Unbundling Dell’s Businesses

Dell made the news recently. The Wall Street Journal reports that it is seeking to sell off a significant portion of its factory network and logistics operations.  This is a big step for Dell but it’s consistent with a much broader trend restructuring business on a global scale.

As I wrote over a decade ago, companies increasingly face an unbundling decision that will force executives to confront the most basic question of all: “what business are we really in?”

Three business types

In brief, most companies today are still an unnatural bundle of three fundamentally different, and often competing, business types:

• Infrastructure management businesses – high volume, routine processing activities like running basic assembly line manufacturing, logistics networks or routine customer call centers
• Product innovation and commercialization businesses – developing, introducing and accelerating the adoption of innovative new products and services
• Customer relationship businesses – building deep relationships with a target set of customers, getting to know them very well and using that knowledge to become increasingly helpful in sourcing the products and services that are most relevant and useful to them

These three business types remain tightly bundled together within most companies today even though they have completely different skill sets, economics and cultures required for success.  Inevitably, companies deeply compromise on their performance as they seek to balance the competing needs of these business types.  More broadly, this tight bundling decreases agility and diminishes learning capacity.

Companies are starting to unbundle but, to date, the efforts have been incremental and driven largely by short-term operational and financial motivations, rather than part of a longer-term strategic initiative.  The broad trend towards outsourcing and offshoring over the past couple of decades can be understood as a systematic stripping out of infrastructure management businesses from larger companies.

The Dell dilemma

To the extent that the reports are true (Dell will only say it is continuing to evaluate its manufacturing and distribution options), Dell’s efforts to shed its factories are part of this trend as well.  It is particularly striking because Dell’s manufacturing and logistics system was such a core part of its early success in the computer industry. It is a bold and unexpected move to walk away from a core business activity, but it represents a clear understanding of the broader business trends that are re-shaping not just the computer industry, but all industries around the world.

Dell pioneered in the design of a “pull” manufacturing system that allowed customers to specify highly customized configurations of a computer and have them delivered within days. For many years, especially when combined with its innovative use of direct selling channels, this lean manufacturing approach was a source of competitive advantage as other computer companies struggled to replicate this capability.

Over time, though, the market shifted.  The market shifted from desktop computers to much more standardized notebook PCs.  The customers shifted as well – consumers became a much more significant part of the market.  They tended to favor purchases through traditional retail channels, rather than the direct selling channels favored by large corporate buyers, which undermined the opportunity to differentiate through on-demand customization.  The focus of manufacturing and logistics shifted from rapid turnaround of direct sales orders for highly customized desktop computers to cost-effective manufacturing of large numbers of relatively standardized notebook PCs for retailers.  Dell’s system has been optimized for the former and was not designed for the latter.

Penalties for bundling

Dell’s story illustrates a broader issue associated with tight bundling of these three business types.  Markets are becoming increasingly volatile, with demand shifting from one type of customer and product to another very quickly. Companies that persist in all three business types will have a much harder time adapting to these changes quickly, especially relative to companies that tightly focus on one of the three business types and develop a broad network of relationships with partners that can flexibly provide elements of the other two business types.

What may be a source of advantage at one point in time can quickly become a liability as conditions change. Product life cycles are compressing and product markets are evolving more rapidly, especially if they involve digital technology. Any company wanting to be successful in  product innovation and commercialization should think long and hard about whether it can afford to compromise on flexibility by locking into proprietary supply chain management or customer relationship management business types.

But it is not just about flexibility.  It is about focus and the opportunity to develop world-class capability that can differentiate on a sustaining basis.  As the Wall Street Journal reports:

Contract manufacturers can generally produce computers more cheaply because their entire operations are narrowly focused on finding efficiencies in manufacturing, as opposed to large firms like Dell, which must also balance marketing and other considerations.

In a world that is changing at an accelerating rate, we desperately need focus in order to learn faster and improve performance more rapidly than our competitors.  If we try to manage activities across too broad a waterfront, we run the risk of losing our edge across more and more of this waterfront.  Even if we find ways to build powerful advantages at the outset through creative linking of new approaches across the three business types, those very links can become chains that hold us back as the markets around us evolve in their needs.

The opportunities for growth and consolidation

Focus and unbundling do not equal shrinking or fragmentation.  At least two of the three business types outlined above – infrastructure management businesses and customer relationship businesses – are driven by powerful economies of scale and scope.  These economics will lead to increasing concentration and consolidation on a global scale.  As an example, look at the process of consolidation that has been playing out for years in the global contract manufacturing industry or global logistics markets.

In fact, unbundling will increasingly become a pre-requisite for creating scalable growth platforms.  Focused growth will be much more profitable and sustainable.  This is the paradox: companies may need to shed in order to grow more rapidly and more robustly.

For this shedding to be most effective, though, it should not be done incrementally in response to near-term operating and financial pressures.  It needs to be driven by clear and unequivocal answers by senior leadership teams to that most basic question: “What business are we really in?”

The Bigger Consequences of the Big Sort

Obama pledges to unite a divided people.  A new book highlights the enormous challenge he faces – and drives home that this challenge is only partially about political division.

The Internet as a unifier or divider
When the Internet emerged, it precipitated a vigorous debate: would it unite or divide?  Would people use the power to connect in a way that would expose them to diverse viewpoints or would they seek other people who shared their views and become even more wedded to those views?

Here’s the concern. In the physical world, we live in communities where we are forced by circumstance to interact with others who hold diverse views, thereby tempering whatever strong views we might hold.  In contrast, the virtual world holds no such constraints.  We can seek out those who share our views wherever they reside in the world and choose to associate only with them. 

Even the smallest fringe groups can find a critical mass of like-minded folks across the world, insulate themselves from divergent views and reinforce each other’s beliefs. Extreme beliefs become even more extreme as we find daily reinforcement for these views in our online cohorts, even if those around us in the physical world clearly hold other views. Cass Sunstein in his book Republic.com is perhaps one of the most vocal proponents of this concern.

Anyone who has wandered through the vast echo chambers of the blogosphere is likely to be sympathetic to this view. Political bloggers on the right and left seem to be preaching to the choir – whether evangelical or secular.  Radical Muslim jihadist sites rally the faithful wherever they reside in the world and create closeted communities where indoctrination and mobilization can proceed without distraction from secular sources.  Digerati cluster in their own discussion forums and social networks, boasting they have never encountered anyone who is not on Twitter.

The truth may in fact be more nuanced.  I actually was surprised at how little empirical research I could find to test whether the Internet in fact divides or unifies (I would certainly welcome pointers to research that addresses this issue).  An interesting study recently published by Eszter Hargittai and two other researchers in Public Choice suggests that liberal and conservative bloggers tend to link much more frequently to those who share the blogger’s ideological position in their postings. While there is some linking in these postings to competing perspectives, roughly half of these links are what they call “straw man links,” pointing to content that the poster is seeking to discredit. Research by Kelly Garrett at the University of California, Irvine, indicates that users of the Internet tend to seek out information that supports their opinions, but do not actively avoid opposing views when they come across them.

Meanwhile, back in the physical world
But, while focusing on these trends in the virtual world, we have missed what is going on around us in the physical world.  Over the past several decades, people in the United States have moved in growing numbers – and they are moving into more and more homogenous communities that reflect their own beliefs.

The migration pattern has been carefully documented in an interesting and alarming new book, The Big Sort: Why the Clustering of Like-Minded America is Tearing Us Apart, by Bill Bishop in collaboration with Robert Cushing. Bishop points out that over the past decade over 100 million Americans have moved from one county to another – 4-5% of the population each year.

We have always been a restless nation, a nation of immigrants and pioneers that journeyed over great distances to escape oppression and pursue opportunity. As Bishop observes,

There have always been patterns to migration and development.  Southern blacks moved to Chicago in the 1950s. White Appalachians took the “hillbilly highway” north to booming Cleveland and Detroit after World War II.  These were migrations in response to economic hardship and opportunity. The movements we saw from 1970 to 2000 were different.  The flows were selective, and they varied by personal characteristics, not broad demographic descriptions.  People were sorting, and the movements themselves were changing economies.

Bishop explains the sorting process in the following terms:

Freed from want and worry, people were reordering their lives around their values, their tastes, and their beliefs. . . . The Big Sort was big because it constituted a social and economic reordering around values, ways of life, and communities of interests. . . . Marketing analyst J. Walker Smith described the same phenomenon as extreme and widespread “self-invention,” a desire to shape and control our identities and our surroundings. . . . People are unwilling to live with trade-offs, he said.  So they are “re-creating their environments to fit what they want in all kinds of ways, and one of the ways is that they are finding communities that fit their values – where they don’t have to live with neighbors or community groups that might force them to compromise their principles or their tastes.”

