Dealing_with_Darwin

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Information Technology, Telecommunications, and Media & Entertainment: Three Industries Separated by a Common Language

As the underlying technologies of IT, telecom, and media converge, the executives of the leading firms in each industry have more and more reason to communicate with one another.  Alas, sometimes the best of intentions lead to unintended outcomes, not for lack of goodwill, intelligence, or experience, but simply from persistent mutual misunderstanding.  How is this possible?

When I say the three sectors are separated by a common language, what I mean is that each speaks a different dialect in which the same words take on different meanings.  Let me illustrate this with three examples:

1. Open.  A simple enough word, you would think, but here are its three meanings in the dialects of IT, Telecom, and Media & Entertainment:

IT:    A published set of shared protocols that allow third parties to co-opt the resources of a system to achieve novel ends.  The opposite of proprietary and closed.

T:     A network that has no controls, either for security or billing purposes.  The opposite of a walled garden.

M:    A system in which media content can be transferred from one modality to another without additional payments made.  The opposite of a publisher-controlled distribution system with strongly enforced IP protections.

2. Real-Time:

IT:    Available whenever an end-user clicks on the appropriate icon.  Measured in seconds.

T:     Linked directly to the laws of physics.  Measured in nanoseconds.

M:    Live performances.  The opposite of recorded and edited.

3. Global:

IT:    Refers to the extended reach of supply chains and distribution chains, and the need to redesign processes and products accordingly.  The opposite of national.

T:     Refers to service level guarantees that operate in real time across many geographies without compromise or failure.  The opposite of local.

M:    Refers to the repurposability of media content to expand markets beyond regulatory or linguistic boundaries.  The opposite of regional.

Now the long-term solution to this Tower of Babel, no doubt, is for Larousse to publish a set of interoperating dictionaries for IT to T, T to M, and M to IT.  Or perhaps this could be a Wikipedia project.  But in the short term, the trick is to know which languages you speak and be able to identify what language someone else is speaking. 

For example, as a consultant I speak fluent IT and have Telecom as a second language, whereas I speak pidgin Media at best.  Many technology infrastructure executives have this profile.  By contrast, executives from the cable industry, raised speaking Media, are becoming bi-lingual in Telecom, whereas CEOs of web properties, raised speaking IT, are becoming bi-lingual in Media.  I can only think of one tri-lingual CEO of my acquaintance, and that would be Paul Sagan of Akamai, who has had to do so as his media content delivery business lives at the epicenter of this converged universe.

That said, the majority of sector executives, I believe, are mono-lingual, which is unsurprising since their careers were shaped in a pre-convergence era.  This is not meant to be a criticism, nor is it incumbent on these folks to go to a language arts training class.  They need, however, to become dialect-aware in both their speaking and listening if they are to avoid talking past each other in converged industry dialogs.  Specifically, when things get contentious and frustrations build, they must continually be checking the perceived meanings of the key terms in the argument and making explicit how they themselves are defining them.  This is awkward, to be sure, but much less so than the consequences of failing to do so.

Dateline Davos: The Shifting Power Equation

Dealing with shifts in power is the theme of this year’s World Economic Forum meeting in Davos, and it makes a very good platform to discuss a wide range of issues, including the following power shift vectors, all bubbled up in from a 750-person multi-track opening plenary:

·          From developed economies to emerging markets

·          From public markets to private equity

·          From established states to rogue states

·          From energy exploiters to energy resource owners

·          From enterprises to consumers

·          From certified authorities to collective intelligence

·          From the middle aged to the young and the old

·          From social to virtual relationships

The shift that has caught my attention, however, is that from computing systems that communicate to communication systems that compute.  The implications for technology vendors are straightforward but dramatic. 

For communications vendors—including companies like Cisco, Motorola, AT&T, and Akamai—the opportunity is to smarten their pipes.  This entails a migration of value creation into the network, achieved by computing more and more on the data it carries while it is carrying it.  All forms of behavioral targeting, real-time transaction resolutions, and the like call out for this shift.

For computing vendors—including IBM, HP, Dell, EMC, Oracle, and SAP—the opportunity is in the opposite direction: to reframe their offers to accentuate their role in a communications system.  This means redesigning the PC, its peripherals, the database, the applications, the storage architecture, the middleware stack, and a portion of the server base to shift from automating transactions to feed systems of record (people in service to computers) to enabling interactions to drive relationships of value (computers in service to people).  Think of the PC as a much better cell phone, the application as an adjunct to a real-time interaction, the googlization of data access, and the like.

The shift from computing to communications also has profound implications for the redistribution of power.  As the Internet continues to work its transformation of the globe, the single most powerful force it is unleashing is memes, that class of ideas that are uniquely able to capture people’s imaginations and shape their behavior.  Some of these memes are inspiring and uplifting (think spirtuality and altruism), some are crass and banal (advertizing and, yes, much blogging), and others are dark and pernicious (sexual exploitation and suicide bombing).  All are vying for a commitment from each of us, and when we give that commitment, we give it for free and put all our life energy behind it.  That is what makes memes so powerful.

The ability both to create and promulgate such memes and to recognize when a meme is acting upon you or one of your constituents is core to being effective in this new reality.  A connected world places an enormous premium on people who are fluent in communications: expressing ideas, positioning offers, inferring power relationships, decoding nuances, deflecting the manipulations of others.  We are witnessing the rise of the articulate and the marginalization of the inarticulate, whether in our political and business leaders or in our leading brands and most favored Internet sites. 

In sume, if the past few decades were heralded as the revenge of the nerds, the next few will be the revenge of the liberal arts graduates.

Platform Innovation: Watch Your Step!

There are few things more seductive to a tech-sector management team than the thought of becoming the next industry-enabling platform.  Virtually every major corporation has a platform strategy, not to mention an equally elaborate set of plans to prevent any other vendor from achieving platform status.  All in all it makes for complicated navigation, both outside and inside the enterprise.

To clarify matters, understand that platform innovation takes on very different properties depending on which of the following three goals you have in mind:

1. Productivity.  This is the most basic domain of platform innovation—platforming your own product line.  Companies which have grown through acquisition or through independent business units operating in silos discover, upon reaching market maturity, they have massive duplication of efforts because they are supporting a wide array of product platforms.  To address this issue they undertake an architecture rationalization effort to migrate toward a common platform.  The goal is to improve their internal productivity and eventually reduce cycle time and time to market.

2. Whole Product.  This is an intermediate domain for platform innovation, where the goal is to build out an ecosystem of partners who will add their efforts to yours to flesh out solutions for target markets.  Hardware vendors seek out system software vendors to this end, system software vendors seek out ISVs, ISVs seek out systems integrators and VARs.  The typical focus of these efforts is on recruiting a large number of partners, which is almost never a good idea.  Rather the focus should be on quality not quantity, making sure you actually make an market for the best type of partner, and providing tools and support to enable them to use your platform productively.

3. De Facto Standard.  This is the dream state, in which your technology becomes a critical enabler of a whole class of applications.  In a book called The Gorilla Game, we identified the critical success factor here as having proprietary control over an open architecture.  This only seems like a contradiction in terms, for the word open here simply refers to the ability of any third party to avail itself of the platform’s services.  (Compare in this context, for example, Windows’s open platform with Xbox’s closed platform.)

As you can see, each stage of platform evolution implies securing the prior stage or stages.  Most importantly, however, Stage 3, becoming the de facto standard, can never be reached directly.  That is, if you announce that you are offering a proprietary technology to serve as a de facto standard in some open architecture, you may be assured that every other member of the ecosystem will resist your efforts to the death.  No one wants to create one more platform vendor to whom they must pay monopoly rents. 

Therefore, the only way a new platform can emerge is indirectly, first by achieving ubiquity as a product or as a component in someone else’s product, and only after having achieved ubiquity, converting to a proprietary platform.  How can anyone still fall for the old Trojan Horse trick?  I can’t answer that—ask the guys at Google.

Apple, Sony, and the Signal-to-Noise Ratio

For innovative offers to create competitive advantage in mature markets, they must clearly and cleanly separate themselves from the crowd.  Otherwise customers and consumers are unmotivated to seek out a specific vendor, and commoditization wins out.

Engineers call this type of problem managing the signal-to-noise ratio.  To optimize that ratio one must simultaneously filter out noise and amplify the signal.  When it comes to innovation strategies, most corporations focus on the latter solely and fail to attend to the former.  The end result is a marketplace that gets noisier and noisier, drowning out everybody's signals. Innovations suck up huge marketing (read: noise-making) budgets but fail to get traction. 

Winning innovation programs take a different path.  Like their failed counterparts, they too create a strong signal to start with.  But unlike them they focus the remainder of their efforts on amplifying that signal and filtering out distracting noise.

Compare Apple to Sony in this regard.  Both companies create innovative electronic products for consumers, and both have created branded retail outlets as a “noise filter” to eliminate competing distractions.  Why, then, is Apple so much more successful than Sony?

When you go into an Apple store, there are relatively few products on display, and each display station has a strong theme.  The goal is to attract, orient, and educate consumers about an activity elegantly performed.  The staff is also application oriented in the way it interacts with people making queries.

By contrast, in a Sony store there are many, many more products on display—everything from TVs and sound systems to laptops to PlayStations and robotic dogs, and, yes, even “noise cancellation” headphones!  Displays are grouped by product category, not application, and the staff are all product oriented.  The net effect is that Sony has reintroduced noise and failed to amplify signal, and their market performance shows it.

If even an iconic brand like Sony can fall prey to this problem, what hope can the rest of us have?  Actually, quite a lot.  The key is to modify every step in the value chain to amplify signal and reduce noise.  This begins with an unambiguous declaration of innovation strategy—identifying the vector of innovation to be accentuated.  It then is executed via a series of management reviews which reward programs for amplifying that vector and filtering out competing innovation vectors and which discipline programs that introduce competing noise. 

No Cokes at Starbucks. 
No coupons at WalMart. 
No refills for BIC pens. 

Pick a theme and get every department in your enterprise to stick to it.

Catch and Release: Good for Fishing, Bad for IP

As markets mature, customers give preference to types of innovation that leverage experience and know-how.  In the consumer sector, for example, marketing innovation and experiential innovation come to the fore—the sort of thing that separates Apple, Startbuck’s and Nike from their would-be competitors.  In industrial markets, meanwhile, process innovation and business model innovation get privileged treatment—areas where operations like Cisco Services, G.E. Medical, and Caterpillar’s remanufactured engine group have all shined. 

None of these forms of innovation directly touch the offers that these companies make and ship—they are all relatively similar to those that their competitors field.  Instead what differentiates them is their ability to mine a broad base of experience to discover insights and best practices, capture them as intellectual property, and then exploit them either by distinguishing their own operations or by licensing them to partners or customers.  Done well, this type of innovation is extremely lucrative as it entails no cost of goods.

Most companies with established positions in mature markets have the wherewithal to pursue one or more of these types of innovation, but tragically very few actually capitalize on the opportunity.  Instead of harvesting their insights and institutionalizing them, they take a “catch and release” approach to IP.  They do not take the time or exert the discipline to capture and scale their best practices.  Instead they reinvent and rediscover these insights over and over, or worse, lose them entirely.  In short, anecdotally they know much; programmatically they leverage little. 

There is no excuse for this behavior, particularly in a mature sector where differentiation is increasingly hard to come by.  The productivity gains alone would pay for the work involved, and the follow-on upside more than warrants the opportunity cost entailed.  Depending on your organization and its management team, this might be a failure of intellect, imagination, or will: take your pick—all three lead to commoditization and decay.  Alternatively, get you team off its duff and get cracking on a ready-made opportunity to improve your market position.

Coins in the Couch

One of the harsh realities in the coming of age of an economic sector is the loss of external funding for growth.  Growth capital is typically attracted by Cumulative Average Growth Rates (CAGRs) of 20% and above—that’s what makes for a growth sector.  When categories mature, their CAGRs drift down toward single digits, and the growth capital goes elsewhere.  What now can management do?

This is the current state in the technology sector, particulary for enterprise IT.  Growth from now on must be funded internally by productivity improvements in existing processes.  We must extract growth capital, in other words, from our own hide.  We call this strategy finding coins in the couch. 

The good news here is that during the rush of the growth years we generate untold numbers of inefficiencies in virtually every core process that operates at scale in our companies.  As a result we enter the mature category era with spare change lying around everywhere.  This is what makes optimization initiatives initially so attractive.  They have a high probability of being successful because they take place in such a target-rich environment. 

The bad news is that management teams all too often fail to reinvest the coins they extract in future growth initiatives.  Instead they use them to prop up commoditizing businesses by improving their operating margins.  In the short term this produces attractive returns—essentially by robbing innovation to feed investor expectations.  In the long term it results in stagnant entities that get acquired and/or disassembled to be incorporated into more vital and vigorous enterprises.

These management teams have succeeded in extracting resources from context, but they have failed to repurpose them for core.  They ate their seed corn instead of planting next year’s crop. 

The key lesson here is simple: Do not undertake reengineering for productivity efforts until you first declare how you intend to invest the proceeds to create competitive advantage for future returns.  Inefficiencies, in this model, are a source of funds, something like body fat.  You want to use that body fat for energy, not just strip it off through plastic surgery.

SOX and the Law of Unintended Consequences

Sarbanes Oxley, Year 4.  The Big 4 cannot hire enough people to administer audit projects, so quality is at record lows, and asininity of compliance rulings is at an all time high.  To paraphrase Jack Nicholson from As Good as it Gets, this is what happens when you start with a normal person and then you take away reason and accountability.  In particular, shame to say, there is absolutely no accountability in the current system for being asinine.  And since nature abhors a vacuum, the staffers in the Big 4 are promulgating absurdities at a record rate.

