Manufacturing and services – part 4 (what customized really means)

I was recently at a conference where Klaus Hoehn, the VP for Advanced Technology and Engineering for John Deere spoke. He made a very interesting off hand comment. He said that Deere was in the business of providing functionality — and was moving toward providing integrate customer solutions.
His comments recalled to mind a story of innovation in Christensen’s The Innovator’s Dilemma about steam shovels (see summary). One company was in the business of building bigger shovels with greater power. And the best technology was the cable system. Another company, however, developed the new hydraulic system was not as good as the steam cable system — but was very suited to narrow spaces. They got in the business not of providing big powerful shovels but of digging narrow trenches (such as for pipe laying or house foundations). Functionality – not a specific product.
The Deere quote is similar to what we keep hearing from a lot of companies. The mass production model (of more and more of the same) is giving way to the customization model. This is a trend we have been talking about for some time — and that helps define competitiveness in the I-Cubed Economy. But we are just beginning to bring our mindsets around to what it means. Originally, customized manufacturing meant the flexibility to run smaller batches of mass produced goods or to add certain features to a basic product. Hence it was also know as flexible manufacturing.
However, at its heart, customized manufacturing really means providing the customer with a product uniquely suited to their needs. The phrase “just-in-time; just-for-me” has been used to describe this level of customized goods. It is not about the product; it is about the customer.
From that perspective, distinction between manufacturing and services begins to blur. What business am I really in? Is my business making backhoes? Or is my business selling contractors ways to make holes in the ground? With that question comes a change in orientation from making the product better to providing “integrate customer solutions.”
The classic case is Rolls-Royce as noted before. The aviation division of Rolls doesn’t sell jet engines, they sell thrust in the form of hot air out the back of airplanes. The monitoring and servicing of the engines is as important as their manufacturing. And the servicing works because they designed and built the engines in the first place.
By the way, the same shift is happening in “services” — at least in some areas. What does the customer need rather than how to I make my particular service faster, better, cheaper. It is really a shift from efficiency (the focus in the industrial age) to customer-focused innovation. (Note: I have to use that clarification of “customer-focused” since most of our view toward innovation is still on making the product the faster, better, cheaper).
That is not to say that faster, better, cheaper is not a factor. But faster, better, cheaper is not any of those if the product really doesn’t suit my needs. If what I want to do is travel a mile from my house to my office, a bicycle or a bus may be a better solution than a Ferrari.
The switch in focus from the product (good or service) to the customer needs is a move beyond the age of mass production/mass consumption. The switch is well underway in the economy. Businesses, like Deere, understand this.
So, what are the public policies appropriate to this new era?

Patent ratings and France’s state bank

There was an interesting piece over in Joff Wild’s blog at IAM Magazine about an Ocean Tomo ratings deal with France’s state bank. According to the piece:

The Chicago-based merchant banc has agreed a working protocol with Caisse des Dépôts, the development bank owned by the French state, that is expected to lead to the creation in the autumn of the first ratings platform for European patents. This would be an OT/Caisse des Dépôts joint venture based on the ratings platform that Ocean Tomo already has for US patents.

Wild implies that this is a move toward setting up a European IP transactions market. In other words, the joint venture will be a patent analytic service.

I wonder if this might be headed in a different direction. One of Caisse des Dépôts responsibilities is the development of French SMEs — especially helping to find financing. Could it be that this new patent rating system is the beginning of IP-based lending on behalf of the bank? Given the need to have such a rating system in place to underpin any lending program and given the bank’s basic mission, it seem like a logical fit.

Anyone out there have any additional information?

