New report on financing of high growth companies – and missed opportunity

Earlier this month, the National Advisory Council on Innovation and Entrepreneurship (NACIE) issued a report on Improving Access to Capital for High-Growth Companies. [NOTE: Formed in 2010 by Secretary Locke, the NACIE should not be confused with the recently established Innovation Advisory Board, mandated under the America COMPETES Reauthorization Act of 2010 or the President’s Council on Jobs and Competitiveness.]
The report calls for a number of steps including:

Recommendations for Early-Stage Access to Capital
1: Provide a 30% refundable tax credit on angel group investments of <$200,000 into small businesses.
2: Provide a 100% exclusion on capital gains tax to small business investments held for 5 years, with deferrals permitted for roll-over investments into other small business within 9-month periods.
3: Provide a 100% exclusion on corporate income tax for the first taxable year of profit, a 50% exclusion on following two years of profit, and tax deferral on exercise of NQ stock options in small businesses.
4: Reduce further the SBIR/STTR grant review process from the current 6-12 months to a 3-month timeframe.
5: Support the SBA's proposed Early Stage Innovation Fund and efforts to further reduce SBIC license processing times and interest rate burden. Recommend future SBIC eligibility consideration be given to emerging investment classes such as angel groups, micro-VCs, and VDOs.
Recommendations for Later-Stage Access to Capital
6: Maintain the capital gains tax rate at 15%.
7: Amend the Spitzer Decree to permit payment for analyst coverage through banking revenue, and mandate analyst coverage of IPO issuers for at least five years.
8: Amend Sarbanes-Oxley Act Section 404 to reduce compliance controls and external-audit frequency on smaller public companies.

However, it also represents a missed opportunity: the use of intellectual property as collateral for loans. The report focuses almost exclusively on on equity financing, with a nod of the head to the SBIR/STTR grants program. But there are opportunities on the debt side as well. As readers of this blog know, I have long advocated for the use of intellectual property (and some other intangible assets) as collateral in debt financing. The irony of this missed opportunity is clear when looking at the SBA announcement (as part of Start Up America) of the Fund. They note that “Early-stage companies face difficult challenges accessing capital, particularly those without the necessary assets or cash flow for traditional bank funding.” This statement is correct in one sense and completely off track in another. It is correct when it states that these companies don’t have assets that traditional bank funding would accept as collateral. It is completely wrong in its implication that the companies don’t have assets. These companies are often sitting on intangible assets that could be used in debt financing. The key is not necessarily to expand the equity route — but to change how the “traditional bank funding” treats these assets.
As I’ve argued for before, there are two action that SBA could take:
•  Develop SBA underwriting standards for IP. SBA should work with commercial lenders to develop standards for the use of intangible assets as collateral, similar to existing SBA underwriting standards. Allowing IP to be used as collateral will increase the amount of funds a company, such as one in the high-tech sector, would qualify for.
•  Create an IP-backed loan fund. Other nations have developed special programs to encourage IP-based finance. The U.S. should set up similar programs on a pilot basis, ideally run by the SBA to take advantage of its lending expertise. Technical support could be provided by the SBA’s Office of Technology, which already coordinates the Small Business Innovation Research (SBIR) program. The SBA technology office also works with the U.S. Commerce Department’s National Institute of Standards and Technology (NIST) on its Technology Innovation Program and has a hand in other federal science- and technology-related initiatives. Such a direct lending program would be a step beyond SBA’s current loan guarantee programs–direct lending is needed to jumpstart the process. Once the process of utilizing IP as collateral is fully established, the program could be converted to a loan guarantee structure.
These two action would begin to unlock the debt financing option for high-growth companies. It is an option the Commerce Department and its National Advisory Council on Innovation and Entrepreneurship should not ignore.

