Innovation in “low-tech”

Earlier this year, the Europeans finishing up an interesting project on Policy and Innovation in Low Tech – PILOT. Their final report was issued in January with the following conclusion:

Much growth and employment in OECD countries still emanate from LMT [low-tech and medium-low-tech] industries, and LMT companies are relevant sources of innovations in the economy.
Innovation policy can be more effective when it is based on a more comprehensive understanding of the relationship between R&D and innovation.
Innovativeness is based on a particular enabling configuration of resources that a company possesses rather than on excellence in R&D alone.
Organisation practices – knowledge management and personnel policy in particular – play a vital role for competitiveness and innovativeness of LMT companies
Network relations between companies and supportive social networks on a regional level are of great and growing importance as resources for firm capabilities.
Interrelationships of low-tech and high-tech sectors in an economy are of major importance for the innovativeness of industry in general.

The report takes on (head-on) the standard image of the knowledge society and intangible economy as simply an R&D/S&T economy:

In the movement towards a knowledge based society in the European Union, the competence to generate, use and absorb new knowledge is increasingly viewed as critical for economic success and societal development. Against this background, the conventional wisdom sees high-tech, research-intensive and science-based industries as the key drivers of future economic prosperity. Such industries are regarded as the main source of highly sophisticated products that are not easily imitated elsewhere and, therefore, the policy conclusion is that high-cost industrialised countries should concentrate their efforts on promoting these industries. In this scenario, non-research-intensive, so-called low-tech and medium-low-tech (LMT) industries are deemed to offer little to enhance prospects for future growth, and as a result, they receive less explicit political attention and support. LMT sectors comprise for the most part mature industries such as the manufacture of household appliances, the food industry, the paper and print industry, the wood and furniture industry, the manufacture of metal products or the manufacture of simple plastic products.
. . .
LMT industries in the OECD countries employ many more people than high-tech industries. Moreover, many firms in these industries are innovative and knowledge intensive without, by definition, engaging in R&D to any great extent. Thus, they provide a striking challenge to currently held notions about the sources of future industrial growth. Our analysis suggests that while new sectors emerge within the economy, and some sectors disappear, this does not account for the processes of growth which actually occur across the OECD. The growth trajectories of the advanced economies seem to rest as much on such sectors as engineering, food, wood products, and vehicles and so on, as they do on such sectors as ICT or biotech. Medium-low and low-tech industries have persisted over the past decades despite the claims that we are undergoing a kind of structural revolution.
. . .
These research findings show that growth is primarily based not on the creation of new sectors but on the internal transformation of sectors that already exist. Over-emphasising the role of high-tech activities ignores this major dimension of change in advanced economies. As a corollary, in order to ensure continued future growth prospects for advanced economies, policy-makers need to focus on the processes of innovation and creativity in firms in all sectors, not just high-tech firms.

The report is also extremely insightful as to metrics of innovation:

Our research results, as reported in Sections 3.1-3.5, suggest that as an alternative to – better: in addition to – R&D expenditures, analysts must use other indicators of innovativeness and of the general level of technology in an economy. Firms may be classified according to their
• R&D intensity
• Design intensity
• Technological intensity
• Skill intensity (human capital orientation)
• Innovation intensity
• Organisational innovativeness.
The basic assumption is that these indicators together will capture the bulk of creativity, explaining successful firms and industries and showing the variety in all economic sectors. Thus we argue that the adoption of a family of indicators rather than a composite indicator is a more appropriate way to improve on available taxonomies.

The policy conclusions are in striking contrast to the standard R&D framework:

The policy problem is, therefore, to support building innovation-enabling capabilities for these companies to access knowledge resources in a critical and selective way.
. . .
In spite of the difficult overall economic situation of low-tech and medium-low-tech industries and the challenges of globalisation and growing competition, the future prospects of many LMT sectors and companies are not bad or may even be bright, depending on some structural conditions. This holds true for companies whose specific competencies cannot easily be copied by potential competitors; for firms that are active in markets where geographical and social proximity is a competitive advantage; and finally for companies that are able to absorb distributed knowledge (be it scientific or of any other type) and to employ up-to-date process technologies systematically and efficiently.
These conditions are not given for all LMT companies, and it is likewise true that not all companies in Europe are able to develop in this direction or really use structural conditions of this type in a competitive way when they face them. But there is no reason to believe that LMT companies are, in principle, less likely to face the challenge than research-intensive firms are.
What separates successful companies from others in the long run is the ability to innovate. And innovativeness is by no means an issue only for those with a high R&D budget. Hence, non-discriminatory support of innovativeness is a major policy topic. Our research findings lead to a number of problems concerning innovation policy in the low-tech and medium-low-tech sectors. Several policy issues should be highlighted.
• First, there is little if any awareness of innovation-supporting policies other than focusing on R&D.
• Second, it is an important policy task to devise measures and to support activities which aim at improving the knowledge base and the capabilities of low-tech and medium-low-tech companies.
• Third, policies should focus on the development of firm capabilities to meet the demands of cross-company co-operation with corresponding channels of communication, gateways and personnel responsibilities.
• Fourth, policies should encourage both the generation of knowledge and its diffusion between low-tech and high-tech sectors, and they should also promote stronger interrelationships between the sectors.
These considerations should also lead to a new understanding of the restructuring of the economic landscape of Europe in the early years of the 21st century. This future does not appear to foretoken wholesale structural replacement of “old” sectors with “new” ones, or a substitution of “old” technologies with “new” ones, so much as a continually changing blend of technologies of various vintages. This process of change is evolving as a restructuring of sectoral and technological systems, transformed more from within than from without. It is not dominated by industrial activities for which competitive advantage, capability formation and economic change are generated by front line technological knowledge. Rather, it is dominated by what are often pejoratively termed low-tech and medium-low-tech industries. And it is unambiguously characterised by the continuous combination and re-combination of high and low-tech attributes.

The result of this research comes to the same conclusion that I have in my own informal look at the economy: in the knowledge society and intangible economy, what matters is what you do with the knowledge and intangibles. Future economic prosperity can not be based on the pure production of knowledge and intangibles. It must be based on their utilization throughout the economy.
And our current “innovation” policy fails to reflect this fact.

Maintaining a competitive advantage in the US

Business Week is running a story on 6 case studies on US companies who have faced the decision to outsource – with different outcomes: Here Or There? – Six entrepreneurs explain why they outsource — or not.
What I found most interesting was the strategies of the 3 companies who chose to stay.

Adam Keller can’t beat competitors who build birdcages in Asia. Instead, CagesByDesign.com, his Neenah (Wis.) company, creates custom cages that run from $300 to $2,000 for customers such as museums and amusement parks. “There are other products we could make, like the typical $39.95 birdcage you see at the pet store, but I won’t even consider it,” says Keller.

. . .

Brenda Lynn knows she could save money by having her Fairfield (Conn.) company’s knitwear made in the Pacific Rim or South America. After all, most of her competitors do. But ever since Lynn sold her first hat to Barneys New York in 1991, she has stayed stateside. “Companies that outsource can offer retailers a similar product at a lower wholesale price, and that has hurt me at times,” says Lynn. “But I retain a competitive advantage because of the desirability of my designs and our ability to maintain a higher level of quality.”

. . .

Eric Poses has a list of reasons his two-person company, All Things Equal, makes its board games in Wisconsin. The first is a matter of principle. “If there were more companies like mine keeping business in the U.S., we could certainly have a positive impact on American labor,” he says. The rest are all business. The factory that produces such games as Loaded Questions and Talent Show is a short flight from his Venice (Calif.) offices and offers free warehousing of his inventory. He pays one-third down before production but says many foreign producers demand half. And Poses can “produce and ship as much product as I need in 3 to 4 weeks, vs. 8 to 12 weeks with overseas production.” Of course, there is a downside: Poses estimates he could save 30% going abroad.

The lessons:
High end customization.
Design and quality.
Close link between office, production and customer.
It sounds like the old story, compete on premium or on price. And the competitive location of premium production is different from commodity production. The trick for governments is to turn that old truth into an economic development strategy.

Supreme court – the next patent case

The Supreme Court continues its review of patents. From Reuters.com – US high court to review patent “obviousness” case:

The U.S. Supreme Court on Monday agreed to review an appeal of a key patent case that could set a standard for when an invention is too obvious to patent.
The high court said it would consider the appeal by KSR International Inc., a Canadian manufacturer of gasoline pedals for cars and light trucks, arguing that a patent held by a rival manufacturer is invalid because it is too obvious.
Patent lawyers have said the case could help clarify U.S. patent law, which requires inventions to be “non-obvious” in order to be patented.
At issue is what standard the courts should use to determine what inventions are obvious.