Finding the new growth model

Here is an interesting bit from a recent article by James Fallows interviewing Nouriel Roubini – Dr. Doom Has Some Good News:

“The question is, can the U.S. grow in a non-bubble way?” He asked the question rhetorically, so I turned it back on him. Can it?
“I think we have to …” He paused. “You know, the potential for our future growth is going to be lower, because of the excesses we’ve had. Sustainable growth may mean investing slowly in infrastructures for the future, and rebuilding our human capital. Renewable resources. Maybe nanotechnology? We don’t know what it’s going to be. There are parts of the economy we can expect to lead to a more sustainable and less bubble-like growth. But it’s going to be a challenge to find a new growth model. It’s not going to be simple.” I took this not as pessimism but as realism. (emphasis added).

I have to somewhat disagree. The new growth model has been in front of us for some time — we have just chosen to ignore it and take the easier path of asset bubbles. That growth model is based on innovation and fueled by intangibles.
As I have noted often (including yesterday), the new model is slowly taking hold. It is a model where there is less consumption of mass produced items and more of customized solutions — which mistakenly show up in our economic statistics as “services” even though they are based on goods. It is a model where American production of goods (which we currently label “manufacturing”) and services are revitalized using knowledge and intangibles — where our trade accounts return to a sane balance.
Seen from a macroeconomic point of view — where all consumption is one big aggregate — Roubini’s question makes some sense. Seen from a microeconomic view, however, the answers are more discernable in the structural transformation.
But let us be clear. We are talking a major transformation. The new growth model is not a return to the economy of the 1950’s or even the 1980’s. It can’t be. The days when a young person could finish high school and get a good paying job on the assembly line with almost no skills is gone forever (as a recent New York Times story highlighted). The days when all a business had to worry about was how to increase efficiency are over.
The fact of the transformation is clear. It will happen. Whether the US takes advantage of the transformation to ensure economic prosperity is another matter. The policies we put in place will determine the outcome. To the extent that we stick with the policies of the industrial age, we will not prosper. To the extent that we miss read the transformation using an industrial age mindset (i.e. its all “services”), we will not prosper.
Thus, our first task it to change the mindset – and understand the transformation. By doing so, we will create the new growth model Roubini and other macroeconomists are searching for.

Networked innovation – and innovation markets

The Knowledge@Warton website has an article Innovation: Sometimes It Takes a Village that summary of a recent conference on innovation networks. The article covers the issues and opportunities of what we generally label “open innovation.”
Part of that discussion focused on the importance of collaboration — and how to manage that collaboration.
Part, however, was focused on a more arms’ length approach of what might be characterized as innovation markets — where a question or challenge is throw out for anyone to try to solve (FYI – the company InnoCentive runs a web-based service to administer this market).

Case in point: Twenty years after the Exxon Valdez oil spill in 1989, as many as 80,000 barrels of oil remain on the floor of Prince William Sound because the oil has been frozen by sub-arctic temperatures, making it difficult to pump to the surface. The Oil Spill Recovery Institute, established by Congress after the spill, ran a $20,000 challenge with InnoCentive in 2007 to try to solve the dilemma, which had perpetually stumped the world’s oil experts. After three months, a construction engineer from the Midwest came up with the winning answer, surmising that vibrating the oil could keep it in a semi-fluid state, in the same way cement is kept flowing while it is poured into a form. Modify the drilling equipment, vibrate the oil and you’ll be able to pump it, he suggested. It worked.

So — what is the public policy needed to stimulate these innovation networks — both collaborative and “market”?

The troubles at USPTO

Much of our focus on patents recently has been on the substance of the reform proposals. Not getting as much attention is the fact that the budgetary wheels are coming off over at that US Patent and Trademark Office (USPTO). In fact, the situation has gotten so bad that according to a story in Tech Daily, Senate Judiciary Chairman Patrick Leahy and ranking member Jeff Sessions last night introduced a bill to allow USPTO to borrow money from its trademarks operations (a fund that is in surplus) to pay for its patent operations. (FYI – the bill has not yet shown up in the Congressional Record).
And how long can we continue to delay fixing this system?

