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Katrina and Institutional Resiliency

In the aftermath of Katrina, the only thing more discouraging than the sad images of people struggling to cope with the devastating impact of a natural disaster is the finger-pointing that overwhelms our media.  The search for the guilty is well under way.  Our national instinct appears to be that individuals are to blame and they need to be exposed and held accountable.  No doubt at this level there is a lot of blame to go around – I have a feeling that few of the decision-makers in the various government agencies from local parishes in New Orleans up to the federal government will escape unscathed.

But I also have a feeling that this search for guilty individuals is missing the real point. It assumes that if we can just find the guilty parties and remove them, everything will be OK.  Perhaps this natural disaster will serve as a wake-up call to reassess the systems we put into place to deal with such unforeseen events and, even more basically, to challenge the assumptions that shape these systems.

John Robb points to an NPR radio interview with Yossi Sheffi, a professor of engineering systems at MIT, who contrasts the proactive actions of a number of companies in dealing with this natural disaster with the bureaucratic response of the government.  Sheffi, who is about to publish a book on The Resilient Enterprise, highlights a number of elements required to respond to unforeseen disruptions:

• push decision-making to the periphery
• instill a culture of communication throughout the organization
• create a sense of urgency in responding to events before they become even more damaging.

Sheffi also emphasizes the importance of standardization, modular design and collaborative relationships with other institutions as important tools to build resiliency. These themes help to explain why global process networks are becoming more prevalent in the global economy.

Now, to be clear, few companies have successfully implemented these elements. But it seems that our government, if anything, has moved in the opposite direction, adding more layers of decision-making in new bureaucracies like the Department of Homeland Security, rather than exploring ways to push effective decision-making to the periphery. As part of this institutional reassessment, the government might also want to figure out more effective ways to harness and amplify the many examples of spontaneous order that emerged both within and outside New Orleans in the aftermath of Katrina, rather than seeking to suppress or limit these efforts. Katrina provides an expensive lesson that our public institutions are still ill-equipped to handle unforeseen disruptions.

Gladwell’s Cellular Church

What do the Communist Party, Alcoholics Anonymous, evangelical Christians and al-Qaeda all have in common?  They adopted and refined the technique of organizing in small cells to achieve change.  This is the fascinating theme of Malcolm Gladwell’s new article, “The Cellular Church” (alas, not available online), in the September 12, 2005 issue of The New Yorker (actually, I added al-Qaeda to the list based on a posting that I will mention later).

Gladwell uses the story of Rick Warren’s Saddleback Church in Orange County, California to make this theme come alive.  For those of you not familiar with Rick Warren, he is the author of The Purpose-Driven Life (23 million copies sold so far and it is just getting started) and founder of the Saddleback Church, an evangelical Christian church with 20,000 members in its congregation and the hub of a global network of 1,100 other evangelical Christian churches.

Gladwell focuses on a core challenge confronting any voluntary organization – how to make it scalable.  On the one hand, many voluntary organizations want to grow so they need to have low barriers to entry. But if they grow too fast or too big, they begin to lose the sense of community and identity that is necessary to retain members. He notes that “historically, churches have sacrificed size for community” but that this changed back in the 1970s and 1980s when the evangelical movement began to build megachurches. It turns out the cellular model has been key to the success of megachurches – cells helped them to solve the scalability challenge.

What are these cells?  Gladwell observes that they are “exclusive, tightly knit groups of six or seven who meet in one another’s homes during the week to worship and pray.” It turns out, at least 40 million Americans now participate in a religious cell of this type. This is also the organizational model that led to the early success of the Communist Party and the continuing success of Alcoholics Anonymous and its many spin-offs.

As Gladwell reports,

Warren’s great talent is organizational. He’s not a theological innovator. . . . What he wanted to learn was how to construct an effective religious institution. His interest was sociological . . . The contemporary thinker Warren cites most often in conversation is the management guru Peter Drucker, who has been a close friend of his for years.

In his article, Gladwell focuses on the role of cells in building tight social bonds among people who share common interests – he mentions one church cell of mountain bikers that “go biking together and . . .are one another’s best friends.” But there is another even more fundamental theme in the article that makes this story more relevant to business executives.

