C.K. Prahalad
•
The Global Middle Class
•
sYlVia Nasar
strategy+business Published by Booz & Company
manufacturing ’ s
wake-up call The Challenge for U.S. CompeTiTiveneSS
Issue 64, Autumn 2011 US $12.95 Canada C$12.95
The riSe of DigiTal fabriCaTion
www.strategy-business.com
“YOU CAN APPLY
EVERYTHING BACK TO YOUR COMPANY. THESE ARE LESSONS YOU WILL ALWAYS REMEMBER.” — Sreeja Kartha Program for Leadership Development 2011
The world’s top executives often need to step outside their organizations to acquire the skills, knowledge, and leadership to successfully address today’s critical business issues. The comprehensive leadership programs at Harvard Business School Executive Education are where they convene. Email us at clp_info @hbs.edu or visit www.exed.hbs.edu/pgm/clp/
HARVARD
“I CAME TO EXPLORE WHAT DRIVES
THE BUSINESS OF MEDICINE. BUT I LEFT WITH SO MUCH MORE.” — Dr. Michael Jaff General Management Program 2010
Learn More
comment editor’s editor’sletter letter comment
Illustration by Lars Leetaru
Disruption and Its Aftershocks The articles in this issue address three major disruptions that have taken place in recent years: the rise of newly competitive emerging economies, the near collapse of an overreaching financial sector, and the business model–dissolving maturation of computer technology. As anyone who has lived through a disruptive event knows, it takes a special skill to lead during the period that follows. You must manage through the aftershocks, while recovering — and help others recover — a belief in building for the future. Before his untimely death in April 2010, C.K. Prahalad was a great scholar of disruption. We are proud to publish in this issue an article he was working on with executive Hrishi Bhattacharyya, who completed it (page 54). It describes a business model with the flexibility and power to manage the burgeoning consumption and competition in emerging markets. In “Competing for the Global Middle Class” (page 62), s+b contributing editor Edward Tse, along with his Booz & Company colleagues Bill Russo and Ronald Haddock take that theme further
by explaining how new markets generate new competitors. And in “The New Web of World Trade” (page 70), Booz & Company senior partners Joe Saddi, Karim Sabbagh, and Richard Shediac trace another group of aftershocks — the evolution of capital, trade, and talent flow among emerging economies, with the Gulf states taking the lead. As for the economic disruption, one ongoing aftershock is the long cycle of seemingly intractable unemployment. In “Manufacturing’s Wake-Up Call” (page 30), Booz & Company manufacturing experts Arvind Kaushal, Thomas Mayor, and Patricia Riedl trace one choice facing the United States: Ignore manufacturing and watch the nation’s prosperity decline, or take the radical steps needed to revitalize it. For counterpoint, we feature commentator Clyde Prestowitz (page 10) on competitiveness, University of Michigan professors Wally Hopp and Roman Kapuscinski (page 36) on manufacturing education, Kaj Grichnik and Jerome Pellan on the dilemma facing France (page 40), and Brian Collie, Scott Corwin, and Patrick Mulcahy on the outlook for the U.S. auto industry (page 6).
The technological disruption is covered by researchers Tom Igoe and Catarina Mota in “A Strategist’s Guide to Digital Fabrication” (page 44), wherein they tour this remarkable aftershock of the IT revolution. To pull all this together, see executive editor Rob Norton’s interview with Sylvia Nasar, whose book Grand Pursuit: The Story of Eco nomic Genius (Simon & Schuster, 2011) recounts the many ways in which disruptions have been shaped by economic theories (page 80). You’ll see some changes in our masthead this quarter. Staffers Jonathan Gage, Alan Shapiro, and Chris Bojanovich have moved on. We wish them all well, and welcome Gretchen Hall, Charity Delich, and Bevan Ruland in their new roles. Further changes, including new features like comments, are happening on s+b’s website, www .strategy-business.com. In print and online, we will continue to seek out insights into the disruptions, the aftershocks, and the rebuilding that hopefully follows. Art Kleiner Editor-in-Chief
[email protected] 1
comment
30
LEADING IDEAS
6
Is the U.S. Auto Industry Ready for Growth? Brian Collie, Scott Corwin, and Patrick Mulcahy The outlook for manufacturers and suppliers may be bullish, but a new survey shows that industry executives see big challenges ahead.
10
The Case for Intelligent Industrial Policy Art Kleiner, Arvind Kaushal, and Thomas Mayor Economic strategist Clyde Prestowitz argues for better support for manufacturing.
14
How to Prepare for a Black Swan Matthew Le Merle Disrupter analysis can help assess the risks of future catastrophic events.
16
10 Clues to Opportunity Donald Sull Market anomalies and incongruities may point the way to your next breakthrough strategy.
44
DATA POINTS
19
Finding Shoppers Where They Live
ENERGY
20
Renewable Energy at a Crossroads Christopher Dann, Sartaz Ahmed, and Owen Ward The wind, solar, biomass, and geothermal sector has grown in fits and starts — and is now poised to become a self-sustaining industry. HEALTHCARE
26
Transforming Healthcare Delivery Joyjit Saha Choudhury, Akshay Kapur, and Sanjay B. Saxena As governments seek to expand services more costeffectively, the stakeholders must collaborate.
62
Correction, Issue 63: In “CEO Succession 2010: The Four Types of CEOs,” by Ken Favaro, Per-Ola Karlsson, and Gary L. Neilson, the citations for “Putting Headquarters in Its Place” should have read: “Gary Neilson, Etienne Deffarges, Paul Kocourek, and John Elting Treat, ‘Putting Headquarters in Its Place: The New, Lean Global Core,’ Booz Allen Hamilton white paper, 1999.”
features
conversation
COVER STORY: OPERATIONS & MANUFACTURING
30
Manufacturing’s Wake-Up Call
THOUGHT LEADER
80
Rob Norton The renowned author discusses how the great economists uncovered the basic truth about progress, prosperity, and productivity, and the reasons you should be careful which ideas you listen to.
Arvind Kaushal, Thomas Mayor, and Patricia Riedl A new study shows how the decisions made today by goods producers and policymakers will shape U.S. competitiveness tomorrow. 36 Revitalizing Education for Manufacturing
Wally Hopp and Roman Kapuscinski 40 France Faces a Dilemma
BOOKS IN BRIEF
90
Closing implementation gaps, the enduring principles of high-tech success, and Toyota’s crisis.
OPERATIONS & MANUFACTURING
A Strategist’s Guide to Digital Fabrication Tom Igoe and Catarina Mota Advances in manufacturing technology point to a decentralized, disruptive “maker” culture, with implications for many forms of enterprise.
In Pursuit of Happiness David K. Hurst
Kaj Grichnik and Jerome Pellan
44
Sylvia Nasar
END PAGE: RECENT RESEARCH
96
Putting a Dollar Value on Academic Business Research Matt Palmquist MBA students who attend schools where teachers publish frequently end up earning more.
Cover illustration by Doucin Pierre
GLOBAL PERSPECTIVE
54
How to Be a Truly Global Company C.K. Prahalad and Hrishi Bhattacharyya Multinationals need to integrate three strategies — customization, competencies, and arbitrage — into a more relevant business model. GLOBAL PERSPECTIVE
62
Competing for the Global Middle Class Edward Tse, Bill Russo, and Ronald Haddock How three types of companies are jockeying to capture the loyalty of billions of new consumers. GLOBAL PERSPECTIVE
70
The New Web of World Trade Joe Saddi, Karim Sabbagh, and Richard Shediac The Gulf economies are forming partnerships with other emerging markets, redefining the trade routes that once linked East and West.
Published by Booz & Company
Issue 64, Autumn 2011
www.strategy-business.com
strategy+business
Published by Booz & Company
editOriAl Editor-in-Chief Art Kleiner kleiner_art@ strategy-business.com
Executive Editor Rob Norton norton_rob@ strategy-business.com
Managing Editor Elizabeth Johnson johnson_elizabeth@ strategy-business.com
Senior Editor Karen Henrie henrie_karen@ strategy-business.com
Deputy Managing Editor Laura W. Geller geller_laura@ strategy-business.com
Senior Editor Jeffrey Rothfeder rothfeder_jeffrey@ strategy-business.com
Senior Editor, s+b Books Theodore Kinni editors@ strategy-business.com
Chief Copy Editor Victoria Beliveau editors@ strategy-business.com
Information Graphics Linda Eckstein editors@ strategy-business.com
Assistant to the Editors Natasha Andre andre_natasha@ strategy-business.com
Designer Mika Osborn
[email protected] Contributing Editors Barry Adler Edward H. Baker Denise Caruso Melissa Master Cavanaugh Tom Ehrenfeld
Ken Favaro Bruce Feirstein Lawrence M. Fisher Ann Graham Sally Helgesen William J. Holstein
David K. Hurst Jon Katzenbach Tim Laseter Gary L. Neilson Matt Palmquist Sheridan Prasso
Randall Rothenberg Michael Schrage Edward Tse Christopher Vollmer
Publisher and Business Manager Gretchen Hall Tel: +1 212 551 6003 Fax: +1 212 551 6732 hall_gretchen@ strategy-business.com
Marketing and Client Service Manager Charity Delich Tel: +1 212 551 6255 delich_charity@ strategy-business.com
Advertising Director Judith Russo Tel: +1 212 551 6250 Fax: +1 212 551 6732 russo_judy@ strategy-business.com
Advertising and PR Coordinator Brooke Clupper Tel: +1 212 551 6013 Fax: +1 212 551 6732 clupper_brooke@ strategy-business.com
Business Operations and Permissions Bevan Ruland Tel: +1 212 551 6159 Fax: +1 212 551 6732 ruland_bevan@ strategy-business.com
Financial Reporting Taryn Grace DiazHarrison
Circulation Director Beverly Chaloux Circulation Specialists Inc. bchaloux@circulation specialists.com
Production Director Catherine Fick Publishing Experts Inc. cfick@publishing experts.com
European Advertising Representative Michael Weatherall Tel: +44 7770 232227 michael@ mwa-media.com
Chairman Joe Saddi
Chief Executive Officer Shumeet Banerji
Chief Operating Officer Cesare Mainardi
Chief Marketing and Knowledge Officer Thomas A. Stewart
Marketing Advisory Council Paul Leinwand Fernando Fernandes Klaus-Peter Gushurst Barry Jaruzelski Karim Sabbagh
Editorial and Business Offices 101 Park Avenue New York, NY 10178 Tel: +1 212 551 6222 Fax: +1 212 551 6732
[email protected] Design Services Opto Design Inc. 153 W. 27th Street, 1201 New York, NY 10001 Tel: +1 212 254 4470 Fax: +1 212 254 5266
[email protected] Retail Comag Customer Service Tel: +1 800 223 0860
Back Issues Tel: +1 800 810 1404 Outside the U.S., +1 817 685 5626
Subscriber Customer Services Tel: +1 877 829 9108 Outside the U.S., +1 570 567 0433
Deputy Art Director Art Director Jessie Clear John Klotnia
[email protected] [email protected] Web Editor Bridget Finn finn_bridget@ strategy-business.com
PuBlishiNg
BOOZ & COMPANY
Reprints www.strategybusiness.com/reprints Tel: +1 703 787 8044
strategy+business magazine contains only paper products that the Forest Stewardship Council™ certifies have come from well-managed forests that contribute to conservation and responsible management.
customer_service@ strategy-business.com www.strategybusiness.com/ subscriber strategy+business P.O. Box 634 Williamsport, PA 17703
strategy+business (ISSN 1083-706X) is published quarterly by Booz & Company Inc., 101 Park Avenue, New York, NY 10178. ©2011 Booz & Company Inc. All rights reserved. “strategy+business,” “Booz & Company,” and “booz&co.” are trademarks of Booz & Company Inc. No reproduction is permitted in whole or part without written permission from Booz & Company Inc. Postmaster: send changes of address to strategy+business, P.O. Box 1724, Sandusky, OH 448711724. Annual subscription rates: United States $38, Canada and elsewhere $48. Single copies $12.95. Canada Post Publications Mail Sales Agreement No. 1381237. Canadian Return Address: P.O. Box 1632, Windsor, ON, N9A 7C9. Printed in the U.S.A.
on iPad and iPhone Download our free App on the App Store℠ and get instant access to the best ideas in business with a complementary issue of strategy+business
Published by Booz & Company customized feeds of s+b’s award-winning content / issue archives / swipe navigation / direct article links from table of contents / choice of magazine format or plain-text reading / social-media content sharing through Facebook, Twitter, e-mail, and more
The outlook for manufacturers and suppliers may be bullish, but a new survey shows that industry executives see big challenges ahead. by Brian Collie, Scott Corwin, and Patrick Mulcahy
T
o many people, the U.S. auto industry appears to be on the mend. After an epic sales collapse in the wake of the 2008–09 recession, General Motors, Ford, and Chrysler were all profitable again in early 2011, and European and Korean manufacturers in the U.S. were also enjoying strong results. Only the Japanese transplants are facing earnings pressure, as they wrestle with massive disruptions to their global supply chains and production facilities, due to the earthquake and tsunami at home. Although the U.S. has slipped to number two behind China in auto sales, the U.S. market is still among the world’s most profitable, thanks to consumers’ enthusiasm for high-margin luxury cars, SUVs, and light trucks. Leading forecasters predict that light-vehicle sales in the U.S. will rise to more than 16 million in 2015, up from 11.6 million in 2010. Yet auto industry insiders themselves are anything but sanguine. A Booz & Company survey of more than 200 executives from 40-plus automakers and suppliers revealed more modest expectations — only 13.5 million in vehicle sales in 2013 and 14.5 million in 2015. The rea-
son: By the executives’ own reckoning, most automobile companies have not fully gotten their managerial houses in order. Almost half of the survey respondents said that the auto industry restructuring of 2009–10 did not go far enough. Two-thirds said that automakers and auto suppliers in general were not yet on a path to achieving sustained, full returns on invested capital. In fact, the auto executives viewed the overall tenuousness of their industry as so potentially serious that almost 30 percent said they expect a major automobile company to fail in the next two years. For U.S. auto companies, the bankruptcies and restructurings — as well as the stronger focus on lean factories and new union agreements that grew out of the recession — have significantly reduced operational costs, sanitized balance sheets, and eliminated health and pension legacy expenses, or at least helped to make them more manageable. In many ways, however, those steps were the bare minimum necessary for the industry to survive the downturn. As Edward Tse, Bill Russo, and Ronald Haddock suggest in “Competing for the Global Middle Class” (page 62), car sales are increasing rapidly in the dynamic new global middle class of emerging markets — but new competitors are
strategy+business issue 64
Leading Ideas
comment leading ideas 6
Is the U.S. Auto Industry Ready for Growth?
Ninety percent of carmaker executives said Chinese automakers would be making cars equal in quality to American-made vehicles by 2021. other words, the executives said they believe that companies like Geely Automobile Holdings, which acquired the Volvo brand from Ford, and BYD Company, partially owned by Warren Buffett, will achieve in 10 years what Toyota and other Japanese companies took 30 years, and Korean automakers took 20 years, to do.
Exhibit 1: Key Challenges Facing Auto Manufacturers Survey respondents from automakers cited increasing competition, pricing, costs, and the macroeconomic environment as most critical. Importance of challenge (% of respondents) Increasing competition Pricing Cost position Macroeconomic situation Labor relations/Legacy costs Financial position Product Manufacturing capacity Dealer capabilities Regulatory requirements Winning strategy Management team Sales and marketing Supplier relations Source: Booz & Company
76%
52% 28%
52%
21%
52%
21%
45%
17%
34%
17%
31%
14%
38%
14%
34%
7%
28%
3%
28%
3%
21%
3%
21% 21% 10%
For auto suppliers, the future is uncertain as well — not because of potential changes in industry dynamics some years down the road, but rather because of a problem they have struggled with for at least a decade: Many find themselves unable to command full value for their products. Owing to an overabundance of competitors in most product categories, many suppliers lack
One of the TWO most important challenges One of the FIVE most important challenges
the leverage to set terms with their automaker customers that would allow them to earn a positive return on their invested capital. They’ve become, in effect, low-cost order takers. As a result, many suppliers find themselves too short of cash to invest heavily in research and development. But that investment is imperative if they hope to distinguish their products from their competitors’ and go beyond merely selling commodities. Not surprisingly, given the dynamics of supplier relationships with the automakers, the two most widely chosen concerns expressed by suppliers in the survey involved cost position and engineering, research, and development (ER&D)/ innovation. (See Exhibit 2, page 8.) “A product’s price is directly proportional to the value it creates,” says David Johnson, chief executive officer of Achates Power Inc., which is developing an energy-efficient engine. “Any time that you aren’t delivering a unique technology or unique features that will create mar-
comment leading leadingideas ideas
Korean, and European rivals are certainly formidable competitors, the looming presence of Chinese companies casts the largest shadow. Fully 90 percent of these executives said that Chinese automakers would be making cars equal in quality to American-made vehicles by 2021. About half of all survey respondents, from manufacturers and suppliers, said this could occur by 2016. In
also proliferating to serve this market. Can today’s automakers continue to thrive in an industry that will be more in flux and more competitive than ever before? According to the survey, auto executives themselves are not sure. “If you look at the industry before the sales downturn, it was hyperinflated,” says Ernest Bastien, vice president of retail market development at Toyota USA. “People were using their home equity and easy-to-get loans to take advantage of extraordinary incentives that were being offered. In fact, the industry was not as robust as it looked. Going forward, automakers are going to have to rely on a more fundamental but complex equation for growth: making the right amount of great, high-quality cars and proving to consumers that their brand is the best in terms of total cost of ownership, drivability, and reliability.” When asked to rank their companies’ most critical challenges, more than 50 percent of the manufacturing executives surveyed chose increasing competitive pressure. (See Exhibit 1.) And although Japanese,
7
Survey respondents from auto industry suppliers cited improving their cost position, innovation, and macroeconomic factors as most critical. Importance of challenge (% of respondents) Cost position ER&D/innovation 27% Macroeconomic factors 26% Customer responsiveness 22% Product 17% Undifferentiated position 16% 37% Excess industry capacity 14% 32% New entrants 7% 28% Financial position 6% 29% Market insight 4% 26%
58%
87% 69% 67% 58% 62% One of the TWO most important challenges One of the FIVE most important challenges
Source: Booz & Company
ket demand or fill a real need in the market, your product becomes commoditized, and the next thing you are doing is price and quality competition. That is not a long-term winning formula.” Clearly, suppliers have a long way to go to improve their relationships with automakers and to drive more value into their products. But according to the survey, auto suppliers do not see the path they need to take to get there. When asked to name the most important keys to winning, most suppliers did not cite two facets of a business’s operations that routinely count among the prerequisites for long-term viability: a well-defined strategy and deep market insight. Understandably, no business leader would argue against the importance of achieving the low cost position or providing superior customer service. But without a well-defined strategy rooted in deep market insight, it is nearly impossible to achieve a sustainable, differentiated position — which, in the end, is key to capturing the value created. Given the responses to the survey, and taking a close look at current conditions in the U.S. auto industry, automakers and suppliers
face different priorities in the United States (and elsewhere in the world). The automakers must: • Focus even more intensely on building attractive vehicles and rebuilding brands. Cars and trucks are still among the most visible, emotional purchases consumers make. In the current frugal and practical environment, U.S. car buyers need to be given reasons to “fall in love” again. • Create vehicles with exciting design and styling; superior quality, reliability, and durability (QRD); and technological innovation. Although the QRD of vehicles sold in the U.S. is better than ever, meaningful gaps still exist between the highest-ranked companies and the rest of the pack, especially in longerterm reliability and durability. In addition, as breakthrough innovations in safety, “connected vehicle,” and power-train technologies emerge, new opportunities must be created to deliver differentiated value to consumers and drivers. • Make sure that each vehicle produces a positive return on investment. Hoping that a few blockbusters will generate most of the portfolio’s returns — as many automakers
have done in the past — is no longer sustainable in a more competitive and smaller U.S. market. • Continue minimizing relative material and structural costs while bringing new technology to market cost-effectively, earning fair returns for product innovation. • Prepare cost structures and innovation processes for a more globally competitive landscape. Auto suppliers should: • Accelerate efforts to find greater leverage with high-quality product lines. This means a supplier must innovate wisely, focusing on features that consumers are willing to pay for, creating end-user pull, and establishing itself as the company best positioned to help solve manufacturers’ problems. • Better manage portfolios, focusing on the markets where the suppliers have the greatest capabilities and opportunities to create a sustained competitive advantage, and to meet changing market needs. Although some companies are able to prosper making disparate components, most do not have the resources and skills to do it well. • Continue to aggressively manage costs. Suppliers reduced operational and structural costs during the downturn. Now, they need to make sure that these expenses don’t creep back in as volumes ramp up. They must also discipline themselves to stop chasing automaker contracts that cost more than they return in the long run. Where possible, suppliers and auto manufacturers should promote collaborative costbased agreements that give manufacturers full transparency into relevant supplier operations and, in exchange, allow suppliers to earn a fair return on investment.
strategy+business issue 64
comment leading ideas 8
Exhibit 2: Key Challenges Facing Auto Suppliers
solidation is likely to intensify. For each core business, suppliers should decide: Am I a buyer or a seller? The U.S. auto industry is in a period of extraordinary transition. Whether one considers alternative drive trains, or ways to fine-tune designs and manufacturing processes, or a raft of new global competitors, it’s fair to say that only the most flexible, lean, and well-managed companies will survive. With that in mind, perhaps the survey’s greatest value is its central finding: Despite the general optimism in the auto industry today as well as the real improvements in efficiency, quality, and lean practices that have been made, many executives are still bracing for further change. They will need all the courage, and skill, they can muster. + Reprint No. 11301
Brian Collie
[email protected] is a principal with Booz & Company in Chicago. He specializes in working with automotive and industrial clients in the areas of business unit transformation, new market entry, and corporate strategy. Scott Corwin
[email protected] is a partner with Booz & Company based in New York. He has extensive experience in assisting clients in developing creative and pragmatic growth strategies for the automotive, media, and consumer industries. Patrick Mulcahy
[email protected] is a senior associate with Booz & Company based in Cleveland. He focuses on product strategy and M&A for automotive and industrial clients. For a detailed analysis of this survey, see “Facing New Realities: What Comes Next for the U.S. Auto Industry”: www.booz.com/ media/uploads/Facing_New_Realities.pdf.
comment leading ideas
• Recognize that industry con-
Economic strategist Clyde Prestowitz argues for better support for manufacturing. by Art Kleiner, Arvind Kaushal, and Thomas Mayor
10
S
tarting with his role as an advisor to the secretary of commerce in the Reagan administration in the 1980s, and progressing to his current position as founder and president of the Economic Strategy Institute in Washington, D.C., Clyde Prestowitz has been a consistent voice on the importance of manufacturing in economic competitiveness. Although the title of his most recent book, The Betrayal of American Prosperity: Free Market Delusions, America’s Decline, and How We Must Compete in the Post-Dollar Era (Free Press, 2010), might seem alarmist to a global audience, Prestowitz’s perspective is nuanced and oriented toward fundamentals. He argues for sustained industrial policy at a national level: for marshaling the forces of business leaders, government officials, labor unions, and academics for the sake of building economic competitiveness and (especially) a strong and distinctive manufacturing base. He also argues that the global economy is more likely to thrive when more countries manage their economies this way, competing wholeheartedly even as they trade avidly. Prestowitz focuses on manufacturing in the U.S.; its decline and revitalization have been a theme in
his work since his first major book, Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It (Simon & Schuster, 1988). He sat down with strategy+business at the Manufacturing Executives Forum, which Booz & Company conducted in Chicago in May 2011. S+B: How did you come to realize the significance of manufacturing to economic vitality? PRESTOWITZ: I grew up in a manu-
facturing environment. My dad worked in the steel products industry, and I visited the original Bethlehem steel mill many times as a boy. The Bethlehem Steel Corporation started to consistently lose money in the early 1980s; it declared bankruptcy in 2001 and closed in 2003.
MIKA: PLS PLACE SPECTRA’S HIRES WHEN AVAILABLE
Clyde Prestowitz
Photograph courtesy of Clyde Prestowitz
comment leading ideas
The Case for Intelligent Industrial Policy
The old steel mill was then replaced with a casino. The passage from steel mill to casino says a lot about the trajectory of the U.S. economy, and about the declining quality of life for the middle class when there is no manufacturing base. Manufacturing, more than other activities, is critical to prosperity because it generates economies of scale. It also sparks innovation, wholly new products and industries. And it has great multiplier effects: Every factory needs accountants, sandwich shops, component suppliers, and other services. One dollar invested in manufacturing creates two dollars or more of income for ancillary industries. By contrast, a dollar invested in retail creates about 45 cents of additional income. Finally, international trade overwhelmingly involves goods. When countries like the United States have trade deficits, they are primarily in manufactured goods. Those trade deficits take away jobs. If you want to get those jobs back, there’s only one way: You’ve got to support manufacturing. I remember, back in the 1980s, debating about whether to subsidize the American aircraft industry against the European upstart Airbus. George Shultz [then secretary of state] said that the Europeans, by subsidizing Airbus, were only hurting themselves — taxing people to pour money down a corporate rathole. Even if he was right, he was ignoring the damage done to our aircraft industry in the U.S. — and the people employed by it, directly and indirectly. Any country that wants to survive needs to focus on the industries that it wants to keep, and support them wholeheartedly. For the past 25 years, U.S. economic policy has been driven by
S+B: For executives of multinational companies, it might seem counterintuitive to focus on the prosperity of their home country as opposed to global economic growth. PRESTOWITZ: I agree that it’s wrong
for the U.S., or any other country, to adopt a zero-sum mentality. For example, a rich and dynamic China can be of great benefit to the United States — but not necessarily. It depends to a tremendous extent on what kinds of policies the two countries adopt. The conventional economic view is that unfettered global free trade will automatically produce optimal results — that China’s gains will also be the United States’ gains, and vice versa. But that view is based on simplistic assumptions: no economies of scale, no transfer of technology or capital across borders. Paul Krugman won a Nobel Prize largely because he pointed out the problems with these assumptions. There are two kinds of global companies. In the United States, the purpose of the corporation is primarily to provide optimal returns to shareholders. This leads to a focus on optimizing short-term results. In continental Europe and most of Asia, the state charters the corporation and gives it a lot of specific ben-
comment leading ideas
consumer welfare, by trying to achieve the greatest variety of goods at the lowest prices, without any focus on producers. This combines with the notion that it doesn’t matter what we make, or how we make it, because globalization will even things out in the end. One top official once said to me, “Clyde, don’t worry. The Japanese will sell us cars, and we’ll sell them poetry.” But now we need jobs, and for that, we need manufacturing.
S+B: What do you mean by a coherent industrial policy? PRESTOWITZ: There’s a lot of mis-
understanding about this. It’s associated with pre–World War II Britain and France, whose governments supported particular companies as national champions. People assume it means having governments pick winners and losers. Look instead at countries like Singapore, Sweden, Taiwan, Germany, Korea, Switzerland, Finland, and China. They’re all very different; some are democratic, others are authoritarian. The Finns and Swedes have strong labor unions, whereas unions in Taiwan and Singapore are weak. But all these countries are economically successful for the same reasons. First, their governments focus on being competitive by promoting selected high-value-added industries, with a long planning horizon. Second, they have a high level of coordination among the government, labor unions, and business management, in investment decisions, wages, and inflation rates. They don’t pick winning companies; instead, they build a consensus on what each of them has to do to contribute [to building a vibrant industry]. Compared to other countries that have taken a more laissezfaire approach, their performance is far superior. S+B: This approach implies a very nuanced attitude toward economic policy — being neither all open nor all closed. PRESTOWITZ: Absolutely. It means
you have to think about how you in-
vest. President Obama is currently [in June 2011] putting money into developing green energy. That’s admirable, but the amount is relatively small compared with the massive programs supporting the same industries in China, Japan, Korea, Germany, and Denmark. And producers of green energy products in those countries have free access to the U.S. market, with much bigger
market and prevented Japanese dumping [selling underpriced goods to drive out competition] in the U.S. market. That was a sensible policy. It was followed by similar agreements with Korea and others. Also in 1987, the government and 14 companies launched Sematech (the name Sematech derived from Semiconductor Manufacturing Technology), which was a
“Successful governments promote selected high-value industries, with a long planning horizon.” scale than the U.S.-based producers have, because their governments have created much bigger projects. If the U.S. really wants to create a viable green industry, it will take more money — but money is not enough. U.S. policies for trade, investment, and research and development all have to fit together, taking into consideration what other countries are doing, and finding a few niches in which to develop dominance. S+B: Is there a good model of some sector that has made this kind of investment work? PRESTOWITZ: The American semi-
conductor industry has handled itself very well over the years. In the 1980s, it was weakened by Japanese, Korean, and Taiwanese competitors, all supported by their countries’ industrial policies. U.S. industry leaders explained it to the requisite officials in the U.S. Commerce Department and persuaded them to act. The result was the U.S.–Japan Semiconductor Agreement of 1986; it effectively guaranteed U.S. producers 20 percent of the Japanese
50/50 government–industry consortium aimed at maintaining the competitiveness of U.S. semiconductor equipment manufacturers. [In 1994, Sematech’s board voted to discontinue federal support on the grounds that the U.S. semiconductor industry had fully recovered; the organization continues today as an international innovation consortium.] S+B: What do you say to business or government leaders who, rightly or wrongly, don’t trust one another enough to act this way? PRESTOWITZ: It should not be that
difficult a problem. Industry needs government all the time — often in ways that it doesn’t fully acknowledge. I hear CEOs talking about how they hate to go to Washington, and how U.S. taxes are too high. At the same time, they want Washington to do more to protect their intellectual property from appropriation by Chinese companies. They complain about the official “buy China” rules [forcing companies that want to sell goods in China to produce there]. And to whom do they com-
strategy+business issue 64
comment leading ideas 12
efits; in exchange, the corporation provides benefits to society. This leads naturally to embracing a coherent industrial policy.