Understand whom this punishes.  It does little harm to the Fortune 2000 industry incumbents.  For the most part their strategies are governed by inertial forces, and thus they do not need to change their processes often enough or rapidly enough to be crippled by SOX regulation.  Indeed, they arguably are made better by SOX audits in the long run, since they inherit the benefits of these documented reviews once they have been able to wash out all the stupidities.

But woe to the start-ups, and woe to the small business innovators.  Their processes are necessarily in flux.  They need to prototype them, test them, modify them, expand them—in short, they need to do anything but document them to a set of standards administered by children who know nothing of business and even less about the industry in which the company competes.  Encumber these companies with SOX audits, as we have, as we are intending to do even more, and basically you take them out of the game. 

The unintended consequences? Well, consider which set of companies has driven our employment engine over the past decade.  It is not the big guys.  They are still laying off people in their effort to focus on core and outsource their context.  Rather it has been the small to medium businesses that have driven all the job growth, and those are the very ones SOX is bringing to their knees. 

Brand: Unclear on the Concept

God love BusinessWeek and Interbrand for their Top 100 Brands survey.  It is absolutely critical that brand be valued as a strategic asset, and the Interbrand approach, while subject to debate, is as good a place to tart as any.

But….

Both organizations seem to be unaware of a fundamental truth about brand value—namely that while it is has extraordinary relevance to B2C volume operations enterprises, it has virtually no relevance to B2B complex systems enterprises.  To prove this point we need go no further than to examine the results of their own survey.

Of the 100 companies listed, fully 70 percent are pure consumer branding plays.  Another 22 percent are mixtures of B2B and B2C lines of business.   Only eight companies are more or less pure-play B2B complex systems companies:  IBM, GE, Cisco, Oracle, SAP, Seimens, Accenture, and Caterpillar are great companies, but it is highly misleading to think of them as great brands.  Here’s why.

In a volume operations business, customer intimacy is achieved by brand identification.  Brand values intermingle with the consumer’s personal values such that the consumer identifies with the product or company and thereby gives it preference during buying decisions.  This drives up both revenues and margins.  Thus brand power is key to sustainable competitive advantage and is thus reasonably framed as a prime determinant of market cap.

By contrast, in a complex systems enterprise the mechanisms are completely different.  Customer intimacy is achieved by face-to-face interactions between representatives of both companies, and buying decisions are made and reviewed by an array of people.  By virtue of these differences the impact of brand is dramatically muted.  Arguably it might still be said to have a role to play ("Nobody ever got fired for buying..."), but only marginally, and it is highly misleading to suggest such brands are a primary contributor to market cap.  Indeed, it is far more likely to be the other way around: high market cap creates the effect that we are calling corporate brand.  In reality it is far better to think of such a brand as a placeholder for a strong corporate reputation and leave it at that.

You, Me, and Dupree, but can I have the ads on the side?

Responding to Robert Young's blog on socially integrated media empires, I, like everyone else on the planet, am fascinated by the self-organized emergence of social media a la YouTube, Flickr, MySpace, Facebook, et al.  Who knew?  How much is fad vs. last paradigm is still anyone’s guess, but let us assume that some subset of the whole is lasting.  The question this raises for me is, what does it mean for marketing?

Media’s relation to marketing—the funding of editorial by advertising—has always been tense and occasionally becomes problematic.  The interests of readers, sellers, and publishers never quite align, but as long as the value proposition is strong enough to each constituency, the system is able to transcend its disconnects.

For this to hold true in social media, however, the industry is going to have to revise or refine the prevailing social contracts pretty dramatically. Creative-expressives—the authors of social content—will not abide by any content code, so advertisers will have to develop some mechanism of their own if they are worried about their ads showing up next to offending content.  Voyeur-viewers—the consumers of social content—are exceptionally adept at deconstructing and filtering out traditional marketing messages, so publishers and advertisers must become even more adept at subtly bringing them back in.  Marketing executives—the ones with the big budgets—are going to find it very hard to be able to spend enough of their budget in one place to make it manageable.  Publishers—the ones who are sponsoring the social site—will have a very fine line to walk: they must maintain their independent status and “cool in order to keep their creators and consumers, but this will make doing business just that more complicated.

Can it be done?  I doubt it can be done at scale.  It is just too hard to maintain.  So I doubt, therefore, that social media is a good business investment for the long term.  I think it will remain—indeed, I would argue that in order to be relevant it must remain—a fringe phenomenon.

Fortune: “The New Rules of Business”

Fortune's  “story” here is that Jack Welch’s rules are wrong, but the writer from Fortune has seven new ones that are right.  Let me say from the outset, this sort of thing drives me nuts.  I would call it “autonomic business writing,” meaning it is a story which writes itself—and has the depth to prove it.

The problem is not with whose rules are right or wrong.  The problem is with the use of the words right and wrong themselves.  Anybody who spends any time actually doing business—as opposed to autonomically writing about it—knows that it is the most situational of all human activities.  There is a time for Jack’s rules, and a time for the Fortune rules, and the real skill is in diagnosing the situation so that you apply the appropriate rules at the appropriate time.

Touting in isolation that the customer is king (Wow!  I bet Jack never thought of that!) is just plain twaddle.  Implying that the shareholder is no longer relevant is also twaddle.  And so it goes.  Niche is better than mass?  Well, yes, for some situations.  By the way, the author is thinking primarily of consumer-oriented volume operations business while Jack was running a conglomerate of primarily enterprise-oriented complex systems businesses.  Very different rules for each.

Our culture's fixation with rules isolated from context (remember Trout and Reis’s Twenty-two Immutable Laws of Branding?) is testimony to H.L. Mencken’s great aphorism: For every complex problem there is an answer that is clear, simple, and wrong.

Kawasaki and the Wrong Tale

Reading Guy’s column makes obvious that Chris Anderson's The Long Tail is a the basis for marketing and distribution company, not a product company.  Indeed, the key idea is that failed products in aggregate make valuable inventory provided that the market remains inefficient for everyone but you to aggregate and sell them.  What the Internet enables is an extraordinarily efficient mechanism for enabling long-tail activities.

That said, I think the long tail is a more interesting idea culturally than economically.  It argues that a diversity of memes rather than a few blockbuster memes will set the next-generation social context.  I am not sure I believe this, but I do agree that the long tail makes it a possibility, something that our mass communication economy never could. 

The reason I am not wildly enthusiastic about the economics of the long tail is that I think the market will become efficient over time, there being few barriers to entry, so that distribution power will dissipate.  So if you have low distribution power in the future, and low product power in the present, it is hard to get excited about capturing economic returns from the model.

Top Ten Truths About the Digital Ecosystem

This piece follows up a request from the World Economic Forum for thoughts about the Digital Ecosystem, in preparation for framing the 2007 agenda at Davos.  I would really appreciate any comments that would expand, improve, or correct these lines of thought.

10. Images are king.  Verbal content, by virtue of its sheer volume, is increasingly perceived as noise.  We are entering a new era of collage, where the mind of the viewer is the assembling artist.  Verbalization happens post facto, the residue of headline skimming and subconscious synthesis. 

The esthetics of digitally enhanced images will become increasingly powerful as a vehicle for cutting through the clutter.  Manipulating semantics or semiotics via images will become increasingly sophisticated, both in the private and public sectors.  High-definition displays and portable form factors will be popular mass markets.  Indexing and searching images, on the other hand, while technologically interesting, will be of peripheral impact.

9. Songs are the spiritual property of the young.  They construct their identities around them and feel they own the rights to them in a way that no economic contract could interpret.  Sharing songs and sets of songs is a type of free speech.  By contrast, films have nowhere near this visceral appeal and matter much less.

Operating on songs is the paradigm for the new creative consumer who will not create content so much as modify it and send it along.  Tools and sites that let people extract, reframe, and re-present will be core enablers, a la MySpace, UTube, and the like.

8. There is no place to hide.  This is good for exposing the horrors of man’s inhumanity to man.  It is bad for the privacy advocates.  It is meaningless for the security forces as no command-and-control big brother can keep up with the sheer volume of self-organizing chaotic systems in flux.

Next-generation security will organize around the person and the personal identity instead of the data and the institution.  Mobility will only complicate this challenge.

7. Wikis rule and “crowd-sourcing” works!  Outsourcing tasks to a self-organizing community of volunteers, a la open source software, is proving to be a powerful tactic for tapping into the collective wisdom and experience of the planet.  Surprisingly, this mechanism is nowhere near as susceptible to demagoguery as edited media.

The wiki model is becoming a de facto collaboration paradigm within private enterprises with global reach.  It seems likely to spawn comparable efforts in the public sector: a wiki-versity, a wike-health-care-system, a wiki-disaster-recovery-effort.  We will get object lessons in the power of memes (or the lack thereof).

6. Games tell all.  Anthropologists of future centuries can be spared digging through layers of sedimentary rock.  Instead they will just need to find game machines that let them play World of Warcraft or play back the history of an avatar in Second Life.  All the metaphors of contemporary culture are being acted out in one or another corner of this virtual universe.  And currency exchanges are beginning to link this universe to the physical one.

The emphasis on symbolic interactions in a digital lifestyle will have unpredictable effects on self-perception and social norms.  Historically the real world has set the norms and the digital world reflected them, but the obverse can be expected to be true going forward.  Games can become living laboratories to explore strategies for living, a role played by literature and drama in ages past.

5. Services displace products.  In the digital world, as bits substitute for atoms, products are reconceived as services.  This is the threat that Google poses against Microsoft. 

Services companies still have not completely caught up with this.  They tend to describe their offers as products, which, although convenient as a means for integrating them into traditional organizational thinking, profoundly misrepresents their dynamics and causes companies to miss whole dimensions of consumer experience, need and value.

4. Everything is media.  While advertising will not pay for everything, everything will become a potential opportunity to advertise.  This means that at least some technology adoption life cycles can be short-circuited by providing the disruptive innovation for free. 

If advertising is the default funder of digital offers, then consumption is the ultimate paradigm.  Over time people and cultures will weary of this, and socially constructed content will become more pervasive as an escape from constantly being pitched.

3. Outsourcing and offshoring are inevitable.   Digitization of work is profoundly world-flattening.  In an Internet-enabled world, as work itself becomes digitized, markets cannot be protected.  This will be hugely dislocating to the developed economies in the short term.   Longer term, it will be the single most effective tool to combat global poverty and its cousin terrorism.

Instrumentation and institutions that create visibility and control over processes that span geographical and enterprise boundaries will become increasingly powerful.  Everything will ultimately resolve to a Service Level Agreement and a series of compliance-assuring mechanisms.

2. Symbolic competence creates competitive advantage.  On the web, as one cartoonist famously noted, no one knows you are a dog.  All they experience about you is a function of your ability to manipulate vocabulary and symbols. 

This puts liberal arts education in high relief.  The digital world will move from being an engineering phenomenon to a cultural one.  Memes, brands, reputations, causes—all will seek to recruit the most powerful symbolists to their ends.

1. Omnipresent distractions increase the need for inner peace.  Digital systems intrude into every aspect of life and, unrestricted and unbalanced, can overwhelm our perception of personal and social values.  The resulting alienation will lead to a search for direct personal spiritual experience.

Traditional religion, with its reliance on belief, will be undermined by digital communications, for as symbolic manipulations becomes increasingly transparent, it creates distrust in any institution that engages in it.  In this context, meditation, yoga, and other forms on non-mediated spiritual experience will become increasingly attractive. 

Intel: Meet Darwin

This past week Intel surprised analysts with the latest in a set of uncharacteristically weak performances, especially in comparison with AMD.  This has led some analysts to question Paul Otellini’s suitability to lead the company, falling prey to an over-fixation on CEO behavior that serves up glib answers on demand.  What is really going on is far more systemic and far-reaching.

Intel has lost proprietary architectural control over the x86 architecture.  AMD demonstrated this conclusively by being the first to design and ship a 64-bit version of x86 called Opteron.  Intel rapidly followed with a 64-bit Xeon, but the genie was out of the bottle.  The market was able to follow AMD without waiting for Intel’s endorsement, effectively communicating the x86 had become an open standard.

How did this happen?  The script is eerily familiar and was set in motion long before Mr. Otellini took the stage.  It is a story of flight from cannibalization¸ a known form of business tragedy, with striking parallels to IBM’s abortive attempt to substitute a proprietary PS2 MicroChannel Architecture in place of the widely adopted EISA architecture that enabled PC-licensed clones to compete with it directly on price.  In that case an incumbent gorilla sought to create distance between a low-end commoditizing standard and a high-end next-generation capability.  Instead the market voted for a third alternative, an upgraded version of the commodity, in the form of the Compaq 386 PC..

So it has been with Intel and its attempt to divide the market between the “scale out” architecture of the x86 and the “scale up” architecture of the Itanium microprocessor family.  To be sure, there is a real and valuable RISC replacement market that Itanium can and will address, one where it competes with IBM’s Power PC and Sun’s SPARC.  But by attempting to minimize x86 cannibalization between the two market dimensions, Intel actually left the door open to AMD to create a third alternative, a 64-bit multi-core x86-compatible microprocessor, something the market has embraced with a vengeance.

That market response, in turn, installs AMD as the leader in this phase of x86 development, just as Compaq’s 386 stole the leadership mantle from IBM.  Whether or not AMD can keep it is an open question.  The significant fact is, it is now in play! 

OK, now what?  The key to navigating market dynamics going forward is to recognize that while markets based on proprietary standards can stabilize at splits as high as 90/10 (Microsoft Windows, Microsoft Office, Cisco routers, IBM mainframes), those based on shared standards rarely tolerate more than a 20% gap between the lead vendor and its closest competitor (application servers, SQL databases, PCs, plasma TVs).  Open choice with modest to low switching costs is the leveling influence.  Under these dynamics, one would expect the Intel/AMD split of x86 products to stabilize at 60/40 or so, meaning AMD can gain another 20 points of share simply by showing up!

