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    Published on: May 4, 2016

    Content Guy's Note: The goal of "The Innovation Conversation" is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and one that Tom Furphy - a former Amazon executive, the originator of Amazon Fresh, and currently CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers - is uniquely positioned to address.

    This week's topic: Why retailers are creating funds being invested in start-ups, the importance of getting beyond legacy cultures, and why money isn't the most important factor when it comes to innovation.

    And now, the Conversation continues...

    KC: We've seen stories in recent weeks about major companies such as Walmart and Target putting money aside so they can invest in start-up companies that they see as helping them innovate.  Are there institutional and/or infrastructural reasons that it makes sense to take this approach rather than creating an in-house engine for innovation?

    Tom Furphy:
    For many established companies, institutional and infrastructural inertia is hard to break. Companies have been built over decades to operate a certain way, to deliver value to their customers and shareholders in a way proven to be repeatable. Factories, distribution systems, stores, people, everything about these businesses have been honed to deliver a consistent experience and a predictable financial return. Every year, budgets are rolled forward, incremental programs are added, some costs are trimmed and sales are expected to grow a rational amount. It becomes difficult to truly innovate from within. It is easy for the team to become complacent and/or make safe choices in the process. It’s very rare to see risk-taking rewarded. To innovate, you have to be willing to fail, and most people and companies are not.

    So, for many companies, putting specific funds aside to engage with and/or invest in startups makes sense. Startups are unencumbered with legacy culture, processes and systems. They are nimble. Their core DNA is about doing things differently. This DNA does not exist naturally in most companies. I hear companies throw around buzzwords like “Vision 2020” and “we’re going to be where the customer is.” That is not innovation. Enabling customers to shop in ways they didn’t think they could is innovation. Breaking business models, developing brand new infrastructure and delivering shopper and shareholder value in completely new ways is innovation. Many times that DNA is easier to find in startups, outside the walls of the company.

    KC: Agreed. In so many ways, the definition of the word "infrastructure" suggests something solid, physical, foundational ... something that does not move. And so, existing infrastructure is not built to accept the existence of something foreign ... in fact, the DNA is almost genetically engineered to reject it.

    So let me ask you this. Is this something that more traditional bricks-and-mortar companies ought to be building into their budgets?  And is it a matter of just allocating X dollars - maybe taking the money out of a cap-ex budget - for such an endeavor? Because I wonder the extent to which cultural issues have to be addressed when undertaking such an initiative.

    It definitely starts with the budget. All companies should set aside a dedicated pool for funding innovation, whether for partnering with startups or developing from within. The amount or how the budget is funded can range widely. Innovation does not have to be expensive. In fact, frugality and scrappiness can foster the best innovation. It forces you to build things that customers want, which they will pay for and that can provide financial return quickly. Putting together a test pilot, getting it in front a limited number of customers, gathering feedback and iterating can be quite inexpensive. Then, once the innovation is proven, scaling can be done confidently.

    KC: It is funny how you say that "frugality and scrappiness can foster the best innovation." As I usually do, I'll go back to a movie metaphor. Jaws is a much better movie because Steven Spielberg did not have an unlimited budget, and CGI had not been invented yet. He had a mechanical shark that didn't work, so he had to shoot a movie about a killer shark that has relatively few shots of the shark ... he had to be creative and innovative about suggesting terror rather than showing the shark, and that makes Jaws far more suspenseful, and I think you can argue that it was the limitations that helped make it that way.

    Absolutely. Regardless of the amount, it behooves every company (in every industry, frankly) to foster and invest in innovation. Perhaps it’s a small amount to make an equity bet on a startup or it’s some budget to put together a test pilot. Or maybe it’s a larger amount, such as the cost of a store or warehouse, once an idea is proven. The key is to establish a culture that rewards risk-taking and learns from mistakes. Establish a culture that is not happy with the status quo. The status quo has always been disrupted in business. Companies should endeavor to put their existing models out of business. Innovation and experimentation should be part of every employee’s performance review. This culture shift does not happen overnight. It happens through experience, failure, more failure and success.

