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I T’S NOT SPYING I F T H E Y’R E ALWAYS W A T CH I NG Month_00 — Month_00, 2016 | bloomberg.com

August 29 — September 4, 2016 | bloomberg.com

Uncovering Baltimore’s Secret Surveillance Program p50


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“EVERYBODY KNOWS THAT

PHOTOGRAPH BY REINIS HOFMANIS FOR BLOOMBERG OMBERG BUSINESSWEEK

HE IS THE GUY YOU CALL

IF YOU FIND A BODY”

p62

“I’m tired of these little hit-and-runs. Let’s have some shootings!”

“I looked at that and thought, Man, I’m in the wrong line of business”

“Machines are not God. We are the gods”

p50

p21

p8

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Cover Trail

August 29 — September 4, 2016 How the cover gets made

Domestic Cover

Opening Remarks How blockchain could end corporations (what is blockchain, anyway?)

8

Bloomberg View Rethinking the $1-a-share money-market fiction • A slower, saner Brexit

12

Movers  Weekly pay for the bottom quartile  Ryan Lochte loses his Speedo

15

Global Economics

① “The cover is on a company that’s been hired to do aerial surveillance over Baltimore.” “Why?”

TPP’s demise may be China’s triumph

16

Russia passes a draconian, impractical cybersecurity law to squelch terror—and dissent

17

An odd shortage in Japan, the fastest-graying nation: Nursery school teachers

18

The world is thirsty for U.S. crude

19

“That seems great. Is there a particular crime it’s been hired to work on?”

20

“Well, the surveillance goes for hours on end, and it’s all over the city, so the idea is that it would be for all crime.”

Companies/Industries Millennials have dropped the Olympic torch. Will NBC have to drop its ad rates? Chinese airlines offer foreign pilots soaring salaries

21

Snap Kitchen serves up ready-made artisanal meals to fast foodies

22

Breakdown: Canada’s Couche-Tard tries to surround 7-Eleven with Circle Ks

23

“Oh. And everyone’s OK with this?” “The public hasn’t been told.” “You enjoy upsetting me way too much.”

Politics/Policy Clinton has Georgia on her mind

“To help solve crimes.”

24

The open-and-shut case against private prisons is a bit ajar

25

Wind and solar farms on public land get help from Obama, but not the kind developers want

26

Technology 2

China’s sharing economy is more and more selfish

29

Amazon pays itself royalties in Europe and avoids taxes at home

30

Siri cares—really, she does—she just can’t hear you

31

The old chip in your smartphone may be heading to Mars

32

Innovation: With flexible robot surgeons, it’s so long, scar stories

33

Markets/Finance

COVER AND COVER TRAIL: DOMESTIC: PHOTOGRAPH BY PHILIP MONTGOMERY FOR BLOOMBERG BUSINESSWEEK

One $5 million bonus in the hand is worth $10 million in the bush

34

How much do public pensions love private equity? It’s a secret

35

The software providers taking advantage of Ponzi schemes taking advantage of day traders

36

Defined: Oatmeal should be “lumpy.” Earnings, not so much

37

Focus On/Small Business Street food in a derelict warehouse—that’s what Londoners call a night out

39

The Bull Moose hit-predicting algorithm, brought to you by two guys in a shack in Maine

40

Startups get all the love, but scale-ups do all the work

41

Small to Big: The “wow” moment for Yasso frozen Greek yogurt came when Tom Brady crashed the website

42

International Cover ① “The cover is on blockchain.” “I have absolutely no idea what that means.”

Features Eye in the Sky Can airplanes solve street crime? Baltimore is finding out

50

Vin de Scam Bamboozling Bordeaux lovers in Berkeley

58

The Things They Buried Historians and grandchildren race against Nazi-grave profiteers

62

Etc. Has North Dakota State’s championship football team had too much of a good thing?

69

Travel: Five fab places to float away

72

The Critic: Cathy O’Neil’s quest to defuse Weapons of Math Destruction

74

Food: Jersey Mike’s wants you to eat a more sophisticated sub

76

Horoscope: You may want to hold off on that product launch until October

78

What I Wear to Work: Personal stylist Skyler McCurine’s aesthetic is “just enough too much”

79

How Did I Get Here? Marne Levine, Instagram’s COO, has come a long way since her days as the Trash Queen

80


Index People/Companies E

Abe, Shinzo 18 Abengoa (ABG:SM) 15 Able Access Transportation 41 Air China 21 Airbnb 8 Airbus Group (AIR:FP) 21 Alibaba (BABA) 29 Altave 52 Amazon.com (AMZN:US) 30, 31, 40, 78 Amplify US 20 Apollo Global Management (APO:US) 35 Apple (AAPL:US) 30, 31 ARM Holdings (ARMH:US) 32 Arnold, Laura 52 Arnold,John 52 Backfeed 8 Baidu (BIDU:US) 29 Bay, James 78 Beijing Capital Airlines (900945:CH) 21 Beijing Rongchang Laundry 29 Berson, Martin 22 Best Buy (BBY:US) 15 Bezos, Jeff 30 Birdy 78 BlackRock (BLK:US) 34 Blackstone (BX:US) 35 Blue Bell 42 Boeing (BA:US) 21 Boustany, Marwan 31 Brown, Aja 52 Brown, Chris 40 BTIG Research 20 Bull Moose 40 Burke, Steve 20 Buterin, Vitalik 8 BuzzFeed 20 Byrne, Matthew 72 Cabify 41 Cameco (CCJ:US) 37 Cancro, Peter 76 CBS (CBS:US) 20 CEM Benchmarking 35 Chengdu Airlines 21 Chevron (CVX:US) 37 China Eastern Airlines (CEA:US) 21 Choset, Howie 33 Chrysler (FCA:IM) 8 Ciobo, Steven 16 Circle K 23 Clinton, Hillary 15, 16, 24 Coca-Cola (KO:US) 78 Coen, Ethan 70 Coen, Joel 70 Community Bank of the Bay 59 Compensation Advisory Partners 34 Consensus Systems 8 Continental Airlines (UAL:US) 22 Cook, Tim 30 Cooley, Ken 35 Corrections Corp. of America (CXW:US) 25 Couche-Tard (ATD/B:CN) 15, 23 Coveney, Patrick 37 Cox, Gary 32 CST Brands (CST:US) 15, 23 Ctrip 29

Easdon, Dale EBay (EBAY) Esmits, Talis ESPN (DIS:US) Everledger

D D.E. Shaw Davis, David De Antonio, Juan Deep Focus Delta Air Lines (DAL:US) Denton, Nick Dianping Didi Chuxing Dimbleby, Henry Doll, Greg Domino’s Pizza (DPZ:US) Donchin, Andy Downey, Jonathan

74 12 41 20 21 30 29 29 39 31 76 20 39

22 15, 64 64 70 8

F Facebook (FB:US) 17, 20, 30 Field, Matan 8 FieldStack 40 58.com 29 Firehouse Subs 76 Fisher, Noël 78 Five Guys Burgers & Fries 76 Fogle, Jared 76 Ford (F:US) 8, 15 Fox, John 59 Fox, Liam 12, 16

Lelis, Andris Lessig, Lawrence Levine, Marne Lochte, Ryan Logos Technologies London Union Lopez, Brenda LSG Sky Chefs Lubin, Joseph Lyfe Kitchen

64 8 80 15 52 39 24 22 8 22

16 Lee Hsien Loong

G Ganji 29 Gartner (IT:US) 32 Gates, Bill 15 Gavekal Dragonomics 29 General Motors (GM:US) 8 GEO Group (GEO:US) 25 Glass Lewis 34 Gnash 78 Goldman Sachs (GS:US) 18 Goodson, Caesar 52 Google (GOOG:US) 8, 17, 31, 52 Gottlieb, Craig 64 Greencore Group (GNC:LN) 37

H Harrington, Drew 42 Hay Group (KFY:US) 34 Hilton Worldwide (HLT) 72 HTC (2498:TT) 78 Hui, Lawrence Wai-Man 59

I IBM (IBM:US) 8 ICV Partners 35 IHS Markit (INFO) 31 Instagram (FB:US) 72, 80 Institutional Shareholder Services 34 Intel (INTC:US) 32, 37 Intuitive Surgical 33 Isenberg, Daniel 41

M Mahoney, Tim 70 Mango Aviation Partners 21 Marriott International (MAR) 72 May, Theresa 12 McCain, John 24 McCurine, Skyler 79 McDonald’s (MCD:US) 15, 76 McNiven, James 32 McNutt, Ross 52 Medivation (MDVN:US) 15 Medrobotics 33 Meitu 15 Meituan 29 Merck (MRK:US) 30 Microsoft (MSFT:US) 8, 31, 40, 78 Motorola (992:HK) 31 MTS (MTSS:RM) 17 Mylan (MYL:US) 15

PwC Qingdao Airlines Qunar

N

R

Nakamura, Noriko 18 Nasdaq (NDAQ:US) 8 NBC Universal (CMCSA:US)20 Nelson, Rory 39 Nokia (NOK:US) 78 Nunn, Michelle 24

Radoff, Bradley Reed, Kasim Reyes Ferriz, José Rishworth Aviation RiskMetrics Group Romney, Mitt Ross, Dave Rottenberg, Linda Royal Bank of Scotland (RBS:US)

J J.M. Smucker (SJM:US) Jelincic, J.J. Jersey Mike’s Subs Jimmy John’s Jones, Hoyt JPMorgan Chase (JPM:US) Juice Generation

15 35 76 76 76 8 78

K Kangaroo Express Kenney, Ed Kirchhoff, David KitDarby.com Aviation KKR (KKR:US) Klane, Amanda Knowles (KN:US) Kosiba, Louis Kroger (KR:US) Krzanich, Brian Kuaidi One

23 72 22 21 35 42 31 35 42 37 29

L L Catterton Lamborghini (VOW:GR) Larsen, Matt Lawson, Nigella Lazarus, Mark Le Red Balloon Lee Hsien Loong

22 15 70 39 20 79 16

69 The NDSU Bison

29, 34 21 29

22 24 52 21 74 24 21 41 41

S

24 Michelle Nunn

OPQ Obama, Barack 16, 24, 80 Oliver, Jamie 39 Ortega, Hector 59 Outlier Ventures 8 O’Brien, Olivia 78 O’Neil, Cathy 74 Parker, Robert 59 Persistent Surveillance Systems 52 Pet Life 40 Pfizer (PFE:US) 15 Piepkorn, Dave 70 Plouffe, David 24 Poppins 18 Power Co. of Wyoming 26 Premier Exhibitions (PRXIQ:US) 15 Pret A Manger 22 Protein Bar 22 Putin, Vladimir 17

Samsung (005930:KS) 31, 78 SAP (SAP:US) 40 SAR Insight & Consulting 31 Schwartz, Tony 78 Segway 78 7-Eleven (3382:JP) 23 Shake Shack (SHAK:US) 76 Shimao Property (813:HK) 59 Sia 78 Sichuan Airlines (1055:HK) 21 Smashburger 76 Smorgasburg 39 Snap Kitchen 22 Snapchat 20 Snowden, Edward 17 Starbucks (SBUX:US) 37 Straface, Samuel 33 Subway 76 Summers, Larry 80 Surfjack Hotel & Swim Club 72

T Target (TGT:US) 42 Technomic 22, 76 Tencent (700:HK) 29 Teva Pharmaceutical (TEVA:US) 15 Time Warner (TWX:US) 20

Tipton, Annette 41 Toll Brothers (TOL:US) 15 Toyota (TM:US) 8 Tristano, Darren 22, 76 Trump, Donald 16, 24, 78 Turnbull, Malcolm 16 21st Century Fox (FOXA:US) 20

UVW Uber United Airlines (UAL:US) Universal Music (VIV:FP) Univision Urumqi Air Vesper Virgin America VOR Holdings W (HOT) Walmart (WMT:US) Walt Disney (DIS:US) Wasinc International

8 21 40 30 21 31 21 21 72 42 20 21

Weight Watchers (WTW:US) 22, 42 Wendy’s (WEN:US) 76 Wentz, Carson 70 Whittlesey, Fred 34 Whole Foods Markets (WFM:US) 22 Wickard, Brett 40 Wine-Searcher.com 59

XYZ Xi Jinping XiamenAir Yandex (YNDX:US) Yarrington, Patricia Yasso Yelp (YELP:US) Yum! Brands (YUM:US) Zia Records Zoës Kitchen (ZOES:US)

16 21 17 37 42 59 15 40 22

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Opening Remarks

This Is Your Company On Blockchain By Peter Coy and Olga Kharif

of technical issues, such as how to reduce the system’s consumption of electricity. The biggest challenge, though, is likely the human element. People aren’t eusocial creatures like ants or termites. They like their freedom. The blockchain community needs to find a way to liberate people from corporate hierarchies without subjecting them to a new master, the blockchain itself. It might seem premature to ponder how blockchain could change the world. When it makes the headlines these days, it’s generally because of a hack or a standards dispute, like the internecine warfare over how to speed up its rate of transaction-processing. But blockchain technology is not to be ignored or

The technology could turn a company into a seamless network of coordinated freelancers

8

You don’t have to be an expert on digital currencies like bitcoin to be intrigued by the potential of the technology underlying them. Blockchain, as it’s called, is something new in computing. It mashes up cryptography and peer-to-peer networking to create what amounts to a shared database of transactions and other information—which can be open to all, controlled by no one. It’s not just for securely recording payments in crypto-coinage; a blockchain can handle complex transactions, even entire contracts. True believers say blockchain could reduce the need for businesses to organize as companies, which get work done via command and control. Using blockchain, they say, collaborators will be able to work together as free agents instead of under a hierarchy of bosses. “Imagine for a moment if people could coordinate themselves in a much more

organic and distributed manner, just like ants. But without giving up on the complexity and the free will that is characteristic of human societies. We can do that,” blockchain researcher Primavera De Filippi said in a TEDxCambridge talk last year. The poetic vision of a blockchain society is a flock of starlings at dusk: decentralized yet perfectly coordinated. Blockchainers like to show video clips of murmurations—those enormous clouds of birds that pivot and wheel, climb and dive, split and merge with amazing grace. Blockchain, in this vision, could replace gobs of bankers, accountants, and lawyers, as well as escrow accounts, insurance, and everything else that society invented pre-21st century to verify payments and the performance of contracts. Can blockchain really change companies as we know them? There are plenty

underestimated. You don’t want to be this decade’s version of Bryant Gumbel on Today in 1994: “What is internet, anyway?” he asked. “What is it? You write to it like mail?” A blockchain, as the name suggests, is nothing more than an ever-lengthening chain of blocks of data. Each block contains a compact record of things that have happened. How it does this is interesting and complicated. The important point is that if something is recorded in a blockchain, it’s deemed by users to be true with a capital T. “Blockchain converges on a single reality. This is the greatness of blockchain, only this,” says Matan Field, an Israeli mathematical physicist who is chief executive officer of a blockchain startup called Backfeed. (De Filippi is Backfeed’s “chief alchemist.”) Blockchain’s design prevents the owner of a currency token from committing fraud by spending it twice. The first spend is recorded for all to see, so no one would ever accept a second spend.


ILLUSTRATION BY 731

The truth-telling feature of blockchain makes it enormously useful to banks, which have been among the first to start testing it. Microsoft launched blockchain as a service last year. Smaller companies are building dozens of apps on blockchain, such as one for musicians to track and collect royalties on their works. According to CoinDesk, an online publisher, a couple in Singapore recorded their prenup on a blockchain, specifying that “every 10 days,

100 minutes must be spent on a date night, that shopping sprees shall be limited to once per fortnight ‘unless it’s for food,’ and that [Sayalee] Kaluskar must agree to watch The Walking Dead after [Gaurang] Torvekar finishes watching every season of Seinfeld.” Nasdaq, an early adopter of blockchain, is using the technology to allow private companies to issue stock and stockholders of public companies to vote their shares. Everledger is using it to create a registry of diamonds to suppress trade in “blood diamonds” from conflict zones. Some ideas for blockchain are a little scary. Toyota Financial Services has toyed with using a blockchain contract in which “if a finance payment isn’t made, the smart contract automatically transfers ownership and doesn’t let the owner use the car anymore. The car wouldn’t turn on,” says Chris Ballinger, the unit’s chief financial officer and global chief officer for strategic innovation. “People

would do this voluntarily, because they can then finance at a lower rate.” A no-excuses, stiff-consequences contract that’s permanently embedded in software is appealing to some people and appalling to others. “In a weird way I think blockchain unifies a lot of different political ideologies,” says Joseph Lubin, a co-founder of the advanced blockchain Ethereum and founder of Consensus Systems in Brooklyn, N.Y., which uses it. “It could map onto socialist or libertarian.” After streamlining companies, the next step for blockchain will be blowing

them up. Ethereum, for one, goes beyond the ledger function to work more like Google Docs—shared software that can be used by all but is tamperproof. You can safely do business with someone you don’t know, because terms are spelled out in a “smart contract” embedded in the blockchain. There could be blockchain versions of Uber and Airbnb that are peer-to-peer: No company would need to sit in the middle of the transaction to gather data about your spending habits or collect a fee. In 1937 economist Ronald Coase theorized in “The Nature of the Firm” that companies exist because markets can’t do everything efficiently; some jobs are easier to do in-house. For instance, it’s more convenient to hire staff than to contract with freelancers every time you need some work done. Firms will grow, Coase said, until they get so big that the cost of doing a transaction inside the company becomes higher than that of doing it on an arm’s-length basis. The internet modified Coase’s equation by reducing the costs of searching for resources outside the firm and contracting and coordinating with outside parties. Take autos, where vertical integration is passé: Fewer than half of

Gobs of accountants, bankers, lawyers, and company bureaucrats would vanish autoworkers are employed by the likes of GM, Ford, and Chrysler. More work for their suppliers, suppliers to those suppliers, and so on, down to makers of nuts, bolts, and wiper blades. Blockchain will further the trend by adding the key element of trustworthiness, allowing companies to pare down staffs and functions to an essential core, write tech authors Don Tapscott and his son Alex Tapscott in the book Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World. “Imagine designing a system where it was very clear what the obligations of all the different parties are, and it was built into code. You would always do the right thing,” the elder Tapscott says. A philosopher might argue that there’s no virtue in doing the right thing simply because you’re prevented by software from doing the wrong thing. On the other hand, Tapscott asks, what successful economic system ever depended entirely on honor? Even after blockchains catch on, some people will probably still be wage slaves, working for a W-2 and doing whatever the boss asks. But to some visionaries, the logical endpoint is a third stage in which entire companies move onto the blockchain and even the functions of the CEO and the board of directors are reduced to contracts rendered in computer code. Shareholders, through online voting, would make any decisions that aren’t programmed in. “One of the many advantages of having a robot run your organization is that it is immune to any outside influence, as it’s guaranteed to execute only what it was programmed to,” says Ethereum’s website. A group of blockchain enthusiasts attempted a leap into this brave new world earlier this year by raising $150 million for a “decentralized autonomous organization,” running on Ethereum, that was chartered to be a leaderless venture capital fund. An anonymous hacker found a way to divert crypto-currency now valued at $40 million from the DAO without technically violating its rules. That created an embarrassing dilemma for the blockchain community: Stick to the letter of the contract and reward the hacker by letting the diversion of funds go ahead, or alter

9


10

the supposedly inalterable record to recapture the money. In July participants in Ethereum chose the latter of those two evils. They rewound the blockchain to how it was before the hack, thus capturing the funds. Some members rejected the rewind, so now there are two versions of Ethereum going. Some people in the community of enthusiasts said after the DAO crackup that a fully blockchained world is still a good idea, albeit one whose time hasn’t yet come. “Each individual project will go through extensive review and a ‘training wheels’ phase with some centralized control before being fully let into the wild,” Vitalik Buterin, a co-founder of Ethereum, wrote in an e-mail. Andreas Antonopoulos, author of Mastering Bitcoin, writes in an e-mail that “blockchain contracts can be democratically upgraded and modified,” though provisions for doing so increase complexity and may jeopardize security. Modifications are simpler on a closed blockchain that involves just a handful of parties. Others argue that it will never be possible to reduce the complex, fast-changing world of business to rules embedded in software. “It’s a fabulous technology. But in practice it is a system that is very elitist,” controlled by those who build the new virtual machines and understand their inner workings, says Marcella Atzori, a political analyst at the University College of London Research Centre for Blockchain Technologies. “Machines are not God,” she says. “We are the gods. We have to take control and change things.” The problem when Atzori says “we” is that she doesn’t necessarily mean the same people that Buterin talks about. There really is no we; blockchain has never had an official governing body. That’s getting to be more of a problem as it grows from experiment to infrastructure. “If we don’t address governance, then the movement could collapse on itself as it disintegrates into warring factions,” the Tapscotts write in Blockchain Revolution. The Tapscotts are trying to gin up a solution. They invited a dozen or so blockchain leaders, including one with ties to IBM and JPMorgan Chase, to their family’s summer compound in Lake of Bays, Ontario, from Aug. 24 to 26. “I don’t know what will come of it,” Don Tapscott said before the conclave. “At a minimum, a small group of people will have a common framework to talk about things.” That would be a step in the right direction. Harvard Law School professor Lawrence Lessig, in a speech in

Sydney last December, warned against the “geek sneer” pose that software is purer than and superior to law and regulation. Blockchain, in other words, can’t float free from society. “There’s a greater realization that some kind of governance is unavoidable,” says Fredrik Voss, vice president and head of blockchain innovation at Nasdaq. It would be nice to invent a system that combined the security of blockchain with the freewheeling nature of the internet. That, sadly, is impossible. Blockchain achieves its security by creating a unified record of reality: who paid how much when, for example, or who performed what task for whom. It acts like a single computer that keeps updating its internal picture of the state of the world. That makes it a “state machine,” in computer-science terminology. A lot of time and energy—including physical energy, i.e. electricity—goes into maintaining this unified picture. The internet, in contrast, is “stateless.” Computers on the internet don’t share an understanding of the state of the world. On the web, no one knows if you’re a dog or a god. It’s supremely open and flexible. The downside is that if one computer says you’ve paid for something and another says you still owe

“If we don’t address governance, then the movement could collapse on itself”

money, there’s no procedure on the net itself for deciding which is right. For that you need a blockchain. Compared with the internet, blockchain is a ball and chain. Perhaps that’s an unfair comparison, though: What matters is that blockchain is far less cumbersome than the trust-creating infrastructure that it partially replaces. “Our existing governance and business processes were designed for a centralized age,” Lawrence Lundy, head of research and partnerships at Outlier Ventures, which develops blockchain companies, wrote in an e-mail. He’s optimistic that blockchain and related technologies “will combine over the next 10 years to redefine every single function within an organization and ultimately the very structure of a corporation.” Melanie Swan, a bitcoin expert at New York’s New School for Social Research, envisions blockchains enabling what Belgian management consultant Frederic Laloux calls “Teal Organizations,” which are selfmanaging and purposeful. So blockchain really can change companies as we know them. People will still be people, though. Blockchain or not, we will never operate in perfect synchrony, just as the Navy’s formation-flying Blue Angels will never equal a murmuration of starlings at dusk.


Bloomberg View

To read Virginia Postrel on what outdoor retailers are really selling and Tyler Cowen on the return of startup nations, go to Bloombergview.com

When a Dollar Isn’t Quite a Dollar Rules governing money-market mutual funds have to be applied more comprehensively

in 2012? Because the exempted funds, it argued, were less susceptible to runs: Retail investors didn’t pull much out of money-market funds in 2008, and funds that invest in government debt attracted money. In other words, the SEC says it’s OK to maintain the buck-ashare fiction as long as investors believe it. This is a poor foundation for stability. A fiction is still a fiction, and investors are likely to work this out at the worst possible moment. Admittedly, it wouldn’t be painless to apply the rule to all money-market funds. Disabusing investors of the notion that the government will guarantee them a dollar a share would probably raise borrowing costs a bit. Failing to disabuse them, however, courts the danger of much bigger costs later, with taxpayers left to pick up the bill.

How Not to Be Paralyzed by Brexit 12

New regulations aimed at strengthening one of America’s most popular savings products, the money-market mutual fund, are causing a minor tempest in financial markets, drawing complaints about unintended consequences. Where they’ve been applied, the rules are working as they should. To avoid unintended consequences, they need to be applied more comprehensively. The idea was to forbid a false promise—that money-market funds can maintain a price of $1 a share, even though they invest in assets that can lose value. The danger of this illusion became clear in 2008, when losses at one fund triggered a race among investors to redeem money-market shares for the full dollar before it was too late. The run starved companies of credit and forced the government to head off further damage with a blanket guarantee. In principle, the remedy for this is simple: Require the share prices of money-market funds to float along with the value of their assets, like other mutual funds. This would erase the incentive to be first out in a crisis, making disastrous runs less likely. After years of deliberation, the Securities and Exchange Commission in 2014 said it would enact this reform—but in a piecemeal manner. It exempted two large categories of funds: those that invest in U.S. government debt and those that cater to retail investors. This differential treatment is distorting markets. Before October, when the rules are due to take effect, investors are shifting tens of billions of dollars from the affected funds— which cater to large corporate clients and invest in the debt of banks, companies, and municipalities—into those that will still be allowed to promise their shares are always worth a dollar. The covered funds are also hoarding cash to prepare for further withdrawals. All this is squeezing credit. Why didn’t the SEC apply the change to all money-market funds, as the Financial Stability Oversight Council recommended

The European Union says it wants clarity on whether U.K. Prime Minister Theresa May is serious in her pledge that “Brexit means Brexit.” That clarity would be good for Britain as well as the rest of Europe, and there’s a simple way to get it: Extend the two-year deadline triggered by Article 50, the formal notification of the decision to leave the bloc. This would give both sides something they want. Europe would get the clarity it’s demanding: Britain is leaving and can be formally recognized as a soon-to-be nonmember. And Britain would get the time it will need to arrange an orderly transition to new trading arrangements with the EU and the rest of the world. To be sure, each side would also lose something. Europe would give up some bargaining power. It wouldn’t be able to use the two-year deadline as an implicit threat to bounce Britain into a harsh settlement. And Britain would lose the option of dithering indefinitely over whether it’s really in or out. On balance, though, both sides would be better off with clarity on “in or out” combined with adequate time to negotiate an orderly and friendly separation. David Davis, the minister in charge of Brexit, has reportedly hired fewer than half the 250 staff designated for his new department. Liam Fox, the international trade secretary, employs fewer than 100 of the estimated 1,000 trade policy experts he’ll need. Elections in France and Germany next year are a further complication. Until those are out of the way, Britain doesn’t know who will be representing the EU’s two most powerful members. It’s fair to say that Britain should have considered these difficulties before voting to quit. It’s also fair to say that Article 50, which nobody ever expected to be used, was illdesigned and shouldn’t be seen as a sacred text. Formally, in any case, it allows for the two-year deadline to be extended.

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Avoid a morass by extending the two-year deadline triggered by Article 50


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ALBRIGHT APPIAH BLOOMBERG BUFFETT CARDOSO FRIEDMAN HALONEN SODERBERGH THE DALAI LAMA TURNER OUR BRIGHTEST MINDS TAKE ON OUR TOUGHEST CHALLENGES.

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Movers By Kyle Stock

 While Britain copes with the fallout from Brexit, the closely watched European Purchasing Managers’ Index rose to 53.3 in July, a seven-month high.

“Collective representation enhances the professor-graduate relationship so important to academic success.”  American Federation of Teachers President Randi Weingarten lauding the National Labor Relations Board ruling that allows grad students at private colleges to unionize.

 Yu Yum! Brands gave away 3,00 3,000 tubes of chickensc scented su sunscreen to p promote KFC. T The specs: S SPF 30, ex extra-crispy.

Ups

24% spike in quarterly revenue as the luxury home market continues to heat up.

