January 11, 2008

Retailers at Risk?

Even the rich are keeping their hands in their pockets. A report from Bloomberg this morning says that owing to an unexpected decline in December sales at Marks & Spencer Plc, the U.K.’s biggest clothing retailer, that it and other major European retailers could run the risk of defaulting on their corporate bond obligations. As a result, the report goes on to say that credit-default swaps on the Markit iTraxx Hi Vol index of 30 investment-grade companies, including seven European retailers, soared 7.5 basis points to 99.5, according to JPMorgan Chase & Co., the highest since the index was created in 2004.
Here's why that's a bad thing. Credit-default swaps are used to specualte on a company's ability to repay debt and are priced inversely to the risk they present. The greater the risk, the higher the price. Other companies that also saw their credit-default swaps rise where luxury goods conglomerate LVMH Moet Hennessy Louis Vuitton SA, retailer Next, and BAA, a subsidiary of Spanish construction giant Grupo Ferrovial which owns and manages seven airports in the U.K., including London's Heathrow, Gatwick, and Stansted.

The report went on to say that in the U.K. consumer confidence fell in December to the lowest in 10 months, according to the Nationwide Building Society.

But companies like LVMH still have plenty of padding to keep them warm during lean times. In June, when the company announced its half-year results, reported more than €1.4 billion ($1.8 billion) in operating profits.

The Travel Industry in 2008

The nice folks over at Deloitte & Touche were good enough to send me their new report looking at what trends to look for in the travel, hospitality and leisure industry in 2008. While there was a lot of good news over the past year there are some potential squalls ahead.

Read on for some of the high- and low-lights:

* In 2007, U.S. travel and tourism demand is expected to generate $740 billion in total industry sales, rising 21.9% since 2004.

* Major U.S. airlines reported better-than-expected results in the third quarter of 2007, despite escalating operating costs and increasingly dissatisfied customers.

* Leisure travel was also up. A survey by Deloitte says that 93% of respondents took a vacation in the 12 months prior, up from 83% in 2005.

* U.S. hotels are continuing to gain in pricing power. A study by Smith Travel Research shows that in the first nine months of 2007, average room rates rose 5.7% while revene per available room (RevPAR) also gained 5.7%, and full year RevPAR is expected to be up 6%.

* U.S.-based cruise lines are also doing well, thanks in large part to both Baby Boomers on holiday as well as to increasing demand from foreign travelers.

* The casino industry continues to have a hot hand. Domestic and international growth is up and gross gaming revenues in the U.S. for 2006 climbed 6.8% over 2005 to reach a record $32.42 billion. Tribal gaming increased 13.7% to $25.7 billion.

* In the food service sector, menu prices rose 4.1% in the 12 months ending September 2007, the strongest year-over-year gain in more than 16 years.

But there are, as mentioned, some disquieting factors too. As the report notes: "The THL industry's positive momentum, however, is tempered by growing concerns in late 2007 around economic indicators such as a tightening in U.S. credit lending, a slumping housing market, and a softening in consumer confidence. Many consumers who previously relied on cash-outs from refinanced mortgages to support THL spending now have limited access to this source. Higher costs for fuel, commodities and labor are likely to put mounting pressure on profit margins, and competition in intensifying in an increasingly global economy. Considering these and other factors, the outlook for 2008 is cautious optimism. Growth for the industry is expected to move at a slower pace than in recent years, but concurrently there are dynamic opportunities for achieving differentiation and deepened customer relationships."

Hmmmm. "Cautious optmism" always strikes me as a dangerous oxymoron. Sounds as though the extraordinary run-up the THL industry has enjoyed over the past few years could be about to stall. My hunch is that those companies that are expanding in developing markets such as China will continue to do well as will those companies that cater to the luxury and corporate traveler. Those that concentrate on middle-of-the-road package travelers could be walloped.

Diageo's Sober Outlook

Normally January is a good time for the wine and spirits industry. Coming off what is usually their most profitable quarter, thanks to the holidays, they are more likely to greet the New Year without the hangovers common to so many of their best customers. But this year even the kings of the booze business may feel in need of a few restorative Bloody Marys.

The reason? Concern about consumer spending and exchange rates in 2008. Even Diageo (nyse: DEO), the world's largest wine & spirits company, is looking a tad shaky. According to the AP, the London-based company's Chief Financial Officer Nick Rose said Tuesday that it was "sticking by its forecast of 9% growth in operating profit for the current financial year but acknowledged the target was "probably feeling a little more stretching" amid tougher business conditions.

The company, which owns such well-known brands as Johnnie Walker, Tanqueray, Cuervo, Guinness, Smirnoff and Sterling Vineyards, is a global powerhouse, trading in 180 markets worldwide and generating more than $15.7 billion in sales in 2006, up 19.5% from the previous year. (The company's fiscal year ends in February.) It is aggressively expanding its reach in developing markets, particularly in China and Russia, and is currently trying to add Absolut vodka to its portfolio.

This expansion is key to the company's long-term growth. As Rose noted sales of Guinness were slowing in traditional markets in Europe while they were picking up in newer markets. Rose took a cautious tone when discussing North America: "the current view...is that it's holding up and will continue to hold up."

Fortunately, the company's portfolio is diverse enough that it covers both the middle and high-end of the bar. They may end up selling fewer bottles of Johnnie Walker Blue, which retails for around $240 a bottle, but more of the less expensive Red Label, which sells for around $200 less. One thing is certain, if the year ahead is as tough as they think, the liquor industry may that it could really use a big drink by next January.

Tommy Designs an IPO

Most fashion designers are lucky if they can take their brand public once but not Tommy Hilfiger. The big-toothed, Elmira, N.Y., native who won the CFDA’s Menswear Designer of the Year in 1995 looks as if he is gearing up for an unprecedented second IPO of his eponymous company early in 2008.

That’s because U.K.-based Apax Partners, the private equity firm that took the clothier private for $1.54 billion at the end of December 2005, is looking to make Hilfiger one of three major fashion labels to go public this year. (The other two are Prada, which we blogged about here, and Salvatore Ferragamo.) Apax’s potential pay day? £2 billion—or approximately $3.9 billion.

The question is whether there is real appetite in the marketplace for another Hilfiger IPO. The reason why Apax bought the company in the first place was that its share price was being pummeled. From a high of $40 a share in the late 1990s it dropped to $6, as the hip-hop crowd it was courting at the time moved on to other looks.

In recent years, Hilfiger--the man and the brand--have kept a lower-profile. The company is today based in Hong Kong and is run by David Dyer, formerly CEO of Land's End. The brand also owns Karl Lagerfeld, the brand not the man. (In addition to his work for his eponymous label, Lagerfeld also designs for Chanel and Fendi.) Once ubiquitous in American shopping malls and magazine ads, Hilfiger is not as high profile as he and his clothes are not as high profile as they had once been.

Maybe keeping out of the public eye will help Hilfiger once again reinvent himself and appear fresh to a new generation of consumers. Lately he has been more on display, introducing a series of live music events in the UK called the Hilfiger Sessions and solidifying his credentials with European soccer fans by signing footballer Thierry Henry as a "global brand ambassador." There is no question that he has design chops. But for a man who was once considered to be the next Ralph Lauren he has a long way to go.

Porsche Goes Green

For years Porsche has paid millions of dollars annually to the U.S. government for its failure to adhere to corporate average fuel economy (CAFE) standards for its cars and SUVs. That could be about to change. According to U.K. site Autocar, Porsche is planning on rolling out hybrid versions of both its Cayenne SUV and its unreleased Panamera GT coupe.

News of the Cayenne hybrid was first announced in 2005 but a prototype went on display last fall at the Frankfurt auto show. It is now expected to be available by 2009. The Cayenne hybrid will feature a 34-kilowatt electric motor with a 3.6-liter, 290-horsepower V-6 and nickel-metal-hydride battery pack. Porsche estimates it will be able to get combined mpg of 24—a big improvement over the regular V-6 model, which gets 14/20 city/highway. Furthermore, the Cayenne hybrid is expected to be able to cruise on electricity at speeds of up to 75 mph.

Harper's Top Hideaways

The Abbaye de la Bussiere in Burgundy. Winner of Andrew Harper’s Hideaway of the Year.
I love Andrew Harper. What Rober M. Parker is to wine, Harper is to luxury travel. (Full disclosure: I edit Parker’s weekly wine column in Businessweek. Call me biased. The man is a genius.) But a hotel getting a rave review from Harper is just like a wine getting a 95 from Parker; it automatically launches it into the stratosphere. When Harper’s newsletter—Andrew Harper’s Hideaway Report—arrives every month, I eagerly rip open the envelope because I know I will be getting what is arguably some of the best—and most original—travel recommendations in the business. I was particularly pleased when his January newsletter landed on my desk today because in it he lists his 2008 Grand Award Winners. But don’t expect to read about any Four Seasons here. These are “relatively small in size and possess a relaxing atmosphere and…demonstrate a consistent devotion to personal service.” To get a synopsis of the ‘08 winners, read on.

--Wheatleigh (Lenox, Mass.)
--The Resort at Paws Up (Greenough, Mont.)
--The Heritage House (Mendocino, Calif.)
--Wickaninnish Inn (Tofino, B.C., Can.)

--Casa de Sierra Nevada (San Migeul de Allende, Mex.)
--Hacienda de San Antonio (Colima, Mex.
--Carlisle Bay (Antigua)

--Convento do Carmo (Salvador)
--Pousada Maravilha (Fernando de Noronha)

--Hotel Caruso (Ravello)
--J.K. Place (Capri)
--Masseria San Domenico (Savelletri di Fasano)

--Abbaye de la Bussiere (Burgundy)
--Hegia (Biarritz, France)
--Hotel Marques de Riscal (Elciego, Spain)

--Cringletie House (Peebles)
--Minmore House (Glenlivet)

Southern Africa
--Little Ongava (Namibia)
--Shumba Camp (Zambia)

South Asia/Japan
--Amankora (Bhutan)
--Gora Kadan (Hakone, Japan)

Australia/New Zealand
--Capella Lodge (Lord Howe Island, Aus.)
--Claremont Estate (Waipara, N.Z.)

