Pursuing Passion

We often talk about passion, but we tend to use it very loosely.  We usually refer to passion in passing – it is rarely the primary focus of discussion or analysis.

I am just as guilty of this.  A couple of months ago, I posted a manifesto for passionate creatives and never explicitly defined what I meant by passion.  In talking with people about this manifesto, I discovered that passion has an infinite variety of meanings. It set me on a quest to find a systematic treatment of passion, especially in a business context, but I have yet to find anything that is very satisfying.  Even outside the business context, surprisingly little explores in any deep way what passion is and the role it plays in our lives. (If I am missing anything out there, by all means reach out and let me know.)

So, this is an early attempt to offer my own perspective on passion and why it occupies a more and more central role in my research and work with clients. I am posting this in the hope that I can spur a discussion that will help all of us to sharpen our understanding of passion and its growing importance.

One view of passion

So, what is meant by passion? For many, it simply means strong emotions of any kind. In this context, it is often suspect because we perceive it to mean that clear and rational thinking becomes overwhelmed by intense emotions. In fact, for many it is viewed as a sign of shiftlessness – passions coming and going with the blink of an eye. For others, passion simply means happiness – pursuing activities that make us happy in the moment.  In other contexts, it is used to mean loss of control – we surrender to passion.

I want to use the term more narrowly, to refer to strong emotions that motivate us to move beyond our comfort zone and to achieve the potential that resides within us.  Passion comes from within each of us; it cannot be imposed or mandated from outside. At the same time, it compels us to move outside, to engage with the world around us.

Passion, in the sense I am using it, orients us; it provides us with focus and direction.  From this perspective, passion is long-lived.  It may be ignited quickly but, once ignited, it endures and even grows as we discover how much potential there really is.  Passionate people are rarely distracted for long; their passion keeps them on track and calls them inexorably back to the quest ahead. Passion is about perseverance.

Passion is also about pursuit. It is not passive. People with passion are driven to pursue and create. They may read books and observe others, but they are not content being bystanders.  They feel an overwhelming urge to engage, to experience for themselves and to test their own capabilities. Passion compels us to act.

In this context, there are two kinds of passion – the passion of the true believer and the passion of the explorer.  Here in Silicon Valley we have many examples of the passion of the true believer – great entrepreneurs are truly passionate about a very specific path and many of them are notoriously not open to alternative views or approaches. Their passion is enduring and it does focus, but it can also blind – leading the entrepreneur to reject critical input that does not match their preconceived views.

I am focused on the other kind of passion – the passion of explorers.  These are people who see a domain, but not the path.  The fact that the paths are not clearly defined is what excites them and motivates them to move into the domain.  It also makes them alert to a variety of inputs that can help them to better understand the domain and discover more promising paths through the unexplored terrain.  They are constantly balancing the need to move forward with the need to be present in the moment and reflect on the experiences and inputs they are encountering.

Passion is certainly not the same as happiness, unless we move beyond the transitory happiness of the moment and seek out a much deeper happiness that ultimately comes from achieving our potential.  Passion comes from the Latin word “pati”,  meaning suffering or enduring.  We forego a lot when we pursue our passions; significant sacrifice is often required.  We are often deeply frustrated – we have an intense desire to move faster and deeper but we encounter obstacles on all sides (including within ourselves) that seem to inhibit our movement.  The unhappiness does not discourage us – it is a natural consequence of desiring something so deeply that we are motivated to confront any obstacle, no matter how challenging, and persist until we find away over, around or under it. Passion is about discipline – self-imposed discipline that drives passionate people to persist and not get discouraged in the face of enormous obstacles. 

Passion is about performance.  People pursuing their passion have a clear sense of performance metrics. These are not externally defined and imposed metrics, but individually adopted metrics that help passionate people to keep track of their own performance on a continuing basis and identify performance gaps.  While many passionate people are amateurs  in the sense of not yet integrating their passion with their profession, passion is professional in the sense that people pursuing their passion are deeply committed to the domain that has engaged them, they have a deep sense of integrity about their quest and they have demanding expectations about themselves in terms of performance.  Passion is ultimately driven by intrinsic motivation rather than extrinsic rewards.  External rewards like recognition and cash compensation are certainly welcome, but they do not drive passionate people.

Passion is about progression – passionate people constantly seek new challenges and opportunities to drive their performance to new levels.  For passionate people, achieving their full potential has little meaning. They see that their potential is constantly being expanded by new possibilities.  Explorers are very adept at discovering new ways to test themselves and discovering new possibilities along the journey. In fact, passion brings with it a willingness to fail repeatedly in the quest for performance improvement, compellingly illustrated by any extreme sports participant. Passionate people see that progression demands failure – if we are not failing, we are not taking enough risk and learning fast enough.

Passion is about connecting.  We all know stories about lone inventors who are deeply passionate about their quest and spend much of their lives locked away in their basement workshops tinkering and experimenting with new approaches to driving performance.  These stories are the exception rather than the rule.  More generally, passion leads us to seek out and connect with others sharing our passion.  We intuitively understand that the best way for us to advance is to connect with and learn from others. Passionate people often seek to connect with others in related domains in a quest for insight that they can bring back into their own domains – witness the big wave surfers who also wind surf or skate board in an effort to understand techniques and technology that can improve their performance on big waves.

Passion pulls.  Passionate people are deeply creative in seeking out and pulling in resources that will help them to pursue their passion.  But passion also pulls in another dimension as well.  People who pursue their passions inevitably create beacons that attract others who share their passion.  Few of these beacons are consciously created; they are by-products of pursuing one’s passion.  Passionate people share their passions and creations widely, leaving trackers for others to find them.

Passion is not predictable.  Because it comes from within and drives people to embrace unexpected opportunities and explore uncharted territories, it does not deal well with prescribed routines and scripts.  It is pursued in the moment and engages with unexpected encounters in ways that may lead to unforeseen twists and turns.  Passion is also about urgency – passionate people have limited patience. They are driven to move forward, regardless of the obstacles put in their way. 

Passion is about risk-taking.  Passion diminishes perceptions of risk and amplifies perceptions of reward.  In a curious way, risk becomes reward for passionate people.  They see that risk is the only way to discover new things and explore new territories. For this reason, passionate people thrive in times of high uncertainty and disruption.  It is also why passionate people tend to come together on various edges of our society and business environment – peripheries that are rich in unmet needs and unexploited opportunities. Passionate people embrace the edge in order to get an edge on their performance.

Passion is about authenticity.  Passionate people have little patience with pretense.  They present themselves as they really are because they intuitively understand that is the only way to explore and discover.  Passionate people discover and develop a uniquely personal voice that provides a deep sense of meaning and personal identity, shaped by what they contribute to the world and how others build on and learn from their contributions . Their identity is not about consumption; it is about shared creation.

Why it matters at a personal level

Passion is becoming increasingly important for our professional success. If we have not found a way to make our passion our profession or to discover passion in our profession, we will very quickly succumb to the growing economic and competitive pressures that are shaping our global business landscape.  The pressures will inexorably mount. Without passion, we will increasingly experience stress, our energy will be steadily drained and we will ultimately burn out under the mounting pressure. At best, we will be marginalized as we find ways to achieve “balance” and safety valves for the mounting pressure at work.

On the other hand, if passion and profession can be integrated, stress turns into stimulus. All of those unexpected challenges suddenly become ways to develop our capabilities more rapidly – we begin to seek out these challenges, hungry for the opportunity to test ourselves and get to the next level of performance more rapidly, like the big wave surfer constantly searching for a bigger, more challenging wave.

Corporate ambivalence on passion

Most executives have considerable ambivalence about passion.  Their speeches often call for passion. Passion can be great if it is harnessed to serve the purposes of a business – it motivates people to work longer and harder than those who lack passion. 

On the other hand, passion resists harnessing –it is about extremes and unpredictability, something that most companies have a very hard time dealing with. Passionate people are loyal to their passion but they are often deeply dissatisfied with the institutions that employ them.  They can see all the possibilities and are greatly frustrated at all the institutional obstacles that prevent them from achieving these possibilities. 

