Let the Triage Begin: Business Performance vs "Stupid Is"
In many ways this is one of my sadder posts with no grain of schadenfreude in it, not matter the justifications. You see we've been warning first about the very visible slowmotion slowdown for well over a year. And well over six months ago we warned that the economy had crossed the Rubicon of tipping over into a severe downturn that was likely to last longer and be deeper than anybody was yet anticipating. In fact deeper than most are still anticipating. The general reaction to those warnings, both to the blog posts and private warnings to my networks, was to poopoo the arguments, tell me that things weren't that bad and all we were really facing was a lack of confidence and things would begin turning around "real soon now". Just wait. Well we've waited and the news continues to worsen at an acclerating rate on a worldwide basis. Here's the real danger though. Like my network and readers most executives were and are being caught flat-footed and ill-prepared. As they scramble to catch up with readily perceptible realities they are again making decisions, likely to be hurried and therefore bad ones, on the fly. As Forrest put it, "stupid is as stupid does" and there are a lot of very ostensibly bright people about to prove him righter than right. In this post we want to review the general business situation and outlook but start by putting a stake in the ground regarding the state of the economy.
State of the Economy
Let's start with one large and overly complicated chart that collapses a lot of the economic arguments we've made recently and been making for all this time into one lump so we can put that topic to bed. As usual these charts are in YoY terms and the first sub-chart shows GDP, GDP ex-trade and Employment. Notice that for the first time in nearly 30 years GDP and GDPxt diverged because of the accounting problems with inflated imports, particularly oil. The more revealing pure domestic indicator (GDPxt) shows a very steady slowdown that peaked in '04 ! Talk about your weak recovery and non-organic growth. It also shows a tipping (recession) beginning in Q407 that accelerated in Q208, and compared historically, looks headed for the basement. The consequences in part two are job growth that was anemic and, measured by jobs net of 150K/month or 450K/quarter, never dug out of the hole. We're now almost six million jobs in the hole. Which in part three is a terrible harbinger of future demand declines, as measured by the sum of the changes in real wages and employment. The best leading indicator we've found. Bottom line - this is likely to get a lot worse before it begins to flatten out. And NOBODY is prepared or anticipating or doing the right things as far as we can tell.
The Wrong Stuff: Flat-footed Executives
In the readings below, which are extensive, you'll find excerpts on the situation facing businesses in the economy, particularly problems with earnings, warnings and debt loads. That's followed by a section on Industry changes, structure and dynamics with three cases in point from Autos, Retail and Pharma. One of our key mantras is Economy-Industry-Company. In other words the Economy defines the ecology in which which particular species (industries) thrive...or not. And how well an invidual member (company) does is dependent on the general health of it's species niche as well as individual performance. The three chosen industries represent a perfect smorgasbord with Autos being the poster child of denial and sustained malfeasance, Retail sufferring from being over-built and over-hyped/marketed but nonetheless not in denial. Just facing the worst of the stormfront. And Merck, as the representative of Pharama, illustrating after the death of their chemistry-based business model the kind of forward-looking changes in research, development and innovation necessary to put themselves on a new path.
Individual business performance is never just a single item however. It is the confluence of many seperate pieces that have to all work in concert. As we try to illustrate with the graphic. First you need a clear and accurate strategic vision that defines what value you provide to the marketplace. Next you need to be able to deliver on that vision thru Marketing, Sales and Customer Service in the shorter-run. And thru satisfactory operational capabilities in the blocking and tackling in the long-run. As Warren says we're in the process of finding out who's been swimming naked. And it looks like the answers are going to be beyond ugly. The third part of the Enterprise Performance Mantra is accountability - that is you have to set goals, provide resources, measure outcomes, develop the right kinds of infrastructure and ultimately hold people accountable for results. So that's our second major mantra - Strategy+Execution+Accountability=PERFORMANCE.
Where you care is all over the place from your job to your investments to the overall health of the economy. As Carl Icahn observes (again if you backtrack some of our earlier posts on Enterprise Performance) lots of corporate execs have been falling down badly on the job and are about to be found out. Stupid is indeed is !