$1b

3.2%

 Rise in weekly pay for the bottom 25th percentile of U.S. workers in the second quarter, the biggest increase since the Great Recession.

Bill Gates’s net worth hits a peak of

 Frank Ocean’s third album, Blonde, packaged with a magazine, started selling for about $375 on EBay. Ocean’s mother, meanwhile, advised fans via Twitter to wait for a wider release.

 Toll Brothers reported a

 Meitu, a Chinabased maker of selfie apps, prepared a fourth-quarter IPO in Hong Kong that could raise as much as

 Best Buy shares soared by almost 24 percent after the retailer posted a second straight quarter of growth in online sales. The chain gets 11 percent of its revenue from the web.

$90b Pfizer buys Medivation in a cancer-drug play

$14b

 The USDA pledged to buy 11 million pounds of cheese to bolster prices for dairy farmers and stock soup kitchens around the country.  California became the first U.S. state to legalize lane splitting by motorcycle riders. The new law takes effect on Jan. 1.

Couche-Tard (aka Circle K) buys rival CST Brands

$4.4b Lamborghini plans to double its annual car production to

7k The U.S. National Park Service celebrates a big birthday

100 Vehicles Ford recalled over fuel-pump issues

FROM LEFT TO RIGHT AND TOP TO BOTTOM: COURTESY KFC; RANDALL BENTON/SACRAMENTO BEE/GETTY IMAGES; GREGORIO BORGIA/AP PHOTO; ILLUSTRATIONS BY 731

Downs

 Shares of Teva Pharmaceutical fell as much as 6.3 percent after a U.S. patent panel invalidated two of the patents for Copaxone, the multiple sclerosis drug that generates 20 percent of its revenue. Rivals are eager to offer generic versions.

 Two U.S. senators called on the Federal Trade Commission to investigate Mylan, the manufacturer of EpiPen allergy shots. After two big price increases last year, the company is now selling some two-pen  Abengoa, a packs Spanish renewable for more energy giant, sold five than U.S. ethanol plants for $600.

 Premier Exhibitions, the bankrupt producer of a traveling Titanic museum, sued France for the right to sell French artifacts from the historic shipwreck.

Portion of Ryan Lochte’s pay that Speedo is donating to charity

$50k New Hillary Clinton e-mails collected in FBI probe

15k Increase in U.S. traffic fatalities in the first half of 2016, as cheap gas leads to more road trips

9%  McDonald’s ’s recalled

J.M. Smucker’s secondquarter sales slumped

29m m

–7%

free fitness trackers after customers said they burned children.

$357m in an effort to avoid what would be Spain’s largest bankruptcy.

91k

 A 6.2-magnitude earthquake razed buildings and killed at least 120 people in central Italy. The epicenter was 105 miles northeast of Rome.

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Global Economics

Is the U.S. Mis The August 29 — September 4, 2016

▶▶With congressional approval uncertain, Pacific nations consider a China option

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Steven Ciobo, Australia’s minister for trade, tourism and investment, isn’t sitting around waiting to see whether the U.S. will approve the Trans-Pacific Partnership. Ciobo says he’s “cautiously optimistic” the TPP, a 12-nation freetrade agreement signed in February, will squeak through Congress despite opposition from presidential nominees Donald Trump and Hillary Clinton. TPP faces plenty of opposition among voters and legislators in Australia. So for now he’s focusing on other proposals, such as a regional deal with China, India, and other Asian countries that would exclude the U.S. Ciobo is also pushing ahead with a bilateral deal with Indonesia; and he hopes to start talks soon on an agreement with the European Union. He’s had discussions with British international trade secretary Liam Fox about a post-Brexit deal with the U.K. “Free trade is good for everybody,” says Ciobo. “It’s crucial that we don’t retreat to a protectionist policy.” Even as President Obama gears up to win approval of TPP during a lameduck session after the November elections, TPP member countries are looking at Plan B in case the deal fails. The TPP will live or die based on what happens in Washington, since U.S. participation is essential for the agreement to succeed. “If the U.S. doesn’t approve” the TPP, says Ciobo, “then it

doesn’t get up.” Renegotiation in search of a better deal that can win over critics in Washington isn’t an option, says Deborah Elms, executive director of the Asian Trade Centre, an advisory firm in Singapore. She adds: “As soon as the U.S. starts to modify the agreement, the other 11 countries are going to say, ‘We have things we would like to add.’ Then it unravels.” In mid-August representatives from 14 Asian countries as well as Australia and New Zealand met in Vietnam for the latest round of talks on the Regional Comprehensive Economic Partnership, or RCEP, a proposed freetrade block that would be the world’s largest. Until recently, the RCEP was a me-too effort by China, India, and other countries excluded from the U.S.-led TPP. Now it may end up being the regional deal with the best chance of survival. RCEP “could serve as a good alternative to TPP,” says Kaewkamol Pitakdumrongkit, assistant professor at the S. Rajaratnam School of International Studies at Singapore’s Nanyang Technological University. While negotiators may not be able to wrap up a deal by yearend, she says, “the momentum is there.” Opposition to TPP is also rising in several countries besides the U.S. In Japan, farmers are upset about provisions to reduce tariffs on agricultural

products. In Australia, quick approval is unlikely after Prime Minister Malcolm Turnbull’s conservative coalition lost seats in July elections. “It’s a bad deal,” says Patricia Ranald of the Australia Fair Trade & Investment Network, an umbrella organization of churches, community groups, unions, and others opposed to the TPP. The government will have a difficult time winning over lawmakers, she says. “We don’t even know if the U.S. itself will pass the legislation,” says Ranald. “It would be foolish for the Australian government to rush into this.” There are some countries where TPP approval isn’t in doubt. Among the dozen that have signed up for the deal, so far Malaysia has made the most progress toward ratifying it, with Parliament in January approving, by 127 to 84, a motion in support of the government’s efforts to join TPP. Ratification is almost assured in Communist-ruled Vietnam. Another reliable “yes” vote is Singapore, where the party of Prime Minister Lee Hsien Loong enjoys a big majority in Parliament. “Your partners, your friends who have come to the table and negotiated, each of them has overcome some domestic political objection, some costs to come to the table to make this deal,” Lee said during a visit to the White House on Aug. 2. If the deal fails, “I think there are going to be people who are going to

TIERFOTOAGENTUR/ALAMY

▶▶“It’s crucial that we don’t retreat to a protectionist policy”


Japan’s preschool problem 18 New customers for U.S. crude 19

ssing TPP Train? e-mails, and social network posts, for as long as six months at their own expense as of July 1, 2018. The providers, which include global giants such as Facebook’s WhatsApp, must also surrender encryption keys to Russian security services. The backers of the

be very hurt, not just emotionally, but damaged for a long time to come.” Congressional rejection of Obama’s trade pact would provide a boost to RCEP, which TPP boosters have dismissed as an inferior deal that wouldn’t meet the needs of 21st century trade. The U.S.-led deal makes it easier for contractors to bid for government work abroad and increases protections for intellectual property, labor, and the environment, says Sanchita Basu Das, a fellow at ISEAS-Yusof Ishak Institute, a research center in Singapore. Moreover, while TPP aims for tariff reductions on at least 90 percent of products, she says, RCEP at best will affect 70 percent to 80 percent. However, if the TPP has no future, then countries that had been counting on that agreement will instead push to make RCEP stronger. “They will double down on getting RCEP done and having a meaningful agreement,” says the Asian Trade Centre’s Elms. A TPP failure “really changes the dynamic of what happens in Asia.” It would also provide an opportunity for Chinese President Xi Jinping, who has struggled to overcome concerns among neighbors about China’s territorial claims in the South China Sea, East China Sea, and the Himalayas. “China is using the RCEP to show they can drive international relations better than the Americans can,”

says Giovanni Di Lieto, lecturer and ­coordinator of teaching of international trade law at Monash University in Melbourne. “If the RCEP goes through and the TPP fails, it’s a huge political message.” �Bruce Einhorn The bottom line The failure of TPP would boost a rival free-trade deal that includes China and India but not the U.S.

Security

Russia Installs a New Firewall ▶▶Russia passes laws ratifying the Kremlin’s desire to know all ▶▶“I don’t think anyone knows yet how bad it’s going to be”

Denis Davydov, executive director of the Safe Internet League, a non­ governmental organization closely linked to the Kremlin, is happy with what the Duma did this summer. Davydov says a piece of legislation signed into law on July 7 by President Vladimir Putin will protect the nation from terrorists. The law requires internet service providers such as MTS, a cell phone operator, and search engine Yandex to store all Russian traffic, including all private chat rooms,

measure argue that by giving the Kremlin total access to internet traffic, the guardians of public safety will never be taken unawares. The law is one of about a dozen enacted over the last four years to police Russia’s cyberspace and cordon it off from the global net. One piece of legislation allows the state to block sites without seeking a court’s approval. Hundreds have been blocked already. Thanks to such measures, Davydov says, “we can be sure that here in Moscow no one will take a truck and ram it into a crowd of people or take an ax and start hacking people on a suburban train.” Apart from restrictions on the internet, the Russian laws stipulate harsher punishment for those aiding terrorism and extremism. The authorities tend to apply the latter term to a wide range of opposition activities, such as staging rallies or, in some cases, sharing critical posts about the government on Facebook. Edward Snowden, the fugitive from American justice who leaked thousands of classified documents belonging to the U.S. National Security Agency, condemned the recently passed law from Russia, where he lives in exile. In a rare upsurge of public concern, a petition against the law posted on the government online platform Russian Public Initiative has collected more than 100,000 signatures. The government is obliged to consider asking the State Duma to revisit the law. It’s unlikely it will be repealed, because only 2 out of 13 petitions have been upheld by the government since the platform was launched in 2013. Internet experts in Russia point

17


Global Economics such huge amounts of data nor sufficient manpower in the security forces to interpret the results. Soldatov says half the traffic is encrypted, and this figure will steadily rise. He finds the demand to hand encryption keys to security bodies outlandishly old-fashioned, because encryption is now mostly done by apps independently from internet service providers. Immediately after signing the legislation, Putin commanded the Russian Federal Security Service (FSB) to come up with solutions for unlocking encryption within two weeks. But when the deadline came on July 20, FSB announced it won’t require companies owning internet chat rooms to hand over the keys, essentially acknowledging the futility of the effort. Leonid Volkov, an IT expert and politician says instead opposition politician, t track terrorists, of making it easier to man the law—which mandates checking all internet traffic—a traffic—aids terrorists by haystac in which one “making the haystack, needs to find the ne needle, much bigger.” informat Personal information, such as numbers will be more credit card numbers, vulnerable to abuse abuse. Volkov cites his Kre own example: A Kremlin-friendly TV channel tracked him down and co harassed him in a country hotel, a location they could o only have found by gove accessing a government database that stores the p passport details of hotel guests. “I don’t think anyone knows yet how bad it’s going to be,” says cy Adam Segal, a cybersecurity expert at the Coun Council on Foreign Relations and author of Hack World Order. The Hacked th law’s two-year Noting the impleme implementation period, he says, “U.S. companies othe are staying very and others w quiet, waiting to see what Russ the Russians actually do.” Russia adopted several repressiv internet laws in repressive yea only to see them past years ignored by Western intergiant Facebook and net giants. w Google were supposed to move servers to Russia by Sept. 1, 2015, to handle Russian citizens’ personal data. Th There’s no evidence they’ve d done so. Neither company would comment.

Yet Davydov is optimistic that Western companies will cooperate. “They are businessmen, and they understand that if they spit on our law, then they shouldn’t work in our country,” he says. Davydov’s group is working on proposed legislation that he hopes will help overcome the problem of encryption and make the Russian internet more autonomous. Will these laws prevent acts of terrorism in Russia? “That’s the $64,000 question,” says CFR’s Segal. “It’s not clear even on the U.S. side that we’ve been successful in using big data to prevent major attacks.” —Leonid Ragozin and Michael Riley The bottom line Putin has sponsored laws granting the Russian government the power to read anyone’s e-mail, but the costs could be prohibitive.

Education

Japan’s Challenging Nursery School Math  Too-low wages plus too much red tape equals a teacher shortage  “I wanted to help, but the rules got in my way”

After six and a half years as a nursery school teacher in Tokyo, Saki Sasamoto had had enough. Her pay barely covered necessities, and the stress of the job was too much. So she quit, joining the ranks of some 760,000 qualified nursery school teachers in Japan who have opted to do something else. “I couldn’t stand it,” she says. “It was absolutely draining.” Low pay and a tangle of government regulations are keeping women, and a few men, away from a profession that is vital to Prime Minister Shinzo Abe’s plans to encourage mothers to return to work and replenish the nation’s dwindling labor force. His administration is pouring money into building schools to address a dearth of affordable options for parents. In Tokyo the process of securing a coveted preschool slot often begins before a child is born. The government is already more than halfway toward its goal of adding 500,000 nursery school seats by the end of March 2018. However, it has

ILLUSTRATION BY BRAULIO AMADO; KIYOSHI OTA/BLOOMBERG

18

out that putting the law into effect will be difficult. The combined cost for all internet providers to store Russian traffic may amount to 2.5 trillion rubles ($39 billion), according to Irina Levova, whose group is part of the Expert Council, a body of academics and industry experts that helps the government draft and implement legislation. She figures Russia would need 59 million terabytes of storage to carry out the law. Irina Yarovaya, head of the Duma committee on security and anticorruption and co-author of the law, declined to comment. Putin made matters worse by telling the government that it should ensure the storage hardware is produced in Russia, which has very little of the infrastructure needed to build the equipment on the scale necessary. That’s only a part of the problem. Internet security expert Andrei Soldatov, who coauthored The Red Web, a best-seller on Russian internet politics, says Russia has neither software to analyze


Global Economics Energy The World Has Been Buying U.S. Crude The lifting of a 40-year ban on U.S. crude exports on Jan. 1 came at a good time for U.S. producers. Canada, which was exempt from the ban, cut its purchases of U.S. crude by more than 29 million barrels, or 35 percent, in the first six months of 2016 from the previous year. Sales to other nations offset that drop, as U.S. companies exported 87.1 million bbl. through June, slightly more than they did in the first half of last year. —Sheela Tobben Barrels of U.S. crude oil exported from January through June

87.1m Bbl. of crude exported by the U.S. in the first half of 2016

Curaçao 8.7m

U.K. 2.8m

Japan 2.6m

Italy 2.3m

Marshall Islands 2.1m

France 1.7m

China 1.0m Canada 53.5m

Up 3.2m bbl. from the same period last year

Netherlands 6m

Bahamas 1.5m

Nicaragua 1.2m

Panama 1.2m

Israel 0.8m Switzerland 0.4m

DATA: U.S. CENSUS BUREAU

balked at tackling the bigger task of reforming regulations and policies that date back to World War II. Those rules guarantee low salaries and frustrating conditions for most teachers. A survey of 31,550 nursery workers conducted by the Tokyo metropolitan government from 2008 to 2013 showed one in five was considering quitting, citing low pay as the top reason. At the heart of the problem is a system of subsidies the government provides to licensed schools, both private and public. Those payments cover more than 80 percent of the cost of running a school in some cases, but the funds come with strings attached, including a raft of regulations that govern everything from pay grades to parent fees to operating times. For instance, Sasamoto says she wasn’t allowed to look after a student whose mother was unexpectedly delayed at work. “I wanted to help,” she says, “but the rules got in my way.” Nursery teachers, most of whom are women, made an average of 219,200 yen ($2,184) a month including overtime in 2015, 34 percent less than an all-industry average of 333,300 yen, according to the labor minisSasamoto try. In Tokyo there are about five nursery school

teacher openings for each applicant. The nursery school teacher shortage will only worsen as more schools open up. The new centers will require an additional 90,000 nursery workers. “Nursery schools can be a growing industry, but unfortunately the government is keeping a lid on the potential,” says Naohiro Yashiro, an economics professor at Showa Women’s University in Tokyo who served on the government’s economic council during Abe’s first premiership. “If there’s a shortage of teachers, their wages should rise naturally.” Poppins, which runs about 160 nurseries across Japan, added 21 schools in 2014, but will open only 10 this year. “We are making an uproar about the shortage of nursery teachers,” says Chief Executive Officer Noriko Nakamura, who wants the state to ease regulations and stop controlling pay rates. “That’s not the government’s business. They should leave it up to companies to decide.” Abe’s government has pledged to institute a 2 percent raise for nurseryschool teachers, plus a monthly 40,000 yen bump for those who are “skilled and experienced,” in the fiscal years starting in April 2017—though it hasn’t specified who will qualify. Neither

Colombia 0.5m

Peru 0.7m

Dominican Republic 0.3m

has it said how the pay increases will be funded. (The administration has twice postponed an unpopular sales tax increase out of concern that it might cause consumer spending to dry up, tipping the economy back into recession.) Yasuhisa Shiozaki, health, labor and welfare minister in charge of nurseries, and Katsunobu Kato, minister for women’s empowerment, declined interview requests. As the leader of the world’s fastestgraying nation, Abe may eventually be forced to prioritize the needs of Japan’s seniors over those of the nation’s toddlers. “Babies don’t vote, but the grandparents do vote. They are naturally voting with their selfinterests in mind,” says Kathy Matsui, chief Japan strategist at Goldman Sachs and a leading proponent of boosting female participation in the workforce. “Many regard childcare and family support measures as a cost, but rather than costs, they should be viewed as investments.” —Yoshiaki Nohara The bottom line The Abe administration’s plans to boost the number of nursery school seats may founder because of a shortage of teachers.

Edited by Christopher Power and Cristina Lindblad Bloomberg.com

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Companies/ Industries August 29 — September 4, 2016

SN

ZE

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 Millennials sat out NBC’s Rio coverage on TV, disappointing advertisers seeking younger viewers  “It’s going to be increasingly difficult for them to justify their ad rates” Two months before the Olympics got under way on Aug. 5, Steve Burke, chief executive officer of NBC Universal, described what he called his Olympics “nightmare.” “We wake up some day and the ratings are down 20 percent,” Burke said at a conference. “If that happens, my prediction would be that millennials had been in a Facebook bubble or a Snapchat bubble, and the Olympics have come and they didn’t know it.” That’s not quite how the two-week event played out for the network, which holds exclusive U.S. broadcast rights to the games, but it’s close. NBC’s prime-time broadcast ratings fell 18 percent from 2012. Among the key demographic of 18- to 34-yearolds, prime-time ratings were down 32 percent. “I doubt they anticipated the percentage declines they’ve had,” says John Martin, CEO of Time Warner’s Turner division. The Summer Olympics ratings slip, NBC’s first since the 2000 games, is a rare blemish on what used to be a sure

thing: attracting more viewers, including young ones, to live sports. Now it’s raised questions among some analysts, media executives, and ad buyers about NBC’s ability to continue profiting from its long-term Olympics investment. In 2014 NBC’s parent, Comcast, paid $7.7 billion to extend the rights to 2032; it had previously paid $4.4 billion for the rights through 2020. “It’s going to be increasingly difficult for them to justify their ad rates,” says Ian Schafer, the founder of Deep Focus, a New York-based ad agency. The network, he says, will have a harder time selling as much TV advertising for the 2018 PyeongChang Winter Olympics in South Korea and the 2020 Tokyo Summer Games because future Olympic ad sales will partly depend on ratings from the Rio games. The network said it generated enough advertising to turn a $120 million profit from the London Games in 2012. NBC won’t say how much profit it made on the Rio Olympics, but still expects them to be the most profitable Olympics ever.

Advertisers traditionally have paid top dollar for live sporting events such as the Olympics because of the large number of viewers eager to watch in real time. That’s why several media companies—Walt Disney, 21st Century Fox, Time Warner, and CBS—made similar long-term bets in

Call Me When Biles Is On Change in NBC’s average prime-time television viewership* since the previous Summer Olympics Total audience (ages 2 and up) 18- to 34-year-olds The average primetime audience fell to 24 million this year, down from 30 million in 2012

50% 25% 0% -25% -50%

1996

2016

*PEOPLE WATCHING LIVE OR WITHIN SEVEN DAYS OF THE BROADCAST; DATA: NIELSEN


This chain is making healthy eating a Snap 22 Couche-Tard convenience stores head south 23

recent years on football, baseball, and basketball. Disney, which owns ESPN and ABC, is committed to spending about $56 billion through 2024, including the contract it renewed in 2014 with the NBA, according to data compiled by Bloomberg Intelligence. One problem is that sports fans are getting older. Over the past decade, the average age of NFL viewers has increased by four years, to 47, and that of MLB viewers by seven years, to 53, according to Ben Thompson, founder of the sports blog Stratechery. Mark Lazarus, chairman of NBC Sports Group, says the network has a plan to reach younger viewers by giving them more options. It posted more than 6,000 hours of Rio coverage online and allowed BuzzFeed to run its Olympics Snapchat channel during the games. NBC says 100 million unique users streamed programming via NBC’s Olympics website and its sports app, up 29 percent from the London Games. “They want to watch on their terms,” Lazarus says of millennials. “And that’s why moving forward, we’ll continue to adapt to viewer behavior with our coverage on multiple platforms,” he says. By offering more online, NBC might have hurt its own lucrative TV ratings, says Turner’s Martin. “Potentially it’s diluted the concentration of viewership on the linear network,” he says. “I wonder if there was less [online] content available—and people felt more compelled to tune in to the traditional network—whether that would bolster ratings.” Lazarus says the network still reached more 18- to 49-year-olds on broadcast TV during the games than its three broadcast rivals combined. But many fans said they were frustrated that events aired on tape delay, so they already knew the winners. The online audience is valuable, Lazarus adds. NBC charged up to 50 percent higher rates for internet ads than for TV because the web audience is younger and marketers are eager to reach them. They had little trouble selling spots on both platforms, he says. Audiences splintered across hundreds of programs, and dozens of

entertainment options may have cut into NBC’s Olympics ratings. “Sports is less ingrained in the younger demographic,” says Brandon Ross, an analyst at BTIG Research. “It has been replaced by other things like video games and e-sports and Snapchat feeds.” During the 2012 Olympics, Snapchat was in its infancy and Netflix had about half as many U.S. subscribers. Given major time differences with PyeongChang and Tokyo, NBC will likely need to persuade fans to watch events on tape delay and not follow the results on social media. For advertisers, few other programs offer as many consumers at once as the Olympics do. The audience “is not as good as it was four years ago, but in such a fragmented media world, it’s such a huge number,” says Andy Donchin, chief domestic investment officer at Amplify US, an ad buyer. “I still see the glass as half full, not half empty.” —Gerry Smith The bottom line An Olympics TV ratings slip among viewers age 18-34 is raising questions about NBC’s ability to profit from the games long term.

Aerospace

In China, In-Demand Pilots Live Like Kings  Carriers are offering generous pay, benefits, and bonuses  Some airlines see “value in having a Western accent in the cockpit”

Giacomo Palombo, a former United Airlines pilot, says he’s bombarded every week with offers to fly Airbus A320s in China. Regional carrier Qingdao Airlines has promised as much as $318,000 a year. Sichuan Airlines, which flies to Canada and Australia, dangled $302,000. Both airlines told Palombo they’d cover his income tax bill in China. “When the time to go back to flying comes, I’ll definitely have the Chinese airlines on my radar,” says Palombo. “The financials are attractive.”

Chinese airlines need to hire almost 100 pilots a week for the next 20 years to meet soaring travel demand. Air traffic in China is expected to almost quadruple in the next two decades, making it the world’s busiest market, according to Airbus Group. Facing a shortage of candidates at home, carriers are trying to entice foreigners who have cockpit experience with lucrative pay packages. Startup carriers barely known abroad are paying about 50 percent more than what senior captains earn at Delta Air Lines. With some offers reaching $26,000 a month in net pay, pilots from emerging markets including Brazil and Russia can quadruple their salaries in China, says Dave Ross, the Las Vegas-based president of Wasinc International, a recruiter that works with more than a dozen carriers in China, including Chengdu Airlines and Qingdao Airlines. “When we ask an airline, ‘How many pilots do you need?,’ they say, ‘Oh, we can take as many as you bring,’ ” Ross says. “It’s almost unlimited.” Also on the negotiating table: signing bonuses, overtime pay, and contract-completion payouts. Earlier this year, Ross saw the monthly paycheck of a pilot he placed at Beijing Capital Airlines: $80,000. “I looked at that and thought, Man, I’m in the wrong line of business,” he says. “They can live like a king.” By comparison, the average annual salary for senior pilots at major U.S. airlines is $209,000, according to KitDarby.com Aviation Consulting. Some U.S. regional airlines pay $25,000 a year or less, according to the Air Line Pilots Association, which represents more than 52,000 pilots in the U.S. and Canada. The number of airlines in China has increased 28 percent, to 55, in the past five years. The total fleet has more than tripled in a decade, to 2,650 aircraft, according to the Civil Aviation Administration of China. The growing ranks of low-cost airlines favor single-aisle jets such as the A320, which can seat about 180 people. With an 11 percent increase in the number of passengers in China last year, carriers are scheduling more

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Companies/Industries be fussy about where they hire, says Ross, the recruiter at Wasinc. Airline officials gave him the OK to hire in bulk wherever he could. “They told me: ‘Any place you can find 15 to 20 pilots that want to interview, we’ll go there,’ ” Ross says. —Angus Whitley The bottom line Regional airlines in China are on a hiring spree, paying top dollar for experienced pilots to meet rising air traffic demands.