Revising GDP

The BEA released its final numbers for 1st quarter GDP showing that the economy declined by 5.5% January through March. Since BEA already released data indicating the depth of the decline, these numbers are in many ways old news. What is new news, at least to me, is the size of the adjustments. The “Advance” estimate (issued in April) had GDP declining by 6.1%. The “Preliminary” (issue in May) had a drop of 5.7%. Today’s “Final” number is 5.5%. According to BEA:

The upward revision to the percent change in real GDP primarily reflected a downward revision to imports and an upward revision to private nonfarm inventory investment that were partly offset by downward revisions to exports and to personal consumption expenditures for services.

So trade (including trade in services) and consumption of service were three of the four reasons for the revisions.
I note that this will not be the last revision to the data. BEA is scheduled to release the 13th comprehensive (or benchmark) revision of the national income and product accounts (NIPAs) at the end of July. More information about the changes is available on their website.
All of this should remind us of the difficulties on measurement in the Intangible Economy — and the reason we need to support BEA’s (and the other statistical agencies’) efforts to improve the data. After all, economic data is a key government provided intangible asset.

Climate change bill moving

The House climate change bill looks like it will be moving soon. The House Rules Committee has announced the next steps for a bill that could go to the floor possible as soon as this weekend. The Committee set a deadline of Thursday morning for the submission of proposed amendments. The Committee also released the text of the bill – the American Clean Energy and Security Act of 2009 – that will be considered.
There is a lot in the 1201 page bill that is worth of commentary — such as the provision requiring a report to Congress (and the media) as to whether India and China have standards as strict as the US, the new energy efficiency standards, the creation of yet another narrow worker adjustment assistance program, the provisions to promote exports of clean energy technologies and protect intellectual property rights, and the actual set up of the emissions rights auctions. Already many of my friends are scrambling to digest the bill’s contents. I will wait for their analysis of what is in and what is out and who is up and who is down.
However, I want to draw attention to just one provision. Section 124(d) creates a domestic manufacturing incentive program similar to the provision in the stimulus bill I mentioned earlier. The difference being that the climate change bill uses emission allowances to pay for up to 30% of the cost of the manufacturing facility.
Maybe with such actions we won’t end up losing our green technology industries.

Losing trade in green

Earlier today, I mentioned the fact that our trade deficit in advanced technology goods stems from a failure of trade and innovation policy — not because we are less innovative. It is the result of an “invent it here; build it there” business model. Well, it looks like we may be going doing the same road with green technology. This morning, the New America Foundation issued a report on the Green Trade Balance. The situation is not good:

Green investment is a major pillar of the president’s economic recovery plan. Yet, America’s dependence on foreign countries to produce green technologies may undermine this recovery strategy. Using a list of green goods derived from the Organization of Economic Cooperation and Development (OECD) and the Asia-Pacific Economic Cooperation (APEC), we have determined that the United States ran an overall green trade deficit of -$8.9 billion in 2008, including a deficit of -$6.4 billion in the critical category of renewable energy, one of the main targets of the Obama administration’s green agenda. The U.S. economy also suffered a significant deficit in the pollution management category. On the positive side, the United States ran modest surpluses in two categories–energy efficiency and a grouping of other environmental goods related to water purification and sustainable agriculture.

If current trends continue, the green trade deficit can be expected to widen further as the administration’s agenda increases domestic demand but without sufficient measures to increase domestic production. If the deficit continues to grow, the United States will forego the creation of millions of high-wage, high-skill green manufacturing jobs and lose its potential to be a global producer as well as a consumer of green technologies.

. . .

The trends in America’s green trade balance should caution policymakers against over-promising about the jobs and investment we can expect from government spending to support the green economy. If the green recovery is to deliver more jobs and spur more domestic investment, it will need government measures to encourage domestic production as well as domestic consumption.

When the stimulus bill was passed, some policymakers recognized this need (see earlier posting). As I reported then, Sec. 1302. (Credit for Investment in Advanced Energy Facilities) of the tax provisions of the bill created a 30% tax credit for the establishment of an alternative energy manufacturing facility. As my old boss, Senator Jeff Bingaman was quoted in the Wall Street Journal as saying, “Several of us have come to recognize that we’ve outsourced the very things we’re going to need to change the nation’s energy mix, and this is a way of encouraging more manufacturing here at home.”