Unless one’s passion aligns completely with one’s role and the institution’s mission – a very rare situation – considerable friction is often the result as passionate workers struggle to achieve the potential that their passion demands.  A strong argument can be made that our 20th century institutions – especially schools and firms – were explicitly designed to suppress passion because it undermined predictability and created friction where scalable efficiency was the imperative. As a result, the day to day practices and processes of the firm seek to contain and mute the very passion that executives so eloquently celebrate.

As a result, it is not surprising that passionate people often flee the confines of larger firms. Indeed, our 2009 Shift Index discovered that the presence of passion diminishes among the workforce as the size of the firm increases.  Scalable efficiency is very effective in containing and diluting passion. As a result, it is perhaps not surprising that the most passionate people are those who are self-employed.

This flight of passion from our institutions is deeply troubling because we are in the midst of a Big Shift where passion is becoming increasingly important for institutional success.  As I have written elsewhere, the rationale for our institutions is changing from scalable efficiency to scalable peer to peer learning as a natural consequence of the Big Shift.  In this context, passionate individuals are essential to driving the quest for scalable peer to peer learning.

As discussed above, passionate people are risk-taking explorers driven by a desire to learn and drive performance to the next level.  They naturally seek out others who share their passion and collaborate to address challenges and obstacles to performance improvement.  They have a sense of urgency and a long-term commitment to their passion. How will institutions harness scalable peer to peer learning without passionate people?  In fact, in the Big Shift, a strong case can be made that the institutions that create a welcome home for passionate individuals will be the ones that thrive in this challenging new world.

Some open questions

As I have thought about passion at the level of individuals, a number of questions remain to be explored and I would welcome input and ideas.

• Clearly, many people do not display passion in the specific form that I have described above – they are consumed with the day to day challenges of life and have not discovered a passion that can focus and drive them.  Does this mean that not everyone is capable of this kind of passion or even wants to have it?

Or does everyone have this kind of passion latent within them waiting to be developed or discovered? My instinct is that the latter is the case.

More generally, I encourage all of you to comment on what I have offered above.  My perspective is all very preliminary and somewhat tentative, but I have a sense it will become increasingly central to all of us.  This is just the beginning of a much longer journey.  I think I am becoming passionate about passion.

The Industry Sequel to the Shift Index

About four months ago, I released the 2009 Shift Index from the Deloitte Center for the Edge.  It showed a significant and sustained deterioration in return on assets (ROA) for all public companies in the US since 1965.  That metric alone attracted a lot of attention from the media and executives.

Many executives were deeply engaged with the findings of that report, but understandably asked what the long-term Big Shift trends were in their specific industry.  They asked and we delivered.  Today, the Deloitte Center for the Edge is releasing a sequel to the original report, systematically examining trends across 14 industries. This report on Industry Metrics and Perspectives is lengthy (over 200 pages) and goes into considerable depth on nine industries in particular.  Interested readers can download the full pdf here but for those wanting the headlines, these are some of the key perspectives emerging from the industry analysis:

Deterioration in performance is widespread
Firms in most industries are experiencing long-term deterioration in ROA since 1965.  Only two industries – aerospace and defense and health care experienced improvements in ROA.  It is perhaps not coincidental that these are two of the most heavily regulated industries and therefore more insulated from the growing competitive pressures challenging other industries. Even firms in these two industries face challenges going forward and it is not clear there are any safe harbors for companies facing the Big Shift

Advances in labor productivity fail to improve return on assets
There is no apparent correlation between improvements in labor productivity and improvements in return on assets across industries.  In fact some of the industries – especially technology and telecommunications – that experienced the most dramatic improvements in labor productivity also experienced the most significant decline in the return on assets. This suggests that, while improvements in labor productivity may be necessary to respond to competitive pressure, they are certainly not sufficient.  Most likely, many of the gains in labor productivity are being captured by more powerful customers and creative talent.

Innovation, at least as traditionally defined, does not appear to offer a solution
Perhaps one of the most innovative industries in the US – the technology industry – has also experienced one of the most significant declines in ROA since 1965.  This suggests that innovation defined as product or even process innovation is also not sufficient as a response to growing economic pressure.  With knowledge flows becoming more and more important as a source of value creation relative to knowledge stocks, we suggest that another form of innovation – institutional innovation – may be much more helpful in turning the performance trends around.  This kind of innovation focuses on redefining roles and relationships among institutions to generate and sustain richer knowledge flows across institutional boundaries, something most institutions find very challenging today.

Traditional measures of competitive intensity understate the challenge
We used a widely accepted measure of competitive intensity that focuses on industry concentration/fragmentation trends. It soon become apparent that this measure, favored by many economists and policy makers, seriously understates gathering competitive forces.  Very often, it ignores significant competitive pressures coming from other parts of the value chain.  In particular, we found that customers are a source of growing competitive intensity as they gain more power over the vendors they deal with and demand more value at lower price. In other cases, growing competition came from companies nominally considered to be in other industries or markets, for example consider the growing role of cable companies and Internet companies like Google in the telecom industry.   

Worker passion is at very low levels across all industries
At best, only about one in five workers are passionate about their work across all industries.  This is a serious concern given our findings that passionate workers tend to be much more effective at seeking out and participating in knowledge flows.  If participation in knowledge flows is key to creating new economic value, most firms are severely disadvantaged by the low level of worker passion among their employees. This is certainly one factor explaining our finding that firms are currently participating in a very small fraction of the knowledge flows available to them.

Bottom line observations
The industry sequel of our Shift Index confirms the key findings of our earlier report.  Firms in the US have been experiencing a significant and sustained deterioration in performance over many decades. The most basic message is that our current approaches to doing business are fundamentally broken.

This has little to do with the current economic downturn.  Certainly cyclical trends aggravate the longer-term pressures, but there is no evidence that any cyclical recovery will return companies to where they were before.  Long term pressure continues to mount and shows no sign of abating. The current economic downturn has understandably consumed our attention, but we run the risk of missing the more profound, longer-term trends playing out around us.

While intensifying competition has catalyzed deteriorating performance for firms, there are significant beneficiaries of these trends. As customers, we all benefit in the form of increased value at lower prices.  Total cash compensation to creative talent has risen markedly over this period, so this part of our workforce has also benefited enormously.  The real challenge is to figure out how firms, caught in a pincer move between more powerful customers and talent, can create more economic value and improve their own profitability.

Given the profound performance deterioration that firms have experienced over decades, it is time to step back and reassess our most fundamental assumptions about what is required to be successful in business. If we have any hope of turning this longer-term trend around, we must be prepared to challenge our current approaches to business.

Despite our findings, we remain optimistic about the opportunities for firms.  In particular, we believe that the two foundational catalysts driving intensified competition – digital infrastructures and public policy shifts favoring economic liberalization- also create the conditions for dramatic performance improvement.  In fact, by harnessing the proliferating knowledge flows enabled by these two catalysts, we believe firms have an opportunity to drive much more powerful approaches to performance improvement.  Experience curves have driven business performance for much of the 20th century.  These curves have diminishing returns.  We believe that for the first time, given a combination of new digital infrastructures and new institutional architectures, it may be possible to turn the experience curve on its side and for the first time generate performance curves with increasing returns – the more participants, the more rapidly performance improves.We use the term collaboration curves to describe this new opportunity.

This is both the challenge and the opportunity confronting firms today.  Those who see this and act upon it will find that the Big Shift creates the potential for enormous wealth creation.

A Labor Day Manifesto for a New World

We speak on behalf of the creatives who are passionate about their work. They experience deep frustration today with the institutional barriers that have been put in their way as they seek to more effectively achieve their full potential.  They want and need platforms that can help them connect with others and drive performance to new levels. They are articulate about their frustrations and needs, but they are often so consumed by their current initiatives that they rarely find a collective voice to express their broader interests.

Who are passionate creatives?

Passionate creatives exist everywhere.  They are not bound by geography, job classification, institutional affiliations or demographic categories – they can be found anywhere from the frontlines of the largest organizations to the garages where entrepreneurs are preparing to unleash the next wave of innovation.   These are certainly not just knowledge workers.  They include mechanics who are passionate about the machines they service, gardeners who see art where others only see plants, retail clothing sales staff who can see the inner person and help them to express it through their clothes and craftspeople who see something amazing in the most mundane raw materials. They also include customers who are not satisfied to take products as given to them, but see the opportunity to make so much more with the products they find. What unites them is the desire to make a difference, to leave the world a better place than they found it and to engage with those who share their passion so that they can get better faster.