Food

Healthy Meals for the Grab-and-Go Crowd  Snap Kitchen aims its recipes at foodies in a hurry  No longer “forcing people to live in this diet mindset”

David Kirchhoff says that when he was chief executive officer of Weight Watchers in the mid-2000s, one thing that always bothered him was the trade-off many of his customers had to make to reach their desired weight. “It was frustrating to me that the food environment forced you to choose between food you weren’t that excited about—you know, kale and water—or food that you wanted to eat” that was unhealthy, he says. “It’s almost like forcing people to live in this diet mindset.” Power Now Kirchhoff thinks he’s found a more palatable way to help Americans stay healthy. For the past year, he’s been running Snap Kitchen, a sixDemand for new pilots through 2035 Senior pilots’ annual salaries, by airline* year-old chain specializing in grab-andAirlines based in China go meals that cater Xiamen $332k to people who look Qingdao $318k for healthy ingrediSichuan $302k 112k ents before checking Europe Airlines based in the U.S. the calorie count—think American $280k gluten-free fettuccine Delta $252k 248k Alfredo or nondairy, grassAsia Pacific United $245k fed lamb lasagna. Kirchhoff says 104k Southwest $223k North Snap is different from Weight America Hawaiian $195k Watchers because it’s about delicious Alaska $192k food, not deprivation. Spirit $192k Snap, which has 44 stores in Texas, 58k JetBlue Middle $187k Chicago, and Philadelphia and also 51k East 44k Frontier $167k sells meals in five Whole Foods Latin Other Virgin America America $156k Markets stores, makes all its own food each day in kitchens near its *CHINESE AIRLINE SALARY FIGURES ARE ESTIMATES BASED ON INTERVIEWS WITH RECRUITERS; U.S. AIRLINE SALARIES ARE AVERAGES FOR THE MOST EXPERIENCED CAPTAINS PILOTING THE LARGEST AIRCRAFT; U.S. DATA: KITDARBY.COM AVIATION CONSULTING; DEMAND DATA: BOEING stores. Kirchhoff says there are plenty

COURTESY SNAP KITCHEN; COUCHE-TARD DATA: BLOOMBERG INTELLIGENCE

22

flights. That requires more captains. captain a Boeing 737 for Urumqi Air A fat paycheck is the only way for can earn $21,333 a month, accordthe newest carriers to attract pilots, ing to recruiter VOR Holdings. They because they have minimal brand would be based at the carrier’s recognition and a limited performance headquarters in Urumqi, a western record, says Liz Loveridge, regional outpost bracketed by Mongolia and director for China recruitment at Kazakhstan. VOR also advertises Rishworth Aviation, a consulting firm similar jobs with XiamenAir, where in New Zealand. Chinese airlines are pay can top $332,000 a year. paying as much as five times more than “There aren’t a lot of expat pilots who some Asian rivals for new hires, she really want to go to China,” says Richard says. “They think money’s the only Laig, a Manila-based partner for the answer,” she says. Asia-Pacific region at consulting firm The salaries make up, in part, for the Mango Aviation Partners. “There are massive bureaucracy pilots will conplaces that are more comfortable.” front in securing work permits. It can The recruits also can bring decades take as long as two years for a pilot to of experience to the flight deck. start flying in China after applying for a According to the International Air job, Loveridge says. “It’s the documenTransport Association, the Asia-Pacific tation, the work permits, the immigraregion’s accident rate—not only crashes tion, the medicals,” she says. “They say but also incidents such as landing gear they want pilots, but there aren’t the malfunctions—has increased since 2011 resources.” No single agency in China and is one of the highest globally: There oversees these procedures. Loveridge were 3.2 accidents per million flights says there aren’t enough people in last year in the region, compared with China handling paperwork and process- a worldwide rate of 1.8 per million. ing. For instance, she says, there might “Some of the airlines see some value be a single medical examiner for pilots in having a Western accent in the for an entire region. cockpit,” Loveridge says. About 30,000 pilots fly for Air Western experience is likely to China, China Eastern Airlines, and become an even more expensive comdozens of regional competitors, and modity in Asia’s skies. Airlines and about 2,200 foreign pilots have Chinese leasing companies in China announced transport licenses, according to the orders last year for 780 planes valued government’s Annual Report of Chinese at about $102 billion. Chinese carriers Airlines Pilot Development. South will need 6,330 new planes worth Korea, the U.S., and Brazil con$950 billion in the next two tribute the most expatriates. decades, according to Boeing. Pilot Foreigners willing to So carriers like Chengdu can’t


Québécois for “night owl”

Companies/Industries of customers like him who crave its foodie-friendly victuals without necessarily fixating on their calorie toll: He eats Snap meals about twothirds of the time, often choosing a large bison quinoa hash (620 calories) or the lamb lasagna (520 calories) to fuel his four-times-a-week weightlifting sessions. “I would characterize myself as a protein hunter,” he says. The field of quick-service restaurants trying to woo such ingredientfocused diners is getting crowded, from Mediterranean cuisine specialist Zoës Kitchen to quinoa-centered Protein Bar to LYFE Kitchen, which promises healthy flavors that match “your life’s journey.” “The saturation is increasing with concepts in fast-casual that are providing healthier, better food,” says Darren Tristano, president of industry researcher Technomic. Snap stands out from the crowd by embracing the grab-and-go concept. Its average shop is just 800 square feet to 1,000 sq. ft., with a counter for people who want to eat there but no tables. Refrigerator cases filled with prepackaged foods and beverages line the walls. Gina Armbruster, who works near Snap’s store in Chicago’s Loop, says she’s not on a special diet and isn’t vegan but still checks the carbs on Snap’s labels when she picks up lunch at the restaurant twice a week. The variety lures her. “You have all different types of meat,” says Armbruster, whose favorite dish is the naked beef with snap peas and cauliflower. “Or you can go completely vegan if you want.” In Snap’s 8,500-sq.-ft. Chicago commissary, which supplies eight of its stores and a Whole Foods, chefs cook from 6 a.m. until 3 p.m. daily. On a recent afternoon they prepared misocarrot dressing for vegan raw rainbow salads, while workers weighed and packed turkey meatloaf meals with mashed sweet potatoes and green beans. Chief Operating Officer Dale Easdon has hired many chefs from the airline industry, where he worked 25 years managing kitchens and

operations for companies including LSG Sky Chefs and Continental Airlines. “These guys are used to volume,” he says, but also “understand the importance of first-class food.” Snap plans to expand to New York, Miami, Boston, Washington, and California. Kirchhoff says the New York area alone could support as many as 200 stores, or 10 times the number he could open in Austin, where the first location opened in 2010. “There’s a lot of demand,” says Easdon. “People are asking us to come in.” Several Snap dinners cost more than $8 and some salads are $8.49— adding steak or shrimp is an additional $3.99. Snap is “more for the middle- to upperclass income area,” says Tristano. And while the chain can grow, unit count may also be limited, he says. “Very few stores have ever gotten to 1,000. A good target might be 500.” Snap has raised more than $50 million from investors. Ownership is split between L Catterton, a private equity firm specializing in consumer brands, and co-founder Bradley Radoff, who along with Martin Berson opened the first Snap. The company is not planning an IPO anytime soon. “At some point the public market could make sense,” Kirchhoff says. “But that’s a ways out.” For now, Snap is expanding its menu to help boost current average annual sales per store of about $1.29 million. That’s 44 percent less than a Pret A Manger sandwich shop, according to Technomic. In July, Snap introduced salads that allow diners to customize meals with different proteins—chicken, tofu, steak, and shrimp. More vegan options are coming in October. The chain will launch a mobile app this fall and start meal delivery next year. It also hopes to expand grocery-store distribution. The trick will be convincing more young professionals that healthy prepackaged food is cool. —Leslie Patton The bottom line Snap Kitchen is expanding nationally by targeting diners who care about healthy ingredients more than calories.

Edited by Dimitra Kessenides and James E. Ellis Bloomberg.com

Breakdown Couche-Tard Eh? A Canadian convenience-store and gas-station operator, with outlets in Europe and North America

① Buying Spree  C-T’s first big purchase was Circle K in 2003, with its 1,663 stores.  In 2014, C-T acquired the Pantry, a U.S.-based chain of Kangaroo Express stores, for $1.7 billion, increasing its locations by 1,500.  On Aug. 22 it announced it was buying Texas-based gas-station operator CST Brands for

$4.4b

23

the largest deal in CoucheTard’s 36-year history. ② The Strategy Turn Circle K into a global convenience-store empire. By 2018, most C-T stores will be rebranded Circle K and focused on what the company calls “insidethe-store productivity” to increase sales of food, drinks, and merchandise. More small acquisitions are likely, too. Total stores at fiscal yearend

After CST deal

14k

7k

0 ’03

’16

The takeway Couche-Tard is trying to narrow the gap with competitors, including 7-Eleven and its 8,500 stores in North America.


Politics/ Policy August 29 — September 4, 2016

Is Georgia Ripe for Clinton’s Picking?  Demographics (and Trump) have put a longtime Southern Republican stronghold up for grabs  “My view is that Georgia is probably in play, which I have never said before”

24

On Sunday, Aug. 21, Hillary Clinton’s campaign opened its Georgia headquarters in Atlanta. About 300 Democrats showed up at a yellow house in the city’s hip Castleberry Hill, a neighborhood of converted factories next to the rising framework of a new Falcons NFL stadium. The crowd took selfies under Clinton’s portrait in the entryway, near a poster emblazoned with Twitter hashtags such as #GAinplay. The guest of honor was actor Tony Goldwyn, who plays a philandering president in the ABC series Scandal. If the event had the feeling of being improvised at the last minute, there’s a reason for that. A week earlier it wasn’t even listed on the Clinton campaign’s schedule. But as polls have shown her pulling even in Georgia with Donald Trump over the past month, Clinton has decided to give it a go, pouring money and staff into a state that hasn’t voted for a Democrat in a presidential election since her husband won in 1992. Ever since Barack Obama came within 6 percentage points of beating John McCain in Georgia in 2008, the state’s Democrats have pointed to a wave of minority, young, and transplanted voters as proof that their deeply Republican state was on the cusp of turning blue, or at least purple. Although whites now make up 58 percent of active voters in Georgia, down from 72 percent in 2002, the demographic shift remains a slow process, and Democrats have yet to capitalize on it in a statewide race. Obama lost ground in Georgia in 2012, and Michelle Nunn, the daughter of a popular former Democratic senator,

got close but ultimately lost her bid to win a U.S. Senate seat in 2014. But this year, Democrats may have a secret weapon in Trump, whose campaign appears to be accelerating an electoral change in Georgia that many political pros thought was still a few years away. “My view is that Georgia is probably in play, which I have never said before,” says Stuart Rothenberg, founder of the Rothenberg & Gonzales Political Report. “It’s entirely due to Trump.” Trump has alienated the kind of middle-class suburban Republicans who turned out in force for Mitt Romney and McCain, more than offsetting his appeal to rural, working-class whites. He may now have to compete for Southern conservative voters who should have been a given. Even if Clinton doesn’t win Georgia, the mere fact that it’s competitive may force Trump to spend money there that he wouldn’t have otherwise, says Brad Coker, managing director at MasonDixon Polling & Research. Georgia still looks solidly red from

the outside. Republicans enjoy a strong majority in the state legislature, and they’ve controlled the governor’s mansion since the 2002 election. As white politicians switched parties to improve their chances of staying in power, the Democratic Party in Georgia increasingly became the province of minority groups and the urban young, both of which are outnumbered. In a way, Georgia became a presidential no man’s land, useful only as an ATM: Candidates of both parties flew into Atlanta to raise money and flew back out to spend it elsewhere, not willing to waste a dime campaigning in a state Republicans could take for granted and Democrats couldn’t win. Recently, as the demographics started to turn, state Democrats have tried to convince national party officials that Georgia is worth fighting for. Atlanta Mayor Kasim Reed remembers taking a limo ride in 2012 with President Obama and his campaign adviser David Plouffe, who were in town for a fly-in, fly-out fundraiser. Reed urged Obama to invest in Georgia 2.1 white voters for every black voter

Bridging the Race Gap Turnout of registered Georgia voters

Georgians who voted 90% 80% 70%

White

3m

Other

2m

Black

60%

Black

50%

Other 1996

4m

2012

1m 0

White 1996

3.7 white voters for every black voter

2012

DATA: GEORGIA SECRETARY OF STATE


PHOTO ILLUSTRATION BY 731; PHOTO: GETTY IMAGES

Jump-starting wind power projects on public lands 26

as he had successfully done in 2008 in North Carolina. “I was just making the case that we should compete for Georgia,” Reed says. “We were raising money in Georgia. We were sending people from Georgia to other places.” The answer from Plouffe: Georgia wasn’t competitive yet. The Clinton campaign won’t say how much it’s spending in Georgia, but state Democrats are happy for the national presence. Even before the Clinton campaign told state party leaders in early August that it planned to compete in Georgia, the state party was boosting its own investment, opening eight offices across the state for the first time in recent memory and “spreading out into places where they are not used to seeing Democrats,” says spokesman Michael Smith. If Clinton wants to win, she’ll have to do a better job of leveraging Georgia’s changing demographics, something Democrats have had more success with in state legislative races. Since 2012, Democrats have flipped five Georgia state House seats, despite a Republican redistricting that year. Rather than focusing on likely voters, Democrats are shifting tactics to persuade minorities to go to the polls for the first time. That’s something Brenda Lopez did this spring to win the Democratic primary for a state House seat in what used to be the Republican stronghold of Gwinnett County, northeast of Atlanta. Asians and Hispanics now make up more than half the district’s population, but they account for only

8 percent of its electorate. Of 1,040 registered Asian Americans in Gwinnett’s 99th district, only 10 voted in the presidential primary earlier this year. Of 1,506 Latinos registered, 7 voted. “People say these are low-propensity voters, and I correct them: These are no-propensity voters,” says Lopez, who repeatedly visited first-time voters and will now run without a Republican challenger in November. “You can’t just have the demographic change. You have to do the outreach to bring them in.” Across Atlanta from Lopez’s district, organizers for Democratic House member Taylor Bennett were already canvassing last weekend and promising four or five visits per voter by November, says organizer Evan Gillon: “They’ll be sick of us by the end.” —Margaret Newkirk The bottom line Rising numbers of minority and young urban voters, plus a Republican backlash against Donald Trump, have put Georgia in play.

Justice

Using Shaky Data To Drop Private Prisons  An inspector general report says such prisons are less safe  Study doesn’t consider “variables such as inmate demographics”

The U.S. Department of Justice made headlines on Aug. 18 by announcing it’s phasing out contracts with private prison companies. Shares of publicly traded incarceration companies Corrections Corp. of America and GEO Group plunged, while liberal prison reform advocates applauded. But there’s a problem: The main source of data that the DOJ used to form the basis of its assessment—that privately operated prisons are less safe than publicly run lockups—is fundamentally flawed. That source, an

80-page report the agency’s own inspector general released on Aug. 9, compared 14 so-called contract prisons with an equal number of facilities that the Federal Bureau of Prisons runs. The IG’s main conclusion was that “contract prisons incurred more safety and security incidents per capita than comparable BOP institutions.” Deputy U.S. Attorney General Sally Yates picked up on that “safety and security” language in her Aug. 18 memo instructing the bureau to wind down outstanding contracts with private prison operators. Unfortunately, the inspector general compared apples with oranges, failing to factor into its comparison of public vs. private prisons such critical variables as the demographics of inmate populations. The Bureau of Prisons began contracting with privately operated prison companies in 1997, at a time of soaring inmate populations. The number of federal inmates in contract prisons peaked in 2013 at almost 30,000, about 15 percent of the total the BOP incarcerated. Changing policies meant to reduce incarceration rates contributed in part to inmate populations moving downward for three years. As of December, contract prisons housed fewer than 23,000 federal inmates, about 12 percent of the total federal population. Federal inmates are but a small portion of the U.S. prison population of about 1.5 million (down from 2.4 million in 2008), most of whom are held in state facilities. The policy change on contract prisons announced on Aug. 18 applied only to the federal system. Analyzing data from 2011 through 2014, the IG reached its conclusions based on a number of factors, including reports of rule-breaking incidents, lockdowns, inmate discipline, telephone monitoring, drug testing, and sexual misconduct. “With the exception of fewer incidents of positive drug tests and sexual misconduct, the contract prisons had more incidents per capita than the BOP institutions in all of the other categories of data we examined,” the IG concluded. “For example,” it continued,

25


“the contract prisons confiscated eight times as many contraband cell phones annually on average as the BOP institutions. Contract prisons also had higher rates of assault, both by inmates on other inmates and inmates on staff.” But what sounds like a pretty airtight case against private prisons starts to deflate on closer examination. The IG report didn’t control for critical variables such as the makeup of prison populations and facility locations. Many contract prison populations are dominated by criminals who are here illegally and serving sentences before they’re deported, often back to Mexico or Central America. Those facilities are harder to manage and more prone to violence because of the entrenched Share of U.S. federal inmate population presence of held in private prisons gangs from Latin at yearend 2015 American nations. The populations in BOP-run prisons tend to be more heterogeneous and, if not easy to keep in line, certainly easier to manage than populations characterized by foreign gang rivalries. “The inspector general makes a naked comparison of public and private prisons with no effort to control for important variables such as inmate demographics,” says Alexander Volokh, an associate professor at Emory University School of Law in Atlanta. Volokh has spent years researching comparisons of public and private prisons. Generally, he says, such studies suffer from flaws similar to those undermining the IG, making it difficult to discern definitively which approach to incarceration is more effective. Consider contraband cell phone confiscation. What does the higher rate of takeaways in contract prisons show? It might show that there are more illicit phones in private prisons, Volokh says. Or it might show that private prisons have tougher, more effective policies about finding and confiscating banned phones. “You can’t tell unless you control for the policies being enforced, and the

12%

26

inspector general didn’t do that,” Volokh says. To its credit, the IG did acknowledge in passing that the report was flawed: “We note that we were unable to evaluate all of the factors that contributed to the underlying data, including the effect of inmate demographics and facility locations.” That concession alone would seem to disqualify the IG report as the basis for a major policy decision. Instead the Justice Department, apparently ignoring the IG’s elephantine qualification, ran with the shaky results. There are plenty of reasons for wanting to pare back the private prison experiment of recent decades. One might argue that contract prisons, if they are less expensive to run, facilitated the vast increase in incarceration rates that occurred from the 1980s through just a few years ago. If the U.S. put too many people behind bars, then perhaps ending private prison contracts would accelerate the reduction in prison populations, by cutting overall capacity. —Paul M. Barrett The bottom line In spite of a flawed safety report, the U.S. government will stop housing federal inmates in private prisons.

Renewable Energy

New Rule Takes the Wind Out of Public Land  Enviros, renewable developers split on feds’ rule to auction land  They may make it “less attractive to pursue public lands projects”

It was supposed to be the largest wind farm in North America, with 1,000 turbines spinning above 320,000 acres of southern Wyoming. Now, more than $50 million later and almost a decade after the Power Co. of Wyoming first asked federal regulators for permission to use public land, its Chokecherry and Sierra Madre megaproject is no closer to reality. Two rounds of environmental scrutiny have slowed its approval, with more government evaluations to come. “We did understand that it was going to [take] several years,” says Roxane

Perruso, a vice president of the power company. “We did not anticipate nine.” The Obama administration has given initial approvals to 46 wind and solar projects on 216,356 acres of public lands since 2009, yet only 15 are in operation. The rest have either been abandoned or gotten stuck in years of mandatory environmental analysis. The feds now say they have a plan to cut through the red tape. A new rule, set to be imposed within weeks, would encourage renewable energy developers to bid on tracts of public land preselected by the government, which have loads of wind and sunshine but none of the big environmental conflicts that can bog down projects. The plan would upend the current first-come, first-served approach, whereby the Bureau of Land Management gives renewable developers the same kind of rights of way used for ditches and power lines. That’s replaced by competitive bidding similar to how the government sells oil and gas rights. Environmentalists who see the old regime as outdated and inadequate back the new rule. But their traditional allies in the renewable energy business are opposed. Wind and solar developers are lobbying the government with talking points borrowed from the oil and gas industry’s playbook, warning that the rule would stifle new projects by hiking costs and creating uncertainty that scares off investors. “If BLM is making it even more expensive, complex, and time-consuming to develop, that’s going to make it that much less attractive to pursue public lands projects,” says Tom Vinson, a vice president for the American Wind Energy Association. Competitive auctions virtually guarantee costs will go up. Rental payments for land use and a proposed megawattcapacity fee that acts like a royalty on oil and gas production will make projects even more expensive, representatives from the Solar Energy Industries Association said in a June meeting at the White House Office of Management and Budget. Regulators are tweaking the fee structure, but the Power Co. of Wyoming says the proposed version would hike rent and capacity charges for its Chokecherry wind farm by as much as 55.6 percent. The extra costs come with the promise of speeding up the permitting process, which the

ILLUSTRATION BY 731. OPPOSITE PAGE: MATTHEW IDLER (3)

Politics/Policy


Rawlins, Wyo. Future site of what would be the biggest wind farm in North America, with as many as 1,000 turbines on more than 300,000 acres of federal and private land

46 15 Number of wind and solar projects initially approved for U.S. public lands since 2009

Number of those projects that are actually in operation

Rawlins rail depot

Saratoga, Wyo.

A proposed 2-mile rail spur would deliver turbines and towers to the site, avoiding county roads

The project would change life in the nearby town, bringing jobs while potentially spoiling some of its wide-open views

BLM claims can be cut in half. Under the new rule, companies would be able to secure formal leases on tracts of public lands that lock in terms for at least 10 years. This provides more clarity than the current system, which allows the BLM to change peracre rents annually and the capacityfactor fee at any time to ensure a fair return for taxpayers. “A right of way can be taken away,” says Bobby McEnaney, senior deputy director of the Natural Resources Defense Council’s Western Renewable Energy Project. “A traditional lease affords far more permanence. It is a much better vehicle for these kinds of [large-scale] projects.” The auction process has already worked once. A federal auction of prime solar real estate in the prescreened Dry Lake Solar Energy

Zone near Las Vegas in 2013 nabbed $5.8 million in high bids. The government fast-tracked the winning projects, with all three approved and one already under construction. But there’s no guarantee that companies will bid on the tracts the government offers. A year before its Dry Lake auction, the BLM tried to sell off about 16,000 acres in Colorado’s San Luis Valley. The sale attracted zero bids. The BLM has set up 19 designated leasing zones for solar power, though none have been earmarked for wind. This raises the prospect that developers will have to wait for years of government legwork before windy hot spots are identified, much less auctioned off. It’s not clear, however, how many big projects the industry will want to build. Renewable developers already

are losing interest in building massive wind or solar farms that require sprawling stretches of land. “It is to the point where they really make a careful calculation: Where is the best place to do my 200-megawatt project?” says Christopher Mansour, vice president for federal affairs at the Solar Energy Industries Association. “Is it going to public lands, where I know I’m going to have a lot of hoops to jump through? Or maybe do I go to some disturbed lands, some farmlands, which may actually be closer to the urban areas where the demand is?” —Jennifer A. Dlouhy The bottom line A new government rule is intended to speed the development of wind and solar power on public land. Developers are pushing back.

Edited by Matthew Philips Bloomberg.com

27


What’s Amazon really worth? Don’t ask Amazon 30

You wouldn’t want the chips in NASA’s next rockets 32

Why Siri and Alexa can’t hear you 31

A robotic arm that opens up new surgeries 33

ILLUSTRATION BY 731

August 29 — September 4, 2016

 As services consolidate, deep discounts are starting to wane  “Great for the consumer, but brutal in terms of burning cash”

Thanks to investors from around the world, Beijing’s Li Weiling lives beyond her means. The 30-yearold advertising specialist gets lunch delivered to her doorstep, summons chauffeured cars during rush hour, and goes to movies for less than she’d pay for a cup of Starbucks coffee. All this on a monthly salary of 6,000 yuan, or about $800. This is the Chinese dream, an ondemand economy underwritten by sovereign wealth funds, venture capitalists, and local internet pioneers. For the past year or so, startups backed by the country’s three internet leaders—Alibaba, Tencent, and Baidu—have offered plentiful and steep discounts on everything from massages to car washes, trying to claim market share in their nascent on-demand businesses at any cost. Now this peculiar golden era for smartphone-wielding consumers may be starting to wane. “Great for the consumer, but brutal in terms of burning cash,” says William Bao Bean, a partner at venture firm SOSV in Shanghai. When local ridehailing leader Didi Chuxing finishes its takeover of Uber’s operations in China, for example, the latter’s supercheap rides will likely be over; already, prices are rising. China’s so-called sharing economy took in $2 trillion last year, as the deep discounts flew and more than 500 million people used at least one on-demand service, according to the government. Chinese internet businesses received $20.3 billion in venture capital in 2015, eclipsing the U.S. haul of $16.3 billion and more than quintupling since 2012, PricewaterhouseCoopers says. But that investment frenzy peaked last fall. PwC’s Wilson Chow says private equity and venture investment may have fallen by a quarter in the first six months of 2016. “A lot of VCs believed in the formula that, if you have tremendous user growth, there will be some way to convert that into profitability,” says Kai-Fu Lee, founder of Sinovation Ventures in Beijing. “Too many people believed that and pumped in more cash.”

29


Technology 13 yuan. Even users of the smaller service Shenzhou Zhuanche, also known as UCar, say subsidies have fallen by a similar margin. Earlier this year, UCar users got a 100-yuan credit for every 100 yuan they spent; now the credit for the same outlay is 20 yuan, says Alice Xin Liu, a literary translator in Beijing. “Still use it, though,” she says. Edaixi, one of China’s largest online laundry services, has begun to back away from its discounts, says Zhang Rongyao, founder and chairman of Edaixi’s parent company, Beijing Rongchang Laundry. “The laundry service can survive without heavy subsidies because of strong demand,” he says. Industries such as entertainment may have more trouble—China’s steep rise in box-office sales is faltering. Following a flurry of mergers and acquisitions, the top four online movieticketing services control two-thirds of the market. Says Po Hou, an analyst for Deloitte China, “The days of heavily subsidized movie tickets may be over.” Even if economic expansion in the country continues to decelerate, the number of affluent households (with annual income of more than 136,000 yuan) could more than double in the next decade, to 180 million, says Arthur Kroeber, managing director of Gavekal Dragonomics, a research service in Beijing. That population would offer a new customer base for on-demand startups. And if consumers have become addicted to their new conveniences, they may be willing to pay for them. Cao Siqi, a journalist in Beijing, is among the hooked. She’s used Baidu’s food-delivery app Waimai for two

“It is a fitting conclusion to this experiment in what happens when you let journalists say what they really think.”” Gawker founder Nick Denton, reflecting on the site’s closure osure in its final post on Aug. 22. Denton will not follow his staff aff to acquirer Univision.

years and misses the early days, when she’d get 5 yuan to 10 yuan back for orders larger than 25 yuan. Now the discount is more like 1 yuan or 2 yuan. But when asked whether she’s kept up ordering anyway, she nods. “Of course.” —Christina Larson and David Ramli, with Jeanne Yang The bottom line On-demand internet services took in $2 trillion in China last year, but they’re cutting discounts to slow their cash burn.

