Barrow’s Dilemma

Barrow, Alaska, may have to move to higher ground sooner than expected.

The northernmost town in the United States is on ground that is 3 to 4 meters above sea level. The immediate area will be below sea level within two centuries because of sea level rise. There is plenty of high ground nearby, but because of the strategic importance of Barrow it might make sense to keep the town relatively where it is.

No one has a plan to accomplish that, though. Local authorities are hoping for a sea wall, but that might cost $1 billion to build, and the Army Corps of Engineers says that’s too expensive. Barrow is a town of 4,000. The cost of rebuilding the entire town on higher ground would be less than half the cost of the sea wall.

Barrow faces a dilemma after last summer, when an otherwise unremarkable storm had onshore winds for hours, just long enough to flood a dozen coastal buildings. The storm lasted nearly long enough to pour sea water into the town’s water supply. With summer sea ice disappearing, similar storms can be expected every few years. The local director of government affairs says last year’s storm made them realize “Barrow is just one storm away from a major catastrophe.” Barrow, then, may not have 30 years to rebuild itself one building at a time. Yet with no funding for anything else, the best answer might still be to start on that approach and hope for the best.

Weekend Retail Traffic

I had been hearing all weekend how busy retail areas were. Yesterday I heard that a farmer’s market and a mall were both crowded. I saw the same thing when I went out myself this morning. The expressway exit for the mall was backed up the length of the ramp, creating a six-minute delay for anyone using that route to get to the mall. It’s all a jarring disconnect from the more gloomy economic statistics of the year so far. My hunch is that some of the shoppers who completely skipped the winter fashion season because of mild weather are now tired of their fall clothes and are getting an early start on spring.

Nipigon River Bridge Reopens, Reconnecting Canada

Two days ago the Nipigon River Bridge opened to two lanes of traffic again. The Nipigon River, which flows from Lake Nipigon to Lake Superior, separates eastern and western Canada, and there is only one two-lane highway bridge across the river. When the bridge came loose in cold weather it was closed for a day, then open to only one lane of traffic. There were half-hour traffic backups and the symbolic effect of splitting a country was equally consequential. Last weekend a “temporary” repair was completed and after tests, the bridge was opened to two lanes on Thursday morning. Canada is properly connected again.

Though considered temporary in an engineering sense, the bridge repair is likely to last for several years while a parallel span is built. In the meantime, the cause of the failure will be determined so that the second span can be built in a way that avoids duplicating the same fault.

The experience of the Nipigon River Bridge failure has given some impetus to the idea of an alternate route. This proposed highway would improve 200 kilometers of existing roads going north from Thunder Bay, then would add 100 kilometers of new road north of Lake Nipigon. This would not be a popular route but it would be nice to have ready the next time a severe weather event or disaster closed the one highway between Thunder Bay and Nipigon that connects eastern and western Canada. When the Nipigon River Bridge closed there was no detour that would keep you in Canada. The proposed highway would be a three-hour detour — no picnic, obviously, but better than having no detour at all.

This Week in Bank Failures

The CEO of the failed Georgia bank Tifton Banking Company, Gary Patton Hall Jr., was sentenced to 7 years and ordered to pay $4 million in restitution for his role in fraudulent loans and records. Hall covered up problems with nonperforming loans and improperly approved a loan for the buyer of real estate he was personally selling. The bank obtained $3.8 million in TARP funds in 2009 based on its falsified records, then failed in 2010.

An expected U.K. referendum vote to leave the European Union on June 23 may have sped up a merger deal between Deutsche Boerse and the London Stock Exchange. While publicly the two parties are reviewing the U.K. referendum as a possible obstacle to the merger, the timing of the tentative agreement on the merger suggests that the deal is designed mainly to protect the London Stock Exchange in the event that the United Kingdom withdraws from the EU. The ruling Conservative party is narrowly split on the referendum question and has officially not taken a position. Exiting the EU would require two years of adjustments in London but it would end up in a stronger position for the future. The financial sector there would be able to stay out of trouble, gain advantage, and provide a platform of stability the next time turbulence and recession arise in the euro zone.