What has been the consequence?  Bishop maintains that

We have built a country where everyone can choose the neighbors (and church and news shows) most compatible with his or her lifestyle and beliefs.  And we are living with the consequences of this segregation by way of life: pockets of like-minded citizens that have become so ideologically inbred that we don’t know, can’t understand, and can barely conceive of “those people” who live just a few miles away.

The clustering process
Reading this reminds me of Neal Stephenson’s wonderful book, The Diamond Age that described a world in the future where nations had receded into insignificance and the population had realigned into enclaves of highly distinctive cultures.  Neal Stephenson’s eagerly awaited new book Anathem, to be released this month, apparently returns to this theme by predicting an even bigger sort – between an ADD pleasure-seeking society and those who pursue intellectual inquiry in monastic separation from the broader society. Maybe William Gibson really is right – “the future is already here, it is just unevenly distributed.”

Of course, marketers have known for a long time that we tend to live in clusters of like-minded folks.  Claritas does very well with its Prizm segmentation data that ties specific zip codes to 66 distinct geo-demographic segments. This segmentation data was nicely summarized two decades ago in Michael J. Weiss’ The Clustering of America.

Bishop provides persuasive data that this process is intensifying and represents a long-term secular trend with no sign of slowing down.  Bishop traces this fracturing of America to 1965 when widespread turmoil caused people to seek the company of others who shared their views.  More recently, he suggests that the process has been sustained through patterns of clustering in cities based on economic drivers.

Where does this take us over time? Bishop is clearly concerned that this segmentation of America will intensify political conflict.  He worries that members of communities become more extreme in their views as a result of reinforcement from their neighbors and diminishing contact with those who hold differing views.  In the extreme, this may lead to the kind of political unbundling of the country anticipated by Juan Enriquez in his excellent book, The Untied States of America (although the segmentation described by Bishop at the county and even neighborhood level makes this political unbundling more challenging).

The bottom line
Bishop does a very good job of tracing out the potential implications and concerns of this sorting process for our civic life. But why should executives care about this process of geographic segmentation? Certainly it intensifies the need to mount segmented marketing programs to reach appropriate consumers, but the implications extend far beyond marketing.

Innovation within companies.  Innovation depends upon cognitive diversity, as Scott Page persuasively argues in his book, The Difference (reviewed here).  If this geographic sorting reduces cognitive diversity in specific locations, companies will need to choose locations for their operations carefully to tap into cognitive diversity across locations.  Otherwise, they may become trapped in geographic silos that inhibit creative processes. More broadly, Bishop cites evidence that in fact innovation, at least as measured in terms of patent production, is accelerating in certain cities while decreasing in others.  Certain values, interests and ways of life may foster innovation while others inhibit it.  If this is the case, companies may need to develop innovation maps to drive decisions regarding location of operations.

Seeking serendipity.  As we gather in geographic areas that reflect and reinforce our values, interests and ways of life rather than testing and challenging them, we may need to look for other ways to enhance serendipity – the chance encounters that introduce us to new resources or ways of looking at the world that we had not anticipated and that spark the creative process.  Large, diverse metropolitan areas used to offer this kind of serendipity on a daily basis, as Jane Jacobs and others so persuasively demonstrated. Bishop’s Big Sort suggests that serendipity in geographic locations may become more limited. We’ll still run into lots of people we didn’t know, but the diversity of their perspectives will be much narrower.

What will we find to enhance serendipity?  Perhaps this is ultimately where the Internet may play a positive role. The first generation of the World Wide Web was driven by search.  The next generation of the WWW may be driven by environments and tools that enhance serendipity. Companies that find ways to amplify serendipity may reap the greatest economic rewards as we all struggle to improve our return on attention.

Seeking productive friction.  Diversity and density create the potential for something else even more valuable – productive friction. When we have to live in close proximity to others with very different ways of looking at the world, three things happen.  We often find ourselves working together, perhaps after a serendipitous encounter. But, because we have diverse perspectives, we will likely discover that we disagree, generating some heated discussions, or friction, but also some new insights as we confront differing perspectives.  Finally, because we live in close proximity, we have strong incentives to find a productive resolution to the disagreements.  Of course, it doesn’t always work out this way – witness the history (at least until recently) of cities like Belfast where friction became very dysfunctional. But the point is, if all the people around us share our perspectives, we are much less likely to generate friction. Without friction, we will probably end up being far less creative.  Serendipitous encounters often lead to creative sparks but significant new knowledge creation tends to require sustained face to face engagement.  As the Big Sort plays out, we may find that our quest for comfort saps our creativity.

Social instability.  Bishop notes that part of the Big Sort is the tendency for people with higher education to migrate to certain cities, while people with lower education are migrating to other cities.  This in turn has led to growing income disparities across cities, reinforced by the growing asymmetries in patent production mentioned earlier.  Younger generations are more mobile than the older generation and the young are gathering in the more economically dynamic cities while the older generation remains in the less dynamic cities. How long can this process continue without some sort of backlash?

As discussed earlier, Bishop describes the Big Sort as a choice people make as a result of increasing affluence and more degrees of freedom in terms of location.  But there is a dark side to the Big Sort.  At least in part, it appears to be also driven by a quest for safety and stability in a time of accelerating change.  Hunkering down with those who think like you can be very reassuring when everything around you seems to be in flux.  If many of these enclaves are also increasingly marginalized, they may become seedbeds for opposition to the public policies that unleashed and sustained the change process.

Whether the Big Sort is driven more by fear or by freedom of association, I worry about its consequences for creativity and innovation.  At the extreme, the Big Sort could become the basis for the Big Backlash. But even without this extreme outcome, we will all be a lot poorer as this social dynamic plays out.

Stupidity and the Internet

Nick Carr has a talent for stirring debate.  I’ve been drawn in to such debates in the past and, once again, I find that I cannot resist.  This time, in an article in The Atlantic, suggesting that the Internet might be making us stupid, Nick set off a firestorm of debate and discussion in the blogosphere as the digerati piled on in defense of the Internet. Some of the best responses (including some rejoinders by Nick) are available at the Edge and the Brittanica blog.  But what was not said was often more interesting than what was said.

As might be expected, much of the debate focused on Nick’s core contention: the Internet is subtly molding our minds to favor brief snippets of information rather than the nuance and complexity that can only be communicated in much longer forms such as books.

Content became the battleground.  Are snippets superior to more in depth writing and analysis?  Some came to the defense of books while a surprising (to me) number of participants celebrated the passing of books from our consciousness – especially since many of the latter had written books themselves. Those who came to the defense of books then divided into two camps – those who agreed that books were endangered by the Internet and those who took a more optimistic view of the ability of earlier generations of media to co-exist with newer forms.

But two things were common across much of the debate.  First, it centered on content.  Second, it took the Internet in its current form as a given.  Perhaps it is time to challenge both of those assumptions and re-frame the debate.

Is content all there is?

To be fair, Nick is primarily concerned about the impact of the Internet on our reading habits.  This is to be expected from someone who is a fine editor (having worked with him) and author. But it is an interesting sleight of hand that Nick performs very early in his article: “I’m not thinking the way I used to think.  I can feel it most strongly when I’m reading.”  Thinking collapses to reading and then the rest of the article focuses on our reading habits.  This sets up the debate about content – short vs. long.

But if the concern is about intelligence, thinking and the mind, then isn’t content just one small piece of the puzzle?  Nick and many of the digerati who line up against Nick have one thing in common – they are content junkies.  They consume content voraciously and care deeply about the form that content takes. 

In the heat of debate, they seemed to often lose sight of the fact that most people are not content junkies.  Most people use the Internet as a platform to connect with each other.  Sure, they are exchanging information with each other, but they are doing a lot more than that.  They are learning about each other. They are finding ways to build relationships that expand their understanding of the world and enhance their ability to succeed in their professions and personal lives.

Now, there’s certainly a lot to debate about the impact of the Internet on this level as well. Are virtual relationships shallower than face to face relationships?  Do virtual relationships enrich or detract from face to face relationships? What is the trade-off between quantity and quality in relationships? To what extent can virtual relationships support the communication of tacit knowledge? Do we seek out virtual relationships that merely reinforce our existing points of view or that expand our perspectives? 

