INDUSTRY ANALYSIS
Ethics and Industry Analysts

One of the biggest questions a person will deal with in his or her life, regardless of the career path, is ethics. We make trade-offs when we "borrow" a stapler from work, take a sick day to go fishing or play golf, and take credit for something that was done by someone else. In the wake of the Enron, WorldCom and even Martha Stewart scandals, maybe its time we took a look at our own ethics and, by way of example, I'll focus this week on industry and IT analysts.

The reason this came up is that Sam Whitmore's Media Survey, which focuses on the most influential of us, has been providing an ongoing list of complaints from PR folks, who are increasingly questioning the admittedly questionable practices of industry and IT analysts.

They actually had Barbra French address this topic in depth last week in one of their seminars. She edits Tekrati, a paper that follows analysts.

While painful, I think it is healthy to take a broad look at this and share some of the practices I know about so you can put our opinions in context.

Industry - IT - Financial

You see a lot of analysts commenting on technology, and, to start, it is likely best we segment them into what they do.

Financial analysts, and we are talking about those who work for the securities firms, are regulated. They specialize in talking about valuations, viability and financial trends. They are regulated by the SEC, and virtually everything they do is under a high level of oversight, thanks to companies mentioned above and the dot com collapse.

Their ethical problem is that they have financial ties to the companies their firms actively trade, and it appears that the conflict of interest some situations have created caused them to favor companies in which their firms have taken positions. Analysts who have found themselves in this position are now at arms length from the securities side of the house, and they are not allowed to take personal positions on the companies they cover.

IT analysts provide advice on what technology products to buy. While the financial analysts are focusing on financial statements, IT analysts focus on products and technologies. Their loyalty is supposed to be tied to the IT organizations that fund them and often provide the deciding vote for deals costing in the tens of millions of dollars.

Oversight Issues

Gartner Group, the most powerful, went head to head with IBM (NYSE: IBM) and won decisively in its early years. With support, they can make a marginal company very successful, and they also can make success very elusive for even the best of firms. There is no oversight, and the opportunity for conflict is high because these firms owe their profit to the revenue they get from vendors, even though most of their revenue comes from IT.

Industry analysts provide outlook on trends and market share. Heavily numbers-based, these analysts are typically the least experienced and lowest paid, though not always, of the types I'm mentioning here.

These folks collect numbers, often from the vendors, who are on the "honor system," and use those numbers to make forecasts. These numbers actually feed the financial analysts, but there is no separation whatsoever between these analysts and the vendors they cover. Forecasts tend to be positive because negative forecasts typically don't sell, and the vendors who make up virtually all of the income for these firms tend to get really upset when you forecast a decline for them.

Natural Conflict

Industry analysts are typically divided into services that produce reports that are then sold to vendors.

The analysts also consult with these vendors on ways to improve their performance in these reports. It might not seem that direct to them, but this is the way it actually works. Some of the reports are funded, as most of you likely know, by specific vendors, and it should be no surprise that these reports favor the vendor that funded them.

That doesn't mean these reports are inaccurate, only that this conflict needs to be taken into account and vetted if you are going to use the report in a decision. In other words, just as you might with a surgeon who makes money from surgery, you should always get a second opinion.

IT Analysts' Growing Conflict

At one time, IT analysts were kept at arms length from vendor revenue. There were those who did a lot of vendor consulting, but generally these analysts didn't do the reports that drove product decisions. Those that did the reports were compensated on things like productivity and quality, not on revenue.

But this has changed over time, and the one firm that had maintained the strongest separation, Giga Information Group, succumbed to this trend last year. Now IT analysts are measured on the revenue they get from consulting with vendors, and this at-risk compensation can exceed 20 percent -- clearly an amount that is materially significant.

Vendors typically don't use analysts who speak badly about their firms or products, and these analysts still are the deciding vote in huge IT technology buys.

This puts the analyst under a huge conflict of interest, and it is my view that it is this practice that has resulted in the sharp decline in the IT analysis firms over the last several years. I know of at least one analyst who has refused to do vendor consulting for this very reason.

Vendor Impact

This doesn't impact just the folks who buy technology. It impacts the vendors as well. In fact, what started this whole trend was a series of complaints from PR folks to Media Survey about analyst practices that appeared to extort money from vendors.

Some IT firms won't take a briefing from a vendor unless they are a client, sort of a tax on doing business in the segment, which sounds incredibly close to extortion.

Some have said they are told that if they want positive coverage, they have to pay up, which, I think, crosses that line, as does the practice -- which is common -- of writing a negative report to get a vendor's attention and funding.

I think you would be surprised which firm regularly made it a practice to send money to analysts who were covering it negatively. We'll call this Reverse PR, but it is wrong regardless of whatever name we use.

I've always had this issue with the gray zone. Something is either right or it isn't, and these practices simply are not right, and all of us are colored by them.

Personal Impact

A few years ago at Giga, I was getting troubled by this trend. At that time, the analysts were separated from vendor revenue. However, I was concerned we would be painted by the actions of the other firms. I had gone to our own CEO and got him to buy off on an ethics panel of IT customers who would oversee our practices.

At that same time, I was doing a weekly radio show for Cnet, and that week it was to be at an Apple (Nasdaq: AAPL) store to celebrate its opening. Apple told Cnet I wasn't allowed on the premises because I was blackmailing them.

I had met with Apple a week earlier, and one of their PR folks had said they were thinking of signing up but, to my knowledge, there was no "or else" part of this.

Apple declined to return calls from my management, and were it not for the fact that I was driving these reforms, I could have easily been compromised. My management, given the timing, thought it was hilarious, and I'd worked with Cnet for years and, fortunately, they trusted me as well, and the show went on.

The only reason I've been able to come up with for why Apple said this is that I'd made them aware of a study I'd done for New York's Department of Education. That study concluded that Apple machines were being purged from schools worldwide. I would have to guess that Apple was worried that I was going to mention this on the air. I hadn't planned to, but I guess that is one way to be sure.

Painful Correction

Apple has always been hostile to analysts but, to my knowledge, this is the only time they went to these lengths to kill an unfavorable report. It does cause me to question the reports that surround the company.

I was incredibly lucky, but were another analyst to be accused of doing this, the defense would be nearly impossible. Given that industry and IT analysts feed financial analysts, I'm becoming increasingly concerned that we might have a painful correction, much like the financial analysts did a few years ago.

There are a series of firms that watch the analysts. I've mentioned two in the opening of this column. One other is The Kensington Group, which specializes in training on how to deal with analysts. If you are using analysts, you should become familiar with at least one of these firms.

Until next week, take the high ground. I've found that, even when it is painful, being truthful and ethical can still be the most rewarding in those areas that really do count. A lot of people do some incredibly foolish things for money. The cost of compromising your ethics always exceeds the benefit.