Bank of England says it is able to reduce interest rates to zero when needed, but probably not below. The bank cautions about the consequences of pushing money out of a country through the use of negative interest rates, its governor saying monetary policy “cannot rely on simply moving scarce demand from one country to another.”

The high-risk business strategies of the past seven years have led Standard Chartered Bank to its first yearly loss in 27 years. Besides the loss from operations, the bank’s outsized exposure to the economy of China puts it in a precarious position going forward.

Royal Bank of Scotland lost £2 billion for the year and says it is not likely to resume paying a dividend in 2017 as previous planned. Securities litigation and several outstanding investigations have to be resolved first, the bank said.

Belgium has filed tax evasion and money laundering charges against Swiss bank UBS. Prosecutors say the new charges are based on bank documents originally obtained by investigators in France and are not closely related to charges the bank already faces in Belgium.

According to published reports, Barclays has decided to get out of Africa and has appointed a committee to look for potential buyers for its interests there. More details may come forward at the earnings report next week.

The NCUA liquidated Mildred Mitchell-Bateman Hospital Federal Credit Union in Huntington, West Virginia. It had 57 members, who were hospital staffers.

Replacement Cycle Bites Best Buy

The durability of phones and computers is good for almost everyone but a bummer for Best Buy, which sees falling sales as consumers replace devices less often. Best Buy had bet big on being a go-to place for mobile devices, and the same as at Radio Shack, that’s turned into a negative now that people are keeping their devices for years. The Reuters story:

Best Buy forecast misses expectations

People are using phones and computers as much as ever, but now only a small fraction of users expect to replace computing devices every year or two. My own desktop computer and phone are 8 years old, and by 2021 that pattern may be the norm. Another change affecting retailers is consumers buying replacement devices directly from the manufacturer. A consumer who can wait two days for a replacement phone can save a trip to the store. Best Buy is not the most convenient place to buy a phone anyway, and Best Buy is reporting a 6.8 percent decline in that category. This is more of a change than than it sounds. Phones and computers might take up 10 percent of the floor space in Best Buy, but they account for nearly half of revenue. Combined with other growing categories (such as home appliances and fitness trackers) and stagnant ones (video games, car stereo) Best Buy expects flat sales this year.

Best Buy’s report is a measure of what is going on across retail, with consumers looking for ways to spend less time shopping. It’s a long-term trend with no single obvious cause, and retailers simply have to adapt.

Beware of the Hidden

Takata air bag inflator recalls in the United States may soon reach 100 million units, according to engineers and managers who talked to Reuters. The problem seems to be that Takata’s records show that defective materials were used in at least 10 million inflators, putting them at risk of exploding without warning — but other records that would have told specifically which units were at risk were destroyed, so it may be necessary to replace a much larger number. Paul Lienert and David Shepardson write for Reuters: Exclusive: Up to 90 million more Takata airbag inflators may face U.S. recalls.

My own car was subject to three airbag recalls. The repairs were completed only last week after I waited for all the parts to be available. It is hard to imagine nearly half of the cars in the United States, excluding those already recalled for this issue, having to have the same parts replaced. Based just on the number of trained workers available, that’s a job that won’t be finished this year or next. It is also, just as obviously, a financial debacle for the manufacturer involved. When a product is recalled for replacement, it is dead money as far as the manufacturer is concerned. The company would be better off if it had not manufactured the defective units in the first place.

So how did a manufacturer carry on delivering a dangerous product, being at least dimly aware of a defect rate above 20 percent, and take more than a decade to correct its problems? Obviously, this question is being studied as a case in management.

In my opinion, the first point to consider is the way airbags are hidden in use. Most cars live a quiet life, retiring after 10 to 20 years (or now, often longer) having never been struck hard enough for the airbags to ever have done anything. In these cases, you never see the airbag at all until the car gets to the junkyard. There, of course, the airbag has to be removed before the car can be melted down for scrap, but if the airbag is missing when the mechanics go to get it, at that stage, no one really cares. Someday we will find out that a factory one day installed trash bags in place of air bags in some cars. If the car is never in a serious accident, how would you ever find out if the car is made with a real air bag or a fake air bag made out of a trash bag? When a product is hidden, that makes it a little too easy easy to pretend that it was made correctly, even when you know it wasn’t.

