Zero-Sum Thinking

In a conversation with Jack Welch earlier this week, he raved about Rich Kaarlgard’s recent column in Forbes on “World’s Worst Disease”.  No, Rich is not talking about cancer, AIDS or avian flu – he is talking about “zero-sum thinking” – the belief that if one person gains, other people must inevitably lose.

Rich focuses on a significant rift in our society.  In fact, this is perhaps the most fundamental rift in any society. It ultimately determines whether the society is progressive and dynamic or stagnant and conflict-prone.

Unfortunately, both of our political parties appear to be captives to zero sum thinking. Rich asks:

Why do so many opinion makers promote the zero-sum view? I think that politicians, even the best and brightest, become zero-sum thinkers because they occupy a zero-sum world. Only one person can be President of this country; only 50 can be governors; only 100 can be senators. . . . Politicians live in a world in which one person’s gain is another’s loss.

Rich goes on to target economists and journalists as being particularly prone to this disease. Now, I agree with all of this, but I wonder why Rich leaves out business leaders in his discussion of this disease. My concern is that many senior executives of our largest companies have fallen prey to this disease.

As JSB and I wrote in the opening pages of The Only Sustainable Edge:

We believe that a new opportunity and a new imperative – the acceleration of capability building – will shift our institutional and collective mind-sets from a worldview that focuses on static, zero-sum relationships to one that emphasizes dynamic non-zero-sum relationships.  As we adopt these different perspectives, we will find that most of our institutions today are fundamentally lacking.

Static, zero-sum worldviews generally arise when people focus on the allocation of existing resources.  Existing resources have a fixed quantity, and with relatively modest exceptions, if one party acquires a resource, other parties are deprived of that resource.  This worldview is a natural orientation for large, well-established players – they become more concerned with defending existing resources because they have a lot to lose on this front, compared with the opportunity to create more resources.

I spend a lot of time with senior executives and I am struck by the inroads made by this disease in corporate boardrooms.  Here are just a few of the areas where zero-sum thinking rears its ugly head in our business arena:

• Squeezing suppliers. In our quest for cost-cutting, we have focused on squeezing the prices of our suppliers as much as possible.  The result has been deteriorating trust and relationships with key business partners. Too many executives under-estimate the opportunity of working together to make both parties stronger and deliver even more value to the marketplace.

• Growing focus on intellectual property protection.  There are certainly valid concerns here, but too often executives seek to protect their existing stocks of knowledge at the expense of the opportunity to participate in broader relationships that could significantly refresh these stocks.

• The militarization of marketing.  Military metaphors abound in our marketing efforts – campaigns, blitzes, targeting – yet war is perhaps one of the most extreme examples of zero-sum games.  What new value could we create if we focused instead on how we could be more helpful to customers so that they will make the effort to seek us out, rather than having us search for them?

• The marginalization of innovation.  With some obvious exceptions, large enterprises have generally become consumed with the quest for cost-cutting – again,  for understandable reasons.  In the process, though, the opportunity to create new forms of value through innovation has been shunted aside.  Innovation has been compartmentalized into R&D departments that have been squeezed for cost-savings along with everyone else.  Rather than assigning innovation to the ghetto of R&D, why not liberate innovation and view it as an activity that everyone in the enterprise should be pursuing every day? Of course, that means breaking the mindset that innovation is about product development. After all, innovation is ultimately about finding ways to deliver new value to the marketplace from existing resources, whether this value is in the form of products, new work practices, improved business processes, new management techniques or new business models. Innovation is the antidote to zero-sum thinking.

Rich also doesn’t talk about this disease in a global context.  Certainly every society has it to some degree.  But I think the story of the rapid growth of China and India in the past decade hinges on the ability of significant segments of the population to find an antidote to this disease and to embrace a positive-sum view of the world.

I fear that the disease is more pervasive than Rich acknowledges.  We need to identify the symptoms in all areas of our life and work hard to find appropriate antidotes.  Our continued growth and prosperity depend upon it.

Stock Buybacks – A Red Flag?

As we move from one year into the next, it is a good time to step back and reflect on patterns emerging in various areas of the business landscape. One pattern that I find disturbing is the growth of stock buyback activity.

Barry Ritholtz recently drew attention to this in his posting on “An Unprecedented Mass of Buybacks” at his blog The Big Picture. Some other articles on this topic have appeared in Barron’s (subscription  required) and the Wall Street Journal (purchase required). In his blog, Barry indicates that the S&P 500 companies bought back $456 billion worth of stock last year.  That’s almost one-half trillion dollars!

When you add in dividends (the other major form of payment to shareholders), the S&P 500 increased their payments to shareholders by 30% over another record year of payments in 2004. What’s going on here?

Now, there are many explanations for why this is happening, some more benign than others.  At one level, this outflow of cash to shareholders is refreshing.  There are strong institutional incentives for managers to hold on to any cash they generate.  Too often, senior management will re-invest this cash in low return business ventures rather than return it to shareholders. Classic finance says that if managers can’t find investment opportunities above the cost of capital, they should return cash to shareholders and let them find more attractive investment vehicles.

And yet, there’s another explanation that causes more concern.  Most large American companies for years have been pursuing aggressive cost-reduction strategies, especially in the aftermath of the 2001 recession.  They have generally been very successful at cutting costs and substantially increasing cash flow generated from operations. But then the question becomes, what to do with the cash? Companies with a high rate of innovation generally have no problem in answering this question – they use the cash to fund the next wave of innovation initiatives.