These individuals go by many names.  Some have adopted the label of pro-amateurs (or “pro-ams”), popularized by Charles Leadbeater, but this label typically refers to amateurs who adopt and pursue professional standards in their pursuit of their passion.  We seek to include those of us fortunate enough to be compensated for work we are passionate about, whether we are entrepreneurs, professionals, knowledge workers, craftspeople or clerical workers who are searching for new and creative ways to do the most “routine” tasks. Of course, these individuals have been around since the beginning of human history and played a more prominent role in some eras than in others. Our goal is to expand their ranks and position them firmly in the center of the institutions that shape our professional and personal lives.

Passionate creatives are everywhere among us, but they are not evenly distributed. They tend to gather on the edges where unmet needs intersect with unexploited capabilities.  Edges are fertile seedbeds for innovation. These edges include emerging economies like China, India and Singapore that are beginning to encourage individuals to pursue their passion.  Other edges include demographic segments like younger generations coming into markets and the workforce with new sets of needs and interests.  Edges also arise around the frontiers of technology, whether it is information technology, clean tech, nanotech or biotech. Edges naturally tend to become spiky as passionate creatives seek out collaborators. In this quest, they gather together in dense geographic settlements to enhance their ability to find and encounter others they can learn from.

To be certain, not all people fall into this category.  Many today are overwhelmed by the changes going on around them and seek stability, predictability and safety.  They long for the time when they knew exactly what needed to be done and what could be expected when they did it.  This is completely understandable – change can be perceived as very destabilizing and threatening – especially if we have very little and are struggling to hang on or if we have accumulated a lot and fear that we will lose it all.

But all of us have the potential to become passionate creatives and more and more will make the transition into this growing cohort.  We all have the capacity to become passionate about some element of the vast world we live in and passion fosters creation, especially if we have the discipline to master the practices required to drive performance to new levels. Passion fosters new dispositions – it not only welcomes new challenges, it actively seeks them out.  It takes challenges and transforms them into opportunities to develop new skills and perspectives.  It moves people from external incentives to instrinsic motivations. It consumes people with the desire to take the game to the next level. It merges personal and professional, intricately weaving the strands so that we can no longer tell the difference.

Many of us have suppressed our passions in an attempt to fit in and integrate ourselves into a world that expected stability, predictability and safety.  But they remain in the margins of our lives or in the daydreams that distract us from our daily tasks.  Our challenge is to re-discover and cultivate them, moving them from the margins into the center of our lives.  We must all make our passions our professions – they will help to focus us and energize us in a world where those without passion will be increasingly marginalized and overwhelmed by mounting pressures.

The Big Shift and the opportunities it creates

Why will more and more people evolve into passionate creatives? Because we live in a world that is shifting inexorably from an obsession with efficiency to an obsession with learning.  We have come to call this the Big Shift.  It is being driven by long-term changes in our technology and public policy infrastructures. These catalysts in turn generate richer and more prolific knowledge flows around the world. Eventually these knowledge flows get harnessed in creation spaces that offer the potential for increasing returns – the more participants that join these spaces, the richer the performance and learning improvement opportunities.

We initially experience this shift in terms of mounting pressure as competition intensifies on a global scale.  But, for those of us already pursuing our passions, this world is enormously liberating because it challenges us to become even better. It also provides us with many of the resources required for this effort. It creates opportunities to unleash our passions, leverage them and scale them in ways never before possible. It gives us opportunities to create and make a difference in ways that we never could before.

Those of us pursuing our passions as our professions will move quickly to address the opportunities created by these new infrastructures, participating in richer and more diverse knowledge flows and challenging each other to new levels of performance. Our success and profound joy will become beacons for the others who have kept their passions bottled up, hidden from sight and far removed from their daily tasks.  From another direction, the growing pressures on those who struggle to succeed in the absence of passion will become unbearable and ultimately create a crisis challenging their most basic beliefs.

But there is an even more profound factor driving the growth of this category.  At a very basic level, to be human is to be a passionate creative. That is what all of us were meant to be, even though many religions and political movements over the centuries have sought to channel or even deny this basic human need.  We live in societies that, often with the best of intentions (and unfortunately occasionally with the worst of intentions), sought to socialize us into a very different mold.  But many of those societies have been disintegrating over the past several decades as technology and public policy infrastructures challenge and undermine the foundations of those societies. Our true nature as human beings will ultimately prevail, aided by the changes going on around us.

The journey to engage our existing institutions

But the journey will not be easy.  This group of individuals today still faces enormous obstacles in pursuing its passions.  While our infrastructures are transforming at a rapid pace, the institutions around us are increasingly at odds with these new infrastructures. Most of the institutions that we must deal with, whether they are schools, firms, non-profits or government bodies, emerged and were shaped in a previous era, driven by earlier technology infrastructures.  These communication and transportation infrastructures rewarded scalable efficiency and we responded accordingly.  The great institutional leaders of the twentieth century enjoyed enormous success and widespread impact as they mastered the practices and institutional architectures required to deliver scalable efficiency. But, in the process, we paid an enormous price. We discovered that scalable efficiency expected all of us to integrate into these new institutional homes by performing highly standardized tasks that were repeatable and highly predictable.

That integration led most of us to suppress our passions. We were taught to treat our work as a price to be paid to accumulate the material resources required to enjoy the rest of our lives.   Passion in the workplace became highly suspect.  Passionate people do not follow standardized scripts well, they are constantly seeking to improvise, challenge conventional wisdom and strike out on new and unexpected paths.  Passionate people are not predictable and, as a result, undermine determined efforts to ensure predictability. These individuals also detest the organizational politics that pervade these institutions as many in the hierarchy begin to focus on hoarding and protecting limited resources.

As a result, we often tend to be deeply unhappy in our current institutions. We are profoundly frustrated by the daily obstacles that we encounter at every turn.  We see all the possibilities, but experience firsthand the barriers that keep these possibilities far out on the horizon rather than within our grasp.  Well-meaning mentors advise us to get with the program and embrace the institutional agenda even if it means leaving our passion at the door every morning as we report for work.  We quickly learn that our passions are viewed as deeply subversive, rather than as treasured assets. As a consequence, many of us have fled these institutions and learned to build independent platforms that are more suitable for pursuing the work that we love.  Others remain in our institutional homes, struggling to make a difference against enormous pressure.

While this battle can seem to be overwhelming in the short-term, we can draw hope and inspiration from one inescapable fact.  Our current institutional homes will have to change. Performance pressures will continue to mount, driven by the broad deployment of new technology and public policy infrastructures. In this environment, our institutions will be forced to change or fall by the wayside as a new generation of institutions emerges, designed specifically to exploit the unprecedented opportunities created by new infrastructures. The recently released Shift Index provides compelling quantitative evidence that the current approaches to scalable efficiency in our institutions are no longer working – performance has been deteriorating at an alarming rate over decades. Institutions are experiencing unmet needs (for new ways to create value and drive performance to unprecedented levels) and passionate creatives will become powerful catalysts for institutional transformation, whether they remain within the institution itself or are now outside the institutional boundaries, operating on the periphery in various roles. Major organizational change initiatives rarely succeed without a clear and present threat.  That threat is now very present for those who care to look.

The opportunity for institutional innovation

True to form, passionate creatives will not sit still for long, complaining about the impediments that stand in their way.  This manifesto is not directed at the barriers holding us back.  It is a call to action – seeking to mobilize individuals within this group to address the opportunity ahead.  Given the new infrastructures emerging around us, we have an unprecedented opportunity to engage in a new form of innovation.  Product and process innovation are still valuable, but they are inevitably limited in scope and potential as long as they are pursued within existing institutional arrangements.

