I have been accused of being the eternal optimist. Guilty as charged. Our economy seems to have turned a corner; employment is gaining steam and the stock market is surging. Yet housing seems to be stuck in quicksand.

I am not here to dispense any investment advice, but instead want to pass on some observations on the plight of the U.S. housing market. While much is being made of the insolvency of European banks, we should be equally troubled by the assets held by the largest U.S. banks.

Consider the prospects of Bank of America. The bellwether financial institution required a government bail out, and an infusion by Warren Buffet after its prepackaged acquisition of Countrywide’s toxic assets. The bank holds a staggering $400 Billion+ in U.S. mortgage debt, a third of it in home equity lines of credit – the true villain in the U.S. real estate collapse.

According to B of A, 5% of its mortgage portfolio assets are “non-performing” or are in default.  Some have accused the bank of uneven accounting on its balance sheet.[i] Some estimates forecast as much as 39% of its portfolio having a combined loan to value rate below 100% (upside-down). It is expected that about a third of those mortgages could default, and that the banks losses for the average loan are far higher than 50%. Unlike past swings in the market, foreclosed homes have little retained value for the lender, and are boarded up or even torn down. JP Morgan, Citibank and Wells Fargo do not fair much better in terms of performing assets[ii].

Perhaps even more perplexing is weakness in the underlying real estate market.  Economist Paul Dales of Capital Economics suggests there is an excess inventory of more than 1 Million residential properties. Housing supply is somewhat stagnant. In Los Angeles for example inventory has gone down 1.65% through September but prices showed 0% change for the year[iii]. As a result, housing starts are projected at a tepid 620,000 for 2012 (according to Federal estimates)[iv]

Even though money is very cheap, many borrowers can’t qualify for a mortgage under the exacting standards being employed by banks. Under tight scrutiny by regulators, we are seeing the familiar rubber band effect as lenders have gone from one extreme to the other – lending to everybody with a pulse to rejecting buyers with cash and good credit scores.

Consumer behavior has also shifted. While lower than 2010, a whopping 17% of defaults are “strategic defaults” where borrowers can afford their monthly payment, but simply walk away.[v]

What is hurtful is not only the affect that the real estate market has on realtors, title companies and mortgage lenders; but the shadow economy it supports. Construction and subprime manufacturers of everything from lighting fixtures to lumber are suffering at the hands of weak U.S. housing demand.  The reality is that much of our economy’s GDP growth over the last two decades is a reflection of a false premise, that Americans can just pull money out of their homes on demand.

So as the housing market goes, so goes our economy. Forecasts of 2 and 3% growth rates are a direct result of consumer affluence being minimized by zero wage growth and declining property values.

While economists are cautiously optimistic about America’s future (as am I), we need to be cognizant that a further depression of the housing market could lead to the failure or bail out of U.S. banks which undoubtedly would reverse recent market gains and economic momentum.

I believe this is a defining moment in our history. Our nation is in a fight for its soul. What kind of country do we want to be? I think we are the nation that takes care of its own.

Twelve percent of the 240,000 American veterans of the wars in Iraq and Afghanistan are unemployed. Thirty percent of those under 24 are jobless, double the national average [i].  This is a national tragedy of epic proportions and those reading this post are the ones who can do something about it.

We can’t begin to repay veterans for the years they served for the country, the friends and family they have lost, or the sleep lost over the horrors of war.

But we can give them a chance to have a life when they come home.

Every company in America who is hiring should put veterans at the front of the line.

Hiring a veteran is a gift, not for them (they have earned the right to work) but for us. We should hire them because:

• Veterans make great employees: loyal, trustworthy, disciplined, hard working and tough.

• The Hire Heroes Act of 2011, passed last month (517-0 in Congress) provides up to $5,600 in tax credits to employers who hire a veteran

• Veterans provide inspiration to other employees, and send a message about what kind of employer you want to be

• Hiring war heroes helps drive home corporate values and messaging that resonates with customers, investors , vendors and the communities we serve

• Veterans are capable, many having mastered transferable technical skills

As the last American soldiers return from Iraq this week, we should take pause. As we celebrate our family, friends and faith, we should be thinking about those who have sacrificed so much, and have been received so little.

Most of us entrepreneurs have been the benefactors of American freedom, and it is time for us to show our appreciation.

Below are a set of resources for searching for qualified veterans:

http://www.vetjobs.com/

http://www.militaryhire.com/?gclid=CMT4ksjyia0CFQg1hwodswjGmg

http://www.hireveterans.com/

http://blogs.payscale.com/compensation/2010/01/tips-for-employers-hiring-veterans.html

Whenever they call a day “black”, you know something bad is going to happen. On the Friday after Thanksgiving, I wanted to vomit. Not because I ate too much, but because of the destruction done to the U.S. economy. As a purveyor of value creation, I find Black Friday repugnant. Even if you are not a retailer, there are lessons here for all of those fighting off commoditization.