Harper also cites his favorite restaurants of the year. They are: Eleven Madison Park in NYC (Bravo Danny Meyer!); Maison Pic in Valence, France; Arzak, gustatory genius Juan Mari Arzak's eponymous eatery in San Sebastian, Spain; West in Vancouver, Canada; and Aria in Sydney, Australia.

If you want to read Harper's comments about all these places you're going to have to pay for it, though. His newsletter is private and costs $499 per year.

How to Build a Temple in 10 Days

An innovative program encourages students to design and build culturally appropriate architecture
Eight-and-a-half days is barely enough time for most people to get over jet lag when traveling, but for a group of nine students from Catholic University in Washington, D.C., it's a period of intense work in far-flung locations such as Nepal, Machu Pichu, or Ireland. Through a program called Spirit of Place/Spirit of Design, taught by architect Travis Price, the students come to these exotic settings ready to build a project they've spent the spring semester designing. The small structure they erect—whether a temple, a pilgrimage shelter, a sweat lodge, or an outhouse—does not just add to the startling beauty of its locale; it taps into and expresses the location's culture through architecture's symbolism.

Almost 15 years ago, Price had a revelation that great architectural forms are often mystical and mythical. He sought a way to introduce students to the "mythic modern" by enforcing the need for "poetic specificity." Much like Sam Mockbee's Rural Studio, which has made a brand of regionalism famous, Price aspired to "counterattack homogenized internationalism" by teaching students to draw on a site's culture to give meaning to architecture.

From the beginning, students have shown an overwhelming interest in the program: As many as 135 applied for the nine spots in the first seminar. Now the program includes both an undergraduate 3-credit course and a 9-credit graduate studio.

There are three parts to the class: First, students study a site, its ecology, and culture, and write poems and create sculptures in response. "It's metaphor-driven in the initial stage," Price says. Then, the students' ideas are combined until a single architectural model is chosen for them to build as a group. The second half of the semester turns into what Price calls "IKEA mode"—where every single screw for the project is accounted for, so that when the team goes on-site, the structure can be swiftly built.

What makes this program different from other design-build programs is the focus on teamwork, consensus rather than compromise, and the search for metaphor in architecture. According to former student Brendan Rogers, "It was an education in culture, place, architecture, construction, self, and life all wrapped up in the building of a temple in 10 days. This is only possible when the group becomes an organ fundamental to the common goal." Another former student, Jennifer Doney, says, "In one word: transformative. While I learned a tremendous amount of practical/professional architectural knowledge during the design development during the school year, it was the physical construction of the temple on-site in Bellmullet that will stay with me forever."

Price's goal is to expand the program to another six architecture schools and to catalog his ideas about site-specific design into a pattern language. For now, his program will continue to expand students' minds. "After doing this program, how can a student build a phony Tudor house somewhere?" Price asks. They probably can't, and almost anyone can agree that's a good thing.

We asked Travis Price more questions about his Spirit of Place projects, and this is what we learned:

About the floating house the students built in the Amazon: The house is part of an ecological research and resort village up river with canopy walks, sub-aqua septic systems, photovoltaic systems, and modernist indigenous architecture. It is occupied by visiting researchers and eco-tourists. It's an amazing place with eco-activists running around with CIA and replete with smugglers and drug runners up river. Google Iquitos if you can.

About how he finds the sites for the projects: The sites are generally privately owned. Most times it's a private owner. Many of the projects are also on the edge of government involvement, especially in Ireland where art is high on the agenda for particular government leaders.

Most of the projects come to me years in advance through a vast network I have at National Geographic, architects, and world clients. For instance, this year we are building the National Monument for the 250th anniversary of James Hoban (an architect of the White House) in Callan, County Kilkenny, Ireland (a three-part project: 1. in Desart – birth spot, 2. Callan – the nearest township, 3. Washington, D.C., near the White House).

In 2009, our project will be a new Chuwa Temple deep into the Eastern Plateau of Chungpa, Tibet. We'll be working with monks, local villagers, and repatriates, all with Chinese applause and approvals.

About his adventures: There are so many, many amazing tales for each and every project, like being fire bombed by Maoists in Nepal, having Shamans and royalty worship at oursite when finished and then dining with the Crown Prince three days before he kills all the royal family. Or swimming with piranhas in the Amazon by day and dining on them at night with live grubs. Or, building on the spot where River Dance was spawned in County Mayo, Ireland. Or paying off the Mafia in Pantelleria for designing the shrine of Venus where Odysseus lay with Circe. Or tricking the bureaucrats at Machu Picchu to drink at the opening party of the Star Gazing Temple to sign permits after it was built, while watching repressed Incans arrive to have their first non-Catholic all Quechwa wedding at the site. Or …

So much I am writing my second major commissioned book right now, Spirit of Place: Architectural Expeditions into the Ethno-Sphere, to be published by Palace Press. I anticipate it will be published by the end of 2009. There is a mini-chapter about it in my current book, The Archaeology of Tomorrow.

Cultures and Sacred Space, in addition to being a full graduate studio and concentration, is now a two-year graduate program at Catholic University's Department of Planning and Architecture. I am the director of the concentration.

Coney Island: Rides Again?

A new zoning plan could require controversial developer Thor Equities to scale back its plans for redeveloping the Brooklyn neighborhood
The New York City Planning Department and New York City Economic Development Corporation (NYCEDC) have unveiled a proposed comprehensive zoning plan for Coney Island that could require developer Thor Equities to scale back its plans for building a massive hotel and entertainment complex in the Brooklyn neighborhood. The new framework also might spare the Astroland amusement park, which faced possible demolition, and provide for the construction of affordable housing.

The proposed zoning covers three areas—dubbed Coney East, West, and North—encompassing approximately 19 blocks running from the New York Aquarium to West 24th Street, and from Mermaid Avenue to the famed beachfront Riegelmann boardwalk. In a move to preserve the amusement district in Coney East, a 15-acre area that is home to institutions such as the 1962-vintage Astroland and the landmarked 1939 New York World's Fair Parachute Jump, the area will be designated as parkland in perpetuity. The plan would allow for improvements to the existing amusements, and the construction of new ones on previously abandoned sites, but it would set height limits to preserve views to Coney Island's iconic structures. New buildings may not exceed the 250-foot-tall Parachute Jump.

"Coney Island is not like any other amusement park and if we are going to preserve the historic neighborhood, we have to keep the amusements there," says Purnima Kapur, director of City Planning's Brooklyn office.

Thor Equities has spent $100 million during the last few years to purchase 12 acres, roughly two-thirds of the amusement district in Coney East, and was planning to spend $2 billion constructing a 2-million-square-foot hotel and entertainment complex designed by Ehrenkrantz Eckstut & Kuhn. Some buildings would possibly have exceeded 250 feet tall. But many local businesses and residents opposed this scheme because they were concerned it would overpower Coney Island's historical character.

"The new plan would allow the city to acquire the property and control the future of how the park gets developed," Kapur says, adding that the city is willing to work closely with private developers. "We strongly believe that the private sector can do this."

The proposed plan will require Thor's accordance, as the city does not intend to use eminent domain but instead will negotiate with property owners to acquire land in Coney East. Until it is able to do this, property owners may operate and build amusements under zoning in place today—although current regulations do not accommodate Thor's proposed buildings.

Joe Sitt, founder of Thor Equities, declined to comment on whether he will hold or sell his 10 acres, but a spokesperson says that he remains interested in the area's revitalization.

For the city's part, Kapur says, "we are continuing discussions with Thor and are trying to work out a solution that works for them and with the new plan." Public outreach on the proposed zoning plan will begin before the city initiates the formal land use review process. "We hope to start the formal public process by June 2008 and have the approvals in place by early 2009."

While Thor would be unable to develop the boardwalk as it originally intended, the proposed new zoning plan offers opportunities in the Coney North and Coney West districts, 10.6 acres and 15.4 acres respectively. It allows for more than 1 million square feet of new development on Surf Avenue including zoning for hotels, water parks, restaurants, and entertainment venues such as bowling alleys and movie theaters.

Just yesterday, the city selected a consultant team headed by EDAW and the Rockwell Group to design Steeplechase Plaza in Coney North. It is proposed that this 2.2-acre area adjacent to the Riegelmann Boardwalk and directly south of the Brooklyn Cyclones' KeySpan Park will include a performance space, a park or a water feature, as well as concessions and pavilions.

The comprehensive plan also allows for the development of more than 1,750 housing units in Coney North, adjacent to existing residential areas, and roughly 2,700 units west of KeySpan Park. Unlike Thor's early plan to build luxury condominiums, which it dropped after public outcry, the city's plan includes 900 units of affordable housing.

The city has pledged $73 million to the entire redevelopment of the area, which it hopes will lead to more than $2.5 billion in private investment, and it will work with the NYCEDC to choose developers. Brooklyn will also contribute $7 million and the federal government another $3.2 million.

Housing Slump? What Housing Slump?

Yet more luxury condo projects for the High Line neighborhood on the West Side of Manhattan
The High Line, the Manhattan elevated railway that's undergoing conversion from industrial artifact to public green space, is the work of a trifecta of design-world giants, including architect Diller Scofidio + Renfro, landscape studio Field Operations, and the lighting design firm L'Observatoire. The park also has cast stylish ripples. Since a June 2005 rezoning, the surrounding neighborhood has boomed with upscale condominiums conceived by Lindy Roy, Della Valle Bernheimer, and Neil Denari.