Patently-O: Patent Law Blog: Supreme Court: Time to Rethink Obviousness describes the case in more detail:

The Supreme Court has granted KSR’s writ of certiorari and now will address fundamental questions of patentability that have been raised. The doctrine of nonobviousness ensures that patent rights are not granted on inventions that are simply throw-away modifications of prior technology. Questions of obviousness are at play in virtually every patent case, in both proceedings before the USPTO and during infringement litigation.
Over the past twenty-five years, the Court of Appeals for the Federal Circuit has developed its nonobviousness doctrine using a motivation/suggestion/teaching test. According to the test, when various pieces of prior art each contain elements of an invention, the prior art can be combined together to invalidate a patent on the invention only when there is some motivation, suggestion, or teaching to combine the prior art.
KSR has asked the Supreme Court to rethink that approach and take a fresh look at the obviousness standard for patentability. The petition specifically questions whether obviousness should require any proof of some suggestion or motivation to combine prior art references.

For those interested, Patently-O has more on the case, including links to documents.
With patent reform legislation apparently bogged down in Congress, it looks like the Court has decided to take the lead on this critical issue.

IP and finance

One of the newest financial innovations (following on last week’s posting on the history of mortgages) is the monetization of intangible assets (a topic I wrote of before). In just the past few weeks, there have been a number of stories about parts of this phenomenon. The Economist ran a piece – “Securitising intellectual property: Intangible opportunities” – based on Dunkin’ Donuts recent sale of $1.7 billion in bonds back by its franchise royalties. As the story points out, use of a company’s intangible assets can be a smart financial move.

Raising money this way can make sense not only for clever private-equity firms, but also for companies with low (or no) credit ratings that cannot easily tap the capital markets or with few tangible assets as collateral for bank loans. Some universities have joined in, too. Yale built a new medical complex with some of the roughly $100m it raised securitising patent royalties from Zerit, an anti-HIV drug.

The Yale example highlights the most common (and growing) part of this trend: securitization of patents. One of the masters of this “space” is the firm Ocean Tomo. A story in the July 2006 issue of Business 2.0 (not yet on line) describes the company’s range of patent related activities: A. Buy and sell patents for private parties; B. Devise an index of patent-rich stocks; C. Launch a website of classified ads from patent holders; D. Broker technology deals for major companies; E. Create funds that allow people to invest in patents; and F. Run the first-ever public auctions for patents.
Some of these are a work-in-progress. For example, the public auction didn’t raise as much as was expected – in large measure because patent owners set their reserve prices higher than buyers were willing to pay. But the company quickly learned from that glitch and most of the patents were later sold in private sales. (For more on the patent auction, see Ocean Tomo Patent Auction – Payne.org Wiki.)
Another variation of this theme of patents for cash is the “idea-generation” firm of Intellectual Ventures (IV), which was recently highlighted in Business Week – ““Inside Nathan Myhrvold’s Mysterious New Idea Machine”. One of IV specialization is quick patenting of the ideas that come out of expert brainstorms:

Over the past three years, Intellectual Ventures has held about 70 brainstorming sessions. The result: 500 patent applications in areas including optics, biotechnology, robotics, e-commerce, and mobile networking.

But this presumptive patenting in is not all IV does:

Intellectual Ventures is not just a think tank where big brains sit around dreaming up ideas. It also has a second business, one that is generating controversy: buying patents. In fact, that’s a much larger part of the operation. Maintaining secrecy through shell companies and nondisclosure agreements, often swooping in aggressively to seal deals, it has scooped up thousands of patents and is on the prowl for many more. That has many people in the tech world worried.

As a result, IV has become rather controversial:

With its vast hoard of patents, IV could turn out to be the world’s biggest patent troll. It could have the power, at least in theory, to sue a vast swath of Corporate America, becoming a force that smothers rather than nurtures innovation. “There’s just a lot of questions about all of these patents they have and what they are going to do with them,” says Christina Schneider, a spokesperson for Hewlett-Packard Co., echoing concerns heard widely in Silicon Valley.

But IV sees itself as leading the new wave of innovation financing:

In response to charges that he is a predator, Myhrvold describes himself as an entrepreneurial financier, somebody who is devising new ways to fund innovation. He likens himself to the first generations of venture capitalists and private-equity investors, who were also widely vilified. Myhrvold believes that there is an emerging trend to treat intellectual property, and patents in particular, as an asset that people and companies will invest in, the same way they do in real estate or stocks. The result, he believes, will be a boon for invention, just as venture capital and private equity have stimulated enormous growth and innovation in the American economy. “I’m one of the first invention capitalists,” he says.
. . .
Just as venture-capital firms took root in Silicon Valley 30 years ago, Myhrvold envisions an industry devoted to funding the earliest stage of the product-creation cycle. “Today invention is an area that people view as too illiquid, too uncertain, and too risky, so that nobody wants to invest in it,” he says. “The world has shown that if you provide capital and expertise to an area that is starved for capital and expertise,” then “really good things will happen.”