Gladwell draws a distinction between self-help books that are inward-focused, “focusing the reader on his own experience,” and Warren’s book which begins with “It’s not about you” and instead draws the reader into a program of personal and social change that requires the participation of others. Warren’s book serves as a powerful coordinating mechanism for a highly distributed network.

Gladwell quotes Robert Wuthnow, a Professor of Sociology at Princeton who has spent many years studying the evangelical movement (Wuthnow is also the author of the interesting book Loose Connections: Joining Together in America’s Fragmented Communities):

Small groups cultivate spirituality, but it is a particular kind of spirituality. . . . They provide ways of putting faith in practice.  For the most part, their focus is on practical applications, not on abstract knowledge, or even on ideas for the sake of ideas themselves.

These groups are not just worshipping and praying together, they are contributing time and money to change the world. They provide a forum for taking initiative, building something very new and making a difference.  Depending on your religious and social views, you may not necessarily agree with what they are building, but they are driven by the desire to create something quite different, rather than passively listening to sermons and reading scripture.

I look for patterns. I see the spread of the evangelical movement with its cellular structure as just one illustration of a much more profound shift in society.  I blogged earlier about distributed creation and production in such diverse domains as music (remix), extreme sports and even illegal drugs, not to mention open source software and electronics devices.  We are seeing this same pattern play out in the evangelical movement.  We are moving from consuming religion in central locations to producing (or re-producing) it in our living rooms.

In the process, considerable diversity is emerging in these living rooms (far more than secular liberals are willing to acknowledge). To quote Gladwell again:

Scratch the surface, and the appearance of homogeneity and ideological consistency disappears . . . . The members of Warren’s network don’t all dress the same, and they march to the tune only of their own small group, and they agree, fundamentally, only on who the enemy is. It’s not an army.  It’s an insurgency.

Which brings me to al-Qaeda. John Robb posted “The Bazaar’s Open Source Platform” almost a year ago on his blog discussing the implications of the disruption of al-Qaeda’s hub of operations in Afghanistan and the evolution of an even more distributed virtual network behind the guerilla war in Iraq.  He makes the case that this virtual network is pursuing many of the same principles outlined by Eric Raymond in The Cathedral and the Bazaar, one of the inspirations behind the open source movement.

Now that’s a pattern – from the Sunni strongholds of Iraq and the Afghanistan-Pakistan border (not to mention working class neighborhoods in British and German cities) to the living rooms of affluent Orange Country, we’re seeing loosely coupled networks surface as spearheads of social change. I certainly have no intention of equating Islamist guerillas with evangelical Christians.  My point in fact is that remarkably diverse movements inspired by deep religious conviction are embracing similar models of organization.

The patterns on this edge map to patterns on other edges that are more directly relevant to business executives, including the emergence of global process networks reshaping the creation and production of goods as diverse as khaki pants and digital still cameras. People are also becoming more involved in the production and creation of the items that are most meaningful to them.  At the same time, these production and creation activities are becoming far more distributed, even on a global scale.  New ways of organizing are creating the potential for significant scalability, flexibility and innovation as well as much deeper relationships with participants. Companies need to figure out what these developments mean for them, both in terms of how they organize their activities and how they build relationships with their constituencies.

Onshore Manufacturing

Executives are scrambling to figure out how to respond to growing competition in manufacturing from China and other emerging economies. They should check out Louis Uchitelle’s article “If You Can Make It Here . . .” in the September 4, 2005 issue of the New York Times. The article profiles three U.S. manufacturing companies that have maintained manufacturing operations in the U.S., rather than following the broader trend towards offshoring.  One of these companies is well-known – Harley-Davidson.  The two others – Haas Automation and Hiwasse Manufacturing – are much less well-known.

The individual stories are interesting but, as always, it is the patterns of behavior that are most informative. What do we learn?  First, the CEO’s of these companies all have deep experience in manufacturing operations.