Washington DC needs more lawyers

Believe it or not, according to a recent economic analysis (see NY Times story The Lawyer Surplus, State by State for details), Washington DC has a lawyer deficit. The analysis projects a market for 618 new lawyers annually. But in 2009 only 273 passed the bar. Interestingly enough, the District of Columbia’s Chief Financial Officer Natwar Gandhi recently cited other statistics showing that the absolute number of lawyers in Washington was declining (see WTOP story). Gandhi said that the decline in lawyers was one of the reasons for lower city revenues.
Now, I’m not sure that the economic analysis is necessarily correct — especially when it come to the supply side. I live in a neighborhood full of lawyers who don’t practice law (I even live with one). And DC has a reciprocity provision that allows lawyers who have passed the bar in other states to be automatically admitted to the DC bar. So that 273 number is suspect.
But the absolute decline in the number of lawyers in DC is interesting. I don’t know if that is a reflection of firms downsizing or firms moving to Maryland or Virginia.
In any event, it raises an interesting point as to whether the District of Columbia will maintain its stock of that particular intangible asset (lawyers). It also raises the question as to whether it should — and whether it matters at all. After all, one can argue that for some intangible assets (lawyers, investment bankers), a certain level is required to the smooth operation of the economy. But an oversupply of those assets might become a negative that simply gums up the works.
So that raises a meta question: contrary to what we normally think of a positive unlimited ceiling for knowledge, are there certain intangible assets that one can have too much of?

Default and the US's reputational capital

As the country lurches toward a showdown over the deficit and the debt ceiling, one argument has come up that is especially worrisome. There are those who say that a short-term temporary default (or “technical” default) would not be damaging. If you look just at the amount involved, that is probably correct. But the amount involved is only a small part of what is at stake. The issue is not about the financial capital but reputational capital. In a piece in the Wall Street Journal last week (What Happens if U.S. Defaults?), Maury Harris, chief U.S. economist for UBS Investment Bank, and Drew T. Matus, senior U.S. economist, UBS Investment Bank, laid out what is a stake:

The U.S. occupies a special place in global finance. The symbiotic relationship between the U.S. dollar as a reserve currency and the U.S. Treasury market’s monopolistic position as the safest, most liquid bond market in the world has served this country well. This unique position has allowed the U.S. to exercise significant authority in the global economy and enhanced its standing as a world power. Even a temporary default would eliminate the safe and liquid nature of the U.S. Treasury market, harming this country’s ability to exercise its power, to the detriment of the U.S. and the global economy.
. . .
if the political impasse continues and the U.S. defaults, it would not simply be a question of whether Treasury investors would get their money; eventually they would. It would be a question of whether the U.S. would lose something that made it special. The answer would be yes and the consequences for U.S. growth could be significant.

They explain:

The main impact on markets would come from sharply reduced liquidity in the U.S. Treasury market, as financial firms’ procedures and systems would be tested by the world’s largest debt market being in default. Given the existing legal contracts, trading agreements, and trading systems with which firms operate, could U.S. Treasurys be held or purchased or used as collateral? The aftermath of the failure of Lehman Brothers should be a reminder that the financial system’s “plumbing” matters. All the legal commitments and limitations in a complex financial system mean a shock from an event that is viewed as inconceivable – such as a U.S. Treasury default – can cause the system to stall. The impact of a U.S. Treasury default could make us nostalgic for the market conditions that existed immediately after the failure of Lehman Brothers.
Post-default liquidity could get even worse in the likely event of a rating downgrade. The liquidity event would not be limited to the Treasury market. Any reduction in the ability to use Treasury debt as collateral for loans would mean funds would need to be found: liquid assets sold to raise cash. Additionally, holders of U.S. Treasurys counting on timely payment could be forced to borrow funds in upset credit markets when those funds do not materialize.

What they don’t talk about is how long it would take to get back to near normal – if at all. Once lost, reputational capital is very hard to regain. Once US Treasurys are no longer the foundation of the financial system, can they ever be again?
Let us hope that this is a question we will not be asking come the beginning of August.

Advanced Manufacturing Partnership

Speaking of manufacturing strategy (see earlier posting), this morning the President announced the start of an Advanced Manufacturing Partnership (AMP). The program was a main recommendation in the new PCAST “Report to the President on Ensuring American Leadership in Advanced Manufacturing.” It’s really a manufacturing technology policy focused (as the PCAST press release puts it) on “precompetitive applied research to accelerate the maturation and manufacturing-readiness of emerging technologies” and therefore not a full manufacturing or innovation strategy.
AMP is heavy on the partnership aspect. But it does include the government investments in domestic manufacturing capabilities in critical national security industries, in advanced materials, in next-generation robotics, and in energy-efficient manufacturing processes:
One of the more interesting parts of the partnership has to do with some modeling and simulation software Procter & Gamble developed with Los Alamos National Lab. They will make this software available at no cost to American small and mid-sized manufacturers. Why? Well, as the President put it in his remarks:

Now, this is not just because Procter & Gamble wants to do good. It’s also they’ve got thousands of suppliers, and they’re thinking to themselves, if we can apply this simulation technology to our smaller suppliers they’re going to be able to make their products cheaper and better, then that, in turn, is going to save us even more money. And it has a ripple effect throughout the economy.

