesomenessTV’s 1 billion monthly video views put it in the big leagues of
in July 2014
The Top 30 YouTube Networks
AT&T and Chernin Group may be closing in on a purchase
WARNER
BROS. led an $18 million investment round
Acquired by
DREAMWORKS for $117 million
Total unique viewers in the U.S. (thousands)
1) Vevo: 42,600 2) Fullscreen: 36,115 3) Maker Studios: 33,488 4) Warner Music: 24,208 5) ZEFR: 22,217 6) BroadbandTV: 19,354 7) The Orchard: 18,115 8) warnerbros vfp: 17,866 9) Machinima: 17,363 10) Zoomin.TV: 16,639 11) Collective Digital Studio: 14,676 12) Universal Music Group: 14,338 13) any.TV: 13,012 14) SonyBMG: 12,579 15) Defy Media: 12,185 16) QuizGroup: 12,043 17) Jukin Media: 11,698 18) Base79: 11,498 19) AETN: 10,778 20) FremantleMedia: 9,863 21) Movieclips: 9,466 22) Rightster: 9,386 23) NBC: 8,688 24) Crackle: 7,967 25) StyleHaul: 7,809 26) Blue Ant Media: 7,716 27) AwesomenessTV: 7,637 28) Believe Digital Studios: 6,613 29) CurseTV: 6,282 30) Storyful: 6,195
Bought by
DISNEY for $950 million
COMCAST Sold to Comcast’s Fandango by ZEFR
HEARST and
21ST CENTURY
FOX
DATA: COMSCORE, INC.
are looking
seminars, happy hours, comedy nights, and movie screenings. YouTube also offers so-called residencies to artists or companies eager to immerse themselves in the community. Amateurs are welcome. So are pros. Currently, one of the official artists in residence is Rupert Murdoch’s new ESPN competitor, Fox Sports 1. Another is Oprah Winfrey’s OWN network. On a recent morning, established media emissaries were working alongside bearded and bespectacled YouTube natives. A dude with a mohawk fiddled with his phone in front of a green screen. A young lady sat on the floor shaping mounds of cotton into puffy white clouds. A woman with washboard abs did calisthenics in front of a camera. A rock band shot a music video. YouTube operates similarly lavish, gratis studios for creators in London and Tokyo. Later this year it’s opening a free studio in New York. Robert Kyncl, YouTube’s head of content and business operations, says the rise of the multichannel networks has been good for everybody. They’re creating value, he argues, by focusing on a range of services, such as talent
management and series development, which are outside YouTube’s purview. “A lot of things are still being figured out,” Kyncl says. “It opens up opportunities for entrepreneurs to follow various theses.” Freddie Wong, a YouTube creator known for his scripted sci-fi comedy series Video Game High School, hopes Hollywood will inject some long-term investment into a world in which many entertainers still scramble to survive. The historically thin margins, he says, have discouraged ambitious storytelling. “In general, a lot of content creators find that their success is unable to support any sort of organization of scale,” says Wong. “It’s pretty difficult to support even three or four employees.” In April, Wong and his production company, RocketJump, formed a partnership with Lionsgate, the entertainment company behind television shows such as Mad Men and feature films like The Hunger Games. “The Lionsgate deal came at an opportune time,” Wong says. “It allows us to get our projects financed and create long-form content without needing to be reliant on brand deals or
crowdsourcing for external financing.” Wong has some concerns about the Hollywood sharks circling the YouTube talent pool. He expects to see clashes in the years to come on YouTube between art and commerce. “If you follow the history of Hollywood movies, there’s always been that struggle,” says Wong. Robbins, for one, says he’s up for the challenge of simultaneously managing the careers of 88,000 or so would-be stars. “I was once that 18-year-old knucklehead who was on TV,” he says. “It’s easy for me to relate. The kids that work here are always like, this one didn’t show up, or this one is complaining.” Robbins adds, “I’m like, ‘Just stop. Try making an Eddie Murphy movie. That’s hard.’ ” Hank Green, a 34-year-old entrepreneur with a boyish face who rose to prominence making geeky science videos on YouTube, gazes across the stage at Jeffrey Katzenberg, a powerful media executive who rose to prominence making big Hollywood movies. Recently, Katzenberg has been delving heartily into Green’s territory, investing in companies that work on YouTube. “Should I be terrified of you?” asks Green. “My company’s budget is not very big. I have, like, 20 employees, and we’re trying to make it work. And you, obviously, if you wanted to, could be like…” Green leans into the microphones and makes a loud splattering noise like what a steamroller driving over a watermelon would make. The crowd laughs, and Katzenberg smiles. It’s a Thursday morning in June, the first day of VidCon, the annual gathering in Southern California of digital-video entrepreneurs, YouTube stars, and the many screaming teenage girls who love them. A large crowd has piled into the Anaheim Convention Center to watch Green, the co-creator of the conference, interview Katzenberg, the chief executive of DreamWorks Animation. Katzenberg assures Green there’s no need to be scared. DreamWorks— the studio behind animated franchises such as Shrek, Madagascar, and Kung Fu Panda—has landed on Planet YouTube with a healthy respect for the native culture. His growing investment there, Katzenberg says, is entirely “in service of everything that is great and unique and singular about what I believe will be the biggest, most valuable media platform in the world, which is YouTube.” “I still feel like this platform is in its infancy,” he adds. “I want to be a part of this as it grows.” For video, go to: Businessweek.com/epicmealtime
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BEYOND BLACK AND WHITE
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Ferguson’s businesses fight for survival By Christopher Leonard
Photographs by Philip Montgomery
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harles Davis showed up at his new restaurant on the morning of Aug. 9 ready for a long day of work. He’d opened the Ferguson Burger Bar & More just a day earlier, and this was his first Saturday night. The restaurant is located on the east side of Ferguson in a low-slung commercial strip, between a barbershop and a beauty supply store. Davis was taking orders and shuttling them back to the kitchen when the phone rang. The call was for his wife, Kizzie, who also works at the restaurant. The news was horrible. A family friend, a young man Kizzie had known since he was a kid, had been shot and killed by a police officer just a few blocks away. Michael Brown was 18 years old, about to start his freshman year of college. Word started circulating among Davis’s customers: Brown’s body was lying in the street, blood everywhere, the cops keeping everyone away. The kid had been shot with his hands up, people were saying. “When things started unfolding, I knew what was going to happen,” says Davis, who is black. “Because the way they were handling things, the police. The way they were hiding things. I knew then: ‘Yeah, it’s going to be a problem.’ ” About a mile away, another local business owner, Beth Thompson, was unaware of the shooting. Thompson, who is white, owns a bakery called Cose Dolci, between a wine bar and a bike shop in Ferguson’s revitalized downtown. That Saturday, she was scouting local farmers’ markets to find new venues to sell her cupcakes, scones, and gooey butter bars, a St. Louis favorite. She only learned of the shooting when she got home that evening. Over the next two weeks, as protests over Brown’s death gave rise to violence and looting on the streets of the town, prompting Missouri Governor Jay Nixon to call in the U.S. Army National Guard, Thompson followed it on the national news. “Initially I was thinking, ‘It’s time to move’—honestly,” she says. “I was shocked. It was very surreal. It did not seem like it was possible that that could happen in this community. But clearly it did.” Long before it became the focus of global attention, a symbol of America’s continuing struggle over race and police violence, Ferguson was a deeply divided place. The wounds from the past—from race riots, white flight, civil rights lawsuits to integrate the city’s schools—have baked segregation into the fabric of St. Louis and the surrounding area. There are white neighborhoods and black neighborhoods; white shops and black shops; white schools and black schools. And the divide is profoundly unequal. The black neighborhoods are poorer, with fewer kids graduating from school, higher crime rates, and higher unemployment. Black and white business owners—people such as Davis
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and Thompson—live in different worlds, too, catering almost entirely to customers of their own race. Most lived uneasily with the status quo until it exploded with Brown’s death. Now business owners are bound together more tightly than anyone ever expected they’d be, having to rebuild a city and its prospects. For years the suburban belt north of St. Louis has seen a decline in the kind of blue-collar manufacturing jobs and retail outlets that once supported the local economy. The metro area had 1.3 million jobs in January, almost unchanged from the same month a decade ago. Its population fell about 1 percent during the Great Recession, while per capita income dropped almost 8 percent, to $50,257 a year. The last few years have been a game of catch-up, with population and income slowly returning to 2008 levels. Ferguson could stagnate for decades, choking out investment and small businesses, as has happened in other urban areas in the wake of riots. “Obviously, it has to have a negative impact on the image, perception, and reputation of the region,” says Richard Ward, principal at Ward Development Counsel and an economic development and real estate consultant who’s worked in St. Louis for more than 40 years. Because the Ferguson riots were contained to a relatively small area— virtually all the unrest was limited to a half-mile commercial strip along West Florissant Avenue—many businesses are still able to operate. That means the city has a chance to rebound. But in a place where emotions remain so raw, no one thinks it will be easy. Almost two weeks after Brown was killed, the Burger Bar is packed. The restaurant has become a haven for the throngs who descend on West Florissant each night. At the height of the protests, the streets in front of Davis’s restaurant filled with marchers holding up their arms in sympathy with Brown. Armored police vehicles patrolled the middle of the avenue before parking in front of Furniture for Less, flanked by troopers in combat gear. Swarms of journalists and cameramen circulated with the crowds. Kids with shaved heads, combat boots, and anarchist T-shirts congregated in parking lots. Young black kids marched around with bandanas over their faces and hoods over their heads. Davis stood behind the bar of his restaurant in the middle of it all, slinging burgers. Davis, 47, is a stocky guy with a shaved head and a bit of gray in his beard. The glasses he wears make him look somewhat like a high school principal, and he exudes a calming confidence from behind the counter, putting patrons at ease even as armored police cars roll by. “Welcome to Ferguson Burger Bar & More,” he calls out, “where the food will tap-dance on your tongue.” Davis is clearly still working to get his system running smoothly. The kitchen is backed up. On a recent, typically busy night, he writes down a customer order on a ticket and pushes open the door to the kitchen to hand it over. The kitchen is steaming hot, with four staffers working in close quarters. The countertop is covered with a haphazard row of order tickets. Davis holds up the new one. “I don’t know where you want this ticket!” he says. “In line!” one of the cooks responds. Davis hurriedly drops the order and goes back out to take more. On Aug. 10, Davis had stood in front of his house, up the street from the restaurant, and watched Ferguson’s social order disintegrate. Earlier in the day there had been protests, which devolved into looting. “Standing outside my house, I’m seeing things I’ve never seen. People pulling up in carloads,” he recalls. “Cars were parking in front of my home. Guys and girls getting out in ski masks running across the street. It was just a madhouse.” The next day, Davis went down to the restaurant, not