Second, Uchitelle observes:

Innovation is often compulsively pursued at the manufacturing companies that stay in America.  The engineers and designers at Harley-Davidson and Haas are constantly altering the companies’ products in ways that are not easily imitated by lower-priced foreign competitors.

Third, these companies “eschew layoffs, but in exchange for job security they require their workers to help squeeze out labor costs through automation and other efficiencies.” The companies are continually looking for opportunities to automate their operations, but at the same time they are committed to redeploying their workers in other parts of the business. In this way, they enlist the active participation of workers in the search for process improvements to generate greater operating efficiency. The high levels of productivity enable these companies to compete against low wage rate suppliers from China. For example, Haas Automation estimates that its productivity rate is 50 times greater than equivalent Chinese manufacturers, more than making up for a 10 times higher wage rate.

Fourth, these companies focus on new sources of growth.  This is a necessary corollary if the companies are to honor their commitment not to lay off workers while at the same time pursuing greater operating efficiency.  Harley Davidson and Haas are both targeting China as a promising export market for their products.

Fifth, these companies have remained relatively specialized.  In fact, Harley-Davidson almost went under about 25 years ago after being owned for more than ten years by a diversified company, AMF. A leveraged buy-out by Harley-Davidson’s management in 1981 marked the beginning of a successful turnaround. In pursuing growth, these companies have concentrated on leveraging their core product expertise rather than diversifying into unrelated businesses. (I would argue they will need to become even more specialized, but that is the subject of another blog.)

Sixth, these companies work closely with their suppliers to enhance quality and support their rapid incremental innovation. They don’t buy from suppliers just on price, but instead focus on building deeper relationships with suppliers that can help them differentiate their products.

Seventh, private equity has played a key role in the success of each of these companies.  Both Haas Automation and Hiwasse Manufacturing are privately owned and the leveraged buy-out was instrumental in the successful turnaround of Harley-Davidson.

Haas Automation also seems to be focusing on modularity and parts commonality to become more competitive.  Although it has a common design for its machine tools, this basic design can be configured “into 100 models and variants to suit specific customers’ needs.”

OK – so what does this all mean?  Bottom line, it means that U.S. companies can still compete in manufacturing with offshore locations. But this means they must adopt the management practices and strategies that companies in offshore locations are pursuing.  Many U.S. executives continue to be misled into believing that the success of offshore locations hinges on low wage rates and that there is no way to compete, especially in the manufacturing arena.  Sure, low wage rates are an important factor, but far more important are the aggressive management practices and strategies being pursued by companies in offshore locations.

What are these management practices and strategies? Well, they include deep senior management experience in manufacturing operations, rapid incremental innovation, aggressive talent development, focus on growth that is consistent with specialized capability, close relationships with suppliers to accelerate innovation, modularity in operations and access to capital that takes a long-term view of business opportunities. These are the focus of the book that JSB and I just wrote – The Only Sustainable Edge.

The New York Times story suggests that these management practices and strategies work just as well here in the U.S. as they do on the edge in emerging economies like China and India.  The problem is that a lot of Western companies have lost sight of these basic management practices.  They have become excessively focused on short-term financial performance, especially short-term cost reduction.

This is the challenge we face in competing with geographic edge companies.  Financial metrics are lagging indicators – they tell us how well we did. We need to restore our focus on the operating metrics of the business and the talent required to drive these operating metrics to higher levels of performance. This is the leading indicator that will tell us whether or not we are really on track in addressing the challenges created by competition on the edge.

By the way, the New York Times article also has an interesting chart showing that U.S. share of global manufacturing value added has declined by only about one percentage point over the period 1982-2004, while the big losers have been Germany, France and Japan.  Over the same time period, China gained global share by 7.5 percentage points.  It is a stunning growth in share. It reinforces my advice to executives to focus on trajectories and relative pace of growth, rather than static snapshots of performance.

DIY Drugs

The edge takes many forms.  One form of edge arises as we move from legal to illegal activity.  Another form of edge occurs as we strive to push our bodies to new experiences and performance levels as I have discussed here and here.  Like all other edges, these become areas of intense innovation and the patterns emerging on all edges play themselves out in interesting ways.

