The Chief Loan Officer of a big bank had to sanction his team’s recommendation to loan money to Zayo Group. “Nope,” he determined after but one question. His question: “What about Price Compression?”. My city-state-of-Babylon response was to babble. My answer was straight from the opening scene of the 1999 horror film “The Looming Telecom Meltdown”. Except in the movie, the Chief Loan Officer loaned the money anyway.

His final comment was “Bandwidth is a bad business.“ My answer should have been: “I agree. So is the iPhone business. You want some data to prove this?”

Below is a chart of iPhone Average Price per Unit.

“Holy crap”, I can hear you gasp. Price per unit has plummeted by half in just three years.

This is the good news part of the bad story. Are you ready for the bad news? Tomorrow…

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Is Bandwidth a Bad Business? Are iPhones?
Short AAPL, as the iPhone Business is Bad
Apple Doing Just Fine, I’m Told
What’s the Story with Price Compression?
You decide, not your customers, where you want to go.

I’m in the Bandwidth Infrastructure business. Lot’s of smart people think this is a bad business. I think it is a damn good one. Is it or isn’t it?

It turns out this question is not so easy to answer. A few months back, a new potential debt sponsor was interested in joining Zayo’s syndicate. A team of eight of the bank’s employees did a bunch of work and concluded they were in. Only one step remained—the chief loan officer had to sanction. In days past, this was a rubber stamp stage. Rarely would a Chief Loan Officer reject a deal that made it through the entire process—and had unanimous support.

These days are not like days past. And, though telecom meltdown was years ago, the memories of those who lost billions are still top-of-mind.

We got through the presentation and the chief loan officer had but one question. “What about Price Compression?”

I went into my best impersonation of the ancient city-state of Babylon… and babbled. “Silicon Economics,” I explained. “How do you think the Internet would grow by 60% a year if the price per unit of bandwidth doesn’t drop?” I opined. “Price compression is the fuel that drives mobile data growth,” I pleaded.

The loan officer looked around the room, smirking. He reached for his folder and stood up. “That’s what I mean. Bandwidth is a bad business. Thanks for coming and good luck.”

Stunned, I sat there in silence. In hindsight, I should have said: “I agree. So is the iPhone business.”

[to be continued…]

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Are iPhones Bad Business?
What’s the Story with Price Compression?
Short AAPL, as the iPhone Business is Bad
Apple Doing Just Fine, I’m Told
You decide, not your customers, where you want to go.

Recall, Principle #1 is:

1. Treat shareholders as long term business partners; and view management as managing partners.

a. An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

b. It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.

Yesterday, I listed several ways that executives could game the system. I opined that the vast majority of recent executive pay debacles involved one or more of the outlined situations. I want to close the discussion of the Management Ethics #1 series by making three points.

First, let’s return to the Mike Hampton series. Like professional athletes, executives should get paid all they are entitled to. It is not government’s business to restrict this, any more than it is government’s charter to not allow Tiger Woods to have made $1B dollars so far in his career. Moreover, it is not the government’s business to “help” investors do a better job of managing executive pay. That is, the market needs to sort out how to do a better job of determining executive pay packages so as to not repeat the recent debacles. [This statement isn’t true in the extreme—as the government must play certain roles—but it should be a guiding principle. I don’t want to expound on this now but perhaps will later.]

Second, I am a director of three companies and am a member of certain compensation committees. Like the other directors, I am limited in the amount of time I can spend in these duties. As such, I know first-hand that there is a strong dependency on management when it comes to structuring and understanding executive compensation packages. The director’s role is not easy to perform. Hiring objective and qualified experts is often prohibitively expensive. Thus, the dependency on conflicted executives remains a very-real aspect of the executive compensation process.

Third is the answer to logical questions. Why does my Management Ethics principle #1 include both 1a and 1b? Why not make them two separate principles, as they both are extremely important? It is because they are so inter-related. A management team is more likely to satisfy their responsibilities under 1 b if it fully embraces that (a) their shareholders as long term business partners and (b) the enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

By the way, the extreme importance of executive compensation—and the inherent conflicts of interest—are why it is covered as part of the FIRST management ethics principle.

Zayo and Envysion employees: I’d like all of our folks to read this bearonbusiness series. Please encourage your co-workers to follow these posts.

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Management Ethics – 1(b) of 4 (cont’d)
Management Ethics – 1(b) of 4
Management Ethics – 1(a) of 4
Management Ethics – the 2nd of 4 Principles
Ethics of Stock Price Management

Yesterday, I discussed part 1b of the first of my management ethics. Management Ethics #1 is:

1. Treat shareholders as long term business partners; and view management as managing partners.

a. An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

b. It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.