But it is interesting that very few sought to expand the terms of debate to address these questions.  Yet, if the debate is really about the impact of the Internet on intelligence, aren’t these just as important, if not far more important, than narrow debates about the forms that content will take?

Where is the Internet headed?

The debate also largely took the Internet, and specifically the World Wide Web, in its current form as a given.  This is a dangerous assumption given the speed of change in the underlying technology foundations of the Internet. 

As one small example, we are seeing rapid evolution of both social network platforms and physical presence tools that will lead to a much more complex interweaving of physical and virtual environments. Sensors and imaging tools will give us much greater visibility into the world around us.

Today, navigation on the Internet is heavily shaped by search tools – but these search tools are geared to locating (surprise!) content. We are just now beginning to see tools emerge to help us find people and more effectively learn who they are.

We are also at the earliest stages of figuring out how to create environments that enhance serendipity and make visible the relationships and patterns that today lurk behind the cascade of events and snippets of information. The World Wide Web that was designed by content junkies for content junkies to more rapidly locate more snippets of content is already giving way to much richer platforms that will help people to connect with each other and engage together in sustained efforts to create new knowledge.

Tacit knowledge – that which cannot be readily expressed in published content of any length, whether snippets or books – has always been our most valuable knowledge. You can read all the books you want on brain surgery, but that alone will never qualify you to perform brain surgery. At an even simpler level, no book can teach you how to ride a bicycle.

The ultimate impact of the Internet on our intelligence will hinge on its ability to support the creation and sharing of tacit knowledge. Again, we are at the earliest stages of tapping into this potential.

Stories offer potential to communicate some elements of tacit knowledge.  They help to provide enough of a sense of context to reconstruct and extend parts of the tacit.  Stories, properly told to communicate the richness of context, do not reduce to snippets.

In the end, though, tacit knowledge will only flow through shared practice and the deep relationships that build up around shared practice.  Some examples of shared practice can already be found on the Internet in such diverse arenas as open source software and online games like World of Warcraft. This is one more area that the Internet will likely evolve to support much more effectively in the years ahead.

Snippets versus books?

OK, so maybe it is unfair to change the terms of the debate.  Maybe we should just take Nick on the terms that he has defined for the debate.  If it is about content, will snippets trump books and will we all be dumber for it? As someone who has never mastered the art of the snippet, let me proudly count myself as one who still sees profound value in the long form where texture and nuance can be teased out and explored.

But let me also align myself with those like David Brin who bridle at the zero sum nature of the debate.  It makes for good copy to proclaim that the book is dead or that snippets rule.  But the truth as always is in that textured middle.  Snippets of information, loosely coupled, have enormous value in enhancing peripheral awareness and provoking new ideas.

At the same time, snippets of information alone are deeply dangerous.  They distract us with never-ending waves of surface events, spreading us ever thinner and obscuring the deeper structures and dynamics that ultimately are shaping these surface events.  Those of us who stay only on the surface, swimming in a sea of snippets, will ultimately lose sight of land. 

We need books, or whatever the digital long forms of content are that will replace the book, to help us penetrate the surface and explore the deeper structures and dynamics that make sense of the changes around us.

Rushkoff is right – we need to develop a better understanding of the strengths and limitations of each medium available to us and find the right mix to give us the greatest insight. Larry Sanger also makes an important point – Nick is adopting a technological determinist view, ignoring the fact that we each have a choice in terms of what media we use.  I, for one, will continue to buy and read (and occasionally write) books while still actively surfing the Net.

Evolution favors those who can make sense out of evolving landscapes. Those who figure out how to navigate both media worlds will tend to survive and thrive relative to those who either abandon books or ignore the power of loosely coupled information.

Innovation on the Edge

I’ve played on the edge throughout most of my professional career, whether it was doing deals in the Sultanate of Oman back in the 1970s, building a start-up around a new technology called the microprocessor in 1980, building a new Internet-focused practice for McKinsey in 1993 or spending more time in places like Bangalore, Shenzhen and Shanghai in the early part of this decade (my first visit to Shenzhen was actually in 1982 when I led a major manufacturing offshoring initiative there).

The emergence of a theme

Instinctively, I have been drawn to various edges because of the opportunity and challenge they represent. Over time, I have focused more sharply and explicitly on the importance of the edge as a source of value creation and strategic advantage – hence the title of my blog “Edge Perspectives,” the title of my most recent book (co-authored with JSB), The Only Sustainable Edge, and the name of the new research center that JSB and I lead at Deloitte – the Center for Edge Innovation.  See a pattern here?

The Business Week column

About six months ago, JSB and I launched another edge initiative. We signed on to do a monthly column on the Business Week website called – are you ready? – “Innovation on the Edge.” Business Week has now made available a repository of our columns here (an RSS feed is also available at this location).

As a brief overview, here are the columns that have gone up on the Business Week website to date:

• Embrace the Edge — or Perish – our opening salvo on the importance of the edge
• Phoning from the Edge – exploring Google’s edge innovation in telecommunications
• Catching the Innovation Wave – discussing insights from innovation in big wave surfing
• Learning from Tata’s Nano – highlighting what was not discussed in the publicity surrounding the unveiling of this new automobile
• Life on the Edge: Learning from Facebook – analyzing some innovation initiatives on the Facebook platform
• Institutional Innovations – exploring an innovative approach to pursuing medical research

Why edges matter

From our perspective, edges take many forms.  They describe and define the edge of a company, the edge of markets or industries, geographic edges like emerging economies, demographic edges (either new generations or older generations) or the edges of specific domains of knowledge.

Most executives scratch their heads when I start talking about the edge.  Why bother about the edge when everyone knows that all the profit is in the core? Besides, edges are risky. Modest revenue, high risk, low return – isn’t the edge just a distraction?

In our first column for Business Week here, JSB and I explained why the edge matters in terms of innovation:

Edges are powerful sources of business innovation because they are places of potential and friction, where traditional products and practices are no longer adequate to address unmet needs or unexploited potential. Much tinkering and experimentation occurs on the edge, as well as heated debate about the most promising options to address emerging needs, intensified by the diverse backgrounds, skill sets, and perspectives of participants gathering on the edge. By playing a part in this experimentation, companies participate in rich flows of new knowledge, flows that are the primary sources of innovation.

Edges tend to be risky places: There are no well-established road maps. Order, to the extent it exists, routinely dissolves into chaos, only to reform again in a very different pattern. Market meltdowns and business failures are commonplace. Relationships form quickly on the edge, because people have less confidence in going it alone and are more inclined to seek out others to help them sort through the challenges and share the risks and opportunities created by edges.

A couple of other factors make edges particularly fertile grounds for innovation.  Edges tend to attract risk-takers, so there are a lot of people on the edge who are not only open to ideas, but more willing to act on them, even if they haven’t been tested yet.  At the same time, there are few entrenched interests or legacy assets on the edge, so there are few resistance points ready to impede those who want to try something different.  Bottom line – there’s less inertia on the edge.

Edges have always been a seedbed for innovation, but there is something different now.  Edges are folding back in on the core much more rapidly than ever before. Think of the telecom industry – it wasn’t so long ago that wireless networks were a minor edge to the wireline networks.  Now, many younger customers only own a cell phone and are somewhat puzzled about why anyone would own a fixed line phone.  Voice communication used to be the core of all telecom networks but now data has become the core of network traffic.

So, there is an even more compelling reason to participate on the edge.  If the edge becomes the core, edge advantage soon becomes core advantage. Those who remain focused on the core risk being blindsided by new forms of advantage that emerge first on the edge.  To use another meaning of edge, participating successfully on the edge will be essential to developing and sustaining a strategic edge.

The bottom line

To reduce this to a simple formula:
Edge = Innovation = Edge

Shift Happens – The Future of Advertising

In a world of rapid change, shift piles upon shift.  One can get thoroughly confused and draw the wrong conclusions by focusing on one change while losing sight of the shifts that are coming up.

Advertising is a case in point.  Seismic shifts are shaking up the world of advertising big time. But which shift is most relevant?  And what are the implications for executives?

Understanding the shifts

In the advertising world, multiple shifts are piling on top of each other and it is often hard to keep track of them, much less understand their implications. Let’s look at just some that are re-shaping the advertising world:

• Shifts from advertising placed in digital content to ads placed in social networks and applications
• Shifts from digital advertisements delivered through conventional PC’s to a growing array of mobile devices, with an increasing ability to target messages based on the physical location of the person
• Shifts in the behavior of digital users in their responsiveness to advertisements online
• Shifts in the way that companies connect with and build relationships with stakeholders (e.g., blurring boundaries between customers, partners and suppliers)
• Shifts in the revenue models for businesses, as online businesses in particular become more and more dependent on advertising as a key revenue source (e.g., is there any Web 2.0 start-up that doesn’t blithely answer “advertising” when asked about their revenue model?).
• If that isn’t complicated enough, we also have broader macro-economic shifts like potential near-term recessionary pressures

Whew! No wonder it’s easy to get confused, especially since one set of changes can offset or even reverse the impact of another set of shifts.  So, how do we make sense of all this?

