Halloween Goblins

It is Halloween, a wonderful pagan ritual with occult overtones that began with the Celts.  It is a day and, more importantly, a night when fear runs rampant as goblins, ghosts and ghouls take over and roam far and wide.  It is a fitting time to step back, reflect on and perhaps even embrace one’s greatest fears. 

Since this is not a personal confessional blog but instead a professional perspectives blog, I’ll spare you an exploration of my personal fears and instead focus on my professional concerns this Halloween eve. What do I fear as the greatest obstacles standing in the way of executives as they seek to create and capture more value for their stakeholders? Here’s my list of goblins:

Data

In a rapidly changing world, data can hold us prisoner to old mindsets and old behaviors.  If executives need lots of data before they feel comfortable making a decision, chances are they will not act until it is way too late.  Don’t get me wrong, data are extremely valuable.  It’s just that, if we insist on too much data, we will often miss significant changes on the horizon.  This isn’t just about analysis paralysis; it’s much more insidious. Data inevitably draws us into the past; after all, there is not much data about the future (or even very recent events), but an abundance of data about the past. Data not only draw us into the past, they also draw us into the core because the core is so well documented and analyzed relative to various edges where data are at best fragmentary and often contradictory. To avoid being blind-sided, we need to pay equal attention to stories and train ourselves to detect patterns in the stories, even if the data supporting the stories remains fragmentary. Stories are generally our first indicators that something really interesting is about to happen; something that data will only reveal to us in full force much, much later.

Core businesses

Everyone’s got a core business and we all know we are supposed to focus on our core. But core businesses can consume our attention and we run the risk of losing perspective on what’s happening on the edge.  As the title of this blog suggests, the edge often provides us with early, faint signals of significant new opportunities and threats – if we’re not paying attention, we may miss those signals until they get amplified into clear and present threats.  Core businesses also tend to breed complacency – they generate cash that can often reduce the sense of urgency required to aggressively exploit new opportunities (see “Complacency” below).

Portfolios

Everyone (well, almost everyone) has them.  The theory is that by creating broad portfolios of investments, executives can more effectively manage risk.  Well, I’m not so sure – count me as a contrarian on this one.  Portfolios of investments work great if you are an investor, but work less well if you are business manager.  They create risks of their own.  First, I see a pronounced tendency to spread resources too thin across too many bets even in the largest of companies.  The result?  Risk actually increases because no single program has the critical mass of resources required for success. But it gets worse.  Complacency also increases as the portfolio expands (see “Complacency” below).  If some of the investments start to hit rough times, executives tend not to worry because there are a lot of other investments that might pay off.  This can become a dangerous mindset.

Adaptation

This has been a buzzword du jour for too many years now. The adaptive enterprise has become the nirvana all large companies strive to achieve. Cognoscenti draw on complex adaptive systems theory to make the case that adaptation ought to be the primary goal of strategy.  Well, maybe . . . if we are reptiles or honey bees.  Here’s my concern.  Adaptation may be much too modest a goal.  Adapting may help to ensure survival, but we will likely miss many of the real opportunities created by rapid change.  When environments go through rapid changes, these changes create far more degrees of freedom for action than more stable environments.  There is more opportunity for purposeful strategies to shape the environment, rather than simply adapting to it, and to reap the rewards that can accrue to successful shapers.  Both Wal-Mart and Microsoft reaped significant rewards as shapers, not as adapters. Here’s the catch – the mindsets, skills and actions required to be a successful adapter are quite different from those required to be a successful shaper, so executives have to choose between these strategies.  Too often, adaptation becomes the default strategy or, even worse, companies try to straddle between the two without making an explicit choice.

Efficiency

Efficiency is a diminishing returns game – there are natural limits.  There’s nothing wrong with efficiency in small doses, but when it becomes an obsession, it leads to dysfunctional behavior.  Efficiency initiatives are seductive because they generally yield more predictable results, at least in the near-term.  But there are problems. Efficiency focuses us back on the core business (see above) because that’s where the biggest gains are.  We also seek to eliminate edges because edges are always messy and often horribly inefficient. The problem is, of course, we can never eliminate edges; we can only shrink our field of operation and vision.  JSB and I talk a lot about productive friction – from our perspective, it is the source of significant innovation – the clash of different perspectives and skill sets is often required to break through to different beliefs and behaviors. But, seen through the lens of efficiency, productive friction is deeply suspect, especially since it tends to be most prominent on the edges of our operations.

Consensus

This goes with efficiency.  Who could argue with it?  Wouldn’t it be better if we all agreed?  Problem is – from my experience, if senior management all agrees, that’s a real red flag.  It means one of several things.  Often it means that no one is asking the right questions – it’s easy to agree if no one is posing hard questions about the future of the business or priorities in near-term allocation of resources.  In other cases, it could mean that everyone’s talking at such a high level that they can say the same words, but mean completely different things.  Other possibilities: management has developed a culture of conflict avoidance or they have been together far too long, drinking from the same kool-aid bowl.  Sometimes it is all of the above.  In any case, high performing and innovative companies generally have lots of friction – it’s just that they have figured out how to make it productive rather than dysfunctional.

Education

OK, now I am really going after a sacred cow.  And it is not just because I was almost expelled from third grade for playing hooky by forging notes from my parents.  Education (and let’s throw in training while we are at it) is bankrupt – we don’t need to fix it; we need to start from scratch and re-think it, starting with the terminology. It represents a huge drain on resources at best and, at worst, takes bright and inquiring minds and slowly but inevitably extinguishes passion for learning. As the very term indicates, education starts with a push mindset. What we really need are more effective pull platforms to foster learning. There are actually a lot of these pull platforms rising up around us, in such diverse and unlikely places as World of Warcraft and the tea houses of Chongqing, China. We need to learn from these experiences to develop new institutional learning architectures recognizing that learning is a life-long requirement and that push approaches play an increasingly marginal role in successful
learning.

Complacency

This is a big issue, although this fear is mainly focused on Western companies.  As JSB and I have noted before, we are struck by the contrast between the complacency we find among many Western executives and the sense of urgency that marks all of our meetings with executives in emerging economies like China and India. Much of this complacency comes from taking a snapshot view of the world versus focusing on the movie. Enough said.

Backlash

When complacency confronts the harsh reality of intensifying competition, we run the risk of flipping into resistance and using whatever means are necessary to protect us from competition. I guess if I had to single out the goblin that I worry about the most, it is the risk of a public policy backlash.  This could play out in two different scenarios.  In one scenario, large established economic interests in more developed economies join forces with domestic workers feeling more insecure about their jobs and push through a set of protectionist measures that roll back much of the liberalization that has occurred in public policy over the past several decades.  Alternatively, the backlash could surface in emerging economies and established political and economic interests capitalize on the growing frustration of the rural populations bypassed by globalization to implement their own protectionist measures.  Either way, the results are likely to be disastrous with public policy retaliation in other parts of the world and growing potential for political and perhaps even military conflict. Boo! Now that’s a really scary thought.

Social Networks and Urbanization

Danah Boyd, one of the most insightful analysts of social network sites, got some great coverage by the Financial Times in an extended article entitled “The high priestess of internet friendship” by Graham Bowley on October 28-29, 2006. The article provides an interesting overview of social network sites and the various roles they tend to serve, especially for kids.  As I read through the article though, I began to crave for a more explicit typology to make sense of the diversity of social network sites that continue to emerge and evolve.  I also began to want a more systematic discussion of the relationship between these virtual sites and physical space.

Here’s an early typology of social network sites that I sketched out after reading the article. Rather than categorize sites themselves it may be more useful to think about three primary functions of these sites – connection, creation and collaboration.  Individual sites can then be analyzed in terms of their relative emphasis on these three functions. It turns out that sites differ significantly in terms of their relative emphasis.

Connection
Connection is the first function – it emphasizes the ability of social network sites to connect participants effectively and conveniently with each other and with resources that are useful to them. An extreme example of this is LinkedIn, the social networking site helping to connect business people based on profile data and knowledge about networks of relationships. In terms of connecting people with relevant resources, think of Digg and del.icio.us. In this context, the primary value is a filtering function, helping participants to sort through a growing array of options and quickly connect to relevant people or resources.

Creation
Creation is the second function.  In this context, let’s differentiate two different forms of creation – identity creation and content creation – by contrasting MySpace with sites like Flickr and YouTube. 

Identity creation. The overwhelming growth of MySpace stems from its success in helping participants to create and evolve distinctive identities.  It does this by providing a robust platform for appropriating and mixing different elements, combining music clips, video clips, graphics and text in engaging ways, to create and communicate a distinctive identity. Bowley’s article does a nice job of communicating how MySpace rapidly gained share against an earlier social network site, Friendster, by emphasizing this functionality.  Bowley reports on her conversation with the two founders of MySpace:

They were getting “antsy” about doing something new, especially in social networks, they told me, and thought they could get away from the pre-programmed “box” that Friends locked users into and instead let people “really open up and do all sorts of things with their profiles.”

“Our site worked,” said DeWolfe. “You actually could log on, surf, customize your web pages and really be creative.”

