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December 21 â&#x20AC;&#x201D; December 27, 2015 | bloomberg.com

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OF COURSE THERE WILL BE SKEPTICISM. THIS IS PART OF A GREAT

ADVENTURE.

PHOTOGRAPH BY PETER BOHLER FOR BLOOMBERG BUSINESSWEEK

ALL I CAN SAY IS, ‘WATCH’ ” p52

“What he’s saying is what everybody’s thinking. Too many people are getting free stuff. We should send the illegals out of the country. I want them off welfare and food stamps”

“I haven’t shopped this much in years. It’s so cheap you can almost buy it by the pound”

“They’re wondering, How can we export American culture to the world? How do we pull off another basketball?”

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Cover Trail

December 21 — December 27, 2015 How the cover gets made

Opening Remarks An economy this shaky breeds mistrust. And that breeds Trump Bloomberg View A vital step on global warming • In praise of plain-vanilla cigarette packs

8 10

Global Economics

① “Cover story is about Mattel losing the Disney Princess business. Hasbro will start to produce them.”

So the Fed’s hiking rates—now what?

Blistering growth in Tibet doesn’t beneﬁt Tibetans

France’s National Front loses the elections, but not its clout

“When we publish stories equally relevant to business leaders and 4-year-old girls, America wins. We should shoot the new Princess dolls mingling with Hasbro toys. What is Hasbro known for making?”

For Saudi Aramco, Asia is the Next Big Thing

“Transformers and Avengers.”

In Japan, strong earnings, healthy bottom lines, and tightﬁsted employers

Companies/Industries Nike grabs the NFL jersey franchise and goes long

“Now I’m interested. There’s really something for everyone here, and I’ve never said that before.”

At Walmart, ’tis the season for guns and ammo

Just how much is the new Star Wars going to make?

Boards dish out the gravy to CEOs—and themselves

The Russian cartoon bear pulling in billions of rubles

Briefs: Damage control at Chipotle; threadbare at Prada

Politics/Policy To be 65, broke, and forced to pay off student loans for the rest of your life

Pennsylvania’s attorney general goes from great Democratic hope to pariah

A Medicaid headache in Iowa

A Bill: Taking the gag off Yelpers

Technology For many startup workers, stock option dreams crash into IPO reality

How SeatGeek aims to steal thunder from StubHub

The last U.S. world’s fair was 1984. Isn’t it time, says Michael Weiss, for another?

Peru’s banks want to turn people’s phones into bank machines

Innovation: Testing for a whole lot of viruses all at once

COVER AND COVER TRAIL: PHOTOGRAPH BY SARAH ANNE WARD FOR BLOOMBERG BUSINESSWEEK

Markets/Finance Junk bonds start to smell up the place

Thanks to an accounting rule, billions of barrels of oil are about to disappear

Citic Securities was China’s ﬁnancial pioneer. But it may have gone too far

Japanese banks and their key clients prepare to loosen the ties that bind

Bid/Ask: Mahindra & Mahindra’s Italian accent; Andy Warhol’s Montauk digs

② “Princesses mingling with Hasbro toys.” “What is Mr. Potato Head doing to Ariel? And what is going on between Belle and Iron Man?!?” “They’re playing. This is how toys play. It’s totally innocent—best not to ask too many questions and let nature take its course.”

Features Runaway Princesses Elsa, Belle, and their Disney sisters ditch Mattel for Hasbro

Faster Fast Fashion Primark launches its supercheap model in the U.S.

Car and Hacker Can George Hotz drive circles around Google, Tesla, and GM hands-free?

Etc. It’s chic! It’s au courant! It’s … Dressbarn?

Design: Sure, your phone has a calendar, but these desktop datebooks are so much prettier

The Critic: Serial’s second season takes its cues from binge-watching

Fashion: Winter boots you won’t want to take off

Merriment: MatzoBall is the season’s hottest not-Christmas party

What I Wear to Work: Raphael Chejade-Bloom goes in for New York monochrome

How Did I Get Here? Ingredion’s Ilene Gordon turns ex-employees into customers

③

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Index People/Companies F

Abe, Shinzo 38 Abercrombie & Fitch (ANF) 48 Accel Partners 29, 30 Adidas (ADS:GR) 18 Albert Fried & Co 30 Alibaba (BABA) 32 AllianceBernstein (AB) 48 Alphabet (GOOG) 21 AMC (AMCX) 63 American Apparel 48 Angeles Investment Advisors 35 Animaccord 22 Apex Marketing Group 18 Apple (AAPL) 54 Arab Petroleum Investment 16 Ascena Retail Group (ASNA) 60 Associated British Foods (ABF:LN) 48 AstraZeneca (AZN) 39 Autodesk (ADSK) 22

Facebook (FB) 21, 54, 66 Fanatics.com 18 Fender Musical Instruments 42 Ferrero 22 Ford Motor (F) 54 Franks, Peter 48 Fraport 39 Frascotti, John 42 Freedonia Group 33 FX (FOX) 63

Backus & Johnston 32 Bartiromo, Maria 68 BB&T Capital Markets 19 Bergdahl, Bowe 63 Berkshire Hathaway (BRK/A) 21 Bertrand, Xavier 15 Berwyn Income Fund (BERIX) 35 Bill Barrett (BBG) 36 Bluestein, Bram 68 Blumberg, Alex 63 BMW (BMW:GR) 54 BNP Paribas (BNP:FP) 17, 35 Boal, Mark 63 Boston Consulting Group 68 Bower, Jeffery 32 Box (BOX) 29 Branstad, Terry 26 BrightRoll (YHOO) 29 Brin, Sergey 21 Brown, Sherrod 24 Burger King (QSR) 22

CDE Cabela’s (CAB) 19 Cambadélis, JeanChristophe 15 Camel (RAI) 10 Canyon Capital Advisors 32 Charles River Ventures 29 Chejade-Bloom, Raphael 67 Chesapeake Energy (CHK) 36 Chevron (CVX) 31 China National Gold 13 Chipotle Mexican Grill (CMG) 23 Cision 39 Citic Group 37 Citic Securities (6030:HK) 37 Clinton, Bill 25 Comcast (CMCSA) 21 Copelouzos 39 Corbett, Tom 25 Credit Suisse Group (CS) 37 Daiwa Securities Group (8601:JP) 37 Danone (BN:FP) 22 Demarchelier, Patrick 60 Dick’s Sporting Goods (DKS) 19 Discovery (DISCA) 42 DoubleLine Capital 35 DreamWorks Animation (DWA) 22 Dressbarn 60 D’Souza, Russ 30 Edelman, Julian 66 Ellison, Larry 63 Ellison, Megan 63 Ells, Steve 23 Endo International (ENDP) 21 Endo, Toshihide 38 ExxonMobil (XOM) 21

GHI Gale International Gap (GPS) Gavekal Dragonomics GE Capital (GE) General Motors (GM) Gerstel, Jeff Gimlet Media Glass, Ira Glassdoor Glidden (PPG) Goldman Sachs (GS) Goldner, Brian Google (GOOG) GoPro (GPRO) Gordon, Ilene Groetzinger, Jack Gronkowski, Rob Gross, Bill Guest Minded Gundlach, Jeffrey H&M (HM:SW) Hasbro (HAS) Hatzius, Jan Haynes, Lawrie HBO (TWX) Hillhouse Resources Hollande, François Hotz, George HSBC (HSBC) Hsieh, Tony IBM (IBM) Ikyu (2450:JP) Ingredion (INGR) Instacart Instagram (FB) Issa, Darrell

31 60 37 39 54 60 63 63 27 42 12, 38 42 54 23 68 30 66 35 67 35 48, 60 42 12 23 63 36 15 54 17 31 29 39 68 29 48 27

Liebmann, Wendy LinkedIn (LNKD) Lipkin, W. Ian Live Nation Entertainment (LYV) Locke, John Loveyko, Dmitry LPL Financial (LPLA) Lucidus Capital Partners Lyft

48 66 33

Macron, Emmanuel 15 Macy’s (M) 48 Mahindra & Mahindra (MM:IN) 39 Marchant, Paul 48 Marlboro (MO) 10 Mattel (MAT) 42 MatzoBall 66 McClendon, Aubrey 36 Mitsubishi UFJ Financial Group (MTU) 38 Mitsubishi UFJ Research 17 Mizuho Financial Group (MFG) 38 Mobileye (MBLY) 54 Moody’s Investors Service (MCO) 17 Mooney, Andy 42 Moran, Jerry 27 Morningstar (MORN) 18 Motiva Enterprises 16 Murphy, Robert 24 Musk, Elon 54

N Nakanishi, Katsunori 38 Nasser, Amin 16 Needham 42 Netﬂix (NFLX) 22, 42, 63 New Balance 23 Newell Rubbermaid (NWL) 39 NFL Players Inc. 18 Nickelodeon (VIA) 22 Nike (NKE) 18 Nomura Holdings (NMR) 38 Northcoast Research 30 NPD Group 42

J.C. Penney (JCP) 48, 60 Jaffe, Elliot 60 Jaffe, Roslyn 60 Janney Montgomery Scott 12 Jarden (JAH) 39 Jawbone 29 Juniper Research 30 Kane, Kathleen 25 Kayak (PCLN) 30 Keefe, Bruyette & Woods 35 Kentucky Fried Chicken (YUM) 60 King Salman 16

O.F. Mossberg & Sons 19 Oasis Petroleum (OAS) 36 Obama, Barack 19, 25 Oculus Rift 54 O’Malley, Brian 29 Oppenheimer (OPY) 42 Orenstein, Peggy 42 Oubina, Jacob 12

KlearGear.com Koenig, Sarah Kohl’s (KSS) Kouzmin, Sergey Kuzovkov, Oleg

27 63 48, 60 22 22

L Le Pen, Marine LeBas, Guy

P Page 1 63 Page, Larry 21 Palmer, Jen 27 Paramount Pictures (VIAB) 42 Peru Digital Payments 32 PetroChina (PTR) 13 Pininfarina (PINF:IM) 39 Pixar Animation Studios (DIS) 22 PR Newswire (UBM:LN) 39 Prada (1913:HK) 23 Primark 48

RST

Kathleen Kane

15 12

Nike’s NFL redesign

30 30 22 35 35 23

Ramsey, James 31 RBC Capital Markets (RY:CN) 12 Regeneron Pharmaceuticals (REGN) 21 Remington Arms 19 Rendell, Ed 25 Revolution Ventures 29 Rhoda, Hilary 60 Roberts, Brian 21 Rolls-Royce Holdings (RR/:LN) 23 Rooney, T.J. 25

Ross, Wilbur 35 Rudnick, Andy 66 Ryan, Arthur 48 Ryanair (RYAAY) 48 Said, Sudirman 16 Sandusky, Jerry 25 Sarkozy, Nicolas 15 Sato, Yasuhiro 38 Saudi Arabian Oil 16 Schatz, Brian 27 Schriber, David 18 Sears (SHLD) 48 SeatGeek 30 Shizuoka Bank (8355:JP) 38 Showtime (CBS) 63 Sieber, Michael 22 Simba Dickie 22 Sinclair, Chris 42 Sinopec (SNP) 13 Sirius XM Holdings (SIRI) 23 SMBC Nikko Securities 38 Social Blade 22 SpaceX 54 SPDR Barclays High Yield Bond (JNK) 35 Spectra Ticketing & Fan Engagement 30 Square (SQ) 29 Stern, Howard 23 Stockton, Bryan 42 Stone Lion Capital Partners 35 Storm8 29 Stride Rite (WWW) 42 Stringer, Scott 21 Sturm Ruger 19 Sumitomo Mitsui Finance & Leasing (8592:JP) 39 Sumitomo Mitsui Financial Group (SMFG) 38 Sustainalytics 21 Sutton, Jeff 29 Suzukigumi 17 Swift Energy (SFY) 35 Takeda Pharmaceutical (4502:JP) 39 Talbots 60 Target (TGT) 48, 60 Telecharge 30 Tenzin Gyatso 13 Tesla Motors (TSLA) 54 Third Avenue Management 35

Thompson, Ojetta Rogeriee Thune, John Toomey, Pat Topshop Toys “R” Us Trivelli, Carolina Tubeﬁlter Twinings Tyson, Neil deGrasse

24 27 25 60 40 32 22 48 31

UVW Uber 23, 54 USA Network (CMCSA) 63 Vagelos, Roy 21 Valls, Manuel 15 Valvo, Carmen Marc 60 Van Horne, Todd 18 Vernon, Lillian 23 Vertex Pharmaceuticals (VRTX) 21 Vicarious 54 Wagner, Lori 60 Walmart (WMT) 19, 48 Walt Disney (DIS) 20, 22, 42

Wang Dongming Weisel, Heidi Weiss, Michael Weston, Galen Weston, George Whitman, Martin Whole Foods Market (WFM) Wolf, Tom Wood, Tony Wozniak, Steve WSL Strategic Retail Wyden, Ron

37 60 31 48 48 35 60 25 23 54 48 24

XYZ Xi Jingping 13 Yahoo! (YHOO) 29, 32, 39 Yellen, Janet 12 Yelp (YELP) 27 YouTube (GOOG) 22, 42 Zara (ITX:SM) 60 Zingales, Luigi 8 Zoeller, Greg 24 Zuckerberg, Mark 21 Zynga (ZNGA) 29

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FOOTBALL MANNEQUINS: PHOTOGRAPH BY ROBBIE MCCLARAN FOR BLOOMBERG BUSINESSWEEK; KANE: MATT ROURKE/AP PHOTO

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Opening Remarks

Jingo Bells By Peter Coy

ILLUSTRATION BY BRAULIO AMADO

A well-functioning economy requires trust. But this election season is all about dread

Diane Farmer, 54, is a lifelong Democrat from the New York City area now living in Palm Beach County, Fla. She attended Catholic schools and later belonged to unions while working for a phone company and then in a court clerk’s office. She voted for Barack Obama in 2008 and 2012. But Farmer says she’s never been more excited about a candidate than she is this time. Her choice? Donald Trump. The convert to Trumpism shared her enthusiasm while stopping by glitzy Trump Tower on New York’s Fifth Avenue to pick up her fifth “Make America Great Again” cap (free with every $30 campaign contribution). “What he’s saying is what everybody’s thinking,” she said. “Too many people are getting free stuff. We should send the illegals out of the country. I want them off welfare and food stamps. Go home, and come back again when you’re ready to work.” As for the Middle East: “We should have dropped the bomb and ended the issue. We need to annihilate that, uh ...,” she said, trailing off. This holiday season, Trump’s glowing fireplace of fury is firing up people like Farmer who used to look to the left— as well as a surprisingly wide swath of the Republican Party—for answers. He’s scoring his highest numbers ever among Republican primary voters—35 percent, according to the latest New York Times/ CBS News poll. Enthusiasm for him only grew after he called for a ban on Muslims entering the country. To some, he seems divisive, but not to Farmer. “I thought Obama would be a unifier since he’s black and white and Muslim [sic]. But he’s an antagonizer,” she said. “We need to try something different. We can’t live like this.” Yup, it’s an angry Christmas, and it’s worth thinking about why. Something has changed to create such a shift in the public’s leanings, from taking a chance on Obama’s audacity of hope to delighting in Trump’s straight-up audacity. Fear of Islamic terrorism has something to do with it. Wars in Iraq and Afghanistan that achieved approximately nothing and the stunning rise of China as a rival power have also left many Americans feeling confused and vulnerable. But the most potent fuel for Trumpism is undoubtedly the sick economy. A long stretch of underperformance

has seeded mistrust in the American Dream among millions of would-be breadwinners, especially people without college educations. As everyone knows by now, a winner-take-all economy is producing big gains for a thin stratum at the top but little for anyone else. Bernie Sanders likes to point out that the top 10th of 1 percent of families control as much wealth as the bottom 90 percent. The inflation-adjusted income of the median American household is lower now than in 2000. On average, young men are earning less after inflation than their fathers did at the same age. More than a fifth of American children live below the poverty line, according to Census Bureau data. Even though the unemployment rate is down to 5 percent and the last

recession ended in 2009, 72 percent of Americans think the country is still in a recession, according to a Public Religion Research Institute survey released last month. This isnâ&#x20AC;&#x2122;t good for business, which is getting targeted for blame: Eightysix percent of respondents in the PRRI survey said corporate offshoring of jobs is somewhat or very responsible for Americaâ&#x20AC;&#x2122;s economic troubles, up from 74 percent in 2012. Two kinds of populists come to the fore when anger over inequality and perceived injustice runs high, says Luigi Zingales. An Italian-born economist at the Universit y of Chicago Booth School of Business and author of the 2012 book A Capitalism for the People, Zingales says Theodore Roosevelt represents the best kind of populist: someone who fought corruption and broke up monopolies to give ordinary people a chance. Trump, says Zingales, is more about affixing blame than creating opportunity. He likens him to Silvio Berlusconi, the freewheeling media magnate who was elected prime minister of Italy four times but was ultimately convicted of tax fraud. Trump and Berlusconi, Zingales adds, â&#x20AC;&#x153;are both very good at talking to the stomach of the people.â&#x20AC;? The erosion of trust thatâ&#x20AC;&#x2122;s both reflected in and accelerated by the Trump phenomenon has real economic consequences. Business is hard to conduct in societies with low levels of trust. The share of people who agree that â&#x20AC;&#x153;most people can be trustedâ&#x20AC;? varied from a high of 66 percent in the Netherlands to a low of 3 percent in Trinidad and Tobago in the World Values Survey, 2010-14. Government and commerce can grind to a halt when trust is absent. The U.S., with 35 percent saying most people can be trusted, is in the top third of countries for societal trust,

which helps explain why it is one of the worldâ&#x20AC;&#x2122;s richest nations. That endowment of stability doesnâ&#x20AC;&#x2122;t come with a lifetime guarantee, however, and U.S. politics has lately taken on a spiteful cast. â&#x20AC;&#x153;While Americans are inclined to â&#x20AC;&#x2DC;hedgeâ&#x20AC;&#x2122; expressions of overt animosity toward racial minorities, immigrants, gays, or other marginalized groups, they enthusiastically voice hostility for the opposing party and its supporters,â&#x20AC;? according to Fear and Loathing Across Party Lines: New Evidence on Group Polarization, a study by Stanford political scientist Shanto Iyengar and Princeton postdoctoral researcher Sean Westwood that was published this year in the American Journal of Political Science. In four experiments, the authors found that discrimination based on political affiliation â&#x20AC;&#x153;exceeds discrimination based on race.â&#x20AC;? Marriages across party lines are down to below 10 percent from more than 30 percent in the 1960s, Iyengar says, citing othersâ&#x20AC;&#x2122; research. The fabric of society is fraying. â&#x20AC;&#x153;I donâ&#x20AC;&#x2122;t want to sound like Iâ&#x20AC;&#x2122;m an alarmist, but I could see the possibility of violence, large-scale street movements which are politically motivated,â&#x20AC;? he says in an interview. Congress isnâ&#x20AC;&#x2122;t helping matters, because itâ&#x20AC;&#x2122;s even more polarized than the society itâ&#x20AC;&#x2122;s supposed to represent. The result is debt-ceiling brinkmanship and repeated stalemates over legislation. The Voting Rights Act of 1965 passed with the votes of 73 percent of Democrats in the Senate and 94 percent of Republicans, a fairly narrow partisan gap. In contrast, the Affordable Care Act of 2010 passed with the support of 100 percent of Senate Democrats and zero percent of Republicans, notes Michael Cembalest, chair of market and investment strategy at JPMorgan Chase. Trump complicates the polarization story because he draws support from some disaffected Democrats, like Farmer. But that might simply mean that the political parties themselves are realigning. The free-trade and open borders philosophy of pro-business Republicans is not, to say the least, on the rise. Absent another Teddy Roosevelt riding into town, thereâ&#x20AC;&#x2122;s no easy solution for what ails the country. The hard solution is to rebuild trust by fixing the economy so it works for everyone. But turning things around will require everyone working together. Which isnâ&#x20AC;&#x2122;t happening because, well, Americans no longer trust each other. Thereâ&#x20AC;&#x2122;s the dilemma in a nutshell. Happy New Year!

Bloomberg View

To read Mohamed El-Erian on turmoil in the high-yield market and Stephen Carter on Star Wars, go to Bloombergview.com

A Climate Deal Worth Celebrating A lot of work still has to be done, but almost the entire planet has agreed on a way forward

The biggest benefit of the Paris agreement may lie less in what governments themselves have promised to do, important as those promises are, than in the signal it sends to everybody else. More credibly than before, the world is organizing itself around a common commitment to curb the use of fossil fuels. That has implications for every decision-maker—consumers and investors alike, whether they’re buyers of power or sellers. Clean energy and more efficient use of energy now look even more attractive than before. A new energy future is finally coming into focus. By itself, the Paris agreement won’t solve the problem of climate change. It’s worth celebrating nonetheless. Perhaps for the first time, a solution seems within reach.

Erase the Glamour From Cigarette Packaging

Governments have taken a vital step in confronting global warming. Until now, there was no universal commitment to address the problem, no common target, and no system for measuring progress. The Paris climate talks have provided all three. That’s enough to justify the claim that the agreement reached on Dec. 12 marks a breakthrough. Yet, as governments acknowledge, the pact won’t succeed without further effort. Paris is a promising departure point. Getting to the right destination is another matter. For the first time, almost all the governments of the world— 195 countries, rich and poor, including all the big greenhouse gas emitters—have come together and recognized their obligation to act. They have adopted the goal of limiting the rise in global temperatures above preindustrial levels to 2 degrees Celsius and say they’ll strive to do better than that, holding the increase to 1.5C. And they agreed to devise a comprehensive and transparent system for measuring progress, with reviews every five years. Critics of the agreement say the national plans submitted so far aren’t bold enough to reach those goals. They’re right. But the good news is that governments aren’t pretending otherwise: They agree they’ll need to do more—and, in effect, have obliged one another to say how. Their commitment to periodic reviews will make a big difference by bringing public opinion to bear more forcefully. It will be easier to see how countries are doing. In addition to creating a global system of goals and plans, the agreement commits rich nations to be more generous in helping poor nations join in the effort. An earlier promise— $100 billion in assistance for cutting carbon emissions and adapting to climate change—will be scaled up. That’s fair: Climate change is being driven by the total stock of greenhouse gases in the atmosphere, not just by the flow of new emissions, and the rich countries of the world are mostly responsible for what’s already there.

Would people smoke less if cigarettes were sold in plain packages? Early evidence from Australia, which has required them for three years, suggests they might. The plain packs— which prohibit design features and logos such as Marlboro’s red-and-white angles or Camel’s dromedary, forbid pictures aside from health warnings, and require brand names to be in a uniform typeface—reduce the appeal of cigarettes, research indicates, and prompt people to think more about quitting. Further proof comes from tobacco companies, four of which are suing to block a rule that, starting in May, will require cigarettes in Britain to be sold in plain packs, too. Obviously, the companies appreciate the power of logos, colors, and other flourishes to give smoking a glamorous appeal. British courts should reject Big Tobacco’s suit. Progress in the battle against smoking addiction is difficult to come by— though governments are using the best strategies available, including higher taxes, age limits, advertising restrictions, and graphic health warnings. Plain packs seem to be another useful weapon. The U.K. can join Australia in leading the way. The companies taking Britain to court argue that the new rule infringes on their intellectual-property rights. Normally, companies should be free to advertise their wares. But cigarettes are deadly, and in this case the court needs to weigh intellectual-property concerns against a threat to human health. Smoking has declined worldwide in recent decades (with the exception of China). But tobacco use still kills almost 6 million people a year—100,000 annually in the U.K. alone— and accounts for 1 in 10 adult deaths. As many as half of all smokers can expect to die of tobacco-related diseases. Plain packaging won’t undo all the harm smoking causes. But allied with other deterrents, including bigger and better health warnings, it can at least undermine cigarettes’ appeal.