In essence, three fundamental shifts are piling on top of each other.

• Advertising is migrating to digital media because it is far more effective in targeting and reaching relevant audiences than most traditional media.
• Aggregate advertising spend in the US is likely to experience a cyclical downturn as the economy softens
• People are confronting a proliferation of sources competing for their attention and becoming less receptive to advertising messages, even when they are very well targeted

Here’s the danger: we may become so focused on the recent growth in online advertising that we dismiss any short-term slowdown in spending growth as a purely cyclical phenomenon. In the process, we may miss the longer-term, and ultimately far more profound, impact of the diminishing returns that online advertising is already beginning to experience.

This is particularly relevant in the Internet space. Virtually everyone seems to be zeroing in on advertising as the basic revenue model. Titanic battles among Internet gorillas, including mega-acquisitions, are at least in part motivated by a desire to occupy choke-points in the advertising value chain. 

The likely evolution of Internet advertising

The basic paradox of the Internet can be framed very simply:  The very platform that makes advertising both more relevant and more measurable is the same platform that longer-term will challenge and ultimately undermine the basic role of advertising in communicating with customers. 

Why will the Internet ultimately undermine advertising?  A number of factors come into play:

• The Internet proliferates resources, all competing for the attention of people.  Even the most targeted and relevant ads over time will have a harder and harder time rising above the noise.
• The Internet creates powerful options for people in terms of how they become aware of new products and services and how they obtain information about the products and services that are relevant to them.
• The Internet offers increasingly powerful tools to filter and block advertisements (and, yes, product placements will be an interesting alternative for a while, until even that space becomes so cluttered that people will mentally filter out the products)

On the second point, social network sites provide increasingly robust platforms for us to learn about what our friends are interested in and purchasing (although in many cases still trying to figure out the appropriate balance between privacy and attention). In this context, Esther Dyson wrote a great op ed piece in the Wall Street Journal on February 11 on “The Coming Ad Revolution” (a longer version is available at her blog here) highlighting the “walled gardens” that users themselves are cultivating to connect with each other and with favored vendors.

Amazon continues to represent a leading edge example of how a trusted third party intermediary can help filter and present information about the interests and purchase patterns of others in ways that are very helpful in discovering new products. We are still a long way from the infomediaries that I wrote about almost ten years ago in Net Worth. However, the proposition of a trusted advisor who can help us sort through the growing array of resources and discover those that are truly relevant and valuable becomes ever more compelling.

As we find richer and more diverse ways to connect with friends and trusted advisors who can help us discover what we need, conventional advertising – even with all of the best behavioral targeting algorithms – will become viewed at best as marginal value and at worst as an increasing nuisance. People want to connect with vendors, especially vendors that can address unmet needs, but they will increasingly want to do it on their terms.

Advertisers are wrestling with this shift in user preferences.  Recent declines in online click-through rates and the especially dismal click-through rates experienced on social network sites like Facebook should be an early red flag regarding the challenges ahead.

Implications for advertisers

For advertisers, the key message should be to build the skills required to genuinely engage people around their products and services in such a compelling way that people seek them out – and keep coming back because they have received so much value. The old game of paying for placement of messages, no matter how targeted, will yield diminishing returns. The long trajectory that will shape the advertising business is the move from random interception to targeting intention to seeking attention and ultimately to attracting attention. 

The end game is collaboration marketing where advertising, meaning paid placements of messages, becomes more and more marginal. The focus shifts to becoming more helpful by creating rich, serendipitous environments that people will actively seek out (there’s a lot more to be said on this front, but this is a blog after all, so the details will be left to the imagination of the reader).

I want to be clear: while I am skeptical about the long-term future of advertising as paid placements of messages, marketing becomes more and more important in an era of abundance.  Companies of all kinds will wrestle with growing challenges in terms of connecting, and building deep relationships, with key stakeholders.  I also understand that advertising does far more than convey information; it also excites and engages people in imagining how their lives could be improved with the vendor’s products.  Marketing will still need to address this emotional and psychological mission – my only point is that advertising in online environments will be increasingly marginalized as the vehicle for accomplishing this mission. Will advertising go away?  Hardly, but it will move from the core of marketing to the edge, challenged by diminishing returns and more robust options for engaging people.

Implications for revenue models of businesses

If advertising is likely not to be a sustainable revenue source, it means that online businesses must find other sources of revenue to support their businesses long-term.  What might be some of those revenue sources? Well, one option is to get customers to pay. In this regard, Kevin Kelly has an interesting post on “Better Than Free”.  Observing that the Internet is a vast copy machine that makes copies of everything super-abundant and free, he concludes that “when copies are free, you need to sell things which can not be copied.” Kevin highlights eight uncopiable values that can in one form or another be sold – immediacy, personalization, interpretation, authenticity (meaning here certification of authenticity), accessibility, embodiment, patronage and findability. It is a thought provoking piece and, for my money, it begins to shine the light on the key question: what will people continue to pay for in this digital networked world?

Kevin’s perspectives are largely framed in the context of digital goods and services that are the core of the Internet today.  More broadly, until fab labs become consumer items, physical goods that cannot be reduced to digital code will still command a price, although we need to be ever watchful about the extent to which these goods will be transformed into services (look at what’s happening to computers as they get sucked into the cloud). 

And, if Chris Anderson is to be believed in the preview to his forthcoming book, more and more things will be free in the economics of abundance. But even Chris ultimately circles around to finding money.  As he observes, “to follow the money, you have to shift from a basic view of a market as a matching of two parties — buyers and sellers — to a broader sense of an ecosystem with many parties, only some of which exchange cash.” While he acknowledges advertising as one source of cash, Chris offers a much more nuanced view, tapping into a number of other cash reservoirs.

So, where’s the money?  Here’s my answer: to find the money, seek out scarcity.  Abundance in some areas inevitably creates scarcity in others. Attention, reputation and talent become relatively scarce in economies of abundance.  Businesses will be well positioned to charge for their services if they can deliver one or more of the following values:

• help amplify attention through more effective advice/recommendations
• foster and protect reputation
• help amplify talent development through rich learning environments

The real winners will realize that amplifying return on attention, building reputation and developing talent are deeply and intricately related – the most valuable platforms will address these needs in powerful new ways.

Bottom line

Bottom line, if entrepreneurs want to build hot properties that can be flipped quickly, relying on advertising as the primary revenue source in the near-term may be OK – it will position you for a robust exit as long as investors stay focused exclusively on the first shift (I can hear a lot of my entrepreneurial colleagues breathing a deep sigh of relief at this point). 

On the other hand, if entrepreneurs want to build enduring businesses that will change the world, resist the temptation to become too dependent on advertising. It’s OK to offer many products and services for free (in fact, that will be essential for success) but just be sure you understand your role in a broader ecosystem where someone (even if it is not directly you) is making a ton of money with platforms and services that people will pay for. In particular, look for ecosystems with platforms and services that generate increasing value as the number of participants expands.

(PS – I appropriated the title of my posting from a great YouTube video of the same name – the video, created by Charles Frisch, looks at globalization and information trends and is well worth viewing. I believe it was Jean-Louis Gassee, a Silicon Valley entrepreneur, who first used the term.)

Addendum: Here’s another great YouTube video that captures the dilemma of many advertisers (hat-tip to Max Bleyleben).

The Service Economy Made Tangible

Everyone knows that we now live in a service economy much more than an industrial economy.  But sometimes it helps to see some statistics to drive this point home.

Here are some that I came across in a recent article on “Old School Economics” by Christopher Caldwell:

• “the U.S. now has more choreographers (16,340) than metal-casters (14,880)”
• “more people make their livings shuffling and dealing cards in casinos (82,960) than running lathes (65,840)”
• “there are almost three times as many security guards (1,004,130) as machinists (385,690)”

According to a chart accompanying the article, there are also more fashion designers (15,670), landscape architects (22,130) and meeting and convention planners (42,510) than metal-casters (14,880).

We’re not in Kansas any more.  It will unfortunately take a bit longer for economic analysis and management practices to catch up to all the implications of this transition.