Preceding pages: Charles Davis in front of the Ferguson Burger Bar & More. Top: Kizzie Davis works a rare slow shift. Bottom: Boarded-up businesses in the protest zone
knowing what to expect. To his surprise, the big, plate-glass windows were intact. The place hadn’t been touched. Davis made up his mind: He would stay open. Despite being in the middle of riots that included flash bombs, tear gas, and looting, he hasn’t missed a night. “I bought a business to make money. Nothing’s going to stop me,” he says, with a broad smile. The restaurant got a boost when the McDonald’s across the street started to shut down daily at 4:30 for the safety of its employees and customers. Davis’s spot was the only place to buy a hot meal during the long nights of protest. Davis is new to the restaurant business. Born and raised in St. Louis, he first ventured into business running a car lot. Then he got into real estate, buying up old houses in St. Louis, rehabilitating them, and selling them off. That business died out with the real estate crash, and Davis says he was looking for a new opportunity when the Burger Bar went up for sale in late July. He bought it with personal savings and had about three days to get up to speed on the restaurant industry. “Every business has their different intricacies, but business is business, to me,” he says. “It was just another venture for me to overcome another obstacle. It’s about getting in, learning, working hard.” Davis is hoping the income from the restaurant will augment what he might make in real estate and a home health business he’s planning to start with Kizzie. He doesn’t see many alternatives. “The economy of St. Louis sucks. Period. All the major
companies are gone,” he says. “There was a time when you’d get a job at Chrysler, and you’d stay on the job 30 years until you retired. We don’t have that anymore.” About a mile and a half from the protest site, there is a different Ferguson, a largely white-owned business district located in some quaint historic buildings that have been refurbished in recent years. There’s a wine bar, a microbrewery, a coffee shop, and Thompson’s bakery. Cose Dolci has pink walls and a brightly lit display counter containing freshly baked cupcakes and other goodies. This business strip is the result of a decade of work. North St. Louis County towns such as Ferguson aren’t shopping destinations. The center of retail gravity has shifted far west to distant exurbs like Chesterfield, about 30 miles from downtown. Throughout the area, there are business owners such as Thompson moving into rehabilitated buildings and trying to stoke economic activity in previously abandoned neighborhoods. They tend to be a nervous lot: Every shooting, every mugging, every report of unruly teenagers fighting in the streets on a Saturday night feels like it might reverse the momentum they’ve been working so hard to build. In a way, the story line of the Ferguson riots has been unfair to its residents and business owners. Ferguson is not so much a standalone city as it is a neighborhood, seamlessly interconnected with municipalities such as Normandy, Dellwood,
Thompson’s bakery is part of downtown Ferguson’s revival
“We’re not going to live in fear. We’ll keep moving forward”
Jennings, and the city of St. Louis itself. A police shooting could have happened in any of these towns. Ferguson’s metamorphosis into #Ferguson singled out a communit y within St. Louis’s inner suburban ring, making it the focal point for regional problems. Thompson, 46, started her business more than a decade ago, selling scones at the Ferguson Farmers Market on Saturday mornings. She’s a slight woman, short and lean, who seems like pure energy wrapped in a small pink apron. Quick to laugh and banter with customers, she’s tireless even in the middle of a busy shift, as employees ask her for help and she assists a customer struggling with the trick handle of the shop’s front door. After she’d sold baked goods at the farmers’ market for a few years, the city approached her and asked if she’d like to open a brick-and-mortar bakery downtown. “I was, like, ‘No,’ ” she recalls. When the city enticed her with tax-increment financing, she decided to go for it. She worked 16-hour days in the beginning. Eventually she had enough money to hire help, and now the bakery has five employees. She says she isn’t trying to get rich. She’s doing it because she loves the work. And she loves that her shop is a community hub: The same group of customers comes back regularly to chat at the counter and pick up treats. Like Davis, Thompson has seen an unexpected upswing in business since the looting started. A local group of civic leaders started a Facebook campaign to encourage St. Louis residents to shop in Ferguson, and it worked. Some days, Thompson can’t keep up with the demand. But just like Davis across town, she worries how business might be in a month, and then three months after that. How badly has the “Ferguson” brand been tarnished by all this? Will people still come to the farmers’ market? Will young couples want to buy a house in town? “A lot of these businesses around here are mom and pop,” Thompson says. “We’re not corporate. We don’t have deep pockets. If we lose our customer base, we’ll have to close our doors.” That prospect fills people such as Paul Morris with dread. He’s the secretary of the Ferguson-Florissant school board, a retired teacher who’s dedicated to living in the area. He calls Ferguson a “point-of-sale city,” meaning that it depends on sales tax receipts from businesses such as Thompson’s and Davis’s. The city is already hurting. Since the real estate crash of 2008, overall property assessments have fallen 15 percent, Morris says, cutting deeply into the school system’s money. Just this summer, the city passed a tax levy to shore up the budget. Thompson says downtown businesses are committed to pulling through. On the first night of looting, business owners were calling each other frantically. “Everybody kind of got on the same page and said, ‘We’re going to wait and not open for a day or two and see what happens. Then we’ll all open at the same time.’ ” They did just that, and for now business is good. “Everybody supports each other around here,” Thompson says. “I’m hoping people don’t forget that we’re here.” The strip of West Florissant Avenue that was the scene of the looting is quiet and partly ruined. Plywood is still nailed over many store windows, spray-painted with slogans such as “WE WILL BE BACK” and “OPEN! BLACK
OWNED.” The looting has ended; most media satellite trucks have left; and the long job of recovery is just beginning. If there’s any bright side to be found in Ferguson’s turmoil, it might be that people are more attuned to the region’s problems. Joe Reagan, the chief executive officer of the St. Louis Regional Chamber and Growth Association, doesn’t try to put a positive spin on events. Even before the looting started, the chamber was focused on the conditions that contributed to it, he says. The first priority is reforming the St. Louis school system. Doing so will be critical to drawing talented workers to the area and narrowing the inequalities between the mostly black residents of St. Louis and its inner suburbs, who live in city neighborhoods with failed public schools, and those, mostly white, who live in more distant towns with better schools. The second task is to reform the region’s deeply dysfunctional government. The city of St. Louis separated itself from surrounding St. Louis County long ago. Over the decades, the suburban population has boomed, while the city has stagnated. Now the county is a patchwork of tiny cities such as Ferguson and St. Ann, with often blurred lines of authority, a problem most evident when it comes to law enforcement. The county government has a police force it provides to cities under contract. But some towns, including Ferguson, choose to field their own police forces, which have varying levels of funding and training. The nearby city of Jennings, for example, fired its entire department a few years ago in part because racial tensions between citizens and police ran so deep. Reforming St. Louis’s governance and fixing the schools are hard, long-term jobs, and talk of doing both has been perennial. What’s different now is a sense of urgency. Nobody wants another eruption, but everyone understands that it’s a distinct possibility. For the moment, the interest in making real changes seems abundant. “Look, our community and our country have solved daunting problems before,” Reagan says. “We’ve just got to make a decision to do it. I think it’s time for the business community to demonstrate—we’ve got to demonstrate leadership.” For all that separates them, Thompson and Davis share a commitment to their city and an indomitable entrepreneurial spirit. “We’re not going to let this slow us down. We’re not going to live in fear. We’ll keep moving forward,” Thompson says, greeting customers at the Ferguson Farmers Market. Her sister, Jackie Mafuli, mans the booth, sweating in the August humidity. She’s already sold out of specialty sugar cookies with a peace sign on them. Across town at the Burger Bar, Davis says, “This is a longterm problem, and it’s not going to be fixed with a shortterm solution.” During the Friday lunch rush, the restaurant is busy, but not as frantic as it had been during the nights of protest, perhaps a preview of what things will look like once all the excitement dies down. A white customer enters. His name is Robert Chabot, and he’s the school board president. It’s Chabot’s first time in the place, and he’s brought a friend with him. Chabot approaches the counter and tells Davis that someone on Facebook recommended the restaurant. “He said you had the best burger in Ferguson,” Chabot says. “Actually, outside of Ferguson, too,” Davis replies without missing a beat. The men share a laugh. Davis scribbles a ticket and takes it back to the kitchen.