S+B: You’re asking for sweeping changes in the way some policymakers think. How do we get from here to there, especially in a very partisan political climate? PRESTOWITZ: It probably takes a
crisis. I think the last economic crisis wasn’t bad enough to force the
changes we need. We should have nationalized the banks or gotten rid of their management. The bankers should have taken a haircut. And we should have much more discipline on Wall Street. The world is going to be tougher for Americans than it was between 1945 and 2000, when the U.S. had absolute economic dominance. That wasn’t normal; we’re just getting back to normal now. But within that new normal, I have great confidence that the United States can maintain a high and rising standard of living. If I think of the global economy like a game of bridge, I think the U.S. has a better hand of cards than any other player: better than the European Union, Japan, China, or India. But as any bridge player knows, it’s very possible to have good cards and lose if you don’t
play the cards well. The U.S. has not been playing its cards well for quite some time. If we change the quality of our game, we won’t have to begrudge China’s success — or the success of Brazil, India, or anyone else. We can all be successful. +
comment leading ideas
plain? To the U.S. government. An astute government official would take advantage of this situation. He or she would do more to enforce international intellectual property rules, and respond more fiercely to China’s innovation policies [in which countries entering China are forced into R&D-sharing joint ventures]. But the official would also say to the CEO, “I’m taking care of my part of the deal, but you need to think more broadly as well.”
Reprint No. 11302
Art Kleiner
[email protected] is editor-in-chief of strategy+business. Arvind Kaushal
[email protected] is a partner with Booz & Company in Chicago. He leads the firm’s North American manufacturing team. Thomas Mayor
[email protected] is a Booz & Company senior executive advisor based in Cleveland, where he focuses on developing operations strategies and leading business transformation programs for the global aerospace, automotive, and industrial sectors.
13
Disrupter analysis can help assess the risks of future catastrophic events. by Matthew Le Merle
14
A
number of unexpected catastrophes and shortages dominated the headlines in the first quarter of 2011. Japan was hit by a magnitude 9.0 earthquake and tsunami that caused a nuclear disaster, persistent power outages, and a host of other major societal and economic challenges. China sharply tightened its limits on exports of rare earth minerals, on which the information technology, automotive, and energy industries rely. The nations of the Middle East and North Africa experienced severe political eruptions, including civil war in Libya and regime-shaking protests in Algeria, Egypt, Iraq, Jordan, Syria, and Tunisia, which pushed oil prices above US$100 per barrel. Portugal and Greece tottered on the edge of insolvency, destabilizing their political leaders. Christchurch, New Zealand, was hit by two major earthquakes in quick succession, and the state of Queensland in Australia suffered the worst floods in recorded history in at least six river systems, resulting in great social and economic disruption. All these events are examples of the kinds of high-magnitude, lowfrequency upheavals that Nassim Nicholas Taleb labeled black swans, after a historical reference to their improbability. In The Black Swan:
The Impact of the Highly Improbable (Random House, 2007), Taleb defined a black swan as “an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact…. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.” Whether environmental, economic, political, societal, or technological in nature, individual black swan events are impossible to predict, but they regularly occur somewhere and affect someone. Some observers argue that the frequency of these events is increasing; others say global communication networks have simply made us more aware of them than we were in the past. In any case, with the rise of global business, it is likely that black swans carry increased risks for your company, including negative impacts on your customers, suppliers, partners, assets, operations, employees, and shareholders. Today, not only can a catastrophe in one part of the world affect the sourcing, manufacture, shipping, and sale of products locally, but the interconnections of global financial, economic, and political networks ensure that the ef-
ERM Is Not Enough
Typically, a large company relies on its enterprise risk management (ERM) department to identify potential business disruptions, map out their most likely effects, and develop mitigation plans and preventive actions to reduce the risk exposures. After the multiple and severe disruptions of the past decade, starting with the terrorist attacks of September 11, 2001, the ERM functions at most companies have become well staffed with risk managers who work diligently to protect their company across strategic, operational, financial, and hazard risk categories. Through this process, ERM has become an indispensable member of the global functional teams in most large companies. Most ERM groups focus their attention on the risks that businesses most frequently encounter — such as whether the enterprise is complying with regulations, suitably accounting for its activities, and operating in an ethical and legal manner — rather than on black swans. And this approach is appropriate. First, ERM resources are limited and must be invested in mitigating highfrequency risks, as well as servicing the growing demands imposed by Sarbanes-Oxley and other financial and regulatory requirements. Second, high-magnitude, low-frequency events can stem from sources too numerous and too varied for the ERM team to identify in full. Third, the internal politics and culture of many large companies unintentionally create blind spots that can be very difficult to penetrate for internal staff members using standard ERM tools.
strategy+business issue 64
comment leading ideas
How to Prepare for a Black Swan
fects of such events ripple around the world.
Photograph © Miguel Vidal/Reuters/Corbis, modified by Opto
A Disrupter Analysis Stress Test
The solution to this conundrum is disrupter analysis. Disrupter analysis does not seek to predict black swans; that cannot be done. And it is not meant to replace ERM, but rather to complement it. Disrupter analysis — which is typically conducted by a separate team working in collaboration with the ERM staff, functional and business unit leaders, and senior management — is designed to periodically administer a stress test to a large company in order to assess its ability to with-
stand black swans. The analysis consists of a fourstep process that will be familiar to professional ERM managers. It quickly and efficiently maps the shape of the enterprise, determines the breadth of potential disrupters, asks the “what ifs” to determine how severely certain events could stress the enterprise, and then implements the contingency plans. 1. Mapping the enterprise. The shape of a company is determined by a number of factors, starting with its geographic footprint, its operations, the composition and construction of its supply chain, and its channel partners and customers. In mapping these elements, it is important to look beyond first-order relationships. Recently, for example, Apple’s supply of lithium-ion batteries, used in iPods, suddenly dried up. Unfortunately, as Apple quickly discovered, almost all its suppliers purchased a critical polymer used to make the batteries from the Kureha Corporation, a Japanese company whose operations were disrupted by
the March 11 earthquake. In fact, Kureha’s share of the global market for polyvinylidene fluoride, which is used as a binder in lithium-ion batteries, is 70 percent. This is why analysts must also map second-order relationships (the suppliers of the company’s suppliers). In some critical cases, even third-order relationships should be mapped. After the shape of the enterprise has been mapped with the help of the ERM staff, finance and other group functions participate in team sessions to map sources and concentrations of revenue, profit, and capital. Then the often-hidden concentrations that exist in go-to-market activities — including the business’s products, services, channels, and customers — are considered. A determination of the company’s shape must also include a mapping of industry structure and competitive dynamics, as well as the firm’s position in both. To determine how a black swan event could stress a company, the team needs to understand the foundation on which the status quo rests. 2. Creating the disrupter list.
The key to creating a list of potential black swan events is to cast a wide net by cataloging possible catastrophic environmental, economic, political, societal, and technological events. The team should add much more to the list than ERM typically does, and continue until the net is wide enough to include representatives of as many different black swan categories as possible. After the long list is compiled, the events are categorized by the type of impact they might have on the business. The result is a shorter, more workable synthesis that encapsulates the black swan events that could threaten the company.
comment leading ideas
Thus, most ERM teams can assure their board and executive team that they have covered the more common risk areas of compliance, ethics, finance, and accounting, as well as safety, quality, and customer experience. But ERM simply does not have the capacity to also monitor high-magnitude, low-frequency disrupters on a continuous or regular basis. This does not mean that black swans can or should be ignored. These events can threaten a company’s survival, and boards and senior leaders are responsible for protecting shareholders and other stakeholders. They must ask, What else can go wrong?
15
the enterprise map and a concise list of disruptive events, the analysis team can begin to ask what would happen to the company if the events, or even combinations of events, occurred. The likelihood of occurrence is not a major concern here; these are, after all, black swans. Rather, the team needs to determine the relative impact and consequences of a given catastrophe. This stage of the analysis often produces surprising results. Revelations can include greater concentrations of risk than were previously recognized, more severe and unexpected consequences, and, sometimes, seemingly obvious mistakes in how an enterprise has been shaped. The widespread adoption of offshoring strategies has spawned one example. At first, offshoring spread out the exposures and risks of operational disruptions because large companies were expanding their ranks of partners and their geographic footprints. But more recently, new exposures have arisen: Offshoring has created greater concentrations of risk in far-flung locations, where high-magnitude, lowfrequency risks are often more varied and where the likelihood of rapid recovery can be much lower. Consider what might happen to the world’s consumer electronics and apparel industries, for example, if the recent labor unrest in southern Chinese factories develops into a disruptive labor movement similar to what the West experienced during the early 20th century.
them by the magnitude of risk exposure as well as the expense and ease of implementation. Sometimes companies complete this final step on their own, using their ERM departments. The ERM staff usually participates throughout the analysis and is the most logical and effective group to shore up any major exposures. However, sometimes internal complexities warrant third-party involvement. Also, most boards prefer to involve an external, objective set of eyes, especially when recommendations include critical strategic and operational issues. No company can be completely prepared for every possible black swan event. But the board, the ex-
ecutive team, and the ERM staff can complement the day-to-day work of the ERM function with periodic disrupter analyses. These analyses can ensure that the company has adequately focused its attention on high-magnitude, lowfrequency events, performed stress tests on its fitness in the face of such events, and prepared itself for unexpected catastrophes. + Reprint No. 11303
Matthew Le Merle
[email protected] is a partner with Booz & Company based in San Francisco. He works with leading technology, media, and consumer companies, focusing on strategy, corporate development, marketing and sales, organization, operations, and innovation.
10 Clues to Opportunity Market anomalies and incongruities may point the way to your next breakthrough strategy.
by Donald Sull
D
uring their heyday in the late 19th and early 20th centuries, transatlantic cruise lines such as the Hamburg America Line and the White Star Line transported tens of millions of passengers between Europe and the United States. By the 1960s, however, their business was being threatened by the rise of a disruptive new enterprise, namely, nonstop transatlantic flights. As it happened, 4. Implementing contingency the cruise ship lines had one potenplans. Typically, the analysis team tial strategy with which to save their systematically generates mitigation business: vacation cruises. Starting options for each major “what if” in- in the 1930s, some of these lines sight. It looks for options that ad- had sailed to the Caribbean during dress multiple risks, and prioritizes the winter, thus using their boats
when rough seas made the Atlantic impassable. And in 1964, when a new port was opened in Miami, Fla., the pleasure cruise business began to boom. But the great cruise lines missed this breakthrough opportunity. They saw their profitability fall while dozens of startups, including Royal Caribbean and Carnival, retrofitted existing ships to offer pleasure cruises and built an entirely new travel and leisure category that continues to grow today. Managers and entrepreneurs walk past lucrative opportunities all the time, and later kick themselves when someone else exploits the strategy they overlooked. Why does this happen? It’s often because of the
strategy+business issue 64
comment leading ideas 16
3. Asking “what if.” Armed with
1. This product should already
Illustration by Stefanie Augustine
exist (but it doesn’t). As the accesso-
ries editor for Mademoiselle magazine in the early 1990s, Kate Brosnahan spotted a gap in the handbag market between functional bags that lacked style and extremely expensive but impractical designer bags from Hermès or Gucci. Brosnahan quit her job, and with her partner Andy Spade, founded Kate Spade LLC, which produced fabric handbags combining functionality and fashion. These attracted the attention of celebrities such as Gwyneth Paltrow and Julia Roberts. Many well-known product innovations — including the airplane, the mobile phone, and the tablet computer — began similarly, as products that people felt should already exist. 2. This customer experience doesn’t have to be time-consuming, arduous, expensive, or annoying (but it is). Consumer irritation is a reli-
its potential. When a low-cost airline such as easyJet or Ryanair announces its intention to fly to a new airport, real estate investors often leap to buy vacation property nearby. They rightfully expect a jump in real estate values. Similarly, the founders of Infosys Technologies Ltd., India’s pioneering provider of outsourced information technology services, were among the first to recognize that Indian engineers, working for very low salaries, could provide great value to multinational 3. This resource could be worth clients. The company earned high something (but it is still priced low). profits on the spread between what Sometimes an asset is underpriced they charged clients and what they because only a few people recognize paid local engineers. able indicator of a potential opportunity, because people will typically pay to make it go away. Reed Hastings, for example, founded Netflix Inc. after receiving a US$40 late fee for a rented videocassette of Apollo 13 that he had misplaced. Charles Schwab created the largest low-cost brokerage house because he was fed up with paying the commissions of conventional stockbrokers. Scott Cook got the idea for Quicken after watching his wife grow frustrated tracking their finances by hand.
comment leading ideas
natural human tendency known to psychologists as confirmation bias: People tend to notice data that confirms their existing attitudes and beliefs, and ignore or discredit information that challenges them. Although it is difficult to overcome confirmation bias, it is not impossible. Managers can increase their skill at spotting hidden opportunities by learning to pay attention to the subtle clues all around them. These are often contradictions, incongruities, and anomalies that don’t jibe with most of the prevailing assumptions about what should happen. Here is my own “top 10” field guide to clues for hidden breakthrough opportunities, observed in a wide variety of industries, countries, and markets. If you find yourself noticing one or more of them, a major opportunity for growth could be lurking behind it.
17
for something (but it’s not clear what that is). Researchers sometimes rec-
ognize that they have stumbled on a promising resource or technology without knowing the best uses for it right away. The resulting search for a problem to solve can lead to great profitability. One example was the founding of the ArthroCare Corporation, a $355 million producer of medical devices based on a process called coblation, which uses radio frequency energy to dissolve damaged tissue with minimal effect on surrounding parts of the body. Medical scientist Hira Thapliyal, who codiscovered this process, founded a company to offer it for cardiac surgery, but that market turned out to be too small and competitive to support a new venture. Undeterred, he looked for other potential uses, and found one in orthopedics, where there are more than 2 million arthroscopic surgeries per year. 5. This product or service should be everywhere (but it isn’t). Some-
times people chance upon an attractive business model that has failed to gain the widespread adoption it deserves. Two archetypal retail food stories illustrate this. In 1954, restaurant equipment salesman Ray Kroc visited the McDonald brothers’ hamburger stand in southern California, and convinced them to franchise their assembly-line approach to flipping burgers. In 1982, coffee machine manufacturing executive Howard Schultz visited a coffee bean producer called Starbucks in Seattle. He recognized the potential of a chain restaurant based on European coffee bars, and he joined Starbucks, hoping to convince the company’s leadership to convert their retail store to this format. When they didn’t, he start-
ed his own coffeehouse chain, later buying the Starbucks retail unit as the core of his new business. 6. Customers have adapted our product or service to new uses (but not with our support). Chinese appli-
ance maker Haier Group discovered that customers in one rural province used its clothes washing machines to clean vegetables. Hearing this, a product manager spotted an opportunity. She had company engineers install wider drain pipes and coarser filters that wouldn’t clog with vegetable peels, and then added pictures of local produce and instructions on how to wash vegetables safely. This innovation, along with others including a washing machine designed to make goat’s-milk cheese, helped Haier win share in China’s rural provinces, while avoiding the cutthroat price wars that plagued the country’s appliance industry. 7. Customers
shouldn’t
want
this product (but they do). When
Joint Juice, a roughly $2 million company that produces an easy-todigest glucosamine liquid, was founded by Kevin Stone, a prominent San Francisco orthopedic surgeon. He learned about the nutrient from some of his patients, who took it for joint pain instead of the ibuprofen he had prescribed. Many doctors might have ignored this or even scolded their patients for falling prey to fads, but Stone recognized he might be missing something. He looked up the clinical research on glucosamine in Europe, where it was the leading nutritional supplement. (Veterinarians, he discovered, swore by it, and their patients fell for neither fads nor placebos.) Then he built a business around it. 9. This product or service is thriving elsewhere (but no one offers it here). In the early 1990s, a Swed-
ish business student named Carl August Svensen-Ameln tried to store some of his belongings in Sweden while at school in Seattle, but found that all the local self-storage facilities were full. He studied the storage industry, already prevalent in the United States, and discovered a business model characterized by high rents, low turnover, and negligible operating costs. Yet self-storage, at the time, was virtually nonexistent in continental Europe. Svensen-Ameln and a friend from business school set up a partnership with an established U.S. company, Shurgard Storage Centers Inc. The resulting company, European MiniStorage S.A., was the first of several such companies that Svensen-Ameln started in Europe, to great success.
Honda Motor Company entered the U.S. motorcycle market in the late 1950s, it expected to sell large motorcycles to leather-clad bikers. Despite a concerted effort, the company managed to sell fewer than 60 of its large bikes each month, far short of its monthly sales goal of 1,000 units. Then a mechanical failure forced the company to recall these models. In desperation, it promoted its smaller 50cc motorbike, the Cub, which Honda executives had assumed would not interest the U.S. market. When the smaller bikes sold well, Honda realized it had discovered an untapped segment looking for two-wheel motorized transportation. (The campaign is still remembered for its catchphrase, “You meet the nicest people on a Honda.”)
shouldn’t make much money (but it
8. Customers have discovered a
does). Established competitors are
product (but not the one we offered).
often surprised when upstart rivals
10. That new product or service
strategy+business issue 64
comment leading ideas 18
4. This discovery must be good
Reprint No. 11304
Donald Sull
[email protected] is a professor of strategic and international management at the London Business School, where he is also the faculty director for executive education. His books include The Upside of Turbulence: Seizing Opportunity in an Uncertain World (Harper Business, 2009).
DATA POINT S
Finding Shoppers Where They Live In consumer packaged goods (CPG), shopper marketing — efforts to observe and influence consumers at the time of purchase — is one of the hottest and fastest-growing activities in advertising and promotions. Shopper marketing includes in-store shelf displays, digital kiosks, shopping list apps, e-coupons, and more, all of which generate digital data that marketers can use to further refine their pitches. In a recent Booz & Company survey of senior CPG executives, 83 percent of respondents said their companies plan to increase their investments in shopper marketing, and a majority (55 percent) ranked it as their number one investment, with plans to boost spending more than 5 percent per year, followed close behind by several forms of online media spending, while traditional, offline activities are in decline.
comment leading ideas
do well. In his 2008 book, The Partnership: The Making of Goldman Sachs (Penguin Press), Charles D. Ellis noted that for decades, Goldman Sachs partners had avoided investment management, which they believed generated lower fees than trading and investment banking. When Donaldson, Lufkin & Jenrette Inc. published its financial performance as part of a 1970 stock offering, Goldman partners were startled to learn that fees and brokerage commissions on frequent trades added up to a highly profitable business. Shortly thereafter, Goldman expanded into managing corporate pension funds, and aggressively built its business. Incongruities like these can offer a critical clue about where your assumptions no longer match reality. From there, you are more likely to uncover the kinds of opportunities that you might otherwise have missed — and that your competitors still don’t recognize. Start by asking yourself, What are the most unexpected things happening in our business right now? Which competitors are doing better than expected? Which customers are behaving in ways we hadn’t anticipated? Take yourself through the list of top 10 clues. Leaders who consistently notice and explore anomalies increase the odds of spotting emerging opportunities before their rivals. +
19
Expected Growth in CPG Manufacturers’ Advertising and Promotion Mix Average Annual Change, 2011–2014
Will DECREASE Spending
Will INCREASE Spending
BY MORE THAN 5%
BY MORE THAN 5%
BY 0 TO 5%
BY 0 TO 5%
Shopper Marketing Social Media Internet Brand Advertising Mobile Marketing Owned Media Paid Search Print Media Other Paid Media Television Consumer Promotions Trade Promotions –40%
–20%
0
20%
40%
60%
80%
100%
Note: Figures exclude neutral responses. Source: Grocery Manufacturers Association/Booz & Company Survey of CPG Manufacturers and Retailers, Summer 2010 (manufacturer responses only) Link to full report: www.booz.com/shopper-marketing-4.0
Expected growth in CPG Manufacturers’ Advertising and Promotion M Will DECREASE Spending
Will INCREASE Spending
20
Renewable Energy at a Crossroads The wind, solar, biomass, and geothermal sector has grown in fits and starts — and now may have the momentum to become a self-sustaining industry. by Christopher Dann, Sartaz Ahmed, and Owen Ward
I
n 2007, renewable energy sources were poised for accelerated growth. Then the global economic downturn intervened, depressing energy demand in general and casting particular doubt on the business case for wind, solar, biomass, and geothermal energy. Now that the sector is beginning to grow again, some industry observers are still questioning whether the market is resilient enough to continue that growth, considering the volatility of energy prices and a shifting political climate. The answer is more optimistic than one might expect, because the market has evolved in several important ways during the last
few years; it is unlikely to experience the periods of decline or stagnation we have seen in the past. One of the hallmarks of the renewables sector today is its structural diversity in terms of technologies, players, and geographic regions — and that will make all the difference. The story of the new wave of renewables begins in 2005, when a number of diverse factors came together. The first was an incentive for change: Power prices jumped as natural gas prices reached a historical high. The second was an opportunity: Technology advances led to significant reductions in renewable energy costs. Finally, the investment community, flush with capital, began to invest in the sector in earnest. But by far the biggest driver be-
hind the growth of renewables during this time was meaningful policy support, at both federal and state levels in the United States, and also around the world. With a focus on fighting climate change and jumpstarting new industries, legislators adopted a wide range of incentive mechanisms to support the development and adoption of renewable energy technologies. Recognizing a favorable investment environment, private equity and venture capital firms committed more and more money to the cleantech sector, which is heavy in renewables, between 2006 and 2008. At the peak, these investments exceeded US$10 billion per year in North America alone. Then the global financial crisis hit. Boom to Bust to Balance
During the first year of the crisis, pessimism about the sector returned. Many of the underlying factors that had converged to drive demand for renewables faded, and others became highly uncertain. For example, one of the key elements supporting the business case for renewables was the high price of electric power, which in turn was anchored to high natural gas prices. That dynamic shifted with the development of unconventional gas resources; most analysts forecast that natural gas prices will remain below $7 per million BTUs for the foreseeable future. The worsening economic conditions have also brought a shift in political priorities, one that favors budgetary restraint over fresh spending on environmental issues. Some federal subsidies supporting renewables may be sacrificed in forthcoming cutbacks. State and local support could likewise fall prey to state budget reductions.
Illustration by Lars Leetaru
comment energy
ENERGY
high-level technology categories such as wind, biomass, and geothermal to the subsectors underpinning them. For instance, the proliferation of different solar technologies such as thermal and photovoltaic (PV) — and the further subsets of thin-film and crystalline silicon — helps to ensure that product characteristics meet the targeted needs of different
Chinese PV module manufacturers have increased their share of the global market in the last four years to more than 50 percent. a return to economic viability and growth. This evolution took place along two broad dimensions. • Technological diversity. The renewables sector is far more diversified today than it was in the early part of the 1980s, when renewable energy generation (other than from long-established hydro sources) was primarily reliant on biomass. Biomass — both wood and waste — accounted for more than 70 percent of renewable power generation installations through 2000. Although it was a convenient and economical source of power in areas like California and the northeastern United States, biomass demonstrated limited potential for either rapid technological improvements or large-scale capacity development. Wind and solar technologies, meanwhile, were in their embryonic stage. Today, the renewable energy portfolio in most countries is much more balanced, in large part thanks to wind and solar, which have grown substantially over the last decade. The diversity extends beyond the
customers (for example, utility versus residential). This technological diversity allows local governments and businesses to mix and match sources of renewable energy. Consider the case of wind power, the most widespread renewables technology. Having already benefited from $3 billion spent on R&D globally over the past decade, it may have reached the point of diminishing investment returns. Still, the slowdown has led to an estimated 30 percent overcapacity, which will result in lower equipment costs and thus help sustain steady growth in wind installations. Meanwhile, the impact of Chinese PV module manufacturers cannot be overstated. These manufacturers have increased their share of the global market in the last four years to more than 50 percent. Today, the top 10 Chinese PV module manufacturers have six times the manufacturing capacity of the top 10 U.S. module manufacturers. Building on their strong position in the module segment, these compa-
nies will continue to vertically integrate, setting themselves up to deliver further cost reductions through both innovation and investments. • Geographic diversity. Renewable energy generation is no longer confined to certain regions around the world, and its new geographic reach has positive implications for political support and implementation. For example, in the U.S. six years ago, just two markets — the western and southeastern regions — accounted for more than 55 percent of the nation’s renewable energy generation capacity. Their share is now down to about 40 percent; other regions have grown at a faster clip. Several states with comparatively little sunlight — Massachusetts, New Jersey, and Oregon — have seen significant growth in PV installations thanks to generous state subsidies. Renewable energy generation and supporting industries have become an integral part of local economies. In the industrialized world, with few other industries in growth mode, local governments are beginning to see renewables as a source of opportunity. In the U.S., local politicians and economic development officials in such locations as Florida and Arizona have extended a range of tax breaks and other incentives to attract renewable energy companies. The sector’s geographic diversity has also helped it address specific technical challenges, including the intermittent nature of renewable energy sources. Distributing renewables capacity more broadly across the country helps to mitigate such variability (that is, the wind blows in different places at different times). Too Broad to Fail
Several decades ago, the renewables landscape was relatively bare and un-
comment energy
The economic slowdown also caused overall electricity demand to decline, resulting in overcapacity in most U.S. power markets. Less generation translated into lower power prices, which weaken the business case for renewables. Yet despite this uncertainty, the market continued to evolve in important ways, setting the stage for
21
satellite business to achieve potentially record-breaking efficiencies for solar panels. Technology firms are increasingly integrating downstream on the renewables value chain. For example, leading Chinese solar PV wafer and cell manufacturers, such as ReneSola and JA Solar, have expanded their businesses to include module assembly, a critical link in the value chain with low barriers to entry. Further downstream, Sharp and First Solar, manufacturers of solar panels and modules, have acquired large solar project developers over the last two years.
• Entrants improving technol-
• Entrants improving project
ogy. In recent years, market entrants
economics. The renewables sector
from other, established industries have brought new technologies into the renewables industry, which has helped lower installed costs and improve efficiency. Nowhere is this more evident than in the solar market. General Electric Company is reentering the solar playing field, directly taking on market leader First Solar Inc. Boeing Company is applying technology first developed in its
has experienced dramatic growth in the number of project developers, financial players, and other intermediaries in recent years, and this trend has been one of the most critical factors behind the recent boom. Large international merchants looking for geographic diversification and small startups with hopes of landing their first customers are among the bevy of project developers that have flooded the renewables sector over the past several years. Their participation has helped to identify the most attractive sites and to secure financing, creating a steady pipeline of renewables installations with great potential. Significant competition among developers has helped maintain pricing discipline in power purchase agreements. Companies such as SolarCity have also helped stoke latent residential demand by leasing solar PV systems for home installations, thereby addressing potential customers’ concerns about financing the expensive systems and managing their maintenance. Although consolidation is likely to occur in the coming years,
Christopher Dann
[email protected] is a partner with Booz & Company based in San Francisco. He specializes in developing strategy, assessing risk, and facilitating decision making for clients in the U.S. power, gas, and renewable energy industries. Sartaz Ahmed
[email protected] is a principal with Booz & Company based in Washington, D.C. She specializes in developing strategy for clients in the energy and infrastructure sectors. Owen Ward
[email protected] is a senior associate with Booz & Company based in New York. He specializes in assessing markets, investment decisions, and risks for clients in the power generation, renewable energy, and nuclear energy industries.
the robust developer market has already provided a strong foundation on which the industry can continue to grow. Meanwhile, in recent years a number of firms have begun specializing in renewables financing, while tax equity partners have become increasingly involved; these solutions have offered innovative approaches to overcoming the limitations of existing financial incentives. Infrastructure funds joined them by adding renewables positions for longterm steady cash flows, a strategy they will likely continue. Intermediaries such as renewable energy credit (REC) brokers and green power marketers have provided additional channels to improve project economics. The creation of companies such as Sterling Planet and Green Mountain Energy, which certify and market low-carbon-footprint electricity to residential and business customers, has enabled project developers to secure incremental sources of revenue to achieve positive net present value (NPV). Going forward, the continued growth of smart grid companies and energy storage providers will play a critical role in enabling the next wave of renewables development. Successful development of economical energy storage technologies would solve many of the intermittence challenges faced by wind and solar, improving project economics. Meanwhile, the widespread adoption of smart meters and variable pricing will make solar power more attractive, given that its greatest output is during the day, when demand is at its peak. In addition, investor-owned utilities will likely begin to diversify upstream into new parts of the re-
strategy+business issue 64
comment energy 22
complicated; today, a diverse range of new constituents have joined with industry veterans to form a strong ecosystem of developers, suppliers, customers, financiers, and others. The emergence of this ecosystem, which accelerated during the recent boom, has brought needed innovation and capabilities to the industry, and helped to reduce its reliance on government subsidies. We segment the new players into three categories: those that primarily improve technology, those that improve project economics, and those that improve commercialization and marketing.