    Working closely with startups is a fantastic way to foster innovation. It doesn’t necessarily require an investment in them. But setting aside funds and staff time to engage in pilots and iterations on their offerings can return itself in spades, both to your company and to the startup. But I would warn companies to be transparent and to not drag the startups along when a project or pilot doesn’t look like it will move forward. Startups have quick cycles where they have to continue to prove themselves to get to the next milestone. They can’t afford to let a project linger if it is not going to launch live. Nothing is more damaging to a startup than customer indecision and the passage of time. Your company does not want to become known as a startup killer.

    KC: Is this an approach that purely is the purview of big companies, or should smaller companies be looking of these sorts of opportunities as well, albeit on a smaller scale?

    Smaller companies should definitely be looking to partner with startups. They are actually a better partner for these early companies because they are often more agile than larger companies. They can often execute test pilots and iterate more rapidly than larger companies. Their decision cycle tends to be shorter than larger companies, which is tremendously valuable to these startups who need quick iterations toward product and market validation. Then, once a smaller company finds a startup solution that works for them, scaling the solution companywide is often quicker than it is for a larger company.

    KC: I have to wonder, to be honest, if some of these start-up companies are making a deal with the devil when they agree to be funded by a big company? It's like in Damn Yankees - Joe Hardy is willing to sell his soul to the devil in exchange for just winning season against the hated New York Yankees for his beloved Washington Senators, ignoring the learn term implications. It is all about short-term vs. long-term gratification. So, how would you advise such a start-up if they asked you about taking money?

    That's the irony. Being funded by a large company, while very tempting, is a bad idea for most startups. Visions of a marquee retailer or manufacturer backing you and leading you to market domination are simply unrealistic. You risk becoming a captive solution, which makes it very difficult for you to build your product for the larger market. Your roadmap is dictated by your investor.

    Also, we’ve seen that when one of these companies backs a startup, competitive retailers or manufacturers run for the hills. Then, down the road when there is no market left to sell into, the retailer or manufacturer ends up acquiring the startup and folding the technology into the IT group and the team somewhere else within the business. This yields a less than optimal outcome for the startup. And while the “acquihire” is initially good for the acquiring company, the employees end up leaving as soon as their earn-out is up. They’re entrepreneurs. The last thing they want is a corporate job.

    There are ways, however, for startups to creatively accept financing from retailers or manufacturers, while maintaining their independence. It is most important that the startup is mindful to keep the playing field level, allowing investment to be made by any partner. The investment parameters can scale based upon performance metrics (i.e. number of stores rolled out or based on the deal size with the startup), which might give a bigger piece to a larger company. But as long as the field is level, and there is a meaningful program in which any partner can participate, it can work very well.

    And the Innovation Conversation will continue...

    KC's View:

    Published on: May 4, 2016

    by Kevin Coupe

    The Wall Street Journal notes this morning that the Baby Boomer generation has been eclipsed by the Millennial generation - in mid-2015, Millennials became a larger group, throwing into second place "the massive generation" that "dominated much of American politics and culture for decades" after World War II.

    But, it points out, Baby Boomers won't be in second place for long. Third place is just around the corner.

    "Within the next few years," the story says, "the baby boomers are likely to also be overtaken by the generation of people born after the millennials in the early years of the 21st century."

    Two interesting passages from the story:

    • The Pew Research Center "has not officially designated a name for the postmillennial generation - though many analysts have already taken to calling today’s children and teenagers Generation Z - that came of age during the post-Sept. 11, housing-bubble-and-bust era. The investment bank Goldman Sachs has argued that this Generation Z 'matters more than millennials' because it will ultimately be even larger."

    • "Millennials and Generation Z surpassing the baby boomers has mostly been driven by births and by immigration, rather than by baby boomers dying. It will take years for these generations to reach their full influence. Earnings typically peak in people’s mid-to-late careers, meaning that boomers will continue to dominate consumer spending and hold more of the nation’s wealth. Voter turnout typically rises with age until voters are in their 70s, so boomers will remain for many more election cycles the dominant generation in U.S. politics."