Regardless of the controversy over IV’s tactics, new financial models focused on intangible assets are here to stay. Yet, they face a number of hurtles before they are more widespread. As the IV story illustrates, creating a stable patent system is one, as is finding the right level of protection of these assets as intellectual property. [For the record, I am on the oppose side of IV on the patent fight].
There are also questions of how federal and state security regulations should be applied to these assets. Another is the problem of valuation. As the Economist noted:

It may be harder for investors to decide whether such deals are worth their while. They are, after all, highly complex and riskier than standard securitisations. The most obvious risk is that the investors cannot be sure that the assets will yield what borrowers promise: technology moves on, fashions change and the demand for sugary snacks may collapse. Valuing intellectual property—an exercise based on forecasting the timing and amount of future cashflows—is more art than science.

The valuation issue ties back to the question of how these intangibles should be accounted, the subject of an earlier Athena Alliance report. As a follow-up to that report, Athena Alliance has an ongoing project on the monetization of intangible assets to look at these issues from a public policy perspective. We hope to publish our report later this year.

A history lesson in financial innovation

A fascinating story in this morning’s Washington Post about a house for sale in Arlington VA provides a great history lesson on financial innovation – “A House Built With a Milestone”. The house in question was the first to qualify for a 10 percent down payment:

In some ways, the house is a direct product of the Great Depression. Before then, the federal government had followed a strict hands-off policy on housing, relying entirely on the private market to make loans and build. The system had worked pretty well, at least for the affluent, though it had its marked ups and downs during cyclical recessions, even some called “panics.” Many people pioneered their land and built their homes themselves with the help of neighbors and relatives.
But real estate boomed in the 1920s, hitting a record construction level in 1925, as lending standards were loosened. Real estate agents told buyers that prices would rise forever, that they had never fallen. People bought the largest houses they could get, stretching to make the payments by using the three-year or five-year interest-only loans that were customary. Those loans cost less each month because borrowers didn’t need to make any payments toward the principal on the loan.
Consumers felt confident they would be able to refinance at the end of the loan term, and lenders felt secure because on many of the loans, the debt represented only about 50 percent of the value. But what they overlooked was that many people had taken out other loans as well, sometimes two or three, to make up the difference between the primary loan and the purchase price. They had in fact financed their down payments.
“The system was full of holes,” wrote Julian H. Zimmerman, commissioner of the Federal Housing Administration, in 1959, describing the housing market in the 1920s. “Juggling several mortgages was difficult even when the going was good; but when things got rough in the late ’20s it became impossible.”
Workers lost their jobs; then they lost their homes to the banks that held the loans. About one in six mortgages in America went into foreclosure. Even people who remained employed found they couldn’t find buyers for their homes at any price. No lender wanted to refinance short-term loans now seen as risky. President Herbert Hoover watched the downward spiral with horror, immobilized.
Within a month after President Franklin Delano Roosevelt took office in 1933, the Home Owners Loan Corp. was established. The federal agency helped homeowners stave off foreclosure by refinancing about one-fifth of the nation’s outstanding residential mortgages, all of them in default. The Home Owners Loan Corp. was successful and was liquidated later at a slight profit.
Amid a surplus of houses and a paucity of buyers, the real estate market languished. To stimulate the housing and lending industries and help renters and moderate-income people buy homes, the Roosevelt administration developed a new kind of insurance program that would cover the losses lenders suffered if homeowners defaulted on their loans. In June 1934, the National Housing Act was passed, creating the Federal Housing Administration loan insurance program. It permitted borrowers to purchase homes with 20 percent down, financed with low-interest, fixed-rate loans to be repaid over 20 years, with mortgages not to exceed $16,000. Adjusted for inflation, that would be a loan value of about $228,000 today. The government in effect promised lenders they would be reimbursed for any losses; home buyers paid a little extra money each month as insurance to cover that expense.
The system worked. The fixed-rate loan for a 20-year or 30-year period became the national standard.
The first house financed under the new FHA program was in New Jersey, and thousands more began cropping up across the nation. The financial losses to the program were so small — only 35 houses were lost to foreclosure in its first three years, out of 229,300 mortgages insured — that legislators decided to permit an FHA expansion to cover houses purchased with only 10 percent down payments, too.
That amended housing law was enacted in 1938, and the Arlington house was the first structure financed and built under the revised housing act. It was viewed as such an important event in the housing industry that the National Retail Lumber Dealers Association’s members made touring the house a priority item for builders visiting the nation’s capital for the group’s annual conference in May 1938. Many built similar houses elsewhere.
The expansion of the FHA program had its critics. Real estate agent Charles E. Lane, chairman of a New York housing committee, told a Fifth Avenue business audience that he disapproved because the expansion would encourage people to buy homes who were not in a “proper economic position” to do so, according to the New York Times. His concerns were echoed by others, who called a 10 percent down payment “too narrow a margin of safety for the mortgagee,” according to another Times article in 1938. But by May 1938, a record $96 million in mortgages were initiated in a single month, including about 40 percent that involved 10 percent down payment loans.

