The Growth Factor

Needham Funds' Commentary by Jim Giangrasso 

This volume of The Growth Factor  was written by Jim Giangrasso, who has been with Needham Asset Management since 2006 and is Secretary, Treasurer and Chief Financial Officer of The Needham Funds, Inc. 
                                                                                                         Vol. 15 - May 5, 2014 
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Team Oracle Keeps the Auld Mug: Lessons in Management from the 34th America's Cup Trial
Occasionally we like to depart from the usual format of The Growth Factor, in which we discuss the companies and industries we follow, and instead highlight successful people and the habits that make them that way. Often we find lessons that could serve those companies well.

I recently attended a dinner at the New York Yacht Club where the keynote speaker was Gary Jobson. Mr. Jobson, author of several books on sailing, was an NBC commentator for last year's historic comeback win by Larry Ellison's Team Oracle USA in the 34th America's Cup Defense. Jobson was also the tactician for Ted Turner when his vessel Courageous won the America's Cup in 1977.

Trailing by eight races to one, and just one defeat away from losing the most prestigious prize in yachting to challenger Emirates Team New Zealand, Team Oracle mounted the greatest comeback win in the history of the America's Cup, and arguably among the greatest in all of sports. We can't help but be struck by the parallels between the successful management of Team Oracle and successful managements of the companies we like. 


How They Did It

In the race to nine wins in defense of the Cup, Oracle lost six of the first seven in large part because their Kiwi rivals dominated on the upwind segment of every race. Team New Zealand had mastered the technique known as "foiling" while running upwind. At a certain speed, the hulls of the AC72 Class catamarans used in this competition will lift out of the water, causing the boat to cruise on its foils, reducing drag and increasing speed. Team Oracle had decided against upwind foiling in practice because it required a greater number of zigzag turns - called tacks - in order to maintain the necessary speed. But the result was that Team Oracle was nearly two knots slower than New Zealand on the upwind legs at the beginning of the competition.


After that first week of losses, Oracle called for their one permitted time out to postpone the next race and regroup. They spent the two-day time off revisiting upwind foiling, and concluded that the speed increase potentially gained more than offset the greater distance travelled due to tacking. The technique allowed them to match their opponents' speed on the upwind leg of each race. After seven days of racing the score was a seemingly insurmountable eight to one lead for the Kiwis. One more loss and the Cup would be taken home by New Zealand.


Once Oracle employed the upwind foiling strategy, they recorded two strong performances, and there was no looking back. Seven straight wins tied the series at eight apiece, setting up a winner-take-all showdown. Over the course of the seven straight wins, Oracle had consistently gained speed and her crew had gained confidence. But in a sport where something as fickle as the speed and direction of the wind at a given moment could decide the winner, in one race anything could happen. And as is often the case in sports, calculated risks and sheer luck played a role in determining the outcome. Early on, Team Oracle took a conservative approach to outfitting their yacht at the expense of running slower. The crews are allowed to add an auxiliary mast at the front of their yacht, designed to hold a larger sail that is necessary to take advantage of lighter wind conditions. In heavy winds the extra mast is not necessary, adds weight, and reduces speed. Oracle carried the extra mast for a week but wound up never using it. They decided to gamble the second week and left the extra mast behind. The gamble paid off because the winds continued to be heavy throughout the remainder of the competition. And no one could argue that luck was not on the side of Oracle. On two occasions, Team New Zealand held a commanding lead only to have the race called off. In one case they failed to complete the course in the maximum forty minutes allotted to each race. In the other, the wind speed exceeded the limits that were put in place after a serious accident involving another team.


But perhaps the most effective "tactic" used by the Americans was their relentless pursuit of improvement over the course of the nineteen race series. After every race they reviewed their performance, the handling characteristics of their yacht, and their opponent. "Rest days" were spent on the water practicing. Technical teams made numerous adjustments to the profile of the yacht and her sails. Rigging was adjusted. And crew changes were made when deemed necessary.