ILLUSTRATION BY MARK PERNICE

British courts should reject a challenge to the U.K.’s plan to require plain packs

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December 21 — December 27, 2

The Fed and Wall Street differ on how high rates will go

back the markets’ view on rates, “you have to be pretty bearish”

The Federal Reserve is indicating that it will raise interest rates four more times before the end of 2016, but traders in the financial markets don’t believe it. They’re expecting just two more hikes in the coming year. The Fed’s lack of believability on rates could complicate its job of steering the U.S. economy next year and beyond. The Fed damaged its credibility over the past half-decade by repeatedly stating that it expected to raise interest rates, only to back down when stronger growth failed to materialize. Traders made easy profits by betting against the central bank, defying an old maxim on Wall Street—“Don’t fight the Fed.” Now Fed Chair Janet Yellen and the rest of the monetary policymakers have to persuade the financial markets that this time, they really, really mean it. On Dec. 16 the rate-setting Federal Open Market Committee raised its target for the federal funds rate to a range of 0.25 percent to 0.5 percent

from a range that touched zero, where it had been since December 2008. The increase signals that Fed rate-setters feel that the U.S. recovery, which began in June 2009, is finally strong enough that they can begin taking it off monetary life support. “The underlying health of the U.S. economy seems to be quite sound,” Yellen said at a press conference. The Fed’s own expectations for rates are set out in the periodically released “dot plot.” Each dot in this chart represents a forecast for the fed funds rate by a member of the FOMC. The panel consists of the people on the Federal Reserve Board in Washington, currently five, and the presidents of the 12 regional Federal Reserve Banks. The committee members are asked to make forecasts for the end of each year. The identity of the person associated with each dot is not revealed. In the forecast that was released on Dec. 16, the median FOMC member—i.e., the one

whose dot was in the center of the cluster—predicted a federal funds rate of 1.25 percent to 1.5 percent at the end of 2016. That amounts to four hikes, assuming each is a quarter point. That range is significantly higher than what the market is expecting. The market is looking for the federal funds rate to be a little under 1 percent a year from now, says Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott. He bases his calculation on trading in the highly active eurodollar market, which traders use to bet on U.S. interest rates. (The federal funds rate is what big banks charge each other for overnight loans; pushing it higher affects a wide range of other rates.) One reason for the gap between the Fed and the markets is purely mechanical: The Fed voters were instructed to pick the single most likely level for the interest rate, whereas the financial markets take into account the entire range of possible outcomes, including

PHOTO ILLUSTRATION BY 731; PHOTOS: GETTY IMAGES (4); DATA: FEDERAL RESERVE, BLOOMBERG: EURODOLLAR CALCULATION BY GUY LEBAS, JANNEY MONTGOMERY SCOTT

Marine Le Pen’s outsize inﬂuence 15

How the Saudis are locking Asia into oil contracts 16 In Japan, Scrooges are everywhere 17

the chance of a recession in the coming year that would drag the rate down. Beyond that, the gap shows that participants in the financial markets, correctly or not, don’t believe that the Fed will raise rates as fast as it says. To justify higher rates, the Fed will need to see stronger economic growth and a rise in the inflation rate, which is below the Fed’s target of 2 percent. Jacob Oubina, senior U.S. economist at RBC Capital Markets, thinks the market may be underestimating the Fed. “To agree with where the market sees rates for next year, you have to be pretty bearish about the prospects for growth in 2016,” he says. It’s common for the market to underestimate the pace at which the Fed will change interest rates, Oubina says. “I think this time it’s even more pronounced because of the length of time we have been near zero.” Jan Hatzius, chief economist of Goldman Sachs, says the Fed’s forecast is probably better than the financial market’s. But he says the Fed rate-setters’ predictions may be a bit on the high side because they contain an element of wishful thinking. The

rate-setters, after all, aren’t just observers; they’re policy-shapers. Their forecasts for the funds rate after 2018 are clustered at 3.25 percent to 3.5 percent. The end-of-2016 dots are just a step along the way to that. “It’s not just a pure forecast,” says Hatzius. “It’s about guiding expectations.” It can be a real problem for the Fed when the market doesn’t believe it because, in monetary policy, expectations matter. Low interest rates in the market reflect low expectations for inflation and economic growth. Those expectations can be self-fulfilling—for example, businesses that don’t trust that growth is coming won’t hire and invest. In a Dec. 2 speech to the Economic Club of Washington, D.C., Yellen acknowledged that market measures of expected inflation had fallen to “historically low levels” this fall. She said that while she’s not greatly worried at the moment, “declines in consumer and business expectations about inflation could put downward pressure on actual inflation.” The danger of losing control of monetary policy is obvious in Europe. The European Central Bank wants the refinancing rate to be 0.05 percent, but it’s actually −0.24 percent. All that said, it looks as though the Fed does have the tools to get what it wants. The labor market has strengthened, and corporate balance sheets are stronger than they’ve been in decades. One Rate, Two Views Projected federal funds rate

1.25%-1.5%

Range for the benchmark rate at the end of 2016, forecast by the median FOMC participant

0.92%

The expected rate on Dec. 21, 2016, as implied by the eurodollar futures market on Dec. 16, 2015

Worries about an emerging-market meltdown have eased slightly as the People’s Bank of China pumps money into the Chinese economy. It may be time to dust off that old maxim: Don’t fight the Fed. —Matthew Philips and Peter Coy The bottom line The markets’ distrust of the Fed’s take on rates could complicate the central bank’s efforts to normalize monetary policy.

Minorities

Tibet’s Potemkin Economy Beijing subsidies have created an unhealthy dependency “The Chinese just come to Tibet to steal our business”

As China’s economy settles into slower growth, President Xi Jinping has been touting the benefits of what he calls the “new normal,” including a more equitable distribution of income and less pollution. But one region isn’t ready to give up on double-digit growth. “We must grow faster,” says Deng Xiaogang, executive vice chairman of the Tibet Autonomous Region, one of the poorest, least industrialized areas in the People’s Republic. “There is a gap between us and the rest of the country.” For the past two decades, Tibet’s economy has outperformed China as a whole. Its growth has averaged 12.4 percent annually over that period, compared with a national average of about 10 percent and Beijing’s 2015 target of 7 percent. But these statistics are misleading: The Tibetan miracle is the result of massive subsidies that have done little to foster productive enterprises in the territory of 3.15 million people. Since China annexed Tibet in 1951 and its religious and political leader, the Dalai Lama, fled into exile in India, the central government has sent more than 648 billion yuan ($100 billion) to the region. Beijing’s subsidies have funded massive transportation and

Oppressive Generosity Annual assistance from Beijing as a percentage of gross regional product

In 2013, Tibet had economic output totaling 81 billion yuan and a net government subsidy of 90 billion yuan

120%

Tibet Autonomous Region

60% Qinghai

Gansu

Guizhou 0

1990

Two of the poorest provinces in China

2013 DATA: ANDREW FISCHER

power projects, including a 156-milelong rail link from Tibet’s capital, Lhasa, to Shigatse, the region’s second-largest city, completed last year at a cost of 13.3 billion yuan. The 9.6 billionyuan Zangmu hydropower station, on the Yarlung Tsangpo River, became fully operational in October. Andrew Fischer, a professor at the International Institute of Social Studies in The Hague and an expert on Tibet, says subsidies from Beijing dwarf the local economy, amounting to about 112 percent of economic output, which was 80.8 billion yuan in 2013. Fischer says it’s “more than one would see in a highly aiddependent African country.” The region’s ethnic Tibetan residents often derive little direct benefit from the investments. Almost all the materials for the infrastructure projects are imported from the rest of the People’s Republic, often along with work crews. “A lot of the construction is not oriented towards building a productive, local economy,” says Fischer. Instead, Beijing’s aim is to tether Tibet tightly to the economies of China’s provinces. There has been a huge influx of Han—the majority ethnic group in China—into the region seeking to set up businesses. Beijing’s policymakers have paired 18 provinces and cities in China with counties and towns in Tibet. The Chinese counterparts have been ordered to build schools, set up businesses, and send officials to work in Tibet for stints of up to three years. China’s biggest state enterprises, including Sinopec, China National Gold Group, and PetroChina, have also been instructed to invest in Tibet. One side effect of Beijing’s subsidizeand-invest policy is that Tibet is afflicted by a version of the profligacy that helped lead to China’s own slowdown. The region is plagued by

inefficient a d money-losing stateowned enterprises. As of 2013, they accounted for about 22 percent of all companies in Tibet, compared with 2 percent in all of China, according to a recent research paper written by Jin Wei, an expert on China’s ethnic minority policy at the Central Party School in Beijing. The state-run companies in construction, mining, and the tourism industry also exacerbate ethnic tensions. They are not big employers of Tibetans, the majority of whom make their living as herders and farmers. Many Tibetans chafe under China’s heavy-handed rule, including a ban on open veneration of the Dalai Lama. Beijing knows that integrating the people of the region into the economy is crucial to controlling unrest. The central government’s “game all along has been to get a critical mass of

Tibetans that have a vested interest in the status quo, so they will be quiet,” says Robert Barnett, director of the Modern Tibetan Studies Program at Columbia University. To encourage small and midsize enterprises in industries such as tourism and traditional medicine, the government is offering tax exemptions, preferential interest rates, and access to public land and state contracts. “Lhasa’s development is not just for GDP. It’s to satisfy the people’s livelihood, employment, and income,” says Lhasa’s Communist Party Secretary Qi Zhala, an ethnic Tibetan. Lobsang, a 50-year-old herder who like many Tibetans goes by a single name, has profited from the policies. China’s foreign ministry arranged for a group of foreign reporters to meet him as part of a tightly monitored fourday excursion into Tibet, the only way media are allowed access. Lobsang still raises animals—30 yaks, 40 sheep, and a horse—but now makes far more money, 100,000 yuan a year, ferrying passengers in and out of the capital in his 14-seat minibus. He used to live in a mud hut without electricity or running water. Five years ago, he moved his family into a two-story stone house along the highway from Lhasa to Namtso Lake. A 90,000-yuan grant from Beijing covered about a

DAMIR SAGOLJ/REUTERS

Global Economics

Global Economics third of construction costs, paying for flourishes such as intricately painted window frames and ceiling beams. “I never imagined I could live so well as I do today. I must thank the government for all its help,” says Lobsang, who joined the Communist Party in 1988. The greater beneficiaries of China’s Tibet policy may be the Han migrants who, eager to make their fortunes, have come to the region. Officials stress that non-Tibetans make up just 8 percent of the permanent population, but independent groups says that it’s senseless not to count the large number of migrants who live and do business in Tibet, often for years at a time. One 30-year-old Han migrant, who hails from Shiyan, in Hubei province, came to Lhasa in June of this year. He declined to give his name because of the sensitivity of the ethnic situation. Now he runs a tourist shop selling Buddhist statuary and prayer beads in a market near the Jokhang, Tibet’s most sacred temple. He will stay for no longer than three years because the high altitude and temperature extremes are hard on a person’s health, he says, which is why he left his wife and 6-year-old son back home in Hubei. “The government gives huge subsidies to Tibet, because it doesn’t want the Tibetans to protest,” he says. “That drives the whole economy

Chinese subsidies covered a third of the cost of building Lobsang’s house

and helps our business, too.” A 27-year-old ethnic Tibetan who earns his living driving Buddhist pilgrims to the holy spots around Namtso Lake has no kind words for the new arrivals: “The Chinese just come to Tibet to steal our business.” Officials in Lhasa say incubating industries run by locals is a priority, as is lessening the region’s reliance on subsidies. “I don’t dare predict what day Tibet will be able to develop independently,” says Ma Jinglin, vice director of the Development and Reform Commission of Tibet, a government body. “It takes time to build industries that will create blood for ourselves, rather than getting a blood transfusion.” —Dexter Roberts The bottom line Still-poor Tibet’s GDP grows at double-digit rates, fueled largely by Chinese subsidies.

Elections

In Defeat, Le Pen May Upend French Reform The government may tack left as it sets its sights on the 2017 vote “The opposite of what’s needed to restart economic growth”

The National Front failed to gain control of any French region in elections on Dec. 13, yet even in defeat the anti-immigrant party could have an outsize influence over economic policy in the next few years. Stunned that the National Front got 6.8 million votes—exceeding its previous record of 6.4 million, set in 2012— mainstream parties are calling for urgent action to overcome the economic malaise that’s fueling public discontent. “There is no place for relief or triumphalism,” Socialist Prime Minister Manuel Valls said in a televised address on the evening of the vote. The government must “act more rapidly, to get more results,” he said. “This is our last chance,” said Xavier Bertrand, the center-right Republican who drew crossover Socialist support to defeat National Front leader Marine Le Pen in northern France. Market-friendly Socialists such

as Valls and Minister of Economy Emmanuel Macron have been in broad agreement with Republicans on key reforms to reduce France’s nearrecord 10.6 percent unemployment rate and boost growth and competitiveness. Their prescriptions include loosening labor rules to make it easier for employers to hire and “There is no place fire, and nudging the longfor relief or triumphalism.” term jobless off the dole —French Prime by trimming their beneMinister Manuel fits. President François Valls Hollande’s cabinet has been preparing for months to bring those and other measures to a parliamentary vote next year, a senior government official tells Bloomberg Businessweek. The National Front’s momentum could derail those plans. Presidential and parliamentary elections are set for mid-2017. All parties face off in a first round of voting, with the top two moving to a second round. It now appears that Le Pen and her Front are strong enough to advance to the runoff, says Bruno Cavalier, chief economist at Oddo Securities in Paris. That 15 means there’s room only for one other party: either Hollande’s Socialists or the Republicans led by former President Nicolas Sarkozy. To win a place in the runoff, the Socialists must “unify the left,” Cavalier says. Within hours of the polls closing, Socialist Party First Secretary JeanChristophe Cambadélis went on TV urging the party to “move toward the left.” That will require making common cause with hard-line leftists who have attempted to obstruct some of the more free-market elements of the government’s agenda. Last February, Hollande had to invoke special powers to quell a rebellion by leftist lawmakers, to pass legislation curbing severance pay for laid-off workers and letting more stores open on Sundays. The Republicans, while publicly endorsing reforms, have no incentive to help enact them quickly. If the economy remains stagnant, they can blame the Socialists during the 2017 campaign. And free-market promises would be unlikely to help Republicans lure far-right voters. The National Front’s economic platform contains anti-business provisions, including calls for protectionist trade measures, a big increase in the minimum wage,

and renationalization of some banks. “It’s exactly the opposite of what’s needed to restart economic growth,” Pierre Gattaz, head of the business lobby group Medef, told the newspaper Le Parisien before the elections. The economy is showing a few signs of life. The consensus among analysts surveyed by Bloomberg is that growth this year will reach 1.2 percent, the best since 2011, and could accelerate to 1.5 percent in 2016. But unemployment remains stubbornly high, and that clearly played a role in the National Front’s electoral showing. The party drew its strongest support in the northern Nord-Pas-de-Calais region, which has the country’s highest jobless rate, 12.8 percent, and in the southern Provence-Alpes-Côte d’Azur region, where the rate is 11.5 percent. Moreflexible labor rules could help create jobs, but those effects wouldn’t likely be felt before the 2017 elections—and in the meantime the National Front could attack the Socialists for weakening protections for workers. For now, the government is being circumspect about what reforms it will tackle next. Valls told France 2 television on Dec. 14 that the governA Louder Voice ment would unveil Share of the vote received by National “new measures,” Front candidates including a training initiative for the April 2012 unemployed. Presidential Burdensome work rules and overly generMay 2014 ous unemployEuropean Parliament ment benefits are only a few of the problems France March 2015 urgently needs to Departmental, ﬁrst round address to make its economy more competitive, says March 2015 Denis Payre, a softDepartmental, ware entrepreneur second round and co-founder of pro-business group Croissance December 2015 Plus. Public spendRegional, ﬁrst round ing swelled to 57.7 percent of gross domestic December 2015 product last year, Regional, second round higher than in any major developed country, while

17.9%

24.9%

25.2%

22.2% 27.7% 27.1%

businesses are suffocated by high taxes and regulation, he says. Payre frets that the mainstream parties, after withstanding the far-right onslaught in the regional elections, may “feel able to manage the risk of the National Front” and won’t press ahead with reforms. “I’m not very optimistic in the short term.” —Carol Matlack, with Mark Deen and Hélène Fouquet The bottom line The National Front’s record 6.8 million votes may dampen mainstream parties’ appetite for labor market reforms.

Oil

For Saudi Aramco, A Pivot to Asia Building reﬁneries there echoes its U.S. strategy from the 1980s “We’re optimistic that we will ... expand our cooperation”

At the heart of Korea’s Onsan refinery lies a street called A.I. Naimi Road, an homage to Saudi Arabia’s oil minister. State-owned Saudi Arabian Oil Co. holds a 65 percent stake in the complex. The investment in Korea’s third-largest refinery highlights the changes Onsan reﬁnery in the oil business as prices have plunged by more than half over the past two years. Saudi Arabia and other oil-rich countries are fighting to lock in customers for their crude, and Asia— which accounts for 70 percent of Saudi oil exports—is the primary battleground. For Saudi Aramco, as the company is widely known, that means purchasing stakes in refineries, with contracts that include clauses guaranteeing most of the oil the facilities process will come from the kingdom. Aramco has invested in three processing facilities in Asia and is on the cusp of a dramatic increase in its commitments to the region, in countries from Indonesia to Vietnam. Owning refineries “in Asia is part of a long-term strategy to consolidate” the Saudi market share in a key region, says Mustafa Ansari, an analyst at Arab Petroleum

Investments, a state-controlled development bank in Dammam, the city at the heart of Saudi oil country. The Saudis pursued a similar path in the U.S. three decades ago to ensure sales as crude prices tumbled, buying into three oil-processing plants in Texas and Louisiana. The strategy worked: Saudi Arabia is the primary source of crude for Motiva Enterprises, the U.S. refiner halfowned by Aramco. This year through August, Motiva imported 65 million barrels of Saudi oil. Selling more oil is critical to the fortunes of the kingdom. The crash in oil prices is forcing the Saudi government to cut its spending. The International Monetary Fund predicts a budget deficit exceeding 20 percent of the nation’s economy this year. Saudi Arabia’s new leader, King Salman, is at the same time pursuing a more aggressive foreign policy that includes major arms purchases and waging a costly war against Yemeni rebels. At Aramco, recently appointed Chief Executive Officer Amin Nasser is overseeing a plan to make the world’s biggest oil company a more integrated operation. Long focused on producing crude, Aramco plans to almost double its refining capacity by 2025, to 10 million barrels a day—equivalent to its current oil production and enough to put Aramco ahead of ExxonMobil as the world’s largest refiner. The Saudis aren’t alone in seeking new customers in Asia. Kuwait is scheduled to open a refinery in Vietnam that’s contracted to get more than 90 percent of its crude from the emirate. Iran and Qatar have floated the idea of investing in the region. They’ve got catching up to do. In 2004, Aramco bought 15 percent of a Japanese refinery with a capacity of 395,000 barrels a day, and in 2007 it paid $1.3 billion for a quarter of a refinery in Quanzhou, China, with a capacity of 240,000 barrels. “The biggest problem for Saudi Aramco is that fuel markets in several key Asian countries aren’t liberalized,”

TOPIC PHOTO AGENCY/CORBIS; DATA: INTERIOR MINISTRY

Global Economics

Global Economics with governments often requiring refiners to sell gasoline and other fuels at subsidized prices—or even at a loss—to keep inflation in check, says Bassam Fattouh, director of the Oxford Institute for Energy Studies. Aramco wants the right to sell what it refines at market prices, but the Chinese are reluctant to let market forces determine the price at the pump, according to people familiar with the situation who asked not to be identified because they aren’t authorized to speak publicly. Although China has taken steps to free up prices, it’s still tough for refiners to make a profit selling gasoline and diesel in the country. The market’s also getting crowded. Russia this year topped the Saudis as China’s biggest supplier of crude, and Iraq and Angola are making inroads. In Indonesia, the Saudis have a preliminary agreement to invest in a refinery with a capacity of 370,000 barrels a day in central Java, and they plan to upgrade two other facilities with Pertamina, the Indonesian state-controlled oil company. Aramco will own half the Java plant, which will primarily use Saudi crude, according to Indonesian Energy Minister Sudirman Said. “We’re optimistic,” he says, “that we will start our cooperation with our first refinery and expand our cooperation.” —Javier Blas and Wael Mahdi, with Nayla Razzouk The bottom line With oil prices plunging, Aramco is trying to lock in customers by building reﬁneries in Asia, as it did in the U.S. three decades ago.

Labor

It’s Not So Merry for Japan’s Workers Corporate scrooges threaten the success of Abenomics “Companies gave with one hand what they took with another”

Shinichiro Takano, a manager at Suzuki Group, a construction company based in Tokyo, is looking for a few good scaffolders. He’s not alone: Across Japan, there are seven scaffolding job openings

Japan’s Zero-Sum Wage Game Annual change in average in winter bonus Year over year change in average base pay* 3%

A recent uptick in base salaries coincides with a drop in bonuses

Forecast -3% 2010

2015

*EXCLUDES OVERTIME; DATA: JAPAN LABOR MINISTRY; 2015 WINTER FORECAST IS THE MIDPOINT OF ESTIMATES FROM BNP PARIBAS AND MITSUBISHI UFJ RESEARCH AND CONSULTING

for every applicant, according to labor ministry data. That might have prompted Suzuki to offer higher salaries, yet the company is reluctant to increase wages because of its gloomy view of the future. Though the 2020 Olympic Games in Tokyo may create some opportunities, the outlook for construction in a country with an aging population and a heavily indebted government is dim. “Our wages won’t go up unless the society improves,” says Takano. By many measures Japanese employers are doing just fine. Corporate earnings are strong, oil prices are low, and many companies are sitting on big cash reserves. The success of Abenomics—Prime Minister Shinzo Abe’s program to revive Japan’s economy—depends in part on consumers’ willingness to spend more. Tightfisted companies such as Suzuki aren’t helping. On Dec. 8 the government reported that annualized gross domestic product grew 1 percent in the three months ended Sept. 30 from the previous quarter, a big improvement on earlier data that showed an 0.8 percent contraction. “The trickle down from corporate profits to household spending is gummed up,” says Izumi Devalier, an economist at HSBC in Hong Kong. Summer bonuses were 2.8 percent lower than last year and employees are in for more disappointment this winter. Compared with last year, the December payouts will be 1 percent smaller, estimates BNP Paribas. Mitsubishi UFJ Research and

Consulting is even more downbeat, projecting a 2.1 percent decline. Base pay excluding overtime has risen for eight consecutive months. But the increases are small, amounting to just 0.1 percent in both September and October, and are canceled out by the reduction in bonuses. “Companies gave with one hand what they took with another,” says Devalier, who estimates private consumption dropped 0.8 percent in 2015, after declining 0.9 percent last year. To stimulate consumer spending, Abe wants to raise Japan’s minimum wage, which averages 798 yen ($6.52) an hour nationally. That barely buys a bowl of ramen and is the lowest among the Group of Seven countries, excluding Italy, which doesn’t have a minimum wage. The prime minister said last month that he wants a 3 percent hike, which Bloomberg economist Yuki Masujima says is double the average annual increase from 1993 to 2013. Only 1.9 million Japanese worked for the minimum wage in the fiscal year that ended Mar. 31, according to the government. Still, Abe is hoping that raising the minimum will exert upward pressure on other tiers of the pay scale. “They’re throwing the kitchen sink at this,” says Christian de Guzman, a senior analyst with Moody’s Investors Service. The administration’s thinking is, “ ‘We need higher wages, and this is something we can do,’ ” says De Guzman. Abe’s not getting much help from organized labor. While Finance Minister Taro Aso has said unions should demand increases of as much as 4 percent in upcoming salary negotiations, the Japanese Trade Union Confederation is seeking just 2 percent or so. Given the shakiness of the economy, small and midsize employers would reject more ambitious goals, confederation President Rikio Kozu says: “If I were running the company, I’d say, ‘This can’t apply to us.’ ” —Bruce Einhorn and Yoshiaki Nohara, with Kyoko Shimodoi and Toru Fujioka The bottom line Private consumption is poised to fall for a second year, as reductions in bonuses offset modest wage rises.

Edited by Christopher Power and Cristina Lindblad Bloomberg.com

Companies/ Industries

No Matter The Score, Nike Always Wins 18

The company expands the audience for pricey football fan gear “They want to make the NFL jersey as iconic as Air Force One”

Every Sunday from August through January, Blondies sports bar on Manhattan’s Upper West Side fills up with quarterbacks—or so it seems. There’s a 300-pound Mark Sanchez, a Latino Eli Manning, and a petite, female Ben Roethlisberger. The barflies, whose heroics involve passing around the chicken wings rather than handing off a football, are clad in the same NFL jerseys worn by their favorite player, right down to the name and the Nike logo. In 2012, Nike bet big on the NFL, agreeing to pay about $220 million a year for five years for the exclusive rights to make all the league’s onfield uniforms and officially licensed apparel, including fan jerseys. “The equipment part of the business is pretty small,” says Matt Powell, vice president for industry analysis at NPD Group. Fan gear, on the other hand, presented a big opportunity. In only three years, Nike has transformed the jersey business. Men and women of all ages are buying official NFL jerseys in greater numbers than ever, according to the league, paying from $100 to $295 each. The jersey “has really become the uniform of the fan,” says Leo Kane, senior vice president for consumer products at the NFL. Even at those prices, it’s less clear whether Nike makes money from the business. The company took over the exclusive contract from Adidas’s Reebok brand—which had paid about $25 million a year—by persuading the league with a lavish bid and touting its finely tuned supply chain and massive marketing team. In April 2012, Nike unveiled a new line of uniforms in a public-relations blitz featuring star athletes from every team. Fans, including many who’d never before bought a jersey, immediately took notice, says Steven Scebelo, vice president for licensing and business development at NFL Players Inc., a licensing and marketing subsidiary of the NFL Players Association. “They put together great marketing campaigns,” Scebelo says. “They used their brand halo and their personalities to drive the sport.”