And, as the saying goes, the rest is history.
Ironically, as the story goes on to point out, the Arlington house is now on the market at a high enough price to not be eligible for FHA financing. To me, this illustrates how we continue to need innovation in housing. I’m not sure the recent financial innovations of interest only loans are the right way to attack the problem of affordable housing. The other innovation embodied in this house was its design. As a two bedroom rambler, it was meant to be the affordable option for the middle-class.
Maybe it is time to return to building for affordability. There are stories on the news about couples trying to unload their McMansions due to the high cost of operation and upkeep. As people attempt to downsize, there should be a great opportunity for new innovations in housing (and finance).
But to make the right policy decisions. As our history lesson shows, the government has a role to play in these innovations – and can either help or hinder depending on how it plays that role.

Work-life balance

As I mentioned in my earlier posting on leisure in the I-Cubed Economy, the balance between work and non-work activities is constantly shifting as the two blend and separate. A recent Economist special report on the “Work-life balance: Life beyond pay” underscores the driving force behind the issue:

To some extent, the proliferation of work-life-balance schemes is a function of today’s labour market. Companies in knowledge-based industries worry about the shortage of skills and how they are going to persuade talented people to work for them.

Numerous people (Richard Florida, Dan Pink etc. etc.) have pointed out that creative and knowledge work is different from the traditional 9 to 5 industrial schedule. In many ways, it is more of a throwback to the agricultural era’s farm-life where work and leisure were interrelated.
We still haven’t figured out the best way to manage that integration. Nor have our labor force policies caught up with the shift. But as the Economist article describes, the bottom line is clear:

For some time to come, talented people in the West will demand more from employers, and clever employers will create new gewgaws to entice them to join. Those employers should note that for a growing number of these workers the most appealing gewgaw of all is the freedom to work as and when they please.

How we do that is the challenge of the I-Cubed Economy.

Separating the brand from the product

The retail giant Target is embarking on an interesting experiment of separating a brand from its underlying product — what I would characterize as creating a pure intangible. Target is licensing its name and logo (the red bull’s-eye) to be used on a line of chic clothing called Target Couture.
So what, you ask. Lots of retailers sell products under their own brand. Here is the difference: Target Couture isn’t being sold at Target stores. It is only available at the boutique Intuition in Los Angeles, with plans to expand sales to other high-end boutiques and department stores.
Needless to say, this is causing a stir. According to a story in this morning’s Washington Post –
Where Target Is Always ‘Tar-zhay’:

Not all Target shoppers are enamored with the concept, however. The Slave to Target blog, which features posts with subjects such as “where are you tara jarmon puff sleeve tee?” had this to say about the Target Couture line: “Target is a Sell Out though — they are sellin’ out to the fads and the faddiest store ever … Intuition.”
Michael J. Silverstein, a senior vice president with the Boston Consulting Group Inc., said he was skeptical of whether Target-branded merchandise would sell outside its stores. It may confuse customers, he said.
“People . . . would say, ‘Well, why is that here?’ They need an explanation,” he said. “And in the world of consumer marketing, explanations cost money.”
It remains to be seen whether the line will catch on, but it almost doesn’t matter. The move is part of the retailer’s efforts to hold onto the elusive and often ephemeral designation of “cool,” according to Marshal Cohen, a senior analyst with consumer research firm NPD Group Inc. Target Couture allows the chain to elevate its brand beyond the walls of its big-box stores and into the glitzy arena of celebrity high fashion. Selling clothes is secondary.
“I think they’ll be tickled pink — or in their case, tickled red — if they make money,” Cohen said. “But I don’t think they care about that. What they’re most concerned about is maintaining the integrity of the brand.”

We shall see. When the brand is divorced from the product, it becomes hard to maintain the brand’s integrity. And its value become subject to the whims of fashion – not the underlying quality of the product.
An interesting experiment, indeed.