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Blindness to the Deep Structures of Globalization

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Alan Blinder is undeniably a smart guy, but that makes his recent pronouncements on offshoring even more revealing.  While seeing some of the surface elements in play, Blinder is blind to the deeper structures playing out in globalization.

Blinder is a prominent economist at Princeton University and former Vice Chairman of the Federal Reserve.  When he speaks, policy makers listen, especially as the next election season approaches.  Blinder made the front page of the Wall Street Journal earlier this week when he expressed growing concern about the implications for the US economy of massive job shifts overseas. Blinder remains a committed supporter of free trade policy, but he is making headlines both in terms of his estimates on the magnitude of potential job shifts associated with offshoring and his suggestions regarding public policies for coping with the dislocations caused by these job shifts.

In the WSJ article entitled "Pain From Free Trade Spurs Second Thoughts" (registration required), Blinder estimates as many as 40 million US jobs are vulnerable to moving offshore over the next two decades.  While many are labeling him as an “alarmist” on this front, I actually think he may be too conservative in terms of long-term impact, as I have discussed at length here, because he assumes that service jobs requiring personal, face to face contact will not be vulnerable to offshoring.  Blinder is careful to stress he is taking a long-term view extending over one to two decades.

The article quotes Diana Farrell of the McKinsey Global Institute as one who believes that these numbers are far too high. Part of the difference in perspective may have to do with semantics as well as time frames.  Blinder is focused on “vulnerability” – as I read him, he is not predicting that these jobs will necessarily move offshore, but merely suggesting that these jobs could be performed offshore.  MGI’s work in this area is much more focused on potential labor supply constraints in offshore locations in the short-term and projects much more limited impact from offshoring.  Nevertheless, as I have also written, while I have enormous respect for the work that the MGI is doing, I believe that the MGI estimates on this front are too conservative.

Both perspectives are much too static in their view of potential job movements.  They rely on the infamous ceteris paribus qualification – i.e., all other things being equal.  Of course, other things are never equal and the dynamics in competitive strategies and talent development initiatives could shift the actual movement of jobs significantly in one direction or another.

On an even deeper level, this debate about job shifts tends to reinforce a “zero sum” mindset – if offshore locations gain a job, onshore locations lose the job.  Under the terms of this debate, the only question is how many jobs are gained or lost. For reasons discussed below, we are moving to institutional architectures that support positive sum outcomes where growth of overall economic value dampens debates over distribution of jobs.

Rather than getting bogged down in a numbers debate, though, I want to focus on the other dimension of the Blinder perspective highlighted by the WSJ article. Expressing concern over “the vast and unsettling adjustments in the way Americans and residents of other developed countries work, live and educate their children,” Blinder urges a much more active role for the US government in helping to dampen the disruptive effects of these job movements.

So, what is he recommending? Well, the article focuses on two things. First,

Mr. Blinder says there’s an urgent need to retool America’s educational system so it trains young people for jobs likely to remain in the US.  Just telling them to go to college to compete in the global economy is insufficient. . . . It isn’t how many years one spends in school that will matter, he says, it’s choosing to learn the skills for jobs that cannot easily be delivered electronically from afar.

This is where Blinder reveals his blindness to the deep structures reshaping the global business landscape.  As JSB and I have written in our “From Push to Pull” working paper, we are in the early stages of a fundamental shift in institutional architectures from push programs to pull platforms.  The offshoring trend needs to be understood within this broader context.  We are moving from a world where demand can be forecast and resources “pushed” to the right place at the right time to a world where we need to flexibly “pull” resources wherever they reside when they are needed.

Our business institutions over the past centuries have focused on scaling push programs.  Toyota and other pioneers of lean manufacturing “pull” systems have more recently begun to pursue limited pull approaches among a limited number of business partners.  The next wave of innovation will focus on the development and deployment of pull platforms across a very large number of institutions.  These pull platforms will not only transform business institutions, but other forms of institutions as well.

Traditional educational institutions represent classic examples of push programs.  We project far in advance what students should learn and then develop curricula and programs to push that knowledge at the appropriate time. Just like the push programs in business, that model is now coming apart at the seams.

Blinder appears to believe that he can project into the future what skills our educational systems should seek to impart so that students need not worry about their jobs moving offshore.  There are two problems with this.  First of all, it writes off entire swaths of the economy and concedes those to offshore providers.  Second, it assumes that there is a stable and predictable set of skills that we can keep onshore.  Leaving aside such uninteresting examples as snow removal, pizza delivery and dry cleaning services (which certainly do not require that much school anyway), I certainly do not pretend to know what skills will drive success ten to twenty years from now.

We are moving into a world where such long-term forecasting becomes an exercise in folly.  What if we gave up this push mindset and instead focused on crafting a set of institutions and platforms that made it possible for people to accelerate learning on demand?

This is a massive undertaking to be sure and it starts with a fundamental shift in mindsets.  But the good news is that we have the blessing of time.  For reasons developed by the MGI report mentioned earlier, these job shifts, if they ever happen, are not going to occur overnight. On the other hand, we also have the curse of time.  If we cling to old push mindsets and refocus our educational institutions based on some long-term forecast of job shifts, we may find at the end of this lengthy undertaking that we have seriously missed both opportunities and challenges.

In the meantime, we will lull ourselves into a false sense of complacency that the “problem” is being fixed.  The problem is not that jobs are vulnerable; the problem is that we have not developed the institutions required to accelerate talent development so that we can continue to push the performance envelope of the jobs we perform.  We need to move from a static view of jobs and the skills required to perform them to a dynamic view of talent development.

The same concern applies to Blinder’s other major public policy recommendation:

Similarly, [Blinder] says any changes to the tax code should encourage employers to create jobs that are harder to perform overseas. . . . Mr. Blinder says the focus should be on jobs with person-to-person contact, regardless of pay and skill levels – from child daycare to physicians.

Once again, Blinder is a prisoner of the push mindset – all we need to do is forecast demand for job categories and adjust fiscal policies accordingly to push employers to create these jobs. Blinder simply does not see the deeper structures that require us to re-think public policy at a much more fundamental level.

Many forces are driving the shift from push programs to pull platforms, including technology innovation and public policy shifts that systematically reduce barriers to entry and barriers to movement. As we discuss in our working paper, pull platforms are much more effective in supporting innovation, learning and talent development.  For this reason, they help to move us from a world of diminishing returns to a world of increasing returns.

The greatest risk is that we remain wedded to push programs that demand accurate forecasting in world markets characterized by increasing uncertainty and accelerating change.  The inevitable forecasting failures will indeed produce severe economic dislocations and significantly increase the risk of a profound backlash that will once again raise barriers to movement across national boundaries. We will then be back in the nasty zero sum world where one country’s gain inevitably becomes another country’s loss.

As I have suggested before, the globalization process is a fragile one, and far from inevitable. If we do not challenge our traditional mindsets, we significantly increase the likelihood that globalization will be reversed.

Community 2.0

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It has been ten years since I wrote Net Gain and many people have asked me what my current view is on the economic opportunities associated with virtual communities.

Well, a couple of weeks ago I had the pleasure of delivering the opening keynote presentation at the Community 2.0 conference held in Las Vegas.  It provided me with a long awaited opportunity to re-visit in a public forum the topic of virtual communities.  Given the growing interest in this topic, I thought I would polish up my speaker’s notes and share this perspective with a broader audience.

I am deeply encouraged about the commercial prospects for virtual community.  When I published Net Gain ten years ago, it unleashed a huge wave of investment – there was a period in 1998 when virtually every business plan submitted to VCs in Silicon Valley claimed to be establishing a virtual community.

Of course, few of these ventures were actually virtual communities and even fewer had any real understanding of what was required to build sustainable virtual communities. As a result, much of this investment was wasted, consistent with the broader pattern of the dot com bubble. An inevitable backlash set in – virtual community became a suspect term.  Lots of interesting initiatives continued to be pursued under the radar screen without much publicity or visibility, but helping to build skill sets, experience and performance results.

Then something interesting happened.  Over the past 6 – 12 months I have received a growing number of calls from senior executives from large, blue chip companies saying, “Remember that book Net Gain? We’d like you to come back and talk to us about it.” So, at least a personal barometer suggests a major climate change.

Challenges in building virtual communities

In reflecting on the experiences accumulated to date by companies seeking to build virtual communities, I’d like to focus on four challenges:

First Challenge – Language. What are we talking about when we use the term "virtual community"?  During the last big wave of investment in virtual communities, the term was used so loosely that it lost all meaning.  Let me offer my own definition of virtual community so that you will at least know what I mean by the term.  For me, virtual community involves:

• establishing connections on electronic networksamong people with common needs

• so that they can engage in shared discussions

• that persist and accumulate over time

• leading to complex webs of personal relationships and an increasing sense of identification with the overall community

The key elements of virtual community, therefore, are shared discussions, shared relationships and shared identity.  Now, these may seem arbitrary but, as I’ll discuss below, they contribute to building shared meaning, shared trust and shared motivation in ways that are distinctive and responsive to the growing needs among participants.