Thanks to the local real estate market's defiance of a downward national trend, developers and architects continue to announce new condo projects that are changing the neighborhood as dramatically as the High Line's own transformation. Although these buildings are clearly intended for the privileged few, they include features inspired by the future public amenity, such as contextual material choices and fenestration patterns as well as large swaths of plants.

For the 19-story tower 200 Eleventh Avenue, for example, architect Annabelle Selldorf designed stainless-steel facades rising from a cast gunmetal-glazed terra cotta base. These elevations are punctuated with large expanses of muntin-gridded glass to evoke industrial-era lofts. The 16 interiors, which include duplex configurations and—a first for New York—elevator-accessible garages integrated with each apartment, hint of suburbia.

Jean Nouvel's second Manhattan condominium project, dubbed 100 11th, responds more abstractly to the opportunities and exigencies of its site. The 72-unit, 23-story building, located five blocks south of the Selldorf project, is designed with Beyer Blinder Belle and presents two unique faces to the neighborhood. In order to approximate the shimmering effect of the Hudson River, which it overlooks, the building's south- and west-facing curtain wall is assembled of 1,700 panes of glass in a variety of sizes and inserted into steel frames at a series of angles. The other elevations, clad in black brick, reflect the neighborhood's industrial buildings, and the residences' all-white interiors are inspired by the art galleries that have been inserted into those original, gritty shells.

At 200 Eleventh Avenue, Selldorf has mounted a vertical mesh screen along one side of the building as a trellis. The lower seven stories of Nouvel's 100 11th overlook a semi-enclosed atrium in which a steel frame suspends containers for trees and shrubs at various heights.

The 1.5-mile-long High Line park will partially open this summer, between Gansevoort and West 20th streets. As its next phases are launched in the following years—between 30th and 34th Streets, the elevated railway is owned by the MTA and still faces an uncertain future—the collection of new architecture surrounding it promises to grow.

Last June, for example, Steven Holl announced that he was designing the Highline Hybrid Tower, the architect's first large-scale project in New York. “In my future vision, New York City would have a great variety of sectional inventions and new urban experiences,” Holl later said in a statement, suggesting that the tower would interact with the public sphere vertically as well as at street level.

And in October, marketing began on Metal Shutters House, Shigeru Ban's first new-build condominium in the U.S. This 11-story structure features pivoting glass walls and motorized metal shutters that can encase large terraces. It is located just steps from 100 11th.

Best Corporate Practices 2008

Sometimes the difference between the best and worst company policies comes down to one thing: trust. Learn how to use it
Last year, we showcased some of our favorite corporate management practices in this space, and BusinessWeek.com readers responded in droves. Easy as it is to focus on the stupidest, most annoying corporate practices we encounter—from no-moonlighting policies to "stitch-level" dress code policies—it makes sense to highlight the smart moves that employers make in managing their teams, at least once a year.

As you readers told us, it's often the simple, "win-win" management practices that carry the day—whether it's a corporate fitness program or an especially smart and effective employee-referral bonus plan—because of the partnership messages embedded in them. For instance, a voluntary corporate fitness program succeeds by involving employees in their own improved health and fitness goals—which benefits employers and employees alike—while employers foot the bill or carry the bulk of the cost. How different is the message encoded in a company-sponsored fitness program from the one carried to workers via a mandatory weight-loss or maintenance program, such as the one proposed (and later revised) by Clarian Health?

A Lesson From Recruiters

In fact, much of the gap between the best and worst management practices can be described by that word: trust. At one point as a corporate human resources leader during the dot-com boom, our company switchboard was bombarded with calls from recruiters, seeking to pull away our sharpest technical talent. Our hardworking phone operators did their best to deter search consultants looking to make contact with talent by any means possible, but it wasn't always easy.

A typical ploy was for a recruiter to call the main number and say, "I was at a friend's poker game last night and met an engineer in your company, who lent me his jacket to go home—now I need to return it to him—but I can't remember his name. I think it was Mike Phillips? Mark? Mike Phipps?"

They'd try every trick in the book to be connected to a possible recruit in those pre-social-networking, pre-Google days. Eventually, we gave up trying to head the headhunters off at the pass, and developed a different strategy.

Turning It Around

We said to our phone operators, "Let the calls through." We said to our technical folks, "Talk to these guys. Write down everything they say. Learn as much as you can about the jobs they're recruiting for, the projects our competitors are working on, and the salaries they're paying. Fill out this form every time you pick a recruiter's brain, hand us the form, and we'll pay you $50." Presto—some of our folks made a bunch of money in a short time, we learned boatloads about the hiring activity around town, and most important, we enrolled our employees in helping the company meet its goals.

An approach like this is a hallmark of many of our favorite best corporate practices. View the slide show to find one you can deploy in your organization in 2008. And be sure to let us know what your company is doing that you think is smart.

Starbucks' CEO Refill

As part of a series of moves, the coffee chain, struggling of late, is replacing CEO Jim Donald with founder and former chief exec Howard Schultz
SEATTLE—Starbucks (SBUX) Chairman Howard Schultz is reclaiming the chief executive's chair as part of a major restructuring initiative to slow the company's U.S. growth and improve offerings for its customers.

The Jan. 7 ouster of CEO Jim Donald, coupled with plans to close some U.S. stores and slow down opening new ones, comes as the world's largest chain of coffeehouses has seen its stock plummet 50% over the last year amid declining traffic in its domestic stores.

Starbucks wouldn't say how many stores would close and declined to detail its revised growth plans until it reports fiscal first-quarter earnings on Jan. 30.

The company's announcement after regular markets closed Jan. 7 sent its shares up 9% in after-hours trading. The shares finished the regular session at $18.38, just above their 52-week low of $18.

New Initiatives

In a conference call with analysts, Schultz was blunt in making the point that Starbucks had lost sight of the mission upon which it was founded, losing for many customers "the romance, warmth, and theater" of visiting the retailer's stores. "Much of the problem we have is self-induced," he conceded. "We are going to fix it. There's going to be a comprehensive focus that hasn't existed around here for a long time," he said. "We have to get back to what has made this company great."

Starbucks said the leadership shuffle is part of a series of other initiatives that include closing U.S. stores which aren't performing well, introducing new products and store designs, and improving training for baristas.

The company said it plans to take some of the capital originally intended for U.S. store growth and use it to accelerate its international expansion.

Schultz, who served as CEO from 1987 to 2000, said he plans to remain the company's top executive "for the long term" and that his agenda will also include streamlining the company's management.

Donald had been CEO since March, 2005, when he was promoted from president of the company's North American division to replace Orin Smith, who retired.

Fierce Competition

Starbucks has struggled in recent months as consumers have cut back on spending amid declining home values and higher fuel prices. Meanwhile, competitors like Dunkin' Donuts and McDonald's (MCD) have cut into Starbucks' customer base by launching their own lines of gourmet coffee.

The Wall Street Journal, citing internal McDonald's documents, reported Jan. 7 that the world's biggest fast-food chain plans to add coffee bars with baristas serving cappuccinos and iced coffees at its nearly 14,000 locations.

Schultz acknowledged the competition has gotten fierce and said the company will focus on making changes that will differentiate Starbucks from its growing field of rivals. But he argued competition, rising dairy prices, and a faltering economy aren't the company's main problems.

He told the Associated Press that Starbucks has spent the last several years "trying to invest ahead of the growth curve—in people, process, infrastructure, roasting plants, coffee buying," and that focusing so heavily on that has taken attention away from the experience customers are having in its stores. "This is a problem that I think we've created, and as a result of that, that we can fix," Schultz said.

Some analysts have questioned whether the company has saturated certain markets as it opens an average of six stores a day. Schultz brushed that theory aside, even while conceding it has grown too aggressively.

"I think perhaps we stretched the real estate too far during this economic time, and we're going to dial it back. But we're not going to dial it back with the purpose of changing the growth trajectory of the company," Schultz said.

Schultz's Task

In an infamous leaked memo last year, Schultz lamented that the company's aggressive growth had led to "a watering down of the Starbucks experience."

Yet Starbucks has stuck to its ambitious long-term goal of having 40,000 stores worldwide. Late last year, however, it announced a slight scaling back of U.S. store openings, among other moves aimed at improving operations.

The company, which has more than 15,000 stores worldwide, said in November that it plans to open 2,500 stores this fiscal year, 1,600 of them in the U.S. That's about 100 fewer U.S. stores than it originally planned.

Without providing details, Schultz said the number of store closures will be "significantly lower" than the slowdown in U.S. store openings, and that Starbucks has no plans to pull out of entire markets.

Robert Toomey, an analyst with E.K. Riley Investments, said Schultz has his work cut out for him.

"The growth potential is less and the cachet has changed to some extent—it's more of a chain than sort of a cozy coffeehouse," Toomey said. "I think Schultz is the right person to do the job, but I think it's going to be a tough job."

CEO Path

Before coming to Starbucks, Donald, 54, was chairman, president, and CEO for Pathmark Stores, a supermarket chain based in New Jersey. He has worked at other retailers, including Wal-Mart Stores (WMT). A Starbucks spokeswoman said Donald was not available for comment Jan. 7.

Schultz, 54, joined Starbucks in 1982 as director of retail operations and marketing, then left three years later to start his own company, Il Giornale, hoping to take the Italian espresso bar mainstream in the U.S.

Il Giornale acquired Starbucks in 1987, ending the year with 17 stores. The company went public in 1992 and had nearly 300 stores by the end of the following year.

A Conversation with Yossi Vardi

Israel's legendary startup guru and tech investor explains what he looks for in a new business and how he assesses an entrepreneur's potential
Yossi Vardi is known as Israel's startup guru. For nearly 40 years he has helped to found and nurture over 60 companies in industries that include software, Internet, telecommunications, and energy. At 26, in 1969, he co-founded his first business, Tekem, one of the first software firms in Israel. Vardi was also the founding investor in Mirabilis, which created ICQ, the first Internet-wide instant messaging program. The company was launched in 1996 by his son, Arik, and three friends, and sold to AOL (TWX) in 1998 for about $400 million. The sale helped open the floodgates for numerous Israeli entrepreneurs.