FROM LEFT: SCOTT EISEN/GETTY IMAGES; PHOTOGRAPH BY ROBBIE MCCLARAN FOR BLOOMBERG BUSINESSWEEK

December 21 — December 27, 2015

Fans have been able to buy the same jerseys as the players’ since Reebok won the uniform contract in 2000. Nike introduced the high-tech fabrics it was using in track-and-field clothing, according to Jack Boyle, president of merchandising at Fanatics.com, which sells official sports apparel. Player names and numbers were more prominently displayed. The biggest change was sizing jerseys for female fans. Nike helped the league move beyond a “shrink-itand-pink-it” approach, the NFL’s Kane says, designing a more fitted top with narrower shoulders, but still in the same colors and patterns seen on the field. Today, women’s and children’s styles account for about half the NFL jerseys sold at Fanatics. Nike also streamlined its supply chain, pushing its factories and partners to shorten lead times and run smaller batches. If a second- or thirdstring player replaces an injured star, the company can put a jersey with the sub’s name in stores within a few weeks. “When a player moves, or gets hurt, or retires, that’s always a sales opportunity,” NPD’s Powell says. Nike sells three to four times as many jerseys as Reebok did 10 years ago, according to the league. “They’ve really taken it to another level,” Kane says. “They want to make the NFL jersey as iconic as Air Force One.” People are buying more jerseys in part because there are more to buy. Boyle, of Fanatics, says Nike expanded Sharing the Swoosh Royalty and sponsorship payments to the NFL Players Association per season $16m

$8m

Paid by Reebok

Paid by Nike $0

2007-08

2014-15 DATA: NFL PLAYERS ASSOCIATION

the number of named players per team to five or six from two or three. Fans can also order custom jerseys. And the NFL has been requesting more elaborate variations: Throwback jerseys, onfield replicas of vintage uniforms, have become New and common, as have Improved camouflagetrimmed verVentilated neck grille sions honoring the Fewer grab points for armed forces. “All the opposition of that gives a little Water-repellent material bit more reason Each uniform is made for the fan to buy,” of 10 fabric panels, down from 36 Boyle says. “And Weighs 20.4 ounces— on the Web, we 4 oz. lighter than the have unlimited current model shelf space.” Nike won’t discuss the size of its jersey business. “The connections we’re getting to the consumer, to athletes, and to fans are all really valuable to us,” says David Schriber, Nike’s vice president for North American brand marketing. But even with the reported hike in fan interest, analysts don’t know whether the company is turning a profit on its NFL contract. The NFL Players Association, which collects a royalty on league apparel, says total revenue from jerseys was $150 million in 2013. The reported revenue in Nike’s men’s training category, which comprises sales of football and baseball apparel, ticked up 4.3 percent in 2014 and 2.2 percent in the most recent fiscal year. Powell estimates Nike is losing money on its NFL deal from a pure product sales standpoint. But, he says, having its swoosh on every uniform, coach, and trainer on the field during broadcasts that consistently draw more than 20 million viewers is invaluable. Apex Marketing Group, a Michigan agency that specializes in sports, estimates the exposure is worth $105 million a season. Morningstar analyst Paul Swinand says for the NFL contract to pay off, Nike will need to cultivate fans abroad. “They’re wondering, How can we export American culture to the world?” he says. “How do we pull off another basketball?”

Star Wars: The Merchandise Awakens 20

Meet Masha, the mall rat from Moscow 22

Corporate directors write big checks— to themselves 21

Briefs: Chipotle eats crow; Stern gets Sirius 23

Early this year, Jarryd Hayne, a professional rugby player from Australia, made the San Francisco 49ers squad as a running back. His jersey immediately became a bestseller at Fanatics for seven weeks, propelled by purchases from the Southern Hemisphere. For Nike, the payoff is good enough that in March it extended its contract with the NFL by three years. (The financial terms were not disclosed.) In early December, the company unveiled futuristic football clothes for the 2016-17 season—their official debut will be during the Pro Bowl all-star game on Jan. 31. The uniforms, dubbed Vapor Untouchable, are almost one-third lighter than the gear currently worn on the field. Nike reduced the weight by cutting back on the number of seams and punching the fabric full of holes for better ventilation. The fan gear will be identical. “I’m very proud of it,” says Todd Van Horne, creative director for Nike football. “The feedback from the athletes is: ‘I’ve got better range of motion and I feel faster.’ ” That’ll work great for a halftime beer run. —Kyle Stock The bottom line In three years, Nike has transformed NFL fan jerseys. It now sells at least three times as many as Reebok did 10 years ago.

Guns

At Walmart, a Season For Guns and Tinsel The elves are busy at the biggest seller of firearms in the U.S. “You go to Walmart to buy your ammo because it’s cheap there”

At the Walmart Supercenter 10 miles east of the Las Vegas Strip, about 45 shotguns and rifles made by companies including Sturm Ruger, Remington Arms, and O.F. Mossberg & Sons are on display toward the back, past the eyeglasses and to the left of arts and crafts. It’s

Movies ‘Tell Jabba That I’ve Got His Money’ Star Wars: The Force Awakens, the latest ﬁlm in the 38-year-old franchise, is expected to generate $734 million in U.S. and Canadian ticket sales. That’s a fraction of the total revenue that analysts say the movie could bring in from TV licenses and sales of toys, DVDs, and video games. —Christopher Palmeri

$500m Disney Inﬁnity 3.0 video game

$780m Star Wars Battlefront video game

More than twice the sum Walt Disney paid for Lucasﬁlm in 2012

$5b Merchandise $1.65b Box-office sales (international)

Less than two-thirds of what the original Star Wars made, adjusted for inﬂation, during its initial 18-month domestic release

$214m TV licensing (international)

$734m Box-office sales (U.S., Canada) $458m DVDs/ downloads

$235m TV licensing (U.S., Canada)

$9.6

Projected total revenue of Star Wars: The Force Awakens in about the ﬁrst year of its release

a popular aisle. Cases housing the guns are adorned with holiday lights made from red shotgun shells. Silent Night and Jingle Bells play. It’s Christmastime, and Walmart, the largest seller of guns in the U.S., is ready to help Santa cross off whatever’s on shoppers’ lists. At the Vegas store, a middle-aged woman goes through her background check with a cashier. She’s purchasing a $114 child-size Crickett .22-caliber long rifle, which comes in black or pink in a box emblazoned: “My First Rifle.” In her cart is a blowup camouflage-clad Santa. For Walmart, guns, and especially ammo, are just good business. Through the years, the company has carefully navigated controversy to avoid affecting profits. Even in this shopping season—fraught because of the Dec. 2 killings in San Bernardino,

Calif.—it’s business as usual for Walmart. “Over the years, we’ve been very purposeful about finding the right balance between serving hunters and sportsmen and ensuring that we sell firearms responsibly,” says Walmart spokesman Brian Nick. “Our merchandising decisions are largely based on customer demand.” In 2008, Walmart was among the first major retailers to adopt a plan recommended by a coalition of mayors, led by Michael Bloomberg, founder and majority owner of Bloomberg LP, which owns Bloomberg Businessweek. The proposal called for more rigorous background checks than those required by federal law, as well as videotaping of all gun sales. “Walmart is definitely the leader in this area,” says Ladd Everitt, a spokesman for the Coalition to Stop Gun Violence. “I feel like they are

approachable on it. It isn’t like with certain other actors, where you know the answer you are going to get. They aren’t ideologues.” Walmart doesn’t break out its gun sales. Among the $3.8 billion in firearm sales in the U.S. last year, 20 percent are believed to be from big-box retailers, including Walmart, Cabela’s, and Dick’s Sporting Goods, says Brian Ruttenbur, an analyst with BB&T Capital Markets. Walmart has a much bigger share of the $2.7 billion ammunition market because its scale allows it to get steep discounts from bullet manufacturers. Walmart decided earlier this year to stop selling AR-15 military-style rifles because of declining demand, not gun politics, according to the company. Rather than pull the guns, it ran a sale to clear out existing inventory quickly, eventually replacing the stock with more popular guns, such as hunting rifles. The retailer continues to offer AR-15 ammunition, one of the hottest sellers. “If Walmart really wanted to ake an impact on the industry, they ould stop selling the ammo, but they ake too much money selling that,” uttenbur says. “You go to Walmart o buy your ammo because it’s heap there.” Military-style rifles, one of the top ndustry sellers in the U.S., were never Walmart’s bread and butter. The majority of those are sold at specialty retailers, which offer a better selection and more knowledgeable sales staff, says Richard Feldman, president of the Independent Firearm Owners Association. The rifles were creating a problem for Walmart. The cyclical nature of their sales, with demand rising every time the gun-control debate resurfaced, made it hard for the data-driven retailer to determine how many to stock and how much display space to allocate, according to the company. Walmart has flip-flopped over the years on how much emphasis to put on its gun business. In 2006 it began phasing out sales of all guns in about 1,000 U.S. stores, citing a lack of demand. The retailer replaced the merchandise with exercise equipment. It then brought the guns back in 2011 after sales rose in 2009 and 2010 on fears that Barack Obama’s election would lead to restrictions.

COURTESY LUCASFILM/DISNEY STAR WARS DATA: MACQUARIE RESEARCH ANALYST TIM NOLLEN; NOMURA ANALYST ANTHONY DICLEMENTE; WEDBUSH SECURITIES ANALYST MICHAEL PACHTER; BOX OFFICE MOJO. DIRECTORS DATA: BLOOMBERG

Companies/Industries

Walmart boasted that it saw gun sales increase 76 percent and ammunition sales advance 30 percent in 2012 after putting firearms into more stores. In the Las Vegas superstore, Jason Pierce, 31, is in line to buy about 50 rounds of ammunition for his .40-caliber Smith & Wesson handgun. His girlfriend leans on their cart, stocked with packages of potato chips and Chips Ahoy! cookies and a pack of ladies’ razors, among other things. It makes sense to own a gun, Pierce says, “with ISIS and everything like that taking off.” —Shannon Pettypiece and Esmé E. Deprez The bottom line Walmart studiously avoids guncontrol controversy as it hangs on to an enormous share of the $2.7 billion U.S. ammunition market.

Governance

Nice Work If You Can Give It to Yourself Some corporate directors pay themselves huge fees “You risk compromising the director’s independence”

Shareholder activists have complained about outsize pay for chief executive officers for years. What’s less known is that the directors on board compensation committees—the very people who decide to give out those large CEO salaries, bonuses, and stock grants—also tend to pay themselves extremely well. Regeneron Pharmaceuticals’ eight nonexecutive directors last year received average annual compensation of $1.9 million in stock and cash, making them the highest-paid board members among companies in the Standard & Poor’s 500-stock index, according to data compiled Board by Bloomberg.

Games

Regeneron

“The challenge is to compensate directors well, but not so well that pay becomes a primary reason for their service.” —Scott Stringer, New York City comptroller

Companies/Industries

At Endo International, directors made an average of $1.4 million. Board members at more than a dozen other companies pulled in $500,000 to $1 million. Those numbers are far above the median board compensation of $256,565 at all S&P 500 companies. “The challenge is to compensate directors well, but not so well that pay becomes a primary reason for their service,” says Scott Stringer, New York City comptroller and custodian of the city’s pension funds, which have more than $160 billion in assets. “When you cross that line, you risk compromising the director’s independence.” Directors typically decide their own compensation with little shareholder review, and the money’s so good they’re often reluctant to relinquish their seats, according to Gary Hewitt, director of governance research at Amsterdam-based Sustainalytics, which provides research to investors. “Beyond the smell of self-dealing with their pay, directors may find their interests in getting the ongoing board fees a bit stronger than their willingness to rock the boat,” Hewitt says. At Regeneron, which makes drugs to treat macular degeneration and other diseases, five of the eight outside directors have each served for more than 20 years. Four of the top 10 highest-paid boards among 500 companies surveyed by Bloomberg are at biotechnology companies where stock option grants boost director compensation. Among them: Regeneron, Endo, and Vertex Pharmaceuticals, where directors got an average of $920,509. Options in these companies are often granted at low strike prices before drugs are developed and approved, then jump in value after successful trials. The options received by Regeneron’s nonexecutive chairman,

Roy Vagelos, during his 21-year tenure have helped him become a billionaire. Regeneron valued his 2014 awards at $20.5 million. “Our board compensation reflects Regeneron’s unparalleled track record of success,” says spokeswoman Hala Mirza. Vertex and Endo declined to comment. Some companies with highly paid boards have tiered share structures that give much of the voting power to insiders, insulating directors from potential investor action. More than 50 percent of the votes at Google parent Alphabet are controlled by founders Sergey Brin and Larry Page. Google directors received average compensation of $500,498 last year. At Comcast, where outside directors were paid an average of $496,785, CEO and Chairman Brian Roberts controls 100 percent of a share class that gives him 33.3 percent of the company’s votes. Google and Comcast declined to comment. “Directors at these dual-tiered stock companies are locked into management to begin with, and their high pay only adds to that,” says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. Not all directors are paid lavishly. Berkshire Hathaway’s directors received average compensation of $3,991 last year, making them the lowest-paid among S&P 500 companies. They received $900 for each meeting attended in person and $300 for participating by telephone; they didn’t receive shares for their time. Directors’ freedom to set their own compensation has been challenged in court by shareholders. The Delaware Court of Chancery in May ruled that directors on compensation committees who approve their own pay aren’t protected by the business judgment rule and can be sued by investors. (The rule typically shields directors from liability for decisions in which they were acting in good faith and

Alphabet

ExxonMobil

Berkshire Hathaway

Whole Foods

Average compensation per outside director

$1,884,698 $500,498 $412,035

$357,582

$3,991

Outside directors

CEO pay

$42m

$33m

$464k

2015 change in share price through Dec. 15

+35%

+42%

-34%

+14%

-10%

Privacy Notice Occasionally, and subject to applicable laws, we may share your name, address, and e-mail address with other units within Bloomberg L.P., its subsidiaries, and its affiliates as well as to selected outside companies whose products or services we feel may be of interest to you. Many of our subscribers ﬁnd these promotions valuable, whether they are shopping for new services or taking advantage of a special offer. Please be assured that we take your concerns about your privacy seriously, and we intend to take every reasonable effort to protect it. To that end, we have developed a comprehensive Customer Privacy Policy. If you’d like more information about our use of customer data, please review our Privacy Policy, located at: www.businessweek.com/privacy. Please note that this information is stored in a secure location in the U.S. and that access is limited to authorized persons. If you would prefer not to have your data shared by Bloomberg Businessweek with either other units within Bloomberg L.P. or outside companies, please go to: bwso.businessweek.com/r/bwo_o.asp If you have any questions or comments, or want to conﬁrm the accuracy of your information you have provided, please call 1-800-635-1200 or write to: Bloomberg Businessweek Customer Service: 2005 Lakewood Drive Boone, IA 50036 Bloomberg Businessweek publishes weekly, except when combined issues are published that count as two issues, and when an additional special issue may be published.

Companies/Industries didn’t have a personal interest in the matter.) A Facebook shareholder filed suit after the court’s decision, alleging the company improperly allowed directors to award themselves $461,000 in stock on average in 2013. Facebook moved to dismiss the case. A Delaware judge ruled in October that even though CEO Mark Zuckerberg is the controlling shareholder, the company failed to allow all investors to vote on the compensation. The case is pending. Facebook declined to comment. Other than bringing lawsuits, shareholders have little say over director pay. Investor votes to amend the terms of board compensation plans typically occur only every 5 or 10 years. Says Sustainalytics’ Hewitt: “That leaves things back in the hands of directors.” —Carol Hymowitz and Caleb Melby, with Hideki Suzuki The bottom line Directors can set their own multiyear compensation plans with little or no shareholder review.

Animation

This Russian Bear Is Hitting the Mall After sweeping YouTube and Netﬂix, Masha looks to licensing “No amount of promotion could have gotten us to that level”

The bear has long been a ferocious projection of Russia’s power at home and abroad. Lately, a Russian bear that’s more like a kindly uncle has been winning hearts from Baltimore to Berlin: the affable and patient companion of a mischievous girl in the cartoon Masha and the Bear . The series, which has won accolades worldwide, is one of the top-rated channels on YouTube and made its debut on Netflix in August. The producers are planning a licensing push into everything from yogurt to burgers to plush animals. Moscow production company Animaccord has released 52 six-minute episodes in which the

hyperactive Masha typically annoys her long-suffering companion, who’s more interested in fishing or playing checkers. In one story, she wakes him up from hibernation and demands that he teach her to ice skate; in another, he must repeatedly launder and mend her dress after she’s covered in mud, food, and ashes. “Our six-minute series suits the YouTube format very well,” logging a total of more than 5.5 billion views, says Dmitry Loveyko, co-owner of Animaccord. “No amount of promotion could have gotten us to that level. The Internet is a very honest thing.” Loveyko started Animaccord in 2008 with Sergey Kouzmin, a friend from his time at Novosibirsk State University in the 1990s. They teamed up with animator Oleg Kuzovkov, who had the idea of adapting the traditional Russian stories of Masha and her bear to a world of TVs and cell phones. They sought to do for television animation what Pixar Animation Studios and DreamWorks Animation were doing for the big screen. The company uses software from Pixar and Autodesk but also developed its own programs to render images such as water, the bear’s fur, and snow (in abundant supply in stories set in Russia). Animaccord says the show costs about $50,000 per minute— expensive for TV—and that the first 52 episodes took seven years to make. An additional 26 are in the works, to be released over the next three years. Animaccord has grown from about 60 employees two years ago to more than 100, including 70 animators. It’s developed two spinoffs from the series, one in which Masha narrates fairy tales but confuses the details, and another called Masha’s Spooky Stories, aimed at kids slightly younger than the original’s primary audience of 3- to 9-year-olds. Loveyko says he doesn’t have the production resources for a feature-length film or a series with new characters, but he doesn’t rule them out.

Companies/Industries The series in February won the best animation award at Kidscreen, By Kyle Stock an annual childrenâ&#x20AC;&#x2122;s entertainment conference in Miami. In October it was the No.â&#x20AC;&#x2030;5 channel on YouTube, with 383 million views for the month, according to researcher Tubefilter. The most popular episode, â&#x20AC;&#x153;Masha + Kasha,â&#x20AC;? has had almost 1 billion views, far ahead of anything from the likes â&#x2014;&#x2039; â&#x2014;&#x2039; Chipotle Mexican Grill founder Steve Ells of Walt Disney or Nickelodeon. Masha has been translated into 25 languages took out a full-page advertisement in the Boston and airs in more than 100 countries. Globe to apologize for a recent norovirus outAn English-language YouTube channel, introduced in September 2014, has garbreak that sickened about 140 people. The burrito New Balance said it would release a limitednered more than 240 million views. chain rushed to implement testing throughout edition running shoe Animaccord hired Elsie Fisherâ&#x20AC;&#x201D;the with a 3D-printed its supply chain. It plans to centralize produce midsole in April. The voice of Agnes, the youngest of the technology could help three girls in the Despicable Me filmsâ&#x20AC;&#x201D; processing at one facility and to bolster its food- suppliers deliver the to dub Masha. Netflix shows Masha in shoes more quickly. North America and says itâ&#x20AC;&#x2122;s considering safety training. The norovirus comes on the heels adding it in other countries. of an E. oli outbreak that resulted in more than 40 store cloAnimaccord doesnâ&#x20AC;&#x2122;t release details about its finances, but researcher sures in the Pacific Northwest. â&#x2014;&#x2039; â&#x2014;&#x2039; In a unanimous City Social Blade estimates the Council vote, Seattle became $70 GoPro shares touched series earns as much as a record low on Dec. 14, $1.5 million a month from the first U.S. city to allow Uber and as retailers offered big advertising on YouTube. The holiday discounts on its $40 Lyft drivers to unionize to negotilatest camera to try to real money, though, is in 23 boost sales. Analysts licensing, which Animaccord ate pay and working conditions. say the company badly says accounts for about twoneeds better software $0 Under the ordinance, ride-hailing for sharing and editing. thirds of revenue. Loveyko 6/15/15 12/15/15 expects retail sales of licensed companies will be required to goods globally to jump next year by give the city a list of all drivers. Uber and Lyft are expected to about 25 percent, to $300 million, which would mean about $15 million challenge the measure in court. â&#x2014;&#x2039;Ă&#x2030;â&#x2014;&#x2039; Prada is starting to look in profit for his company. Last year, a bit ragged. The fashion house reported a 26 percent drop in Italian confectioner Ferrero sold profit for the nine months ended Oct. 31. Excluding favorable 37 million chocolate bars with Masha and the Bear on the label in Russia, currency fluctuations, global revenue slumped 7 percent in and Danone sold 33 million licensed the period. Prada said itâ&#x20AC;&#x2122;s looking to better control costs in yogurts in Ukraine. Burger King has been offering a Masha-branded kids all areas. â&#x2014;&#x2039;Â&#x201D;â&#x2014;&#x2039; Howard Stern signed a deal with Sirius XM menu in Russia since January, and German toymaker Simba Dickie is Holdings that will keep him at the satellite radio service In introducing Masha-themed plush Memoriam for another five years. In his 11 years there, animals and construction sets. Masha the producer and host of The Howard Stern has â&#x20AC;&#x153;proven that it works perfectly for merchandising, not only for toys but Show has helped Sirius increase the number apparel, school bags, and sweets,â&#x20AC;? says of subscribers to 29 million from 600,000. Michael Sieber, Simba Dickieâ&#x20AC;&#x2122;s chief executive officer. â&#x20AC;&#x153;It has great potenâ&#x2014;&#x2039;qâ&#x2014;&#x2039; Rolls-Royce Holdings ousted two tial. It wonâ&#x20AC;&#x2122;t be just a short hype but a senior executives in an attempt to turn â&#x20AC;&#x153;Live like a miser in the long-term story.â&#x20AC;? â&#x20AC;&#x201D;Ilya Khrennikov

Briefs Tex-Mex Mea Culpa

CLOCKWISE FROM BOTTOM LEFT: COURTESY ANIMACCORD; COURTESY NEW BALANCE; JOE CORRIGAN/GETTY IMAGES

The bottom line Sales of licensed goods from Masha and the Bear could reach $300 million next year as the Russian cartoonâ&#x20AC;&#x2122;s popularity soars.

Edited by Dimitra Kessenides and David Rocks Bloomberg.com

around its flagging engine business. Tony Wood, president of the aerospace division, will leave next year; Lawrie Haynes, president of the land and sea unit, will retire.

beginning. Reinvest all the money you earn.â&#x20AC;? â&#x20AC;&#x201D;Advice to entrepreneurs from catalog queen Lillian Vernon, who died on Dec. 14 at the age of 88

Politics/ Policy December 21 — December 27, 2015

Loans Are Due’ An unemployed 65-year-old litigant is among millions of seniors still paying off tuition Robert Murphy is 65 and broke. He hasn’t worked since 2002, when he lost his job as the president of Thermo BLH, a manufacturing company in Canton, Mass., after it moved operations overseas. He and his wife, Eileen, live on her salary as a teacher’s aide, which comes to about $13,200 a year. His bank recently began foreclosure proceedings on his house in Duxbury, Mass., which was worth less than his mortgage. Four years ago, hoping for a fresh start, he declared bankruptcy. But there’s one debt he hasn’t been able to erase: the $246,500 he amassed paying for his three children to attend college. From 2001 to 2007, Murphy took out 12 Parent PLUS loans originally valued at $220,765. Like those made directly

to students, Parent PLUS loans are federally backed and almost impossible to discharge—that is, to be forgiven. The total outstanding education loans held by people 65 and older, including debt that financed their own schooling and their children’s, grew to $18.2 billion in 2013, the most recent year available from the U.S. Government Accountability Office (GAO), from $2.8 billion in 2005. That’s twice as fast as the overall growth in student debt. The number of borrowers age 60 and up has increased to 2.2 million, from 700,000 in 2005, according to the Federal Reserve Bank of New York. Twenty-seven percent of education loans held by people age 65-74 were in default in 2013, meaning they hadn’t made a payment in 270 days or more.

More than half of education loans held by people 75 and older were in default. And the government can garnish wages or suspend tax refunds for anyone who fails to pay their student loans, but it has an extra tool when it comes to senior citizens: taking money out of their Social Security payments. In 2013, 155,000 seniors lost part of their retirement benefit to repay education debt, up from 31,000 in 2002, according to the GAO. “There’s no statute of limitations, so these loans go with you to your death,” says John Rao, a lawyer with the National Consumer Law Center, a consumer rights nonprofit. “That makes it different for someone who is elderly who might think at a certain point in their life they are immune from collections.”