But, companies with low innovation capacities run into a real problem.  The accumulation of cash becomes an embarrassment and they start paying it out.  So, one way to interpret the surge in dividend and buyback activity is that it reflects a fundamental imbalance in management focus: aggressive cost-cutting initiatives combined with low innovation capabilities.

This is a real danger signal in a global economy with intensifying competition.  In this environment, cost savings are generally not sustainable – they rapidly get competed away and captured by the customer.  Unless companies have the innovation capacity to redeploy these savings rapidly into productive new business initiatives, they will end up shrinking.

Now, many managers will reply that this is unfair.  In fact, one of the often cited reasons for share buybacks is management’s belief that the public capital markets have undervalued their stock. If this is the case, buying the company’s own stock may in fact be one of the best investments available – when public investors finally come to their senses and realize the true value of the company’s stock, the stock repurchases will earn a healthy return on investment.

While this may be true in some isolated cases, there’s something that just doesn’t ring true.  There’s growing liquidity in capital markets around the world.  Investors are competing with each other to find attractive investment vehicles.  Can it really be the case that there are so many instances of undervalued stock among the S&P 500 to justify such widespread and massive buyback activity?  Maybe investors are appropriately skeptical about the innovation capacity of these companies and discounting management’s rosy projections about sustainable profitability and growth potential.

For those who are interested in understanding recent trends in share repurchases and their financial consequences, Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital Management, has recently released a great report on “Clear Thinking about Share Repurchase".

What’s the bottom line here?  Simple – a growing number of US companies have reached a point where short-term cash generation exceeds their innovation capacity.  In the short-term, they are doing the right thing – giving cash back to shareholders and relying on them to find more attractive places to invest their funds.  But in the long-term, this is a formula for shrinking the business.  Senior management teams have got to find ways to unlock the innovation potential that resides in all their companies.  If they don’t, they will find recent cost-savings competed away, cash flows eroding and shareholder value shrinking.

Consumer Electronics Show – in Shanghai?

I have real affection for the Consumer Electronics Show held every January in Las Vegas. I have attended it off and on since 1982 when I first made the trek as an executive at Atari.  Unfortunately, this year I was not among the 130,000 people who descended on the city for the show.  Watching from afar, I was struck by what was not covered as much as by what was covered.  The media paid lots of attention to the keynotes by tech leaders and gave lots of coverage of the latest gadgets.

One thing that the media failed to cover was the continuing shift in production and design of more and more of consumer electronics devices to Taiwan and mainland China. It would have been interesting to do an analysis of how many of the products on display in Las Vegas were manufactured in Taiwan or mainland China and then to determine how many of these products were also designed in those countries.

A good news hook for the story might have been the recent announcement that “China has replaced America as the world’s largest exporter of IT goods” according to new figures released by the OECD.  Actually, this happened in 2004, but it was just reported last month. Also, the statistic applies to all IT goods, not just consumer electronics. 

OK, I know all the objections.  Most of China’s exports are in low-end IT products.  A lot of the exports are sub-systems and components that get integrated into IT devices sold by US companies.

Granted.  But those of you who read my writings know that my focus is not on the snapshot.  My focus instead is on the trajectory and relative pace of change. This is what the Economist had to say about the dynamics:

Given China’s importance as a centre of low-cost manufacturing, its rise as an industrial power in technology goods is hardly surprising. What is startling is the speed of its ascent. From $36 billion in 1996, its world trade in tech goods – both imports and exports – has grown as much as 32% a year, to reach $329 billion in 2004.

China’s rising share of the market has been matched by a fall in the dominance of America – which invented the electronic computer and transistor that launched the digital era.

The contrast would be even starker if we focused on consumer electronics where the relative competitor would have been Japan.  China surpassed Japan as a global exporter of IT goods even earlier – in 2003. The impact of China’s competition with Japan was aptly summarized in a Financial Times editorial (registration required) last November 22 headlined “Threat of oblivion in consumer electronics: Japan’s once invincible giants are fighting a losing battle.”  The editorial observed:

How the mighty have fallen.  Two decades after Japan’s once invincible consumer electronics industry consigned most western competitors to the graveyard, it too is fighting to avoid oblivion – and for many of the same reasons.

Pioneer yesterday became the latest company to be forced into emergency restructuring after plunging into heavy loss, following Sony and Sanyo.  Others, such as JVC, Toshiba and NEC are struggling.  So poor is the industry’s health that Japanese media have started publishing league tables of the companies most likely to go bankrupt.

The main cause of the industry’s woes are Chinese competition and the switch from analogue to digital technology. . . . .

Of course, if the reporters wanted to take an even broader lens, they might have also built upon the news that broke in late December indicating that China’s economy was actually bigger than previously believed.  The New York Times ran an article (purchase required) on December 21, 2005 headlined “That Blur? It’s China Moving Up In the Pack.”  The reporters suggested that:

With China’s announcement on Tuesday that its economy was considerably bigger than previously estimated, economists and financial prognosticators are scrambling to rethink their assessment of China’s rise and its role on the world stage.  China’s new figures suggest that it probably has passed France, Italy and Britain to become the world’s fourth-largest economy.

Some economists are even accelerating their timetables for when China may eclipse the United States as the world’s biggest economy.  With the new figures offering a more expansive view of economic activity, some said China could overtake the United States as early as 2035, at least five years earlier than previous projections.

Now that would have been a story with global dimensions from CES.  Add it all up and I expect that we may not see CES in Las Vegas that much longer.  Any bets on when it will move to Shanghai?

B2B – Back to Bangalore

In Silicon Valley, B2B is back with a vengeance, only now it stands for something else – Back to Bangalore (we also have a new version of B2C – Back to China, but that’s another story).

