Research in Motion

A perennial favorite in the tech industry, Research in Motion (RIMM), has fallen out of favor with investors ahead of the release of its new Playbook tablet on Tuesday. This is seemingly perplexing to CEO Mike Lazaridis. He told the New York Times:

Why is it that people don’t appreciate our profits? Why is it that people don’t appreciate our growth? Why is it that people don’t appreciate the fact that we spent the last four years going global? Why is it that people don’t appreciate that we have 500 carriers in 170 countries with products in almost 30 languages? I don’t fully understand why there’s this negative sentiment. 

Well, Mike, I've got an answer for you: You became complacent with your core product (Blackberry) and are now scrambling and attempting to enter a market with an unrefined product. In managerial accounting, there's something an industry/market size variance. Basically, it tells a manager how much his sales have expanded due to his company's success vs. the overall market expanding. Based on this table showing RIMM losing 5% of the smartphone marketshare in the last four months, I'd wager that most of the growth he mentions is due to the industry expanding faster than RIMM is losing its share. 

Five years ago, before the iPhone and Android, whatever iteration of the Blackberry was unquestionably the best smartphone available. Sure, there were a small number of people using Treos, but most power users were on Blackberries. RIMM had developed a method that was fast and secure, and the Blackberry was the preferred phone by many corporations. RIMM owned this market. With that established, it began to try to win over the consumer market. Consumers, like myself, wanted access to our email from wherever we were. We also wanted access to the internet for sports scores, news, etc. 

RIMM was able to successfully bring over the email from the corporate side. In addition, BBM is a cult hit amongst Blackberry users, so much to the point that some people carry around a Blackberry only to BBM. I've never owned a Blackberry, so I can't attest to the greatness of BBM, but I can't imagine how much better it is than a quick email or text. (The rumor of RIMM bringing BBM to iOS and Android would be extremely detrimental to the company). While RIMM has a hit in that department, it has struggled in most others. Blackberries have never had a full functioning browser. People complain about the lack of flash support in iOS, but the amount of stuff you can do on iOS Safari blows the Blackberry mobile browser out of the water. It's noteworthy that on the current Blackberry Curve product page, web browsing capability isn't even mentioned on the feature list. The bigger problem with the Blackberry phones is the lack of apps. RIMM has basically ignored the concept of an app as its UI and phones are so difficult to develop for that all but the biggest developers ignore the platform. It's gotten so bad for the Blackberry App World that RIMM is going to allow users to download Android apps in the near future. I have a PS3 for the sole purpose of playing MLB the Show. If I could play MLB the Show, a PS3 game, on my Xbox, I wouldn't a PS3. 

That brings us to the Playbook which RIMM debuted last September. At the time, there was a lot of positive vibe surrounding the announcement. RIMM had just acquired QNX and added TAT in December. Both companies brought a good reputation of developing outstanding software platforms and UI platforms. As this was and remains the major problem for the Blackberry smartphones, everything looked to be moving in the right direction. I, however, was still skeptical. RIMM had never pushed out a successful major hardware or software upgrade. The last time it tried to step significantly outside its comfort zone was the launch of the Storm, the first touch screen phone, in summer of 2009. It was terrible. Since then, I have doubted RIMM's ability to put out cutting edge products. 

The reviews of the Playbook were released earlier this week and reviewers have been lukewarm thus far. Virtually everyone agrees the user interface is very slick and the hardware is much great. The problem is what can the Playbook really do? It turns out, not much. It has no data connection. It has no app store. Incredibly, it has no email app. Let me repeat: It has no email app. The only way to get email on your Playbook is to use the web browser or connect it to your Blackberry phone. I don't understand how a product can be in development for at least the last 16 months and have no email app. Particularly from a company like RIMM that was built on its email functionality. If I were designing any kind of a mobile computing product, an email app (let alone Facebook, Twitter, etc) would be one of the first things I designed. The other problem with RIMM's "solution" to an email app is that in order to fully utilize your new Playbook, you must have a Blackberry. They're already restricting their market to those Blackberry users who don't already have an iPad! Is there really a great opportunity here? 

The other complaint I have with the Playbook is the whole idea of it. RIMM has to have known that its core smartphone marketshare has been under attack for the last 2-3 years by Apple and Google and now Microsoft (by way of Nokia) is entering the fray. The smartphone is RIMM's bread and butter: It was the first there and has a great product. Why is RIMM choosing to abandon this in favor of a tablet? There are two schools of thought here. First, from a strategic standpoint, we can talk about core competency. RIMM's core competency is delivering email to phones. It isn't designing consumer electronic devices (that would be Apple). What's the one point that's missing from the Playbook? Email! Second, costs of product development are very high. I am sure RIMM has invested a lot in the development of the Playbook and it will likely be able to recover most of these from sales. The less visible cost (and more important in my opinion) is the opportunity cost of developing the Playbook. RIMM had its top brainpower and enlisted the services of its two new subsidiaries to develop the Playbook for the past 16-24 months. What if this effort had been focused on improving the Blackberry phone? We could be talking about RIMM introducing a killer new phone that had an incredible OS. Alas, RIMM felt an underdeveloped tablet was the better route. 