These elements also help to distinguish virtual communities from a variety of other Internet enterprises:

• Social networks – focus on identity creation and connection with friends, but lack the same degree of shared discussions and shared identity as VCs

• Electronic markets – primary focus on transactions rather than relationships

• Content aggregation sites – display and access interesting content but limited focus on shared discussions and shared relationships

Virtual communities inexorably seek to extend their interactions into physical space and a complex interweaving of physical and virtual communities occurs over time.  This will become even richer and more powerful as presence and mobility technologies enhance abilities to connect anytime and anywhere, either in physical or virtual space or blends of the two.  Similarly, virtual communities as economic enterprises represent a complex interweaving of social and commercial dimensions.

Second challenge – Integrating diverse skill sets.  Three distinct skill sets (and cultures) must come together to create a successful virtual community:

• Content – effectively integrating published content with contributed content, making it easily accessible

• Social interactions – catalyzing and sustaining rewarding interactions among participants in ways that promote the creation of enduring relationships

• Economic business models – establishing rewarding and sustainable economics to support the growth of virtual communities

Almost every virtual community starts with deep spike in one of these three areas but has difficulty striking right balance with other two areas, leading it to stall rather than scale.

Third challenge – Shifting mindsets.  This is especially a problem for large companies seeking to organize virtual communities.  They must navigate through three major mindset shifts:

• Participant focus vs. vendor/sponsor focus – most companies spend a lot of time on what they want to accomplish with virtual communities but much less time focusing on what participants might want to accomplish   

• Long-term value creation focus vs. short-term “get rich quick” focus – of course, commercial viability is essential for businesses, but the time frames are critical – with a short-term time frame, commerce becomes corrosive of community, but with a longer term time frame, commerce and community powerfully reinforce each other

• Bottom up emergent organization vs. top down imposed organization – executives fear loss of control but fail to understand the potential to shape and influence

As with most things in life, there is a balance that needs to be established, but most companies tend to bring mindsets from traditional businesses that are corrosive to community

Fourth challenge – Organizational barriers. These occur at three levels:

• Structure – who’s accountable? Do they have the status and influence required to mobilize appropriate resources? Are they too narrowly focused in terms of interests (e.g., marketing vs. customer support vs. product development)?

• Systems – what is measured/rewarded? How will a company define success? What are relevant operational metrics? Are there systematic reviews to enhance performance?

• Skills – who has relevant experience?  This is challenging – the most critical skills sets such as discussion moderation and discussion archiving are in very short supply. Mindsets and measurement systems often don’t even reveal the need for specific skill sets

So, there are four big challenges to building successful virtual communities. But there’s an even greater set of opportunities that make me optimistic about the potential for virtual communities.

Opportunities for virtual communities

Companies need virtual communities in order to successfully respond to growing pressure on performance coming from two directions simultaneously – customers and talent. We all know the story about customers gaining more power and how the Internet is enhancing and accelerating this.

The talent story is a little less well known and yet it is increasingly relevant to the virtual community opportunity. Two forces are coming together to increase the bargaining power of talent:

• Talent is becoming increasingly valuable to companies. The basis of competition is shifting from structural and physical asset advantages to advantages based on intangible assets – intellectual property, networks and brand – all of these hinge on talent. On top of this, intensifying competitive pressure driven in part by growing customer power is making talent more central to sustained value creation

• At the same time, talent has more options available than ever before. The Internet provides greater visibility on alternative employers. Employees have more mobility – both geographically and institutionally. Talent has more opportunities to strike out on its own and continue to create value as an independent contractor.

Companies can respond to this growing bargaining power by paying talent more money, but a more powerful and sustainable approach is to provide institutional environments that accelerate talent development, including enhanced opportunity to connect into talent pools that extend beyond the enterprise.

Shifting performance metrics

Dealing with the growing profit squeeze from customers and talent requires a shift from conventional measures of business performance to a new set of metrics. To make it easy, I keep the same acronyms – ROA, ROI and ROS – but just attach different meanings. These metrics will increase the importance of virtual communities but they also make it imperative for community organizers to rigorously monitor these metrics in their own operations.

ROA – Return on Attention
This performance measure is driven by the proliferation of options available to us in all domains of our life, increasing the relative scarcity of an increasingly valuable resource – our attention.  ROA must be measured both from a participant and organizer perspective.

The key question for community participants is: Of the total attention I allocate to this particular source, what is the productivity of that attention in terms of value received for effort and time invested?  There’s a related question: How much attention do I receive from other participants and how much value do I derive from that attention?

The key question for community organizers is: How much effort and resource is required to gain attention from participants and how much value am I able to generate from that attention over what period of time? Virtual communities demonstrate compelling economics in terms of reducing cost to attract attention, leveraging resources of others to deliver value in return for attention and retaining attention for longer periods.  The power of communities in these domains is well documented, although I am struck by how few companies track these metrics on an ongoing basis.

Virtual communities can be particularly powerful in delivering ROA – enhancing serendipity rather than just search.  This is the highest form of ROA – finding highly valuable resources that I didn’t even know existed or were relevant to me. In this context, one of the biggest missed opportunities in virtual communities is to archive, edit and organize participant contributions. It is the most valuable asset of the community but often the most difficult to access. In this context, I recommend that everyone study Peter Morville’s Ambient Findability a book that I have blogged about here.  Here are two key takeaways: usability presumes findability and findability leads to fundability.

In thinking about ROA, beware of framing the opportunity solely as one to one marketing or personalization. From a one to one marketing perspective, nirvana is one vendor connecting with each individual customer in a walled garden. In contrast, the real opportunity is to help connect customers with a growing array of resources, including each other, in environments that maximize relevance. This expanded choice can be exhausting, but virtual communities can help filter and present relevant choices.

This is one challenge that vendors face in sponsoring virtual communities. Most participants want to find the full range of resources relevant to them, regardless of vendors, so third party sponsors may be best positioned to offer greater ROA because they have less incentive to restrict options.

ROI – Return on Information
In this context, I emphasize information in the form of participant profiles – participant backgrounds, interests, activities and relationships.  Again, ROI needs to be evaluated from both a participant and an organizer perspective.

From a participant perspective, the key question is:  How much information about myself and my needs have I provided, how much effort did it require and, relative to both of these, how much value have I received in return from the information provided?

From an organizer perspective, the question becomes: How much effort and cost did I invest in acquiring information about individual participant and how much value have I been able to generate in return, both for the participant and for me? I am struck by how few community organizers explicitly focus on leveraging the profiles of their community members – they accumulate large amounts of information but invest little time in leveraging.

Some of the specific questions this metrics leads to:

• Are we fully utilizing the information we already have about participants in terms of delivering value back to them?

• What more can we do to learn about participants and their needs by watching their interactions? (We all know the drawbacks of lengthy registration forms.)

• How can we be more helpful to participants through recommendations of resources based on prior behavior? This ties back to serendipity in return on attention.

• How can we shorten the time between information collection and value delivery?

ROS – Return on Skills
This more accurately should be return on talent, but I find it hard to get executives excited about maximizing ROT. Besides, ROS has better symmetry with ROA and ROI.

As before, we need to measure ROS from the perspective of both participants and organizers.

For participants, the key question is: given the amount of effort I devote to participation, how rapidly am I improving my ability to deliver value to the people that matter the most to me?  This could be either through development of my skills or amplifying the value of my skills through social and structural capital available in the virtual community. Could I develop my skills even more rapidly by participating in other virtual communities or collaboration environments?

For organizers, the question is: am I able to attract and retain the most valuable contributors to this community?  What can I do to enhance the ability of these contributors to deliver greater value to the people that matter most to them?

Blurring of boundaries

These metrics will become more tightly integrated for virtual communities. Today, it is common to make a distinction between communities of interest and communities of practice. In communities of practice, people come together to generate joint work products as in open source software communities. I expect that we will see an increasing blurring of boundaries between these two types of communities for two sets of reasons:

• As pressure intensifies for people to deepen their skills and increase the value they deliver from those skills, they will tend to adopt their passions as their professions and seek out communities that enable them to accelerate their talent development while pursuing their passions. We see this very much in open source communities where talent development and reputation building are key motivations for participation

• As customers gain more power, they will want to become more deeply involved in the design, delivery and tailoring of products and services to meet their needs. This is also a prominent factor in open source software communities where many of the participants are users who want to tailor functionality to their specific needs.

Today, we also see communities emerging around all three of the core processes that define most enterprises – customer relationship management, supply chain management and product innovation and commercialization. These are relatively segmented now, but over time I anticipate that we will see a significant blurring of boundaries, especially driven by prosumer trends.  For example, customers will want to connect with other customers to learn about products, then get involved with product developers to tailor products and then want to track and perhaps reroute shipments of products, all in one integrated environment.

The Bottom Line Opportunity

In this context, the evolution of virtual communities will be a key catalyst in the shift from push programs to pull platforms that JSB and I have written about.  As we have written,

push programs treat people as passive consumers even when they are producers like workers on an assembly line. In contrast, pull platforms treat people as networked creators even when they are customers purchasing goods and service.  In this context, virtual communities have the potential to become kernels of massive pull platforms.

