The True Cost of South Limestone

The South Limestone streetscape project began with the closure of South Lime two months ago today, and the project is slated to continue for another 10 months.  Meant to better connect downtown with the University of Kentucky campus, the project includes the widening of sidewalks, the installation of bike lanes, and the underground placement of utilities.

When the project started, we wrote about the chaotic process of closing the street and about the need for practical planning and design on South Lime and other urban development projects.  How has the project evolved since then?

Not well.

Severed Artery
The closure dramatically impacted traffic patterns between downtown
Lexington and the south side of our city, resulting in gnarled traffic
on a number of alternative routes to downtown.  At various points in the project, intersections with cross-streets (High, Maxwell, and Euclid) have also closed with little notice, adding to confusion and gridlock for downtown commuters and shoppers.  In effect, the closure of South Limestone has walled off downtown from Lexington's south side.

Several businesses along South Lime have struggled to cope with the substantial loss of customers and the physical disruption of their businesses.  Last week, Joe Graviss, the owner of the McDonald's on South Lime, pleaded with Lexington's Mayor and Urban County Council to add extra shifts or more workers to speed the project.  

City officials responded that extra shifts will not accelerate the project.  The project's manager noted that the city's concrete supplier closed in the evenings and that local utilities were already providing personnel to assist with the location and relocation of utility lines.  At one point, he admitted that he had no ideas for speeding the South Lime project along.

Vice Mayor Jim Gray – the CEO of Gray Construction and the only councilmember to oppose the project – countered the project manager's claims.  "It would be wise of us not to be extravagant in describing the difficulties of this project…  With 2000 projects under my belt, I've never seen a project that couldn't be improved or accelerated."

At this point, most elected leaders and city bureaucrats seem unprepared to take significant action to accelerate the South Limestone streetscape project.

That's because they have been thinking about the impacts of South Lime on the wrong scale.

Estimates on the price of the South Lime project vary, but the early $5.2 million estimate has ballooned to somewhere between $13.1 and $17 million.  The newer, higher price was partly meant to help expedite the project. 

But, as we'll see in a moment, that price far underestimates the true cost of the project to our city, our economy, and to our future. 

South Limestone's closure is not a mere inconvenience – it is a severed
artery that is bleeding the life from downtown.  It demands an urgent response from our leaders.  The cost to the city is too
dear to delay action, especially in this difficult economy.

Disruption: Anecdotes and Hard Data
A number of weeks ago, on the first day that the High Street intersection with South Lime was closed, I worked in my office and overheard two different customers from the south side of Lexington talk about the enormous problem of getting to our downtown shop – the confusion from suddenly closing the High Street intersection had made traffic especially difficult to decipher.

Then, we had an elderly customer from Nicholasville make an appointment for the next day, asking for directions on how to get to the shop with all of the construction.  Concerned about getting lost, she decided to do a dry run the day before.  After experiencing the jams, diversions, and delays, she called back and canceled her appointment.

Last month, I talked with another downtown business who is in our same industry.  They were scratching their heads about why their August business "fell off a cliff".  I talked with them again last week, and their business was still much slower than usual.

Yesterday, a regular customer who owns a shop in Festival Market came into Lowell's and opened the discussion with a flat "Business sucks".

When I started hearing these anecdotes, I began to think that the impacts of the South Limestone closure extended far beyond South Lime.  I wondered about the effects of South Lime as a customer deterrent for our business:

  • How many of our customers come from the south side of Lexington?
  • How many of those south-siders might have chosen to stay away from "the mess" downtown?
  • What could that data tell us about the impacts to all of downtown Lexington?

And what I saw in the data was astounding and troubling:

  • About 30% of our customers come from ZIP codes which would use Nicholasville Road (which turns into South Limestone) as the primary corridor to downtown
  • Since July 22nd – the date of the closure – we have lost one third of the business we'd normally expect from those ZIP codes.  By comparison, the rest of Lexington is relatively flat or growing.
  • The net of this was a loss of 10% of our sales (and a much bigger hit to our profitability) directly attributable to the South Lime closure.

I disclose these facts not as a woe-are-we pity party, but as a fact-based assessment of how "the mess downtown" affects one downtown business.  Our business is a relatively healthy, well-respected business with incredibly loyal customers (Last week, we won "Best Honest Mechanic" from Ace Weekly readers).  And, still, the closure of South Limestone accounted for a loss of a full third of south-side customers.

Ripple Effects
Can we extrapolate from just one business to the whole of downtown?  Not with any degree of certainty.  But my conversations with other business owners make me believe that my business' experience with the South Lime closure is not exceptional.  Admittedly, not every downtown business is as impacted by traffic disruptions, but most are impacted in some fashion: lost customers, lost productivity, supply chain delays, etc.

Hard data for downtown Lexington is difficult to come by.

  • Just how much of Lexington's $11 billion economy takes place downtown?
  • Which businesses depend upon the smooth flow of traffic?  To what degree?
  • How many of their customers / employees / suppliers come from the south side?

Depending on the assumptions used, the estimate of impacts to downtown can vary wildly.  Our best "conservative" estimate?  Downtown Lexington loses about $360,000 each business day that South Limestone is closed.  (Depending on our assumptions, the estimates ranged between $275,000 and $600,000 each day.)

That translates to between $7.0 to $7.7 million in lost business every month, or between $84 and $92 million for the year-long duration of the South Limestone project.  That's around 700 to 1000 jobs which could evaporate from downtown Lexington, especially as the closure drags on.

Are these numbers absolute?  Not by any means.  But they do provide a ballpark idea of the true cost of the South Limestone project. 

Much of the focus on the costs of South Lime have focused on either a) the direct taxpayer costs ($17 million) or b) the costs to businesses on South Lime.  And while those South Limestone businesses deserve special attention for the degree this project impacts them, our estimates suggest that our leaders and our community have been thinking about 'cost' on the wrong scale.  There is a much bigger, much more urgent cost which must be addressed.

The irony of South Limestone – as the cycle of lost customers, declining businesses, lower employment, and more lost customers continues – is that the project may well end up strangling the very downtown that the streetscape is meant to connect with.

Our leaders frequently assert the necessity of a vibrant, livable downtown.  It is time for them to live up to their words. 

With the South Limestone closure, they must now choose: Will they continue to choke off downtown from a significant portion of the city, or will they act with urgency and extraordinary effort to accelerate and improve the project?