In addition to the mantra there are two really stupid mistakes we're likely to see a lot of in the coming months. What we're looking for are the ompanies who avoid them. In general we'll see a lot of blind meat-axe cost cutting which'll actually leave them worse off in the long run and is only justified if, in the leveraged euphorias of the last several years, they got themselves into such bad financial positions that no options are left. The hard, courageous and intelligent alternative is to carefully way each of the functions and initiatives of the enterprise, judge it's value and needs in both the short- and long-runs and make judicious cuts while continuing to support high-value, high operational leverage investments. The two typical areas that ware likely to be damaged are people and innovation.
Our final section points to some fundamental longer term changes that are happening at deeper levels in the global geo-economic ecology with both China and India moving up the value-stack while at the same time watching growing deteriorations in their old value propositions. As/when/if we come out of this mess the world will have changed on us yet again.
Business Economy
The Earnings Reality Check Forecasting earnings is tough when visibility on the economy hardly stretches to the end of the week. For analysts relying on company guidance to predict future growth, it's almost impossible. But continued bullishness in the face of such uncertainty suggests stock markets may be a long way from any sort of sustained rally. The technology sector is a good example. Analysts have trimmed earnings forecasts in the DJ Euro Stoxx Technology Index by 16% in the past six months, according to brokerage house Equinet. Yet sector earnings are still expected to rise on average 21% in 2009. That looked overoptimistic even before the latest profit warning from the industry's global bellwether, Intel. Wednesday, the chip maker cut fourth-quarter revenue guidance by up to 20% due to weaker demand across all geographies and market segments, just a month after its last downward revision. No wonder analysts are rushing to catch up. Intel's profit warning dispels any lingering notion of technology as a safe haven, especially as sales of electronic goods are typically strong at the end of the year. But downgrades are indiscriminate across sectors. Wal-Mart has just guided lower for fourth-quarter and full-year earnings, blaming the stronger dollar. And in Europe, as Germany entered a recession, Siemens may have understated the economic impact of a European slump and global slowdown on its business. It maintained full-year guidance, while recognizing its targets will be harder to meet. Not surprisingly, downward revisions are coming thick and fast across all sectors, as once strongly performing companies are hit by the sudden, dramatic economic downturn. Macroeconomic indicators look a better basis for assessing earnings. They don't make happy reading. In the euro zone, the purchasing managers' index for October showed manufacturing contracted at the fastest rate on record. The International Energy Agency said world demand for oil is on the brink of falling for the first time in 25 years, with demand expected to grow just 0.1% in 2008. In that context, anything other than dramatic cuts to forecasts looks optimistic, even if CEOs would like to pretend otherwise.
The Earnings Collapse, Growth in a Downturn
Corporate Profits and Q3 GDP Preliminary Estimate Corporate profits with inventory valuation and capital consumption allowances decreased 0.9% in the third quarter following a 3.8% decline in the second quarter. On a year-to-year basis, corporate profits fell 9.0% vs. an 8.3% drop in the second quarter. Corporate profits have now dropped for six straight quarters on a year-to-year basis (see chart 16). The back-to-back declines in corporate profits suggest impending weakness in business spending in the quarters ahead. There was a bit of positive news — corporate profits of the non-financial sector rose 6.1% after four straight quarterly declines.
FedEx Corp. Reports Expected Second Quarter Earnings. Reaffirms Full Year Earnings Outlook; Reduces Capital Spending Plan . FedEx Corporation (NYSE: FDX - News) today announced that it expects to report earnings of $1.58 per diluted share for the second quarter ended November 30. Previous earnings guidance for the quarter was $1.40 to $1.60 per diluted share. For fiscal 2009, the company has reduced its earnings guidance to $3.50 to $4.75 per diluted share from the previous guidance of $4.75 to $5.25, as significantly weaker macroeconomic conditions are expected to offset the benefits from lower fuel prices and the announced departure of DHL from the U.S. domestic package market. This outlook assumes stable fuel prices. “Second quarter results benefited from rapidly declining fuel prices and continued cost management,” said Alan B. Graf, Jr., executive vice president and chief financial officer. “However, demand for our services weakened sequentially throughout the quarter and global economic trends continue to worsen, substantially reducing our second half outlook. We are adjusting our expense plans to more closely align with the weaker business conditions, and are now targeting capital spending of $2.5 billion for fiscal 2009, down from $3.0 billion at the start of the year.”
