Why design is a competitive advantage

It is easy to fall into the trap of thinking of design as only skin deep. Products with good design have a competitive edge because they are “cool” and fashionable. Apple’s iPod and Motorola’s RAZR cell phone are examples that immediately spring to mind. And the business and design community often foster that view – just look at any article on Business Week about the latest hot new design.
Fashion is important – especially in this age of aesthetics (see Virginia Postel’s book on the subject The Substance of Style and her blog The Dynamist).
But usability may be even more important as a competitive advantage. If people can’t use the product, it really doesn’t matter how “cool” it is (at least for most people). And usability is where many products fail, as a recent Reuters story “Complexity causes 50% of product returns” points out:

Half of all malfunctioning products returned to stores by consumers are in full working order, but customers can’t figure out how to operate the devices, a scientist said on Monday.
Product complaints and returns are often caused by poor design, but companies frequently dismiss them as “nuisance calls,” Elke den Ouden found in her thesis at the Technical University of Eindhoven in the south of the Netherlands.
A wave of versatile electronics gadgets has flooded the market in recent years, ranging from MP3 players and home cinema sets to media centers and wireless audio systems, but consumers still find it hard to install and use them, she found.
The average consumer in the United States will struggle for 20 minutes to get a device working, before giving up, the study found.
Product developers, brought in to witness the struggles of average consumers, were astounded by the havoc they created.
She also gave new products to a group of managers from consumer electronics company Philips, asking them to use them over the weekend. The managers returned frustrated because they could not get the devices to work properly.
Most of the flaws found their origin in the first phase of the design process: product definition, Den Ouden found.

Product definition starts with understanding the user. In the 1990’s there was a movement in the engineering profession called “participatory design.” The idea was that maybe it was a good thing to have users involved in the design. That movement is still alive, but seems confined to software. In the traditional industrial design field, I am told that the concept of involving users — or even paying attention to user requirements — is still an alien idea. Students in leading design school are taught that the most important relationship is between them and the object. What the user does with the object is secondary. The notable exceptions to this mindset in the US apparently are the Stanford d-school and the Institute of Design at the Illinois Institute of Technology. (For example of Stanford’s approach to interdisciplinary teams see The Stanford Daily.)
I have complained earlier that design has been left out of the current discussions about improving our economic competitiveness. As part of the process of using design as a competitive weapon, maybe we need to also change the focus of design and stress the need for usability. Bringing the user into the process seems to me to be a common sense approach. At least any businessperson should be able to quickly understand the business opportunity that is presented by having 50% of your returns due to incomprehensibility of your product (unless of course you have the same boss as Dilbert).
Last month, in a piece in Business Week, Jeneanne Rae argued for “Bringing Innovation to the Classroom.” Part (but, as she argues only part) of that greater awareness of innovation is a better knowledge of product design. Maybe what we need to do as part of this whole competitiveness discussion is to get the business schools to work on product design — along with the design schools and engineering schools.
So, how about a series of fellowship, as Patrick Whitney suggested to me, that would bring practitioners and users — engineers, doctors, businessmen — into the design schools for a three month period? Or fellowships to have design students study mechanical engineering?
Product design can be one of America’s great competitive advantages. But we have to get over the hurtle of still designing products that people have a hard time using. That will take teamwork and interdisciplinary activity. Government policies and programs can, as they have in the best, help move business and academia in that direction. The result would surely boost our economic prosperity.