Now, of course, Intel can and will fight this shift, but if the genie truly is out of the bottle (I think it is, but the point is clearly debatable), then it is no longer a matter of if, only a matter of when the market “normalizes” (a condition which will certainly not look normal to Intel).  That is why the company was correct when earlier this week it refused to launch an expected scorch-the-earth price war with AMD.  It makes no sense to claw back market share in price-only competitions if there is no way to retain that share profitably.  It does make sense, of course, to leverage the company’s immense manufacturing resources to fight profitable battles against AMD, slowing erosion and pocketing literally billions of dollars before the new equilibrium is achieved.  But in a world of 60/40 splits, that is still a strategy of “not if, but when.”.

There is one other strategic alternative open to the company, one which admittedly at first glance looks like calling in an air strike on one’s own position: Intel could license the x86 architecture to one or two additional manufacturers!   Why in the world would it ever do that?  Well, 60 percent market share is a more powerful position in a 60/25/10/5 split than in a 60/40 split.  The bet would be that the overwhelming preponderance of revenues going to vendors 3 and 4 would come at AMD’s expense, not its own. 

Is this a good idea?  Who knows?  If it worked, it would be brilliant; if it failed, it would be idiotic.  All one can say right now is that it would be an awfully gutsy bet.  Would it be more gutsy than, say, Sun putting Solaris out as Open Source?  Yes, because Sun was in direr straits at the time, not only losing the war against Linux but the battle against IBM and HP Unix as well. 

My main point here, however, is that there are times when dealing with Darwin demands counter-intuitive actions, specifically when the environment has changed in some fundamental way that invalidates one’s traditional source of competitive advantage.  Intel’s abandonment of its Intel Inside positioning in favor of migrating from a product to a platform innovation strategy (see earlier blog) is one manifestation of such action.  It is a move that clearly anticipated the erosion of power we are now witnessing.  But I have to believe Intel management assumed a softer landing than it is now experiencing.  In any event, they have set a self-imposed deadline of 90 days to respond.  When Darwin comes calling, it important not to keep him waiting in the lobby.

Strategic Acts of Generosity

As more and more leading corporations in developed economies butt their heads against the demands for top-line growth, they are finding that their “Defend and Grow” strategies are spending most of their time defending rather than growing. 

Much of the problem is due to the tiredness of the categories in which they play.  Market positions have matured, and there is little stimulus for growth left in the system.  Migrating to new categories is an option, but to do so the company must forsake the leverage it enjoys in its established lines of business. 

A better path is to revitalize your existing category by opening it up to a next generation of participants.  We call such a move a strategic act of generosity. 

The idea here is that market share leaders in mature markets offer up access to their customer base to a new generation of partner/competitors in order to stimulate a new round of customer interest in their category.  In this new round the legacy systems provider’s role shifts from being a solution provider to being a platform or environment for next-generation solutions, which may or may not come from its company.  But everyone benefits from the renewed level of investment.

We have seen strategic generosity work in market development before, but mostly from companies on the rise.  The Open Source movement was founded upon one such act and thrives by a continuing stream of them.  Salesforce.com is doing the same thing by opening up its installed base through its AppExchange.   Google offering to underwrite the deployment of WiFI in downtown San Francisco is another example.  These are all ecosystem-friendly market-expanding acts that increase company power and thus long-term competitive advantage.

SAP is doing something similar, but gutsier, because it has a large legacy position at stake.  The company is opening up its entire mySAP installed base to partners—and competitors—through its Business Process Platform.  This puts near-term revenues from module upgrades at risk, as those dollars may be diverted to partner/competitor offers.  The bet is, however, that this risk will be more than compensated by the overall stimulation to invest in reinvigorating the platform. 

The challenge for such strategic acts of generosity in an established gorilla is that the Defend team becomes understandably outraged by such acts of treason and seeks to curtail the Grow team’s radicalism.  It is supported in the actions of Wall Street traders who dump the stock in fear of short-term erosion in stock price.  Board reprisals can lead the executive team to retreat from their offer, creating a miserably compromised, semi-strategic head fake that leaves everyone disillusioned.  It takes real fortitude to navigate a company through these obstacles. 

That said, it is a less risky option, in my view, than trying to migrate your company into a whole new catgegory.  And it is a better option too than sitting still, clinging to a dominant position in a stagnant category, watching and waving to investors, customers, and partners as they move on to greener pastures.

Competing for Market Share—Maybe

Competing for market share drives some of the best—and some of the worst—management decisions in business.  Companies are particularly susceptible to going astray at the end of the quarter when they seek to use market share impact to justify horrendous deals—that is, deals that sell out all future quarters in order to make the current one.  Here are some guidelines to help you stay on the straight and narrow.

In the category of good reasons to compete for market share, the nominees are:

1. In categories where purchases are infrequent and switching costs are high, making sacrifices to acquire new customers can be offset by future revenues from established relationships.

2. When an emerging category goes inside the tornado of hyper-growth, making sacrifices to acquire new customers can be offset by winning market-leader status, something that confers bargaining power with suppliers, partners, distribution channels, and future customers.

3. In any category where the transactions are profitable and you are not, therefore, making sacrifices to gain market share, more market share is simply a trailing indicator of competitive success.

But each of the nominees above has an evil twin, one who seeks to masquerade as the good child but who must instead be exposed and banished.

1. In categories where purchases are frequent and switching costs are low, making sacrifices to gain market share is a fool’s errand.  There is no way to recoup your investment downstream since each new round of purchases reopens the bidding to all comers.  As purchasing folks like to say, “You want loyalty?  Buy a dog.”

2. When a mature category has a low rate of growth, or worse yet, is heading into a decline, making sales sacrifices to gain market share organically makes no sense.  The winning play—to be the last one standing and have enough life left in the category to make that worth while—is only achievable through consolidation.

3. When customers are unprofitable over the lifetime of the relationship, making sacrifices to gain more of them is a bad idea.  This is the deadbeat problem, and strategic companies win twice when they prune these customers from their installed base and see them go onto a competitor’s.  (On the other hand, if you can convert the added risk into added returns, then one company’s cast-offs are another company’s crown jewels.  Just remember, you are not making sacrifices to gain them.)

“Best in Class” is a Sucker Bet

As my colleagues and I developed our model for Return on Innovation, we saw three sources of attractive returns.  They are:

1. Differentiation leading to sustainable competitive advantage.  The return comes from customers preferring your offer over the competitor’s (more revenues) and paying a premium for it (higher margins).

2. Neutralization of a competitor’s current competitive advantage.  The return comes from being able to compete in more sales opportunities than you previously could (leading to incrementally more revenues, but not better margins).

3. Productivity leading to better overall profit margins.  The return does not come from any change in competitive advantage but rather from your ability to accomplish the same outcomes with fewer resources.

Note the difference between the first two goals, neither of which correlates to best in class.  Differentiation requires you to be unique in class or “beyond the class.”  Unless you escape from the norms of the category, you cannot gain sufficient bargaining power to drive increased sales and higher margins. 

By contrast, neutralization requires only that you make it “into the class,” that is, meet the minimum market standards for an acceptable performance.  Once you have, you can check this item off your list, and your competitor has lost the leverage it once held.

Best in class falls between these two goals.  It is not sufficiently differentiated to be unique, and thus it does not create bargaining power.  But it goes well beyond the minimum acceptable standard, which means you have spent a bunch of resources beyond what you had to and achieved no economic return for so doing!

That’s why “best in class” is a sucker bet.

In essence, best-in-class projects should be classified as waste.  That is, they are competitive advantage projects that aim too low.  They do achieve some level of differentiation, but it is not enough to create the bargaining power with customers that leads to higher revenues and margins.  In effect they are a form of corporate entertainment whereby teams enjoy the moral authority of a lofty-sounding objective but in fact have no accountability for any measurable economic outcome. 

Darwin will not be fooled.

Paper or Plastic? It Really Matters When Your Are Buying a Company

I was thinking about the Skype acquisition by eBay the other day—some $2 to $4 billion dollars, depending on earn-outs—and how shocking that sum sounds, especially for a company with very small revenues.  But management and investors both make a big mistake when they equate paying cash for a company to buying it with stock.  The two are radically different transactions, and to say that they converge on a common price is to misunderstand the nature and function of currency.

Paying cash for a company makes sense for accretive acquisitions which will improve the acquiring company's financials in the coming year, top and bottom line.  After all, cash is money that you could have given back to investors, and so when you don’t, it is right that you put it to work in ways that will generate immediate returns for them at your existing P/E ratio.

Paying equity for a company is an entirely different matter.  It makes sense when you are making strategic acquisitions that are dilutive in the short term but which you expect will fundamentally change your competitive advantage profile, and thus your earnings potential, in the long term.  In effect, you are not acquiring a going concern but instead mixing two gene pools to create a next generation of capability.  You are going to create a new P/E ratio.

Equity is not actually currency, it is ownership rights, and although markets are willing to trade one for the other, they should not confuse the two.  eBay gave up around 4% of its ownership rights to gain Skype.  That is a good deal if Skype can change eBay’s future earnings potential by more than 4%, a bad deal if it cannot  The cash value of the transaction is a distraction in this calculation.

Too many boards and CEOs are unwilling to pay up for major acquisitions because they see them only as adding in cash flows and not as marriages with the potential to create wholly new offspring.  As a result they do not improve their competitive advantage sufficiently to deal with the next round of natural selection in their marketplace.  Their stocks languish and eventually decline because, like marriage-averse bachelors, they are never able to take the plunge.

Values-Based Performance and Performance-Based Values

Values-based performance characterizes collaboration cultures who commit to altruistic ideals, live these values in their work, and earn thereby the trust of customers and partners .  Performance-based values characterize competition cultures who continually hold themselves accountable to objective metrics of success, regardless of who gets uncomfortable.  The two cultures tend to repel each other, creating nice guys who finish last and jerks who drive Porsches.  But sustainable, good-to-great companies have to combine both. 

I think the proper path here is to begin by establishing values-based performance (no Enrons need apply) and then realize that every time we do not hold ourselves accountable to performance commitments, we are actually selling ourselves short.  Why do we do this?  Because we flinch in fear of the pain that confrontation entails. We are not being nice to the other person, we are protecting ourselves from the demands of stepping up.  Once we acknowledge that this, in effect, means we are not living our values, we can use the energy of shame to change our behavior. 

Finally, this all ties in to Dealing with Darwin because natural selection is the ultimate performance management system, and like it or not, we are all being managed by it.

What do we mean by Innovate?

This blog entry is in reply to Tom Foremski's challenge to one of the points in the previous blog.  Before proceding further, please do read that piece (see below) and then his piece.

Now I could just agree with Tom, because he is making some fair points, but what fun is that?  Instead I will try to maximize the difference between our points of view in hopes some new ideas will emerge.

Tom's key point is that innovation needs to be tightly tied to disruption, and that therefore the other forms of innovation I cite should be considered as categorically different, not really belonging to the set labeled innovation.  His first supporting point is that non-disruptive innovations will not overcome the inertia of the status quo, and therefore will not be classed as innovative. 

My pushback is that, if you are a member of the establishment, you do not want to overcome the inertia of the status quo.  It works to your advantage.  What you want to do is overcome the force of commoditization, which works to your disadvantage, eroding your margins.  But you do not want to disrupt the market, because that creates too much opportunity for new entrants.  What you need, therefore, is some kind of innovation that is not disruptive but does create new differentiation--essentially what all the othe forms of innovation I cite are all about.

Later Tom makes a similar point: "I think that innovation has to be very disruptive and offer a superbly excellenct ROI in order to gain attention, and overcome cost of switching barriers."  And thus he concludes, "every Silicon Valley start-up had better have some kind of disruptive innovation in its garage otherwise why bother?"  When it comes to start-ups, he and I agree completely.  For them the status quo is the enemy, and only disruptive innovations can penetrate it. 

But in my view Silicon Valley is no longer all about start-ups.  It is now somewhat about start-ups and somewhat about established enterprises, and both are under pressure to innovate, though from different quarters.  And I think it is the established companies that are having the bigger struggle with innovation.  And I think the main reason they are struggling is because they are defining innovation the way Tom does, and then realizing they can't do it very well, and then getting all down in the mouth about not being able to innovate.

Baloney.  They just need to innovate with their age group!  Don't try the tattoo.  Lose the earring.  And for God's sake, don't do your next pep talk as rap.  But do step up to reinventing your adult self.  Do redefine the way in which you can be of service to your customers.  Do reengineer your processes to be more adaptive.  Do improve and enhance, and even on occasion reinvent, your product lines.  And do it all as innovatively as you can, with the goal of creating outcomes that your competition will be unable to match.

Top Ten Myths about Business Innovation

NOTE; I wrote this piece for Sandhill.com.  I am reprinting it here a) for your convenience, and b) because Tom Forenski is taking issue with a key point I am making, and I want to be able to reference that in my next blog.

If you are worrying about innovation, take heart.  Only successful companies do.  By contrast, unsuccessful companies either aren’t around to do any worrying or have more pressing concerns, like meeting payroll or paying their bills.  At the other end of the spectrum, venture-backed start-ups have lots of worries, but innovating isn’t one of them—they actually worry more about not innovating, as in why are making up a whole lot of procedures that others have standardized before us?

But you are not a start-up.  You have some success, some momentum, and therefore some inertia, and it is the inertia that has you worried.  By design inertia resists change.  This is a good thing, as long as you are headed in a direction you want to go.  But when the market changes, inertia acts against your future interests.  Now you are right to be worried.