Companies start to stagger under unwieldy debt burdens It is funny to think that 18 months ago debt was fashionable. It was all the rage for companies to "gear up" their balance sheets and return the proceeds to shareholders or spend it on acquisitions. If they did not, they ran the risk of being targeted by a private equity company who would do it for them via a leveraged buy-out. Of course attitudes towards leverage have changed dramatically over the past year. But as the economic outlook continues to deteriorate, and primary credit markets remain virtually closed, investors are becoming more and more wary of companies with debt. And it is not just heavily indebted pub, retail and housebuilding companies that the market is running scared of. Take Rio Tinto, for example. Since rival BHP Billiton abandoned its $62bn bid its shares have fallen 57 per cent. The reason for this slump (which has happened in the space of two weeks) is a growing debt phobia. Now, Rio has lots of debt - around $40bn against a market capitalisation of $25bn. The company says it does not need a rights issue and will be able to meet all its debt repayments ($8.9bn is due next year) through a combination of disposals, cuts in capital expenditure and cash flow. However, the market is not listening. And the reason for this is the economic downturn. If demand for Rio's key products - iron ore, aluminium and copper - continues to fall, many investors are worried that Rio will not be able to service its debt and will need some sort of capital increase. As been the case many times in the past year, what is happening in the equity market merely reflects the credit market. Consider the spread between the 10-year gilt and the 10-year BBB corporate bonds. Over the past decade they have tracked one another closely, at a spread of around 150-200 basis points. But this spread had now widened significantly, and currently trades at more than 500 basis points. This shows, according to Darren Winder of Cazenove, that investors are concerned about a significant increase in corporate defaults. This has also been picked up by some of the credit indices.
Corporate Bond Risk Surges to Record on Concern Slump Is `Too Hard to Fix' The cost of protecting corporate bonds from default soared to a record on concern central banks are reaching the limit of what they can do to ease the severity of the global economic recession. Credit-default swaps on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 18 basis points to 956, according to JPMorgan Chase & Co. prices at 9:36 a.m. in London. The Markit iTraxx Europe index of 125 companies with investment-grade ratings climbed 3.5 basis points to 191.5 and earlier traded at a record 198. “The economic slump is too hard for anyone to fix right away,” said Tetsushi Nagato of Schroder Investment Management Japan Ltd., whose parent manages the equivalent of $205 billion.
Industry Assessments
Using ‘power curves’ to assess industry dynamics Major crises and downturns often produce shakeouts that redefine industry structures. However, these crises do not fundamentally change an underlying structural trend: the increasing inequality in the size and performance of large companies. Indeed, a financial crisis—for example, the one that erupted in 2008—is likely to accelerate this intriguing long-term tendency. The past decade has seen the rise of many “mega-institutions”—companies of unprecedented scale and scope—that have steadily pulled away from their smaller competitors.What has received less attention is the striking degree of inequality in the size and performance of even the mega-institutions themselves. Plotting the distribution of net income among the global top 150 corporations in 2005, for example, doesn’t yield a common bell curve, which would imply a relatively even spread of values around a mean. The result instead is a “power curve,” which, unlike normal distributions, implies that most companies are below average. Such a curve is characterized by a short “head,” comprising a small set of companies with extremely large incomes, and drops off quickly to a long “tail” of companies with a significantly smaller incomes. This pattern, similar to those illustrating the distribution of wealth among ultrarich individuals, is described by a mathematical relationship called a “power law.” The relationship is simple: a variable (for example, net income) is a function of another variable (for example, rank by net income) with an exponent (for example, rank raised to a power).
