CEO blames ôOld Sonyö and crisis for profit collapse

Howard Stringer says there is ôtoo much old Sony at Sonyö despite the fact that he has been in charge since June 2005.
Sony CEO Howard Stringer yesterday blamed the latest awful profit outlook for JapanÆs favourite electronics company on not adapting fast enough to new conditions, as well as the ôworst recession in (his) lifetimeö. At a press conference, Stringer announced that Sony was revising its fiscal 2008 (ending March 2009) consolidated net income forecast to a Ñ150 billion ($1.6 billion) loss from an earlier estimate of a Ñ150 billion profit, off expected revenues of Ñ7.7 trillion ($86 billion).

ôThere is too much old Sony at Sony,ö said Stringer in his introductory comments, despite the fact that he took the helm almost four years ago û specifically to make a ônew Sonyö.

Stringer finds it easy to articulate the right strategy: Sony must become more of a pure design and marketing company (like arch rival Apple) in a world where hardware is becoming increasingly commoditised. It must also urgently reduce its huge fixed cost base, as reflected by the gulf between its revenue and its earnings. (To rub salt in the wound, Apple on Thursday beat analysts' expectations with a $1.6 billion profit for its fiscal first quarter to end-December, off sales of $10.2 billion.)

Converting Stringer's theory into practice has proved a challenge, however. Indeed, veteran Sony observers note that Stringer talked about the same challenges four years ago when he first became CEO. At that point, he established his mission as knocking down the companyÆs notorious silos in films, mobile phones, games and electronics; cutting fixed costs; and making SonyÆs elite hardware engineers understand that they had to work more closely with the software engineers.

The company has scored some successes in terms of the integration of its software and hardware capacities, especially in the US market, with a Will Smith film having being downloaded to Bravia TV sets ahead of its release on DVD. However, according to a December Credit Suisse report, only 5% of Bravia TVs are æactiveÆ, that is are currently linked to a network. This makes StringerÆs comment that ônot even Apple can do network TVsö less impressive than it might have been. It may be true that the concept of supplying films to TV sets over a network, thereby avoiding third-party satellite and cable companies, is an impressive one û but itÆs a concept that still has not been translated into sustained profitability.

Making a rare appearance at a press conference in Tokyo (his family lives in England), Stringer expressed a sense of frustration with the companyÆs slow progress. Drawing a parallel with President ObamaÆs inauguration speech, he said that ôtough decisions can no longer be avoidedö. Later, he said that ôclosing ones eyes to avoid the crisisö was not the way forward.

There was a widespread belief that when Sony appointed the first-ever foreigner to the top post, he would have the power and freedom to carry out restructuring in a way that a highly-obligated Japanese manager could not.

However, his troops do not appear to have responded. He appears to be having trouble in bringing the company along in his restructuring plans. Japanese companies often operate with a high degree of consensus, in which middle managers have a surprisingly large say by Western standards.

The company looks as if it is in danger of falling between two stools. If traditional management pre-Stringer failed, and the foreign cost cutter also fails to turn the company around, where does that leave Sony? And Stringer?

For now at least, Stringer is still pushing his strategy of a strong CEO. Several times during the press conference he extolled the virtues of ôtop-down leadershipö, as opposed to traditional Japanese consensus leadership. Stringer made the surely valid point that in a crisis, the company needs to move fast, and that requires strong leadership. Given his lack of success so far, it is possible that Stringer is hoping that the crisis could finally give him the authority to bring some kind of fundamental change to Sony. Things might still work out that way, but it is a costly way to persuade people to follow him.

When asked by a reporter whether he feels responsibile for the companyÆs current debacle, Stringer contented himself with describing his responsibility as ôreturning the company to profitabilityö. However, it was announced he and two other executives would forfeit their bonuses for FY08.