U.S. retailing used to be the Pareto Principle in action, with as much as 75%-80% of profits being realized in the 4^th quarter. The holiday season has turned into a race of who can open the earliest, and sell the cheapest flat screen TV (you could have bought a 42 inch flat screen at Best Buy for $199).

Last year I was talking to a corporate Vice President who was quite happy with herself after doing all of her Christmas shopping on a single day (I believe 4 AM is still the middle of the night if you want to get technical). I asked her, “how many items did you buy”, “17” she said. “How many were on sale” I asked- “17” she replied.  The defense rests.

Retailers work on “blended margin”, the ability to attract customers with lower priced goods, only to flip them to higher margin products.  In grocery stores, staples such as milk which are very low margin are at the back of the store, and higher margin produce and deli at the front in the “traffic pattern”.  Black Friday represents the destruction of 100 years of merchandising evolution, and creates a frenzy of deep discounts (one shopper in Porter Ranch, CA used pepper spray on another over an Xbox).

Some may argue that the “strategy” is to win shoppers for future trips and control market share. That may work for the low price leader (WalMart), but it doesn’t work for other retailers and boutiques. Those are the retailers trying to train their customers to realize the value of their service, knowledge, and unique offerings, and may only have one or two shots at the buying crazed mother with three kids.

Here is the single most important and basic business principle one could ever communicate in a business blog: prices should be high when demand is high, and prices low when demand is low. The destruction of the industry is inevitable if retailers continue to discount the deepest when demand is high. The shame, the shame!

Here is a prime illustration of how deeply this perverse thinking has infiltrated the industry. Recently I was shopping at Macy’s, selected a garment and brought it to the register, clearly marked with the price I was willing to pay. The cashier pulls out a coupon and says, I can give you another 25% off.  The defense moves for an immediate verdict your honor.

Defenders will say that the competition made me do it. What competition? China, WalMart, Best Buy? The true answer is Amazon and other online retailers who have changed the game forever, and this year kicked in free shipping to make their offer more compelling (online purchases are predicted to rise another 17% this year). So the real problem is not some evil empire. We have seen the enemy and it is us.

In order to fend off deep discounting:

1. Find products that can co-exist with online purchases. How can your products compliment the deeply discounted products? An iPad offers very little margin to the retailer, but accessories such as head phones and adapters are very high margin and offer the opportunity for repeat business.
2. Reinvent your model so that you are purposeful in selling complimentary goods. If you are going to sell them a gun at cost, you had better have the staff, expertise, merchandising and inventory to sell them some bullets as well.
3. Teach your employees the profit formula. Most of your employees think you are making a ton of margin on those handguns, so you need to teach and incent based on your objective of selling more ammo (I would have picked a more pleasant example but I am feeling like a curmudgeon after all of this discounting).
4. Provide the ultimate in-store experience that rivals or beats the online experience. Perhaps customers can see, touch and feel products that are shipped to them later, or to their loved ones.
5. Select targets (product, location, etc.) that are less vulnerable to price attacks from discounters and online retailers.

Let the treasure hunters go to the competition; they are the least loyal of shoppers and you can’t make any money selling to them anyway.

With the sluggish selling season will be plenty of opportunities for deep discounts. Deep discounting marginalizes a business (unless you are the low cost leader). Retailers may need to offer products at cost, but should do so with a clear pricing strategy built on balancing market share and profit.

Many CEOs feel that they are the victims of a lackluster economy and a government that is ineffective at offering any meaningful stimulus. In fact, 79% of CEOs fear that the fundamentals of our sluggish economy will remain the same or get worse.[i]

Economists have long understood that our thinking about the economy is governed by emotion. U.S. history is riddled with periods of growth and decline steered by the mood of the nation.

My generation grew up with a relative level of stability. We are simply not accustomed to the notion of “economic uncertainty” and we are not very happy about it. As a result, we have the tendency to overreact to stimuli in the form of collective euphoria or collective despair. This emotional response explains the nature of bubbles, as we all race to adhere to the conventional wisdom of the moment.

Today’s wisdom is that we should be scared…about sluggish growth, high raw material prices, health care costs, China, the Federal deficit, taxation and lots of other things. You know our psyche is a bit fragile when people are worried about inflation and deflation at the same time.

Our thinking often crystallizes around “the economic cycle,” which is something of a misnomer. Every business participates in this broader cycle, as well as a monetary cycle, industry cycle and company life cycle. The economy itself is merely a component in a spider-web of stressors that can be triggered by a myriad of forces from around the world.

Our expectations seem unrealistic, framed during a time when banks over leveraged, real estate was overpriced and stock market multiples were in the stratosphere.