• Entrants improving commercialization and marketing. The
introduction of new and innovative business models — particularly those that address the technology’s sometimes steep up-front costs — will likely decide the pace at which renewables are deployed in the marketplace. In the U.S., one of the most important drivers of growth in commercial solar installations was the introduction of long-term, fixed-price contracts for electricity. The SunPower Corporation, a solar
segments will have different wants and needs, but the most successful offerings are likely to include quick and economical installations, predictable power prices with no upfront investment, and more elegant designs. A number of companies are already engaged in sophisticated commercialization and marketing; additional business model innovation will no doubt occur as the renewables market matures. Application Diversity
Any one of these forces would have led to some change in the industry. Together, they are pushing it past the tipping point to large-scale viability. Gone are the days when solar PV panels were considered only for small rooftop systems. Renewables technologies have broadened in scope to the point at which they can be accepted as contributors to any regional energy mix. At the same time, renewables are finding a home at a micro scale — with some macro effect. Consumer goods, such as briefcases with solar
Gone are the days when solar PV panels were considered only for small rooftop systems. technology manufacturer, and other companies have introduced new pricing structures whereby they install solar panels on customer rooftops and charge monthly fees, similar to a lease arrangement, rather than requiring the customer to incur large, up-front capital expenditures. Similar approaches will be needed if the sector is to fully tap the potential of the residential and small commercial market. Different
power chargers for mobile phones, are expected to spur a compound annual growth rate of 30 percent in the $300 million market for flexible thin-film PV modules. The military is another likely channel for future growth. The energy demands of the military are considerable: Every gallon of fuel that reaches Afghanistan from the U.S. requires six more gallons to get it there. Solar PVs have the potential
to substantially alter the military’s dependence on fossil fuels. PV modules could also bring electricity to many in emerging economies, where the grid is underdeveloped and consumer electronics such as mobile phones have leapfrogged the infrastructure built for them. Much work remains to make these markets commercially viable for PV applications, but all have the potential to drive disruptive change. One day, these new markets could dwarf the traditional rooftop solar-panel market. A New Level of Scrutiny
Renewables have been a hotbed of activity in the past decade, and the evolving entrepreneurial environment continues to present opportunities for investment. However, given the uncertainty and complexity in the renewables marketplace, investment decisions are now much more difficult, requiring decision-making skills and tools that were not essential before the economic downturn. Going forward, investment decisions will need to explicitly address uncertainty through effective risk management and contingency planning. For utilities, renewables are not viable baseload technologies. Even as a complementary energy source, they carry costs that make them uncompetitive without subsidies. Power source decisions will therefore depend largely on local conditions, including the presence of renewable energy mandates, government incentives, and site availability. Here too, the array of incentives and technologies will make comprehensive business case planning and risk analysis imperative. Many utilities are more accustomed to man-
strategy+business issue 64
comment energy 24
newables value chain. Companies such as Duke Energy and Exelon have already acquired large assetownership and development positions. Utilities that build and own the renewable energy generation and transmission infrastructure, as opposed to simply acquiring energy through power purchase agreements, will have more balance sheet flexibility than smaller renewables financial players to build the new transmission lines required to bring renewable power from remote areas to load centers.
Reprint No. 00082
comment energy
aging older generation assets and will need to consider new operating models and program management capabilities. Meanwhile, for large energy users, rooftop solar PV remains the only alternative to the grid. Although historically it has been the most expensive renewables option, PV costs are falling, in part because a growing number of installers are willing to take on the investment risk. In locales with sufficient tax and other incentives (for example, those offered by the California Solar Initiative), investments are NPV positive. Still, users need to be cognizant of ongoing technological, regulatory, and political risks that may shift the economics against them. Furthermore, it will be critical for companies to develop the capabilities needed to both evaluate and add value to the assets and technologies that are likely to reenter the market in the months and years ahead. The relatively favorable investment climate of the past decade attracted a number of companies that ultimately lacked the expertise to endure and win in today’s more difficult investment environment. For example, a number of small utilities and other companies made subscale investments in renewables where they could add little value, and they may soon be forced to divest those assets. The companies that can pick up the assets and position them to create a sustained competitive advantage will be the ones that establish the right to win in this market. Clear industry leaders are already starting to emerge, but plenty of opportunity remains for those with the vision and the capabilities to power the next move forward in global energy markets. +
26
Transforming Healthcare Delivery As governments seek to expand services more cost-effectively, the stakeholders who pay the bills must collaborate. by Joyjit Saha Choudhury, Akshay Kapur, and Sanjay B. Saxena
W
hen it comes to healthcare, many nations are not getting enough for their money. For example, in the U.S., an estimated 30 to 40 percent of total healthcare spending is wasted through systemic underuse, overuse, and misuse, even as costs climb at a rate that far exceeds overall inflation. Although medical costs in the U.S. are among the highest in the world, its healthcare system ranks only 37th in quality, according to the World Health Organization. A study by the Commonwealth Fund found that the U.S. spends twice as much per capita on medical care as do other industrialized nations, but is in last place in preventing deaths.
The United States is not alone in its healthcare conundrum. Statistics like these and the accompanying warnings about the unsustainable nature of healthcare systems around the world have been circulating for years, if not decades. Many government leaders are heeding these warnings. Some are undertaking massive reform initiatives, including President Barack Obama’s efforts in the U.S., which resulted in the Affordable Care Act, and Chancellor Angela Merkel’s ongoing efforts to stem the escalating cost of healthcare in Germany. But these national efforts raise fundamental questions. To what ends should reform be directed? How will those ends be achieved? The answer to the first question is simple: Reform should be directed
at bringing healthcare costs under control while improving the quality of care and patients’ experience. In the U.S., this conclusion is often translated into an immediate goal of limiting healthcare cost increases to the growth rate of the consumer price index. This goal is easy to set, but how is it to be achieved? Unlike a business, a healthcare system can’t simply slash head count, operations, or overhead to bring costs under control. The impact on patients’ access to medical services and the quality of care would be draconian. Instead, most systems face the challenge of controlling costs while expanding patient access and improving care quality. The only way to meet this challenge is to focus on care delivery — the primary source of healthcare costs. In the U.S., care delivery, which includes physician and clinical services, hospital care, prescription drugs, tests, and procedures, accounted for approximately 85 percent of the US$2.5 trillion spent on healthcare in 2009 (the remainder is investment and administrative expense). To achieve the quality improvement and cost reduction needed to ensure the long-term stability of the system and the success of the medical industry, healthcare systems need to transform the full spectrum of care delivery. Systemic Obstacles
The already considerable challenge of care-delivery transformation is magnified by inefficiencies that persist throughout healthcare systems and contribute to rising costs. These inefficiencies are often rooted in the structures of healthcare systems. In the U.S., for instance, four major structural flaws impede the efficient delivery of high-quality care.
Illustration by Lars Leetaru
comment healthcare
HEALTHCARE
ment payors, such as Medicare, or through plans offered by their employers, and as a result do not need to consider the cost-benefit tradeoffs inherent in care decisions or the overall cost of their care. Some patients may prefer to remain uninvolved, but the system itself fails to reward informed decision making by other patients, even when it could lead to more effective prevention and treatment. Even consumers who would never buy a flat-screen television or a laptop without thoroughly researching their options are reluctant to question physicians about decisions that are often critical to their future well-being. Bold Goals for Reform
To overcome the structural barriers to systemic reform and transform care delivery, the three principal stakeholders in healthcare systems — providers, payors, and patients — have to work together toward common goals. This will demand some difficult adjustments in the traditional stances of these three stakeholder groups, but their closer alignment throughout care delivery is the best approach to achieving transformative change. Other industries have been successful in finding new value by making similar adjustments. Automakers, for instance, have collaborated with their vendors throughout the design, production, and distribution processes to create value; ongoing innovation has led to vastly better quality at much lower cost. By building a system based on trust and well-aligned incentives, carmakers were able to draw on their suppliers’ knowledge as well as provide constructive feedback that helped the entire industry become much more productive. Consider
the returns that such a collaborative effort could yield in the untamed and bloated U.S. healthcare-delivery system alone: The elimination of the 30 to 40 percent of spending that is wasted would result in annual savings of $750 billion or more at current expenditure levels. To attain such savings, broad collaborations and bold goals are necessary. In the U.S., healthcare initiatives championed by a single stakeholder group have been unable to deliver better-quality care or lower costs. In the 1980s, for example, insurers attempted to push down the cost side of the medical value equation through managed care approaches, such as HMOs, but they were forced to back away when consumers and employers raised concerns about choice and quality. A decade later, providers failed to generate new value through major consolidations of hospitals and physician practices. Incremental efforts involving multiple players have also proven unsustainable. For example, recent initiatives that attempted to create medical value by linking a small portion of provider pay to patient outcomes did not generate significant results because they were implemented on top of the traditional fee-for-service model that rewards complex and extensive care. Indeed, these well-intentioned measures can also create another layer of complexity — and cost — for providers and payors, because they need to add administrative processes to their operations to measure and manage the outcomes-based framework. A Collaborative Vision
What might the collaborative models necessary to transform care delivery look like? The recently enacted
comment healthcare
First, healthcare providers, such as doctors and hospitals, get paid for the type, volume, and complexity of the care they deliver, not the quality of care. At best, this fee-for-service payment model creates a disturbing disconnect between providers and care quality. At worst, it gives rise to abusive practices, such as churning (the unnecessary scheduling of repeat visits by physicians to bolster revenue or productivity) and selfreferral (the prescription of unneeded tests or services at facilities in which the referring provider has an ownership stake). Second, many providers are needed to treat serious illnesses, and the lack of coordination among them adds complexity and cost to care, as well as myriad opportunities for medical error. For example, the Cleveland Clinic review of “sentinel events” — unanticipated events in a healthcare setting that result in death or serious physical or psychological injury to a patient, but that are not related to the natural course of the patient’s illness — and near misses in 2007 and 2008 found that 43 percent were related to suboptimal communication. Third, the lack of adoption of proven, standardized approaches to care and evidence-based guidelines frequently results in expensive, flawed care. Intermountain Healthcare, which runs hospitals and clinics in Utah and Idaho, offers a good example of gains that can be captured. By implementing standardized care protocols, the company successfully halved both adverse drug events and the death rate for coronary bypass surgery. Fourth, patients are largely disengaged from their own medical care. In the U.S., 81 percent of patients are insured through govern-
27
Joyjit Saha Choudhury
[email protected] is a principal with Booz & Company in New York. He advises health-services clients on corporate and business unit strategies as well as strategy and capability building to drive medical value. Akshay Kapur
[email protected] is a principal with Booz & Company in Chicago. He specializes in the development of corporate and business unit strategies for healthcare clients, with an emphasis on care-delivery innovation and transformation. Sanjay B. Saxena
[email protected] is an M.D. and a partner with Booz & Company in San Francisco, and leads the firm’s West Coast health practice. He advises health-services clients on strategy development and capability building, specializing in payor–provider collaboration, next-generation payment approaches, and innovative care-delivery models. Also contributing to this article were Booz & Company senior associate Scott Strand and partner Jack Topdjian.
such as targets for cost reduction or market share. Moreover, there must be overriding principles that stakeholders can use to resolve the conflicts that inevitably arise when trade-offs must be made. And all parties should understand what’s in it for them — that is, what rewards they can expect to reap for meeting their targets. These elements are the foundation for mutual trust and genuine engagement on the part of all stakeholders. Once the stakeholders in caredelivery transformations have a clear understanding of where they are headed, they can address the three major components of potential models: delivery, payment, and consumer engagement. Delivery. Collaborative caredelivery approaches vary widely in both the level of integration and the degree of collaboration they require. Many other variables, such as provider mix and the underlying IT structure and capabilities needed to share information among all those involved in a patient’s care, also play into the choice and development of a care-delivery approach. One of the approaches generating the most interest among providers and payors in the U.S. is the accountable care organization (ACO), which is a coordinated network of provider partners, such as hospitals, primary care physicians, and specialists, who work together to improve care delivery and control costs, often in association with a healthcare insurer. Typically, ACO provider partners assume responsibility for meeting care quality and cost goals, and earn a share of the savings they produce. Another intriguing approach is the patient-centered medical home (PCMH), in which primary care physicians manage all aspects
of patient care, serving as team leaders and care coordinators when patients require specialist services, and seeking to involve patients as active participants in their own health and well-being. Payment. Getting the payment scheme right is especially complex and is the most data-intensive part of the collaborative process. Because practice follows payment, however, it also holds the most potential for transforming healthcare systems. In designing a payment scheme, participants must first decide how healthcare services will be priced. New, more collaborative models are often based on bundled case rates (fixed payments for a full episode of care, such as the aggregated set of procedures and services involved in a coronary artery bypass) or global payments (single, risk-adjusted payments coupled with quality metrics designed to discourage the withholding of care, encompassing all the care needed for a specific patient population, such as diabetics). Global payments offer the opportunity to cap the healthcare cost trend, but do not necessarily reduce absolute current spending. All payment scheme designs come with implications regarding how cost increases will be controlled, quality will be managed, and patients will be engaged. In the U.S., the payment schemes of the future are likely to take cues from the consumer goods industry, adapting increasingly sophisticated pricing methodologies. For example, payors and providers may move toward tiered pricing based on controllable variables, such as length of stay or quality of service. Other future schemes may embrace more dynamic, varied pricing to improve care-delivery economics. For
strategy+business issue 64
comment healthcare 28
healthcare reform legislation in the U.S. calls for some demonstration projects based on collaborative models, but before leaping into the adoption and implementation of these models, healthcare providers and other industry players need to step back and think hard about the vision and objectives of their collaborative efforts. Transformation of the caredelivery system on a scale that will generate the cost savings necessary to revitalize the medical system will require myriad initiatives. In each one, the collaborating hospitals, physicians, and payors need to define and commit to an overarching vision and clear objectives. A vision defines what, in essence, the initiative is trying to achieve, whether that is cost reduction, improved quality, a better experience for patients, or some combination of those factors. Objectives define specific goals,
cardiac care services. To encourage its employees to take advantage of its terms, Lowe’s waives deductible, out-of-pocket costs and pays travel and lodging expenses for employee
In the U.S., the payment schemes of the future are likely to take cues from the consumer goods industry. Consumer engagement. Collaboration models need to determine the proper role of healthcare consumers in the overall integration. The objective of increased engagement is for consumers to take a greater degree of ownership in their health and make better, more informed lifestyle and healthcare consumption decisions. The level of consumer participation in collaborative models varies depending on their health status and medical conditions, as well as the level of care they require — for example, consumers can be assigned differing levels of responsibility in their own care by treatment type and level of risk. The use of consumer engagement to transform care delivery and control costs is common in employer plans. These plans often include value-based benefit designs that motivate employees to make optimal choices in their consumption of care. Workplace incentives for programs such as smoking cessation and weight loss have existed for several years. Some large employers are expanding their efforts by assuming a more proactive role in steering employees toward better healthcare choices. For example, in 2010, home improvement giant Lowe’s Companies Inc. struck a three-year deal with Cleveland Clinic for bundled
plan members who are willing to travel to the clinic for qualified cardiac surgery. Tomorrow’s Healthcare Today
The Lowe’s example is only one of many experiments in the transformation of care delivery under way in the United States. Geisinger Health Plan in Pennsylvania is conducting another: The company is developing disease- and procedure-based products — integrated, end-to-end care bundles that are designed especially for specific diseases, conditions, or procedures, and that span the entire episode of care — under the ProvenCare brand. ProvenCare products, which include packaged solutions for back pain, hip replacements, and cataracts, are supported by bundled payments that cover all professional and hospital services from pre-operative care through 90 days of post-operative care, as well as a “warranty” that covers post-operative complications. Early results are promising, demonstrating reduced lengths of stay and reduced readmissions. A number of U.S. payors and providers are piloting PCMHs. By increasing provision of preventive care by primary care physicians, PCMHs can reduce the need for high-cost specialty and tertiary care. For example, a PCMH pilot
between insurer Humana and Metropolitan Health Networks Inc., which manages a network of physicians in South Florida, reported 33 percent lower hospital readmission rates compared with Medicare readmission rates in its first year. Several Blue Cross and Blue Shield Association plans are experimenting with new payment schemes. Blue Cross Blue Shield of Massachusetts has implemented an “alternative quality contract” that is one of the largest global payment systems in operation in the United States. Blue Cross and Blue Shield of Minnesota (BCBS MN) has established a promising “shared incentive” partnership with major care-delivery systems that is designed to bring its costs in line with the consumer price index. Toward that end, BCBS MN and its provider partners are restructuring care delivery. For example, some provider systems have begun conducting e-consultations in place of traditional office visits, and BCBS MN is reimbursing them for this cost-saving service. Additionally, the payor is sending staff into hospitals to support case-management activities and help providers plan more seamless care for their patients. These are all worthy experiments, and they suggest that the will to transform care delivery does indeed exist in many healthcare systems. But these efforts are still in their early stages, and if the U.S. and other nations are to create sustainable healthcare systems, all their stakeholders must continue to develop, test, and refine new collaborative approaches to medical value, seeking to increase care quality and manage costs. + Reprint No. 11305
comment healthcare
instance, providers might charge less for using an MRI machine 30 miles from a patient’s home where demand is lower than for using one that is closer but busier.
29
features operations & manufacturing
30
A new study shows how the decisions made today by goods producers and policymakers will shape U.S. competitiveness tomorrow. by Arvind Kaushal, Thomas Mayor, and Patricia Riedl
manufacturing’s
call
features operations & manufacturing
wake-up
31
Illustration by Doucin Pierre
A debate over the future of U.S. manufacturing is
intensifying. Optimists point to the relatively cheap dollar and the shrinking wage gap between China and the U.S. as reasons the manufacturing sector could come back to life, boosting U.S. competitiveness and reviving the fortunes of the American middle class. Whenever production statistics in the U.S. surge, it seems to bolster that hope; as New York Times columnist and Nobel laureate Paul Krugman put it in May 2011, “Manufacturing is one of the bright spots of a generally disappointing recovery.” But then when disappointing economic growth indicators are released, the pessimists weigh in. They argue that the U.S. has permanently lost its manufacturing competitiveness in many sectors to China and other countries, that the sector is still declining after years of
offshoring and neglect, and that it might never return to its role as the linchpin of the U.S. economy. Both the optimists and the pessimists are partially correct. U.S. manufacturing is at a moment of truth. Currently, U.S. factories competitively produce about 75 percent of the products that the nation consumes. A series of identifiable smart actions and choices by business leaders, educators, and policymakers could lead to a robust, manufacturing-driven economic future and push that figure up to 95 percent. Alternatively, if the U.S. manufacturing sector remains neglected, its output could fall by half, meeting less than 40 percent of the nation’s demand, and U.S. manufacturing capabilities could then erode past the point of no return. Those findings emerge from a recent sectorby-sector analysis of U.S. industrial competitiveness,
features operations & manufacturing 32
Thomas Mayor
[email protected] is a senior executive advisor with Booz & Company based in Cleveland. With more than 20 years of consulting experience, he focuses across industries on supply and manufacturing strategy, operations turnaround, purchasing, and supply base management.
along with a survey of 200 manufacturing executives and experts, conducted by Booz & Company and the University of Michigan’s Tauber Institute for Global Operations. (So researchers could best analyze the relationship between U.S. employment and the future of manufacturing, plants located in the United States were counted as American, regardless of where the company that owned them is headquartered.) The studies — which included comparisons to similar Booz & Company studies of China and Switzerland — found that the U.S. has a much more productive manufacturing base than many people think. But no single country, not even China or the U.S., can claim to be the factory of the world, in the way the United States was after World War II. Instead, for the foreseeable future, manufacturing will largely be regional. To be sure, exports play a critical role in any strong economy, and as we’ll see, a global play (including offshoring) can be viable, especially when there are challenges at home. But for many manufacturers, economics and market dynamics increasingly suggest that they locate factories close to their major markets, including the United States. This type of region-oriented footprint is a clear way to provide adequate scale and volume, minimize transportation and logistics costs, increase market responsiveness and innovation, and customize products for the unique preferences of different regions and cultures. If factory labor costs and currency rates were the sole enablers of manufacturing success, then the West could not compete with emerging nations or offshoring. More and more, though, these factors play a smaller part in manufacturing decisions. Four other considerations, all more complex, drive manufacturers’ choices
Patricia Riedl
[email protected] is a principal with Booz & Company based in Chicago. She works with manufacturers and retailers, specializing in driving value through manufacturing and supply chain strategies.
Also contributing to this article were Booz & Company senior associate Siddharth Doshi, associate Mustafa Al-Shawaf, and s+b contributing editor Jeffrey Rothfeder. We wish to thank the following individuals from the University of Michigan, Ross School of Business, Tauber Institute for Global Operations: professors Wally Hopp and Roman Kapuscinski, and Matthew Brady, Lucas Harmer, John Seaver, Michael Trent, and Ashish Vatsal. We also thank Conrad Winkler, executive vice president of the Long Products group at Evraz Inc.
about where to place and expand factories: 1. The skill level and quality of factory employees, especially for high-tech facilities. 2. The presence of high-impact clusters, in which many companies can learn from one another and innovate more readily. 3. Access to nearby countries with emerging consumer markets and lower-cost labor (for the U.S., this means building a future with Mexico). 4. A reasonably competitive regulatory and tax environment (for the U.S., this means simplifying and streamlining the current tax and regulatory structure). Will U.S. business leaders and policymakers rise to the challenge and create the conditions that would support manufacturing? Or will they fritter away the opportunity now being presented to them? Why Manufacturing Matters
As trade policy expert and author Clyde Prestowitz points out, manufacturing is critical to prosperity for several reasons: its economies of scale, impact on innovation, and multiplier effect on the rest of the economy. (See “The Case for Intelligent Industrial Policy,” by Art Kleiner, Arvind Kaushal, and Thomas Mayor, page 10.) In the United States, manufacturing directly accounts for 11 percent of the nation’s GDP: an absolute figure of US$1.47 trillion, larger than Spain’s entire domestic product. When all economic activity expressly linked to manufacturing is accounted for — including equipment maintenance, transportation, scientific and technical services, and construction — the share of GDP attributable to manufacturing grows to 15 percent. That means one in seven U.S. private-sector jobs, or 13.5 percent, is directly linked to manufacturing. The sector’s share of
strategy+business issue 64
Arvind Kaushal
[email protected] is a partner with Booz & Company based in Chicago. He leads the firm’s North American manufacturing team and specializes in manufacturing and product strategies and assessing relative competitive positions across the value chain.
Exhibit 1: Productivity in the United States For more than 20 years, the U.S. manufacturing sector disproportionately propelled growth in multifactor productivity (the changes in economic output per unit of combined inputs) — a critical key to prosperity. 150 Index: 1987=100
CAGR 1987–2008
140
Manufacturing 1.6%
130
120 Total of private business sector 1.0%
110
100
1987
1990
1995
2000
2005
2008
Note: CAGR is compound annual growth rate. Source: Bureau of Labor Statistics, Booz & Company
Manufacturing’s contribution to worldwide production value — its “value add,” calculated as the revenues generated minus the costs of raw materials — has grown most not in Germany and Japan, as some assume, but in China and the United States.
operations & manufacturing features featurestitle of the article
GDP increases to as much as 25 percent when secondorder linkages such as retail sales near plants, systems development, and legal services are included. Historically, manufactured goods are more tradeable than other categories. Thus, a strong manufacturing base is essential to reducing the U.S. trade deficit, which hit $497 billion in 2010 and is an unnerving drag on GDP. Unless steps are taken to revitalize manufacturing, up to 50 percent of the “value add” of the U.S. economy — the value of manufactured goods beyond their raw material costs — is at risk of disappearing. If that happened, the U.S. trade deficit would top $1 trillion, a troubling level for any country seeking economic growth. Perhaps the least understood benefit of manufacturing is how closely it is related to innovation in design, product development, quality control, and factory processes. In 2008, 67 percent of all private-sector R&D was conducted by manufacturing companies, according to the National Science Foundation. And from 2006 to 2008, 22 percent of U.S. manufacturing companies reported a new or significantly improved product, service, or process, compared with 8 percent of nonmanufacturing companies. Innovation propels improvements in worker output, capital flow, usage of materials and energy, energy conservation, and other components of productivity. Increased productivity, in turn, leads to faster economic growth and a higher standard of living. Between 1987 and 2008, productivity grew in the U.S. manufacturing sector 65 percent faster than in business as a whole. (See Exhibit 1.)
Many U.S. manufacturing leaders are well aware of the role that innovation plays in a nation’s economy, and in their own performance. “The labor component — the need to choose where to set up manufacturing facilities based primarily on where the wages are cheapest — is not the major driver anymore,” says Eric Spiegel, president and CEO of Siemens Corporation. “Instead, other factors — access to skilled labor, modern infrastructure, the ability to drive innovation with world-class R&D, and capabilities like new manufacturing technologies or innovative lean production systems — propel decisions about new factories. These play well to the U.S.’s strengths. So we’re adding new manufacturing in the U.S.”
$9,000 Global manufacturing value add, in US$ billions (real 2005)
33
America’s Lost Decade
The conventional wisdom says that the decline of U.S. manufacturing began in the late 1970s, when Japanese automakers and electronics companies outpaced their U.S. rivals in design, quality, efficiency, and costs. But a Exhibit 2: Global Manufacturing by Country
$8,000 Rest of World $6,000
China $4,000 U.K. Germany Japan
$2,000
U.S.
1980
1985
1990
1995
2000
2005
2009
Source: UN National Accounts Main Aggregates Database, Booz & Company
Exhibit 3: U.S. Manufacturing Employees, 1980–2010 Manufacturing employment fell only slightly during the 1980s and 1990s — but has fallen sharply since 2000, a consequence of technological change as well as offshoring and other factors. 18 Millions of Employees 16
–0.5%
14
–4.3%
12
Production Employees
10 8
–0.2% –3.4%
6 Non-Production Employees
4 1980
1985
1990
1995
2000
2005
2010
Source: Bureau of Labor Statistics, Booz & Company
Exhibit 4: U.S. Manufacturing Competitiveness for Exports A number of U.S. industries stand out as global leaders, based on two key indicators of manufacturing export competitiveness: costs compared with Chinese manufacturers for products consumed in China (the y-axis) and general worldwide export advantage (the x-axis). CIRCLE SIZE = U.S. CONSUMPTION
25%
$100 BILLION
Electrical Equipment and Components
U.S. Cost Advantage for Products Consumed in China
34
Paper Auto Final Assembly
Appliances
Global Leaders
Auto Vehicle Parts
Computer Equipment
0%
$500 BILLION
Primary Metals
Petroleum/Coal Electronics Food MACHINERY
–25%
Textiles and Fibers
CHEMICALS
Cloth Goods (Non-Apparel) AEROSPACE
Furniture Printing
SEMICONDUCTORS
Beverages and Tobacco
–50%
MEDICAL EQUIPMENT
Apparel Plastics
Nonmetallic Mineral Products
Other Transportation Equipment Pharmaceuticals Fabricated Metals
–75%
Wood Products
LOW
U.S. Manufacturing Positional Advantage for Export
HIGH
Note: The U.S. cost advantage represents the labor and logistics costs compared with those of Chinese manufacturers, for products consumed by people in China. Source: U.S. Census Bureau, Bureau of Labor Statistics, UBS Research, CapitalIQ, Energy Information Administration, World Bank, Eurostat, World Trade Organization, IRS Statistics, Tauber Institute for Global Operations, Booz & Company
strategy+business issue 64
features operations & manufacturing
closer examination of the historical data covering 1980 through 2010 presents a somewhat different picture. During the 1980s and 1990s, although there were high-profile problems in specific sectors such as autos and textiles, U.S. factories as a whole held their own. Even manufacturing employment held steady. Between 1980 and 2000, production jobs fell by only 0.5 percent annually; in fact, the U.S. outperformed both Germany
and Japan in the value of manufacturing output as a percentage of global production. (See Exhibit 2, page 33.) However, in the 2000s, U.S. manufacturing output as a percentage of global production fell dramatically. The ratio of exports to imports, a critical sign of manufacturing viability, also fell. The number of manufacturing jobs dropped as well, by 4.3 percent per year, and 3.4 percent of non-production jobs were eliminated annually. (See Exhibit 3.) Many factors contributed to a relentlessly troubling decade for U.S. manufacturing. Capital investment in new and old plants slowed, dropping below replacement levels. In some industries, innovation lagged, and some U.S. companies faced a shortage of critical skills. The rapid pace of globalization and competition from emerging economies exacerbated these effects. Still, the data shows clearly that U.S. manufacturing as a whole has great potential to rebound. When considered sector by sector, many U.S. companies can and should be the supplier of choice for the vast majority of goods sold in North America — and some can still be a primary source of production for global markets. This resilience was evident in the survey of manufacturing professionals; more than 65 percent of respondents said that it was unlikely they would stop investing in new U.S. manufacturing assets and technologies by
2025. Many of them are shifting manufacturing activities back to North America from Asia and other offshore locations. Four Kinds of Industries
• Regional powers: food, beverages and tobacco, nonmetallic mineral products, wood products, and
• Global leaders: aerospace, chemicals, machinery,
petroleum/coal. Focusing on North American demand
medical equipment, and semiconductors. Companies
will continue to be a lucrative strategy for many U.S.