So you raise the topic of innovation in hopes of getting some insight.  Good luck.  My recent research leads me to believe that innovation, as a topic, leads the business writing industry in twaddle per page.  With that in mind, let me dispel what, in David Letterman tradition, we might call the Top Ten Myths about Business Innovation:

10. We don’t innovate around here any more.    Baloney.  You are innovating all the time.  The problem is, you are no longer differentiating your offers in distinctive ways.  Your innovations, in other words, parallel your competitors’ innovations, with the result that you all look more or less alike.  Customers, seeing little to no difference, put more and more emphasis on price.  Unable to distinguish your offer, you have no bargaining power, and most capitulate to their pressure.  On weekends you complain about commoditization, but during the week you do nothing to address the problem.

9. Product life cycles are getting shorter and shorter.  And whose fault is that?  If you do not differentiate in hard-to-copy ways, you cannot expect what differentiation you do create to be long-lived.  iPod’s product life cycles are longer than its competitors, not because it has a way-cool form factor but because iTunes is part of the iPod experience that Apple’s rivals are still struggling duplicate.  And as cars make their dashboards iPod compatible, then once again the competitors have to run around catching up to Apple instead of making their offers distinctive in some other dimension.  Sustainable differentiation requires barriers to entry and barriers to exit.

8. We need a Chief Innovation Officer.  Like a hold in the head.  Think about what your true goal is:  you want innovation that creates differentiation that leads to customer preference during buying decisions.  That sounds about as close to a core business strategy as you can get.  It has to be grounded in the realities of operational capabilities, customer feedback, competitor investments, and capital constraints.  So your chief innovation officer by default must be your P&L owner.  If that person isn’t stepping up to the innovation task, replace them with someone who will.

7. We need to be more like Google.  Not on your life.  Google is a once-in-a-decade phenomenon, a company riding a wave of adoption so powerful that not only is the first derivative of its growth curve positive, but so is the second derivative as well.  If that describes your market, we doubt you are worrying about innovation.  If it does not, and you want outside help, seek it from someone who has had recent experience with markets like yours.

6. R&D investment is a good indicator of innovation commitment.  No, it is not.  In the first half of this decade, HP invested 15% in R&D and Dell invested 5% and cleaned their clock.  How?  They out-innovated them in process innovations led primarily by their operations folks.  Innovation that leads to sustainable competitive advantage can be initiated and led by any organization in the company.  R&D represents the engineering department’s lead, and in general pays off well in double-digit growth markets and increasingly poorly in single-digit growth markets.  Continuing major investments in R&D in slow-growth markets is a good measure of lack of innovative thinking.

5. Great innovators are usually egotistical mavericks.  Not any more (although there is no shortage of egotistical mavericks that would have you think otherwise).  In the current decade there is more competitive differentiation to be gained through collaboration than through busting out on your own.  That’s because our extended supply chains reward each company for focusing on its core and outsourcing the rest of the offer to someone else in the chain.  But actually orchestrating these chains to perform effectively in real time requires enormous innovation.  And that is a job for people who listen well, empathize deeply, and make the differentiated performance of the chain as a whole as important as their own local success.

4. Great innovation is inherently disruptive.  Not necessarily.  To be sure, authors like Clay Christensen and myself have spent much of our life’s work chronicling the impact of disruptive innovation, but it is only one type among many.  And the more established your company, the less likely it is a type for you to specialize in.  Alternatives include application innovation, product innovation, platform innovation, line extension innovation, design innovation, marketing innovation, experiential innovation, value engineering innovation, integration innovation, process innovation, value migration innovation, and acquisition innovation.  This last one, in particular, is usually an established enterprise’s best bet for dealing with disruption.

3. It is good to innovate.  No, it is good to differentiate on an attribute that drives customer preference during buying decisions.  Innovating elsewhere costs money and entails risk but does not create competitive advantage.  It might still be worth doing, either to neutralize another company’s competitive advantage or to improve your own productivity, but you would be surprised about the amount of innovation going on in your company right now that serves no economic purpose.  Rather it is being undertaken as a form of corporate entertainment, creating the illusion of purpose and meaning while carefully skirting the need to be economically accountable.

2. Innovation is hard.  Actually, it is not.  What is hard is deploying innovation, especially in an established enterprise.  That’s because the critical deployment resources are all engaged trying to make the quarter on the back of the existing offer set in the existing market categories.  They cannot be bothered with next-generation responsibilities when their current ones are hanging by a thread.  The net result: Too often, when a genuinely innovative offer is ready to go to market, there is simply no one there to sponsor it, and it dies on the vine.

1. When innovation dies, it’s because the antibodies kill it.  Yes, but not how you think.  The murder takes place in the customer’s world, not in yours.  Here’s how.   As a management team you hope to leverage the current relationships managed by your sales force to introduce the next-generation innovation.  But the synergies implied by this tactic are revealed over time to be false—the current team does not have any relationships of merit with the new target customer.  Instead it has legacy commitments to the old target customer who in turn is threatened by and resents the intrusion of the new innovation.  Thus your own sales force finds itself more or less honor-bound to sabotage your next-generation effort.  Whether they actually do or not, they are in no position to lead the kind of charge required, and it is no wonder when some piddly little start-up beats your finely tuned sales machine to the punch.

Dateline Davos: Technology Pioneers

My favorite thing to do at Davos is to help facilitate the Technology Pioneers program.  Each year the Forum invites two to three dozen technology entrepreneurs to come to the Davos meeting, to share their visions and participate in the dialog.

This year we held a workshop where 20 of these pioneers pitched their company and technology to a table full of Forum participants, after which the room voted out their top choices for most warranting additional investment.  The five companies voted to have the most investment-worthy technologies were:

1. Amyris Biotechnologies Inc, enginnering microbes to cost-effectively produce high volumes of high-value complex molecules--essentially bugs as factories.

2. ThereVitae Ltd, developing cardiac tissue from adult stem cells for use in heart attack therapies.

3. Energy Innovations, halving the cost of solar power through photo-concentrator systems.

4. EnOcean GmbH, producing battery-less sensors that harvest the energy they need from sources in their immediate local environment.

5. MBA Polymers, a lowest-cost producer of plastic leveraging next-generation recyling technology.

Check 'em out!

Dateline Davos: The Future of the Technology Sector

Yesterday I had the good fortune to moderate a Davos session on the future of technology where the panelists were Bill Gates, John Chambers, Eric Schmidt, and Niklas Zennstrom.  For those interested in the full record, there is a podcast on the World Economic Forum website.

The premise of the dialog was that we needed a new framework for thinking about the future of technology for two reasons.  FIrst, technology issues are no longer confined to technology companies--they have equal or even greater inpact on the technology-enabled sectors.  It's not just about IT anymore; it's also about telco, financial services, media, advertising, retail, pharmaceuticals, supply chain and logistics, with many more in the queue.  So we need a broader understanding that shares a common vocabulary across these sectors.

Second, Moore's Law--the model that for twenty-five years was the most effective at explaining how technology evolves-- is losing its explanatory power.  Up until about 2000, you could pretty much explain the state of every element in the technology sector by pointing to how semiconductor capabilities would increase 10X every few years, thereby obsoleting all the design assumptions underlying the current generation of systems, and driving wholesale replacements.  But now we have so much legacy from past waves of innovation, infrastrucutre displacement is no longer in the cards.  At the same time, the impact of the Internet has shifted a lot of our focus from product models to service models, which only indirectly correlate to core technology advances.  In short, Moore's Law still applies, but it no longer explains the full range of what is happening in tech.

So what would?  After 45 minutes of very enlightening discussion, we generated three principles that, taken together, I will offer as Release 0.8 of a new explanatory model.  They are:

1. The core enabling resources of IT--computing, memory, bandwidth--are asymptotically apporaching zero.  For scenario planning purposes, assume they are free.  (This is where Moore's Law continues to have its impact.)

2. Expect the digitization of everything.  Either digital format will substitute for a prior analog reality, as in media, or it will serve as a proxy for the underlying reality, be that a natural resource, a customer order in transit, or a physical meeting.  This allows for the full repertoire of computing to be applied to value creating metamorphoses, whether it be enhancing sensory impact, improving consumer experience, detecting change triggers, or the like.

3. Expect the value proposition of IT to migrate from enabling transactions to enabling interactions, whether it be in customer service applications, design collaborations, or self-calibrating sensor-enabled systems.  This allows for iterative processes to have shorter and shorter cycle times, resulting in better understanding, faster time to market, more reliable operations, and the like.

The test to apply to these principles is to ask to what degree they explain the changing impact of IT on business and consumer processes in your sector.  If they don't do a good job, I'd be interested in hearing why not; and if they do, I'd like your feedback on how they can be made even better.

Dateline Davos: Dealing with Darwin—or Not

One of the things I love about coming to Davos is that the perspective is Euro-centric, not US-centic, and everything looks different when you change the lens.  This time I had not even got to the hotel before I had my first Davos moment.

Taking the shuttle from the train station I met a European executive and his wife who commented to me about how odd America's denial of evolution and preference for intelligent design seems to a European sensibility.  How could so international and cosmopolitan a power be so backward in its thinking?

I think there are actually a number of good answers to this question, most of which center on a loss of moral confidence brought on by a post-modern culture, the remedy (for some) being a return to fundamental—and fundamentalist—values.  But set that aside for a moment.  Today, as I participated in a series of economic workshops, I was struck by an ironic reversal:  In the world of economics, it is the U.S. that believes in natural selection, and it is Europe, specifically the EU and its leading countries, which clings to an outmoded ideology of intelligent design. 

Specifically, a key theme of the conference is one that is central to Dealing with Darwin, namely the commoditizing impact of global competition driving the need for a more innovative enterprise.  Surprisingly to me, this appears to be a predominantly American idea.  Europeans tend either to deny the need for a radical response or shirk the issue because they know their country cannot mount the political and social will to embrace such change.  Meanwhile, the Americans are scared witless, don’t mind saying so, and are casting about for more effective alternatives.

This bodes well for us and ill for Europe.  As someone remarked today, in Europe the safety net has become a hammock.  Still, let's be fair: entitlements are sweet to those that have them.  Unfortunately, Darwin doesn't care.  France has 12% unemployment, largely held in place by the entitlements of the current and prior generation of workers—how high does it have to get before policy makers say enough is enough?  Alitalia is bankrupt in all but name, yet still its workers go on strike to protect their current entitlements and indeed to try to extend them, with the prime minister tacitly supporting the action by refusing to let the airline go into bankruptcy.  Alitalia, he argues, is a symbol of national pride—how long before he and his colleagues acknowledge this is not a performance to be proud of? 

Now, when you directly ask policy ministers talk about how to address these problems, their answer is, by introducing more intelligent policies.  Unfortunately, the last set of policies were also presumed to be intelligent, as were the set before them.  The problem with intelligent design is that it is rarely intelligent enough to out-perform self-organizing systems shaped by natural selection.  Consider the recent example of the Katrina hurricane in the US, where our intelligently designed FEMA agency could not mount a response in less than a week, whereas a self-organizing Internet-enabled volunteer community was at work within hours.

To be sure, embracing the risk and uncertainty of natural selection is painful, and entitlement-rich constituencies will always work powerfully to defeat reform.  It is enough to discourage even the most passionate reformers.  But we before we simply give up in despair, we should recall Peter Dricker’s famous remark, made when he was asked if the kind of changes he advocated were really necessary.  His answer was, “No, change is not required—because survival is not mandatory.” 

There is a secular change under way in the world economy that will devastate those who do not realign their values and priorities to meet it.  This is one battle where the U.S. is positioning itself reasonably well.  I wish I could same the same about the E.U. 

Business Analytics: Friend or Foe?

Ever since I got involved in the information technology sector back in the 1970s, the promise of business analytics has been a siren song.  Mine the transaction data under your management to detect trends and extract insights that will give you competitive advantage.  Who would not want to do this?

And it only becomes more compelling with every year’s exponential expansion of the universe of accessible transaction data (we’ll leave the discussion of access and privacy rights to another forum).  Internet enablement of IT systems has driven this resource to unimaginable dimensions from just a few years ago.

Of course, sorting through all the hay to find the needles is non-trivial.  But God bless the math geeks and their indomitable imaginations (see BusinessWeek’s cover article of its January 23 edition for an overview of some of their recent accomplishments).  From the relational calculus that brought us report-writers and spreadsheets to the correlation algorithms of regression analysis to the neo-geometries of semantic space mapping, there are tools that are adequate to task—or promise to be so shortly.

So why is business analytics always a bridesmaid and never a bride?  For that has been its status ever since I can remember.  It is never a bad business, but it has never come close to fulfilling the potential that everyone involved in it believes is latent.  What is the problem?

The problem is closing the loop.  To complete the journey from generating the insights to using them to drive operating procedures that can systematically capitalize upon them in time and at scale has been the exception rather than the rule.  Mind you, when the exception happens, as it has with programmed trading on Wall Street, and as it must and will in anti-terrorism intelligence, the results are transforming.  But for the most part we see a landscape of intermittent connections, flashes of insight, but no systemic gain.

Despite the fact that some of these tools are way too hard to use, this is not in the main the vendors’ fault.  It is the customers.  In most companies, business analytics represent a highly evolved form of corporate entertainment.  Its core practitioners generate insights without accountability.  They communicate those insights to business managers, who do have accountability and who are moved to act, but who are unable to do so in time.  As a result the insights become part of a growing library of great but lost opportunities, supporting a culture eroding into passive aggressive despair.