Today Vardi remains active in investing and building startups, including Answers.com; Gteko, which was sold to Microsoft (MSFT); Airlink, which was sold to Sierra (SW.TO); and Tivella, which was sold to Cisco (CSCO). His expertise has been sought by companies all over the world. He has been an adviser to the chairmen of AOL, Siemens (SI), and Amazon (AMZN), among others.

Recently, staff writer Stacy Perman spoke with Vardi about places that foster entrepreneurship, what he looks for in a startup, and how he assesses an entrepreneur's potential. Edited excerpts of their conversation follow:

Why is Israel such a hotbed of entrepreneurial activity, particularly in high tech?

It's not about technology. Technology is like a piano. You need to have it to create music but you really need the pianist. The entrepreneur is to technology as the pianist is to the piano. This is why we see countries with great technologies like those in Western Europe that don't have great entrepreneurs. Western Europe has great companies but not a vibrant startup environment. There is this culture in places like Israel and Silicon Valley where there is a certain energy, where people are willing to take chances and risks and fight for new ideas. It is at a totally different level.

A number of companies, including Google (GOOG), Microsoft, and Intel (INTC) have set up research and development centers here. More are in development.

What do big multinationals see in Israel's small startups?

U.S. multinationals do more R&D here than any other country in the world, more than in China and India, which are known for their manufacturing and software [respectively]. We are in the role much earlier in the food chain. This is a 'startup country,' socially and culturally, it is in our heritage, our ethos. It all started with the kibbutz that started a new way of life in agriculture. The country is constantly renewing itself all the time.

This question often comes up: Is entrepreneurship something that can be learned? Where do you stand in this debate?

No. It can be honed but not learned. Either you have it or you don't. You can learn to write a business plan or to develop software. After ICQ exploded and was downloaded millions of times, I asked myself what was the secret attraction. If you look up ICQ on Google there are 675 million mentions. It is a huge brand. I spent three years trying to figure out why it was so compelling as a product and at the end of the day my conclusion was that it was just something brilliant. It is like Spielberg at the movies or a great painter, you can't learn to be a genius. Either you are or you aren't. The question is: Can you teach someone to be talented? Being an entrepreneur and being talented, those are God's gifts.

You've created quite a reputation for yourself as someone who can divine the next big thing. When you go to invest in entrepreneurs and new ideas, what do you look for?

Let me start by telling you what I don't look for. I don't look at business plans. After 38 years I've found that 100% of business plans say that their idea is very good. I think they are useless. I also don't like PowerPoint presentations. I don't think you can judge the validity of an idea. Maybe someone else is working on the exact same thing elsewhere. I found the more I liked the idea the bigger my losses were. Falling in love with an idea makes your vision blurry. I don't like demonstrations because the young guys showing me are so enthusiastic they think it is the greatest thing in the world—at least in their life, and if you don't fake an orgasm, they go away very disappointed.

What do you look for?

First, I am most focused on the Internet and mobile consumer interface applications because it is the consumer who judges the product every time.

When I go to invest, I am first of all looking for talented people. Second, someone with good character. Third, that they are nimble and their way of thinking is fast because they have a terrific advantage. Fourth, I want them to be focused on one thing. Fifth, I like investing in the very early stage, the first investment where the risk is the highest and the valuation relatively low. This is an area where I feel most comfortable but most other investors do not.

How do you know if someone is talented or not?

This is a very good question. It is like in high school. Who really knows who is talented isn't the teachers or the parents, it is the peers. I have a panel, the best panel of people who know what is going on. I don't take cold calls. First, if someone is going to meet with me they have to be referred to by someone on my panel. It's been working for me. So far this year [2007] I've had five successful exits.

Over the past 38 years how would you measure your wins vs. your losses?

I'd say about a third of my investments have been losses and two-thirds have been winners. But let me qualify the wins: One-third are dragging and not doing great. One third gives a very good return. Of the remaining one third, about 10% gives a very high return, like 10 times the initial investment. In the last five years, I've invested in about 65 companies, and in all of my life about 90.

How do you feel about investing in people whose previous ventures have failed?

If someone has failed that is not a deficiency for me. I think that he has more motivation. I've seen many examples where someone was successful first and failed later and failed first and then succeeded. If they failed in an honest way, I don't see it as a deficiency. In the end, I think that people that are not willing to take the risk to fail are not true entrepreneurs. If you are afraid to fail, then you should go and become a banker.

Market Research on the Cheap

There's no need to spend a bundle on professionals when you can do Internet surveys, mine government data, or even take a clipboard to the mall
Large corporations spend millions on sophisticated surveys and focus groups from established researchers such as Harris Interactive (HPOL) and Survey Sampling to determine whether their products or services will appeal to customers at a price they're willing to pay. But for entrepreneurs operating on a shoestring budget, there are ways to gather key information about your customers and prospects without hiring an outside firm. Here are five practical suggestions to keep in mind.

1. Research the same way you sell. While "market research" may bring to mind spreadsheets and pie charts, your first step before introducing a new product or launching a business should be to interview your potential customers the same way you plan to sell to them, according to Rob Adams, director of the Moot Corp Business Plan Competition at the University of Texas, Austin and author of A Good Hard Kick in the Ass: Basic Training for Entrepreneurs.

"If you sell in person, survey in person. If you sell over the phone, survey over the phone," he says. And for entrepreneurs who plan to sell primarily online, a Web survey can gauge interest. "If you get no results, that should tell you something," says Adams. If you're not sure who to talk to, he says, take a clipboard to the mall (BusinessWeek.com, 11/19/07) on Saturday morning.

Above all, you must have a direct interaction with the people you imagine will buy your product, marketing experts say. John Hauser, a marketing professor at MIT's Sloan School of Management, says his students are astonished when they actually talk to members of their target market, because reality can be so different from their expectations. "I force them to go out and talk to customers. They come back and say, 'Wow, what an experience.' They're just overwhelmed," says Hauser.

2. Mine public data. You've already paid for some of the most expensive market research available—with your taxes. The U.S. Census Bureau Web site contains demographic information you can use, often broken down to the neighborhood level. The census data is far more detailed than just population and income levels. Trying to reach customers during their morning commute? Find out what time most people in your county leave for work. Starting a baby clothing company? Check how many women gave birth in the last year.

Beyond the census, you can search federal databases on banking, labor, housing, agriculture, and imports and exports, all without paying a cent. "You don't have to do primary research, you can do secondary research," says Tom Miller, president of Research Publishers in Madison, Wis., and a former market research professor. "Those data are free." To get started, visit this government site.

3. Recruit B-school students. You may not be able to afford professional researchers, but you can call a local business school and see if a marketing class can help you with your research needs. Many professors are eager to create assignments from projects for small business owners, and students benefit from real-world experience. "The business owner's obligation is to provide the time, share information about the company, and give feedback to the students when it's all over," Miller says.

A marketing class won't match the depth or access to specialized sample groups that professional firms offer. But you'll get a rigorous study at little, if any, cost. "The MBA students learn very systematically all the methods.

We teach them survey, focus groups, in-depth interviews," says Hai Che, marketing professor at UC Berkeley's Haas School of Business. "That can be a high-quality but low-cost method."

4. Survey online. You can select from an array of Internet survey companies to get a quick take on a product or service. Some online polls are free for a limited number of responses. The premium version from Zoomerang, at $599 a year, allows unlimited surveys of your existing customer lists. For extra fees, you can tap into the company's global panel of 2.5 million people and tailor your survey to specific niches. "We offer the ability for companies of any size to select samples of a particular group," says Pam Kramer, chief marketing officer of Zoomerang's parent company, MarketTools. Kramer says purchasing a sample runs around $1,500, but the narrower the group you want to sample, the more you'll pay.

Vizu, which places survey questions in banner ad spaces on blogs and Web sites, can target polls based on the audiences of those sites. "If they want to access business people or tech enthusiasts, we'll limit where we place the poll," says Vizu Chief Executive Dan Beltramo. Marketing experts caution that using online samples may not be as accurate as professionally selected panels. But Beltramo says Vizu's results line up with national polls. For entrepreneurs looking to test a concept before acting on it, online surveys can provide a quick and cheap solution.

5. Create an online community. Web-based businesses in particular can set up and moderate panels online to glean insight from customers. Forums or live chats reveal customers' experience with your product or perception of your brand. If you already have a database of customer information, you can handpick which customers to invite to the forum to get the sample you want.

"Community management is less expensive than traditional market research consulting," says Barry Libert, co-CEO of Mzinga, which creates and moderates customer communities. The company's self-service option, in which the client moderates the community, costs $1,000 per month. Another player in the customer community space, Networked Insights, charges several thousand per month, based on the number of interactions users have in the forum.

Dan Neely, Networked Insights' founder, says companies value being able to gather information directly from their communities. "It's not just small businesses, but businesses all over are looking for tools to let them do the research themselves," he says. The online community provides that tool, he says. "It's like having 500 of your customers standing in a room chatting and you just get to stand there and listen."

Most survey companies like Vizu or Zoomerang offer templates for questions, and marketers suggest asking several iterations of your question to get a sense of how reliable your data are. Even with do-it-yourself solutions available, hiring a professional market research firm can be worth the price. You might test an idea with some homespun queries, but formal surveys provide more precise data to inform a potentially costly decision. Adams, of the Moot Corp competition, advises companies to budget 5% to 10% of their startup costs for market research before making a bigger investment. "I'd rather find out after spending $10,000 that nothing's there, than find out after I personally guaranteed a lease," he says.

Raikes to Follow Gates Out the Door

Microsoft Business Division President Jeffrey Raikes has announced he'll be stepping down in September
Bill Gates won't be the only Microsoft (MSFT) veteran leaving the software giant later this year. Jeffrey Raikes, who joined the company in 1981 roughly as its 100th employee and rose to become president of Microsoft's business division, said on Jan. 10 that he'll retire in September.