Exhibit 5: U.S. Manufacturing Competitiveness in Domestic Markets Based on two key indicators of manufacturing competitiveness within the U.S. — cost and positional advantage — U.S. manufacturers sort into four groups. Global leaders and regional powers are well positioned to compete; sectors on the edge and niche players are more challenged. Nonmetallic Mineral Products
U.S. Cost Advantage for Products Consumed in the U.S.
300%
CIRCLE SIZE = U.S. CONSUMPTION $100 BILLION
100%
$500 BILLION
Petroleum/Coal
Global Leaders Regional Powers Sectors on the Edge Niche Players
75% Wood Products
50%
Paper Plastics
25%
Appliances Textiles and Fibers Cloth Goods (Non-Apparel)
0%
Beverages and Tobacco
Food
Primary Metals Auto Final Assembly Auto Vehicle Parts Other Transportation Equipment
CHEMICALS
MACHINERY AEROSPACE
–25% Furniture Apparel
–50%
Computer Equipment Printing
–75%
LOW
MEDICAL EQUIPMENT SEMICONDUCTORS
Electronics Pharmaceuticals Fabricated Metals Electrical Equipment and Components
U.S. Manufacturing Positional Advantage for U.S. Demand
HIGH
Note: The U.S. cost advantage represents the labor and logistics costs compared with those of Chinese manufacturers, for products consumed by people in the United States. Source: U.S. Census Bureau, Bureau of Labor Statistics, UBS Research, CapitalIQ, Energy Information Administration, World Bank, Eurostat, World Trade Organization, IRS Statistics, Tauber Institute for Global Operations, Booz & Company
operations & manufacturing features features title of the article
With unit labor costs playing a smaller part in manufacturing decisions, other factors — including talent availability, market accessibility, innovation, regulations, intellectual property protections, barriers to entry and exit, and scale of operations — increasingly drive decisions about where to place and expand factories. Based on the relative economics for each segment, we charted which U.S. industries can compete as exporters, which can be dominant in the regional North American market, which can survive but are threatened by foreign competitors, and which are already mostly overseas but can still manufacture in the U.S. to serve niche markets. (See Exhibits 4 and 5.)
in these industries have a critical worldwide advantage stemming from their high investment scale, established intellectual property, skilled workforces, and close ties with customers. For example, the U.S. commercial aerospace segment (primarily Boeing Company and its suppliers) benefits because aircraft development is so costly and knowledge-intensive that few new companies can compete. In addition, aerospace manufacturing requires uniquely qualified labor, substantial participation from corporate R&D, and proprietary technology efforts, often with national security implications. Thus, much overseas production is ruled out. However, even this sector could lose manufacturing to overseas sites if demand in emerging markets skyrockets, providing a sound economic rationale for some global leaders to establish manufacturing bases in China or elsewhere.
35
by Wally Hopp and Roman Kapuscinski
C features operations & manufacturing 36
as the quality of the workforce.
though enrollments in U.S. commu-
Thus, in today’s flat world, an
nity colleges have increased recently,
economy can justify high wages only
the graduation rates at these schools
in return for high skill levels. Indeed,
have fallen below 40 percent.
whereas total manufacturing em-
To remain globally competitive
ployment in the U.S. has declined
for manufacturing, U.S. education at
since 1980, the number of high-skill
all levels must be improved in four
manufacturing jobs has increased by
fundamental ways. First, there must
roughly 40 percent.
be more relevant instruction, start-
onversations about the future
It is well known that the qual-
ing with a revitalization of the indus-
of manufacturing often be-
ity of a nation’s education affects
trial arts curriculum. Once common,
come conversations about education.
its manufacturing prowess. Between
“shop” and other vocational courses
A host of factors are raising the skill
1850 and 1940, compulsory univer-
have been crowded out of most high
levels required for employment in
sal education and a broad system of
schools thanks to a preoccupation
this sector.
public universities, community col-
with college preparation. We must
• Technology: Any job that in-
leges, and other schools ensured
provide a better, more technologically
volves fully prescribed tasks is at risk
that the U.S. workforce was better
astute avenue for the large number of
of being taken over by a machine.
trained than the rest of the world.
students who are not college-bound
• Globalization: As manufactur-
This fueled a period of unparalleled
but who will need to participate in the
ing has moved to regions with low-
productivity and economic growth,
economy of the future. Revitalized
cost labor, the huge comparative
led by the manufacturing sector.
industrial arts courses would also
advantages enjoyed by the U.S. work-
But in 2011, the United States no
benefit college-bound students who
longer has the best-trained work-
are interested in engineering. Beyond
• Economics: In many sectors,
force. Most countries have passed
this, because K–12 education cannot
the financials do not favor either local
the U.S. in such metrics as hours
fully equip workers for the technical
or overseas production. Manufactur-
spent in school each year, math and
demands of high-skill manufactur-
ers increasingly base their location
science scores, literacy rates, and
ing jobs, community colleges and
choice on non-financial factors, such
high school graduation rates. Al-
technical schools must adapt their
force have dissipated.
manufacturers. The United States is the world’s largest market — wealthy and still growing (albeit not as fast as emerging economies) — and Mexico and Canada offer additional opportunities. For food, beverages, tobacco, and many other consumer products companies, the incremental disadvantages of importing (for example, the cost of transporting products to the U.S., plus long shipment lead times and product safety concerns) outweigh pro-offshoring factors such as the higher cost of U.S. production. For nonmetallic mineral and wood products segments, product transportability requirements and proximity to the supply base give U.S. factories a leg up. • Sectors on the edge: paper, plastics, electrical
feel the presence of low-cost overseas rivals nipping at their heels. To compete effectively, they need simplified government regulations and permitting processes, as well as more certainty and speed in gaining approval to expand old plants and build new facilities. In addition to better government support, many companies in these sectors must rethink their strategies, investing in the specific U.S. markets where they are best suited to compete. Some industries, such as printing, can maintain a foothold in the U.S. for specialized or customized products targeted at the North American market. Meanwhile, they can produce mass-quantity products with less stringent delivery schedules in lowercost countries.
equipment and components, fabricated metal products,
• Niche players: textiles, apparel, furniture, com-
pharmaceuticals, automotive vehicle parts, other trans-
puter equipment, and appliances. Most companies in
portation equipment, final assembly of motor vehicles,
these sectors have moved production outside the United States. The remaining activity generally serves small-
printing, and electronics. These manufacturing segments
strategy+business issue 64
Revitalizing Education for Manufacturing
curricula in response to the needs
manufacturing-related career op-
companies. Not surprisingly, Tauber
of industry.
portunities. Although U.S. univer-
graduates are in high demand.
sities still set the standard for the
When it comes to the future of
the quality of their execution; better
world in terms of quality of research
manufacturing, all roads lead to edu-
classroom instruction for non-col-
and education, they are struggling
cation. But education infrastructure
lege-bound students is desperately
to lure domestic students into sci-
takes a long time to build and is dif-
needed. Third, schools must become
ence and engineering fields related
ficult to maintain. The countries that
more effective at engineering and
to manufacturing. These programs
strengthen and reinforce it most rap-
vocational guidance, ensuring that
are filled with international students
idly and effectively will be winners in
students know about the continually
who excel in their studies, but then
the global economy.
evolving career paths in manufactur-
have difficulty obtaining visas to re-
ing. Fourth, access to learning should
main in the United States. We need
Wallace (Wally) Hopp
be expanded. The U.S. might consider
to promote manufacturing as a field
[email protected] subsidizing tuition for technical train-
of study, and relax U.S. visa policies
is the Herrick Professor of Manufac-
ing programs, thus competing more
to allow more well-trained students
turing at the University of Michigan’s
effectively with the established prac-
from overseas to work in the United
Stephen M. Ross School of Business
tice in other countries.
States. The University of Michigan
and a faculty member at the Tauber Institute.
An excellent model for achiev-
(our own institution) is addressing
ing all these goals is South Caroli-
the former issue through the Tauber
na’s state-funded ReadySC program
Institute for Global Operations, which
Roman Kapuscinski
(www.readysc.org), which maintains
provides students with an integrated
[email protected] regular communication between in-
engineering and business curricu-
is a professor of operations and man-
dustrial leaders and local colleges
lum. To ensure that they acquire the
agement science at the Ross School
about the skills needed in industry.
skills that manufacturers and manu-
and a co-director of the Tauber Insti-
This program benefits both employ-
facturing consulting companies are
tute. For more on the institute, see
ers and students.
looking for, the institute maintains
www.tauber.umich.edu.
In addition, higher education
an active advisory board consisting
can and must do more to highlight
of senior executives from 30 major
scale, highly specialized niche markets. For example, the small company Timbuk2 Designs Inc. allows customers to design their own briefcases, backpacks, and totes; it has a strong customer community among cyclists on the West Coast. The furniture segment is similarly bifurcated. Flat-pack furniture for the U.S. market is mostly made in China, whereas preassembled furniture is more likely to be made domestically. In short, nearly 50 percent of the value added by U.S. manufacturing and more than 50 percent of U.S. manufacturing jobs are at risk. (See Exhibit 6, page 38.) In these sectors, on the basis of labor and logistics tradeoffs, many U.S. manufacturers have opted to build plants in emerging markets such as the BRIC countries (Brazil, Russia, India, and China). They also feel pressure from investors and other influential internal players to be proactive in the fastest-developing regions, where billions of people are joining the consumer economy.
(See “Competing for the Global Middle Class,” by Edward Tse, Bill Russo, and Ronald Haddock, page 62.) This strategy has paid off for global players and for those who target specific emerging markets in a wellplanned way. But it hasn’t worked out for all manufacturing businesses; for example, it can leave them more exposed to competition in the United States, which is still their largest market. Nonetheless, if the trend continues unabated — that is, if U.S. companies rush toward emerging economies without continuing to invest in their own country — then U.S. manufacturing could fall woefully behind in new plant and production technologies, losing important links to high-value innovation and making revival more difficult. Manufacturing Momentum
Our analysis translates into clear recommendations for improving the competitiveness of U.S. manufacturing.
features features title operations of the article & manufacturing
Second, schools must improve
37
features operations & manufacturing
Advantaged sectors (those that are global leaders and regional powers) represent about half of manufacturing employment; the rest (sectors on the edge and niche players) are more vulnerable to job loss.
Manufacturing Value Add
Manufacturing Employment
US$1.6 trillion
11.9 million employees
53%
41%
Advantaged Sectors (Global leaders and regional powers)
Sectors on the Edge
45%
43%
38 6%
Niche Players
11%
2009 Note: Due to rounding, percentages may not total 100. Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Annual Survey of Manufacturers-U.S. Census Bureau, Booz & Company
The following strategies can provide the greatest momentum in both the public and private spheres: 1. Attract the best workers. Qualified manufacturing employees are surprisingly scarce in the United States. As companies transform their plants from hubs of manual work to automated facilities with complex control systems and sophisticated processes, they struggle to fill multiple holes in their workforce: technical (programmers, IT developers, designers), professional (engineers, scientists, functional support), and skilled
(equipment operators, specialized maintenance experts, craftsmen). A contributing factor to this employee scarcity is traditional manufacturing’s lack of appeal to students. A recent Booz & Company survey of more than 200 engineering, science, and math undergraduates found that although 80 percent of the engineering students had some exposure to manufacturing— through either firsthand experience, college courses, or conversations with factory workers — only 50 percent regarded it as an attractive career. That number dropped to 20 percent among the science and math students. Around the same time, Siemens reported having nearly 3,500 open manufacturing positions in the U.S. requiring high-level science, technology, engineering, and math skills, with low expectations of filling many of them. The talent issue is particularly pronounced in the pharmaceutical and high-tech sectors, where science and engineering graduates are needed for many operations positions. Manufacturing recruiters must compete with R&D for qualified individuals, and some have relocated to higher-cost cities because such places attract people. Many companies — especially those in electronics, medical equipment, pharmaceuticals, and other sectors requiring high levels of knowledge on the factory floor — find that the shortage of qualified employees in the U.S. leaves them no choice but to shift some operations to other countries. This is particularly disturbing because these job categories often involve innovation and are thus essential catalysts for productivity increases and economic growth. The shortage of technical, professional, and skilled labor also contributes to substantially higher wages in U.S. manufacturing than in other countries, including other developed economies. Educational initiatives that promote engineering
strategy+business issue 64
Exhibit 6: U.S. Manufacturing Jobs at Risk
Many companies find that the shortage of qualified employees in the U.S. leaves them no choice but to shift some operations to other countries.
specialized training programs or attend faraway recruitment events. 2. Invest in high-impact clusters. Since Michael Porter coined the term in his 1990 book, The Competitive Advantage of Nations (Free Press), clusters have been a widely recognized way to spur economic growth and development. In the context of manufacturing, clusters are essentially geographic concentrations of interconnected companies, suppliers, service providers, and associated institutions (such as university research labs). Silicon Valley; the collection of life sciences companies in eastern Massachusetts; and the aerospace cluster in Wichita, Kan., are good examples. Clusters have several benefits. They increase productivity and efficiency because they bring together suppliers with customers, designers with engineers, and university researchers with corporate production managers to better share information and new ideas. This collaborative ecosystem helps new companies and innovative business models emerge. Because they represent strong, self-supporting communities — where interactions among employees inspire enthusiasm for their work and help them gain more diverse skills — companies located in manufacturing clusters tend to have lower turnover and attract better talent than non-clustered companies. State and local governments can encourage clusters by investing in infrastructure — roads, ports, rail lines, and communication links — for centers that have begun to form organically. Policymakers can also provide up-front tax incentives or other inducements to attract companies. Both the state and federal governments can fund research institutes and university programs, but studies have shown that governments should not seek to micromanage cluster creation. They are better suited
features title features operations of the article & manufacturing
can increase the talent pool. China already graduates more engineers each year than the U.S., and a number of other countries graduate a higher proportion of their population as engineers. It would also be helpful to relax federal immigration regulations for trained knowledge workers: for example, liberalizing H-1B visa restrictions to allow foreign national students in science, technology, engineering, and math programs to remain in the U.S. more easily after finishing their education, rather than returning to their home countries. State governments are well positioned to abet manufacturing education with scholarships and programs such as South Carolina’s ReadySC program, which establishes partnerships with businesses to provide customized training in colleges. (See “Revitalizing Education for Manufacturing,” by Wally Hopp and Roman Kapuscinski, page 36.) “The philosophy [here] has been that if you invest in South Carolina, South Carolina will invest in its people to prepare them to work in your plant,” says Bobby Hitt, South Carolina’s secretary of commerce and a former BMW executive, who was a leading figure in the automaker’s 1994 decision to build its only U.S. factory in Greenville. Manufacturing companies must also offer a more collaborative workplace experience, engaging workers and giving them opportunities to continuously improve and seek productivity gains. They can also attract workers by showcasing their latest technology at campus recruitment events and industry job fairs, increasing college internships, forming partnerships with local colleges and universities to identify and sponsor talent, inviting students of all ages on factory tours to show that manufacturing can be a rewarding career, and partnering with other manufacturers to jointly support
39
by Kaj Grichnik and Jerome Pellan
T
features operations & manufacturing 40
tics provides important clues about
by a whopping €13 billion ($18.5 bil-
whether France and other western
lion). By contrast, the United States’
European countries are more likely
trade imbalance with China grew
to enjoy a manufacturing recovery,
more than threefold in that period
or whether the U.S. is — and that
while the U.S. trade deficit with Ger-
distinction clearly favors the United
many held steady.
he United States is not alone
States. Unlike U.S. losses, the lion’s
The implications of this for
in its manufacturing malaise.
share of France’s losses in manufac-
France and for the United States
In virtually every Western country,
turing capacity are not due to China
could not be more different. If manu-
factory employment is disappearing
and other low-cost nations; instead,
facturing does, in fact, become more
and trade deficits are dangerously on
French production and jobs are mov-
and more regional, the United States
the rise. Take France, for example.
ing primarily to Germany.
stands to gain from the movement
Between 1999 and 2009, the country
In other words, the deterioration
back to North America of Chinese
moved from a positive trade balance
in France’s manufacturing capacity is
and other low-cost production fa-
of €17.8 billion (US$25.4 billion) to a
the result of a shift within its region.
cilities. France, though, doesn’t have
deficit of €21.1 billion ($30.1 billion),
Of the €38.9 billion ($55.5 billion) to-
that luxury.
a disturbing change in direction that
tal decline in France’s trade balance,
took 30 percent of France’s manufac-
only about €7.2 billion ($10.3 billion)
ing trade deficit with China has been
turing jobs with it.
is directly attributable to the growth
driven
Moreover, chiefly
France’s by
worsen-
manufacturing
And although these numbers
of its trade deficit with China. Yet be-
losses in lower-tech, lower-margin
mirror trends in the U.S., one very
tween 1999 and 2009, France’s trade
products, such as apparel, furniture,
big distinction hidden in these statis-
imbalance with Germany increased
and office machines. France’s trade
to supporting and promoting these industrial networks while allowing them to develop naturally. Individual companies (or trade groups associated with clusters) can also take steps to fashion clusters and attract businesses and talent. They can set up improved connections between suppliers and buyers, and maintain up-to-date standards and innovative practices in infrastructure, renewable energy, and plant processes and technology. 3. Build a future with Mexico. For many companies on the edge, Mexico offers a cost-conscious and attractive alternative to China and other distant offshoring sites. By developing production facilities there, manufacturers can tap a relatively low-cost labor pool and maintain tight links with R&D talent and facilities in the United States. A Mexican footprint also helps companies tailor their supply chains: shifting less-demanding, high-labor products or components with relatively stable designs to Mexico while keeping highly skilled work or rapidly evolving technology in the U.S., where the workforce is generally more educated. Then products can be shipped around the Western hemisphere at relatively low expense. “When you combine the U.S. and Mexico as a
manufacturing partnership, for the most part it wins over [a combination of] the U.S. and China, especially in terms of economics, demand proximity, and responsiveness of the supply chain,” says Ron Weller, vice president of global operations and power solutions at Johnson Controls Inc. (JCI), a maker of vehicle electronics, batteries, and interiors. Of course, to build a viable U.S.-Mexico manufacturing base, substantial obstacles must be addressed by the public and private sectors of both countries. Narcotics-related violence along the border has hurt manufacturing companies’ ability to produce and ship without disruption. Mexico’s rail and road infrastructure is subpar, the country produces few basic raw materials and needs better access to inexpensive commodities (which might be supplied from the southern U.S.), and Mexican workers need further training and skills development. It may take concerted collaborative effort by government and business leaders in both countries to address these problems, but the payoff could be immense. 4. Simplify and streamline the tax and regulatory structure. At 39 percent, the official U.S. statutory corporate tax rate is the second-highest of all countries
strategy+business issue 64
France Faces a Dilemma
imbalance with western European
companies pay an amount equal to
dustries that are. But it will take more
nations has come at the expense of
about 83 percent of net salaries in
than new fiscal measures for France
higher-value products such as au-
so-called social charges, compared
to regain its former manufactur-
tomobiles, advanced chemicals, and
with only 47 percent in Germany. And
ing glory; a 21st-century cultural and
industrial machinery. Consequently,
industrial labor relations in France
social transformation is needed for
for France, the regional manufactur-
are extremely adversarial.
France to again resemble the country
ing model could turn out to be a very expensive development.
By addressing these and other
that spawned such legendary indus-
equally problematic issues adroitly,
trial figures as Peugeot, Eiffel, Citroen, Hussenot, Renault, and Schlumberger.
France’s inability to compete ef-
France could possibly dissuade some
fectively against other countries in its
CEOs from closing French factories.
backyard for factory capacity is linked
But if France doesn’t address these
Kaj Grichnik
to a set of labor and cost dynam-
issues in the next 10 years, the coun-
[email protected] ics that are increasingly antiquated
try stands to lose an additional 7 per-
is a partner with Booz & Company in
in a more globalized and malleable
cent of its manufacturing workforce,
Paris and the coauthor (with Conrad
manufacturing environment. For ex-
or about 200,000 jobs.
Winkler) of Make or Break: How Manu-
ample, France’s 35-hour workweek,
There are some indications that
imposed in 2000 just as other coun-
improving the fortunes of manufac-
tries were liberalizing production
turing is increasingly important to
shift rules, increases the overall cost
French politicians of all stripes. One
Jerome Pellan
of labor. Further, because of France’s
of the more audacious proposals calls
[email protected] generous medical, unemployment,
for taxing sectors that are not exposed
is a senior associate with Booz &
and pension benefits for residents,
to international competition to help in-
Company in Paris.
vitalization (McGraw-Hill, 2009).
States, and if you’re in our position you might want to repatriate money to invest in an asset or to fund an expansion,” says Michael Rajkovic, chief operating officer of auto supplier Tower International Inc. “So if you need money in the United States and you already paid taxes on that money in another country, you have to pay taxes on it again before you can invest in your business in the U.S. What kind of sense does that make?” The U.S. regulatory system also contributes unnecessarily to complexity and uncertainty. In 2008, federal regulations — including economic, workplace, environmental, and tax rules — cost companies an estimated $1.75 trillion, or 14 percent of national income, according to the U.S. Small Business Administration Office of Advocacy. In the Booz & Company survey, 61 percent of respondents cited government regulations and policies as having a negative impact on their companies’ U.S. manufacturing output. This was, by far, the survey respondents’ most frequently cited risk. In general, many executives complain that the regulatory process has become paperwork-driven rather than outcomedriven, requiring companies to navigate an expensive labyrinth just to gain approval for, say, a plant expansion. The associated delays make opening up facilities
features features title operations of the article & manufacturing
in the Organisation for Economic Co-operation and Development; only Japan has a higher rate. Because of tax credits, deductions, and tax law complexities, the federal government collects only about 28 percent. But manufacturers spend much of the difference on compliance costs and sophisticated tax minimization strategies. Unfortunately, many companies use the 39 percent figure for evaluating investment options, because it is too risky otherwise; in cost-benefit calculations, they can’t assume that deductions will be available in the future. This often dissuades them from opening or expanding factories in the U.S. Reducing taxation levels and tax code complexity would be a revenue-neutral way to put U.S. manufacturing on a more level playing field with other leading economies. This step alone would encourage new investments in manufacturing assets, which in turn would expand the tax base, potentially resulting in higher government income. Another step would be changing tax rules to allow manufacturers to move dollars from overseas back without a tax penalty. This would make many companies more likely to reinvest foreign profits in U.S. manufacturing. “We operate in a lot of places outside the United
facturers Can Leap From Decline to Re-
41
Exhibit 7: A Framework for Manufacturing Capabilities In the ISSR framework, the vertical pillars represent activities undertaken by manufacturers. The horizontals represent contextual enablers, generated by government and the business environment (the floor) and the mix of available resources (the roof). RESOURCES
Creating Competitive Capabilities
Within companies, manufacturers can make the most of their U.S. footprint by building up their company’s bedrock capabilities. Basic manufacturing capabilities are needed in many sectors just to stay in business. However, in each company, some capabilities will deserve extra investment, to help ensure that manufacturing prowess is tightly aligned with the company’s competitive strategy and helps to set its line of products apart from the crowd. The capabilities that manufacturers need are captured in the “ISSR” framework developed by Booz & Company. (See Exhibit 7.) Inherent capabilities involve technological excellence and market understanding. Structural capabilities cover the makeup of a company’s manufacturing footprint, the structure of its supply chain, and the efficiency of its distribution network. Systemic capabilities address manufacturing and crossfunctional processes, including lean production systems. Realized capabilities focus primarily on aligning employees with the overall strategic thrust of the organization and driving efficiency improvements. Supporting these four pillars of manufacturing prowess are other capabilities that both the private sector and federal and state governments have a hand in developing. Among them: finding and developing the right human and natural resources at the right cost, as well as ensuring that the business environment — taxes, regulations, and labor and trade rules, for starters —
INHERENT
STRUCTURAL
SYSTEMIC
REALIZED
Technology and market requirements
Facilities and supply chain footprint
Operationsrelated processes and policies
Deployment of people and assets
BUSINESS ENVIRONMENT
Regulations, taxation, infrastructure, macroeconomic outlook, and ease of doing business
Source: Booz & Company
enhances manufacturing innovation and growth. To be truly distinctive and to sustain a competitive advantage, manufacturers must go beyond basic operational capabilities; they must develop specific and unique capabilities that match their strategic goals. “You’d better focus on reinventing manufacturing and process technology and on finding the next breakthrough process that’s going to be leaving everyone behind, a process that the rest of the world can chase,” notes JCI’s Weller. For example, a Tier One auto supplier that was a firm believer in a “small plant philosophy” was losing its competitive position as product designs standardized and more rivals with advantaged cost positions emerged. The company went through a “no constraints” strategy process to focus its effort on the winning technology and build a footprint that leveraged global scale. This dual strategy — enhancing the company’s capabilities in both the inherent and structural pillars — differentiated the supplier from its closest competitors and turned around its fortunes. Toyota is well known for its attention to the systemic pillar; its acclaimed lean production system has led to substantial quality and productivity gains and a leadership role in the industry. Many other auto manufacturers have followed suit, building their quality and reliability. But lean initiatives are hard to sustain unless the realized pillar is well developed. One global diversified manufacturer learned this when its
strategy+business issue 64
features operations & manufacturing 42
overseas much more desirable. “If your market window is 18 months and it takes you 18 months to get a permit in the U.S. and eight weeks to get one in Taiwan, where are you going to go?” asks Jack McDougle, senior vice president of the U.S. Council on Competitiveness. To move forward, current and new regulations should undergo a regulatory process analysis to ensure that they are necessary to deliver health, safety, environmental, or other benefits to the community. A number of manufacturing leaders have commented that other countries have even higher environmental and regulatory standards than the U.S., but with fewer bureaucratic hurdles.
Availability, quality, proximity, and development of the right human and natural resources
Designing production systems that align employees’ activities with the company’s overall strategy and that empower employees to improve manufacturing processes can unlock productivity and innovation.
Chief Manufacturing Optimists
This is a defining moment for U.S. manufacturers — and, indeed, for the U.S. economy. Although the challenges may seem daunting, the executives who responded to the Booz & Company survey are generally optimistic. In stacking U.S. manufacturing facilities against plants in other countries, only 5 percent viewed offshore plants as better in quality, and only 14 percent said that other countries’ facilities would respond more effectively to volatile demand. Every country needs creative, engaged, and profitable manufacturers if it hopes to have a healthy economy that supports the aspirations of all of its citizens. If you are a manufacturing leader in the United States, you shouldn’t have to go it alone. You should have support at all levels of government and culture — from
Washington to the local cluster. Like all businesspeople, you must come to terms with the fact that the world has changed. But as the data shows, the U.S. has a strong base to build on. The future of U.S. manufacturing in general, and of your company in particular, can be extremely bright. The current wake-up call represents an opportunity for you to clarify your strengths, channel your investment, and create your own distinctive direction. + Reprint No. 11306
Resources Joni Bessler, Stephen Li, and Sophia Pan, “China Manufacturing Competitiveness 2009–2010,” Booz & Company and AmCham Shanghai, 2010: Forecast of prospects and dangers for the burgeoning manufacturing industry of Greater China. Kaj Grichnik and Conrad Winkler, with Jeff Rothfeder, Make or Break: How Manufacturers Can Leap from Decline to Revitalization (McGrawHill, 2008): Explains the ISSR framework in more detail and how to foster a manufacturing renaissance. Ronald Haddock, Niklas Hoppe, Olaf Bach, and Martin Naville, “A Renaissance at Risk: Threats and Opportunities for Swiss Manufacturing,” Booz & Company and Swiss-American Chamber of Commerce, 2010: Analysis similar to this one for a country with great strengths and some vulnerabilities in manufacturing. Wallace (Wally) J. Hopp and Mark L. Spearman, Factory Physics (McGraw-Hill/Irwin, 2008): Influential textbook articulating ways in which manufacturing leaders can develop stronger capabilities and higher strategic performance. For more on this topic, see the s+b website at: www.strategy-business.com/operations_and_manufacturing.
features title features operations of the article & manufacturing
attempt to build efficiency and eliminate waste fell flat at first. Then, by segmenting its products into “stable and predictable” and “variable and customizable” buckets, the company created two production streams, simplifying the assembly line for its workers. The employees’ motivation rose as supervisors gave them more freedom and responsibility. The result was significant inventory reduction and substantially improved worker productivity. In general, designing production systems that align employees’ activities with the company’s overall strategy and that empower employees to improve manufacturing processes can unlock the productivity and innovation potential of the well-educated U.S. workforce. For at least a generation to come, this in itself could provide a competitive advantage for manufacturing in the United States.
43
A Strategist’s G Digital Fabric a features operations & manufacturing 44
by Tom Igoe and Catarina Mota
Rapid advances in manufacturing technology point the way toward a decentralized, more customercentric “maker” culture. Here are the changes to consider before this innovation takes hold.