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Jeff w Luhno
raph Photog n by Rya Lowry
Can a forme r McKinsey consultant b uild championsh a ip baseball tea m? The Houston Astros are ďŹ nding o u By Joshua G t reen
57 Si Me g jda l
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rofessional baseball is an insular business, so when Jeff Luhnow showed up for his first day of work as the St. Louis Cardinals’ vice president for baseball development, he already had two strikes against him: He was a former management consultant at McKinsey, brought in to shake up the organization. And the sum total of his baseball experience was the McKinsey fantasy league and a business school paper he’d written on how the Chicago Cubs could win the World Series. It was the fall of 2003. Michael Lewis’s book Moneyball, about the statistics-driven approach of Billy Beane’s Oakland A’s, sat atop the bestseller list. It caused a number of owners to rethink their own approach, which provided Luhnow entry into a game that otherwise wouldn’t have had a place for him. “I wanted to make sure we were cutting-edge on all fronts and thought having someone from the outside would give us a fresh look,” says Bill DeWitt Jr., the Cardinals’ owner. Depending on whom you asked, this was either an odd or an inspired idea, since the Cardinals had made the playoffs three years running and didn’t appear to need help. But DeWitt worried the team wasn’t built to last. The farm system was weak, and because his club was a midmarket franchise, he couldn’t afford to replenish it with pricey free agents. So DeWitt asked his son-inlaw, a McKinsey vet, if he knew any consultants with a passion for baseball. He replied, “I’ve got the perfect guy for you”—Luhnow. DeWitt wanted Luhnow to design a better system for evaluating players. Luhnow hired a NASA engineer to help him make sense of all the new data that were becoming available for assessing ballplayers. “We talked a lot about how we could gain a competitive edge,” DeWitt says. But the people running the Cardinals’ old system resented the bespectacled interloper with his MBA and ideas about how they could do their jobs better. Behind his back, they referred to Luhnow as “Harry Potter” and “the accountant.” To a management consultant, this is familiar territory. “When you arrive, you’re always met with a lot of skepticism from people inside the organization,” says Michael Farello, a friend from Luhnow’s consulting days. Once, during a client engagement (as McKinsey calls them), Luhnow’s boss had his tires slashed. “McKinsey trains you how to build bridges to garner support,” says Farello. On draft day, Luhnow tried to lighten the mood by showing up with the magic wand from his son’s Harry Potter Halloween costume. Although he never quite won over his critics, Luhnow impressed DeWitt. The owner eventually made him head of the Cardinals’ scouting department—a real baseball job—which caused a rift in the organization that prompted the departure of the general manager, Walt Jocketty. “Putting Jeff in that role was more than a little atypical and therefore controversial,” says DeWitt, “but I thought the work he’d done and his insights would lead to success in that role.” Sure enough, Luhnow proved a wizard at the draft. During the seven years he ran amateur scouting, no team had more draft picks make it to the big leagues than the Cardinals. Last October, when St. Louis faced off against the Boston Red Sox in the World Series, 16 of the 25 players on the Cardinals’ roster had been drafted during his tenure. By then, Luhnow was long gone. When Jim Crane bought the Houston Astros in 2011, he tapped Luhnow to become general manager and revitalize a woeful franchise—the Astros had just finished the season with 56 wins and 106 losses, their worst record ever. A good ol’ boy with an industrial safety degree from Central Missouri State University, Crane had twice been an All-American pitcher. He went on to make a fortune in the logistics business, which had taught him
the value of superior data. “If you have better information, faster than your competitors, you can run ’em ragged,” he says. Crane had one overriding goal for the Astros, and that was to turn them into the St. Louis Cardinals. And he wanted to do it as quickly as possible. Luhnow’s pitch was what you might get if you put McKinsey in charge of a major league team: He wanted to go even further than the Cardinals or A’s in using data to guide the team’s decisions. So long as it yielded a winner, Crane was willing to go along. “If it takes more money, more computers, more horsepower, I’m ready to do it,” he says. Together, he and Luhnow have embarked on a project unlike anything baseball has seen before. Luhnow has done to the Houston Astros what Mitt Romney used to do to steel companies while at Bain Capital: stripped them down with ruthless efficiency to build them back up again, stronger and better than before. Crane agreed that the Astros would go where the numbers told them to go. The numbers told them to lose. The Astros were so bad that, financially speaking, it didn’t make sense to spend millions of dollars fielding a team whose best hope was mediocrity. If Crane could withstand the criticism that comes with losing for a couple of seasons, Luhnow told him, then that money could be allotted to the farm system, the analytics staff, and the new baseball academies in the Dominican Republic that Luhnow’s staff had determined were an especially cost-efficient source of talent. Crane bought into this vision knowing it wouldn’t be pretty. “You get beat up on ESPN,” he says. “Everyone’s an expert who will give you their opinion. But I can take the heat.” In 2013 the Astros began the season with the lowest payroll in the league, $27 million. But Luhnow didn’t stop there. He traded away much of the Astros’ major league roster for prospects, making a bad team even worse (the Astros ended the 2013 season with an active payroll of just $13 million). Someday, if their talents ripen, these youngsters may form the nucleus of a winning franchise. In the meantime, Luhnow’s plan all but assured a terrible team—which the Astros have been. While other clubs were trying to reach the World Series, Houston seemed to be galloping in the other direction, toward the worst record in the league and the top draft pick that distinction confers. “The perception in the industry is that they tanked,” says Buster Olney, ESPN’s national baseball columnist and a critic of the Astros’ approach. “When you run out a team with a $27 million payroll, you’re essentially designing your team to fail. There’s no chance you avoid colossal, record-setting losses, which is exactly what they got.” From 2011 to 2013, Houston was worse than any team since the 1962-64 New York Mets. Passing on Free Agents, Investing in Prospects Annual ESPN rankings of talent and depth of MLB franchises’ minor league players Luhnow joins the Astros
Astros farm system ranking 1st 10th 20th 30th
2009
2010
2011
2012
2013
2014 DATA: ESPN
Secon d basem a José A n ltuve
DAVID DUROCHIK/AP PHOTO
Most teams couldn’t even contemplate the Astros’ experiment. “In places like Boston or New York, you could never do what the Astros are doing because the fans wouldn’t accept it,” says Ben Cherington, general manager of the Boston Red Sox. Other owners might consider it unsportsmanlike or worry about becoming pariahs. In May, the Houston Chronicle’s beat reporter, Evan Drellich, wrote a much-discussed article about exactly this phenomenon (“Radical Methods Paint Astros as ‘Outcast’ ”) in which Bud Norris, a veteran pitcher Luhnow had flipped for prospects, was quoted as saying, “They are definitely the outcast of Major League Baseball right now, and it’s kind of frustrating for everyone else to have to watch it.” The Astros’ front office takes exception to this, likening the criticism of Luhnow to that directed at any disruptive force. “He’s an agent of change in an industry that, to be quite frank, didn’t want him,” says Sig Mejdal, the ex-NASA engineer brought over from St. Louis who is the Astros’ director for decision sciences. The hostility Luhnow’s faced isn’t surprising. Being baseball’s Mitt Romney has exposed the raw economic calculus of winning, shattering the romance and mystery that’s supposed to lie at the heart of the game. If Luhnow succeeds, other teams are sure to follow him—as Beane and the Oakland A’s can attest. “I joke with Billy,” says Olney, “that this is the spawn of Moneyball. It’s the most pure, numbers-driven experiment baseball has ever seen.” One of the first things you notice when visiting the Astros’ front office is how much it resembles a consulting firm—full of bright, eager, impressively credentialed Ivy Leaguers, confidently at ease. The tension between old ways and new that divided the Cardinals is not evident. Luhnow has surrounded himself with a flock of adherents, including engineers, consultants, data scientists, and a physicist—people who, like Luhnow, wouldn’t have had a place in baseball until recently. “These sorts of skills were not valued 10 or 15 years ago—or really valuable—because the data that you can use today to help you make decisions wasn’t available,” he says. Many of them occupy a room, dubbed the Nerd Cave, that’s lined with whiteboards covered with algebraic formulas. Last summer, when Luhnow hired a Barclays economist whose last job was valuing credit-default obligations, the team had to christen Nerd Cave Two. In Houston’s front office, the motto is “In God we trust—all others must bring data.” Calling someone Harry Potter would register as a compliment.