Intellectual Property

Amazon’s Shifting Tax Story  The value of its e-commerce assets depends on who’s asking  Its figures are “absurd for anyone with a basic command of math”

Jeff Bezos’s relentless focus on user experience has helped the chief executive officer of Amazon.com build the world’s most valuable e-commerce company. But European and U.S. regulators say the value Amazon places on the technology behind that experience varies radically on either side of the Atlantic—depending on which appraisal lowers its tax bill. In Luxembourg, where Amazon moved its technology assets in 2005, the company tells European authorities its shopping platform and brand are worth the billions in tax-free revenue it’s collected there. In the U.S., the company downplays the value of those same assets to explain why it pays so little in taxes for licensing them. The IRS is suing Amazon for $1.5 billion in back taxes, and the European Union’s executive body, the European Commission, is investigating whether Amazon received illegal aid from Luxembourg, which would also require repayment. “Amazon pays all the taxes we are required to pay in every country where we operate,” the company said in a statement. “We disagree with the IRS statem position and are contesting the matter.” positio Lots of U.S. companies, from Apple and Facebook Fa to health-care giants such as Merck, Mer move intellectual property to foreign tax havens. They then license their own o innovations from these

THIS PAGE: EVE EDELHEIT/THE TAMPA BAY TIMES/AP PHOTO; ILLUSTRATION BY 731. OPPOSITE PAGE: PHOTO ILLUSTRATION BY 731

30

As investment in China’s tech businesses has dropped, consolidation has risen. Since last year, there’s been a string of multibillion-dollar mergers among on-demand startups, including: in the ride-hailing business, Didi and Kuaidi One, then Didi and Uber’s Chinese operations; Meituan and Dianping (food delivery and group coupons); Ganji and 58.com (classified ads); and Ctrip and Qunar (online travel). Each of these deals was backed by some combination of Alibaba, Tencent, and Baidu, which, as investors, were said to have orchestrated the mergers to stanch losses. Uber and Didi are estimated to have spent billions trying to undercut each other. “It’s not that they want to feed the Chinese consumer and give them goodies,” says Richard Lim, managing director at GSR Ventures, an early investor in Didi. “It’s that they thought the end result would be a monopoly.” Less competition is starting to lead to higher prices in many of these arenas, where big-ticket mergers have created dominant players. “Before, Meituan and Dianping worked with owners like me for free,” says James Jiang, who runs the High Altitude Coffee shop in Beijing. This year, he says, “they take 15 percent of sales.” Didi’s prices in Beijing are rising, and discounts on peak-hour Uber rides have fallen more than 80 percent, to about 1.4 yuan (19¢) from 8 yuan, in the past three months, according to one customer’s record. That means a ride that cost 8 yuan in May will now cost about Quoted


Technology “We insist on this fiction that we can ask firms to report where they had their income and expenses, and that a global firm is going to distinguish these in a way that is true to economic reality”

overseas subsidiaries. The biggest of these companies shift billions of dollars to the tax havens through royalty payments, diverting taxes from the jurisdictions where the parent companies are headquartered and lowering the parent companies’ overall bills. Executives whose companies are most aggressive in their tax planning, notably Apple CEO Tim Cook, say such moves comply with the letter of the law, serve shareholders, and keep them competitive. The separate investigations of Amazon’s tax accounting provide an unusually clear look at the contradictions underlying this kind of corporate two-step. Documents filed by Amazon in U.S. Tax Court show that in 2005, as it was moving its IP assets to Luxembourg, it told U.S. tax officials they were worth $217 million. Amazon’s operating units in Europe have since paid its Luxembourg subsidiary—called Amazon Europe Holding Technologies SCS, or AEHT—about €5.2 billion ($5.9 billion) in royalties, not adjusting for inflation or exchange rates, according to the company’s filings to Luxembourg authorities. The figures reported by Amazon are “absurd for anyone with a basic command of mathematics,” says Fabio de Masi, a German member of the European Parliament. AEHT is a limited liability partnership, which allows it to be exempt from taxation in Luxembourg. While officials in other countries have said Luxembourg uses sweetheart tax deals for multinational corporations to boost its law and accounting firms, local political leaders say their corporate tax deals are comparable to those made elsewhere in Europe and that they’re just trying to remain competitive. The documents Amazon filed in its IRS case illustrate the company’s

Many Happy Returns Yearly license fees, in euros, on Amazon IP, valued at $217 million in 2005

1b 750m

DATA: AMAZON.COM

500m 250m 0 2006

2015

28-step plan to shift profits to Luxembourg. (The plan even has a name that wouldn’t be out of place in a James Bond movie: Project Goldcrest, as in the country’s national bird.) Amazon EU Sarl, an operating subsidiary in Luxembourg, takes in revenue from Amazon’s subsidiaries in other European countries. That unit is subject to taxes, but it slashes its taxable income by making royalty payments to AEHT. In U.S. Tax Court, Daniel Frisch, an economist called to testify by IRS lawyers, said the 2005 value of the IP was $3.6 billion, more than 15 times Amazon’s estimate. He also said most of the assets would hold their value for decades. Amazon’s experts said the IP was expensive to develop and perishable given the high failure rate of tech companies. Judge Albert Lauber is expected to rule this fall. The European Commission’s preliminary findings, released last year, concluded that Luxembourg illegally allowed Amazon to conduct a significant amount of business across the continent while paying minimal taxes. The EC also said it suspects that Luxembourg let Amazon exaggerate the royalties collected by the IP unit from other Amazon businesses. Amazon’s director for public policy, Andrew Cecil, told U.K. lawmakers four years ago that the company had European sales of €9.1 billion in 2011 and a tax outlay of about €8 million, an effective tax rate of less than 0.1 percent. Amazon says its taxable profits in the region, crimped by heavy IP investments and strong competition, are far lower than its revenue. The EU is expected to issue a decision in its case in the next few months. Analysts say the investigations of Amazon and other multinationals have helped deter further use of such tax strategies. Last year, Amazon stopped booking transactions from Britain, France, Germany, and Spain through Luxembourg and instead attributed the revenue to the countries where the sales occurred—and are subject to tax. Amazon officials declined to say what motivated the policy change. Tax authorities shouldn’t let companies assign a market value to

their own assets in the first place, says Kimberly Clausing, an economics professor at Reed College who studies international tax avoidance. “We insist on this fiction that we can ask firms to report where they had their income and expenses,” she says, “and that a global firm is going to distinguish these in a way that is true to economic reality.” —Gaspard Sebag and David Kocieniewski The bottom line Amazon’s Luxembourg subsidiary has collected about €5.2 billion in royalties from the rest of the company since 2005.

Hardware

Virtual Assistants Need Assistance

31

 Device makers are pushing mic companies for better gear  “Microphone performance has not really improved that much”

Apple, Amazon.com, Google, and Microsoft are among the companies trying to get you talking—to your phone, to your TV remote, to the funny-looking speaker on your desk. Amazon’s Alexa can order a cookbook and Apple’s Siri can set an oven timer for the cake, while Google’s Home silences the smoke alarm and Microsoft’s Cortana texts party guests to bring a dessert, all via voice commands. It’s impressive right up until the virtual assistants start responding with a familiar chorus along the lines of: “I’m sorry, I didn’t get that.” These kinds of features test the limits of the microphones they require. The mics in most consumer technology haven’t kept pace with the advances in, say, cameras. They still aren’t great at focusing on faraway voices or filtering out background noise, and they often require too much power to be listening at all times. So the race into


Technology

$1

32

says the company hopes that will speed voice recognition and reduce power consumption. Other companies, like upstart Vesper, are experimenting with entirely new designs. A conventional microphone condenses sound waves into electrical signals based on the movement of a metal plate in relation to a second, static plate—which tends to collect dust and moisture over time, reducing its sensitivity. Vesper’s flexible piezoelectric technology generates its own voltage and eliminates the need for the static plate, improving signal and power use, says Chief Executive Officer Matt Crowley. Vesper says U.S. consumers won’t be using that design until at least mid2017; it’s in talks with manufacturers, but declined to name them. For now, the smart money’s on tech leaders to keep crowding their devices with more mics, and hoping the virtual assistants can make sense of them. “The next major step,” says IHS’s Boustany, “is not until a new technology comes along.” —Matthew Braga

Cosmic Recycling

1998

1987

Intel 386 processors running at 12 MHz to 40 MHz are used in various systems on board the International Space Station

The first personal computer to run the i386 at 20 MHz was the Compaq Deskpro 386, in 1987

2011

1997

The Curiosity Rover uses dual RAD750s, radiation-hardened variants of the PowerPC 750, to scout Mars

The Power Macintosh G3 launched in 1997 used the PowerPC 750 series processors available in 233 MHz to 333 MHz models

2020—

2014

ARM’s A53 processor core would be an upgrade for NASA’s Orion program, meant to take humans to the red planet and beyond

The Samsung Galaxy Note 4’s octacore processor is composed of four 1.3 GHz A53 cores and four 1.9 GHz A57 cores

The bottom line The $1 billion digital microphone industry is racing to accommodate the growing demands on its technology.

Semiconductors

For Chips, Space Isn’t The Final Frontier  NASA is ordering old, durable designs for future rockets  “We can’t just send a repairman out there”

Earlier this summer, NASA announced that ARM Holdings’ A53 will be the microprocessor core design at the heart of the agency’s next generation of spacecraft. By the time the microprocessors are delivered in 2020, however, they’ll be so outmoded you wouldn’t want them in your phone. The A53 was introduced in 2014 and is already old by industry standards. ARM calls it “suitable for entry-level smartphones.” But most entry-level smartphones don’t have to avoid midair collisions or execute pinpoint landings. Of course, as any user of an iPhone

can attest, even the smartest of smartphones can hitch up and come to a screaming halt. In space, where tech support can’t hear you scream, Moore’s Law is less important than sheer durability. The spacecraft for NASA’s Orion program is meant to take humans to Mars and into deep space, where the temperature gets as low as -455F and the radiation is deadly, at speeds as fast as 20,000 mph. Bigger than the Apollo, which took man to the moon, it will carry as many as six astronauts, but has only about 316 cubic feet of space in its cabin. That doesn’t leave much room for spare parts—the program isn’t budgeting space for a chip factory or Genius Bar—so the chips Orion uses can’t fail, ever. “We can’t just send a repairman out there,” says Gary Cox, Orion’s manager of avionics, power, and wiring.

THIS PAGE: COURTESY NASA (3), COURTESY SAMSUNG (1); DATA: NASA, ARM, INTEL. OPPOSITE PAGE: ILLUSTRATION BY CHRIS PHILPOT; SURGEON’S HANDS COURTESY PENN STATE CANCER INSTITUTE; COURTESY MEDROBOTICS (2)

voice control by device makers is putting fresh pressure on the handful of obscure companies leading the $1 billion global market for microelectromechanical systems (MEMS) microphones. The message: We need better hardware, software, or both. “No doubt, there is an arms race,” says Peter Cooney, an analyst at SAR Insight & Consulting. The big tech companies are thinking a lot more about mics than they have for the past few years. Since the 2012 launch of the iPhone 5, “microphone performance has not really improved that much,” says Marwan Boustany, an analyst with research firm IHS Markit. Apple and its rivals have challenging, albeit billion straightforward, demands. They want a higher Annual market signal-to-noise for MEMS ratio, meaning the microphones mic can isolate voices more clearly and from farther away, and a higher acoustic overload point, the threshold at which the mic can no longer distinguish signal from noise. And the chips have to improve in both areas without getting bigger, becoming less reliable, or using more power than before. Those factors are becoming more important as device makers add more mics. There’s one in the first iPhone, three in 2014’s iPhone 6, and four in last year’s 6S. Motorola’s Droid Turbo smartphone has five mics, and Amazon’s smart speaker, Echo, has seven. The extra mics boost clarity for voice controls or recording when some are muffled, overwhelmed, or pointed the wrong way. The trade-off: More mics cost more money and power and, in some cases, can add their own noise, making for diminishing returns. For now, Samsung’s Galaxy phones are sticking with two. Market leader Knowles, which shipped about 1.4 billion MEMS mics last year, has turned to software. The company is building audio-processing algorithms into the mic chips themselves, which can recognize when to activate a device’s other audio processors. Greg Doll, Knowles’s vice president of product management for mobile consumer electronics,

Originally found in …


Technology NASA says it rigorously tests every chip that might end up in one of its craft, putting them through their paces within the electronics they’re meant to run. It can take six months just to agree on the tests, says Cox, who helped design avionics for the International Space Station. ARM’s advantage is its relatively low power consumption compared with its level of computing power. The A53 is also ubiquitous. More than half a billion of the processors have shipped around the world, a record for 64-bit models, and hundreds of companies use them in everything from phones to cars. So even before NASA’s screening process, the design has been tested thoroughly in a wide range of circumstances. James McNiven, general manager of the company’s CPU and media processing divisions, says the A53 met NASA’s need to balance “performance and efficiency.” The A53 should be able to process images before transmitting them, which NASA’s current processors can’t. A53based chips will need to use terrainfollowing radar to recognize ground contours based on visual data, and improvise changes, like a revised flight path, if something goes wrong. “Safety is the ultimate arbiter,” says Martin Reynolds, an analyst for researcher Gartner. “These programs will run for two decades. There aren’t many things in the modern world that are still used after 20 years, except by the military and NASA.” Orion, which looks a lot like an Apollo spacecraft, will first go into space equipped with processors NASA bought a decade ago. The chips aboard the ISS, the space agency’s other big internetera effort, look even more archaic. The space station, arguably human history’s most complex engineering project, coasts along at 17,500 mph partly controlled by computers running Intel 386 processors. Those chips made their debut in 1985. Cox says a handful of ISS computers are being updated, but the rest won’t need replacement for the foreseeable future. “If you have good reliability,” he says, “you don’t need to upgrade.” —Ian King The bottom line NASA’s processor of choice for the next decade’s spacecraft is ARM’s A53, widely used in cheap smartphones.

Edited by Jeff Muskus Bloomberg.com

Innovation Flexible Surgical Robot Form and function

Innovator Howie Choset

The Flex Robotic System is equipped with a high-definition camera and can bend to conform to a patient’s anatomy, allowing a surgeon to guide instruments through the patient’s body.

Age 47

1.

Setup A surgeon inserts the robot into a patient’s mouth and maneuvers it into place using a joysticklike controller.

Title Professor at Carnegie Mellon University’s Robotics Institute and co-founder of Medrobotics in Raynham, Mass.

Origin Choset conceived of Flex in 2004 and developed the first prototypes with Marco Zenati, then a surgery professor at the University of Pittsburgh, and CMU postdoc Alon Wolf. The three co-founded Medrobotics in 2005.

Funding Medrobotics Chief Executive Officer Samuel Straface says the company has raised more than $130 million, mostly from anonymous private investors.

33

① Market The robot is intended to extend surgical options to a wider range of patients. It can, for example, remove otherwise inoperable tumors and reduce the need for radiation treatment for certain cancers. Rival Flex’s chief competitor is Intuitive Surgical’s da Vinci robot. That machine’s inflexible instruments restrict surgeons to line-ofsight procedures. It costs $1.9 million to $2.3 million, vs. $980,000 for Flex.

2.

Operation The surgeon uses hand controls to manipulate lasers, graspers, and other instruments attached to the robot, guiding them through the tubing to where they’re needed.

Next Steps Regulators in the U.S., Europe, and Australia have cleared Flex for procedures entering the mouth, and a Medrobotics spokesman says the company applied for clearance for colorectal procedures on Aug. 19. David Goldenberg, surgery professor at the Penn State Cancer Institute, says Flex overcomes the shortcomings of linear surgical robots. With Flex, he says, “we can now treat disease in a minimally invasive fashion more effectively.” —Michael Belfiore


Markets/ Finance August 29 — September 4, 2016

We’re Paying CEOs All Wrong 34

 And not in the way you might assume. It’s about how, not how much

Fred Whittlesey, a compensation consultant for more than three decades, would like his colleagues to take more seriously the weird ways our brains work. In a 2009 paper, he argued that when corporate boards decide how to pay chief executive officers, it’s best to heed behavioral economics, which shows that people are irrational when interpreting and acting on financial data. Whittlesey, now 58, was blunt. Existing compensation plans had “no empirically demonstrated validity.” Rather, they were a hodgepodge of reactions to “accounting rules, tax law, shareholder requirements, and legal considerations.” Missing from the equation: any assessment of how millions in cash and stock motivate the executive brain—or don’t. Seven years later, Whittlesey’s

theories have yet to win adherents. “It’s gotten worse,” he says, from his office in Seattle. “There’s less attention paid to behavior than ever before.” CEO compensation is shaped by regulations and broad, decadeslong trends. In the 1990s pay experts favored the use of stock options, until a soaring market made some paychecks obscenely large. Then awards of stock that vest over time became popular. Now, according to consulting firm Hay Group, a full third of pay is triggered only if CEOs hit performance targets. Increasingly, that target is simply a higher stock price. Investors like this arrangement because it suggests that executives have the same goals they do. Yet it flies in the face of what little we know about behavior and pay. Consider a CEO whose board promises her a $5 million

pot if company shares rise a certain amount over three years. Behavioral economists argue that the executive won’t weigh the true value of the award because of a psychological quirk called “hyperbolic discounting,” or our tendency—demonstrated in dozens of academic studies—to prefer a dollar today to two dollars some time from now. In theory, this means the board could extract the same effort from the CEO with, say, $3 million doled out at closer intervals. Huge grants of stock are likely inefficient, says Michelle Edkins, global head of BlackRock’s investment stewardship team. “We still haven’t addressed this fundamental issue of how do we measure whether these plans, which cost shareholders a fair bit, are actually driving and rewarding the behaviors that we think they

ILLUSTRATION BY BRAULIO AMADO

 Stock grants “are nowhere near as effective as people think”


What Ponzi schemes look like on the web 36

do?” she says. Steven Slutsky, a principal at PwC, agrees. “You’re not getting the bang for the buck you think you are, because the executive will mentally discount that future value,” he says. “Our research shows long-term plans are nowhere near as effective as people think.” That’s counterintuitive. Many critiques of CEO pay focus on the pitfalls of short-term thinking, with examples of leaders hitting their quarterly numbers to the detriment of their company’s overall health. But the behavioral economics approach argues that shortterm incentives can improve long-term performance, if designed carefully. “You want executives to focus on a company’s longer-term needs, but how you choose to focus them is critical,” Slutsky says. Executives are more likely to put priority on their annual bonuses, which arrive sooner and are more often tied to measures over which they have some control, such as profit and efficient use of capital, he says. Over time, improvement in those metrics should mean a higher stock price. Even if this makes sense academically, don’t expect U.S. companies to start creating innovative pay structures. The 2010 Dodd-Frank financial reform law, which gives investors a nonbinding vote on pay practices, has had a homogenizing effect. The compensation disclosures that public companies must file with the Securities and Exchange Commission now average more than 9,000 words, the length of a novellette. “An unintended consequence of transparency is that you don’t want to stick out at all,” says Dan Laddin, a founding partner at New York-based Compensation Advisory Partners. Few investors have the time or inclination to read those reports, especially those who own shares in hundreds of companies. That’s swelled the power of proxy advisers such as Institutional Shareholder Services and Glass Lewis. They provide recommendations on corporate governance votes, with sets of best practices that take little account of any business’s specific circumstances. To avoid the black eye of a failing vote on CEO pay, companies have changed plans to reflect

“An unintended consequence of transparency is that you don’t want to stick out at all.” —Dan Laddin, Compensation Advisory Partners

the advisers’ preferences, and they’re all starting to look the same. More than half the CEOs in the S&P 500 index received compensation last year that was at least in part linked to stock returns, a metric preferred by ISS. “When you’re looking at companies at different stages of the corporate life cycle, when you’re looking at the different personalities, at different stages of their careers, who run these businesses, there’s no way that makes sense,” Laddin says. Still, he’s hopeful things will change and says businesses owned by private equity firms, outside of the public eye, are more willing to experiment. “I think the pendulum is going to swing back toward driving behaviors,” he says. “But it’s going to be the brave companies that do it first.” —Caleb Melby The bottom line Behavioral economists say boards could pay CEOs less by giving them more near-term incentives.

Private Equity

Pensions Fight Bills Meant to Help Them  They don’t want private equity funds to fire them as clients  “It’s always nice to be asked what you think might work”

Private equity managers can’t be trusted, and state and city pension officials, with $420 billion invested in the asset class, know it. The U.S. Securities and Exchange Commission told them so two years ago, when it reported that the majority of buyout fund managers were cheating investors with excessive and undisclosed fees. Since then the agency has repeatedly settled with funds it has accused of defrauding investors, including a $30 million settlement with KKR in June 2015; another for $39 million with Blackstone in October; and one for $52.7 million with Apollo Global Management on Aug. 23. (The firms didn’t admit wrongdoing.)

Defined: When business isn’t going smoothly, it’s lumpy 37

Legislators in at least seven states have responded this year by introducing bills that would force the private equity industry to disclose more about how it operates. But those efforts look likely to fall short, in part because of pushback from an unlikely source: the same public pension funds they were drafted to protect. In a few states, including New Jersey and Alabama, bills have already died. In Kentucky, a bill passed the Senate but failed in the House. Washington passed a bill in March that even enshrined the right of pension funds to keep details of their private equity investments secret. That leaves legislation actively in play in only two states: California, where a watereddown bill went to the governor for signing on Aug. 24, and Illinois, where a measure faces serious opposition. “We all need results, and the best private equity firms will not want to do business with us if this legislation passed in Illinois,” says Louis Kosiba, executive director of the Illinois Municipal Retirement Fund. Nationwide, cities and counties have only two-thirds of the assets they need to pay out the benefits they’ve promised to workers. With bond yields near historic lows, pensions have turned to alternative assets—including private equity, venture capital, and hedge funds—to make up the difference. Since 2006 public pensions have more than doubled their share of assets in private equity, according to the Pew Charitable Trusts. Historically, returns in this asset class have been among the highest going, and expectations that they’ll come in at 10 percent or so relieves pressure on public officials to pour in dollars from taxpayers and workers. The sense that pensions have nowhere else to turn lets private equity drive a hard bargain. Typically, the firms charge management fees of 1 percent to 2 percent, plus 20 percent of profits. They can also stick companies in their portfolios with “monitoring” charges that reduce the value of the pensions’ investments. The all-in cost can run upwards of 3 percent— or 100 times what an institution might pay for an index fund. The pensions

35


Markets/Finance

sign contracts that keep most of the invested. During numbers hidden from outsiders. Private Equity in hearings this The Statehouse Investors are so strictly bound by year, the funds’ secrecy provisions that even pension investment staffs Status lauded greater State directors report being restricted from Alabama Failed transparency—yet reviewing contracts their own investCalifornia Active also warned of dire ment staffs have signed. J.J. Jelincic, Illinois Active consequences. In a board member of the California Kentucky Failed June, CalSTRS’s Public Employees’ Retirement System Louisiana Pending legislative affairs (CalPERS), says it took his fund New Jersey Failed 10 days to approve his request to manager, Jocelyn Rhode Island Pending review documents. He had to agree to Martinez-Wade, Washington Enacted take only minimal notes and not talk testified that if to anyone about the contents. private equity “The terms of industry contracts funds “see the requirements in this are negotiated over months bill become law and don’t wish to comply with them, they between sophisticated This bill became law—but unlike may not want to contract with parties,” says James Maloney the others, it of the American Investment increases what city us anymore.” That could cost Council, a private equity pensions will keep CalSTRS up to $400 million confidential about in returns over time, its staff trade group in Washington. their investments “The pension funds see in alternative asset has said. Christopher Ailman, CalSTRS’s chief investment everything. It’s just not open classes. officer, offered to provide “actual to the public.” examples” of funds that would kick the Many state pension funds have come public pension out—but only behind out against the disclosure bills because closed doors. they fear the legislation will reduce Ultimately, CalPERS reportedly protheir investing options, with private posed industry-friendly amendments equity firms electing to refuse their that were adopted in June. Among business rather than open up their the changes: Private equity managers contracts. In Illinois, Kosiba points won’t have to say how much they take to a letter his fund received from ICV out in fees from the companies they Partners, a private equity shop with run for their many clients, but instead $440 million under management, warning that complying with a Freedom only the “pro rata” portion paid directly by California pensions. —Neil of Information Act request for fee data Weinberg and Darrell Preston would violate an exemption for “trade secrets” and “may cause competitive The bottom line At least seven states have harm.” ICV declined to comment. considered bills to help pensions pierce the secrecy of private equity fees. The Illinois bill remains on hold until after the November elections, giving the private equity industry a chance to shape the legislation. “It’s always nice to be asked what you think might Fraud work,” says Maura O’Hara, executive director of the Illinois Venture Capital Association. “The worst thing that could happen for our industry would be to have it be a big legislative and administrative burden complying with more  Scams attract people who think than 50 different state standards.” they’re in on it (they still lose) In California, Assemblyman Ken Cooley this February introduced a bill  “I see this as just providing a that would require state pensions to service. If I don’t do it, others will” account for how much their outside It’s the financial equivalent of a game of fund managers earn off them. The chicken: Put money into a likely Ponzi state is home to private equity’s two scheme, get paid for a while, and then largest public pension clients, CalPERS try to get out before the collapse. and the California State Teachers’ That’s how some people seem to be Retirement System (CalSTRS), which using online “high-yield investment together have more than $42 billion

Day Trading in Online Ponzi Schemes

programs,” or HYIPs. The sites promise ludicrous returns—the equivalent of 1,000 percent or more annually—based on vague investment plans involving, say, bitcoin or currency trading. In reality, many are just passing money from new investors to old ones, and they’ll fail once they run out of recruits. Dozens of sites pop up every week; HYIP aficionados can track them on aggregator websites that purport to rank the schemes. “Ten years ago, people didn’t know” that HYIPs were Ponzis, says Christian Mueller, a self-taught coder who sells software kits used to create HYIP sites. He says he learned about the business after losing a couple of hundred dollars in an HYIP in 2006. Now, he says, many participants are just “speculating when to get in and when to get out.” That may make HYIPs sound like an almost victimless variant of gambling, but many participants aren’t in on the scam. A study by two security researchers, Richard Clayton of the University of Cambridge and Jens Neisius of the Technical University of Munich, suggests that only 21 percent of HYIP users know they’re putting money into a fraud. Even speculators in the know, the study estimates, lose an average of 24 percent of their investment. In all, $47 million flows through HYIPs each year, Clayton and Neisius say. Among those who can make money are the aggregators, who are paid by HYIPs to rank them, as well as kit programmers such as Mueller. Clayton and Neisius say such kits, which sell for $130 to $1,000, allow people with few programming skills to quickly set up an eye-catching site, with payment systems and stock photos of happy customers. Mueller, who was interviewed via Skype after he responded to an e-mail, says he’s doing nothing illegal and has never been questioned by foreign or local authorities about his work. He declined to reveal his location, other than to say he lives a few hundred miles north of Bangkok. “I see this as just providing a service,” he says. “If I don’t do it, others will do it.” Indeed, Mueller’s product, SurfscriptPro, is just one of dozens. Clayton and Neisius estimate that successful software writers and aggregators are able to earn far more than the average HYIP operator. Another group that tries to profit

DATA: NATIONAL CONFERENCE OF STATE LEGISLATURES; OPPOSITE PAGE: FROM LEFT: (KRZANICH) MICHAEL SHORT/BLOOMBERG; (SANDWICH) STEVE BAXTER/COURTESY GREENCORE GROUP

This bill proposed better disclosures, a ban on placement agents, and adding financial experts to fund boards. It passed one chamber of the legislature and failed in another.


Markets/Finance are so-called referrers. They put money into HYIPs but also receive a commission for bringing in new investors. Max Guimaraes, a retiree from the town Artur Nogueira in Brazil, says he complements his pension by running a website called maximusconsultor. com. It funnels investors to three HYIPs in which he says he’s invested about $1,500 of his own money. He says all three have proven to be “serious.” One of the HYIPs, Coince.com, says it’s a wholesale power distributor incorporated in the U.K. The website says the company sells electricity to bitcoin miners, whose powerful computers can rack up huge utility bills. Coince says it can double investors’ money weekly “within a safe and nonrisk investment environment.” E-mails and calls to Coince’s office went unanswered. A visit to its London address found no company called Coince or Power Supplies & Equipment, another name listed on the site. A Coince ad shows an exultant investor praising the program. The same person also appears on fiverr. com, a site where anyone can pay as little as $5 to generate a promotional video. The U.S. Securities and Exchange Commission warns on its website that HYIPs are “often frauds.” It’s frozen the assets of U.S.-based sites it says are Ponzis, including a Utah-based company called Traffic Monsoon in July. But HYIPs are an international game. Although U.S. authorities work with foreign agencies, overseas fraudsters can be hard to track down, says John Reed Stark, former chief of the SEC’s office of internet enforcement. Mueller says the would-be scammers sometimes end up being the ones who lose. To make an HYIP seem convincing, they may need to pay out a bit of their own money to investors at first. Mueller says some naive HYIP operators get hit by investors who quickly pile in and then flee en masse after a few payments. The scheme falls apart before it can draw in a critical mass of gamblers and the gullible. —Eduardo Thomson and Janan Hanna, with Laura Wright The bottom line Software makers and speculators help to keep $47 million a year flowing through a world of fraudulent online investment schemes.

Edited by Pat Regnier and Nick Summers Bloomberg.com

Defined Lumpy adj. | lum•py

By Ben Steverman

Inconsistent, as pertaining to business activity. Often used by companies that rely on large, one-time orders, for whom a single disrupted deal can skew results. The term has been adopted by a range of industries: Chevron, Intel, a Canadian uranium miner, and the world’s largest sandwich maker have all recently suffered lumpiness. “You’ll notice that sales got a bit lumpy after our largest client was indicted.” ①

“We have a number of transactions ransactions under der way,” said Chevron evron CFO Patricia ricia Yarrington in April, discussing cussing asset sales. es. “Getting the precise timing … is ing … is where the difficult challenge allenge lies. ey can They be very lumpy.” mpy.”

“It’s going to be lumpy,” Intel’s CEO Brian Krzanich said in July. “These guys”— cloud services clients—“don’t build out their data centers in a linear fashion.”

Addressing results at Cameco, analyst Rob Chang noted in July that “some of the underperformance appears to be attributable to lumpy sales timing—as is the nature of the uranium business.”

Greencore ore Group’s major U.S. S customer t is Starbucks. A setback there meant results “will be lumpy period-on-period,” Greencore CEO Patrick Coveney said in July. “Clearly, this is proving to be lumpy, to use your word,” analyst Martin Deboo said, adding, “Do we just have to live with the lumpiness?”

