What is the basis of your latest thinking?
The basic proposition of my recent work is that most of the things which moved earnings and share prices upwards during the last decade have reached their arithmetic limit.
One hundred years from now people will look back at the last decade, especially the last half of the decade, as an economic aberration. time when variety of forces conspired together positively to create buoyant economic climate.
First, there was huge growth in technology and IT spending. Go back to 1990 and US companies invested about 19 percent of their capital expenditure on technology. By 2000 they were spending 59 percent. It was the longest capital-spending boom in history. It fuelled the share prices of IBM, Cisco and Sun and everyone else in the technology sector. That won’t happen again. Capital spending won’t triple over the next decade.
The second positive force was an unprecedented attack on inefficiency. The last decade saw re-engineering, restructuring, downsizing, enterprise resource planning and customer relationship management. All of these, whatever their names, were essentially concerned with doing more with less. Current data suggests companies have now reached the point of diminishing returns in their efficiency programmes.
The third thing was an orgy of mergers and acquisitions (M&As). In 1990 there was roughly $600 billion worth of global M&As. There were $3.5 trillion by the end of the decade. If M&As had continued to grow at that rate there would have been one company left in the United States.
Executives relied on rising economic tide to float their boat. The tide is now receding. There is no evidence that substantial economic expansion will rescue the day.
So you take pessimistic view on the prospects for economic growth?
I am not pessimistic about growth overall, but right now few companies have any strategy which goes beyond retrenchment. Suddenly, timidity is in fashion once again. Retrenchment doesn’t buy you growth, it doesn’t buy you future. At best it buys you time. There is enormous enthusiasm for moving back to basics. At one level you can’t argue with that. The dilemma is most companies don’t have many options. Most companies, for example, can’t grow revenues by selling the same things in the same old way to the same customers.
Managers have forgotten that productivity has two elements – the efficiency with which you use inputs, labour and capital, and the value placed on output. Executives know lot about the efficiency side of the equation but not about their output.
Despite all the consolidation in the global car industry in recent years, the most profitable carmakers are BMW and Porsche and they are two of the smallest. They may not have the global purchasing efficiencies of GM or Ford, but they create things people love.
On the cost side most companies have reached the point of diminishing returns. But if you look at companies which are doing best in difficult times, companies like Dell, Wal-Mart, Jet Blue, and Ryanair, all brought radical innovation to the cost structure. Their costs are not five or 10 percent lower but 50 percent or 80 percent.
Are you saying that retrenchment simply won’t lead to growth?
The more difficult the economic times, the more one is tempted to retrench, the more radical innovation becomes the only way forward. In discontinuous world, only radical innovation creates new wealth.
At one level, executives are getting that message. They know they can’t do the same things. But there is huge gap between the rhetoric and the reality.
CEOs say they need to innovate and put innovation as one of their top two or three priorities. But go down few levels in the organisation and talk to mid-level employees and ask if they have been trained in innovation? What is the process they plug into if they have new idea? How quickly can they locate talent to push ideas forward? Ask these questions and it’s obvious that most companies have not institutionalised innovation in meaningful way.
Innovation is ghetto. It is seen as something for few people in product development, research and development, or the corporate business development function. It is not seen as the responsibility of every single employee every single day. Most companies haven’t even begun to unleash or monetise the imagination which exists (within them).
Around 1970 people knew that quality was important but didn’t know the processes or systems to enable this to happen. All the processes and systems – pareto analysis, quality circles and so on – later known as total quality management, were being built at the time. Executives had very little knowledge of them and didn’t know what to do.
The question I have been asking is; how do you do for innovation what W Edwards Deming and others did for quality?
What is the pay-off from understanding innovation better?
Innovation drives wealth creation. There’s no other conclusion you can reach. product advantage can come and go but if you commit early to building complex and deeply embedded capability it is difficult to catch up. Companies which commit themselves to innovation – like Whirlpool, Cemex, Shell and few others – have profound advantage. It might not be immediately evident, but once you get lead it is difficult for others to catch up. Western carmakers haven’t recaptured single point of market share from their Japanese competitors over the last 40 years.
How can companies develop the capability to innovate?
Making innovation real capability requires more than an overlay of few small adjustments, it requires fundamental re-think of basic business principles. The goal of becoming incrementally better is ingrained in our thinking, our language, our reward mechanisms and everything we do. Innovation is seen as an exceptional thing which happens once in while, almost by accident, on the fringe. It’s not easy to change that.
Think of the legacy of the industrial age – hierarchy, control, replication, quality. These are hugely important but in many ways toxic to the process of innovation and creativity, experimentation, imagination, self-organisation.
We haven’t really challenged the primacy of optimisation and incremental improvement. Innovation can’t be at the edge. It has to be central to the purpose of organisations. We have to systematically train people in new ways of thinking. To create new metrics. Most of the metrics companies use – ROI, EVA and so on – push us into thinking simply about incremental improvements.
We still have very deep belief in management processes which are the antithesis of innovation. One of them is that alignment is always virtue – everyone reading from the same page, all the wood behind the arrow, whatever metaphor you use. Perfect alignment is death.
In world of enormous change the scope for experimentation inside your company must match the scope for experimentation outside. We have to re-engineer management processes to minimise the time between an idea and wealth creation. It’s not the supply chain which needs shortening and automating, it’s the innovation chain.
What needs to happen now?
Companies shouldn’t mistake what happened in the 1990s as real innovation. The 1990s were product of the dealmakers and the dream merchants. Three principles are the foundation for trying to move forward:
• First, radical innovation: in an increasingly non-linear world only non-linear ideas create wealth. Innovation is the only insurance against irrelevance.
• Second, requisite variety. Is there scope for experimentation within the company? Is there willingness to make mistakes? Most organisations have way too little strategic experimentation.
• Third, resource attraction which is different from resource allocation. We need to learn from markets about how to attract resources. Markets out perform hierarchies every time. Most organisations toda