It is management’s responsibility to ensure executive compensation and perks:

• are clearly understood

• are approved by its investors

Both aspects to this must be satisfied. Unlike a professional athlete, a CEO/executive team has more of an opportunity to game the compensation dynamic. The fact that this opportunity exists does not entitle managers to exploit it.

How does management game the system? Here is how:

• Allowing employment contract language to be unnecessarily complex, thereby making it difficult for investor representatives (e.g., compensation committee) to evaluate

• Providing summaries that, although perhaps accurate, are incomplete or misleading

• Providing supporting analysis that fails to identify relevant scenarios—like when an executive makes millions while the company is crumbling

• Failing to identify flaws in the plan—for example, if the plan encourages management to pursue inappropriately risky investments which conflict with the overall Management Ethics #1 principle

• Manipulating accounting results to benefit management compensation without the intended benefit to the owners

• Using professional services experts—such as human resource or financial analyst consultants—who are inappropriately influenced by management

• Having the investors’ representatives (e.g., comp committee members) having inappropriately cozy relationships with management

I will not blame only management for all the recent debacles on executive pay. Certainly, investors/directors shoulder some of the responsibility. However, the vast majority of debacles involved one or more of the situations above.

More tomorrow…

Zayo and Envysion employees: I’d like all of our folks to read this bearonbusiness series. Please encourage your co-workers to follow these posts.

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Management Ethics – 1(b) of 4
Management Ethics – 1(b) of 4 — the last one
Management Ethics – 1(a) of 4
Management Ethics – the 2nd of 4 Principles
Management Ethics and the Origins of BearonBusiness

Yesterday, I shared color on the 1a part of the first of my management ethics. Today, I will provide some color on 1b. Management Ethics #1 is:

1. Treat shareholders as long term business partners; and view management as managing partners.

a. An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

b. It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.

I wrote a long series on salaries in baseball. I know I haven’t completed the series—and I will return to it at some point. However, this post provides a clue on my beliefs.

A major league baseball players’ job is to do whatever it takes—within the rules of the game—to help his team win. Managements’ job is to do whatever it takes—while abiding by the law AND appropriate ethics—to maximize value for its stakeholders.

However, our society is not socialistic. Core to our capitalistic system is that employees are entitled to get paid what they are worth. Baseball players want to help their team win—but at contract time, they want to get as lucrative a contract as possible. Good management wants to maximize return for their shareholders—but they too want to get paid as much as possible. Here is the difference.

Professional sports athletes do not have an opportunity to game the system. That is, their contacts are the result of intense negotiations with management. Whether the contract works out well (e.g., Peyton Manning) or poorly (e.g., Mike Hampton), management cannot blame the player for manipulating the circumstances. It is a balanced and transparent negotiation. The team’s “front office” will take the blame if, in hindsight, the contract was ill-advised. Team manager and/or general manager might get fired.

When it comes to executive pay packages, the dynamic could be different. A CEO/executive team has more of an opportunity to game the situation. The point of Management Ethics 1(b) is to clearly state management’s responsibility to not game the system. Instead, it is management’s responsibility to ensure executive compensation and perks are:

• clearly understood

• approved by its investors

Both aspects to this must be satisfied. More on this tomorrow.

Zayo and Envysion employees: I’d like all of our folks to read this bearonbusiness series. Please encourage your co-workers to follow these posts.

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Management Ethics – 1(b) of 4 (cont’d)
Management Ethics – 1(b) of 4 — the last one
Management Ethics – 1(a) of 4
Management Ethics – the 2nd of 4 Principles
Management Ethics and the Origins of BearonBusiness

I am committed to the highest level of management ethics. I would rather see the company fail financially than see it compromise on its ethics. With this in mind, I articulate four management ethics principles that I believe capture the responsibilities management has to its investors. This post will cover the first of the four.

1. Treat shareholders as long term business partners; and view management as managing partners.

a. An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

b. It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.

Today I will focus on 1a. I’ve seen too many situations where management teams lose sight of their role as managers of a company. At the end of the day—and at the beginning of the day for that matter—the company belongs to the investors. A company’s purpose is to maximize value for its owners. Conversely, an enterprise does not exist to “serve” the management nor its employees. This might sound cold—but it is essential belief a for-profit enterprise must have to maintain long term success. When it loses this perspective, it begins to make inappropriate decisions which, over time, erode the viability of the business. As this happens, investors suffer but so do employees and customers.