Across the business landscape, we are moving to more collaborative forms of commerce: collaboration marketing, creation nets and global process networks.  Virtual communities will become a powerful foundation for collaborative commerce on three levels:

• Connection – communities are not just helpful in finding people with relevant interests or capabilities, but help to foster broader and deeper trust-based relationships among these people.

• Conversation – by providing rich discussion environments for the sharing of common interests, virtual communities accelerate the building shared meaning

• Construction/creation – virtual communities can provide platforms, governance structures and tools for building jointly developed work products, as the open source software arena confirms.

In short, we are moving from a stage where virtual communities were largely associated with consumers and hobbies to a new stage of opportunity where communities become a rich environment for bringing people together to accelerate their talent development and deliver even more value to their relevant constituencies. In the process, the value creation potential of virtual communities will exponentially increase.

Unsafe Harbors for Viacom and Google

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The blogosphere has been engaged all week about the $1 billion Viacom suit against Google. Even for jaded media and technology executives, $1 billion can still get attention. Unfortunately, most of the commentary seems to be missing the real strategic point.

Watching the press releases fly back and forth between Viacom and Google, I am reminded of Kabuki theater – actors engaging in highly stylized and scripted movements.  Let’s acknowledge first of all that this lawsuit is largely a negotiating ploy applied by Viacom in an effort to extract more cash payments from Google for access to its copyrighted material. It is unlikely ever to reach the courtroom.

Most of the commentary in the blogosphere acknowledges this, but chooses to focus on the copyright issues raised by the lawsuit.  You can always trust copyright to get people on both sides of the debate to hit the keyboards.  Reason rapidly gives way to emotion as both sides insist that creative talent and innovation will wither away if their particular view of copyright is not upheld.  As Fred Wilson notes, copyright is not just a political issue, it has become a religious issue, calling forth all the fervor that theological debates can generate.

I take a somewhat jaundiced view of all this, although I will be the first to acknowledge that our intellectual property rights regimes need some serious re-thinking. Ultimately, I view this as a contractual, rather than a legislative, issue and I expect that appropriate contractual forms will emerge in response to shifting market forces. As Umair Haque notes, our current view of property rights “is based on an industrial-era understanding of economics that’s utterly obsolete.” Umair has a nice paper on “New Strategies for Property Rights” that outlines both the challenges and opportunities in this area.

Before moving beyond the copyright issues, though, I want to savor briefly the irony that the DMCA, a piece of legislation that represented a victory for copyright hawks, actually contained a few “safe harbors” that are now providing refuge for Google in its dispute with Viacom.  No doubt the copyright hawks will mobilize their lobbying forces to try to close these safe harbors, sooner rather than later.

Rather than getting distracted by copyright issues, I want to explore in a little more detail the strategic issues percolating beneath the current negotiations between Google and Viacom.  There is a very real possibility that Viacom may win the battle, at least in the sense of extracting more payments from Google for access to its content, but then go on to lose the war.

Justin Fox in a recent column notes that Sumner Redstone, the founder of Viacom, is credited with coining the phrase “content is king.”  This is a perspective that has long dominated the media industry, even though one can challenge whether it has ever been true. Certainly, the ability to extract more payments from Google will reinforce the belief that content still is king.

That would be a shame, because it would make it more difficult to focus on the real opportunities in the media business.  Don’t get me wrong – content, especially high quality content, will always have value.  But, on a relative basis, the opportunities for value creation are shifting.  As content proliferates, the ability to help audiences connect with content that matters the most to them will become the real sweet spot of the media industry.

As I have observed about companies more generally, media companies are an unnatural bundle of three very different kinds of businesses – product innovation and commercialization businesses, customer relationship businesses and infrastructure management businesses.  By proclaiming that content is king, Redstone plants himself firmly in the product innovation and commercialization business in terms of mindset, even though Viacom today is involved in all three of these business areas. 

All media companies are ultimately going to have to choose what business they are really in. If they choose to focus on content, or the product innovation and commercialization business, they will face increasing challenges in building a sustainable and scalable business.  I advise large media companies that, if they don’t want to shrink in size and profitability over time, they would be better off building out their customer relationship business and, over time, shedding the other two businesses.

From my experience, if you want to transition from a content business to customer relationship business in the media industry, you need to start focusing on content platforms.  In a traditional content business, you rely on professionals to deliver content that is meant to be experienced exactly as produced.  Content platforms still rely on professionals, but the role of professionals in a platform business is to catalyze further contributions by a growing range of third parties, including audience members.  A platform is meant to be built on and will rapidly evolve over time.  A product, once produced, never changes.

As I have written before:

Products are designed to be used on a standalone basis – you buy it and you view it or listen to it in the specific way the content creator intended.  Platforms are designed to be built upon – they create opportunities for the original creator, third parties or the customers themselves to extend, enhance and tailor the content in ways that the original creator never anticipated. Offered as a platform, content can create far more value than any equivalent standalone product.

What do content platforms include?  They may start with content produced by the platform owner, but that is just the beginning.  Content platforms point to other content and resources available anywhere on the net that are relevant to the focus of the platform – a key role of a content platform is to “curate” content, helping audience members to connect with high quality and relevant resources. Platforms also provide tools for participants to comment on and add to content that is already available – everything from tagging to discussion boards to content production tools.  In the process, they provide environments for complex webs of relationships to be built among people who share an interest in the content, whether they are participating in its production or simply experiencing it.

If done well, content platforms provide a natural transition to audience platforms.  It’s a subtle shift, but an important one.  In content platforms, the primary focus is still on the content.  In audience platforms, the primary focus is on understanding the needs and interests of a specific audience segment and using that understanding to help audience members increase their “return on attention”. 

This, by the way, is the challenge that YouTube faces.  YouTube in many respects is a rich content platform (although it is missing some key elements like pointing to content that is not available on YouTube and providing rich discussion environments that go beyond comment posting and tagging). The risk for content platforms over time is that they get pushed into the background, evolving as infrastructure management businesses, rather than becoming true customer relationship businesses – but that’s the focus for another blog.

In this respect, YouTube’s acquisition by Google is not helpful since Google is genetically very far from being a customer relationship business. If I had to predict, I would wager that YouTube ends up becoming an infrastructure management business – a powerful and scalable repository for video content that gets accessed by a growing array of customer relationship businesses that do a better job of tailoring video content (and integrating it with a broad array of other media) to address the needs of specific audience segments.

Without effective competition from large media companies on the customer relationship business front, Google is likely to become complacent and settle into what it knows best – infrastructure management business.  There’s nothing wrong with that, if it is an explicit choice with a clear understanding of the consequences.

So, here’s one risk for Viacom – by “winning” in this latest negotiating round with Google, it becomes even more deeply entrenched in the content business rather than taking more aggressive steps towards becoming a customer relationship business. Redstone should be careful to make sure that, if content is king, it is not King Louis XVI on the eve of the French Revolution.

But, there’s another, deeper risk as well.  Viacom’s suit reflects a mindset that is all too prevalent in executive boardrooms across all industries today.  For too many executives, existing stocks of knowledge represent the primary source of value – this is why they spend so much time on intellectual property protection and related issues like defending copyrights. It’s a problem because it inevitably focuses on defensive strategies – protecting what has already been created. 

In rapidly changing environments, the focus of value creation rapidly shifts from existing stocks of knowledge to effectively participating in diverse flows of new knowledge and rapidly learning from these flows. If you’re focused on defending what you already know, the chances are you will not devote adequate attention on strategies to learn more rapidly – or recognize that you need to share your existing intellectual property in order to participate in a broader range of flows. If Viacom “wins” this latest negotiating round, it will feel vindicated in focusing on the value of its existing properties and potentially feel less urgency about participating in, much less shaping, new flows.

Once again, the image of King Louis XVI comes to mind, sitting in his palace in Versailles nervously peering out the windows at the milling masses below, not quite sure what they are unhappy about, and giving orders to his attendants to make sure that the gates are firmly locked.  The media companies that shift away from defensive strategies to protect existing content and that find ways to engage audiences by increasing their return on attention will most likely navigate successfully through the turbulent times ahead.

Wasting Talent

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Corporations around the world face a systematic and sustained squeeze on profitability.  This squeeze comes from two different directions simultaneously – customers and talent.

Our performance measurement systems are woefully unprepared for this squeeze – indeed, the squeeze is occurring precisely because most managers are not measuring the levers that count for sustained profitability. We are saddled with accounting and measurement systems that measure last century’s drivers of profitability, not the drivers of twenty-first century profitability.

The need for new performance metrics

We all know about the growing power of customers, and I have written here about two new forms of performance measurement that will be required to respond to this growing power – return on attention (ROA) and return on information (ROI).  Few, if any, companies measure these new dimensions of performance.

Even fewer executives are focused on the growing power of talent.  Sure, just like all executives talk about how they are customer-focused, executives are quite comfortable giving speeches about how they value and develop talent within their companies. But, what do they measure? 

In terms of customers, how many companies have identified the 20% of their customer base that generates 80% of their profits?  And how many companies could tell you the turnover rate among this 20% of their customer base?