Saritha Rai wrote an article titled "Indians Find They Can, Indeed, Go Home Again" (purchase required) for the New York Times over the holidays (January 26, 2005) that did a nice job of discussing this trend. She reports that:

Nasscom, a trade group of Indian outsourcing companies, estimates that 30,000 technology professionals have moved back in the last 18 months.  Bangalore, Hyderabad and the suburbs of Delhi are becoming magnets for an influx of Indians, who are the top-earning ethnic group in the United States.  These cities, with their Western-style work environment, generous paychecks and quick career jumps, offer the returnees what, until now, they could only get in places like Palo Alto and Boston.

30,000 in the past 18 months! That’s a lot of movement.  I have been looking for statistics on this reverse migration (comments would be appreciated from anyone who has seen more systematic views of inflows and outflows over time of Indian technology professionals in the US).  Anecdotally, I have to tell you that this is becoming a significant trend – and it is not just low level engineers, but some of the best and brightest of technology architects and entrepreneurs. Rai quotes one of the returnees:

“When I left India 25 years ago, everybody was headed to the United States,” said Mr. [Ajay] Kela, who pursued a Ph.D. at the University of Rochester and stayed two decades, working for companies like General Electric and AutoDesk.  For India’s best and brightest, a technology or engineering career was an irresistible draw to the United States, even until four or five years ago.  “But now they all want to get on the plane home,” said Mr. Kela, who returned with his wife and two children.

Now, to be fair, not all of these returning Indians are leaving U.S. companies. Rai does a good job of illustrating the range of opportunities to return to India through her profiles of the Indians on a street of Palm Meadows, a residential community outside Bangalore:

One of his neighbors recently returned to India from Cupertino, Calif., to run a technology start-up funded by the venture capital firm Kleiner, Perkins, Caufield & Byers. Across the street from Mr. Kela [who returned from Foster City, Calif., and is president of Symphony Services, an outsourcing firm based in Palo Alto], is another Indian executive, this one from Fremont, Calif., who works with the outsourcing firm Infosys Technologies. On the other side is the top executive of Cisco Systems in India, who returned here after decades in the Bay Area and New York.

As a denizen of Silicon Valley, I can’t help but notice that these returnees have all left Silicon Valley.  Many are still working for American companies, at least for now – that’s the good news. The bad news is that this is a significant loss for Silicon Valley as a geographic location for innovation, especially if their departures are not matched by arrivals of equally talented Indians.

I know, geography is not supposed to matter any more in this flat world.  As I wrote in an earlier posting on "The World Is Spiky", I think this is only part of the story.  I worry about the future of Silicon Valley as a spike aggregating talent on a global scale and creating an incredibly rich environment for innovation, learning and capability building.

Make no mistake about it, the entrepreneurial success of Silicon Valley in the past has depended heavily on the technical and entrepreneurial talent of immigrants from Asia – as anyone can see by walking into a meeting room of a Silicon Valley start-up and looking around the room.

If we lose our ability to attract and retain the best talent from around the world, I believe that our ability to innovate and to get better faster will suffer as a consequence, even with high bandwidth connections to Bangalore and other ecosystems across the globe.  Spikes still matter, big time.  I will go further and suggest that, in a world of accelerating change, spikes matter more than ever.  We lose sight of this at our own peril.

Detroit – The Pressure Mounts

There was little holiday cheer in Detroit this year as US manufacturers announced significant layoffs in response to intensifying competition. As I discussed in an earlier posting, the most depressing aspect of this drama (or, more appropriately, tragedy) is that the US manufacturers show limited understanding of the real obstacles to competitive success in a globalizing economy. These companies have made some improvements, but they have been unable to break out of continuing pressure on market share and market capitalization performance.

The McKinsey Global Institute has just published an in-depth report on "Increasing Global Competition and Labor Productivity: Lessons from the US Automotive Industry"(Executive Summary pdf). Although the report only covers trends in the auto industry up to 2002, it yields some interesting insight into the drivers of competitive performance. In particular, it highlights the role of process innovation in driving labor productivity in the US auto industry.  It turns out, on this dimension, US auto manufacturers have done quite well, at least relative to the rest of US business and even relative to "transplants" – non-US auto companies with US manufacturing operations.  Over the period 1987-2002, labor productivity for US auto companies grew more than 50% faster than the rest of the non-farm business sector in the US.

This productivity growth stemmed from a number of factors, but the most significant one by far was process innovation – specifically, the adoption and deployment of lean manufacturing techniques pioneered by Japanese car companies. The report is clear that process innovation alone is not sufficient – capability building is the key to significant productivity improvement:

. . . we show that far more important to overall sector productivity than the innovations themselves are companies’ capabilities in rolling out process innovations company wide and product innovations into the market.  It is the widespread diffusion of innovations that drives significant improvements in industry productivity rather than innovation itself.

US auto companies differed significantly in their pace of capability building, in part shaped by their perception of threat:

The weaker the company’s financial position at the outset, the more keenly it felt the competitive threat, and the faster and more comprehensive its response.  Ford’s serious financial troubles after the 1981-82 recession had prompted it to focus on lean production before 1987, while the more financially comfortable GM did not see the need for process transformation until 1992, when the Gulf War recession hit its performance.

One problem with the MGI report is that it tends to focus on process innovations within the enterprise rather than across enterprises, especially in the supplier networks.  It is in this area that US auto companies still fall very short relative to their Japanese competitors.