Their actions now will determine whether the prediction from our Chaos post will come true:

"And the results of the chaos are easy to predict.  Confused commuters
and shoppers stay away from 'the mess' downtown.  Downtown businesses
die.  And, after fits and starts, Lexington ends up with a beautiful
street.  To nowhere."

Time to choose.

LowellsSquare

Health care reform: A small business perspective

This week, we’re finalizing our shop’s health insurance requirements for the next year.  Our policy will be 25% more this year for the same coverage.  Last year, it grew by 16%.  Compounded, that’s 45% in two short years.  No other cost increases on that scale for us.

As a small business, the spiraling costs of health care hit us particularly hard each year.  And the need for a new approach to health care is particularly acute, for us and for our employees.

I’ve been puzzling over health care for a long while – and I won’t claim to have the answers here.  But I thought it could be helpful to step away from the town hall and cable channel histrionics and fear-mongering to share some observations on health care from a small business perspective.

Insurance companies are like casinos: The house always wins.
Insurance companies have received a lot of criticism during the
health care reform debate.  But they are doing precisely what they are
designed to do.  They make money for investors by taking bets on the
health requirements of their customers. 

Insurance companies operate like casinos or racetracks: the table is
always tilted in favor of the house.  They may lose big on a single
‘jackpot’, but across the full array of customers they nearly always win.  And when they don’t win ‘enough’, they’ll raise the cost of making bets with them. 

When we enter into agreements with insurance companies, we’re always taking a sucker’s bet that we’re very likely to lose.  The only reason an insurance company takes our money is because they ‘bet’ that we won’t need that amount of medical care.

Ultimately, as with the casino, the house wins.

The oddity of employer-provided health insurance.
We don’t really question it much today, but it is just plain strange that something as personal and as private as health care is mediated by employers at all.  We don’t usually involve our employers in house payments or banking or appliance purchases or car insurance.  But, somehow, we’ve come to expect them to provide health care insurance.

Employer-provided insurance is an historical artifact from negotiations between General Motors and labor unions in the late 1940’s and early 1950’s.  Charles Wilson, GM’s CEO, saw it as a last-ditch concession to help prevent the ‘nationalized healthcare’ system that Harry Truman was championing – which Wilson saw as a threat to the integrity of the free enterprise system.  (Funny how many things just don’t change.)  Soon, other employers adopted health care coverage as a standard part of their benefits packages, and employer-provided insurance became the norm.

But, really, why are we employers involved at all?

Leverage
One reason that employers remain involved is that they often have more buying power than individuals.  Over the past 60 years, we’ve been able to provide leverage which lets us negotiate somewhat better plans with insurers and medical providers. 

But small businesses have scant more negotiating leverage than an individual.  Often, our employees choose to get independent coverage rather than participate in our group plan. 

When Lowell’s bid out to three other health insurance companies, the results were disheartening.  The other three companies offered rates that were 200% to 300% higher than our current rates with Anthem.  So we’re ‘trapped’ with Anthem.

Expanding waistlines, increasing costs.
As a nation, we’re getting a lot unhealthier.  We eat more.  We exercise less.  We sleep less.  We’re in worse health.  We’re living longer.  And we need more care.

We don’t spend much time, effort, or money on the preventative health care and self-care which would help eliminate the much more expensive catastrophic care.  We’re too busy to exercise.  We don’t want to pay for the mammogram.  We don’t like waiting in the doctor’s office. 

And we require more medical care as a result.  Often, we get that
care after a catastrophe built upon years of self-abuse: We have a heart
attack.  Our knees fail.  The cancer spreads.  (We see the same phenomenon with routine maintenance in the car business – put it off, put it off, put it off, then replace an engine.)

Health care is getting more expensive, in part, because we are getting unhealthier.

Rising expectations, increasing costs.
We’ve
come to expect more from our medical system.  We expect our doctors,
staff, drugs, equipment, and facilities all to improve.  And we should expect improvement as medical science advances.

But
those advances are costly.  The astronomical research and development
costs for the medical ‘miracles’ of MRIs and cholesterol-fighting drugs
and ‘little blue pills’ have to be paid for in some fashion.

And doctors, hospitals, and insurance companies won’t simply absorb those costs.  They will pass them on to patients.

Health care is getting more expensive, in part, because health care is getting better.

There are no painless solutions.
We’ve seen politicians, lobbyists, pundits, and fellow citizens all offer various versions of ‘painless’ solutions to the healthcare problem.

They promise that government should bear more of the burden. Or that government shouldn’t bear any of the burden.  Or that we just need full, universal insurance.  Or that insurance companies should pay.  Or drug companies.  Or hospitals.  Or doctors.  Or that we shouldn’t have to pay for the chronically uninsured.  Or that we should just collar all the lawyers and their malpractice suits.  Or we should just have more competition.

Nobody says that we must bear the responsibility.  But we must.

If we refuse to provide insurance or government coverage for the roughly 45 million uninsured Americans, what happens to those who can’t pay?  Hospitals and emergency rooms will still provide care.  Their costs will go up.  And they will pass those costs to other patients in the form of, say, an $8 dose of ibuprofen.  We pay.

If we provide government-paid health care to them (or to ourselves), what happens?  Our national deficit will rise.  This week’s projection of a $9 trillion deficit over 10 years amounts to about $30,000 per man, woman, and child.  Which will have to be funded through taxes.  We pay.

If we have full universal coverage in a government program, what happens?  Because they don’t bear the initial brunt of the costs, patients get more health care than they really need.  And doctors and medical institutions will happily provide (or suggest) that profitable care.  More deficit.   More taxes.  We pay.

If we squeeze insurance company profit (or put greater requirements on them), what happens?  They will likely refuse coverage for the riskiest, least profitable customers.  Unable to find private coverage, those customers will opt to go without coverage or to go with a public plan.  More $8 (or, now, $10) ibuprofen.  More taxes.  We pay.  

If we squeeze drug or equipment company profits, what happens?  They have less to invest in research and development.  They take fewer risks, and release fewer blockbuster drugs or fewer equipment breakthroughs.  Improvements in our medical care falter.  We pay.

If we collar lawyers and malpractice suits, what happens?  Doctors’ malpractice insurance costs will likely go down.  But a few careless doctors who commit malpractice may inflict injury or death without significant penalty.  And who ultimately bears the cost of that irresponsibility and that injury or death?  We do.  We pay.