Similarly, most companies now have reasonably well established development programs for their top executive ranks, but how many systematically measure talent development throughout their organization?   I certainly don’t mean counting the number of training programs or even participants in training programs or any other activity based measurement.  I am talking about systematic measurement of results of talent development efforts. In this context, I suggest another performance measure that will become critical to corporate performance – return on skills (ROS).  (A more accurate label would be “return on talent”, but unfortunately I can’t energize executives around increasing ROT. Besides, I like the symmetry with the new measures of ROA and ROI mentioned earlier.)

What doesn’t get measured usually gets wasted, leading to an even more severe squeeze on profitability.  And that is certainly the case with talent in most Western companies. There’s a reason that Dilbert and “The Office” attract such a large and appreciative audience – talent throughout our organizations confront obstacles at every turn rather than operating in institutional environments that leverage and develop talent as a precious asset.

Perhaps this will soon change.  The bellweather for change surely must be the simultaneous publication of articles in the McKinsey Quarterly and Harvard Business Review exploring new metrics for performance regarding talent development.  Unfortunately, the articles also reveal some of the deep challenges in moving to new measurement approaches.

Defining talent

As is often the case, it starts with definitions.  What is talent?  For most Western companies, the term is often confined to senior executives or, in more expansive discussions, might include highly educated employees like “quants” in stock trading or physicians in medical care.  It rarely includes all employees.

For me, talent is ultimately about the ability to deliver superior value through one’s activities, whether it is the janitor or the CEO.  There are no caps to talent – no matter how good people are at what they do, there are infinite opportunities to deliver even more value. Talent is ultimately a function of human capital, intellectual capital, social capital and structural capital working together to amplify the value that can be delivered – again, whether we are talking about janitors or CEOs. Talent to some degree is about an individual’s knowledge and skills, but it ultimately hinges on the ability of the individual to leverage the resources of others as well – that is why social capital and structural capital is so critical to talent.

Talent is by definition scarce, as Azim Premji, the head of Wipro, recently reminded me. At another level, though, talent is becoming even scarcer relative to growing demand.  And people with talent are acquiring more bargaining power than ever, strengthening their ability to capture the value of their talent for themselves. The growing power of talent and the growing power of customers are intimately related as I noted here. I have written about the broader dynamics of talent scarcity here.

Aggregate ROS performance metrics

Lowell Bryan, in his McKinsey Quarterly article, “The New Metrics of Corporate Performance: Profit per Employee” (registration required) focuses on the growing importance of talent.  As the title suggests, he proposes that executives focus on “profit per employee” as a key metric of performance, observing that

. . . it’s time to recognize that financial performance increasingly comes from returns on talent, not on capital. . . . This shift in perspective would have far-reaching implications – for measuring performance, for evaluating executives, even for the way analysts measure corporate value.  Only if executives begin to look at performance in this new way will they change internal measurements of performance and thus motivate managers to make better economic decisions, particularly about spending on intangibles.

As Lowell points out, profits per employee as a measure has the strong virtue of simplicity.  It also makes it very easy to compare performance across public companies.  But, as Lowell indirectly acknowledges, it also has some drawbacks.  For example, companies can potentially increase profits per employee through automation and through outsourcing – initiatives that have little, if anything, to do with increasing the talent of the remaining employees. 

Of course, there is nothing wrong with these initiatives if they enhance overall profitability net of the cost of capital. Automation, outsourcing and other cost reducing initiatives have largely driven the performance of large American companies over the past couple of decades.  But, here’s the problem.  These are diminishing returns initiatives over time – cost reduction has a logical limit.  In contrast, talent development has some very powerful increasing returns dynamics – the more rapidly a firm develops talent, the more readily it can develop the next wave of talent. Unfortunately, Lowell’s measure cannot differentiate between people reduction measures and talent development measures.

One modest enhancement would help.  As I keep stressing, snapshots of performance are much less helpful, and often seriously misleading, relative to trajectories of performance.  By focusing on growth of profits per employee over time we might at least start to see whether this growth diminishes over time (reflecting the diminishing returns of people reduction measures) or whether it accelerates over time (suggesting real impact in terms of talent development). It would also help to better assess competitive dynamics – it provides a measure of relative pace of talent development, alerting executives to companies that may be increasing profits per employee at a more rapid rate.

Granular ROS performance metrics

The article in Harvard Business Review, “Maximizing Your Return on People” (purchase unfortunately required), takes a very different tack. Rejecting more conventional HR measures such as employee turnover rates or total hours of training provided, it proposes a complex scorecard of performance measures.  These performance measures cover a broad range of categories, ranging from leadership practices to learning capacity, and they rely heavily on surveys and subjective assessments of performance.  As a result, these measures cannot be used from the outside to compare performance across companies – they require access to employees who will complete the surveys. I also yearn for some more quantifiable measures that can help to benchmark performance more objectively.

While this approach helps to capture some of the qualitative dimensions of talent development, I worry that it creates too much complexity.  I am a strong believer in the philosophy of “closely watched numbers” – being very selective about the performance measures that matter on the belief that too many measures dilute focus. The authors do point out that the HR measures that matter the most will differ across and even within organizations, and will change over time, so there is an opportunity to focus on the sub-set of measures most relevant to performance.

In reflecting on both the McKinsey Quarterly article and the HBR article, I am also struck by how enterprise-centric these perspectives are.  There is little recognition in either article that much of the potential for talent development hinges upon building effective networks of relationships far beyond the walls of the enterprise, as JSB and I suggested in The Only Sustainable Edge. Of course, Lowell will reply that his measure of profits per employee indirectly captures this dimension along with everything else that contributes to return on skills.  That is both the strength and vulnerability of his measure – it captures everything but offers little assistance in highlighting the specific drivers of return on skills.

These two articles provide reassuring evidence that increasing attention will be paid to performance measures related to return on skills.  At the same time, these articles highlight that we are still at the earliest stages of identifying and developing appropriate measures for a critical dimension of corporate performance.

Some key ROS performance metrics

So, in the interim, what would I suggest as some early measures of drivers of return on skills?  Here are a few key numbers:

• Annual growth in profits per employee over a five year period, with particular attention to acceleration or deceleration patterns and pace of growth relative to key competitors

• Improvement in relevant output metrics for pivotal jobs – the job categories that have the greatest impact on overall corporate profitability and growth (e.g., utilization rates for refinery capacity to assess the talent of capacity planners)

• Attrition rates over time for the top 20% of performers in all functions of the company

• Qualitative assessment by the lead customers in your market and top performing suppliers of your industry of your firm’s ability to help accelerate their (not your) talent development.  (Not serving the lead customers or working with the top performing suppliers in your industry?  Well, that’s a warning sign.)

Bottom line:  Success in increasingly challenging global markets will require much more focus on talent-centric and customer-centric performance measures.  We are all familiar with ROS, ROA and ROI measures, but they need to take on a fundamentally different meaning as we confront a growing squeeze for more powerful customers and talent. We are only beginning to understand the implications of this shift.

Innovation and Talent in the Indian IT Industry

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NASSCOM, the Indian trade association for its rapidly growing IT enabled services industry, recently concluded its annual Leadership Forum, bringing together the leaders of this industry.  Although there was no official overarching theme defining the conference, it was clear that the big issue shaping most of the discussions involved the intersection of innovation and a growing scarcity of talent. In the process, though, I fear that the industry leaders are under-emphasizing some important opportunities.

I was privileged to be able to attend this conference and participate in a number of the panels and discussions. It was truly an energizing and inspiring experience, impressive in terms of the scope of the program, with over 100 speakers addressing a broad range of topics.

The Indian IT outsourcing industry has achieved substantial scale and very impressive growth. NASSCOM estimates that, for the financial year ending in March, the industry will grow to $31 billion in revenue, 32% over last year’s revenue.  The industry now employs 1.6 million people, driving much broader prosperity within India. According to Julio Quinteros, an analyst from Goldman Sachs, Indian IT services companies have rapidly grown shareholder value in sharp contrast to the more disappointing performance of established American IT services companies.

The most impressive thing about the conference was that, in spite of this enormous success, there was little if any complacency.  Instead, the leaders of the Indian IT services industry continued to show the same sense of urgency that has driven their success so far.

The competition for talent

Many of the discussions focused on the intensifying competition for talent within the IT services industry.  Continued growth of the industry hinges on the ability to access and develop talent.  Turnover rates are generally rising, especially in the business process outsourcing industry, further increasing the challenge of sustaining profitable growth. Wage rates are also rising as companies compete more aggressively to attract and retain the available talent. In the meantime, other countries such as the Philippines, Vietnam, China and the Eastern European countries are competing more effectively for IT outsourcing work.

Indian IT services firms are responding to these challenges on a number of fronts.  They continue to invest heavily in scaling their recruiting and training efforts, increasingly branching out and establishing facilities in second and third tier cities in India to reach a broader pool of talent.  In many cases, they are establishing development and operations centers in other low labor cost countries.