Auto Bailout: What Drucker Would Have Said In the mid-1970s, Peter Drucker stood before a group of executives at New York University and listened to one of them gripe about his struggles in a difficult economy. Drucker offered a bit of advice, but the executive evidently was not persuaded. "I don't think that will work for me," the man said in an exchange recounted in John Tarrant's book, Drucker: The Man Who Invented the Corporate Society. "Then you had better go out of business," Drucker replied. "There is no law that says a company must last forever." I imagine Drucker would have said pretty much the same thing had he been able to spend a few minutes with the CEOs of the Big Three automakers as they trekked to Capitol Hill this week to plead for $25 billion in federal relief. He wouldn't have done this cavalierly, mind you. For Drucker understood all too well the personal pain and social dislocation that can result when an industry implodes. Six decades ago, he watched the mechanical cotton picker begin to sweep across the South, obviating the need for labor in the fields. "No doubt," he wrote, "the replacement of the economically most inefficient sharecropper by the efficient machine should eventually result in a higher income for all, including the displaced sharecroppers or their descendants. Drucker's relationship with the auto industry was long and at times quite strained. His words of warning about the Cotton South, in fact, were penned as part of his 1946 book, Concept of the Corporation, which was first and foremost a study of the most troubled of the automakers today, General Motors. By the 1990s, Drucker took another look at GM and concluded that, on some level, not much had really changed—although now, instead of being highly profitable and widely admired, the company was faltering badly (especially against its Japanese rival, Toyota (TM), which had welcomed many of Drucker's ideas, particularly in the area of human relations). The Detroit giant, as Drucker saw it, was as slow-footed and resistant to fresh thinking as ever. The reasons for GM's "inability to pull itself out of the mire," Drucker wrote in a new introduction to Concept of the Corporation, "are largely the problems…pointed out 50 years ago." The question today is: Why would anybody think anything's suddenly going to be different because of a $25 billion infusion?
Retailers Wallow and See Only More Gloom U.S. retailers reported the worst monthly sales in more than 30 years and many are overhauling their plans for Black Friday. Wal-Mart, with a 2.4% rise, was an exception to the dire data. U.S. retailers reported dismal sales for October, prompting them to resort to steeper discounts and earlier promotions as they try to salvage the coming holiday season. Almost 60% of chain stores reported sales for the month that fell below already-weak forecasts. Even a 40% decline in the price of gasoline since July did little to motivate penny-pinching consumers to buy more than the basics. Department stores, apparel retailers and luxury emporiums posted the worst results. Sales by department stores and upscale retailers slid 11.7% overall from a year ago, led by a 17% decline at Saks Inc., while J.C. Penney Co.'s sales fell 13% and Kohl's Corp.'s slid 9%. All three said customers just weren't walking in the door. Upscale retailer Neiman Marcus said its same-store sales fell a staggering 28% while catalogue and Internet purchases plummeted 23% compared to a year ago. Once again, the exception to the dire data was Wal-Mart Stores Inc., whose reputation for lower prices has siphoned off shoppers from other retailers. Wal-Mart's sales at stores open at least a year rose 2.4%, well above its prediction of a 1% to 2% gain. The Thomson Reuters index of 34 retailers showed a comparable-store sales decline of 0.7% for October, its lowest level since the company began tracking figures in 2000. Without Wal-Mart, the index fell more than 4%. The pallid U.S. economy, drained by rising layoffs, the credit crunch and havoc on Wall Street, led retailers to sharply reduce their already grim Christmas sales predictions in just the last six weeks. In a survey of the 40 biggest retailers, 60% now expect sales in November and December to be flat at best, while some say they will decline up to 15% , according to consulting firm Hay Group. In mid-September, when the firm conducted a similar survey, the majority of retailers expected holiday sales to rise 5% to 10%. Retailers had been braced for a slow holiday season, and most thought they had planned for the worst by paring back inventories. But since September, sales slowed far more than expected. Retailers now have pinned their hopes on heavy discounting.