ILLUSTRATION BY 731

“There’s no statute of limitations, so these loans go with you to your death”

Iowa plunges into Medicaid privatization, and it ain’t pretty 26 “Congress broke the system, and it’s their fault we didn’t have just a little bit of debt being extinguished each year based on some going bankrupt.” —Indiana Attorney General Greg Zoeller

Most forms of consumer debt can be canceled after people file for bankruptcy protection. Education debt is the one exception. Congress said in the 1970s that such debt can go away only if a debtor can prove repaying it would impose an “undue hardship.” Acting as his own attorney, Murphy has spent the past three years arguing in court that he should be covered by the standard. On Dec. 10 his case was heard by a federal appeals court in Boston. In court filings, Murphy has calculated that even if he were able to find a job paying $50,000 a year until he turned 77, the balance of his loans would still grow to $500,000— an impossible sum to repay. Congress never defined undue hardship, so it’s been left to the courts to determine just how desperate someone needs to be to qualify for relief. Bankruptcy judges have said that to get education loans wiped away, borrowers must show their entire lives would otherwise be characterized by a “certainty of hopelessness” or that repaying the debt “strips [the debtor] of all that makes life worth living.” “Creditors have been able to stack the deck in their favor as they have litigated what undue hardship means,” says Rafael Pardo, a law professor at Emory University, who filed a brief on Murphy’s behalf. At the Dec. 10 hearing, attorneys representing a debt collector that works for the U.S. Department of Education described the moral hazard built into letting Murphy clear his Parent PLUS balances: “Here we have somebody who Student loan borrowers over 60

2m $19,521

1.5m 1m

Average balance

0.5m $11,780

Q1 2005

0 Q4 2012 DATA: FEDERAL RESERVE BANK OF NEW YORK

is potentially on the verge of considering retirement, and is unemployed, and then takes out seven loans in succession over a course of years … and then seeks to come back and say, ‘Oh, I am getting up there in years, and I’m unemployed.’ ” If borrowers run into trouble, the Education Department would prefer they enter a repayment plan than be allowed to eliminate the debt altogether. “This is the problem with a bankruptcy discharge: It is permanent,” Jeffrey Clair, a government attorney, argued at the appeals hearing on Murphy’s case. “Once the debt is discharged, it is gone, and no change in economic circumstances that might occur one year or three years or five years hence is going to result in any substantive recovery for the government.” Yet some say that because the bankruptcy exemption for education debt can allow financial hardship to worsen as people age, it winds up costing the government in other ways, such as increased social services. “Congress broke the system, and it’s their fault that we didn’t have just a little bit of debt being extinguished each year based on some going bankrupt,” says Greg Zoeller, the Republican attorney general of Indiana, who has urged Indiana lawmakers to oppose federal rules allowing education debt collectors to auto-dial borrowers’ cell phones. “They should take a little credit for the [money] that’s uncollectible,” he says. “It should be in bankruptcy, and it’s not.” On Dec. 10 a group of Democratic senators led by Ron Wyden of Oregon and Sherrod Brown of Ohio introduced a bill that would stop the government from garnishing Social Security to pay federal debts, including student loans. “Americans are getting hit by a wrecking ball of increasing college costs, and the last thing they can afford is to have their Social Security benefits reduced to pay off student loans,” Wyden said in a statement. Murphy’s kids graduated from Loyola University Maryland and

A Bill: Protecting the right to leave no-star reviews 27

Bridgewater State University, and they are currently employed, according to court filings. Judge Ojetta Rogeriee Thompson, one of the three judges considering their father’s appeal, said during oral arguments that his situation seemed sufficiently hopeless to merit forgiveness: “If this doesn’t constitute undue hardship, what would?” —Natalie Kitroeff The bottom line The amount of education debt held by people 65 and older ballooned to $18.2 billion in 2013, from $2.8 billion in 2005.

State Politics

A Political Darling Loses Her Luster Pennsylvania’s indicted attorney general refuses to step down “Kathleen started off with a tremendous amount of promise”

In 2012, Kathleen Kane was a rising star of the Democratic Party, a former county prosecutor and political neophyte who had become the first woman and the first Democrat elected to the post of Pennsylvania attorney general, thanks in part to an endorsement from Bill Clinton. Three years later, her fairy tale seems unlikely to have a happy ending. Kane was charged in August with perjury and other crimes in connection with her 2014 release of documents to the Philadelphia Daily News connected with a closed 2009 grand jury investigation. Kane, who’s pleaded not guilty, has said the charges are political retribution for a review she conducted after taking office of how her Republican predecessor as attorney general, former Governor Tom Corbett, handled the investigation of Jerry Sandusky, the former Penn State assistant football coach convicted of serial child sexual abuse in 2012. Kane’s review uncovered misogynistic, pornographic, and racist e-mails sent by state officials that were unrelated to the Sandusky case. That created a new scandal that’s led to

Pennsylvania Attorney General Kathleen Kane at a Nov. 10 hearing in her perjury case

the resignation of one state Supreme Court justice and an inquiry by the state judicial oversight board into whether another should be forcibly removed from the bench. “It’s a mess that seems to continue to unravel,” says T.J. Rooney, a former state legislator and ex-state Democratic Party chairman. “Every time you think you’ve gotten to the point of no return in terms of how crazy it all is, there seems to be another layer.” Party leaders including Pennsylvania Governor Tom Wolf have called for Kane, who faces reelection in 2016, to resign. Their concern isn’t just about keeping Kane’s post in Democratic hands. Pennsylvania, which backed Barack Obama in 2008 and 2012, is crucial for whoever wins the Democratic presidential nomination. The party is also looking to unseat Republican Senator Pat Toomey, a former U.S. representative who was president of the fiscally conservative Club for Growth before winning election in 2010. “I can’t imagine that any Democrat running in 2016 is happy that Kathleen Kane is still around,” says Charlie Gerow, a Republican strategist based in Harrisburg, the state capital. “It puts them in a position of having to consistently call on her to resign, and that’s not where you want to be when you’re running for office on the same party ticket.” Pennsylvania’s state senate, which is controlled by Republicans, has scheduled a Jan. 12 hearing on whether to invoke a rarely used constitutional provision to remove Kane from office. She has called the senate’s actions unconstitutional, arguing the appropriate course would be an impeachment

hearing. “That allows her more of an opportunity to make her case and gives more legislators an opportunity to cast their votes,” says Chuck Ardo, Kane’s press secretary. She has at least one senior Pennsylvania Democrat not calling for her to go: Ed Rendell, the state’s former governor. “Kathleen started off with a tremendous amount of promise,” says Rendell, who initially called for Kane to take a leave of absence but now believes she should remain in office while fighting the charges. “People thought if she did a good job as attorney general, she might be a good candidate for governor or Senate down the road. Obviously, the controversy has removed that as a possibility.” —Sophia Pearson and Romy Varghese, with Jef Feeley The bottom line Democrats in Pennsylvania want the state’s indicted attorney general to step aside to avoid blowback for other 2016 candidates.

Health Care

Medicaid Privatization Gets Messy in Iowa The latest state to subcontract care is running into snags Hospitals believe “this thing is moving way too fast”

In Iowa about 600,000 people get medical care through Medicaid, the public-health program for the poor and disabled. That includes more than a third of the state’s children. Doctors currently bill Iowa’s Medicaid

program directly for their services, but starting as early as Jan. 1 the state will move all of its Medicaid patients onto managed-care plans offered by four private insurers. Governor Terry Branstad, a Republican, estimates the switch will save Iowa $51 million in the first six months of 2016, about 1 percent of the state program’s $4.2 billion budget. It’s been a complicated handoff. In November the federal Centers for Medicare & Medicaid Services, which oversees state programs, wrote to Iowa officials to express “significant concerns” about the speed of the switch. By mid-December, with Iowans on Medicaid facing a Dec. 17 deadline for signing up with one of the private plans, many of the state’s hospitals and other medical providers—such as clinics, nursing homes, and home health-care services—still hadn’t signed contracts with the Medicaid Iowa’s Medicaid insurers. That expenditures made it impossi$5b ble for patients to know whether they could keep their existing doctors. “This thing is moving way too fast,” says Scott $0 McIntyre, vice 2004 2015 Estimate president for communications of the Iowa Hospital Association, which sued in November to block the privatization plan. Three companies that lost bids to administer Medicaid plans have also sued, arguing that the bidding process was unfair. Amy McCoy, a spokeswoman for the Iowa Department of Human Services, says the change is necessary to contain a state Medicaid budget that’s doubled since 2004. Iowa plans to allow patients to see doctors outside of the managed-care networks for the first three months to smooth the transition. “We wanted to do something more proactive that’s going to be able to have more impact on health outcomes,” she says. The question is whether that impact will be positive or not. Since the 1980s, 39 states have privatized some or all of their Medicaid programs, paying private medical plans a fixed monthly sum to manage care for the poor and disabled. At least 39 million Americans—more than

MATT ROURKE/AP PHOTO; DATA: IOWA STATE BUDGET

Politics/Policy

Politics/Policy half the total Medicaid population— were enrolled in Medicaid managedcare plans in March 2015, according to data compiled by the Kaiser Family Foundation, a nonprofit focused on health-care policies. Some of the growth comes from the federally financed expansion of Medicaid under the Affordable Care Act. In 2013, Governor Branstad arranged for special permission to use the new funding to buy qualifying residents private insurance through the state Obamacare marketplace, a precursor to moving all of Iowa’s Medicaid beneficiaries to private plans. Nationally, the shift to Medicaid managed care hasn’t been proved to save money, and the approach has a mixed record on how patients fare, according to a 2012 review by the Robert Wood Johnson Foundation. Another study, published this year by authors at the Urban Institute, a liberal think tank, found that for nondisabled adults, managed care is associated with increased likelihood of emergency room visits, trouble seeing specialists, and difficulty getting prescription drugs. “We don’t have as much evidence on what works and what doesn’t work as we would like to have,” says Julia Paradise, associate director at the Kaiser Commission on Medicaid and the Uninsured, a bipartisan policy group convened by the Kaiser Family Foundation. Charles Bruner, executive director of the Child & Family Policy Center in Des Moines, says he’s unsure whether the managed-care plans will be required to cover the early-childhood care and social services his group supports. Such programs can help prevent children from developing chronic illnesses such as obesity or diabetes later, but they don’t offer immediate savings. He fears managed-care companies are going to ask, “Can we get rid of the peanuts on the airplane?” Iowa Department of Human Services spokeswoman McCoy says those worries are misplaced: “The benefits that are offered through our Medicaid program are going to stay the same.” —John Tozzi

A Bill Free Speech for Yelpers

By Alexis Kramer, Tiffany Young, and Melissa Avstreih

S. 2044 Consumer Review Freedom Act of 2015

The essentials

Some hotels, retailers, and other service providers include nondisparagement clauses in their terms of service, a step intended to deter customers from posting negative reviews online. On Dec. 14 the U.S. Senate voted unanimously to prohibit the use of blanket gag clauses in commercial transactions and empower the Federal Trade Commission to go after companies that try to fine or otherwise penalize customers who leave bad comments.

The bill advanced after a November committee hearing at which an Oregon woman named Jen Palmer described how KlearGear.com, an online merchant, wrecked her credit. She and her husband refused to pay $3,500 the company demanded in 2012 because of a critical review Palmer posted on Ripoff Report. The battle with KlearGear, which ended only when Palmer won a default court judgment in 2014, made her “feel anxious, terriﬁed, humiliated, and helpless,” she said.

3. Vital statistics

A provision letting states hire outside attorneys to help enforce the law was dropped (a) (c) Deﬁnitions Prohibition pp. 2-3 p. 6

Sponsor John Thune (R-S.D.) Co-sponsors Brian Schatz (D-Hawaii) Jerry Moran (R-Kan.) Section 1 Short Title p. 2

The bottom line To cut Medicaid costs, Iowa plans to switch patients to managed-care plans, but health providers say there may be hidden costs. Edited by Allison Hoffman Bloomberg.com

A version of the bill has been introduced in the U.S. House by California Representative Darrell Issa, a Republican. Yelp, Glassdoor, and several nonprofits that advocate for stronger First Amendment rights online jointly came out in support of passage in a November letter to the Senate: “Non-defamation clauses stifle free speech and harm citizens’ ability to make informed purchasing decisions, while rewarding bad businesses that are willing to bully their clientele into silence.”

Section 2 Consumer Review Protection pp. 2-11

(b) Invalidity of Contracts That Impede Consumer Reviews pp. 3-6

(e) Enforcement by States pp. 7-10

(f) Education and Outreach for (h) Businesses Effective pp. 10-11 Dates p. 11

(d) Enforcement by Commission pp. 6-7

(g) Relation to State Causes of Action p. 11

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SeatGeek bets on mobile to move it up to the front row 30

Peru’s plan to make its money mobile 32

The 25-year-old trying to bring the future back to the U.S. 31

Innovation: Detecting 1,000 viruses with just one test 33

December 21 — December 27, 2015

Tiny payout

Side deals and volatile shares make stock options a bigger gamble for startup employees “Certain founders think it’s their job to paint a rosy picture for employees” Jeff Sutton led the corporate IT team at Box for four years, as the online filesharing company grew from 50 employees to more than 1,000. He joined Box from IBM, making about $95,000 a year—forgoing the higher salary somebody with his decade of experience in systems administration could have made so he could collect stock options, roughly 21,000 in all. When Box went public at the beginning of 2015, Sutton’s bet seemed to be paying off. On their first day on the New York Stock Exchange, the company’s $14 shares jumped 66 percent, to $23.23. But Sutton, subject to an employee lockup agreement, had to wait 180 days before he could cash out. By then, the stock had fallen more than 20 percent from that high; it’s now trading at about $13, below its initial public offering price. “I thought the stock was going to keep skyrocketing,”

Sutton says. “Obviously it didn’t work out that great.” Let’s be clear: Sutton knows it worked out just fine. He made about $350,000 before taxes on his Box stock, more than enough to buy the world’s smallest violin. It wasn’t, however, the life-changing windfall he’d hoped to secure in exchange for four of his prime Silicon Valley years. The frustrated expectations of early employees like Sutton have become a common thread in the latest round of technology IPOs. It used to be “the getrich story happened for people who joined in the early days,” says Saar Gur, general partner at Charles River Ventures. Now they can be among the few left behind. Many executives, early investors, and even later investors are able to cash out before the rank and file, or bargain for guarantees that help ensure a bonanza.

In an era when multibillion-dollar private valuations have almost become the norm in tech, employee stock options may appear more valuable than ever. That, however, presumes a business’s public valuation keeps pace with the often too optimistic internal one. Square, the mobile payment company, maintained a website with an internal stock ticker before its IPO, showing the estimated price steadily rising with each new private investment. Yet when the company went public in November, it priced its shares at $9, well below the expected range. One former employee says the internal ticker sat at $16 when she got her options last year, and her boss told her to expect a post-IPO jump to $50. As of Dec. 16, Square was trading at about $12. Whatever happens with an IPO, executives tend to hang on to enough equity to guarantee huge payouts when they

Technology who helped him shift to venture capital when Bowstreet crumbled. He says he’s found it better to be as clear as possible with people about their potential earnings to avoid dashed hopes later. Again, none of this means startup workers are poor, even without accounting for the catered meals, free laundry, lavish parties, and other perks in their playground offices. Average engineers at early-stage startups make $127,000 a year, estimates recruiter Riviera Partners. “It’s a pretty great deal, if you ask me,” says Garrett Remes, an early employee at Zynga. Remes, now a freelance graphic designer, in 2008 walked away from Zynga—and options that eventually would’ve been worth $2 million—to co-found mobile game maker Storm8. Less than a year later, after disagreements with his cofounders, he left that company, too. Nonetheless, he says, the startup lifestyle “was better than I was used to, living in the Midwest.” Sutton hasn’t given up on the startup world, either. Since Box, he’s managed IT for video advertising company BrightRoll, later bought by Yahoo!, and is now a manager at Instacart, the food delivery startup. But he’s a little more jaded. “It’s almost like winning the lottery for your company to do an IPO and do well,” he says. “It’s definitely not something that happens to everybody.” —Sarah Frier and Adam Satariano The bottom line When companies fail to meet expectations as they go public, options-holding employees bear much of the brunt.

Apps

The Kayak of Tickets Thinks Bigger After a snub, SeatGeek is trying to beat StubHub at its own game Desktop ticketing services “were built 10 years ago”

Six years ago, Dartmouth College graduates Jack Groetzinger and Russ D’Souza created an online marketplace to collect listings for concert and sports tickets the way Kayak does for flights. Their website, SeatGeek, now draws more than 8 million monthly visitors

SeatGeek’s app allows people to call up their tickets and transfer or sell them to other users

Tap “sell,” enter a quantity, and set your price to list tickets, or buy seats together and instantly divvy them up among friends

who can compare prices from ticket resellers, see a photo of the view from a given location, and get tips on the best time to buy. Like Kayak, SeatGeek built its business without its own inventory. Until last month, all its listings came from about 500 outside vendors who paid SeatGeek a cut of referred sales, usually around 10 percent. Under pressure from industry heavyweight StubHub, SeatGeek has begun moving away from aggregation and into the resale market. Earlier this month, Groetzinger and D’Souza’s company released a version of its mobile app that lets people freely send tickets to one another using their smartphones. Users can also list and sell tickets in exchange for giving SeatGeek a 15 percent cut, a function added to the company’s desktop site in November. On a beta version, mobile tickets can be listed with two taps on a phone and bought or transferred with a few more. A concertgoer who buys four seats to a show can almost instantly deliver three to friends and collect payment without added fees. Like all good apps, it needs no manual. The pages are accessed from buttons at the bottom of a menu screen, including “my tickets,” where purchases appear automatically. Tickets can also be uploaded as PDFs (via the desktop site or e-mail) without entering information about the seat. From there, it’s a matter of tapping “sell” or “transfer.” With more venues offering paperless entry, scanning bar codes off smartphone screens instead of printouts, tickets can live inside phones from the first purchase to the turnstile—and during every change of hands along the way. The co-founders say SeatGeek’s

FROM LEFT: COURTESY SEATGEEK (2); COURTESY NEW YORK PUBLIC LIBRARY (1)

sell their shares. Most early investors get a chance to sell options on secondary markets before a company’s IPO. Later investors increasingly demand preferential treatment, including agreements that if an IPO underperforms the terms of their investment, they’ll be made whole with an equivalent amount of additional shares. Latestage investors in both Box and Square had such so-called ratchet agreements in place, further devaluing locked-up employee equity. When those kinds of deals are in place, employees often find their payouts disappoint“It’s almost like ing because they’re so winning the lottery for your company to diluted, says Clara Sieg, do an IPO and do a partner at Revolution well. It’s deﬁnitely Ventures. Box and not something that happens to Square declined to everybody” comment for this story. Ordinary employees are typically without meaningful financial protections or even a clear sense of what their equity stakes mean, says Chris Zaharis, who’s worked at startups for about 20 years and as a volunteer teaches people about their equity rights. 30 Options grants often don’t come with information on strike prices (discounts on shares), preferential treatment, or even the total number of shares outstanding. “People on average overestimate what they are going to make by about 10X,” he says. One employee at Jawbone, a maker of fitness-tracking wristbands, says he’s no longer sure of the value of his options given the company’s recent round of layoffs and debt financing. It looks less likely Jawbone will be able to go public at or close to its $3.3 billion private valuation, he says, and it may opt to stay out of public markets entirely, rendering the options worthless. Jawbone declined to comment. The current crop of overly optimistic workers reminds Brian O’Malley of his younger self. O’Malley, a partner at venture fund Accel Partners, was fresh out of college at software startup Bowstreet when the dot-com bubble burst, taking with it the options the company told him would be worth six figures at IPO. Like many of today’s employees, he says, he was too busy counting his money to consider the risks. “Certain founders think it’s their job to paint a rosy picture for employees,” he says. Luckily he found a mentor

That was easy

U.S. world’s fairs have played host to some big debuts

mobile interface can handle all those transfers more smoothly than its rivals’ systems. “Those ticketing platforms were built 10 years ago, or built around ideology of 10 years ago,” D’Souza says. Since the first version of SeatGeek’s app went live in 2012, mobile traffic has grown to 75 percent of the service’s 4,000 daily transactions, SeatGeek says. For North America’s event ticket industry as a whole, mobile accounts for 44 percent of traffic, according to Juniper Research. StubHub and Ticketmaster lag, with 36 percent and 21 percent, respectively, so far this year. SeatGeek began the shift toward reselling after StubHub—which controls almost half of the more than $5 billion U.S. resale market, according to Northcoast Research—pulled its inventory from the site last year. John Locke, a principal at SeatGeek investor Accel Partners, says StubHub deemed the aggregator a threat, “and frankly, it should.” StubHub spokesman Glenn Lehrman says his company ended its partnerships with SeatGeek and other referral sites because they weren’t delivering enough new customers to justify their fees. To beef up its offerings, SeatGeek has made agreements to list primary inventory from Spectra Ticketing & Fan Engagement, a box office that specializes in college sports, and Telecharge, which handles Broadway plays. SeatGeek says its month-old resale marketplace is seeing tickets uploaded for sale at a rate of one per minute. Still, the great majority of the $1 million worth of tickets it helps sell each day are from other vendors’ resale listings, the company says. Moving into primary sales pits SeatGeek more directly against industry leader Ticketmaster, which moved 154 million tickets last year, bringing in almost $1.6 billion in revenue. Ticketmaster, owned by Live Nation Entertainment, has also entered the resale arena with TM+, a service that combines primary and secondary listings. “The difference between selling 500,000 tickets or a million tickets, and then selling 150 million tickets a year, is a big difference,” says Richard Tullo, an analyst at brokerage Albert Fried & Co. Still, Tullo says, “I wouldn’t discount the power of an interface, because the consumer loves the path of least

Technology

resistance.” Ticketmaster’s and StubHub’s apps don’t let users transfer tickets, for example. SeatGeek’s founders are counting on this kind of sharing to spread their software beyond the current tally of 4 million-plus downloads while the bigger companies slug it out on PCs. “Ticketing is still a desktop thing for the most part, which is sort of strange given how naturally it lends itself to mobile,” Groetzinger says. As for news reports that SeatGeek met last year with Live Nation to discuss a possible acquisition, he says, “We’re not really thinking about that stuff.” —Ira Boudway and Jing Cao

TV (1939, New York); videoconferencing (1964, New York); and touchscreens (1982, Knoxville). “For the world’s fair Telephone, 1876 to matter again, it has to happen in America,” Weiss says. “America is where the future happens.” The expos have continued around the world, lasting six months in a different location about every five years. Shanghai was the host in 2010, Milan this year, and Dubai will be the site in 2020. What’s been missing is a prominent U.S. presence since the 1984 New Orleans expo became the only world’s fair to declare bankruptcy. In The bottom line SeatGeek is betting on a 1994, Congress banned the revamped mobile interface to siphon business from StubHub and Ticketmaster. federal government from spending money on such fairs in a move to trim fat from the budget. Ferris wheel, 1893 U.S. delegations have turned to nonprofits and corInnovation porate backers, notably Citigroup and Chevron, to cover the cost of a fair pavilion, which now runs about $60 million. The results have been “embarrassing,” says James Ramsey, A 25-year-old event planner is the architect of New York’s proposed trying to raise $16 billion subterranean park, the Lowline. At the Shanghai fair in 2010, “the U.S. An expo “affects our sense of pavilion just looked like a Costco with possibility” ‘USA’ written on it,” he says. What’s the future Shanghai’s record attendance done for you lately? of 73 million helped reboot the Our hoverboards fair as a confidence booster don’t hover, our akin to the Olympics, says Anna Roombas are no Jackson, a curator at London’s Rosie the Robot, Victoria & Albert Museum and and almost half the author of a history of X-ray, 1901 a century after Neil Armstrong international expos. Earlier became the first person to walk on this year in Milan, Secretary of State the moon, the U.S. relies on Russia to John Kerry trumpeted the U.S. pavilget to space. Maybe the problem, says ion’s record-setting 65,000 visitors in Michael Weiss, is that Americans don’t a single day. “The fairs help people do things big anymore. adjust to changing times,” Jackson says. Weiss, 25, is the founder of Worlds Weiss hopes to lure the expo back Fair USA, a crowdfunded company to the U.S. in the next decade. By that plans to raise $16 billion to begin February, he says, he’ll have a pool of the process of bringing the expo back to 10,000 interested attendees and the the U.S., which last hosted a world’s fair first $6 million in 1984, in New Orleans. For a century in hand, which before that, the country played host he’ll use for a to expos that saw the public debuts of website, marketthe telephone (1876, Philly); the Ferris ing, feasibility wheel and zipper (1893, Chicago); studies on site the X-ray machine (1901, Buffalo); the proposals, and baby incubator (1909, Seattle); the fairground

Bringing the World’s Fair Back to the U.S.