Innovating on the Edge of Big Waves

On Saturday, January 12, surfers from around the world converged on Maverick’s to challenge each other on the big waves that have made this a legendary surfing destination. The sixth Maverick’s Surf Contest had been announced only forty-eight hours earlier to ensure optimal wave conditions for the contestants. Surfers from as far away as Australia, Brazil and South Africa scrambled to make their way to this invitation only competition at Pillar Point, just a few miles away from San Francisco. It was magical to watch these athletes challenge twenty foot waves with an ease and grace that made it all seem so natural.

Beneath the surface, though, there is a different story here, one that contains important lessons for business executives. While all attention was on the athletes riding their surfboards, the technology and techniques used to master big wave surfing have evolved over decades, driven by dedicated, perhaps even obsessed, groups of athletes and craftsmen. Executives can gain significant insight into the innovation process by looking in unexpected places like the big wave surfing arena.

Innovations in big wave surfing

Surfing has a long and distinguished history.  The activity had been pursued for centuries by the Hawaiians, where it was a central part of their daily life.  Surfing was pursued with great rituals and it served a key role in Hawaiian culture to strengthen the status of the king and nobility relative to commoners. The surfboards used by the king and nobility were made of fine woods,  and were long and very heavy, measuring up to 25 feet long and weighing up to 175 pounds. Surfing fell into disrepute and became virtually extinct in the 19th century under the pressure of newly arrived Western missionaries, who disapproved of the state of undress and mixing of sexes associated with surfing at the time.

Surfing slowly regained a following in the early part of the twentieth century but it was not until the early 1950’s that big wave surfing began to attract attention.  Ten foot single-finned surfboards with a balsa core and wrapped in a new material coming out of the aerospace industry – fiberglass resins – were introduced in the early 1950’s specifically to tackle big waves – at the time considered to be 10 to 20 foot waves. Along with new materials like Styrofoam and polyurethane foam, surfboard shapers were able to cut the weight of the surfboard in half while increasing the strength of the board. These advances made the sport accessible to a much broader group of younger enthusiasts.  Surfing enthusiasts in southern California developed a distinctive lifestyle and culture on the margin of 1950’s button-down culture.  Known disdainfully as “surf bums”, one of the early participants indicated that “surfing was not something you did, but something you became.”

In 1953, a group of these southern California surfers, including Greg Noll, inspired by newspaper photos of surfers tackling fifteen foot waves, boarded flights to Hawaii and made the trek out to Oahu’s Makaha Beach. There, the warm water and gently tapered waves proved to be a fertile ground for the next stage of big wave surfing. A couple of years earlier, a mainland transplant by the name of George Downing, one of the early pioneers of big wave surfing, had come up with the idea of adding a changeable stabilizing fin to his surfboard to provide greater control. Known as an “elephant gun”, later shortened to just “gun”, these boards helped surfers to tackle 15 foot waves with ease.

In 1957, Greg Noll, one of the California émigrés, headed to the North Shore of Oahu where famed Waimea Bay became the next test bed for athletes seeking to push the boundaries of big wave surfing. In the isolation of the North Shore, dedicated surfers spent 8 – 10 hours each day, every day, challenging themselves and each other on the big waves of Waimea Bay. Using the skills and techniques mastered there, Noll succeeded in riding a 35 foot wave at Makaha in 1969, the largest wave ridden until that time, staying that way for another 20 years. In his autobiography, Noll described “looking over the . . . edge at the big, black pit. . . . I didn’t think so at the time, but in retrospect I realize it was probably bordering on the edge.”  Noll had a magnetic personality and was instrumental in generating interest and publicity in big wave surfing, helping to build a very large surfboard business – Greg Noll Surfboards was the largest surfboard maker at the time.

It wasn’t until the early 1990’s that another surfing pioneer, Laird Hamilton, working with a couple of other surfing greats, came up with the innovations that would finally allow big wave surfers to tackle waves significantly greater than 30 feet.  Hamilton and his team looked for inspiration to wind surfing where sails helped windsurfers to achieve the speeds required to tackle really big waves and flat water freeboarding where boats were used to tow surfers much like water skiers. From these arenas, Hamilton and his team latched on to the idea of towing surfers into big waves with inflatable Zodiacs and then jet skis. Harnessing a sling shot effect made it possible for surfers to gain the speed required to catch and ride larger and larger waves.

Tow-in surfing, as it became known, was further helped by insights from snowboarding.  Working with leading surfboard shapers, Hamilton and his team challenged the conventional wisdom that longer boards were required to surf big waves and instead introduced much shorter boards with straps for the feet to provide much greater control in coping with the speed and turbulence of really big waves.

Pursuing these new practices and design ideas, Hamilton and the others working with him recognized that challenging larger and larger waves required a team effort.  Honing their craft at Jaws, a break off Maui, these surfing teams by the end of the decade were regularly riding 50 foot waves with ease.

While many of the surfboard design breakthroughs and towing techniques were first developed on the relatively remote north shore of Oahu, groups of dedicated surfers around the world at big wave sites like Maverick’s in California and similar breaks in places like Western Australia and South Africa worked closely with each other locally to perfect the practices required to fully exploit the potential of these new technologies and designs. Practicing in isolation, these surfers would regularly convene to test their capabilities and learn from each other in big wave competitions in places like Maverick’s, Waimea, Todos Santos and Pico Alto.

Bottom line for business executives

So, what can business executives learn from the experiences of these intrepid surfers?  First, if you want to push your performance levels, find the relevant edge.  In the case of big wave surfers, there has been an ever-expanding search for the breaks that would produce bigger and rougher waves to test new board designs and surfing practices.  Major breakthroughs in performance did not occur in the milder surf of Malibu, but in the pounding surf of Waimea and Jaws or the notorious Teahupoo break of Tahiti.

Following the lead of big wave surfers, business executives need to find relevant edges that will test and push their current performance.  For example, companies making diesel engines and power generators should be actively engaged in finding ways to more effectively serve lower income customers in remote rural areas of emerging economies. These demanding customers could prompt significant innovation in both product design and distribution processes in an effort to deliver greater value at lower cost. The innovations resulting from these efforts on the edge could lead to significant improvements in their product lines more broadly.

Second, attract motivated groups of people to these edges to work together around challenging performance issues.  There are great stories about Jeff Clark who surfed Maverick’s solo for fifteen years before the “break” was discovered by the broader surf community, but the real advances in surfing technology and practices occurred at the breaks where surfers gathered and formed deep relationships over extended periods of time.  They learned rapidly from each other and pushed each other to go to the next level.

Large companies have become very adept at establishing remote outposts in places like Beijing, Hyderabad, Haifa and St. Petersburg to attract local talent and push challenging research and development projects. Often, though, these outposts either become disconnected from their parent companies or fail to establish deep linkages with other leading edge participants in the local area.  The key challenge is to connect these company-owned facilities more effectively with their local environments as well as with each other through challenging and sustained innovation initiatives that build long-term trust based relationships.

Performance improvement generally comes first in the form of tacit knowledge that is difficult to express and communicate more broadly. You literally have to be there to gain access to this tacit knowledge.  Big wave surfers who watched Laird Hamilton tackle the Teahupoo break in Tahiti for the first time in 2000 noticed that he put his right hand into the wave on a left breaking killer wave, something unheard of in surfing. It was an instinctive move on Hamilton’s part; he had never done it before and he was not even aware of doing it, but it was enormously effective in coping with the distinctive power of these waves. Those who were there to observe this and who had deep understanding of the practice of big wave surfing realized immediately that a powerful new practice was being developed.

Third, recognize that the people who are likely to be attracted to the edge are big risk-takers. Greg Ambrose, a surfer, observed that "When surfing Waimea it is essential to have the proper crazed attitude that implies a certain reckless disregard for personal safety. If you paddle out thinking you are going to get hurt, you will. If you think you can’t make the drop, you won’t. If you begin to wonder what in the world you’re doing out among those menacing waves, it’s time to be thankful you’re still alive and head for the beach."

This is a key reason why the edge becomes such a fertile ground for innovation.  It attracts people who are not afraid to take risks and to learn from their experiences. They have a different disposition, relentlessly seeking out new challenges. Executives need to be thoughtful about how to attract these people, provide them with environments to support risk-taking and reward them for both successes and failures.