Merck to Develop Biotech Generics In a new challenge to the biotechnology industry, Merck & Co. said it is creating a unit to make copycat versions of top-selling biotech drugs, a potentially lucrative market long immune to generic competition. The big pharmaceutical company said it already has several generic biotech medicines -- sometimes called follow-on biologics -- in development, including some that take aim at the industry's biggest sellers. Its first -- an anti-anemia drug that would compete with Amgen Inc.'s anemia treatment Aranesp -- is slated for launch in 2012, and it will have at least five others on the market by 2017, Merck said. "We believe we can become the leading provider of high-quality, competitively priced follow-on biologics," Chief Executive Richard T. Clark said of the new division, which Merck unveiled at a meeting with analysts and investors at its Whitehouse Station, N.J., headquarters. There isn't a clear regulatory-approval path in the U.S. for companies that want to sell their own versions of other companies' biotech drugs. But the arrival of the Obama administration has raised expectations that Congress will clear the regulatory path as soon as next year, either in stand-alone legislation or as part of a broader effort to overhaul the health-care system. Follow-on biologics differ from generic versions of traditional drugs, such as those now available for Merck's Zocor cholesterol pill. Merck's anti-anemia drug, for example, would be similar to Amgen's Aranesp but not identical. While it is targeting products already on the market, Merck said it believes its drugs will be different enough from the current versions that they will avoid patent infringement. Its reasoning lies in how Merck plans to make the drugs. The Merck BioVentures division is being built on the foundation of GlycoFi, a biotech company Merck acquired two years ago that uses yeast cells to develop protein-based drugs rather than the mammalian cells commonly used by others. Merck is the second major pharmaceutical company after Novartis SA of Switzerland to take aim at the follow-on biologic market. The strategy is not without irony for an old-line chemistry-based giant like Merck, which like its rivals has struggled to come up with blockbuster new pills. Now it is placing a big bet on churning out new products derived from biotechnology's innovations. Merck said biologics accounted for $94 billion in sales last year and will have $187 billion in sales in 2014. Amgen's Aranesp had sales in 2007 of $3.6 billion.
Operations and Fundamentals
From lean to lasting: Making operational improvements stick For companies seeking large-scale operational improvements, all roads lead to Toyota. Each year, thousands of executives tour its facilities to learn how lean production—the operational and organizational innovations the automaker pioneered—might help their own companies. During the past 20 years, lean has become, along with Six Sigma, one of two kinds of prominent performance-improvement programs adopted by global manufacturing and, more recently, service companies. Recently, organizations as diverse as steelmakers, insurance companies, and public-sector agencies have benefited from “leaning” their operations with Toyota’s now-classic approach: eliminating waste, variability, and inflexibility. Yet in our experience, organizations overlook up to half of the potential savings when they implement or expand operational-improvement programs inspired by lean, Six Sigma, or both.Some companies set their sights too low; others falter by implementing lean and other performance-enhancing tools without recognizing how existing performance-management systems or employee mind-sets might undermine them. Still others underestimate the level of senior-management involvement required; for example, they delegate responsibility for change programs to their lean experts or Six Sigma black belts—practitioners who are technically skilled but often lack the authority, capabilities, or numbers to make change stick. The broader challenge underlying such problems is integrating the better-known “hard” operational tools and approaches—such as just-in-time production—with the “soft” side, including the development of leaders who can help teams to continuously identify and make efficiency improvements, link and align the boardroom with the shop floor, and build the technical and interpersonal skills that make efficiency benefits real. Mastering lean’s softer side is difficult because it forces all employees to commit themselves to new ways of thinking and working. Toyota remains the exemplar: while many companies can replicate its lean technology, success on the softer side often eludes them. Some companies, however, overcome the challenges and get more from their operational-improvement programs. Against a backdrop of growing economic uncertainty, their success can be a source of inspiration and enlightenment for industrial and service companies and for public- and social-sector organizations looking to extract greater value from these efforts.