Television, 1939

Technology Quoted Waiting another year for Yahoo to ﬁgure out its next move is “simply unacceptable,” Canyon wrote

“We ﬁnd it difficult to comprehend that in the face of months of tax uncertainty … there was apparently no plan B.” Investor Canyon Capital Advisors, in a Dec. 11 letter to the Yahoo! board after the company abandoned plans to spin off its stake in Alibaba

though he wouldn’t say how much he’s raised. By May, he says, he’ll open an online vote for the expo’s location, to be set by next fall. Asked how he plans to make the leap from $6 million to $16 billion, Weiss laughs and cites a viral video shot in November by a man taking a jet-pack-powered spin around the Statue of Liberty. “I don’t think I’ll have trouble finding people who dream like I dream and can make this a reality,” he says. —Richard Morgan The bottom line Weiss is tapping his real estate contacts to help win and host a world’s fair, but he may need more than twice what he’s projected.

E-Commerce

Opening a Nationwide Mobile Wallet Peru’s banks push through a uniﬁed digital payment system “Dealing in cash requires a lot of processing by hand … and risk”

Four in five Peruvians don’t have a bank account, but in a country of 30 million people, there are about 32 million cell phones. So the leading Peruvian banks have teamed up to get money moving through those phones. On Dec. 15, Peru Digital Payments, a company owned and operated by the country’s leading financial institutions, launched Bim, a mobile payment program that unites all their online customer interfaces on one system. “We want this program to reach the people who don’t have bank

accounts,” says Carolina Trivelli, who’s overseeing Bim and previously ran the government’s development ministry. “That’s the woman who lives in the countryside and has a nine-key cell phone, a 2G connection, and a prepaid phone plan.” Peru’s software is the first of its kind: While there are 255 mobile money programs in 89 countries around the world, no other program includes all of a country’s banks, and the majority allow transactions only between customers of the same phone company. By February all three major Peruvian carriers will offer users access to Bim. The software works with relatively low-tech cell phones—only a quarter of those in Peru are smartphones— and features a simple menu with numbered options, such as buying voice minutes or sending money to someone for a 15¢ fee. To better work with basic phones and keep transactions secure, Bim sends data over voice channels, much like SMS text messaging. Once customers begin using Bim, the bank hosting their account will be able to establish credit scores for them and start pitching loans and other products, says Trivelli. Peru’s program was funded at first by $10 million split among 34 of the country’s financial institutions and aims to attract 5 million users within five years. Some of Peru’s biggest companies, including beermaker Backus & Johnston, have signed up to start using Bim for transactions with retailers beginning in March. Backus, a subsidiary of SABMiller, collects mostly cash payments weekly from 115,000 bodegas and small shops,

FROM LEFT: YOUTUBE; ILLUSTRATION BY 731; COURTESY COLUMBIA UNIVERSITY

models, as well as to pay contractors. He’s been working to identify potential 1,000-acre fairgrounds in six parts of the country. The atmosphere and excitement generated by the fairs are as important as innovations displayed in the pavilions, says Neil deGrasse Tyson, the astrophysicist and pop futurist. At age 5, he visited the 1964 New York World’s Fair, which he says “affected me deeply, as the 1939 fair affected Carl Sagan.” He remembers the IBM pavilion’s 90-foot IMAX forebear and his first swig of Fresca. “It affects our sense of possibility.” Vicente Gonzalez Loscertales, secretary-general of the Bureau of International Expositions, an intergovernmental body in Paris that oversees the fairs, says his organization “greatly welcomes” any plans to bring one to the U.S. Weiss, who has an undergraduate business degree from Washington University in St. Louis, for three years worked for and eventually ran Escape, a popular annual real estate conference. “I think anybody would be a fool to bet against Weiss,” says Stan Gale Jr., president of developer Gale International’s New York office, who attended an Escape conference featuring water jet packs alongside lectures from chief executive officers such as Tony Hsieh of Zappos. Gale recalls the general takeaway among the industry attendees as, “Wow, that was awesome.” That’s not to say real estate developers’ interests necessarily dovetail with high tech. For example, the Sunsphere from Knoxville’s 1982 expo has been near-derelict for decades. “This feels like a pipe dream,” says Timothy Kellison, an assistant professor of tourism at the University of Florida. He says Weiss’s $16 billion budget is too low—and a projection double that would still be conservative. Weiss has been touring the U.S. to raise money: New York in November, Chicago in December, San Francisco planned for January. “I have more than ample high-net-worth people in my immediate network,” he says,

Technology many high in the Andes or near the Amazon. “Dealing in cash requires a lot of processing by hand, expenses, and risk,” says Luis Guzman, the company’s treasurer. “Each year we receive over 15 million coins.” Bim may cut down on loose change and the threat of robbery or passing off counterfeit money, but the 15¢ charge for remittances will feel steep to the poorest Peruvians, says Jeffery Bower, a United Nations digital payments specialist who’s advised Peru’s program. The interface’s security and low-tech approach can also be annoying to smartphone users familiar with the ease of switching among apps. The connection to the payment server drops out if you swipe to another screen—say, to find the phone number of the person you’re paying or the e-mail that says how much you owe. Trivelli says she’s negotiating with carriers to lower transaction costs and expects eventually to develop a more sophisticated app for smartphones. To catch on, the network will need continued development, aggressive marketing, lots of retail partners, and a brick-and-mortar network of distributors who help million people buy and redeem electronic Number of cell phones money. “What in Peru, though we know is that only a quarter are it is not an easy smartphones business,” says Mireya Almazan, a manager of the mobile development program at GSMA Mobile, a group that represents mobile operators and related companies worldwide. But the system has a lot going for it. “No other country in the world has all of those pieces in place, with the right kinds of partnership and the right kind of momentum, to push things forward,” says the UN’s Bower. “Hopefully, Bim will be more successful at reaching all Peruvians across the country, making a significant impact on increasing financial inclusion nationwide.” —Catherine Elton

Innovation Universal Virus Test Form and function

Innovator W. Ian Lipkin

Lipkin and six researchers developed a shoeboxsize add-on to a genetic sequencer they say can accurately identify more than 1,000 viruses known to affect vertebrates, so doctors don’t have to test for infections one at a time.

Age 63 Title Professor of epidemiology at Columbia University

Origin In 2013, Lipkin’s team began building a database of DNA sequences for those viruses known to affect vertebrates.

1. Sampling A technician adds a tissue or ﬂuid sample to a solution with strands of DNA that attract various viruses.

Funding The tests have been funded by a $2 million grant from the National Institutes of Health.

The bottom line Peru’s banks and carriers aim to get one-sixth of the country’s 30 million citizens using their mobile money program in ﬁve years. Edited by Jeff Muskus Bloomberg.com

Cost Lipkin says his lab device can test a sample and obtain a deﬁnitive diagnosis for $100 or less. Market Bill Martineau, senior health-care consultant at market researcher Freedonia Group, says about 10,000 labs would be interested in Lipkin’s tests, plus “all the hospitals.”

2. Analysis The technician runs the solution through a sequencing machine to identify the virus and assess its resistance to treatment.

Next Steps Columbia is starting to look for Big Pharma partners to commercialize the tests, Lipkin says. Ahmet Ali Yanik, assistant professor of electrical engineering at the University of California at Santa Cruz, says a manufacturer would probably want to make the device more portable. “It’s a big step forward in terms of laboratory research,” Yanik says. “But there’s still a lot to do to make it a point-of-care diagnostic tool.” —Olga Kharif

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Markets/ Finance

Shale oil is swallowed by an accounting rule 36

How low crude goes 36

The most painful cut for Japan’s banks 38

A Chinese broker crosses the line 37

Bid/Ask: Crock-Pot ﬁnds a new home 39

December 21 — December 27, 2015

SPDR Barclays High Yield Bond ETF Percent change

12/31/14

PHOTO ILLUSTRATION BY 731; PHOTOS: ISTOCK (2)

12/14/15 -13%

It’s Getting Ugly In the Junkyard A fund freezes withdrawals, and fear grips the market “We’re looking at some real carnage”

Investors who piled into the riskiest corners of the debt markets searching for higher yields are getting a reminder of what a credit crunch looks like—just eight years after the one that led to the global financial crisis. The woes of the high-yield debt market can be traced to the decline in commodity prices, which has crimped revenue at many companies that issued junk bonds. Also, investors fretted over the prospect that the Federal Reserve would raise interest rates for the first time in seven years—which it did on Dec. 16—because higher rates could depress prices of existing bonds. After suffering redemptions of almost $1 billion this year through November, the Third Avenue Focused Credit Fund, which specialized in low-rated junk bonds, froze redemptions on Dec. 9. Martin Whitman’s Third Avenue Management, which operates the mutual fund, said raising cash to give shareholders their money back would force it to unload bonds at fire sale prices. Lucidus Capital Partners, a high-yield hedge fund founded in 2009, said on Dec. 13 that it had liquidated its entire portfolio and would return money to investors in January. And a hedge fund run by Stone Lion Capital Partners said it stopped returning cash to investors after clients sought to pull out too much money. “It’s definitely a dark cloud over the market,” says Anthony Valeri, a strategist at LPL Financial, an advisory firm in Boston. Investor withdrawals “are driving the high-yield market now.” Investors Jeffrey Gundlach, Bill Gross, and Wilbur Ross predict more losses. “We’re looking at some real carnage in the junk-bond market,” Gundlach, chief executive officer of DoubleLine Capital, said on a Dec. 8 webcast. He says he finds it “a little bit disconcerting” to talk about rising rates with “corporate credit absolutely tanking.” Other money managers are worried that panic in junk bonds could infect healthier markets. The selling “may lead to a cascade of more selling and liquidity issues,” says Michael Rosen, chief investment officer of Angeles Investment Advisors. Financial markets have seen that scenario play

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-29.1% -28.6% -11.6% -10.5% -9.6% DATA: MORNINGSTAR, BLOOMBERG

out before: In 2007, Bear Stearns and BNP Paribas halted redemptions at several of their investment funds after the value of their subprimemortgage holdings plummeted. That was a harbinger of bigger losses and liquidity issues at major banks that hobbled the global economy. “A lot of this looks like late 2007 or early 2008,” says George Cipolloni, manager of the Berwyn Income Fund. “But instead of housing and mortgages, it’s energy and materials leading the decline.” For every junk-bond issuer that had its rating boosted this year, two have been downgraded, a ratio not seen since 2009, according to data compiled by Bloomberg. Defaults are increasing. Swift Energy’s failure to make an $8.9 million interest payment in early December raised the global tally of defaults to 102 issuers, a figure last exceeded in 2009, Standard & Poor’s says. The SPDR Barclays High Yield Bond exchange-traded fund, which serves as a proxy for the market, fell 13 percent this year through Dec. 14. More than economic problems are at play, though: Liquidity is also an issue. There are now 35 U.S.-based high-yield exchange-traded funds with $43 billion under management, compared with three funds with $1.3 billion in 2008, data compiled by Bloomberg show. The number of high-yield bond mutual funds has grown to 252, from 100 in 2008, and assets increased to $326 billion, from $126 billion. Mutual funds and ETFs promise investors ready access to their cash, but bonds can be hard to sell in a hurry. The Third Avenue Focused Credit Fund in many instances had

purchased 10 percent or more of smaller bond offerings. Such large positions in infrequently traded debt are especially challenging to dispose of. The fund also bought the debt of bankrupt companies, which often must be held for years to pay off. Focused Credit was the biggest holder of one set of bonds issued by bankrupt power producer Energy Future Holdings, regulatory filings show. The fund, which had assets of $3.5 billion as recently as July 2014, was down to $788 million when it halted redemptions. The fund had lost 13 percent in the month leading up to the announcement and was down 27 percent this year, according to data compiled by Bloomberg. The financial system is less vulnerable to junk bonds than it was to subprime mortgages. Today, in part because of the Dodd-Frank Act of 2010, banks are better-capitalized and have smaller inventories of thinly traded debt. According to the most recent filings, the trading units of the five largest Wall Street banks had a combined $6.7 billion of corporate debt designated as Level 3, meaning it’s difficult to value and sell. That’s less than 1 percent of their combined $803 billion in common equity. Lehman Brothers Holdings by itself had $25.2 billion of Level 3 mortgage-backed and assetbacked securities in its trading book at the end of 2007, a total that exceeded its $21.4 billion in equity. “I don’t see any systemic risks out of this,” says Fred Cannon, a Keefe, Bruyette & Woods bank analyst, likening the current situation more to the popping of the Internet bubble than to the credit crunch that crippled the financial system. “If this is a signal of a recession, then you have to believe any kind of downturn in the economy, as it relates to the large banks, will look a lot more like 2001 than 2008.” Yet some investors can’t shake the shadow of the financial crisis. After all,

it took almost a year for Bear Stearns to collapse after it closed its mortgage funds. “This isn’t going to be the big systemic unwind that everyone’s been waiting for,” says Jon Mawby, a bond-fund manager at Man Group’s GLG unit. “In my view, that comes with a lag of 6 to 12 months from now and will be caused by a bigger fund falling over.” —John Gittelsohn, Michael J. Moore, Sridhar Natarajan, Charles Stein, and Miles Weiss The bottom line After suffering almost $1 billion in withdrawals and losing 27 percent, a junk-bond fund stopped redemptions, rattling the market.

Energy

Billions of Barrels of Oil Are About to Vanish An accounting rule is erasing reserves from drillers’ books “There was too much optimism. … It was a great game while it lasted”

Across the American shale patch, drillers are being forced to square their reported oil reserves with the hard economic reality of today’s depressed oil prices. Under accounting rules that the industry lobbied for, drillers must now acknowledge what their investors already know: With crude trading below $40 a barrel , a lot of oil isn’t going to see t e light of day anytime soon. The mov by Congress to lift restrictions on U.S. c ude exports is not expected to have a significant effect on prices. Chesapeake Energy, co-fo nded by fracking pioneer Aubrey McClendon, and other shale producers pu hed the Securities and Exchange Com ission for an accounting change in 009 that made it easier to claim eserves from wells that wouldn’t e drilled for

Crude Cheap Grades Near $20 While price declines in West Texas Intermediate and Brent crude oil make headlines, grades that cost more to process are trading for even less, reducing revenue for producers worldwide. —Angelina Rascouet and Javier Blas

West Texas Intermediate $ Brent $37.44 Price per barrel

$40

Markets/Finance years. Having more reserves on the reported reserves in February and books makes it easier for a company March of this year. The 2015 average, to raise money from investors to including the Dec. 1 price, comes out fund operations. But there’s a catch: to $51 a barrel. “They got such a break The rule requires that the undrilled with the price for last year,” says Ed wells claimed as part of reserves be Hirs, a managing director at Hillhouse profitable at a price determined by an Resources, an independent energy SEC formula, and the wells must be company. “But it sure as hell isn’t going drilled within five years. to happen this year.” —Asjylyn Loder Time is up, prices are down, and The bottom line With oil trading below $40 a the rule is about to wipe out billions barrel, Chesapeake Energy will have to reduce the reserves on its books by 45 percent. of barrels of shale drillers’ reserves. The reckoning is coming in the next few months, when the companies report 2015 figures. “There was too much optimism built into their forecasts,” says David Hughes, a fellow Investing at the Post Carbon Institute. “It was a great game while it lasted.” The rule change will cut the inventory at Chesapeake by 45 percent, regulatory filings show. Discoveries and expansions of existing wells will offset some revisions, the company said. A spokesman for Chesapeake declined to comment further. Other drillers reducing reserves include Bill Barrett, which will lose as much as 40 percent, and Oasis Petroleum, which will erase 33 percent, according to filings. A Bill Barrett spokesman declined to Citic is accused of helping comment, and Oasis didn’t respond foreigners bet against stocks to questions. When industry advocates lobbied the “The sands of regulation in China SEC, they argued that hydraulic fracturare always shifting” ing was a new technology that unlocked A year ago, it looked as if Citic oil and gas in underground rock, Securities, China’s biggest brokerage making drilling more predictable than and investment bank, was heading it used to be—so untapped oil should be for a great 2015. The company precounted as part of a company’s assets. dicted in November 2014 that its A quirk in the SEC’s pricing formula annual revenue could climb sixfold, allowed the drillers to meet the rule’s to 120 billion yuan ($18.6 billion), by profitability requirement last year. The 2020. In December it passed Credit agency’s yardstick is an average of the prices on the first day of “More than one-third Suisse Group in market value, making it the fourth-largest each month during the cal- of the global oil production is not global securities company. In endar year. That average economical mid-June, Citic raised $3.5 billion came to $95 a barrel at the at these prices.” selling shares in Hong Kong, end of 2014, even though —Ehsan Ul-Haq, senior consultant, with sovereign wealth funds oil was trading below $50 KBC Advanced from Kuwait, Malaysia, and by the time the companies Technologies

ILLUSTRATION BY 731. CRUDE DATA COMPILED BY BLOOMBERG

The Fall of China’s Goldman Sachs

$35.35

Ecuador Oriente $29.27

Iran Forozan $31.07 Saudi Arab Heavy $29.42 Venezuela basket $31.24

Venezuela’s national budget for next year assumes a price of $40, but its own crude is trading at about $30

Colombia Vasconia $3 .02

Mexico mix $27.74

$30

Indonesia Duri $28.91

Singapore among the investors. Everything changed after Chinese stocks began to plunge, falling 43 percent from June 12 through Aug. 26. Now Citic is embroiled in a police investigation and a probe by the China Securities Regulatory Commission. Its chairman is being replaced and its top leadership reorganized. At least nine Citic executives have been investigated for alleged insider trading or haven’t shown up to work and can’t be reached. The company’s stock has fallen more than 50 percent from its peak in April. The downfall of the company sometimes called the Goldman Sachs of China stems from its special role in the nation’s rapidly developing financial industry. Citic Securities’ privileged position as a unit of Citic Group, China’s first state-owned investment company, allowed it to experiment in ways few other brokerages could, testing the limits of China’s push to open its securities markets to foreign investors. Citic Securities became a leader in products such as stock-index futures and cross-border return swaps that had approval from regulators, until the rules changed and suddenly they didn’t. “The sands of regulation in China are always shifting, and the rules are never quite as solid as you would expect in a more advanced economy,” says Arthur Kroeber, managing director of Gavekal Dragonomics, an economic research firm in Beijing. The initial police probe of Citic Securities focused on whether the company was giving foreigners a way to short mainland stocks—that is, bet the stocks would decline— at the same time it was engaged in government-sponsored efforts to prop up the market, says a person familiar with the events of the past few months, who asked not to be identified because of the sensitivity of the investigation. Only after the inquiry began did police expand it to insider trading

Mexico used put options to secure a price of $49 a barrel for 212 million barrels of planned 2016 exports

Iraq Basra Heavy $25.72

Western Canada Select $21.82

Western Canada Select, which is heavy and sulfurous, has slumped 75 percent in the past 18 months

$20

Markets/Finance and other possible violations, say people familiar with the investigation. A Citic Securities spokeswoman says the company “has and will continue to fully cooperate with the regulators in the relevant investigation and strictly fulfill its disclosure obligations in accordance with the relevant requirements.” China’s Ministry of Public Security and the regulatory commission didn’t respond to requests for comment. Citic Securities got approval to offer cross-border swaps on a pilot basis in early 2013, says a person familiar with the matter. Swaps provide a way for investors to get the gains and losses on assets—shares, stock indexes, bonds— without owning them. In this case, Citic Securities owned the asset, exchanging a fixed payment from the foreign investor for the returns Change in Chinese stocks from the asset. from June 12 China’s govthrough Aug. 26 ernment limits how, and how much, foreign institutions can invest in the nation’s domestic securities markets. With its total return swaps, Citic was effectively allowing foreign investors to trade in China’s markets without the investors having to get government approval. A diagram in a Citic investor presentation reviewed by Bloomberg shows how profits or losses from onshore trading would be paid or billed to a foreign investor via Hong Kong-based Citic Securities International. In exchange, Citic Securities International would receive money from the investor. In theory, no foreign money would cross the border, because Citic Securities and Citic Securities International would be transferring funds within the same corporate structure. The company wasn’t shy about promoting the swaps. Wang Dongming, Citic Securities’ outgoing chairman, discussed them in an interview with the China Securities Journal in May 2013, calling them an innovation that brokerages could use to serve foreign institutional clients and high-net-worth individuals. The city government of Shenzhen named the swaps one of the top financial innovations of 2014. The investor presentation said, “Rendering

-43%

greater market opportunities to foreign financial institutions will be a vital prerequisite for the firm’s global strategy and sustainable development.” A hedge fund adviser who sat in on a pitch for the swaps says Citic touted them as a shorting tool. He also says that in a meeting with Citic in June he discussed using swaps to short index futures. He asked not to be identified because of Chinese regulatory scrutiny. If Citic’s woes deepen, regulators could encourage a rival to buy the company, say analysts at Daiwa Securities Group. Wang, 64, who hasn’t been implicated in the government investigations, is retiring because of his age, according to a company statement in November. Because China’s markets have long been plagued by insider trading and fraud, “a well-targeted and fair anticorruption probe there would be welcomed by many people,” says Barry Naughton, a professor of Chinese economy at the University of California at San Diego. “But this process looks from the outside like an unfair and arbitrary search for someone to blame for the summer market meltdown, and it is making everybody in the industry extremely nervous.” —Bloomberg News The bottom line After pioneering new ﬁnancial instruments, Citic is under investigation by the police and the securities regulator.

Finance

Japanese Lenders Get Ready to Cut the Cord Banks will sell stakes in their top clients to comply with new rules “Now we’re entering the more tricky conversations”

Japanese banks finally seem ready to relinquish a crucial tie to their best corporate clients. Mitsubishi UFJ Financial Group and two other large lenders pledged in November to sell as much as $15 billion in crossshareholdings—stock in companies they do business with—a long-awaited move that analysts say will benefit the banks and make companies more responsive to outside investors. As part of the process, the lenders

Prime Minister Abe wants big companies to stop owning shares in one another will have to allay the fears of clients who have long relied on them as friendly shareholders to ensure financing, fend off takeover threats, and keep more demanding investors at bay. Although banks have slowly been trimming their cross-shareholdings for years, they’ve generally held on to stakes in their most important customers. “A lot of the easy unwind has already taken place,” says Kathy Matsui, vice chair and chief Japan equity strategist at Goldman Sachs in Tokyo. “Now we’re entering the more tricky conversations.” Prime Minister Shinzo Abe is encouraging big companies to stop owning shares in one another as part of the corporate governance code he introduced in June. The Financial Services Agency has been urging lenders to pare the stakes to make them less vulnerable to stock market swings. “Risks from equity volatility should be reduced,” Toshihide Endo, director general of the FSA’s supervisory bureau, said on Nov. 16. “We encourage them to make steady progress in cutting such equities.” Mizuho Financial Group will lower its cross-shareholdings by 40 percent in coming years, it said in a statement on Nov. 13. Sumitomo Mitsui Financial Group said it will reduce its ratio of stock holdings to common equity Tier 1 capital—a regulatory measure—by half within five years. Mitsubishi UFJ said it will trim its holdings to 10 percent of Tier 1 capital. It was “groundbreaking” for the lenders to specify numerical goals, says Hideaki Miyajima, a commerce professor at Waseda University in Tokyo, a sign that they are serious about following through. Cross-shareholdings emerged in postwar Japan after the U.S.-led occupation forced the breakup of conglomerates into separate companies. Those companies then cemented alliances by purchasing shares in one another. Such holdings accounted for 51 percent of all stocks in Japan by around 1992, says Kengo Nishiyama, a senior strategist at Nomura Holdings. Lenders sold much of their crossholdings during the nation’s banking

ILLUSTRATIONS BY OSCAR BOLTON GREEN

Markets/Finance crisis in the 1990s and early 2000s to comply with global capital requirements and a new domestic law limiting stock ownership. The largest banks cut their holdings from a peak of 27 trillion yen ($222 billion) around 1999 to 13 trillion yen in March 2003, and then gradually down to 8 trillion yen in March 2010, Miyajima says. The banks retained stakes in companies they had the deepest relationships with. With the Topix index doubling in the past three years, the three banks have unrealized gains of 5.9 trillion yen on their cross-holdings, estimates Shinichiro Nakamura, a senior analyst at SMBC Nikko Securities, adding that profits from selling the stock would help them bolster capital ratios and increase profits. Miyajima says banks may face resistance from their own executives worried about alarming clients who fear that selling pressure will push down their share prices. Based on what the three big banks have pledged, shares worth about 1.9 trillion yen could reach the market over the next five years or so, Nakamura says. So far the banks are not meeting much resistance. “We’ve started negotiating with the customers,” said Japanese Bankers Association Chairman Yasuhiro Sato, who’s also chief executive officer of Mizuho, on Nov. 19. “And of course, there aren’t that many that just say, ‘OK, go ahead and sell them.’” Yet they understand that companies need to comply with the new corporate governance guidelines. As a result, “almost no” clients have threatened to take their business elsewhere, Sato says. Some bank cross-holdings are in other banks. Mitsubishi UFJ owned 3.59 percent of Shizuoka Bank, a regional lender, as of September. A 20 percent to 30 percent reduction in that stake would be appropriate, says Shizuoka CEO Katsunori Nakanishi. “If you take a medium- to long-term view,” the reduction in cross-holdings “simply isn’t negative,” says Goldman’s Matsui. “Governance will be stronger, and the interests of true shareholders will be protected.” —Gareth Allan and Shingo Kawamoto The bottom line Three big Japanese banks have pledged to sell as much as $15 billion of stock they hold in their corporate clients. Edited by Eric Gelman Bloomberg.com

Bid/Ask

By Kyle Stock

$185m Mahindra & Mahindra buys Pininfarina. India’s biggest producer of tractors and SUVs is bringing some style to its cars and aiding its push into planes, yachts, and other playthings of the affluent. Pininfarina, a storied Italian design house best known for shaping a parade of vintage Ferraris, has designed trains, boats, and planes since the early 1980s, though it recently closed its car business.