37


Focus On/ Small Business

Sophisticated software from the woods of Maine 40

Forget the startups. It’s time to get behind the gazelles 41 Small to Big: Yasso hits the sweet spot with its frozen yogurt 42

August 29 — September 4, 2016

Chipuffulo wings, bhangra burger, mai tai, masala fries, crispy duck topped with Ossau-Iraty cheese, 16-hour brisket, short-rib taco, ricotta and pecorino blanco pizza, craft beer, doughnut bites, king prawn bun  London Union’s vibrant food markets turn unused spaces into nighttime destinations

COURTESY STREET FEAST

 “In London, anything that’s interesting gets priced out of the market right away” Some of the tastiest, most inventive food in London is served from trucks and open-air market stalls. But chasing down mouthwatering tuna-sashimi tostadas or curry-infused burgers, then finding a place to sit down and enjoy them, can take some effort. Entrepreneurs Jonathan Downey and Henry Dimbleby have a solution. Their 18-month-old company, London Union, turns derelict buildings into venues where street foodies can find top-quality fare every weekend, including late nights on Fridays and Saturdays, when most food trucks and open-air markets aren’t open for business. “We’ve created a whole new kind of night out,” says

Dimbleby, tucking into a plate of crispy Thai noodles and a smoked brisket sandwich at Dinerama. Located in the hip Shoreditch neighborhood on a site that housed an armored-car depot, the space accommodates 11 food vendors, 4 bars, a DJ booth—and on a recent Friday evening, a burgeoning crowd of twenty- and thirtysomethings. It’s one of four sites that London Union operates, and Downey and Dimbleby are plotting expansion, including an outpost in Miami they plan to open next year. The U.S. is experiencing its own street-food boom, including multivendor sites such as Smorgasburg, which started out in Brooklyn, N.Y., and has since expanded

to Los Angeles. But they are daytimeonly and “don’t have the vibe” that London Union has created by pairing street food with “a big, lively bar and a DJ,” says Downey, a 20-year veteran of the London nightlife scene. London Union traces its roots to Dalston Yard, a street-food venue that Downey helped set up. It opened in 2012 in Hackney, a fast- gentrifying East London neighborhood, on a 1,200-square-foot site that used to be a warehouse and a parking lot. With rent at about £5 ($6.60) per square foot and bare-bones furnishings (think concrete floors, rows of picnic tables, and scaffolding strung with Christmas lights), Dalston Yard cost £90,000 to

39


Focus On/Small Business

40

open. It took only a few weekends to recoup that sum, as the venue was soon thronged. Dimbleby, who previously ran a chain of health-food eateries, was intrigued when Downey proposed they go into business. Within months of launching London Union in early 2015, the pair had raised £2.5 million from investors including food writer and TV personality Nigella Lawson and celebrity chef Jamie Oliver. They opened Dinerama in 2015 and two additional sites this year— all replicating the Dalston Yard model. London Union draws 75 percent of its revenue from the bars it operates at each site; the rest comes mainly from food vendors, who pay the company 10 percent to 15 percent of their revenue. Most vendors charge no more than £6 to £8 per dish, but because they have barely any overhead, their annual pretax earnings can run well into six figures, London Union says. Rory Nelson, who runs a gourmet pizza stand at Dinerama with his brother, says they had struggled to make a living selling at farmers markets and sidewalk stands. Now, he says, they serve as many as 350 pizzas an evening— and on weekdays, when the venue is often rented out for private events, they make extra money from catering. “It’s given us a lot more freedom to build our business,” Nelson says. Dimbleby says London Union’s profit margin before interest, taxes, depreciation, and amortization is a healthy 50 percent during the peak summer season. (McDonald’s Ebitda margin, by comparison, is about 36 percent.) Earnings are being plowed back into new projects, such as turning an abandoned part of London’s historic Smithfield meat market into a food hall. Still on the drawing board: a floating street-food barge on the Thames. The company pays minimal rent on its run-down properties, and one site, in the Canada Water section of East London, is rent-free because the landlord is a developer who wants to drive up property values in the area. Indeed, some of London Union’s venues may become victims of their own success. “In London, anything that’s interesting gets priced out of the market right away,” Dimbleby says. Dalston Yard’s owner recently informed the company that he may not renew its lease because he wants to redevelop the property.

That has spurred Downey and Dimbleby to search farther afield. Model Market, which they opened this summer at an abandoned 1950sera market in the London suburb of Lewisham, draws many families with children, rather than the 35-and-under crowd that is the core of the company’s clientele. “It’s nice that they’re using a site that was here, kind of up-cycling it,” says Beth Boorman, who lives in the area and was enjoying a dinner of burgers and craft beer with her husband and brother. “It’s given us a lot more choices.” —Carol Matlack The bottom line London Union is less than two years old and already has four food markets to its name. The company is planning a move into the U.S.

Retailing

A Chainlet With A Big Data Edge  Bull Moose’s algorithm can predict which albums will sell  “We ordered stuff far better than others”

A visitor to any one of Bull Moose’s 12 stores in Maine and New Hampshire would be hard-pressed to see the future of brick-and-mortar retailing there. The uniform display racks and fluorescent lighting are utilitarian, offering up a warehouse-size selection of new and used CDs and LPs, movies (including straight-to-VHS horror flicks), video games, and books that evokes the golden era of the 1990s. What sets Bull Moose apart from other independent media store chains is the software behind it. Created by founder and President Brett Wickard, the program drives most of the stores’ operations and has produced a standalone technology company called FieldStack. Wickard and his friend Chris Brown were still in college when they opened the first Bull Moose store in 1989, in Brunswick, Maine. For a while, they ran it while living in the woods in a shack with no running water. Wickard was always tinkering with computer programs, and his early analysis of sales data evolved into an algorithm

Dimbleby

that could often predict hit records. So Bull Moose was able to anticipate demand for then-unknown bands such as Pearl Jam and Limp Bizkit before competitors. “We ordered stuff far better than others,” Wickard says, “but we also returned far less merchandise.” Over the past two decades, Wickard and a handful of programmers working in Portland have expanded the software’s capabilities into a retail-management system that pulls data from various parts of a store’s operations—online sales, loyalty programs, point-of-sale systems, Amazon .com—to make inventory decisions. It instantly places orders and restocks merchandise driven by large demand factors (say, the death of Prince), and smaller ones (one store is selling more Bollywood movies than others). After Universal Music offered to license the system to a national chain of record stores in 2003, Bull Moose began marketing it to other independent stores on its own. Brian Faber, general manager of Zia Records, with nine locations in Arizona and Las Vegas, says the software, which he’s been using since 2003, helps him and his staff make decisions based on hard data rather than personal tastes. “If someone brings in Alanis Morissette and my clerk says, ‘I hate this record,’ but the system says, ‘Hold on, you sell 10 a week,’ well, a preference can cost you thousands of dollars.” Wickard says his algorithm is “additive” rather than “subtractive,” which means it’s designed to broaden the selection of outlying, one-off items that may appeal to a single customer (such as an Anne Frank-themed opera), rather than winnow down inventory to just the best-sellers. “If you carry the same exact thing everyone else carries, how are you different?” he says. Revenue growth at Bull Moose has doubled in the last two years even though the tech business was hived off in 2013, Wickard says, and both companies are profitable. FieldStack pitches its product to small and medium-size regional chains, whose needs may not be served by the likes of SAP and Microsoft. One early adopter, Pete Risano, president of Pet Life, a New England chain of pet food stores, calls it “one of those tools that’s essential to make good business decisions,” adding that the savings from installing the

COURTESY STREET FEAST (2)

Downey


Focus On/Small Business software—including a move to centralized purchasing—have accelerated the company’s growth. These days, Wickard spends most of his time managing FieldStack, whose staff has grown to 25, while Brown looks after Bull Moose. But he says at heart he’ll always be a record store clerk: “We’re retail guys first. We eat, sleep, and breathe retail.” —David Sax The bottom line Bull Moose, a chain that sells music, movies, and books, developed data analytics software that it licenses to other small retailers.

Training

Scaling Up Is ar

small companies with proven business models. Helping increase sales at these kinds of enterprises does more for economic development, a growing chorus of academics and policymakers say, than promoting startups or luring large corporations with tax breaks. Business schools, governments, and nonprofits are beginning to fill the gap. “It’s actually pretty easy within 6 to 12 months to show a $3 million company how to be a $4 million company,” says Babson professor Daniel Isenberg, the creator of Scale Up Milwaukee and similar initiatives in Brazil and Colombia. The Milwaukee curriculum emphasizes what Isenberg calls “practical basics” such as customer acquisition and hiring. “You don’t need to do all the buzzwords,” he says. Academics and government agencies usually group businesses like Tipton’s into a category variously called scale-ups, high-impact companies, or gazelles—the parameters differ somewhat. The Organisation for Economic Co-operation and Development defines them as enterprises with greater than 20 percent annual growth in revenue or head count for three years running, after reaching a minimum of 10 employees. High-impact companies are “believed to create nearly all net new jobs” even though they make up a minority of companies in Share of U.S. the U.S., according to businesses that fit a 2011 study for the the definition of U.S. Small Business high-impact companies* Administration’s Office of Advocacy. A 2014 paper by the Royal Bank of Scotland suggests that shifting just 1 percent of all

to D o

 Mature businesses lack the support network of startups

 “Show a $3 million company how to be a $4 million company”

In late 2013, Annette Tipton enrolled in an experimental training program in Milwaukee for area companies with at least $1 million in revenue and ambitious expansion plans. Her goal: manage the growing pains at the van service she and her husband started in 2001 to serve seniors and the disabled. Part of an economic development initiative called Scale Up Milwaukee, the free six-month program consists of workshops led by Babson College professors on topics such as sales management and operational finance, plus mentoring sessions and networking events with fellow entrepreneurs. After a professor urged her to think bigger, Tipton began seeking contracts with state and federal agencies instead of just local ones. Today, Able Access Transportation has 42 employees, up from about 20 in 2013, and Tipton projects sales will increase by 50 percent this year. The program, held annually and funded largely by private sources, “is an anomaly” she says, because it teaches a “completely different” set of skills from those needed to a launch a startup. There’s no shortage of incubators and accelerators to help fledgling ventures get off the ground. But there’s not much of a support system for more mature,

6%

Job Generators 15m

Net change in employment

10m 5m High-impact companies ’94-’98

’98-’02

’02-’06

0 ’04-’08

0

All other U.S. companies -5m

U.K. businesses with more than 10 employees into high-growth mode would generate 238,000 jobs and almost £39 billion ($51 billion) in additional revenue at the end of the third year. Persuading the public and private sectors to support scale-ups hasn’t been easy. It’s counterintuitive to help businesses that are already profitable, Isenberg says, and they’re not as “sexy” as startups. To cater to what he calls these “neglected” entrepreneurs, Verne Harnish, founder of 12,000-member mentoring group Entrepreneurs’ Organization and author of Scaling Up, has begun a training program that will generally last for three years. Tuition at ScaleUpU will run $60,000 annually in the U.S. The first session, with room for 15 companies, will kick off in Kansas City, Mo., in November. “There’s a big difference between accelerators trying to get startups to their first $1 million in revenue—or even get revenue”—and giving multimillion-dollar companies the tools to handle later stages, says Harnish, who plans to extend ScaleUpU to 150 cities over the next decade. Supporting the growth stage makes sense, because it’s harder than the startup phase, says Linda Rottenberg, co-founder and chief executive officer of Endeavor. The New York nonprofit runs a selective mentoring network for about 1,300 entrepreneurs from 25 countries. Rottenberg says Endeavor’s more than 800 companies have created 500,000-plus jobs since they joined the network. “To get to $1 million in revenue and then die doesn’t really move the needle of your economy,” she says. “This is where people get stuck. We get people unstuck.” Juan De Antonio, the founder of Cabify, a ride-hailing app backed by $143 million in venture capital, joined Endeavor’s network in 2015. He says it’s helped him make the “right connections” with lawyers and regulators across Latin America, where the Madrid-based company is expanding rapidly. Cabify had 150 employees at the start of the year and will have about 1,000 by yearend, he says: “If you want to grow your company exponentially and go through all the chaos that that means, Endeavor will be really helpful.” —Nick Leiber

-10m *ENTERPRISES THAT HAVE AT LEAST DOUBLED THEIR SALES OVER THE PAST FOUR YEARS AND INCREASED EMPLOYMENT BY A FACTOR OF TWO; DATA: U.S. SMALL BUSINESS ADMINISTRATION

The bottom line After years of neglect, mature, profitable small businesses have access to training programs to help them expand.

41


Focus On/Small Business

42

Drew Harrington and Amanda anda Klane, both 30, had graduated from college ge and were keeping an eye on food industryy trends when they noticed that Greek yogurtt had caught on in a big way in the U.S. The childhood h ildhood friends, who met in kindergarten in the h e Boston suburb of Easton, had an idea: Why not not turn the stuff into a frozen treat that doesn’t pack quite as much fat, calories, and guilt as rregular egular ice cream? They launched Yasso in 2009 009 and two years later landed their frozen yogurt ogurt bars in stores. Several national chains now ow carry the product, and the Quincy, Mass., Mass., company expects to end the year with more than $50 million in sales. Here they revisit some of the key milestones of their young business.

Yasso revenue

$50m

$25m

0 2011

2016 projected

Harrington: Despite pite all ofitable that, we were profitable last year and will be again in 2016. In June hed our website crashed when Tom Brady put a picture of his freezer ezer on Facebook and our bars were visible. That was one of those “wow” and. moments for a brand.

By Craig Giammona

Harrington: We initially launched with fruit flavors, and those products did pretty well. But we’d go to events, and people were always asking if we had cookie dough or chocolate. They wanted traditional ice cream flavors.

Harrington: By the end of 2013 we were in almost 10,000 stores, including Walmart, Target, and Kroger. We hired a full-time food scientist and doubleddown on indulgent flavors. We came out with sea salt caramel, mint chocolate chip, and chocolate fudge. That’s when it really took off. Now we’re catching up to brands like Skinny Cow and Weight Watchers.

Har Harrington: We ran into trouble last year trou when we couldn’t fill whe orders. We were out ord stock for most of of s the summer. The Blue Bell ice cream recall increased orders for incr competing brands. That com gobbled a lot of the gob excess manufacturing exce capacity, so we couldn’t capa find factory Klane: We were space. spac fortunate the retailers

were patient as we figured out the issue. And it helped that we run a lean operation and we had cash to get the issues sorted out. We eventually found a plant in Nova Scotia, and we now have six facilities that make our products.

Edi Edited by Cristina Lindblad Bloomberg.com Blo

PHOTOGRAPHS BY TONY LUONG FOR BLOOMBERG BUSINESSWEEK

Small to Big Yasso

Klane: The e early recipes were bad. We were just taking Greek yogurt and freezing it to see how it tasted tasted. We attended an ice cream camp at Penn State, and p people there thought th we were wer crazy. It took about two years, but bu in 2011 we started start to get into store stores in New England. England


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SPECIAL ADVERTISING SECTION Enterprise Technology

Saar Shwartz, Vice President of Strategic Marketing at BMC Software, prefers the term “life-driven technology� to describe the evolving business mindset. “It’s not about the enterprise anymore—it’s about what constitutes life, at work and at home,� he says. “The consumption of technology today is really about augmenting the way people experience life.�

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Contemporary consumers interact with business on their own terms, rather than according to an enterprise’s proscribed procedures. People now use mobile apps WRGRHYHU\WKLQJIURPEDQNLQJDQGĂ€OLQJ LQVXUDQFHFODLPVWRUHĂ€OOLQJSUHVFULSWLRQV DQGERRNLQJĂ LJKWDQGKRWHOUHVHUYDWLRQV The shift to digital and mobile is forcing businesses to a critical juncture. “Companies must either adopt and adapt to technology to meet the demands of customers—people who expect products and services faster than ever before, delivered easily anytime, anywhere and on any device—or risk becoming obsolete,â€? says Shwartz. “For example, look at what’s happening in the TV industry. Viewers want to see shows when it’s convenient for them, not according to a set schedule as determined by the broadcasters. Thus, the rise RIVHUYLFHVOLNH1HWĂ L[$PD]RQ3ULPH7L9R and Hulu, which give viewers the ability to see what they want, when they want and on whatever device they want.â€? In fact, consumer expectations are causing mainstream companies to rethink their business models and adopt a digital mindset in order to transform customer-facing services.

$QRWKHUVKLIWHPSRZHUHGODUJHO\E\GLJLWDO WHFKQRORJ\LVĂ H[LELOLW\LQZKHUHDQGKRZ employees work. Open-minded companies

realize that work doesn’t begin and end at WKHRIÀFHQRULVOLIHFRPSOHWHO\VHSDUDWHG from work. Employees in these enterprises DUHDOORZHGWRXVHRIÀFHHTXLSPHQWDQG DWWHQGWRSHUVRQDOPDWWHUVZKLOHDWWKHRIÀFH and work after business hours, at home or on the go, using digital technology and GHYLFHV7KLVà H[LELOLW\LQWXUQLVUHLQYHQWing the workplace, attracting motivated, independent people who embrace change and are helping companies compete in a digitalized world. To facilitate this transformation, software companies are emphasizing unprecedented ease of use, as businesses demand the creation and delivery of digital services and PRELOHÀUVWDSSOLFDWLRQVWKDWDUHLQWXLWLYH and intelligent.

In order to address the changing consumer and employee landscape, businesses must adopt a digital mindset. This mindset—and the new technologies that both inspire and nurture it—is disrupting traditional business models. Clayton Christensen, a Harvard Business School professor and an expert RQGLVUXSWLYHLQQRYDWLRQGHÀQHVGLVUXSWLRQ as the process by which smaller companies with limited resources challenge established enterprises, either by targeting business segments ignored by a dominant company LQIDYRURILWVPRVWSURÀWDEOHPDLQVWUHDP products, or by delivering more functionality, usually at a lower price. The disruptors then gain a foothold in the marketplace with both new and improved products and services. $SULPHH[DPSOHRILQQRYDWLYHGLVUXStion is Uber, the transportation network company that, through its mobile app, allows consumers with smartphones to UHTXHVWULGHVWKDWDUHURXWHGWRGULYHUVZKR are using their own vehicles. Uber has not only disrupted the taxi and rental car in-

dustries, but is poised to send mainstream pharmacies like Walgreen and CVS through some changes. 'XULQJWKHà XVHDVRQ8EHUQRZRIIHUV RIÀFHYLVLWVIURPUHJLVWHUHGQXUVHVZKRXVH 8EHUGULYHUVWRGHOLYHUà XVKRWVDWDFRPpetitive rate—$10 for 10 shots—without HPSOR\HHVKDYLQJWROHDYHWKHRIÀFHWRZDLW in line at a pharmacy. The upstart is also said to have its eyes on the package delivery industry, potentially disrupting FedEx DQG836$QGE\WXUQLQJWKH8EHUDSSRQ or off, drivers can work when they want to. Meanwhile, the marketplace is littered with the remnants of once-mighty enterprises that lost ground by not adapting to changing consumer tastes and options. Kodak and Blockbuster are examples of companies that experienced devaluation of their brands because, by failing to embrace change, they let other companies disrupt their businesses. They’re far from alone.

“COMPANIES MUST EITHER ADOPT AND ADAPT TO TECHNOLOGY TO MEET THE DEMANDS OF CUSTOMERS–PEOPLE WHO EXPECT PRODUCTS AND SERVICES FASTER THAN EVER BEFORE, DELIVERED EASILY ANYTIME, ANYWHERE AND ON ANY DEVICE–OR RISK BECOMING OBSOLETE. FOR EXAMPLE, LOOK AT WHAT’S HAPPENING IN THE TV INDUSTRY.� –SAAR SHWARTZ, BMC SOFTWARE


SPECIAL ADVERTISING SECTION Enterprise Technology

Other companies face the devaluation of their brands if they don’t keep pace. BMC’s advice? “Think like a disruptive company,� Shwartz says. “Companies should consider: If they had to go after their own business, what would they do? They have to disrupt WKHPVHOYHV$QGGLVUXSWLRQDQGLQQRYDWLRQ always go hand in hand. It’s really hard to disrupt without innovation.�

S5

Companies willing to take risks—and even risk failure—by placing bets in areas where data doesn’t indicate immediate returns tend to realize breakthroughs in transforming themselves to serve the new consumer. The speed of success for companies receptive to change can be stunning. $OLEDEDWKH&KLQHVHHFRPPHUFHFRPSDQ\ that provides sales services via web portals, achieved a multibillion-dollar valuation in less than four years. More recently, Nintendo, the aging Japanese consumer electronics and software company, saw its value double—virtually overnight—with the launch of PokÊmon Go, the free, locationbased augmented reality game for IOS and $QGURLGGHYLFHV Enterprises that avoid risks and digitalization, on the other hand, face disruption, devaluation and obsolescence.

The main emphasis in digital technology today is on raw speed—a critical factor for companies considering software. “It’s no longer the complexity of software and what it can and can’t do,� says Shwartz, “but how fast someone can get up and running on a piece of software, become productive and drive outcomes for the business.� “Slow� is the new “broken� as consumers lose patience with technology that doesn’t match their pace and lifestyle. Shwartz recalls speaking to clients who have moved bank accounts because the check-reading app on their smartphones took 35 seconds longer than that of a competing bank. “We’re not talking minutes or hours, but seconds!� he stresses. In addition, software-as-a-service (SaaS) delivery models help companies drive

innovation to market faster, eliminating the burden of upgrades, hosting and maintaining software solutions, and reducing perceived risks.

7RPD[LPL]HHIĂ€FLHQF\DQGFRVWHIIHFWLYHQHVVHQWHUSULVHVPXVWĂ€UVWplan for digitalization. “I think people have a tendency to just go and buy a popular piece of technology, and believe that it’s the cure for all ills,â€? Shwartz says. “Their thinking is, ‘If I just hook up with this cloud vendor I’m going to solve the problem,’ or, ‘If I just buy this application development technology, I’m going to be golden.’ But they miss looking up and down the stack to really XQGHUVWDQGWKHLUXQLTXHVLWXDWLRQDQG where they have gaps. Is it in their Big Data strategy, in their application delivery strategy, in their cloud strategy or in their security strategy?â€? $QRWKHUSRLQWWRFRQVLGHU´&RPSDQLHV can develop or buy the most beautiful app without realizing they’ve just given people one more door to enter,â€? Shwartz cautions, noting the growing importance of security. “There are a lot of things they have to pay attention to.â€? Businesses today need to make hard choices on their strategy going forward. Will it be business as usual, or will they proacWLYHO\FKRRVHWRGLVUXSWWKHPVHOYHV"$VWKH hockey legend Wayne Gretzky said when asked why he is so successful: “I skate to where the puck is going to be, not where it has been.â€?

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Since January, contractors like th studying the citizens of Baltimore, to prove that constant surveillan And the city didn’t tell anyone

50

By Monte Reel


ese two have put in 10-hour shifts using camera-equipped planes ce can help police solve crimes. Operation Unblinking Eye

51

Photographs by Philip Montgomery


52

PHOTOGRAPH ILLUSTRATION BY CREDIT TK

T

he sky over the Circuit Court want us to keep flying, but the clouds are getting in the way.” for Baltimore City on June McNutt said something about not being able to control the 23 was the color of a dull weather, pretending to shrug it off, but he was frustrated. He nickel, and a broad deck of wanted to please the cops. Since this discreet arrangement lowering clouds threatened began in January, it had felt like a make-or-break opportunity rain. A couple dozen people for McNutt. His company had been trying for years to snag a with signs—“Justice 4 Freddie long-term contract with an American metropolitan police departGray” and “The whole damn ment. Baltimore seemed like his best shot to date, one that could system is guilty as hell”—lin- lead to more work. He’s told police departments that his system gered by the corner of the might help them reduce crime by as much as 20 percent in their courthouse, watching the cities, and he was hoping this Baltimore job would allow him network TV crews rehearse to back up the claim. “I don’t have good statistical data yet, but their standups. Sheriff ’s offi- that’s part of the reason we’re here,” he said. McNutt believes cers in bulletproof vests clus- the technology would be most effective if used in a transpartered around the building’s ent, publicly acknowledged manner; part of the system’s effecdoors, gripping clubs with both hands. tiveness, he said, rests in its potential to deter criminal activity. Inside, a judge was delivering the verdict in the case of Caesar McNutt is an Air Force Academy graduate, physicist, and Goodson, the only Baltimore police officer facing a murder MIT-trained astronautical engineer who in 2004 founded the Air charge for the death of Freddie Gray. In April 2015, Gray’s neck Force’s Center for Rapid Product Development. The Pentagon was broken in the back of a police van, and prosecutors had asked him if he could develop something to figure out who was argued that Goodson purposefully drove the vehicle recklessly, planting the roadside bombs careening through the city, to toss Gray around. that were killing and maiming The verdict trickled out of the courthouse in text messages: American soldiers in Iraq. In not guilty, all counts. Ralph Pritchett Sr., who’s spent each of 2006 he gave the military his 52 years in Baltimore, stood on the sidewalk among the pro- Angel Fire, a wide-area, livetesters. He chewed on a toothpick and shook his head slowly. In feed surveillance system that a city with more than 700 street-level police cameras, he won- could cast an unblinking eye dered, shouldn’t the authorities have had video of Gray’s ride? on an entire city. “This whole city is under a siege of cameras,” said Pritchett, The system was built a house painter who helps run a youth center in a low-income, around an assembly of four high-crime neighborhood called Johnston Square. “In fact, they to six commercially available observed Freddie Gray himself the morning of his arrest on those industrial imaging cameras, cameras, before they picked him up. They McNutt at Persistent Surveillance’s office in Baltimore could have watched that van, too, but no— they missed that one. I thought the cameras were supposed to protect us. But I’m thinking they’re there to synchronized and positioned just contradict anything that might be used against the City of at different angles, then attached to the bottom of a Baltimore. Do they use them for justice? Evidently not.” Pritchett had no idea that as he spoke, a small Cessna airplane plane. As the plane flew, comequipped with a sophisticated array of cameras was circling puters stabilized the images Baltimore at roughly the same altitude as the massing clouds. from the cameras, stitched The plane’s wide-angle cameras captured an area of roughly them together and transmit30 square miles and continuously transmitted real-time images to ted them to the ground at a analysts on the ground. The footage from the plane was instantly rate of one per second. This archived and stored on massive hard drives, allowing analysts produced a searchable, conto review it weeks later if necessary. stantly updating photographic Since the beginning of the year, the Baltimore Police map that was stored on hard Department had been using the plane to investigate all sorts of drives. His elevator pitch was crimes, from property thefts to shootings. The Cessna some- irresistible: “Imagine Google times flew above the city for as many as 10 hours a day, and the Earth with TiVo capability.” public had no idea it was there. The images weren’t perfect. A company called Persistent Surveillance Systems, based in Analysts on the ground could Dayton, Ohio, provided the service to the police, and the funding see individual cars moving came from a private donor. No public disclosure of the program through the streets, but had ever been made. they couldn’t tell what make Outside the courthouse, several of the protesters began or model they might be. marching around the building, chanting for justice. The plane Pedestrians were just pixelated continued to circle overhead, unseen. dots; you couldn’t distinguish a man from a woman, or an A half block from the city’s central police station, in a spare Iraqi civilian from an American office suite above a parking garage, Ross McNutt, the founder soldier. Individual recognition, of Persistent Surveillance Systems, monitored the city’s reac- however, wasn’t the point; tion to the Goodson verdict by staring at a bank of computer any dot could be followed monitors. “It’s pretty quiet out there,” he said. The riots that backward or forward in time, convulsed the city after Gray was killed wouldn’t be repeated. which opened up all sorts of “A few protesters on the corner, and not much else. The police investigative possibilities.