In contrast to Friendster, MySpace encourage people to put up wacky art or even pipe music on to their pages. . . . As Friendster fell back, MySpace became the leading social network site, its millions of pages a cacophony of teenage self-declarations, friends’ testimonials, flirting, provocation, scrawls, art and music.

Content creation. Now let’s contrast this with Flickr or YouTube.  Here, the emphasis is on a different form of creation – it’s more about content creation than identity creation.  Surf through Flickr and you encounter impressive photography.  YouTube provides a great platform for presentation of videos, some appropriated from other sources, but an increasing number produced by the contributors themselves. On these sites, you get some sense of the identity of the contributors, but the real focus is on showcasing the content itself. Networks in these sites begin to organize around a shared interest in certain forms of content. The content is the anchor and shaper of social networks.

It is interesting to note that MySpace really took off initially as a showcase for indie bands and their music.  As music fans flocked to this site, MySpace was able to evolve into an environment for broader identity creation and experimentation because of the flexible platform it had created.  Sites like Flickr and YouTube are likely to have a harder time doing this because their sites are optimized for content capture and display.

Collaboration
Collaboration represents a third function that defines social networking sites. Collaboration in turn breaks down into three very different types of collaboration – commentary, conversations and construction.

Commentary. Commentary is pretty pervasive across most social networking sites – even the narrowly focused LinkedIn offers an ability to provide testimonials regarding the work of participants and sites like Flickr and YouTube offer participants an opportunity to comment on the contributions of others. In most cases, though, this commentary consists of one-off postings and rarely evolves into sustained conversations.

Conversations. Conversations represent more sustained interactions around topics of shared interest.  True to form, the conversations at MySpace tend to revolve around the individual profiles, although forums and interest groups have begun to form as well. In general, though, on most of the recent wave of high profile social networking sites, structured and sustained conversations take a back seat to other types of functionality.  If they exist at all, they tend to be awkwardly tacked on.  The social networking sites that do the best job of promoting these kinds of conversations remain places like Yahoo! Groups and other forms of virtual communities that have emerged around an extraordinary diversity of topics.  These sites tend to be highly fragmented in contrast to social networking sites focused on other types of functionality.

Construction. Construction is a third form of collaboration.  Here we are talking about shared creation initiatives that are undertaken across a large number of distributed participants.  If you look at the creation sites discussed earlier like Flickr and YouTube, the creation there is largely confined to individuals or, at best, small groups who come together in physical space to make a video and then post it on YouTube. Construction requires platforms for participants to come together in shared practice. At this point, we are no longer talking about purely technology platforms, but instead also need to define a set of governance mechanisms that can help structure and focus the collaboration. Here we encounter a diverse set of sites ranging from World of Warcraft, with its emphasis on collaboration in guilds, to Wikipedia and a variety of open source software sites.  Complex and more structured social networks emerge as participants wrestle with the challenges of coming together online to create shared objects or engage in joint efforts.

Some broader observations on social networks
All social network sites are likely to have some elements of all three functionality types – connection, creation and collaboration – but, as I hope the examples illustrate, there are significant differences in relative focus.  I don’t have the time now to explore all the implications of the differences in focus, but I will assert that these difference matter, not only in terms of design, but also in terms of business model and growth potential.

By the way, learning is a potentially interesting overlay on all three types of functionality.  In other words, these sites can be largely configured as a way to organize and present existing social networks and related resources or they can be designed with a more dynamic view to accelerate and amplify the ability of participants to learn more rapidly.  While much learning is certainly going on today on a variety of social network sites, I suspect there is a much greater opportunity to foster learning than is currently being addressed. The Financial Times article quotes Fred Stutzman at the University of North Carolina at Chapel Hill regarding Facebook:

One of the things students do is they test out identities. Maybe that is one new thing we are seeing now – more rapid changes of identity. Online you can get feedback and you can change at a moment’s notice.

We can also analyze social network sites in terms of attention economics.  In some cases, these sites are very good at enhancing return on attention by acting as filters to connect people with relevant resources.  In other cases, they can help attract and amplify attention from others. These ought to be two sides of the same coin but, in practice, design of social networking sites can favor one side over the other. In general, there’s a lot of untapped potential to focus on the attracting attention side of the coin, but to do it in a way that accelerates learning rather than fostering attention-getting Ponzi schemes. Especially as we move from connection to creation and then to collaboration, social network sites will become more powerful platforms to attract and amplify attention from others.

In trying to anticipate the likely direction of social network sites, pay attention to the edges.  The FT article quotes Danah Boyd on an important point in discussing the early success of Friendster, one of the early social network sites:

Freaks, geeks and queers all invaded Friendster in the early days and they made certain that all of their friends were there.

Often, the fringe elements in our society find the greatest value in amplifying social networks that exist in physical space.

Urbanization
I mentioned the relationship between social network sites and physical space at the beginning of my post.  Too often, social network sites are viewed as a substitute for coming together in physical space. In fact, quite the opposite is true – social network sites are more often a supplement to physical space relationships.  Even when participants first meet online, there is a natural and strong desire to connect in face to face meetings in physical space – witness, as one small example, the growing number of offline World of Warcraft guild gatherings.  In the FT article, Danah Boyd is quoted as observing that social network participants

. . . . were using [social network sites] to reinforce existing relations with the group of friends they already had from their offline lives.  For them, MySpace had become an electronic version of the local mall or park, the place they went to with their friends when they just wanted to hang out.

A lot of forces are at work on a global scale that increase the need for us to both broaden and deepen our network of social relationships. These forces will continue to drive the growth of even richer social network sites online but, in parallel, we will see a growing tendency to aggregate in physical space as well.

Those of you who have been following my blog for a while know that I am a strong believer in the growing value of cities as we seek to broaden and deepen our network of social relationships.  Urbanization trends are very strong on a global basis. In fact, one interesting study suggests that 95% of the world’s population growth over the period 2000 to 2025 will occur in urban areas.

This is clearly a strong trend in less developed economies, but the tendency for urbanization will become even stronger in developed economies.  Over the past several decades, we have seen a pattern of dispersal of population in the US into edge cities on the periphery of more traditional urban areas.  I anticipate that we are going to see a growing reverse migration into urban centers, led two broad demographic groups – young people entering the job market for the first time and aging boomers who are less and less content with traditional retirement models. Rather than isolating themselves in retirement centers, boomers will want to go where the action is so that they can refresh and renew. The collision of younger and older generations in our urban centers will reshape social networks in interesting ways.

When you reflect on the three functions of social network sites described above – connection, creation and collaboration – it is useful to keep in mind the key insights of urban champions from Alfred Marshall to Jane Jacobs regarding the unparalleled ability of cities to create and nurture dense and productive networks of social relationships.  These social relationships span significant edges – age, culture and vocational – just to name a few.  The relevant edges are no longer on rural frontiers; they are deep in our urban fabric. As we all begin to appreciate the importance of rapid and sustained learning, more and more of us will make our way into city centers to extend and deepen our social networks. Urban centers foster both specialization and serendipity – two key elements in learning.

Far from substituting for urbanization, social network sites will increase the value we reap from locating in urban environments. The two will play off each other in interesting and unexpected ways.

Offshoring and Healthcare

Events have a way of overtaking analysis, as the contrast between a Foreign Affairs article earlier this year and a New York Times article last week drives home with great force. 

Executives seeking to understand the offshoring challenge became very excited about an article on “Offshoring: The Next Industrial Revolution?” (subscription required) which appeared in the March/April 2006 issue of Foreign Affairs.  The article drew considerable attention in part because it was written by Alan Blinder, a prominent economist at Princeton University and former Vice Chairman of the Federal Reserve.

In brief, the article sought to define what kinds of jobs were vulnerable to offshoring and what kinds were not.  Highly critical of the focus on manufacturing jobs in discussions of offshoring, Blinder observed that

. . . the boundary between what is tradable and what is not is constantly shifting. . . . this change . . . moves in only one direction, with more and more items becoming tradable.

The old assumption that if you cannot put it in a box, you cannot trade it is thus hopelessly obsolete. . . . the key distinction will no longer be between things that can be put in a box and things that cannot.  Rather, it will be between services that can be delivered electronically and those that cannot.

So far, so good.  Anyone who has watched the phenomenal growth of the IT services business in India and the move of call centers to offshore locations certainly understands that the provision of many services has already started to move offshore. But Blinder is really interested in trying to define the boundaries between what is tradable and what is not in services. He draws the line between “personal services” and “impersonal services”.  Blinder elaborates:

Services that cannot be delivered electronically or that are notably inferior when so delivered, have one essential characteristic: personal, face-to-face contact is either imperative or highly desirable. Think of the waiter who serves you dinner, the doctor who gives you your annual physical, or the cop on the beat.  Now think of any of those tasks being performed by robots controlled from India – not quite the same.  But such face-to-face human contact is not necessary in the relationship you have with the telephone operator who arranges your conference call or the clerk who takes your airline reservation over the phone. He or she may be in India already. 

The first group of tasks can be called personally delivered services, or simply personal services, and the second group impersonally delivered services, or impersonal services.