The New America Foundation report highlights how urgent that task is.

Reports on innovation – and lessons for policy

Some updates on innovation policy:

This week is the annual OECD Ministerial meeting. The overall theme of the meeting is The Crisis and Beyond: For a stronger, cleaner, and fairer world economy. As part of the preparation, OECD has issued a new report: Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth. The report argues that the focus on innovation should increase during the economic crisis, stating that “[T]he crisis should not damage the drivers of
long-term growth, but should instead be used as a springboard to accelerate structural shifts towards a stronger, fairer and cleaner economic future.” In that vein, they recommend continued support for focused research and public-private partnerships, enacting policies to lower obstacles to entrepreneurship (including addressing the liquidity problems facing start ups and small firms), and continue investments in information technologies and in human capital. The report goes on to describe policies being taken by OECD countries.

Thanks to Intellectual Property Watch for point this out.

– – –

A much more pessimistic view comes from Mike Mandel’s recent Business Week cover story The Failed Promise of Innovation in the US. His basic argument is that the innovations of the 1990’s have failed to deliver – especially in biotech. I have to say that I find his arguments rather unconvincing. It seems like he desperately wanted all the high tech hype to be real. It wasn’t. It couldn’t have been. And it won’t be in the future. But the failure of reality to live up to the hype does not mean that innovation has failed.

I was especially interested, however, in his comments on trade and innovation. He take the growing trade deficit as an indicator of a lack of innovation. I disagree. The real reasons for the growing trade deficit are many. But part of it was the innovation business model: invent it here, make it over there. That is a failure of trade policy, economic policy and innovation policy, not innovation per se.

– – –

Then there is the story in today’s Wall street Journal In Search of Innovation. They use one of my favorite analogies: the dunk under the light post. “Why are you searching here under the light post when you lost your keys over there,” asks the cop? “Because this is where the light is,” answers the drunk. The authors point out that much of the search for “innovation” is where the current light is — rather than where the innovations are. They offers a number of tips for how to broaden the search — all of which generally fall under the rubric of open innovation.

One other thing I would point out is that there definition of innovation is a broad one — encompassing new products, services and process. One of the most interesting example is this:

Doctors at the Great Ormond Street Hospital for Children in London, for example, consulted with members of a pit-stop crew from Italy’s Ferrari Formula One motor-racing team to explore ways of improving how children were being moved out of heart surgery and into intensive care.

In contrast, Mandel’s complaint is about the failed promise of high-technology.

– – –

So let me go back to the light post story. In our search for innovation policy, we have been looking in the usually places where there is light. In this case, in technology policy. But I will reiterated what I have said time and time and time again: technology is not the same as innovation. Business gets that. But government policy makers don’t. Until we have a broader definition of innovation policy, we will continue to be like the drunk under the light post — search for answers in all the wrong places.

Manufacturing in the Intangible Economy

There is a lot of misunderstandings about the Intangible Economy (or the “dematerialized” economy or the “weightless” economy or the really misleading “services” economy). One of the greatest misunderstandings is that manufacturing has no role. Or that a national economy can survive without manufacturing. For example, a recent story in the Wall Street Journal on Michigan and the Knowledge Economy: Manufacturing won’t support the middle class. The story advocates an abandonment of manufacturing for knowledge industries, which they define as “information, finance, insurance, professional services, health care and education.”
There are two fallacies to that argument:
1) that “manufacturing” and “services” are completely separate and unrelated activities
2) that a large nation can export enough “services” from the knowledge industries to pay for the importation of manufactured goods.
Let’s start with the first argument. One of the hallmarks of the intangible economy is the fusion of manufacturing and services. As I have noted before, even the very nomenclature manufacturing and services has become misleading. This is highlighted in a new report from the Work Foundation in the UK on Manufacturing and the Knowledge Economy. (Part of their series on the Knowledge Economy.)
The reports make a number of important points about manufacturing:

Modern manufacturing has been reshaped by exactly the same forces driving our transformation into a knowledge based economy. There are two closely related major consequences of these changes.
• Firstly, modern manufacturing invests more heavily in knowledge based intangible assets than services and provides large numbers of knowledge intensive jobs;
• Secondly, the conventional boundaries between manufacturing and services are blurring as manufacturers incorporate high value added services into the production process.

