[MUSIC] Okay, so I have an example for us, drawn from the headlines about, about shareholder value. [NOISE] and, and the kind of logic that it's that it creates. So, this is an article from the New York Times reporting on Apple's first quarter results, I'm sure many of us are familiar with the fact that Apple stumbled little bit in its first quarter. But I was going to read this, for the language, and for the kind of logic that it suggests. And I want to, I want to, have you, I want to ask you to observe that, on the one hand, the kind of neutral tone or the sort of general tone of the article that's there. And then map that onto some of the kind of un discussions that we've been having here. The underlying meaning of what this idea of shareholder logic is. So, we'll just read a few highlights. Apple's found a big investor that still has faith in it's future itself. On Tuesday the technology giant announced that it planned to more than double its program to return cash to shareholders through stock buybacks and a higher dividend, spending a hundred billion dollars on the effort through the end of 2015. Its share repurchases alone will increase to sixty billion from the ten billion it committed previously. The largest such plan in history. The move to renew investors' love affair with Apple's stock came as the company announced its first profit decline in a decade. Apple said its net income fell 18%. As one of the most successful technology franchises, the iPhone sowed, showed signs of slowing. The rarity of Apple's profit decline, which, note, was expected. Underscores how one of the most remarkable winning streaks in business has come to the end, to an end at least for now. Investors have battered the company stocks for months, sending it's share down from their peak of more than $700 last year as warning signs began to emerge about it's growth prospects. Note here that one of the biggest questions, facing Apple, one of the biggest questions facing Apple. What is one of the biggest questions facing Apple? This should not surprise us, having now gone through this class. What does Apple need to do in order to survive going forward? >> Innovate. >> Innovate, right? because if it doesn't innovate, it will die. So, no pressure. No pressure. It just needs to innovate its way out of its funk by a delivering a breakthrough new product, right? So you're Apple, you're like, eh, I don't know, it's future. Some say, well, don't worry, innovative breakthrough new product; everything will be fine. Tim Cook, the company's chief executive said that the stock price was very frustrating to all of us, but our teams are hard at work on some amazing new hardware. The note, the, the issue really that's, that's going on here, which is Apple's gross profit margin is one of the most closely watched measures of how profitable it is, are already declining, falling to 37.5% from 47.4%. So, roughly from 50% to 38% with further declines expected. This is the fourth consecutive quarter of decline, declining gross margins at Apple, and the company signaled that they may decline further. nonetheless, despite this, Apple said, Apple then has committed itself to this plan to repurchase its own shares, presumably that's sort of demonstration of the company's commitment to its own future. It believes in itself You 'll note this last comment from Tim Cook. We believe so strongly that repurchasing our shares represents an attractive use of our capital that we have dedicated the vast majority of the increase in our capital return program to share repurchases. We believe so strongly that this is the most compelling opportunity for us in terms of what we can do with our money. That we've dedicated the vast majority of our capital allocation strategy to this plan. It's a remarkable statement. Okay, well. What is it that underscores, what's the larger situation here, facing Apple that makes this announcement from the company necessary. What's been going on. That Apple has to come out and tell its shareholders, don't worry we're going to increase our dividend and buy back our at bunch of our shares, declining share price, right. Apple is sitting there trying to figure out what to do about its declining share price. Let's look at Apple's share price over the last five years. This is the catastrophe that Apple is having to contend with. And we should feel sorry for Apple, and Apple's investors. Right? The company's only making $42 billion a quarter. It's profit margins are a barely perceptible 38%, and likely to fall to an anemic 34%. If it makes any kind of money at all with those kind of numbers is extraordinary. No wonder shareholders are angry. Grabbing the pitchforks, rushing to Cupertino, California, threatening to burn the place down. Can we blame them for their hostility or disappointment? Well let's look at their share price. 