All this expertise is geared toward trying to master new data sources that have suddenly become available. Major league stadiums are wired with systems such as Pitch f/x and TrackMan that use Doppler radar to track the ball in three dimensions. “For every single pitch thrown in every game,” says Mejdal, “we now know the location, acceleration, movement, velocity, and the axis of rotation of the ball. If you believe, as we do, that this data has predictive ability, then you’re in an arms race to learn it and take advantage of it.” One person who clearly believes this is Mr. Moneyball himself, Beane. In the Wall Street Journal recently, he wrote an essay heralding the approach of “technologybased roster-building and algorithmdriven decision-making” as Big Data courses through baseball. MLB teams, he suggested, like certain hedge funds, will soon differentiate themselves according to how well they are able to exploit this information. (Adding credence to that analogy, the Economist reported in June that an unnamed major league team had purchased a Cray supercomputer of the sort hedge funds use to run market simulations.) Luhnow’s appreciation of the predictive power of data grew out of his experience selling designer jeans. In the early 2000s, with a former president of Levi Strauss, he co-founded an online custom apparel company that made jeans for Lands’ End shoppers. “You’re taking self-reported inputs from a human being,” he says, “and then trying to figure out exactly what pair of pants to make them. Are they being honest with themselves? Is there vanity sizing involved? How do they perceive themselves relative to how they actually are?” These were critical questions because if wishful thinking led customers to order jeans that didn’t fit, they would send them back. Over time the company amassed enough data to anticipate and correct for these tendencies. “We used neural nets and other artificial-intelligence technology to develop algorithms to predict these patterns,” says Luhnow, who still holds two U.S. patents for custom-fitted apparel. “When I Most defensive shifts* got to the Cardinals, I thought, this on balls in play in 2014 is probably something that can be *When fielders move out of applied over here.” position for a batter He found a kindred spirit in Mejdal, whose NASA research had Team Shifts uncovered similar examples of the Astros 1,145 limits of human intuition in preYankees 633 dicting performance. For example, Pirates 567 Mejdal showed that a drunken Blue Jays 564 astronaut was a better pilot than a Orioles 537 sober one flying four hours after his DATA: BASEBALL INFO SOLUTIONS normal bedtime. After reading Moneyball, he sent unsolicited reports to each major league team outlining how they could improve their draft. Years later, when the Cardinals’ drafts were the envy of the league, other teams tried to emulate their strategy. “If they’d just hung on to their junk mail,” Mejdal says, “it would have been right there.” Over the last three years, the Astros have examined conventional baseball wisdom to see what holds up to statistical rigor and what doesn’t. “We’ll have brainstorming lunches and just ask, why do teams throw good money after bad?” Mejdal says. “Why aren’t the minor leagues a meritocracy? Why does the firstround pick get treated differently than the 40th-round pick if, at some point, the 40th-round pick looks like a better prospect?” This exercise, backed by the Nerd Cave’s regression analysis, has persuaded the team to do things on the diamond that look strange to the casual fan. The Astros lead the league in defensive shifts, the practice of moving the shortstop to the right side of second base against left-handed pull hitters, which looks
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you,” he says. He scrolls through screen after screen listing every player in the organization. Along with statistics and notes, Ground Control displays the team’s projected performance for each player alongside the real thing. Some players have green tabs next to their names. This is a signal, generated by an algorithm, that the player is ready to be promoted. It’s also evidence that the algorithm-driven decisionmaking Beane predicted has already arrived. (A gray tab indicates that a player should be demoted, black that he should be cut.) “I look at this all the time,” says Luhnow. He clicks on José Veras, a reliever in Triple-A. Veras has a green tab. “The tool says his skill percentile is 97. He’s produced so far at 75 percent, so he’s producing in the top quarter of the league. His pressure to promote is extreme.” The next day, Veras is called up to the majors. In late June, Luhnow and his brain trust gathered in the general manager’s box at Minute Maid Park in Houston to watch a 27-yearold pitcher whom they consider an indicator of what their process can yield. Collin McHugh was plucked from the scrap heap last December after bouncing between the Colorado Rockies and their Triple-A affiliate. The Rockies had been intrigued by McHugh’s sinker, which the team thought would play well in hitter-friendly Coors Field. It didn’t. When they waived him, McHugh’s career earned run average was 8.94. The Astros’ analysts noticed that McHugh had a world-class curveball. Most curves spin at about 1,500 times per minute; McHugh’s spins 2,000 times. The more spin, the more the ball moves during the pitch—and the more likely batters are to miss it. Houston snapped him up. “We identified him as someone whose surface statistics might not indicate his true value,” says David Stearns, the team’s 29-year-old assistant general manager. After consulting with the analytics staff, pitching coach Brent Strohm altered McHugh’s repertoire. Gone was the sinker. In its place, McHugh began throwing more four-seam fastballs. And he started throwing them high in the strike zone. This defied the standard wisdom that pitching up is dangerous, since good hitters can crush fastballs. “Everybody says, ‘Keep the ball down, keep the ball down,’ ” says Strohm. Major league teams have long favored ground-ball pitchers, since grounders tend not to result in doubles, triples, or home runs. But here again, advanced data yielded a useful insight: Major league hitters had become so adept at hitting low pitches that they were vulnerable to high ones. Beane had discovered a particularly clever countermove. “Beane Pitch performance
Using data to identify his best pitches, the Astros have helped pitcher Collin McHugh have a breakout season Year
Team
W-L
ERA
IP
SO
WHIP
2012
Mets
0-4
7.59
21.1
17
1.641
2013
Mets, Rockies
0-4
10.04
26.0
11
1.923
2014*
Astros
6-9
3.03**
119.1
126
1.123
*As of Aug. 25 **He’s given up seven fewer runs per nine innings than he did the previous year W-L: Wins-Losses, ERA: Earned run average, IP: Innings pitched, SO: Strikeouts, WHIP: Walks and hits per innings pitched
The secret to his success: more curveballs In his first two seasons, McHugh threw a steady diet of fastballs and sinkers—and batters crushed them. The Astros recognized that batters struggled against his curveball and had him throw it more often.
Pitch usage 59% Fastball/sinker 52% Curveball/slider 39% ’12
DATA: BLOOMBERG SPORTS, BASEBALL PROSPECTUS, BASEBALL REFERENCE
’13
43% ’14
u
Better | Worse
e
Fastball/ Curveball Slider Sinker Opponents’ batting average ’12 The number of hits off a given pitch divided ’13 by the number of at-bats that end on that pitch ’14 Opponents’ slugging percentage The number of total bases from hits off a given pitch divided by the number of at-bats that end on that pitch
.130
.375
.400
.200
.414
.448
.128
.222
.250
’12
.304
.813
.822
’13
.333
.552
.845
’14
.200
.413
.425
HARRY HOW/GETTY IMAGES
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odd but lowers the batting average on ground balls by about 30 points by forcing the hitter to face three defenders (shortstop, second baseman, first baseman) instead of the usual two on the right side of the infield. To uncover starting pitching talent, baseball’s costliest commodity, the Astros’ minor league teams instituted a tandem rotation. In a traditional five-man rotation, a starter goes as deep into the game as he can. In a tandem system, every game features two “starters” who throw four or five innings in succession. This increases the number of pitchers given an opportunity to prove they can start and reduces the chance that human subjectivity will cause the team to miss hidden talent. (It’s also thought to prevent injury.) Luhnow cites a soft-tossing lefty named Tommy Shirley as a diamond this system unearthed. “He would have been pegged as a lefty specialist [relief pitcher],” he says. Instead, Shirley emerged as an All-Star starter in Double-A and was promoted to the club’s Triple-A team in July. Beyond any specific strategy, Luhnow boasts that the data-driven process the Astros have devised is their true achievement. He offers the hypothetical example of a college draft prospect. “Let’s say he’s played two summers in a wood-bat league,” he says. “He’s got hundreds of Division I at-bats with a composite bat but against a wide variety of competition. You’ve got scouts’ input on his potential. Your video analyst says his swing is in the top quartile of swings he’s seen that lead to success in the major leagues. Your area scout says his character is in the top 10 percent of players. But he’s a C-minus student. Not academic, doesn’t learn well. Your doctor says he’s got a slightly above-average risk of sustaining an injury. I’ve just given you nine pieces of information. How do you weight them? I can’t do that in my mind. It’s overload for any human being. But we have a thousand players on the draft board we’re trying to rank in order.” Luhnow wanders over to his computer to show off what the Astros’ process has yielded: a program called Ground Control that takes all these variables and weights them according to the values determined by the team’s statisticians, physicist, doctors, scouts, and coaches. It’s the repository of the organization’s collective baseball knowledge— the Astros’ brain. “Let me show
stayed ahead of the curve,” says Strohm, “by finding hitters with a steep upward swing path to counter the sinking action of pitchers trying to induce ground balls.” It worked: The A’s hit the fewest ground balls and into the fewest double plays in the league. So the Astros began teaching their pitchers how to adapt. “To counteract the upward swing,” says Strohm, “you elevate the ball—the hitter can’t get on top of it.” In his first start of the season, McHugh struck out 12 batters and walked none, beating the Seattle Mariners. “He was open to [instruction],” says Stearns, “and it’s led to a significant amount of success.” McHugh won a spot in the Astros’ starting rotation and has gone on to lead the team in strikeouts and deliver a sterling 3.03 ERA.