To thrive and to draw others into our camp, we need to find ways to re-think our institutional architectures – the roles and relationships that define how institutions function – in ways that amplify our efforts to get better faster.  Rather than treating us as irritants to be neutralized, institutions must be redesigned from the ground up to address a totally different rationale.  Instead of pursuing scalable efficiency, institutions must learn how to pursue scalable peer learning.  Said differently, institutions must find ways to make talent development the core rationale for their existence.  Everything about these institutions – strategy, operations and organization – will need to be reconceived through this talent development lens. As this rationale focuses our efforts to craft a new set of institutional arrangements, we will move from the edges of our institutions to their core.

We must make this long and difficult march through our institutions.  Without it, we will be forever limited in terms of the scope of our learning and our impact.  Properly configured, institutions can provide extraordinary platforms to amplify and accelerate our individual efforts.  Without these institutional platforms we will surely still make a difference, but the difference will be far more contained.

This long march will begin at the edges of our existing institutions and on the edges of our world – those edges where unmet needs first encounter unexploited opportunities.  We will find ways to catalyze new institutional arrangements first where the need is most pronounced.  Our existing institutions are largely helpless to participate in the emerging growth opportunities spawned on the edges of our world. Yet, they must find ways to redeploy resources from their core to these edges if they are ever going to effectively respond to growing profit pressure in the core. We can find ways to help lead our institutions to these edges.

At these edges, we will find more receptivity to institutional innovations that help to effectively target the growth opportunities emerging there. We will also master new practices that can help make these institutional initiatives even more impactful.  These pull techniques – accessing resources, attracting resources and achieving our full potential  – are already used by many of us, but in a very limited and fragmented way. As we engage on the edge, we will find that we are applying these techniques in much more systematic and creative ways. The growing impact on the edge will position us to draw more and more resources out of the core and onto relevant edges. New institutional forms will evolve rapidly, enhanced by a new set of individual practices that make passionate creatives even more successful.

Coming together to make a difference

To accomplish all of this, passionate creatives everywhere must find each other and join forces to expand our impact.  It is time to move from the margins of our institutions to the core.  It will be a long and difficult journey but all we have to lose are our institutional chains. The path is clear – we now have an opportunity to move from passion to profession to periphery and finally to potential.

There is so much potential – we need all the leverage that we can mobilize to achieve our full potential.  Without appropriate institutions, we will forever remain limited in our ability to achieve impact.  We have already begun to pursue institutional innovation on the edge of our existing institutions, in areas as diverse as the Creative Commons, open source software, extreme sports and motorcycle design in China. These innovations give an early indication of the opportunity ahead. But imagine what could be accomplished if we mobilize the vast resources residing within our existing institutions.
 

We need to move forward and engage the institutions around us. And the institutions have more and more need to listen to us. Twentieth century institutions are not succeeding in the twenty-first century as new infrastructures take hold. They must change or they will slowly shrink into shadows of what they once were and make way for a new generation of institutions more suited to the harnessing the potential of these new infrastructures. With the right effort, we can turn these institutions from prisons to creation platforms and achieve the potential that we have long dreamed about, both for ourselves as individuals and for the institutions that support us.

(For more informatin about the Big Shift and the perspectives leading to my next book, check out the Big Shift blog that I write with John Seely Brown and Lang Davison on the Harvard Business Publishing site)

Defining the Big Shift

About one month after the release of our Shift Index report, one question that keeps coming up is whether we can offer a succinctly define what the Big Shift is that our Shift Index seeks to measure.

Given the magnitude, depth and far-reaching impact of the Big Shift, succinctness is a challenge.  At the highest level, we would characterize the Big Shift as moving from a world of push to a world of pull.  In other words, given the growing uncertainty in the world around us, we must master a new set of techniques required to access, attract and accumulate resources to unleash peer based learning in far more flexible ways than conventional push programs permit.

But perhaps this is too high level.  It may help to develop this perspective just a bit more in the context of “from-to” contrasts. 

From knowledge stocks to knowledge flows. We are moving from a world where the source of strategic advantage was in protecting and efficiently extracting value from a given set of knowledge stocks – what we know at any point in time.  As knowledge stocks depreciate in value at an accelerating pace, the focus of economic value creation shifts to effective and privileged participation in knowledge flows. Finding ways to connect with people and institutions possessing new knowledge becomes increasingly important. Since there are far more smart people outside any one organization than inside, gaining access to the most useful knowledge flows requires reaching beyond the four walls of any enterprise.

From knowledge transfer to knowledge creation.  Most companies today will acknowledge the importance of knowledge flows, but they tend to focus on transferring knowledge more efficiently, especially within corporate boundaries.  While useful, this is ultimately a diminishing returns game on multiple levels.  The greatest economic value will come from finding ways to connecting relevant yet diverse people, both within the firm and outside it, to create new knowledge. They do this best by addressing challenging performance requirements that motivate them to get out of their comfort zone and come up with creative new approaches that generate more value with fewer resources.

From explicit knowledge to tacit knowledge.  Here’s a paradox.  Just at the time when more and more information is becoming available about more things, the driver of value creation is shifting from explicit knowledge – that which can be expressed abstractly and statistically – to implicit knowledge – that which drives our day to day practices but which we generally have a very difficult time expressing, much less quantifying.  Why is this the case?  Because knowledge tends to evolve over time.  In its earliest stages, knowledge tends to have a much more significant tacit component.  Over time, we are more successful in articulating larger portions of our knowledge by abstracting and quantifying it, even though a significant tacit component inevitably remains. But the most valuable knowledge is the knowledge that is in the early stages of emergence is generally the most difficult to express. And, once again, it is not just within the firm but distributed broadly outside the firm.

From transactions to relationships.  Western corporations have increasingly focused on short-lived transactions as the way to generate profit – buy low, sell high and wherever possible squeeze partners in transactions to extract as much profit as possible.  If one group can’t meet our short-term requirements, let’s move on to find another group that can.   But here’s the problem – that transactional mindset undermines the ability to build long-term, trust based relationships.  And in the absence of those relationships it becomes almost impossible to effectively participate in the knowledge flows that matter the most.  It is very difficult to get diverse people to come together and constructively engage around challenging performance issues by sharing their tacit knowledge unless long-term trust-based relationships already exist.  Once again, since the most valuable knowledge flows are distributed well beyond the boundaries of the firm, these trust based relationships must also extend into broad, scalable networks that literally span the globe.

From zero sum to positive sum mindsets.  If we approach interactions with the zero sum mindset – that there is a fixed quantity of resources that must be distributed and your gain will inevitably be my loss – we virtually ensure that we will end up with short-term transactions and undermine any efforts to build longer-term relationships.  In contrast, if we adopt a positive sum mindset – that through our collaboration we can generate a growing pool of resources – we are likely to be much more successful in building long-term trust based relationships. In turn, this means we will be more effective in participating in the knowledge flows that have the potential to generate the most economic value, thereby creating a virtuous cycle that builds upon itself and generates powerful network effects.

From push programs to pull platforms.  In a world driven by efficient exploitation of relatively fixed knowledge stocks, scalable push programs became the best way to extract value from these stocks.  Accurately forecast demand and make sure the right resources are in the right place at the right time to produce and deliver against the demand.  If new knowledge creation through effective participation in a growing range of knowledge flows is the goal, push programs become an obstacle by enforcing routines and predictability.  Scalable pull platforms become essential to ensure that participants distributed across a broad and diverse range of institutions can effectively access and attract resources when relevant to support their performance improvement initiatives.

From institutions driven by scalable efficiency to institutions driven by scalable peer learning. We emphatically do not believe that the Big Shift will lead to the disintegration of large institutions.  Today’s large institutions are more often than not barriers to effective participation in scalable knowledge flows so it is no wonder that passionate and creative talent is increasingly fleeing established institutional homes to set up shop as independent contractors and entrepreneurs. On the other hand, institutions can provide unique opportunities to scale pull platforms and build ever growing networks of long-term trust based relationships on top of these platforms.  If institutions viewed their primary rationale as fostering scalable peer learning, they could create learningscapes that would help individuals develop their talent much more rapidly than these individuals ever could on their own. Of course, there is a huge transition required to get from here to there, but growing competitive and economic  pressures will ensure that institutions either make this journey or fall by the wayside as a new generation of institutions emerges to take their place.