If we allow more competition between insurance companies, what happens?  The insurance companies look at the same basic actuarial tables.  They evaluate risks in the same way.  They put a price on the ‘bets’ they are willing to take in the same way.  And their prices remain about the same as without as much competition.  We pay.

We want ever-better medical care.  We are getting unhealthier.  We want someone else to pay for it.  But they won’t.  We must bear the responsibility.  We must pay.

Can government, insurance companies, hospitals, and doctors get more efficient?  Sure.  Are there opportunities to eliminate waste?  You bet.  Can we patients get healthier and do more preventative care?  Absolutely.  But it will cost us in some way.

There are no painless solutions.  In the end, we all pay.

The moral obligation
“Is health care a right or a privilege?”

It is a question that we don’t talk about enough, and which underlies much of the national divide about health care today.  Is health care a right to which all people are entitled?  Or, is it a privilege bestowed only upon those who have earned it?  

It is an interesting question, and the health care debate has hinged upon how people answer it.

Except that I think that it is the wrong question.

The “right or privilege” question presupposes that rights and privileges are somehow separable. I don’t think that they are.

I think of health care in many of the same ways as I think of citizenship or, even, to being a human being.  As citizens and as humans, we have certain ‘inalienable’ rights.  Heck, our country was built upon them – “Life, liberty, and the pursuit of happiness”.  

But those citizen’s (and human) rights come with deep responsibilities.  We must participate.  We must act in certain ways.  We must work together to improve our nation and our well-being.  We can’t abuse the fundamental rights we have been given.

For me, health care comes down to a moral issue.  I can’t tolerate 45 million fellow citizens living without a safety net.  I can’t tolerate wasteful spending on needless tests and procedures on the public dime.  I can’t tolerate 45% increases in insurance costs over 2 years.  I can’t tolerate ‘competition’ which triples my existing rates.  I can’t tolerate people (including me, unfortunately) who don’t take good enough care of themselves.

I can’t tolerate the status quo.  Can you?

For me, health care is a citizen’s right.  And an earned privilege.  We must strive to provide health care for fundamental human needs whenever possible, while simultaneously striving to ensure we grapple with the responsibilities that come along with that privilege.

So to the politicians, lobbyists, pundits, and citizens engaged in the public debate, I say: Grow up.  Step up to the plate.  Quit attacking.  Get realistic.  Have adult discussions.  Lose the scare tactics.  Work together.  Compromise.  Take responsibility.  Live up to your moral obligations.

Then, maybe, just maybe, we can build a better health care system.  For our nation.  And for one another.

LowellsSquare

LexMob: Final Schedule

When we started LexMob on July 22nd, the idea was to keep patronizing
businesses affected by the closure of South Limestone for a month. It has been extremely rewarding to meet fellow LexMobbers and to meet owners and workers in the targeted businesses.

It has also been very time-consuming.  I’ve decided to stop organizing LexMobs after Monday, August 31st, so that I can better tend to my business.

This doesn’t mean that LexMobs have to stop.  In fact, we’d be thrilled if LexMob continues into the fall.  And anyone can organize a LexMob for South Limestone: The idea is to ‘show up’ with our feet and our wallets to help out these businesses.  Whether it is a mob of 1 or a mob of 100, simply show up and ask others to show up as well.

The easiest way to organize a LexMob: Send out a notice on Twitter with the hashtag phrase “#LexMob for #SoLime”.  In my experience, it is good to send out a few tweets at different times of the morning to let different people know when and where the LexMob will be.  Then, after your LexMob, tell the twitterverse how it was and thank those who came.  That’s all it takes. 

I’ve had a number of suggestions for how LexMob could continue:

  • LexMobs could be weekly (or a couple of times a week) instead of each day
  • Perhaps the businesses on South Limestone could organize LexMobs themselves
  • We could just see what happens; Hopefully, other LexMobbers could continue to organize mobs without a central planner

We support any or all of these options. 

In any case, here is our ‘final’ schedule for LexMob:

  • Wednesday 8/19, Lunch: Sav’s Grill
  • Thursday 8/20, Lunch: Hanna’s, Zag’s, & Failte Irish Imports
  • Thursday 8/20, 7 PM: Social Event at Pazzo’s Pizza Pub (sponsored by the Lexington Fashion Collaborative)

  • Monday 8/24, Lunch: Banana Leaf
  • Tuesday 8/25, Lunch: Tolly Ho
  • Wednesday 8/26, Lunch: Cloud 9
  • Thursday 8/27, Lunch: Han Woo Ri, The Album, Sqecial Media, and ReBelle
  • Friday 8/28, Lunch: Sav’s Grill and Oneness

  • Monday 8/31, Lunch: Pazzo’s Pizza Pub and CD Central

We hope to see you there!  Who’s in?

LowellsSquare

What you told us: How Zappos would fix cars

This week we asked for your help in defining an astoundingly great car repair experience.  We summed it up this way: How would Zappos fix cars?

In Wednesday’s post, we talked a little about what Zappos does and why customers love them, including the famous I Heart Zappos post.  And in the past two days, we’ve gotten some really great responses on Twitter, Facebook, and here on the blog – including one response from a Zappos employee!

Zappos

Over on Facebook, Joan commented that she thought that Zappos was actually the “Lowell’s of selling shoes“.  (We heart Joan.)  We love that sentiment and will try to live up to it, but still think we have a lot to potential to improve our own customer service.

On Twitter, Jim suggested that Zappos “would come to your house and fix it at night while you slept“.  Allan and Mari joked about needing to buy parts online from Amazon (an allusion to Zappos’ recent purchase by Amazon.com).

But the strongest theme running through the comments: The need for greater transparency in auto repair.  I’ll run through some of the comments, and then talk a little about what Lowell’s does (and what we could do based on your comments).  On Twitter, Jupiter said he’d like to prevent that “being had” feeling, perhaps by getting greater detail on what was being repaired and why it was needed.  Ace Weekly chimed in “They would spoon you before giving you the bill?”  Here on the blog, Letha (a Zappos employee) shared a friend’s experience with a body shop which sent her daily text messages about the status of her car after a wreck, including a countdown to when it would be ready.  Jim added this comment:

“The thing the frustrates me about car repair is the unexpected nature
and size of the expense. It would be nice to provide as part of the
service an educational piece that says here are the expected life
cycles for key systems for your car and what you might expect to pay.
And here are indicators of failure so we can start to diagnose these
issues BEFORE they happen. At some point, owners need to start
BUDGETING for system replacement and failure and that takes planning
and information.”