One of the common patterns I have discussed here and here involves the movement toward distributed creation and production – “do it yourself” approaches reign supreme as participants push the boundaries of current capabilities and seek to tailor products for their own needs.

Peter Schwartz, the founder of Global Business Networks, has an interesting piece in the current issue of Foreign Policy on The War on Drugs suggesting that this pattern may also be playing out in the production and use of illicit drugs:

The model drug of the future is already here in the form of crystal methamphetamine, a drug that is sweeping the United States and making inroads abroad.  It’s cheap and easy to make – little more than Sudafed doctored up with plant fertilizer.  One hundred percent of the profit goes to the manufacturer; no intermediary or army of couriers required. Made of locally acquired materials in the garage or the basement, the drug’s production is nearly impossible to stop.  Only the stupid and the incompetent get caught.

Thirty five years from now, the illicit professionals who remain in the business will be the custom drug designers catering to the wealthy.  Their concoctions will be fine-tuned to one’s own body and neural chemistry. . . .

The boundary between legal performance enhancement (Viagra) and the illegal drugs of pleasure and creativity will blur.  The political and social pressure against drug use will remain, but it will increasingly resemble the campaigns against performance-enhancing drugs for athletes.  Widespread use will spark debates about fairness and authenticity: Is a drug-using musician better than one who composes and performs naturally?  Is it fair for only the wealthy to have the richest sexual and culinary experiences?

Just as the legal system is struggling with new realities of intellectual property in a digital age, it will struggle to control innovation in the chemistry of pleasure.

As in other domains, this move towards distributed creation and production is being driven by more affordable and accessible tools of production. At a more fundamental level, it is being driven by a continuing desire to shape one’s own experiences and to push established boundaries. In the case of drugs, the drug of choice may be different, but the backwoods meth producer is a direct descendant of the backwoods hootch producer during the Prohibition. We may not like what they are producing, but history has shown they will be quite creative in finding ways to produce it themselves. The MIT fab lab participant, the remix DJ at the local hip nightclub, the extreme sports enthusiast and the backwoods meth producer all share a common passion – producing goods and experiences on their own terms.

In the process, they will spark a fundamental restructuring of industries and enterprises.  Executives had better start figuring out how they can provide their customers with better tools to make their own products and services. This won’t happen everywhere, and it certainly won’t happen all at the same time, but it will be a significant edge where a lot of economic value will be created by those who understand what is happening.

Thanks to Alex Soojung-Kim Pang on his excellent blog IFTF’s Future Now for the pointer to Peter’s article.

Product Innovation and the Red Queen Effect

I’m back from vacation and staring at an inbox that brings to mind the Red Queen from Through the Looking Glass – a metaphor that comes up with greater and greater frequency in my conversations with executives. So, I was especially vulnerable to a videoblog posting from Dave Bayless, at Evergreen Innovation Partners, on "Innovation, Clockspeed & the Red Queen Effect."

Basically, Dave constructed a highly simplified model to demonstrate what happens when the average product life in a business declines by a relatively modest 10% per year. In fact, this is roughly the rate of decline occurring in recent years across a broad range of industries. It may seem like a relatively modest decline each year, but the compounding effect means that product lives shrink in half every seven years. Dave’s model quantifies the Red Queen effect in a particularly compelling way.

There are some other effects that Dave doesn’t address that make life even more challenging.  For one, a steady decline in product life cycles also significantly increases the level of uncertainty in a business.  In Dave’s simplified model, each new product produces a predictable revenue stream. In real life, each time a new product is introduced, the company takes a big gamble – will the product succeed or will it fail?  In increasingly competitive global markets, product success rates are likely to decline. Even if the products succeed, the margins generated by the new products are likely to be squeezed.  His model focuses on maintaining steady revenue levels.  If the goal is to maintain steady operating margins, the hurdle becomes even more challenging.

One quibble I would make is with Dave’s definition of innovation as "the adoption of products by customers".  This is a product-centric view of innovation and ignores the impact of process innovation (which also includes innovations in work practices).  In fact, process innovations are ultimately much more powerful in terms of generating business value because, if done right, they can generate a compounding effect of their own – they keep on giving, in contrast to most product innovations where the tyrrany of product life cycles limits the potential value creation.  Rapid incremental process innovation combined with aggressive leveraging of third party resources may in fact hold the key to diminishing, if not overcoming, the Red Queen effect.