Most management, from what I have seen, is management by failure. Managers wait until they see something go wrong, then they try to correct the problem. Management by failure is a poor approach in any case, but it works extraordinarily badly when problems are hidden, as is the case when the problems are located in products that are hidden in ordinary use.

Takata had tests that showed its manufacturing controls weren’t working, but instead of trusting its own tests, it waited until it heard government complaints. It can take thousands of serious injuries and deaths before a product defect forms a statistical pattern so clear that safety investigators who have no clue where the problem is coming from can sort it out. That’s how Takata’s problem got to be so expensive. Managers were able to bury their heads in the sand for a long time.

Beware of the hidden. Make sure the success of your business does not depend on things you cannot see. It is a lesson that should be obvious enough to anyone following the Takata case. Unfortunately, management being what it is, it will take hundreds of cases like Takata before this point finally sinks in.

Two Weather Records

Tropical Cyclone Winston, which just hit Fiji, had the highest sustained wind speed ever seen in a tropical system in the southern hemisphere. Dr. Jeff Masters at WunderBlog: Winston's 185 mph Winds in Fiji: Southern Hemisphere's Strongest Storm on Record

Total global sea ice is, by all available measures, the smallest ever seen, apparently the result of more warm water available to melt the ice. Neven at Arctic Sea Ice Blog: Global sea ice extent record minimum

This Week in Bank Failures

Virtually all pre-1980 large banks have arcane and convoluted ways of keeping financial records, presenting the possibility that a bank could fail and the FDIC might not be able to determine who the depositors were or how much they were owed. It’s a situation that the FDIC faces about every five years in a small bank failure, but it presents a systemic risk should it occur on a large scale. For the first time, the FDIC has adopted a time-based recordkeeping rule for banks. The new rule says that a bank’s records must be sufficiently clear and timely to allow the bank to determine owners and balances of deposit accounts within 24 hours after the bank fails. The rules are obviously very vague and are arguably unenforceable, and they only apply to the largest banks, those with at least 2 million deposit accounts. These are generally banks with well over $1 billion in deposits. Still, the new rules represent a step forward, as previously there were no rules at all on this matter. I have argued that the banking system would be safer if essential deposit account information were required to be copied to a standardized XML data format at the end of every banking day so that the FDIC was not so dependent on each failed bank’s proprietary technology, but such a requirement would be well beyond the current information technology of the Wall Street banks.

Citigroup reportedly plans to shut down its retail banking operations in Argentina and Brazil. Some sort of move in Argentina has long been expected since that country accused the bank of breaking national laws by processing some transactions, but the withdrawal from Brazil seems to be purely a reaction to that country’s uncertain economic future.

All small and medium-sized banks with strong balance sheets will be eligible for a reduced schedule of regulatory review under interim rules from U.S. regulators.

Five directors of China state-owned bank ICBC were arrested in a money-laundering probe in Spain.

With a long-running dispute over nuclear power resolved, Iranian banks are plugged into the global banking network again.

After a board-level review HSBC has decided to keep its headquarters in London. Not all board members and executives were happy with the decision, with some eagerly anticipating a move to Hong Kong, and the bank will have to go to some trouble in the coming weeks to keep key staffers on board.

Cap Holds in California Gas Storage Disaster

One of the largest artificial disasters of 2015 is under control now, with infrared and radar images showing that the Aliso Canyon natural gas storage facility in California is holding after a series of patches since last week. More than 10,000 people were evacuated for four months and it is hard to estimate the medical consequences of the gas leak. A no-fly zone was declared around the area because of the risk of the leaking gas to aircraft. The greenhouse gas impact of the leak was large enough to be compared to the normal greenhouse gas impact of the entire United States.

The natural gas storage facility was built more than 60 years ago in an abandoned oil field, and the natural deterioration of equipment over time made this kind of leak inevitable. The residual oil from the former oil wells acts as a contaminant in the natural gas, making it more harmful than natural gas would be on its own. The disaster got sparse news coverage, in part because there are risks involved in every form of large-scale energy storage and news outlets are loath to emphasize the social risks inherent in the conventional lifestyle that news advertisers represent.