RIMM's "effort" with the Playbook reminds me a lot of a classic episode of Southpark:

RIMM has designed a potentially great product in a growing marketplace, but it clearly has no idea of how to get from designing the product to making money off a product. Buying companies like QNX and TAT won't help RIMM determine what people want in a tablet computer. iOS really hasn't changed that much since Apple opened it to developers in 2008. Sure, a rudimentary form of multitasking was introduced, but it's a far cry from the multitasking offered by the Playbook, among others. Apple, however, has a fantastic idea of what people want: They want a device that allows them to do a ton of things (apps) in a simple and intuitive way. Apple doesn't have the technically superior products in either the smartphone or tablet market, yet they will dominate it. RIMM needs to pay more attention to the Blackberry. If some of the rumors are true and it opens BBM to any UI and allows Android apps to run on Blackberries, what is the point? More and more corporations are supporting the iPhone and Android devices. Once this market is gone, RIMM will be obsolete. 

Whether it's entirely due to Steve Jobs, or not, Apple "gets" it. If the underpants gnomes applied Apple's methodology, they would be profitable in whatever line of business they operated in. Until RIMM changes its methodology, it's going to be stuck in neutral. There is a growing pile of evidence that suggests new or different management could be very helpful in this arena, but it will always be difficult to get rid of the founder of a company. 

Gamestop is the Next Netflix?

There's a piece over at Forbes that talks about a research analyst who compares Gamestop (GME) to Netflix (NFLX). Gamestop is attempting to shift its business from brick and mortar stores to digital download. It has even been rumored to be developing its own gaming tablet. The research analyst believes that Gamestop will become the Netflix of gaming. I couldn't disagree more.

Let's review the history of Netflix as summarized by this piece from the New York Times. Netflix was founded in 1997 and from its beginnings had an eye on digital, not mail order, distribution. In 1997, I don't believe I owned a DVD player, yet Netflix already envisioned a future beyond DVDs. This allowed it to negotiate favorable contracts with the studios who like the rest of us lacked the foresight to realize how valuable these rights could become. It's no surprise that studios are now either extracting massive amounts of money from Netflix or digitally distributing their content themselves. Netflix had a massive first to market advantage and while the company won't be going away in the near future, it will certainly face more competition.

If anyone is familiar with Gamestop, they will know a comparison to Netflix is offbase. The game industry is less mature than the movie industry and therefore has had the benefit of watching what has happened between Netflix and the studios. Gaming studios will not make the same mistake and if they do, it certainly won't be in Gamestop's favor. Why? Publishers have a long tradition of hating Gamestop since Gamestop's used game sales take money out of the company's profits. Additionally, Gamestop bears almost zero marketing expense as the publishers do most of the heavy lifting. Have you ever seen a Gamestop TV commerical? No, but EA has had Super Bowl commercials for its games. The publishers have adopted new strategies like the online pass (a one time code required to activate certain features of a game) to counter used game sales. The publishers will look to squash Gamestop whenever possible.

There are two things that makes this comparison so far off base. First,  Gamestop isn't a digital company: Per its most recent 10K, it has 6,670 stores around the world. Netflix never had a single store. Second, Gamestop doesn't do great selling new games- its margin on those is 7.3% (FY ended 1/29/11), a far cry from its overall margin of 26.8%. Where do the rest of the profits come from? "Buying low and selling high." A whooping 46.2% of Gamestop's profits came from the sale of used video game profits. Nearly half its business! Gamestop relies on a steady stream of people who either don't care or don't know how to get the best possible price for their used gaming equipment. Buy a new game, play it for a week or two and you'll likely be able to sell it back to Gamestop for $25-35. They will then turn around and resell it for $55 and likely do so quickly. Both consumers are leaving money on the table as copies of recently released, used games trade on marketplaces like eBay for $30-45. That's not to fault the consumer, as there is some value in Gamestop's convenience. It is, however, a huge concern for Gamestop going forward. There are no used digitally downloaded games. Once the game is downloaded, it's on the user's hard drive until he deletes it. He cannot resell this to a friend, Gamestop, or anyone else. If Gamestop were to become a digital distributor, it already loses 50% of its business.

Could there be a Netflix like growth story for video games? Sure, there already has been- www.steampowered.com. Gamestop might be able to establish a presence in this industry, but it won't grow nearly as quickly as Netflix, nor will it get such favorable distribution rights, if it gets them at all. I won't even begin to think about how short sighted the idea of a video game retailer developing a tablet. One of the research analyst's ten points of comparison is that Gamestop, like Netflix was during its rise, is one of the most shorted stocks on the board. In fact, as of March 31st, Gamestop was the 38th most shorted stock in the whole market with 26.8% of outstanding shares short and a short ratio (short shares/avg. daily volume) of roughly 6. Netflix saw its short ratio approach 9 over the past year, but the shorts have gotten squeezed out with its continued rise.

So what are we left with? Netflix was a forward thinking company that saw about ten years into the future, compared to Gamestop which was caught flat footed by digital distribution and entered the market in August of 2010. Less than one year ago! Gamestop is a massive retail chain that is thinking of developing new hardware while Netflix has never had a retail presence and placed a heavy emphasis on software (see various streaming methods- XBox, iPad, Roku, etc). But, the research analyst forgets about these obvious differences instead arguing:

Netflix was heavily shorted.

Netflix thrived and burned the shorts. 

Gamestop is heavily shorted. Gamestop will burn the shorts. 

It's clear this is a flawed argument. Sure Netflix may have outlasted the shorts (to this point), but short sellers are typically able to generate high returns. Albert Pujols doesn't get a hit everytime (as his early season slumps show).

I am short Gamestop and opinions like this continue to drive Gamestop higher, I will likely add to my position.