Team Payroll vs. Wins Luhnow slashed the Astros’ payroll to the lowest in baseball in 2013 … $120m
Astros’ regular season win percentage
League average
$100m
55% 50% 45%
$80m
40% Luhnow joins the Astros
$60m $40m
The Astros made the World Series in 2005; in 2013, they lost a league-leading 111 games
Astros’ Opening Day payroll* average
$20m ’05
For beleaguered Astros fans, this was supposed to be the year things started to turn around. And, like McHugh’s first start, there were good omens. ESPN ranked Houston’s farm system the best in baseball, promising a steady stream of talent. Payroll crept up to $44 million, still the American League’s lowest but much higher than before. The Astros made a surprise run at Japanese mega-free agent Masahiro Tanaka. He signed with the New York Yankees for $155 million, but Houston’s bid showed that it might finally be ready to open its wallet. Once the season was under way, the team called up two of its heralded young sluggers, George Springer and Jonathan Singleton, to inject power and excitement into a moribund lineup. And for the third year in a row the Astros held claim to the top pick in July’s amateur draft—a first in major league history. Given Luhnow’s reputation for draft wizardry, this seemed a bit like giving Mike Trout a fourth strike. After a rough April, something clicked. The Astros put together a seven-game winning streak and played .500 ball in May and June, encouraging for a team that had gone 162-324 (.333) the previous three seasons. Attendance rose. Springer emerged as a Rookie of the Year candidate. In June, Sports Illustrated put him on the cover, cheekily anointing the Astros the “2017 World Series Champs.” And then, suddenly, things went south. On June 30, Deadspin published 10 months’ worth of internal Astros trade discussions leaked (or hacked) from Ground Control. Luhnow had to call around the league to apologize. The draft began to seem less like a salvation than a problem. Houston’s top choice in 2012, shortstop Carlos Correa, broke his ankle. Last year’s top pick, Stanford University pitcher Mark Appel, fell apart, compiling a 2-5 record and 9.74 ERA in Single-A ball. Also in late June, this year’s top pick, a high school flamethrower named Brady Aiken, arrived in Houston with his family expecting to sign a $6.5 million contract and step into the spotlight as the Astros’ latest prized acquisition. Nothing happened. A few days later, Aiken quietly left town. As the July 18 signing deadline approached, the Chronicle’s Drellich reported that a post-draft physical had shown Aiken to have an unusually small ulnar collateral ligament in his elbow. Technically, he was healthy. But the Astros, citing a heightened risk of injury, cut their bid to $3.1 million, the least they could offer and still retain their right to a compensatory pick in next year’s draft if Aiken didn’t sign. Aiken’s agent, Casey Close, took the rare step of publicly excoriating the team, telling Fox Sports: “We are extremely disappointed that Major League Baseball is allowing the Astros to conduct business in this manner with a complete disregard for the rules governing the drafts.” On deadline day, Luhnow made a series of escalating bids that Aiken rejected, becoming the first top pick in 30 years not to sign. Although this was a huge black eye, Luhnow defiantly insists that losing Aiken won’t hurt the team. “Not every move is going to be popular, but we did what we thought was in the best interests of the Astros,” he says. “The reality is, we’ll get the second
... when the team lost more than twothirds of its games
’14
’05
35% 30% 25% ’14
*PAYROLL DATA IN 2014 DOLLARS DATA: BASEBALL PROSPECTUS, BASEBALL-REFERENCE.COM, U.S. BUREAU OF LABOR STATISTICS
pick next year and more money to spend [under baseball’s slotting system], so there’s a very strong possibility that whoever we take gets to the big leagues faster than Brady would have. So it’s hard to say it’s any sort of setback at all.” The suspicion around baseball, fanned by Close, is that Luhnow cut his offer not because he worried about Aiken’s elbow but because he saw an opportunity to increase his draft haul. The Astros’ final bid of $5 million left them just enough money under the league’s collective bargaining agreement to sign two additional pitchers, Jacob Nix and Mac Marshall—but only if Aiken accepted. In the end, Luhnow missed out on all three, coming away with nothing but a storm of bad publicity and a grievance filed by the players’ association for failing to honor the Astros’ offer to Nix. While he insists the team operated in good faith, using coldly rational cutthroat tactics has become the Astros’ hallmark. The attacks on Luhnow and the Astros highlight a big difference between his old job and his new one: Turnarounds at McKinsey didn’t play out on as public a stage as baseball’s. “One of the reasons people get into this job is that we’re intensely competitive,” says Stearns, the assistant general manager. “We enjoy the notion that our report card is in the paper every single morning, that success and failure is so easily defined by wins and losses. Where we are right now in our organizational cycle, that report card isn’t as flattering as we would like.” Nevertheless, Luhnow insists the Astros’ project remains on track. “I learned at McKinsey how to have a thick skin,” he says, “and that’s carried over into baseball.” The Astros, he notes, have already surpassed last season’s win total. But there are signs the clock is ticking. Earlier this year, Crane brought in Nolan Ryan, the epitome of old-school baseball toughness, as a special assistant. At the trade deadline, the Astros halted their annual fire sale and kept their best players. And in July, Appel and his 9.74 ERA were promoted to Double-A, leapfrogging more accomplished prospects and squelching the Astros’ conceit that the minor leagues should be a meritocracy. Several Astros expressed their displeasure to the Chronicle and let it be known that they felt like lab mice in Luhnow’s grand experiment. They’re right, of course. Back when he was a consultant, Luhnow worked on several long-term projects. “People were always skeptical around change—especially when that change wasn’t producing results right away,” says David Becker, a friend from those days who has kept up the fantasy league. In the end, the McKinsey folks would pack up and return home to Chicago, leaving someone else to carry out their designs. In Houston, fans will have to wait a little longer to find out if baseball’s most controversial general manager can also become its most successful. The plan is in place. And this time, Luhnow and his team aren’t going to get on a plane and fly home.
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OCTOBER 7-8, 2014 RADIO CITY MUSIC HALL® NEW YORK CITY
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Etc. t’s time to start dressing up again. Over the past 10 years, workwear has gotten increasingly casual, to the point where everyone from the intern to the boss is wearing sneakers and jeans. Perhaps you haven’t heard that informal office environments are linked with lower productivity. If that’s not enough to get you into a suit or dress, the fantastic array of more formal clothing landing in stores this fall should be. We’ve compiled 50 tips and trends to help you get back to looking like you’re ready to do business or, at the very least, stop treating every day like casual Friday. As some good book said: Dress for the job you wish you had.
Long Camel Coats
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The official jacket of the Ivy League gets a much-needed makeover with a longer length and more casual fit for both men and women. The coat should fit in the shoulder and sleeves and billow out from the body a bit. Shorter women, stick with knee-length.
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Wear a skirt with a hem that hits just higher than the coat’s
02 Leather Separates A motorcycle jacket is a bit too rock ’n’ roll for the office, but skirts and tops are fair game. Wear with other dark pieces to add texture— and prove to colleagues you’ve still got a little edge. Alexander Wang sleeveless shirt, price upon request. Cushnie et Ochs leather mini trumpet skirt, $1,495
Him: Calvin Klein lofty cashmere overcoat, $4,995. Steven Alan Oliver suit jacket, $495, and pants, $295. Thomas Pink button-cuff shirt, $185. Saint Laurent Classic 1 sunglasses, $310. Ralph Lauren burnished-calf loafers, $475. Her: Tibi cashmere maxi coat, $845. Derek Lam bonded-crepe turtleneck, $890. Michael Kors houndstooth circle skirt, $110. Karen Walker northern lights sunglasses, $250. Chrissie Morris pointed-toe pumps, $830
Previous page: Jenni Kayne narrow stripe pullover, $595. Frame Le Classic blouse, $188. Helmut Lang veneered angora skirt, $495. Topshop guapa suede Mary Janes, $100. Hermès watch, $8,700
03 Fall Fashion
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Etc. A pattern can sometimes intensify color, but here the white tones it down
Go with a larger size on a duffel coat, so you can wear it with a suit
First-Person
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A Non-Nerdy Sweater Vest They’re practical and preppy and seem like the perfect thing to wear in early fall’s in-between weather. This comfy mohair Saint Laurent vest ($725 at mrporter.com), with its argyle pattern and slimmer silhouette, looked great on the rack. I imagined it would become my new go-to garment—a contemporary version of an old-school item that looks just as cool now as it did in the Fifties. But, actually, I looked sort of lame. When I put the V-neck on over a dress shirt, the V was a little too low, and the whole thing read too math-teachery. I’m not giving up just yet: Next week, I’m trying it with a navy blazer. Maybe then. —Kurt Soller
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“I’m pleased to see looser pants come back. They enable you to carry things in your pocket once more.”