When Cutting Costs is Not the Answer Given the fragile state of the economy, it's not surprising that employers are more likely to hand their workers a pink slip than a turkey this Christmas. But perhaps bloodletting isn't the only answer. Certainly, it isn't the only one that Peter Drucker would prescribe. Not that Drucker was blind to the need for keeping a lid on costs. Indeed, he taught that enterprises big and small should always be asking themselves not how to make a particular aspect of the business more efficient but whether it should exist at all. "The question should be: 'Would the roof cave in if we stopped doing this work altogether?'" Drucker explained. "And if the answer is 'probably not,' one eliminates the operation. It is always amazing how many of the things we do will never be missed."What's important, Drucker said, is to make this a routine exercise—not something that happens only during downturns. "Businesses that actually succeed in cutting costs," he said, "don't wait until they have to cut costs." In the same way, Drucker believed in investing in productive assets as a regular, everyday function—and there was no doubt as to where he thought investment should be channeled in this day and age. "The most valuable assets of the 20th century company were its production equipment," he wrote. "The most valuable asset of a 21st century institution…will be its knowledge workers." One person who has acted on these words—with extraordinary results to show for it—is K.H. Moon, the former chief executive of Korean consumer-products maker Yuhan-Kimberly. It was during the late 1990s, amid the Asian financial contagion, that Moon looked around and was disgusted by what he saw. "At almost all companies," he recalls, "the management just followed the old wisdom—massive layoffs." Yet Moon felt that simply to slash employment was irresponsible, and he began to persuade his colleagues that there was a better way to go—not just to survive but to grow and prosper. This "was not the time to lose jobs," he says, "but to build our capability, personally and companywide."
Under New Management: Why Should Recession Stop the Recruiters? Clearly, it takes courage for employers to recruit right now. Which employers in their right minds would hire a batch of new workers when the economy and the financial markets are in disarray? The reality, though, is that not hiring — or seriously thinning the ranks of junior employees — can lead to problems down the road. Companies that are not in dire shape would do well to think long and hard before they pull back from new recruiting or dismiss their newest workers. For one thing, word spreads quickly when an employer lets a lot of people go or rescinds job offers. That can hamper future recruiting efforts. The reality for employers is that scarce talent will still be scarce when the economy improves, said Laura Sejen, practice director for strategic rewards at Watson Wyatt, the consulting firm. In past recessions, “the employers that emerged more intact were the ones who had not done the very extensive slash-and-burn kind of layoffs,” she said. “I’m not saying never do layoffs,” Ms. Sejen added. “I’m saying do it only when you have to, and mindfully and carefully. Make sure you really analyze the demographics of your work force,” and determine where the greatest future growth — and demand for employees — will probably be. “The across-the-board 5 percent reduction,” she said, “is not the best way to go.”
Strategic Resilience
Survival is Competitive Differentiation Surviving the economic downturn is a requirement for you to grow after the economic downturn. Capital, including both debt and equity, is not likely to be easy to come by for some time and even if you can get it, it will come at a premium (debt) or discount (equity) to what you would like to have in a more nurturing economic environment. As such, creating a “healthy” business defined by positive cash flow is paramount to survival. Being able to live off what you kill and grow for the coming months will ensure that you have a chance to thrive in the next economic boom. Moreover, you may exit the downturn with fewer competitors and a better opportunity for the “home run.” Here are our recommendations on what you can do NOW to survive and thrive
Corporate Hell-Raiser One problem is lack of accountability: "You had very few real, functioning boards to control what went on on Wall Street," he says. The CEO "puts friends on the board, his cronies, and in the end those guys aren't going to throw him out. These CEOs, with many exceptions, are very mediocre guys." When Wall Street crashed, he adds, the guys that drove the companies off the cliff made off with huge severance packages. "It's worse than what Marie Antoinette got guillotined for! They just walked off with hundreds of millions, leaving shareholders and employees stranded. And where's the outrage?" The problems Mr. Icahn describes could take a long time to fix. In the meantime, he'll be out there demanding accountability. "I can go in and save 30% in almost any company because there is so much waste and mismanagement," he says. "I'm not even a manager, and I don't claim to be. But I can put the right guy in, I don't micromanage him, and if he ain't doing the job he knows I can throw him out. And very rarely do I have to throw him out. Because even some of these CEOS that are doing a terrible job and playing golf all day . . . if they knew they could be accountable they could probably do a much better job." So ideally, would corporate America get to a point where it doesn't need a Carl Icahn anymore? "You still need people to do it, what I do," he says. "Somebody's still going to have to go and raise hell a little bit."