As I’ve noted before, P&G is a leading practitioner of open innovation. Helping build up technological capabilities of the supplier base is a key means of strengthening the open innovation process. This collaboration with P&G is a great example of the type of new policy initiatives geared to the reality of the collaborative I-Cubed Economy. Let’s hope we see more of them.

Creating a manufacturing strategy – JEC hearing

Earlier this week, the Congressional Joint Economic Committee held a hearing on “Manufacturing in the USA: Why We Need a National Manufacturing Strategy?“. Some of the testimony was the standard laissez-faire rhetoric on don’t worry about manufacturing (i.e. “it’s all part of economic evolution”) or the problem is all taxes and regulations. But the testimony by Scott Paul of the Alliance for American Manufacturing and by Mark Zandi, Chief Economist for Moody’s Analytics are worth noting.
Zandi was surprisingly optimistic about manufacturing’s future prospects:

While it will take many years for the U.S. trade deficit in manufactured goods to disappear, the process is under way in earnest. U.S. manufacturers who have long seen the dark side of global trade are moving toward the bright side, where they will be long into the future.

In part, he felt the worst is over, stating that, “any U.S. manufacturer that survived the Great Recession must be doing something right, staying very cost effective and/or holding a global market niche.” Companies that can build on those strengths can expand as the global economy recovers.
While issuing the standard warning about protectionism and “industrial policies” of subsidizing specific companies, he did offer a number of systemic policy proposals. These including confronting the Chinese currency issue, addressing the skills problem, reforming the tax code, lowering the cost of capital through increased SBA lending (including SBA equity financing) and improving infrastructure to lower the cost of transportation, telecommunications and energy.
Zandi also advocated work-share programs:

Manufacturers would also benefit from reform of the unemployment insurance system, including the expansion of work-share programs. Work-share allows manufacturers to avoid some layoffs by cutting workers’ hours, with government making up some of the employees’ lost compensation. This allows businesses to avoid severance costs and keep valuable employees whose skills are difficult to replace. Workers are increasingly willing to give up some hours to avoid being laid off. The unemployment insurance program should also provide incentives to unemployed workers to invest in their own retraining. Federal efforts to facilitate the retraining and education of displaced workers have been inadequate, and there has been little research into the design and implementation of effective retraining programs. This is especially important for unemployed workers in distressed regions of the country.

As I have noted before, work-share programs could effectively be combined with training programs so that workers spend those hours away from the job in training activities. But I would go beyond Zandi’s call to reform worker training programs for dislocated workers. We need to revisit the entire unemployment insurance system and revamp the worker “retraining” system into a worker training system.
Paul outlined his own set of policies for fostering a vibrant and economically prosperous manufacturing sector. These too included enhanced skill training and expanding infrastructure investment. He also called for confronting the Chinese currency issue as well as dealing with other Chinese unfair trade practices. But Paul also warned about any strong dollar policy that would but US manufacturers at a competitiveness disadvantage.
In addition, he called for a reorientation of the Administration’s trade goal of doubling exports to one of eliminating the manufacturing trade deficit. As he noted, “That’s a far more accurate metric for success or failure in the manufacturing sector than increases in exports that may be offset by a flood of imports.”
On regulation, Paul warned about cutting regulations:

while duplicative and unnecessary regulations should be reformed or eliminated, pursuing a race to the bottom with countries like China is foolhardy and ineffective as a means to boost our global competitiveness. A high-road strategy is the only feasible one for our nation. Advances in technology are making industries more sustainable, and ultimately, more competitive. The idea of rolling back decades of protections for workers and the environment is an exercise in futility, and time and resources would be better spent elsewhere. The goal should be for other nations to aspire to the quality of life that Americans enjoy, not to discard our efforts through a downward competitive spiral.