Indian firms are also investing in developing more value added services to generate more revenue per employee.  One of the hottest growth sectors for the Indian outsourcing industry is so-called “knowledge process outsourcing”, focusing on providing such high value services as financial research, clinical research and engineering services for product development programs.

More generally, these Indian firms are also focusing on tightening their operational performance to enhance profitability per employee and to become more responsive to increasing customer expectations.  McKinsey & Co. discussed a major report on “Operational Excellence: The Next Frontier in Offshoring” (executive summary available here) at the conference.  The report offered a framework for benchmarking operational performance and found a high dispersion of performance across Indian offshoring service companies. Offshoring service companies could do a much better job of absorbing increasing wage rates if they focus more aggressively on enhancing the productivity of their operations. One of the interesting sidelights in the report was the finding that third-party service providers generally outperform captive offshore facilities.

Innovation blowback opportunities

Another key theme emerging from the discussions at the conference involved the increasing need for innovation in the offshoring business.  Unfortunately, there did not appear to be any consistent definition of innovation so, at times, it was unclear what the exact nature of the opportunity is.  NASSCOM has announced a joint research effort with BCG on “Developing an Innovation Ecosystem for the Indian IT Industry”.  This effort in particular seems to be focused on identifying opportunities for the Indian IT industry to collaborate with other stakeholders in the Indian economy to address challenges in providing more cost-effective products and services to the Indian population.

This is a huge opportunity and has generally been under-emphasized by the IT services industry which historically has focused on overseas markets rather than the domestic market.  There are some notable exceptions to this.  Infosys, for example, has developed a strong partnership with ICICI Bank, one of the most innovative and successful banks in India.  ICICI Bank used the Finacle application software suite from Infosys to develop an extremely cost-effective and scalable operational platform.  This collaboration has helped ICICI Bank to grow rapidly, increasing its transaction volume by five-fold over a five year period.

This opportunity is particularly intriguing because it extends far beyond the domestic market, even though that is certainly attractive in its own right.  As JSB and I have written, there is an opportunity to pursue “innovation blowback” strategies, using the Indian market as a catalyst for breakthrough innovation in products and services that can then be used to support global attacker strategies designed to challenge incumbents in the more developed Western economies. In recent years, ICICI Bank has started to expand internationally, leveraging its innovative operational platforms to deliver more cost-effective services to customers in countries like the UK, Canada, Singapore and China. The Indian IT services industry could fuel enormous growth for the Indian economy by more aggressively supporting these innovation blowback strategies.

Fostering talent networks

But the biggest opportunity of all requires a different form of innovation.  It also requires a very different mindset for the leadership of the Indian IT service companies.

Rather than continuing to focus on attracting and retaining talent within their own companies, these firms could create enormous value by developing the management techniques required to mobilize and leverage specialized talent wherever it resides. This would require building scalable talent networks encompassing a broad range of smaller, more specialized companies. 

The Indian IT services companies have been very effective in building relationships with technology product companies on a global scale.  But when it comes to expanding their own IT services, they immediately focus inward.  If they don’t have the capability already in place, they may go out and acquire a smaller, more specialized company, but their instinct is to bring the capability in house.

As an alternative, these companies could take their emerging skills in partnering with technology product companies and apply them to building talent networks to mobilize and leverage large numbers of more specialized service providers.  The real power would be to master the techniques required to accelerate the development of talent across such a distributed network of partners, thus creating stronger incentives for partners to join the network.  Focusing on this challenge would create an opportunity to innovate in “Learning 2.0” capabilities, moving from traditional training programs to more distributed learning platforms and ecologies.

Ultimately, the opportunity would be to become leaders in the formation and orchestration of creation networks. This would require mastering open innovation management techniques to attract and mobilize talent, focus the innovation initiatives across multiple participants and accelerate commercialization and learning from these initiatives.

Even broader innovation opportunities

These efforts in turn would expose the Indian IT service companies to the challenges of coordinating activities across large networks of partners given existing IT architectures. By gaining firsthand experience in the limitations of these architectures, Indian IT service companies would be well-positioned to drive another wave of innovation in IT architectures.  In my talk on Web 2.0 at NASSCOM, I suggested that Indian IT service companies are natural candidates to define and deploy fundamentally new IT architectures that work from the “outside-in”. 

In contrast to traditional IT architectures that emerged in the center of the firm and imperfectly extend their reach beyond the boundaries of individual enterprises, we are in desperate need of IT architectures that start with the assumption that the task is to coordinate activities across hundreds, if not thousands of firms. By starting with this perspective, we would need to re-think the nature of transactions and define roles and governance processes accordingly. In fact, we would likely move from today’s transactional architectures to much more helpful relational architectures designed to support enduring and deepening relationships across individuals and institutions.

There’s no shortage of opportunities at both the product and process level to drive the growth of Indian IT services companies.  The sense of urgency that continues to pervade the leadership of these companies will serve them well in identifying and aggressively pursuing these opportunities.

Brokerage and Closure

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Having just reviewed Scott Page’s “The Difference”, I wanted to also call attention to an important book published a little over one year ago – “Brokerage and Closure: An Introduction to Social Capital” by Ronald Burt, one of the leading academics on social capital and social networks.  In many respects, these books are great complements to each other. 

Page’s book makes a compelling case that cognitive diversity contributes to superior problem solving and predictive tasks.  He analyzes the nature of cognitive diversity and the specific ways that this diversity can contribute to superior problem solving and predictions. Yet, he spends very little time exploring the relationships across diverse individuals and how these relationships contribute to superior performance of the individuals.

This is where Burt’s book starts.  Burt doesn’t spend a lot of time analyzing categories of diversity in or across the nodes – he is far more interested in the structure of relationships that connect the nodes.  This is another important part of the puzzle. Page assumes that the diverse participants are connected and engaged in collaborative problem-solving or prediction tasks.  Burt reminds us that a lot of the value is in creating new connections and that not all connections are created equal. Relationships can amplify the power of diversity and diversity can amplify the power of relationships.

A warning for my business readers – although Burt writes in a compelling style, he still is very much writing in the academic genre, so the book is dense and far from a light read.  Yet, the insights he conveys make the reading effort richly rewarding.

For those not familiar with Burt, he is Professor of Sociology and Strategy (I love this – talk about crossing important boundaries!) at the Graduate School of Business at the University of Chicago. Fifteen years ago, he wrote a seminal book on “Structural Holes: The Social Structure of Competition.” That book argued that “structural holes” defined by gaps in connections among complementary resources in the competitive arena provide significant opportunities for entrepreneurial initiative.  As he succinctly put it, “competitive advantage is a matter of access to holes.”

Structural holes still form the centerpiece of Burt’s analysis but, in his new book, he focuses on two sets of activities required to generate value from structural holes – brokerage and closure.

• Brokerage is the function performed by people whose relationships bridge across structural holes in social networks – they help to connect non-redundant flows of information. 

• Closure on the other hand helps to build alignment among diverse individuals by creating rich connections with third parties that establish powerful reputation mechanisms. As Burt makes clear, closure is typically not the direct result of efforts by individuals but instead is a by-product of interactions that naturally arise when dense networks of relationships form.

Burt’s book explores the complex relationship between these two activities, especially the paradox of tension and interdependence. On the one hand, brokerage is about reaching out and embracing new flows of knowledge while closure is about focusing inward and enforcing conformity, rejecting that which does not fit.  At this level, brokerage and closure are deeply at odds.  On the other hand, brokerage cannot function effectively without the trust that closure creates.

Part of the paradox hinges on the Janus-like nature of closure.  Closure at one level is enormously beneficial – it helps to build the trust that is essential for collaborative activity and rich information flows.  On another level, though, closure tends to amplify existing opinion and reinforce group identities at the expense of openness to new participants or perspectives.

Resolving the brokerage/closure paradox is made even more difficult by the “closed networks of scholars that have sprung up devoted to brokerage or closure but not both.” In this respect, Burt himself is performing the role of a broker, helping to bridge two very distinct academic communities that tend not to interact a lot with each other. Burt’s offers this resolution of the tension between brokerage and closure:

Brokerage is about coordinating people between whom it would be valuable, but risky, to trust. Closure is about making it safe to trust.  The key to creating value is to put the two together.  Bridging a structural hole can create value, but delivering the value requires the closed network of a cohesive team around the bridge.

This is perhaps easier to state than to put into practice.  Burt acknowledges that the inertial effects of closure tend to predominate over time, even though in times of rapid change the value of brokerage increases relative to the value of closure. Getting the balance right is challenging under the best of circumstances.

Burt’s book is a rigorous exploration of social capital and the activities required to build social capital.  He expresses concern that

Clear-thinking observers can be frustrated with the vagaries of social capital left as a metaphor. Social capital is the Wild West of academic work.  There are no skill or intellectual barriers to entry.  Contributions vary from rigorous research to devotional opinion, from carefully considered to bromide blather.  Research and theory in economics, political science, and sociology are distributed across loosely related perspectives and specialties, each a group of connected experts purporting to have a productive view across groups.  The variety is as interesting and exciting as it is corrosive to cumulative work.

Burt’s book is tightly organized around four “stylized facts”:

• Brokers perform better than others in social networks – they typically “receive a premium in compensation, recognition and responsibility.”