By the way, Dave’s reference to "clockspeeds", prompts me to recommend the excellent book that really developed this concept in a business context – Charles Fine’s Clockspeed: Winning Industry Control in the Age of Temporary Advantage.

JSB on NPR

I am stuck in Paris on vacation (I know, things could be worse!), but my co-author and collaborator, John Seely Brown, is going to be interviewed by Neal Conan on "Talk of the Nation" on NPR this Wednesday Thursday, August 24th 25th (sorry, in my enthusiasm about this, in my original posting I had this listed as occurring one day earlier – the show will be broadcast live on Thursday, August 25th – blame it on excess absinthe consumption). "Talk of the Nation" is doing a special series on China and JSB will be interviewed on some of the key themes covered in our book, The Only Sustainable Edge, regarding the extraordinary innovation emerging in China. I expect that JSB will be as controversial as ever, stirring up more than a few hornets nests with some provocative views on what is going on in China.

The interview is scheduled to air live at 2 PM EDT, but to check for specific NPR affiliated radio stations that will broadcast the interview, check out this link. Also, this is a call in show, so if you want to engage with JSB on this topic, you can call in to "Talk of the Nation" during the live broadcast by dialing 800-989-8255 or pose questions via e-mail at TOTN@npr.org.

Patterns of Business Innovation in China and India

Sorry for the gap in postings, but I have finally escaped to my first vacation in three years.  While on vacation, I came across the special August 22-29 Business Week double issue focusing on “China and India: What You Need to Know Now” (the online edition has a lot of material not available in the print edition). It is full of interesting articles on these two emerging economies and reflects growing interest in the business impact of these two countries – the focus of The Only Sustainable Edge.

Unfortunately, though, the articles reflect the weaknesses of much Western coverage of China and India.  This coverage tends to veer from eye-opening macro-economic statistics to interesting stories about individual companies.  From a strategist’s viewpoint, though, what I miss in such coverage is any deep analysis of the patterns of business innovation that might help to explain the explosive growth in both economies or the implications for Western companies.

Open distribution – the first pattern of innovation

In this respect, Business Week does a better job on the India front. Manjeet Kripalani has a particularly good article, “Asking the Right Questions” on innovation among Indian companies. She tells interesting stories about Indian companies like ICICI Bank, Indian Tobacco Company (ITC) and Tata Motors. (For more detail on the efforts of ICICI Bank and ITC in particular, see the case studies included in C.K. Prahalad’s The Fortune at the Bottom of the Pyramid.) If you step back from these stories an interesting pattern emerges across three very different industries in India – let’s call it “open distribution” innovation. In our article on innovation blowback, JSB and I discussed the experience of a U.S. company, Cummins Inc., which has successfully pursued a similar pattern of innovation in India.

These companies are extraordinarily innovative in re-conceiving the economics of distribution.  They are focused on the enormous challenge of reaching the mass domestic market. Their target customers are distributed in rural areas with very limited physical infrastructures and the customers are far less affluent than the typical customers in Western economies. They need to deliver more value at lower cost than they could with the traditional business approaches of Western companies. 

What have the companies done to address these challenges?  They have innovated both in terms of products and processes.  The innovations cover a number of dimensions:

• increased modularity (both in products and processes)
• aggressive leveraging of existing third party (and often non-commercial) institutions in rural areas to more effectively reach target customers
• creative use of information technology carefully integrated with social institutions to encourage usage and deliver even greater value.

These innovations are quite different from the innovations in U.S. retail distribution pioneered by such companies as Wal-Mart and Dell.  These U.S. companies developed completely self-contained and highly standardized customer-facing facilities and services.  The open architecture approach pioneered by Indian companies may offer much greater opportunity to deliver more tailored value to customers than the closed architecture U.S. approach. In this respect, the techniques initially developed to reach poor and rural customers may have even greater potential when used to reach highly demanding affluent and urban customers in Western economies.