What is the right answer here?  It is to grow business analytics in closed-loop systems where operationalizing the insight, making the bet, and keeping track of wins and losses, is inseparable from the generating the insight.  Deny yourself the guilty pleasure of insight without accountability: it will only delude you and your colleagues into thinking you are smarter than you really are.  Force yourself instead to contain the scope of the system and let it take you places you had not idea were even there.  Then and only then will you generate the economic miracles of which the sirens have always sung.

Intel: From Product to Platform Innovation

Intel’s shift from product focus to platform focus has been well chronicled, both in the cover article of the January 9 BusinessWeek and elsewhere.  As described, it is completely consistent with the innovation models set forth in Dealing with Darwin and in our view is absolutely the correct strategy to pursue.  That said, executing it will be no picnic.

First of all, most of Intel’s revenues for the foreseeable future will come from PC microprocessors.  By any lights this makes the category mission-critical.  But in a platform-oriented strategy targeting the hyper-growth markets enabled by mobile devices, game machines, set-top boxes, and the like, the PC market is no longer, in our parlance, core.  That is, it is no longer the source of future gains in competitive advantage.  Screw it up, and Intel is in deep trouble.  Perform brilliantly, however, and there is no net gain in advantage.  No upside, only downside--that's what defines mission-critical context--and it makes for challenging dynamics indeed.

What classically happens in such cases is that revenue commitments are able to extract resource commitments to support them, even when those resources come at the expense of core.  That is, mission-critical trumps core in the battle over resource allocation.  It shouldn’t.  It’s bad when it does.  But it is the normal way of things.  Why?

Well, for starters, mission-critical is what makes the quarter.  Core, by contrast, is mostly about making future quarters.  At the margin, most executive teams shy away from making and keeping the full commitment needed, choosing instead to compromise on critical resources, and ending up jerking around the core project just enough to throw it off its tracks.  And why is this?  Because the executives in charge of the mission-critical outcomes are the most execution-oriented people in the company, and such people excel in securing the resources they need (and then some).  When inspired core executives meet hard-boiled mission-critical counterparts, trench warfare ensues, and it is the latter who control the trenches.

By the way, it doesn't help that what has now become Intel's context is still AMD's core.  They aren't trying to convert to a platform strategy.  They are going to go full bore continuing to attack the PC.  And this will hurt Intel to some degree.  How much pain Intel is willing to take remains to be seen.  But if they redirect too many guns back on AMD, they defeat their own plans.

But let us supposes that Otellini and team solve this conundrum.  It is solvable, by the way, it just takes alignment, courage, and commitment to actually execute the solution.  Well, Intel has done that sort of thing in the past, so I wouldn’t put it past them to do it again.  We’re still not out of the woods.

The key to the platform play is to leverage a ubiquitous product into a market-making platform.  Intel has ubiquity in PCs, but not elsewhere.  It needs to invade new spaces where it is not ubiquitous.  It needs to recruit new partners who have not been part of the PC whole product team.  It needs to develop relationships of trust with service providers who have been loath to allow the PC pair of Wintel near their franchises (although, to be fair, this has probably been more due to fear of Microsoft than Intel). 

Finally, Intel needs to convert from a competition culture where only the paranoid survive to a collaboration culture which trusts first and plays tit-for-tat later.  That's the only way to engender partnership dynamics.  This is a tough transition for any gorilla company who rose to power as a fierce competitor, as the folks at Cisco, Microsoft, and SAP are all willing to testify.  It is even harder when a traditional competitor like AMD is nipping at your heels.  But transition it must if it is to make the platform strategy a success.

VC Money, Yes or No?

Greg Gianforte, CEO of RightNow Technologies, wrote a piece for Tom Foremski’s Silicon Valley Watcher called “Most startups should avoid venture funding, not pursue it.”  At Tom’s request, here is my rebuttal, heavily influenced, to be sure, by my ongoing experience as a venture partner at Mohr Davidow Ventures. 

GG: If you start by selling your concept to potential prospects (rather than stock to VCs), you will either end up with initial customers or a conviction that your idea won't work. Why raise money and then find out which one it will be?

GM: If the offer lends itself to being delivered as a project, this approach is fine, assuming you can assemble the necessary back-up band for a pick-up gig.  But if you need infrastructure, inventory, or employees, this is not an option.

GG: Raising money takes time away from understanding your market and potential customers. Often more time than it would take to just go sell something to a customer. Let your customers fund your business through product orders.

GM: My experience is that raising money actually forces you to think more deeply about your market and potential customers than you otherwise would because investors won’t fund you unless you come up with genuinely new insights.  And since investors are selected by Darwin to be effective crap detectors, you can actually learn a lot from the fund-raising process. 

GG: Adding VCs to the mix early gives you an additional set of masters you must serve in addition to your customers. It is always hard to serve two masters, especially in a startup.

GM: Yes, investors represent a constituency that is different from customers, but each has a key role in a start-up.  The customer helps you build a better offer, the investor, a better company.  If that has not been your experience of VCs—and I know for many it has not—it just means you’re working with the wrong ones. 

GG: With no money you can't make a fatal mistake. This is a blessing. Without VC money, you are forced to figure out how to extract funds from your customers for value you deliver. Ultimately that is the only thing that really matters.

GM: Oh, please.  Without the risk of making a fatal mistake, what makes you think you are going to generate a venture-like return?  If that is not your intention, why would you talk to a VC under a false pretense?  Let’s be clear here: Extracting funds from customers may be deferred by funding, but only in the interests of creating a greater extraction down the road.  Never mistake capital for income.

GG: Money removes spending discipline. If you have the money you will spend it - whether you have figured out your business model and market or not.

GM: This is what I mean about mistaking capital for income.  If you think that by accepting capital from an investor, you can reduce your life risk by transferring some portion of it to them, you sadly misunderstand the nature and obligations of business management.  This is how “family and friends” funding can turn sour, not only for the life of a company but for the company of a life.

GG: Raising VC money determines your exit strategy. You will either sell the business or take it public. What if you end up with a very profitable, modest sized business that you want to just run? That is no longer an option once you raise VC money.

GM: True.  If your intent is not to create venture returns, you should not talk to a venture capitalist.  Not all start-ups have to be venture-backed, as, for example, The Chasm Group, The Chasm Institute, and TCG Advisors can bear witness.  Understand, though, we chose our path to produce income with life-style freedom, not to create equity.

GG: You sell your precious equity very dearly before you have a proven business model. This is the worst time to raise money from a valuation perspective.

GM: Precious indeed, but to whom?  How valuable can equity be in a firm that has no proven business model?  How could you tell?  It is indeed the worst time to raise money from a valuation perspective, but that’s true for investors even more than it is for you—as hence the so-called “low valuations.”  Don’t kid yourself: market effects rule pricing in all financial transactions including this one.

Home Depot: New Innovation Vector Required

The last Sudnay paper of 2005 ran a nice piece by Renee DeGross of Cox News, “Home Depot Improves Under Nardelli.”  Basically, she reports that ex-GE executive Bob Darnelli has successfully applied organizational discipline and six-sigma methods to right a listing ship.  No small feat.  That said, it’s the subtitle of her article that calls out for attention: Stock price hasn’t shown much growth.

This is basic issue that Dealing with Darwin is intended to address.  Major brand names like Home Depot, Intel, Microsoft, Cisco, Southwest, and Dell have persistently resisted increases in market valuation, despite superior competitive performance within their respective categories.  What’s going on?

The answer, as we have previously discussed, is that while investors appreciate Home Depot’s exceptional market performance to date, they do not see its competitive advantage increasing much from here on out.  That is, the U.S. market is relatively saturated, and while there are clearly tweaks that can generate additional revenues and profits, there is nothing on the horizon that would substantially change the game.  In our parlance, Home Depot’s core business is no longer core.   It has instead become context.

To be sure the base business is as mission-critical as it ever was—screw it up even mildly, and the stock will tank.  But perform brilliantly, and the stock will not soar.  As one investor queries, “Where do we go from here?  Nardelli has to communicate a vision.”  For shareholder value to appreciate, a new innovation vector is required. 

Let’s see if we can’t figure out what that vector has to be.  Home Depot’s sector is mature, so none of the growth innovation vectors—disruptive, application, product, or platform—are appropriate.  On the other hand the sector is not losing its value, so a major focus on category renewal, be home grown or via acquisition, is also not required.  That leaves eight innovation types to choose from.

Since the company’s business model is volume operations, it has to take value engineering and process innovation vectors as table stakes (the six-sigma fix-up was necessary but not differentiating).  Moreover, Home Depot’s category killer approach to retail rules out micro-niche strategies around line extension or enhancement innovation—they won’t provide enough scale.  That leaves four to look into more deeply: marketing, experiential, integration, and value chain migration.

I’d put my money on a combination of the latter two, both of which imply entering new businesses focused on volume operations services to complement its existing market-leading position in volume operations products.  These operations would be likely be downstream from the retail purchase decision., and many customers for them are likely to be a service providers themselves.  As a result, the company will have to tread carefully not to compete with its own customers.  The key will be to identify the low-margin context work these customers have to do and take that work off their plates so they can focus on the high-margin work that really pays the bills.  While this boundary is never obvious, it is always present and can be exploited if the company takes enough care to gain the advice and counsel of its most valued customers.

Very Small Businesses: Stuck in the Middle (with Mossberg)

It’s so much more fun to read The Wall Street Journal on vacation because you get to linger over pieces that you only have time to scan otherwise.  Case in point: a 12/29 column by Walt Mossberg entitled “Computer Makers Cater to Big Business, Slight the Rest of Us.”  Well, yes they do, but not for the reasons that Walt proposes.

Mossberg argues that computer systems vendors are overly infatuated with enterprise IT customers and inappropriately inattentive to the rest of us.  Baloney.  First of all, computer vendors for the most part are complex systems vendors, not volume operations vendors, and as such their primary job is to tackle the kind of complexity that entails when enterprises seek to operate of a global scale.  But to be fair, Mossberg was not really thinking of these folks so let’s just set them aside.

The vendors he really has in his sights are Dell and HP.  They both do run volume operations businesses around the PC, and both do strongly prefer enterprise customers to consumers, for reasons of profitability.  (Reminder to Walt: This is a key value espoused by your editors who routinely reams these folks when they are not profitable)

That still leaves hanging, however, the question of what happens to the entrepreneur caught out in between these two models.  The truth is, as Mossberg notes, direct vendor-to-customer service to this customer is inherently compromised.  The reason why, however, is not inattentiveness on the vendor’s part.  It is that neither the complex systems model nor the volume operations model is designed to meet their needs—and there is no third model to draw upon!

In other words, volume operations PC vendors are appropriately neglecting the VSB customer because their business model allows no other option.  Very small businesses (VSBs) need more complex functionality than consumers but cannot afford the dedicated IT infrastructure to implement it. 

There are two solutions to this problem.  The first is to leverage a disaggregated value chain and let the resellers provide the necessary services.  Specifically, independent value-added resellers use the resale of products as an entrée to establish an ongoing service provider relationship with the VSB owner/operator.  It is not a great solution, but it does all the VSB to leverage a lot of horsepower at pretty close to free pricing.

The long-term solution to the VSB dilemma, however, involves transitioning to a new business model altogether.  This model will combine complex systems hubs with volume operations outlets—akin to the telephone network—creating a business model people are calling software as a service.  In this model there will be IT, but only at Service Central where it belongs.  The VSB will act as a utility customer.  There will be much less customization than the current system allows, but ask yourself, how much “value” has all that customization created, particularly if value is defined as advantages minus headaches, heartaches, and moments of near-suicidal desperation.  Unless computing is core to its competitive advantage strategy, a VSB should be more than happy to make these trade-offs.

The key point is, software as a service is unlikely to come from Dell, and certainly not from Apple, both of whom are strongly ensconced in product models.  In the shrot term it is showing up from the likes of Salesforce,com, but in the long run, because of their superior reach, it looks again like the Yahoos and Googles of this world will be the service providers of choice, with the AT&T’s and Verizons grumbling in the background about how they are getting money for nothing and using their pipes for free.

Movies: From Product to Platform Innovation

Good op ed piece by Edward Epstein in 12/29 Wall Street Journal explaining why box office receipts are no longer the keys to the moviemakers’ kingdom.  Makes all kinds of sense financially, but it could be misleading strategically.  Here’s why.

Epstein argues that only 15% of the revenues of major studios come from theater receipts, the vast majority coming from free TV, paid TV, DVD, and videos.  This is a great illustration of how movies have migrated their innovation strategy from product innovation to platform innovation.

Product innovation recaptures its investment primarily in the first sale of the product, secondarily in after-sales warranties and consumables.  This is how movies made money prior to the digital economy.

Platform innovation recaptures its investment by having other entities incorporate the platform offer into their product innovations, thereby leveraging the investment across many more markets.  This is how the great tech sector franchises of IBM, Oracle, Microsoft, and Intel have been built. 

The key thing to remember, however, is that an offer cannot present itself as a platform until it has achieved ubiquity of use as a product.  In the tech sector, many “superior” platforms never made it out of the chute because, although meeting every design spec requested, they could not achieve widespread ubiquity.  No one wants to help another company gain a monopoly for its proprietary technology.  So the only way platforms can happen is either “by accident” (the Trojan horse approach) or “for free” (the Netscape, Adobe, Linux approach).

Ubiquity for a movie means widespread audience engagement with the characters and costumes involved so that they have the drawing power desired by the downstream vendors who license them.  The early weeks of box office performance constitute the launch event for creating this drawing power.  The power of the platform—its ultimate reach—is set by the trajectory of this launch.  So it matters hugely whether we go out or stay home.

In a world where it is increasingly more comfortable to stay home, this poses a genuine challenge for the movie business. Winners in recent years have taken advantage of the Internet to create desired buzz, but that is now an increasingly over-exploited ploy.  What will be next?  Some form of marketing innovation, to be sure, but as to what kind, I leave to the creative types in Hollywood.