From stable environments to dynamic environments. One final point – the Big Shift label can be misleading.  It suggests that we envision a movement from stable Point A to a new stable Point B.  That is far from the case.  If the logic of the Big Shift holds true, we are moving from a relatively stable business environment to one characterized by rapid rates of change with ever more disruptions generating increasing uncertainty and unpredictability.  The economic imperatives and the management practices and institutional arrangements required to address those imperatives will lead to more instability rather than less.  What we need are management practices and institutional arrangements that can turn that instability from a threat to an opportunity. 

OK, so this is not very succinct.  It is certainly not a sound bite ready to be broadcast and consumed in our national media. But it does capture some of the key logic behind the overarching, and perhaps more succinct, point that the Big Shift involves a movement from the world of push to a world of pull. And perhaps it will help those who rightly point out that we have not yet systematically and explicitly defined the Big Shift.

Shift Happens Redux

Today is a big day.  It is the first time that we can offer a view of something I have been working on for the past year.  About one year ago, we began an undertaking that some described as bold, and others characterized as foolhardy. The first product of this effort is just now being released – we call it the Shift Index. Hopefully the scope and size of this undertaking will help to explain why it has been a while since I posted to this blog.  I have been just a bit distracted.

The catalyst for this effort was a meeting about one year ago.  We were looking at economic indices and struck by the fact that most of the well-known indices focus on very short-term cyclical events – unemployment, inflation, purchasing activity, consumer confidence levels, etc. Of course, these are extremely valuable in helping executives to assess the current context for their operations.

On the other hand, everyone acknowledges that we are in the midst of a fundamental shift playing out on the business landscape on a global scale over many decades. We may not all agree on the exact dimensions of the big shift, but the reality is so widely recognized that it is often unstated. When we looked for indices that gave us some insight into the nature and pace of this big shift, we pretty much came up drive.  There were isolated measures and one-off analyses, but there was nothing resembling a comprehensive index of key metrics updated on a regular basis.

So we decided to develop one.  We had a team work for about six months developing the conceptual framework for describing the dimensions of the big shift and how these dimensions related to each other. We then spent the next six months working to define the specific metrics for a Shift Index and collect and analyze the data related to these metrics.

The result is now being formally launched – we call it the 2009 Shift Index.  It initially focuses on the US economy although over time we intend to expand the Shift Index to cover other economies around the world.  In the fall, we will release a separate report pulling apart the data for fifteen industries in the US economy and comparing performance at the industry level.

For the moment, though, we have a report that draws attention to some of the key findings in the Index.  The report is accessible here.  Perhaps the most interesting findings can be summarized as follows:

• Return on assets (ROA) for U.S. firms has steadily fallen to almost one-quarter of 1965 levels at the same time that we have seen continued, albeit much more modest, improvements in labor productivity.
• The ROA performance gap between winners and losers has increased over time, with the “winners” barely maintaining previous performance levels, while the losers experience rapid deterioration in performance.
• The “topple rate,” at which big companies lose their leadership positions, has more than doubled, suggesting that “winners” have increasingly precarious positions.
• U.S. competitive intensity has more than doubled during the last 40 years.
• While the performance of U.S. firms is deteriorating, the benefits of productivity improvements appear to be captured in part by creative talent, which is experiencing greater growth in total compensation. Customers also appear to be gaining and using power as reflected in increasing customer disloyalty.
• The exponentially advancing price/performance capability of computing, storage, and bandwidth is driving an adoption rate for our new “digital infrastructure” that is two to five times faster than previous infrastructures, such as electricity and telephone networks.

Given these long-term trends, we cannot reasonably expect to see a significant easing of performance pressure as the current economic downturn begins to dissipate—on the contrary, all long-term trends point to a continued erosion of performance. So what can be done to reverse these performance trends?

The answer to this question can be found in the three waves of deep change occurring in today’s epochal “Big Shift.” The first, the “Foundation” wave, involves changes to the fundamentals of our business landscape catalyzed by the emergence and spread of digital technology infrastructure and reinforced by long-term public policy shifts toward economic liberalization. The metrics in our Foundation Index monitor changes in these key foundations and provide leading indicators of the potential for change on other fronts. Changes in foundations have systematically and significantly reduced barriers to entry and to movement, leading to a doubling of competitive intensity.

The second, the “Flow” wave, focuses on the key driver of performance in a world increasingly shaped by digital infrastructure. This second wave looks at the flows of knowledge, capital, and talent enabled by the foundational advances, as well as the amplifiers of these flows. Because of higher unpredictability and volatility created by the Big Shift, knowledge flows are a particular key to improving performance. Developments on this front will likely lag behind the foundations metrics because of the time required to understand changes in foundations and develop new practices consistent with new opportunities.

The third, the “Impact” wave, centers on the consequences of the Big Shift. Given the time it will take for the first two waves to play out and manifest themselves, this third wave—and its related index—provides an even greater lagging indicator.

While current trends in firm performance indicate sustained deterioration, we expect, over time, that performance will improve as firms begin to figure out how to participate in and harness knowledge flows. Doing so will require significant institutional innovations, not just changes in practices, resulting in value creation through increasing returns performance improvement. In the end, these innovations will lead to a fundamental shift in rationale from scalable efficiency to scalable learning as firms use digital infrastructure to create environments where performance improvement accelerates as more participants join. Early signs of these changes are visible in the varied kinds of emerging open innovation and process network initiatives underway today.

The Shift Index seeks to measure these three waves of deep and overlapping change operating beneath the visible surfaces of today’s events. The relative rates of change across the three indices will help executives understand where we are in the Big Shift and what to anticipate in the future. Current metrics indicate that we are still in the first wave of the Big Shift and facing challenges in moving forward into the second. Changes still manifest themselves much more as challenges rather than opportunities because our institutions and practices are still geared to earlier infrastructures. At the same time, an understanding of these three waves leads to significant insights about the moves required to reverse current performance trends.

I would love to get your comments and reactions to this report.  Are we on to something? What does it mean? Are we missing anything? What additional research could be done to build on this initial work?

Alas, the release of this report does not mean that I will be soon picking up on posting here.  I am now in the middle of a book project that will consume me for the summer. The book basically picks up where the Shift Index leaves off and focuses on what executives need to do in order to thrive in the Big Shift. If you haven’t already checked it out, I am posting some early views of the book themes at my blog, The Big Shift.  This is all in real time development so a great opportunity to help me shape the perspectives and ideas in the book.  I’ll look forward to hearing from you.

With Liberty and Talent for All

America has always been a land of hope. As we plunge headlong into a recession, it is becoming harder to hold on to that hope.  With the Obama inauguration tomorrow, we have an opportunity to define a public policy agenda that translates hope into action. Rather than a “New New Deal”, perhaps what we need is a “Different Deal.”

One theme could shape a broad public policy agenda: the opportunity and imperative to develop everyone’s talent more rapidly. At first glance “talent development” smacks of corporate lingo better suited for the executive suite than the assembly line. But surveys show workers of all ranks and vocations share similar worries about keeping pace with intensifying global competition.

Talent development reframes a broad range of hotly debated public policy issues. Of course, educational policy directly impacts talent development. But we need to move beyond just fixing schools or designing new retraining programs.

We need to foster work environments that create the opportunity, incentives and capabilities to discover one’s passions and to learn throughout our lives as we pursue these passions. Indeed, we need to re-conceive the work place as a “learningscape.”

We also need to harness the forces enabling Silicon Valley and Manhattan to become global talent spikes, attracting talent from around the world. Rather than confining this success to elite knowledge workers, we need public policies that provide opportunities for everyone, whether a machine tool worker in Cincinnati or a farmer in Nebraska, to get better faster and thrive in our global economy. Within this perspective, we might think twice about policies that preserve jobs but lock people and firms into increasingly obsolete skills and management practices.

This talent development lens could lead to unexpected and exciting solutions to hotly debated issues including immigration, telecommunications policy, intellectual property protection and trade policy. For example, in trade policy why not define policies that harness the benefits of free trade while at the same time developing talent more rapidly so that workers can continue to find productive roles?

Free trade policies force U.S. companies to compete with innovative products from many different parts of the world. They provide these companies with access to innovative components and suppliers as well access to diverse markets with unmet needs. As an example, companies from the U.S., Canada, Finland and Korea are all pushed to innovate more rapidly in high end mobile handsets because of the need to compete in global markets.