What’s clear from this last batch of comments is that automotive service is all-too-frequently a kind of mysterious ‘black box’ where a car goes in one side and nasty, unpleasant surprises emerge from the other. 

At Lowell’s we try to prevent such surprises in the following ways:

  • On each invoice, we print a list of factory-recommended maintenance given vehicle mileage, including a rating of the severity or urgency of each one, and pricing.  We try to review that list with our customers when they pick up or drop off their vehicle.  We sometimes fail to discuss maintenance needs during busy pick-up and drop-off times.
  • We always get customer approval before doing work on a vehicle, providing customers with estimates of the costs before we do the work.  If they are available, we’ll also offer less-expensive alternatives, like fixing or cleaning a part instead of replacing it.  (Ace, we try to reduce the need for ‘spooning’ whenever possible.)
  • When we call a customer to get approval, we tell them what a technician found and explain why action might be needed.

Based on your comments to us, here are some ideas of what we could do:

  • Explainers.  For frequently-done maintenance and repair service items, we could provide detailed “explainer” sheets, including text and pictures regarding what the service is, why it is needed, and what a part might look like when it needs replacement. 
  • Schedules.  With ongoing maintenance, it is easier to implement Jim’s suggestion
    that we provide more of a roadmap of service.  And we do that, to some extent,
    with our list of factory-recommended maintenance.  But it is very
    difficult to predict with accuracy when something will break and
    require repair, and for many repairs there are few warning signs until
    something breaks.  When visible, we’ll tell customers about signs like
    brake or belt wear or engine leaks.  One idea: We could take pictures of the actual parts that are wearing or of the places that are leaking, to show the thing that needs service.
  • Convenience.  Not sure yet how we might do something like this, but Jim’s other suggestion of working on vehicles overnight is interesting.  Perhaps we could pick a car up and have it back in the morning for very basic items, but a big part of our process is communicating back to customers about what we find (and they probably won’t welcome updates at 2 in the morning).  But Jim’s suggestion got us thinking: Are there other ways we could make getting auto service easier?
  • Updates.  As a mechanical shop, most of our repairs are completed same-day, so we almost never have the 20-day delay in getting completed that Letha’s friend had at the body shop.  But Letha’s post got us thinking: Are there other ways you’d prefer to be contacted?  While the phone is our usual way of updating customers, we do frequently find ourselves in a kind of phone tag during the service approval process.  We could provide more contact alternatives: text messages, Twitter DM’s (direct messages), etc. 

Which of these things would matter to you?  What other things would create an astounding car repair experience for you?

We really appreciate your thoughts, and please, keep giving us ideas on how to improve.

LowellsSquare

Chaos: South Limestone Closure Lawsuit Details

When we initiated LexMobs to help businesses on South Limestone on Wednesday, we noted that the closure of the street seemed hasty and poorly-planned.  Well, now we’ve obtained the Fayette Circuit Court filing from a lawsuit intended to stop the work on South Limestone (first reported by Jake at Page One Kentucky).

And that filing reveals just how chaotic the closure process actually was.

Filed by the owners of several businesses and properties lining the route, the lawsuit seeks an immediate injunction to halt the roadwork and to reopen South Limestone to traffic.  It also seeks damages for the interruptions to business operations along the street.  The suit names the Mayor, LFUCG Urban County Council, and ATS Construction (the firm contracted to renovate SoLime) as defendants. 

And the filing tells a story of a poorly-communicated, hastily-assembled, highly-inconsistent project with an escalating price tag:

  • Communication.  Initial letters from the LFUCG Public Works Commissioner to the affected businesses invited them to a open house to discuss “a streetscape design” and “utility needs”, but didn’t indicate a complete road closure was immanent. The actual details of the project (and of the changes to the project) were usually disclosed to owners through rumors or media accounts.
  • Timing.  Owners had six days’ notice before the first open house (May 18th), and there was no mention of a road closure.  A second “utility needs” meeting was held on June 3rd, and the full closure of South Limestone was disclosed.  But some owners didn’t learn of the possibility of closing SoLime until the day before; The letter announcing that meeting didn’t mention closing the street.
  • Consistency.  In June 3rd discussions, South Limestone was to be closed from Euclid to High.  After voicing opposition, property owners were told on July 10th that SoLime would initially be closed from Euclid to Maxwell, opening up a full block between Maxwell and High Streets.  On July 21st – the day before the project began – owners learned from media accounts that SoLime was now to be closed all the way to High Street again.  That day, owners met with the Mayor and others from LFUCG to learn that ATS and LFUCG won’t know what they’re dealing with until they dig up the street.
  • Price.  The “Downtown Streetscape Master Plan” proposed improvements to South Limestone costing more than $5.2 million.  The LFUCG council approved the streetscape plan in August 2008.  On July 7th, 2009, the council approved the $13.1 million contract with ATS.  Two weeks later, media accounts put the total at $17 million.

The patterns emerging from this (admittedly one-sided) account of the closure of South Limestone parallels with what we’ve seen recently from LFUCG on urban development projects:

  • Projects languish for years, then are suddenly initiated.
  • Decisionmakers seem to have little sense of the full scope or true impacts of their decisions.
  • The true impacts of the project are only understood, if ever, after it is long underway.
  • Communication with citizens is unclear, intermittent, and/or non-existent.
  • The project changes direction suddenly.
  • It is unclear who is accountable for the success or failure of such projects
  • Because they are so committed to the (frequently noble) idea of the project, decisionmakers accept a series of concessions which cause the project’s price to balloon to multiples of original estimates.

We’ve seen some or all of these elements in numerous recent urban development projects: CentrePointe, Tax Increment Financing (TIF), the Lyric Theatre, the Newtown Pike extension and, now, the South Limestone Streetscape.  

What results is chaos.

Business owners on South Limestone had 2 months to prepare to lose customers for 12 months.  Many owners had one day to figure out how to get customers and suppliers to their door.  The cost of the project is 3 times what was initially approved. 