Dark matter II

In my earlier posting on the dark matter thesis, I argued that there is an alternative explanation for why we continue to have a positive investment income even though our overall asset position is deeply negative. That explanation has to do with the huge growth in our overall foreign asset position (to over $12 trillion) – at that same time as our debt is growing.
There is one aspect of the dark matter concept I want to elaborate on. The real issue behind the dark matter thesis is whether or not our exports of intangibles will be sufficient to offset our trade deficit. And whether the flow of embedded know-how is captured in our trade statistics.
It is clear that our accounting/statistical systems do not adequately capture intangibles. For a discussion of the company specific account issues, see the Athena Alliance paper Reporting Intangibles. For a discussion of the macro-economic issues, I would recommend a new paper by Corrado, Hulten and Sichel “Intangible Capital and Economic Growth” and an article in The Economist (“Getting a grip on prosperity“) about that paper.
There are two ways we can attempt to measure the value of our intangible assets (know-how, etc) that may be missing from our trade and foreign investment statistics. The first is to calculate part of the income we receive that is based on the intangibles portion of the assets, by backing out that portion from the income generate by financial and physical assets, and then imputing the missing size of the asset base from that intangibles income flow. [This is similar to the approach Baruch Lev uses to calculate the size of any particular companies intangible asset base – for a lay version of the idea see “Accounting Gets Radical”].
The heroic assumption here is that the entire intangibles portion of the asset base is missing from the existing statistic; that it is not captured in any way, shape or form.
So, let’s start with the value of US-owned foreign assets:$9.052 trillion. Of that $2.367 trillion (at current cost valuation) is direct investment (Direct Foreign Investment – DFI). The rest is portfolio (aka financial) investment. Any intangibles know-how “dark matter” that is exported is only part of DFI.
[By the way, US DFI is $3.287 trillion using market value. Through out this example we will use current cost, since that is what BEA uses for the International Investment Position and International Transactions Account.]
That direct investment earns the US an income of $233.1 billion for a return of 10.5%.
[By the way, Foreign Direct investment in the US is $1.708 trillion, which given the US a net asset (tangible and intangible) of $658 billion. So the US has a net surplus in our direct foreign investment. The debt problem is that of our portfolio investments.]
The income stream due to tangible (physical) assets is calculated by multiplying the asset base by the “average” rate of return for tangible assets (Lev uses 7%). That means an income flow from the tangible portion of our direct foreign investments abroad of $165.7 billion ($2.367 trillion time .07).
Subtracting out that portion of the income that is due to a 7% return on tangible assets (remember we are assuming that the entire DFI value is only tangibles – the intangibles are completely missing) give us the income flow that is due to a return on our intangible assets: $233.1 billon – $165.7 billion = $67.4 billion.
[I apologize for not putting this into economist-speak of elaborate formulas, but I think simply arithmetic should suffice.]
Dividing that income flow time the rate of return for intangible assets (Lev uses 10.5% – the rate of return in software and biotech) given us the value of the intangible assets missing from the DFI data. $67.4 billion divided by 10.5% = $641.4 billion.
So, using these estimates of 7% return on investment for physical assets and an intangible rate of return of 10.5%, then there is about $640 billion of “dark matter” i.e. intangibles that are not accounted for in the US-owned foreign asset base. And it does not include an estimate of the intangible asset base of foreign direct investment in the US, for which we are paying income to outside the US. So the net amount would be even smaller.
This is a far cry from the missing $4.2 trillion that has made up our capital accounts shift. And from the claimed in the dark matter thesis that “the US owns about $3.1 trillion of unaccounted net foreign assets.”
– – –
Another way of looking at the entire issue it to of estimate the capital basis for our intangible exports: our know-how that foreigners rent and pay for in the form of royalties and licensing fees (what might be called “intangible goods” since they are often embedded in some form of a transferable asset – a software programs, a licenses agreement, a patent, a copyright) and our sale of business services (which might be call “intangible services” since they are one-off uses of the know-how).
Our income from the “export” of intangibles is $213.3 billion. Based on Lev’s estimate that intangible assets return 10.5%, our foreign-income earning intangible capital base within the United States is a little over $2 trillion. However, we pay for (rent) a foreign intangible capital base of over $1.2 trillion ($130.9 billion in imports of intangibles). If we consider the net intangible asset position as the mysterious “dark matter,” it comes to about $785 billion.
Again, a far cry from the missing $3 trillion needed to balance our current accounts, as is claimed by the dark matter proponents.
By the way, Corrado, Hulten and Sichel estimate that the total stock of intangible assets in US businesses is an unreported $3.6 trillion. Nakamura estimated that the total value of intangible assets to be roughly $5 trillion in 1999.
So if this estimate that $2 trillion of intangible assets in the US is earning income from abroad (and thereby offsetting our trade deficit) is correct, then somewhere between two-thirds and two-fifths of our intangible asset base is already earning foreign income. That is a large percentage of our asset base to be earning foreign income. Lat us assume that 100% of that $5 trillion asset base was earning foreign income. At 10.5% return on investment, that would mean an income inflow to the US of $525 billion, rather than the current $213 billion. The additional income would be $312 billion. That income would not even cover the $340 billion in payments that flows out of the US in income foreigners make on their direct invest here. And it would not even come close to making a dent in the outflow of funds that make up our financial debt service payments (remember that other $6.5 to $7 trillion in foreign portfolio investment in the US).
Bottom line:
Yes, our statistical system may not adequately capture the value of our intangible assets – here and abroad. But the magnitude of those assets and the income we gain from them are utterly and completely swamped by the size of our foreign portfolio debt.
As long as we continue to rack up IOUs, we are headed for a painful realignment in our international accounts – regardless of claims by the theorist that “dark matter” can prevent a financial “big bang.”
Our intangible assets wouldn’t save us from our free spending way – no matter how hard you try to count them.

