Inside Outsourcing: The End of the Employee?

No one in the airline industry comes close to Virgin America Inc. on a measurement of efficiency called revenue per employee. That is because baggage delivery, heavy maintenance, reservations, catering, and many other jobs are not done by employees. Virgin America uses contractors. “We will outsource every job that we can that is not customer-facing,” David Cush, the airline’s chief executive, told investors last March. Never before have American companies tried so hard to employ so few people. The outsourcing wave that moved apparel-making jobs to China and call-center operations to India is now just as likely to happen inside companies across the U.S. and in almost every industry.

The men and women who unload shipping containers at Wal-Mart Stores Inc. warehouses are provided by trucking company Schneider National Inc.’s logistics operation, which in turn subcontracts with temporary-staffing agencies. Pfizer Inc. used contractors to perform the majority of its clinical drug trials last year. The contractor model is so prevalent that Google parent, Alphabet Inc., ranked by Fortune magazine as the best place to work for seven of the past 10 years, has roughly equal numbers of outsourced workers and full-time employees, according to people familiar with the matter. About 70,000 TVCs—an abbreviation for temps, vendors, and contractors—test drive Google’s self-driving cars, review legal documents, make products easier and better to use, manage marketing and data projects, and do many other jobs. They wear red badges at work, while regular Alphabet employees wear white ones.

The shift is radically altering what it means to be a company and a worker. More flexibility for companies to shrink the size of their employee base, pay and benefits means less job security for workers. Rising from the mailroom to a corner office is harder now that outsourced jobs are no longer part of the workforce from which star performers are promoted. For companies, the biggest allure of replacing employees with contract workers is more control over costs. Contractors help businesses keep their full-time, in-house staffing lean and flexible enough to adapt to new ideas or changes in demand.

For workers, the changes often lead to lower pay and make it surprisingly hard to answer the simple question “Where do you work?” Some economists say the parallel workforce created by the rise of contracting is helping to fuel income inequality between people who do the same jobs. No one knows how many Americans work as contractors, because they do not fit neatly into the job categories tracked by government agencies. Rough estimates by economists range from 3% to 14% of the nation’s workforce, or as many as 20 million people. Companies, which disclose few details about their outside workers, are rapidly increasing the numbers and types of jobs seen as ripe for contracting. At large firms, 20% to 50% of the total workforce often is outsourced, according to staffing executives. Bank of America Corp., Verizon Communications Inc., Procter & Gamble Co. and FedEx Corp. have thousands of contractors each. In oil, gas and pharmaceuticals, outside workers sometimes outnumber employees by at least 2 to 1, says Arun Srinivasan, head of strategy and customer operations at SAP Fieldglass, a division of business software provider SAP SE that helps customers manage their workforces.

Janitorial work and cafeteria services disappeared from most company payrolls long ago. A similar shift is under way for higher-paying, white-collar jobs such as research scientist, recruiter, operations manager, and loan underwriter. According to data from the Bureau of Labor Statistics, 25% of all medical transcriptionists, who type medical reports recorded by doctors and nurses, were employed in what the agency calls the business support services industry in 2015. The percentage has jumped by more than a third since 2009, a sign that transcriptionists are being pushed out of many doctors’ offices and hospitals.

The trade group Staffing Industry Analysts estimates businesses spend nearly $1 trillion a year worldwide on what it calls “workforce solutions,” or outside services to place and manage workers. As more companies outsource jobs, the resulting improvement in some measurements of productivity puts pressure on other companies.

Eventually, some large companies could be pruned of all but the most essential employees. Consulting firm Accenture PLC predicted last year that one of the 2,000 largest companies in the world will have “no full-time employees outside of the C-suite” within 10 years. Along with many rivals, it is pitching chief executives on the idea that their company’s core business is smaller than they think. Few companies, workplace consultants or economists expect the outsourcing trend to reverse. Moving noncore jobs out of a company allows it to devote more time and energy to the things it does best. When an outside firm is in charge of labor, it assumes the day-to-day grind of scheduling, hiring and firing. Workers are quickly replaced if needed, and the company worries only about the final product. Steven Berkenfeld, an investment banker who has spent his career evaluating corporate strategies, says companies of all shapes and sizes are increasingly thinking like this: “Can I automate it? If not, can I outsource it? If not, can I give it to an independent contractor or freelancer?” Hiring an employee is a last resort, Mr. Berkenfeld adds, and “very few jobs make it through that obstacle course.”

Citations

1. http://on.wsj.com/2kW0IBi Wall Street Journal
2. http://bit.ly/2bMv2qc – Accenture PLC

The Strategy Behind Hudson Bay’s Interest in Macy’s

Americans may need to brace for the demise of America’s largest department-store chain. Hudson’s Bay Co., the Canadian owner of Lord & Taylor and Saks Fifth Avenue, is in talks to take over Macy’s, according to a report from The Wall Street Journal. It would be a spectacular end to a years-long struggle for what was once the star of the retail world.