$15b $4.8b $1.3b $841m

Newell Rubbermaid acquires Jarden. The purchase brings the kitchen giant Coleman camping gear, Mr. Coffee machines, Crock-Pot cookers, and Rawlings baseball gloves. Sumitomo Mitsui Finance & Leasing taps GE Capital. The company is buying GE’s Japan leasing business a few months after snapping up its European private equity ﬁnancing arm. Greece privatizes 14 airports. The government awarded a 40-year concession to Frankfurt-based Fraport and Copelouzos, a private Greek contractor. Cision purchases PR Newswire. Cision, which helps companies create media campaigns, now has a leading platform for pitching. PR Newswire will keep its name. Yahoo! Japan buys Ikyu. The travel website will help Yahoo sharpen its reservation game in Asia, where restaurant bookings still haven’t migrated to the Internet.

$575m $50m

AstraZeneca gains breathing room. The company purchased a respiratory business from Takeda Pharmaceutical, including a treatment for chronic obstructive pulmonary disease. A record Warhol house. The artist’s 5.7-acre compound set a record for Montauk, N.Y., a town on the tip of Long Island. It was sold by J.Crew Chief Executive Officer Mickey Drexler.

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Claire Su d d a t h P h o to g ra p h s by

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uniper Keithler is 3 years old and wants to be a princess. Her parents aren’t thrilled. “It started a year ago. She went to a friend’s house for a play date and saw the Elsa and Anna dolls, then came home singing Let It Go from Frozen,” says her mother, Athena Lutton Keithler, who lives with her husband and daughter in Denver, along with princess-themed bedsheets, T-shirts, dresses, sleeping bag, lunchbox, and backpack. Juniper would have even more if her parents hadn’t asked family members to stop buying the stuff. Every morning, Juniper asks to wear a princess dress and “loud shoes” with hard plastic heels. When she puts them on, she declares, “I’m becoming a woman!” “I really didn’t think this would happen. She’s not even in preschool yet,” Keithler, 31, sighs. She knew about the so-called princess phase that little girls go through, but, she says, “I assumed it was something girls do when it’s thrust upon them.” Keeping a 3-year-old girl away from Disney’s princesses is a lot like trying to get through January without hearing about the Super Bowl. Since Walt Disney lumped Sleeping Beauty, Belle, and its other poofy-dressed ladies together under the brand Disney Princess in 2000, the market for all things pink and sparkly has skyrocketed. Princess merchandise—dolls, clothing, games, home décor, toys—is a $5.5 billion enterprise and Disney’s second-most-profitable franchise, after Mickey Mouse. (Disney’s new Star Wars movie might change that.) That doesn’t even include Frozen, which came out in 2013 and which Disney measures separately. The movie spawned the top toy brand in the U.S. last year, selling $531 million worth of dolls and dresses, according to NPD Group. Di sney doesn’t manufacture most of the Princess products.

ro’s Hasb Snow n ew i t e Wh

“Wetook Disney for granted. We weren’t focusing on them.

Shame on us”

It licenses them to all sorts of companies: Glidden makes pink and purple wall paint, Stride Rite makes sparkly shoes. In toys, the most lucrative Disney Princess license is dolls. Specifically, 12-inch Barbie-esque figurines that girls can dress and undress until the dolls’ hairdos get tangled, they’ve lost their shoes, and it’s time to buy another. Mattel has worked with Disney since 1955, when it became the first sponsor for the Mickey Mouse Club, and it’s been the company’s go-to dollmaker since 1996. Last year, Mattel put the size of its Disney Princess doll business at $300 million, though analysts at Needham say it’s closer to $500 million. With sales of Mattel’s most famous toy, 56-year-old Barbie, tumbling 20 percent from 2012 to 2014 and still falling, Princess dolls have been a much-needed revenue stream. But not for long: The princess business disappears on Jan. 1, when Disney packs up its glass slippers and takes them to Mattel’s biggest rival, Hasbro. “Disney Princess was probably the greatest coup that Hasbro has had in the last three decades,” says Gene Del Vecchio, a former Ogilvy & Mather executive who has worked with Mattel and Disney in the past and helps Hollywood studios translate their movies into what he calls “merchandise opportunities.” Adweek likens Hasbro’s achievement to the Chicago Cubs winning the World Series. Disney is taking a risk turning to Hasbro. Mattel owns the doll market, and despite her recent stumble, Barbie is still the best-selling doll of all time. Hasbro, meanwhile, has traditionally kept to the boys’ side of the toy aisle, with brands such as Nerf and Transformers. But it has big plans for the princesses. Hasbro and Disney are redesigning and rereleasing every Princess doll, even Pocahontas, which few stores carry. Hasbro hired a few dozen people, mostly designers and developers, who work out of its newly expanded production studio in Burbank, just minutes from Disney. “We’re going to make the Princess brand far bigger and more ubiquitous than it has been in the past,” says Brian Goldner, Hasbro’s chief executive officer. If Athena Keithler thinks she’s got princess overload now, a lot more pink is headed her way.

Mat

tel

Disney used to market movies, not characters. Jasmine dolls were on store shelves only when Aladdin was out— either during its initial run or when it was rereleased. (The studio releases its animated films for just a few years at a time, then takes them out of rotation to drive up anticipation and demand.) That changed in 2000, when a newly hired Disney executive named Andy Mooney went to a Disney on Ice show in Phoenix. “I saw these girls ages 5 and 7, waiting to go see the show in full regalia— tiara, shoes, the works,” says Mooney, who is now CEO of Fender Musical Instruments. “I asked the mothers, ‘Where did you buy this?’ They said, ‘Well, we had to make this. You don’t sell it.’ I said, ‘If we made this, would you buy it?’ They said, ‘Loads of it.’ ” That year, Disney started selling products that featured all eight princesses, many from movies that weren’t in theaters. Hasbro made games, Mattel made the dolls and plastic

Fisher-Price figurines. Disney had never before sold or marketed merchandise picturing princesses from different movies together. “The prevailing wisdom at the studio was that somehow having the princesses gang together would destroy their individual mythology and therefore the value of their films,” says Mooney. To guard against this, Disney invented marketing rules: The princesses couldn’t look at each other. Their dresses had to be different colors. Sleeping Beauty and Cinderella both wore blue, so Sleeping Beauty, marketed under her first name, Aurora, changed into bubblegum pink. Eve n w i t h a l m o s t n o formal marketing plan in place beyond a few toy commercials, the Disney Princess brand surpassed $1 billion in sales within three years. “This was unheard of,” says Mooney. Disney made more movies and now has 11 princesses—13 if you include Elsa and Anna from Frozen. The next, a Polynesian named Moana, will make her debut in her own film next year. As Mattel was raking in money from the princesses, Hasbro underwent a transformation. The company, headquartered in a series of squat buildings in Pawtucket, R.I., hadn’t had a hit since the 1980s, when it came up with Transformers and My Little Pony. During the Pokemon craze, it survived on licensing fees. When that ended, Hasbro found itself selling a bunch of outdated toys. It barely survived a takeover attempt by Mattel in 1996. Transformers, once worth hundreds of millions of dollars, made only $25 million in 2000. “We’d let our brands lie fallow, and were losing a lot of money,” says Goldner, who came to the company that year as Hasbro’s president of U.S. toys and in 2008 became CEO. At 52, with thick brown hair and a youthful face, he has a sense of credibility when he talks about toys, as if he’s not too far removed from childhood himself. “I still remember a conversation about a cost-saving initiative, and someone asked me if we should close the FunLab,” he says, referring to the room at Hasbro’s headquarters where research teams watch children play with toys through a two-way mirror. “I said, we’re not going to close the FunLab, we’re going to use it to build back our own brands.” Goldner sent a team of 25 to travel the country, talking to parents and kids about their toy-shopping habits. They found that children still liked playing with Transformers, they just hadn’t seen them on TV. (The original Transformers series ended in 1987.) The toys they really wanted were all connected to movies and shows. “Kids respond to characters and stories,” says John Frascotti, president of Hasbro’s brand division. If Hasbro wanted to get children to embrace its toys again, it would have to give them something to watch. This wasn’t a new idea. The toy industry has known about

the power of movie-based merchandising since 1977, when the first Star Wars came out and Han Solo and Darth Vader action figures became so popular that Kenner Products, a now-defunct toy company, resorted to selling empty boxes with IOUs inside. But what had changed was that toy tie-ins had gone from something associated with a few smash hits to the near-universal requirement that toys come with a movie or TV show. Today, the $23 billion U.S. toy industry fluctuates a few percentage points every year, but sales of toys that don’t have their own movies or shows are flat or declining. “Five years ago I would’ve told you that technology was hurting toys because kids were watching their iPads instead. Now I think it’s helping—even preschoolers are engaging with brands,” says NPD Group’s Juli Lennett. Hasbro stopped calling itself a toy company. Today, executives prefer to describe their business as “creating play experiences.” In 2007, Hasbro co-produced Transformers, directed by Michael Bay, with Paramount Pictures. The movie made $710 million worldwide and was such an astounding hit that Hasbro opened its own film studio in Burbank. It has since made three more Transformers movies, each more successful than the last. Whenever a new one opens, toy sales double. Hasbro transferred a handful of toy designers from Rhode Island to Burbank to “work with the filmmakers to ensure that the characters you see on the screen can be turned into toys,” says Patrick Marr, director for model development. It also collaborated with the Discovery Channel to launch the Hub television network (later Discovery Family) to serve as a home for shows based on its brands. Hasbro used the network to revive My Little Pony. It’s become one of Hasbro’s topselling lines, with nearly $1 billion in sales last year, thanks to its My Little Pony: Friendship Is Magic show. Not everything Hasbro touches has been a hit. Battleship, the 2012 movie based on the game, flopped. Jem and the Holograms, released in October, has yet to earn back its $5 million budget. But the successes have more than offset the bombs. Unlike Hasbro, Mattel didn’t think it needed movies to sell toys. “I wouldn’t say there’s been a major sea change,” says Tim Kilpin, Mattel’s former chief commercial officer, who left the company in November. “The way we were selling toys in the ’70s and ’80s is the way they’re selling toys today.” Talks of a Barbie movie cropped up internally from time to time—Del Vecchio, the former adman, says he saw scripts 15 years ago and once wrote a draft himself—but nothing ever came of it. Instead, Mattel preferred to go small. A 2012 Netflix series starred Barbie and her Dream House, complete with a talking closet. A Barbie YouTube channel posts three-minute videos once

“These

princesses

kids in the same way that they taught them which sports teams to root for. “We have a fancy term for it that we made up,” says Frascotti. “We call it trans-generational emotional resonance.” Disney liked Hasbro’s FunLab reports. “They’d seen them work quite well for Star Wars and Marvel,” says Goldner. “Then they asked us what we knew about girls.” Hasbro researchers found that girls—young girls, particularly—weren’t nearly as into clothes and boys and happily-ever-after as they thought. “What we found was that girls loved the idea of a brand that embraced friendship and kindness,” Goldner says. Impressed with Hasbro’s analysis, Disney gave it a small license for Descendants, a made-for-TV movie it was developing about the teenage kids of its princesses. Meanwhile, Mattel made what, in hindsight, seems like a pretty dense move: In 2013 it released its own line of princess-themed dolls, Ever After High. Unless you’re a girl under 10—or the parent of one—you’ve probably never heard of them. Designed to be the teen children of Cinderella, Snow White, Little Red Riding Hood, and other characters, they wear platform shoes, bodices, and short, sometimes see-through skirts: tartedup versions of Disney’s Princesses. Stephen Sumner, a former Barbie designer now at Hasbro, did early sketches of the line. He says Mattel envisioned a line of witch dolls, then realized another company already had one. “So they had to turn it into princesses, even though there was kind of an overlap,” he says. Because the dolls were based on traditional fairy tales, Mattel didn’t have to pay Disney licensing fees. Disney didn’t like the competition. Several former Mattel employees point to the 2013 release of Ever After High as the last straw for Disney. Chris Sinclair, a Mattel board member who took over as CEO in January, agrees. “We got too competitive with them on Ever After High,” he says. According to Mattel’s annual report, Ever After High accounted for just $53 million in added sales last year. Hasbro was busy working on its Descendants line when Disney called in early 2014 with a new proposal. “They said,” Goldner recalls, “ ‘What would you do if we gave you the entire Disney Princess business?’ ” Disney explained that it was reimagining its princesses. Its license agreement with Mattel was coming up for renewal, and it was shopping for a new dollmaker. The company was starting to hear you’re-sending-the-wrong-message-to-our-daughter complaints from parents. The most biting criticism came from New York Times Magazine writer Peggy Orenstein, author of the 2011 book Cinderella Ate My Daughter. She often opined about the time her daughter’s dentist asked her to sit in his “princess chair” so he could “sparkle” her teeth. “Parents were talking about the ‘princess phase’ as if it were an actual stage of development,” says Orenstein. Disney decided to try to portray the princesses more as heroines than damsels. The company worked with Jess

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a week. None of it’s very good. But it’s safe. “If you make a big movie about Barbie and it bombs, it could have long-term repercussion for Mattel’s toy business,” says Del Vecchio. “You have to be extremely careful with the golden goose.” When Mattel started to make Disney Princess dolls 15 years ago, they came with their own sleek, sparkling movies, and it was basically creating competition for its best-selling brand. It didn’t help that the dolls were the same size and shape as Barbie, giving the impression that Barbie had just gotten a job as a Cinderella or Belle impersonator. Things got more complicated in the late 2000s, when Mattel released a line of princess-themed Barbie DVDs and dolls, essentially pitting them against Disney’s line. When Barbie’s sales started to fall in 2012, she became Mattel’s problem child. “Barbie is going to continue to be a brand that we spend a lot of time and attention on to make sure she [improves],” Mattel’s then-CEO, Bryan Stockton, told investors last year. Mattel’s focus on Disney’s Princesses waned. “Disney essentially said, ‘Yo, Mattel, you have a Barbie problem—in the process of fixing that problem, are you going to [still] pay attention to my brand?’ ” says Sean McGowan, toy analyst at Oppenheimer & Co. In 2013, Disney set up a meeting with Hasbro, which already had Disney’s Star Wars and Marvel licenses, and its FunLab ran regular tests for the company. Before each Star Wars movie, for example, Hasbro tested kids’ familiarity with the franchise. They discovered that parents—“dads mostly,” says Frascotti—passed down their love of Star Wars to their

D P isn $7 rinc ey 2 2 es m s

Weiner, a branding consul- Retail Value of Toys and Games Sold, 2014 tant who helps companies Girls’ toys rethink the way they market Fisher-Price Barbie to women. “Disney wanted $2.8b $1.9b to reach girls and women in more authentic ways,” says Weiner. “We looked at the My Little Playskool Nerf Pony $421m $621m $629m Princess products. On backMonster High packs and things, these prin$716m Littlest Pet Shop cesses had always been fairly $257m Play-Doh FurReal Furby homogenous-looking and in $403m Friends $167m passive poses. Anyone who’s $185m American spent time with a 5-year-old Monopoly Other toys Girl $352m $401m and games knows they’re not into passively posing.” In new movies, Other girls’ toys Hasbro Transformers Disney was able to create couOther toys Hot Wheels MEGA Bloks $390m Mattel and games $854m $612m rageous, independent women Star Wars from scratch. In Frozen, $377m the princess Elsa winds up Pixar Cars $240m without a prince. Star Wars: Magic: The Matchbox $191m Gathering $329m The Force Awakens focuses on Uno $172m a female warrior named Rey, DATA: EUROMONITOR Mattel Hasbro who runs and fights and at no point becomes enslaved in a gold bikini. But the older princesses one of his first moves was to call Disney and apologize. Disney needed some work. “The Princess franchise has to evolve,” says executives drove across town in Los Angeles to Mattel for several Josh Silverman, executive vice president for global licensing at meetings and to see what other toys Mattel had in the works. Disney Consumer Products, the division that handles all the Since January, two-thirds of Mattel’s senior executives have brand licenses. “The focus will be on empowered heroines.” stepped down or been laid off. “We’ve dealt with it as directly and forthrightly as we can,” Sinclair says. He and Disney insist To win Disney’s Princess license, Hasbro had to ﬁgure out that their relationship is fine and point out that Mattel still makes how to translate this lofty vision of “empowerment” into a plastic toys for other Disney brands, including Mickey Mouse. doll. Hasbro’s researchers talked to thousands of girls at the company’s Pawtucket headquarters, as well as in Hong Kong, When Hasbro’s Disney Princess dolls go on sale on Jan. 1, London, and Los Angeles, and found that girls thought about all 11 will be available in toy stores for the first time. The dolls princesses in much the same way that boys viewed superheroes. will have different heights and waist sizes (though not by much). Sometimes they liked a character because of her dress; other Their flawless skin will come in various shades of—well, mostly times they focused on her abilities, such as archery and sword white—and their facial features have been directly modeled fighting (Merida, from Brave) or the ability to conjure ice and after the characters in the films, not painted on a preexisting snow (Elsa). “Sometimes they want a prince, sometimes there mold. Their arms are stiff, and their hair isn’t as easily brushis no need for a prince,” says Frascotti. Disney didn’t have to able as Barbie’s, but they’re simpler, cleaner, and easy to tell reimagine the princesses, it turned out. Girls had already done apart. They look like Disney’s animated characters come to life. it themselves. The dolls had just never been marketed like that. These distinctions are subtle, but, Hasbro and Disney hope, “Every girl knows Cinderella, but there are 11 princesses,” they’ll make each princess feel like a fully realized person, not says Andrea Hopelain, a former Disney marketing director who’s just one of 11 lookalikes separated only by the color of her dress. vice president for global brand strategy at Hasbro. In toy stores Hasbro CEO Goldner admits that the first few months of sales today, at the end of Mattel’s reign, the available Disney Princess will probably be slow as stores discount Mattel’s old dolls to get dolls almost always come from one of four movies: Cinderella, rid of inventory. “After that, it’s our brand to manage,” he says. The Little Mermaid, Beauty and the Beast, and Frozen. Toys “R” Both Hasbro and Disney say they plan to highlight the prinUs’s flagship store in Times Square is 110,000 square feet and cesses’ bravery and skills in future advertising, and to give sells toys to millions of children every year, but right before the nonwhite princesses more shelf space. “A 4-year-old girl Christmas this year, it had only one Tiana toy (Disney’s only doesn’t realize how the world she lives in is different from 10 or African American princess, from The Princess and the Frog). 15 years ago, but her parents do,” says Frascotti. And parents, That will change with Hasbro. “We can reintroduce Mulan,” he points out, are the ones who buy the toys. Little girls’ worlds will soon be filled with even more dolls says Hopelain. “We can play up that Tiana is a great cook.” Hasbro’s ideas impressed Disney. “It was pretty late in the and dresses and sparkles and tiaras as Disney churns out more game last year when we became aware the loss was a poten- movies and Hasbro makes more toys to go with them. The tial,” Sinclair says. “It deteriorated in about three or four Frozen sequel, the new Moana movie, and a live-action Beauty weeks.” Disney officially gave the Princess license to Hasbro and the Beast film are all coming out in the next few years. “I in September 2014. Mattel is tight-lipped about how and when had no idea the princesses would grow into this,” marvels it found out, but Sinclair was surprised when Stockton, still Andy Mooney, who still can’t believe how one trip to a Disney CEO, called him to say they’d lost the business. “We took on Ice show could inspire an empire now worth more than the Disney for granted. We weren’t focusing on them,” Sinclair Dallas Cowboys. “The phase when little girls play dress-up is a brief moment in time. But it’s a brief moment in time when says. “Shame on us.” Three months later, Stockton was out and Sinclair was in; they spend a lot of money.”