The departure is another sign of a changing of the guard at Microsoft, with Gates stepping down June 30 to work full time for his philanthropic foundation. Raikes says he has no specific plans after his retirement, though he's considering a second career in teaching or public service. "I have a lot of passions beyond the industry," Raikes says. "I may explore those."

Successor Named

Raikes will be replaced by Stephen Elop, who stepped down as chief operating officer at Juniper Networks (JNPR). Elop previously held jobs at two Microsoft rivals, Adobe Systems (ADBE), where he was president for worldwide field operations, and Macromedia, where he was president and CEO when it was acquired by Adobe (BusinessWeek.com, 6/19/06). The experience should serve him well in his new role, where he'll run Microsoft's Information Worker, Business Solutions, and Unified Communications businesses when he starts at the end of January. The only part of Raikes' job he won't get is the Server & Tools business, run by Microsoft Senior Vice-President Bob Muglia, who will report directly to CEO Steven Ballmer.

Though he's little known outside of techdom, Raikes, 49, has had more impact on Microsoft than just about any other employee, save Gates and Ballmer. "He's really one of the pioneers of the business," says Pete Higgins, a former group vice-president at Microsoft, who was hired by Raikes and now works as a venture capitalist in Seattle.

Creation—and Revival—of Office

Raikes led the group that wove together Microsoft's word-processing and spreadsheet programs to create Office, one of the twin monopolies that the company has used to dominate the PC industry. The product generated more than $100 billion in sales and has more than 500 million users worldwide. "I'm incredibly proud of that," Raikes says. "I really do feel as though I was part of changing the world."

In the early 1990s, Gates asked Raikes to switch his focus to Microsoft's sales. In 1996, Raikes took over Microsoft's global sales operations. Revenue tripled in the six years he was at the helm.

He returned to Office in 2002, when it was sputtering at 1% growth, turning the old franchise into a business that registered 13% growth in fiscal 2007. Raikes revived sales by shelving the old paradigm of merely adding new features to Office, instead redefining the business to include new markets such as business intelligence, which helps companies analyze data, and unified communications software, which helps link together a company's various communications systems.

Ballmer, in an e-mail to employees about Raikes' departure, wrote, "Very few people have contributed more to Microsoft than Jeff."

Raikes leaves behind a business that, while growing at a good pace, faces a host of new competitors. Longtime Microsoft partner SAP (SAP) competes in the market for small and midsize business software . The company is duking it out with Cisco Systems (CSCO) in unified communications software and services. And it's even crossing paths on the Web with Google (GOOG), which is trying to lure users to its online word-processing and spreadsheet applications.

A Tough Competitor

In addition to contributing to Microsoft's business growth, Raikes etched his name in the company cultural history as well. During the federal antitrust hearings a decade ago, U.S. District Judge Thomas Penfield Jackson cited a memo from Raikes—in which he wrote that "Netscape pollution must be eradicated"—as an example of the company's hypercompetitiveness. Turns out that Raikes was writing lyrics to a rap-parody video, shot for the company's sales force, in which Coolio's Gangsta's Paradise becomes Windows Paradise, with Raikes decked out in Guardian Angel garb.

Of course, Raikes is as competitive as anyone at Microsoft—part of the reason for his success. Back in the early 1990s, when Raikes ran the applications group, Gates once suggested that executives should wake up thinking about their main competitors. So Raikes decided to learn the names and birthdays of the children of Pete Peterson, then head of top rival WordPerfect, something Peterson has since laughed off. But to this day, Raikes still knows all six kids' names.

Raikes long ago made his fortune at Microsoft, and has personally invested in other businesses. Raikes holds 15.4 million shares of Microsoft stock, according to a recent regulatory filing, worth more than $525 million. He's also a part-owner of the Seattle Mariners and the Kelowna (B.C.) Rockets, a minor-league hockey team. He owns a luxury resort on Hood Canal in Washington.

A Nebraskan who proudly flies a University of Nebraska Cornhusker flag from his home during football season, Raikes still owns a piece of his family's nearly 4,000-acre farm in and near rural Ashland, Neb. He just completed a home there where his family will stay during visits, though he intends to remain in Seattle. As work-related travel becomes a thing of the past, that's something he'll get to do a lot more often come September.

So You Want to Publish That Novel

Blurb lets you create any sort of book—even one with photos—for as little as $20
The writer A.J. Liebling famously observed that "freedom of the press is guaranteed only to those who own one." Of course, blogs have made it possible for all to share their views in electronic form. Now advances in printing technology mean you can immortalize your thoughts in a bound book for as little as $20.

Web sites that assemble a collection of your pictures into photo books have been around for a while from Eastman Kodak (EK) and Hewlett-Packard's (HPQ) Snapfish, and from MyPublisher.com. What's new—from a startup called Blurb—is the opportunity to create just about any sort of book and even to sell the finished product online.

Blurb takes advantage of new printing technology, best exemplified by HP's Indigo press. Think of it as the love child of a laser printer and a conventional offset press. Although the actual printing is done with traditional liquid ink instead of toner, the process is laser-guided, eliminating the extremely expensive step of making lithograph plates. As a result, very small press runs and even single copies become practical.

I decided to create a book about a trip I took last summer to Haida Gwaii, the islands of the Queen Charlotte archipelago, just south of the British Columbia-Alaska border. My wife and I came back from the vacation with hundreds of photos. I wanted to combine pictures with text describing what we had seen and learned.

Blurb's BookSmart software is a free download for both Windows (MSFT) PCs and Macs. I chose the Mac version, which integrates with iPhoto for picture management. The Windows version works with Google's (GOOG) Picasa. You create your book one page at a time, choosing a layout for pictures only, text only, or pictures and text. You then edit the photos with whatever program you like, and drop the results onto the page.

Easy, but a Few Glitches

I used Adobe's (ADBE) Photoshop CS3 to edit my pictures, wrote the text in Apple's (AAPL) Pages word processor, and then pasted it into BookSmart.

The Blurb software is easy to use, letting the publisher (that's you) focus on the hard work of getting the text and pictures right. I'm afraid there's no way to truncate this creative part of the job. It took me at least an hour a page to write the text and select and edit the pictures.

I found some aspects of BookSmart frustrating. There are dozens of page layouts to choose from, but sometimes none of them seemed quite right. And I really wanted to be able to resize picture boxes, but there was no way to do that. Also, there is no provision for changing the typeface settings used by default for print, so unless you like Blurb's choices, you must manually change the type settings for each text element. Blurb promises improvements in future software updates.

I created my book by selecting the page layouts I wanted one at a time, but Blurb also offers a number of templates, including cookbooks, poetry, and wedding books. And it can "slurp" the contents of blogs in several popular formats into a book. As soon as you're happy with the way your book looks, you hit "submit," and a few days later it arrives in the mail.

Bound for Glory

I was delighted with how my little 28-page project, Northern Vision, turned out. It's a real book, complete with a glossy jacket and even a standard book number code. It's well printed on heavy stock, the photos are faithful to the originals, and it cost me just $29.95 for a single copy. (It's $10 less for softbound.) There are volume discounts for orders of more than 10, and you can set your own price for copies sold through Blurb's bookstore. That's useful mostly for organizations that want to offer, say, a cookbook as a fund-raiser.

Vanity publishing has been around for about as long as books, but it used to be an expensive indulgence. Technology has democratized publishing, as it has so many things, to the point that anyone who has secretly longed to be an author can go for it.

What's a Widget Worth?

Software developers say their impact is being underrepresented; comScore hopes a new measurement tool will paint a clearer picture
Online social networks will continue to grab the attention of Web users and the advertisers who want to reach them in 2008, but some software developers who help make the networks popular say they're missing out on the spoils.

Social sites such as MySpace, Facebook, and Google's (GOOG) Orkut could crack $1 billion in ad sales by year's end. Yet makers of the so-called "widget" software, whose programs have helped propel the networks' growth, have yet to see much of that revenue, in part because of a lack of reliable data about how many people use their products. "There are a huge amount of page views in social networking, but no one's figured out how to monetize them properly," says Duncan Davidson, a venture partner at VantagePoint Venture Partners, which invests in News Corp.'s (NWS) MySpace and smaller social networks Multiply, FanIQ, and Bluepulse. "It's still an experiment."

Who's Using What Widgets?

Market researcher comScore (SCOR) wants to end the mystery. Considered by many to be the industry standard for audience tracking on the Web, comScore will use a revamped yardstick that could give advertisers, software makers, and investors a better handle on just how many people are using the programs. Under the new method of calculating, almost 586 million individual Internet users viewed a piece of widget software in November, 2007, according to an exclusive look at the data comScore provided to BusinessWeek.com. That's nearly double comScore's estimate in July, the last month it measured using an old system. ComScore plans to release the new widget usage data in mid-January.

What's different? For starters, comScore will now include activity on Facebook, one of the fastest growing social networks. The new method can do that because it records how many Web users click on a given widget. ComScore's previous method only tracked the presence of Adobe Systems' (ADBE) Flash software. That's useful since Flash is used to create many of the widgets used today. But the method didn't work for Facebook, which bars the automatic loading of Flash animations.

The new version of comScore's tool will also account for widgets built with JavaScript, a Web programming language, in addition to those based on Flash. ComScore also plans to measure usage of Google's Gadgets software in future surveys. Linda Abraham, an executive vice-president at comScore, says the new data could give software developers, and companies that want to advertise through their applications, a truer picture of who's using what widgets, and how often. "Widgets are looked on as not yet proven," she says. "We talk to widget companies all the time, and it comes up in every conversation."

"Lumpy" Revenue

Two of the biggest agitators are Silicon Valley startups Slide and RockYou. The competing companies make lighthearted software that lets users add pizzazz to profiles on Facebook, MySpace, and other sites by creating slide shows, comparing friends, or scrawling messages on each others' home pages.