• This superior performance results from the improved vision that brokerage offers in terms of detecting and developing new ideas.

• Appropriately balanced, brokerage and closure can work together to amplify performance

• Closure’s reputation mechanism is a powerful inertial force and, left unchecked, reinforces the status quo

As I have already hinted, one of the frustrations in reading Burt’s excellent book is that he doesn’t delve deeply enough into the management practices required to effectively balance brokerage and closure.  He makes a compelling case that these two reinforce each other and he also highlights the continuing risk that closure will prevail at the expense of brokerage.  So there’s a lot of incentive to get the balance right, but how precisely does one do that?

At the end of the day, Burt’s perspective is also largely a structural and static view of social networks and the advantages created by brokerage positions in networks.  In his final chapter he offers some tantalizing, but ultimately unsatisfying, hints about the need for a perspective on network dynamics, something that he suggests will be forthcoming from his own research program.  In particular, he draws some intriguing contrasts between the equilibrium views of conventional economics and the more dynamic, process views of Austrian economics, suggesting that the latter offers a much richer foundation for understanding network dynamics.

This is a powerful intuition.  A more dynamic perspective may ultimately be key  to overcoming the tension between brokerage and closure.  If we move from static diversity to dynamic specialization, we create opportunities to build trust that are simply not available in the  more challenging zero sum world of equilibrium economics. We would then complete a powerful triad – diversity, relationship and dynamics – to offer a much more robust view of the opportunities to create strategic advantage.

So, what should executives take away from all of this?  First of all, an increased awareness that our firms are much more optimized for closure than brokerage, yet enhanced performance, especially in times of great change, hinges upon shifting the balance more in favor of brokerage activity.

Second, network analysis provides an opportunity to be much more insightful about the structural holes that provide opportunities for improved performance.

I would add a third observation – that all structural holes are not created equal.  The structural holes on the edges of economic activity – whether it is the edges of firms, industries, economies or demographic segments – are particularly rich with opportunity for performance improvement.

Finally, if all of this is true, executives who want to strengthen brokerage activities across the most promising structural holes need to master the management techniques associated with outsourcing, loose coupling and productive friction.

Difference and Friction

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I can think of no better day than Martin Luther King Day to focus on Scott Page’s new book, The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools, and Societies. The book was officially published today and it provides the most penetrating and systematic exploration yet available of various forms of diversity and precisely how diversity enhances both problem-solving and predictions.

To be fair, Page is not directly concerned with exploring racial diversity (a form of “identity diversity” in Page’s taxonomy).  Instead, he focuses on cognitive diversity and unpacks four “frameworks” of cognitive diversity:

• Diverse Perspectives: ways of representing situations and problems

• Diverse Interpretations: ways of categorizing or partitioning perspectives

• Diverse Heuristics: ways of generating solutions to problems

• Diverse Predictive Models: ways of inferring cause and effect

While sympathetic to the case for identity diversity, Page cautions that “. . . we can take the connection between identity and cognition too far. Identity diverse people can think alike . . . If well managed, identity diversity can create benefits, provided it correlates with cognitive differences and provided the task is one in which diversity matters.”

A blog posting can hardly do justice to the sophistication and nuance of Page’s argument. As Professor of Complex Systems, Political Science and Economics at the University of Michigan and an External Faculty Member of the Santa Fe Institute, Page is adept at crossing disciplinary boundaries to define points of view and muster evidence to support those perspectives.

Let me instead just highlight some of Page’s more provocative findings.  First, in discussing problem-solving, he develops a perspective that “diversity trumps ability: random collections of intelligent problem solvers can outperform collections of the best individual problem-solvers.”  To be clear, Page labels this a conditional claim that only holds under specific circumstances, but he helps us to understand why this assertion is often true.

Page then turns to predictive tasks and highlights two key conclusions from his analysis:

. . . that diversity and accuracy contribute equally to collective predictive performance, and that a crowd’s collective prediction must always be at least as good as the average prediction of a member of the crowd.

Page also looks at the role of preference diversity – “differences in what we value.”  Here he makes a distinction between fundamental preferences (preferences about outcomes) and instrumental preferences (preferences about how we get what we want). In discussing the role of preference diversity, he observes:

Diverse perspectives, which we have touted as a panacea, have a dark side – they lead to the discovery of lots of possible alternatives.  If people have diverse fundamental preferences, they less likely agree when they have more possible choices.  On the flip side, diverse fundamental preferences, which cause so many problems when making choices, prove beneficial for problem-solving.  What we desire influences how we look at problems, the perspectives we choose.  Thus, collections of people with diverse preferences often prove better at problem solving than collections of people who agree.  Difference of opinion not only makes a horse race, it also makes for effective, albeit sometimes contentious, teams.

This is an important point and, for my money, Page does not emphasize it enough.  Diversity aids problem-solving enormously, but it also generates significant friction.  We have come to believe in the business world that friction is bad but, in fact, certain forms of friction are essential to innovation.  Even in the absence of diversity in fundamental preferences, people with diverse perspectives and tools and the best of intentions are naturally going to clash over potential solutions to problems that they believe are important before they converge around an answer. JSB and I have explored the growing importance of productive friction in driving innovation in both an HBR article (purchase unfortunately required) and our book, The Only Sustainable Edge.

Page’s book is enormously helpful in making the case for certain forms of diversity in enhancing both problem-solving and predictions.  It is perhaps too much to ask for him to also explore the institutional implications of all of this.  On the margin, Page makes some useful suggestions on this front in the final section of his book but, as he admits, it is only a preliminary start.

I left the book feeling that Page is much too sanguine about the capacity of existing institutions to embrace and reap the benefits of diversity.  In stepping back from Page’s compelling analysis, I became even more convinced of the need to re-think at a fundamental level most of the institutional architectures that we have come to accept as givens – firms, schools, governments, NGOs, etc.

We are already seeing new institutional forms emerge on the periphery of existing institutions with the potential to embrace diversity in far more effective ways than most conventional institutions, whether it is in the many different forms of creation networks (e.g., open source software initiatives and process networks) that JSB and I explore here and here (registration required) or the X Prize initiative or the Creative Commons initiative or the Santa Fe Institute that Page is affiliated with, just to name a few.

Those who understand the power of cognitive diversity and even preference diversity need to explore the institutional mechanisms that are most powerful in mobilizing the appropriate forms of diversity, focusing diverse participants on appropriate problems, motivating them to engaging in collaborative problem-solving and creating the appropriate governance mechanisms to resolve disputes and facilitate convergence.  On the one hand, the very meaning of institutional boundaries needs to be re-examined in a world where greater cognitive diversity yields superior insight.  On the other hand, new ways to think about value appropriation become critical if new institutional forms are to become sustainable.

Page points us in the right direction, but there is much opportunity – and need – to innovate at the institutional level in order for the path to become clear. In many respects, the analogy with Martin Luther King holds up.  MLK provided a compelling vision of a society that embraced the potential of all of its participants and celebrated the diversity that made American society so robust.  The specific institutional mechanisms required to realize this vision may not even yet be clear, but we all had a much deeper sense of the destination as a result of his persuasive communication. 

MLK had a knack for creating friction, but he also had a talent for turning it into productive friction rather than dysfunctional friction. As we confront the institutional implications of the value of cognitive diversity, we are likely to see much friction as existing institutions wrestle with the need to expand the scope of cognitive diversity. We can only hope that this will be productive friction, although it can rapidly turn into dysfunctional friction that will produce waves of creative destruction as new institutional forms replace the old.

Retailers and Customers

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I love patterns, especially emerging and evolving patterns.  In this context, anomalies are troubling, but always an opportunity for learning. For me, the Gap represented one of those anomalies for many years.

Almost a decade ago, I detected an intriguing pattern regarding the unbundling and rebundling of firms (purchase unfortunately required). Those of you have been following me for a while know the drill – I believe that most companies are an unnatural bundle of three very different types of businesses:

• Infrastructure management businesses – high volume, routine processing businesses – think of managing a logistics network or manufacturing assembly operations
• Product innovation and commercialization businesses – coming up with creative new products or services, getting them to market quickly and accelerating adoption
• Customer relationship businesses – getting to know a set of customers extremely well and using that knowledge to be more helpful in configuring tailored bundles of products and services to meet the needs of individual customers

These three business types have very different economics, skill sets and even cultures, yet they are tightly integrated into most companies today.  The first wave of outsourcing can be understood as the systematic carving out of the infrastructure management businesses from companies, but we’re just on the cusp of a second wave that will unbundle product innovation and commercialization businesses from customer relationship businesses. 

That’s the short story. Of course, the pace and trajectory of unbundling (and related rebundling) differs across industries and geographies – the patterns are complex and fractal.

Take retailing as an example.  Most retailers don’t own product businesses – they are primarily customer relationship businesses (merchandising) and infrastructure management businesses (store operations). When I first wrote about the broader unbundling pattern in the late 1990s – there was one big anomaly that many people kept pointing out to me – the Gap.  In the late 1990s, the Gap was a real highflier, with a share price that rose from about $10 to about $50 over a five year period.  It could do no wrong. It was taking the retail world by storm.