This challenge was particularly highlighted in an article on “Building Deep Supplier Relationships” (purchase required) by Jeffrey Liker and Thomas Choi in the December 2004 issue of Harvard Business Review. The authors draw a compelling contrast between the way US auto manufacturers continue to treat their suppliers with the way Toyota and Honda build long-term supplier relationships. These Japanese manufacturers have successfully transported this approach to relationship building to their US manufacturing plants dealing with US suppliers, refuting the view that differences in these relationships are culturally determined.

In short, US auto manufacturers continue to squeeze their suppliers for short-term cost-savings, generating an adversarial relationship that effectively precludes mutual understanding, collaborative innovation and shared learning.  In contrast, Toyota and Honda take a long-term perspective on relationship building, emphasizing the opportunity for all parties to get better faster by working together:

To be successful, an extended lean enterprise must have leadership from the manufacturer, partnerships between the manufacturer and suppliers, a culture of continuous improvement, and joint learning among the companies in the supplier network. That’s what Toyota and Honda are ultimately trying to achieve through their remade-in-America keiretsu.

US auto manufacturers still have a lot to learn from the Japanese in managing supply networks, but that alone is not sufficient.  These companies should be striving to achieve competitive advantage, not just struggling to reach competitive parity.  So, what else can they do?

They could start by exploring more radical ways to restructure their firms.  An interesting article in Forbes on “The Fabless Car Company” (purchase required) suggests one option:

. . . another idea gaining speed would transform the industry more radically: give smaller contract manufacturers responsibility to build entire vehicles, like the Solstice. The big automakers, under this model, would do less automaking and more designing, engineering and marketing.

To some extent, this process has already been playing out within the auto industry as car manufacturers have handed off more and more of the sub-system manufacturing and assembly operations to their suppliers. But take this to its extreme: shed all manufacturing.  To use the terms of my broader perspective on unbundling the enterprise, get rid of the infrastructure management business.

This alone would not do the job, but it would force US auto executives to focus more tightly on potential sources of competitive advantage in design and marketing.  Once they do this, they might look to China and the evolution of its motorcycle industry for inspiration on how to organize broad networks of specialized suppliers to quickly come up with innovative product designs.  Chinese motorcycle assemblers are rapidly taking global share from Japanese motorcycle companies.  It is only a matter of time before these design process networks begin to emerge in the automotive industry.

Look, I know this is a stretch, but what’s the alternative?  Death by a thousand cuts? A desperate race to achieve competitive parity – made difficult, if not impossible, by a significant wage and benefits disadvantage? Maybe it is time to break the mold and come up with a new wave of process innovations that go well beyond the boundaries of a single enterprise.

Globalization and Diversity

It’s a new year – and a time to step back and reflect on some of the broader changes going on.  My writing has increasingly focused on the implications of globalization from an economic and business perspective, but globalization also has profound social and cultural implications. We should all be worried about the risk of economic protectionism halting the process of globalization, but there is also a risk of cultural protectionism.

Kwame Anthony Appiah, a professor at Princeton University, wrote an interesting article for the New York Times Magazine last Sunday on “The Case for Contamination.” (registration required)  No, the article is not about environmental pollution, but instead it is a thoughtful defense of globalization from a social and cultural perspective.

Appiah makes the case that we must develop a new cosmopolitanism. He rejects efforts of cultural preservationists to block cultural change shaped by the process of globalization:

If we want to preserve a wide range of human conditions because it allows free people the best chance to make their own lives, we can’t enforce diversity by trapping people within differences they long to escape. . .  Cultures are made of continuities and changes, and the identity of a society can survive through these changes.  Societies without change aren’t authentic; they’re just dead.

He is particularly scathing in his critique of efforts to preserve an “authentic” culture:

Talk of authenticity now just amounts to telling other people what they ought to value in their own traditions . . . Trying to find some primordially authentic culture can be like peeling an onion.  Traditional West African cloths arrived in the 19th century with the Javanese batiks sold, and often milled, by the Dutch.

Appiah recognizes that living cultures evolve:

Living cultures do not, in any case, evolve from purity into contamination; change is more a gradual transformation from one mixture to a new mixture, a process that usually takes place at some distance from rules and rulers, in the conversation that occur across cultural boundaries.  Such conversations are not so much about arguments and values as about the exchange of perspectives.

Appiah’s article reminded me of the perspectives of two friends of mine who have a lot to say about globalization and cultural diversity.  Tyler Cowen, a professor of economics at George Mason University has written Creative Destruction: How Globalization is Changing the World’s Cultures.  It is a great book focusing on the impact of trade on cultures. Tyler discusses an interesting paradox: as trade spreads, diversity tends to increase within a society, even as cultures become more like each other. Tyler observes that:

The observed increases in homogeneity and heterogeneity are two sides of the same coin, rather than opposing processes.  Trade, even when it supports choice and diverse achievement, homogenizes culture in the following sense: it gives individuals, regardless of their country, a similarly rich set of consumption opportunities.  It makes countries or societies “commonly diverse” as opposed to making them different from each other. . . . Cross-cultural trade does not eliminate difference altogether, but, rather, it liberates difference from the constraints of place. . . . Ironically, individuals become more diverse only when their societies become more alike.

Tyler embraces the value of cosmopolitanism and, in particular, the value judgment that “poorer societies should not be required to serve as diversity slaves” (italics his).  Citing Appiah among others, Tyler notes that “Third World writers have been some of the strongest proponents of a cosmopolitan multiculturalism.” Appiah also zeros in on the elitist assumptions of cultural protectionism:

Talk of cultural imperialism ‘structuring the consciousness’ of those in the periphery treats people . . . as blank slates on which global capitalism’s moving finger writes its message, leaving behind another cultural automaton as it moves on.  It is deeply condescending.  And it isn’t true.

