Business

You wake up tomorrow morning and find that the Board of Directors of General Motors has decided on a management change, and has appointed you as the new CEO of GM. (Actually they met with you the previous evening and, after a few drinks during the discussion, you signed the contract. “Resign” is not an option.)

What do you do?

The threat of an adverse opinion on a public company’s internal controls was not an idle one. According to Compliance Week, nearly 10% of the 10-K (annual report to the SEC) filings in January included an adverse opinion because of material weaknesses in their internal controls. There may be more coming, since companies with a December year-end have until March 16 to file.

I noticed a pattern to the adverse opinions: they are nearly coterminous with companies having restated their earnings for earlier quarters. This begins to make sense: if a company’s internal controls were well-designed and operating as intended, no restatement would have been necessary. Earnings restatements and accounting problems are often punished more severely than earnings or performance disappointments, and are easy targets for class-action lawsuits. When more data is available, it will be an interesting exercise to separate the effect on share prices of the adverse opinion from that of the restatement. Maybe someone with better math skills will attempt it.

Here is a partial list of companies that have had an adverse Sarbanes-Oxley opinion, but a clean opinion on their financial statements, from their auditors:

BearingPoint Inc. (ticker: BE; formerly KPMG Consulting)
Auditor: PricewaterhouseCoopers
Material weakness: Revenue recognition (preliminary only; filing due March 16,2005)

Calpine Corporation (ticker: CPN)
Auditor:PricewaterhouseCoopers
Material weakness: Provision for income taxes.

Eastman Kodak Company (ticker: EK)
Auditor: PricewaterhouseCoopers
Material weakness: Provision for income taxes.

Flowserve Corp. (ticker: FLS)
Auditor: KPMG
Material weakness: Provision for income taxes, intercompany accounts, consolidation, others.

Netbank Inc. (ticker: NTBK)
Auditor: Ernst & Young
Material weakness: Estimated fair market value for rate locks and hedges.

Sapient Corporation (ticker: SAPE)
Auditor: PricewaterhouseCoopers
Material weakness: Controls over health insurance accruals and lease accounting.

SunTrust Banks, Inc. (ticker: STI)
Auditor: PricewaterhouseCoopers
Material weakness: Internal controls at a recently-acquired subsidiary; loss provision errors.

I also checked MCI, formerly WorldCom, since it was one of the companies whose accounting problems led to the adoption of Sarbanes-Oxley, and since it may hold the world record for earnings restatements in prior years. MCI is getting a clean opinion. An interesting pattern, don’t you think?

This blog earned a tiny amount of money in 2004 by accepting Blogads. I like Blogads. I wish we had the traffic to earn more from them.

I asked Blogads to send me a check, but they are currently setup to use only Paypal for such small amounts (~$60) as were in our account. Why not use Paypal then? I prefer not to. The Blogads representative asked me why, and here is most of the response that I emailed to him:

. . . my objection to paypal is based mainly on having read over the years many complaints about its privacy practices and customer service. Obviously paypal is extremely convenient, and I know that lots of people use it without problems. However, I prefer not to deal with businesses that do not communicate well with customers, or for which it appears that any problems that come up are not likely to be handled in a way that is easy for customers. For the amount of money in the small transactions for which paypal is most convenient, it doesn’t seem worth my time to use their system and take the risk that any screwup could cost me a lot in time and aggravation.

It’s similar with Google’s ads, which I signed up for [i.e., enrolled in but didn’t agree to the TOS] but haven’t used (because I won’t sign anything that I don’t understand, and for my taste it’s too much work, relative to the amount of money involved, for me to analyze Google’s over-lawyered TOS).

Also, I don’t like dealing with businesses that have agendas that conflict with my interests as a customer. Paypal may have such an agenda WRT data mining, Google probably does too, and so do companies such as Doubleclick. Blogads does not (nor does Intrade, with which I have an affiliate relationship). Nor do I want to do business on the Internet with anybody who wants to lock me in with nondisclosures, noncompetes and so forth. The TOS that I prefer are simple, clear and minimally restrictive: You use our service; if you don’t like it you stop using our service; if we don’t like you we cancel your service. Complexity is OK until it starts costing the customer a lot of time, and then it becomes another cost for him to minimize.

I’m probably an extreme case, but I suspect that a lot of people share my views in milder form.

Blogads and Intrade have straightforward business models, are easy to use, and are easy to deal with if there’s a problem or question. (The fact that the Blogads rep was interested in a small customer’s feedback on payment methods is itself a good sign.) Google’s advertising program is tempting, but Google’s terms of service are too restrictive, and my time gets wasted whenever I try to get Google to answer a question. That’s a deal killer, given the small amounts of money that are likely to be involved. A lot of people handle this kind of tension with a prospective business partner by ignoring it and signing up anyway, because the stakes appear to be low, and what’s Google going to do anyway?

But I’m reluctant to do business with people or companies that operate like Google does, because if they won’t attend to my concerns when the stakes are low, how are they going to treat me in the future if we have a misunderstanding about something that’s worth real money? I suspect that I’m not alone in thinking this way.

The error which these companies seem to make is to assume that customers on average will not respond to a high level of attention to detail and service from counterparties or middlemen in small transactions. In reality, small transactions especially require good execution and service, because if the value of a deal is sufficiently small it can be easily exceeded by the nonmonetary costs of any hassles, and because customers will tend to interpret a high level of service in small transactions as an indicator of a company’s good faith that justifies greater use of its products or services. How many more people would use Paypal, and how much more business would Paypal do, if it had a reputation for being trouble free?

According to an unsubstantiated rumor, PricewaterhouseCoopers (the largest of the Big 4 accounting firms) has sent one of three letters to the boards of directors of their audit clients with December year-ends. The first says that the company is likely to pass its tests of internal controls; the second that the company could maybe pass if they bust their humps; the third is that they are unlikely to get a clean opinion. The unsubstantiated rumor also has it that as many as one-third of their clients are getting letter number 3 and are truly, deeply unhappy about it. I will be happy to retract this post as the occasion requires, since my source could be blowing more smoke than Pittsburgh in its heyday. We should know shortly.

It’s all about low transaction, marketing and distribution costs. This excellent article explains the common denominators in the successful business models of Amazon, eBay and Netflix. All of these businesses exploit network-enabled low costs to mine huge and previously inaccessible market sectors amalgamating numerous tiny niches. There’s nothing really new here, but the article is worth reading because it explains so clearly what’s going on. It also reminds that current online retailers are essentially 1990s web-economy dreams made flesh. IOW, it wasn’t a bubble; today’s retail and marketing survivors arose from a combination of good ideas that were left over after the shakeout, and new business models built on the hard-won knowledge gained in what many people now deride as speculative failures.

(via Tim Oren)

UPDATE: What also strikes me here is the difference between Amazon et al‘s business models, in which most of the value is contributed by participants on the margins of the network, and the (unsuccessful) business models which software makers and others were promoting until recently, in which value flowed outward from the servers of some “service provider” or other. Of course David Isenberg said this years ago.