The startups are waging a programming and PR battle for users and advertisers. "It's like Coke and Pepsi," says Jeremy Liew, a general partner at Lightspeed Venture Partners, which invests in RockYou.

But both companies say their popularity has been vastly undercounted, holding back their ability to sell advertising. Other executives and investors in social networking and widget software companies say the absence of accurate usage data for widgets has capped growth in the market: Widget ad revenue was estimated at about $20 million in 2007, or about one-thousandth of Internet advertising as a whole. According to the new comScore data for November, Slide claimed almost 144 million unique viewers, for a 16% market share, and RockYou claimed a 11.7% share, with 104 million individual viewers. In July, Slide had 130 million individual users, or a 15% share, while RockYou boasted 96 million users, or 11.1% of the total.

Improved measurement tools are only one of the ingredients software companies will need in order to build lasting businesses on the backs of Facebook, MySpace, and other networks. Widgets present an attractive new market for advertisers—usage of the software has exploded since Facebook began allowing third-party software on its site in May, 2007, and MySpace is developing an advertising system (BusinessWeek.com, 11/5/07) for independent software vendors as well.

Yet competition among different networking sites means it's harder for advertisers to reach a large audience using the medium. Then there's the lack of a standardized widget ad unit: Should you run a "banner" ad across the top of the page rather than a long, narrow "skyscraper" ad along its side? Factor in advertisers' unease with risqué material on users' profile pages, and it's not surprising revenues have been low. "Current revenue is going to be lumpy," says Lightspeed partner Liew.

Other Obstacles to Ad Sales

Not counting Facebook activity "was absolutely a gross omission" by comScore, says Liew, but Web companies' lack of agreement about whether they're selling widget views, clicks, or installations is a larger barrier to ad sales. "This is a great step forward," he says of comScore's revised numbers, "but it's not enough."

Disney (DIS), for one, has opted not to advertise on pages associated with widgets for such reasons, according to people familiar with the company's thinking. Coca-Cola (KO) has held off on advertising through Facebook's Beacon feature, a controversial program (BusinessWeek.com, 11/30/07) that broadcasts users' online purchases to people in their networks. And while social networks' popularity has attracted sizable investments by some of the computer industry's biggest players—Google spent $900 million in 2006 to place ads on MySpace, and Microsoft (MSFT) in October, 2007, took a $240 million stake in Facebook that valued the company at $15 billion—more serious money from those companies may wait until the networks and widget companies iron out the advertising kinks.

The numbers for social networks are still heady. Traffic is expected to climb 31% in 2008, to 489 million broadband Internet users, according to research company eMarketer. Advertisers are expected to spend $1.56 billion on social networks in 2008, up 69% from $920 million in 2007. But that's still less than 6% of all online ad spending, which eMarketer pegs at $27.5 billion for 2008. And only a tiny fraction is likely flowing through widget software. Will Price, a managing director at Hummer Winblad Venture Partners, which invests in a widget software exchange site called Widgetbox, estimates advertisers will spend just $20 million to $40 million on advertisements linked to widget software in 2008. Others have put the number even lower (BusinessWeek.com, 10/27/07). "No one knows what a Facebook user is worth," says Price.

House of Cards?

In the interim, widget publishers are looking for creative ways to generate revenue. Slide, which makes applications like FunWall, Top Friends, and SuperPoke, has tried offering users branded slide shows with characters from movies Bratz and Bee Movie. The company also sells online photo frames that look like magazine covers.

RockYou, which publishes widgets including Superwall, Likeness, and X Me, has struck deals to promote other widget software makers, collecting 50¢ each time a user installs one of those applications based on an ad on a RockYou page. The company stopped embedding ads in its slide shows after finding that click-through rates ranged between one-fifth of one percent to a little more than 1%, says founder and CEO Lance Tokuda.

But widget software companies need to be wary of foisting too many ads on their users and of building a house of cards based on promoting lots of small companies that, if history is any guide, will eventually go out of business. Says VantagePoint's Davidson: "Widgets live on Facebook, and can also die from it."

A Little 'Intel' on Apple's Next Move

Wondering what Steve Jobs will announce in his Macworld keynote on Jan. 15? The newest chips from Apple's sole supplier offer some intriguing hints
With Macworld Expo just days away, the pre-"Stevenote" buzz is building fast. The rumors about what Apple Chief Executive Steve Jobs might unveil in his keynote speech run the gamut from a new movie-rental service for iTunes and Apple TV to a new tablet PC.

But when guessing what Apple (AAPL) will do in the coming year, it's particularly helpful to look at the roadmap of Intel (INTC), which has been Apple's only chip supplier since 2006. And from the looks of things, the chipmaker may help lead Apple into uncharted, possibly lucrative, territory starting in late 2008.
Subnotebooks: A Perfect Fit

A lot of the speculation has focused on Apple's apparent plan to introduce a small notebook computer, and I think these rumors are pretty close to the mark. For one thing, beyond switching from PowerPC chips to Intel processors in 2006, Apple hasn't made any serious revisions to its notebook line in some time. And the most obvious hole in Apple's computer lineup is in the subnotebook category. Right now, the smallest MacBook sports a 13.3-inch screen and weighs a hefty 5 pounds.

That's why it's time for Apple to launch a new product some are calling the MacBook Mini, with a screen of less than 10 inches and weighing no more than 2 pounds. A new family of Intel chips named Silverthorne may go a long way toward helping Apple get there. These chips will be notable for their very small size, relatively beefy computing power, and very low power consumption.

The first chip of the Silverthorne family, code-named Menlow, is expected to arrive in the first half of this year, probably before June. A second, known as Moorestown, due in late 2008 or early 2009, will be built on Intel's 32-nanometer manufacturing process, which means it will be even smaller and more powerful and it will consume even less power than the Menlow. This will make it a contender for use not only in subnotebooks, but in a new generation of iPhone devices.

There are hints from other vendors using Intel chips that the subnotebook category could be a winner in 2008. Consider the Asus Eeepc, a tiny, $350 notebook with a 7-inch screen that weighs less than a pound and uses an Intel Celeron chip. It runs Linux, supports Wi-Fi, and from what I'm hearing has sold some 400,000 units worldwide. There's also the tiny LifeBook U810 from Fujitsu that sports a 5.6-inch rotating screen, weighs about a pound and a half, and uses an Intel A110 mobile chip.
Expanding the iPhone Universe

Although the tiny Silverthorne is not as powerful as Intel's top-of-the-line Core2 or Core2 Duo, it will support the x86 instruction set that makes a PC chip a PC chip. That's especially noteworthy in terms of the iPhone. Right now, the main chip inside the iPhone comes not from Intel, but from Samsung. And the Samsung chip is not an x86 chip, but one based on a core from Britain's ARM Holdings (ARMHY).

The possibility of squeezing an x86 chip like Silverthorne inside a future iPhone would make adapting software from a future Mac computer for Apple's handheld substantially easier. (This assumes that Apple makes good on its promise to make the iPhone software development process easy and open.) Suddenly, the iPhone would be capable of running pretty much any Mac software with few, if any, programming changes.

While Intel's tiny new chips will be an important factor, Apple may have more dramatic changes in store.
News Flash: No Hard Drive?

I'd expect the new little notebook to ship without a traditional hard drive, relying instead on at least 32 gigabytes of flash memory for storage. Already the world's largest consumer of NAND flash memory after SanDisk (SNDK), Apple is in a better position to popularize solid-state storage in mainstream computing devices than any other vendor. Long-term supply contracts with Samsung, Toshiba (TOSBF), and Micron (MU) give Apple plenty of incentive to design software that can take advantage the unique properties of flash memory. Windows-based vendors such as Dell (DELL) and Hewlett-Packard (HPQ) will have to follow its lead.

But will this new mini-MacBook also get a touch screen like the iPhone's? Perhaps, but probably not. The bigger the screen, the more it will cost. I think that means Apple will skip the multitouch screen to keep the retail price manageable.

The MacBook Mini could conceivably be unveiled as the "Just One More Thing" that appears at the end of every Jobs keynote. It's doubtful the machine would be available for immediate sale because Menlow isn't thought to be shipping in volume yet. But Apple and Intel could surprise us. Intel shipped some 210 million PC chips last year, 7 million of which were for Macs, making Apple one of Intel's most important customers and giving it a reason to move faster than anyone expects.

European Indexes Decline


After an encouraging ascent yesterday, the FTSE 100 (-2.02%) fell deep into the red as weaker-than-expected US non-farm payrolls jolted Wall Street, which also traded lower. The jobs data made the spectre of stagflation reappear stateside, and close to half of the market appears to now be anticipating a 50bp cut by the Fed at the end of the month. In London, the market is bracing itself for some key trading updates next week, including M&S (-4.52%) and SIGNET (-5.86%), which have both been the recipients of some negative broker comments today after bleak updates from NEXT (-5.67%) and DSG (-1.28%) yesterday. CARPHONE WAREHOUSE (+2.64%) escaped unscathed on renewed speculation that VODAFONE (+0.75%) or BestBuy may be interested. The board of Australia's Resource Pacific rejected XSTRATA's (-1.48%) AUD2.85 per share bid, calling it neither fair nor reasonable. Some sources note talk that Brazil's Vale may have initiated due diligence. BA (-2.5%) said passenger traffic was up 1% in December; one analyst noted that a 6.5% rise in premium traffic was disappointing. Insurer ADMIRAL (-2.91%) fell as Merrill Lynch removed the stock from its insurance most preferred list. In the broader market, SHANKS (+2.17%) jumped on M&A hopes whilst NESTOR (+41.18%) rallied after confirming it received approaches and is in very preliminary discussions with potential offerers.