On this second point – the blurring of manufacturing and services, the classic case is Rolls-Royce as I’ve noted before. But not only is the business model blurring the boundaries, the jobs linkages remain strong. The Work Foundation report references a 2004 report from the EU High-Level Group Report Manufuture Technology PlatformManufuture: A Vision for 2020. This report notes that for every job in manufacturing there were two jobs in manufacturing related services. They also cite a report to the UK Department of Trade and Industry – A Portrait of Trade in Services – that about 25 per cent of all exports of business services and between 40 and 45 per cent of trade and technical related service exports were generated by manufacturing companies.
And those manufacturing sector jobs are more knowledge intense. The Work Foundation finds that in the UK high to medium high tech manufacturing have the same level as knowledge intensive services — around 40% of the workforce in both.
In other words, manufacturing and services are not two sides of the same coin – they are parts of the design of the face of the coin. Losing the manufacturing base means losing knowledge-intensive jobs and knowledge intensive value added.
– – –
The second part of the “let-manufacturing-go” is that we can export enough services to pay for imports of goods. That may be partial true for a very small economy — say Singapore. However, for an economy the size for the United States, the ability to produce goods is vital for our international financial position. While manufacturing may be under 15% of GDP, it makes up a large part of our trade deficit. Even if we were self-sufficient in energy, we would be running a $300 billion trade deficit because of our deficit in manufactured goods.
Our trade surplus in services is so small relative to our deficit in goods — as illustrated below and in my earlier posting. In addition, we need to be careful in the definition of services – since it included travel, tourism and transportation. The core of what people think of is in just two of the categories: royalties and “other business services”. I label these as “intangibles” and publish that data monthly. At current levels, our intangibles surplus (business services and royalties) would have to be 6 times as large as it is now in order to offset our goods deficit.
Annual Trade Balance 2008.gif
In addition, trade in intangibles is subject to the same competitiveness pressures as trade in goods. Other nations are expanding their knowledge based service industries as well. In fact, our imports of intangibles grew faster than our exports in 7 of the last 10 years. There is no reason to believe that our exports in these sectors can grow 6 times as large in the near future.
There is one other way to look at the importance of manufacturing to the US economy. Let us undertake a thought experiment as to what would happen if manufacturing output declined. The chart below illustrates the impact on the trade deficit — using the Federal Reserve’s data on industrial production for total consumer goods and durable goods. Let us simply see how much more we would have to import if domestic production declined — assuming consumption remained at 2008. This does not include any decline in manufacturing exports. If output of durable goods (the smallest US manufacturing sectors) were eliminated, the deficit would increase by 60%, If output of all consumer goods (durable and non-durable) were cut in half, the deficit would double. And if the entire consumer goods manufacturing base disappeared, the deficit would triple.
Manufacturing scenarios and trade deficit - imports only.gif
Now, let’s also take away our exports in consumer goods. Here we have to be a little creative with the data since the categories of “consumer goods” for trade data and for industrial production are not the same. For this thought experiment, we will subtract out from the goods balance any exports of what fall into the trade categories of “automotive vehicles” “consumer goods” and “other goods”. The impact is even more dramatic.
Manufacturing scenarios and trade deficit - imports-exports.gif
Bottom line: manufacturing still matters. But it is a different from the past – more sophisticated and knowledge intensive that ever. As such, it is an integral part of the Intangible Economy