044-053_digitalFab-JC3-FIN.indd 44
7/19/11 5:41 PM
s Guide to c ation features operations & manufacturing 45
Photographs © Derek Quenneville
At a research meeting in late 2010, a primatologist
studying monkey genetics took a tour of a university’s digital fabrication shop. She mentioned that her field research had stalled because a specialized plastic comb, used in DNA analysis of hair tissue, had broken. The primatologist had exhausted her research budget and couldn’t afford a new one, but she happened to be carrying the old comb with her. One of the students in the shop, an architect by training, asked to borrow it. He captured its outline with a desktop scanner, and took a piece of scrap acrylic from a shelf. Booting up a laptop attached to a laser cutter, he casually asked, “How many do you want?” This question is central to most manufacturing
044-053_digitalFab-JC3-FIN.indd 45
business models. Ten units of a comb — or an automobile component, a book, a toy, or any industrially produced item — typically cost a lot more per unit to produce than 10,000 would. The price per unit goes down even more if you make 100,000, and much more if you make 10 million. But what happens to conventional manufacturing business models, or to the very concept of economies of scale, when millions of manufactured items are made, sold, and distributed one unit at a time? We’re about to find out. The rapidly evolving field of digital fabrication, which was barely known to most business strategists as recently as early 2010, is beginning to do to manufacturing what the Internet has done to information-
7/19/11 5:41 PM
features operations management & manufacturing 46
Catarina Mota
[email protected] is a Ph.D. candidate at the Faculdade de Ciencias Sociais e Humanas Universidade Nova de Lisboa and a fellow at the International Collaboratory for Emerging Technologies, a partnership between the Science and Technology Foundation of Portugal (FCT-MCTES) and the University of Texas at Austin. She is cofounder of the openMaterials research group (www.openmaterials.org).
based goods and services. Just as video went from a handful of broadcast networks to millions of producers on YouTube within a decade, and music went from record companies to GarageBand and Bandcamp.com, a transition from centralized production to a “maker culture” of dispersed manufacturing innovation is under way today. Millions of customers consume manufactured goods, and now a small but growing number are producing, designing, and marketing them as well. As operations, product development, and distribution processes evolve under the influence of this new disruptive technology, manufacturing innovation will further expand from the chief technology officer’s purview to that of the consumer, with potentially enormous impact on the business models of today’s manufacturers. Some early signs of change are visible in the development and use of relatively low-cost digital fabrication devices. The leading producers of these tools are firms like 3D Systems (a US$51 million maker of 3-D printers founded in 1986 and based in Rock Hill, S.C.), Stratasys (a $117 million printer-maker founded in 1986, based in Eden Prairie, Minn.), and Epilog Laser (a privately held company founded in 1988 in Golden, Colo.). Their products were originally used for rapid prototyping, giving mainstream manufacturers and university researchers the means to test concepts and identify problems early in the design cycle. Now, the devices are being applied to end-product manufacturing by a burgeoning number of small-scale manufacturers and one-person factories. In mid-2010, 3D Systems and Stratasys reported on the information site MakePartsFast.com that more than 40 percent of their customers used digital fabrication tools to manufacture not just prototypes, but end products and parts. These
044-053_digitalFab-JC3-FIN_2.indd 46
Previous pages: A 3-D printer generates a bust of Beethoven in less than a minute, using a design uploaded to Thingiverse.com by a contributor identified only as “dino-girl.”
tiny companies are often started with little or no external funding; the proprietors tend to work from plans encoded in software that are often openly available for download on the Web. Digital fabrication also continues to attract press attention — in part because of stunts designed for that purpose. For example, in 2009, Stratasys teamed up with a Canadian automotive company called Kor Ecologic Inc. to announce the hybrid Urbee, the first automobile with a body fabricated by 3-D printers; in 2010, the laser-sintering company EOS (a privately held business founded near Munich in 1989) manufactured a violin within just a few hours. In the long term, many aspects of today’s conventional supply chain are likely to change. But even in the next few years, digital fabrication technology — and the way it is used — will pose new and unusual challenges for conventional manufacturers, both large and small. It also represents enormous opportunities for brand building, cost saving, consumer outreach, innovation, and global competitiveness: in short, for a manufacturing business model that no longer depends only on economies of scale. Tools of Change
The first step in building this new manufacturing business model is to take stock of the new fabrication tools. Digital fabrication devices fall into two categories. The first is programmable subtractive tools, which carve shapes from raw materials. These include laser cutters (which cut flat sheets of wood, acrylic, metal, cardboard, and other light materials), computer numerical control (CNC) routers and milling machines (which use drills to produce three-dimensional shapes), and cutters that use plasma or water jets to shape material.
strategy+business issue 64
Tom Igoe
[email protected] is an associate arts professor at New York University’s Interactive Telecommunications Program (NYU-ITP), where he oversees work on innovative manufacturing and computer-control technology. He is the author of Making Things Talk (O’Reilly Media, 2007), and a cofounder of Arduino LLC, an open source microcontroller platform.
7/21/11 4:02 PM
Most digital fabrication devices can follow designs created by people using mainstream programs like Adobe Illustrator or even iPad apps.
software and extensive training. They can follow designs created by people using mainstream programs like Adobe Illustrator or even using iPad apps; the techniques can be learned in an afternoon. To be sure, digital fabrication tools have limits. Currently, they are best suited to production runs of 1,000 items or less. Although a few high-end routers and cutters are fast enough to produce dozens of products in an hour, 3-D printers can’t yet make goods with the same speed as traditional injection molding. Some 3-D printers can combine different types of plastic (to make, for example, a hairbrush with a hard plastic body and soft bristles), but this kind of hybrid printing is still a high-end process. Most can handle only one type of material at a time. Metals and other nonplastic materials require specialized devices. Thus far, no digital fabrication device, professional or personal, can efficiently produce in one fell swoop a complex multi-material product such as a mobile phone. For these reasons, no one expects digital fabrication to replace conventional manufacturing anytime soon. According to a 2010 report from the technology market research firm Wohlers Associates Inc., the most common applications of the technology are the production of functional models, prototype components and patterns (used for tooling or to test fit and assembly), and visual aids. All of these are areas where production runs of one unit are often necessary. Nonetheless, even these early forms of digital fabrication could become highly disruptive to conventional manufacturing practices. How is one factory making 1 million units different from 10,000 factories making 100 units? For one thing, the 10,000 factories offer the safety and ability to experiment that comes with redundancy. For an-
features title features operations of the article & manufacturing
The second category is additive tools, which are primarily computer-controlled 3-D printers that build objects layer by layer, in a process known as fused deposition modeling. They work with a wide variety of materials: thermoplastics, ceramics, resins, glass, and powdered metals. Technically known as “additive rapid manufacturing” devices, 3-D printers also use lasers or electron beams to selectively shape the source material into its final form. Because additive devices require little setup time, they make possible the production of any quantity at the same cost per unit, and also allow easy, rapid switching between products. A single machine can shift from making combs to making clamps to making iPhone stands within minutes. In some cases, a 3-D printer can fabricate in a single piece an object that would otherwise have to be manufactured in several parts and then assembled. And because it composes objects bit by bit, instead of carving them from larger blocks, additive printing considerably reduces the waste of materials. Additive technologies have been following a path comparable to that of Moore’s Law; the capabilities of the devices are growing and the cost is decreasing exponentially. In 2001, the cheapest 3-D printer was priced at $45,000; by 2005, the cost had dropped to $22,900, and now you can buy a professional 3-D printer for less than $10,000, an open source personal version for less than $4,000, and a desktop do-it-yourself kit for less than $1,500. Subtractive tools, such as laser cutters and CNC routers, have also become more affordable, mostly because manufacturers have produced models to fit the low-volume needs (and lower budgets) of small businesses, schools, and individuals. Most of these digital fabrication devices no longer require custom CAD
47
features operations management & manufacturing
All of these objects were created with 3-D printers (clockwise from top left): a bracelet with a corallike texture, soles for running shoes, a model of cellular dynamics, jewelry modeled after radiolaria (amoeboid protozoa), an architectural model of a proposed skyscraper, a tooth model created by scanning a person’s mouth, and an orthopedic implant.
other, they offer proximity to local customers, and thus useful information about their needs and wants. Having a large number of small shops immediately at hand ensures that when one shop is not available, another can be brought into service. The rapid tooling turnaround afforded by digital fabrication means that each shop can change production runs for different clients as needed. The ability to augment mass production with highly customized components and parts, to reduce inventory by making components on demand, or to make setup changes more rapidly at a lower cost, could dramatically affect supply chain design, finance, and management. The potential for transforming manufacturing business models is most evident in healthcare, an in-
dustry that requires mass customization because every person’s body is different. Wohlers estimated the 2009 revenues from 3-D-printed medical devices at $157 million. British manufacturing expert Phil Reeves says more than 10 million 3-D-printed hearing aids are in circulation worldwide (it takes just an hour and a half to fabricate one), along with more than 500,000 3-Dprinted dental implants. Medical researchers are using fabricators to turn CT and MRI scans into 3-D models and, at a still very experimental level, to “bioprint” artificial bones, blood vessels, and even kidneys layer by layer from living tissue. Established manufacturers still have the upper hand when it comes to larger quantities or complex assembly. That could change, however, as the devices foster new waves of experimentation.
strategy+business issue 64
48
middLe coLumn, top: ©
Left coLumn, top: ©
Open Source Manufacturing
Probably the most disruptive element of this technology is not the tools themselves, but the maker culture — the community of people who sell, use, and adapt the tools of digital fabrication. This community is, in effect, a self-organizing global supply chain, consisting of hundreds of interlinked businesses, user groups, online shopping sites, and social media environments. Online fabrication services such as i.materialise (a Belgian company founded in 1990) and Sculpteo (a Paris-based service founded in 2009) provide on-demand 3-D printing and laser cutting in small volumes and at rates that are affordable to individuals. Customers upload a digital design and receive the corresponding physical object by mail a few days later. Ponoko (a New Zealand startup founded in 2007) and Shapeways (a Netherlands-based spin-off of Philips Electronics) go one step farther: They are supply chain management tools for garage inventors, enabling creators to exchange plans and instructions, coordinate production, and sell their designs and fabricated objects directly to the public. Complementing these businesses are open repositories like Thingiverse, a website created and managed by MakerBot, a New York–based manufacturer of 3-D printers that was founded in 2009. At Thingiverse, people can freely download one another’s designs and programming code for such ubiquitous products as gears, bottle openers, and coat hooks. Distributed manufacturing networks like Makerfactory and 100kGarages enable the communities further by connecting digital fabricators with potential customers, allowing customers to post job requests that are then bid on by individual fabricators. There are also successful new small enterprises using digital fabrication to make customizable
iPhone accessories (Glif), jewelry (Nervous System), cases for prosthetic limbs (Bespoke), and other products such as kitchenware, toys, and furniture. They generally make their goods on demand, with short production runs, catering to both local and global markets. The makers who start and run these enterprises don’t work alone. Nor do they rely on university or company labs, as innovators did in the past. Instead, they are forming open source collaboratives and workshops that take advantage of the dropping costs of digital fabrication and the connectivity of social media. In the past few years, many informal workshop collaboratives have sprung up around the world. These spaces are not centrally owned or organized, but they share information collectively and help one another advance. One such operation, TechShop, has six locations in the United States and markets itself with the slogan “Build your dreams here.” Another group, the community fabrication spaces called Fab Labs, is affiliated with MIT’s Center for Bits and Atoms; there are 50 Fab Labs in 16 countries. Even more numerous are “hackerspaces”: community-organized workshops that share an ethic of collaboration and information sharing on tools and processes. The world map on hackerspaces.org registers about 500 of these collectives. Centers for bio-fabrication also exist; the New York–based Genspace offers the tools to perform synthetic biology experiments, DNA analysis, and more. Within the maker culture, people are expected to publish their plans and specifications, typically under an open source license, which allows others to copy, adapt, and learn from the designs, always with credit and mutual access to ideas. Makers tend to design their business models accordingly. They make short runs of
features title features operations of the article & manufacturing
Jessica Rosenkrantz/www.n-e-r-v-o-u-s.com; middLe: © 3D Systems; bottom: © 3D Systems Z Corporation; bottom: © Z Corporation Right coLumn, top: © Jessica Rosenkrantz/www.n-e-r-v-o-u-s.com; bottom: © Sarah St Clair Renard/www.n-e-r-v-o-u-s.com
More than 10 million 3-D-printed hearing aids are in circulation worldwide. It takes just an hour and a half to fabricate one.
49
features operations management & manufacturing 50
each product and make frequent changes based on customer feedback; two makers might work together easily while creating competing products that draw on each other’s specifications. Many successful manufacturing startups are emerging from this community, with strong ties to its open source ethic. SparkFun Electronics Inc., founded in 2003 in Boulder, Colo., makes electronic component modules and devices. Its revenues reached $18 million in 2010. Makerbot and Arduino (based in Ivrea, Italy, and making microcontroller modules) had revenues of more than $1 million each, and Adafruit Industries (New York, electronics kits and sensors) reported sales of well over $2 million. The Arduino microcontroller board, an open source microcontroller platform, sold almost 300,000 units in its first seven years, and has spawned dozens of derivative products because its design is freely available for copying and innovation. Open source software is already a billion-dollar business, and Adafruit partner Phillip Torrone estimates that open source hardware will reach that threshold by 2015. (Torrone is also an editor of Make magazine, which is devoted to the maker culture.) A noteworthy parallel to, and inspiration for, the Western maker community is the shan zhai movement in China. These fast-moving “knockoff” manufacturers are genuinely innovative in their own right. They respond to local needs and tastes, they make continual improvements in their products, and they repeatedly invest in future developments. (See “Knockoffs Come of Age,” by Edward Tse, Kevin Ma, and Yu Huang, s+b, Autumn 2009.) Andrew “Bunnie” Huang, vice president of engineering for Chumby, an Internet browsing/ receiving device whose plans are published under open
source licenses, adds that many shan zhai companies share information about materials and other design elements, and credit one another with improvements. As do other maker groups, the shan zhai community enforces this policy itself and ostracizes those who violate it. Already, digitally enabled open source manufacturing is changing the way people think about the production and use of goods. As Eric von Hippel, a professor of technological innovation at MIT’s Sloan School of Management, put it in his book Democratizing Innovation (MIT Press, 2005): “User-centered innovation processes offer great advantages over the manufacturer-centric…systems that have been the mainstay of commerce for hundreds of years. Users that innovate can develop exactly what they want, rather than relying on manufacturers to act as their (often very imperfect) agents. Moreover, individual users do not have to develop everything they need on their own: they can benefit from innovations developed and freely shared by others.” This change is likely to translate into greater levels of product and process innovation. Von Hippel notes that “users were the developers of about 80 percent of the most important scientific instrument innovations, and also the developers of most of the major innovations in semiconductor processing.” And it will make supply chains more robust: As small shops and home shops come online and share information, networks of vendors grow more dense, more diverse, and less dependent on any one supplier or region. Lessons for Large Manufacturers
Any disruptive innovation requires changes in basic operating practices, and digital fabrication is no exception.
strategy+business issue 64
As early as 2020, every auto dealership and home improvement retailer may have a backroom production shop printing out parts and tools.
For example, many large manufacturers have separated high-expense “creative” or “innovative” R&D from lowcost production processes. But in the maker community, those two practices are merging again. The changes to come will accelerate moves that some leading manufacturers are already making: toward open source innovation, flexible production, and knowledge-intensive production lines. If you are a mainstream manufacturer intending to become a leader in this new environment, here are some directions worth considering. • Prepare now for the capabilities you’ll need when some of your products are digitally fabricated. As early
• Establish a hybrid product line that mixes complementary mass-production and individual-production items. For some objects, digital fabrication will allow
• Combat reverse engineering with open innovation. Digital fabrication will inevitably enable amateur
enthusiasts to knock off and alter commercial products in their garages. Although it’s unlikely that any one individual will replicate complex goods such as laptops, cameras, or cars in large quantities, the Internet is already flooded with blueprints for customizing consumer goods, repurposing game controllers, and replacing broken parts. Just like the music and movie industries, manufacturers now face a choice between engaging in eternal court battles with their own customers and assimilating this new culture of sharing and remixing into their design and production processes. Deploy the new tools to help consumers adapt and personalize their products, and use this to learn about their unspoken wants and needs. There are already several examples to emulate. Quirky.com, a site where inventors can propose their ideas for fabrication, invites the 35,000-plus members of its community to vote on whether a product should be made. The result is imaginative devices and housewares as varied as precision plungers, cord organizers, and new types of Swiss Army–style knives. Customers whose ideas are manufactured get a cut of the profits. The Microsoft Corporation has learned from customer innovation on its Kinect sensor, a popular acces-
features title features operations of the article & manufacturing
as 2020, every auto dealership and home improvement retailer may have a backroom production shop printing out parts and tools as needed. Manufacturers that figure out how to make their wares out of printable composites, investing now in the requisite changes in materials, could have a considerable advantage. One way to gain skills and experience is to participate in fabrication-oriented supply chain networks, leasing out excess capacity to smaller manufacturers or startups or using those customers to diversify your existing business. SparkFun has done this for clients that want small numbers of custom-printed circuit boards, spinning off a business called BatchPCB.com, which aggregates small circuit-board jobs into larger batches for mass production. For the end customer, it means waiting a few more days for the board, but at a drastically reduced price. Experience suggests that your own company’s capabilities will improve when your employees get their hands on the tools of fabrication. For the past 50 years, the separation of manufacturing from R&D has produced engineering graduates with too little hands-on manufacturing experience. Now that fabrication tools are increasingly driven by digital information, the two functions can work more closely together. Many factory-floor workers are already highly skilled at reading and interpreting design files and operating and maintaining machinery, and should be seen as allies in adapting shop processes to match new tools. As computer-controlled fabrication tools become more flexible and product runs become shorter, a typical factory worker might be making tripod handles in the morning and watchbands in the afternoon, and the gap between R&D and manufacturing will narrow.
you to shorten product life cycles and make rapid improvements. Limor Fried, founder of Adafruit, notes that “you can sell 2,000 of anything on the Internet” with little effort. If you can finance development by planning a run that size, you can innovate at a profit. Digital fabrication tools make it easy to swap in new features, change the production line, or restart production of old products if demand resurfaces. In this environment, it’s helpful to think of product planning as designing a continuous information flow, rather than designing separately launched objects. For other items, such as commonly used products, exploit the competitive advantage that scale provides. Whether it’s the mounting bolt used in all camera tripods, the USB cables that connect to more and more electronic devices, or the ubiquitous aluminum drink can, things that are universally compatible and consumed in large quantities will always be needed. Because standards hold a complex system together, they must be openly available, clearly defined, and changed only when necessary. This makes them good anchor products for large manufacturers that have capable supply chains.
51
• Help in the development of new and better materials for fabrication. Independent fabricators are eager for materials, and they are experimenting fervently. Forward-thinking manufacturers can form powerful partnerships by making their scrap materials available for experimentation. Advanced materials emerging today include conductive thermopolymers and inks (useful for printing electronic circuits), organic semiconductors, metal filaments with low melting points, and paper pulp that can feed into 3-D printers for additive packaging. The list grows daily, and materials information is ever-morereadily available on open access blogs such as formlovesfunction.com and openmaterials.org. Better materials are particularly needed to reduce waste and hazard at the end of a product’s life, especially because the faster production cycles of digital fabrication may lead to increasing numbers of discarded products. Ultimately, the disposal of goods is a problem of information and logistics. Recyclers need to know what’s in a product to break it down into component materials safely. The companies that manage assembly of a product can (and, in our opinion, should) partner with recyclers, providing the information needed to safely and profitably disassemble it into raw materials. • Be prepared for new misuses of technology. The most troubling side of digital fabrication is the potential for new forms of crime and abuse. In June 2010, i.materialise.com received an order for a custom skimmer, a card-reading device that fastens to the card slot on an ATM. Cleverly designed skimmers can look just like part of the machine. Every time a customer inserts a debit card, the skimmer copies the card numbers and
strategy+business issue 64
features operations management & manufacturing 52
sory for its Xbox 360 game console that allows games to track and respond to people’s body motions. Just after the Kinect’s North American introduction, Adafruit announced a competition for an alternative open source driver for the device. This started a frenzy of “Kinect hacking,” generating numerous novel applications for the device — including 3-D mapping for robotic devices, 3-D holographic images, and many other applications. The Kinect, which was originally marketed as just a sophisticated video game controller, could thus be made into a motion-detection device with endless applications, appealing to a much broader customer base. Although Microsoft initially threatened legal action, it ultimately chose to capitalize on the excitement. (It later turned out that Johnny Chung Lee, a member of the Kinect design team, had financed the original Adafruit competition without asking permission from the company.) Microsoft now provides a software development kit to cultivate its “unofficial” Kinect developers. Texas Instruments Inc. (TI) also combines proprietary and open source products in its portfolio. Its open source products include the Beagle Board, a low-cost computer-processing device with the computational capabilities of a typical smartphone or tablet computer. Jason Kridner of BeagleBoard.org, a developer community that includes several TI employees, told Make magazine editor Phil Torrone, “The revenues on board sales are in excess of $1 million annually and continue to rise, but the business model here is one of enabling the technology partners, not making money off the board sales. That said, all parties in the value chain are making money off the board sales — and this helps to keep the ecosystem alive where people can participate at almost any level.”
Are there enough interested customers to justify such efforts? One 2010 research study of United Kingdom consumers, conducted by Eric von Hippel, Jeroen De Jong, and Steven Flowers, found that 2.9 million people, or 6.2 percent of the nation’s adult population, have taken part in some form of consumer product innovation since 2006. “In aggregate,” they wrote, “consumers’ annual product development expenditures are 2.3 times larger than the annual consumer product R&D expenditures of all firms in the UK combined.”
The Future of Detroit
Taken as a whole, digital fabrication and information sharing herald a diversification of the manufacturing ecosystem. Economies of scale will still exist. Large manufacturers that adapt will benefit significantly. Not every customer will be a maker. Most will be happy to purchase products created by others, but they will choose from among a far greater number of producers and innovators. Remember that despite the popularity of file sharing, the music and movie industries are not dying. The mainstream producers of goods may face similar challenges and opportunities. To Dale Dougherty, publisher of Make magazine, Detroit represents the prototypical city of the future for digitally enabled manufacturing. Detroit has a large population in need of employment, knowledge of a wide range of manufacturing techniques, and a surplus of affordable real estate. In July 2010, Dougherty convened the first of a series of “Maker Faire” expos in the Motor City (similar expos had taken place since 2006 in the San Francisco Bay area and Austin, Texas). Three hundred and twenty-five Michigan-based manufacturers of products, including knitted goods, soap, machine tools, rockets, and auto components, showed off their work to the public. Dougherty envisions cities like Detroit fostering new industries of digitally enabled fabrication. Large manufacturers might outsource designs to local micro-factories, leveraging supply chains to build highly
responsive production networks. Unions might help their laid-off members become entrepreneurs, providing group buying power for health insurance as well as materials and services. Whether digital fabrication will have this kind of transformative effect on troubled economies isn’t known; indeed, no one can predict exactly how the new, disruptive technology will play out. But we can already guess at the capabilities that will be needed by manufacturers to win in this new game. The history of digital technology suggests that the winners will be those that embrace decentralized models, exchanging the kinds of information, materials, fabrication processes, knowledge, and labor that, for the first time, can travel freely across a network of avid makers. + Reprint No. 11307
Resources Limor Fried and Phillip Torrone, “Million Dollar Baby,” 2010, www .adafruit.com/pt/fooeastignite2010.pdf : Overview presentation of open source hardware companies by Adafruit. Phillip Torrone, “Open Source Hardware 2009,” 2009, http://blog .makezine.com/archive/2009/12/open-source-hardware-2009-the-def .htm: List and overview of open source hardware projects in existence in 2009. Edward Tse, Kevin Ma, and Yu Huang, “Knockoffs Come of Age,” s+b, Autumn 2009, www.strategy-business.com/article/09315: Introduction to China’s shan zhai companies and their transition from piracy to competitive innovation. Eric von Hippel, Jeroen De Jong, and Steven Flowers, “2010: Comparing Business and Household Sector Innovation in Consumer Products: Findings from a Representative Study in the UK,” 2010: Survey of the development and modification of consumer products by product users in a representative sample of 1,173 U.K. consumers age 18-plus. Wohlers Associates, “Wohlers Report 2011,” 2011, www.wohlersassociates.com/2011report.htm: Yearly in-depth analysis of the additive manufacturing industry worldwide. For more on this topic, see the s+b website at: www.strategy-business.com/operations_and_manufacturing.
features featurestitle operations of the article & manufacturing
PINs for later extraction. The proprietors of i.materialise refused to fabricate the skimmer, but other 3-D printing services may not be as ethical. Disruption has its downsides. A diversified supply chain, more widespread manufacturing literacy, and changing intellectual property practices will inevitably bring new forms of abuse and mishap. Regulations and conventional law enforcement might not be agile or thorough enough to keep up. Manufacturing as an industry will need to promote new best practices and professional norms — in collaboration with a more engaged customer base and a wider range of manufacturing, distribution, and reclamation partners.
53
features global perspective
54
How to Be a Truly Global Company by C.K. P r a ha lad a nd H r ish i Bhat t acha r y ya
Photo illustration by Holly Lindem, portrait by Martin Mörck
During the high-growth years between and other emerging markets. The 1 bil1992 and 2007, the globalization of com- lion customers of yesterday’s global busimerce galloped at a faster pace than in any nesses have been joined by 4 billion more. These customers reside in a other period in history. Now, much larger geographic area; amid the chronic unemploythree-quarters of them are new ment and anti-trade rhetoric of to the consumer economy, and the post-financial-crisis world, they need the infrastructure, some observers wonder whether products, and services that only globalization needs a time-out. global companies provide. However, the experience of The problem is not globalizamultinational companies in the tion, but the way our current infield suggests the opposite. For them, globalization isn’t hap- C.K. Prahalad, 1941–2010 stitutions are set up to respond to this new demand. The prepening rapidly enough. Whereas GDP growth has stalled in the industrial- vailing corporate operating model does not ized world, consumption demand is still work well with the structural changes that expanding in China, India, Russia, Brazil, have taken place in the global economy.
features global perspective
Many multinational business models are no longer relevant. Skillful companies can integrate three strategies — customization, competencies, and arbitrage — into a better form of organization.
55
features global management perspective 56
Hrishikesh (Hrishi) Bhattacharyya
[email protected] is a management consultant and was formerly a senior vice president at Unilever with global responsibility for the health and wellness category. He has also taught at the University of Michigan’s Ross School of Business and at the London Business School.
Most companies are still organized as they were when the market was largely concentrated in the triad of the old industrialized world: the U.S., Europe, and Japan. These structures lead companies to continue building their global strategies around the trade-offs and limits of the past — trade-offs and limits that are no longer accurate or relevant. One of the most prevalent and pernicious of these perceived trade-offs is the one between centrally driven operating models and local responsiveness. In most companies, an implicit assumption is at play: If you want to gain the full benefits of economies of scale — and to integrate common values, quality standards, and brand identity in your company around the world — then you must centralize your intellectual power and innovation capability at home. You must bring all your products and services into line everywhere, and accept that you can’t fully adapt to the diverse needs and demands of customers in every emerging market. Alternatively (according to this assumption), if you want locally relevant distribution systems, with rapidly responding supply chains and the lower costs of emerging-market management, then you must decentralize your company and run it as a loose federation. You must move responsibilities for branding and product lineups to the periphery, and accept different trade-offs: more variable cost structures, fewer economies of scale, more diverse and incoherent product lines, and more inconsistent standards of quality. Some companies try to use strict cost controls to manage these trade-offs. They put in place a decentralized operating model with some central oversight, usually augmented by outsourcing. But this is a tactical move based on expediency, rather than a global strat-
egy. This approach leads to suboptimal results in today’s complex world. Other false trade-offs are visible in the tension many companies experience between their current business model and the needs of the emerging markets they are entering. They wonder: • Whether to serve existing customers in their home countries or new customers in emerging countries. • Whether to meet competitive quality standards demanded by consumers in wealthy countries or offer just the “good enough” features that poorer customers can afford. • Whether to pursue a strategy of premium or discount pricing. • How to attract and retain resources and talent, which are perceived as draining away from emerging markets to the industrial world whenever employees are permitted to migrate. • Whether, in using resources strategically, to follow the typical Western orientation (toward reducing labor and accumulating capital) or the view from emerging markets (where labor is inexpensive, capital is difficult to accumulate, and therefore it is worth investing in building large workforces for growth). Corporate leaders expect to have to make stark choices as they expand. But the time has come to embrace a new business model that encompasses both the established advantages of industrial markets and the opportunities of emerging economies. (Also see “Competing for the Global Middle Class,” by Edward Tse, Bill Russo, and Ronald Haddock, page 62.) Instead of struggling to apply a Western business model everywhere, you can adopt a business model that treats decentralization, centralization, current prac-
strategy+business issue 64
C.K. Prahalad passed away on April 16, 2010. He was the Paul and Ruth McCracken Distinguished University Professor of Corporate Strategy at the University of Michigan’s Ross School of Business and the author of The Fortune at the Bottom of the Pyramid (Wharton School Publishing, 2005). This article, which was in progress at the time of his death, is published with the permission of his family.
Instead of struggling to apply a Western business model everywhere, you can adopt a business model that treats decentralization and centralization not as trade-offs, but as complements.