The lack of news coverage shouldn’t lead anyone to underestimate the impact of this kind of disaster, however. Whether covered in the news or not, an event like this does show that we are all living beyond our means, hoping that disaster doesn’t strike but knowing that, realistically, things will continue to break down at a rate similar to what we’ve seen.

This Week in Bank Failures

Bank stocks, which had already retreated to 1996 levels as the week began, continued their decline. The selloff was especially evident on Thursday when many U.S. banks fell 5 percent, after many European banks had already retreated by 8 percent. On Friday Bank of America cut its one-year outlook for the S&P 500 by 9 percent, a move that could almost be attributed to the ongoing decline in the banking sector alone.

Bank stocks have been closely tied to the fate of oil in recent weeks, with investors worried about the scale of banks’ involvement in the oil industry. Most oil companies are expected to fail if the price of oil does not rise above $50 by the middle of 2017. The current price of oil, though, is $29 and shows little sign of a large-scale near-term recovery. When oil companies go bankrupt, many of their loans will go unpaid, possibly rendering banks insolvent if their exposure is too large.

Deutsche Bank sought to reassure investors of its capital strength after last year’s steep losses. It then announced a €5 billion bond buyback plan to be funded by a small part of the bank’s pending asset sales. The bank will need to reduce its debt load as it scales down.

Morgan Stanley agreed to pay $3.2 billion in penalties and restitution to settle charges of misrepresenting the mortgage loans backing some of the securities it issued around 2008. The bank reduced the quality of the mortgages it included in securities but told buyers it had not done so. The settlement was not unexpected and the bank said it had already set aside the funds involved.

The Financial Conduct Authority (FCA) fined a senior manager at JPMorgan £792,900 for failing to cooperate with regulators. The manager failed to disclose problems with the bank’s synthetic risk derivatives portfolio and told regulators in a March 2012 meeting that the problems were resolved even as the bank’s liabilities had by that time ballooned to $6 billion and the bank was holding daily crisis meetings.

Sources for The Wall Street Journal say U.S. and U.K. authorities are in the late stages of their Libor-rigging investigation and are likely to charge several banks in the two countries. Misconduct in other countries might lead to separate charges.

MetLife is formally challenging its “systemically important” status in court. The insurer is seeking to overturn the part of the Dodd-Frank Act that defines “systemically important” financial institutions. In court it argues that issuing life insurance policies should make it exempt.

The Federal Election Commission wants to know if Citibank and Goldman Sachs were secretly bankrolling the Ted Cruz presidential campaign. Loans totaling $1 million weren’t disclosed in the candidate’s electoral filings. Cruz is one of several presidential candidates with close ties to Wall Street, but apparently the only candidate to receive this kind of secret funding. Besides the loans, Cruz’s wife is an employee of Goldman Sachs.

History Repeats As Time Buys Myspace

Myspace is not exactly a social media platform anymore. It’s more like a web site for watching music videos. But it is Myspace’s social media past that got Time Inc. interested in purchasing it — for data mining of the user data, if you believe the official announcement.

Time Inc. has purchased Myspace in what is not a repeat of the AOL Time Warner deal, described as “the biggest mistake in corporate history.” Or is it? Is the following quote from a Time Warner executive describing the AOL deal from 2000 or a Time executive describing the Myspace deal this week?

Marketers are selecting media partners that have either data-driven capabilities or premium content; we will be able to deliver both in a single platform, and will stand apart from those that offer just one or the other.

I know, I couldn’t tell either. It might just as well describe either deal. It seems the myth of marrying access and content is just as easily believed today as it was 16 years ago.

But wait. Didn’t Time Inc. just get done unloading Time Warner Cable and before that, AOL, exactly because the marriage of access and content didn’t make sense? Well, yes, but . . .