The reality is that our economy is still growing (although perhaps in tepid fashion). Forecasts are for GNP growth of 1-2% for the remainder of 2011. When our GNP is growing at 4% we are bulls, but at 2% we are bears.  This meager difference illustrates that our fear is based on perception and is somewhat irrational. It is like the fear of flying: one knows that statistically there is virtually zero chance of a crash, yet to some, the fear is quite real.

Perhaps what we really have to fear is fear itself.  We should not be scared of a 2% variance, we should embrace it. In many instances, it will be the confidence of the CEO that will drive the level of investment businesses make, which will in turn either be the impetus for growth or maintain mediocrity.

Of the CEOs recently surveyed, 41% believe that prices of their products or services will rise next year. The potential for rising raw material and energy prices in 2012 could actually be a boon to vendors who are posturing to raise prices.

It is time to reset expectations with our customers, vendors, employees and ourselves. Within this data, there is plenty of salt, but perhaps there are a few grains of sugar as well.

A good leader must exude confidence in his or her business every day. If you don’t see the value in your products and services, no one else will. When the competition is weak, it is time to attack. Let your competitors have the scarcity mindset, while you focus on the strategic gambits that will grow your business and create sustainable competitive advantage. We will get our 2% back some day—we just need to be a little patient.

[i] Vistage CEO Confidence Index

I recently had a conversation with a CEO who was lamenting about the disparity between public company valuations and those of privately held concerns. As of July 2011, the S&P is trading at a multiple of 14, while private company multiples remain in the 5-6 range. Investors value public company access to capital, and scalability into large consumer markets.  Of the Top 10 U.S. companies by size, none are pure play B2B companies.

Small companies come in all forms; some compete with larger branded companies, and some market directly to them.  In the age of confluence, some do both. How can small companies survive in a land of giants?

The primary difference between Fortune 1000 companies and smaller ones is more fundamental than which markets they serve. Intel founder Geoffrey Moore makes a distinction about business architecture – the difference between “complex systems” and “volume operations”[i].

Many smaller B2B companies are built to support specialized and custom solutions, while most Fortune 500 companies are built from the ground up to serve the masses. While customization may command higher prices (per transaction) than generalization, high volume companies cross a threshold where their infrastructure promotes a lower cost per unit and the experience curve takes full affect. Thus, B2B companies face an inherent profitability disadvantage.

Where Microsoft offers its highly useful suite of Office products at around $400 per license, Apple’s B2C model (which is often utilized by small businesses and micro-businesses such as designers and the like) offers Pages and Numbers at $9.99 each. One offer is based on high intellectual capital value and the other on mass appeal and ease of use.

For smaller B2B companies to reach new levels of profitability, requires they find a path to scalability. Of course not every business wants to be big. Some entrepreneurs prefer a “family culture” and more tempered growth (with less risk).

One way to effect profitable volume is to find a balance, where products and services are “mass customized”. Mass customization is all the rage in consumer products where individuals can even build their own handbags and Nike basketball shoes to their specifications.

Smaller companies (B2B and B2C alike) should seek out solutions that allow for better utilization of existing solutions across more customers. In other words, the provider should not need to reinvent the wheel with each project. Often, optimizing margin requires leverage of a base product or service that can be replicated, at times with features configured to the customer’s individual needs. To configure from a menu of choices is considerably different than satisfying each specific whim, which may offer greater intimacy with the customer, but may also require the business to sacrifice profit. For every feature created for an individual customer, there is a resulting opportunity cost (time, money and energy that could be invested elsewhere).

The other requirement for getting big is a shift towards systems thinking, where management teams make decisions within the framework of their company’s capabilities. For a new initiative to succeed requires careful analysis of the resources required to implement it. The key for smaller companies who aspire to do business with larger ones it to utilize systems and processes consistent with the expectations of the customers they serve.

Competing against larger companies requires a unique mindset. Often small businesses use concepts like judo (where the larger opponents energy is often used against him) to beat the larger foe at the point of attack. Consider the depth and width of the market you want to serve, and scale your resources accordingly.

Revelations about Apple and Google tracking the movements of mobile devices has caused quite a stir. It seems their mining of data and ability to construct complex algorithms that can predict future behavior incited outrage on the part of privacy and civil rights groups. In a bit of a twisted irony, it turns out that the very apps that have enabled smart phones have also provided a wealth of data for inquiring minds who want to know.

The confluence of social media and cloud computing is shaping a new world order, where marketers have access to relational databases and a litany of information that has until now been seemingly unfathomable. The implications are extraordinary, as emerging technologies will propel mind numbing analytics about how we work, live and interact.

Consumers are fearful of things like electronic medical records which evoke an emotional response about our privacy, even though they are nearly certain of advancing medical science and improving patient outcomes. Business owners must embrace the potential of a new universe of analytics that will open a window to insight on customers unlike any we have ever seen.