The natural response is to create highly segmented organizations – one part of the company focuses on the core business while separate organizational units focus on highly innovative (and more risky) business initiatives.   The challenge with this approach is to bring the edge back into the core.  The innovations spawned in the edge organizations are often critical to the continued success of the core business, yet the different cultures, mindsets and skill sets create significant barriers to learning.  Executives need to balance organizational focus with aggressive performance challenges and incentive structures that reward collaboration across these organizational units.

Fourth, recognize that the edge fosters not just risk-taking, but very different cultures that are also “edgy”.  The advances in big wave surfing did not come from the casual surfers, but those who developed an entire lifestyle and culture, fostered by intense and even obsessive concentration on pushing the envelope.  The early big wave surfers in Waimea were so obsessed they lived in close quarters right on the beach and relied on the sea and the occasional stolen chicken or pineapple for food. Dismissed as “surf bums” by mainstream society, they developed their own distinctive identity.  Executives need to find ways to protect and honor these edgy cultures, whether it is the tattooed web designers or the next generation of employees who learned how to innovate as members of guilds in World of Warcraft.

Fifth, find ways to appropriate insights from adjacent disciplines and even more remote areas of activity.  The aerospace industry could not be further removed from surfing, yet early advances in surfing technology came from this industry, because some of the employees in this industry were also avid surfers.  Some of Laird Hamilton’s greatest insights came from his experiences as an expert windsurfer and his colleagues’ experiences with snowboarding. By attracting diverse backgrounds and experiences to the edge, executives can foster creative breakthroughs.

Sixth, bring users and developers of technology closely together at the edge.  It is no accident that the most innovative surfers also tended to be expert shapers of surfboards. These folks not only designed surfboards but shaped the materials into the finished product and then took them out to life-threatening breaks to test them and refine them. They were relentless tinkerers, integrating experience, intuition and craft making skills to come up with creative new boards. Downing and Noll were both proficient shapers, driven by their experiences in using their own surfboards, and Laird Hamilton is the adopted son of one of the most renowned surfboard shapers, Billy Hamilton.  Eric Von Hippel has written extensively about this phenomenon in other extreme sports arenas and the same pattern plays out here – technology and product innovations critically depend upon deep and extended interaction with leading edge users.

Technology and practice are intimately linked.  Very little performance improvement comes directly out of the technology itself.  It is only when seasoned practitioners engage with the technology, especially in close-knit communities, and evolve their practices to better use the technology that the real performance breakthroughs occur. One of the big wave surfers watching Laird Hamilton first getting towed into a big wave said the wave was no bigger than the waves that had been paddled before, but the technique was clearly different. It set the stage for a new “S-curve” of performance improvement. Evolving practices in turn generate insight to the product designers for future waves of design innovation.

Finally, executives could profit from understanding the loose practice network that evolved around big wave surfing.  Key individuals like Greg Noll, Laird Hamilton and Jeff Clark have played pivotal roles in shaping and growing this network.  They certainly have not applied the traditional management techniques that most executives use, but they have been very effective in attracting world-class talent, focusing that talent on challenging performance goals and helping to disseminate the learning that came from these efforts. Complex and shifting relationships among athletes, commercial enterprises and competitions shaped the advances we have seen in big wave surfing. These new management techniques, or perhaps more accurately, orchestration techniques will increasingly determine who creates value and who destroys value when seeking to innovate on the edge.

(Note: This is a longer version of a column that John Seely Brown and I have written for Business Week. JSB and I have written a working paper on Creation Nets that focuses more explicitly on the management techniques required to deliver business value from the kind of collaboration described above. Also, for other examples of innovation on the edge of other extreme sports, check out Eric von Hippel’s Democratizing Innovation and The Sources of Innovation). Finally, for those really energized about this brief description of the history of big wave surfing, check out the fantastic documentary Riding Giants or just go ahead and buy  Riding Giants (Special Edition) at Amazon.  There’s a clip from the documentary at Youtube that highlights the tacit knowledge example of Laird Hamilton surfing in Tahiti (hat tip to Ethan Eismann.  For those who want to learn even more about the history of surfing, check out Matt Warshaw’s excellent The Encyclopedia of Surfing.)

Fractal Spikes and Global Competition

In my last blog posting, I mentioned the increasing value of place.  At a time when information technology is supposed to make location irrelevant, we need to wrestle with the paradox that location is becoming more, rather than less, important. In fact, place is becoming an ever more critical dimension of competition in global markets. Executives who dismiss the value of place are likely to find themselves marginalized.

Microclusters

In this context, Steve Lohr wrote a fascinating article in the New York Times on December 20 entitled "Silicon Valley Shaped by Technology and Traffic" making the case that Silicon Valley actually consists of multiple “microclusters”.  Geographically, the microclusters array as follows:

While there are plenty of exceptions, it is generally true that hardware clusters – semiconductors, disk drives and network equipment, for example – are in the South Valley, around San Jose and Santa Clara. . . . . Moving farther north in the Valley typically means moving farther away from the guts of the machine and climbing up the tiers of computing – from chips and layers of business and consumer software and then into San Francisco, home to people with online advertising and digital design skills.

Lohr might have also mentioned emerging microclusters around biotech in South San Francisco and nanotech in the Menlo Park/Palo Alto area.

These microclusters are defined by skills, but they also generate cultural friction as well.  Lohr writes:

There is a certain visual identity to the clusters, and a hint of cultural tension among them. The clearest schism, perhaps, separates Valley dwellers from San Francisco residents.

The hard core in the Valley jokes that San Francisco, with its Internet advertising and design cluster, has a “high P.I.B. coefficient,” for People in Black.  The city’s companies also have more women than those in the Valley.  San Franciscans regard Valley engineers as denizens of a style-free suburban zone for whom being well-dressed means wearing jeans and a T-shirt with a company logo.

Marc Andreesen, co-founder of three Silicon Valley companies, sums up the culture clash best with this quote from the article:

“ . . . in general, the nerds with minimal social lives like me are well down in the Valley, and the cool kids with the trendy glasses and Prada shoes who like to go to parties are in San Francisco.  You can guess who has the leg up in building companies.”

Some companies like Google need to access talent from multiple microclusters, leading to solutions like Google’s 32 shuttle buses that help ease the commute to its campus for some 1,000+ employees.  There is no word about the culture clashes that surface as the buses from San Francisco discharge their people in black on campus (perhaps they don camouflage before boarding the buses).

(For the record, I live in the mid-Peninsula area, close enough to drop in on the cool San Francisco parties, but far enough away to get some serious work done.)

Why Place Matters

Lohr’s article provides compelling evidence that geographic proximity still matters, even down to the neighborhood level, even in the most technologically sophisticated talent pool in the US.  Why is this the case?

It is all about talent development.  No matter how talented any of us are these days, our talents must be continually and quickly refreshed and augmented if we are to thrive in this rapidly changing global economy.

The best way to refresh and augment talent is not to attend some training course.  In this fast-moving world, by the time knowledge has been expressed and packaged in a form that can be used in a training course, it is probably out of date. We all need to find ways to connect with people who are at the leading edge of relevant talent pools. 

The most valuable knowledge these people have is tacit knowledge – especially the knowledge that is so new that they have difficulty in articulating it, much less abstracting and codifying it. This is a key point for business strategy – when the pace of change accelerates, the balance of value between explicit knowledge and tacit knowledge shifts profoundly. Strategies focused on developing and protecting explicit knowledge fall when confronted with effective strategies to tap into and leverage tacit knowledge.

This is exactly why talent spikes become so strategically important in times of rapid change.  They provide rich opportunities to connect with people at the leading edge of relevant talent pools and more effectively access the tacit knowledge that is so valuable. These connections can take many different forms.  It starts with the casual encounter at the soccer game as described by Steve Lohr in his article. It could be connections that are made possible by a rich infrastructure of specialized service providers, including financers, lawyers, marketing firms or even real estate firms.  One of the key roles of good venture capitalists is to serve as a talent hub, making introductions helpful to their entrepreneurs in accessing relevant talent.

These connections can be very helpful in terms of exposing someone to a new idea or story that sparks some creative insight.  For many, including myself, it is about the patterns that emerge from countless encounters and conversations.

But the true richness of talent spikes comes from the opportunity they provide to engage in real work with other people who are at the leading edge of their fields.  It is one thing to have a casual conversation at a party or even a business meeting.  It is a completely different thing to engage in a challenging work project where all the participants are pushing their skills to the limit and learning deeply from the experience and expertise of others.  It is here that tacit knowledge becomes the most visible and accessible. JSB and Paul Duguid did a masterful job of highlighting this role of talent spikes in their essays “Mysteries of the Region: Knowledge Dynamics in Silicon Valley” and "Local Knowledge: Innovation in the Networked Age."