For those seeking to find a “safe haven” from the challenges of offshoring, this seemed like a compelling distinction.  After all, who could imagine a waiter, physician or police officer providing their services from India?

Well, not so fast.  This is where that New York Times article on October 15, 2006 comes in. Written by Jennifer Alsever under the headline “Basking on the Beach, or Maybe on the Operating Table”, it provides an interesting view of the emerging “medical tourism” industry.

It turns out more and more patients in need of expensive operations are traveling to distant locations to have these procedures performed. Certainly one of the key drivers of this trend is the escalating cost of medical care in developed economies. There’s a potential for significant cost savings when the procedures are performed in countries like India or Singapore. The New York Times article tells the story of Gary Hulmes, a furniture store manager from Florida who went to New Delhi to have spinal surgery done and paid a total of $9,000 including airfare, a five-day hospital stay, and a total stay of three weeks in India (with some sightseeing thrown in).  If performed in a US hospital, the same procedure would have cost $36,000 – 50,000.

But like the broader offshoring trend, cost is only part of the story.  The interesting part (only briefly addressed in the article) has to do with the emergence of highly specialized hospitals in offshore locations that offer state of the art equipment and highly trained physicians that can equal or better the quality record of US physicians. The surgeries being performed include very challenging cardiac, spinal and ophthalmologic procedures. 

In part, the sophistication of these hospitals stems from a high degree of specialization in terms of procedures performed (something that US healthcare providers are also starting to do). But many of these offshore facilities are also pioneering innovative organizational approaches that give the surgeons exposure to higher volumes of procedures than their counterparts would typically see in a US or European facility. The organizational approaches also provide much more rigorous performance feedback to physicians and analysis of complications that may arise during the procedures.

The New York Times article does a great job of describing the rich and varied ecosystem that is emerging to support the medical tourism business.  For example, specialized travel services like Medical Tours International in the US have nurses and doctors on staff to help patients plan medical treatment and trips. The article observes that

. . . medical tourism has spawned a cottage industry of travel agencies willing to book hotels and air travel, find doctors and arrange surgeries. Often, they provide concierges who pick up patients at the airport, provide them with cellphones and wait with them at the hospital, consulting with doctors and keeping relatives apprised.

Books like Patients Without Borders: The Smart Traveler’s Guide to Getting High-Quality Affordable Healthcare Abroad (to be published in 2007 by a new imprint – Health Travel Communications) will help to raise awareness and reduce the perceived risk of heading abroad for medical care. According to the article, Joint Commission International, an arm of the US-based Joint Commission on Accreditation of Healthcare Organizations “. . . ensures that hospitals [overseas] have translators, qualified doctors and nurses and are up to American standards for safety and cleanliness."

On the other side of the healthcare equation, a growing number of insurers are becoming interested in the medical tourism option and offering it to their clients. The article reports that the British government in certain cases is now authorizing patients to seek medical care overseas.

Both the tourism and the healthcare industries in a number of offshore locations are joining forces to create attractive destinations for patients from the US and Europe. The projections for growth are very promising. A joint study performed by the Confederation of Indian Industry and McKinsey & Company in 2004 estimated that the medical tourism business in India alone might generate revenues in excess of $2 billion by the year 2012.

So, bottom line, Blinder got blindsided by focusing on personally delivered services. He assumed that the customers of these services will remain in developed economies rather than seeking out higher quality experiences at more affordable prices in offshore locations.

So, large segments of the healthcare industry might move offshore over time under the banner of medical tourism (of course, Emergency Room facilities will remain onshore, but big ticket elective procedures all seem vulnerable).  This is bad enough, especially given Michael Mandel’s recent analysis of the role of the healthcare sector in job creation over the past five years, both in a cover story on "What’s Really Propping Up the Economy?" in Business Week and in his blog postings.

But is this the only personal services sector vulnerable to movement offshore?  A broad range of leisure businesses like health spas and gambling are already on the radar screen of ambitious entrepreneurs in offshore locations.  Anyone who has watched the construction frenzy in Macao will think twice about the complacency of destinations like Las Vegas that card dealers cannot be offshored (even though the US Congress is doing its best to protect domestic gambling businesses from Internet based competition).  Similarly, the notion that masseurs and masseuses are protected from offshoring crumbles when one looks at the rapid growth of the health spa business offshore. You can’t find much more of a high touch business than massage. Those counting on serving aging boomers also better study the migration of a growing number of retirees offshore.

We need to broaden our horizons on offshoring.  This is not just about service providers moving offshore.  In a growing number of cases, it is also about service customers heading offshore in the quest for higher quality experiences at lower cost.  OK – I can’t resist one more pun – let’s not put blinders on and assume that the customers stay fixed.  In this flat world, that is a dangerous assumption.

Peace and Entrepreneurship

The media coverage of the award of the Nobel Peace Prize last week drew attention to the microfinance movement but, in the process, missed the real significance of this movement.

Last week the Norwegian Nobel Committee awarded the Nobel Peace Prize to Muhammad Yunus, one of the most prominent evangelists for micro-credit in developing economies, and to the Grameen Bank in Bangladesh, the lending institution that Yunus founded. As the official press release indicates, the award was made

. . . for their efforts to create economic and social development from below. Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty. Micro-credit is one such means. Development from below also serves to advance democracy and human rights.

This award left many people scratching their heads – certainly Yunus and Grameen Bank are not playing any direct role in promoting peace.  The Economist magazine even raised the question whether it was appropriate to award the Nobel Peace Prize at all this year.

Now, if Yunus and the Grameen Bank are making a significant contribution to the elimination of world poverty, they are certainly indirectly helping to foster global peace.  The problem is that the evidence for this contribution is mixed at best, as suggested by analysts here, here and here. 

Truth be told, it is likely that micro-credit will be only one element in helping to address global poverty. Its impact can be, and likely is, greatly over-stated. Without the broader institutional reforms that are required to release and amplify the entrepreneurial energies of people in developing economies around the world, micro-credit is likely to remain a band-aid that fails to address the more profound causes of global poverty.

The growing hype about the role of micro-credit in relieving third world poverty, intensified by this award, risks diverting attention from the real significance of the broader microfinance movement and parallel business innovations.

Muhammad Yunus and the Grameen Bank, founded thirty years ago, created significant innovations in terms of distribution approaches for delivering low monetary value products to dispersed populations of very low income customers. Initial loans from Grameen Bank start at about $15 and the average size of a loan is only about $200.

How does Grameen Bank do this?  It fosters social networks in remote villages that take on a lot of the administration and monitoring costs that banks traditionally assumed. Rather than establishing expensive branch offices in each remote village, Grameen Bank sent “center managers” out into the villages.  Yunus, in his book Banker to the Poor, outlines his philosophy:

Conventional banks ask their clients to come to their office. It’s a terrifying place for the poor and illiterate. . . . The entire Grameen Bank system runs on the principle that people should not come to the bank, the bank should go to the people. . . . If any staff member is seen in the office, it should be taken as a violation of the rules of the Grameen Bank. . . .It is essential that [those setting up a new village Branch] have no office and no place to stay. The reason is to make us as different as possible from government officials.

Rather than setting up a branch office, the center managers help to organize lending groups of 5 – 10 borrowers, typically women, the target customer segment of Grameen Bank. These lending groups assess each participant’s needs and this determines  sequence of who will get loans first – the most needy get the first loans. The loans are not covered by any legal documents or collateral. As loans are made, Grameen Bank relies on a variety of mechanisms to manage risk – for example, initial loans are for very small amounts and weekly payments are required as a way to get early visibility on potential default risks.

But the most potent risk management mechanism is the lending group itself.  Since a default by any member of the lending group means that the entire group will be unable to obtain any further loans, there is both significant support from the group as well as peer pressure to keep default rates low (how low is actually open to some debate). Over the years, Yunus has used this innovative distribution model, relying on locally organized groups of consumers, to spin out a series of affiliated enterprises.  These enterprises offer a broad range of services, ranging from cell phone service to equipment leasing services. For more information about Yunus and Grameen Bank, check out Banker to the Poor, written by Yunus and David Bornstein’s The Price of a Dream: The Story of the Grameen Bank.

Looked at through an innovation lens, Grameen Bank represents one of the earliest examples of a powerful form of business innovation that I have described as open distribution.  This innovation is being pioneered by a range of companies in South Asia (primarily India) to deal with the challenges of cost effectively reaching dispersed populations of low income, rural customers. Early pioneers of this model in India include ICICI Bank, ITC with their e-chaupal network, Tata Motors and Cummins (a US company pursuing these innovations through their Indian subsidiary). (For great summaries of the first two pioneers, see C.K. Prahalad’s The Fortune at the Bottom of the Pyramid, for a brief discussion of Tata Motors, see Manjeet Kripalani’s article in Business Week "Asking the Right Questions" and for the Cummins Story, see my article (with JSB) on "Innovation Blowback".)