If a roadside bomb exploded while the camera was in the air, analysts could zoom in to the exact location of the explosion and rewind to the moment of detonation. Keeping their eyes on that spot, they could further rewind the footage to see a vehicle, for example, that had stopped at that location to plant the bomb. Then they could backtrack to see where the vehicle had come from, marking all of the addresses it had visited. They also could fast-forward to see where the driver went after planting the bomb—perhaps a residence, or a rebel hideout, or a stash house of explosives. More than merely identifying an enemy, the technology could identify an enemy network. McNutt demonstrated the prototype to a group of Marines at a California base in 2006. “They called up their general,” McNutt recalls, “and when he saw it, he said, ‘I need this, and I need it right now—in Fallujah.’ ” Eventually another military unit took control of the project and completed the development of Angel Fire at the Los Alamos National Laboratory in New Mexico. In 2007 the technology was deployed to Iraq. Angel Fire was eventually upgraded with allweather and nighttime capabilities and then used as the basis

for another system, called Blue Devil, which coupled wide-area cameras with narrow-focus zoom lenses in the same package. McNutt retired from the military in 2007 and modified the technology for commercial development, increasing the number of cameras in the assembly to 12 and making the apparatus lighter and cheaper. He began attending security trade shows to fish for clients. His first real customer approached him at a security expo in Miami. His name was José Reyes Ferriz, and he was the mayor of Ciudad Juárez, in northern Mexico. In 2009 a war between the Sinaloa and Juárez drug cartels had turned his border town into the most deadly city on earth. Reyes Ferriz offered enough money for a couple months’ worth of surveillance, and McNutt, who’s married with four children, left Ohio to temporarily set up shop at the border. Within the first hour of operations, his cameras witnessed two murders. “A 9-millimeter casing was all the evidence they’d had,” McNutt says. By tracking the assailants’ vehicles, McNutt’s small team of analysts helped police identify the headquarters of a cartel kill squad and pinpoint a separate cartel building where the murderers got paid for the hit.

PHOTOGRAPH ILLUSTRATION BY CREDIT TK

53


The technology led to dozens of arrests and confessions, McNutt says, but within a few months the city ran out of money to continue paying for the service. Reyes Ferriz left office to mount an unsuccessful campaign for state governor. For the next couple of years, Persistent Surveillance survived by providing services such as traffic-flow analysis for municipal planners, wildlife monitoring and border surveillance for Persistent Surveillance’s Cessna

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federal agencies, and security monitoring for single events ranging from the Brickyard 400 Nascar race to Ohio State University football games. The company also did short-term projects in six countries, including in Central America and Africa, but the nature of that work is confidential, protected by nondisclosure agreements. The combination of those projects earned Persistent Surveillance about $3 million to $4 million a year in revenue, according to McNutt. A single, long-term contract with an American police department would be worth about $2 million a year, he says. By 2012, McNutt was approaching the police departments of the 20 most crime-ridden jurisdictions in the country, marketing his services. He floated several of them an offer: Let us fly over your city to show you what we can do, and then you can decide if you want to hire us. The Los Angeles County Sheriff ’s Department quietly took him up on the offer, allowing him to conduct a nine-day trial run over Compton, a largely minority city south of L.A., in 2012. According to Patrick Bearse, operations lieutenant for the Aero Bureau of the sheriff ’s department, the county recognized the potential of Persistent Surveillance’s service, but it didn’t sign a contract with the company because the technology, particularly the quality of the images, didn’t meet the department’s expectations. The city’s residents didn’t find out about the flights until a year later. Angry protesters demanded a new “citizen privacy protection policy” from local leaders, but even those leaders—from the mayor on down—hadn’t been told about the test program. “There is nothing worse than believing you are being observed by a third party unnecessarily,” Compton Mayor Aja Brown told the Los Angeles Times. The next city to try McNutt’s technology was his home base of Dayton. After the L.A. County trial, he improved the system by more than doubling the resolution, to 192 megapixels, increased the archive’s storage capacity, and sped up the image processing to allow analysts to conduct multiple investigations simultaneously. The Dayton police department and the city council were sold on it, and they aired the idea for a contract at a series of public hearings. Joel Pruce, who teaches human rights studies at the University of Dayton, helped organize the opposition. To the objecting residents, it seemed as if it hadn’t occurred to city leaders that the surveillance program might be interpreted as a violation of some vital, unspoken trust. “At the hearings, nobody spoke in favor of it except for the people working for the city,” Pruce recalls. “The black community, in particular,

said, ‘We’ve seen this type of thing before. This will target us, and you didn’t even come to us beforehand to see how we’d feel about it.’ ” Dayton’s city leaders dropped their attempts to hire the company after those hearings. Last year the public radio program Radiolab featured Persistent Surveillance in a segment about the tricky balance between security and privacy. Shortly after that, McNutt got an e-mail on behalf of Texas-based philanthropists Laura and John Arnold. John is a former Enron trader whose hedge fund, Centaurus Advisors, made billions before he retired in 2012. Since then, the Arnolds have funded a variety of hot-button causes, including advocating for public pension rollbacks and charter schools. The Arnolds told McNutt that if he could find a city that would allow the company to fly for several months, they would donate the money to keep the plane in the air. McNutt had met the lieutenant in charge of Baltimore’s ground-based camera system on the trade-show circuit, and they’d become friendly. “We settled in on Baltimore because it was ready, it was willing, and it was just post-Freddie Gray,” McNutt says. The Arnolds donated the money to the Baltimore Community Foundation, a nonprofit that administers donations to a wide range of local civic causes. In January, McNutt opened the office above the parking garage. The only sign greeting visitors is a piece of copy paper taped to the door that reads “Community Support Program.” Almost everything about the surveillance program feels hush-hush; the city hasn’t yet acknowledged its existence, and the police department declined requests for interviews about the program. On Aug. 10 the U.S. Department of Justice released a 163-page report that detailed systemic abuses within the Baltimore Police Department, including unlawful stops and the use of excessive force, that disproportionately targeted poor and minority communities and led to “unnecessary, adversarial interactions with community members.” Within a week, civil rights groups filed a complaint with the Federal Communications Commission claiming that the department’s warrantless use of cell phone tower simulators known by the trade name StingRay—an activity the police acknowledged last year in court—violated federal law and targeted minorities. “The


He was little more than a faint, grainy dot w i t h n o identifying characteristics problem of radicalized surveillance is particularly pronounced in Baltimore,” the complaint stated. The city was already on the defensive, even as the aerial surveillance program was shielded from the public eye. Around 11 o’clock each morning, a printout is delivered to the Persistent Surveillance office listing all the crimes logged the previous day by Baltimore’s computer-aided dispatch—or CAD— system. The company has hired a former Baltimore cop to act as a liaison between the company and the police force, and he scans the list for cases Persistent Surveillance’s analysts might help solve, highlighting them with an orange marker. On a Friday in late June, not long after the Goodson decision, six analysts sat at separate workstations inside the office suite. The analysts ranged from their early 20s to their late 50s.

McNutt brought four full-timers with him from Dayton, and he’s hired several more from a local temp agency, paying $10 to $15 per hour for entry-level trainees. Terrence Rice, a 25-year-old from Baltimore County, was one of the local hires. It was his third day on the job, and he was still getting the hang of the software. For practice, he worked on a weeks-old case involving the illegal dumping of wood. He stared at an aerial image on the twin large-screen monitors on his desk. He struggled to track a pickup as it proceeded north, squinting to differentiate between the target vehicle and others it passed on a busy roadway. He kept his cursor over the truck as it advanced frame-by-frame. “It reminds me of playing a video game,” he said, his eyes rarely leaving the screen, his back bent as he leaned in close. “And that’s what they told me over the phone. They said that if I was into video games, I might like this work.” The highlights of the previous day’s CAD list included 13 burglaries and 11 hit-and-runs, and all of the analysts were reviewing archived images instead of tracking the live feed. They were prepared to instantly drop their individual investigations and

collaborate, however, if the police called with a report of a highprofile crime, like a homicide or violent assault. One afternoon in February, every analyst in the office had pitched in when the police responded to the shooting of a 90-year-old woman and her 82-year-old brother, who’d been hit while walking in front of a bus stop on Clifton Avenue in the Western District. In a city where gun violence had lost much of its power to shock, the crime struck a local nerve. TV crews descended on the scene, sensing a big story. McNutt’s analysts called up the aerial images and began tracking vehicles leaving a busy shopping center across the street from the bus stop, where witnesses had placed the shooter. For about two hours, they mapped the routes of several cars leaving the parking lot, until a detective informed McNutt that the shooter probably had left the area on foot. Rewinding to the moment of the shooting, they quickly pinpointed a person who appeared to scramble away from the scene just after the gunshots. He was little more than a faint, grainy dot with no identifying characteristics. After he crossed the parking lot, he walked past a Subway sandwich shop and proceeded down a hill behind the shopping center. He cut a corner to cross a vacant lot and ducked between two houses on a quiet residential street. Then he approached what seemed to be a Trexler aboard the plane stationary object sitting in the backyard of one of the houses. The analysts toggled their screens to pull up Google Earth’s Street View, and the image—taken months earlier—revealed that the object in the backyard was a car, abandoned on the grass. The suspect stopped briefly at the car before walking a few doors down and into a house. While he was inside, a vehicle pulled up to the front of the house; a person exited the house, got in the car, and traveled about three miles to Bons Secours Hospital. The analysts tracked him into the emergency room entrance. Because the analysts had lost so much time while tracking the cars leaving the parking lot, all of the movements they were watching were a few hours old. When the police went to the emergency room, the hospital wouldn’t release any patient information. With no identifying information at hand, the trail seemed cold. It wasn’t. The police later that day determined that the house the suspect may have entered before he went to the hospital belonged to the girlfriend of Carl Anthony Cooper, a man with a long criminal record. Additionally, they discovered that when the suspect walked away from the shopping center, he’d passed in front of a ground-based security camera. Accessing that footage and reviewing Cooper’s mug shots on file, they found a possible match. The police couldn’t immediately figure out why he went to the hospital; some speculated that his gun might have accidentally gone off when he tucked it into his pants and the bullet grazed his leg. Two days after the shooting, the Baltimore Police Department posted an archived picture of Cooper on its Facebook page, labeling him the city’s “Public Enemy #1.” It also posted the footage captured by the ground-based security camera, which showed him calmly carrying what appeared to be a

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bag of food in one hand and his cell phone in the other. The footage baffled Facebook users, who couldn’t figure out how it implicated Cooper. In the comments section, one wrote that if the man on camera really was the shooter, he surely would have dropped his food and run. Another commenter typed: “Not saying this isn’t the suspect but what is being seen that we, the public, isn’t seeing???” Finally someone posted, “Can a detective chime in and let us know what additional information leads you to believe that he is the suspect?” No one from the department responded. But Cooper was eventually apprehended by federal marshals in North Carolina and sent to Baltimore, where he remains in custody. The police held a press conference to announce Cooper’s capture, saying he’d face charges for the shootings, including attempted murder and assault. Nothing was said about the surveillance plane.

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Even six months after the flights began, some Baltimore police officers still didn’t know exactly how the surveillance program worked. But word was spreading. One morning in June, three plainclothes officers showed up to see McNutt. They were members of a special unit charged with investigating dirt bike crews—groups of primarily young men who recklessly drive illegal off-road motorcycles through the city. In Baltimore the crews are infamous for aggressively disrupting traffic, ignoring stoplights, and occasionally injuring and killing bystanders. Should a car accidentally collide with group members, other riders have been known to assault the driver before speeding away. City policy prevents police from chasing the bikers, because high-speed pursuits are deemed too risky. The officers wanted to learn more about the surveillance system, and McNutt led them to a conference room to give them a demonstration. Using two large projection screens, he delivered the sales pitch he’d honed for trade shows. He called up old images from a murder in Juárez and walked the detectives through the tracking process that had led him to a cartel safe house. The spiel lasted about 20 minutes. When it was over, the sergeant in charge of the unit sat in silence for a moment, his arms crossed on his chest. “I’m sorry,” he said. “But oh my God—this is just overwhelming right here. This is amazing.” One of the other officers slapped the tabletop. “Let’s go get some dirt bikes, Sarge!” The sergeant said he expected the dirt bikes to be out in force that Sunday, and some might be entering the city from out of town on Saturday. When one of the officers asked if the plane might be flying that weekend over the west side of the city, where police suspected several of the bikes would be stored, McNutt said he would make sure of it. That Saturday morning, the Cessna rolled out of a hangar at the Martin State Airport, about 10 miles east of downtown Baltimore. The plane was scheduled to make two flights of about five hours each, with a break to refuel. The pilot for the first flight was a man who declined to identify himself but said he was a local firefighter who’d flown for the U.S. Army. David Trexler, Persistent Surveillance’s director for operations, rode along in the back of the plane in case there were glitches with the

cameras’ data link to the analysts. Trexler met McNutt when both were in the Air Force, and he’d worked on Angel Fire in Iraq. The plane took off, and as it rose over the buildings of East Baltimore, the cockpit was noisy. The camera array was bolted onto the floor rails where seats normally would be, and it hung out of a broad opening in the fuselage, where the wind rushed through. The Cessna leveled out at 8,500 feet, an altitudinal sweet spot between the planes approaching for landing at BWI Airport and those flying higher en route to the Washington airports. Occasionally, the Cessna has had to share airspace with an FBI airplane. Last year, two days after the Freddie Gray riots began, the FBI flew over Baltimore for five days—actions that were discovered when local aviation enthusiasts noticed a plane’s strange flight orbits on a public website that tracks radar data. According to information and footage released this summer by the FBI, its plane wasn’t doing the sort of wide-area motion imaging that Detail from an analyst’s screen Persistent Surveillance does but instead was zooming in on specific targets. McNutt says the FBI doesn’t coordinate its flights with him, and he doesn’t know what the agency is investigating; however, when his plane is in the air at the same time as the FBI’s, air traffic controllers insist that McNutt’s plane remain at a lower altitude than the federal craft. From 8,500 feet, some of the landmarks below were easy to pick out. Pimlico Race Course to the north. The bold diagonal line of Pennsylvania Avenue. Paddleboats dotting the Inner Harbor close to the shore and sailboats scattered farther out. The just-detectable baseball players taking the field at Camden Yards. The Orioles were playing a doubleheader against the Tampa Bay Rays that afternoon; Trexler commented that the police were concerned Black Lives Matter demonstrators might try to disrupt the games. (Those concerns proved to be unfounded.) Trexler was able to look at the cameras’ integrated aerial image on the computer on the plane, and he could chat with the analysts on the ground via instant message. About two hours into the flight, while he and the pilot were trading war stories about their respective tours in Iraq and Afghanistan, a message popped up. “Here we go,” Trexler said. The police had called in a shooting on the west side. “They’re probably following a bad guy through the city right now,” he guessed. The analysts were, in fact, tracking a black SUV that had left the crime scene, and they saw that it had passed in front of three different ground-based police cameras. Those images gave them a clear picture of the suspect’s vehicle. Eventually, however, the vehicle drove beyond the range of the plane’s cameras, out of the city. They lost its trail. Minutes later, Trexler announced, “Looks like we’ve got a new priority!” An off-duty Baltimore police detective had collided with a dirt bike rider in West Baltimore. When the detective got out of her unmarked car, other riders assaulted her. The crew probably had no idea that the officer was Dawnyell Taylor, the lead homicide detective in the case of Gray. It was exactly the sort of crime McNutt and the analysts on the ground had been primed to follow. They tracked the motorcycle involved in the accident and followed it for an hour and a half. It passed several ground-based cameras, and the police

“I’m sorry. But oh my God—this is overwhelming just right here. This is amazing”


got good images of the rider and the passenger sitting behind him. Police eventually found the motorcycle, confiscated it, and arrested the man they found sitting on it. McNutt prides himself on being a student of efficiencies. In the airport residence hotel where he’s been living since January, he keeps a closet of cargo pants and identical black polos—a uniform that saves him the trouble of choosing what to wear each day. His goatee is a recent experiment to see if he can cut grooming time by limiting the surface area he shaves (results are pending; tending to the edge work, he’s discovered, takes

time). And in 2014, when he was strategizing how he might best silence the sort of criticism he’d attracted in Compton and Dayton, McNutt attempted to save time and trouble by directly approaching the ACLU, the organization he figured would be most likely to challenge his system on privacy grounds. He visited the ACLU’s headquarters in Washington, and in the office of Jay Stanley, a senior policy analyst and privacy expert, McNutt explained why his cameras weren’t a threat. The aerial images couldn’t identify specific people, because the target resolution would be limited to one pixel per person. The analysts zoomed in on specific areas only in response to specific crimes reported to the police. To further ensure that his employees weren’t spying on random people or addresses, everything they did was logged and saved—every keystroke and every address they zoomed in to for a closer look. Vehicles would be tracked only over public roads in areas where people have no expectation of privacy. McNutt cited a couple of U.S. Supreme Court cases to show Persistent Surveillance wasn’t in the business of wanton intrusion. In 1986 a case from California hinged on whether police had the right to fly over a man’s property to see inside a fence in his backyard and then bust him for growing marijuana. The court backed the police, saying that “any member of the public flying in this airspace who glanced down could have seen everything that these officers observed.” Three years later, the court similarly upheld the arrest of a man busted for growing marijuana in a greenhouse after police in a helicopter spotted the plants through the roof, which was missing two panels. Stanley heard McNutt out and thanked him for taking the initiative to seek the ACLU’s feedback. But McNutt’s presentation

shocked him to the core. As he listened to his visitor describe the type of surveillance the company was capable of doing, Stanley felt as if he were witnessing America’s privacy-vs.-security debate move into uncharted territory. “My reaction was ‘OK, this is it,’ ” Stanley recalls. “I said to myself, ‘This is where the rubber hits the road. The technology has finally arrived, and Big Brother, which everyone has always talked about, is finally here.’ ” The meeting took place before McNutt’s work with Baltimore was arranged, and Stanley knew other companies were beginning to work in the same general field. For example, the creators of Constant Hawk, a system that had competed for military adoption with McNutt’s Angel Fire, started a company called Logos Technologies, which provides wide-area motion cameras to organizations that can mount them to aircraft and analyze the images. (“We sell the diamond, and someone else has to mount it in the ring,” company spokesman Erik Schechter says.) This year, Logos landed its first nonmilitary contract, partnering with a Brazilian company called Altave to provide aerial monitoring of the Olympic Games in Rio de Janeiro, via blimplike aerostats floating above the city. As the sector continues to mature, Stanley predicts that more companies will enter the marketplace, and each will try to one-up the other to please law enforcement agencies, creating more flexible—and more intrusive—camera and tracking systems. The Supreme Court decisions that McNutt cited, he says, might not apply. The previous court rulings didn’t take into consideration the constancy of these systems: It’s true that anyone might be able to see into someone’s fenced-in backyard from a passing plane, but was it reasonable to argue that anyone could follow a person’s movements across a city for hours at a time? To Stanley, these are open questions. One afternoon in June, McNutt watched his analysts dig through archived images of traffic accidents. “I’m tired of these little hit-and-runs,” he said. “Let’s have some shootings!” If it sounded crass, it wasn’t intentional; he meant the statement as a declaration of confidence in his system’s ability to solve the worst crimes, the ones that most gravely endanger public safety. He’s convinced his system can be used to examine police behavior, too, in an objective, dispassionate, and nondiscriminatory way. McNutt often says that when he stares into the computer monitors, the dots moving along the sidewalks and streets are mere pixels to him. Nothing more. If anyone else wants to project identifying features onto them—sex, race, whatever— that’s their doing, not his. Even as the technology advances and the camera lenses continue to get more powerful, he says, his company will choose to widen its viewing area beyond the current 30 square miles rather than sharpen the image resolution. He’s exasperated when his system is criticized not for what it does, but for its potential. Yet for critics like Stanley, the two can’t be separated. When told that Persistent Surveillance Systems had been operating over a major city for months, Stanley predicts, “I would expect fierce controversy over this.” McNutt says he’s sure his system can withstand a public unveiling and that the more people know about what his cameras can—and can’t—do, the fewer worries they’ll have. But the police ultimately decide who and what should be tracked. In a city that’s struggled to convince residents that its police can be trusted, the arguments are now Baltimore’s to make.

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s so many love affairs do, financier Lawrence Wai-Man Hui’s began with a bottle of 1982 Château Lafite Rothschild. It was 1990, and Hui was working as an accountant for Deloitte in London. While visiting one of his firm’s clients, a Scottish whisky brand, his hosts served the ’82 with lunch. This is a legendary Bordeaux vintage, one that made critic Robert Parker’s career when he championed it for ushering in a new era of complexity and balance for French wines. Smitten by the Lafite’s grapy charisma, Hui began learning all he could about wine. As his career grew over the next couple of decades—Hui retired two years ago as the chief financial officer of Shimao Property, one of China’s largest real estate developers—he amassed a strong collection of Bordeaux and Burgundies, along with a smattering of acclaimed Spanish, Californian, and Italian wines. In 2011, while browsing Wine-Searcher.com, he discovered Premier Cru, a merchant based in Berkeley, Calif. Hui explained in an e-mail from Hong Kong, where he now lives, that it struck him as having a “beautiful” store, and prices were 10 percent to 30 percent below what other retailers charged for First Growth Bordeaux and Grand Cru Burgundies. One of the biggest players in the fine wine market, Premier Cru had $20 million in annual revenue in the mid-to-late 2000s. Hui inquired about purchasing 2009 and 2010 Bordeaux. The wines were being offered on “pre-arrival,” defined on the company’s website as “wines we have purchased (typically abroad) that have not yet arrived. Depending on the particular wine, the arrival time is typically 6+ months to over two years.” This practice isn’t that unusual. Pre-arrival is a way for collectors to lock in allocations of highly sought-after bottles that might sell out—and often on favorable terms. To many clients, this arrangement had another advantage. Premier Cru sold mostly young wines; rather than having to age them in their own cellars, buyers were happy to let Premier Cru hold on to them. Better yet, its owner, John Fox, never charged for storage. Although Premier Cru was just an hour from Napa, European wines were the cornerstone of its business. No matter how good California wines have become, they’ve never eclipsed the best French vintages for a deep collector. Fox promised clients access to these nuanced beauties through a gray market. This means buying from brokers and other secondary merchants, mainly in Europe, as opposed to working with official importers. Although it’s legal in California, the gray market has its share of shady operators. Poor storage and handling is a common problem. The discounted bottles that Fox obtained, though, were always pristine, according to the four clients interviewed for this story. The trade-off was that Premier Cru was slower to deliver. Other gray-market retailers usually kept customers waiting no more than four to six months; with Premier Cru, the waits ran to years. Hui was hesitant to pay upfront without knowing when exactly he would get his wines, but he was dazzled by the deals. He placed an order that immediately marked him as a whale. He purchased cases of the most exalted names: Lafite, Latour, Haut-Brion, La Mission Haut-Brion, Petrus, Cheval Blanc—all at $200 to $300 less per bottle than anywhere else. In all, it added up to 642 bottles and $420,820.53. Over the next three years, despite receiving only one magnum, he bought an additional 949 bottles, bringing his total to $981,642. But by the summer of 2015, with a single bottle to show for his almost $1 million, Hui brought a lawsuit against Premier Cru in a San Francisco federal court for fraud and misrepresentation that would lead to one of the largest U.S. indict-

ments for wine wire-fraud and Fox facing a prison sentence. Fox, it would be revealed, easily bilked wealthy bankers, experts who’d amassed fortunes reading the market, of hundreds of thousands of dollars. He led less wealthy oenophiles into deluding themselves they’d found a too-good-to-be-true source. And Fox, now 66, managed a remarkable juggling act for more than 20 years, all while fitting into his complex financial contortions a series of twentysomething girlfriends he found and paid online. In the end, he owed former clients $45 million. How so many people seemed to remain soundly in denial about this now-obvious Ponzi scheme, in Northern California—where every professional who isn’t an academic, a tech nouveau riche, or an artisanal food maker, is a therapist— is another of the mysteries surrounding Fox and the buckets of cash that ran through his accounts. Premier Cru started modestly in 1980, a storefront on Oakland’s Piedmont Avenue, before relocating to Emeryville and then Berkeley. Fox worked as a waiter at several Bay Area restaurants before going into the wine business. He opened Premier Cru with his friend Hector Ortega, who’d worked for the U.S. Postal Service. For years, the company enjoyed a solid reputation, and through the 1990s and most of the 2000s, its business boomed. It appeared that Fox was using a low-margin, high-volume strategy, but that couldn’t fully explain the size of the discounts. Many clients chose to think of him as a wizard-behind-the-curtain figure, uniquely adept at finding rare wines at below-market prices. Hui never had direct contact with Fox, but few customers did, since Fox made his connections on the web. Most clients knew him only through the e-mail newsletter he sent out listing Premier Cru’s latest offerings. Some 20,000 people received the newsletter in 2012. He was never seen at the frequent wine events in the gourmandising Bay Area, and in contrast to other merchants, who routinely visited wine regions, Fox hardly ever traveled. He once went on vacation to Tahiti but cut it short, because the Wi-Fi connection at his hotel was balky and he had trouble sending out his e-mail blasts, said a former employee. He worked six days a week and kept long hours, typically arriving at the store at 7 a.m. and rarely leaving before 6 p.m. According to a former employee, Fox’s wife, Gail, had no involvement with the business, and Fox kept his private life to himself. Tall and solidly built, he had a personal gym in the office and was known to be a fitness buff. He dressed well, but in the low-key, Bay Area business standard—suits without ties. By most accounts, he was a good boss. “He was a very nice guy,” recalled an ex-employee. “I don’t think I ever saw him get in anyone’s face. He was very even-tempered.” He covered 100 percent of the health benefits for the 20 to 30 people he had on staff. For happy hour on Fridays, he would open pricey wines to try. But he was not so forthcoming when it came to opening the books, maintaining a mystique around his marvelous deals. Still, the staff noticed certain things. They knew, for instance, that Fox was exceedingly slow to pay suppliers, and that Premier Cru had been cut off by a handful of them. Some chalked it up to disorganization: “His workspace was a disaster area,” said one. “Papers were sky-high everywhere.” Others speculated that it was a cash-flow issue. Over time, employees started advising suppliers that the best way to get paid was to visit the store; if Fox knew someone was coming to collect, he could usually be shamed into signing a check. No one could miss his fancy cars—over the years, a Ferrari, a

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Maserati, a Corvette, and a handful of vintage muscle cars— which he parked in the store’s handicapped spot with impunity. (In Berkeley.) A former employee, who didn’t want to be named (as was the case with many who’d come in contact with Fox), said that, perhaps in hindsight “there was something scuzzy about” Fox. Then the 2008 global financial crisis hit. Sales dropped at Premier Cru as they did for many wine merchants. Warning signs that something might be more deeply amiss appeared. In 2009, Fox bought a large quantity of 2005 Bordeaux from a retailer in suburban New York. This merchant said that in the months that followed, Fox made four additional purchases from him, spending around $50,000 in all. The store owner was puzzled. Premier Cru, like other retailers, had sold the ’05s as futures. These are different than pre-arrivals because they’re paid for before the wine is bottled, a gamble on a potential prime crop. So why, four years later, was Fox buying ’05s, and paying full retail for them? “It was clear to me he was covering orders,” said the merchant. A longtime Premier Cru customer also had an experience that aroused suspicion. During a weekend auction, he was outbid for a parcel of rare vintages. The next day he noticed the same wines had been added to Premier Cru’s online inventory. It had obviously been the winning bidder. He found it odd that Premier Cru was participating in auctions, but what happened next was even stranger. Initially, Premier Cru marked the wines up around 20 percent from what it had paid. They didn’t sell, and the store quickly began discounting them. Soon it was offering the wines below the auction price. At that point, the customer swooped in and bought them. “You shouldn’t lose money on those wines,” he said. “You could tell they needed capital.” He started scaling back his purchases from Premier Cru and advised friends to do the same. Meanwhile, the store was becoming even slower to deliver. In February 2012 a participant on Wineberserkers. com, a popular discussion board, started a thread titled “Why does Premier Cru take so long” that would continue unspooling into outrage for the next four years. Outwardly, Premier Cru still looked all right. In 2011 it moved to a 27,000-square-foot facility on University Avenue in Berkeley. Fox paid $4.1 million for the property and hired prominent local architect David Trachtenberg to oversee a $500,000 renovation that included a spacious walk-in retail shop replete with mahogany walls and racks and a temperature-controlled bottle room for the rarest wines. It was near, but not in, the posher Fourth Street shopping district. Neighboring businesses were package stores and delis selling Gallo Hearty Burgundy. But Premier Cru did its big deals online, and a slightly seedy location is catnip for food-fad-foraging Bay Areans anyway. Choosing to buy a more affordable building fit a pattern of Fox’s, who seemed only half-committed to being a high roller. His extravagant cars were balanced by what appeared to be a workaday life. He and his wife purchased a relatively affordable (considering the absurd local market) $2.3 million house in Alamo, an upper-middle-class enclave east of Oakland. Not long after its move to University Avenue, however, Premier Cru lost an important revenue stream. Starting with the 2011 vintage, Bordeaux had a string of mediocre crops. Many oenophiles had already soured on Bordeaux because of the exorbitant prices; others were still reeling from the recession. The weak vintages made it easy to forgo buying Bordeaux futures. Without that upfront money, Fox began to noticeably falter.