On taxes, Paul took issue with the especially the notion that manufacturing specific tax incentives should be eliminated in exchange for lower rates (see earlier posting):

The idea that a revenue-neutral corporate tax cut would be good for manufacturing is tenuous, at best. There appears to be little or no correlation between marginal tax rates and global competitiveness. A more significant factor is the presence of value added tax (VAT) systems with rebates for exports in virtually every industrialized and industrializing country except ours.

I agree with much of what Paul and Zandi said. I would add that we need to make sure these policies are crafted in a way to also foster the transition that manufacturing is undergoing. As I discussed in previous postings, manufacturing is becoming a more knowledge based activity and the distinction between manufacturing and services is disappearing. Our Policy Brief Intellectual Capital and Revitalizing Manufacturing outlines some of the steps that could be taken. These include work sharing and expanded worker training programs as mentioned above. But they also include recommendations to directly help companies and entrepreneur better utilized their intellectual capital. One step would be to expand the Manufacturing Extension Partnership (MEP), SBA assistance programs and EDA business incubator programs to include intellectual resource management that covers a broad array of assets, beyond help with intellectual property. Another would be to help companies use their intellectual capital to gain access to more financial capital. For example, SBA underwriting rules should be changed to allow companies to use their IP as collateral on loans and SBA could create a specific IP-backed loan fund. The paper also outlines other steps that could be taken in the financial system to encourage better recognition and utilization of intangible assets.
It is clear we need an overall manufacturing strategy. That strategy should build upon the current transformation of the economy — neither fight it nor assume that a laissez-faire direction will be in the best interest of the nation. Let us hope the policymakers were listening to the good suggestions coming out of the JEC hearing.

Tax breaks for worker training?

Apparently, the President’s Council on Jobs and Competitiveness is proposing a tax break for worker training. At the meeting of the Council with the President on June 13, the group argued that worker training should be treated as a depreciable expense under Section 179 of the tax code. “Currently, equipment can be treated on a deductible basis, but improving our human capital is just as important to the tax code,” Darlene Miller, President and CEO of Permac Industries said (see video below at the 73 minute mark). The tax incentive was part of a discussion on a pilot program to provide workers with manufacturing skills, essentially tying specialized school training and manufacturing internships.
I say apparently because the tax proposal is not yet included in any public documents of the Council and came up at the end of the discussion. There were hints of this in Miller’s comments during the Council’s first meeting (see previous posting). But the documents on the two websites (Jobs Council and White House website on the Council) restrict the worker training discussion to working with community colleges and others to better train manufacturing workers. This is an initiative already supported by the White House. The President spoke before on the importance of community college and spoke earlier this month on the manufacturing skills certificate initiative as part of the Skills for America initiative.
Adding a tax incentive would be a major step forward. As readers of the blog know, I have long advocated a knowledge tax credit (see earlier posting and my recently published “Comment on Cragg and Stiglitz: Invest in Intangible Assets” in The Economists’ Voice. Using Section 179 to provide a tax incentives for worker training would be a way of implementing such a knowledge tax credit. While I realize the Jobs Council brought this up as tied to a specific pilot manufacturing training program, I urge the Administration to look at is more broadly as well.

For those interested in the details, there are two different websites for the Council. The Jobs Council website has documents on the “framing” document and an idea fact sheet outlining what was to be presented to the President as the June 13 meeting (as well as an a link to the Jeff Immelt and Ken Chenault oped in the Wall Street Journal). The second website is the White House website on the Council. That website’s posting for the June 13 meeting has a copy of the President’s remarks, a link to the White House blog PR type posting, a link back to the Jobs Council website (and documents) and the video of the meeting.

Norm Ornstein on the need for regulations

In an earlier posting on regulations, I talked about the Agricultural Department’s Food Safety and Inspection Service implementing a new program on regulating mobile slaughter facilities. This was note worth because, as the Ag Department noted, “approval of a mobile slaughter facility required a great deal of stakeholder involvement, creative thinking, and problem solving.” Thus it was an example of new smart regulations.
In that piece I tossed out as an aside that “No one would want slaughter houses to be deregulated — for obvious reasons of public health.” Turns out, that is not the case. Recently, the House passed a farm bill that cuts food safety funding, arguing that safety in the food supply is self-regulated (i.e. the private sector can handle this just fine without government intervention).
Norm Ornstein of the American Enterprise Institute has written a piece on how foolish these cuts are (Mindless Cuts Can Have Dangerous Results). In it he details what the consequences of the cuts might be.