An Operating Model without Trade-offs
Some companies are already following these three imperatives, pursuing all of them simultaneously. Among those that we have studied in detail are Toyota, Marriott, McDonald’s, GE Healthcare, and several global cellular telephone companies. Leaders in these enterprises have trained themselves and their teams to be very deliberate
about where to customize, how to build competencies, and what to arbitrage. With this type of operating model, there is no longer a need to choose between a centralized and a decentralized structure, between current and future customers, or between a strategy grounded in industrialized economies and one grounded in emerging economies. To illustrate these three imperatives, we draw on the experience of GE Healthcare (customization), McDonald’s (competencies), and the Chinese and Indian mobile telephone industries (arbitrage). It’s important to remember, however, that all these stories involve integrating all three elements — a rare feat. Only with the full operating model can a company gain the benefits of decentralization, centralization, and outsourcing without making compromises. • Customization. The key to this imperative is to deliver products and services in a locally competitive way. That means they must satisfy the needs and wants of diverse customers, in terms of features, affordability, and cultural affinities. Because needs and wants vary greatly among people at different income levels, this objective is complex and expensive to reach in any centralized way. That is why companies must leverage the diversity of a decentralized structure. Is there a simple and coherent way to deliver customization to customers in 200 countries spread over five continents? The answer is yes, through the hub system: Companies customize only in a maximum of 20 gateway countries. With this limited investment, they can serve customers everywhere, on every level of the income pyramid, from the wealthiest to the poorest. These 20 countries have enough scale in themselves to offer the necessary economies and growth potential.
features title features global of the perspective article
tices, and potential disruptions not as trade-offs, but as complements. In a previous article, “Twenty Hubs and No HQ” (s+b, Spring 2008), we proposed an essential part of this business model: a global corporate structure with no headquarters. Instead of a single center, companies would establish core office “hubs” in many or most of the 20 gateway countries in the world that house 70 percent of the world’s population and account for 80 percent of its income. These 20 countries include 10 from the industrialized world: Australia, Canada, France, Germany, Italy, Japan, the Netherlands, Spain, the United Kingdom, and the United States. The other 10 are emerging markets: Brazil, China, India, Indonesia, Mexico, Russia, South Africa, South Korea, Thailand, and Turkey. A hub strategy enables a company to provide products and services everywhere. But it will not in itself resolve the trade-offs of globalization. Companies can accomplish this only with a more comprehensive business model that (1) customizes their products and services in hubs around the world, (2) unites business units around a platform of proprietary knowledge and the building of competencies, and (3) arbitrages their operating models to gain cost-effectiveness, productivity, and efficiency.
57
features global management perspective 58
They are also well equipped with skills: Manufacturers of goods will find the suppliers and employees they need to meet reliable quality standards in operations, and they will also find innovation and R&D facilities already existing there. The logistical and institutional infrastructure is well developed in most of these gateway countries, integrated into international regulation and trade. Each gateway country can independently perform most necessary business activities; when linked together, they make up a formidable network. Many companies will settle on fewer than 20 hubs; each industry requires a different selection of gateway countries to meet differing tastes and needs. Reducing complexity in this way also dramatically reduces a wide range of overhead costs for large global companies, while enabling them to travel the last mile to customers. For example, by trimming back supervisory layers to only those needed by the gateways, companies can cut overhead costs significantly. GE Healthcare’s story illustrates how expanding through a few gateway countries enabled it to thrive in many locations. Its primary business is high-end medical imaging products. In the late 1980s, GE Healthcare started investing in ultrasound machines, designing separate devices for use in obstetrics and cardiology. Over time, the business became a market leader, with a portfolio of premium products employing cuttingedge technologies, sold primarily to big hospitals in rich Western countries. Very few devices made by GE Healthcare were sold in China and India in the 1990s, although the medical need was enormous and the region represented a huge potential market. In these large but poor countries, the general population relied (and still relies) on poorly
funded, low-tech hospitals and clinics in small towns and villages. None of these organizations could afford sophisticated, expensive imaging machines. There was a significant need for customization: Someone needed to create low-priced machines with basic features that were easy to use. The devices also needed to be portable, so that medical workers could bring the machine to the patient, rather than the patient to the machine. GE Healthcare started a major effort in 2002 in China to tackle this problem. The initiative was favored by a corporate policy put in place a few years earlier: reorganizing some emerging-market enterprises into semi-autonomous “local growth teams” with their own P&Ls. This meant that GE Healthcare could now create a local business oriented to China’s particular needs and advantages, drawing on local talent and combining product development, sourcing, manufacturing, and marketing in one business unit. The price of a conventional Western ultrasound machine is between US$100,000 and $350,000. GE’s first portable machine for China was launched at a price of only $30,000, and by 2007 a newer machine was on the market for $15,000. Sales took off in China and then in a few other emerging-market gateway countries. Soon, customization worked in the other direction. Applications were found for these devices in several rich countries as well, at accident sites and in clinics and emergency rooms. Sales rose from zero to more than $300 million in five years. In 2009 — as recounted by GE chief executive officer Jeffrey Immelt and innovation experts Vijay Govindarajan and Chris Trimble in the Harvard Business Review in October 2009 — GE announced that “over the next six years it would spend $3 billion to create at least 100 healthcare innova-
strategy+business issue 64
The menus at McDonald’s restaurants vary widely around the world, while unity remains firmly entrenched where it should be — in branding, technology, and business processes.
of the world, McDonald’s was identified with American tastes, and seen as being out of sync with the needs of non-U.S. consumers. The McDonald’s leadership responded by creating a new platform on which the company could unite: not standardization, but a common thrust to provide fresh food, healthier menu options, and customized offerings for different cultures. Product offerings were no longer centralized, and the menus at McDonald’s restaurants vary widely, while unity remains firmly entrenched where it should be — in branding, technology, and the business processes that gave the company its differentiation, cost bases, and productivity. The brand logo, color schemes, and store layouts are the same around the world. Procurement and distribution systems are centrally managed to ensure that deliveries take place on time to more than 32,000 individual restaurants. Structured training from a common playbook is given every day to store associates in all locations. The company’s proprietary knowledge remains centrally and rigidly controlled. • Arbitrage. The final imperative involves gaining effectiveness and reducing cost by finding less expensive materials, manufacturing processes, logistics systems, funds sourcing, or infrastructure. Most companies have addressed this tactically, by offshoring back-office work or moving manufacturing to locations with lower-cost labor. This is generally a defensive or reactive move, rather than a well-considered strategy. An arbitrage initiative is much more systemic. The business looks at its production flow and disaggregated cost chain as a whole, seeking optimized sourcing, sales conversion, and go-to-market options. The initiative approaches materials, factory locations, and people as part of a single system, taking into account the processes and procedures within the most important hubs, and among hubs as well. The history of mobile telephony in China and India provides a good example of the power of arbitrage. These two countries together have more than 1 billion cell phone users, and the number of new connections in India alone exceeds a staggering 10 million a month. In the early 2000s, the groundwork for new networks in China and India was laid by a few farsighted telephone companies. At that time, landline networks were sparse, and the number of homes with phone lines was a minuscule fraction of the total households. The only way to build a profitable phone system was to create “network value”: access to enough other people and institu-
features title features global of the perspective article
tions that would substantially lower costs, increase access, and improve quality.” • Uniting around a platform of competencies. This initiative means aligning your entire global company with a common core purpose, a body of proprietary world-class knowledge, and the competencies that distinguish your company from all others. The core purpose must be understood equally in all functions and geographies of the corporation. Every individual should know the strategic principles of the business — which are the same around the world, but adapted differently in each locale. For example, providing “everyday low pricing” is the core purpose of Wal-Mart Stores Inc. Although that principle remains constant, the implementation varies considerably; Walmart in India is a joint venture wholesale operation, and Walmart in Mexico operates restaurants and banks as well as superstores. The core competencies at the heart of this platform include proprietary technology and intellectual property. These are the unique pieces of knowledge and know-how that distinguish any company — not the applications or technologies, but the standards and platforms of knowledge that the company creates and makes its own. They may include manufacturing processes, supply chain and logistics systems, customer insight–gathering processes, or distribution and access systems. They are made available to all operations, everywhere in the world, and are used to customize offerings and arbitrage procurement and costs. At the McDonald’s Corporation in the mid-2000s, this type of unity represented a dramatic shift away from the rigid hierarchies, brands, financial performance metrics, and reporting relationships of its old centralized model. The restaurant chain had embodied the centralization model for many years. Every aspect of the system had been standardized around the world: brand identity, product offerings, packaging systems, franchise arrangements, and the design of the stores. All this had come out of a single manual, and the company’s rigidity had helped it prosper, because it was seen as exporting an image of the American lifestyle. But standardization began to reach its limits around 2001. There was a distinct shift in consumer taste toward healthier, more nutritious foods. In the U.S., fast-food restaurants in general and McDonald’s in particular were blamed by many for the emerging obesity epidemic, especially among American children. Customers started switching to other chains. In the rest
59
Bringing the Elements Together
Some companies recognize the benefits of customization; they are moving into new geographies through gateway countries. A growing number of companies are uniting around platforms of competencies. And, of course, many companies practice arbitrage. But until they join the few pioneers that combine these three elements, most companies will not get the full payoff of the new operating model. Indeed, the three cases described in the previous section are successful precisely because they integrated all three elements. For example, GE Healthcare had to drop the price of its ultrasound machines by more than 90 percent in order to have its products accepted in emerging markets. Its solution involved not just customization, but arbitrage: It used an ordinary laptop computer instead of proprietary hardware. These machines did not have many of the features of their expensive counterparts, but they could perform such simple tasks as spotting stomach irregularities or enlarged livers or gallbladders. This made them critical tools for doctors at rural clinics. The laptop-based design, in turn, drew heavily on GE’s platform of competencies: specifically, experience with other projects that had shifted from using custom hardware to using standard computers. The new devices also incorporated breakthrough ideas from scientists in the GE system with deep knowledge of ultrasound technology and biomedical engineering. Similarly, the McDonald’s story did not only involve unity around a platform. The company also saw the power of customization. Today, McDonald’s offers rice burgers in Taiwan, vegetarian entrees in India, tortillas in Mexico, rice cakes in the Philippines, and wine with meals in many European cities. McDonald’s also extended its already impressive arbitrage capabilities through sophisticated sourcing and distribution practices, tailored to each location’s opportunities. The arbitrage in the Chinese and Indian mobile phone story also depended on the other two elements. Although the prices were low, the equipment was standard quality; networks had to seamlessly integrate with the world’s telecommunications systems. The companies involved, including the vendors such as Siemens,
strategy+business issue 64
features global management perspective 60
tions to make the system feel indispensable. This meant providing telephone access to millions of prospective customers who had never used a phone, who lived on $2 a day, who had no money to buy the phones outright, and who lacked the bank accounts and credit cards that would allow them to sign service contracts. The pricing structures reflected these realities. In India, for example, Reliance Industries Ltd. (a large nationwide conglomerate) sold Nokia and Motorola handsets for as little as $10, lowered call rates to two cents per minute for these phones, and sold prepaid cards that customers could use both to pay for and to ration their telephone use. It took skillful collaboration among cell phone manufacturers and carriers to accomplish the arbitrage needed for them to offer such prices. Manufacturers such as Nokia, Motorola, and Samsung offered their products, product knowledge, and R&D capability at a reduced cost; carrier companies such as Vodafone, China Mobile, and Airtel invested in cell phone towers and switching equipment with minimal return at first. Then Airtel in India took a hugely innovative step. Realizing that its own capital for network expansion was constrained, it brought in Ericsson, Siemens, Nokia, and IBM as network equipment and IT vendors, convincing them to forgo their ordinary fee structures. Instead, Airtel paid these companies on the basis of usage and revenue. Airtel thus converted fixed infrastructure costs to variable costs and improved its ability to offer low prices to customers. Another form of arbitrage, deploying the most inexpensive marketing and distribution channel available, was an essential factor in creating a mass mobile phone market. Reaching people in remote Chinese or Indian villages was a huge challenge. Little grocery shops, often housed in temporary structures, were often the only commercial channels available to consumers there. These stores sold everyday-use products such as soap, cigarettes, and matchboxes. Instead of creating a new channel of dedicated telephone stores, the phone companies established partnerships with these outlets; they stocked and sold the prepaid cell phone cards. This would never have happened if the telcos had followed their old pricing and distribution models.
The company’s collegial culture allows it to pare back the expenses of oversight and supervision; everyone naturally pays attention to cost and efficiency. Marriott also demonstrated its facility for arbitrage through its early adoption of the Internet as a vehicle for making and confirming reservations. Many CEOs and top managers are still asking themselves when the bad times will end. No one has the answer, and even in a robust recovery, competition will not slacken. A better question is, What can we do now to establish ourselves in the new global economy? Consumer-oriented companies will need to deliver worldclass quality in their products and services, customized for purchasers in multiple locales and circumstances, with significant price reductions (affordable to people at the lowest income levels). They must also provide their customers varying forms of access (owning, renting, or leasing equipment). This cannot be done when a company is striving to balance decentralization and centralization. It can be accomplished only by companies that transcend the old trade-offs and seek operating models that allow them to serve the largest numbers of people while meeting the highest possible standards. + Reprint No. 11308
features featurestitle global of the perspective article
Motorola, and Ericsson, drew upon their platforms of proprietary knowledge to make it work. Everyone customized relentlessly, varying the payment plans, the amounts coded into phone cards, and the services offered to support the different needs and interests of telecom users in each country. For another example of the way these three elements can be deliberately combined, consider the case of Marriott International Inc. Throughout most of its history, the company followed a centrally driven strategy with tight controls over the look and feel of its properties. But the company was also willing to experiment. For example, in 1984, it was the first hotel chain to offer timeshare vacation ownership. Like McDonald’s, Marriott learned the problems of rigorous centralization firsthand. In 2001, when it opened a timeshare in Phuket Beach, Thailand, the venture failed. Gradually, Marriott realized that the reason had to do with cultural differences: Asian tourists, especially the Japanese, want to visit multiple places during a single vacation. They typically stay two or three days in one location and then move on. This made them very different from Marriott’s U.S. and European holiday travelers, who prefer to stay in one place for a week or more. In 2006, the hotel chain launched a timeshare network called the Marriott Vacation Club, Asia Pacific. Customers could hop among locations, spending their annual club dues anywhere in the network. This customization initiative turned a failed project into one of the company’s fastest-growing businesses. In initiatives like this, Marriott draws on its central strengths, including a devotion to knowledge at starts with the CEO (and son of the founder) J.W. (“Bill”) Marriott Jr. In his 1997 book, The Spirit to Serve: Marriott’s Way (with Kathi Ann Brown; HarperBusiness), Marriott wrote, “Our principal product is probably not what you think it is. Yes, we’re in the food-and-lodging business (among other things). Yes, we ‘sell’ room nights, food and beverage, and time-shares. But what we’re really selling is our expertise in managing the processes that make those sales possible.” This approach is reflected in Marriott’s strong “spirit to serve” philosophy and its highly centralized recruiting approach for seeking out dependable, ethical, and trustworthy associates. The company is known in the U.S., for example, for its robust efforts to train welfare recipients to make a permanent transition into the workforce, and worldwide for its extensive profit-sharing practices and human resources support.
Resources Jeffrey R. Immelt, Vijay Govindarajan, and Chris Trimble, “How GE Is Disrupting Itself,” Harvard Business Review, October 2009: Inside story of the GE Healthcare initiative to overcome “glocalization” and innovate within emerging economies. Jon R. Katzenbach and Jason A. Santamaria, “Firing up the Front Line,” Harvard Business Review, May–June 1999: On Marriott’s strategy. Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011): The capabilities system resembles this article’s unity of platform. C.K. Prahalad, “The Innovation Sandbox,” s+b, Autumn 2006, www .strategy-business.com/article/06306: Why arbitrage does not mean thoughtless substitution, but rather creative low-cost alternatives that transform conventional business practice. C.K. Prahalad and Hrishi Bhattacharyya, “Twenty Hubs and No HQ,” s+b, Spring 2008, www.strategy-business.com/article/08102: First publication of the customization concept, with an operating model for transforming the headquarters–local office relationship. Ellen Pruyne and Rosabeth Moss Kanter, “Pathways to Independence: Welfare-to-Work at Marriott International,” Harvard Business School Case Study 9-399-067: More detail about Marriott. For more thought leadership on this topic, see the s+b website at: www.strategy-business.com/global_perspective.
61
Competing for the Global Middle Class by Edward Tse, Bill Russo, and Ronald Haddock
features global perspective 62
Three types of companies are jockeying for position in emerging economies, seeking to capture the loyalty of billions of new consumers.
features global perspective
Illustration by TK
63
Bill Russo
[email protected] is a senior advisor with Booz & Company. Based in Beijing, he has more than 20 years of experience in the automotive industry, most recently serving as vice president of Chrysler’s business in Northeast Asia.
In the 1920s, when Alfred P. Sloan Jr. reorganized
features global management perspective 64
General Motors Company, he promised shareholders “a car for every purse and purpose.” Sloan tapped into a teeming middle-class market of Americans who couldn’t afford luxury cars, but nonetheless wanted product options far beyond the “any color so long as it’s black” Model T Ford. This immense U.S. middle-class cohort propelled GM past Ford into a leadership position among carmakers that lasted for the rest of the century. Today, leaders of multinational corporations have a similarly lucrative opportunity on a much bigger playing field: a global middle-class market. This worldwide economic phenomenon encompasses a huge customer base. In 2011, it includes about 400 million people in the mature middle classes of the U.S., Europe, and Japan, and another 300 to 500 million people, depending on how the middle class is defined, in emerging economies. (The World Bank defines middle class as people who are above the median poverty line of their own countries. This might make them poor by the standards of Europe or the U.S., but gives them enough purchasing power to become consumers of manufactured goods and services.) This new global middle class is particularly evident in Brazil, China, India, Indonesia, Mexico, Nigeria, Turkey, Vietnam, and other countries with relatively large working populations and rapid economic growth rates. The middle class in each of these emerging economies has its own unique profile of demand. However, they all have one thing in common: They are recovering from the global recession with an increasingly urbanized lifestyle, and their numbers are expanding at very high rates, especially compared with the rest of the world. The value chain of companies that provide this
Ronald Haddock
[email protected] is a former partner at Booz & Company, where he helped companies build businesses in China, India, Korea, Russia, and other emerging markets.
Previous pages: In China’s Sichuan province, farmers look over Haier’s flat-screen TVs.
population with goods, services, and infrastructure is becoming known as the “global middle market.” Companies that secure leading positions within that market could well become the 21st-century equivalents of Alfred Sloan’s General Motors. One such company may be China’s Haier Group. In 1985, Haier was a bankrupt domestic refrigerator manufacturer. Product quality was so bad that general manager Zhang Ruimin (now chairman and CEO) built his case for change by lining up 76 defective units and ordering workers to destroy them with sledgehammers. Today, one of the sledgehammers is on display in corporate headquarters, and Haier is one of the world’s largest appliance makers — a multinational corporation with a reputation for world-class quality and 2010 revenues approaching US$20 billion. Zhang put in place three successive strategic initiatives, aimed, respectively, at improving product quality, expanding globally, and diversifying the company’s product line: for example, offering washers at a range of price points for consumers in different income segments, just as GM did with its cars early in the 20th century. Then, in December 2005, Zhang announced a new thrust. Haier would stop shipping products from China to the rest of the world; instead, it would design and manufacture products elsewhere, customizing them for specific national and regional markets. Today, Haier produces extra-large-capacity washers that can accommodate the robes of Middle East consumers; electronically sophisticated washers that can cope with the frequent power fluctuations in India; whisperquiet, timer-equipped washers for Italians who want to take advantage of the lower power rates available late at night; and other locally targeted variants.
Photograph © Imaginechina via AP Images
Edward Tse
[email protected] is a senior partner with Booz & Company and the firm’s chairman for Greater China, based in Hong Kong and Shanghai. He is the author of The China Strategy: Harnessing the Power of the World’s Fastest-Growing Economy (Basic Books, 2010).
Haier produces extra-large-capacity washers that can accommodate the robes of Middle East consumers and quiet, timer-equipped washers for Italians whose power rates are lower at night.
Momentum in the Middle
The first step toward becoming a leading company for the global middle market is recognizing the pace of development in the countries where you hope to do business. All industrializing countries follow an “arc of growth”: an evolutionary path of economic change. They start as nascent economies (emerging from subsistence, with large numbers of young people). They gradually evolve into mature economies, with relatively flat growth and large numbers of aging people. In between, there is a critical stage of urbanization and economic momentum. During this “momentum phase,” many countries have large, relatively young populations and high economic growth rates. These countries are the seedbed of the emerging middle-class markets. Three types of corporate players are jockeying for position in these markets: 1. Local upstarts are companies that have traditionally provided low-priced goods for bottom-of-the-pyramid customers in their home markets. They are migrating upward into their domestic middle markets as their customers become more prosperous. These companies now provide products and services with more features, better quality, and increased brand status. 2. Global aspirants are local companies that have
already developed products for their domestic middle markets. Now, they seek to expand their geographic reach and power, parlaying their existing capabilities and knowledge into serving the global middle class. 3. Multinational incumbents are mature global companies, often from Japan, Europe, and the United States. They are intent on adapting their existing product lines to capture the attractive growth opportunities in emerging middle markets. You can see all three types of competitors in most sectors in countries that are in the momentum phase. For example, in China’s automobile sector, local upstarts are represented by players that have traditionally made low-cost cars, such as Chery Automobile Company, Great Wall Motor Company, and Geely Automobile Holdings. They are moving up the product pyramid. In 2010, Geely purchased the Swedish carmaker Volvo from Ford at the bargain-basement price of $1.8 billion and immediately raised production plans to 300,000 Volvos annually, almost double the previous worldwide production. Global aspirants in China’s middle market include South Korea’s Hyundai Motor Company. Hyundai entered China in 2002 and has since achieved remarkable success in the middle market with a major redesign of its Elantra model. Among the multinational incumbents are longestablished automakers aggressively seeking to carve out significant shares of China’s middle market. These include GM, with its Chevrolet Spark and Buick Excelle, and Volkswagen, with its Polo and Golf models. All of these multinationals pursue this market through joint ventures with Chinese partners. For example, the Guangzhou Automobile Group makes Honda-branded
features title features global of the perspective article
Haier is not the only company that has transformed itself to seek a share of the global middle-class market. In a variety of industries — including consumer packaged goods, electronics, automobiles, medical products, and agricultural equipment — corporate leaders are discovering that they must rethink their product and service lines, go-to-market strategies, and operating models to build a presence in emerging economies.
65
Shopping for air-conditioning units at a Beijing appliance store.
features global management perspective cars for the middle-class market. The Shanghai Automotive Industry Corporation launched the Lavida with Volkswagen and is working with GM on a newgeneration small car called the Baojun (Chinese for “treasured horse”). Incumbent automakers such as Honda, Volkswagen, and GM aren’t simply exporting cars from their home countries to China. Since 2005, they have been modifying and restyling their vehicles to better align them with the needs and tastes of Chinese consumers. For example, Volkswagen installs smaller engines in some vehicles, such as the Polo GTI and the Golf 6. Such changes enable incumbents to offer two types of vehicles. They make low-priced cars for entrylevel Chinese consumers who prioritize cost and value,
and cars with added features for more affluent midmarket consumers who can pay for the quality and brand status associated with foreign cars. One sign of the value of the Chinese auto market to incumbents is GM’s sales there, which exceeded its U.S. sales in 2010 — the first time sales in another national market eclipsed U.S. sales in the company’s 102-year history. The same three types of competitors — local upstarts, global aspirants, and multinational incumbents — are active in China’s construction equipment market, probably the most vibrant construction equipment market in the world right now. Local upstarts such as Zoomlion and Longking have been moving into the domestic middle-class market in China. Some, like the LiuGong Machinery Corporation and Sany Heavy In-
Photograph © Imaginechina via AP Images
66
A More Complex Market
The world is far from homogeneous. The buying power, needs, and desires of the middle classes vary by nation and region. In developing nations, for example, middlemarket customers are seeking products that have some of the premium features and quality that customers in developed nations are used to, but at lower price points. Furthermore, customers in each geographic market are drawn to buy products that fulfill local needs and de-
sires. As Pankaj Ghemawat, professor of global strategy at IESE Business School, notes in World 3.0: Global Prosperity and How to Achieve It (Harvard Business Press, 2011), there are numerous casual examples of cultural difference [in consumer products]…. The Czechs drink way more beer than people in Saudi Arabia, and even more than the Irish, who come in second. Pakistanis google sex more often than any other national population, just slightly more than the Vietnamese and far more than the Irish and Czechs. Eritreans google god the most as well as figuring in the top five nationalities searching for sex. India and China are so close geographically that they still haven’t resolved their territorial disputes, but couldn’t display more distinct food cultures, particularly around which animals and parts of animals should or shouldn’t be eaten. Argentines see psychotherapists more than other nationalities, and Brazilians spend a higher proportion of their income on beauty products than the citizens of any other major economy. To successfully serve middle-market customers, companies must identify which product attributes the customers in a specific market value and don’t value. Then, they must either add those attributes to or cull them from their existing products. Ghemawat uses the examples of McDonald’s, KFC, and Coca-Cola, all of which vary their products geographically: Coke, for instance, uses cane sugar as sweetener in some countries and corn syrup in others. This type of variation adds complexity across product and marketing mixes, and in all the operations and functions related to them. It can require much extra expense and attention from companies, especially those with heavily centralized, scaledriven business models. But companies that seek leadership positions in their industries may have little choice but to pursue the global middle market. The developed middle markets are a huge and indispensable source of sales volume,
features title features global of the perspective article
dustry, have become global aspirants. In 2008, LiuGong opened a factory in India. In 2009, Sany announced it would invest €100 million ($144 million) in an R&D and manufacturing center in Germany; it also has major plants under construction in the U.S. and Brazil. Incumbent construction equipment makers, such as South Korea’s Doosan Infracore, Japan’s Komatsu, and U.S.-based Caterpillar, are aggressively targeting the Chinese middle market as well. Caterpillar’s stated goal is to become the top brand in its sector in China by 2015. In the 1990s, the company was focused on developing government relationships to facilitate sales of its existing product lines. But as the middle market heated up, Caterpillar found its market share squeezed by Japanese and Korean competitors and rising local players. In the late 2000s, Caterpillar’s leaders recognized that the company’s traditional product line and business model were not adequate for China. It lowered its cost base through the establishment of local R&D centers and through the acquisition of Shandong Engineering Machinery, a leading Chinese wheel loader manufacturer. Just as countries evolve over time, so do companies. Many of today’s local upstarts will be global aspirants tomorrow; today’s global aspirants often become multinational incumbents. The differences among them appear primarily in the way they choose to compete, and in the level of resources that they use to enter a market. The more intelligent they are about their approach, the more likely they are to move to the next level. Unfortunately for the incumbents, local companies are increasingly intelligent about the way they make the transition, using joint ventures or regional expansion to gain the experience they need to compete on a larger scale.
67
features global management perspective 68
and market share can decline precipitously as local upstarts or global aspirants redouble their efforts. In most of these markets, competition is already intense: Companies track their market share gains and losses in tiny increments — a point or even a fraction of a point at a time. In addition, most developed middle markets are driven more by the rise and fall of macroeconomic cycles than by underlying fundamentals, such as an unusually fast-growing customer base. This means that during the stable parts of the cycle, the gains that new players make will come out of the pockets of incumbents. The global middle market is also spawning gamechanging new products that can migrate to and eventually threaten the status quo in developed markets. Tuck School of Business at Dartmouth College professors Vijay Govindarajan and Chris Trimble have coined the phrase reverse innovation to describe the process by which products designed for developing economies become hits in developed economies because they fill undiscovered needs and desires of customers in those nations. (See “How to Be a Truly Global Company,” by C.K. Prahalad and Hrishi Bhattacharyya, page 54.) Myths and Realities
Because the case for pursuing the global middle market is compelling, and the complexities are daunting, it is understandable that many senior executives at major consumer and industrial product companies are ambivalent about — or even resistant to — the idea. Their resistance, however, should be reconsidered. It is usually based on one or more of the myths below. Myth: It’s too early to enter the middle markets in emerging economies.