According to an employee, a French wine dealer showed up unannounced one day at the store, accompanied by two burly guys (“they looked like they were just off the dock in Marseille”) who were clearly there as muscle in case Fox needed some help finding his checkbook. He didn’t. By late 2014 only 120 bottles of Hui’s initial order of 642 had arrived at Premier Cru’s Berkeley warehouse. The 2009 Bordeaux had been released three years earlier; the 2010s had been in circulation for two years. As Hui pressed for details and tried to arrange shipping, he found that his e-mails weren’t getting answered as quickly as before, and some not at all. Around the same time, James Gillerman, a long-serving employee who’d been Hui’s point of contact, left the sales desk and went to work in the warehouse. Colleagues speculated that Gillerman had grown tired of fielding calls from irate customers. Michael Glasby, a top salesman for 20 years whose English accent had given Premier Cru added polish, left to start his own wine company. Neither would speak on the record. Wine-Searcher.com delisted Premier Cru in May 2015 after receiving numerous complaints about undelivered wines. That same month, a Bay Area chiropractor sued for $230,000 in undelivered wines going back 12 years. Amid all this, employees noticed that the five or six shipments from Europe that usually arrived over the course of a year had been reduced to one. “I would go in to John and ask him to give me a real ETA for a shipment,” an employee said. “He would sit there, stroke his chin, and say something like, ‘It will definitely be next spring.’ He was pulling the date out of his ass. He had no idea when the container was coming in, because he had no idea when he was going to pay for it.” Court records reveal that, maxed out on his credit cards, Fox now asked some employees if he could use theirs to make purchases. He charged $25,000 to a card that belonged to Brian Nishi, Premier Cru’s longtime IT guy. When Fox couldn’t come up with the cash to reimburse Nishi, he paid him back with wine. In June 2015, “The Haggler” column in the business section of the Sunday New York Times ran a letter from a Paul Higgins of St. Louis, who was seeking help getting Premier Cru to cough up some wines he’d purchased almost six years earlier. David Segal, aka the Haggler, managed to get Fox on the phone. Fox said newbies like Higgins were “not used to extended waiting periods.” But he conceded that Premier Cru was guilty of giving overly optimistic delivery projections, a problem he blamed on his employees. “We’ve been working on getting our staff to give people correct information,” the Haggler reported him saying. “Not false estimates because they want to get off the phone.” That remark infuriated his staff—it was Fox who gave them the projected delivery dates. The article, said the former employee, “really started the run on the bank.” Fox cutting the ribbon at the opening of his California store in 2011


Hui, back in Hong Kong, never saw the Times story; all he knew was that he’d received just one bottle of wine. He finally came to the conclusion that he’d been scammed and filed his lawsuit last August. In October, Wine Spectator magazine wrote about it. The San Francisco law firm that is representing Hui, Shartsis Friese, was bombarded with inquiries from other Premier Cru clients. “We were getting phone calls and e-mails every day,” said attorney Arthur Shartsis. Those who’d not yet sought legal redress pelted the store with calls and e-mails. Berkeleyside, a local newspaper, reported that Premier Cru owed Alameda County $270,000 in property taxes for the years 2011-14 and the state of California more than $200,000 in sales taxes. In addition, Premier Cru’s bank, Community Bank of the Bay, had placed a lien on the property. Fox had also not paid for insurance on the complex in more than a year, despite the millions of dollars of wine stored there. By this point the office was rife with gallows humor. Staffers thought the saga had the makings of a Hollywood drama, and it was agreed that Kevin Costner or Robert Redford would play Fox. One day a customer walked into the store and helped himself to multiple bottles, saying he was owed wine and that the employees were welcome to call the police if they wanted to stop him. No one called. For his part, Fox was still a cheerful presence; the only outward sign of strain was the acute back pain he was suffering. He added to his car collection, acquiring a $165,000 Ferrari in a lease-to-own agreement. He did ask one employee if anything could be done to counteract the beating Premier Cru was taking on Yelp. Employees were amused when a “John F” contributed a glowing review, lauding Premier Cru as “the greatest wine store in the U.S.” In October, the same month he took delivery of the new Ferrari, Fox put the Berkeley property up for sale, asking $7.5 million. Some more optimistic workers thought that unloading the building would provide enough capital to stay afloat. But a few weeks later the staff was hastily summoned to the second-floor conference room. Fox was absent. Instead, there were two lawyers: Petra Reinecke, secured to give them legal advice, and Robert Breakstone, a criminal attorney representing Fox. Breakstone told them that their boss was under investigation by the FBI and that agents could raid the premises at any moment. The dark humor immediately gave way to panic. In the days following the meeting with the attorneys, Fox posted several security guards at the front and back entrances. Along with the specter of an FBI raid, staffers were fearful of possibly violent confrontations with empty-handed buyers. While updating their résumés, employees frantically tried to get wines to as many customers as possible. They advised clients who had bottles stored in the warehouse that it would be a good idea to retrieve them ... now. They also tried to compensate those whose wines had never arrived from the retail shop’s rapidly dwindling inventory; one customer was given Riedel glasses as partial repayment. Throughout, Fox continued to promote offers. In November he e-mailed one that included 31 bottles of 2013 Domaine Ramonet Montrachet, a grand cru white Burgundy made in minuscule quantities. Coveted by collectors, it usually sold for $1,200 or more; Fox offered it at $360 per bottle. A few days later, Fox shaved $11 off. But even his few remaining defenders on Wineberserkers.com weren’t biting. In mid-December, Fox

announced that Premier Cru would now sell online only and closed the store. Multiple sources confirmed that in late December, Premier Cru offered wine out its back door to several Bay Area merchants; one nearby retailer, they said, bought $200,000 worth of wine from Premier Cru’s warehouse. At the beginning of 2016, Premier Cru filed for bankruptcy, claiming $7 million in assets and an astonishing $70 million in liabilities. The filing listed 9,200 creditors; some were suppliers, but most were clients, a number of whom were facing six-figure losses. In addition to Hui, the victims included famed venture capitalist Arthur Patterson ($837,000) and former Credit Suisse investment bank chief Adebayo Ogunlesi ($479,000). A few weeks after Premier Cru declared bankruptcy, Fox filed for personal bankruptcy. In the hallway outside the courtroom after the spring hearing in Oakland, Fox, dressed in jeans, sneakers, and a hoodie, his face flush and haggard, pretended not to hear reporters. During the bankruptcy proceedings, Fox took the Fifth on every question the court-appointed trustee put forward. There was no word of the criminal investigation until Aug. 11, when Fox pleaded guilty in a federal courthouse in Oakland to one count of wire fraud connected to the sale of wines to a client identified in the government’s complaint by the initials H.W.M.L.—presumably Lawrence Wai-Man Hui. As part of his deal, which would guarantee no more than six and a half years in prison, he’s required to pay $45 million in restitution to clients. None of his staffers have been implicated. Reached by phone, Breakstone said that his client “decided to cooperate with the government at a very early stage.” He said it was clear they had the evidence to secure a conviction. “This case would have had a terrible outcome for Mr. Fox. It was in his best interest to move forward with a resolution,” Breakstone said. Fox also agreed to detail his crimes in his plea agreement. He confessed that he’d begun selling what he called phantom wines sometime around 1993 or ’94, selling $20 million worth from 2010 through 2015. He’d used money from new customers to obtain wines for old ones; he’d tapped the company bank accounts and credit cards for mortgage and tuition payments, credit card bills, car purchases and leases. And he spent $900,000, via PayPal, on women he’d met online. One dogged Berkeleyside reporter, Frances Dinkelspiel, tracked down witnesses to these affairs. In a story that lit up the food blogs, workers at Artis Coffee, a “live roast bar” on Fourth Street, said he had assignations there several times a week with women in tiny outfits who looked 40 years younger. Meanwhile, on online forums and in wine circles, speculation flared that Fox had squirreled money away overseas. Breakstone was adamant that this was not the case. “Is there a secret treasure trove? No, there isn’t. He has nothing left.” Aug. 30 is the final bankruptcy auction date for the 71,000 bottles still in Fox’s warehouse. (So far, only one bidder has come forward, with an offer of $2.3 million.) Nestled among the cases are 2,500 wines with clients’ names on them. Because of a class-action suit concurrent with the bankruptcy proceedings, these have been called “segregated” bottles, and their buyers will be allowed to collect them. Hui wrote in an e-mail, “As my wines were not physically separated, I did not and cannot secure them. It’s very, very unfortunate.” A few other patient customers, though, will finally get their great deals.

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RISING PRICES FOR WORLD WAR II RELICS HAVE PITTED PRESERVATIONISTS AGAINST SELLERS WITH SHOVELS

PHOTOGRAPH ILLUSTRATION BY CREDIT TK

BRING UP


PHOTOGRAPH ILLUSTRATION BY CREDIT TK

THE BODIES

BY THOMAS ROGERS PHOTOGRAPHS BY REINIS HOFMANIS


 Andris Lelis searches for artifacts

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TALIS ESMITS WAS FELLING TREES near his home in Latvia when he received a phone call about two Nazi soldiers. The caller, a national guardsman in the Courland Peninsula, a horn of forested land between the capital, Riga, and the Baltic Sea, said that a friend had unearthed their remains while driving his tractor and wasn’t sure what to do. It was a Wednesday in March. Esmits told the man to leave the bones where they were and that he would come pick them up. A few days later, Esmits drove a white van rapidly down a country road. A stout 52-year-old, he had dressed for the occasion in golden army boots, a replica World War I hat, and darkgreen camouflage. Esmits is the co-founder of a Latvian volunteer group, Legenda, that exhumes the scattered and forgotten bodies of World War II combatants for proper burial. In the van sat his crew of six diggers and a flatulent 150-pound Italian mastiff named Bagram, all of them violently jostling back and forth on the bumpy road while Rebecca Black’s song Friday played on the stereo. Most of the diggers were also dressed in camouflage and wouldn’t have looked out of place in the Latvian army. Toward the rear, Viktors Duks, a professor of screenwriting at Riseba University in Riga, slouched and moaned about a hangover. Further up, Andris Lelis, a 22-year-old militaria seller, cheerfully pointed out battle sites next to the road. “There are still probably lots of bodies in that farmer’s field,” he said. Each year, Esmits handles about 700 human remains in Latvia; he sometimes also works in Russia and Lithuania. “Everybody knows that he is the guy you call if you find a body,” Lelis said. Esmits started Legenda in 1999 with Duks and Viktors Lelis, Andris’s father, who was also in the van that day. They had all met when Duks was trying to have some skeletons removed from his grandparents’ property in Baldone, 20 miles outside Riga. “In Latvia, it is normal for

you to have dead soldiers in your yard,” Esmits said. “When people came back to their homes after the war, they saw there was a dead soldier here and a dead soldier there, and they just buried them.” During the final months of World War II, Latvia was the site of especially bloody battles between German and Soviet forces. Approximately 350,000 Nazis were cut off here from the rest of the German line in the autumn of 1944, in what became known as the Courland Pocket. In the months that followed, about 100,000 of them were killed. After Latvia came under Soviet control in 1945, authorities had little interest in exhuming dead soldiers, and today, 26 years after independence, numberless bodies are still buried in the country’s forests and fields. That has left well-meaning volunteers like Esmits’s group to exhume, identify, and rebury dead soldiers. But in recent years, the often illicit market in Nazi memorabilia has intensified, creating a new class of diggers across eastern Europe that is at odds with Esmits’s work. Of particular interest are relics—items dug up from the ground. “When we first started, the market for relics was a local one—you couldn’t even call it a market,” Esmits said. “Then the internet appeared, and Europe and the world opened up, and many things changed.” Some $50 million in military memorabilia is sold each year, according to an estimate by the Guardian, and Nazi items fetch a premium. There are two distinct tiers. At the high end are large vehicles, such as tanks, and rare items with direct connections to specific, notorious Nazis, which are sold by a small number of international dealers to wealthy collectors. In 2015, for example, Hermann Göring’s sweat-stained uniform was sold by a British auction house for about $126,000. In 2011 an


PHOTOGRAPH ILLUSTRATION BY CREDIT TK

AFTER THREE HOURS OF DRIVING, Esmits and the Legenda crew entered the grim, empty village of Priekule. Some buildings were still pockmarked with bullet and shrapnel holes from the intense fighting that took place here during the war. “Everybody leaves for Riga or Europe,” Lelis said. “The only people who stay are people who can’t afford to leave, or drunks.” The contact for the soldiers’ bones, a man in a motorcycle jacket, was waiting alongside a jeep in a parking lot, smoking a cigarette. There’d been a hiccup, Lelis discovered. The farmer had decided that he didn’t want Esmits’s men on his property and had dug up the bodies himself. Esmits grabbed two plastic bags, jumped in the passenger seat of the man’s jeep, and disappeared, leaving his diggers to wait impatiently in the van. Ainis Barkovics, a greasy-haired warehouse worker, fell asleep with his face against the window, a relic swastika belt buckle shining at his waist. Bagram slobbered on Lelis’s neck. A spindly and eerily composed young man with Justin Bieber hair, Lelis has sold militaria online for about six years. While his business makes him ineligible to be a full member of Legenda, which is strictly noncommercial, he’s one of the group’s most eager volunteers. His specialty is Nazi dog tags, which he digs up in areas where soldiers surrendered to the Soviets. “I do not rob anything from bodies,” Lelis said emphatically. He said he’d been one of the first relic sellers in Riga to make use of EBay, but that over the past five years, perhaps spurred by the European debt crisis, the number of competitors had increased dramatically. Other sellers noticed how successful he’d been, he said, though he also had the sense that demand for Nazi objects was growing around the world. For Lelis, the digging is mostly a way of connecting with his nation’s bleak, complicated history. “The history of Latvia,” he said, “is the history of war.” The country has been occupied at various points by Swedes, Russians, Germans. As Lelis’s father put it, “Everyone has been through Latvia except Genghis Khan and the Martians.” During World War II, the Soviets arrived first, deporting thousands of Latvians to Siberian work camps. Then came the Nazis, who murdered approximately 70,000 Latvian Jews,

 Nazi militaria recovered from a trench

Orthodox Jewish man bought the diaries of Josef Mengele at auction for $245,000. At the lower end are objects such as medals, uniforms, and helmets. In the decades after the war, such items sold through militaria conventions, flea markets, and catalogs. Many pieces came from the homes of former soldiers, in more or less pristine condition, and prices were cheap—a Wehrmacht helmet might have cost $20. The arrival of EBay in the late 1990s allowed anyone to become a seller, and the market saw a surge in items, especially from the formerly inaccessible Eastern bloc. Sellers say that in recent years, as the number of living witnesses to the war has dwindled, they have noticed more collectors deciding to hold on to their items permanently, driving up prices for genuine Nazi memorabilia. “It’s a limited quantity,” Andris Lelis said, “and you can’t manufacture new ones.” Wehrmacht helmets have almost quadrupled in price over the past three years, to about $90. That’s prompted more people from Latvia and elsewhere in the region to dig for relics, sometimes racing Esmits to a freshly discovered pile of bones.

most infamously in Bikernieki Forest. Each side conscripted locals to their armies, and today many Latvians, including Lelis, have an ambivalent relationship to both. “Each side did terrible things,” he said. As a militaria dealer, however, he had no qualms about selling reminders of that history to foreigners. Esmits returned, carrying only one bag of bones. The farmer, it turned out, had mixed the two remains together when he ran them over with his tractor, rendering them impossible to tell apart. Esmits casually threw the bag into the back of the van, next to a napping Duks. The grayish-brown remains, after 70 years in the dirt, would have easily fit into a school backpack. “The skulls are in tiny pieces because of the tractor,” Lelis said matter-of-factly. Fortunately, the farmer had recovered the soldiers’ dog tags— pieces of zinc embossed with numbers and the soldiers’ units. The two relics showed that one man was a member of the 36th Infantry Division’s veterinary company and the other a member of the fourth company of Infantry Ersatz Battalion 9. Nazi dog tags like these would fetch about $60 online, while similar tags from SS units could go for several hundred dollars—more than a teacher’s monthly salary in parts of eastern Europe. Esmits said he would pass the information about the bodies, along with the tags themselves, to the German War Graves Commission, known as the Volksbund. Every year, the Volksbund supervises the exhumation and reburial of almost 30,000 lost German soldiers around the world. “We believe all people have the right to a worthy grave,” says Fritz Kirchmeier, the commission’s spokesman. “There are lots of people who want to clear up their relatives’ fates. Before 1990 we couldn’t work in Eastern Europe, and now many of these descendants are 70 years or older and in a phase where they want to clear up these questions and find some inner peace.” For the Volksbund, grave robbing remains a persistent problem, especially in Russia and Ukraine. “Grave robbers blight our work,” Kirchmeier says. Many illegal diggers dutifully give over information to officials if they come across a dead body, he says, but others “open graves and then take out anything they can sell—steel helmets, pieces of equipment, medals, belt buckles, personal mementos belonging to the dead, sometimes even the skull, leaving the rest of the bones on the forest floor.” Yngve Sjodin, a Norway-based militaria seller who sometimes digs with Legenda, says he was confronted with a “black digger” during one of his first digs for soldiers in Latvia, in 2014. “He screamed at us that it was his forest,” he says, “and started attacking the guy next to me.” He

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 Esmits in a lost Nazi cemetery in a forest clearing

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adds, “The driving force for the black diggers is money, which they need to survive, or party, or whatever.” Robin Schäfer, a former collector and a military historian from Germany, says the problem is endemic, particularly in Russia. “It’s gotten to the point where official diggers who are exhuming bodies in Russia need to post guards at night,” he says. The country has become particularly attractive to grave robbers because of its large numbers of German war dead and the presence of blue clay in its soil, which can allow items to remain pristine after decades on a rotting corpse. In early 2008, Schäfer traveled to a forest outside the town of Tosno, in northwestern Russia, to search for the remains of his great-uncle, Heinrich Gilgenbach. Schäfer knew that Gilgenbach had been sent to the Russian front as a pioneer in the German infantry in 1942. “It may sound trivial, but for his grandson, it was very important that we would one day find him,” Schäfer says. “He has a photo of his grandfather in his bedroom and the letter his grandmother received when he died, with her dried tears on it.” Official records said that Gilgenbach was shot in the chest by Soviet partisans on March 21, 1942, two months after arriving, and spent his final moments saying “his farewells to his wife and daughter” before “dying in the arms of a soldier.” Using information from veterans and German diaries, Schäfer pinpointed Gilgenbach’s remains to a regimental cemetery in the abandoned Russian village of Glubochka. During the war, the Germans usually buried dead soldiers near the front, and after the German retreat, the village had been abandoned. “There were three grave hills,” he says. “It was covered in grass, untouched.” Schäfer alerted the Volksbund to the location of the cemetery and his great-uncle’s remains, but by the time a team of German army reservists and Russian soldiers arrived to exhume the bodies, the site had been plundered. “The bones had been scattered, and the dog tags were gone,” Schäfer says. Of the 600 supposed soldiers that were buried in the cemetery, only about a dozen complete human remains and two dog tags were recovered. Neither of them belonged to Gilgenbach. Schäfer assumes his great-uncle’s items were stolen by grave robbers who sold them to collectors. The Nazi soldiers “may be the oppressors, the conquerors, the criminals,” Schäfer says, “but in the end they are also just people that someone loves.” SINCE JOINING THE EUROPEAN UNION in 2004, Latvia has developed fitfully. In the Courland, the farms are gray, the fields are largely empty, and there are few manufacturing jobs. Progress elsewhere has been hampered by corruption or flawed big projects, such as Riga’s hideous national library, which looks like a cruise ship mated with a shovel. In the capital, a former Hanseatic trading hub with stunning art nouveau architecture, perhaps the most visible growth industry is stag parties. In the EU era, cheap accommodation

and passport-free travel—flights from London to Riga can cost as little as $40—have made a common sight of packs of bloated British men in sweatpants, lumbering from pub to pub in the city’s Old Town. More recently, Riga has also begun attracting a different class of visitor: relic hunters. Europe has some 10,000 to 15,000 amateur metal detectorists, and for those interested in military history, the Courland’s isolated and largely untouched battlefields make for ideal scavenging. “In Latvia, you can drive into a forest where nobody will see you for 20 kilometers,” says Schäfer, “and nobody will inspect you” at the border. Metal detectorists use Facebook groups and online forums to share information, and on YouTube, a search for “Courland digging” yields hundreds of videos. Some clips depict people excavating helmets and discovering that there is still a skull inside. The rise of relic tourism is a source of concern for the Legenda crew. Since digging licenses are usually available only to Latvian residents, almost all metal-detecting tourists are digging illegally, and so may be disinclined to report bodies they find to the authorities. Back behind the wheel of his van, Esmits mentioned another factor in the surge in interest for Nazi kit: Battlefield Recovery, a reality show about metal detectorists that recently aired on Channel 5 in the U.K. The program follows a memorabilia dealer named Craig Gottlieb and three amateur British diggers as they travel around eastern Europe, digging for Nazi relics and remains. For several episodes, Gottlieb came to the Courland. Legenda arranged the permits and the locations for the show, and it did most of the behind-the-scenes digging. “It’s very good,” Duks screamed over the engine noise from the back of the van. Even before Battlefield Recovery, Gottlieb was the most recognizable face in the Nazi memorabilia market. A fast-talking Florida native and Ayn Rand devotee, he runs one of the world’s biggest Nazi militaria websites. Gottlieb gained notoriety in 2014 for selling a trove of Adolf Hitler’s personal items, including stationery, books, and clothing, for as much as $3.5 million. These days, most people know him as a star of the History channel’s Pawn Stars, a reality show about a Las Vegas pawnshop. Gottlieb’s participation in Battlefield Recovery has made him


“HE SCREAMED AT US THAT IT WAS HIS FOREST AND STARTED ATTACKING THE GUY NEXT TO ME” a reviled figure among conflict archaeologists. The early promotional materials for the show, which was originally titled Nazi War Diggers and set to air on National Geographic Channel before being canceled unaired, showed a cast member wrenching a bone out of the ground with his hands and presenters confusing a leg bone with an arm bone. In an affront to archaeological technique, one episode featured another cast member sticking a pole into a suspected mass grave. Tony Pollard, the head of the Center for Battlefield Archaeology at the University of Glasgow, told the New York Times about the promotional materials, “I have never seen such a casual and improper attitude toward the treatment of human remains.” Gottlieb compares the uproar over the show to criticizing a tennis player for having poor golf skills. “We were doing battlefield recovery, not archaeology,” he says. Until the past decade, World War II was largely seen as unworthy of archaeological study, but that is rapidly changing. “Four or five years ago in the Netherlands, no serious archaeologist would be interested in World War II,” says Max van der Schriek, a Ph.D. candidate in modern conflict archaeology at Vrije Universiteit in Amsterdam. But as interest among archaeologists grows, they’re facing a constant battle against amateurs with metal detectors and shovels. Shows like Battlefield Recovery, they worry, will only encourage aspiring diggers and grave robbers, making their work more difficult. “For archaeologists, the context of the findings means everything: the way people died, the way people lived, the way battle evolved,” says Van der Schriek. “When people with a metal detector dig stuff up, there’s no context—a helmet is just a helmet. In 100 years we’ll look back at the Second World War in the same way we look at the Napoleonic Wars, and in 1,000 years it’ll be like the Roman times. But when you’ve destroyed everything that came before, there will be nothing left to investigate.” To Esmits this stance is infuriating. “They’re living in a different reality,” he said, yelling as he weaved to avoid potholes. The van passed a group of teetering drunk men on the side of the road. “How are you going to find enough archaeologists to dig up 700 bodies every year? We could use better methods, but that would take more money and much more time. We are just volunteers with a dirty van that do this for free.” Lelis agreed with him. “Maybe the archaeologists want to dig up a skull that’s been hit with a splinter and put it in the middle of a museum like they do with the Romans, but that seems very wrong and strange,” he said. “I think it must be more important

 Bags of human bones recovered from a dig site

to give a soldier back to his family. That person is still alive in the memory of someone. Here, that history hasn’t died.” ESMITS PULLED TO A STOP AT AN isolated forest clearing. The Courland region is still crisscrossed with the war’s trenches, bunkers, and craters. During the summer, the woods fill with clouds of mosquitoes, and the foliage becomes so dense you can barely walk, but on this March morning, the tall trees were empty, and the ground was a quagmire of mud and gnarled branches. Esmits’s men planned to search the woods for further undiscovered soldiers and relics, and as they fanned out with their metal detectors, their bleeps and bloops echoed through the trees. Although they have a policy of not selling anything they find when they locate bones, the Legenda members are all collectors of Nazi memorabilia and will happily take home a rare relic or two. Lelis walked through the forest at a near jog, his detector going off every few seconds. He zeroed in on some ground near a crater and dug in his spade. A few seconds later, he held up a long metallic shard. “A splinter,” he said, from either a Soviet or German shell. During the war, artillery shells were loaded with shrapnel in order to maximize damage—the pieces could fly hundreds of feet before embedding themselves in a tree or a soldier. Until recently, dug-up splinters like this were worthless to militaria dealers. “Now I could sell it for up to $5,” Lelis said. “Some crazy American would put it in his living room.” Around noon, Lelis’s father located a grouping of about 10 large depressions, grown over with moss and filled with mud and leaves: a former bunker complex. All the group found there were metal food canisters and ammunition, so they turned their attention to a nearby machine gun emplacement. Duks, examining a mortar shell, said, “I’ll turn it into a vase for Grandma.” His apartment in suburban Riga is filled with items, such as candleholders, that have been fashioned from recovered relics. By 5 p.m., the Legenda group’s energy began to wane. One member found the remnants of a Panzerfaust, a shoulder-fired missile used by Germans to destroy Soviet tanks, but when Duks noticed a civilian cemetery nearby, the group quickly piled into their van and drove to another forest. “We don’t want people thinking we’re digging up the graves,” Duks said. Soon after, the battery in Lelis’s metal detector died, and most of the diggers passed out in the van. Duks resumed moaning about his hangover. As the sun dropped below the horizon and a gentle rain began to fall, Esmits pulled the van into Latvia’s largest German cemetery, outside of Saldus. This is where many of the bodies exhumed by Esmits end up. The countless small crosses, each of which represents eight dead soldiers, stretched up a hill to a large metal cross. A total of 30,000 Nazi soldiers are buried here—double Saldus’s current living population. Some of the graves were decorated with flowers or small lights. The bones Esmits had recovered from the farm would be buried here. Because the remains were inseparable, they would lie under the same cross, amid those of hundreds of other men he’d recovered over the past year. He walked for five minutes, stopped at a far corner of the cemetery, and pointed proudly at an empty patch of grass. “All of the bodies buried here,” Esmits said, “are mine.”