Lean process management – the second pattern of innovation

This pattern of open distribution innovation in India is quite different from the innovation of the IT enabled services companies clustered in Bangalore and other high tech outposts in India.  These companies largely serve the export market – especially large Western companies who are increasingly offshoring both software development activities and a growing variety of administrative business processes like human resources management and finance and accounting.

Steve Hamm, in his article “Taking a Page From Toyota’s Playbook”, describes how companies like Wipro and Infosys have been heavily inspired by Toyota’s disciplined focus on rapid process improvement and are applying Toyota’s methodology to their business process outsourcing businesses. These companies have become so sophisticated in their use of process innovation techniques that they are now offering consulting services to help their clients in Western companies apply similar techniques in their own operations.

So, here we have a second pattern of innovation – let’s call it “lean process management” – quite different from the “open distribution” innovations pioneered by Indian companies focused on the domestic market.  Lean process management as applied by the Indian IT companies focuses on activities within a single enterprise while open distribution innovation seeks to reach out and mobilize specialized institutions already in place in rural areas to deliver more value to customers.

Open production – the third pattern of innovation

Now, what about China?  This is where the Business Week coverage is most disappointing. In fact, one of the articles makes the observation that “China is surprisingly weak in innovation.”  I beg to differ.  In fact, I would argue that China, along with India, is rapidly becoming the global center of management innovation.

What explains this divergence of views?  First, at least in its coverage of China, Business Week seems to equate innovation with product innovation, while I give at least as much emphasis to the importance of process innovation.  Second, Business Week seems to ignore the fact that there are three Chinas: rural China, the state-owned enterprises (SOEs) and the private, entrepreneurial sector.  Much of Business Week’s coverage concentrates on the state-owned enterprises which still account for the bulk of China’s industrial production and are usually the partners that Western companies choose to affiliate with when they enter China.  But, the state-owned enterprises, favored with massive subsidies from the government and low-cost loans from the state-owned banking system, have almost no incentive to innovate. In this arena, it is not surprising that Business Week finds little innovation.

The cauldron of management innovation is in the third China – the growing array of privately-held companies emerging on the edge of the Chinese economy.  These companies rarely receive much attention from the Western press, in part because they have developed a culture of keeping a low profile. JSB and I have written extensively about the management innovations being pioneered by these companies in The Only Sustainable Edge.

The contrast with the patterns of innovation among Indian companies is intriguing.  These entrepreneurial Chinese companies (which also include a number of high tech Chinese companies in Taiwan) are focused primarily on competing in global markets in product categories like electronics hardware, textiles and motorcycles where product lives are compressed and demand is highly uncertain.  These companies are pursuing a third pattern of business innovation focused on re-conceiving the economics of production in order to more effectively mobilize distributed expertise for both product development and manufacturing – let’s call this the “open production” pattern of innovation.  The process innovations in this case include:

• modular design of products and processes
• management techniques to flexibly configure highly customized business processes encompassing hundreds, if not thousands, of specialized business partners
• management techniques to encourage business partners to work together in ways that enable them to get better faster than they could on their own.

These are innovations in their own right, but their real power comes from the fact that these management techniques establish the conditions for even more rapid incremental innovation in products and processes. Think of it as meta-innovation – management innovations that spawn a continuing series of innovations.

Comparing the three patterns of innovation

So, what is the bottom line here?  We are seeing three powerful forms of business innovation propelling the economic growth of India and China.  The second form – lean process management – is heavily inspired by Toyota’s management innovations, but Indian companies are applying these management techniques to rapidly improve the performance of a broad range of administrative business processes. If Western companies do not master these techniques in their administrative business processes, they had better be prepared to outsource and offshore these business processes to Indian companies who are mastering these techniques.

The two other forms of business innovation emerging in India and China – open distribution and open production – are largely being pioneered within these countries – they are not inspired by management practices in other countries. Open distribution innovation focuses on customer facing business operations while open production concentrates on product development and manufacturing activities. These innovations are not mutually exclusive – in fact, their real power may only be realized when they are combined.  Both forms of innovation share some basic principles:

• focus on rapid incremental innovation – both in products and processes
• design both products and processes in modular fashion so that flexibility and innovation can be maximized
• use this modularity to aggressively mobilize the resources of third parties to add more value to your own companies products and services.