Education and Health Care: Complex Systems Dreams, Volume Operations Budgets

While different in many ways, education and health care share a common predicament.  The receivers of these services—parents and students on the one hand, patients and advocates on the other—are cultured to expect superior, personalized attention, the sort of thing that a complex systems business model excels at.  The immediate providers of these services, teachers and doctors, share these same aspirations as well. 

Unfortunately, the complex systems model is not scalable to the needs of a large society.  The only model that scales is the volume operations model.  (For a discussion of the contrasts between these two models, see Harvard Business Review, December, 2005, “Strategy and the Stronger Hand”).  It does so by transforming unique relationships into standardized transactions.  It is not driven to achieve excellence but rather to meet minimum quality standards as economically as possible.  This is the model that legislatures and health plans fund, that administrators seek to administer, leaving teachers, aides, doctors, and nurses with the task of mediating between complex systems expectations and volume operations budgets. 

It does not take a great deal of reflection to realize that the volume operations path is the only feasible one to take from a social safety net point of view.  More affluent citizens may avail themselves of the complex systems model, but only at a considerable price.  The key point is that such service is not, and should not be represented as, a social entitlement. 

And this is where things get hairy, specifically in a society dedicated to egalitarian principles.  The economics of education and health care do not support entitlements beyond a basic safety net.  Yet the public dialog implies those entitlements exist, or would exist if only the economically privileged would be more generous.  At this juncture in the dialog a liberal/conservative split ensues, something which has played out over my entire adult lifetime, with no end in sight, and no insight in sight either.

I think the constructive path forward begins with abandoning any expectation of providing broader access to the complex systems model and instead focusing our creative energies on raising the standards of the volume operations capability as much as possible.  This means focusing public investment on the mean, not the extremes, of the health care continuum, investing in more efficient, effective, and pervasive basic health services.  Private funding can pursue the esoteric edges—that’s its privilege—but public funds should not.  We need to focus those dollars more on process, on access, on communication, on methodology, and on resetting societal expectations about the nature and value of primary care. 

Southwest: Darwin Calling, Again

WSJ for December 19 has an interview with Gary Kelly, CEO of Southwest Airlines, which recaps the points made in an earlier interview (see "Southwest, Meet Darwin" entry below).  What is it that Kelly is missing?

Well, let's be fair.  All his first-derivative indicators are positive.  Southwest is the market leader, and they do have the most privileged fuel prices, and they are expanding into Fort Worth and Denver, and they do have a great company culture.  What more could we be asking of him?

For starters, a recognition that his second-derivative indicators have gone negative.  That is, he is no longer gaining, but rather losing, competitive advantage relative to the new crop of competitors he has attracted.  To be sure, he would argue that his competiion is benefitting from the law of small numbers, and that is true.  It is not that they are a better bet than Southwest, it is that Southwest, competing with them, is not as good a bet as Southwest competing with traditional airlines.  Kelly's stop-gap defense here is to assert that Southwest has better people.  Bad defense for a volume operations business model, where transaction efficiency, not personal attention, is the only differentiator sustainable at scale.

What we are witnessing is the playing out of Christensen's Innovator's Dilemma thesis from the attacker's point of view.  Clay's key point is that the low-cost , no-frills disrupter model is wickedly effective competing against entrenched high-cost incumbents, but when the last of them is ejected from the market, what ensues is profitless cutthroat competition, and the smart players move upstream to find another incumbency to attack. 

In Kelly's defense there is still a lot of market development to play out before we reach that end, and Southwest still holds the best hand at the table.  In the investors' defense, however, you hold stock in the expectation of stronger future performance compared to past, and Kelly, despite significant encouragement from the WSJ, has yet to offer a compelling story for that thesis.

Comments to George Colony on “My View: The Google Future”

I love the thesis of your argument and find myself about 75% in agreement with what you say about Google’s significance to the IT industry.  That said, let me outline what the remaining 25% consists of and get your thoughts on it:

1. You say Web pages will get replaced by programs.  I think it is more accurate to put the idea the other way around:  Programs will get replaced by Web pages.  Technically, this is the same point, but stated this way shows why Google is such a threat to Microsoft. 

2. You think Google will be significant in large corporations.  I do not.  The reason is that the monetization model that fuels its competitive advantage is inconsistent with use inside a corporation.  Corporations prefer a software licensing model to protect their privacy and secure their relationship to the vendor.  Google offers will either be well-behaved programs or be gelded at the firewall.

3. You think Google’s stock price may not be insane.  Of course it’s insane, but only because public markets have never found a way to properly discount the risk of disruptive innovations.

4. Finally, you think Microsoft needs to reinvent itself to respond effectively to Google’s threat.  I don’t.  I actually agree with Bill on this—it is 1995 all over again, only with a much tougher competitor.  Then it was, now it is Google, and there is nothing that better ignites the Microsoft competitive response engine than getting mooned. Bill (and Steve, and Ray) just have to properly fan the flames, harness the outrage, and let the games begin!

G.E., Viacom, and the DreamWorks Deal

The Wall Street Journal did a front-page piece recently (December 12) on Viacom snatching DreamWorks from G.E., its expected acquirer.  The article contrasted G.E’s methodical analytics-driven approach to M&A negotiations with Viacom’s Hollywood-style go-with-your-gut deal making, the implication being that G.E. lacked the decision-making style necessary to compete effectively in a new media economy. 

Well, maybe.

The story highlights the differences between three business cultures that, respectively, celebrate invention, deployment, and optimization.  These are the three disciplines that must be coordinated in order to perpetually refresh an enterprise.  They are the key, that is, to what we are calling dealing with Darwin.  Ignore any one of them, and the system must go outside itself for repair.

In the case of Dreamworks, the discipline of choice is invention, most notably symbolized by the work of Steven Spielberg.  By teaming up with Jeff Katzenberg and David Geffen, the idea was that their deployment skills would combine with his creativity to make a terrific studio.  Alas, the deployers apparently became distracted, so Dreamworks never scaled the heights to which it aspired.

Enter two suitors.  General Electric came first.  It is a master of optimization.  It’s view of the media sector is that it’s made up of a bunch of cowboys who need a good dose of six-sigma discipline.  When the G.E. folks analyzed the cash flow of Dreamworks, especially when they factored in some of its latest misses, the initial valuation of the deal no longer computed, and they came back for a price reduction.  That created an opening for a competitor.  Nonetheless, it was totally correct procedure—for an optimization-oriented deal.

Now enter Paramount.  It approached Dreamworks as a deployment opportunity.  In that light who cares about the misses, it’s all about making the biggest bang you can from the hits.  Spielberg may not make a hit every time, but his batting average rivals a Barry Bonds.  You can’t do better than that, and Paramount, starving for good hitters, was quick to pay up.  It is confident its deployment engine can generate profits from the hits that more than make up for the misses.

So who was right?  Well, in one sense they both were, because both GE and Paramount played the game according to their own lights.  In this case, I’d argue the better fit was with Paramount because Dreamworks looks to me more like a deployment than an optimization opportunity.  Deployment cultures typically must acquire their inventions to keep them thriving (think of how well Cisco did this in the 1990s), and so Paramount is doing what is normal for it to do.  Optimization cultures, by contrast, are better served buying up flagging enterprises in solid markets and then installing the kind of management practices required to thrive.  Lots of GE acquisitions fit this mold, but not Dreamworks.

Ideally a company would be able to balance all three disciplines in a continual cycle of invention, deployment, optimization, with the last focused on generating the cash and freeing up the management resources needed to reinvest in the first two.  But no company is able to fire on all cylinders all the time—hence the value of an ongoing M&A capability.  The key principle to follow there is to acquire the kind of companies you can digest and not to let your competitive juices lead you to swallow something you can’t.

Google—What’s the big idea?

Everybody gets that there must be a big idea behind Google’s googoolian market valuation, but what exactly do we think it is?  Not product innovation, although arguably their original claim to fame, Google Search, was just that.  Not acquisition innovation, especially if you can believe BusinessWeek’s write-up of December 5.  No, the only way to decode their market cap is to say it is yet another public market attempt to value disruptive innovation. 

Our view on this is that public markets do not ever get this valuation right, and therefore that the stock is a horrible investment vehicle, but frankly there is little Google can do about that, and almost no upside to any action they might take.  We and they just have to let that scenario play out.

The more interesting question is, what exactly is the disruptive innovation that Google represents?  What is the big idea here?  Let me propose the following:  Any stream of electrons delivered over the Internet to a human being on the other end, regardless of whatever attributes it may also possess, is a form of media, and can be monetized as such. 

Obviously this is true of content.  The interesting thought is that it is also true of products and services.  Word processor, spreadsheet, presentation software, live update, back-up, auction, VOIP, video—if there is a human being in the room paying any attention at all, regardless of their other value, these products and services are all forms of media.  To be sure, some lack the capability to attract and then divert our attention in the moment, but all have the potential to help  differentiate and characterize us as end users, and that information can be used to create more targeted communications to be sent our way at a more opportune time.  Thus all can be monetized in an advertizing based modek, on a deferred basis if not in real time. 

So what?  Well, for starters, anything—and I mean anything—that Google throws against the Internet wall and that subsequently sticks will drive its media business model’s economic engine.  So giving everyone one day a week to think up weird stuff makes all kinds of sense—more stuff for the wall.  And the more stuff that sticks, the more diluted the competitive advantage of media properties with traditional content, like Dow Jones or Yahoo, becomes. 

But most importantly, in any competition with a product provider—say, Microsoft, to pick a non-random example—or with a service provider—say, SBC to pick another—Google can give away the elements which their competitors must monetize.  They have nothing to lose.  By contrast, their competitors have everything to lose, and therefore cannot counter their assault directly.  They must maneuver to respond, which takes time and costs them the initiative.

Is it any wonder that the osmotic migration of talent is moving toward Google at this time?

Southwest, Meet Darwin

In an earlier post, "Dell, Meet Darwin," we looked at how a great pioneer of process innovation was coming to the end of a great run of competitive advantage.  A similar case in point, Southwest Airlines, made the front page of The Wall Street Journal yesterday.  The occasion for the piece was Southwest’s expansion of service to the Denver Airport, a tactic that breaks its traditional formula of low-cost second-tier airport service and puts them in direct competition with an entrenched low-cost competitor, Frontier Airlines, as well as bringing them face to face with a legacy competitor, United Airlines, on the latter’s home turf.

Southwest, to be sure, still has reserves of competitive advantage, not the least of which is a hedged fuel position that is the envy of the industry.  Still, one hears the bell tolling when its CEO, Gary Kelly, says things like Southwest’s core advantage is its performance  in areas like on-time flights, baggage handling, frequency of complaints, cancelled flights.  Baloney.  These things are not core.  They are context. 

The distinction is critical to business strategy.  Core is differentiation in some attribute of the offer that leads to customer preference at the time of a purchase decision.  Context is acceptable performance in all other attributes.  Unlike core, with context, while it is critical not to under-perform, there is no reward for over-performing.  Southwest’s core is price, supplemented with availability and selection—the classic retail formula.  That has not changed.  What has is that competitors are now matching these dimensions of their offer.

The impact of this matching is that Southwest’s core is becoming context. This is the essence of Darwinian dynamics.  No form of competitive advantage can deliver perpetual expansion.  All ecosystems find ways to curtail further encroachment eventually.  The difference between nature and business, however, is that the latter has a stock market.  Public investors call for continued growth—in the case of Southwest, 15% per year.  If and when that growth is curtailed, investors will sock the stock, which, in turn, will sock the employees of Southwest who are all share owners.  That is likely to trigger a whole spiral of negative consequences, so we can be sure Mr. Kelly and his colleagues are deeply motivated not to let that happen.

Once again, we are up against what we call “The Nasty Bit,” the transition from one wave of competitive advantage strategy to another.  The key thing right now is for Southwest to target its next innovation vector and actively begin the process of extracting resources from context to repurpose for core.  This is particularly challenging when the context in question used to be core.  To be sure, there is always the possibility of feathering in the new while gracefully retiring the old to legacy status—but the far more common scenario is to cling desperately to the old until you have a near-death experience, then suffer a cataclysmic shock to performance and stock price, and only then emerge phoenix-like from the ashes as a new entity.  Or not.

Cisco, Linksys One, and Scientific Atlanta: Gorilla At Work

In Dealing with Darwin, the discussion of platform innovation focuses on how it is a natural strategy for any gorilla company that has achieved ubiquity with a proprietary technology—with particular attention to Intel, Microsoft, Oracle, IBM, EMC, and SAP.  Cisco’s recent announcements are a great illustration of how such strategies play out.

Cisco is pretty much the undisputed leader in enterprise networking (although Huawei hopes to have something to say about that in the future), but it has been more than a little challenged in both the telecommunications service provider market and the small business marketplace.  The former requires a highly specialized in-house services-led workforce, something that is not really compatible with Cisco’s business model, and the latter just the opposite, a services-free offer for the person who has no in-house IT help.  Cisco, by contrast, grew up in a general-purpose networking world selling into an IT-rich enterprise environment.  Not a good fit.

But now we can see where its next moves are heading.  Linksys One is an appliance-like offer that will be resold through telecommunication service providers (SPs), both traditional and non-traditional, as a hosted service.  This does not require Cisco to develop deep SP expertise, and it gives it a leveraged entrée into the small business market through a channel that is already a trusted source of services.  Moreover it brings to market a next-generation platform from which one can readily envision launching a broad array of services. 