As I indicated in the earlier blog posting, this open distribution model has several key components:

• increased modularity (both in products and processes)

• aggressive leveraging of existing third party (and often non-commercial) institutions in rural areas to more effectively reach target customers

• creative use of information technology carefully integrated with social institutions to encourage usage and deliver even greater value

This open distribution model stands in sharp contrast to Western forms of innovation in retail distribution by companies like Wal-Mart, Tesco and Metro. Rather than leveraging economies of scale and scope in the branches and regional distribution centers as these Western companies have done, the pioneers of the open distribution model seek to tailor the value delivered to customers through creative leveraging of third party institutions and social networks.

Western distribution models work great if the customers know exactly what they want or are prepared to invest in the search through endless aisles of products (and not a salesperson in sight!) to find what they need. In contrast, the open distribution models represent a promising cost-effective approach to help customers find products that are most relevant to them and then help them to get the most value out of the use of the products.

Now, reading this, some will see that this is a very interesting business innovation in developing economies but will remain skeptical about its relevance for Western economies.  This is where innovation blowback comes in.  There are some interesting opportunities to use innovations being pioneered in developing economies to fashion attacker strategies designed to take market share from established incumbents in the larger, more developed Western economies.

Think about it.  As competition intensifies, why couldn’t the open distribution approaches emerging in South Asia be used to create powerful new ways to significantly reduce the costs of reaching customers in more developed economies while at the same time delivering much more tailored value to these customers? Of course, some modifications may be required.  Rather than lending groups in remote villages, why not think of creative ways to catalyze and shape social networks in cyberspace?  Rather than tapping into local social institutions, why not find interesting ways to leverage the shared experiences that give rise to reputation systems or other social institutions emerging on the Internet?

Let’s tie this in to another popular concept shaping business initiatives today – the long tail.  As Chris Anderson defines the long tail business opportunity, it is shaped by three forces – and one of them is something he calls “democratizing distribution”.  In particular, he is talking about reducing the cost of access to small niches of customers.

Now, Chris is a media guy so the examples he uses for democratizing distribution generally come from the media business and especially digital media. But when I look at the open distribution models emerging in South Asia, I see some powerful examples of democratizing distribution that extend well beyond digital media products or services to include such hard core physical products as automobiles and diesel engines.  Surprisingly, Chris doesn’t even acknowledge, much less discuss, these innovations in democratizing distribution in his book. Yet, these examples add powerful evidence of the opportunity to extend the long tail business opportunity into a much broader range of physical products.

As the long tail unfolds, customers are going to look for more and more help in finding the products and services that matter most to them.  As I have discussed before, they will look for agents and partners that can help them to significantly increase their return on attention. Massive, standardized “big box” retail formats will continue to play a role in driving efficient physical product distribution.  The real value, though, will increasingly be created and captured by those who harness open distribution models to develop a much deeper understanding of individual customer needs and use that understanding to be more helpful in connecting customers with the products and services that matter most to them.

In this context, the business innovations pioneered in remote rural villages of South Asia may be more relevant than we might first perceive.  Perhaps Yunus and the Grameen Bank will end up having less impact on eliminating world poverty than they might hope.  But they might just be early pioneers in a much bigger trend – business innovation seeking to deliver more value at lower cost to customers around the world.

Entrepreneurship and business innovation are key ingredients in shifting economic activity from zero sum to positive sum games.  Positive sum games, by expanding the overall returns, tend to dampen conflict and foster collaboration while zero sum games, with a fixed set of resources, intensify conflict.  In this respect, the entrepreneurship of Muhammad Yunus indeed may contribute to global peace by inspiring entrepreneurs everywhere.

BenQ and Siemens – Western Envy

One year ago, a high profile acquisition got me into trouble.  It seemed to directly contradict some broader themes that I have written about extensively.  A number of my clients and colleagues used the news of the acquisition to question whether these themes were valid. At the time, I was skeptical about the acquisition and recent events appear to justify this skepticism.

What was the acquisition?  It was BenQ’s acquisition of the mobile telephone equipment business from Siemens.

What were the themes it appeared to challenge? First, I have anticipated that all companies over time will unbundle into three much more focused business types – infrastructure management businesses, product innovation and commercialization businesses and customer relationship businesses.  Second, I have pointed to the success of a new generation of Chinese companies that are in fact growing very rapidly by pursuing business models focused on one of these three business types – their success stems from their focus and relentless efforts to get better faster by working with others. Third, I have made the case that at least two of these business types – infrastructure management businesses and customer relationship businesses – are highly scalable and can provide the foundation for rebundling strategies that leverage the benefits of focus as well as economies of scale and scope in order to generate significant economic value.

Well, the BenQ acquisition was certainly an exception to these patterns.  Based in Taiwan, BenQ is not very well known to the general public in Western countries, even though many people use their products on a daily basis.  The reason: BenQ makes mobile telephones, as well as a variety of other consumer electronics products, that are sold under the brand names of prominent Western companies.  It operates as a contract manufacturer making, and in many cases designing, consumer electronics products for other companies. So, in my terminology, BenQ had become very successful as a focused infrastructure management business, leveraging not only low wage rates in Asia but rapid incremental innovation to deliver increasingly sophisticated and reliable products in markets around the world. It has developed world class capabilities in terms of managing high volume, routine processing activities and designing products for manufacturability.

All well and good – very consistent with the broader themes I have described.  But the Siemens acquisition that took effect in October of 2005 came out of left field.  Now BenQ was diversifying from a focused behind the scenes manufacturer and designer into a full-fledged product innovation and commercialization company with its own brands and distribution operations in Western companies.  This was certainly contrary to the broader pattern of unbundling and rebundling that I have described. It also suggested that one major Chinese company was departing from the tight focus that had driven its early growth and success.

What was going on?  Well, from the beginning, this was an unusual acquisition.  It turns out Siemens was actually paying BenQ to take over its ailing mobile telephone business – it paid out 250 million euros to BenQ to support the venture and invested an additional 50 million euros in newly issues shares of BenQ as part of the transaction.  BenQ had already been a significant contract manufacturer for Siemens mobile telephones, so I guess the assumption was that, by combining the two elements of the business, BenQ would be able to overcome the financial difficulties that Siemens had experienced in the business.

If that was the assumption, it proved to be horribly wrong. Siemens’ payments to BenQ at the time of the acquisition pale in comparison to the 600 million euro losses sustained by BenQ’s mobile division since the acquisition. The Financial Times reported on September 29, 2006 that BenQ was pulling the plug on the former Siemens operation, as its Munich-based subsidiary filed for insolvency:

BenQ Corp in Taipei said it had decided not to put any more money into the business because if it had it might have threatened its own survival

Now, undoubtedly there were many factors contributing to BenQ’s difficulties following the acquisition.  Siemens’ mobile telephone business was a relatively marginal player – it was number six in an industry where the top five handset companies account for 80% of the mobile telephone market. The mobile telephone business is an intensely competitive industry in which the increasingly concentrated service providers have growing bargaining power relative to equipment vendors.

But BenQ was venturing into a very different business type with different economics, skill requirements and even business cultures (not to mention national cultures).  In its efforts to master this new business type, it risked losing focus both in terms of management attention and financial resources. This was particularly unfortunate as competition was intensifying in its core business.

BenQ also apparently alienated many of its other customers.  In its contract manufacturing business, BenQ served many of the other major handset product companies but, as it forward integrated into selling its own handsets, BenQ found it more difficult to avoid being viewed as a potential competitor by its contract manufacturing customers.  As the International Herald Tribune reported on September 29, “. . . BenQ’s contract sales [of mobile telephones] have fallen to fewer than two million handsets a quarter, compared with five million per quarter last year.”

There’s a more fundamental issue here.  Many Chinese companies unfortunately suffer from something that I have described as Western envy. Despite enormous success in pioneering innovative business models and business practices, many entrepreneurial Chinese companies still have a sense of inferiority and want to look like larger Western companies with their own manufacturing, R&D and sales and marketing operations.  The irony is that, just as many Western companies are unbundling (in part offshoring and outsourcing to more focused Chinese companies), many Chinese executives are tempted to build more tightly bundled operations that mimic the model many Western companies are abandoning. About a year ago, I wrote about a similar cautionary tale provided by Moulin Global Eye Care, a Hong Kong company.

Chinese executives appear particularly envious of the product brands owned by many Western companies.  Once again, this is ironic given the growing evidence of the general weakening of product-centric brands and the emergence of very different kinds of brands.  These new brands are much more compatible with the kinds of focused businesses that are being built by Chinese entrepreneurs.

BenQ’s stock price rose following the announcement of its decision not to pour any more money into the business it acquired from Siemens.  Hopefully, BenQ’s executives will heed this message from its investors and return to the focused strategies that led to its early success.

In the meantime, rather than viewing the BenQ acquisition as a troubling exception to a broader set of patterns that I see playing out on a global level, I can now point to it as an example of the deep challenges executives will encounter if they ignore these patterns.

Misconceptions About China

There is no China.  The sooner Western executives grasp this, the less likely they will be to make serious investment mistakes in this area.