Western companies would do well to study, understand and, wherever possible, adopt these business innovations in their own companies. To some extent, these management techniques can be accessed through outsourcing relationships, but these innovations span the full scope of a company’s operations. Outsourcing is not a panacea – ultimately, Western companies will need to master these management techniques in at least some areas of their operations or they will find their businesses rapidly eroding through a combination of outsourcing and intensifying competition from companies which were quicker to recognize and adopt these management innovations.

Three Variations on Offshoring

For those of you who haven’t seen it, I wanted to point out a column on “The Benefits of a Long Distance Relationship” that JSB and I wrote for the Financial Times Summer School series in today’s issue of the newspaper.

In this article, we explore the various motivations driving offshoring decisions by Western companies.  Unfortunately, most Western executives still make these decisions based on near-term operating considerations, especially driven by the quest for rapid operating savings given lower wage rates in emerging economies like China and India.  Elsewhere, we describe this as “wage arbitrage”.  This motivation frequently leads to disappointing results and, over time, can create a vicious cycle that ultimately threatens the viability of the enterprise itself.

More sophisticated companies view offshoring from the perspective of “skill arbitrage”.  They understand that offshoring creates an opportunity to access distinctive skills.  We point out that offshoring locations are evolving rapidly.  Any decision based on comparative skills must be based on an understanding of the dynamic context, rather than on a static “snapshot” of comparative skills at any point in time.

This leads to a third way of viewing offshoring – as “skill-building arbitrage”.  We believe that the real opportunities created by offshoring can only be captured by companies that adopt this view. Rather than merely seeking to access distinctive skills, Western companies will benefit a lot more from offshoring if they view it as a powerful opportunity to participate in relationships and environments that can build capabilities more rapidly than would be possible elsewhere. In this context, we highlight three levels of opportunity:

• Different management techniques made possible in part by lower wage rates
• Specialized business ecosystems emerging in cities like Bangalore and Shenzhen
• Global process networks to help connect companies across distributed regions.

This is a more dynamic, long-term view of the opportunity – offshoring is not just about accessing the distinctive skills or cost advantages that exist today, but positioning for longer-term capability building. With this perspective, offshoring relationships change from relatively narrow and opportunistic transactions to much more enduring and evolving relationships designed to help both parties get better faster.

Just like any relationship, the benefits are great but offshoring requires deep understanding and sustained effort to reap the rewards.

Silicon Valley’s Risky Complacency

JSB and I just published a column on Business Week’s web site regarding "SIlicon Valley’s Risky Complacency".  We are both struck by how complacent U.S. business executives are regarding the business implications of offshoring. It is in sharp contrast to the intense urgency we see when we talk to executives in China and India.  Complacency has always been risky and it is even more so today.

Confronting the Offshoring Challenge

Geoffrey Colvin wrote a cover story entitled “America Isn’t Ready [Here’s What To Do About It]” in the July 25 issue of Fortune magazine.  It is a real wake-up call to American workers regarding the growing challenge from offshore labor pools.  It’s a very good article, but it ultimately diverts attention from the key element required to address the challenge.

Colvin begins by outlining three familiar drivers:

• the increasing importance of information in economic activity
• the ability to digitize this information and stream it anywhere in the world more and more cheaply
• the large number of college graduates, especially engineering graduates, being produced in China and India relative to the U.S.

In discussing these trends, he reviews the findings of the recent study from the McKinsey Global Institute that I blogged earlier. Bottom line?  More and more U.S. jobs are vulnerable to offshoring and the U.S. educational system is producing fewer graduates able to compete in technology-related jobs. Some of the most interesting charts in his article contrast the number of Asian students earning doctorates in the U.S. versus in Asian universities.