And it seemed to fly directly in the face of the pattern I outlined above.  Here was a highly successful retailer that was not unbundling, it was in fact adding a third business type – product innovation and commercialization – to the two business types that retailers typically operated.  I can still recall the triumphant smirks of executives who would cite the Gap and say “OK, John, what do you have to say about that?”

At the time, I said that it was an anomaly whose success hinged on getting the product innovation and commercialization business right – at the time, they focused on basics like khaki pants and wearable tops so it was not as risky as the more fashion-oriented part of the apparel business – but that trying to manage all three business types simultaneously would make it very hard for the Gap to sustain its success.  Of course, that came across as a lame attempt to downplay a troubling exception to the pattern I was describing.

Well, starting in 2000 the Gap began to hit the wall and it never really recovered.  Earlier this week, the company announced that it was weighing its strategic alternatives, including a possible sale of the company.  Rumors are swirling about private equity firms discussing how to team up to take the company private.

As is often the case in business, when the troubles first started to surface at the Gap, the search began for the guilty.  Mickey Drexler, the mercurial CEO of the Gap at the time and the guy who drove much of the growth of the retailer, was fired in 2002 and Paul Pressler, a well-respected executive from Disney, was brought in as CEO. Significant turnover throughout the management ranks has occurred since 2000, yet the business challenges persisted.

What if the problem is not about people, but something even more fundamental?  What if the problem stems from having to manage three very different business types in an increasingly competitive market?  When evaluating “strategic options”, one can only hope that the Board of the Gap takes a hard look at the strategic option of unbundling. In many respects, this would be a “back to the future” play for the Gap – the retailer’s first wave of growth, before it started adding its own in-house apparel designers, was driven by its aggressive promotion of jeans designed and made by Levi Strauss. Rather than shrinking the business, this unbundling may actually provide a platform for another wave of profitable growth.

Now, of course, retailers can still guess wrong in terms of fashion trends even if they do not have their own product design business.  But it is easier to guess wrong if you have your own designers who often become locked into certain styles.  Retailers with their own designers start to look inward to their designers for insight about trends, rather than interacting with a broad range of independent designers who are likely to have much more diverse views of potential market opportunities.  Attracting and retaining the best creative talent in-house also can become challenging if this talent has to cope with the divergent cultures required to run infrastructure management businesses and customer relationship businesses as well as product businesses.

But the Gap should go beyond simply shedding its product business.  The company should re-think what it means to be in the customer relationship business.  Retailers pride themselves on being in the customer relationship business, but when you take a hard look at their operations, most large retailers are really much more focused on the infrastructure management business.

Let’s take a simple, yet very revealing, indicator of business focus.  What are the relevant metrics of profitability?  Most retailers focus relentlessly on profitability by store and, even more granularly, profitability per foot of shelf – these are facilities-based measures of profitability.  True customer relationship businesses focus on profitability by customer, yet few retailers (with the possible exception of some direct marketers) even have a clue of their profitability by customer.  Ask them which 20% of their customers generate 80% of their profitability and you get a blank stare. Ask them about customer churn rates and they start looking for a way to change the subject.

Or, take a stroll down the aisles of your nearest “big box” retailer.  Try to find someone to talk to in order to get a suggestion for a product you need or to get a question about a product answered. Good luck. It is pretty hard to talk about being in a customer relationship business when you are not available to talk to a customer. Big box retailers are the epitome of an infrastructure management business – reducing operations to high volume, routine processing activities with as few people as possible.  They dream of even eliminating the cashiers and automating the check-out process.

Of course, merchandisers live or die based on their ability to anticipate the evolving needs of the market.  Some retailers have become very sophisticated in understanding certain customer segments – teens, techies, suburban soccer Moms, etc. In this sense, they are very customer focused. But that’s a pretty shallow notion of customer relationship – all businesses have to do that to stay in business.

True customer relationship businesses set a much higher bar.  Deep, lasting, trust-based relationships with customers – the hallmark of a customer relationship business – are generally built one customer at a time.  They require the investment to learn about each customer’s needs and then they require the skills to take that understanding and turn it around into relevant, timely suggestions regarding products and services that might be most meaningful for that customer.  Think of a good Mom and Pop retailer where the clerk knows you by name and greets you with a suggestion about an interesting new product when you walk in the door.

Ah, but that’s not scalable, the skeptic will say.  Ever heard of Amazon? They do something pretty much like that for millions of customers.  Ah, but that’s on the Internet and not in a physical store, the skeptic responds.  True, but that’s one of the problems – with few exceptions, we still draw hard lines between physical facilities and virtual services.

Now, this is not just an opportunity; it is rapidly becoming a necessity, shaped by the shift from shelf space scarcity to attention scarcity, something I have written about frequently.  In the face of this shift, retailers have two choices.  They can become vast, automated warehouses with a high return on assets – in other words, infrastructure management businesses.  Or they can find creative ways to build real relationships with customers in ways that significantly increase the return on attention for their customers – in other words, customer relationship businesses.

This is the vast blue ocean that awaits enterprising retailers.  It will require extraordinary innovation, inspired perhaps by examples of open distribution in unlikely places like India (not in conventional retailing, which is generally very inefficient, but rather in such unexpected arenas as financial services and diesel engines).

As the Gap assesses its strategic options, it might start by asking the most fundamental question of all – what business are we really in?  There’s a lot of money to be made by getting the answer to that question right.

Gaming and Learning

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As the world around us fragments into endless niches populating a kaleidoscope of Long Tails winding their way around the world, where will economic value reside?  Certainly there will be a lot of economic value within individual niches, but the real money will be made by those who can navigate across the edges of niches and help us to see and connect with resources deeply embedded in distant niches.

Put into more tangible terms for enterprises, they will need to become more specialized and carve out their own economic niches (although these niches can be very large) while at the same time continually appropriating and evolving new capabilities – something that JSB and I have called “dynamic specialization”.  This in fact becomes a meta-capability, with its own perspectives, skills and practices. But where are firms going to look to help build this meta-capability within their own ranks?  Well, look to the edge – in this case, video games.

Many years ago, I was a senior executive at Atari.  Ever since, I have had a strong interest in video games. Despite their broad usage and economic scale (exceeding the sale of movie theater tickets in the US) and the valiant efforts of analysts like Steven Berlin Johnson, video games have always retained an “edge” identity, viewed with suspicion by “high culture”. My collaborator, JSB shares a similar fascination with the gaming world.

Recently, JSB has joined up with Douglas Thomas, a professor at the Annenberg School for Communication at USC and editor of Games and Culture: A Journal of Interactive Media, to explore some of the broader implications for learning of one particular form of video games – massive multiplayer online games (MMOGs) like World of Warcraft.  Two products of this collaboration deserve particular attention – an article in Wired and a working paper at USC.

The article in Wired, entitled “You Play World of Warcraft? You’re Hired!”, has received a lot of attention, in part because it is written in such an accessible style.  It highlights an important distinction between intentional learning and accidental learning:

Unlike education acquired through textbooks, lectures, and classroom instruction, what takes place in massively multiplayer online games is what we call accidental learning. It’s learning to be – a natural byproduct of adjusting to a new culture – as opposed to learning about. Where traditional learning is based on the execution of carefully graded challenges, accidental learning relies on failure. Virtual environments are safe platforms for trial and error. The chance of failure is high, but the cost is low and the lessons learned are immediate.

JSB and Thomas focus in particular on the role of games like World of Warcraft in building leadership talent:

In this way, the process of becoming an effective World of Warcraft guild master amounts to a total-immersion course in leadership. A guild is a collection of players who come together to share knowledge, resources, and manpower. To run a large one, a guild master must be adept at many skills: attracting, evaluating, and recruiting new members; creating apprenticeship programs; orchestrating group strategy; and adjudicating disputes. Guilds routinely splinter over petty squabbles and other basic failures of management; the master must resolve them without losing valuable members, who can easily quit and join a rival guild. Never mind the virtual surroundings; these conditions provide real-world training a manager can apply directly in the workplace.

Unfortunately, this focus on leadership skills, while insightful and important, diminishes the real significance of MMOGs.  JSB and Thomas hint at the real significance in the following passage:

The fact that [the game players] don’t think of gameplay as training is crucial. Once the experience is explicitly educational, it becomes about developing compartmentalized skills and loses its power to permeate the player’s behavior patterns and worldview.

The working paper by JSB and Douglas at USC, entitled “The Play of Imagination: Extending the Literary Mind”, explores the real significance of MMOGs much more deeply, although in a much denser, academic style that many business people may have trouble accessing. That’s a shame because the business implications are profound.

A key theme of the paper is learning across boundaries, as JSB and Douglas lay out early on:

While a traditional “game” remains at the core of MMOGs, the rich social fabric that the game produces blurs many of the boundaries that we tend to expect such as the distinction between the physical and the virtual, the difference between player and avatar, and the distinction between work and play. Further, we argue throughout the essay that the learning that happens in MMOGs is tied to practices, but those practices are not solely the practices of game play or even skills such as resource management. They are, instead, the skills of learning how to use one’s imagination to read across boundaries and be able to find points of convergence and divergence between different worlds to understand their relationships to one another.