Lessons of Survival, From the Dot-Com Attic Mr. Kirsch, a professor of strategy and entrepreneurship at the University of Maryland, saw a way to ensure that the next generation of entrepreneurs could avoid the problems of that bubble, or “at least make new mistakes”: He would document what did and didn’t work during the flurry of business activity around the new technology called the Internet. Looking at a data set of 1,018 companies, Mr. Gera determined that not a single entrepreneur received venture capital funding by submitting a business plan “over the transom.” By contrast, about 5 percent of entrepreneurs who knew the venture capitalist or gained a personal introduction received funding. Asked what his finding meant for today’s entrepreneurs, Mr. Gera says, “In this economy, the social network will be even more necessary.” Another striking finding is the high percentage of dot-com businesses that survived the shakeout. Mr. Kirsch, along with Brent Goldfarb, a colleague at Maryland, and David Miller of the University of California, San Diego, have found that 48 percent of dot-com companies founded since 1996 were still around in late 2004, more than four years after the Nasdaq’s peak in March 2000.
Innovation
Innovation for Hard Times Everyone is familiar with financial leverage. It is a powerful way to improve performance when times are good. The danger, of course, is that financial leverage magnifies the impact of downturns in demand as well. It can literally kill a company, as we are witnessing in the financial-services industry. But there are other forms of leverage. And executives should be searching for them in order to navigate the current crisis and allow firms to continue to create economic value, rather than becoming a victim of the destruction in value unfolding around us. Capability leverage, for instance, seeks to connect with the resources and capabilities of a large number of other companies to deliver even more value to the marketplace, without requiring significant up-front investments for organic growth or acquisitions. Companies like Li & Fung in China have built a global network of more than 10,000 business partners that access a broad range of specialized capability in the apparel industry. The company has enjoyed double-digit growth over the past couple of decades, as well as return on equity in excess of 20%—an impressive achievement in a low-growth industry known for razor-thin margins. Learning leverage goes one step further. This form of leverage builds scalable relationships across large numbers of companies that help to accelerate the development of all participants. When done right, it creates powerful opportunities, rapidly increasing the value delivered to the marketplace and allowing all participants to reap increasing rewards. Effectively harnessing capability and learning leverage requires another form of innovation—institutional innovation. Companies will have to redefine governance structures as well as the roles and relationships required to effectively mobilize and coordinate activities of large numbers of firms. There's significant complexity in trying to scale the number of participants in networks and conventional rules might not apply.
A gathering storm? Confronted by Asia’s technological rise and the financial crisis, corporate America is losing its self-confidence. It should not. LISTEN to the growing cries of despair coming from some leading business people, and you might imagine that corporate America’s competitiveness could be the next victim of the global financial crisis. But Jeffrey Immelt, the boss of GE, the world’s largest industrial firm, sees opportunity amid the woe. “Companies and countries that really play offence vis-à-vis technology and innovation are going to come out ahead,” he said this week at an event in New York to present GE’s coming innovations in health-care technology. With those words, he touched on a debate that has been heating up for many months. Even before the financial crunch began, many businessmen were worried that America was losing its lead in innovation to India and China. So does the relative decline of America as a technology powerhouse really amount to a threat to its prosperity? Nonsense, insists Amar Bhidé of Columbia Business School. In “The Venturesome Economy”, a provocative new book, he explains why he thinks this gloomy thesis misunderstands innovation in several fundamental ways. First, he argues that the obsession with the number of doctorates and technical graduates is misplaced because the “high-level” inventions and ideas such boffins come up with travel easily across national borders. Even if China spends a fortune to train more scientists, it cannot prevent America from capitalising on their inventions with better business models. That points to his next insight, that the commercialisation, diffusion and use of inventions is of more value to companies and societies than the initial bright spark. America’s sophisticated marketing, distribution, sales and customer-service systems have long given it a decisive advantage over rivals, such as Japan in the 1980s, that began to catch up with its technological prowess. For America to retain this sort of edge, then, what the country needs is better MBAs, not more PhDs.America also has another advantage: the extraordinary willingness of its consumers to try new things.