    It is an Eye-Opener.
    KC's View:

    Published on: May 4, 2016

    The Cincinnati Business Courier reports that Rick Shea, president of Minneapolis-based Shea Food Consultants, is saying that Kroger plans to use its investment in the Lucky’s Markets natural/organic supermarket chain to get it into the Minneapolis market.

    Shea tells the Courier that not only is Lucky's actively seeking sites in the Minneapolis/St. Paul market, but Kroger may be "considering an acquisition that would make it a major player in the Minneapolis/St. Paul market. That means it could be eyeing Supervalu, the Minneapolis-based parent of Cub Foods. Cub has the top share among supermarkets in Minneapolis."

    "“It’s a crowded market, so it’s going to be hard to add scale unless you do it through an acquisition,” he says. “The obvious candidate is Supervalu and the Cub chain. And Cub Foods is struggling. It would be a logical acquisition for Kroger.”
    KC's View:
    Logic, Spock says in Star Trek VI: The Undiscovered Country, "is the beginning of wisdom, not the end."

    I think that we all have to be a little careful about this kind of "logical" speculation. Kroger clearly is in a somewhat acquisitive mood lately, but there will be the temptation - especially among the analyst/consultant class - to fuel speculation and maybe even client fees by suggesting that Kroger is going to buy everything and anything that may or may not be available. Only a small percentage of these possibilities will be realized, because the folks at Kroger are smarter than most about this stuff.

    I got a bunch of emails yesterday asking if I thought Kroger might be interested in buying Fairway, which just filed for bankruptcy. This made me realize that there's an enormous gap between wishful thinking and intelligent speculation - I might like Kroger to buy Fairway because it'd be interesting to see how it would make this market more competitive, but that doesn't mean it should or will happen.

    Published on: May 4, 2016

    The Chicago Tribune follows up on yesterday's stories about Kmart offering a lifetime guarantee on certain plants and trees sold at its garden centers by pointing out that the fine print offers a lot of caveats.

    Like, if "the expired shrub or tree wasn't adequately watered or otherwise neglected." Other exclusions: "Plants damaged by vehicles, lawn mowers, snowplows, chemicals, animals or vandals are out, too, according to the fine print on the company website. Same for plants finished off by 'acts of God, including, but not limited to: disease, insects and related plant pests, or weather'."

    "They've covered just about everything that's going to go wrong," Ken Johnson, a horticulture educator with the University of Illinois Extension, tells the Tribune.
    KC's View:
    So by offering all these exclusions, Kmart has not only covered acts of God, but also acts of Kevin.


    Now, I have to make an admission here. When I wrote this story yesterday and commented on it, I missed the obvious joke ... which was pointed out to me by literally dozens of readers who sent me emails saying, in a variety of ways, that the Kmart guarantee probably wouldn't last very long because Kmart's lifespan would be a lot shorter than that of most of the trees and plants that it sells.

    While I'm chagrined by the fact that I missed the joke, I am enormously cheered by the fact that I got so many emails. We're all mostly on the same page here, which makes me very happy.

    Published on: May 4, 2016

    MarketWatch has a story about how RBC analysts are suggesting that Walmart may have grown about as much as it is going to, saying that after years of growing, “virtually everyone that was going to shop at Walmart, already shops at Walmart."

    What this means, the analysts say, is that "recent store closures and labor investments are a step in the right direction, but we feel that a lot more changes need to be made, from greatly improving retail basics to further simplifying the portfolio ... We also believe the company’s significant earnings reset is likely a ‘necessary evil’ as it adapts to today’s rapidly changing retail environment.”