And the results of the chaos are easy to predict.  Confused commuters and shoppers stay away from “the mess” downtown.  Downtown businesses die.  And, after fits and starts, Lexington ends up with a beautiful street.  To nowhere.

Chaos is no way to run a business.  And chaos is no way to run the business of our city.

LowellsSquare

LexMobs on South Limestone?

The South Limestone streetscape project gets underway this morning.  Using Twitter, Lexington’s Mayor announced that the closure will result in traffic delays of up to 45 minutes. 

From a public point of view, the closure seems hastily and poorly planned, although the promised streetscapes look wonderful.  The project stems from a noble goal: to better connect the University of Kentucky campus with downtown Lexington. 

But businesses lining South Limestone (SoLime) had little time to adapt to the closure, and I wonder how many can survive being starved of traffic for so long.  When Lexingtonians realize that there is a “mess” surrounding SoLime, they will stay away in droves.  (With a business just off of North Limestone, I’m concerned about the disruptions to our southside Lexington customers making it in to Lowell’s.) 

There are a lot of great businesses along SoLime that would be a shame to lose: Sav’s, Pazzo’s, Tolly Ho, Failte, Sqecial Media, and many, many others.  Some (maybe all) of these are Lexington institutions.

How long could they operate without significant customer patronage?  How long could they retain employees?  How long can they make debt / rent payments?  How long can they pay bills?  How long can they survive?

So, here’s a challenge for our readers: Let’s go out of our way to demonstrate that we care about those businesses.

Beginning today, and continuing through the next month, let’s pick one or two businesses to “flash mob” each day.  Let’s get together to show, with our feet and our wallets, that we want those businesses to survive.  Let’s show up.  And eat.  Or buy.  Or drink.  Let’s refuse to let these businesses fail.

If our LexMobs get too big, that’s OK – I’m sure that the plentiful nearby businesses would also love some of our overflow business.

Will this effort be well-organized and well-thought-out in advance?  Not a chance.  Will it be messy?  Yes.  Will it be chaotic?  Absolutely.  Will it be inconvenient?  Certainly.  Will you be too busy to interrupt your day?  Undoubtedly.

But that is precisely the point: to go out of our way to demonstrate we care for these businesses.

So… Let’s LexMob South Limestone.  Look for more details on Twitter with the hashtags #LexMob and #SoLime.  See you there!

Update: The inaugural LexMob will be Wednesday, July 22nd @ Pazzo’s Pizza Pub at 11:30 AM near Euclid on SoLime.  Can’t make it?  We’ll try for other times and places with future LexMobs!

LowellsSquare

What to look for in Lexmark’s earnings release

Lexmark reports its second-quarter earnings tomorrow.  Since we've written about the decline and fall of Lexmark and the recent rise in its stock price, we thought we'd tell you what to look for tomorrow to determine Lexmark's health.

Under its current management, Lexmark has been very conservative in its earnings guidance (what it hopes to earn in the near future).  This conservatism has historically created two notable dynamics around earnings announcements:

  • The vast majority of Lexmark's earnings announcements have exceeded analysts' expectations, primarily because management guided those expectations lower.  This is the epitome of "under-promise and over-deliver".
  • Because the future guidance has been so low – with management essentially saying "we don't expect to make much money in the future" – the stock market's reaction has been overwhelmingly negative, driving Lexmark's stock price down the day earnings are released.

Update 7/21/2009: Lexmark announced earnings (before restructuring charges) that were 55 cents, while analysts projected 60 cents per share.  Lexmark management also provided lower 3Q guidance.  By both missing 2Q expectations and giving lower 3Q guidance, Lexmark was down over 20% in early trading, approaching 12-year lows.

So, tomorrow, don't be surprised if Lexmark beats Wall Street's expectations for the second quarter, and yet the stock price falls because of very conservative guidance.

But these regular dynamics around Lexmark's reporting dates tell us little about the true health of the company.  Here's what to really look for tomorrow:

  • Failing to meet expectations.  If Lexmark fails to meet already-conservative expectations, it is a sign that earnings are deteriorating even faster than Lexmark's management anticipated.  It is also a possible sign that Lexmark is entering the death spiral we talked about here.

Update 7/21/2009: As mentioned above, Lexmark missed expectations by 5 cents (nearly 10%).

  • Continued / accelerating declines in supplies, especially in PS&SD.  The majority of Lexmark's revenues (and the vast majority of its profits) come from its supplies business.  In other words, Lexmark makes much more from toner and ink than it does from the printers that use them.

Lexmark's inkjet division (Imaging Solutions Division, or ISD) has seen continuous erosion in its supplies sales, which implies that the installed base of Lexmark inkjet printers is shrinking.  Because of the upside-down economics of the printer business, a decline in supplies business can rob the division of its ability to fund future growth, and signal the impending doom for that business. 

If the Printing Solutions and Services Division (PS&SD – ISD's larger sibling) continues to lose supplies sales – a trend which started within the last year – then Lexmark's decline will be even more pronounced.  Without the supplies-driven profit to 1) maintain its existing business structure and 2) invest in future growth, the company will continue to spiral downward with little prospect for pulling out.

Update 7/21/2009: Overall supplies sales dropped by 18%, and dropped in both PS&SD and ISD (both major divisions).  This is a very troubling sign that Lexmark is entering the death spiral we've written about previously.

  • Additional restructuring.  Over the past few years, Lexmark has announced a series of "restructuring" efforts: Closing plants, reducing headcount, shifting resources, reducing costs.  Unfortunately, those efforts have done little to stem the bleeding at Lexmark.  If they announce similar moves tomorrow, it is a sign that management is still flailing and failing.

Update 7/21/2009: No additional restructuring was announced this morning.

It is tough to gauge the health of a company from a single quarter of earnings, and tomorrow will be no different.  But if some (or all) of these items find their way into Lexmark's earnings report, it will be another nail in Lexmark's coffin, and will be troubling confirmation of the continuing failure of Lexmark's executive team.

Update 7/21/2009: Second quarter earnings indicate that Lexmark is continuing the long, downward slide that we have seen over the past 5 years.  As they have 1) invested in ways that don't promote real growth at the company, and 2) made continual strategic missteps, Lexmark's management has slowly bled economic vitality from the company, and robbed it of its ability to invest in the future.

Why has Lexmark’s stock price jumped?