Now, of course, there is a political entity known as China. It has embassies around the world and exercises significant political power domestically, moving vigilantly against any signs of political opposition. And, from an investment perspective, the central government of China has been a catalyst for, and general supporter of, the economic liberalization that has helped to transform the country over the past several decades. The central government also has control of some powerful economic levers like currency policy. But these basic facts also generate many misconceptions that can get executives into a lot of trouble.

Western views of an authoritarian central government in China that controls all activity in the country help to reinforce the misconception that there is a single China. There is no doubt that the central government is authoritarian, but it is easy to overstate the control it exercises throughout the country.

Andrew Browne’s article on the front page of the Wall Street Journal on September 15, 2006 helps to challenge this misconception.  Carrying the headline “Booming Municipalities Defy China’s Effort to Cool the Economy” (registration required), the article points out that:

Local governments are encouraging a frenzy of construction to boost their economies – even as China’s central government seeks to throttle back economic growth . . . .

More than a quarter century of economic overhauls has produced a striking contrast in China.  Politically, the Communist central government maintains a tight grip over the entire country: economically; it is losing control.

China’s leaders are caught in a trap as they cast around for ways to rein in investment.  The old administrative methods – ordering state banks to stop lending, restricting land sales, halting government approvals for major projects – aren’t working as well as before, partly because local governments are defying Beijing

It is ironic to find an article in the Wall Street Journal lamenting the diminished power of the central government to more effectively control investment.  The article darkly suggests that unrestrained investment by municipalities could lead to property bubbles and rapid escalation of inflation with ripple effects throughout the global economy.

There is no doubt legitimate concern about the efforts of municipalities to outdo each other in terms of elaborate and often uneconomic construction projects.  But the article misses a more fundamental point. 

Much of the economic growth of the country has been triggered by intense competition across municipal and provincial governments to attract private investment.  As I pointed out in an earlier blog, this is in sharp contrast to Europe and even the United States. In these regions, public policy discussions tend to emphasize the benefits of harmonization of economic policy. China has been pursuing a different approach. Economic policy diverges significantly across provincial and municipal boundaries, leading to very different trajectories of growth and rates of growth. This produces a rich environment of public policy competition, where local governments compete with each other to design more attractive economic policies to attract investment. In many cases, as illustrated by the example of Panyu’s emergence as a center of diamond polishing, the competition leads local governments to choose not to enforce burdensome regulations defined by the national government.

The result has been an increasingly complex tapestry of economic policies across China. This in turn has led to the emergence and evolution of highly diverse local business ecosystems that make regional centers like Beijing, Shanghai and Shenzhen quite different from each other in terms of business specialization, infrastructure capabilities and talent pools.  Adam Segal’s book on Digital Dragon remains one of the most insightful explorations of the business impact of this regional diversity in China’s economic policy.  Although his particular focus is on the high tech industry, the dynamics he explores are playing out in such diverse industries as diamond polishing, motorcycles and textiles.

Recently, the newspapers have carried stories (registration required) about the high profile dismissal of Chen Liangyu from his post as Shanghai’s Communist Party secretary. The charges against Chen focus on corruption related to the mishandling of Shanghai’s $1.2 billion pension fund.  There has been much speculation that this dismissal represents an effort by China’s central government to assert greater control over provincial and local governments in terms of economic policy.  Shanghai certainly has been one of the most aggressive regions in attracting foreign investment and funding ambitious commercial real estate development, not coincidentally in part using funds from the city’s pension fund. If this is the motivation behind the corruption charges, it is unlikely to lead to a wholesale shift towards centralized control of economic policy but instead may lead to a re-balancing on the margin to slow the growing power of local governments in setting economic policy.

As always, though, politics in China are complicated. This high profile dismissal could have other motivations.  It is true that the central government has a penchant for using corruption probes and charges selectively to discipline party and government officials. But in this case, it is not entirely clear what the focus of discipline is. The charges against Chen may represent jockeying for political position within China’s Politburo in anticipation of a meeting of party leaders next year.  Chen has been a member of the Politburo and widely viewed as a protégé of former President Jiang Zemin, now officially retired but continuing to exercise influence.

However the Shanghai saga plays out, Western executives need to move away from a view of China as a single economy or country and craft much more nuanced business strategies designed to tap into the increasingly diverse ecosystems and markets emerging regionally within China. It is no longer (if it ever was) sufficient for companies to have a “China strategy” – they need to define a Shanghai strategy, Shenzhen strategy, etc.

But this is not the only dimension where nuanced strategies are required.  Generalizations about China can get Western executives into trouble in other ways as well. 

I have written before about the need to differentiate three Chinas.  In this context, the second China refers to the massive state-owned enterprises (SOEs) that still dominate the economic landscape in terms of employment and production statistics.  Many of these SOEs are now being privatized (at least in part) in terms of ownership structures, but they retain the cultures and work practices of large, bureaucratic entities.

In sharp contrast, the third China consists of smaller, entrepreneurial companies that have emerged on the periphery (literally, in the sense of coastal regions, as well as figuratively).  These companies were the focus in part of my recent book, The Only Sustainable Edge. They represent an innovative group of companies that are reshaping global industries as varied as textiles, consumer electronics and motorcycles.

When most Western executives go to China, they tend to meet with counterparts in the second China and these meetings become their frame of reference for thinking about the capabilities and potential of Chinese business.  They rarely even become aware of the companies comprising the third China and completely miss the strategic challenges and opportunities created by these much less visible companies.

A prominent article in the September 18, 2006 issue of Fortune provides just one example of this misconception. Written by Alex Taylor, III, the article entitled “A Tale of Two Cities” contrasted the performance of a plant opened by Tenneco, a maker of auto parts, in Shanghai in 1998 with another plant owned by Tenneco in Litchfield, Michigan. These two plants make the same product for the same company, so they appear to be particularly useful to compare performance across two countries.

The conclusion, written in sweeping terms, is very comforting for Western executives:

China can be scary. . . .  For many people in high-wage countries like the U.S., Pu exemplifies the China threat – a hard worker making a tenth of U.S. wages.  Who can compete with that? . . . There is no question that, thanks to the labor of tens of millions of people like Pu, China has become a genuinely fearsome economic competitor.

Although wages in Shanghai are rising sharply, labor is still comparatively cheap.  But that is an advantage that goes only so far. Consider: At Tenneco’s plant in Shanghai, labor represents just 1% of production costs; at its Michigan plan the figure is 12%.  It is Michigan, however, that wins hands down in terms of profit, reporting gross operating margins that are a third higher.  The death of U.S. manufacturing has been greatly exaggerated.

Phew! Don’t be scared – we still can beat them in head to head competition. Dig deeper into the story and the article mentions one interesting fact but doesn’t really develop its significance.  Tenneco’s Shanghai operation is actually a joint venture with a state-owned company, Shanghai Tractor & Engine Co., a subsidiary of automaker Shanghai Automotive. So, we are comparing the performance of a state-owned company in China (albeit in a joint venture with a Western company) with a the domestic facility of a U.S. manufacturing company. The challenges faced in the Shanghai operation that limit its performance – resistance of workers to change, friction between workers and supervisors, high turnover of workers, difficulty in firing troublesome workers (meaning the good ones get hired away and the low productivity ones stay forever), primitive tools – are all classic symptoms of the low productivity state-owned enterprises in the second China.

There is no indication of any awareness of a completely different set of companies operating in China – the private, entrepreneurial companies of the third China where worker productivity is world class, where rapid incremental innovation is a foundation and where value is amplified by sophisticated networks of companies with complementary capabilities. If we generalize from the experience of state-owned enterprises in China, we build misconceptions that lead to complacency. 

Look to the edge in China – operating below the radar screen of many Western companies, the entrepreneurial companies of the third China are pioneering sophisticated management techniques that make them formidable competitors – or potentially helpful allies – in global markets. Combine this with a clearer view of the diverse ecosystems evolving in China and Western executives may finally discover ways to harness the enormous economic potential emerging in this part of the world. In fact, it is the complex interplay between these entrepreneurial companies and the diverse ecosystems reshaping the business landscape in China that makes these companies such formidable players in global markets.

Just keep reminding yourself – there is no China. It will help to keep you out of trouble and make you more alert to the developments that are reshaping both the domestic Chinese economy and, increasingly, the global economy.

Langlois and the Vanishing Hand

Richard Langlois has been guest blogging over at Organizations and Markets, a great blog that focuses on recent developments in academic thinking in economics and management. Langlois, a Professor of Economics at the University of Connecticut, is one of my favorite economists because has been fighting for years to drag economics out of its obsession with static equilibrium models and re-focus it on the dynamic processes that are the source of value (and wealth) creation.

Back in 1995, Langlois wrote a great book on Firms, Markets and Economic Change: A Dynamic Theory of Business Institutions with Paul Robertson (warning: this is not a light read, but it is a very rich and rewarding exploration of the theory of the firm).  Langlois and Robertson lay out the thesis of their book as follows:

. . . the rationale for the theory of the firm is what we might legitimately call a strategic, entrepreneurial, or Schumpeterian theory of vertical integration.  The superiority of centralized control of capabilities lies in the ability to redeploy these capabilities in the service of an entrepreneurial opportunity when such redeployment would otherwise be costly.  The firm overcomes the ‘dynamic’ transaction costs of economic change.  It is in this sense that we may say the firm solves a coordination problem: it enables complementary input-holders to agree on the basic nature of the system of production and distribution of the product.  It provides the structure in a situation of structural uncertainty.