Chandran Kukathas, a professor at the University of Utah, has written The Liberal Archipelago: A Theory of Diversity and Freedom.  Chandran’s insightful book on political philosophy is not explicitly about the processes of globalization, but it offers a creative approach to governing societies marked by significant diversity. If we accept Tyler’s observation that cross-cultural trade increases individual diversity within societies, then Chandran’s perspectives take on added importance. If we cannot effectively govern across this diversity, we risk violent conflict. Chandran wrestles with the challenges of creating appropriate principles for a free society marked by cultural diversity and group loyalties:

Liberalism is a doctrine about human freedom responding to a world of diversity and disagreement.  The solution it presents to the problems posed by diversity is not a theory of how the many can be made one, but of how the many can coexist – since many of the many do not wish to be a part of the one.  It advocates mutual toleration and thus peaceful coexistence.  A liberal regime is a regime of toleration.  It upholds norms of toleration not because it values autonomy but because it recognizes the importance of the fact that people think differently, see the world differently, and are inclined to live – or even think they must live – differently from the way others believe they should.  It upholds toleration because it respects liberty of conscience.  It upholds toleration by protecting freedom of association so people can live as they think they should – as conscience dictates.

Appiah, Cowen and Kukathas certainly have their own differences, but they  all focus on understanding social and cultural diversity and its implications for how we conduct our economic and political affairs. Business executives ignore these issues at their own peril.

To continue to benefit from the processes of globalization, we must resist both economic and cultural protectionism.  The most potent resistance to globalization will ultimately come from the convergence of these two forces. Rather than recognizing the value of flows of trade and ideas, these forces seek to preserve the status quo.  In the process, they foster a zero-sum view of the world – the gains of one party inevitably come at the expense of the losses of another party.

In contrast, we must strive to understand how the economic forces of globalization re-shape and strengthen diversity.  By adopting a more dynamic view of these forces, we can begin to see the potential for positive sum outcomes, where all benefit from enhanced access to resources and markets.  Static views of diversity inevitably build walls.  Dynamic views of diversity help us to see the pathways towards growth and expanding options, not only as firms, but as individuals.

Ready for Web 3.0?

Are we really ready for Web 3.0?  Phil Wainewright seems to think so.  In a series of postings here, here, here and here, he  argues that we are embarking on a transition to Web 3.0.

I have enormous respect for Phil, one of the most insightful analysts regarding software trends.  I am a loyal reader of both his Loosely Coupled and Software as Services blog. But, having participated in the discussion about the emergence of Web 2.0 here and here, I have to admit that I am a bit skeptical about rushing to announce the arrival of Web 3.0.

What Phil really seems to be talking about is the migration into the enterprise space of many of the technologies that are shaping Web 2.0 in the consumer arena. As Phil suggests, this is part of the broader “consumerization” of IT.  This is an important development and it is only in its earliest stages.

One significant barrier delaying deployment of these technologies is the cultural gap separating many of the early pioneers of Web 2.0 initiatives and enterprise CIOs. The pioneers of Web 2.0 generally view large enterprises as dinosaurs. Enterprise CIOs, if they are even aware of developments associated with Web 2.0, tend to dismiss them as marginal novelties with little relevance for “real” business. 

One of the few large enterprise CIOs to anticipate and act on Web 2.0 developments is JP Rangaswami, CIO of the global investment bank Dresdner Kleinwort Wasserstein. Phil has just returned from a gathering organized by JP to explore new principles of software architecture for the enterprise that he discusses here and here.

Phil believes the on-demand architectures that are re-shaping Web 2.0 consumer applications will have an even more profound impact on the enterprise marketplace:

Don’t be surprised, then, if Web 2.0 also turns out to be just a staging post on the way to a much more mature and durable Web 3.0 era. . . . As with any shift from one generation to the next, there’s plenty of scope for new leaders to emerge – and for established front-runners to stumble – in the battle for supremacy.

I take all that as a given, but I still resist categorizing this change as “Web 3.0” (I have even more trouble with Phil’s more recent efforts to label this change as “Enterprise 3.0” – by my count, enterprises have been through at least five or six major generations of technology shifts).

Phil is focusing on two related changes. First, the emergence of the traditional enterprise as a significant new customer set for the technologies that are shaping Web 2.0.  Second, and related to the first, an urgent need to define and deploy more sustainable business models. In particular, he has been hammering appropriately on the need to define other revenue models beyond advertising for the enterprise market. But these are not profound technology shifts.  These are marketing opportunities and business challenges created by Web 2.0 technology.

Certainly the building blocks in the form of XML, RSS and Ajax (among others) are all in place. Yes, a profound re-architecture of software applications will be required to effectively exploit these technologies in the enterprise market (a while back, Phil did a great riff on Same old Software, as a Service driving home this point), but there is still a profound re-architecture of software applications pending in the consumer space as well.

Bottom line, if you take the definition of Web 2.0 that I offered in a previous post – "Web 2.0 refers to an emerging network-centric platform to support distributed, collaborative and cumulative creation by its users" – the issues identified by Phil all fit comfortably within this definition. Phil is discussing with great insight how Web 2.0 will play out in the enterprise market, something that few others have even addressed – but he is not pointing to a new generation of foundation technology.