JSB and Douglas set out to offer “a set of analytic categories designed to help us understand what virtual worlds do that is different from the typical learning environment.” In part, the paper builds on the notion of disposition in JSB and Paul Duguid’s essay on “Stolen Knowledge” when they suggested that learning “is not simply a matter of acquiring information; it requires developing the disposition, demeanor and outlook of the practitioners.”

JSB and Douglas argue that gaming develops a disposition of play – “a way of thinking about more than what we know” – but that the player’s dispositions are continually shaped by the social network of the game itself.

As a result, players are forced to continually adjust and readjust their dispositional stances not only to the game world, but also to other players within the world. In doing so, players develop a correspondingly flexible attitude toward dispositions which is, as Sherry Turkle has described it, protean in nature.

At another point, JSB and Douglas discuss the way MMOGs promote a “vivid situational awareness that provides the opportunity for the player to live in a space of possibilities, which we see as a powerful training for innovative thinking.”

At the highest level of abstraction, the disposition of a gamer is one that recognizes the importance of situational awareness and develops practices to heighten and refine that disposition. What the gamer learns and what is transferred is not any particular skill set . . . , but the recognition that situational awareness itself is important. The game can tell you very little about how to be situationally aware in different contexts (such as work or home), but it can dispose one to behave with awareness regardless of the context or environment. While different contexts may require awareness of different things, they each require the same kind of imaginative thinking.

JSB and Douglas make a key distinction between the learning that occurs in MMOGs and in simulation-based training:

The learning that occurs in MMOGs is a kind of learning by metaphor, by which two radically different spaces (the virtual and the physical worlds) offer up a single points of experiential convergence (a trigger) which invite (or require) reflection and imagination to translate. Learning by analogy, the kind of learning that happens in simulations or simulation based games, focuses on creating spaces which are measured based on their convergence between the real and virtual worlds, and attempt to minimize divergence. The purpose is to remove imagination and reflection as requirements for learning, and provide a system of instruction and direct transfer of skills and knowledge from the virtual to the physical.

This leads them to emphasize the capability of “conceptual blending”, a concept introduced by Mark Turner in his book The Literary Mind.  JSB and Douglas elaborate:

At its most basic level, conceptual blending is a system of projection, where we take a source image and project it upon a target image. Conceptual blending occurs when the two image schemas are able to align and not conflict. Turner’s example of such blending is the blend of the “talking animal” familiar to us from fables, stories, tall tales and the like. The blend occurs when we project speech onto an object such as a donkey. . . .

While a blended space must show some “conformity to its own logic,” it remains “free of the constraints that restrict its input spaces”. Blended spaces get all the richness of their input spaces, but only some of their constraints. . .

The ability to negotiate, manage, and make sense of this continual sense of blending, which is to say the agency a player develops within that world, are what we see as the tools for innovation for the 21st century.

In their conclusion, JSB and Douglas explore the implications of MMOGs for re-thinking the very meaning of education itself:

The model that virtual worlds provide offers a glimpse into the possibilities of what our classrooms might become: spaces where work and play, convergence and divergence, and reality and imagination intertwine in a dance where students grow to understand the importance of communities of practice and learn how to be the things they imagine.

But the implications are far broader than that.  Educational institutions are becoming progressively marginalized as it becomes apparent that learning is a life-long undertaking and that the success of all of our institutions hinges on the ability to support learning activity.  As the working paper makes clear, the most valuable learning is certainly not at the level of compartmentalized skills; it is much more about developing and evolving appropriate dispositions and the ability to integrate in new ways, as suggested by the notion of conceptual blending.

The irony, and the tragedy, is that MMOGs may promote this kind of learning far better than our educational institutions.  These institutions may be so broken that it may be much more productive to design and deploy new institutional frameworks and practices to foster this different form of learning rather than trying to implant it into existing institutions.

Fostering these new forms of learning will be a key challenge, and opportunity, for firms if, as JSB and I have maintained, the rationale for the firm increasingly becomes the ability to accelerate talent development. In a world of proliferating and rapidly evolving niches, the ability to build and sustain economic scale will depend on integrative and adaptive dispositions, at least as much as individual skills.

As JSB and Douglas conclude their Wired article:

The day may not be far off when companies receive resumes that include a line reading “level 60 tauren shaman in World of Warcraft."  The savviest employers will get the message.

Internet Strategy – Red Ocean or Blue Ocean?

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The management shuffle announced by Yahoo last evening is only the latest evidence of strategy decay that pervades the leading ranks of the Internet business world.  Yahoo says it made the changes to allow the company to move faster.

Fine, but in what direction do they want to move? What does Yahoo! want to be when it grows up? And what does that imply for what it will choose not to do?

In our celebrity culture, we love to focus on people.  Decker gained, Rosensweig is out, Braun is out, Semel’s still there, Yang’s mentioned, but where’s Filo and who the Hell is going to head up the audience group (and why can’t Yahoo find anyone internally to take this on)?

People matter, of course, but in this context strategy matters even more. Faster movement is dangerous if you have no sense of direction.  It just means you do more things more quickly, spreading that peanut butter even more thinly.  To paraphrase an old quote by Casey Stengel: “if you don’t know where you are going, you will never get there.”

And let’s not just single out Yahoo.  I have a growing sense that all the major Internet players – Google, MSN, Amazon, Ebay and AOL – have lost their sense of direction and differentiation. Rather than carving out and rapidly enhancing areas of distinctive advantage, these major players appear to be leaping like lemmings into the red ocean. Here are some of the red flags that give me cause for concern:

• Rather than helping people to connect more effectively with resources across the Web, they all seem increasingly focused on aggregating their own resources.

• They are becoming more and more obsessed with advertising revenue and risk losing focus on what is required to add more value to users. Advertising revenue is a dangerous narcotic – it shifts you more and more into a vendor mindset rather than a user mindset.

• They are investing large sums of money on infrastructure, further diverting time and attention away from development of new services for users (infrastructure services like Amazon’s EC2 and S3 are a very different business).

• They seem to be looking more and more at each other and trying to replicate each other’s services rather than focusing on the user and trying to be truly innovative in terms of new services.

Now, this growing homogenization of the leadership ranks might be understandable if the Internet were a maturing business arena.  Given the rapid and sustained pace of innovation in the underlying technology, the rapid growth of usage, the continuing shift of spending to the Internet and the proliferation of new businesses created on the Internet, I find it hard to characterize this space as “maturing” – my sense is that it is still in its infancy.

Some observers have even begun to hail the emergence of “Internet conglomerates” as the wave of the future. Looking from the outside in, one can make explicit the assumptions that seem to be driving the investments, business initiatives and strategies of these leaders. These assumptions seem to converge on this view of the future: leading companies will be vertically integrated and horizontally integrated, offering a broad range of their own resources to users who will “settle” into their spaces.  Certainly, the strategies of these companies seem to assume that Internet conglomerates are the wave of the future. Is this really the way the Internet will evolve as a business platform?

As I have written in Harvard Business Review, I believe that a quite different future will unfold, marked by a distinctive process of unbundling and re-bundling of firms. This perspective suggests that all the Internet leaders confront the same difficult choices that more traditional companies also face.  Over time, will these companies choose to be customer relationship businesses, product innovation and commercialization businesses or infrastructure management businesses? None of the Internet leaders appear prepared to confront these choices yet.

Of course, there’s another interpretation of the initiatives pursued by the Internet leaders.  They may be explicitly avoiding any view of the future and instead spreading their bets across many initiatives in the hope that some of these bets will pay off while others will prove to be dead-ends. Nick Carr refers to this as the spaghetti strategy – “throw a lot of stuff against the wall and see what sticks.”

As uncertainty increases, this has become the preferred “strategy” of many companies, not just in the Internet sphere.  While strategy used to be viewed as the discipline of making choices, this approach proudly rejects the need to make any choices. It is a particularly seductive approach for large companies with lots of resources.

And yet this approach stands in sharp contrast to the strategies that enabled the Internet leaders to carve out their leadership positions in the first place. Unlike the thousands of other dot.com start-ups that embraced hustle as strategy and speed without direction, the founders of these companies started with a very clear, even though high-level, long-term destination in mind.  It helped them to make difficult choices in the near-term and to launch waves of initiatives that cumulatively built very large and successful businesses. It has stood them very well in the first decade of their business.

In my own work, I use a FAST strategy methodology. It emphasizes the need to have a clear, but high-level view of a long-term destination while in parallel focusing on a limited number of high impact initiatives in the operations and organization that can accelerate movement towards this destination. What the Internet leaders seem to have lost is any distinctive long-term view of what kind of business they will need to build to remain successful in a rapidly evolving business landscape.

People can be moved in and out of executive positions. Large, high visibility acquisitions can be announced.  "Strategic" relationships across leading companies can be negotiated. But without a clear and differentiated sense of long-term direction, all of these initiatives will make for good newspaper copy, but count for little in terms of sustained value creation.