Since we chronicled the implosion of Lexmark on June 25th, Lexmark's stock has seen a remarkable run-up in its stock price.  In less than 4 weeks, the stock has moved up over 22%: from just over $15 a share to $18.61 at Friday's close.

So does the run-up prove we were wrong on our assessment of the failures of Lexmark executives?

No.

While a 20% increase in a single month seems impressive, Lexmark needs to turn in a 1000% increase to overcome the failures of the past 5 years.  And even after the gains of the past month, Lexmark's market value is still down almost 90% from where it was five years ago.

But such an aggressive jump in price still begs the question: Why has Lexmark's stock price jumped?  The question is especially interesting given that there has been no significant news coming from the company.

There are three plausible explanations for such a run-up in stock price:

  1. Earnings Surprise.  Lexmark announces its earnings on Tuesday.  It is possible that some traders believe that Lexmark will have higher profits and better future prospects than are currently expected by Wall Street analysts.  In the past couple of weeks, there has been a heavy increase in options calls – bets that the stock price will rise.  This could be in anticipation of much-better-than-expected earnings.
  2. Takeover Speculation.  As we mentioned in the Implosion post, Lexmark's ability to generate cash has led to the company being seen as a potential takeover candidate, with Dell, Xerox, and Lenovo frequently cited as potential suitors.  Lexmark takeover rumors pop up occasionally, with the last batch in late 2007.  Traders could be speculating that such a takeover would include a "buyout premium" – a buyout price well above the current trading price to help "seal the deal".  This could also explain the unusually high activity in options calls.   
  3. "Window Dressing".  Over the past five years, Lexmark executives have bought back the company's stock on a massive scale.  The $3.2 billion of stock buybacks have been a catastrophic failure – losing over 70% – which destroyed Lexmark's mountain of cash.  In our last Lexmark post, we talked about how such buybacks could boost stock price while simultaneously insulating the company's failed management from takeovers.  Lexmark's management could be buying back stock as a form of "window dressing" to improve their stock price in advance of Tuesday's earnings announcement.

So which of these explanations is most likely?  A chart of Lexmark's stock price (below, from Google Finance) shows that almost all of the recent increase came in July, with a conspicuous jump in price on July 1st.  July volumes have also been nearly 50% higher than average.  The July 1st pop in price was the first significant move up after drifting downward throughout June.

LXKJune25

Why would the price jump on that date, and continue to increase through July?

July 1st is the first day of the third quarter.  More importantly, it is also the first day after the second quarter, and second quarter financials will be reported on Tuesday morning. 

The timing and volume of the surge in Lexmark's stock price make us suspect that Lexmark's management has been buying back even more of the company's stock – the "window dressing" explanation above.  By buying back stock beginning July 1st, they could improve stock price while not having to report buybacks until September (and not having to include those purchases in Tuesday's report).  If management is buying back a lot of stock, that could also account for the increase in options calls as traders try to feed off of the temporary boost in stock price.

The recent run-up in stock price is probably not due to improved business fundamentals at Lexmark.  All outward signs show that those fundamentals are deteriorating.  Instead, our bet is that Lexmark's stock price has risen because of share buybacks, a traditional crutch for Lexmark's management.

And, historically, buybacks have been a failed long-term strategy for Lexmark.

Update 7/21/2009: After Lexmark's earnings announcement this morning, Lexmark stock has given up all of the gains from the past month.  If Lexmark's management did buy back stock early in July, it would fit the long-term pattern of failed buybacks.

Implosion: The Decline and Fall of Lexmark

I have written a great deal about the failure of CentrePointe, the downtown Lexington development which has failed to produce promised jobs and economic contributions to our city.  It has left a scar in the middle of our city which has persisted for the better part of a year.  It has exposed just how flawed Lexington's planning and economic development processes are.

As much as I have commented on CentrePointe, however, it is primarily a failure of omission, of delivery.  There is a far larger and more important story about a failure which has actively destroyed jobs and economic contribution in our city.

It is a story of the colossal mismanagement of one of Lexington's biggest employers.  It is a story of the destruction of shareholder value and the bleeding of high-tech jobs in Lexington.  It is a story about how a $12 billion company became a $1.2 billion company in just 5 years.  It is a story of wasted opportunity.

It is a story which serves as a damning indictment of the failed executives who have presided over this corporate implosion.

This is a story of the decline and fall of Lexmark International.

About 5 years ago, Lexmark had a market value of over $12 billion, and its stock was over $95 a share.  As of this writing, it is worth less than $1.2 billion, and its stock is struggling to stay above $15 a share.  What happened?

Through a series of misinvestments and strategic blunders, Lexmark's executive management has simultaneously squandered a huge pile of cash, strangled most of their inkjet division, and destroyed some $11 billion in shareholder value. 

In this post, we'll explore a big strategic mistake which is leading to the downfall of Lexmark's inkjet division.  Then, we'll look at how management has failed to invest properly for the Lexmark's future.  But in order to understand the true extent of this failure we need to start with how a printer company makes money.

Business Model
Essentially, a printer business has two major components: 1) Printers and 2) Supplies for printers.  (Lexmark has also been trying for years to expand a services business for corporate customers, but we'll keep it simple here.)  Lexmark has two major divisions: the Printing Solutions and Services Division (or PS&SD) which focuses on enterprises and uses more-expensive laser-based technology; and the Imaging Solutions Division (ISD – formerly known as the Consumer Printer Division, or CPD), traditionally a more consumer-oriented division which mainly uses cheaper inkjet technology.

The printers are relatively expensive to buy, but are narrowly profitable or even unprofitable – especially with inexpensive 'low end' inkjet printers – for their makers.  Printer sales can be fairly volatile – up one quarter, down the next.  All of the active printers that a manufacturer has in the market are considered the 'installed base' of printers. 

Compared to printer costs, supplies tend to be relatively inexpensive.  Even though they cost less to customers, they offer a high profit percentage for their makers.  Supplies sales also tend to be much more stable and reliable, because supplies are generated from multiple years of sales of printers.  In other words, supplies are not generally subject to excessive swings like printers are.

Most of the printer industry tries to offset each high-dollar, low-margin printer with several low-dollar, high-margin supplies sold over the life of that printer.  The initial printer sale yields little profit (or a loss – as Lexmark has admitted they lose money on many of their inkjet printers), while supplies sales from that printer help (eventually) drive high profits. 