I have two reservations about Phil’s specific perspectives on the migration of these new technologies into the enterprise:

• Phil suggests that application services will be the most economically attractive layer in this new software architecture. I am more skeptical – these application services will certainly be profitable, but will they be scalable?  I suspect that most application services will address very profitable, but very small, niches. The real way to create scalable value in this new world will be to find out how to become someone else’s platform – in other words, to persuade others to develop services on top of one’s own services. Rather than thinking about software as a service, from my perspective, it will be much more productive and rewarding the re-conceive software as a platform, but that’s the topic for another posting.

• Phil doesn’t explicitly discuss the potential for service grids in his topology (although they might be implicitly covered in his notion of aggregation services).  JSB and I have written about service grids here (pdf) and here (abstract only, purchase required).  We continue to believe these will be a significant source of value creation, especially as Web 2.0 technologies disseminate into and across enterprises. Ensuring that services are reliable, secure and warranted will be critical – and more and more challenging as services get nested in more complex ways within other services.

Unbundling Time Warner

Having lived through decades of M&A in the media industry, we are now on the cusp of another major restructuring of the industry. The previous rounds of M&A focused on two objectives: vertical integration tying content businesses with major distribution channels and efforts to build scale by buying properties across different media types. It is becoming increasingly obvious that neither strategy works very well.

The battle by Carl Icahn and Bruce Wasserstein to mobilize investor support for a break-up of Time Warner is one early indicator of the coming restructuring. Icahn and Wasserstein want to break-up Time Warner into four separate companies – the AOL Internet business, Time Warner Cable, the print publishing business and the video and movie business. Yesterday, Steve Case joined Icahn and Wasserstein in advocating a break-up of Time Warner, indicating that he had proposed this move to Time Warner’s Board of Directors last July, shortly before resigning as a Director of Time Warner.  In a column in the Washington Post, Case indicated that:

Although I played a key role in bringing AOL and Time Warner together six years ago, it’s now my view that it would be best to "undo" the merger by splitting Time Warner into several independent companies and allowing AOL to set off on its own path.

At one level, Icahn, Wasserstein and Case have it right.  The earlier wave of M&A was largely driven by an assumption that physical distribution channels (e.g., broadcast or cable channels and movie theaters) were the key bottleneck in the media business.  If you didn’t own your own distribution channels or build sufficient scale to achieve greater negotiating power with distribution channels, the thinking went, your content businesses would be at a permanent disadvantage.  The growth of the Internet challenges this assumption at its core.

As the bandwidth of Internet connections, both wireline and wireless, steadily increases, physical distribution constraints erode rapidly.  But media companies face a different challenge and opportunity that could provide a basis for restructuring the media business. We are seeing content proliferate and a new bottleneck emerging: our attention. We each have only 24 hours of attention each day – no amount of technology innovation will change that basic fact of life. How we choose to allocate that attention among a growing array of options competing for our attention will determine who creates value and who destroys value. I have posted about the significance of this development in transforming brands.

This same development will also force a restructuring of the media industry.  Content will not be king – audiences will be king.  The largest media companies will restructure around specific audiences.  Several years ago, I used Martha Stewart as an early example of this new strategy. Martha Stewart has a very specific audience focus – homemakers – and she has built a new kind of media conglomerate consisting of media properties all focused on addressing the needs and interests of this one audience.  She has steadily expanded her share of mind of this audience and, increasingly, also her share of wallet (through direct marketing on her Internet properties and through her branded product offerings available in retail channels). Stewart is not alone in this – many celebrities (for example, Oprah Winfrey and Russell Simmons) have started to build media conglomerates targeted to specific audiences.

In contrast to Martha Stewart, I looked at Time Warner three years ago and offered the following advice (reproduced with a few minor edits):

• Divest the distribution business and retain the content business.

• Create audience segment business units to address specific audiences that are economically attractive and fit with some of Time Warner’s existing properties – some natural examples: business executives, sports enthusiasts and teen-agers.

• Assign content businesses to report to specific audience segment business units (e.g., Sports Illustrated would report to the sports enthusiast business unit) or establish content production businesses as shared services units (e.g., Warner Brothers movie studio) to support the targeted audience segments

• Build distinctive overarching audience-centric media brands aggressively

• Invest in businesses and skill sets to deepen database marketing capabilities

• Acquire businesses selectively to broaden share of attention and share of wallet within targeted audience segments and develop licensing relationships to access an even broader range of relevant resources to serve target audience segments.

That was three years ago.  My recommendations still stand, not only for Time Warner, but for the other four major US media companies – Disney (which actually would face the least amount of restructuring, given its traditional focus on parents with small children as a distinctive audience), NBC Universal, News Corporation and Viacom.

For these media conglomerates, this kind of restructuring would be the only viable option to the break-up championed by Icahn and Wasserstein. It would require a significant shift in mindset, organizational structure and skills. In the terms of my broader perspective on the unbundling of companies, these companies would need to morph from a portfolio of product commercialization businesses to a portfolio of customer relationship businesses. If successful, the specific content assets of these reconstructed companies would eventually become secondary. Their primary asset would be deep relationships built with individual members of specific audience segments. Companies targeting large audience segments could achieve significant scale by leveraging powerful network effects.

The alternative is simple: the managers of these unwieldy conglomerates should unbundle their product businesses. This would let the owners of the independent and focused content businesses develop the edge competencies that Umair Haque argues will be required to maximize the value of content assets in the networked media world. Their survival will depend upon it. If they don’t do it to themselves, impatient investors will do it for them.

Dubai – Global Talent Magnet

Dubai is not China or India.  Far from it.  In fact, in terms of population, it is entirely at the other end of the scale.  But, having just returned from a trip there, I came back with a growing sense that Dubai has an opportunity to become a much more significant player in the global economy.