. . . the superiority of the firm rested on its ability to cheaply redeploy, coordinate, and create necessary capabilities in a situation in which (1) the entrepreneurial opportunity involved required systemic change and (2) the necessary new capabilities were not cheaply available from an existing decentralized or market network.  In situations, however in which one or both of these conditions is missing, the benefits of the firm are attenuated, and its rationale slips away.

In a recent blog posting, Langlois pointed to his new book The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy that will be coming out shortly – for a limited time, the full text of the book is available online here.  In this book, especially in Chapters 4 and 5, Langlois develops the theme of the historical transition from the Invisible Hand to the Visible Hand and now to the Vanishing Hand. More concretely, he sets out to try to explain why the large integrated firm described by Alfred Chandler emerged in the late nineteenth century but, more importantly, why the large integrated firm began to unravel in the late twentieth century. As he puts it, “vertical disintegration and specialization is perhaps the most significant organizational development of the 1990s. My goal is to explain this development . . . “

His book covers a lot of ground, including an interesting discussion of Joseph Schumpeter’s theory of the firm, thoughts on the co-evolution of technology and organization, a discussion of the importance of modular systems in improving access to distributed capabilities, and a section entitled from “Friedrich Hayek to Nicolas Hayek”, a great historical view of the evolution of the Swiss watch industry.

A blog posting cannot possibly do justice to the richness of his argument but, in essence, to explain the current trend towards unbundling of business activity, Langlois points to the combination of another wave of technology innovation that reduces economies of scale, the emergence of “thicker” markets (broader reach, richness of interactions and affluence of customers) and the increasing ability of modular systems to take over the function of buffering economic activity from the inevitable uncertainty of markets.

These factors are all important, but two other factors that may be implicit in the notion of thicker markets ought to be given more prominence.  First, a global public policy shift playing out over the past fifty or more years has progressively removed barriers to entry and barriers to movement, leading to intensified competition and growing pressure to accelerate capability building.  Second, information technology has also given customers much greater ability to evaluate, monitor and switch among vendors, increasing their relative power in markets and leading to what I have characterized as “reverse markets”.

This book served as a catalyst for me to think more historically about the unbundling of the corporation that I began describing almost a decade ago.  I have been less focused than Langlois on vertical disintegration and more interested in the unbundling of three businesses that today are tightly integrated within most firms – infrastructure management businesses, product innovation and commercialization businesses and customer relationship management businesses.

As I have noted before, this unbundling is occurring in two broad waves, although the timing and exact nature of the unbundling process differs across industries.  In the first wave, infrastructure management businesses – high volume, routine processing activities like assembly line manufacturing, logistics network management and certain types of call center operations – are being systematically carved out of large enterprises and taken over by highly focused and specialized companies. These are precisely the kind of activities that led to the rise of the large, integrated firm in the first place – they are the high fixed cost, high throughput systems that Alfred Chandler described in his historical studies. Much of Langlois’s analysis seems to be focused on this type of carve out.

But another wave of unbundling is at an even earlier stage of playing out.  This is the separation of product innovation and commercialization businesses from customer relationship businesses.  Of course, at some level, the emergence of traditional retailing could be viewed as an early example of separation of customer relationship businesses from product businesses.  Langlois has some interesting observations about the role of generalist merchants in early nineteenth century America who provided loose coupling within the market economy.

But if you look closely at most traditional bricks and mortar retailing businesses, they actually resemble infrastructure management businesses with high fixed costs where throughput becomes the driving consideration. If you doubt that, look at how retailers typically measure profitability and performance – sales and margin generated per square foot of retail space. Life time value of customers – the hallmark of focused customer relationship businesses – is only gradually beginning to draw the attention of retailers. Most retailers are only peripherally customer relationship businesses.

Customer relationship businesses develop deep knowledge of individual customers and use that knowledge to become more and more helpful in configuring the appropriate bundle of products and services for the customer.  Personal physicians, personal financial advisors and personal shoppers are all early examples of this kind of focused business.  In the past, these businesses largely served affluent customers because only these customers could justify the investment required to build a detailed understanding of individual customer needs.

Chandler makes the case that development of new technologies, especially communication and shipping technologies, helped to catalyze the development of the large, integrated firm in the late nineteenth century.  A similar wave of technology innovation will accelerate the next wave of unbundling of product and customer businesses.  On one side are the technologies that help to capture detailed profiles of customer behavior and to mine that data to become more helpful in terms of advice.  On the other side are technologies that are reshaping the economics of production and distribution, contributing to phenomena like the growth of the Long Tail.

As in the era that Chandler profiled, this new wave of technology may lead to the development of a new generation of large enterprises.  The dynamics described by Chandler favored significant economies of scale, especially in production.  This new wave of technology favors significant economies of scope for customer relationship businesses. These businesses can become more helpful and create more value when they broaden their relationship with any individual customer and when they broaden the number and diversity of customers served.  Unbundling of businesses may in fact be a necessary precursor to significant rebundling of enterprises focused on one of the three business types mentioned earlier.  The one business that is likely to fragment over time is the product innovation and commercialization business. As Langlois points out, “industrial structure is an evolutionary design problem” and, in a period of accelerating change, we are likely to see very innovative new firm and network designs emerge.

The firm will certainly not go away during this next wave of restructuring. As JSB and I argued in The Only Sustainable Edge, though, the rationale for the firm will certainly morph significantly.  For the past century, large firms have justified their existence based on their superior ability to economize on interaction costs.  Now, firms will only be successful if they can deliver on the potential to accelerate capability building and the talent development of their employees. This is one of the key drivers of the unbundling process at play – a growing number of executives are beginning to realize that they cannot get better faster unless they focus more tightly on one of the three business types and shed the other businesses.

This is not just an abstract theoretical issue. As I have suggested in earlier postings here and here, the forces re-shaping our business landscape are creating significant opportunities for wealth creation for those who focus on the creation of customer relationship businesses. Those who fail to understand the imperative to unbundled are likely to destroy significant economic value. A clear view of the likely trajectory of market and industry structure evolution is essential to make the most effective near-term moves.  The FAST strategy methodology provides a helpful toolkit in navigating through this turmoil.

Mastering New Marketing Practices

Last month, I had the pleasure of addressing a CMO Summit held in New York.  I was given 15 minutes to set up a discussion on the future of marketing. It forced me to be even more concise than usual, but I was  able to pull together a number of themes from my client work that I will eventually develop in a more systematic form.  In the meantime, I thought it would be useful to write up my speaking notes to share a high level view of where marketing is going.

Shifts in business economics

We are in the early stages of a profound shift in the economics of business that will transform marketing (along with many other things). Three shifts in economics are occurring in parallel.

First, we are moving from a world of relatively scarce shelf-space to relatively scarce attention.  Second, costs of production and physical distribution are significantly declining on a global scale and customer acquisition and retention costs are rising.  At the risk of over-simplification, value creation is shifting from businesses driven by economies of scale in production to businesses driven by economies of scope in customer relationships. Layer in a third factor at work – the systematic and significant decline in interaction costs that make it easier for customers to identify vendors,  find information about them, negotiate with them, monitor their performance and switch from one vendor to another if they are not satisfied with performance.

These three forces reinforce each other and help to explain the growing power of customers in markets around the world.

Redefine marketing strategy

These shifts have broad implications in terms of marketing strategy, branding and marketing performance metrics.  To start with marketing strategy and again at the risk of over-simplification, conventional marketing is built upon the three “I’s”:

• Intercept – target and expose customers to your message wherever you can find them.
• Inhibit – make it as difficult as possible for the customer to compare your product or service with any other options.
• Isolate – enter into a direct relationship with the customer and, wherever possible, remove all third parties from the relationship.

Nirvana is the walled garden of direct marketing.  It is captured in the mantra of “one to one marketing” – one vendor dealing individually with each customer.

A different approach will be required to succeed in a business landscape defined by the economic shifts described earlier. I describe this marketing approach “collaboration marketing” and define it in terms of three “A’s”:

• Attract – create incentives for people to seek you out.
• Assist – the most powerful way to attract people is to be as helpful and engaging with them as possible – this requires a deep understanding of the various contexts in which people might use your products and a willingness to “co-create” products with customers.
• Affiliate – mobilize third parties, including other customers, to become even more helpful to the people you interact with.

In contrast to the “one to one marketing” mindset of conventional marketing, collaboration marketing requires a “many to one” mindset.  The winners in this new world will be orchestrators who can mobilize rich networks of resources to serve customer needs.

Move to a different brand promise

I have written about this before here, here and here. Conventional brands are built upon product or vendor-centric promises: “Buy from me because I have great products or because I am a great vendor.”  These brands are generally eroding in value.