Talent spikes differ in terms of their ability to provide this opportunity.  Annalee Saxenian, in her historic work, Regional Advantage, captured the advantage of Silicon Valley relative to Route 128 outside Boston as a high tech talent spike precisely in these terms.  In the Route 128 corridor tech companies tended to operate as self-contained and relatively secretive entities with limited flows of employees across enterprise boundaries.  Silicon Valley companies in contrast were much more prone to collaborate with other companies. Among employees, rapid changing of employers became a badge of honor.  Staying too long with one company was viewed with some suspicion. The opportunity to engage deeply with diverse collaborators and access tacit knowledge was far greater in Silicon Valley. 

Silicon Valley further enhanced this advantage by emerging as a more effective global talent magnet, attracting skilled and entrepreneurial engineers from around the world. People often overlook this aspect of Silicon Valley in seeking to uncover the “secret sauce” driving SV’s success, yet it has been central to the innovation that has been a hallmark of this talent magnet.  The ability to attract and retain talent from around the world drives the continuing success of Silicon Valley.  Current patterns of talent flows have been impressively documented in Joint Venture Silicon Valley Network’s Index of Silicon Valley 2007. Its report notes that “Silicon Valley’s population is increasingly more global in character than in California or the U.S.”

A New Basis for Competition

Now, as we move into the 21st century, a new dynamic is beginning to play out.  As captured by Annalee Saxenian in her more recent book, The New Argonauts: Regional Advantage in a Global Economy, Silicon Valley capitalized on globalization to build a rich network of personal and institutional connections with emerging talent spikes in Israel, Taiwan, China and India.  In many cases, these connections arise as successful entrepreneurs in Silicon Valley who came here from abroad return to their home countries to participate in local spikes.

Saxenian does a great job of describing the connections that are emerging and evolving across these talent spikes but, from my perspective, this is just the first step in the next wave of global competition.  We need some profound institutional innovation to more effectively harness the capabilities that are developing in spikes around the world. 

On this dimension, I fear that Silicon Valley companies are falling behind more innovative Asian companies. A number of Asian companies are mastering the management techniques and institutional architectures of process networks required to access and mobilize talent across hundreds or thousands of business partners on a global scale.  While many Silicon Valley companies participate in process networks, very few have successfully organized and orchestrated these process networks.

The Bottom Line

Place still matters in shaping talent development and competition. Place matters because density matters. Density increases opportunities for serendipitous encounters and sustained and rich collaboration. Place not only matters; it is becoming even more important and much more complex. 

Depending on whether you zoom in or zoom out, relevant spikes emerge at the neighborhood, metropolitan or global level.  In fact, they are fractal, down to the level of corridors and work areas within specific buildings. Some companies have developed explicit location strategies, seeking to locate facilities in key spikes in an effort to attract local talent.  Far fewer companies have successfully tackled the challenges of effectively connecting talent across geographic spikes in ways that accelerate learning and talent development.  Technology tools can help support these efforts, but the real opportunity is to define new environments that foster productive friction on a global scale. In a flat world, where you stand really does matter.

Restoring Balance in the New Year

A new year is upon us and it is time to make those resolutions, promising ourselves that we will do better this year.

In keeping with this time-honored tradition, let me start with a firm resolution to up my game on this blog.  Over the past six months, my postings have tended to be few and far between.  I have been consumed with the challenge and excitement of building a new research center for Deloitte & Touche USA LLP here in Silicon Valley.  We are now up and running (well, at least walking quickly but still in stealth mode) so I feel comfortable devoting a little more time and attention to these postings. Of course, I continue to be hampered by my inability to master the art of the pithy blog posting – once I get started on one of these, it is really hard to stop.

This posting won’t be any different. In the spirit of New Year’s resolutions, I’d like to offer a set of resolutions regarding some of the themes that I want to explore in the year ahead.  Many of these resolutions offer a contrarian take on some of the conventional wisdom floating around these days, especially in the Internet world.  Without revealing too much (at least not yet), this posting will offer a preview of some of the perspectives that will shape this blog over the next year.

I will explore the growing value of stability.  As I venture into the dot com corridors of Silicon Valley these days, I get more than a whiff of those heady days in the late 1990s when all moorings were cast aside and we plunged into the strong currents of change, celebrating the fact that “nothing will ever be the same.”  In the process of embracing change, though, we often lose sight of the paradox that stability becomes ever more valuable as more and more of our surroundings are put into play.  Institutions and individuals that understand where and how to offer stability will create enormous value in the changing times ahead.

I will explore the diminishing value of transactions.  Many of us have become enamored with the ease of doing transactions on the Internet.  One click shopping is deeply seductive.  The transaction mindset has even made headway on social networking sites where the ease of “inviting” friends has drawn many of us into an escalating game of building ever larger social networks of “friends.”  We talk glowingly about relationships on the Web, but too often when we take a closer look, we find that many of these “relationships” are simply transactions under a different guise. Focusing on transactions will guarantee diminishing returns. Deep relationships become increasingly valuable in times of widespread change (and, yes, I know that “weak ties” are also important, but not as a replacement for deep relationships – in fact, deep relationships are essential to capture the full value of weak ties).  Once again, institutions and individuals that understand where and how to build these deep relationships will have a significant advantage.

I will explore the diminishing value of advertising.  Ask the management team of any Internet business about revenue models and, more likely than not, you’ll get the confident answer that advertising will provide the necessary revenue.  Even enterprise software businesses are beginning to consider advertising as a promising revenue source.  There’s no doubt about it, Internet advertising expenditures will continue to rapidly grow over the next several years. But I have more than a passing suspicion that advertising revenue streams are vulnerable in the longer term.  As the long tail of advertisers crowds onto the Internet and as customers become more protective of our attention, I suspect that online advertising will begin to run into seriously diminishing returns. Without developing the detail right now, let me suggest that traditional models of advertising where vendors pay for messages to be delivered to prospective customers will be challenged longer-term by various forms of collaboration marketing and advisory services where customers pay trusted advisors to recommend relevant products and services.  In the short-term, steadily improving algorithms for targeting ads will continue to draw advertisers onto the Internet and provide an attractive revenue source for Internet businesses. Unfortunately, this short-term advertising revenue growth has had a narcotic effect and made a lot of online businesses lazy. Longer-term, I anticipate that most businesses online will have to make money the old fashioned way – by offering products, services and experiences so valuable that people will actually pay money for them. Those who begin to develop this discipline today will profit in the long-term.

I will explore the growing value of place.  I have actually addressed this theme already.  As many of you know, I believe the world will become a lot more "spiky" , while paradoxically becoming flatter in terms of connectivity.  The much vaunted “death of distance” joins the “paperless office” as a too simplistic extrapolation of information technology. The more connected we become, the more intense our need to accelerate talent development will become.  People who come together in dense urban areas will be much more successful in developing their talent than those who remain isolated in remote rural areas, even if they have the best broadband connections.  Most people understand this.  That is why, on a global scale, the trend towards urbanization is accelerating rather than slowing down, even among the most wired digital elites in our younger generations. Place matters more than ever and where we choose to live will increasingly determine how successful we become.

I will explore the growing value of bold leadership.  In an era where the “wisdom of crowds” and empowerment are the watchwords of the digerati and where we generally have become increasingly cynical about the leaders of many of our largest institutions, we may lose sight of the importance of visionary leadership. We can take the notions of emergence and self-organization too far and dismiss the role of forceful leaders. In times of great uncertainty and rapid change, unprecedented opportunities arise to shape our environments to create even more value.  Shaping requires deep insight into the fundamental forces at work and powerful personalities to communicate conviction and persuade many who are on the sidelines that the rewards outweigh the risks. Even our most cited examples of collective intelligence, initiatives like Linux and Wikipedia, would have died stillborn (as most open source initiatives do) if it had not been for the forceful leadership of personalities like Linus Torvalds and Jimmy Wales. To be sure, this new generation of leaders employs a different set of techniques relative to more traditional leaders, but their leadership is essential to the success of these initiatives. Those who are able to exercise this forceful leadership and attract and mobilize others will reap significant rewards in the decades ahead.