Meanwhile, its acquisition of Scientific Atlantic gives it’s a second SP play—by resurrecting the CLEC vs. ILEC play.  Only this time the C in CLEC stands for Cable-enabled.  The ILECs are still deeply engaged with the traditional telecom switch providers—Lucent, Nortel, Alcatel, Seimens, Ericsson—and while the company will no doubt continue to knock on those doors, the exercise is a bit like pushing a rope uphill.  The cable folks, on the other hand, are absolutely delighted to get help with their own version of the voice/data/video triple play.  What Scientific Atlantic brings to the table is the possibility of an end-to-end platform play with Cisco controlling both ends. 

In the Enterprise Microsoft has always controlled the edge end of things, as it hopes to in the home via XBox or the media PC.  Sony has the same idea with its Playstation.  Linksys, on the other hand, is the leader in home routers, and Scientific Atlanta has north of 40% market share in set-top boxes.  So pull up your armchair and let the games begin.  This is going to be reality TV at its finest. 

Renovating

Maybe it’s age, but I am getting increasingly attracted to the notion of renovation as opposed to innovation.  Renovation is simply innovation adapted to mature markets.  Mostly we think of it as a tame undertaking, like painting a back bedroom, but it doesn’t have to be.  Indeed, the renovation I am thinking of could shake things up quite a bit.

We need a new UI.  God bless the GUI—it has changed my life more than any other technology—but we are both suffering from the same deficit: a deterioration in our multi-tasking capabilities.  Young people and young systems want to run many threads at once.  Definitely be on the net, but watch TV at the same time, keep your eye on the IM list, check your email, oh, and do your homework.  No problem.

Except that the UI on our PCs is not constructed to optimize this mental landscape.  It is too single-state oriented.  It reminds me of, well, me.  These days I like doing things in single-threaded fashion.  I think of it as becoming more Zen.  My wife and children, on the other hand, think of it as, “Don’t talk to Dad when he is driving.”  Be that as it may, I am certainly not the target demographic for the next PC.

The current UI is still tied indirectly to the PC’s original root metaphor, a typewriter.  It needs to transition to another—the stock trader’s workstation on Wall Street.  It needs to recast itself as a media machine, with many concurrent feeds that enable traders to scan for information, detect trends, and transact, all very rapidly.  Switching between states, foregrounding one without losing the context of the others in background, is the technical requirement.  Picture-within-picture on a TV is a crude example.  I think we can do much better.

In the new UI there should be designated ad space.  That’s how most everything will get paid for in the end, so rather than have billboards all over our highways, let’s apply zoning principles and contain them to a certain section of real estate.  The same principle applies to other recurrent processes—an email space, an IM space, a video feed, and the like.  And then there’s the issue of getting around.  The mouse is getting old too.  We need to supplement it with key stroke conventions that speed our ability to do context switching. 

In short, we need to recognize that the role of the user has shifted from passive consumer to active director, someone continually choosing from among multiple feeds to construct the desired experience, and reconstruct the UI to serve that new end.   

Beyond “Innovation”

Tim Brown and Tom Kelley run IDEO, one of the best innovation consulting companies around.  Tom has a new book out, The Ten Faces of Innovation , and the company is getting a lot of play in the business press.  I have had a chance to spend time with both of these gentlemen, as well as with Tom’s brother David, who runs the D School (for Design School) at Stanford, and all three are the real deal.

And that, in a way, is the problem. 

Firms like IDEO are so charismatic in their approach and so delightful in their outcomes that they tend to preempt the whole space of innovation.  In fact, however, they occupy a relatively small corner of that universe, specializing in a certain strain of innovation that has its greatest applicability in mature markets for consumer goods.  That is, these firms are world class at sparking what we call enhancement innovations for volume operations offerings targeted at consumer markets.  But there are thirteen other types of innovation in our overall innovation model, and every one of them plays out very differently in the B2B enterprise model of complex systems versus the B2C consumer model of volume operations.  So there are twenty-eight trajectories of innovation all told, and we need to keep the other twenty-seven in view.

To be valuable from a business point of view, innovation must provide a deviation from the norm that creates differentiation in the company’s offering which in turn leads to customer preference at the time of a buying decision.  In this light, the big challenge may not be coming up with the initial deviation—there are usually lots of good ideas in play.  No, the real challenge is coming up with all the supporting innovations that reinforce the initial vector, aligning all the other functions in your company to reengineer their processes in such a way as to further accentuate the new value proposition, thereby creating a sustainable differentiation that can generate deep and lasting competitive advantage.

This doesn’t happen in creativity labs or at offsites, although it can gets it start there.  Such systemic reinforcement of a single vector of differentiation represents instead a deep commitment from top management to align the entire enterprise, supported by a careful cascade of strategy down through each function, each being asked to show how it can reengineer some aspect of its work to further the differentiating effort.  Such plans are then reinforced through resource allocation prioritization, through balanced scorecard metrics, through compensation incentives, and through constant reiteration of the differentiating line of innovation being pursued. 

People like to say that innovation has to bubble up from below.  Maybe at the start.  But lasting differentiation cascades down from above.  Innovation management, in other words, is as much a part of the outcome as the initial spark of innovation itself.

Microsoft, Meet Darwin—Again

Once again Microsoft is being asked to reinvent itself in the face of a competitor coming from an unexpected direction.  This time it is Google, and the challenge is nothing less than the reinvention of the software business model in light of the stagnation in enterprise computing, the rise of consumer computing, and the convergence of computing with media.  In this context does the licensed software model, the bedrock upon which the entire Microsoft empire has been built, evolve or get marginalized?

Microsoft has been under siege before, most recently by Netscape and then by the open source business model.  Both have forced reinventions.  But neither challenged the fundamental paradigm of software as a product.  Google does.  Its offers are not products.  Arguably, they are services, but they are not paid for as such.  They are better thought of as media properties—services that attract eyeballs to be monetized by advertising.  (Aaghh!  After the dot.com crash, I swore I would never say such phrases again!  Ah well, perhaps it is true as Emerson said that consistency is the hobgoblin of petty minds.)

The only thing harder to fight than a free product is a free service.  For at least with a product you have to go through some effort to license it, install it, maintain it, etc.  With services, it’s all done for you.  That is real ease of use. 

Now this model is not likely to resonate with the enterprise.  At the Vortex conference in October of this year, CIOs told John Gallant and me that they had little interest in seeing a Google desktop inside their firewalls any time soon.  But the enterprise is caught in a Sargasso Sea of client-server complexity, and until it works itself free, it is not the happening place for a software company to be.  That instead would be on the web, in the air, on the phone, in the iPod.  And that is precisely where Microsoft needs to catch up.

Ray Ozzie is leading the charge.  He talked to us at Vortex about the role he is playing.  Essentially, he has to lead by influence across the established business units at Microsoft.  This will create a classic core-versus-context battle for control where the legacy business models, the one that make all the money as they will be quick to remind folks, will resist yielding their most precious resources—time, talent, and management attention—to an unproven, high-risk endeavor for which Microsoft historically has demonstrated little competence.  Yet yield they must—indeed, actively collaborate they must—for Microsoft to reinvent itself yet again. 

The old innovation type of Microsoft was product innovation, while the new one is value migration innovation.  That is, the web-enabled world has forced a value migration from product to service, the latter already beginning to marginalize the former, and the question is, can the company reposition itself in the new value chain to continue to capitalize on its intellectual property?  The answer, at least in part, is not without deconstructing its current workload and organizational structure to repurpose it for the new endeavor.  That’s a lot of cheese to move, and there are bound to be a lot of disgruntled mice resisting the effort.  It is going to require a very clear-eyed, long-term approach to change management to bring this off—not the sort of thing that technology companies have ever been noted for. 

People say, never bet against Bill.  But in my view, the key person in determining the outcome of this effort will not be Bill, or even Ray, but rather Steve.  Great leaders emerge with great undertakings.  For the past several years Steve Ballmer has had to deal with a lot of murky challenges that have frustrated his passionate leadership style of Just do it!  Like Gulliver tied down by the Lilliputians, struggling to wrench himself free, he has needed a galvanizing occasion to break out.  Well, here it is.  This issue is not murky, and it absolutely lends itself to passionate leadership.  A lot of heads are going to have to get cracked if Microsoft is really to reinvent itself in this new context.  This strikes me as Ballmer’s kind of work, and with arguably the future of Microsoft hanging in the balance, an opportunity to define his tenure once and for all.  It's what all great athletes dream about: game in the balance, last second shot, gimme the ball!

Amazon: Bad Idea

When Amazon announced it was enabling the sale of portions of books as well as on-line access to books, it was clearly intended as a positional move relative to Google’s “information wants to be free” approach to the market.  The parallel we are all intended to draw is one to Apple versus Grokster/Napster.  These excerpts are to be like the iTunes of literary form.  They will allow the publishing industry to make its peace with the Internet and lead to a new flourishing economy enabled by sales at a unit level.

Except they won’t.

The reason is simple.  A song is the consumable unit of an album.  Indeed, an album is nothing more than an aggregation of songs.  People connect to the song, not the album.  The opposite is true for books.  The chapter, the excerpt, is not the consumable unit.  It does not matter what you price these units at—they are the wrong unit.  Even if they were free, it wouldn’t work.  It’s not how people think of books.  People don’t say, “Hey, don’t you just love Chapter 23 of Harry Potter?”  Same goes for non-fiction as well.  The closest approximations literature has to this format are the poem, the short story and the essay, none of which have ever sold as units in any quantity.

You cannot teach consumers that they should refocus on a new consumable unit.  Indeed, you cannot teach consumers anything.  Consumer business models must avoid such friction-creating strategies at all costs.  Amazon knows this.  It was the most friction-free e-commerce site of its generation, and that is why it enjoys the position it holds today.  So what could it possibly be thinking?

Well, currying favor with the publishing industry does come to mind.  Clearly publishers are looking for some leverage against Google, and if Amazon were to be able to provide it, that would further secure its hegemony in the industry.  But this is a head fake.  It does not deal with Darwin.  The evolutionary force of the Internet will force much more radical mutations to the publishing industry in our lifetime, marginalizing the current leaders, displacing them with God knows what.

Publishers today have little differentiation.  Their primary value is access to distribution which they do not do themselves but feed through established relationships.  Disintermediating their role in the value chain is easy to imagine.  Amazon, interestingly, is probably the single best positioned established enterprise to bridge this gap.  But it has too much at stake in its relationships with the current regime to drive this change.  Instead, it will likely begin with second-tier publishers selling direct over the Internet, leading some weakening first-tier publishers to do the same, leading then to Amazon publishing its own list of titles in self-defense.

The critical success factor for the next generation will be marketing capability.  Whoever can "make" the next J.K. Rowling or Dan Brown will have the power.  That is a skill set we have seen in Hollywood for some time.  Going forward we should expect to see it in publishing next.

Unbalanced Scorecards, Please

I recently had an opportunity to address the attendees at a Balanced Scorecard conference, and I was once again reminded of how important the right metrics are to driving effective execution and, specifically, how distorting a purely financial set of metrics can be.  Bob Kaplan and Dave Norton are to be commended for their ongoing efforts to give management teams tools that properly represent the entire picture.  I only have one gripe: I think they should call for an unbalanced scorecard, not a balanced one.

Our work in innovation makes clear that unless companies differentiate beyond the norms of the competitive set in which they participate, they cannot get paid a differential return.  They simply lack the bargaining power to gain it.  Too many other offers are “good enough,” and the customer can play vendors off one against the other to get a bargain price. 

The goal of vendors, therefore, should be to create such a separation from their competitive set that customers will not be willing to substitute another offer for theirs.  This is a non-trivial undertaking, particularly because competitors are quick to copy any innovation that appears to be leaving them behind.  The only way to well and truly leave your competition behind is to go where they are either unable or unwilling to go.  That is what our innovation strategy models are all about.

Now, any company taking this path can benefit greatly from a balanced scorecard provided it is unbalanced.  That is, it should profoundly overweight the differentiation-enabling elements in the strategy and systematically underweight all other values.  Otherwise, management teams will commit to too many initiatives in too many areas and lose the velocity and energy needed to escape their competitors’ gravitational field.

In this context, one thing stands out:  Being best-in-class should never be the goal! Here’s why.  If you are talking about your differentiation zone, then you want to escape the class altogether—be out of class!  And if you are not in your differentiation zone, then you do not need or want to be best in class, just good enough to meet market standards.  Any further efforts are a waste of resources that could be better used on further differentiating yourself on your primary vector.

Dell, Meet Darwin

One of the prime tenets of Dealing with Darwin is that established enterprises must pursuer a single vector of innovation so intently as to leave their competitors behind.  No company better exemplifies this strategy than Dell in the 90s and reaching into this decade.  Their vector was process innovation, and it stood in stark contrast to the strategies of product innovation that were being pursued by HP, Compaq, and IBM.  While these other firms labored to create innovations that garnered diminishing returns—in large part because they could not distance themselves from each other—Dell reengineered both the customer-facing and supplier-facing ends of their value chain, creating sustainable competitive advantage for the best part of a decade.

Alas, all things must come to an end.  While Dell has not extracted everything it can from process innovation, it does feel like they too now are reaching diminishing returns, in part because HP, Lenovo, and Gateway have innovated themselves to neutralize Dell’s advantages, in part because there is only so much gold to mine from any vein.  The signals we see today—the two quarters of sub-guidance performance, the challenges in China with the direct model, the reported concerns about customer satisfaction—all point not to a catastrophe but rather to a wearing down.

Now what?  Oh, and by the way, this question is not just for Dell.  As John Donne wrote when hearing the funeral bell, “Ask not for whom the bell tolls—it tolls for thee.”  This is a fate that even the best innovator must eventually face.   What are we supposed to do?