One analyst at the press conference, who preferred not to be named, said in private that the presentation was weak on detail. ôSure, the company is saying it will save Ñ250 billion in the next financial year. But I donÆt see any details as to how it plans to accomplish that. The company is essentially asking us to trust it.ö

Unfortunately, in some corners of the analyst community, trust appears to be running out. One of the first to turn bearish on Sony, brokerage CLSA has come out with a string of devastating reports, arguing that Sony management has completely failed to transform since Stringer arrived in June 2005. The report quotes Stringer in a letter to shareholders dated June 2008, congratulating himself that ôFY07 represented the culmination of our three-year restructuring initiativeàwe have achieved nearly every goal that we set ourselves three years agoàwe successfully re-engineered our company by dramatically reducing operating costs, streamlining our operations, and reducing headcountö. (During the restructuring 10,000 employees were laid off.)

FY07 figures are important because Sony presented them as a huge improvement on FY2006, with operating income of Ñ375 billion compared to Ñ72 billion in FY2006. Recall that Stringer joined in mid-2005.

But the CLSA report goes on to argue that much of the FY07 operating profits were due to one-off items and a weak yen (in direct contrast to the current losses which are partly due to a strong yen).

ôSonyÆs management has failed to deliver what it promised (5% operating profit margins) about three years ago. In FY07, Sony promised operating profit margins of 5% (=Ñ450 billion in operating profits) but could barely deliver Ñ375 billion...(and) even that included Ñ160 billion in one-off gains, and another Ñ203 billion of forex gains at the operating profit level," says the report.

Most damningly, the report goes on to say that ôthe most worrying aspect of such one-off gains is lack of disclosure. Sony has written off nearly Ñ25 billon for PS3 inventory for FY05 (when PS3 was not even under production), then another Ñ81 billion for PS3 inventory in FY06. Of the combined Ñ106 billion in inventory write-offs, it has written back nearly Ñ46 billion in FY07, artificially boosting its profits. We wonder if a company can be allowed to choose the timing of its write-off and write-back!ö(æWriting backÆ refers to the re-inclusion of cash on the balance sheet that has previously been stripped out.)

Regarding the weak yen, the CLSA report argues that of SonyÆs Ñ216 billion operating profit for FY2007 (with the one-off earnings and the PS3 write-backs stripped out), Ñ113 billion was due to the gains from a weaker yen. In other words, the report argues that Sony made just Ñ103 billion in operating profit in FY07.

Clearly its operating margins are so narrow that they make currency fluctuations the determining factor in Sony being either profitable or loss-making. One analyst say that Sony should have foreseen the inevitable end of the weak yen and carried out much more thorough cost reductions (thus increasing operating margins) when macro conditions were more forgiving.

The conclusion of the report, therefore, is that SonyÆs previous restructuring has essentially failed to turn the company around û and that there is little reason to hope the existing management team will do any better in a considerably worsening macro environment.

It is a sensational report, and very damning for the companyÆs management. Indeed, it might well test StringerÆs commitment to ætop down leadershipÆ. After all, itÆs the recognised leaders who have to take the blame, as well as the plaudits. One of the attractions of consensus leadership is that it makes pinning down who is responsible somewhat more difficult.

In the meantime, conglomerate Sony continues to be outfought by more focussed, leaner companies: Nintendo in games, Apple in audio entertainment, Cannon in cameras, Samsung in TVs and Microsoft in software. And while most of these companies have billions of dollars in cash on their balance sheet, Sony has net debt of $5 billion. Sony may be about to learn the hard way that in the current recession, sheer size and diversity is no barrier to catastrophic failure. It only has to look at the woes of another conglomerate, Citibank, to understand that.

At part of yesterday's announcement, Sony estimated that it generated a net profit of Ñ10 billion for its fiscal third quarter, which ended on December 31, down 95% from the same period a year earlier. Third quarter revenues are expected to have fallen 25% to Ñ2.15 trillion. The final figures will be announced at a press conference on January 29.

The profit outlook revision came after the Tokyo market closed, but the disappointment among investors was obvious by the fact that Sony's US-listed shares lost 14.4% over night to $19.33. The stock fell 2.6% to Ñ1,938 in Tokyo trading Thursday.
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