Urgency

What Dubai has in common with China and India is a sense of urgency.  This urgency is deep and it is pervasive, starting at the top with Sheikh Mohammed bin Rashid al-Maktoum, Dubai’s crown prince and de facto leader of the country. Mohamed Ali Alabbar, the founder and chairman of Emaar, one of the leading real estate development companies in Dubai, provided an example of this urgency in a recent article:

This region is way behind all the regions of the world, except sub-Saharan Africa.  There’s no time to stop, the world is so advanced compared to us, we’ve been sleeping for so long.

Unlike many of its Arab neighbors, Dubai’s oil is going to run out soon, some time in the next 5 to 15 years. From the outset, Dubai has been serious about using its oil revenue to bootstrap its way into a much more diversified economy.  While Dubai can continue to prosper from the petroleum wealth of its neighbors, Dubai’s aspirations are much grander.  As grand as these aspirations are, Dubai has even greater potential.

Dubai, along with Abu Dhabi, is one of the most significant participants in the United Arab Emirates, a federation of Arab states along the Arabian Gulf.  The people of Dubai have historically been traders, successfully participating in both regional and global trade flows. Over the past 30 years, Dubai found innovative new ways to play the role of middleman. I spent quite a bit of time in Dubai almost 30 years ago and the transformation since then has been staggering.

The development of a vibrant tourist industry is the most apparent transformation. One source of urgency on this front involves the troubles further north in Beirut.  Thirty years ago, Beirut was a key tourist center for the Middle East.  Famed for its cosmopolitan atmosphere and wonderful climate, Beirut attracted affluent tourists from the rest of the Middle East as well as from Europe.  After the civil war broke out in Lebanon in the 1970’s, Dubai saw an opportunity to step into the vacuum and launched an ambitious program to establish itself as a major tourist destination. But Dubai had a limited window – as the civil war subsided (even if random car bombings continue to scare away more risk averse tourists), entrepreneurs were scrambling to re-establish Beirut as a regional pleasure center. With a less accommodating climate (temperatures in the summer average 104 degrees Farenheit), Dubai sought to compete with Beirut in terms of physical facilities.

The building boom

The construction boom playing out is awe-inspiring as Dubai seeks to establish itself as a combination Miami/Orlando (another analogy would be Las Vegas, but Dubai lacks the gambling) for tourists from Europe, Asia and Africa. Extraordinary resort complexes continue to rise along the beaches of Dubai. Hotels compete for opulence – the winner so far is the Burj al Arab, the world’s tallest hotel built on an artificial island and boasting a distinctive and eye-catching shape like a spinnaker filled with wind. The Burj al Arab bills itself as the world’s only seven-star hotel, with Rolls Royces and helicopters ready to ferry its guests to and from Dubai’s airport. Among many other hotel projects, plans are under way to build the Hydropolis, a large five star hotel completely under water in the Arabian Gulf.

Since beach real estate was relatively limited, Dubai addressed that natural constraint by launching massive programs to fill in land in the Arabian Gulf, initially in the shape of massive palm trees (the first – and smallest – of these covers an area of several square miles) and then in the shape of the world itself (I kid you not, The World is a major real estate development three miles off Dubai’s coast consisting of over three hundred man-made islands designed to mirror a map of the world – interested investors can buy an island in the shape of France or India). These developments will create almost 400 miles of new waterfront property to augment the 40 miles of natural beachfront. Hotels will occupy some of this new land, but an increasing amount of the land is being set aside for posh villas and apartments. Residential developments sell out almost as quickly as they are announced.

Dubai lacks much in the way of natural attractions other than desert (covering over 90% of the 1,517 square mile country), so it is building massive recreational facilities to keep its tourists entertained. Ian Parker’s fascinating article on “The Mirage: The Architectural Insanity of Dubai” in the October 17, 2005 issue of the New Yorker (the article itself does not appear to be online, but an audio slide show based on the article is available here) provides some sense of the scope of Dubai’s ambitious construction projects.

Modern shopping malls sprout up almost overnight, each one out-doing the previous ones in terms of scope and amenities. One of the newest, the Mall of the Emirates, boasts over 400 retailers and an indoor skiing facility (no, I am not kidding, it produces over 6,000 tons of snow), including a choice of five ski and snowboard runs, with the longest measuring 1,300 feet long with a 200 foot vertical drop, a black diamond run of 900 feet and a ski jump.

Offices are going up even more rapidly, with the foundations of the world’s tallest new building, the Burj Dubai, already in place (the final height of the building is a closely guarded secret, but it is expected to be on the order of one hundred and sixty stories). This contender for the tallest building will have an Armani-run hotel on the lower floors, about one hundred floors of apartments and fifty or more floors of office space above that. As one further sign of the urgency in Dubai, the crews on many construction projects work 24 hours a day, seven days per week.

Dubailand – Dubai’s competition to Disney World is under construction. Dubailand, of course, will be bigger.  Covering a one hundred square mile area, the five billion dollar Dubailand project will be three times the size of Manhattan.  When it is built out, Dubailand will include Eco-Tourism World, Sports & Outdoor World, Auction World, Virtual Games World and Themed Leisure & Vacation World.  It will include replicas of the Eiffel Tower (70 feet taller than the original), the Taj Mahal (150 percent bigger than the original) and other major attractions

A vibrant night club scene with hundreds of night clubs featuring a bewildering array of world music from reggae and salsa to hip hop and bhangra attracts some of the hottest DJ’s from around the world, keeping tourists entertained until late at night. In this context, the Las Vegas analogy becomes more appropriate – a vast entertainment complex is arising out of the desert.