Brands will become even more important and valuable in this new marketing world, but they will be based on a very different customer-centric promise: “Buy from me because I know you as an individual customer better than anyone else and you can trust me to use that knowledge to configure the right bundle of products and services to meet your individual needs.”  Note that this is different from customer segment brands like Nike or Disney – customer-centric brands require a deep understanding of the needs of individual customers. Not all companies can or should make the transition to this new kind of brand promise, but those who do will be richly rewarded.

Adopt new performance metrics

Given the shift in business economics defined earlier, companies need to move from measures of performance based on product or facility economics to measures based on customer economics.  Two key questions will increasingly shape business performance. First, what is the average life time value of customers – how much does it cost to acquire a customer, what is the average length of a relationship with a customer, and how much profit is generated over the lifetime of the customer? Second, what is the 80/20 segmentation of customers – which 20% of customers generate 80% of the profitability and why? Few companies today can systematically answer these questions.

We will also move to a new form of ROA measure – this time, it means Return On Attention, both from a customer perspective and from a vendor perspective. From the customer point of view, the question that customers will increasingly ask is: “Of the total attention I allocate to a particular source, what is the productivity of that attention in terms of  value received for effort and time invested?”

We’ll also see a new form of ROI measure – Return On Information, again from both a customer and vendor perspective.  From a vendor point of view, the key question will be: “How much effort and cost did I invest in acquiring information about individual customers and how much value have I been able to generate in return, both for the customer and for me?” In this context, lead-times matter; the more quickly a vendor can turn around and deliver tangible value in return for information from a customer, the more quickly and effectively the vendor will be able to build trust and willingness to provide even more information.

Vendor response disappointing so far

Sorry to say, vendors are responding as vendors – old habits and old instincts die hard. While there is a broad recognition among marketers that attention scarcity is becoming a big issue, the response has been increasing desperation to get some of that scarce attention.  Intrusive ads are appearing in more and more places – projected in lights on the sides of buildings at night, plastered on the sides of farm animals in fields and running on video displays above urinals. Rather than just focusing on how to get attention, vendors might also want to consider how they can help their customers receive attention that is important to them and not just from the vendor, but from others that matter to the customers.

Vendors also tend to commoditize attention, viewing attention as a fungible good that can be bought and sold.  Successfully attracting attention requires an understanding that attention is highly context sensitive – it is both deeply personal and social at the same time.  Attention is deeply embedded in, and shaped by, relationships.  These relationships are not static, but increasingly dynamic.  The key challenge and opportunity for vendors is how to participate in, and enrich, these relationships in order to construct more value for their customers and to amplify the value of attention.

Vendors also narrow the focus very quickly from attention to intention, asking “how can we more effectively intercept people who have already formed an intent to buy?”  The missed opportunity is how to engage the attention of customers at a more fundamental level in ways that create more value for the customers and for the vendor.

Finally, vendors tend to develop a narrow focus on new, network-enabled marketing tools like blogs, wikis, virtual communities and social networks, treating them like a checklist to be deployed like  artillery in a military campaign – “yes, we’ve set up some blogs.”    Few of them systematically ask how these tools might be used to increase return on attention for customers.  Even fewer ask who else already has deployed these tools and how they might help their customers find and connect to these resources and perhaps where they might participate in existing environments in ways that provide more return on attention.

Actions to take

To navigate through this fundamental shift in marketing, CMOs will need to recognize that this is an organizational change challenge, something that most CMOs are not very comfortable in confronting.  They would much rather design and deploy a clever marketing program than figure out how to change the hearts and minds of people throughout the organization.

At its most basic level, adopting these new marketing approaches will require a shift in mindset.  Rather than viewing markets as places where vendors seek out customers and try to sell them as much stuff as possible, successful players will recognize that we are increasingly participating in “reverse markets” where customers seek out vendors when it is relevant and then negotiate to get as much value as possible from the vendors they deal with.

To support this shift in mindset, CMOs will need to focus on three things in particular.  First, find some ways to demonstrate impact through focused initiatives designed to demonstrate the power of new marketing approaches.  Identify specific opportunities to be more helpful to some of the company’s most profitable customers.  Find partners who can help to leverage the value of the firm’s resources and then define a set of near-term value exchanges with customers that can help build trust and earn the right to more attention from these customers.  Measure and celebrate the results.

Second, and more broadly, change organizational roles where necessary so there are executives that have clear accountability for specific customer segments – and sufficient influence to mobilize the resources required to serve those customer segments effectively.  Third, adopt performance metrics throughout the organization that recognize and reward initiatives designed to increase the life time value of customers and deepen relationships with the most profitable customers (while working to improve the profitability of the rest of the customer base).

Customers are rapidly gaining more power in dealing with vendors.  Marketing practices have only modestly changed to reflect that new reality.  There is still enormous opportunity to master the new marketing practices required to compete successfully in reverse markets.  The change in mindsets and practices is significant, but there is a pragmatic migration path that companies can pursue. 

Innovation and the Competition for Talent in China and India

The Financial Times ran an article on July 20, 2006 headlined “Up to the job? How India and China risk being stifled by a skills squeeze” (registration required) looking at the growing competition for talent in these countries.

It’s interesting on a number of levels, but primarily because it underscores the danger of continuing to view India and China as offshoring locations offering simple wage rate arbitrage – a view that too many Western companies still hold. In the more developed cities like Bangalore and New Delhi and Shanghai and Shenzhen, competition for talent is intensifying, with predictable consequences for wage rates and employee turnover.

In the IT services industry in India for example, the article quotes Nasscom, an Indian trade association, as reporting that annual employee turnover rates are approaching 40 percent and pay inflation reaching 20 percent this year. As a result, according to the article, some Western companies like Apple and Powergen (a UK utility) have announced closure of support centers based in India.

Now, there are two ways to view this intensifying competition for talent.  Looked at through the narrow lens of wage arbitrage, this may be viewed as easing the pressure for Western companies to offshore their own operations and to compete with Chinese and Indian companies benefiting from lower wage rates in their home countries. So, perhaps this is good news for Western companies.  Maybe all this talk about the rise of China and India is just like the scare talk about Japan decades ago – remembers how the Japanese were going to buy up all our companies?

But wage arbitrage has always been much too narrow a lens for viewing offshoring and the changing shape of global competition. As JSB and I suggested in an oped piece in the Financial Times almost one year ago, a much more productive way to view these developments involves focusing on skill building arbitrage – the opportunity to participate in relationships and environments that can build capabilities more rapidly than would be possible elsewhere. This broader perspective begins to bring into sharper focus the significant management innovations that certain Chinese and Indian companies are pursuing to build capability more rapidly. In an earlier blog posting, I outlined three forms of management innovation that these companies are pioneering.

In this context, the intensifying competition for talent will only accelerate the management innovations that are already under way in these countries, making the companies even more formidable competitors or providers, depending on where you stand in the global value chain. In fact, from their earliest days, these companies have understood that their success depends upon attracting and retaining talent.  More importantly, they have discovered that if they develop their talent more rapidly than anyone else, they will also have an advantage in attracting and retaining talent, so that has been the focus of many of their management innovations.

They have also understood that not all talent needs to reside within their enterprise if they can collaborate effectively with a broad range of specialized companies, so another dimension of innovation has been the development of scalable process networks that bring together hundreds, and often thousands, of specialized business partners.

By the way, skill shortages and employee turnover are often signs of healthy local business ecosystems.  Here in Silicon Valley executives routinely complain about the limited supply of qualified engineers, escalating compensation packages and high turnover rates.  The 40% employee turnover rates reported by Nasscom are admittedly high, but those are averages and skewed by the large number of smaller offshoring service providers that have been most active in playing the wage arbitrage game.  These companies are losing talented or experienced employees to competitors willing to pay more while their clients suffer the consequences in terms of deteriorating performance. Leading firms like Infosys report turnover rates in the range of 10 – 15%, much more equivalent to what we experience in Silicon Valley.  In fact, as Annalee Saxenian reminded us in her insightful book, Regional Advantage, that kind of employee turnover is a key driver of innovation activity as companies routinely acquire new talent with a differ
ent set of experiences and perspectives.

While I’m at it, note the irony that the FT article is appropriately critical of the education systems in both China and India while at the same time many in the US focus on the deficiencies in our education system as a key factor in undermining our competitiveness in the global economy.  Without in any way diminishing the severe flaws that plague our public education system, too many people spend too much time focused on the deficiencies of education systems in shaping global competitiveness.

The economic growth of China and India only marginally depends on their formal education system – much more important has been the emergence of a set of innovative companies that have figured out how to access and develop talent much more rapidly than most Western companies. Both countries have also benefited from a flourishing (and admittedly very uneven) ecosystem of private training institutes and services that help to bridge the gap between what the public schools produce and what businesses require in terms of technical, language and management skills. Once again, a sense of urgency regarding talent development seems to matter much more than any objective measures of public education system performance. Young employees in entrepreneurial Chinese and Indian companies appear to have a much greater sense of urgency about their advancement than comparable employees in most US companies have.