This business model is often called a razors-and-blades model for its
similarity to how Gillette made enormous profits: Sell the razors for
as little as possible, and make it up with profits from blades.

As the installed base of printers ramps up, more and more of the company's revenues (and, of course, profits) come from supplies sales.  Eventually, the more stable and reliable supplies business will outpace the more volatile printer business.  Over the past 5 years, supplies have accounted for between 60 and 70% of Lexmark's revenues. 

Upside-Down Economics
In order to get access to the market, most inkjet products are sold through major retailers like Walmart, Best Buy, and Staples.  These retailers wield enormous influence over printer manufacturers. 

Retailers are driven to maximize the profitability of their limited shelf space.  If a product isn't creating enough selling "velocity" for a given space, then the retailer will discontinue, or "de-list" it.  And because manufacturers are in a blind competition with one another for shelf space, de-listing poses an enormous threat to future supplies sales.  Lexmark's competition for retail shelf space is intimidating: it includes market-leader Hewlett-Packard (HP), as well as Canon, Epson, Brother, and Kodak.

To ensure continued access to the retailer's customers (and to the future supplies sales), manufacturers often feel compelled to sweeten the pot for retailers when their selling velocity isn't high enough.  Most often, this comes in the form of price cuts for printers. 

Lexmark was in the vanguard of the low-priced printer movement,
offering the same (or more) functionality for lower prices than the
competition.  For a few years, this was Lexmark's main competitive edge in the inkjet market.  But in 2003, HP – who had almost always used its market leadership to demand premium prices – changed its strategy and began to match Lexmark's pricing.

Over time, the printer industry kept giving more and more ground in this Faustian bargain with retailers, driving printer prices lower and lower, until they ultimately lost money on many of the printers they sold in order to get access to profitable supplies sales. 

But when a company loses money on its initial printer sale, funny things start to happen to the business model.  If it grows too fast, then the losses from printers can drain the profits from supplies: In other words, building the business for long term profit can require the sacrificing of profitability in the short term.  Conversely, if printer sales drop dramatically, then the business can appear enormously profitable: Management can enhance short-term profit even while destroying long-term business fundamentals.

These upside-down economics can be difficult to manage, especially during strategic shifts: it is expensive and uncomfortable to change, but it is also expensive and uncomfortable to remain in place.  In the case of Lexmark's inkjet-focused ISD, Lexmark executives failed to manage those economics – to the detriment of the ISD business.

Strategic Blunders
For several years, Lexmark executives have signaled their intent to get "higher-usage customers" for ISD.  The premise of these announcements was that Lexmark would sell fewer printers, but that they wouldn't lose (as much) money on printers and would simultaneously gain
enormously-profitable customers who used lots of supplies. 

HP has traditionally been very strong among small businesses and
other high-usage customers, and Lexmark was attempting to crack into
that market.  Repositioning to get higher-usage customers would also be a marked departure from Lexmark's history (and its brand image) of cheap, low-end inkjet products.

Trouble is, the executives never identified any sustainably differentiated qualities in their high-end products which would tempt customers to leave the vaunted HP brand for the Lexmark label.  To date, Lexmark's products are "me-too" products: the same basic functions, features, and performance as the products offered by other printer manufacturers.  The few differentiated features that Lexmark has introduced (wireless printing, for example) have been quickly matched by rivals.

And it isn't clear that Lexmark has, in fact, gained higher-usage customers with the few printers it has managed to sell.  Spot-checking product prices in stores and online, it is common to see Lexmark's "high-end" inkjet products at nearly half the price of competitive products from HP.  This is a clear signal that Lexmark's products aren't getting the velocity of HP's products, and that retailers are extracting price concessions as a result.  Further, as these high-performance, heavily-featured products drop in price, two other upside-down dynamics kick in:

  • The magnitude of losses for high-end products might be greater than the losses for low-end products.
  • The lower prices likely appeal to the same lower-usage consumers which Lexmark is attempting to avoid

An example: a feature-laden product designed for the, say, $200 price
point might lose even more money when repriced to $149 than a sibling
product which was designed for $49 and reduced to $29.  And that bigger financial hole might be even harder to get out of if Lexmark "wins" customers who don't print frequently.

So, how did this "repositioning" strategy play out?

With new ISD leadership in
2008, Lexmark began to aggressively abandon low-end
printers in the pursuit of the high end of the printer market. 
Almost immediately, Lexmark's retail presence was dramatically reduced
as it
was de-listed at or kicked out of retailer after retailer, ending up
with a significant presence only at Walmart and Circuit City – not the kinds of retailers where higher-usage customers would be expected.  Perhaps feeling the sting of being locked out of so many
retailers, a more flexible Lexmark began regaining listings earlier
this year. 

By the
end of 2008, the damage was done: Lexmark lost almost half of the
printers sold in 2007.  2008 revenues were down 22% from 2007, while profits were up 47% in the same period.  Remember when we said that a dramatic drop in printer sales usually creates a temporary boost in profits?  Well, in this case, Lexmark's supplies revenue and profit – usually the most stable part of a printing business – have also been dropping, which is a particularly worrisome trend.  This implies significant deterioration in Lexmark's cash cow – its installed base of printers.

In the past 5 years, the attempts to move to the high end have has disastrous effects: Since 2004, ISD has lost two-thirds of its printer sales and 40% of its revenues.  Profits in the division have dropped by nearly 60%.  And the prospects for the future are not good.

Death Spiral
When the most stable generator of cash (supplies) starts drying up, it can put a printing company in a kind of death spiral.  Because of its leveraged, upside-down economics, the company can no longer fund the aggressive growth initiatives which could help pull it out of the downward spiral.

Will the move to higher-usage printers pull Lexmark out of the death spiral?  No.  As we outline above, Lexmark has failed to offer truly differentiated products with a compelling business model, and it appears that the aggressive move upmarket may actually speed the division's demise. 

What's even more troubling are the warning signs of a similar death spiral in Lexmark's larger, more-business-focused PS&SD.  While not as volatile as ISD, the same patterns are emerging to point toward flat or falling supplies revenue: declining overall revenue, declining printer sales, and what appears to be a shrinking installed base.  Once both divisions have entered the spiral, it will be difficult for Lexmark to maintain long-term viability.