How many of the disaster stories of the past couple of years—or during the telecom meltdown—could be attributed to management teams failing to treat their shareholders as long term business partners? Lots!

By the way, “long term” is an important part of this principle. Without doubt, short term and extraordinary high risk tactics were at the core of the housing and banking collapse. A management team that is constantly thinking about the long term treatment of their business partners will resist these tempting short term tactics.

Tomorrow, I’ll focus on 1b.

Zayo and Envysion employees: I’d like all of our folks to read this bearonbusiness series. Please encourage your co-workers to follow these posts.

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Management Ethics – 1(b) of 4 — the last one
Management Ethics – 1(b) of 4 (cont’d)
Management Ethics – 1(b) of 4
Management Ethics – the 2nd of 4 Principles
Management Ethics and the Origins of BearonBusiness

I launched bearonbusiness.com in late 2007. My early posts centered on the articulation of my approach to business.

Since I posted these, much has changed. USA has an African American president. Mayor Daley was unsuccessful in bribing officials–in this case by failing to entice the International Olympic Committee to support Chicago’s bid. Zayo has progressed from a spirited idea to a near $300M company. And the Bears have a legitimate NFL quarterback.

Yet, in the three years since bearonbusiness has been launched, much is the same. Just last week, Level 3 Communications raised yet more debt to ensure it has sufficient runway to avoid bankruptcy. Envysion is a couple big customers deals away from being an enormous success. Bandwidth is growing at a rapid pace. And Chicago Cubs fans are waiting until next year.

I am going to circle back on the early posts on management ethics. This week, I will focus on the first of the four Management Ethics principles. Perhaps next week I’ll focus on the second. As I do so, I will add color and perspective. I am doing this to share my business underpinnings with newer members to our family. I am hoping this helps orientate them to our way of thinking, accelerating their ability to play significant roles in our businesses. Long term members of our team will benefit from this review.

I would be remiss if I didn’t credit Warren Buffett’s influence in my sets of beliefs. My perspective is more that of an operator instead of Buffett’s investor point-of-view—and my articulation reflects this. Nonetheless, you can trace most of my thoughts directly to those shared so generously by Warren Buffett in his annual reports.

One additional note…. Over the weekend, some non-business friends asked “what is this blogging all about”. This question is always hard to answer. Hopefully this series will provide some foundation.

Zayo and Envysion employees: I’d like all of our folks to read this bearonbusiness series. Please encourage your co-workers to follow these posts.

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Management Ethics – 1(a) of 4
Management Ethics – 1(b) of 4 — the last one
Management Ethics – 1(b) of 4 (cont’d)
Management Ethics – the 2nd of 4 Principles
Management Ethics – 1(b) of 4

A Video Primer on Fiber Backhaul, By Stacey Higginbotham

We’ve spilled a lot of digital ink on the need for backhaul for next-generation (and even current generation) wireless networks, so while at the FTTH show in Houston, I chatted with Geoff Burke, director of marketing for Calix, a provider of optical equipment for carriers, about the mobile backhaul opportunity for both the company and its customers. CenturyLink, a rural telecommunications provider, yesterday announced that it would deploy Calix equipment in order to offer fiber connectivity for its cell towers. In the video below, Burke talks about how rural carriers can take advantage of the need for backhaul and explains how Ethernet over fiber compares with alternative technologies such as Ethernet over copper. There are doubters, of course, those that allege fiber is still too expensive for cell towers, and that cell towers don’t need the full capabilities of a fiber connection, but I believe the demand for mobile broadband will continue to grow, and so I’m putting my money on fiber.

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Got Fiber, Business?
Zayo One of Four in TMobile Deal
Fiber: the Workhorse of Bandwidth
Format for Fiber Texas Hold’em Tournament
Zayo in the News

At Zayo, we are committed to data. Using salesforce.com, we gather data. We make sure it is accurate. We organize it. We trend it. And we analyze it.

We break out our business into manageable size business units—and we put leaders in charge of them who have end-to-end financial visibility. We expect these leaders to show command and control of the data that underlies their business.

We constantly grapple with “Value Created”. Are we creating value? If so, can we see it in the numbers—both historical and forward looking?  Are we building up durable and growing cash flow? If so, what is an appropriate EBITDA multiple for each of our businesses?