Xetra-Dax (-1.26%) closed firmly below breakeven on Friday as Wall Street traded in the red after non-farm payrolls came in lower than expected. Key for the banking sector, Merrill Lynch may take an additional write-down of as much as US$10 billion, CNBC said. Among the outperformers, there was renewed talk of Dow Chemical being interested in LINDE (+4.38%). The deadline for bidding for a stake in Slovenia's largest telco, Telekom Slovenije, was extended until 14 January. DZ Bank reckons the group would fit in well with DEUTSCHE TELEKOM's (+0.67%) Eastern European portfolio. UNITED INTERNET (-1.67%) was reportedly thinking of buying all or part of Pipex, a UK
business broadband service with a market cap of £215 million. Hurting the auto sector today were GM CEO's comments that the US car market may see no growth this year. Sales of VW (-1.75%) cars and light trucks in the US were down 8.8% year-over-year in December, DAIMLER's (-5.95%) Mercedes-Benz Cars division saw a 3% slide, BMW (-2.83%) sold 1% more cars across the Atlantic, while PORSCHE (-7.54%) sold 2% more cars year-over-year in North America last month. Key on the broker front, Merrill Lynch added MUNICH RE (-0.02%) to its most preferred list and ALLIANZ (-1.97%) to its least preferred list. Citigroup removed POSTBANK (+1.24%) from its stocks to avoid list.


The CAC 40 (-1.79%) closed the session firmly in the red as Wall Street traded lower at European close after US non-farm payrolls rose less than expected and US unemployment rate rose to 5%, more than expected. in Paris, RENAULT (-7.58%) tumbled after Nissan Motor fell the most in more than six years on the Tokyo Stock Exchange, plunging 9.2% at the close, after Toyota Motor cut its forecast for US sales and as the JPY rises against the US$. PSA (-6.79%) and MICHELIN (-6.44%) also dived. France
TELECOM (+0.33%) has sold 70,000 iPhones since November, Les Echos reported. In the UK
, Carphone Warehouse rose on bid rumours surrounding Vodafone. VINCI (-2.30%) and AREVA (+0.94%) are in talks to bid together to build nuclear power plants, Bloomberg reported. Areva bought Nokian Capacitors Ltd, a Finnish manufacturer of power system components. No financial terms were disclosed. GDF (-0.31%) has spun off its natural gas distribution activities into a new fully consolidated subsidiary, Gaz reseau Distribution France. The move will have no impact on GDF's accounts. IPSEN (+2.01%) sees R&D spending reaching 19-21% of net sales this year. In broker news, Citigroup downgraded French banks to underweight and removed SOCGEN (-1.06%) from its buy focus list. UBS, however, upgraded SocGen to buy from neutral.


Italian shares ended lower on Friday, with the MIBTEL index down 1.84% and the MIB30 down 1.62%, in line with Wall Street's weak performance. US jobs figures for December, released today, pointed at a slowing US economy. In local news, TERNA (-2.32%%) declined after forecasting €1.085 billion tariff revenues for 2008, based on Italy's new 2008-2011 tariff system. FIAT (-7.29%) sunk deep into red on higher oil prices. Sources added that the Italian carmaker is under pressure after data revealed weak US car sales in December -even though FIAT's presence in the US market is marginal. ENI (-0.91%) and SAIPEM (-2.18%) fell as investors cashed in profits from Thursday. Negative sentiment weighed also on GENERALI (-0.36%) that snapped earlier gains and ended lower. The market had welcomed reports that the company's chairman Antoine Bernheim may move to an honourary position, to be replaced by Claudio Costamagna as the operating chairman. SAES GETTERS (-2.52%) announced it has acquired Shape Memory Alloys from Special Metals Corporation for US$30.2 million. In broker news, Morgan Stanley said INTESA SANPAOLO (-0.75%) is a 'must-have' in 2008.


In line with other European markets, the AEX (-1.59%) closed firmly lower, mirroring negative trading on Wall Street as firmly lower-than-expected non-farm payroll data in the US along with a more-than-expected rise in US unemployment dampened sentiment. Back home, KPN (+2.76%) outperformed amid rumours of a takeover by Spain's Telefonica. WOLTERS KLUWER (+0.32%) also bucked the trend as it wants to acquire Stewart Lender Services. Defensive stock HEINEKEN (+0.57%) was up, while S&N said the Arbitration Institute of The Stockholm Chamber Of Commerce advised that the dispute with Carlsberg over the BBH shareholders' agreement will be resolved by 3 July 2008. S&N began arbitration in October after Carlsberg and HEINEKEN made an unsolicited offer. Financials were in focus, but all traded lower amid current fears about the state of the US economy: AEGON (-1.93%), ING (-1.61%), FORTIS (-1.71%). S&P Ratings Services removed Merrill Lynch Life Insurance, which AEGON has acquired, from CreditWatch. In an interview with the FT, ING Direct's CEO said he wants to add more products to cover the five major needs of consumers: savings, mortgages, brokerage, consumer credit and current accounts.

European Movers Renault, Linde, KPN

CARPHONE WAREHOUSE was up £0.09 to £3.41... Shares jump on bid talk - Stock rallies on market specualtion that the company may be a takeover target for Vodafone.

XSTRATA was down £0.53 to £35.22... Resource Pacific rejects bid The board of the Australian group recommended shareholders reject the company 's AUD2.85 per share bid, calling it neither fair nor reasonable. Resource pacif says an independent expert report valued Resource Pacific shares in the range AUD3.56 to AUD4.09, with a preferred value of AUD3.82 per share.

ADMIRAL was down £0.32 to £10.68... Merrill removes from most preferred list Merrill Lynch removes the stock from its insurance most preferred list. Replaces the company with MUNICH RE and STOREBRAND.


RENAULT was down €7.09 to €86.45... Nissan plunged 9.2% in Tokyo - Nissan Motor fell the most in more than six years on the Tokyo Stock Exchange, plunging 9.2% at the close after Toyota Motor cut its forecast for US sales and JPY rose against the US$. the company 's 2007 vehicle sales rose 2.2% to 2.487 million vehicles. December vehicle sales rose 13.4% to 207,272 vehicles.

FRANCE TELECOM was up €0.08 to €24.30... Sold 70,000 iPhones since November - Les Echos - The newspaper adds the company expects to sell a further 50,000 to 100,000 iPhones this year.

SOC GEN was down €1.04 to €96.70... UBS upgrades to buy / Citi cautious - UBS upgrades to buy from neutral and raises target to €130 from €114. Notes that the company is 40% off its high, compared with a 24% sell-off in the sector. The company says recent price performance suggests the market is once again concerned about the sustainability of earnings. Adds this is nothing new, and also occurred in 1998 and 2002, when the company sold off c.50% - periods that proved to be the best time to invest in the company Believes this time is no different and that problems relating to US subprime will not permanently impair core CIB or group profits. Citigroup removes the company from its buy focus list and downgrades French and Investment banks to underweight.


LINDE was up €3.98 to €94.88... Renewed talk of Dow Chemical interested - Stock reaches YTD high on technical breakout, reckons trader.

VW was down €2.65 to €149.16... US December sales disappoint - Due to the A4 model change, sales of VW cars and light trucks were down 8.8% year-over-year in December. Brand car sales rose 3% to 20,543 units last month.


GENERALI was down €0.12 to €30.42... Possible management changes in focus - Opponents of the company 's chairman Antoine Bernheim are seeking to move him to an honourary chairman post and have banker Claudio Costamagna become the company 's operating chairman instead, Reuters reports citing the Italian press.


KPN was up €0.34 to €12.67... Telefonica deal would make sense - sources - Shares of the company are upbeat on rumours that Telefonica could be interested in making a bid, according to market sources, who add that the rumour has been circulating for a few months now. One source says strategically such a move would make sense for Telefonica as the company 's business would complement that of Telefonica, especially in Germany. Adds, however, that Telefonica recently said it would limit growth in countries where it already has a presence. As a result the company 's Dutch and Belgian business would not fit.


YARA was up NOK14.00 to NOK264.00... Merrill Lynch upgrades to buy vs neutral and raises its EPS estimate for 2008-09 by 30% and 40%, respectively. The broker's DCF is NOK305. Points out, the scale of price increase for CAN (calcium ammonium nitrate), the company 's most significant fertiliser product, was very significant in fourth quarter07 and should outweigh headwinds from gas prices in 2008.

Notes, industry sources indicate that CAN could rise to US$350/tonne in the near-term from the current level of US$310/tonne.

CARLSBERG was down DKK19.00 to DKK585.00... Increased bid possible due to exchange rates - Since the takeover bid for Scottish & Newcastle (S&N) was launched on 15 November, the DKK/£ exchange rate has declined c.4%, one Nordic broker points out,. The broker says this means that the GPB7.50/share bid can, from the company 's point of view, be raised to £7.81 without becoming more expensive, adding it believes this increases the possibility of a third proposal. Meanwhile, the cost for the company to raise its bid, which it plans to do through a rights issue, is increasing as the company 's share price has dropped c.7% since the beginning of December. Furthermore, S&N has reportedly said it may divest Hartwall in defensive move.

NORSKE SKOG was down NOK2.55 to NOK41.80... The company reiterates 2008 newsprint capacity reduction - the company says it maintains its 2008 plan to reduce European newsprint capacity by c.300,000-400,000 and that it will consider an IPO of its Asian units. the company guides for 2008 capex of c.NOK1.6 billion and sees potential property divestments for the year of c.NOK0.5-1.0 billion. the company also says its committed to reduce debt and is looking for consolidation in China.


ACERINOX was down €0.30 to €16.25... Koplowitz raises stake to 13.27% - Alicia Koplowitz has increased her stake in the company to 13.27% from 11.11%, according to stock market records.