Yes, you can wear a silk dress to the office, as long as it’s not gownlike
One bright shade per outfit, please
Red gets a bad rap, even though it’s surprisingly flattering for most people—sorry, redheads—and pops nicely against neutrals. On the runways, almost every major designer showed head-to-toe vermilion looks, often created from many separates in the same fabric. That’s far too intense for most workplaces (and most humans). Instead, buy one piece you love and wear it alone or with other basics. It will be great for when you’ve got an after-work dinner and don’t want to look like an office drone. Left: Prada silk dress, $3,040. Hermès yellow-gold bracelet, $15,200. Topshop guapa suede Mary Janes (also at right), $100. Center: Ami unlined hooded wool coat, $900. Michael Michael Kors glacier check shirt, $125. Polo Ralph Lauren classic-fit chinos, $85. Cole Haan for Todd Snyder boots, price upon request. Right: Tory Burch Kendra dress, $425. Hue opaque tights, $13.50
Contrast saddle shoes, a fun take on flats, with a ladylike dress
Put Down the Beanie
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Vermilion: The Color of the Season
Jeremy Langmead Chief content officer, Christie’s
The hipster’s favorite winter accessory may have gone mainstream, but that doesn’t mean these dumb little hats are a good idea. They’re not particularly warm and always leave you with hat hair. On truly cold days, stick with a coat that has a hood.
Not as short as it looks, but dark tights are still a good idea
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MixedMaterial Accessories Stuart Weitzman’s shearling and leather handbag ($900) represents the next iteration of the colorblocking trend. If this fuzzy texture isn’t for you, seek out similar bags and shoes that incorporate different types of leather, snakeskin, and synthetics such as neoprene. Or try on Weitzman’s women’s brogues ($395), featuring a sleek combination of matte and “goosebump” leather, which looks a lot more chic than it sounds.
OPENING PAGE: PHOTOGRAPH BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. ILLUSTRATIONS BY CARI VANDER YACHT. THIS SPREAD: 01: PHOTOGRAPH BY GEORDIE WOOD FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 02, 07, 08: PHOTOGRAPHS BY JODY ROGAC FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: ELIZABETH OSBORN. 03, 06: PHOTOGRAPHS BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 05: PHOTOGRAPH BY EVA O’LEARY FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: JOHN OLSEN
Tailored Flannel
Etc.
Pair with a textured tie, solid shirt, and plain shoes
With slightly relaxed jackets and slim-but-not-skinny pants, brushed-wool suits aren’t just for Mad Men anymore.
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Real-Person Problem
“I’m looking for something outside my preppy element.”
“The cuffed sleeve gives the whole look a more casual feel. You can never go wrong with a white shirt.”
“I wear short skirts, so I never would have picked this one! But the pleats make [me] look longer, as well as older.”
Left: Brooklyn Tailors unstructured blazer, $595, and tailored trouser, $305. Gitman Bros. English spread shirt, $145. Tie Bar wool tie, $15. Jack Erwin bluchers, $195. Right: Gant by Michael Bastian MB pinstripe blazer, $795, and pants, $325. Todd Snyder dress shirt, $225. Tie Bar wool tie, $13.50. J.Crew Ludlow wingtips, $318
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If pants are a lightweight fabric, cuffs help them hang better
A Dandy-ish Scarf
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“The shoes are edgy and show off my nail polish, which I love. They make the outfit more fashion-forward.”
Kate Pratt, 26 Director of team partnership sales, Madison Square Garden “I find sponsorship partners, and I’m in meetings with clients in my usual classic style from breakfast until 10 p.m. I also wear the same pumps and jewelry every day, so I’d love to expand my options. This outfit is very sophisticated. I like it!” Cos white button-up, $89. Salvatore Ferragamo pleated leather skirt, $4,330. Rebecca Minkoff jewel-box-clip-clasp bangle, $58. Jennifer Meyer pyramid cuff, $6,800. Paul Andrew Lennox sandals, $895
Use one in place of a tie to lighten up a dark topcoat. Burberry’s bottle-green cashmere version ($1,250) is on the ultrahigh end, but maybe that means you won’t lose it in a cab.
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Printed Pants Drapey, colorful trousers, stocked in women’s stores since last spring, are sticking around for fall. In expensive silks and more affordable polyblend fabrics, they are an unexpected match with fall’s crew neck sweaters and suede boots. Opt for subtle prints at the office.
No belt, even if pants come with loops; it ruins the shape
12 Wear solids on top, or vastly vary the scale of patterns if mixing two or more
Go for a straight-leg cut that’s not too wide and hits at your natural waist
Less Formal Fur Coats New versions aren’t like the ones your mom wore: They’re short and sleek, with clean lines that elevate skinny jeans and pencil skirts. Try one in a light color, like this Yves Salomon stunner.
PHOTOGRAPH BY CREDIT TK BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 10: PHOTOGRAPH BY JODY ROGAC FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE 09: PHOTOGRAPH BY B. ILLUSTRATION BLANCHET FOR BLOOMBERG ARTISTS. 11: PHOTOGRAPH BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK. 13, 14: PHOTOGRAPHS BY GEORDIE WOOD FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: JESSI BUTTERFIELD. OPPOSITE PAGE: ILLUSTRATIONS BY CARI VANDER YACHT
Yves Salomon pink beaver coat, $7,273. Calvin Klein windowpane blouse, $70. Frame Le Skinny denim jeans, $200. Jimmy Choo Mimi pumps, $595. Meadowlark silver bands, $75 and $169
13 Find a specialist for cleaning: It’s more expensive, but regular dry cleaners aren’t equipped to handle fur
Beware of heavy petting by co-workers
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14 … On Second Thought, Go With Faux Fake fur is best for those with ethical concerns or tighter budgets: The real one costs 43(!) times more than this Zara knockoff. Zara faux fur coat, $169
Etc.
Fall Fashion
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Superior Overcoats
Those gigantic Canadian puffers are ugly, and black’s too depressing. Invest in a wool topper that’s cut longer, with an interesting collar or lapels that help dress up clothes underneath. It’s the one thing you’ll wear almost every day this winter, so don’t feel bad about spending a bit more than you might like—though affordable options, such as the Cos one below, do exist.
Colorful Knee-High Boots Rounded toes, chunky heels, and jewel-toned leather make these standouts. Have a third-party cobbler (not the store) waterproof them to protect from damaging snow.
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Slightly long with a minimalist cut looks fresh
The quilted nylon lining keeps you warm and dry
Break the rules: Springlike pastels add a stylish twist
Burgundy: Gianvito Rossi Mattie leather boots, $1,785. Olive: Bally knee-high boots, $1,795. Tan: Pedro García Beryl suede boots, $775
16 Brand to Know
The End of Crazy Socks Bright pairs emerged over the past decade as a sign that men care about style. That’s now well established, so go back to basics: Socks should be just lighter or darker than your pants, preferably plain, and hopefully inconspicuous.
J.Hilburn Year established: 2007 Known for: Custom suits, shirts, and other preppy guy essentials, tailored in person and sold online Buy: Classic made-to-fit blazers like this unlined navy staple ($600)
For shorter guys, this three-quarter length is sharp
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Green: Cos oversize coat, $290. Bottega Veneta technical crepe dress, $4,100. Gianvito Rossi suede pumps, $250. Gray: Brioni single-breasted overcoat, $8,250. Hardy Amies gray plaid suit, $1,595. Emporio Armani wool tie, $145. Tod’s derbys, $645. Navy: Michael Kors Melton officer’s coat, $695. Rag & Bone Trevor crew, $350. DKNY white cotton button-down, $65. A.P.C. petit standard jeans, $185. H.E. by Mango bluchers, $129.99. Aqua: Apiece Apart Esta coat, $595. Jenni Kayne overlap top, $325. Zero + Maria Cornejo Madi skirt, $695. Manolo Blahnik Marcafac, $695. Eddie Borgo bell drop earrings, $100
15: PHOTOGRAPH BY JODY ROGAC FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: ELIZABETH OSBORN. 16, 17, 23: PHOTOGRAPHS BY EVA O’LEARY FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: JOHN OLSEN. 18, 20, 21, 22: PHOTOGRAPHS BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 25: PHOTOGRAPH BY GEORDIE WOOD FOR BLOOMBERG BUSINESSWEEK. OPPOSITE PAGE: ILLUSTRATION BY CARI VANDER YACHT
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Geometric patterns are more figurefriendly than curves or squiggles
Etc. New Hair!
A Bob With Bounce
Unconventional fabric works best with a demure shape
Avoid tightness with a flared A-line skirt
Get your hair cut above the shoulders, and “wrap 2-inch sections around a medium curling iron,” says hairstylist Kyle Malone. Run fingers through, then set with Oribe’s Après Beach Wave and Shine Spray ($21.50). If you have longer hair, tuck it behind your collar to fake the length.