Negative Interest Rates: Technical Readiness

The Fed has told banks to be prepared for negative interest rates, at the same time saying that it’s not a likely scenario. The most likely scenario would seem to be a copy of Japan, where banks are being charged an annual rate of 0.10 percent for excess reserves on deposit with the central bank. It’s a way of discouraging banks from keeping cash. The hope is that banks will be more eager to make loans, but for banks that don’t want to make loans, there are plenty of other places they could put their money. A small amount of it could be in gold, for example. Banks may need to keep excess reserves on deposit for short periods of time while large transactions clear, and the negative interest rates could lead banks to charge higher transaction fees, but not so large that they would deter the large business deals the payments are part of.

There has been confusion this week about the Fed’s plans. As I understood it, the Fed only meant to caution banks to be ready in a technical sense for interest rates that could go below zero. The United States has never had negative interest rates, so it’s not likely that many of the old-line banks are technically prepared to record the negative interest rates in their transaction systems. In clarifying its position, the Fed said it had no plans to lower interest rates. That compounded the confusion, though, and today the Fed had to clarify that it could adopt negative rates in the future and banks really did need to prepare. That’s the bottom line, I think: bank managers need to go to their computer system architects to ask, “If we tried to put in a negative interest rate tomorrow, what would happen?” Someday bank stress tests may be more than just back-of-the-envelope calculations and banks may be formally obliged to test their operational readiness for scenarios such as these.

Update, February 12: CNBC just published a roundup of negative interest rates: Next country with negative rates could be… Canada?

Twitter’s Tinkering

At some point during the blizzard two weekends ago, Twitter stopped showing me advertisements. Maybe I should have been flattered. A Fast Company story, “Twitter Has Stopped Showing Ads To Its Most Valuable Users,” said an ad-free timeline is now the ultimate Twitter status symbol. The risk of being flattered would be that I might feel insulted the following weekend when the ads started to trickle back in.

“Most valuable” would be an exaggeration in my case, but Twitter has enough statistics to show that I am more valuable to it for the content I provide than for the advertisements I view — not really a surprise for a professional writer who has taken considerable trouble to master the 140-character format. You could make a case for not showing me any advertisements on Twitter. Some advertisements are irritating enough to push me off the service for a day at a time. But what would be better for Twitter is if it can get the content I provide and have me take in hundreds of advertising impressions. So Twitter is experimenting on me. If it perseveres, it will discover the kinds of advertisements that drive me away and will reserve those for other users (or perhaps start turning down those advertising placements if most users find them equally irritating). It will also find that I read and remember everything it puts in front of me and have a lower tolerance for repetition than the advertising industry would normally expect. Eventually I may have an effectively personalized advertising feed on Twitter.

Assuming Twitter succeeds at this, it is good news and bad news. Twitter needs advertising to survive and prosper, but effective marketing in any form is a double-edged sword. The goal of advertising is to control the mind of its target, yet if it accomplishes this consistently, it leads to avoidance in one form or another. To cite one of the most extreme examples of this, the charitable fundraising industry has learned to target retirees whose mental functioning has declined enough that they are highly suggestible in phone calls. These prime targets may make reliable donors, but if they go too far, a court may step in and takes their checking accounts away from them for their own protection, and then the charitable fundraisers get nothing. To look at a more pragmatic example, some of the retailers that were most effective at selling clothing in-store five years ago are now out of business. After spending a small fortune in these stores just two or three times, the best customers feel a twinge of guilt or fear when they think of going back. Customers then condition themselves to walk past the store without going in. For the store, this leads to bankruptcy. The issues with the advertisements in my Twitter feed are more subtle. If Twitter persuades me to take on the point of view of their advertisers, that takes away the distinctive point of view that makes my content valuable, and that in turn makes Twitter less compelling for those users who follow Twitter in part to see what I am saying. It matter little whether I start writing dull tweets that echo what the advertising on Twitter is already saying or censor myself, realizing that my thoughts are not so interesting, and write fewer tweets. Either way, the result is less content to discover on Twitter. Multiply this by a few million net content providers, and a breakthrough in advertising effectiveness could lead to a burst of revenue for one year, followed by a collapse as users abandon the suddenly stale platform.