SYNGENTA was down CHF3.00 to CHF299.25... Merrill ups price objective to CHF330 from CHF310, reiterates buy. The broker has increased its EPS estiamtes due to two likely positives for Crop Protection in 2008. Firstly, in light of the fourth quarter07 rally in grain prices, now assumes a 6% increase in Selective Herbicides volumes for 2008. Secondly, sees a 15% increase in glyphosate (a generic nonselective herbicide) pricing in 2008.

PETROPLUS was down CHF0.55 to CHF83.60... Hydrogen leak had no effect on output - Yesterday, there was a hydrogen leak at the company 's Ingolstadt refinery in Germany. the company reportedly said it did not affect output.

Shorting Orient-Express?

From Venice’s Hotel Cipriani to New York’s 21 Club, the properties owned by luxury travel company Orient-Express Hotels (OEH) may be among the priciest in the world but is the company’s share price overvalued? Eric Wolff, writing for Seeking Alpha, seems to think so. Wolf explains that the reason why OEH has been trading at the “richest multiple of any publicly traded lodging company” with a P/E of 53 and an EV/EBIDTA of over 20 (comparable companies are trading at P/Es of 20x and EV/EBIDTA of about 10x, he writes) is because investors have been sniffing an acquisition ever since company founder and former chairman and CEO Jim Sherwood stepped down in June. The problem is that management has shown no inclination to sell. Wolff thinks it’s time to short the stock.

Now, don't get me wrong, I love the properties. Over the years, I have had the pleasure of staying at many of them, but the company has always had the air of being run more as a rich man's hobby than as a serious business. That is because that is more or less how it got it's start, when Sea Container's founder Jim Sherwood acquired the Cipriani in 1976 as part of Sea Container's luxury division. (Sherwood stepped down from his position as chairman and CEO of OEH in June of 2007 though he remain on the board. Sea Containers declared bankruptcy in October 2006. Both Sea Containers and OEH are headquartered in Hamilton, Bermuda, and are still tightly connected. Sherwood's son Charles is a director of Sea Containers, John D. Campbell sits on the board of both companies, and Edwin Hetherington serves as vice-president, general counsel and secretary for both.)

Over the years, the portfolio expanded to include more than 50 properties in 25 countries, including luxury trains (the eponymous Venice-Simplon Orient-Express, which Sherwood literally brought out of mothballs), restaurants, safaris and condominiums. In 2000, the company went public and, according to the company's web site, for 2006, which was the last year for which figures are available, Orient-Express Hotels had net earnings of $39.8 million on revenue of $510.5 million.

2007 looks to have been a good year for the company too. The Q3 earnings report states that EBIDTA was up 20% year-over-year and net earnings for the first nine months through Sept. 30 were up 16% to $38.6 million.

The questions are whether this growth is sustainable--and whether the company's share price deserves to remain so buouyant if no acquisition should arise. Wolff, who is short the stock, seems not to think so. He points out three factors that could lead to a drop: 1) the company's overdependence on U.S.-based leisure travelers, many of whom might be adversely affected by unfavorable exchange rates; 2) a slow down in its real estate developments and a concern that several existing projects may not be able to recoup costs in a timely manner; and 3) despite the announcement in November that it was building its first luxury hotel in Manhattan--a project that is expected to cost around $220 million--the acquisition frenzy that has characterized the company over the past few years will slow.

Can OEH continue to go it alone? There are a long line of suitors, many from emerging markets, who are hoping they can't. Wolff evidently thinks that won't happen but the board could change their mind. The only thing that would be a shame would be if either scenario included OEH dropping some of its properties. Think what you may about the company's performance but they sure do know how to cater beautifully to their well-heeled guests.

Vital Signs: Stronger Medicine from the Fed

On tap: December retail sales, industrial production, consumer prices and housing starts, and the Federal Reserve's Beige Book report
The economy isn't looking too healthy these days. New symptoms keep emerging: higher unemployment, weakening demand at home and abroad for factory goods, and tumbling stock prices. More evidence that the economy is getting sick could show up in the latest examination of economic data.

Economy watchers are forecasting a weak 0.1% gain in December retail sales. Figures on holiday spending already confirmed fears that this season would be the weakest in years. According to the International Council of Shopping Centers, same-store sales were up just 0.9% from a year ago.

December industrial production probably posted an outright decline. A national report on manufacturing activity from the Institute for Supply Management earlier this month already showed a decline in production and orders. A decline in factory output is a reliable indication that businesses are also feeling jittery and scaling back on investment and expansion plans. If such a defensive mentality grows stronger, it bodes poorly for hiring and wage growth.

The Federal Reserve's Beige Book, a compilation of anecdotal reports on economic activity from the regional Fed banks, will shed some light on whether once strong parts of the economy, such as the service sector, are feeling more pain.

Last autumn, the Federal Reserve was unsure how the housing recession and credit crunch would affect other parts of the economy. As a result, the Fed opted not to inoculate the economy by aggressively cutting interest rates. To be fair, the Fed was concerned at the time that slashing its target fed funds rate could spawn a very nasty side effect of faster inflation once the economy started to improve.

But inflation pressures look set to ease. December data on consumer and producer prices are expected to be quite mild compared to the energy-induced spikes in November. And inflation pressure could keep moderating. Higher unemployment should put a damper on wage growth and barring any geopolitical turmoil, weaker global economic growth will take pressure off oil prices.

When assessing the health of the economy, the Fed seems to finally feel it's time to prescribe some stronger medicine in the form of bigger interest rate cuts.

Where the Stock Market Will Find Relief

Despite the year's lousy start, S&P expects Fed rate cuts and decent corporate earnings to lend support to stocks in 2008
The U.S. equity markets had every reason to slip into bear-market mode in 2007, in our opinion. Oil prices rose nearly 60% last year, while the average home price declined for the first time since the Great Depression, slipping 6.1%, according to the Standard & Poor's/Case-Shiller Index. That contributed to tumbling consumer confidence.

Earnings growth for the Standard & Poor's 500-stock index went from a 16% advance in 2006 to a near 1% decline in 2007 (as of midyear, S&P equity analysts were still calling for a year-over-year rise of more than 7%) as a result of the cascading effects of lower home prices, the rise in subprime defaults, and the resulting megabillion-dollar writedowns from unmarketable collateralized debt obligation (CDO) investments, which triggered the as-yet-unresolved credit crunch.

Despite all of these potentially psyche-damaging factors, the S&P 500 gained 3.5% for the year, bested by the Dow Jones industrial average's rise of 6.4% and the Nasdaq composite index's jump of 8.7%. S&P's Equity Strategy group believes that has something to do with expectations toward E.I.E.I.O., or employment, inflation, earnings, interest rates, and oil.

Solid Earnings Growth

Despite the less-than-expected 18,000 increase in nonfarm payrolls announced on Jan. 4 (November's data were revised upward, however) and a rise in unemployment to near 5% (due to a sharp drop in construction jobs), S&P Economics believes the dramatic decline in home prices will not trigger a deep consumer-led recession, such as was experienced in the mid-1970s and early 1980s. We forecast job growth to hold up better than many may be expecting. In fact, S&P Economics projects payroll employment to rise to an average 139.2 million in 2008, vs. 138 million in 2007, and to hit 140.1 million in 2009.

We also don't see the gradual rise in inflation preventing the Fed from its rate-reduction efforts. We see both headline and core (excluding volatile food and energy prices) inflation rising 2.1% in 2008, with the highest year-over-year increase in the first quarter. Our belief is that the Fed is focused on averting recession, and it will live with a slight uptick in inflation for the time being.

Earnings growth expectations continue to support investors' outlooks, in our view. Despite the weekly downward adjustments to 2007 estimates, S&P equity analysts forecast a 15.7% year-over-year increase in 2008 earnings per share (EPS) for the S&P 500. Wall Street consensus estimates are not too dissimilar, according to Thompson First Call.

S&P projects the largest advances in the Telecommunications Services (+35%), Consumer Discretionary (23%), and Information Technology (+23%) sectors, while Energy (+7%), Materials (+7%), and Industrials (+10%) are likely to record the lowest EPS increases. Reasons for these strong EPS advances in the face of a possible recession include easier 2008 comparisons with dismal 2007 results, plus the eventual benefits to U.S. economic growth brought on by lower interest rates. In addition, we project international economies will continue to grow more rapidly than that of the U.S.

Oil Prices Peaking

Since the economy is projected to slow, and inflation is not likely to rise uncontrollably, we think the Fed will continue to cut short-term rates, bringing the Fed funds rate to 3.5% by this summer. What's more, we don't believe the U.S. central bank will be the only one lowering rates. We project the European Central Bank to follow the U.S. and British leads and begin lowering rates by midyear.

The wild card is oil, in our view. To the dismay and disbelief of many, prices for the benchmark grade of West Texas Intermediate (WTI) crude oil rose from an average $26 per barrel in 2002 to a shade more than $100 just a few days ago.

Of course, the natural inclination is to forecast stubbornly high oil prices for the foreseeable future. We disagree. S&P's Energy Group sees WTI oil prices averaging around $76 in 2008. In fact, our Investment Policy Committee recently stated that it believes oil prices may be near a peak, because of the large oil and gas projects beginning to come on stream, the typical seasonal slowdown in global oil demand during the second and third quarters, the projected decline in U.S. growth this year, and the impact of high oil prices on demand.

From Near Lows, Indexes Will Rise

That's not to say there won't be rough sledding over the coming months. On the contrary, even though the S&P 500 has experienced 11 one-day declines of 2% or more since Feb. 27, when we experienced our first in nearly four years, we believe more such days are quite likely. In fact, we think that with at least a 40% chance of recession, the major U.S. equity averages are likely to retest their August and November lows before moving higher later this year. According to Mark Arbeter, S&P's chief technical strategist, critical levels include 1407 for the S&P 500 and 12,743 for the Dow.

Despite the less-than-reassuring start to the new year, we believe the S&P 500 will have surprised many investors by posting a respectable advance of around 12% in 2008, and will close the year near our Investment Policy Committee's target of 1650.