The current debate centers on whether such mining is legal and ethical and how it could be abused. Attorneys search the Facebook pages of potential jurors to determine their biases. Cellular phone providers track which users are most likely to switch carriers based on the behavior of their friends. While these unseemly usages of data may threaten our sensibilities, social norms are shifting to the point that privacy is becoming an expectation of a past era.

Physicists at Northwestern University tracked the movements of over 100,000 people and 16 million records, and assert that they can predict (within 93% accuracy) the location of a user at a given time in the future[i]. Those with an entrepreneurial bent will find productive uses of such information and will find legal ways to exploit it. Microsoft, Apple and Google rank in the top 10 amongst the world’s most valued companies because they are the ones that allow us to organize our information.

Those seeking competitive advantage will invest more heavily in technologies and analysts who not only tell us how our customers have behaved but how they will behave in the future, and react to the stimuli we produce. Decisions ranging from inventory selection, marketing spend, labor utilization, etc. will be driven by more precise data, promoting further improvement in U.S. productivity.

The use of such data will become the keys to the castle.  As Bill Gates once said, “be nice to the nerds, chances are you’ll end up working for one.”

[i] The Really Smart Phone by Robert Lee Hotz Wall Street Journal April 23, 2011

There is an old saying in poker; if you can’t see the sucker in the room…it is probably you.  The same can be said of advancements in technology. Forrester’s recently forecasted increases in IT spending of 8% in 2011 and 2012[i]. Recent M&A activity suggests the sector is heating up.

In many industries, market leaders create proprietary technologies and information systems that improve the customer experience directly or indirectly through information flow, efficiency, cycle time, etc.  At the current rate of change, a company either realizes a technological advantage, or is likely at a competitive disadvantage.

We have numerous clients who are either in the midst of ERP implementations, or considering similar upgrades to their systems. At some point the business owner must ask the strategic question; are our technology improvements truly game changers, or only an enhancement to existing ways of doing business?

More than 90% of ERP type systems are delivered late, and their implementations can be taxing to small and mid-market businesses. It is not difficult to spend $1 million+ (in hard and soft costs) in such systems, which is a drop in the bucket compared to the cost of disappointing customers due to errors or missed timelines.  If entrepreneurs are going to expend valuable resources (time and money) on technologies, they had better select the right ones, and prime their organization to implement them seamlessly.

I find there are often two extremes during such implementations.  In some companies, functional department heads (such as sales, engineering, design) lack experience in software integrations and do not become invested in the deliverables until it is too late. Other times, companies become so fascinated with perfection, they lose sight of the objective, and become paralyzed in analysis. If a company’s enterprise system becomes dated because of their inability to act, competitors can seize the upper hand.

If you are considering such upgrades to your technology, it is often sensible to take the aggressive but measured approach. In other words, the strategist is always looking to leverage technology that reshapes the customer experience, improves efficiency or reduces costs in some material way while simplifying or automating processes.  Such decisions should not be left to the technologists, but shared by the leadership team who must be equally responsible for selection, scoping and integration.  Failure is not an option as an unsuccessful project can put a company years behind.

Don’t be the sucker.

I will ask that you all oblige me this week as I am going a bit off script with a post that is highly personal.

I live in Santa Clarita, a sleepy suburb of Los Angeles. My friends in the city mock our little enclave of 175,000, because it seems so remote, and vanilla. While our little community may be light on clubs and tattoo parlors, it is rich in something else…soul.

Last week we learned we lost one of our own;  U.S. Army Spc. Rudy A. Costa was killed in Afghanistan. He was 19.  He is not the first from our village to give his life to his country. And like the other times, the community celebrated his life. 5,000 lined a packed funeral procession, children adorning hand written signs and holding miniature American flags.  800 packed into a little church with hundreds more watching on televisions outside. Stoic soldiers from past wars openly wept.

I want to live in a place where I know my neighbors, and they know me. The business community here is so tight knit that you can’t go to a restaurant or a business function and not see droves of people you know. That is the way it should be.

There are times that we need to take a minute and remember that our business colleagues and our employees all want to be part of something bigger than they are. Last week I took note that some employers in town sent their employees to honor their lost hero. Those are some business people with perspective.

We are also reminded that there are things we should believe in above and beyond making a profit. We need to send a message to others that we value our community, and we need to make investments within it.

Unknown to most Americans, professional golfer Ryo Ishikawa is also 19, not even old enough to order a cocktail. But this young man of uncommon maturity understands his community.  In an unprecedented gesture, he has pledged his entire earnings for 2011 to the relief effort in his native country, Japan…every nickel!

I am going to be rooting for Ryo this year (I don’t even know how to pronounce that, but I am going to learn). And of course I will be thinking about Rudy Costa and his family. Support your community. You will get your investment back in spades.