The answer is not pretty.  Undertaking a new vector of innovation during a decline in your traditional vector’s performance exposes companies to something we call “the nasty bit.”  Basically, the old engine runs out of steam faster than anticipated, and the new engine is slower to ramp up, and so you steal a bit from the future to prop up the present, and then you still a bit more, and then a lot more, all to prop up an increasingly precarious present.  And eventually you miss, and miss by a mile, and blame Wall Street’s quarterly performance orientation for the fall.

That’s the bad outcome.  The good one is not a lot better.  It says take your miss early, suck it up, and get through the nasty bit as fast as you possibly can. Pick the new vector, commit like crazy to meeting its new demands, and align them with your legacy wherever possible for additional force.  But make no mistake, you are going to take a hit, and the best you can do is explain it properly to the constituencies that care the most about you—your customers and your employees.  As for shareholders, don’t kid yourself.  There are no more long-term shareholders.  Your stock will tank.  If it really tanks, and you can swing it, buy back in, especially if you have strong faith in your path forward.

This is all Darwin at work.  Nobody ever said he was nice.  But as they also say, whatever doesn’t kill you makes you stronger. 

Product, System, Solution? Not Exactly.

Large engineering-driven product enterprises like Cisco, Intel, and Microsoft are all struggling these days with the competing demands of three business models—product, system, and solution.  All three rose to economic prominence on the back of a core set of products that proliferated on the back of a killer app.  They all made their money, in other words, as products.  But now their customers are beating them up to step up to systems responsibility and integrate end-to-end the domains which today they have anchored as platforms around which complementers have filled in the cracks.  While this architecture works well during growth periods, because it is highly flexible and adaptable, it is too complicated and expensive to maintain during periods of stasis or retrenchment—hence the demand for systems that will absolve customers of this responsibility. 

At the same time, the sales and marketing forces in all three companies, with strong encouragement from investors and top management, are off trying to find and climb the next hill.  That effort requires a solution mentality.  New markets come into being because of unmet needs and unsolved problems.  Chasms are crossed, in other words, by solutions.  Only when the market wants to replicate those solutions at scale does it turn to the product form factor, which trades off the pleasures of customization for the reliability and cost reduction of standardization.

Unfortunately for both the current customers wanting systems, and the sales and marketing folks wanting solutions, the inertial vector of all three corporations is firmly directed toward products.  That is, despite the well-intended proclamations of all three executive teams, at the ground level engineers are organized by product, sales quotas are assigned and recognized by product, marketing budgets are allocated by product.  All of which leads to nightmares for the services function which is expected to perform superbly at all three levels concurrently.

All this poses the question, where do we go from here?  But before we get into that, I’d like to hear other people’s thoughts about this issue.

Misusing Product Innovation?

In the innovation types model we make a big deal of selecting an innovation that is appropriate to the maturity of the market category you are addressing.  Product innovation, as opposed to enhancement innovation, is called out as a high-risk, high-reward tactic suitable for growth markets where gains in market share augment gains in revenue and profits, supplementing present returns with an increased probability of future ones.  At the same time, its use is discouraged in mature markets, particularly consumables markets where large changes in market share are rare.

With this in mind, we think the companies referenced in Businessweek, October 10, "Wooing the Starbucks Crowd," are making a big mistake.

The article is about three highly engineered home-brew coffee-making systems of the ilk showing up in high-end offices these days, where the coffee comes in prepackaged units of one and is a considerable cut about “office coffee.”  Big guns are involved, including Kraft with its Tassimo, Procter & Gamble with its Home Café, and Sara Lee with its Senseo.  All three have Starbucks envy and are looking to resurrect falling shares in their coffee brands.

The problem with their approach is twofold.  First, mature markets are dominated by conservative late adopters who hate new systems of any kind.  This is only marginally related to age, and has everything to do with habit.  That’s why when the Bweek editor says “So the big bet now is gadgetry,” investors and managers should shudder.  Sure they will make a dent in Christmas gifts at Sharper Image and Bridgestone, but once that has been exhausted it will fall flat with the hyper-young who cannot afford the consumables, and with the rest of us, who cannot be bothered. 

The second problem is that the new business model is so radically self-serving that even the dullest consumer must give pause.  Here is the text from the article: “In a nod to Gillette’s proven razor-and-blade strategy, the idea is to get people hooked on the branded premeasured coffee “pods” and “disks” (notice the editor’s continued sensitivity to gadgetry).  Gillette’s strategy, like Kodak’s with film and HP’s with printer cartridges, works because it had first achieved ubiquity with its product before it sought to achieve lock-in with its consumables. Announcing a complex product that implies committing to expensive consumables is like showing up in front of a walled city with a large wooden horse and a sign that says, “Don't look inside!”

What’s the lesson to learn here?  Competitor envy and fear of market share loss are good motivators to start an innovation effort—that is Darwin at work—but they should not be allowed to drive from then on.  Instead, one must genuinely engage with the consumer or customer need, genuinely improve upon their condition, and do so in a manner consistent with the maturity of the category.

Of course, if any one of these machines is a runaway success, I am an idiot for writing this blog, you perhaps for reading it, but hey, at least it’s free, and lock-in is zero.

Line Extension Innovation on Broadway

Recently The Wall Street Journal had a nice piece on "How 'Wicked' Cast Its Spell,” showing how the Broadway musical business is taking a page out of Hollywood’s business playbook by using line extensions to monetize a media asset. 

The initial Broadway showing was undersold and got a deadly NY Times review, which should have put the kibosh on the effort.  But leads actors got Tony awards, and the producers still believed in the property, so instead of folding their tents, the marketing folks discounted the tickets to get enough traffic to allow its popular appeal to kindle.  Now they have reframed Wicked as a brand franchise—a la Lion King, Shrek, and Mamma Mia, so the book, the play on tour, the T-shirts, even golf balls and necklaces all interact to reinforce the brand theme.  A movie, DVDs, a line of toys, all are part of foreseeable future.

What is interesting here is that the innovation strategy of line extension, normally thought of as a way to fill up the nooks and crannies of a product category, is actually jumping across multiple product categories, the brand image being the common thread that makes the connection.  In other words, it used to be consumers determined the category of offer they wanted and then chose the brand within it that most appealed to them.  Now we are seeing consumers choose the brand they want and then selecting the offer that most appeals to them.

The underlying message is that in an increasingly digitized, symbolized world, the value of thematic assets increases.  It is the same force that leads on-line game players to purchase digital accessories for their avatars.  We are living increasingly abstracted lives in which our norms are being set more via fantasy than social interaction.  This has disturbing implications on all kinds of fronts, but one thing is sure from an economic point of view: the value of brand symbols in such a world can only escalate.

Rethinking innovation

One of the more annoying aspects of intellectual life is when a good idea gets so popular it becomes over-invoked to the point that you want to ban it from public use.  Such is the current fate of innovation.  Most of what you read about it these days is either discouragingly familiar or just plain twaddle.  Unfortunately for this blog, however, the concept is central to the whole issue of how U.S. enterprises will compete effectively in the 21st century.  So how can we rescue it from the Sargasso Sea in which it currently languishes?

First of all, understand that innovation in and of itself is of no economic value.  The latter comes instead from innovation that creates differentiation that causes customer preference during buying decisions.  We call this concept escaping the gravitational field of your competitive set.  If you are unable to do so, then after you first win the attention of the customer, you must then match or beat the price of any other competitor still in the field of play.  This leads to ruinous price competitions.  Only by leaving all competitors behind can vendors gain the kind of pricing power they need to profitable enterprises.

Innovation, in other words, should be thought of as a vector.  Companies need to innovate in a particular direction and continue to proceed in that direction until their competitors either cannot or will not match their efforts.  Alas, most companies do not.  Instead, like disoriented hikers, they innovate a little bit in this direction, a little bit in the in the other, going a mile north, then a mile east, then south and west, ending up back where they started, having exhausted their resources while achieving nothing.

What these companies require is an innovation compass (click on Ideas in Action)a model of innovation types that sets forth the various paths they can take.  In this model, arrayed against the backdrop of the technology adoption lifecycle and the category maturity life cycle, are fourteen different innovation types which may be grouped into four clusters, as follows.

In the west lies the product leadership zone, where the following innovation types live: disruptive, application, product, and platform.  Head north and you will find the customer intimacy zone, where you will choose from another set of innovation types: line extension, enhancement, marketing, and experiential.  Go south and enter the operational excellence zone and innovation types such as value engineering, integration, process, and value migration.  And finally, go east into the category renewal zone, where companies reinvent themselves through organic and structural innovation. 

Each innovation type is a compass point, a vector along which companies can proceed, and which if they pursue with enough consistency and commitment will lead them to the competitive separation they require.  Each has unique attributes as you will see when you click on them, and should any two seem confusingly related, you can consult Darwin's Dictionary, which is also on the site.  Finally, what companies have gone which directions is the subject of the new book, not that we need to wait for it to start our dialog.  What I would like that dialog to consist of in part is discussions of companies in the news relative to their success or failure in achieving competitive separation and how a model of innovation types might help us—and them—better see what they are up to.

Enter Darwin

have a new book coming out in January about the themes in this blog.  Its full title is Dealing with Darwin: How Great Companies Innovate At Every Phase of Their Evolution When people hear about it, the first question they usually ask is, why Darwin?

Of course, the parallels between economic and ecological systems have long been appreciated.  Both involve competitions for scarce resources.  Both are driven by relentless mutations which seek to alter competitive dynamics in favor of the new strategy.  In each there is a natural selection that dispenses with underperforming strategies and reinforces successful ones, with the effect that every year the overall bar of competence gets set a bit higher, and the next round of mutations has to go a bit further in order to gain the next generation of advantage. 

When we are on the winning side of this equation, we call it progress, and we laud the rewards it creates for consumers and enterprises alike.  On the other hand, when we are on the losing side, we call it globalization, and we cry out for protectionist measures to insulate our workforces and our companies from the natural selection that would otherwise decimate them. 

All this is well understood. But in the midst of all this there is one thing we often forget and of which we must continually remind of ourselves:

Darwin doesn’t care.

AT&T long distance has been one of the most respected and honored institutions in the history of American business, now gone.  Darwin doesn’t care.  The workers at Delphi, General Motors, Bethlehem Steel, and United Airlines all negotiated in good faith and at considerable personal sacrifice to secure rock-solid contracts with superior health and pension benefits, now gone or going.  Darwin doesn’t care.  The Chinese repeatedly violate their commitments to restrict exports and set a fair value on their currency.  By the way, the U.S. similarly acts in bad faith with regard to agricultural subsidies and protections.  Darwin doesn’t care.  The U.S. standard of living requires a very high wage to meet it, far higher than required by other countries.  Darwin doesn’t care.  Because capital flows to its source of greatest return, we cannot hold it captive and may see it abandon our shores in time of our greatest need.  Darwin doesn’t care. 

Dealing with Darwin means forsaking the mindset of entitlement.  We are either going to evolve to leverage the new opportunities and meet the new competitive threats, or we are going to be marginalized.  Either way, evolution will go on, with us or without us.  We do not have a choice of system, only how we participate within it.

So the first principle of the new rules of business for the 21st century is: Get over it!  We only have a limited amount of time on the planet, and there is nothing to be gained from complaining.  To be sure, we can still hold people to their commitments, we can still invoke laws, contracts, and norms, we still makes clear that we care, and that we will intervene with our energies.  We just have to remember that Darwin doesn’t.

Why This Blog?

This is a blog about what it will take for American businesses to be successful in the 21st century.  In my view, global competitive dynamics, for the first time in my memory, no longer favor U.S. enterprises.  The favored economies for this coming era will be on the western shores of the Pacific, not ours.  That is where the most vibrant home market will be, where the largest population of do-whatever-it-takes entrepreneurs will come from, where the education advantage will build, where the public policy will be most business favorable, where the capital markets will increasingly gravitate.

From the point of view of world peace, this is a terrific outcome.  Creating large middle classes is the most stabilizing contribution economics can make to social welfare.  By outsourcing large amount of work to China and India, U.S. enterprises accomplished what U.S. foreign policy never could—they realigned global interests to reinforce rather than undermine the values of liberal democracy and free markets.  Outsourcing injected the necessary nutrients of jobs, capital, and customer relationships.  Now the indigenous organizations are self-organizing to come into their own and to develop a local economy that will first match and eventually exceed their export markets.  This, in turn, will attract an influx of labor from surrounding failed states, and a second tier of outsourcing will eventually evolve, increasingly marginalizing the outposts of terrorism.  Of course, there will be all kinds of grief along the way, but the trend is excellent.

That all said, from the point of view of business executives and entrepreneurs in the U.S., the winds of competitive advantage have shifted.  For the entirety of the twentieth century we had the home court advantage—we had the largest most homogeneous market the world had ever known, supported by the best educational systems, the most nimble capital markets, the most forgiving and entrepreneurial of cultures.  Now in this century we will be ceding some—albeit not all—of these advantages to other countries.  We will be sailing into the wind, not with it, and thus we can no longer count on our old rules to guide us properly.  Hence the focus of this blog: New rules. 

What is it going to take for us to generate the kinds of revenues and margins needed to support a way of life to which we have truly become accustomed?  We know how to win home games: what will it take for us to win away games, the way Toyota has learned to do in automotives, SAP in enterprise software, Nestle in consumer packaged goods?  How will we avoid the entanglement of entitlements that have held back a GM, a Delphi, a United Airlines?  What is our sustainable competitive advantage in the new system—Marketing? Ideation?  Financing?  What forms of innovation will be most called up—Product? Process? Experiential?  What do we insource and what do we outsource, and how do we move between the two modes? 

These are the questions that will drive this blog.  My hope is that you will weigh in on them, and that together we can help chart the new century.