Taking over the 158-year-old Macy’s would be quite a feat for Hudson’s Bay, given that its $1.4 billion in market value is a fraction of Macy’s $13.4 billion market capitalization. (Macy’s also has $7.5 billion in debt on its balance sheet.) But Hudson’s Bay is not some retail mastermind looking to bolster its brand with the iconic department store immortalized in “Miracle on 34th Street.” Hudson’s Bay is a shrewd real-estate operator more interested in the big buildings that house the clothes and shoes Macy’s sells than the retail operation itself. So if Hudson’s Bay does buy Macy’s, there’s no doubt its next steps would include shuttering hundreds of stores. And Macy’s would lose its place as the leader of brick-and-mortar retail.

The best-case scenario then would be a chain of Macy’s stores running a more-efficient business at a much smaller scale. The worst-case scenario: Hudson’s Bay ends up looking more like Sears Holdings Corp., a decades-long asset sale that appears to heading toward the bankruptcy of one of America’s most storied companies.

So how would a Macy’s takeover work? A look at the Hudson’s Bay playbook shows how adroit it has been at buying companies and properties using complicated financial structures and very little cash. For example, Hudson’s Bay bought Saks Inc. for $2.4 billion in 2013, financing the deal with mostly new equity and debt. A few years later, Hudson’s Bay took some of Saks’s stores, among other properties, and formed a real-estate joint venture with mall operator Simon Property Group. Then, the joint venture borrowed millions of dollars, which Hudson’s Bay used to pay down some of the debt it took on to buy Saks in the first place. The result was that Hudson’s Bay got Saks, the company, for less than the price of Saks’s flagship Fifth Avenue store. Hudson’s Bay used similar magic to buy German retailer Galeria Kaufhof for $2.5 billion in 2015, financing the deal by selling 40 of 59 Kaufhof properties into its joint venture with Simon. No need to issue additional shares or take on more debt.

The best public data on what Macy’s real estate is worth comes from a January 2016 presentation from activist hedge fund Starboard. Based on Starboard’s estimates, Macy’s owned real estate is worth nearly $18 billion. ($21 billion minus $2.8 billion of leased space, excluding some properties Starboard valued at zero).

Here is one potential financing plan, put forth by Bloomberg analyst Shelly Banjo. Hudson’s Bay could sell some of Macy’s property into its joint venture with Simon, or another mall operator, given the interest such REITs (real estate investment trusts) would have in the chain, which operate in most big U.S. malls. Hudson’s Bay may have to issue additional shares and / or take on more debt to buy Macy’s. But it could then get bank or other financing to mortgage the $18 billion worth of property at 60% to 70% of total value. That would bring in $10 to $13 billion which could pay off most of the debt taken on to buy Macy’s in the first place.

Whether or not an acquisition by Hudson’s Bay moves forward, the future of the department store chain is murky. Macy’s has struggled in recent years amid increasing competition from upstarts as shopping habits change and consumers buy more online. Its stock has fallen more than 50% from the highest level it reached in 2015. Its sales in the quarter ended in late October fell 4.2% from a year earlier to $5.63 billion. It is facing mounting investor pressure to turn around its performance and reverse the stock drop. One thing is clear, however: Macy’s is in play. And a sale to Hudson’s Bay could be the end of the department-store chain as we know it.

Citations

1. http://bloom.bg/2kdFP38 – Bloomberg
2. http://bit.ly/2l9TZzO – Forbes

The Good News Is . . .

• Nonfarm payrolls grew by 227,000 in January, the Bureau of Labor Statistics reported. Economists had expected payrolls to grow by 175,000, compared with 57,000 in December. There was little wage pressure, however, with average hourly earnings up just 3 cents and 2.5% on an annualized basis. The average work week was unchanged at 34.4 hours. Job creation was strongest in retail, with 46,000 positions added. Construction gained 36,000, financial activities were up 32,000 and professional and technical services saw a 23,000 gain. Bars and restaurants contributed 30,000 to the total, while health care added 18,000.
• Apple Inc., a global consumer technology firm, reported earnings of $3.36 per share, an increase of 2.4% over year-earlier earnings of $3.28 per share. The firm’s earnings topped the consensus estimate of analysts by $0.15. The company reported revenues of $78.4 billion, an increase of 3.3%. Management attributed the results to fourth quarter revenue growth in all product lines, led by iPhone and App Store sales.
• Johnson & Johnson, the world’s largest health care company announced a $30 billion deal to acquire Actelion, a Swiss biotechnology firm. The deal would add Actelion’s treatments for pulmonary arterial hypertension, or high blood pressure in the lungs, to the American giant’s stable. As part of the deal, Johnson & Johnson will pay $280 a share in cash for Actelion. As part of the transaction, Actelion would spin off its drug discovery operations and early-stage clinical development assets into a new Swiss biopharmaceutical company, which would be listed in Switzerland. Johnson & Johnson would initially own 16% of the new research and development company, with the right to acquire an additional 16%. Actelion shareholders would also receive shares in the new company.