The need to strike this balance between content value and advertising influence is nothing new. Newspapers know if they try to go past 10 percent advertising space on the front page and 80 percent inside, readers will learn not to open the paper. Commercial television has yet to find a way to push past 23 percent advertising time without losing the mass audience. Twitter is something new in the advertising world and no one really knows how far Twitter can push advertising without eclipsing the essential value of the service. That’s why it is important for Twitter to experiment at this point.

Panama Canal Expansion Prepares to Open

Good news for global shipping: the Panama Canal expansion is set to open around June, the canal authority said this week. That puts the project relatively on schedule. The construction of locks, the core of the construction, might be 2 years late and 60 percent over budget, but it substantially follows the original scope and design. The construction team has started testing the new locks, the last step before opening.

With the expansion, the capacity of the canal will, for the first time, depend mainly on the weather. When ships pass through at the capacity of the locks and channels, the supply of fresh water that makes the locks operate will eventually run out, forcing a slowdown. This has historically been a possible constraint in very dry years in the Panama Canal, but now becomes a concern in all but the rainiest summers. With few options for expanding the fresh water supply to the canal, it may not be possible to expand its capacity any further than this.

This Week in Bank Failures

Stock prices are evidence enough that Wall Street is worried about banks. Major U.S. banks are trading below stated liquidation value, an indication that investors don’t quite trust the management, balance sheets, or future prospects. An unguarded comment by the Goldman Sachs CEO on CNBC, referring to current U.S. politics as “a dangerous moment,” reinforces the impression that Wall Street banks are, to put it mildly, not feeling comfortable. A who’s who of European banks have also seen their stocks tumble this year and now there is worry about the possible disruption of a United Kingdom exit from the European Union. Oil countries have mostly been able to keep their banks standing so far, but at considerable cost. Oil country banks will not recover until global oil prices double from current levels, but analysts are beginning to wonder if that will ever happen. Besides the problems of oil industry loans, a broad decline in the prices of industrial commodities may put banks’ mining and manufacturing loans at risk.

Finally, the size of the banking system in China is cause for concern. Bank assets and liabilities in China are larger than all of North and South America combined, a risky top-heavy arrangement that, absent a global economic miracle, will require state intervention this year. Banks in China face bubbles in stocks and real estate (both financed largely by bank lending), an overextended manufacturing sector, the overhang of a decade of lax regulation, a series of natural and man-made disasters, a slowing national economy, and worries about a possible global recession. Everything has to go nearly perfectly to avoid a systemic failure. China will surely have to pursue inflationary policies for several years to rescue its stock market and banks and to try to prop up its flagging factories.

Former bond giant Pimco continues to shrink at a startling but manageable rate, with its Total Return Fund showing $1.1 billion in outflows in January. Outflows make it harder for fund managers to maximize returns, as liquidity has to be given greater priority, and the fund is hurt by a lackluster performance, with a return under 1 percent in 2015.

Legal setbacks this week: Barclays, Credit Suisse, Wells Fargo, Deutsche Bank. Cutting costs: Lloyds Bank, with 1,755 retail job cuts announced.

A credit union was rescued by a NCUA-assisted merger. Montgomery County Credit Union in western Ohio was already in conservatorship and as of January 31 was merged into Bridge Credit Union. Prior to the merger, Montgomery County Credit Union had 6,000 members and $27 million in assets.

State regulators in Ohio placed another credit union into conservatorship yesterday. Cory Methodist Church Credit Union has 700 members. For now, members can conduct transactions at Steel Valley Federal Credit Union.

Today, Wisconsin state regulators ordered the liquidation of CTK Credit Union. It had 400 members, who were members of Christ the King Baptist Church of Milwaukee.

Undersea Tunnel Sought to Connect Helsinki and Tallinn

Helsinki and Tallinn, the capitals of the Baltic Sea countries of Finland and Estonia respectively, have agreed in principle to build an undersea rail tunnel connecting the two cities. The 80-kilometer rail link will be the first major rail connection between Finland and the outside world, but it is equally important for Estonia, making it practical for Tallinn residents to work in Helsinki. Already, thousands of people make the daily commute from Tallinn to Helsinki despite a 2-hour ferry ride. The reverse trip is also a popular day trip for Helsinki residents, who may see sights or visit restaurants in Tallinn, then drink beer to pass the time on the ferry ride home. The tunnel, which is hoped to be complete in 2030 at an estimated cost of €13 billion, will effectively bring the two cities closer together.