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Every day around 5 p.m., a human wave builds at the and promoter of clothes so ridiculously cheap west end of London’s Oxford Street. It gathers energy as that buying them on a whim because you like it approaches a pile of gray stone and scuffed brick that someone’s outfit on Instagram is an entirely reatakes up almost a full block, and then crashes through sonable idea. A rust-colored “bandeau crinkle double doors into a cavernous space garlanded with bright maxi” dress? £13 ($19.70). “Rip and repair” T-shirt dresses and tasseled scarves. skinny jeans? £15. A slim-cut floral-print This is rush hour at fast-fashion retailer Primark’s flagmen’s shirt can be had for £8, and denim ship store. The tide comes in around lunchtime, again after espadrilles are £4. work, and then periodically throughout the weekend. On What’s trending or not gets evaluated ES companywide every day, so buyers in a dark October afternoon, Peter Franks is just inside the STOR IN ED entrance, wearing a skinny-lapel suit and a correspondingly OPEN EAR Dublin or Reading, England, know whether Y L slim tie and trying to stand his ground against the crowd. For to make a rush order for more “suedette” FISCA D IN E Franks, Primark’s store-design guru, these surges—students A-line skirts or gray twill kick-flare trouD EN MBER sers. Their decisions are the sharp end of in jeans and tank tops, suited banker types, women in E T P SE face-covering niqabs tapping on rhinestone-studded iPhones— one of retail’s most regimented logistics operations, present certain problems, such as moving customers through stretching from countries such as Bangladesh to shopping the 44 fitting rooms, preventing endless lines at the 104 cash drags all over Europe. registers, and getting seven or more daily deliveries of new Thanks to aggressive expansion in the U.K. and Ireland, styles onto the floor. Another dilemma: price tags—specifically, where Primark has about 200 stores combined, where to put them. and in Spain, Germany, and France, the company The crowds get so thick, Franks says, that has become a household name for Europeans. seeing anything below 5 or 6 feet Now Primark is testing its low-price stratwould be like trying to egy in the U.S., the world’s most competitive read a Post-it through retail market. In September it opened its first a swarm of bees. That American store, a 77,000-square-foot, fourmeans price tags have floor flagship in downtown Boston—chosen to be placed high up, in the hope that the city’s many college stuas does signage to tell dents, who come from all over the country, people where to go in the would sing Primark’s praises on Instagram, 71,000-square-foot store, spreading the message beyond New which has a maximum England. A second elaborate store, at the occupancy of about 3,200 King of Prussia mall outside Philadelphia, and can get close to it at opened in November. Both are part of a busy times. test run of eight or so U.S. locations. The idea is to Each table of stacked jeans offer prices Americans are used to seeing on less-than-hip or bathrobes or sweaters has clothes from Kohl’s or Walmart on trendy pieces another price display lower down, often in a laminated that change from day to day. stand. That’s so once shoppers elbow their way to the goods, Primark is entering the neat columns don’t turn into disheveled heaps as they paw a cutthroat retail landthrough looking for tags. It took a while for Primark to figure scape that’s recently stalled once-hot brands this bit out, Franks says. Before, things were a lot messier. It’s Franks’s job to worry about the physical feel of such as American Apparel Primark’s stores. Price tags are a consideration of titanic and Abercrombie & Fitch. importance. They’re more important even than the ideal The expansion is taking number of window displays (five, with two for women’s place in the void left by wear and one each for men, kids, and home), or whether another U.S. retail casujeans should be hanging or folded (hanging for more fashion- alty, Sears, which is leasing M GRARS forward styles so you can see the detailing, folded for basics). Primark space it’s abandoning. A T INS LOWE Price is by far the biggest reason Primark is the undisputed “We cer t ainly weren’t FOL victor in Britain’s cheap-fashion war. Secondary scared by what we saw at the are its up-to-the-minute designs, jazzy value end of American retail,” stores, and tireless promotion on social George Weston, chief executive officer of Primark parent media. Primark doesn’t sell online and Associated British Foods, says in his compact London office, barely advertises. Instead, customers furnished in utilitarian blond wood, a couple of blocks from advertise it for free, posting thousands of Oxford Street. “The Walmart offer, the Target offer, Kohl’s as selfies with their latest outfits, using the well—it didn’t look like something that would be any more dif#Primania hashtag to be rated and critiqued. ficult to compete against.” The move to the U.S. is undoubtThe best images get cycled onto giant in-store edly Primark’s riskiest yet, and a splashy one for a retail brand LED screens to spur impulse buying. that until 2006 hadn’t even expanded beyond the British Isles. Controlled by the Weston family, a clan of Anglo-Canadian billionaires whose other prodET If Primark has a father, it’s a man named Arthur Ryan, but RE FE ucts include food additives and Twinings tea, SQUA ORES TO he’s not easy to get to know. Having hardly ever given an Primark has become the unlikely apex predator OF STPENED IN interview or a speech, he’s the Keyser Söze of retail. “I’ve 6 EO of disposable fashion. It’s a relentless curator B ISCAL 201 never spoken to him, and I’m not even sure I know anyone

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who has,” says Wendy Liebmann, a 20-year industry veteran who’s the CEO of consultant WSL Strategic Retail. ABF won’t confirm Ryan’s age—he’s thought to be in his late 70s, though Wikipedia puts him at 85—let alone make him available for an interview. Approached by a reporter at the opening of the Boston store, Ryan immeAlexanderplatz, an diately turned to introduce his wife and in art nouveau take on the one fluid motion disappeared, heading deeper grand European department store on inside, all within about 10 seconds. Madrid’s label-choked Gran Vía, and so on. What is known is that in the late 1960s, Much of the international interest is a result of what Ryan was hired by Garfield Weston and his son Galen, who’d CFO Bason calls the “Ryanair effect,” after the ultrabudget made a fortune running bakeries in Canada and Britain, to European airline that whisks continentals to London for fares expand their Irish businesses. Ryan had an idea for a store as low as a few euros. About half of shoppers at the London selling cheap, trendy clothes and opened it in 1969. Dubbed flagship are tourists. On a November evening, two of them Penneys, it was a hit in Ireland; when it came to are Madiha Shatila, a 27-year-old doctor from Lebanon, and Britain, it was renamed Primark to avoid stepping her sister Marjan, 24. After an epic journey through the store, on J.C. Penney’s toes. the pair sit on a ledge outside, recovering with a cigarette, He spent much of his time as Primark CEO making surrounded by five of Primark’s trademark brown paper bags unannounced store inspections to scrutinize minu- jammed with dresses, tops, shoes, and gifts for relatives. tiae such as the dimensions of signage, the height They’d spent about £250. “My friends in Lebanon said, ‘You’re of shelving, and, of course, the placement of price going to London? You have to go to Primark,’” Madiha says. tags. That Primark prices are almost always round “I couldn’t believe how much we bought,” she adds. “There’s numbers without decimals—not .99s or .95s—was nothing like this at home.” a Ryan call, says ABF’s chief financial officer, John Bason, because he thought “the price is After Ryan left as CEO, the company continued doing fast the price” and didn’t require gimmickry. fashion faster, cheaper, and trendier than its competitors, Ryan’s obsession with details meant he some- and it did it in more places. From 2009 to 2012, sales climbed times needed to be nudged toward big moves. more than 50 percent, to £3.5 billion a year. Then, on April 24, When ABF bought the 120-store Littlewoods 2013, Rana Plaza, an eight-story complex of garment workchain a decade ago, intending to use some shops in Bangladesh, collapsed. More than 1,000 people died. locations for new Primarks and sell the rest, Survivors described the floor disappearing beneath them, Ryan initially wanted to keep only three, trapping workers in a tangle of metal rods and smashed conGeorge Weston recalls. (George, Garfield’s crete. In all, about 670 employees of a Primark supplier were grandson and Galen’s nephew, took over killed or injured. as head of ABF in 2005.) ABF brass had to Fast fashion—and plenty of slow fashion—wouldn’t exist push Ryan “quite hard” to keep 41 stores. without places like Bangladesh, where suppliers have develThe move made Primark a U.K.-wide heavyweight oped a huge export industry sewing clothes as cheaply and for the first time. quickly as possible. Regulation and safety standards are inadRyan became chairman in 2009. His successor as Primark equate. At Rana Plaza, workers who saw cracks developing CEO, Paul Marchant, has focused on international expansion in the structure sensibly left, but they were ordered back to and ever-snazzier stores to woo customers with a sense of occa- their posts before the disaster. sion they wouldn’t usually associate with bargain bin prices. Although many other retailers also That’s where Franks comes in. Before joining Primark in 2008, N he worked in store design for both Louis Vuitton and TK THE BOSTO N DEC. 5 O K R Maxx, a European cousin of TJ Maxx. “The design chal- PRIMA HE MEN’S ); T lenge for us is how to take a volume operation, in (LEFT TMENT R A DEP terms of retail, and make it fun” rather W) BELO ( than stressful, Franks says. At this, Primark doesn’t always succeed. Depending on your perspective, it might be the first or last place you’d want to spend a Saturday afternoon. At peak times, crowds jostle for fitting rooms. Shirts get balled up on the floor, bringing to mind the world’s largest teenage bedroom. Jeans are knocked from shelves. It can all begin to feel a bit, well, cheap. To counter that sentiment, Primark is adding polish to new stores, each of which seems higher-spec than the last. Stylized city maps and localized architectural vibes have become a trademark: a brutalist feel in Berlin’s

PHOTOGRAPHS BY AMY LOMBARD FOR BLOOMBERG BUSINESSWEEK (2)

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used Rana Plaza workshops, the British media pounced on Primark. Labor groups picketed the Oxford Street store and demanded it change sourcing practices. With a prominent brand and analysts at Bernstein. Primark should super rich owners, Primark was an easy expect competitors to respond with steep discounttarget, almost offering a morality tale: ing and fresh products, WSL’s Liebmann says. Already smartToo-good-to-be-true prices were possible ing from price wars, she says, U.S. retailers “can’t only by risking lives. afford to lose that extra trip or that ABF says it did all it could to respond to the disaster and extra spend.” improve conditions afterward, paying $14 million in aid and For Primark’s U.S. flagship, it compensation for workers and families, covering medical would have been hard to choose costs, providing food, and hiring engineers to conduct struc- a venue more evocative of the tural surveys. Executives are always eager to highlight the promise and peril of selling clothes company’s Bangladesh efforts in interviews and speeches. The in America. The Boston store occuresponse won praise from some activists, who say Primark pies the Burnham Building, a Beauxwas quicker than other retailers to help. Others argue that Arts confection known to generations of the very concept of prices low enough to make clothes dis- New Englanders as the home of Filene’s. ERS posable puts workers at risk. The department store was a Boston instiWORK PLY “As one of the drivers of fast fashion, which we’ve seen tution throughout the 20th century, until P IN SU IN has overall had a significant negative impact on workers’ it lost market share to larger competitors. CHA rights, [Primark] has a lot to answer for,” says Ilona Kelly, In 2005, Filene’s was swallowed by Macy’s, campaigns director at Labour Behind the Label, a U.K. group which shut the Boston store, leaving the building vacant. that pushes for stricter standards. And tragedies still occur. Primark came along in 2013 as it scouted locations for its U.S. In September the rooftop canopy of a Pakistani factory that debut. While the “received wisdom was that an unknown produced for Primark and other brands caved in, killing brand needed to go to Manhattan,” Weston says, real estate four people. Primark says it’s investigating the accident and prices drove the search to Boston, with its bargain-hunting providing support. students and historic links to Ireland. Ultimately, concerns about workers’ lives haven’t deterred The huge store is the purest distillation yet of the Primark customers. Primark’s sales soared 22 percent the year of Rana philosophy, with a few tweaks for local sensibilities. Facing Plaza and have climbed an additional 25 percent since, reachbusy Summer Street is a 1,000-square-foot boutique, ing £5.35 billion annually. Weston is emphatic that known as the trend room, showcasing the latest TAIL OTAGE Primark’s prices don’t come from outfits, which change every week depending on E 50 R . O cutting corners on labor. “We buy U.S ARE F what buyers think is in. Up the escalators, one of U clothes from the same factories SQ the first things shoppers see is a broad display that everyone else buys from,” he of workout wear, which in European stores is Kohl’s Sears 84m says. “Everyone.” Instead, he says, something of an afterthought. That was a con124m undercutting competitors is basically cession, Franks says, to Americans’ propensity a matter of volume—selling low-margin for wearing yoga pants all day, a habit Europeans items many, many more times. find bizarre. k r a Prim There are other tricks, too. When The store is a finely tuned machine designed 0 0 RG 158,0 H&M OMBE IL , BLO clothes get delivered to a Primark store, to encoura age Instagramming. RETA R 11m* TA AN ATA: K ATE . D the cardboard boxes go right back onto There’s Wi-F Fi everywhere, and the *ESTIM the truck—to return a few weeks later #Primania hashtag is inscribed on mirrors as cheap-and-cheerful brown paper in fitting rooms big enough for two—friends can bags. Because items sell so fast, deliveries often pile in together, phones ou ut, snapping away. go straight onto the floor, meaning stores have Deep couches with charging ports are placed relatively small stockrooms and more square at strategic intervals, inclu uding one set up footage for selling. as a man cave for bored boyfriends, b with An executive at a company that works with ESPN on a TV. Primark, who asked not to be identified discussShortly after the flag gship opens, nd her sister ing a client, says the chain has stronger relation- Julianne Delapp, 26, an ships with suppliers than its rivals do. Primark Caitlyn, 28, finish a major e expedition for nd, has built a reputation for early, aggressive fall wardrobes. The sisters are among a la e Ir U.K., , In the , Belgium orders of styles its buyers think will trend, steady flow of back-to-scho ool-shopping ia , r t y s n u a A erm and for sticking with them, the person says. students, parents push hing strollG , e , c s Fran therland ers, and office workers fr In an industry where retailers cancel orders om nearby e the N al, Spain, g that are already on freighters and force sup- skyscrapers—a sizable crowd for a Portu he U.S. pliers to take financial hits when product Friday afternoon. “I haven’tt shopped and t doesn’t sell, that edge gives suppliers the con- this much in years,” Caitllyn says, fidence to cut better deals for Primark, the person explains. struggling with two enormo ous bags When the company’s daily sales analysis shows a need to stuffed with pants, tops, and d skirts, change direction, it marks down and moves on. all bought for about $150. ““It’ss so In the U.S., Primark is trying to beat the competition cheap you can almost buy y it by on price. A basic women’s outfit can be bought for $14, the pound.”

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GEORGE HOTZ MADE A DRIVERLESS CAR 52

BY HIMSELF IN HIS GARAGE AND IT WORKS BY ASHLEE VANCE

PHOTOGRAPHS BY PETER BOHLER

A few days before Thanksgiving, George Hotz, a

26-year-old hacker, invites me to his house in San Francisco to check out a project he’s been working on. He says it’s a self-driving car that he’d built in about a month. The claim seems absurd. But when I turn up that morning, in his garage there’s a white 2016 Acura ILX outfitted with a laser-based radar (lidar) system on the roof and a camera mounted near the rearview mirror. A tangle of electronics is attached to a wooden board where the glove compartment used to be, a joystick protrudes where you’d usually find a gearshift, and a 21.5-inch screen is attached to the center of the dash. “Tesla only has a 17-inch screen,” Hotz says. He’s been keeping the project to himself and is dying to show it off. We pace around the car going over the technology. Hotz fires up the vehicle’s computer, which runs a version of the Linux operating system, and strings of numbers fill the screen. When he turns the wheel or puts the blinker on, a few numbers change, demonstrating that he’s tapped into the Acura’s internal controls. After about 20 minutes of this, and sensing my skepticism, Hotz decides there’s really only one way to show what his creation can do. “Screw it,” he says, turning on the engine. “Let’s go.” As a scrawny 17-year-old known online as “geohot,” Hotz was the first person to hack Apple’s iPhone, allowing anyone—well, anyone with a soldering iron and some software smarts—to use the phone on networks other than AT&T’s. He later became the first person to run through a gantlet of hard-core defense systems in the Sony PlayStation 3 and crack that open, too. Over the past couple years, Hotz had been on a walkabout, trying to decide what he wanted to do next, before hitting on the self-driving car idea as perhaps his most audacious hack yet. “Hold this,” he says, dumping a wireless keyboard in my lap before backing out of the garage. “But don’t touch any buttons, or we’ll die.” Hotz explains that his self-driving setup, like the autopilot feature on a Tesla, is meant for highways, not chaotic city streets. He drives through San Francisco’s Potrero Hill neighborhood and then onto Interstate 280. With Hotz still holding the wheel, the Acura’s lidar paints a pixelated image on the dash screen of everything around us, including the freeway walls and other cars. A blue line charts the path the car is taking, and a green line shows the path the selfdriving software recommends. The two match up pretty well, which means the technology is working. After a couple miles, Hotz lets go of the wheel and pulls the trigger on the joystick, kicking the car into self-driving mode. He does this as we head into an S curve at 65 miles per hour. I say a silent prayer. Hotz shouts, “You got this, car! You got this!” The car does, more or less, have it. It stays true around the first bend. Near the end of the second, the Acura suddenly veers near an SUV to the right; I think of my soon-to-be-fatherless children; the car corrects itself. Amazed, I ask Hotz what it felt like the first time he got the car to work. “Dude,” he says, “the first time it worked was this morning.”

Breakthrough work on self-driving cars began about a decade

ago. Darpa, the research arm of the Department of Defense, sponsored the Grand Challenge, a contest to see how far autonomous vehicles could travel. On a course through the desert in the inaugural 2004 event, the top vehicle completed just 7 of 150 miles. In subsequent years, the vehicles became quite good, completing both desert and city courses. It took a great deal of sophisticated, expensive technology to make those early cars work. Some of the Grand Challenge contestants lugged the equivalent of small data centers in their vehicles. Exteriors were usually covered with an array of sensors typically found in research labs. Today, Google, which hired many of the

entrants, has dozens of cars in its fleet that use similar technology, although dramatic advances in computing power, sensors, and the autonomous software have lowered the overall cost. Artificial-intelligence software and consumer-grade cameras, Hotz contends, have become good enough to allow a clever tinkerer to create a low-cost self-driving system for just about any car. The technology he’s building represents an end run on much more expensive systems being designed by Google, Uber, the major automakers, and, if persistent rumors and numerous news reports are true, Apple. More short term, he thinks he can challenge Mobileye, the Israeli company that supplies Tesla Motors, BMW, Ford Motor, General Motors, and others with their current driver-assist technology. “It’s absurd,” Hotz says of Mobileye. “They’re a company that’s behind the times, and they have not caught up.” Mobileye spokesman Yonah Lloyd denies that the company’s technology is outdated. “Our code is based on the latest and modern AI techniques using end-to-end deep network algorithms for sensing and control,” he says. Last quarter, Mobileye

INSIDE HOTZ’S ACURA ILX A 21.5-INCH SCREEN DISPLAYS THE CAR’S AUTONOMOUS TECHNOLOGY (THE OPERATING SYSTEM IS UBUNTU LINUX), ALONG WITH FEEDS FROM THE CAMERAS AND LIDAR SYSTEMS HOTZ ADDED A JOYSTICK TO THE CAR’S CENTER CONSOLE. A PULL OF THE TRIGGER ENGAGES THE SELF-DRIVING SYSTEM

reported revenue of $71 million, up 104 percent from the period a year earlier. It relies on a custom chip and well-known software techniques to guide cars along freeways. The technology has been around for a while, although carmakers have just started bragging about it. Tesla, in particular, has done a remarkable job remarketing the Mobileye technology by claiming its cars now ship with “Autopilot” features. Tesla’s fans have peppered the Internet with videos of its all-electric Model S sedans driving themselves on freeways and even changing lanes on their own. Hotz plans to best the Mobileye technology with off-the-shelf electronics. He’s building a kit consisting of six cameras—similar to the $13 ones found in smartphones—that would be placed around the car. Two would go inside near the rearview mirror, one in the back, two on the sides to cover blind spots, and a fisheye camera up top. He then trains the control software for

the cameras using what’s known as a neural net—a type of selfteaching artificial-intelligence mechanism that grabs data from drivers and learns from their choices. The goal is to sell the camera and software package for $1,000 a pop either to automakers or, if need be, directly to consumers who would buy customized vehicles at a showroom run by Hotz. “I have 10 friends who already want to buy one,” he says. The timing for all of this is vague. Hotz says he’ll release a YouTube video a few months from now in which his Acura beats a Tesla Model S on Interstate 405 in Los Angeles. The point of the exercise is twofold. First, it will—he hopes—prove the technology works and is ready to go on sale. Second, it will help Hotz win a bet with Elon Musk, chief executive officer of Tesla.

Hotz lives in the Crypto Castle. It’s a white, Spanish-tiled house,

which, other than the “Bitcoin preferred here” sticker on the front door, looks like any other in Potrero Hill. The inside is filled with a changing cast of 5 to 10 geeks. The bottom floor largely belongs to Hotz. His room is a 15-by-5-foot closet with a wedged-in mattress.

THE GLOVE COMPARTMENT HAS BEEN TURNED INTO A COMPUTING HUB WITH A MINI PC, A NETWORKING SWITCH, AND GPS SENSORS

The space is lined with shelves packed with boxes, car parts, towels, and a case of women’s clothes left behind by a former resident. There’s a living room in the back with couches and a television. “I hate living alone,” Hotz says. “I was playing Grand Theft Auto with my roommates last night. It was super fun.” Just a couple feet from his closet is the garage where Hotz works. His two-monitor computer sits on a desk next to a water heater. On a wooden table, there’s a drill, a half-dozen screwdrivers, a tape measure, some black duct tape, a can of Red Bull, and a stack of unopened mail. Most of the garage is taken up by the white Acura. Hotz has decorated its hood with a large, black comma, and the back bumper reads “comma.ai”—the name of his new company—in big, black letters. “A comma is better than a period,” he says. Hotz grew up in Glen Rock, N.J. His father oversees technology

for a Catholic high school, and his mother is a therapist. “Like, Freud talking and stuff,” Hotz says. At 14, he was a finalist in the prestigious Intel International Science & Engineering Fair for building a robot that could scan a room and figure out its dimensions. A couple years later he built another robot called Neuropilot that could be controlled by thoughts. “It could detect differentfrequency brain waves and go forward or left based on how hard you were focusing,” he says. The next year, 2007, he won one of the contest’s most prestigious awards, a trip to attend the Nobel prize ceremony in Stockholm, by designing a type of holographic display. “I did terrible in high school until I found these science fairs,” he says. “They were the best thing for me. I could build things, and there was the salesmanship, too, that I loved.” He hacked the iPhone in 2007 while still in high school and became an international celebrity, appearing on TV news shows. Three years later, he hacked the PlayStation 3 and released the software so others could use it. Sony responded by suing him, and the two parties settled their feud shortly after, with Hotz agreeing never to meddle with Sony products again. These achievements were enough to earn him a profile in the New Yorker when he was 22. “I live by morals, I don’t live by laws,” Hotz declared in the story. “Laws are something made by assholes.” But Hotz wasn’t a so-called black-hat hacker, trying to break into commercial systems for financial gain. He was more of a puzzle addict who liked to prove he could bend complex technology to his will. From 2007 on, Hotz became a coding vagabond. He briefly attended Rochester Institute of Technology, did a couple fivemonth internships at Google, worked at SpaceX for four months, then at Facebook for eight. The jobs left him unsatisfied and depressed. At Google, he found very smart developers who were often assigned mundane tasks like fixing bugs in a Web browser; at Facebook, brainy coders toiled away trying to figure out how to make users click on ads. “It scares me what Facebook is doing with AI,” Hotz says. “They’re using machine-learning techniques to coax people into spending more time on Facebook.” On the side, Hotz produced an application called towelroot, which gave Android users complete control over their smartphones. The software is free to download and has been used 50 million times. He kept himself entertained (and solvent) by entering contests to find security holes in popular software and hardware. In one competition, Pwnium, he broke into a Chromebook laptop and took home $150,000. He scored another $50,000 at Pwn2Own by discovering a Firefox browser bug in just one day. At a contest in Korea designed for teams of four, Hotz entered solo, placed first, and won $30,000. By the fall of 2012 he was bored with the contests and decided to dive into a new field—AI. He enrolled at Carnegie Mellon University with the hope of attaining a Ph.D. When not attending class, he consumed every major AI research paper and still had time for some fun. At one point, the virtual-reality company Oculus Rift failed to man its booth at a job fair, and Hotz took it over, posing as a recruiter and collecting résumés from his fellow students. None of this was enough to keep him interested. “I did two semesters and got a 4.0 in their hardest classes,” he says. “I met master’s students who were miserable and grinding away so that they might one day earn a bit more at Google. I was shocked at what I saw and what colleges have become. The smartest people I knew were in high school, and I was so let down by the people in college.” Although Hotz makes his university experience sound depressing, it left him brimming with confidence and eager to return to Silicon Valley. He’d devoured the cutting-edge AI research and decided the technology wasn’t that hard to

master. Hotz took a job at Vicarious, a highflying AI startup, in January to get a firsthand look at the top work in the field, and this confirmed his suspicions. “I understand the state-of-the-art papers,” he says. “The math is simple. For the first time in my life, I’m like, ‘I know everything there is to know.’ ” He quit Vicarious in July and decided to put his conviction to the test. A friend introduced him to Musk, and they met at Tesla’s factory in Fremont, Calif., talking at length about the pros and perils of AI technology. Soon enough, the two men started figuring out a deal in which Hotz would help develop Tesla’s self-driving technology. There was a proposal that if Hotz could do better than Mobileye’s technology in a test, then Musk would reward him with a lucrative contract. Hotz, though, broke off the talks when he felt that Musk kept changing the terms. “Frankly, I think you should just work at Tesla,” Musk wrote to Hotz in an e-mail. “I’m happy to work out a multimillion-dollar bonus with a longer time horizon that pays out as soon as we discontinue Mobileye.” “I appreciate the offer,” Hotz replied, “but like I’ve said, I’m not looking for a job. I’ll ping you when I crush Mobileye.” Musk simply answered, “OK.”