Providing freer access to investment funds for entrepreneurial ventures ensures that domestic talent with creative ideas can learn faster by participating in these global markets, even if larger companies may be less innovative. Providing portability in benefits programs enhances the mobility of domestic talented workers as they seek out the companies that are most effective in developing their talent.

In telecommunications consider how an ambitious broadband and open spectrum policy might transform learning-on-demand. Such an infrastructure could provide people in all jobs with access to a powerful medium to expand their social networks in unexpected directions and collaborate with other distributed participants to create and learn from each other.

On immigration, we can learn from the Silicon Valley model where talented immigrants from around the world help domestic engineers to learn faster by engaging with others who see the world quite differently. Few people outside Silicon Valley realize that about half of the entrepreneurial talent fueling the success of Silicon Valley came from outside the United States. Perhaps we should offer a green card to every non-U.S. citizen who receives an academic degree from a U.S. university. We can deepen the talent of all by working with talented individuals from elsewhere. Inclusiveness fosters the diversity that drives creativity and talent development.

Even more promising, a focus on talent development can transcend parochial or national interests. After all, if we are serious about developing the talent of our own people, we must find creative ways to access and connect with talent wherever it resides around the world. We will all develop our talent even more rapidly if provided with the opportunity to interact with other equally talented people outside our country. This is not a call for building walls and sheltering our talent from the challenges of others.

More substantively, our public diplomacy place more emphasis on assessing talent development trajectories of countries around the world. We might become much more focused on building deeper relationships with the countries that are most successful in developing the talent of their people, so that the talent of our respective countries can get better faster by working with each other. At the same, we might provide a more compelling role model for governments, and perhaps more importantly the populations, of countries that are lagging in talent development.

Accelerating talent development could help to re-conceive both domestic and foreign policies. Indeed, the theme will lack credibility and power unless applied consistently and continuously in both domains. For more details regarding what such a public policy agenda might look like, the epilogue of The Only Sustainable Edge develops this perspective more fully.

A world increasingly dominated by catchy sound bites and charismatic personalities will doubtless provide challenges to developing a narrative around helping people get better at what they do. It requires sustained effort and a respect for the texture of complex issues and diverse perspectives. But the rewards are worth the effort.

By systematically pursuing public policies helping people get better at what they do, we will move from the zero-sum mindsets dominating our current political debates to a positive sum outlook, where overall rewards increase at an accelerating rate, allowing everyone to share more fully in an expanding pie.

Now, that would be a change worth celebrating. After all, this is not really about something so sterile as talent development.  It is ultimately about creating environments where we are all much freer to achieve our true potential.

Pareto Power and Leveraged Growth

The Pareto 80/20 rule can be used to drive significant cost restructuring, but it can also generate powerful leverage, enabling companies to deliver far more value to the market with far fewer resources.  In a time of increasing economic pressure, more companies are likely to discover the power of Pareto.

Cost restructuring

My previous blog posting focused on the application of the Pareto 80/20 rule to cost restructuring. It is a powerful tool to achieve significant cost reduction in a short period of time, far more effective than the usual cost-cutting techniques used during downturns. 

Yet, most companies have not yet learned that cost reduction buys temporary relief at best.  As competition intensifies in global markets, cost savings get competed away and captured by the customers.  Cost reduction is a necessity, but it is far from sufficient. If a company focuses only on this, the executive team will find itself managing a steadily shrinking business. To avoid value destruction in the process, executives have to find powerful new platforms for growth.

The challenge of growth

This posting shifts to the leverage side of the Pareto 80/20 rule, offering the potential to drive revenue and, more important, profit growth. How does the 80/20 rule apply here?

The Pareto 80/20 rule can be used to get more value into the market more quickly with lower investment.  Significant growth initiatives have a challenging economic profile – they typically require significant upfront investment, long lead-times before a return can be earned on the investment and considerable uncertainty about results.  This profile applies to both organic growth and acquisitions where effective post-merger integration often takes far longer than executives ever anticipate.Companies need to pursue leveraged growth.

How to change this profile?  Networks and power laws hold the key. It turns out that networks often generate power law relationships – that is, a very few nodes in the network account for a vast share of the connections. It is the Pareto 80/20 rule once again in action – 20% of the nodes often account for 80% or more of the connections. 

If one can identify and target effectively those few “Pareto nodes”, there is a potential for enormous leverage.  Limited effort, appropriately directed, can mobilize a vast network of participants to add value to your business initiatives. 

The role of networks in supporting growth

So, let’s start with the various roles that networks can play in amplifying growth:

Generating new product ideas – Not much need be said here. We are all familiar with the role of networks in scanning the environment for promising technologies and product ideas as well as evaluating product ideas.  Companies are rapidly overcoming “not invented here” cultures to leverage creativity wherever it resides. James Surowiecki addressed some of this opportunity in his best-seller, The Wisdom of Crowds.

Accelerating product development and delivery to market – Many companies are also beginning to understand the power of open innovation networks to significantly compress product development lead-times, tap into deep and diverse expertise, resolve challenging development problems and push performance envelopes much more rapidly than any individual company could. JSB and I have written about the extraordinary management innovations emerging in China to create highly scalable networks in areas as diverse as apparel, motorcycles and consumer electronics.

Accelerating new product adoption – This is the territory marked out by many, including Malcolm Gladwell in The Tipping Point where he highlighted the role of “mavens” – a much sexier term than “Pareto nodes” – in influencing broader consumer adoption of new products.

Enhancing the value of products in the market – Fewer people have focused on this, but it involves mobilizing large networks of highly specialized participants to add value in tailored ways around core product or service offerings.  Salesforce.com does this with their platform, aggregating an increasing number of software developers that offer more specialized functionality tailored to specific customer needs.  To fully realize this opportunity, companies would be well advised to re-configure their products as platforms.

Increasing customer satisfaction – Companies are beginning to understand the power of mobilizing passionate customers to provide advice and help others get more value out of using their products. JSB and I have recently written about the impressive initiatives by SAP in mobilizing an ecosystem of over 1 million participants to more effectively address customer needs. Scott Cook’s recent article in Harvard Business Review on “The Contribution Revolution” also highlighted this opportunity.

So, networks can provide increasing leverage in driving all phases of growth initiatives.  As I indicated, many companies are beginning to understand and address this leverage potential.  In another context, JSB and I have called this capability leverage, and it is extremely helpful in driving economic performance, especially in hard times. Rather than using other people’s money, as in financial leverage, companies can be much more successful using other people’s resources to add value to their business initiatives.

Achieving even more leverage with Pareto nodes

Fewer executives understand that even greater leverage can be achieved by identifying and targeting Pareto nodes within these networks. Rather than engaging with all participants in these networks on an undifferentiated basis, more targeted approaches can achieve much greater impact with less investment. By building deep, trust-based relationships with the participants that represent the Pareto nodes, a company can more cost-effectively access and mobilize the resources of the entire network. These Pareto nodes can help a company identify, understand needs and connect with all of the participants that they deal with.

The first challenge of course is to identify the Pareto nodes.  Fortunately, a variety of powerful network mapping tools are now becoming available to help executives accomplish this.  In the past, network structures have evolved below the surface, not easily detected by the casual observor. Whether it is mapping patent activity to surface networks of expertise or looking at the pattern of website network ecosystems through linking structures as my collaborator Christian Sarkar does so well, new analytic tools can help to make connections visible much more cost effectively. They quickly identify the nodes that represent concentration points for connections within the network.

The second challenge is to effectively engage with these Pareto nodes.  Unfortunately, even the companies that understand the power of Pareto nodes fall far short in terms of building sustainable and effective relationships with these nodes.  Here’s the problem. Executives revert back to conventional mindsets when they reach out to these nodes.  All they can think about is “what’s in it for me?”  They are extremely clear about what they want out of the connection.  But they generally don’t have a clue of what would motivate or be valued by the other party. They also tend to view the interaction as a short-term transaction or, at best, a series of standalone events, rather than the opportunity to build a longer-term trust-based relationship. It is no surprise, therefore, that they often come away from these meetings disappointed with the meager results.