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Almost Invisible Nail Polish
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A Small Swoop Let your hair grow out an inch or two, then push it slightly forward and to the opposite side of your part. Next, apply a dimesize amount of Baxter of California clay pomade ($20) for what Malone calls “a rugged-yet-polished effect.”
After seasons of neon and nail art, nude varnish looks elegant. Find one that’s a shade lighter or darker than your skin tone. It shouldn’t match exactly.
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Caudalie Beauty Elixir, $18
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“Try a face mist. It tightens features and makes you look more awake.” 24 Katia Beauchamp Co-founder, Birchbox
Allover Patterned Dresses Different from other printed frocks, these have a single motif spanning the entire garment rather than a small, repeating design. Wear one to exude confidence during a big presentation, or pair it with a cardigan to brighten up your Monday morning.
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erson First-P ion sh Fa Experiment
A Long Blazer Oversize blazers, done right, look impossibly chic. And impossible to pull off yourself. Can someone who’s not 5 foot 10 wear one without resembling a kid in Mom’s clothes? I paired mine, an AllSaints Calia blazer ($415), which hits at the lower hip, with a cream and black polka dot miniskirt from J.Crew and a long-sleeve gray T-shirt from Cos. Even though I’m short, the blazer looked great—sophisticated and not too slouchy. The trick is to get one that’s fitted in the shoulders and wear it with a sleeker silhouette underneath. If you roll up the sleeves—or buy them prerolled, like this one—the jacket’s also less likely to overwhelm your frame. —Emma Rosenblum
WITH LONG BLAZER: THEORY BLOUSE, $235; ROW SKIRT, $1,050; WANDERLUST BRACELET, $60. WITH NEW HAIR: EQUIPMENT HOUNDSTOOTH REESE BLOUSE, $268; MARC JACOBS JACQUARD SHIRT, $560
Left: Joseph dash trousers, $374. Hardy Amies gray peacoat, $1,295. Hugo Boss grid shirt, $155. Giorgio Armani belt, $375. Christian Louboutin brogues, $1,275. Right: Hardy Amies grid trousers, $1,595 (entire suit). Joseph chunky stitch polo, $540. Burberry polished brogues, $695. Uniform Wares watch, $375. Brooks Brothers ribbed crew socks, $19.50
Not Jeans. Not Chinos. Trousers.
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Up your game with well-cut dress pants. A glen plaid or subtle check looks great with a plain shirt or polo. Finish it all with heavy-soled brogues.
Fall Fashion
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The New Briefcase: 16 Structured Satchels for Men and Women 15
This season’s best bags are big enough to hold more than “just the essentials.” They’ll withstand any commute’s abuse, thanks to thick leather, locking metal clasps, and reinforced top handles that lend some retro charm. * for men
1. Lotuff zip-top briefcase, $680. 2. Sophie Hulme tote bag, $975. 3. Filson leather brief, $785. 4. Marni metal and calf-leather bag, $2,140. 5. Ralph Lauren Cooper black briefcase, $2,500. 6. Billykirk schoolboy satchel, $365. 7. Prada leather bag, $2,600. 8. Mulberry Somerton briefcase, $2,500. 9. Zara tricolor bowling bag, $99.90. 10. Claire Vivier suede Sandrine bag, $483. 11. Proenza Schouler Elliot shoulder bag, $6,975. 12. Bally corner MD handbag, $1,695. 13. Ann Taylor mini satchel, $158. 14. Valextra portfolio briefcase, $2,230. 15. Paul Smith leather shoulder bag, $1,230. 16. Time’s Arrow Helene bag, $795
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… And Very Little Ladies’ Gloves
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A style that hits below the wrist, as in this pair from Carolina Amato ($45), is easy to take off when texting your colleagues. They look pretty with bangles, too.
Etc.
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Monochrome for Men
Wearing one neutral from head to toe is a surprisingly versatile strategy, especially if you’ve got a complicated schedule. Stick to navy, charcoal, or black, then mix up the textures to keep from looking like a human paint swatch. Wake up, choose your color, and go.
Experiment
A Hefty Turtleneck
A classic light blue oxford keeps it from being too out there
Too lightweight, and you look like a mime. Too heavy, and you’re auditioning for the L.L. Bean catalog. Still, there’s something classy and European about a turtleneck, and this Bally one ($850) is great. The cashmere feels like a soft animal hugging your neck. The lines at the shoulder provide a flattering fit. Despite that, it isn’t something I can recommend for any but the most self-assured of gentlemen. Yes, I was teased. And the bigger problem is that nothing looks good over the sweater or, of course, under it. It’s just you. And your precious turtleneck. —K.S.
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Brand to Know
A checked blazer adds dimension and creates a focal point
Rather than dark jeans, choose distressed ones with varied tones
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A cotton shirt looks too flat; go for a cable-knit sweater instead
Byredo Year established: 2006 Known for: Slightly off-kilter fragrances for men and women that won’t offend co-workers but will improve your day Buy: Musky, floral Mojave Ghost ($145) 12
30 Mandatory: black shoes, black belt … lint brush
Simpler Sneakers 16
New Balance has become status quo among tech dudes, so put yours on ice. Instead, go for a luxe riff on Adidas’s classic Stan Smith. This one, the Royale in stark white ($159), is from Greats, an Internet startup that makes its pliable leather kicks in Italy.
Slim pants will make you seem taller
Navy: Ovadia & Sons houndstooth flannel jacket, $1,495. Club Monaco classic fit shirt, $59. Nudie Alf straight-leg jeans, $199. Florsheim oxford shoes, $175. Black: Marni overcoat, $1,810. Todd Snyder cable crew sweater, $395. Salvatore Ferragamo wool trousers, $900. Robert Clergerie oxford shoes, $595
26, 27: PHOTOGRAPHS BY GEORDIE WOOD FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: ELIZABETH OSBORN. 28, 30, 31: PHOTOGRAPHS BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 29: PHOTOGRAPH BY EVA O’LEARY FOR BLOOMBERG BUSINESSWEEK
Etc.
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Try a bright sweater below Tod’s suede jacket ($3,795)
Fall Fashion Autumnal Colors
Foliage-inspired clothing always looks good when the leaves are falling. This season in particular, designers and fast-fashion labels have churned out a range of saffrons, burnt oranges, burgundies, and muddy greens. Mix and match with neutrals to create a wardrobe that fights the gray, dreary weather.
Club Monaco’s plum skirt ($169.50) is light enough for Indian summer
Pair Derek Lam’s jacket (price upon request) with highwaisted pants
Brand to Know
Simon Miller
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Save Officine Generale’s plaid shirt ($280) for Friday
This Cos turtleneck ($175) is cashmere for a cut-rate price
Year established: 2009 Known for: High-quality Japanese denim, made in L.A. Buy: The men’s M002 in selvedge ($245); you have to break them in yourself
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Solid
Pinstripe
Bouclé
Add a colorful belt if black feels too bland
Play up the menswear influence with a collared shirt
Heavy Knits Ditch that sad sweater hanging off your desk chair and buy a cozier version, such as Karen Walker’s blue-and-cream turtleneck ($290). Choose a subtle texture, and go a size up if you plan to wear it with skinny jeans, pencil skirts, or other fitted garments.
This fabric and the feminine cut feel especially ladylike
Power Dressing (Without the Shoulder Pads) Skirt suits are back, but updated versions of the Melanie Griffith classic forgo the boxy cut, cheap polyester, and flimsy buttons that defined their Eighties forebears. Look for ones in traditional tailoring fabrics, as shown above, so the figure-flattering separates also work well on their own.
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Solid: Elizabeth and James Madison jacket, $465, and Salem skirt, $295. Ports 1961 metal-sculpted heels, $750. Bouclé: Ann Taylor bouclé jacket, $169, and skirt, $98. Tsovet watch, $200. Jimmy Choo Mimi pumps, $595. Wolford opaque tights, $55. Pinstripe: Bally wool pinstripe blazer, $1,995, and skirt, $650. Frame Le Classic blouse, $188. Manolo Blahnik Durut in navy suede, $825
32, 33, 38: PHOTOGRAPHS BY EVA O’LEARY FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: JOHN OLSEN. 34, 35: PHOTOGRAPHS BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 36: PHOTOGRAPH BY JODY ROGAC FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. OPPOSITE PAGE: ILLUSTRATION BY CARI VANDER YACHT
Dangly, Delicate Necklaces
Mod Shifts Sixties-inspired short dresses are everywhere this fall. The flower-child style can be professional so long as the fabric is in a darker shade and has a nonpsychedelic print.
Orla Kiely snowdrop tunic dress, $448. Loeffler Randall Remy pump, $325. Daniel Wellington Sheffield watch, $199
Drape them over dress shirts and knits to add polish to basic work clothes. Come holiday party time, loop the pearls or precious metals twice around your neck for an elegant look.