Citations

1. http://reut.rs/2jLhL4a – Reuters
2. http://cnb.cx/1gct3xa – CNBC
3. http://apple.co/2jzQT74 – Apple Inc
4. http://nyti.ms/2jP4wQ1 – NY Times Dealbook

Planning Tips

Guide to Selecting a Mutual Fund

Are you thinking about investing in a mutual fund, but are not sure how to go about it or which one is the most appropriate based on your needs? You are not alone. Selecting a mutual fund may seem like a daunting task, but knowing your objectives and risk tolerance is half of the battle. Below is some straightforward due diligence you can perform before selecting a fund that will help increase your chances of success. Be sure to consult with your financial advisor to determine whether mutual funds are consistent with your investment goals and risk profile.

Identifying Goals and Risk Tolerance – Before acquiring shares in any fund, you must first identify your goals and desires for the money being invested. Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses for grandkids, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 8,000 mutual funds in the public domain. You must also consider the issue of risk tolerance. Can you afford and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment warranted? Identifying risk tolerance is as important as identifying a goal. Finally, think about your time horizon. You must think about how long you can afford to tie up your money, or if you anticipate any liquidity concerns in the near future. This is because mutual funds have sales charges that can take a big bite out of your return over short periods of time. Ideally, you should have an investment horizon of at least five years.

Style and Fund Type – If you intend to use the money for a longer-term need and can handle a fair amount of risk and volatility, the best bet may be a long-term capital appreciation fund. These types of funds typically hold a high percentage of their assets in common stocks and are, therefore, considered to be volatile in nature. They also carry the potential for a large reward over time. Conversely, if you are in need of current income, you should acquire shares in an income fund. Government and corporate debt are two of the more common holdings in an income fund. Of course, there are times when you have a longer-term need but are unwilling or unable to assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds, may be the best alternative.

Charges and Fees – Mutual funds make their money by charging fees to the investor. It is important to gain an understanding of the different types of fees that you may face when purchasing an investment. Some funds charge a sales fee known as a load fee, which will either be charged upon the initial investment or upon the sale of the investment. A front-end load fee is paid out of the initial investment made by the investor, while a back-end load fee is charged when an investor sells his or her investment, usually prior to a set time period, such as seven years from purchase. Both front- and back-end loaded funds typically charge 3% to 6% of the total amount invested or distributed, but this number can be as much as 8.5% by law. Its purpose is to discourage turnover and to cover any administrative charges associated with the investment. Depending on the mutual fund, the fees may go to a broker for selling the mutual fund or to the fund itself, which may result in lower administration fees later on. To avoid these sales fees, look for no-load funds, which do not charge a front- or back-end load fee. However, be aware of the other fees in a no-load fund, such as the management expense ratio and other administration fees, as they may be very high. The management expense ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower your return will be at the end of the year.

Evaluating Managers and Past Results – As with all investments, you should research a fund’s past results. To that end, the following is a list of questions that you should ask yourself when reviewing the historical record:

• Did the fund manager deliver results that were consistent with general market returns?
• Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
• Was there an unusually high turnover (which can result in larger tax liabilities you)?

This information is important because it will give you insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return. With that in mind, past performance is no guarantee of future results. For this reason, prior to buying into a fund, it makes sense to review the investment company’s literature to look for information about anticipated trends in the market in the years ahead. In most cases, a candid fund manager will give you some sense of the prospects for the fund and / or its holdings in the year(s) ahead as well as discuss general industry trends that may be helpful.

Size of the Fund – Typically, the size of a fund does not hinder its ability to meet its investment objectives. However, there are times when a fund can get too big. A fund that is too large may lose its ability to be nimble and responsive to market conditions and opportunities. There are no benchmarks that are set in stone, but the $100 billion in assets mark certainly makes it difficult for a fund manager to acquire a position in a stock and dispose of it without dramatically running up the stock on the way up and depressing it on the way down. It also makes the process of buying and selling stocks with any kind of anonymity almost impossible.

Citations

1. http://bit.ly/2ktIRhU – US Securities & Exchange Commission
2. http://bit.ly/2eXmChs – Kiplinger
3. http://bit.ly/1GxKejw – Investopedia
4. http://bit.ly/1NeZRy5 – US News & World Report
5. http://bit.ly/2ktGPi1 – The Motley Fool