The final race had its moments of drama. Team Emirates was first out of the start and looked ready to pounce. At the first turn, Oracle hit a small wave at an unfortunate angle and took a severe nosedive into the water; they lost vital seconds, but managed to recover. Emirates put up a great fight and throughout the first half of the race, the lead changed hands a number of times. In the end, however, Emirates could not cope with the superior speed of Team Oracle who won with a margin of forty-four seconds.


Incremental Change or Major Overhaul?
Each of the nineteen races was a learning experience, particularly the defeats. Throughout the competition, both teams made small but important design changes in an effort to eke out small increases in speed and handling. When a change is made to a boat, the team is required to submit a measurement certificate to race officials disclosing the change. Team Oracle submitted nineteen such certificates - one for every race - in their relentless pursuit of improvements (Team Emirates submitted eight to ten changes). Some changes worked and others did not, but the feedback loop was critical as each side carefully analyzed their opponent to look for an edge and play to their own strengths. Team Oracle also was not afraid to make major changes when things were not going their way at the outset. Oracle changed its chief tactician mid-series after losing three races, a rarity in the sport. It was a bold move to add five-time Olympic medalist Ben Ainslie, but it galvanized the team.


Successful companies adjust to the changing market and competitive landscape. Managers with vision know when small changes will give an incremental benefit and when major ones are necessary to survive and thrive. In a previous Growth Factor, we mentioned how World Wrestling Entertainment (WWE) has evolved from a risqué brand, perhaps inappropriate for most audiences and advertisers, to family-oriented entertainment.


Technology Is (Just) a Tool
The 2013 America's Cup Trial was a marriage of technology and tradition. The Oracle is a titanium and carbon fiber catamaran with a wing sail designed to hydrofoil, capable of sailing at about twice the speed of the wind (up to near-freeway speeds of fifty miles per hour). Her mainsail is a rigid wing about 50 percent larger than the wing of an Airbus 380 airplane. Several of the crew took flying lessons to better understand her handling characteristics. Hundreds of onboard sensors monitor strain and pressure on every major component and relay data to the crew in real time onto PDAs built into their wetsuits. To say she is a far cry from the schooner (named America) that won the first Cup in 1851 is a gross understatement. Purists of the sport lament the fact that the competition nowadays seems to be about whichever sponsor is willing to spend the most money designing these marvels of physics and engineering. Yet despite all the technology, the yachts still must be sailed by hand - mostly with traditional, centuries-old techniques. When Russell Coutts, Team Oracle's chief executive, was asked how they did it and what changes were made, he told the media, "Everyone talks about the technology: What changes did you make. The guys on board changed a lot. For sure there was a use of the technology change where we manipulated the force or manipulated the balance of those forces. But the guys on board the boat changed their technique, so there's this fantastic human element to this which really won the day in the end, which is great."


Successful companies and their managers leverage technology to achieve their goals but also know that technology is a tool: a means, not an end. Retail companies use social media to develop their brands. Yet the message conveyed still must be on point. CRM systems are a wonderful tool for customer-facing personnel - if they help drive sales. Hard work, focus, determination and traditional skills such as understanding the customer's needs still apply. 


CarMax (KMX), the nation's largest retailer of used cars, uses a proprietary inventory management and pricing system that tracks each vehicle throughout the sales process. Statistical modeling techniques optimize inventory mix, anticipate future inventory needs at each store, evaluate sales consultant performance and refine vehicle pricing strategy. The system generates recommended initial price points and retail markdowns tailored for each CarMax location based on complex algorithms that take into account factors such as sales history, consumer interest and seasonal patterns. Yet despite all the technology CarMax's success comes primarily from knowing their customer. Their consumer-friendly "no haggle" pricing policy lets customers shop for cars much as they would shop for goods at other "big box" retailers, removing the biggest source of discomfort for their customers: The negotiation process. Sales consultants generally are compensated on a fixed dollars-per unit standard, allowing them to focus solely on meeting their customers' needs. CarMax CEO Tom Foillard (featured in Growth Factor Vol. 7 - The WOW Factor - Game Changers)  started with the company as a senior buyer in 1993 and worked his way through the ranks. His duties as VP of Merchandising and EVP of Store Operations surely gave him valuable perspective on their customers and has helped him succeed in changing the way consumers shop for used vehicles.