. . . the cuts in meat inspection would mean serious furloughs among meat inspectors and their support staff, who account for more than 90 percent of the agency budget.
That in turn could be extrapolated to mean about a million pounds of tainted meat and poultry being put on the shelves in supermarkets and butcher shops and on the menu in restaurants.
Given the statistics we have on the number of foodborne illnesses that hit Americans each year–48 million–that result in 128,000 hospitalized and 3,000 killed, those cuts would surely mean more hospitalizations and more deaths.
Cuts in the FDA mean fewer inspections of plants in China that provide food additives, many of which have included toxic substances.
Cuts in the CDC mean a lesser capacity to deal with an epidemic if and when one arises.

He dismisses the argument made during the House debate that the private sector is already handling this because of fear of lawsuits:

Of course, no food supplier wants to get sued. But if the private sector could self-manage this problem, we would not have seen the meat inspectors pull 9 million pounds of tainted meat and poultry from the system last year.

Parenthetically, I have to say I found the argument about how we can rely on the private lawsuit to protect the food supply especially ironic coming from a group of policymakers who are dedicated to the principle of reigning in private lawsuits (aka tort reform).
Ornstein goes on to note:

Whether it is offshore drilling, building construction, airline travel or sausage production, stuff happens and corners are cut to reduce costs or make bigger profits. Independent inspections are mandatory. Regulators can be captured by interests, as happened for decades at the Interior Department when it comes to oil drilling, or can be slothful or inefficient. But they are necessary for both public safety and public confidence.

And I would point out, regulations can be spurs to innovation — as companies use them to create innovative processes and/or use compliance with the regulation to build brand reputation. So in this new rush to deregulate, I how we don’t end up making matters worse — not only jeopardizing health and safety, but in the name of economics worsen our innovative economy.

We need to better tell the innovation story

The innovation story is getting lost in the jobs story. Case in point was the critique by George Mason University economist Russell Roberts on a comment by President Obama on technology and jobs (Obama vs. ATMs–Why Technology Doesn’t Destroy Jobs – Roberts takes the President to task for suggesting that some technologies replace workers and thereby create short term dislocation. Roberts discusses at great length the benefits to wealth creation of technology-induced productivity.
I agree with everything he said about the power of productivity (while I disagree with his political potshot at the President). But, when it came to tying technology to job creation, here is the best Roberts could do: “Somehow, new jobs get created to replace the old ones.”
If we can’t explain the “somehow”, we will lose the policy debates.
Roberts more detailed explanation given was this: “Fifty years ago, the computer industry was tiny. It was able to expand because we no longer had to have so many workers connecting telephone calls.” In other words, the computer industry grew because all those unemployed telephone operators (unemployed because of advances in computer technology) could all get jobs building the computers that replaced them.
Wrong. This is the fallacy of supply creating demand. Creative destruction is the process of new industries drawing resources from old industries. Freed-up labor doesn’t magically create new jobs. Free-up labor fills new jobs that are created by new opportunities. It is the new opportunities part that keeps growth going — not simply the higher productivity part. Higher productivity allows those workers greater output – thereby allowing labor to switch to other activities while maintaining the same or greater levels of production. But if it was simply greater output of the same old stuff, the system would grind to a halt with excess labor. This is the fear that has arise over the centuries.
Turns out these fears have not been realized — because of innovation. Innovation creates new demand as well as increases productivity. The new demand for new products absorbs the labor freed up by productivity gains in a virtuous cycle – each side reinforcing the other.
In a posting on the Innovation Policy blog, Stephen Ezel had a more nuanced version of the productivity story. But I believe even he missed the central point that productivity and innovation are a coupled process. Productivity frees up resources; innovation grows by utilizing those resources.
So, by getting the story only half right, Roberts got it wrong. If we are don’t pay attention to the innovation side of the equation, or economic prosperity will suffer. Here I agree with Stephen’s comments “what the U.S. economy needs to restore job growth is a serious national innovation and competitiveness strategy”.
But let me make one final point. It is not about technology; it is about innovation. The two are not necessarily the same. Innovation is broader concept. We need to focus on that broader concept of innovation in all its forms. Only then can we get the story right. And we desperately need to do a better job of telling the innovation story if we are to get the public policies in place to foster more sustainable economic growth.