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Gillian Steinhardt hand-andpearl opera necklace, $525. Jennifer Fisher 18k-gold longlink chain, $4,600
A tunic with sleeves is the most flattering way to wear the trend
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“Play with proportion this fall. Pair big oversize knits with wide-leg pants or long skirts.” Roopal Patel Fashion consultant
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Peak lapels balance the jacket’s shape
Go solid, wool, and fully “canvassed” (lined) so it better molds to your frame
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Sturdy block heels make the outfit look more mature
37 Textured Tights Falke’s merino wool stockings ($74) bring the dress into the modern era. Plus, they’re super warm.
Keep closed at all times; only fasten the middle row of buttons
The hem should hit around the pants’ pockets
Double-Breasted Blazers They’re in style again, but they’re still tough to wear. To ease your way in, try one in place of your standard navy blazer, rather than as part of a suit, and pair it with your regular pants, shirts, and ties.
Etc. Hued Suits
If you’re timid, dark green is the most wearable of this bunch
All your suits are boring and gray. The solution: Invest in one that’s colorful—red, purple, blue, green, whatever—but barely. Opt for a classic cut in a fabric with texture and depth, so it doesn’t look like it came from a costume shop.
Red: Brioni cherry-brandy silkand-wool suit, $5,600. Gitman Bros. point collar shirt (throughout), $145. Bally Rendy oxfords (throughout), $1,025. Purple: Todd Snyder plum glen plaid suit, price upon request. Blue: Canali bird’s-eye wool two-button suit, $1,610. Green: Ralph Lauren Purple Label olive houndstooth suit, $4,995
The rich burgundy and double-breasted cut are good for fancy work events
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Sweater Dresses This season’s comfortable crew neck dresses are the easiest way to get out the door in a hurry. Add dark tights and ankle boots, and for once be on time.
Full sleeves and the vertical cable-knit make you look taller
ed trat Illus e Guid
Avoid pockets on the sweater if you don’t want to accentuate your slight paunch
No bright colors—this isn’t boarding school
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No zippers! For a better fit, leave the bottom button undone
A placket and cuffs that are “tipped” (i.e., in a different shade) add structure and keep the knit from looking schlubby
Men’s Cardigans
Zara ecru sweater dress, $79.90. Hue tights, $13.50. Donna Karan leather crocodile-printed satchel, $1,695
Part sweater, part blazer, part jacket, a cardigan is the one garment in a guy’s wardrobe that can look casual and dressy. Avoid the Mr. Rogers look by choosing one that’s lightweight (say, a fine-gauge merino wool) and not too tight. Otherwise, it will inevitably gape at the buttons and pull at the shoulders. Pair with a sharp oxford button-down and a tie, then rise above the grandpa jokes.
Brand to Know
Military Details
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Army green, shoulder epaulets, cargo pockets on a slim pair of men’s khakis, the belt on this Salvatore Ferragamo coat ($4,230)—nods to officers’ uniforms are all over fashion this fall.
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Trademark Year established: 2013 Known for: Colorful takes on vintagey sportswear for men and women, designed by Chris Burch’s daughters, Pookie and Louisa Buy: Simpler work basics like this pleated wool skirt ($398)
“This fall, I’m into buttoning up and dressing up more. It’s time to outdress your boss.”
Etc.
Fall Fashion
Real-Person Problem
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“I need executive attire for my tech startup.”
“I usually wear a belt and don’t tuck in my shirt, but here the beltless tuck-in made sense.”
“The sport coat is a huge deal for me. It’s nice to be more buttoned-up but not corporate.”
Alexander Olch Menswear designer
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“They’re nearly jeans. Not denim, but with that silhouette. And very lightweight.”
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Clasp this Marni beauty ($300)— or one of the more affordable options in stores—around your waist to give new life to a work dress you’ve been wearing forever.
Fashion Exper
iment
Oversize Culottes I bought a pair of G.V.G.V. culottes for $270 from the New York store Opening Ceremony. Culottes, for those who didn’t live through the Eighties, are hybrid shorts-skirts wide enough that they sometimes look like cutoff M.C. Hammer pants. These don’t—they’re navy, well made, and have an awesome fit: loose but not baggy, offering mobility and femininity. I wore them to a meeting at a new client’s office and was complimented almost immediately. Several strangers stopped me during my subway commute home. One woman said I looked “amazing,” while another called me “so chic.” Near the end of the trip, a third lady simply pointed at my shortspants. “Those are so great,” she enthused. Get a pair and wear them with heels and a fitted top. I swear, they’re not too weird. Really. —Shibon Kennedy
Statement Belts
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Mark Cooper, 45 Co-founder and vice president for customer success, Offerpop “Our office is laid-back, but I need a wardrobe that works at other companies, since I never know what environment I’m walking into. I spend my time in customer meetings and hiring interviews. This look has a conservative silhouette, but it’s riskier with colors and patterns.” Ted Baker blue-check blazer, $525. Ralph Lauren Black Label Sloan shirt, $325. Theory Haydin five-pocket pants, $195. Shoes, Cooper’s own
Contributors: Shibon Kennedy (styling), Julie Simon (styling assistant), Alis Atwell, Arianne Cohen, Jaci Kessler, Emma Rosenblum, Peter Samuels, Kurt Soller
The Way We Shop Next
Retail companies are obsessed with getting mobile commerce right. No one’s nailed it. Spring, an app released in August, may get closer to persuading customers to buy designer items on their phones. Its clean, easy-to-navigate interface resembles Instagram, and any fashion brand can sign up for an account. Goods are displayed one by one in pictures that are more aspirationally pretty than those on traditional e-commerce sites. Shoppers can follow their favorite labels— Michael Kors, Derek Lam, and almost 500 others have joined up—and, when they see something they like, snag it with the swipe of a finger. (Goodbye, digital shopping cart.) The app takes a cut, but it’s a smaller percentage for companies that offer free shipping and easy returns. Suddenly, spending real money feels like a game. Download at your own risk—it’s really fun.
41, 46, 47: PHOTOGRAPHS BY B. BLANCHET FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 42: PHOTOGRAPH BY GEORDIE WOOD FOR BLOOMBERG BUSINESSWEEK; HAIR AND MAKEUP: KYLE MALONE/EXCLUSIVE ARTISTS. 44, 49: PHOTOGRAPHS BY EVA O’LEARY FOR BLOOMBERG BUSINESSWEEK; SOFT-GOODS STYLIST: JOHN OLSEN. 50: PHOTOGRAPH BY JODY ROGAC FOR BLOOMBERG BUSINESSWEEK. ILLUSTRATIONS BY CARI VANDER YACHT. WITH CULOTTES: TIBI BEE MULES, $262. WITH MILITARY JACKET: J.CREW PLAID SWEATER, $128; CLUB MONACO CLASSIC SHIRT, $59
44
Mindy Grossman
M in Ti dy’s ps
Chief executive officer, HSNi
“My father was in the produce business, so my first job was as a grocery checkout clerk. I can still pack the best grocery bag.”
Education
n tia in ri s ut t Ch ubo oo b Lo ate 95) C $1, 3 (
“Never leave home without a great black boot and a fitted leather jacket—they can take you anywhere.” 76
Valley Stream South High School, Valley Stream, N.Y., class of 1974 George Washington University, Washington, D.C., class of 1977
Work Experience
1977-78
“I got engaged at 19. In my last semester, I had an epiphany that I didn’t want to get married and go to law school. I moved to New York instead.”
Assistant, Manhattan International
1978-80
Account executive, Jeff Banks menswear
“People were asking if I was going to make it in a boys’ club. I was the most senior ranking woman in the company.”
1980-81
Account executive, Ron Chereskin menswear
“At the time, it was a small company, and sales were meteoric. They went from around $38 million to $350 million. When I had my daughter, I went from the office to the hospital and back.”
1981-85
National sales manager, Oxford Industries
1985-88
Vice president for menswear, WilliWear
1988-91
Vice president for sales, Tommy Hilfiger
Welcome message from Nasdaq
1991-94
“We went public in July 2008, right as the markets were imploding. It was tenuous, but we believed in our strategy.”
“Forget superheavy coats. Layer. And for women, use a wrap—especially if you travel.”
President, Chaps Ralph Lauren
With her family in 1990
“Willi [Smith] was one of the first wellknown African American designers. Unfortunately, he was also one of the first designers to pass away from AIDS.”
1995-2000
President and CEO, Polo Jeans Ralph Lauren
2000-06
Vice president for global apparel, Nike
2006-08
CEO, IAC Retailing
2008PRESENT CEO, HSNi
Life Lessons
“Animal prints are a neutral. Wear one every day.” “Tommy was the hottest in the business, and people thought I was crazy to leave, but I felt that there would be very few opportunities for a woman to be president of a menswear company.”
we 1. “Have passion, purpose, and impact.” 2. “Don’t be afraid of risk—and there’s a difference between risk and suicide.” 3. “If you can do well in fashion, you can do
Courtesy subject (3). Alamy (4). Getty Images (1)
In 1962
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