Insourcing human capital

But the physical facilities, as impressive as they might be, aren’t the most interesting aspect of Dubai’s tourism play.  It’s the human capital that Dubai has mobilized to support this initiative.  Just the construction projects alone require more people than Dubai has (there are only about 120,000 citizens of Dubai), so Dubai imports construction workers by the hundreds of thousands from a broad range of countries, especially India and Pakistan. In fact, over 80% of Dubai’s population consists of expatriates from over 160 countries.  About 200,000 of these expatriates provide a diversified managerial class for many of Dubai’s commercial enterprises. Unlike many other countries where immigrants are resented as potential competitors for jobs, Dubaians recognize that they cannot realize their ambitions without lots of foreign labor.

Richard Florida in his book The Flight of the Creative Class reports one study showing that Dubai leads global cities in the proportion of foreign born population to native born population.  Even more significantly, Dubai ranks third in the world on Richard Florida’s Mosaic Index, measuring immigrant population diversity.

In staffing its hotels and entertainment facilities, Dubai has taken a very targeted approach to attracting appropriate talent.  Tourists could spend weeks in Dubai without ever meeting a native of Dubai.  The hotels are largely staffed by people imported from countries known for their hospitality, including Thailand, the Philippines and Indonesia. Tourists venturing out into the desert for a camel ride are apt to find that the “Bedouin tribesman” tending to the camel is actually an immigrant from Tunisia. In effect, Dubai has become a new kind of tourism middleman – it attracts tourists from around the world and serves them in great style with highly trained hospitality staff also imported from around the world. This strategy is paying off – the World Tourism Organization recently declared Dubai to be the fastest growing tourism destination on earth.

Expanding the role of middleman

In commercial activity, Dubai has also capitalized on its role as a middleman, spawning a growing financial services industry (it has created a free zone known as Dubai International Financial Centre) and trading industry (it built the world’s largest man-made harbor in 1976 to expand its role in the shipping industry).  I wrote earlier this week about Dubai’s growing role as a global outsourcing provider of containerized port management services.

Building a global e-business hub in Dubai

Dubai also has aspirations in the e-commerce and Internet arena.  It is building Dubai Internet City in the hope of attracting and incubating a growing set of e-businesses.  It is in this area that Dubai’s aspirations fall short of its potential.  Dubai’s government and business leaders tend to talk about its opportunities in this area in terms of becoming a center of e-business for the Middle East.  Why stop here? Why not seek to become a center of e-business for the world by pursuing the same kind of human capital insourcing strategy that has driven its success in the tourism industry?

Given Dubai’s growing attraction as an entertainment and pleasure center, it could potentially attract techies from around the world to build entrepreneurial e-businesses targeting global markets.  With enterprise zones offering modern telecommunications infrastructure and office facilities along with the lure of no corporate or personal income tax, many Internet entrepreneurs might be willing to brave the summer heat to build promising e-businesses headquartered in Dubai and staffed with skilled techies imported from Eastern Europe and Asia.

Of course, potential tech immigrants would have to forego the pleasures of pornography and drugs (Dubaians tend to be pretty unforgiving about such vices, even though they are in general much more liberal than their Saudi neighbors).  Those with families might find it an attractive environment to raise their children and others might be enticed to come for a few years in search of interesting business and technology opportunities. Given the growing global shipping, trading, financial services and travel and leisure businesses being built in Dubai, there are ample opportunities to extend these business initiatives on the Internet.

Opportunities in global education

On a related note, Dubai has a similar opportunity to use its insourcing strategy to build out innovative educational businesses targeting faculty and students on a global scale.  By creatively using the Internet to extend its reach, Dubai could establish itself as a major educational destination for students from Asia and Africa as well as the rest of the Middle East to come for technical and professional training. It could then provide continuing learning services over the Internet after the students return to their home countries.  Once again, Dubai’s growing status as an entertainment and pleasure center might be helpful in attracting both faculty and students from around the world.

The bottom line

If they play their cards right, Dubai’s leaders could establish their country as much more than a tourism and trading center.  Harnessing the capabilities of global technology networks and an innovative insourcing strategy attracting talent from around the world, Dubai could become a global e-business and educational center as well.  Dubai’s leaders have the sense of urgency and the ability to think big in their construction projects.

The irony is that they just may not be thinking big enough.  The formula driving the success of their tourist industry is much more robust than they realize.  The tourism industry could serve as a powerful bootstrapping device to position Dubai as a global talent magnet. Sure, it is hot in Dubai but, with some creative promotion, business investment could get a lot hotter – and it is tax free.

Private Equity and Offshoring

Buried on page 22 of the Financial Times today is a brief news item announcing that Michael Marks, the outgoing CEO of Flextronics, is joining Kohlberg, Kravis and Roberts.  Marks was a key architect of the aggressive move by Flextronics, one of the world’s leading contract manufacturers for the high tech industry, into China and India.

This is a significant signal regarding the growing interest of private equity firms in the offshoring market.  Private equity firms look for situations where companies are slow to restructure their operations in response to intensifying competitive pressure.  Many Western companies have been slow to exploit the potential created by offshoring, both to reduce cost and, more importantly, to participate in skill-building arbitrage.

Private equity firms see a substantial opportunity to accelerate this process. They can take companies private that are under-performing, re-structure them by stripping out operations that can be better performed offshore and then take the company public at a much higher valuation. There is a key message to senior executives – if you don’t move aggressively to take advantage of offshoring opportunities, private equity firms may step in to do it for you.