Engaging with Pareto nodes effectively

Effectively engaging with Pareto nodes requires a form of collaboration marketing. Collaboration marketing emphasizes the need to attract others, creating a motivation for them to seek you out wherever you are, rather than trying to reach out, intercept them and get their attention. Of course, in order to do that you need to develop a deep understanding and appreciation for what motivates the other party.  It forces you to get out of the “what’s in it for me?” mindset. 

The best way to attract others is by offering assistance to them, by being more helpful to them than anyone else.  Once again, this requires a deep understanding of the unmet needs of the other party.  Finally, the most cost-effective way to assist them is to affiliate with others.  The trick here is to understand what relationships you already have that can be enormously helpful to the Pareto node participants and how these relationships can be mobilized to attract the participants you want to engage with.

If companies approach this challenge from the perspective of developing a long-term relationship with Pareto node participants, they can begin with small initiatives to attract and add value to these participants. Most tend to approach this with a “big bang” mindset where everything needs to be accomplished in a single interaction and disappointment is a more likely outcome.  By structuring an escalating series of value exchanges with these participants, a company can rapidly build deep trust.

Here’s the interesting thing.  If done right, this effort to engage and build long-term relationships with Pareto nodes fundamentally changes the shape of the network.  Over time, the companies systematically connecting with Pareto nodes have an opportunity to become a Pareto node themselves.  But that is the focus of yet another blog post.

The bottom line

The bottom line here is that Pareto analysis is not just useful for deeply and strategically cutting cost.  It can be equally effective in driving leveraged growth, which in a time of economic stress, is even more valuable than in more prosperous times. The two applications of Pareto analysis go hand in hand. Together, they ensure that a company creates significant economic value rather than destroying value, even in the most challenging times.

Pareto Paring – Achieving Strategic Cost Reduction

As secular and cyclical performance pressure mounts, leadership teams wrestle with the appropriate response.  Unfortunately, most teams end up taking the easy way out, causing long-term damage to their performance. An old Italian economist holds the key to a much more promising approach.

Taking the easy way out – and paying the price

As revenues erode, cost cutting becomes a top priority for all firms.  What are the favored approaches?  There is the great leveler – everyone is mandated to take the same percent out of their cost base.  Most can see that this makes no sense – all costs are not equal and some parts of the business are much less productive than others.  Unfortunately, this tends to be the most common approach to cost reduction. 

Some companies are slightly more sophisticated – they mandate the same percent reduction but then establish an appeals process where executives can make the case that their costs are different and require special treatment.  This gives a release valve for the executives who are most politically adept at lobbying for their special interests but it rarely provides objective metrics to make an independent judgment about the need for exceptions to the broader rule.

Support services operating as cost centers are disproportionately targets for cost reduction in challenging times.  Unfortunately, executives often fail to realize that, if these services are doing their job, they are actually critical to generating revenue and profitability.

Some companies are organized into P & L driven business units and the exercise is to prune low performing businesses – targeting them for sale or closure.  This is certainly better, but it is more of a meat cleaver than scalpel approach.

What’s the result of all of this?  Near-term performance improves because costs do come out of the business, but longer-term performance suffers as the consequences of unfocused cost cuts become visible.

Asking a different set of questions – the Pareto questions

So, what is the alternative? There’s one approach that can be implemented quickly. It  provides an opportunity for very significant cost cutting in the near-term while at the same time strengthening the longer term performance of the business.

I first wrote about this approach over five years ago as many companies were wrestling with the aftermath of the dot com bust.  It is based on a key insight by an Italian economist, Vilfredo Pareto, over one hundred years ago.  Pareto discovered that much of human activity follows the 80/20 rule – 20% of the inputs often generate 80% of the results.  He first noticed this during a study of wealth and income distribution in England.  He discovered that 20% of the population accounted for 80% of the wealth. As he explored other domains of human activity, he realized that this was a remarkably pervasive pattern.

So, what does this have to do with cost cutting?  The 80/20 rule provides the foundation for a relatively simple exercise for executives.  It involves answering the following questions:

• Which 20% of the products or services generate 80% of the profitability?
• Which 20% of the customers generate 80% of the profitability?
• Which 20% of the geographies generate 80% of the profitability?
• Which 20% of the assets generate 80% of the profitability?

These are powerful and revealing questions, yet few companies today are able to answer these questions given the way their accounting and information systems are set up. As a result, the answers are generally hidden from management view. Unfortunately, the questions themselves rarely get asked.

Accounting and information systems need to be restructured to provide greater visibility along these dimensions on an ongoing basis. But, from my experience, quick and dirty approximations of the answers to these questions can be generated relatively easily – especially if management can get comfortable with “directionally correct” answers. The results are usually eye-opening. For example, one management team discovered that the product line it thought was most profitable was actually its biggest money loser.

One caution: in answering these questions, executives often focus on one financial period.  Unfortunately, profitability of resources needs to be measured over a lifecycle, not a snapshot of one period.  For example, one can get very misleading results by looking at customer profitability over one financial quarter.  Real measures of profitability include an assessment of customer acquisition cost, the average lifetime of a customer and the margin generated from the customer for each period over that lifetime. The same principles apply to products and assets as well.  Try getting that out of today’s accounting and information systems!

Leading to the more fundamental question

Once these questions have been answered, here is the question that can focus management discussions around strategic cost cutting:  why are we continuing to invest in the 80% of the resources that generate only 20% of the profitability?  Of course, the answer is not to mechanically cut the 80% resources that are low performing in terms of profitability, but to create a series of reasonably objective screens that can be used to test whether these resources are in fact playing a productive role. Some of these screens are:

• What is the growth profile of these resources? Many business initiatives are at an early stage of investment but have already started to show promising growth potential. The key is to focus on actual revenue and profitability growth trajectories or some other form of operational leading indicator to test growth potential.
• What are potential interdependencies between these resources and the high profitability resources?  Explicit dimensions of interdependencies need to be laid out and used to test any claims in this area.
• What short-term initiatives might be taken to significantly improve the performance of these resources?  Defining explicit six month milestones for operational and financial performance improvement becomes critical to ensure results.

The causes of invisible diversification

Bottom line, though, most companies spread their resources much too thinly across too many product, customer, geography and asset plays. This is a much deeper problem than the diversification across many different businesses or business units.  Even within an individual business unit, portfolios of products, customers, geographies and assets have become broader and broader.

There are many reasons for this invisible diversification.  In far too many cases, it is the result of incremental, near-term strategic thrusts over a long period of time that have never been rationalized.  In other cases, it is the outcome of organizational fragmentation and politics and the lack of clear and uniform metrics to drive decisions on new business initiatives.

Another driver of this invisible diversification is risk aversion.  We launch portfolios of initiatives to cope with risk by placing bets across a broad front.  Unfortunately, most companies lack the discipline to remove bets even after the results are known. 

But there is also a more fundamental economic driver of this kind of invisible diversification.  Many companies have built up a large fixed cost infrastructure either on the supply chain side or on the sales and distribution side or, in too many  cases, on both sides simultaneously.  Once these infrastructures are in place, an insidious logic takes hold.  The only way to cover these costs is to drive more volume through the infrastructures, even if the incremental volume generates minimal margins.  The infrastructures begin to run the show even though they were originally deployed to support the main act. The economic logic is compelling in the short-term but can lead to deteriorating profitability over time. 

The most basic question of all

The only way to escape this bind is to pull back and question the need for these fixed cost infrastructures.  Thus a simple and relatively straightforward application of an 80/20 analysis can lead to a discussion of the most basic question of all: “what business are we really in?” This in turn requires a systematic framework for thinking about business unbundling, something that I have covered in other venues.

If companies want to move beyond marginal cost-cutting that can often hamper long-term performance, they would be well advised to apply the 80/20 analysis to their business. It can deliver quick and very deep cost restructuring that actually positions the business to perform far better in the future. It is a powerful tool for reframing the cost structures of the business through a new lens.