IBM and the fusion of service and manufacturing

Yesterday’s brief piece on IBM noted that Big Blue’s success is due to its intangible assets. One of those intangible assets is it close relations with its customer base. As a recent story in the Economist (“IBM: 1100100 and counting”) points out, that close relationship was part of the company’s culture from the beginning. It allowed the company to understand the demand for “electronic calculating machines” (aka computers) as a replacement for mechanical devices. According to some, IBM got in trouble in the 1980s when it stopped paying attention to that customer feedback.
The closeness has helped the company make the next switch — from a producer of things to a supplier of solutions. Economist story explains:

From the beginning, as a maker of complex machines IBM had no choice but to explain its products to its customers and thus to develop a strong understanding of their business requirements. From that followed close relationships between customers and supplier.
Over time these relationships became IBM’s most important platform–and the main reason for its longevity. Customers were happy to buy electric “calculating machines”, as Thomas Watson senior insisted on calling them, from the same firm that had sold them their electromechanical predecessors. They hoped that their trusted supplier would survive in the early 1990s. And they are now willing to let IBM’s services division tell them how to organise their businesses better.

The result is a company that embodies the structural shift in the I-Cubed Economy from a sharp division between goods and services to a fusion of the two. As the Economist notes:

“IBM is not a technology company, but a company solving business problems using technology,” says George Colony, chief executive of Forrester Research, a consultancy.

IBM is, of course, not the only company to realize this shift. According to a recent story in the Wall Street Journal, Xerox is looking toward services:

For Xerox Corp. Chief Executive Ursula Burns, the future of the venerable printer and photo-copy machine maker isn’t in making copies.
Ms. Burns has spent the nearly two years since she took on the CEO role trying to transform Xerox into a services-based business, as the rise of digital technology has cut into the company’s traditional hardware line. In three years, two-thirds of company revenue will likely come from “services,” or contracts to manage other companies’ back office operations such as printing, human-resources and other areas of their business, she says.

I’m not sure from reading the story, however, that Xerox truly understands the nature of the shift. Conspicuously absent from the interview was any discussion about the customer, customer needs and solving customer problems. She notes the “managed print services that are really close to the document technology” which would be an extension of Xerox’s current intangible assets. But the strategy seems to focus on acquisition of companies already in business process outsourcing, which appears to have little to do with Xerox’s existing strengths. This seems to be a continuation of the mindset of services as something separate.
That mindset is one of the major traps that, I believe, both company executives and public policymakers continually fall into. An example of a counter to that mindset is the recent work of Henry Chesbrough. A recent interview in Strategy+Business notes:

Economists debate whether a service-based economy can be truly robust — or whether prosperity depends on having enough of a manufacturing base to support service businesses. But what if this turned out to be a false dichotomy? That’s the question raised by innovation expert Henry Chesbrough. All successful manufacturers, in Chesbrough’s view, need to come to terms with a fundamental change: the accelerating flows of knowledge and information that are shortening product cycles and commoditizing their products. They can do this, he says, only by reinventing themselves, not as pure manufacturers or service providers, but as hybrid product-service companies that design their business models around creating more meaningful experiences for their customers.