Reality: It may already be too late. The competitive collisions between local upstarts, global aspirants, and multinational incumbents are occurring at different speeds in different industries, and some industries are already becoming saturated with competitive rivals. In major appliances, for example, most countries now have offerings from Haier (which not long ago was an upstart); South Korea’s LG and Samsung (which were recently considered global aspirants, but now operate as full-fledged global incumbents); and GE, Whirlpool, and Electrolux (multinational incumbents trying to win share in emerging middle markets and defend their shares in the mature middle markets of developed nations). The fortunes of companies will be made or lost depending on the timeliness of their entry into the emerging middle markets. If the current pattern holds true, those that fail will likely become the acquisition targets of global aspirants. This has already happened to some carmakers, such as Volvo and Saab. Midsized domestic companies in developed markets will also become targets as new competition enters their home markets and their home markets become an ever-smaller percentage of the global middle market. Myth: We can’t make money in the middle markets of emerging economies. Reality: Yes, products aimed at the middle classes of developing nations are usually priced 20 to 40 percent lower than their counterparts in developed nations. But in emerging economies, lower prices do not necessarily mean lower profits, because the sales volume is potentially two to three times greater than the volume in more mature markets. Multinational incumbents need to develop the capability to profitably address consum-
strategy+business issue 64
In emerging economies, producers tend to rely on a simpler value chain, with more of it located in low-cost countries, which reduces costs and boosts margins.
into products and services is another key to success. The manufacturing footprint will likely expand in many companies as the number of products designed for specific middle markets begins to grow. In lower-income markets, manufacturing processes may need to emphasize volume and efficiency over customization. Farther back in the value chain, suppliers will be rewarded for minimizing complexity and meeting the value and cost expectations of middle-market customers. Marketing will need to identify distinct middleclass markets and gain an intimate understanding of the customer segments within each one. It will have to craft and effectively communicate tailored value propositions that don’t undermine more expensive offerings, especially when they bear the same brand names. Sales and service will need to be rightsized for each market — often, this will entail more of a self-serve approach that keeps costs low. For executives of multinational corporations, it may take a change in the conventional business mindset to tap into global middle markets effectively. The most successful companies are establishing new business units; rethinking their decision rights and other practices; and giving their leaders the freedom, authority, financial resources, and talent needed to develop and run these businesses. The opportunities in the global middle market are worth the effort. +
features title features global of the perspective article
ers in these price segments, because that is often where emerging competitors gain their initial foothold. Moreover, the cost of making products tends to be lower in emerging economies than in mature markets. These products usually have fewer premium features and often, as with the smaller engines in Volkswagen’s Polo and Golf, have less-expensive parts. The producers of these goods tend to rely on a simpler value chain, with more of it located in low-cost countries, which also reduces costs and boosts margins. Finally, companies earn additional dividends in shareholder value as they expand into new, higher-growth markets. Myth: We don’t need to alter our products — we just need to educate our customers. Reality: In the near term, many newly minted middle-class consumers cannot afford developed-market products no matter how much they might value them. As the middle classes mature and their purchasing power grows, this will change. Nonetheless, customers in countries such as India, Brazil, and Turkey will continue to want distinctive features and options. Many of their needs, wants, and tastes stem from unique cultural or environmental conditions, and are unlikely to change soon. Too often, companies try to create middle-market variants of higher-priced products by subtracting a few features and pushing them through the existing business model and value chain. This results in compromised products at overly high prices. The better alternative is to rethink the value chain entirely. For example, the papermaking machinery industry in China is a rapid-growth, low-margin sector with many local upstart competitors. Multinational incumbents that want to enter this market must provide integrated manufacturing packages, including fiber systems, environmental solutions, automation, and rolls and fabrics. To accomplish this, they often build their capabilities through acquisitions and partnerships. Myth: Entering the global middle market will be too disruptive to our operations. Reality: Companies need a business model suited to the task. The R&D function, for example, should avoid innovation races and the creeping elegance associated with sophisticated and expensive products. Instead, take a more local approach to innovation, designing products for specific markets. The products can then flow elsewhere, finding support and additional markets wherever they strike a chord. Investing in local R&D that can rapidly turn middle-market customer insights
Reprint No. 11309
Resources Pankaj Ghemawat, Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter (Harvard Business School Press, 2007): A highly effective approach to global strategy, one middle market at a time. Vijay Govindarajan, Jeffrey R. Immelt, and Chris Trimble, “How GE Is Disrupting Itself,” Harvard Business Review, October 2009: Describes reverse engineering in GE’s medical systems business. Ronald Haddock and John Jullens, “The Best Years of the Auto Industry Are Still to Come,” s+b, Summer 2009, www.strategy-business.com/ article/09204: The global middle-market opportunity in motor vehicles. Richard Shediac, Rainer Bernnat, Chadi Moujaes, and Mazen Ramsay Najjar, “New Demographics: Shaping a Prosperous Future as Countries Age,” Booz & Company white paper, May 2011, www.booz.com/media/ uploads/BoozCo-New-Demographics.pdf: The underlying dynamics that have created the global middle class. Edward Tse, The China Strategy: Harnessing the Power of the World’s Fastest-Growing Economy (Basic Books, 2010): How to successfully enter one of the largest global middle markets. For more on this topic, see the s+b website at: www.strategy-business.com/global_perspective.
69
features global perspective
70
The Gulf economies of The middle easT are forminG parTnerships wiTh oTher emerGinG markeTs, redefininG The ancienT Trade rouTes ThaT once linked easT and wesT.
illustration by opto
w
hen kinG abdullah bin saud, The
current ruler of Saudi Arabia, came to power in August 2005, he wasted little time in demonstrating his vision for the country’s future. His first official overseas visit, in January 2006, was not to U.S. president George W. Bush, U.K. prime minister Tony Blair, or German chancellor Angela Merkel — but to Chinese president Hu Jintao. The meeting reflected both countries’ desire to forge closer economic ties. Before King Abdullah went on to other emerging markets, including India, Malaysia, and Pakistan, he and President Hu signed an agreement of cooperation in oil, natural gas, and minerals. This agreement built on existing relationships between the countries’ national energy companies, Saudi Aramco and Sinopec, which had formed a partnership in 2005 to construct a US$5 billion oil refinery in eastern China’s Fujian province. In 2011, they signed a memorandum of understanding to build a refinery in Yanbu, on the west coast of Saudi Arabia. Sinopec is also engaged in a joint venture with Saudi Arabia’s petrochemicals giant SABIC; in 2010, they began producing various petrochemical products in a $3 billion complex in the city of Tianjin in northeast
features global perspective
by Joe Saddi, K arim Sabbagh, and richard Shediac
71
features global perspective 72
Karim Sabbagh
[email protected] is a Booz & Company senior partner based in Dubai. He leads the firm’s work for global communications, media, and technology clients. He is a member of the firm’s Marketing Advisory Council and the chairman of the Ideation Center, the firm’s think tank in the Middle East.
China, and have recently announced that they will build a $1 billion–plus facility there to produce plastics. The rise of emerging markets in the global economy has sparked a great deal of discussion, particularly in the wake of the worldwide financial crisis. The implications are often framed in terms of the potential impact on the economies of the U.S. and Europe — for instance, business leaders discuss whether emerging nations’ consumers might be interested in purchasing American products, or whether European telecom operators can counter stagnation in their own markets by investing in new mobile networks in Asia. But a closer look reveals a separate trend that could shift the economic focus away from the West. Emerging markets are building deep, well-traveled networks among themselves in a way that harks back to the original “silk road,” the network of trade routes between East Asia, the Middle East, and southern Europe, some dating to prehistoric times and others to the reign of Alexander the Great. Most of these routes were central to world commerce until about 1400 AD, when European ships began to dominate international trade. Today’s new web of world trade is broader and more diverse than the old silk road. It is a network among emerging markets all over the world, including China, the Middle East, Latin America, and Africa. It is a path not just for expanded trade in goods, but for short-term and long-term investment and the transfer of technological and managerial innovation in all directions. Witness, for example, China’s investments in Africa, where the construction of roads, railways, and communications infrastructure provides revenue to China’s state-owned enterprises and also facilitates China’s access to the continent’s natural resources and its consum-
Richard Shediac
[email protected] is a senior partner with Booz & Company based in Abu Dhabi, where he leads the firm’s Middle East work for publicsector and healthcare clients. He has led and participated in strategy, operations improvement, and organization projects in the Middle East, Europe, and Asia.
Also contributing to this article were Booz & Company principal Mazen Ramsay Najjar, Ideation Center director Hatem A. Samman, and s+b contributing editor Melissa Master Cavanaugh.
ers. Or consider the fact that in 2009, China surpassed the U.S. to become Brazil’s primary trading partner; bilateral trade between the two countries grew more than 600 percent between 2003 and 2010, from $8 billion to $56 billion. Also in 2009, the Korea Electric Power Corporation, a state-owned South Korean firm, won a $40 billion contract to build nuclear reactors in the United Arab Emirates (UAE), beating out French and U.S. companies that had bid on the opportunity. And in 2010, Russia and Qatar announced that they would work together to develop gas fields on Russia’s Yamal Peninsula. Such developments remain largely separate activities in the global economy, but taken together, they are early evidence of a pattern that public-sector and private-sector leaders in every part of the world should take into consideration. An Important Stop on the Road
The countries of the Gulf Cooperation Council (GCC) — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE — represent one regional powerhouse whose relationships with emerging peers can offer valuable insights into the way such alliances are forming. In the last five years, ties between the GCC and the BRIC countries (Brazil, Russia, India, and China) as well as the “Next 11” countries (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam) have expanded strongly. (See map, pages 74–75.) The speed with which the new silk road is being constructed between the GCC and these other rapidly emerging economies is a clear indicator of the GCC’s rising importance. Even the recent unrest in the Middle East, which included
strategy+business issue 64
Joe Saddi
[email protected] is the chairman of the board of directors of Booz & Company and the managing director of the firm’s business in the Middle East. His work covers multifunctional assignments in the oil, gas, mining, water, steel, automotive, consumer goods, and petrochemical sectors.
saudi arabia’s exporTs To The u.s. sTill revolve around oil, whereas iTs exporTs To The “bric” counTries include chemicals, plasTics, and minerals.
39 percent in 2010. The governments in the region are eager to continue investing their oil revenues in knowledge-intensive industries that will create jobs for local populations, and they will cultivate trade partners that help them. This is one major reason that 19.4 percent of the GCC’s trade flows now involve the BRIC countries, compared with just 8.9 percent involving NAFTA countries. And GCC trade flows with BRIC countries are also more diverse than those with the United States. For example, Saudi Arabia’s exports to the U.S. still revolve around oil, whereas its exports to BRIC countries include chemicals, plastics, and minerals. The UAE’s exports to China, similarly, are split among a range of products, led by plastics (28 percent), electronic equipment (15 percent), and vehicles (9 percent). The GCC’s non-oil exports to the Next 11 countries are also on the rise. Such exports (including chemicals, plastics, and aluminum) from the GCC to Vietnam, Indonesia, and Turkey are still quite small in absolute terms, just $11.6 billion in 2008. However, they increased by 389 percent between 2001 and 2008, an indication of things to come. In future years, GCC companies will be looking to expand in a number of directions that will affect their exports. They will build manufacturing bases, as well as act as importers and resellers for automobiles and other advanced manufacturing products; they will also continue developing expertise in critical areas such as water desalination and complex infrastructure and construction projects, and may begin looking outside the region for destinations for those services. Trade partners that support the GCC’s economic goals will find themselves in favorable positions.
features title features global of the perspective article
a few of the GCC nations, has not impeded the Gulf’s global ambitions. The GCC is also noteworthy because of its traditionally strong relationships with the U.S. and Europe. The Gulf nations have to maintain their relationships with these large but relatively stable economies while fostering new relationships with the high-growth economies in emerging markets. This balancing act could lead to a new set of policies and ambitions in the region, with significant implications for companies that hope to enter this market, and for the nations (which include the U.S., China, Japan, and most of Europe) that compete for the GCC’s oil and gas resources and have a vested interest in ensuring that regional security issues do not destabilize global oil prices. By analyzing the dynamics behind the growth of the GCC’s alliances with other emerging countries, GCC leaders can see where there could be potholes in the new silk road and what reforms will be necessary to avoid them. At the same time, the companies and governments of Europe and the U.S. can develop a better understanding of what they will need to do to ensure that their own opportunities in the GCC are not lost in the years to come. The primary drivers of the relationships between the GCC and the BRICs and Next 11 countries are trade, people, and capital; equally important, though more difficult to track with data, is the exchange of knowledge and technology. 1. More than oil. The top item on the strategic agenda for every GCC country is to diversify its economy and thus decrease its dependence on oil. Despite significant efforts, achieving this goal has so far proven challenging: Oil and gas accounted for 38 percent of GDP in the GCC in 2000, 42 percent in 2005, and
73
The Gulf Economies’ Emerging Partnerships The GCC’s connections with the BRIC and “Next 11” countries are illustrated through trade and investment flows. The blue lines represent total bilateral trade between the GCC and these nations. By comparison, in 2010, trade with the U.S., Europe, and Japan was US$72.5 billion, $122.3 billion, and $115.5 billion, respectively. The GCC’s trade with China and India has already outpaced trade with the United States.
2010 BILATERAL TRADE In US$ billions
features global perspective GCC Capital Outflows by Destination, 2003–08 Capital outflows are still dominated by the U.S., but Asia is becoming a more important destination.
Mexico $0.6
74
U.S.
49.3%
Nigeria $0.9
Europe 21.9% MENA* 13.2% Asia
In 2009, the International Petroleum Investment Company of Abu Dhabi invested $328 million in the Brazilian arm of Spain’s Banco Santander; the emirate’s investment arm, Mubadala, is considering major investments as well.
Other Brazil $9.8
2.4%
*Middle East and North Africa
Sources: European Commission’s Directorate-General for Trade, International Trade Centre, World Bank, Samba Financial Group, Booz & Company
strategy+business issue 64
BRAZIL
13.2%
RUSSIA
GULF COOPERATION COUNCIL: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates
GCC investments in Russia include $500 million from the Qatar Investment Authority and $800 million from UAE-based companies Damac and Crescent Group in September 2010.
BRIC: Brazil, Russia, India, and China “NEXT 11”: Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam
Turkey $10.4
Iran $13.6
China $91.6
GCC Egypt $7.0
Pakistan $13.0
India $90.6
features title features global of the perspective article
Russia $1.3
South Korea $61.0
Bangladesh desh $1.7
75 Philip Philippines $4.5
Vietnam $1.3 Indonesia $9.8
INDIA
CHINA
As of March 2010, Indian companies had invested more than $2 billion in Saudi Arabia via approximately 500 joint ventures.
Saudi petrochemicals company SABIC has invested $3 billion in production facilities in China and committed an additional $1 billion for a new facility in May 2011.
billion, followed by $20 billion for Western expats and $17 billion for Arab expats. As countries that are poor in resources but rich in talent send their people to the GCC, they not only further the GCC’s own growth aspirations; they also put their expats in a strong position to encourage and maintain the GCC’s relationships with their countries of origin. 3. New sources of capital. GCC nations have long been investors in other countries — primarily in the U.S. and Europe — via their sovereign wealth funds and other state-owned entities. Although Western countries are still the primary recipients of GCC investments, accounting for 71 percent of capital outflow from the GCC between 2003 and 2008, they are slowly losing share to other Middle East countries and Asia. In light of the strong role that GCC governments play in determining the direction of their countries’ capital investments, this trend could accelerate if GCC governments decide that other emerging markets are a better strategic destination — both economically and politically — for their riyals, dirhams, and dinars. To some degree, of course, all governments play a role in their national economy. In the aftermath of the global financial crisis, most governments’ roles are larger than they used to be, thanks to bailouts of critical industries in Western countries. But major emerging economies such as China, Russia, Brazil, and Mexico, and the countries of the GCC, among others, are active proponents of “state capitalism” — defined most recently by political risk expert Ian Bremmer as a system in which governments direct state-owned companies, private companies, and sovereign wealth funds in ways that will maximize the state’s resources and power.
strategy+business issue 64
features global perspective 76
2. Rich in talent. As goods and services flow across the borders of the GCC and other emerging markets, so do people. Air arrivals in the GCC from China more than tripled between 2005 and 2009; arrivals from India, which historically has had deep ties to the GCC, increased by 35 percent. Arrivals from Turkey, Egypt, Indonesia, Pakistan, and Iran are on the rise as well: The GCC saw 2.2 million visitors arrive from Egypt in 2009, compared with 1 million in 2005. During the same period, the number of visitors from Pakistan increased from 769,000 to 1.4 million. The most significant aspect of this change is the skill level of many of the people entering the GCC. No longer do executives come from the West and laborers from the East; instead, skilled individuals from emerging markets are deepening their impact in the GCC with influential positions in the region’s financial, energy, transportation, and public sectors. India, in particular, has a large community of professional expats in the region, stretching back several decades. Because GCC countries do not publish data on the types of jobs that expats come to the GCC to perform, this trend is difficult to quantify; we are discussing it here primarily on the basis of our own extensive experience and observations. One indicator of the size and status of the Asian expat population, though, is the fact that this group’s private wealth (for which data is available) is now equal to or greater than private wealth among Western expats, and private wealth among Arab expats from outside the GCC is rapidly catching up. In Saudi Arabia, for example, Asian expats held $46 billion in private wealth in 2009, compared with $41 billion for Western expats and $21 billion for Arab expats. In the UAE, Asian expats also led the pack at $27
The new silk road runs underwaTer, in The form of submarine cables ThaT connecT The Gcc To india, Thailand, malaysia, souTh korea, pakisTan, souTh africa, niGeria, and sri lank a.
information and communications technology (ICT) sector. Like many other developing nations, they have recognized the importance of building knowledge economies to accelerate their development, and have made infrastructure investments and policy changes accordingly. Their rankings on the World Economic Forum’s Networked Readiness Index, which measures “the degree of preparation of a nation or community to participate in and benefit from ICT developments,” reflect their efforts: The UAE moved from number 28 on the list in 2005 to number 24 in 2010 (out of 138 nations on the list that year); Qatar jumped from number 40 to number 25 during the same period; and Saudi Arabia, which made its debut on the list in 2007, improved from number 48 in that year to number 33 in 2010. In making these advances, GCC countries have frequently looked to their counterparts among other emerging nations, many of which have similar initiatives under way. As a result, the nations of the Gulf and their partners in other emerging markets have collaborated to boost their ICT development in ways that they might not have been able to do alone. Shared infrastructure, for instance, has been crucial. The new silk road runs underwater, in the form of submarine cables that connect the GCC to countries including India, Thailand, Malaysia, South Korea, Pakistan, South Africa, Nigeria, and Sri Lanka. Chinese companies Huawei and ZTE have provided equipment for GCC telecom networks; Huawei has even gone beyond infrastructure to invest in talent in the GCC, sponsoring an academic chair in information technology and communication at the UAE’s Higher Colleges of Technology. Telecom operators, too, are looking to emerging
features title features global of the perspective article
(See “Surviving State Capitalism,” by Art Kleiner, s+b, Summer 2010.) These countries approach state capitalism not as a last resort in times of crisis but as a sensible policy for protecting national interests while still encouraging economic growth. For decades, the prevailing view in Western capitalist societies has been that this model cannot succeed — that the bureaucratic nature of government agencies could never compete against a nimble free market. And certainly, some state-owned enterprises in the GCC have stumbled, such as the real estate companies in Abu Dhabi and Dubai that required bailouts. In recent years, however, the track record of some statesupported sectors in the GCC shows that the issue is not quite so black and white. The state-owned airlines in the UAE and Qatar — Emirates, Etihad, and Qatar Airways — have quickly achieved global prominence. In fact, some European carriers (many of which used to be state-owned themselves) complain that it is unfair to have to compete against airlines with the power, and perhaps the economic support, of the state behind them. Thanks to strategic global investments, the size of the GCC’s sovereign wealth funds has nearly tripled in the last decade; they now hold approximately $1.1 trillion, compared with just $321 billion in 2000. And the GCC’s oil companies — the original source of the region’s wealth — are renegotiating their contracts with the foreign oil companies operating within the countries’ borders in ways that give them greater control over national resources while still allowing them to exploit the foreign oil companies’ technology and expertise. 4. Getting connected. As GCC countries seek to branch out and build relationships with other emerging markets, they have found one point of entry in the
77
features global perspective
markets to drive their business. Since the GCC deregulated its own national telecom markets in the 1990s, local operators have been on an acquisition spree, expanding their international footprint from 28 markets in 2005 to 44 markets today. These new outposts are mostly in emerging markets, spanning Indonesia, South Africa, South Asia, the Middle East and North Africa region, and sub-Saharan Africa. These investments run the other way, too, as companies like India’s Bharti consider investments in the GCC. For emerging markets to play any significant role in the global economy of the 21st century, they will need to invest in ICT infrastructure and talent. Pooling their resources to do so can advance them more effectively. Global Relationships for the 21st Century
78
The bonds between the GCC countries and the BRIC and Next 11 nations are growing stronger — a development that Western countries to date have viewed with trepidation, fearing that a zero-sum game will leave them cut off from increasingly significant consumer markets and sources of natural resources, goods, and services. But in an interconnected world, unexploited opportunities await players all over the globe. The fact that these emerging alliances are still in their infancy means that companies and governments in the U.S. and Europe can act now to formulate a response. In doing so, they will need to recognize that the weakening of their own economies during the financial crisis has undermined their historical advantages in the GCC region and has enhanced the appeal of fast-rising emerging markets. To succeed, then, developed economies will need to capitalize on the strengths that their emerging competitors cannot yet match. For example,
the U.S. and Europe are still world leaders in terms of building the capabilities and infrastructure that are crucial for innovation, and they have a history of helping GCC countries develop these assets as well. Many of the region’s oil companies relied heavily on contributions from their international partners in their early years, exchanging access to oil resources for foreign talent and technology. This trend continues today: For instance, King Fahd University of Petroleum and Minerals in Dhahran, Saudi Arabia, has formed a partnership with U.S.-based Cisco Systems to create a regional Cisco Networking Academy, which is intended to ensure that the university’s students are prepared to succeed in the digital economy. Companies in developed countries can also build on their extensive global supply chains to easily integrate new partners — whether as suppliers or as customers. For their part, as the nations of the GCC look around the world to develop their network of relationships, they will find many opportunities with partners in both developed and developing nations. In order for these relationships to have the greatest impact in the GCC, the Gulf nations must seek the investors and trade partners that can help them address their pressing priorities: the creation of new jobs, competition that will spur their own national champions to greater success, and investment in their physical and educational infrastructure. Gulf nations have begun building these relationships already, and in doing so their economies have become much less insulated than they were in the 1970s and 1980s. However, to increase their appeal to international partners, GCC countries will need to continue making progress on the internal reforms that are under
strategy+business issue 64
The counTries of The Gcc have much more clouT as an economic bloc Than as six separaTe enTiTies, and They musT conTinue To implemenT policies ThaT reflecT This perspecTive.
nomic bloc, the entire region will become a less risky, more attractive proposition for investment. The GCC is at a critical juncture as it determines the parameters of its relationships with partners both old and new, Western and Eastern. But there’s no doubt that the new silk road can be a path toward future prosperity for the GCC countries, building trade and creating wealth as powerfully in the 21st century as the old silk road did in ages past. + Reprint No. 11310
Resources Ian Bremmer, The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, 2010): The potential power of state capitalism. Economist Intelligence Unit, “GCC Trade and Investment Flows: The Emerging-Market Surge,” 2011: Presents research on the strengthening economic ties between the GCC and other emerging markets. Gideon Rachman, Zero-Sum Future: American Power in an Age of Anxiety (Simon & Schuster, 2011): A zero-sum approach to global economics, in which one country’s gain is another country’s loss, is undermining attempts to restart the world’s growth engines after the recession. Joe Saddi, Karim Sabbagh, and Richard Shediac, “Oasis Economies,” s+b, Spring 2008, www.strategy-business.com/article/08105: Overview of the GCC’s growing economies and the nature of their development. Joe Saddi, Karim Sabbagh, and Richard Shediac, “The Challenges of Balance,” s+b, Summer 2009, www.strategy-business.com/article/09202: Analysis of the difficulties confronting the GCC’s rapid economic growth. For more on this topic, see the s+b website at: www.strategy-business.com/global_perspective.
features featurestitle global of the perspective article
way. Of the six nations in the GCC, only Saudi Arabia ranks in the top 20 countries in the 2010 World Bank Doing Business report, at number 11; Bahrain comes in at number 28, the UAE at number 40, and Qatar at number 50. They need to reduce the amount of red tape required to start or invest in a business, provide more transparency in business fundamentals, and invite more private-sector investment in industries that still have substantial government involvement. They should also expand their overall talent base by making it more appealing for foreigners who have critical skills to live in the region, while simultaneously developing their own people and ensuring that they have the right capabilities to build critical sectors such as energy, education, and communications. GCC countries will also need to keep pushing forward on economic integration within the region, which will bolster their presence on the world stage. The countries of the GCC have much more clout as an economic bloc than as six separate entities, and they must continue to implement policies that reflect this perspective. A recent Booz & Company study assessed the progress of the GCC toward regional integration on a number of measures using a scale of 1 to 5, with 1 indicating “major setback to the goal” and 5 representing “accomplishment or near completion of the goal.” When all measures were taken into account, the study found that the GCC had achieved an overall score of just 2.9 out of 5. The Gulf nations must redouble efforts toward the creation of a monetary union, improve the coordination of customs and border policy, promote greater intraregional investment, fulfill joint infrastructure commitments, and increase collective efforts in research and development. If the GCC can become a stronger eco-
79
thought leader
the thought leader Interview: Sylvia Nasar The renowned author discusses how the great economists uncovered the basic truth about progress, prosperity, and productivity, and the reasons you should be careful which ideas you listen to.
conversation thought leader 80
M
any of the powerful forces that help business, hurt business, and shape our civilization today stem directly from the theories formulated by economists in the past, put into practice in the real world. That is the subject of Sylvia Nasar’s new book, Grand Pursuit: The Story of Economic Genius (Simon & Schuster, 2011). And yet, as Nasar would be the first to acknowledge, the field of economics has suffered from a lack of respect since its formative years; Scottish essayist Thomas Carlyle dubbed it
“the dismal science” in 1849. Today, when economics makes headlines, it’s typically as a whipping boy (“Why Economists Failed to Predict the Financial Crisis”) or as part of a sales pitch (“Prominent Economists Support Changes to Medicare”). Add the fact that economics has been delivered to undergraduates over the past 50 years in an offputting package of mathematical equations and unintuitive charts, and it’s no surprise that most people tend to see it as a difficult subject producing dubious results.
But economics has in fact made profound contributions to our understanding of how society functions. Nobody has done a better job of bringing its story to life than Sylvia Nasar. Launching into her narrative via Charles Dickens and Jane Austen rather than Adam Smith and David Ricardo, she shows how some of the most important ideas of modern times came together in London in the mid-19th century, as Britain entered an era of unprecedented economic growth — the first time in human history that the living standards of average people began to rise significantly. The key insight around which the book revolves is that business productivity drives economic and societal improvement, and the book’s narrative shows us how an idea like that can be developed, debated, and accepted over the decades as empirical evidence mounts and the scholarly consensus builds. Along the way, Nasar rights some perceptual wrongs of conventional economic history. One hero of the tale is British economist Alfred Marshall (1842–1924), who hasn’t always gotten the respect he deserves. Grand Pursuit reveals what Karl Marx was wrong about (practi-
Photograph © John Blais
by rob NortoN
doomed to failure. But the dismal science has less to say about how to balance the roles of governments and markets or how to determine the optimal level of taxation. As examples, she cites the United States and Sweden, two countries with very different policy and fiscal profiles, but very similar — and enviable — standards of living. Nasar, a former economist herself and a writer for Fortune and the New York Times, is the author of A Beautiful Mind (Simon & Schuster, 1998), the best-selling biography of mathematician and game theorist John Nash, later adapted into a hit Hollywood film. She is also the John S. and James L. Knight Professor of Business Journalism at the Columbia Graduate School of Journalism. She discussed her research and conclusions with s+b at Booz & Company’s New York office in May 2011. S+b: John Maynard Keynes, who plays a large role in your book, once observed that “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.” Would you agree? NaSar: It’s true to an extent, but
where people tend to go astray is
when they are slaves of an economist outside the mainstream, or, worse yet, of a noneconomist. When you look at the ideas that distinguish successful economies from unsuccessful ones, it’s not the difference between, for instance, Paul Samuelson and Milton Friedman, or even Keynes and Hayek. It’s the difference between any of them and something or someone whose ideas are completely dysfunctional. Marx would be an example. If you look around the world today, it’s the difference between Venezuela and Chile. Venezuela is rich in resources, with some of the world’s biggest oil reserves, and once was one of the region’s most prosperous nations. But over the last dozen years, the average standard of living has been declining. Chile is also a big commodity producer, and certainly has lots of problems, but on the other hand, the standard of living there has been rising steadily since 1970. That’s the kind of dramatic difference that really adds up over time. It’s the difference between a society where living standards are rising, thanks to a growing business sector and rising productivity — as well as greater attention to law and to alleviating poverty — and a
conversation thought leader
cally everything) and why (intellectual laziness); it paints rich portraits of neglected thinkers such as prototypical feminist Beatrice Webb (1858–1943), who formulated the idea of the social safety net in the 1890s, and American economist Irving Fisher (1867–1947), who presciently discovered portfolio theory, countercyclical monetary policy, and index numbers, as well as inventing the Rolodex and founding the company that became Remington Rand. Nasar also provides carefully reported assessments of the achievements of such betterknown economists as John Maynard Keynes, Friedrich August von Hayek, and — the last in her line of profiles — Amartya Sen, whose work she sees as pointing to new directions for the field. In Nasar’s view, economics has progressed to the point where it can explain definitively how to avoid the kinds of economic catastrophes that produced the Great Depression. All the nations that have grown steadily in recent years, she believes, are following the basic economic playbook that began to take shape as Marshall visited the factories of Britain’s Industrial Revolution, whereas countries that ignore those lessons are
81
rob Norton norton_rob@ strategy-business.com is executive editor of strategy+business.
S+b: So what’s important is whether or not the ideas influencing a leader’s policies or a nation’s policies are within the economic consensus? NaSar: It’s that the big insights
conversation thought leader 82
from the best economists, over time, have become the consensus. Take the idea that the key to rising living standards is productivity gains. Today that seems elementary; it’s something you learn in your first economics class. But it took many decades of intense debate by really smart people before it was accepted. That meant realizing the difference between the kind of world that existed before the Industrial Revolution and the one that became possible as a result of it. From the beginning of civilization to the 19th century, 90 percent of humanity was stuck in place, even if their country did comparatively well. Average people lived like livestock — they didn’t go anywhere, read anything, or wear much; they ate bad food and didn’t live a very long time. Today, in an increasing number of places in the world, the majority of people have escaped poverty and have some measure of control over their lives.