The proposed tunnel lends more weight to another rail project to connect Tallinn to Poland by way of the two countries in between, Latvia and Lithuania. This would make Finland more readily accessible from the other countries of the European Union, largely taking away the current commercial perspective that Finland is effectively an island that must be approached by sea or air. In the live music business, for example, this could result in more tours visiting Finland and more Finns traveling to music festivals across Europe.

It would be a bit of an exaggeration to say that all this is on the drawing board, however. Only preliminary studies have been done and it will take at least two years of detailed engineering studies before funding can be sought for construction. Once funded, the construction itself would take at least several years, as you would expect for a project of this scale.

I am always encouraged to see plans for high-speed rail being placed underground, as in the case of the Talinn-Helsinki tunnel. I believe the future high-speed rail network must be mostly underground for safety and efficiency reasons. A tunnel is protected from weather events, for example, and it provides the shortest route between two points.

Low Oil Prices Boost Hotels

Low prices for energy, particularly oil-based fuel, are good for the economy in general but are particularly good for the hospitality sector. Energy costs represent a significant part of the cost structure of a hotel, most notably for climate control in winter and summer, so lower energy prices reduce the cost of operating a hotel. At the same time, low prices for fuel make people more willing to travel, particularly by car and airplane, and that results in more customers at the hotel. E-forecasting.com in its latest monthly HIL index is projecting a boost of 0.2 percent in the hotel business, largely on the basis of the decline in energy prices in December. This follows a series of upward moves in the HIL previous months. E-forecasting.com says the HIL is a leading indicator that is four to five months ahead of changes in business results at U.S. hotels.

Answers in Chipotle Report

The earnings report from U.S. restaurant chain Chipotle Mexican Grill hints at answers to two of the questions customers have been asking. The more important question of the two is why Chipotle can’t change its slapdash food preparation approach. Chipotle’s financial results point at the answer to this. Revenue at Chipotle was down 15 percent as customers stayed away following three highly publicized disease outbreaks originating in the restaurant chain. Profit, though, was down 45 percent. When a business’s profit falls faster than its revenue, this points to the fixed costs of the business. These are the costs the business must bear regardless of the number of customers. If profit falls three times as fast as revenue, this is a business that has an unusually high proportion of fixed costs for the restaurant sector. To make a profit at all, Chipotle must bring in as many customers as it can, regardless of its ability to handle the workload. To put it another way, Chipotle has to force its customers to wait in long lines and push its food-assembly workers to work an unnaturally fast pace to make a profit at all.

The unfortunate other side of this effect is that Chipotle will fail spectacularly when consumer tastes change, something that inevitably happens within a matter of years in the fickle restaurant business, all the more so in restaurants like Chipotle where the novelty factor is intrinsic to their appeal. A decline in traffic of one third would not be a drastic change from the customer’s point of view — you would be waiting in a shorter line, but still waiting in line — but it would have the restaurant chain operating at a loss. Any adjustments Chipotle might make at that point to return to profitability, such as raising prices, closing stores, or reducing the quality of the product, would further erode revenue in what would likely be a downward spiral. Chipotle’s suggestion that heavy spending on food safety will wipe out its profits in the current quarter suggests that this downward spiral may have already begun.

The other big question was whether any of the official investigations into Chipotle’s operations have turned up anything. A criminal investigation in California may have turned up something about actions in other states, because we now know that a California criminal investigation of a single location in Simi Valley has turned into a federal investigation by the Department of Justice. Chipotle says it received the first subpoena in the federal investigation last week. The documents sought by the subpoena hint that investigators suspect a company policy directed toward covering up problems with food quality.

Chipotle ultimately probably cannot fix its quality problems because slowing down food assembly enough to fully control the process would mean giving up the high volume that it requires to turn a profit. I believe Chipotle can fix all its other quality problems, but it is easy to see why management turns a blind eye to the actual problem that it faces. There may not be a solution that allows the company to stay in business.