The FT article quotes a McKinsey Global Institute study that has received a lot of attention regarding supply constraints on skilled labor in China and India. In fact, the FT gave this study a front page story under the headline “Foreign threat to service jobs overblown’” (registration required). The study is very useful in pointing out some of the challenges in these countries but, as I pointed out in a blog posting a while ago, the study is weak in terms of its methodology for projecting future skilled labor supply.  This is a rapidly changing environment where demand pull for talent already is leading to innovative approaches that have the potential to significantly reshape supply dynamics. 

Bottom line: the intensifying competition for talent in China and India will only increase the sense of urgency already felt by the leading companies in these countries in terms of the need to pursue management innovations that can accelerate talent development. In this context, the FT article quotes N. R. Naryana Murthy, one of the founders and the “chief mentor” at Infosys, warning about the growing competition from China’s IT industry: “China is running very fast to catch up with India. Chinese are much more determined than we are.” At the same time, Western companies reading the stats on rising wage rates and average employee turnover rates in China and India are likely to become more complacent about competition from companies in these countries.

The Long Tail and the Structure of the Media Industry

Almost two years after his initial article on “The Long Tail” first appeared in Wired, Chris Anderson’s long-awaited book The Long Tail was officially released last week.  As a tribute to the power of the meme which he has diligently discussed and refined in his blog, Chris’s book has shot up to #1 at Amazon. The book about the long tail has made it up into the short head, big time.

Even for those who have been following The Long Tail blog, the book is a welcome contribution to our understanding of a fundamental force reshaping the media industry. At this point, virtually everyone has heard of the long tail but, just in case, here’s the capsule summary.  While more and more media businesses have become blockbuster-driven over the past century, three forces are working to increase the economic and cultural importance of the “long tail” – the growing abundance of products that individually sell in small numbers but that, in aggregate, account for substantial consumption.  These three forces are:

• Democratizing of the tools of production – especially affordable digital technology that makes it economically feasible to make products, even in small quantities.  In Chris’s words, this results in “more stuff, which lengthens the Tail”.

• Democratizing distribution – here Chris places particular emphasis on the role of a variety of Internet aggregators in creating “infinite shelf space” businesses where virtually every product in a category can be economically accessed.  Again, to quote Chris, this creates “more access to niches, which fattens the Tail”.

• Connecting supply and demand – Chris focuses here on the emergence of businesses and taste makers  that act as filters, helping to cost-effectively and flexibly connect people with available goods, no matter how narrow the interest or specialized the product. These filters can take a variety of forms, including search algorithms, sorting algorithms, editorial recommendations and customer reviews. Chris suggests that more efficient tools to connect supply and demand “drives business from hits to niches”.

Chris does a great job of exploring these three forces and their role in enhancing the economic attractiveness of long tail markets.  While he clearly believes that these forces are playing out in a growing range of product and service businesses, Chris spends the bulk of the book discussing examples from the media business, ranging from video to music to books.

Given the importance that he attaches to the long tail, it is a bit surprising that Chris does not pursue in more detail the implications for the structure of the media industry.  His perspective is certainly suggestive in terms of direction, but he never really steps back and spells out how the long tail might re-shape media businesses, with particular attention to the most basic question of all: who is going to create economic value and who will destroy economic value?  Perhaps it is prudent for Chris to avoid such speculation given all the uncertainties in how this might play out, but this is the question that all media executives are confronting.

At one point in his book, Chris appears to suggest that there really may not be profound changes to the existing power structure, that perhaps this is all additive:

This shift from the generic to the specific doesn’t mean the end of the existing power structure or a wholesale shift to an all-amateur, lap-top culture.  Instead, it’s simply a rebalancing of the equation, an evolution from an “Or” era of hits or niches (mainstream culture vs. sub-cultures) to an “And” era.  Today, our culture is increasingly a mix of head and tail, hits and niches, institutions and individuals, professionals and amateurs.  Mass culture will not fall, it will simply get less mass.  And niche culture will get less obscure.

But, is that all there is – a simple and smooth “rebalancing of the equation”? Let’s take a look at some of the questions raised by Chris’s perspective.  Chris spends a lot of time profiling the rise and role of aggregators like Amazon, Netflix, Rhapsody and iTunes.  Within specific media categories like books, videos and music, these aggregators have played an increasingly prominent role and have become quite concentrated in a short period of time.

In the early days of the Internet, “disintermediation” was the buzzword – all intermediaries were going to disappear and customers would connect directly with content creators.  The long tail perspective, with its emphasis on the economic role of aggregators, suggests just the opposite – intermediaries rule, albeit a different set of intermediaries than have prevailed in the traditional media business. From the early days of Net Gain and Net Worth I have advanced a similar view, highlighting the growing importance of intermediaries as options proliferate.

But let’s go one level deeper.  What kind of aggregators will prevail?  Today, we have an interesting phenomenon – highly specialized aggregators focusing on one media type: Netflix for DVDs,YouTube for videos, Rhapsody and iTunes for music, Flickr for photos, etc. In many respects, this is a perverse replication of traditional media boundaries in what was once conceived to be a multimedia business. Amazon stands out as the major exception, although its real depth is in the book category. MySpace is another interesting exception, even though it retains a deep spike in music, perhaps because it, more than most aggregators, represents a deeper blend of community and content.

Will these media ghettos persist?  Will new generations of aggregators emerge that more creatively mix and match media types?  What about the efforts of major portals and search engines like Google, Yahoo and MSN to carve out major long tail aggregation plays of their own, not to mention the budding efforts of wireless network portals to aggregate wireless content?

My own view is that the current generation of aggregator businesses represents an unstable transitional form that will unbundle into two very different kinds of businesses: infrastructure management businesses and customer relationship businesses. As I have argued elsewhere, these businesses require different skill sets and cultures and they have different economics, yet most aggregators keep these tightly bundled.  I don’t think that will last.  Both of these businesses can be very profitable and can lead to high levels of concentration and consolidation but, to sustain world-class performance, they need to be managed as focused businesses, not bundled together.

Where does that leave traditional media businesses?  Well, by and large, they represent a third kind of business today – product innovation and commercialization businesses. Here’s the problem – in the long tail world, this kind of business tends to fragment as creative talent tends to seek out smaller and more hospitable organizational homes.

So, what are the large media conglomerates to do? As I have suggested here and here, they can either unbundle or rapidly evolve into something else.  Because of their broad reach to high quality audiences, they have an opportunity to make the transition to customer relationship businesses, potentially even preempting today’s generation of online aggregators if they move smart enough and fast enough. The problem is that this is a huge transition for most media companies today – the product mindset dies hard.

Here are two tests.  Most media companies today are driven by product centric economics – they track in great detail what it costs to make a media product, how many units are sold or distributed and the revenue generated by product. How many of them effectively track the life time value of their audience members or customers – what it costs to acquire an audience member or customer, how long their relationship endures and how much revenue and profit is generated by audience member or customer?  These customer centric economics drive customer relationship businesses.

Second test – how ready are most media companies to point their audience members or customers to media products offered by their competitors? From my experience, very few. A customer relationship business acts as an agent on behalf of the customer, helping to connect them with whatever resources are most valuable or relevant to them, regardless of source.

Why is this transition from product business to customer relationship business so important?  I’ve mentioned one reason – scalability, which in a long tail world becomes harder and harder for product businesses and more and more feasible for customer relationship businesses.  But there’s another reason – brand.

Chris and I have debated this before – here, here, here and here.  Chris appears to believe that in a long tail world brand fractures and fragments as customers themselves, or at least the tastemakers and celebrities among us, develop reputations as trusted advisors to help others navigate through the long tail. I hold that, in a long tail world, customer relationship businesses have an opportunity to create very powerful and scalable brands based on the proposition that they know individual audience members or customers better than anyone else and can be trusted to use that knowledge to become ever more helpful to the audience member or customer.

I am also a bit more skeptical than Chris appears to be about advertising as a sustainable business model for many media companies over the longer term. It’s a topic for another blog posting, but the very efficiency of advertising aggregators like Google in making it possible to sell “tens of millions of unique ads” will over time just contribute to the growing clutter as more and more options compete for our limited attention. The increasing current focus on intention and transactions in online advertising, while understandable, distracts from the real opportunity: to build deep and sustaining relationships.

Bottom line, the dynamics of the long tail (combined with other factors) will lead to a profound restructuring of the media industry.  In contrast with many others who believe that the long tail will lead to fragmentation, I see the potential for concentration and consolidation of focused infrastructure management and customer relationship businesses. I also see an opportunity to build much more powerful brands in the media business.  While there are early leaders in this effort, we are still very much in the early innings with lots of opportunities for new players to emerge and create significant economic value.  Current leaders risk significant value destruction if they don’t rapidly adapt to the changing rules of the game.

All of this is not meant to detract from Chris Anderson’s accomplishment.  He has crafted a compelling meme to capture a fundamental shift occurring in the media business and his book explores many of the dimensions of this shift with great insight.  It is a tribute to his book that it prompts an even broader and richer set of questions that media executives and, ultimately, all of us will need to wrestle with as we navigate through the long tail. Perhaps these questions will be the focus of his next book.