But that’s not all folks

The Pareto 80/20 rule can be used to reframe the business across two other dimensions as well – growth platforms and institutional innovation – but these are topics for future posts.  Let me leave you with two key messages.  As competition intensifies on a global scale, companies will not be able to survive with marginal or incremental approaches to cost reduction – they must restructure and reduce costs at a much more fundamental level.  Cost reduction alone is necessary but not sufficient. Without finding powerful new sources of growth and leverage – even in trying times – cost reduction alone will only shrink the business as cost savings get competed away and captured by customers.

Exploring New Forms of Economic Leverage

We watch in disbelief as financial markets retreat and the investment banking industry morphs into something yet to be determined. We are witnessing the dark side of financial leverage. While “de-leveraging” has become the buzzword du jour, we may miss the real lessons of the current crisis and the real opportunities for leverage.

The lure and risks of financial leverage

Financial leverage is a powerful accelerant in growing markets.  Companies can extend their reach far more rapidly by borrowing other people’s money.  They can also generate much higher returns for the equity investors if companies have opportunities for profitable growth. This is especially true when companies operate in an environment with relatively low interest rates and significant growth in global liquidity, as we have had over the past decade or so.

At every level of our society – individual, firm and government – financial leverage has proven very seductive.  To given an idea of how seductive , the total amount of credit market debt in the U.S. in 1980 was about the same as our GDP but, by 2007, it had increased to 350% of GDP.

But, as we are learning, financial leverage has a significant downside as well. If the “real” economy turns down or the company fails to appropriately assess the risks with its growth strategy, financial leverage quickly becomes an albatross.  The company is stuck with fixed interest payments that have to be covered every quarter.  If the value of the assets being financed also deteriorates the company gets a double whammy when it comes time to refinance.  And if liquidity dries up, the company is vulnerable to a triple whammy.

Financial leverage is challenging enough at an individual company level. It becomes even more challenging in our highly connected global economy, as our current crisis illustrates.  When many companies are highly leveraged, if one company runs into financial trouble, it can generate a domino effect as each company struggles to cover its debt obligations and puts pressure on the companies that have borrowed from it. This is the scramble to “de-leverage” that we are now witnessing.  Cash is king and leverage, once worshipped as a god, now becomes the devil.

One option – capability leverage

But, as we begin to see the very real downsides of financial leverage, we might want to explore other forms of leverage that are far more robust in times of economic downturn. For example, capability leverage—the ability to access and mobilize the resources of other companies to add more value to customers—is a powerful force for creating value in markets. Rather than one company trying to do everything, it can mobilize a broader network of participants to deliver highly specialized and flexibly tailored value to individual customers.

This approach frees up each company to focus its own resources on what it does best while accessing the world-class capability of other companies in the network. Rather than relying on a few select business partners, companies can now employ innovative new management techniques to create and coordinate networks of thousands of business partners that provide far more leverage than ever possible before.  I explored this opportunity in an article on Leveraged Growth in Harvard Business Review.

Financial leverage is insidious because, unless carefully monitored, it can undermine incentives to pursue capability leverage.  If a company has ready access to cash through various forms of debt, it is much more likely to feel that it can support a much broader range of business initiatives than if cash is tight.  As a result, it is much easier to support a “not invented here” culture and attempt to do everything oneself.  It is no accident that some of the most sophisticated examples of capability leverage have emerged among entrepreneurial companies in Asia that did not have access to financial capital.

Another option – learning leverage

Yet there’s an even more powerful form of leverage for companies to tap into: learning leverage.  Learning leverage seeks to build relationships with other companies that help each company get better faster by working with others. Rather than treating existing resources as fixed, learning leverage recognizes the value for everyone in finding ways to continually push the performance envelope for all participants.  In rapidly changing global markets, learning leverage provides a powerful approach to increase value delivered to customers. Learning leverage introduces a powerful compounding effect – not only does the value delivered increase with the number and diversity of participants, but more value is created by each participant over time.

Comparing the three forms of leverage

Here’s one way to look at the three forms of leverage.  Financial leverage magnifies returns, but does not increase the value delivered to the marketplace.  Capability leverage increases the value delivered by flexibly connecting resources that otherwise might not be accessible to customers or that might require great effort by customers to assemble on their own.  Learning leverage adds even more value by enabling individual participants to deliver higher levels of performance to the marketplace as they learn more rapidly from each other.

Capability leverage and learning leverage amplify value in times of economic prosperity, but they are even more valuable in times of margin pressure.  Rather than requiring one company to bear the brunt of this margin pressure, these forms of leverage make it easier for the company to focus on investments that can enhance differentiation while relying on others to deliver complementary value to the customer. In contrast to financial leverage, these forms of leverage alleviate and diffuse pressure during economic downturns, rather than magnifying pressure on the leveraged company. 

With some notable exceptions in arenas like high tech and biotech, most Western companies are still just scratching the surface of the potential for capability leverage and learning leverage.  Perhaps during this challenging economic time companies will have much greater incentive to explore these alternative forms of leverage. They may find that capability and learning leverage trump financial leverage.

Shaping Strategies

In times of high uncertainty, adaptation is the winning strategy.  So goes the conventional wisdom.  But, what if that misses a big opportunity?

In a new article just published in Harvard Business Review, I suggest in collaboration with John Seely Brown and Lang Davison that shaping strategies may hold far greater promise.  Executives have far more degrees of freedom to shape target markets and industries in times of high uncertainty and rapid change than in more stable times.

The concept of shaping strategies

These strategies use positive incentives to mobilize and focus thousands of participants in shaping specific markets or industries.  In times of high uncertainty, we all have a natural tendency to discount rewards and magnify risk.  The result is often paralysis or, at best, hesitant small moves on the margin while we wait for the fog to clear.  The opportunity for aspiring shapers is to flip that risk/reward perception by magnifying perceptions of rewards and discounting perceptions of risk. By re-shaping mindsets, shapers can unleash significant investment by many participants and ultimately re-shape broad markets or industries.

We explore in the article examples of successful shaping strategies in industries as diverse as shipping, apparel, financial services and high tech. Three key elements come together in these strategies – a compelling shaping view to provide focus for investment by participants, a powerful shaping platform that provides economic leverage for participants and a set of acts and assets by the shaper to communicate conviction and capability to potential participants.

Shaping strategies can be very powerful because they unleash increasing returns. Once a critical mass is achieved, the value of participation increases as the number of participants expands.  But, the challenge of any increasing returns opportunity is getting to that critical mass of participants – many efforts have foundered in this early stage. Shaping strategies help to reach that critical mass quickly and cost-effectively.

Distinctive ecosystems

Shaping strategies depend upon mobilizing large ecosystems of participants.  Now, of course, all companies operate within broader ecosystems of business partners. But there are four critical, and related, differences in shaping strategy ecosystems. 

• The first is the scale of the ecosystems involved.  Rather than dozens of participants, shaping strategies typically involve thousands, and in some cases hundreds of thousands, of participants.
• Second, these ecosystems come together and are focused by an explicit long-term shaping view that defines a very different industry or market structure and the opportunities created not just for the shaper, but for all participants.
• Third, these ecosystems are characterized by a significant diversity of participants.  Rather than pitting individual participants against each other, these ecosystems generate diverse niches that encourage participants to specialize in their areas of greatest expertise and to differentiate themselves from other participants.
• Fourth, these ecosystems create incentives for distributed innovation among participants.  We are all familiar with the concept of open innovation.  Shaping strategies encourage thousands of participants to innovate aggressively in their particular domains but help to focus and integrate this innovation so that it ultimately re-shapes broader markets or industries.

Not everyone can be a shaper, but all companies need to make explicit choices on this front. If they choose not to be a shaper, they need to understand the shaping strategies that are in play in their relevant markets and make choices about what role to play in the shaping strategies of others.  Our perspective can help executives evaluate the likely success of aspiring shapers and make choices regarding the roles that may be appropriate.

Broader applications

While our HBR article focuses on the application of shaping strategies in the business arena, this approach to strategy has the potential to to be applied in many other domains.  For example, we have held workshops exploring its application in such diverse fields as public diplomacy and and education.  Even movements for social change may find that shaping strategies can provide significant leverage.

Further discussion

If you find this perspective intriguing, Harvard Business Review has created an online discussion forum for this article and I’d welcome your participation to help test, challenge and refine the shaping strategy concept.