2009 to today. And what do we find? We find that for 2009, 2010, 2011, looks pretty nice. You could skateboard down that trend line, pretty much. Even I could skate board down that trend line, and I have very bad balance. But in 2012, something odd happened, did it not? Imagine if we took 2012 out of the equation and simply continued the trend. Would Apple have a problem? >> No. >> Would there be any issue here? No! 2012 is the problem. So what, so look at what's going on. Apple is essentially establishing a radical sort of dedication to this capital allocation strategy buying back it's own shares because of something that happened to it's share price in a few, over a few months in 2012. What happened to it's share price in 2012? Looking at that chart, what would we describe that as? What's the word that we should use to describe the behavior in Apple's shares in 2012? >> [INAUDIBLE] [CROSSTALK] >> Spike? Sorry? >> Bubble? >> Who said it? >> Bubble. >> It's bubble. Isn't that a bubble? Right? Rapid inflation of the share price over a few periods of months up to an unsustainable high followed by inevitable collapse. Classic bubble behavior. We looked at the bubble. We know what a bubble means. What's the nature of investment reasoning in a bubble? Irrationality, sometimes even perfect irrationality, the exact opposite of what you would expect. So, in 2012 essentially investors in Apple share prices became subject to irrational forces leading to the bid up of its share price from $400 was it. Yeah. $400 to $700 a share over a very short period of time, over a couple months. Followed by the last fool jumping in, at which point the share price went back down again. Is Apple responsible? Well, let me rephrase it. Should Apple be responsible? For investors, who chose to take a position in it's share price at any level. Let alone in conditions of a bubble. That, I think, is a legitimate question for us to ask. Clearly, the company feels it is because it's announced that it's capital allocation strategy is now overwhelmingly geared towards it's share price that those people who jumped into Apple's shares during the bubble shouldn't feel too much pain. And it is pretty clear that investor expectations that accumulated behind the share price in 2012 were not realistic and unsustainable. One of the metrics, presumably, one of the ideas that informed investor expectations in 2012 was, Apple would continue to be able to maintain a 50% profit margin. Is that a reasonable expectation? The companies in a competitive landscape get to maintain a 50% profit margin? No. It doesn't happen. Who knows it's not going to happen? Apple's management. Apple itself knows that 50% profit margins are not sustainable. Is it reasonable? Have you made a reasonable risk assessment if you jump into a share price? Based on the expectation that over the longterm the company's going to be able to maintain a 50% profit margin. Seems to me probably not. Is it Apple's fault that you have made that investment decision based on an artificial or highly optimistic reading of its longterm profitability? Apparently it is. But should it be? One of the questions that this event begs is why could Apple not have done something in 2012 so that it wasn't then forced into a position in 2013 to give $60 billion back to its shareholders through increased dividends and share repurchase. Why couldn't Apple's management have looked at the direction of its share price in 2012 and said, we need to do something because if we don't, it's going to constrain our future strategic options and latitude. I asked you to read Professor Martin from the Rotman School of Business who has an interesting article on customer capitalism. Isn't this the ideal moment for a customer capitalist intervention? Couldn't Apple's management have gotten up and said, we have been a company whose success has been driven only by our unwavering commitment to our customers, by giving customers the kind of value that they have come to expect with Apple. And as a consequence of that unwavering commitment, we have seen tremendous success over the last decade. We are very excited that shareholders seem warmly to endorse our strategy. But shareholders should know that the way that we as management see the company going forward, the kind of sustainable growth that we were seeing in our share price in 2009, 2010, and 2011, strikes us as much more reasonable. Given our own internal understanding of our operations and our own commitment to our customers than the kinds of recent trends that we've been seeing in the market place. Is that not a reasonable thing for the ship, for the, for the company's management to say? Should it not be able to say that in order then to secure for itself better results going forward so that it doesn't have shareholders who bought in it unreasonable, unsustainable prices like, $650, $680, $700 a share. And yet I'm sure that all of us in this room would agree that if a manager said that, if senior management ever said, we think our share price is too high. That's somebody who is soon going to be looking for a job. That we do not have that in our arsenal of management, isn't that an example though of management failure? Management failure, we should define as an inability to take decisions that lead to the best results for your firm. That's management failure. If you can't take good re, good decisions that lead to the best results for your firm you're failing in the practice of management. And so and I don't blame Apple management for management failure I blame the environment for management failure. That management doesn't even have that as an option is an example of systemic management failure driven by what? Driven by the logic of shareholder value and think then about the outcome for the firm itself. Go back to Tim Cook's own words, it's a big world out there, there's lots of things that you can do with your money and Apple has lots and lots of lots of money. If you think about it does Apple really need to worry about its share price at all? Cost of capital, we mentioned cost of capital. Does Apple have a cost of capital problem? No. One of the advantages of having a mountain of cash in the bank is you don't have a cost of capital problem. So, is Apple's cost of capital in any way affected by its share price. Nope, no cost of capital question. Perhaps, it's danger be de-listed. It's a penny stock. It's about to be disappear from the markets altogether. No, it's trading