What’s the answer?  If you read Colvin, the most urgent priority is to fix the educational system.  Other prescriptions include immigration reform, more spending on R&D (especially government funded research), more investment in communications infrastructure. But then Colvin warns that all of this still might not work.  The more fundamental problem is that American workers are more expensive than similarly skilled workers in Asia, raising the most important question: “How can they be worth what they cost?” Colvin suggests that “what happens next in the U.S. depends on how workers respond.”

I beg to differ.  What happens next depends on how U.S. companies respond. Despite cursory references to companies like Trilogy, the article largely lets companies off the hook.  According to the article, the answers either involve public policy initiatives or efforts by workers to get the training required to justify their higher cost (despite the earlier point in the article that workers at all skill levels are available for lower wages in Asian countries).

In searching for a more satisfying answer, we might start with the observation of Robert Litan, an economist at the Brookings Institution, quoted in a side-bar to the article: “By and large government retraining programs don’t work. The best training takes place on the job.” Amen.

Let’s also add that the best way to protect American jobs is not to focus narrowly on the training of individual workers. Instead, we need to figure out how aggressively build the capabilities of groups of workers – it’s not just about skills, it’s about shared practices and  the processes required to amplify the value of these shared practices.

Finally, let’s also recognize that this is not a one-time challenge, but an ongoing requirement.  What matters is not just relative skill levels or organizational capability at any point in time, but the relative pace and trajectory of capability building. The growing competitiveness of Asian companies is not just due to their lower wage rates or access to large pools of educated workers. It increasingly stems from their mastery of management techniques that enable them to get better faster by working with others.

If we recognize all this, the search for answers shifts squarely onto companies, not individual workers or government policy. Companies need to re-conceive their role. American companies, responding in part to impatient financial markets, have increasingly focused on efficiency, especially in terms of near-term cost reduction.  This focus is driving the current trends towards offshoring and outsourcing. Efficiency is essential, but it is not sufficient.

Rather than viewing themselves as narrow efficiency engines, companies need to re-conceive their roles in terms of accelerating capability building. In an increasingly competitive global economy, the reason people will join companies is because they believe that they can get better faster by working with others in a company rather than acting as free agents.  If companies don’t deliver against this expectation, they will find it harder and harder to attract and retain talented employees. Delivering against this expectation will require a much greater focus on growth and innovation, rather than narrow efficiency.  It will also require deeper skill in collaborating with other highly specialized companies to get better even faster.

Let’s face it, one reason our schools are not graduating more engineers is that students look out into the job market and don’t see as much advancement opportunities for engineers and scientists as in years past.  This is not just a problem of our educational system – it’s a problem of opportunity creation by our companies.

I have a growing concern that corporate executives are beginning to use our educational system as a scapegoat. Sure, it is broken – severely broken. It may even need to be fundamentally re-conceived rather than reformed. But it is far too convenient for CEO’s to point the finger at our educational system and avoid looking at what their own companies need to be doing to create more opportunities to pull and develop talent.

A similar concern applies to immigration policy.  One of my biggest concerns is the growing trend of Asians who already reside in the U.S. deciding to return to their home countries.  What is driving this?  There are many factors, but one that my Asian acquaintances increasingly cite as they pack up and move out is that they have become convinced that the most significant opportunities for advancement are now over in Asia rather than here. We can relax immigration policy as much as we want but, if the best and brightest in Asia perceive that their best opportunities for advancement are at home, these policy reforms will have little impact.

The answers to the challenges outlined in the Fortune article begin in the executive boardroom.  Before pointing the fingers at others, executives need to ask themselves three basic questions:

• What is the really distinctive capability that will allow us to compete successfully in the global economy?
• What do we need to do to get better faster in these areas?
• How can we learn to work with other companies in ways that help all partners to get better even faster?

The Fortune article asks “where to start?”  Senior executives should start by looking in the mirror and asking themselves hard questions about what their own companies need to do to get better faster.  By spending so much time on public policy and the workers themselves, Fortune did its readers a disservice. Sure, there is a lot to be done on those fronts as well, but the senior executives that Fortune targets as its readers can have the greatest impact by focusing on their own companies first. The article would have been a lot more powerful if Fortune had begun with what its own readers could do.