I would argue that these hybrids ae the core of the I-Cubed Economy. Just a companies who mastered the complexities of the economies of scale and scope dominated in the industrial age, companies that understand the amalgamation of manufacturing and services will prosper in this new economy.
The public policy question, which we articulated years ago in our paper Info Age: Recast Issues Demand New Solutions and reiterated more recently in a previous posting, remains: what are the policies needed to foster and harness these new economic structures for the benefit of the society as a whole.
On that note, let me repeat what I’ve said before. Manufacturing is in the process of being transformed into a much more knowledge-intensive activity. The process is analogous to the transformation of agriculture. Agriculture did not disappear from the US, to be shifted to some other nation that continued to do things the way it had always been done. Agriculture was transformed; it mechanized (industrialized, if you prefer).
The key is not the output (“agriculture,” “manufacturing,” “service”). It is the production process that is important. During the industrial revolution, machine power replaced human and animal power. The key input was energy. Today, knowledge has become the key input (factor of production). Thus, we should not abandon “manufacturing” as an activity but embed it in the new economic structure.
Transforming manufacturing will take more than restructuring a couple of companies. It will take restructuring the entire production process. One of transformations is through a “high road” strategy that puts its emphasis on all upgrading of the inputs to the production process: technology, worker skills and cooperative/collaborative organizational structures (see previous posting).
It also means changing the manufacturing mindset. While the line between manufacturing and services has blurred, many companies are still fixed in the industrial age mentality of turning out a large volume of a commoditized product. The very nature of the supply chain forces 3rd and 4th tier suppliers in to this mode. These companies are not involved in product design and innovation; they simply respond to specs and price. Changing that structure will be painful and disruptive. Trying to revive that structure will be futile.
Thus, one of the major tasks for our new manufacturing policy needs to be focused on the lower tiers. How does the policy help these small companies re-orient themselves to the 21st Century?
It will take a multi-fold approach. Let me suggest one set of activities–by no means a complete list, but some ideas. We need more research on the service-manufacturing linkage to understand the transformation. That would be an excellent part of the “services sciences” agenda. We also need to find creative ways that the smaller supplier can move up the value-chain to take advantage of this shift. We then need to instill this notion of the fusion of manufacturing and services into the Manufacturing Extension Partnerships. The MEPs were on the front lines helping small and medium size companies during the quality revolution. They need to be on the front lines of the innovation and “customer solution” revolution.
These are but a couple of steps we could begin to take. As IBM illustrates, the transformation is already happening. Our public policy needs to catch up.

Innovation at P&G

One of my pet peeves is our continually wrong mindset that innovation = technology and that only “technology” companies are innovative. Wrong! One of the most innovative companies in the world today is the consumer products company Procter and Gamble (P&G). P&G has innovation baked so deeply into its corporate culture that for anyone who studies the subject, the terms P&G and innovation are synonymous.
Years ago, Athena hosted a Congressional luncheon briefing on Innovation and Design that featured P&G. Last month, I was at a presentation by Bruce Brown, P&G’s CTO, hosted by the Wilson Center. A summary of that presentation (Innovation in the Global Environment) is now available. Yes, P&G has a huge R&D effort. But, as Brown pointed out, P&G is a pioneer in open innovation with half of their innovations come from outside the company.
What especially continues to impressed me is P&G’s commitment to all levels of innovation – not just those coming out of the lab. Their motto is that “the consumer is boss.” As former head of P&G, A.J. Lafley explained in a 2008 article:

In other words, the people who buy and use P&G products are valued not just for their money, but as a rich source of in­formation and direction. If we can develop better ways of learning from them — by listening to them, observing them in their daily lives, and even living with them — then our mission is more likely to succeed. “The consumer is boss” became far more than a slogan to us. It was a clear, simple, and inclusive cultural priority for both our employees and our external stakeholders, such as suppliers and retail partners.
We also linked the concept directly to innovation. From the ideation stage through the purchase of a product, the consumer should be “the heart of all we do” at P&G. I talked about it that way at dozens of company town hall meetings during my first months as CEO. More and more people began thinking about how to apply the “consumer is boss” concept to their work. Resources were still scarce, and there were fierce debates about which ideas deserved the most attention and where to de­ploy money and people. But this concept came to matter more than those other concerns. People became more willing to subjugate their egos to the greater good — to improving consum­ers’ lives.

That also means permeating the idea of innovation throughout the company. Lafley went on to explain:

When I became CEO, we had about 8,000 R&D people and roughly 4,000 engineers, all working on innovation. But we had not integrated these innovation programs with our business strategy, planning, or budgeting process well enough. At least 85 percent of the people in our organization thought they weren’t working on innovation. They were somewhere else: in line management, marketing, operations, sales, or administration. We had to redefine our social system to get everybody into the innovation game.
Today, all P&G employees are expected to understand the role they play in innovation. Even when you’re operating, you’re always innovating — you’re making the cycles shorter, or developing new commercial ideas, or working on new business models. And all innovation is connected to the business strategy.

To me, what he said should really be slogan: “Even when you’re operating, you’re always innovating.” That is how innovation really works — not our fixation with a linear flow from laboratory to final product.
And so where is the public policy that implements the “when you are operating, you are innovating” concept?