For Innovators, There Is Brainpower in Numbers DESPITE the enduring myth of the lone genius, innovation does not take place in isolation. Truly productive invention requires the meeting of minds from myriad perspectives, even if the innovators themselves don’t always realize it. Keith Sawyer, a researcher at Washington University in St. Louis, calls this “group genius,” and in his book of the same name he introduces a scientific method called interaction analysis to the study of creativity. Through studying verbal cues, body language and incremental adjustments during team innovation efforts, Mr. Sawyer shows that what we experience as a flash of insight has actually percolated in social interaction for quite some time. “Innovation today isn’t a sudden break with the past, a brilliant insight that one lone outsider pushes through to save the company,” he says. “Just the opposite: innovation today is a continuous process of small and constant change, and it’s built into the culture of successful companies.” It’s a perspective shared broadly in corporate America. “The best innovations occur when you have networks of people with diverse backgrounds gathering around a problem,” says Robert Fishkin, president and chief executive of Reframeit Inc., a Web 2.0 company that creates virtual space in a Web browser where users can share comments and highlights on any site. “We need to get better at collaborating in noncompetitive ways across company and organizational lines.” THAT’S exactly what innovators at a dozen health care systems throughout the country had in mind nearly four years ago when they formed the Innovation Learning Network, says its director, Chris McCarthy. The problem, he says, is that there are so few health care innovators within each organization that introducing technologies and processes can be painstakingly slow. “We thought if we could get all these experienced folks together to push each other’s thinking continually, we’d all be better off,” he says.
Global Structural Changes
India's Design Boom Next March, Desmania expects to move to a new $3 million building in a Delhi suburb, and founder Anuj Prasad is adding teams specializing in cars and toys. "There's tremendous potential for all areas of design in India—products, packaging, automobiles, anything," Prasad says. Desmania's growth parallels that of India's design industry. As domestic companies start building global brands and multinationals seek to boost sales in India, design firms are thriving. Indian manufacturers realize they need better products if they want to break out of their home market and get more money for their goods abroad. And foreigners are learning that Indian consumers are no longer content with imported, me-too designs. The profession is growing in popularity at Indian universities, and scores of design firms have sprung up across the country. While this new growth isn't immune to the global slowdown, there's reason to expect this fledgling industry will flourish in India. For decades, with protected markets, there was little reason for Indian companies to bother with good design; most people were happy to buy whatever they could get their hands on. But as the economy has opened and incomes rise, consumers have begun to demand better products. Even if growth slows, companies will be reluctant to skimp on design and risk losing customers.
China Losing Luster with U.S. Manufacturers Two years of disastrous quality-control breakdowns, from foul fish and lead-tainted toys to poisoned drugs and dairy products, are taking their toll on China's allure as a manufacturing platform. A new study by supply-chain consulting firm AMR Research found that quality concerns are among the chief reasons U.S. manufacturers are scaling back plans to source more goods from China. Instead, U.S. companies are looking harder at Mexico and other locales closer to home when exploring where to put new capacity. The reasons for the shift suggest serious problems for China's export machine that go far beyond the concerns over rising costs for wages, shipping, and materials that got a lot of attention earlier this year. AMR asked U.S. manufacturers to rate different regions around the world (China and the U.S. were each counted as region unto themselves) on 15 different risks tied to sourcing products for sale in America. Just a few months ago the biggest concerns over China were rising factory wages and the hike in trans-Pacific shipping costs owing to soaring fuel prices. Since then, the 60% plunge in oil prices and a sharp falloff in U.S. imports from China have caused spot freight prices on ocean shipping to crash. Now, the biggest concerns over China are quality and theft of intellectual property (BusinessWeek.com, 4/27/06). Half of respondents to the survey cited China as the biggest source of "risk" for product quality failure. Fifty-seven percent rated China as the biggest risk of intellectual-property infringement. Both categories represented sharp increases from May. No other region was named as the biggest source of risk in those two areas by more than 7% of respondents. In fact, China ranked highest in 9 of the 15 risk factors. Rising labor costs are still an important factor for businesses, with 35% citing China as the leading source of concern. Other risk categories where China ranked highest included regulatory compliance, commodity price volatility, supply-chain security breaches, and information technology problems. The shortage of Chinese managerial talent—long one of the top risk factors during the go-go era that ended last year—has tailed off as a major worry.