A Global Outlook Is No Longer Just an Option

When Team Oracle USA crossed the finish and defended its title, there was only one actual American on board: sail trimmer Rome Kirby, a Newport, Rhode Island native. Oracle combined the talents of the best in the sport from seven other nations: Oracle's helmsman was Australian, its tactician was British, and the crew was from Antigua, New Zealand, Italy, the Netherlands and Ireland.  This was consistent with owner Larry Ellison's global approach to talent recruitment: Competition and business are more about brand identity and pushing technological boundaries than about national identity and a patriotic agenda. Similarly, companies should source the best talent from wherever it may be without fear of losing their identity.


San Francisco, California-based Xoom Corporation (XOOM) is a leader in the digital consumer-to-consumer international money transfer industry. Xoom's customers use its service to send money to family and friends in 31 countries in the Philippines, India, Latin America, Europe, Australia, Canada and South Africa. CFO Ryno Blignaut hails from South Africa and indeed Xoom has a broad international employee base. The diverse group of talent that Xoom has assembled affords them a deep understanding of their customers and how they use Xoom's service. 


Pessimists Need Not Apply
There was no shortage of reasons for Team Oracle to give up. Penalized for an earlier modification deemed illegal by race officials, they started the competition two races in the hole, with one crew member disqualified. After being completely dominated by Emirates in the first two races it was apparent that Oracle was second best in terms of speed. Even Oracle's sailing tactics and strategy seemed to not measure up to their Kiwi rivals. Despite the adversity and long odds, Oracle skipper Jimmy Spithill seemed able to ignore everything around him except the immediate tasks at hand. He said he focused just on being first out of the gate, winning the current leg, winning that day's event. Day after day he told the press, "We can win races."  And win they did. Spithill's optimism was contagious; one day the Cup they were defending mysteriously appeared on the dock in front of the team - a not-so-subtle message.


Likewise, companies and their managers have any number of reasons to blame for falling short of their goals:  a poor economy, a lack of qualified talent, a weak competitive position relative to competitors. Effective managers know how to navigate the headwinds of an unfavorable economic environment, and know how to motivate their employees.


In late 2008 and early 2009, semiconductor equipment company Entegris (ENTG) was facing broad macroeconomic headwinds and resultant significant revenue declines, and a battered stock price (which went from $11.96 to $0.79 in less than two years). The August 2008 acquisition of Poco Graphite augmented their base of business in the semiconductor industry and provided growth opportunities in a variety of other high performance markets. The acquisition was completed using debt and the leverage combined with revenue declines left them in a precarious financial situation. Management, led by former CEO Gideon Argov, then EVP Bertrand Loy and CFO Greg Graves could have attempted to sell Poco to raise cash. Instead they saw through the downturn and successfully integrated Poco. Today Entegris has seen its stock price recover back over $11.00 (+26.3% in 2013), is executing on its vision to be a leader in materials science and enjoys the flexibility to make key R&D investments as highlighted in The Growth Factor Vol. 7.

We spend our days looking at companies and industries and the hard data they generate and meeting with the management of those companies. The common denominator among successful companies often seems to be effective management. And many of the traits they possess intersect with those of the managers of Team Oracle as demonstrated by their remarkable win.
*The Needham Funds aggregate ownership as a percentage of net assets in the stated securities as of 3/31/14:  WWE, 0.61%; KMX, 3.34%; XOOM, 0.11%; and ENTG, 2.00%.

The information presented in this commentary is not intended as personalized investment advice and does not constitute a recommendation to buy or sell a particular security or other investments.
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