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HIGH-END HOAGIES

INSTA’S OPERATIONS CHIEF

Players pile into the back of a pickup before heading to lunch

North Dakota State University’s football team has won five straight national championships. Is it time to tackle stiffer competition? By Eben Novy-Williams Photographs by Benjamin Rasmussen


f you know anything about Fargo, it’s likely the harsh winter and funny accent portrayed in the movie and television series that take their name from North Dakota’s largest city. But residents want you to know a few other things: Fargo adds 10 people a day, says the mayor, and its unemployment rate is about 50 percent below the U.S. average. Spend a night, and someone will remind you that the Coen brothers shot their 1996 film mostly in Minnesota. One thing Fargo’s residents don’t have to get defensive about? Their football team, the North Dakota State University Bison. Riding a deep tradition, smart local recruiting, and oil money from the western part of the state, the Bison have won five straight national titles—and they’re a preseason favorite to win a sixth. The team’s dynasty is unmatched in the 146-year history of college football’s top ranks. You get attention when you’re that dominant. The Bison— pronounced “BI-zun” in the North Dakota parlance—begin their title defense on Aug. 27 in front of a national audience on ESPN. The network’s popular College GameDay show has twice traveled to Fargo, and SportsCenter broadcast live from the Fargodome. If that wasn’t enough of a spotlight, the Philadelphia Eagles took Carson Wentz, last year’s starting quarterback, with the No. 2 pick in April’s NFL draft. No college town at NDSU’s level gets half the attention. “The energy that creates and the exposure— that’s positive in ways I can’t even describe,” says Paul Richard, an NDSU graduate and executive vice president for Sanford Health’s Fargo division, the city’s biggest employer. If you’re thinking, “Didn’t Alabama win the national championship this year?” you’re right. To geek out for a second: NDSU plays in the National Collegiate Athletic Association’s (NCAA) Division I, but in its second tier, the Football Championship Subdivision (FCS). Alabama and big-name programs like it play in Division I’s top tier, the Football Bowl Subdivision (FBS). If you’re also thinking, “Why does this matter?” there’s a reason. Moving into the FBS, which the team has faced increasing pressure to do, would give the Bison the chance to play against the Alabamas, Ohio States, and Oklahomas of the college football universe, grab more media attention, and possibly rake in huge financial rewards—but it could also cost them money and championships. Stay put in the FCS, and the Bison should keep winning. ESPN stops by. The executive director of the booster program, Pat Simmers, continues to receive $250,000 donations from fans who don’t want to wait for season tickets. What’s a ridiculously dominant small-town football team to do? It’s a question with the potential to roil the Bison faithful and ruin this overachieving team’s role as ambassador for an overachieving city. Matt Larsen, the university’s athletic director, who was hired to make this decision, says he’s torn: “Our teams can compete at that level, but we need to ask, ‘Can we afford to make the jump?’ A lot of programs have moved up, looking for glitz, glamour, and glory, and sometimes it’s not there.” Glitz, glamour, and glory aren’t really the Fargo way. Dave Piepkorn, the deputy mayor, says jokingly: “On the East Coast or West Coast, nice cars are Ferraris. Here, whatever kind of car you have, if it starts in the winter, that’s a nice car.” A former NDSU offensive lineman, Piepkorn is an advocate of jumping. He owns a downtown lawncare company two blocks from the Fargo Theatre, where

“A lot of programs have moved up, looking for

and

and sometimes it’s not there”

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Bison prep for the upcoming season at training camp in August, here and opposite page

9,000 people packed in for GameDay’s 2014 visit. Each home game contributes about $1.5 million to the local economy; FBS status would mean more people and more money. “You always have to look for the next level,” Piepkorn says. He’s not alone in thinking this way, according to an unscientific poll of locals taken in early August. A construction worker on 1st Avenue says the team is ready, because the Bison have won five straight games against FBS teams in periodic interdivisional matchups. In a brewery, a recent NDSU grad from Michigan says he’d love to bet on the Bison in a game against the University of Michigan Wolverines, one of college football’s most storied programs. It’s a “no-brainer” that he’d take his friends’ money, he says. They don’t know just how well the Bison play. It’s more complicated for Larsen. The New York transplant arrived in Fargo with his wife and kids in 2014 after rising to become chief financial officer of the athletic department at New York’s Stony Brook University. He played wide receiver for the Seawolves and worked in the athletic department when the school’s football team moved from Division II to I. He says he’s asked about the jump weekly—by fans, the media, even administrators. It’s a natural question when a team wins games by more than 30 points, which has happened 14 times in the past three years. “It’s easy to argue both


FROM LEFT: GETTY IMAGES (1); PHOTOGRAPHS BY BENJAMIN RASMUSSEN FOR BLOOMBERG BUSINESSWEEK (3)

Sports sides,” Larsen says. “This can’t be emotional. It has to be a budgetary decision.” Right now, Larsen’s budget is $22 million. The nation’s top programs have kitties in excess of $120 million, built largely on the billions networks pay for broadcast rights. Each school in the Southeastern C o n f e r e n c e—t h e o n e Alabama plays in—raked in $31.2 million last season, mostly from TV. North Dakota State won’t be paid to have ESPN broadcast its opener—nor any of its contests against Missouri Valley Football Conference opponents—mainly because there aren’t enough eyeballs on its games when FBS games are being broadcast at the same time. Moving up to the FBS wouldn’t guarantee that revenue will pour in, but if NDSU established itself, it could make millions. Getting anywhere near being established would take more than a few buffalo nickels. There’s paying coaches FBS-caliber salaries, offering students an FBS-caliber experience, and, most costly, building FBS-caliber facilities. “To do it the right way, making the move would mean doubling the athletic budget,” Larsen says. That money won’t come from tax revenue or the school: The state’s economy is influenced chiefly by oil and agriculture prices, both of which are in a downswing. NDSU’s new $50 million athletic complex was privately funded, as was a $5.5 million indoor track-and-field venue. “They’re very good stewards of their money,” Mayor Tim Mahoney says. Even so, there’s no escaping that an FBS move would require a new stadium. This means NDSU would need more buy-in from donors. The booster program has raised a record $4.5 million so far this year, Executive Director Simmers says, because of growing ticket demand. By contrast, Florida State University’s boosters generate 10 times that annually. “I could sell out 30,000 tomorrow, but that’s not enough for an FBS program,” he says. “We’d likely need at least 40,000 seats.” The 40,000-seat stadium the University of Houston is building will cost $120 million. So those Bison boosters would have a lot of banquets to plan. Larsen knows there are no guarantees, no matter what decision he makes. Boise State University was only a decade into FBS life when it stunned the Oklahoma Sooners in the 2007 Fiesta Bowl. Now the program is perennially ranked in the Top 25 and last year received a $9.4 million payout. But two years after the University of Massachusetts at Amherst stepped up in 2012, an internal report found costs had outstripped

Etc.

projections, with students and taxpayers kicking in an extra $2.1 million. The Minutemen are 8-40 since the move, home crowds average less than the NCAA’s minimum requirements, and the team is no longer affiliated with a conference. UMass architecture and history professor Max Page, who co-authored the 2014 report, says, “Just don’t do it.” Financial uncertainties make Larsen’s decision tough, but there are other factors. Fargo doesn’t part easily with tradition. Abandoning outdoor Dacotah Field for the city-owned Fargodome in 1993 took convincing, as did the move to Division I from II in 2004. Many in the city worried about cost and whether the team could compete. One tradition that would be lost forever is the annual pilgrimage to Frisco, Texas, for the FCS title game. An app called BisonTracker keeps tabs on the 20,000 fans journeying to “Fargo South”; the first to hit the state line plant a Bison flag. Another might be lunch: After the first half of a mid-August practice, linemen pile onto the bed of a pickup—pads, cleats, and helmets—and drive off to get lunch at a dining hall; it’s a scene more reminiscent of high school than college. At the University of Oregon, on the other hand, a new 145,000-square-foot facility has a cafeteria that feeds all its athletes. Unwinding these traditions could threaten the sense of community Fargo has worked hard to build. Downtown Fargo has benefited in recent years from its close ties to NDSU, beginning in the mid-2000s, when the university moved its architecture and business programs into the heart of the city. That brought in young people, which in turn created demand for new bars and restaurants that breathed life into the once-staid part of town. A move to the FBS could put distance between the Bison and their city, subtly undermining the university’s relationship with its hometown if all that glitz, glamour, and glory materialized. Technically, the Bison would have to be invited up to the top tier, and though Larsen says he hasn’t received a formal offer, he says he’s spoken with a few commissioners. He’s cagey about details, however, and commissioners of the five smaller FBS conferences who might be most inclined to make an invite either declined to comment or didn’t return calls seeking comment on any Bison rumblings. Some players have no hesitation about speaking out, including 6-foot-3, 245-pound linebacker Nick DeLuca, who was playing for NFL scouts at the mid-August practice. “We’re at the top of FCS right now,” he says. “Why change that?” It’s a question Larsen ponders, as well, while watching the team practice from his sparse corner office in the new athletic complex. “Now that I’ve been here two years, having been through two national championship runs, having the last six playoff games at home, in the Fargodome, sold out, on ESPN,” he says, “that’s tough to trade.”

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The Critic

THE ’RITHM IS GONNA GET YOU

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T

MathBabe Cathy O’Neil is out to stop the Big Data monster. By Katherine Burton

he decision to leave her job as a tenure-track math professor at Barnard College and join hedge fund D.E. Shaw in 2007 seemed like a no-brainer. Cathy O’Neil would apply her math skills to the financial markets and make three times the pay. What could go wrong? Less than a year later, subprime mortgages imploded, the financial crisis set in, and so-called math wizards were targets for blame. “The housing crisis, the collapse of major financial institutions, the rise of unemployment—all that had been aided and abetted by mathematicians wielding magic formulas,” she writes in Weapons of Math Destruction: How Big Data Increases Inequality and Threatens Democracy (Crown, $26). The book chronicles O’Neil’s odyssey from math-loving nerd clutching a Rubik’s Cube to Occupy Wall Streeter pushing for banking reform; along the way, she learns how algorithms—models used by governments, schools, and

companies to find patterns in data—can produce nasty, or at least unintended, consequences (the WMDs of her title). Her first move to rehabilitate math’s image came in 2009. Dismayed by the banking fiasco, O’Neil quit Shaw—the company traded in a wide range of securities—and vowed to fix the system. She took a job with RiskMetrics Group, which analyzes risk for banks, but soon discovered that clients had little interest in hearing about findings that cautioned against risky practices. By 2011 she’d left finance for good. O’Neil’s next step was a tad curious. She rebranded herself as a data scientist and joined a startup that built models to predict consumer behavior on travel websites. Belatedly, she realized what should have been obvious from the beginning: Finance and e-commerce companies “replace people with data trails, turning them into more effective shoppers, voters, or workers to optimize some objective.” About the same time, O’Neil started a blog called

M MathBabe. She wanted to spread the word about WMDs and stop the use of w ssloppy statistics and biased models that ttended to hurt the poorest people most, whether those stats were used to senw ttence prisoners or target consumers with predatory ads. w When Occupy Wall Street began in llate 2011, she heard interviews with prottesters who were often ignorant about tthe basic concepts of finance. So she decided to join them. “Soon I was facilid ttating weekly meetings of the Alternative Banking Group at Columbia University, B where we discussed financial reform,” w sshe writes. That’s the sole description of her work with the movement, and it’s o a lost opportunity. A person with her background would have had unique b iinsight into the group’s inner dynamics. Some of the “math destruction” O’Neil writes about has been reported O elsewhere, but it still provides ammue nition for her argument. She describes n ccompanies using ZIP codes as a proxy for creditworthiness, which leads to predatory lending and hiring discrimination. And she discusses the model Starbucks created to staff stores that left employees with erratic schedules, causing childcare nightmares and sleep deprivation. Other examples are more surprising, if only because they illustrate how small decisions can have huge consequences. She says the U.S. News & World Report college rankings have contributed to skyrocketing tuition because of a basic design flaw. The magazine came up with 15 proxies, including SAT scores, student-teacher ratios, and acceptance rates, that seemed to correspond with a successful institution. One factor U.S. News didn’t consider was cost. If it had, administrators might have been more concerned with fees, and a lot of us might be in a lot less debt. Sometimes O’Neil’s comments on corporations are not as nuanced as you’d expect from a math-prof-turned-hedgefunder. “The model is optimized for efficiency and profitability, not for justice or the good of the ‘team.’ This is, of course, the nature of capitalism,” she writes. Yes, but there are responsible companies and others that behave badly. The book does raise acute awareness about the vigilance of data scientists. The choices they make in constructing models, she says, shouldn’t just be about logistics, profit, and maximizing efficiencies. They need to be about fairness, too.

ILLUSTRATION BY JAY DANIEL WRIGHT

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1956 Mike’s Subs opens in Point Pleasant, N.J.

Marketing

1971 Peter Cancro, 14, gets a job at the shop

1975 Cancro buys Mike’s Subs for $125,000, helped by an investment from his high school football coach

1978 The restaurant adds its first hot sub, cheesesteaks, to the menu

1987 Cancro changes the name to Jersey Mike’s and begins franchising

2007 The company hires as president Hoyt Jones, who’d spent more than 20 years at Domino’s Pizza

Submarine

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F

or a restaurant chain trying to build a national brand based on quality and freshness, a strong association with the state of New Jersey is a mixed blessing. A ­reference to the Garden State can evoke pleasantries such as tailgating at a Bruce Springsteen concert or the whiff of something rotten—the Lincoln Tunnel, waste management, Bridgegate. Despite the marketing challenge, Jersey Mike’s Subs, based in Manasquan, N.J., is, uh, eating away at market share across the country at a time when ­industry leader Subway is faltering. For the last three years, the trade publication Nation’s Restaurant News has named Jersey Mike’s the fastest-­growing chain in America: The company had about 700 stores at the end of 2013 and now has more than 1,500 open or in development. Annual sales have grown from an ­estimated $402 million in 2013

to $675 million last year, according to Technomic, a research company. Despite its rapid expansion, you may have never heard of Jersey Mike’s. The chain keeps a low profile in the media and only recently began advertising on national television. Even so, it’s hardly a hoagie arriviste; it traces its roots to a family- owned business, Mike’s Subs, which opened in the beach town of Point Pleasant in 1956. Peter Cancro, the owner and chief executive officer, landed a job at Mike’s as a teen in 1971. A few years later he bought the place. In the ’80s, Cancro changed the name and began selling franchises. Jersey Mike’s grew gradually through the years, but a broader trend in American dining is driving its sudden proliferation, says Darren Tristano,

Technomic’s president: the surging ­ opularity of fast-casual chains. They p offer quickly prepared, c­ ustomizable meals that are slightly more healthy than traditional fast food and cost a bit more. The concept first shook up the hamburger industry when Five Guys Burgers & Fries and Shake Shack started luring away some customers from Wendy’s and McDonald’s. Tristano says the same dynamic is now roiling the pizza, chicken, and sandwich businesses. Among other submarine slingers benefiting from the upheaval are Jimmy John’s and Firehouse Subs, Tristano says, all of which are expanding. In the meantime, Subway is struggling. In the past two years, according to Technomic, U.S. sales at Subway, the largest fastfood chain in the world, have fallen

FAST-CASUAL CONQUERED BURGERS. NEXT UP: HOAGIES

PHOTOGRAPH BY PAT O'MALLEY FOR BLOOMBERG BUSINESSWEEK; STYLIST: PETER B. SAMUELS

Jersey Mike’s is taking a bite out of the fas


The company begins its annual Month of Giving, raising $600,000 for 66 local and national charities

Etc.

Cancro buys a Manhattan condo for $15.7 million

2011 Jersey Mike’s receives federal trademark protection for “Mike’s Way,” proprietary terminology for one of its most popular topping combinations: sliced tomatoes, shredded lettuce, red wine vinegar, olive oil, and Italian spices

2014 The company begins an ad campaign in 35 local cableTV markets (tag line: “A Sub Above”)

2015 Jersey Mike’s opens 197 restaurants, passing the 1,000 mark

2016 The company will become an official sponsor of University of Notre Dame home football games on NBC

e Warfare

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t-food sandwich business. By Felix Gillette 3.5 percent as consumers have rejected its fast-food approach in favor of more artisanal breads, meats, and cheeses. In 2015 longtime Subway spokesman Jared Fogle went to prison after pleading guilty to sex crimes. “Our brand led the way for thousands of entrepreneurs to own and operate their own business around the world and for other brands to enter the sandwich segment,” a Subway spokesperson says. The dining area inside a Jersey Mike’s has a nostalgic, seaside vibe—a surfboard here, a vintage boardwalk postcard there. Customers place orders with an employee in a blue apron standing over a manual deli slicer. The apparatus is at once f­ unctional—the meat on each sandwich is sliced to order—and t­ heatrical, turning the act of hero making into a rhythmic procession of ham and salami, pepperoni and provolone, tomato and shredded lettuce. (Add olive oil, vinegar, and Italian spices, and you’ve got it

“Mike’s Way.”) Hoyt Jones, president of the company, says slicing meat in front of lunchgoers is key to establishing Jersey Mike’s bona fides as a purveyor of superior, handcrafted subs, not a rote assembler of prepackaged foodstuffs. “The slicer is the quarterback of the store,” Jones says. “It’s a coveted position.” It also helps, he says, that the hot sandwiches are cooked to order on flat-top grills and not heated up in microwaves. The resulting subs deliver livelier flavors than what you get at Subway. They’re also more expensive. Nationally, a regular-size original Italian plus a fountain soda and chips goes for about $11. Josh Funderburk, the director for training, who joined the company 20 years ago, says the menu at Jersey Mike’s has changed only slightly since its inception. (Bologna sandwiches were removed.) Despite its growing success, the company tamps down the swagger. If you invert the preening, hot-tub

splashing, ab-flashing attitude made famous on MTV’s Jersey Shore, you get the culture of Jersey Mike’s. “One of the sayings we have is, ‘Don’t spike the football,’ ” Funderburk says. Across the country, seasoned fastfood franchise owners are scrambling to join the fast-casual wave. For about 20 years, Jim Denburg owned almost a dozen Domino’s Pizzas from New York to Amsterdam. Five years ago he sold his franchises and got into the betterburger business, opening up several Smashburgers. Recently, Denburg hooked up with Jersey Mike’s. Later this year, in Uniondale, N.Y., he’ll open the first of five sub shops slated to colonize the Long Island suburbs. Although the burger space has become crowded, Denburg says, he sees room to grow in the delisphere. “Americans love a great sub, and in most places the choices are limited,” he says. “Jersey Mike’s fills that void.” He r­ ecommends the roast beef. <BW>


Astrology

M E T

H ORO R E B S By Ashleigh D. Johnson

SE

PE

U The four most ill-timed product debuts in recent U.S. history, according to Noël Fisher, administrator for the annual Most Memorable New Product Launch Survey —Katie Morell

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Segway, December 2001 It cost $5,000 in a recession. Coca-Cola C2, June 2004 With half the calories and carbs of regular Coke, it was marketed as a more masculine alternative to Diet Coke. Too bad Super Size Me had just killed Americans’ thirst for soda. Microsoft Zune, November 2006 Five years too late to catch the iPod. Amazon Fire phone, July 2014 With no real differentiating features, it launched alongside better phones from Nokia, Samsung, and HTC.

4

The top five songs on sad-themed Spotify playlists: i hate u, i love u (feat. Olivia O’Brien) by Gnash Breathe Me by Sia Let It Go by James Bay Skinny Love by Birdy Fix You by Coldplay

C O

P

Etc.

Mercury, the planet of communication and sales, goes into retrograde on Aug. 30. Save your energy, avoid the bad timing, and gear up for a big October. September begins with a new moon in Virgo that’s also a solar eclipse. Think of this time as an emotional reboot, especially as it pertains to your productivity, health, and wellness. Fortune favors the well connected on the ninth. That’s when Jupiter, which handles foreign relations, education, banking, and public relations, moves into collaborative Libra. Jupiter spends about a year in each sign, so for the next 12 months, your luck will come from maintaining harmonious affiliations. Can you work through problems and compromise? Make sure all deals are a win-win for the best results. Beware: A week later the lunar eclipse could send your month into a tailspin. Lunar eclipses show us the darkest parts of ourselves, and under introspective Pisces, you may be grappling with angst. It won’t last long, however. On the 22nd, Mercury moves out of retrograde and the sun moves into Libra, showing you that life isn’t so bad after all. The next day, Venus shifts into strategic Scorpio. Venus is the planet of company assets, popularity, and partnerships, so find out what your clients want and start figuring out how to deliver it as of Oct. 1. Helping you work hard toward those goals is Mars, the planet of action, drive, and energy, which moves into discipline-loving Capricorn on the 27th. Closing out the month is a new moon in Libra on the 30th, which brings calm to your relationships.

H

Three important aspects of closing a deal, from 1987’s Trump: The Art of the Deal by Donald Trump and Tony Schwartz 1. Play the numbers: “For starters, I keep a lot of balls in the air, because most deals fall out, no matter how promising they seem at first.” 2. Use your leverage: “The worst thing you can possibly do in a deal is seem desperate to make it.” 3. Brace yourself: “If you plan for the worst—if you can live with the worst—the good will always take care of itself.”

This month seem especially eclipsey? That’s just a coincidence: Solar and lunar eclipses always occur in pairs, spaced two weeks apart, on the full and new moons.

A 0

For even more energy, blend a version of Juice Generation’s Energy Kick smoothie (20 ounces, $7.25) at home. It has about 40 percent of the caffeine of a cup of coffee. —Kayleen Schaefer 10 oz. orange juice ½ cup blueberries ○ ½ Sambazon acai pack ○ ½ banana (frozen) ○ ½ tsp. matcha ○ ½ tsp. maca root ○ ½ tsp. yerba maté ○ ½ cup ice ○ ○


What I Wear to Work What is Le Red Balloon? I work with women in leadership—most are the only female or person of color at their level. I’m working to redefine the standard of beauty in America. That’s my goal.

DITA EYEWEAR

FOREVER21 What’s your style? Just enough too much. I like your necklace. It’s really expensive and fragile. No. It cost $8.

Etc.

SKYLER MCCURINE

29, personal stylist, founder, Le Red Balloon, San Diego VINTAGE SEIKO

FOREVER21

H&M

Tell me about your hair. I grew it out for nine years, and everyone was like, “Don’t buzz it off!” But I was starting to hide behind my hair—like that was what was making me beautiful. You can’t hide behind a bald head.

STEVE MADDEN

PHOTOGRAPH BY CHRISTOPHER LEAMAN FOR BLOOMBERG BUSINESSWEEK

ANTHROPOLOGIE

Your shoes are a traditional men’s style. I like taking menswear and making it feminine— effortlessly sexy and easy.

What was the thought process behind buying that shirt? I was looking for something to wear to a concert, and I figured my friends would never lose me in this. Highlighter yellow is one of my favorite colors.

Your shorts are reflective. They’re metallic spandex. I didn’t even know that was possible.

Your bag kind of matches that curtain. I purchased it before the world started fringing out. I love unique details: pompoms, neon—the wilder, the better. TARGET Interview by Arianne Cohen

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MARNE LEVINE Chief operating officer, Instagram

Laurel School graduation

Education

Laurel School, Shaker Heights, Ohio, class of 1988 Miami University, Oxford, Ohio, class of 1992

“Freshman year everybody had posters of Prince on the walls. I had a DukakisBentsen poster. I majored in political science and speech communication.”

Harvard Business School, class of 2005

Greeting President Obama with her sons, 2009

1993–2000 U.S. Department of the Treasury

2001–03

Chief of staff for Harvard President Larry Summers

2006–08

“I worked on person-to-person online money transfer. One of my first tasks was to prioritize 1,000 bugs after user testing. I didn’t know what a bug was. It was a long night.”

“You name a part of the world, I traveled to it.”

Director of product management, Revolution Money

2009–10

Chief of staff, National Economic Council, special assistant to the president for economic policy

With Summers (center); her father and mother, Mark and Teri (left); and a family friend, mid-’90s

feel they have permission to own their mistakes, too.” 3. “Make ‘Why?’ your favorite question. It feeds your curiosity.”

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“I worked under three secretaries. We worked on everything from the Asian financial crisis to low-cost bank accounts to predatory lending.”

Work Experience

“I was supposed to go to business school, and Larry said, ‘You’re already planning to go to Harvard. Why don’t you come and be chief of staff?’ One year turned into two.” “My second child came in September 2008, and I joined the Obama transition team in November. I was part of the group that opened the White House doors on Inauguration Day. And then I basically didn’t leave for two years.”

2010–14

Vice president for global public policy, Facebook

2015– Present

COO, Instagram

Speaking at a U.S. Department of Labor news conference, 2011

“Video is just exploding on Instagram—motion is the new filter. We’re going to help people use visuals to tell their stories.”

ot

Life Lessons

In a photo on her Instagram account, celebrating six years at Facebook, 2016

hers

“My senior project was about solid-waste management. They nicknamed me Trash Queen.”

1. “Say thank you, and say it often—publicly, privately.” 2. “Be open about mistakes. I often ask people what I did wrong in the last meeting, because th

en

Bloomberg Businessweek (USPS 080 900) August 29 – September 4, 2016 (ISSN 0007-7135) H Issue no. 4488 Published weekly, except one week in January, April, June, and August, by Bloomberg L.P. Periodicals postage paid at New York, N.Y., and at additional mailing offices. Executive, Editorial, Circulation, and Advertising Offices: Bloomberg Businessweek, 731 Lexington Avenue, New York, NY 10022. POSTMASTER: Send address changes to Bloomberg Businessweek, P.O. Box 37528, Boone, IA 50037-0528. Canada Post Publication Mail Agreement Number 41989020. Return undeliverable Canadian addresses to DHL Global Mail, 355 Admiral Blvd., Unit4, Mississauga, ON L5T 2N1. E-mail: bwkcustserv@cdsfulfillment.com. QST#1008327064. Registered for GST as Bloomberg L.P. GST #12829 9898 RT0001. Copyright 2016 Bloomberg L.P. All rights reserved. Title registered in the U.S. Patent Office. Single Copy Sales: Call 800 298-9867 or e-mail: busweek@nrmsinc.com. Subscriber Services: Call 800 635-1200 or log on to our website: http://www.businessweek.com/ custserv/manage.htm. Educational Permissions: Copyright Clearance Center at info@copyright.com Reprints & General Permissions: The YGS Group at 800 290-5460 x100 or businessweekreprints@theYGSgroup.com. PRINTED IN THE U.S.A. CPPAP NUMBER 0414N68830

How Did id I G Get et H Here?

Courtesy subject (4). Getty Images (2)

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DATA LEADS TO INSIGHT. INSIGHT LEADS TO OPPORTUNITY. OPPORTUNITY LEADS SILICON VALLEY TO OHIO. Saama is smart. Which is why they’re expanding in Ohio. Saama, the Silicon Valley-based leader in mining data-driven insights, needs talent and thriving business ecosystems to succeed. Which is exactly what they discovered in Ohio. But don’t take our word for it. Take theirs. See why Saama chose Ohio at jobs-ohio.com/Saama

Welcome to Ohio. It’s on. Tech pioneer Ken Coleman, Saama Chairman


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