Cash Burn
For years, Lexmark's executives have touted the company's amazing ability to generate cash from its supplies-heavy business model.  But how have they deployed that cash for investors' and the company's benefit?  They haven't.  It is another troubling example of the mismanagement of the company.

At a recent meeting with analysts, Lexmark executives crowed about returning $3.2 billion to shareholders through stock buybacks.  As we delve into the effects of those buybacks, we have to wonder what they were so proud of…

With a buyback, management essentially tells shareholders, "We've determined that the best investment we can make is in our own company, so we're going to buy back our own stock."  After a buyback, since there are fewer shares on the market, each remaining share owns a bigger chunk of the company. 

Normally, a buyback is a great thing for long-term shareholders.  Because each share owns a bigger chunk of the company, the share's price usually goes up.  And a buyback usually acts as a signal from management that they believe in their company's health and prosperity.

But sometimes, buybacks are used by management as a weak attempt to prop up the share price of a flagging company.  Buybacks are especially worrisome when they are the primary use of cash by technology companies: Executives are signaling to shareholders that they can find no innovative technology more worthy of investment than simply plowing that cash back into the company's stock.  As a result of depriving technology development and acquisition, a buyback company's technology often falls far behind that of competitors.

In Lexmark's case, the buybacks have backfired.  Over the past 5 years, management has used $3.2 billion to buy back some 59 million shares of Lexmark stock at an average price of approximately $54 a share.  At $15 a share, that $3.2 billion investment is now worth about $900 million – a loss of over 70%. 

But it is worse than that.  The 59 million shares Lexmark's executives repurchased represent about 45% of the shares they started with in 2004.  So each share should have nearly doubled in value.  Without the buybacks, Lexmark's share price would likely be around $8, instead of $15.    All in all, Lexmark's value has dropped by a scandalous 90%.

In 2004, Lexmark was sitting on $1.5 billion in cash and securities.  By 2008, Lexmark had burned through that cash (and other cash it had generated since 2004) through share buybacks.  So, it took on a $650 million long-term loan, and began using that to continue purchasing new shares. 

Rather than deploying this arsenal of cash to fund growth with significant new technologies (which might have helped to differentiate their products – see discussion above), Lexmark invested in its failing status quo.  And, by any measure, that investment failed.  Miserably.

Is this executive incompetence?  Perhaps.

But there is another, equally-distressing, explanation for why Lexmark's management engaged in this failed buyback strategy on such a massive scale: They were protecting themselves.

When a company builds a large mountain of cash, it becomes an attractive takeover target.  In Lexmark's case, this is especially true, because it has also had (until recently) a reliable stream of cash from its supplies business coupled with a depressed stock price.  A private equity firm would look at buying the firm and using the cash and future profits to finance the acquisition.  In 2005, one of the industry's best analysts (Toni Sacconaghi, now with Bernstein Research) suggested that Lexmark was ripe for precisely such a scenario.  

By buying back almost half of Lexmark's outstanding stock, executives could solve multiple 'problems' at the same time:

  • They reduced their cash holdings, thereby reducing their attractiveness as a takeover target;
  • They could potentially buy out dissatisfied shareholders (further reducing takeover potential); and,
  • They could prop up their flagging stock price, with the hopes of deferring shareholder judgment on their failures.

All in all, such a strategy would have allowed Lexmark's executives and board to maintain and concentrate control of the company.  In the process, however, they have failed their shareholders, their employees, and the communities in which they live and work (especially Lexington).  

Incompetence.  Or self-interest.  Neither explanation is satisfactory.  And both are deeply troubling.

A call for change
CEO Paul Curlander, ISD President Paul Rooke, and PS&SD President Marty Canning have all been with Lexmark for over a decade.  They presided over the destruction of 90% of Lexmark's market value.  They have marshaled failed (and failing) business strategies.  They have continually pursued failed financial strategies through stock buy-backs.  They have destroyed some 600 mostly-local US jobs.

By every meaningful business measure, they have failed.

It is time for Lexmark's board to act decisively.  Lexmark needs a vibrant new strategy 1) to survive and 2) to grow profitably.  The current standard-bearers are clearly not up to the task.  My hope is that the board can bring in new executive management who can articulate and execute that strategy. 

As a Lexington business owner, I want and need Lexmark to thrive.  Lexmark's current leaders have failed its shareholders, its employees, and our community.  It is time for meaningful change at Lexmark.

* * *

A few disclosures are in order: 

  • As a former Lexmark employee, I'm prohibited from using knowledge and insights I gained while I was employed by the company.  I'm not allowed, for instance, to talk about how board meetings are orchestrated.  I also can't use the insights I may have gained in meetings with current and former executives at Lexmark.  I can't talk about the specific products, internal strategies, and personalities which might have led to the failures which I document here. 
  • As a result, this story is stitched together entirely from studying
    publicly-available financial statements, presentations to analysts, and
    other public releases from the company and others.
  • I have not owned Lexmark stock for over 1 year.
  • I have friends, family, and customers who still work at Lexmark. 
    This in no way reflects their views, or conversations I may have had
    with them.  I did not consult with any of them before writing this. 
    These observations are mine and mine alone.
  • Finally, this critique is aimed squarely at Lexmark's executive management.  The failures I document here are theirs, not the failures of Lexmark's smart and creative rank-and-file employees.

We Were Wrong

Six months ago, the Lowell's Corporate Office of Fearless Predictions forecast that "Gasoline will be well above $3 a gallon by June, if not sooner."  As part of the prediction, we also said oil prices would reach $80 a barrel.

Well, we were wrong.

As of this writing, most stations in Lexington have gasoline at $2.65, and oil has been around $71 a barrel.

At the time of our forecast, gas was about $1.49 a gallon, and oil stood at $39 a barrel.  We predicted that a number of forces (weaker dollar, production cutbacks, greater demand, and speculation) would come together to drive oil prices upward.  We were generally right about the forces driving prices up, but we were wrong about their strength and timing.

In particular, it appears that the economic rebound and infrastructure build-out we foresaw to drive greater demand really didn't kick in as soon or as strongly as we expected.  We're slowly starting to see some signs of the rebound, but it didn't happen when we said it would.

We still expect $3-a-gallon gas by the end of the summer, and wouldn't be surprised to see $3.50 to $4 a gallon by the end of 2009.

That's what we see in our crystal ball.  What do you think?  Where will gas and oil prices go from here?