at $400 a share. It pays out a nice dividend, which means that there is a certain yield. At some point, investors are going to find that attractive. Is Apple unlikely to be able to find investors willing to buy it's stock if it doesn't commit to this kind of strategy? Surely not. If people are willing to buy a no growth utility stock for 6%, surely they are willing to buy a company with potential growth prospects that's paying a dividend yield of 3%. So it doesn't need to this in order to secure investors going forward. Does it need to do it in order to secure the remuneration of it's own internal talent? In other words, it's share price decline means that maybe it's own employees will leave because now, they are sitting on options that weren't worth as much as they before. I have a solution for that, too. When you have a $188 billion in the bank. One of the things that you can do is you can simply change the remuneration from options that may not be as valuable to actual bonuses for something like that. It's one of the nice things that companies could to that have a lot of cash. So, why does Apple need to worry about it's shareholders? Perhaps, it's for the larger mojo question. Will Apple lose it's mojo? If its share prices seen to be declining, if its financial performance is seen to be under threat. Are customers likely to walk into Apple stores, ready to buy an iPad and then say hang on, let me just check the share price. Oh, down $10, I think I'll buy a Surface tablet instead. Is that likely as an outcome? >> No. >> No, so why does Apple care so much bbout its share price. Why does it want to commit so much of its money to buying back its own shares? Quite aside for the literature that I could site to you that show systematic management is a very poor timing participant in the market, surely the answer is because by buying back its own shares it's responding to the logic of a marketplace that exists within the shareholder value paradigm. Such that even a company like Apple, this is why I'm using Apple as an example, that has really almost no need whatsoever to worry about its share price has succumbed to this logic. There was somebody at Apple who famously couldn't care less about shareholders. But he, unfortunately, died. He stepped down from the company in 2011. In fact, one of the reasons maybe why there was a run up in price in 2012 was because Steve Jobs wasn't there and now shareholders thought, well with this new management maybe we'll find some more compliant people that we can, let's not say bribe, let's say incentivize in the right way in order to move some of that cash off of their books and into our pockets. Shouldn't be too, too surprising to us to see that shortly after Steve Jobs leaves Apple, the first of the ridiculous share holder law suits is filed against Apple asking Apple to return some of their money, meaning the share holders' money, to Apple. A lawsuit, by the way, that was dismissed out of hand. Why? Cause there's no legal basis to assert ownership on the basis, on the behalf of the shareholder to the company. But then think about it then in terms finally of the point of view of firm outcomes. Apple says, that the best thing for Apple is to take $60 billion and to move it into the hands of its shareholders. Who are the shareholders? Top 10%. Overwhelmingly, the top 1%. That's what the company says is the best thing for Apple. When Apple was looking around at all the strategic possibilities for it's capitol, at every possible thing it could do, it's decided that the best thing that Apple can do to secure it's future profitability is to take a large portion of the cash that it has made off of it's customers over the last years and put them into the pockets of a small number of people. That's what's best for Apple. That's ridiculous. Why not offer employees more money? Why not invest in their human capital? Why not invest in their knowledge networks? No. What's best for Apple, what best secures our own future, what is best in terms of generating an optimal outcome for this firm. Is to take $60 billion, $100 billion, and move it into the hands of 10% and preponderantly one percent of the population. That's what's best for Apple. That's perverted logic. I cannot read in any way Apple's strategy going forward which produces the answer, and the best thing for our firm is to make extremely wealthy people even wealthier. I just don't see how that helps Apple. I see how it helps the shareholder. I see how it helps the 10%, the 1%. But I don't see how it helps Apple sell more iPhones, sell more iPads, generate new products, continue to be a prosperous company going forward. So how is it then that a well run company, a respected brand like Apple ends up in such a re, remarkable position? Identifying is the most compelling use of its capitalist strategy that seems to bring it almost no benefit whatsoever. And the answer I have for you is that's the power of the shareholder value paradigm. If this is the kind of result that it creates we should consider very seriously whether this is a good idea. And we should consider very seriously whether this is the kind of managing principle that we want to practice going forward. If it's creating dangerous levels of wealth and equality. If it's taking long term stakeholding and making it subsidiary to short term shareholders. If it's leading to bad outcomes for the firm. If it's restricting the latitude of management to take decisions that serve the firm's own self interest, it is definitionaly management failure. And management failure has no place in the boardroom, has no place at the heart of any firm. [BLANK_AUDIO] [BLANK_AUDIO]