Immigration and competitiveness

While R&D funding and S&T education get most of the attention, there are many other parts to the emerging competitiveness agenda. For example, reform of US immigration laws are addressed in both S. 2109 – the National Innovation Act (NIA) and S. 2198 – the Protecting America’s Competitive Edge Through Education and Research Act of 2006 (PACE-Education Act). Both of these bills generally defer to other immigration reform legislation pending in the Senate. The NIA has only a sense of the Congress on immigration reform. The PACE-Education Act has both Sense of the Senate language and specific proposals for changes in visas for scientists and engineers.
Today the US Senate begins debate on that immigration reform legislation in the Judiciary Committee. Competitiveness will not be on the tip of every Senator’s tongues, however. The debate will be focused on the issue of illegal immigrants and national security. As the Wall Street Journal – “Senate to Weigh Immigration Overhaul” puts it:

None of the four bills the Senate is likely to consider this month require the 11 million illegal immigrants to pack up and leave — a move that would throw the construction, food-preparation, maintenance, agriculture and manufacturing industries into a tailspin.
Instead, the debate will be about “what hoops you make them jump through to stay,” says Tamar Jacoby of the Manhattan Institute, a conservative think tank in New York. As public sentiment turns against illegal immigration, those hoops are trickier to maneuver.

The competitiveness issue may be raised as amendments dealing with visas for engineers, scientists and computer programmers, either in Committee or on the Senate floor – or both.
That limited scope of debate is a missed opportunity.
The debate on illegal workers needs to focus as much on the economic issue and the national security. Those workers are an un-recognized key to our economic competitiveness. As the Journal article goes on to say:

Almost everyone in the immigration debate agrees they want to bring illegals in from the underground economy where they are prey to unscrupulous employers, can evade taxes, pose a security problem by their anonymity and aren’t available to industries that want to see valid work papers. Anything less generous than permission to stay in the U.S. legally won’t bring them in, [Senate Judiciary Committee Chairman Arlen] Specter argues.
“It is in our national interest to better protect our borders,” Mr. Specter wrote his fellow senators this week. But it is also in the national interest for employers to be “able to find and hire available workers,” he added.

But not only are those workers part of the low-skilled economy, they can and should be part of the I-Cubed Economy. There is no reason why creativity and innovation shouldn’t infuse their jobs as well. As I’ve argued before, if we “dumb-down” jobs, we will loss the creative potential of the workers engaged in that activity; if we “smart-up” jobs, we open the door for greater innovation and productivity.
We also need to remember that it is the more ambitious, better skilled, more entrepreneurial persons who undertake the often hazardous journey to the US. These workers (and their children) represent a pool of talent that we can not afford to simply dismiss. If we treat them as just another cog in the economic machine, the opportunity to harness that talent will be wasted. If we continually force them back, we lose their contributions completely.
As Senator Specter noted, it will be important in this legislation to address both the issue of national and border security and economic competitiveness. A bill that does only one is not in our national interest. And regardless of what we do in other areas of the competitiveness agenda, this is one are we need to get right.
As the debate begins, America’s economic competitiveness will probably not be at the forefront of the rhetoric. It will be, however, at the forefront of the economic reality confronting the Senators. I hope they will recognize that reality – and act accordingly.

Emerging markets and US deficits

There is a general belief in Washington (at least in the economic community) that the solution to the US trade deficit is for other countries to grow faster. This view is exemplified by Robert Samuelson’s piece “The Next Big Spenders” in today’s Washington Post:

Purchasing power would slowly shift from consumers in Chicago and Denver to those in Shanghai and Sao Paulo. What we call “emerging markets” would increasingly drive the world economy. If this transition occurs — a big “if” — everyone would benefit. The U.S. economy would depend less on Americans’ spendthrift habits and more on exports and investment.
. . .
For countless reasons, this benign outcome might not materialize: Asian countries might cling to export-led growth; sloppy practices in consumer lending might create large losses (that’s already happened in South Korea); and even a slow reduction in U.S. trade deficits might not prevent a currency crisis. But at least there’s one plausible path from today’s unsustainable trade imbalances to a more stable future.

A major part of this argument is macroeconomic: the trade deficit is a function of America’s low savings rate (and therefore high spending rate). Or as Fed Chairman Ben Bernanke once called it (back in 2005 when he was a mere Fed Governor) “the global savings glut.”
I agree in part that faster grow in other countries will help the US economy. But I disagree that this growth automatically creates the “soft landing” which avoids a painful currency crisis.
The foreign growth will save us argument is about a shift in consumption patterns. It says nothing about a shift in production. As Samuelson notes,

Their [multinational companies] investments in emerging markets increasingly focus on serving high-wage consumers as opposed to creating low-wage export platforms.

In other words, the production to meet that growing consumer demand in emerging markets may not come from the US — but from production within those emerging markets themselves. Unless we take steps to improve the competitiveness of US-based production, it won’t matter if the consumption is by Americans or people in merging markets — it will still all come from factories in China and software houses in India.
That is, it won’t matter short of a massive currency crisis that turns the US into the low cost producer.
And, as I constantly point out, pure trade in intangibles won’t solve the problem either — not with an unchanging $6 billion surplus compared to a growing $726 billion overall trade deficit.
We need to harness intangibles to make all of our production more competitive. Only them will American-based production and American workers and citizens be able to benefit from the grown wealth and incomes in other countries.