I will celebrate length while appreciating brevity.  OK, this may be somewhat self-serving.  Having never mastered the art of the short form, I necessarily harbor a certain attachment to longer essays and, dare I say it, even the endangered book.  In times of rapid change, there is an understandable temptation to sample briefly and quickly from many sources, never lingering too long with any one idea or source.  As we race to keep up, we avoid or quickly discard anything that threatens to take up too much of our valuable time and attention.  But the risk is that we lose any sense of texture or deep structure that would help us to make sense of the changes going on around us and to make connections that might otherwise remain hidden in the whirlwind of events and distractions occupying our day. Vicious cycles begin to play out, where the more we surf from one source to another, the more sense of urgency we develop about falling behind amidst the rapidly proliferating long tail of resources available to us.  Those who invest the time to go below surface events and explore deep structures will be in a far better position to anticipate change and stake out positions that matter rather than simply racing to react to the latest unexpected event and spreading themselves precariously across to many fronts.

Before everyone jumps on me for the contrarian and somewhat retrograde views expressed above, let me hasten to add that I too appreciate the value of change, transactions, advertising, virtual connections, empowerment and brevity. Having recently returned from Vietnam, though, I have gained a renewed appreciation for the traditional Asian concept of yin and yang – two fundamentally opposing forces that come together to complete the world.  I simply want to restore some of the balance that we often lose when we get caught up in the events of the moment.  That’s the essence of my New Year’s resolutions – invest the time required to maintain balance in a time of great flux. I promise to be more frequent in my postings, but probably not a lot shorter.

Institutional Innovation

Executives spend a lot of time these days worrying about innovation.  Innovation is a key engine for growth and profitability yet few companies do it well and consistently.  Even more fundamentally, few companies think broadly enough about innovation.

Mention innovation and most executives immediately focus on product innovation.  Some will expand the scope to include process innovation.  But few venture beyond to explore other levels of innovation.

Seeking More Robust Forms of Innovation

Here’s the rub.  Product and process innovation tend to be event driven – someone comes up with a great new idea, applies it and reaps the rewards. But the rewards offer diminishing returns.  We all know that product life cycles are steadily compressing and markets are fragmenting into a long tail of endless niches.  Early growth from new product introductions rapidly peters out and then revenue begins to slide precipitously towards the inevitable (and increasingly near-term) product retirement.

Process innovation can yield longer-term returns.  Yet, even here, process life cycles are also compressing in the face of rapidly changing business environments.  In a much more connected world, processes can also be more readily copied. The ability to generate more value through process learning soon runs into the diminishing returns reality of the well-known experience curve – greater and greater effort must be invested to yield the same degree of performance improvement.

In a world where profitable growth is the key to value creation, companies need to find ways to sustain and amplify the rewards of innovation. To do this, executives will need to expand the scope of innovation well beyond product and process to a much broader terrain – institutional innovation.

What do I mean by institutional innovation?  It redefines roles and relationships across independent entities to accelerate and amplify learning and reduce risks. The next generation of institutional innovation will seek more productive ways to connect with talent wherever it resides and build relationships that foster and focus learning rather than taking the walls of the enterprise as a given.

Institutional innovation in the twentieth century focused on creating scalable institutions through standardized product design and design of business processes to cost-effectively serve mass markets. In the twenty first century, the focus of institutional innovation will shift to foster scalable learning across institutions.

What’s Different?

This is much broader than the current fad of open innovation.  Open innovation focuses narrowly on accessing third party resources to support product innovation initiatives.  The institutional innovation perspective expands the horizon to include all core operating processes of the enterprise – supply chain management, product innovation and customer relationship management.  Most of the prominent examples of open innovation tend to highlight transactional approaches to accessing existing third party resources, especially knowledge that can be codified.  The institutional innovation perspective focuses on approaches to build scalable, long-term trust based relationships that can accelerate learning on all sides by more effectively accessing tacit knowledge.

This is also quite different from the concept of “management innovation” that Gary Hamel first outlined in his Harvard Business Review article "The What, Why, and How of Management Innnovation" (see my review here) and more fully develops in his recently released book The Future of Management. For Hamel, the primary focus of innovation remains within the walls of existing institutions – he rightly points out that significant value can be created by re-thinking the management processes that drive these institutions but, as the examples he uses in his article and book demonstrate, he is largely concerned with different approaches to managing the resources within institutions rather than across large numbers of institutions.

The companies that excel at institutional innovation will lead the next wave of wealth creation.  We are only at the earliest stages of this kind of institutional innovation, so there is both a lot of opportunity and a lot of uncertainty regarding the approaches with the most promise. JSB and I have offered some early perspectives on this in our writing on The Only Sustainable Edge, Creation Nets and From Push to Pull.

Institutional Design Principles

In thinking about institutional innovation, it is useful to highlight promising design principles that offer the potential to accelerate learning:

Diversity.  As Scott Page and others have persuasively suggested, new insight and learning tends to increase with cognitive diversity. This principle highlights the importance of designing institutional arrangements that extend well beyond a single institution, with particular attention to the opportunity to connect to diverse pools of expertise and experience. Diversity can often be enhanced by connecting into spikes – geographic concentrations of talent – and by targeting “brokers” within social networks, creating a multiplier effect in terms of the number of participants that are potentially accessible.

Relationships.  It is not enough to have cognitive diversity.  By itself, cognitive diversity often breeds misunderstanding and mistrust, seriously limiting the opportunity for people and institutions to learn from each other.  Long-term trust based relationships, on the other hand, make it easier to engage in productive friction – the clash of diverse perspectives in ways that produces deep new insight and learning. The challenge is that these kinds of relationships often take a long time to develop and are hard to scale.  Innovative institutional arrangements can help to accelerate and scale the formation of these kinds of relationships.

Modularity.  When activities are tightly specified and hard-wired together, the opportunities for experimentation and tinkering are very limited.  Segmenting people and activities into discrete modules with well-defined interfaces can help to create much more space and opportunity for distributed innovation and learning.

Federated decision-making.  To encourage distributed innovation and learning, it is helpful to distribute decision-making into self-governing units while at the same clarifying dispute resolution and escalation protocols to ensure that prompt action can be taken across business units when required.  If structured appropriately, these dispute resolution mechanisms can become fertile grounds for productive friction that in itself drives learning.

Reputation mechanisms.  As relationships scale, it becomes harder to develop a clear view of the full range of experience and expertise available to address challenging problems.  Reputation mechanisms can play a vital role in enhancing findability but also help to reinforce incentives to participate and contribute.

Feedback loops.  More broadly, there is enormous value to investing in performance measurement systems and structuring performance feedback loops so that participants can reflect on their practices and focus their efforts to improve performance.  This task becomes much more challenging when activities and participants are scattered across a large number of institutions and geographies, but the rewards in terms of learning are far greater given the opportunity to compare and contrast performance across a larger number of participants.

Incentive structures.  Focusing narrowly on near-term cash incentives undermines the ability to build trust and foster learning. By expanding incentives to include talent development and capability building, institutional innovators have the potential to turn zero sum games into positive sum games, where the prospects of expanding rewards encourage participants to adopt longer time horizons and invest more in collaborative undertakings.

Deployment Approaches

There’s a massive opportunity for institutional innovation building upon these design principles.  One of the key pitfalls, though, is the temptation to map out detailed blueprints of new institutional arrangements before deploying any changes.  In the highly specified, hardwired institutions of the twentieth century, this level of advance analysis and planning was critical.  These new design principles, however, make it possible to pursue a much more incremental approach to institutional innovation. New institutional arrangements consistent with the design principles above can be deployed in stages to facilitate learning and refinement.

Bottom Line

As executives start to focus on the opportunity for institutional innovation, they could begin by asking the following questions:

• What are the top one hundred companies with world-class capabilities that are complementary to our own?
• What, if any, relationships have we built with these one hundred companies?
• How could we re-design these relationships along the lines of the principles presented earlier to enhance the potential for learning on both sides?
• What relationship networks are these one hundred companies participating in and how could we begin to participate in relevant networks to further expand our opportunities for learning?

In thinking about innovation, executives would be well served not to focus exclusively on finding talented product design maestros or even process design experts, but rather creative institutional designers who can challenge and re-think their existing institutional arrangements from the ground up.

These institutional designers will unlock a steady flow of product and process innovations.  Without their help, executives will continue to struggle with isolated innovation initiatives that show great promise at the outset, but rarely deliver on their full potential.  Even when the full potential of these initiatives is realized, this potential is inherently limited.  Far better to re-think the innovation opportunity at a much more fundamental level – a level that keeps on giving.

For those who doubt the power of institutional innovation, reflect on what has been the single most wealth creating innovation over the past several centuries.  The steam engine? The telephone? Ford’s assembly line approach to manufacturing? Fuhgeddaboutit.  It was the development of the limited liability joint stock company – a profound institutional innovation.