Through our business units and the data, we constantly question “conventional telecom wisdom”.  Do we have the “right” amount of sales people?  Are we pricing appropriately?    Are we walking away from business that doesn’t add much value?  Are we focusing our activities and capital on activities that create equity value?   Do we have forward-looking visibility into our true cash flows so that we will know whether or not we are being successful with our day-to-day decisions?

Are we questioning the “telecom handbook” by thinking through what “conventional wisdom” is right versus wrong?   Are we constantly probing into the key questions—either to validate that what we are doing is value-creating or to alter course toward more value creating activities.

Are we—at Zayo—developing an analytical foundation that is part of our long term competitive edge?  I hope so—because that is our goal.  To use Billy Beane as an analogy—can Zayo borrow from the Oakland A’s playbook and achieve success in creating equity value for years to come?

This is integral to what we are trying to create at Zayo.  We demand command and control over business data. We emphasize deep and broad understanding by our employees of “Value Creation”.  We frequently question and challenge conventional telecom wisdom to either validate firmly held beliefs or to identify new angles to take.    We rely on objective and thorough analysis to guide our decision-making.  Through all of this, we hope to discover a constant flow of competitive edges that allow us to create value for our stakeholders.

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Blind Side and its Relevance to Business
Blind Side and the Value of the Left Tackle
Blind Side and the Story of Michael Oher
Criteria for Measuring “Today’s Value”
Operating Culture Weaves Them Together (part 4)

The last two posts were about Michael Lewis’ book titled Blind Side. Prior to 2000, Left Tackles were treated about the same as any other offensive linemen. And offensive lineman were at the bottom of the NFL salary totem pole. All they do is block. And they are big and bulky, instead of lean and muscular. It was no surprise they got paid the least.

In the post Lawrence Taylor era, this changed dramatically. Out of nowhere, Left Tackles became the second highest paid position in football. With the benefit of hindsight, the reason is obvious. The Left Tackles protects the quarterback’s Blind Side. A great Left Tackle keeps the franchise quarterback healthy. A mediocre Left Tackle could leave the quarterback exposed to a 350 lb defensive lineman, potentially ending the quarterback’s season. Fans lose interest. Playoff money goes elsewhere. The value of the franchise suffers by millions. If you have a great quarterback, you better invest heavily to get a great Left Tackle.

A huge business lesson can be taken from this story. Over time, certain NFL coaches discovered the importance of the Left Tackle position. And they quantified its importance. That is, they quantified the relative value of a great Left Tackle relative to an average Left Tackle. And they used this intelligence advantage to sign the best Left Tackles at salaries well below their value. Over time, other teams caught on. but for several years, those who figured it out were able to prosper.

Certain coaches discovered this intelligence despite the fact that it was not obvious. In fact, conventional wisdom would have steered them elsewhere. Conventional wisdom was that running backs or receivers were more valuable. Conventional wisdom was that the lean and muscular defensive lineman was far more valuable than the big and bulky offensive lineman.

Conventional wisdom was challenged. Perhaps the ideas originated during coaches’ brainstorming sessions over pizza and beers. Perhaps the ideas were a result of highly analytical college grads looking to discover a new angle. Either way, the key was the pursuit of new ideas that create a competitive edge. What might we do different that might give us an advantage over our rivals?

A second key is perhaps more important. Analytics. Fact based financial analysis. The conviction to act on the idea—and to know how to act—comes from the quantifying the “value”. That is, a team must carefully compute the relative value of a great Left Tackle relative to a mediocre one. And, even more difficult, the calculation needs to compare the value of a great wide receiver on relative terms as well. Are we better off spending $10M on a great Left Tackle, leaving us only $5M for a middle-of-the-road receiver? Or would we create more value by spending $3M on a mediocre Left Tackle, which would leave us $12M to get a prime-time wide-out?

Developing conviction in the answers requires a strong commitment to data gathering and quantitative analysis. Your average football coach circa 1995 was unlikely to be receptive to such an approach. They were more likely to rely on the gut instincts of a 30 year lifer, who almost certainly never used excel and thought NPV was the Swedish expression “No Puck’en Vay”.

How does this apply to what you do? Are you committed to data gathering? Do you challenge conventional wisdom? Do you rely on quantitative analysis to help discover where value can truly be created for the enterprise? Or are you more like a football coach circa 1995, relying on the time-tested instincts on how to get the job done. If so, you should be worried about who is protecting your Blind Side.

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Blind Side and the Value of the Left Tackle
Blind Side and the Story of Michael Oher
Blind Side and the Culture of Zayo
Lessons from Maggie Lott
Mike Ditka’s Approach to Retail