The gulf that separates successful economies from the real basket cases today is almost as big as the gulf that separates the modern standard of living from the one in Jane
philosophy. And yet if you rank countries by the rate of growth of their productivity and living standards, it’s really Sweden and the United States, over a long period of
“Alfred Marshall’s idea was that from a social point of view, the purpose of corporations is to raise the standard of living.” Austen’s time. And that suggests that even in a globally integrated economy, what your country does locally still matters the most. And what determines that? Well, it doesn’t seem that it’s whether you have oil or whether you have a big population or a big territory — all those things that in the early 19th century were thought to be the source of the wealth of nations. It also doesn’t seem to be whether you have a large government or a smaller one. Look at two of the most successful economies today, the United States and Sweden. The U.S. has traditionally had a much smaller government than Sweden’s — different institutions, a very different
time, that come out on top, even though they would seem to be on opposite ends of the spectrum. What the U.S. and Sweden have in common is a pretty good environment for business, and they always have had that. That was the basic insight of Alfred Marshall. S+b: So Marshall was the first person to completely grasp that idea, and systematize it in his Principles of Economics in 1890, which became the most influential book in the field for many decades. NaSar: Right. Marshall’s idea was
that it’s businesses that drive increases in productivity. Obviously, that’s not what stockholders or managers
strategy+business issue 64
society that is teetering on the brink of collapse.
decision to study economics one day when he was on vacation and wound up walking through the appalling slums of Manchester, which existed within a few hundred yards of luxurious neighborhoods. He began to question whether poverty was a necessity of nature, which is what had been believed by earlier economists — including many who were very liberal in a political sense, like John Stuart Mill, who was a socialist at the end of his career. Marshall felt that humanity could work its way out of what was then almost universal poverty, and he decided to understand why it existed, and how things could change.
workplace layouts. He questioned everyone, from the company owners to the workers on the shop floor. He knew many businessmen and trade union leaders. He knew a lot about technology. Marshall felt that he needed this knowledge to inform his scholarly work. In fact, he could have written his theoretical insights 20 years before he produced his great work, Principles of Economics, but he felt an obligation to assure himself that his ideas and assumptions were grounded in reality. He also understood that to persuade others that economics had something to say about the real world, he, the economist, had to understand it.
learning from business
S+b: Which is in real contrast to Marx, who did none of those things. NaSar: I don’t know that I’m the
S+b: What were some of the experiences that led Marshall to develop this line of thought? NaSar: The first was his experi-
S+b: And one of the ways he did that was by actually spending time visiting factories and learning about business. NaSar: Marshall spent his sum-
ences with poverty. He grew up in a lower-middle-class household of very modest means, and when his father arranged for him to attend a private school, he had a long commute through some of London’s worst slums. After studying mathematics at Cambridge, he made the
mers traveling to factory towns and interviewing businessmen, along with his wife and partner [Mary Paley Marshall], who was one of the first women to be educated in economics at Cambridge. He spent hours observing, recording manufacturing techniques, pay scales, and
very first person to discover that Marx had never been in a factory at the time that he published Das Kapital, but it blew me away. In fact, he only ever visited one factory: a porcelain factory when he was at a spa in Czechoslovakia. The thing about Marx is that he was a brilliant journalist in many ways, but he was a terrible reporter. Despite his reputation for being the great chronicler of the Industrial
conversation thought leader
are thinking about, but from a social point of view, the purpose of corporations is to raise the standard of living by raising productivity. His corollary to that, which was a matter of great debate that has continued to this day, was that the productivity gains that business drove would be shared out to workers — that competition in the labor market would force businesses to share the gains — and that wages would thus rise over time. It’s since been substantiated by 100-plus years of empirical data. It’s still true today, as it was then, that the share of the national income that went to wages would not decline as some people, like Marx, believed, but would stay steady or rise, even as the national income grew.
83
conversation thought leader 84
S+b: Where did that conclusion come from? NaSar: It came straight out of the
Book of Revelation, which was a bit of a revelation for me, and came to me because I spent some time at a research institute with [Princeton professor of religion and author] Elaine Pagels, who was writing a book about the Book of Revelation. I found that Marx really got all his economics, and the bones of his narrative, from Friedrich Engels, who was his coauthor, financial benefac-
tor, and all-around guardian angel. Engels, in fact, ran a cotton factory in Manchester to support his slacker friend — who spent 20 years not writing his book — and had been reared as a sort of fundamentalist Lutheran. Engels knew the Bible inside and out, and the Book of Revelation was his favorite book. And there it all is: the world splitting into two great armies; the fundamental conflict that ends history, that brings justice; and finally the downtrodden will prevail. I was able to trace that link in their correspondence and their writing. That to me answers the question of why people embrace bad ideas or ideas that don’t work. It’s because we’re human beings, and we find narratives that are very powerful and appeal to our emotions. S+b: So Alfred Marshall was spectacularly right, and Karl Marx was spectacularly wrong, yet Marx is much better known. NaSar: This is the weird thing. If
S+b: Another thinker whom you rescue somewhat from the past — and who built on Marshall’s work — is Beatrice Webb. She doesn’t feature much in most conventional accounts of the history of economics, and few people are likely to recognize her name, or realize that she was the inventor of the concept of the social safety net. NaSar: Yes, the idea of the mini-
you look at the first edition of Robert Heilbroner’s The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers [Simon & Schuster], which was published in 1953, Marx is the hero and Alfred
mum wage, the notion that government policy could actually prevent poverty, starts with her. Many people today would call her a sociologist, but in her lifetime, she was regarded as an authority on eco-
strategy+business issue 64
Revolution and its evils, he was more like a Web news aggregator. The worst thing about Marx was that he began with an answer, and then set out to find the facts that would support it. He was actually quite isolated. He lived in London, which was the center of the economic and intellectual world, within a mile of the greatest geniuses who were living at the time — George Eliot, John Stuart Mill, Charles Dickens — all of whom were obsessed with economic issues and were talking about them and debating them. Yet he never engaged with them. The reason he didn’t was that he already knew capitalism was rotten, that it was doomed.
Marshall is this little Victorian prune who was totally out of touch with what was really going on. So it was really amazing to find out that the opposite was true. Marshall was very well regarded in his own time. One of the striking things about him that I found was that he was so clearly focused on poverty. He was supportive of labor unions, so he was very different from some of the earlier economists, and he really differentiated himself in the policies that he supported. He favored antipoverty measures and public schooling, which in England was controversial much longer than in the United States. He also was certain that antipoverty measures would not fatally undermine the competitive mechanism that was driving business to pursue greater productivity, which was something many people believed then. Some people believe it even today.
nomics. She took from Marshall the idea that one cause of poverty was poverty, and she worked out policy solutions. She was a great empiricist. She wrote a book about poverty [The Prevention of Destitution, coauthored with her husband, Sidney Webb] that should be read today. What’s brilliant about it is that it recognized that poverty was not a homogenous condition — that there are different kinds of poor people, who are poor for different reasons. Webb showed that while some poverty would be eliminated through economic growth, other kinds of acute, short-term poverty are simply due to unemployment and could be cushioned by having either public works jobs or unemployment insurance. She saw that other kinds of poverty wouldn’t be
ideas was the young Winston Churchill. The welfare state did not emerge after World War II; it emerged before World War I. And it was not a coup by the left, nor was it a product of bad times or a reaction to crisis. It was a product of Britain’s boom in living standards, which enabled people to see that there was a process for eliminating poverty through growth, and that we could afford to speed it up. Keynes and the great depression S+b: The Great Depression is the other major drama in your narrative, with John Maynard Keynes and Irving Fisher playing large roles. What struck you most as you studied Keynes? NaSar: I came to really admire his
willingness to change his mind.
at all affected by the state of the economy — in particular, the kind of poverty that was passed on from one generation to another. She understood that this kind of self-reinforced poverty required a different kind of intervention. The politics are rather surprising, because the first person who picked her brain and applied her
Once one has said something publicly, such as “There’s not going to be a recession,” there’s a human tendency to stick to your guns and keep defending your point of view. Keynes was different. He had a very acute sense of circumstances. When you look at the world as it went into the Great Depression, you have to remember it was hap-
strategy-business.com
Discuss the biggest ideas in business with the best minds in business…
“
”
…log in using your social identity of choice to comment on s+b’s awardwinning mix of analysis, in-depth commentary, and leading ideas. Sign in with strategy+business is published by the global commercial consulting firm Booz & Company. www.booz.com
conversation thought leader
“The welfare state was not a product of bad times; it was a product of Britain’s boom in living standards.”
Join the conversation
and the subsequent research of Milton Friedman and Anna Schwartz, we can see that perhaps what Keynes thought was general was in fact more special and more particular to the circumstances of the 1930s. Again, the chronology is instructive, and it reinforced my sense that ideas really were important. People talk about the Great Depression as if it were a uniform malaise across the
S+b: Most people, if they’ve heard of him at all, probably know Fisher only for his famously incorrect forecast in October 1929, that stock prices had reached “a permanently high plateau.” NaSar: Irving Fisher was the quint-
essential American entrepreneur. You have to remember that the 1920s was a fabulous decade. Contrary to what people said after the
The global macroeconomic environment is not the main determinant of the success of companies, or even of countries. world, but it was not. The United States had a Great Depression, but it wasn’t typical. The Scandinavians, the Japanese, the British — all the countries that went off the gold standard early — didn’t suffer the same kind of extreme collapse. So that suggests, again, they were doing something different, and what they were doing was pursuing different monetary policies, and that experience supports Fisher’s point of view in the 1920s.
stock market crash — that the 1920s were an economic mirage — it was in fact a fantastic decade for technological innovation, for the growth of important businesses and industries, and for productivity and wages. There was no inflation; the price/ earnings multiple of the market in 1929 did not seem to be that high. So being upbeat about stock prices wasn’t unusual. But Fisher had so identified himself with the “can-do” school of
strategy+business issue 64
conversation thought leader 86
pening in a different time frame in England than in the United States. At the beginning of the Depression, Keynes believed it was caused by monetary mismanagement, and that monetary intervention could cure it. His thinking about this, I discovered, had been heavily influenced by the work of the American economist Irving Fisher in the 1920s. So initially, Keynes was confident that if Britain and the United States went off the gold standard and reversed the deflation, that would end the Great Depression — which, of course, at first looked like just a really bad recession. Well, that didn’t happen. So Keynes came up with a theory explaining why it was possible for the economy to settle into an equilibrium in which it wouldn’t repair itself. And in those circumstances, he showed why monetary policy might not work, and why government would need to supply the demand that the private sector couldn’t generate. When you look at the chronology of events, you see that Keynes got there in a step-by-step fashion. He was in many ways very conservative; he wasn’t a big government guy. With the benefit of hindsight,
S+B: So what should we learn about the usefulness of economics from the fact that one of the smartest and most creative economists of his time could be so spectacularly wrong? NASAR: Well, you have to be careful
about what you listen to. If what you listen to is that business managers
should focus on making their businesses better, because that’s what drives productivity and growth, then I think you’re golden. I think one thing we’ve learned — and the lesson has been repeated recently — is that we can’t predict the macro economy very well. Another thing to keep in mind is that the global macroeconomic environment is not the main determinant of the success of individual companies, or even of countries. Because if it were — if that’s what made the difference — then we wouldn’t have the huge disparities in performance that we see, because everyone’s sharing the same global environment. Why was Britain such a success? It’s an island with no resources. Shouldn’t it have been Russia? No, Russia was a basket case. You can compare countries that have been split apart: East Germany and West Germany, North Korea and South Korea. It seems to come down to the local environment, and the decisions that countries and companies make. What is important is whether or not you have an environment that encourages productivity growth, in which managers can focus on running their businesses.
conversation thought leader
American thought that it was difficult for him to realize what was happening. Unlike Keynes, who had suffered some business reversals in his life, Fisher, bless his heart, had only seen things go up, both in the economy and in his personal affairs. His achievements were impressive. He was a pioneer in discovering the role that money played in the economy’s stability or volatility, and in establishing the link between prices and unemployment. He created the idea of inflation indexing. As early as 1911, he had argued that a diversified portfolio of stocks was a better long-term investment than bonds. He invented the Rolodex to help himself keep track of his contacts and started a company to manufacture and promote it, which later became Remington Rand. He was also the leading wellness guru of the early 20th century.
87
S+b: What lessons can we learn from the policy experience of the Great Depression, compared with the recent Great Recession? NaSar: Policymakers made a total
conversation thought leader 88
mess out of the Great Depression. In both 1929 and 1936–37, the Federal Reserve made some disastrous decisions. We have learned quite a bit in the interim. True, the fiscal stimulus this time may have been poorly designed and too small. But on the other hand, the Federal Reserve kept the financial system from collapsing. Today’s policymakers acted with a kind of conviction that was not possible in the 1930s, when the ideas of economists like Fisher and Keynes were very new. That conviction about what to do made action possible. You also had international cooperation instead of each government trying to solve its problems at the expense of its neighbors. Nobody is going to be happy with the explanation that things could have been much worse if we hadn’t learned these lessons from the past, or even with the fact that the U.S. actually did not have a worse recession than the rest of the world this time, and in fact is having a bet-
ter recovery. But if you want to ask, Have we learned anything from economics, the answer is: Oh yeah. Look at George W. Bush and Barack Obama. We think of them as being on different planets politically. But guess what? They did pretty much the same things in response to this crisis. They saw a situation in which the whole financial sector was shutting down, and concluded that the government had better do what it could on every front. And sure, it would be nice if it had worked faster or been cheaper, but economic policy worked. What we had was a recession that was in the same league as the recessions of the mid-1970s and especially the early 1980s, albeit somewhat nastier. But it was nothing in comparison to the Great Depression. S+b: How do you view the political– economic debate in the U.S. today, where one party is urging a return to the pre-Keynesian, pre-Fisherian economic policies of the early 20th century? NaSar: It’s a lot of noise. It’s like
the people who, in the middle of the recession, were saying that this is the end of capitalism and we now have to do everything different. No, ex-
cuse me, let’s not. People tend to talk about economic policy as though there is a blank slate. It’s more like we are climbing a mountain, and the question is where do you take the next step. We are always going from where we are, even though the language of the debates suggests that it’s all or nothing. S+b: Here’s another Keynes quote: “If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.” Do you agree? NaSar: Yes. That’s a great quote.
Keynes had a very modest view of what economics could and couldn’t do. He once offered a toast to “economists, who are the trustees, not of civilization, but of the possibility of civilization.” He felt that the real trustees of civilization were the artists and philosophers of the world, and that economists could best help civilization by minimizing crises and setbacks, and ensuring that there was a continual rise in the standard of living. + Reprint No. 11311
strategy+business issue 64
lessons of the great recession
books in brief
in Pursuit of Happiness Closing implementation gaps, the enduring principles of high-tech success, and Toyota’s crisis.
conversation books in brief 90
the economics of enough: How to run the economy as if the future Matters
by Diane Coyle Princeton University Press, 2011 Economist Diane Coyle, a visiting professor at the University of Manchester and former advisor to the British government, sees the recent worldwide financial crisis as a valuable opportunity to grapple with fundamental shortcomings in the creation and measurement of eco-
nomic policy. In The Economics of Enough: How to Run the Economy as if the Future Matters, she identifies and addresses what she regards as the two root causes of the crash of 2008: the failure of macroeconomics to frame and measure policy objectives and the chronic inability of politicians to make policy decisions that are in the best long-term interest of their constituents (i.e., that address the “trilemma” of efficiency, equity, and liberty). Coyle divides the book into three unequal parts that cover the
challenges (about 60 percent of the book) and the obstacles (25 percent) to better economic policy, and a manifesto for achieving it (15 percent). As this proportion suggests, the book is long on problem identification, but rather short on solutions. Nevertheless, it is helpful for the targets it identifies. For instance, Coyle tackles the current monopoly of GDP growth as a measure of collective happiness. Like most economists, she thinks that growth and happiness are causally connected, but cites evidence showing that maximizing growth isn’t always appropriate when the future is taken into account. This is the central dilemma of “enough”: that we need enough growth to make us happy, but not so much as to make future generations unhappy. Coyle’s adoption of the intangible objective of happiness, with its dependency on multiple, complex phenomena, underlines the inadequacy of GDP as a metric. Measurements of GDP are already seen as deeply flawed in their failure to discriminate among differences in quality and to capture the value of unpaid work, such as parental care and volunteer activities. In addition, GDP’s focus on the flow of value
Illustration by Leigh Wells
by DaviD k. Hurst
include our descendants? Mainstream economics has been such a prominent part of the consciousness that led to the Western world’s current predicament that one wonders how — and perhaps even whether — it can play a leading role in our escape from it. It’s disappointing that Coyle fails to address this.
the art of action: How Leaders Close the Gaps between Plans, actions and results
by Stephen Bungay Nicholas Brealey Publishing, 2011 In The Art of Action: How Leaders Close the Gaps Between Plans, Actions and Results, Stephen Bungay, director of the Ashridge Strategic Management Centre in London, integrates military history and management to help us understand the essence of implementation and its challenges. Bungay, also an acclaimed military historian, begins by describing a disease endemic to large organizations — the inability to translate elegantly phrased plans into
action. He identifies three symptoms: a “knowledge gap” between plans and outcomes, an “alignment gap” between plans and actions, and an “effects gap” between actions and outcomes. Corporate leaders usually respond to these symptoms by trying to fill the gaps with more detailed information, instruction, and control, respectively. But this just makes the situation worse by hampering their employees’ ability to take effective action toward a common goal. A better cure, argues Bungay, is to address the root causes of the disease by embracing a discipline of execution. For an understanding of the causes, the author turns to the thinking and practices of the famed German General Staff as exemplified by the writings of Carl von Clausewitz (1780–1831) and the practices of Helmuth von Moltke (1800–1891). That formidable institution, defunct since 1945, continues to inspire military establishments around the world with the sheer competence of its practitioners. From the military perspective, the root causes of the three gaps are imper-
conversation books in brief
versus its accumulation allows nations to enhance their output at the expense of their balance sheets. When you add to this the realities of democratic political systems, in which the need to get elected regularly swamps the interests of not-yetvoting future generations, and the revolution in information and communications technology, which has enabled a global economic system that has left its political and social counterparts far behind, the challenges and obstacles to improving economic policy seem daunting. In fact, Coyle finds precious successes responses she can point to, although she does single out the Australian Bureau of Statistics and its “dashboard” of indicators of progress. Coyle criticizes bankers for their greedy ways, but she remains staunchly loyal to mainstream economics. This seems inconsistent. The great promise of the “dismal science” is that it harnesses individual desire to make us collectively better off. But if the invisible hand allows bankers to pursue their happiness to the detriment of the rest of us, can it really help when the definition of “us” is expanded to
91
David k. Hurst
[email protected] is a contributing editor of strategy+business. His writing has also appeared in the Harvard Business Review, the Financial Times, and other leading business publications. Hurst is the author of Crisis & Renewal: Meeting the Challenge of Organizational Change (Harvard Business School Press, 2002).
all levels of the organization, such that the emphasis of action moves from “plan and implement” to “do and adapt.” The dynamics of directed opportunism are similar to those of the Toyota production system. For example, Bungay’s template for strategy briefings includes feedback from bottom to top, and bears some resemblance to the famed Toyota A3 report — a seven-step problemsolving process arranged on a single
used by the German General Staff and Toyota. One intellectual hurdle that the author acknowledges: If directed opportunism is to be embraced as a practice, we have to overcome a knee-jerk antipathy to the idea of command. This response is surely a legacy of our experience of authoritarian leaders whose orders went far beyond what they could know, who allowed their subordinates no discretion, and who were intolerant of
If directed opportunism is to be embraced as a practice, we have to overcome a knee-jerk antipathy to the idea of command. sheet of paper roughly 11 by 17 inches. It is less clear how directed opportunism works in a management context. The faux management sessions presented by the author, in which executives grope forward to eventually find their way, are the book’s least satisfactory sections. They suggest that the approach would have to be inculcated in staff in the same rigorous ways
feedback that even hinted that they might be wrong. More generally, this antipathy can be seen as a lack of appreciation for and acceptance of the adaptive role that the use of power can and must play in every successful organization. To overcome this, Bungay suggests that we add the function of directing to the familiar duo of leading and managing. The resulting “executive
strategy+business issue 64
conversation books in brief 92
fect information, faulty communication, and external factors, such as weather and accumulating complexity and risk. The solution is what the Prussians called auftragstaktik (or “mission command”), a discipline that requires the mastering of command skills by individuals at all levels, as well as the setting up of organizational processes. When this is translated to a business setting, the author calls it directed opportunism. Practiced up and down the corporate hierarchy, directed opportunism closes the knowledge gap by issuing no command and making no plan that is more detailed than allowed by the circumstances of the commander. No distinction is made between strategy development and execution — decisions and actions coevolve. Directed opportunism closes the alignment gap by ensuring that the broad intent of commanders is conveyed as clearly as possible, while allowing subordinates to decide not whether to obey the order but how best to carry it out. Thus, the effects gap is closed by people at the appropriate levels of the organization being granted freedom of action within the bounds set by the intent. The result is a cascade of intent informed by learning at
trinity” aids our understanding of what the legitimate role of power is in organizations and how it might be exercised.
staying Power: six enduring Principles for Managing strategy and innovation in an uncertain World
by Michael A. Cusumano Oxford University Press, 2010
conversation books in brief
In Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Uncertain World, Michael A. Cusumano, Sloan Management Review Distinguished Professor of Management at the Massachusetts Institute of Technology’s Sloan School of Management, reports the latest findings from his research into high-tech companies. The result is a book that offers fascinating insights into management trends and practices in the high-tech sector. As the subtitle suggests, the book is organized into six “enduring” principles; but, as Cusumano points out, their exact meaning and their practical applications have not been fully determined. The princi-
ples represent organizational outcomes in successful firms. They can be thought of as effective resolutions to the tensions between what the author describes as a tight focus on competitive advantage at the product level and a broader way of thinking about agility and advantage in contexts where customers buy systems rather than just “boxes.” Thus, the author contends that successful firms adopt product platforms, not just products, and they add services to those platforms, creating rich ecosystems with positive network effects. Think of Apple’s iPhone and its swarm of apps. Such firms are founded on capabilities, not just strategies; they incorporate pull-style concepts, not just push; they look for economies of scope, not just scale; and they pursue flexibility, not just efficiency. Cusumano devotes a chapter to each principle and illustrates the principles with a variety of interesting examples. He examines Microsoft’s agile development system and Toyota’s lean production system, for example, to show how continual learning is incorporated into both, allowing employees the freedom to explore
divining the secrets of success, organizations are incommensurable with one another. This final qualification of the applicability of his findings suggests that Cusumano’s principles are better interpreted through a wide-angle learning lens than a tight focus on implementation.
toyota under fire: Lessons for turning Crisis into opportunity
by Jeffrey K. Liker and Timothy N. Ogden McGraw-Hill, 2011 In August 2009, Jeffrey K. Liker, professor of industrial and operations engineering at the University of Michigan, and Timothy N. Ogden, executive partner at the communications firm Sona Partners, were putting the finishing touches on a book about how Toyota develops leaders when the news
authors produce the most comprehensive and detailed review to date of the circumstances that led to the crisis, and the events and contexts that caused it to escalate. Their report is based on extensive interviews with insiders, including company president Akio Toyoda, whose appearance before the U.S. Congress in February 2010 marked the turning point in the firm’s efforts to give peace of mind to its many customers. After briefly reviewing Toyota’s history and the development of its production and management systems, Liker and Ogden show how
Toyota survived the recession and the recall because of the strengths of its entire ecosystem — suppliers, dealers, employees, and culture. came of the horrific deaths of four people in a Lexus sedan that had accelerated uncontrollably. The tragedy marked the beginning of a crisis that severely damaged Toyota’s reputation and revenues. In Toyota under Fire: Lessons for Turning Crisis into Opportunity, the
adroitly the manufacturer responded to the recession of 2008. Toyota, which famously treats its people as appreciating assets rather than variable costs, did not lay off any permanent employees, as many of its competitors did; neither did it bully its suppliers. Instead, the firm reduced
strategy+business issue 64
conversation books in brief 94
and experiment within well-framed spaces. The result is short cycle times and standardized work with fast feedback. It is difficult to argue with Cusumano when he writes, “Managers who grasp the principles described in this book — all of which have withstood the tests of time and geography, as well as rigorous academic scrutiny — should create firms that stay ahead of the competition most of the time and adapt quickly to unpredictable change as well as adversity.” But although the principles are unimpeachable, the managerial reader is left to figure out how to apply them in his or her own context. This leaves us with principles that are true but not very helpful, a pervasive problem in business books and perhaps in the giving and taking of advice in general. Cusumano seems to acknowledge this tacitly in the book’s very interesting appendix. It is a refreshingly frank look at the problems and pitfalls of trying to extract best practices and principles from the analysis of corporate performance. He compares his principles with those enumerated by Tom Peters and Robert Waterman in In Search of Excellence: Lessons from America’s Best-Run Companies (Harper & Row, 1982) and Jim Collins in Good to Great: Why Some Companies Make the Leap — and Others Don’t (HarperBusiness, 2001). What quickly becomes clear is the difficulty of rigorous analysis and the ephemeral nature of corporate success. One is left with the suspicion that when it comes to
es, and policies — not just at Toyota, but also at regulatory bodies such as the National Highway Traffic Safety Administration — became linked together, spinning the public narrative out of control. For instance, safety and recall matters are engineering issues at Toyota, and decisions regarding them were centralized in Japan. Oblivious to the mounting hysteria in the U.S., the engineers in Japan worked methodically through the problem. They saw no systemic safety concern: Toyota had issued a recall on the allweather floor mats for the ES 350 in 2007 to eliminate the possibility that they might jam the accelerator pedal, and there had never been any evidence of electronically induced acceleration in any of the company’s vehicles. This geographic disconnect between the problem and the people solving it violated one of the central tenets of the Toyota Way: Decisions must be made as close to the scene of action as possible. Today, the story has almost disappeared from the news, and the authors contend that Toyota’s reputation and market position have largely recovered. They say that the
company survived both the recession and the recall because of the strengths of its entire ecosystem — suppliers, dealers, employees, and culture. Internally, Toyota executives made a number of changes to bridge the gaps between the center and the regions, and overall, their actions seem to have reassured both employees and customers. So in the end, this is a story of how the good guys suffered a setback, but ended up better for the experience, reaffirming Nietzsche’s adage that “what does not kill me, makes me stronger.” +
conversation books in brief
work hours and instituted temporary pay cuts. It also seized the opportunity to work on projects aimed at improving profitability and flexibility, such as reducing the breakeven point of its plants from 80 percent of capacity to nearly 70 percent — a huge challenge for a company already noted for running lean. By the summer of 2009, it appeared that Toyota would come through the recession with flying colors. Then an auto retailer in California placed a large floor mat from a Lexus SUV in a smaller ES 350 loaner sedan, which caused its gas pedal to jam in the wide-open position. Unfortunately, this did not become known for two months after the fatal accident occurred, while speculation became rife that there was a mysterious fault in the computers that control the pedal– throttle connection. As the media coverage became a circus and the lawyers and politicians started to circle overhead, the public began to believe that Toyota was covering up the facts. As Liker and Ogden describe the crisis, it becomes clear how hitherto unconnected incidents, practic-
95
Putting a Dollar Value on Academic Business Research MBA students who attend schools where teachers publish frequently end up earning more. by matt palmquist
conversation end page 96
Scholarly research from business schools is often lambasted for having little practical application. But this study finds that MBA students who go to schools where the research level is high get paid more than peers who went to other schools — as much as 21 percent more after three years in the real world. The reason has less to do with the research itself than with the effort that goes into it. “Active engagement in knowledge creation through research,” write the authors, “as opposed to simply teaching from textbooks…may help faculty hone their analytical skills and consequently emphasize a more rigorous approach to problem solving.”
To assess faculty research productivity, the authors used a social science citation index from 1999 through 2006 — the period during which the MBA students being studied were in school. The study tracked faculty publications at 658 business schools (82 percent of which were in the United States). They counted how many papers appeared in A-level journals (the top 40 in terms of citations), B-level journals (those ranked 41 to 120), and C-level journals (all the rest). The analysis indicated that MBAs from schools whose faculty published in both A-level and B-level journals had substantially higher salaries three years after graduation than did graduates from the 25 percent of schools in the study whose faculty produced little or no published research. Using a financial model and citing the 2009 Financial Times survey of MBA programs, which found that the average salary three years after graduation was US$115,000, the researchers estimated that graduates of schools with optimal publication records received an average “bonus” of 21 percent that year, or an extra $24,000. How-
ever, too much research and publishing in elite journals — and presumably less focus on teaching — can drive down that bonus; this phenomenon was noted in about 20 schools, all in the top 3 percent of research productivity. (Those graduates still earned more than peers who went to institutions that did little research.) The authors controlled for several factors that can affect postgraduate salaries, such as a school’s reputation and its financial resources. For those who can’t get into or afford a top school, targeting one ranked lower overall but with a strong research record can be almost as beneficial in terms of salary. Bottom Line: Academic business re-
search has economic value: MBA students from schools where teachers frequently publish in high-level academic journals tend to earn more after graduation. + s+b Recent Research Online See more coverage of research papers — including our complete archive — at www.strategy-business.com/recent_research.
Illustration by Ellwood Smith
Title: Does Business School Research Add Economic Value for Students? (Subscription or fee required.) Authors: Jonathan P. O’Brien (Rensselaer Polytechnic Institute), Paul L. Drnevich (University of Alabama), T. Russell Crook (University of Tennessee), and Craig E. Armstrong (University of Alabama) Publisher: Academy of Management Learning and Education, vol. 9, no. 4 Date Published: December 2010