Hotz has filled out since his days as a scrawny teenage hacker,

although he dresses the same. Most often, he wears jeans and a hoodie and shuffles around the garage in socks. He has a beard of sorts, and some long, stray whiskers spring out from his Adam’s apple. His demeanor doesn’t match the slacker get-up. Hotz’s enthusiasm is infectious, and he explains just about everything with flailing hands and the wide eyes of someone in a permanent state of surprise. It’s easy enough to draw a connection between Hotz and 56

way for a computer to identify a chair in a photo would be to create a really precise definition of a chair—you would tell the computer to look for something with four legs, a flat seat, and so on. In recent years, though, computers have become much more powerful, while memory has become cheap and plentiful. This has paved the way for more of a brute-force technique, in which researchers can bombard computers with a flood of information and let the systems make sense of the data. “You show a computer 1 million images with chairs and 1 million without them,” Hotz says. “Eventually, the computer is able to describe a chair in a way so much better than a human ever could.” The theory behind this type of AI software has been around for decades. It’s embedded in products consumers take for granted. With the help of Google, for example, you can search for “pictures of the beach,” and AI software will comb through your photo collection to turn up just that. Some of the biggest breakthroughs have come in voice recognition, where smart assistants such as Apple’s Siri and Microsoft’s Cortana can pick up a person’s voice even in noisy situations. The same goes for instantaneous translation applications, which have largely been taught new languages via deep-learning algorithms that pore over huge volumes of text. With his car, Hotz wants to extend the same principles to the field of computer vision. In the month before our first drive on I-280, Hotz spent most of his time outfitting the sedan with the sensors, computing equipment, and electronics. Once all the systems were up and running, he drove the vehicle for two and a half hours and simply let the computer observe him. Back in his garage, he downloaded the data from the drive and set algorithms to work analyzing how he handled various situations. The car learned that Hotz tends to stay in the middle of a lane and

“FOR THE FIRST TIME IN MY LIFE, I’M LIKE, Steve Wozniak. Like Hotz, Wozniak began his hacking days on the fringes of the law—in the early 1970s, before he and his pal Steve Jobs founded Apple. Woz was making small devices that let people place free long-distance phone calls. Even in Silicon Valley, few people are equally adept at hardware and software. Woz was, and so is Hotz. Hotz began working in earnest on his self-driving technology in late October. He applied online to become an authorized Honda service center and was accepted. This allowed him to download manuals and schematics for his Acura. Soon enough, he’d packed the glove compartment space with electronics, including an Intel NUC minicomputer, a couple GPS units, and a communications switch. Hotz connected all this gear with the car’s main computers and used duct tape to secure the cables running to the lidar on the roof. There are two breakthroughs that make Hotz’s system possible. The first comes from the rise in computing power since the days of the Grand Challenge. He uses graphics chips that normally power video game consoles to process images pulled in by the car’s camera and speedy Intel chips to run his AI calculations. Where the Grand Challenge teams spent millions on their hardware and sensors, Hotz, using his winnings from hacking contests, spent a total of $50,000—the bulk of which ($30,000) was for the car itself. The second advance is deep learning, an AI technology that has taken off over the past few years. It allows researchers to assign a task to computers and then sit back as the machines in essence teach themselves how to accomplish and finally master the job. In the past, for example, it was thought that the only

maintain a safe distance from the car in front of him. Once the analysis was complete, the software could predict the safest path for the vehicle. By the time he and I hit the road, the car behaved much like a teenager who’d spent only a couple hours behind the wheel. Two weeks later, we went on a second drive. He’d taken the car out for a few more hours of training, and the difference was impressive. It could now drive itself for long stretches while remaining within lanes. The lines on the dash screen—where one showed the car’s actual path, and the other where the computer wanted to go—were overlapping almost perfectly. Sometimes the Acura seemed to lock on to the car in front of it, or take cues around a curve from a neighboring car. Hotz hadn’t programmed any of these behaviors into the vehicle. He can’t really explain all the reasons it does what it does. It’s started making decisions on its own. In early December, Hotz took me on a third ride. By then, he’d automated not only the steering but also the gas and brake pedals. Remarkably, the car now stayed in the center of the lane perfectly for miles and miles. When a vehicle in front of us slowed down, so did the Acura. I took a turn “driving” and felt an adrenaline rush—not because the car was all over the place, but because it worked so well. Hotz’s approach isn’t simply a low-cost knockoff of existing autonomous vehicle technology. He says he’s come up with discoveries—most of which he refuses to disclose in detail—that improve how the AI software interprets data coming in from the cameras. “We’ve figured out how to phrase the driving problem in ways compatible with deep learning,” Hotz says. Instead of

the hundreds of thousands of lines of code found in other selfdriving vehicles, Hotz’s software is based on about 2,000 lines. The major advance he will discuss is the edge that deeplearning techniques provide in autonomous technology. He says the usual practice has been to manually code rules that handle specific situations. There’s code that helps cars follow other vehicles on the highway, and more code to deal with a deer that leaps into the road. Hotz’s car has no such built-in rules. It learns what drivers typically do in various situations and then tries to mimic and perfect that behavior. If his Acura cruises by a bicyclist, for example, it gives the biker some extra room, because it’s seen Hotz do that in the past. His system has a more general-purpose kind of intelligence than a long series of if/then rules. As Hotz puts it in developer parlance, “ ‘If ’ statements kill.” They’re unreliable and imprecise in a real world full of vagaries and nuance. It’s better to teach the computer to be like a human, who constantly processes all kinds of visual clues and uses experience, to deal with the unexpected rather than teach it a hard-and-fast policy. In the coming weeks, Hotz intends to start driving for Uber so he can rack up a lot of training miles for the car. He aims to have a world-class autonomous vehicle in five months, something he can show off for Musk. He’s heard that Teslas struggle when going across the Golden Gate Bridge because of the poor lane markings. So he plans to film a video of the Acura outperforming a Tesla across the bridge, and then follow that up by passing the final test on I-405 in Los Angeles where Musk lives. Hotz’s YouTube videos get millions of views, and he fully expects Musk will get the message. “I’m a big Elon fan, but I wish he didn’t jerk me around for three months,” he says. “He

Sitting cross-legged on a dirty, formerly cream-colored couch in

his garage, Hotz philosophizes about AI and the advancement of humanity. “Slavery did not end because everyone became moral,” he says. “The reason slavery ended is because we had an industrial revolution that made man’s muscles obsolete. For the last 150 years, the economy has been based on man’s mind. Capitalism, it turns out, works better when people are chasing a carrot rather than being hit with a stick. We’re on the brink of another industrial revolution now. The entire Internet at the moment has about 10 brains’ worth of computing power, but that won’t always be the case. “The truth is that work as we know it in its modern form has not been around that long, and I kind of want to use AI to abolish it. I want to take everyone’s jobs. Most people would be happy with that, especially the ones who don’t like their jobs. Let’s free them of mental tedium and push that to machines. In the next 10 years, you’ll see a big segment of the human labor force fall away. In 25 years, AI will be able to do almost everything a human can do. The last people with jobs will be AI programmers.” Hotz’s vision for the future isn’t quite as bleak as The Matrix, where robots mine our bodies for fuel. He thinks machines will take care of much of the work tied to producing food and other necessities. Humans will then be free to plug into their computers and get lost in virtual reality. “It’s already happening today,” he says. “People drive to work, sit in front of their computer all day, and then sit in front of their computer at home.” In 20 years, the sitting in front of the computer part will be a lot more fun, according to Hotz, with virtual worlds that far exceed anything we’ve managed to build on earth. “Stop worrying about the journey,” he says. “Enjoy the destination. We will have a better

‘I KNOW EVERYTHING THERE IS TO KNOW’ ” world. We will be able to truly live in a society of the mind.” Hotz started the autonomous car work because he sees it as Step 1 in the revolution. Transportation is an area where AI can have a massive impact. He hopes to take his technology to retail next, building systems that provide flawless selfcheckout at stores. His desire to have AI take over so many jobs stems partly from a near-religious belief in the power and ultimate purpose of technology. “Technology isn’t good or bad,” he says. “There are upsides like nuclear power and downsides like nuclear bombs. Technology is what we make of it. There’s a chance that AI might kill us all, but what we know is that if you’re on the other side of technology, you lose. Betting on technology is always the correct bet.” All this talk represents an evolution in Hotz’s hacker ethos. He used to rip apart products made by Apple and Sony, because he enjoyed solving hard puzzles and because he reveled in the thought of one person mucking up multibillion-dollar empires. With the car, the retail software, and the plans to roil entire economies, Hotz wants to build a reputation as a maker of the most profound products in the world—things that forever change how people live. “I don’t care about money,” he says. “I want power. Not power over people, but power over nature and the destiny of technology. I just want to know how it all works.” HOTZ IN HIS GARAGE

can buy the technology for double.” (Says Tesla spokesman Ricardo Reyes: “We wish him well.”) There’s really no telling how effective Hotz’s software and self-learning technology ultimately will be. His self-funded experiment could end with Hotz humbly going back to knock on Google’s door for a job. “Yeah, of course there will be skepticism,” he says. “This is part of a great adventure. All I can say is, ‘Watch.’ ”

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BOOTS MADEFOR WINTER

THESECONDSEASONOF SERIAL

COOL CALENDARS

Dressbarn rebrand itself as fashion-forwardâ&#x20AC;&#x201D; while keeping its name Photograph by Natalia Mantini

Branding

ast July a 2,400-pound bull named Count found himself in Manhattan’s fashionable Chelsea neighborhood for a photo shoot. To get him to the second-floor studio, the bull’s handler coaxed the massive animal into a freight elevator. Once upstairs, Count was given half an hour to relax before joining supermodel Hilary Rhoda under bright lights. Behind the camera was sought-after French fashion photographer Patrick Demarchelier. The elaborate, star-studded shoot was for Dressbarn—an attempt by the aging discount women’s clothing chain to find relevance. In addition to Count, it featured a sheep, a rooster, and an unruly pig. Even surrounded by barnyard animals, Rhoda looked runway-skinny and sophisticated in heels, dresses, and big earrings. The photos turned into a series of ads with cheeky slogans that began appearing in mid-September. “Think you know Dressbarn? Think again,” one says. “It’s our name. Deal with it,” reads another. Today the ads are on Times Square billboards, in publications like O, the Oprah Magazine, and on websites from Refinery29 to Facebook. The fashion world has taken notice: “Dressbarn is upping its fashion game, and managing to poke fun at itself at the same time,” wrote Women’s Wear Daily. “Dress Barn [sic] Might Soon Become Your New Favorite Store (Yes, Really)” gushed a Huffington Post headline. The campaign was unexpected from a company with a name like Dressbarn. The retailer had developed a reputation for frumpy, house-brand dresses that were far less fashionable than the clothing sold at Topshop and Zara. For some observers, though, the company’s problem was nine letters long. “That name is of a distant era,” says Marlene Morris Towns, a marketing professor at Georgetown University. “It was totally appropriate in the ’60s, ’70s, and even

L 60

“What’s in a name? The Gap is a space between your

the ’80s, a terrible style decade when retailers had names like the Pants Corral.” She adds, “The word ‘barn’ just implies cheap— it’s like ending something with the word ‘mart’ or ‘warehouse.’” Moreover, she says, it would have been easy and infinitely classier to rebrand as Dressbar, a name the company recently started using within stores and online. “They could have built the whole campaign around dropping the ‘n’.” Dressbarn did briefly consider renaming itself. “About three years ago, we were ready to do it,” says Lori Wagner, who joined Dressbarn as chief marketing officer in 2012 after stints at Kenneth Cole, J.Crew, and Cole Haan. But she and her team discovered their loyal customers would rather have newer, more stylish clothes than a new name. “Someone once said, ‘A name is like tofu: It takes on the flavor you add to it,’” Wagner says. “I mean, what’s in a name? The Gap is a space between your teeth. Yahoo! is an idiot, not a tech company.” Dressbarn also wanted to stay true to its 53-year heritage. Founded in Stamford, Conn., by Roslyn and Elliot “E.J.” Jaffe, the first store occupied a tiny space inside a factory building that also housed a lamp manufacturer and a driving school. “It was a discount, scrubby thing. There was no dressing room,” recalls Roslyn, now 86. “When the driving school was in session, we had to use the bathroom down the street.” On a Tuesday in November, Jaffe—whom employees affectionately refer to as “Mrs. J”—is making her weekly visit to Dressbarn’s new headquarters, in Mahwah, N.J. The airy, modern building was designed by the Gensler architecture firm, which has also created buildings for Facebook, Airbnb, and Four Seasons hotels. It includes a cafe, outdoor terraces, and an employee gym that hosts Spinning and Zumba classes. Barely 5 feet tall, Jaffe is wearing a navy pinstriped pantsuit, gray blouse, and black flats. Her short-trimmed nails, painted white, match her quartersize fake pearl earrings and short snow-white hair. Both Jaffes still work at Dressbarn, mostly as advisers, as do two of their three children. Dressbarn’s name, Jaffe admits, was chosen without much care. “E.J. walked in and said, ‘We need a name, don’t fuss around,’” she says. “Dressbarn just popped into my mind.” Back then, the Jaffes’ plan was to offer affordable clothing for the growing number of women joining the workforce. In those days, plenty of stores offered bargains on hard goods, such as toasters and radios, but discount clothing was a novelty. For the first year, Elliot kept his job as a merchandising manager at Macy’s, while Roslyn ran Dressbarn. Soon, demand grew to the point where both Jaffes came onboard full time. In 1964, they’d opened a second store. Five decades later, Dressbarn has 825 locations across the U.S., most in suburban strip malls. That’s a lot of stores, even compared with better-known brands. Banana Republic, for example, has only 618 locations in North America. For a long

teeth.Yahoo! is an idiot, not a tech company”

LEFT: DAILY BILLBOARD BLOG; RIGHT: THESTOREGUY/ ALAMY

Etc.

Dressbarn vs. Ann Taylor

Same owner, different customers—and there’s a reason it’s not named Ann Taylor Stable RSVP lace sheath dress 100% polyester

RSVP long halter dress 94% polyester, 6% spandex $29.99

Ribbed stitch sweater dress 20% baby alpaca, 20% merino wool, 60% nylon

$139

Lace sheath dress 29% nylon, 24% rayon, 47% cotton $140

$278

$110

Shimmer sweater dress 63% rayon, 37% nylon

Size chart comparison for a size 4 (bust/waist/hip) Dressbarn 35/28/38 Ann Taylor 34/26.5/36.5

$179

V-neck gown 89% acetate, 11% polyester

time, Dressbarn enjoyed a captive audience with its target demo- of the stores haven’t been renovated. Next, the company plans graphic, which tends to be older and larger than the typical to revamp its online platform—a badly needed move, given that Banana Republic shopper. “There aren’t that many brands only 4 percent of its sales happened online in 2014. that focus on 50-plus-year-olds,” says Bloomberg retail indusName changes alone don’t usually work. Several storied comtry analyst Poonam Goyal. panies have attempted it and failed. J.C. Penney and Kentucky Even so, with the rise of fast-fashion purveyors such as Fried Chicken tried to rebrand respectively as JCP and KFC, H&M and competition from insurgent retailers like Target only to come back to their original monikers. RadioShack failed and Kohl’s, Dressbarn’s sales eventually slowed. “In a world miserably in trying to rename itself the Shack. The number where everyone had 40 percent off every day, our point of of successful rebrandings is vanishingly small, particularly in distinction was losing ground,” Wagner retail. Following the barnyard campaign, says. “Our customer was aging, and we Dressbarn isn’t even considering the were aging with her.” option. “If you try and change the name The company kept growing through of the brand today, you’d have murder on smart acquisitions, snapping up retailers the streets,” Wagner says. “It’s been fun that focused on women in the suburbs watching the press go from ‘Dressbarn, and middle America. In 2011 it founded really?’ to ‘Dressbarn, I know!’ ” the Ascena Retail Group, an umbrella That said, sales were down 4.7 percent company that now owns tween brand in the quarter that ended Oct. 24, and on Justice, low-price retailer Maurice’s, and a recent Thursday afternoon foot traffic at plus-size chains Catherine’s and Lane one of Manhattan’s two Dressbarns is slow. Bryant (famous for its recent #ImNoAngel A few women browse the racks and trade Dressbarn’s old identity campaign). Earlier this year, Ascena purstories about their holiday plans with saleschased Ann Taylor, the quintessential ladies—they seem like regulars. A sign in image of mainstream working-woman chic, for $2.2 billion. The the window reads “How to Holiday: Best Hostess Ever.” The vibe company is now America’s fifth-largest apparel retailer, with is distinctly more Talbots than Hilary Rhoda high fashion—there’s annual sales of more than $7 billion. nothing luxe or sassy. Assistant manager Courtney Glorioso says To jump-start Dressbarn’s growth, Wagner and Chief Executive the store has gotten somewhat busier since the ads went up. Officer Jeff Gerstel set about repositioning the company. “In the She sees maybe 10 more people a day than she used to. “A lot of end, we probably changed everything but the name,” she says. them had previously heard the name Dressbarn and thought it They hired known fashion designers, including Heidi Weisel and was an old-lady store, or a plus-size store,” she says. Many, she Carmen Marc Valvo. They also launched Dressbar for people to says, end up buying something. But there’s at least one problem. “When it comes to sizing, shop online. Some things, however, haven’t changed: Dressbarn plans to stick with suburban strip malls, Gerstel says, and while we only go down to a 4,” Glorioso says. “We received some a few pilot locations have introduced dressing rooms with light- high-fashion customers who could really use a 0 or a 2, and we ing that can be adjusted to simulate different times of day, most don’t have that.”

The Critic

ON-DEMAND AUDIO

The second season of the podcast Serial surprises and delights fans—and gets Hollywood interested. By Felix Gillette

ILLUSTRATION BY SAM ISLAND

n the morning of Dec. 10, Americans woke up to an unexpected gift. WBEZ, a public radio station in Chicago, had posted online the first episode in the second season of Serial, the hit podcast from the creators of This American Life. As word spread, fans scrambled to download or stream the episode. They fretted about a possible sophomore slump. They posted flash assessments on Twitter. And they expressed their feverish reverence, or studied ambivalence, for Sarah Koenig, the podcast’s auteur-host and executive producer. All of which felt entirely familiar—like watching the Internet welcome a season of Game of Thrones. It felt, in short, like television. Such was the intention from the start. In 2014, Ira Glass, host of This American Life, a thematic, nonfiction radio show from WBEZ, announced his colleagues would be starting a series online. The weekly podcast, he explained, would be called Serial and would be devoted to telling a single true-crime story, chapter by chapter, across the span of an entire season via a dozen or so interwoven episodes. The show’s format, in other words, would be serialized, rather than episodic.

“Our hope is that it’ll play like a great HBO or Netflix series, where you get caught up with the characters and the thing unfolds week after week, but with a true story, and no pictures,” Glass wrote. For the second season, Serial has cranked up the Hollywood quotient, teaming up with Oscar-winning screenwriter Mark Boal and Page 1, a TV and movie production company backed by Megan Ellison (daughter of Oracle billionaire Larry Ellison) to tell the story of Bowe Bergdahl. In 2009, Bergdahl, a soldier in the U.S. Army, walked away from his unit in Afghanistan under mysterious circumstances, was held captive by the Taliban for five years, and then was set free in a controversial prisoner swap. He’s back in the U.S., facing court-martial. Boal taped hours of interviews with Bergdahl as part of research for his screenplay. The recordings also form the foundation of Serial’s second season. As a result, the show has extraordinary access into Bergdahl’s head. We get to learn how someone could make the decisions he made and what happens when everything goes horribly wrong. In some ways, this season shows even more promise than

Etc. the first, as the payoff is less binary than “Did he do it?” and more an investigation of a complex, morally ambiguous antihero—like Homeland’s Carrie Mathison and Breaking Bad’s Walter White. After decades of daytime soap operas and the occasional prime-time novelty (such as Twin Peaks or Dallas), the serialized story structure has recently spread far and wide in TV land including premium cable networks like HBO (The Leftovers) and Showtime (The Affair), basic cable networks such as AMC (The Walking Dead), FX (Fargo), and USA (Mr. Robot), and subscription video on-demand services like Netflix (Narcos). Robert Thompson, director of Syracuse University’s Bleier Center for Television & Popular Culture, says the creative explosion was enabled by underlying changes in TV viewing technology. For decades, TV executives tended to shy away from serialization because the standard weeklong hiatus between new episodes was too long, they said, for viewers to keep track of multiple, meandering storylines. But the advent of the DVR led to binge watching, and Serialization Nation was born. “Now there is absolutely the same potential for radio,” Thompson says. Radio used to be full of serialized programs, but TV’s rise meant they disappeared in favor of round-the-clock sports, news, and talk shows. Now the breakout success of Serial—last year it reached 5 million downloads on iTunes faster than any other podcast—has stirred hopes of a renaissance in audio. Every major media property now has a podcasting strategy, with hopes to create the next great podcast success such as 99% Invisible, Professor Blastoff, or Limetown. Last year, Alex Blumberg, a former producer for This American Life, created a startup in New York called Gimlet Media, dedicated to the production of high- quality podcasts. The company has already released three seasons of a serialized show called StartUp. To date, Gimlet has raised more than $6 million in venture capital funding. “The technology has made it a lot easier to appointment listen,” Blumberg says. “Serial is an inspiration to us.” Along with the show’s competitors, Hollywood is also trying to tap into Serial’s fervent fan base. The podcast will form the basis of a major motion picture, directed b y T h e H u r t L o c k e r ’s Kathryn Bigelow.

What I Wear to Work

What do you do for work? I’m a licensed real estate agent in New York and California, but I recently launched Guest Minded, a modern guest-services agency.

THE CAST NYC

What does that mean, exactly? You sign up, create a client profile, and then can click, for instance, “My kids need the best tutor,” and our experts will find you answers.

PHOTOGRAPH BY CHRISTOPHER LEAMAN FOR BLOOMBERG BUSINESSWEEK

Describe your look. I don’t know if I STEVEN ALAN should answer that. Sounds like an opportunity for my buddies to rag on me. Fair. What’s

your work style? I think New Yorkers appreciate simplicity, as well as tailoring and bold colors of the darker persuasion.

Etc.

AMERICAN APPAREL How do you get your hair to do that? I use a Japanese product called Magic Move wax. I have a barber, Massimo, who always cuts my hair. How’d you meet Massimo? My co-worker said, “You gotta meet Massimo. He’s crazy, but he gives a great haircut.” He was right.

RAPHAEL CHEJADEBLOOM 32, founder, Guest Minded, New York

Any jewelry? Absolutely not. That’s just the way I was raised.

Like a lot of black. Monochromatic is my approach. If I’m in a navy phase, I wear a lot of navy. Generally, I stick with navy, black, and gray.

BARKER BLACK

Interview by Arianne Cohen and Jason Chen

ILENE GORDON

Chairman, president, and chief executive officer, Ingredion Education

MIT Sloan School of Management, class of 1976

“I majored in math and graduated Phi Beta Kappa. The ratio of men to women there was 10-to-1. I lived in the women’s dorm, and we all still keep in touch.”

Work Experience

1976–80

Management consultant, Boston Consulting Group

68 At Sloan, 1976

1980–82

Director of strategic planning, Signode

1982–94

Vice president, Packaging Corp. of America

On the cover of MIT Management magazine, 1995

“I was the first female corporate officer, commuting from Chicago to Houston and New York.”

1994–97

“Alcan bought Pechiney in 2003, and they asked me to head up the $1.5 billion packaging business for the Americas. Then in 2006 they promoted me to run the global packaging business, which was $6.5 billion and based in Paris. Then we were taken over by Rio Tinto.”

VP for operations, Tenneco

1997–99

VP, general manager, Packaging Corp. of America

1999–2006

President, Pechiney Plastic Packaging, Alcan Food Packaging Americas

2007–09

President and CEO, Alcan Packaging and Rio Tinto Alcan

With husband Bram Bluestein (center) and Maria Bartiromo (right) in Davos, Switzerland, 2013

2009– Present

“It was a chance to run a publicly traded company. When I joined, revenue was $3.7 billion; now it’s $5.7 billion. On my board, we have 40 percent women.”

Chairman, president, and CEO, Ingredion

With Ingredion engineering manager Guillermo Hernandez Quintana in Cali, Colombia, 2015

Life Lessons

1. “International assignments put you on the fast track to success.” 2. “Find a mentor who will push you out of your comfort zone.” 3. “Always actively hel

people you’ve let go find new careers. Executives I’ve let go are now my customers.”

MIT, class of 1975

“I met my husband at BCG. We moved to the London office together, and then they wanted us to open up a Chicago office. We were married on the way back from London and moved to Chicago the day after the wedding.”

Newton South High School, Newton, Mass., class of 1971

Bloomberg Businessweek (USPS 080 900) December 21 – December 27, 2015 (ISSN 0007-7135) H Issue no. 4456 Published weekly, except one week in January, March, June, and August, by Bloomberg L.P. Periodicals postage paid at New York, N.Y., and at additional mailing offices. Executive, Editorial, Circulation, and Advertising Offices: Bloomberg Businessweek, 731 Lexington Avenue, New York, NY 10022. POSTMASTER: Send address changes to Bloomberg Businessweek, P.O. Box 37528, Boone, IA 50037-0528. Canada Post Publication Mail Agreement Number 41989020. Return undeliverable Canadian addresses to DHL Global Mail, 355 Admiral Blvd., Unit4, Mississauga, ON L5T 2N1. E-mail: bwkcustserv@cdsfulﬁllment.com. QST#1008327064. Registered for GST as Bloomberg L.P. GST #12829 9898 RT0001. Copyright 2015 Bloomberg L.P. All rights reserved. Title registered in the U.S. Patent Office. Single Copy Sales: Call 800 298-9867 or e-mail: busweek@nrmsinc.com. Subscriber Services: Call 800 635-1200 or log on to our website: http://www.businessweek.com/ custserv/manage.htm. Educational Permissions: Copyright Clearance Center at info@copyright.com Reprints & General Permissions: The YGS Group at 800 290-5460 x100 or businessweekreprints@theYGSgroup.com. PRINTED IN THE U.S.A. CPPAP NUMBER 0414N68830

With classmates at her college graduation, 1975

How Did I Get Here?

Courtesy subject (6). Alamy (2)

Etc.

“IT’S NOT JUST STREETLIGHTS. IT’S ABOUT A SENSE OF COMMUNITY.” ODIS JONES CEO, PUBLIC LIGHTING AUTHORITY OF DETROIT

At one point, 40 percent of streetlights in Detroit didn’t work. This made life even more difficult for a city that was already struggling. The Public Lighting Authority of Detroit devised a plan to reilluminate the city. But finding a bank to finance the project during Detroit’s bankruptcy was challenging. Citi stepped up and committed its own capital, which encouraged other investors. So far, thousands of new LED lights have been installed, lighting the way as a model for similar projects around the world. For over 200 years, Citi’s job has been to believe in people and help make their ideas a reality.

citi.com/progress

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