    And, the analysts say that Walmart's e-commerce investments, while yielding results, are "unlikely to move the needle in the near future, and we expect it to be margin dilutive over time.”
    KC's View:

    Published on: May 4, 2016

    • The Los Angeles Times reports that the US Supreme Court has declined to review an appeals court ruling that Pom Wonderful, the company selling pomegranate juice, misled consumers in advertising making a wide range of health claims, including that it would help consumers "cheat death" by preventing heart disease and prostate cancer.

    While Pom Wonderful spent millions on studies that reached these conclusions, the appeals court said that there was enough scientific evidence to support the claims.

    • The Wall Street Journal reports that the US Supreme Court has "declined to consider a challenge by franchise businesses to parts of a closely watched Seattle minimum-wage law that will eventually raise hourly pay rates to $15 an hour."

    The story notes that the International Franchise Association has argued "that the law applies unevenly to businesses affiliated with a national chain by requiring them to fully comply with the new pay rates four years sooner than local businesses," and that "the law discriminates against interstate commerce, arguing some city officials were hostile to their businesses because they didn’t like franchise operations such as McDonald’s or Subway."

    The lower courts disagreed, saying that "there was nothing unlawful about viewing franchise businesses as more akin to large employers and thus better able than small businesses and nonprofit groups to absorb the increased labor costs in the near term."
    KC's View:
    Can't help but wonder if this would play out differently if SCOTUS were fully populated with justices.

    Published on: May 4, 2016

    The Wall Street Journal reports that Kroger has decided to not move forward with "a controversial plan to charge alcohol suppliers for how it organizes beer, wine and liquor on store shelves."

    Earlier this year, Kroger said that it "wanted the alcohol industry to pay quarterly fees based, in part, on volume to Southern Wine & Spirits, which would handle shelf planning for the supermarket chain," the Journal writes. "However, prohibition-era laws designed to discourage aggressive marketing of alcohol ban manufacturers from giving retailers anything of value.

    "The Kroger plan met fierce opposition from alcohol producers who worried the fees would be illegal and costly. Craft brewers also expressed concerns that it would create a pay-to-play system that favored larger producers who could spend more on displays."

    Now, Kroger says, it will hire P.L. Marketing "to help design shelving plans for alcohol brands." By hiring the marketing company itself, rather than using a distributor paid for by supplier funds, it avoids legal and regulatory problems.

    And, the story says, Kroger plans to abandon the traditional "category captain" approach, using the marketing company to make decisions about shelf space and prominence that will based on traffic, sales and trends, rather than on promotional fees.
    KC's View:

    Published on: May 4, 2016

    • The Wall Street Journal provides some follow-up on yesterday's stories about Fairway Holdings filing for bankruptcy protection, noting that "the chapter 11 plan calls for Fairway’s senior lenders to swap out their debt for equity and new debt in a restructuring that leaves trade creditors, employee contracts and landlords unaffected, according to papers filed in the U.S. Bankruptcy Court in New York by Fairway Group Holdings Corp. and related companies ... Sterling Investment Partners, which controls about 80% of the voting power in the chain, and other shareholders will lose their stakes in Fairway, when the company emerges from bankruptcy."

    The Journal also reports that Fairway "is hoping for a quick trip through bankruptcy, with a lighter balance sheet and more cash to invest in capital improvements, court papers say."

    • The Chicago Tribune reports that McDonald's "is testing garlic fries in a handful of restaurants, a nod to its efforts to experiment with core menu items and focus more on food quality, freshness and taste." The fries are being sold "in four restaurants in the San Francisco Bay Area with the potential to expand to 250 in the area in August, depending on customer feedback."

    The new item has been named "Gilroy Garlic Fries," after Gilroy, California, one of the major sources of garlic in the US.

    Fortune reports that Target "is testing robots in a San Francisco department store," using them to "track inventory on its store shelves including shampoo and laundry detergent."

    According to the story, "Simbe Robotics, a Silicon Valley startup, built the robot called Tally that it says can roll autonomously around the store while scanning products to determine if they have been misplaced, mispriced, or are low in stock."
    KC's View:

    Published on: May 4, 2016

    ...will return.
    KC's View: