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 – WSJ.com). 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.

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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?

IBM's intangible assets

IBM is celebrating its centennial this month — which has prompted many to ask how a company can survive in the volatile information technology industry. Probably the best answer comes from Steve Lohr’s piece in the New York Times (I.B.M. at 100 – Lessons in Tech Longevity):

One central message, according to industry experts, is this: Don’t walk away from your past. Build on it. The crucial building blocks, they say, are skills, technology and marketing assets that can be transferred or modified to pursue new opportunities. Those are a company’s core assets, they say, far more so than any particular product or service.
In I.B.M.’s case, the prime assets included strong, long-term customer relationships, deep scientific and research capabilities and an unmatched breadth of technical skills in hardware, software and services.

In other words, it’s all about the company’s intangible assets. But of course, you already knew that.
IBM’s strategy also reviles another hallmark of the changing economy structure of the I-Cube Economy: the fusion of manufacturing and services. More on that tomorrow.

Apple's hidden intangible asset

Everyone knows that Apple is the premier high-tech company in this knowledge economy. And everyone knows that brick and mortar retailing is the dinosaur of the information/internet age (just ask Borders). But, what everyone knows is only partially correct. The knowledge economy is far more complex and interesting when you peel back the cover and look inside. Case in point: Apple’s retail stores. As a recent article in the Wall Street Journal notes (Apple’s Retail Secret: Full Service Stores):

Steve Jobs turned Apple Inc. into the world’s most valuable technology company with high-tech products like the iPad and iPhone. But one anchor of Apple’s success is surprisingly low tech: its chain of brick-and-mortar retail stores.
A look at confidential training manuals, a recording of a store meeting and interviews with more than a dozen current and former employees reveal some of Apple’s store secrets. They include: intensive control of how employees interact with customers, scripted training for on-site tech support and consideration of every store detail down to the pre-loaded photos and music on demo devices.

According to the article, Apple stores have become highly visited destinations. Key to success is store design (no surprise given Apple’s design orientation) and extensive employee training. Also important is the sales approach. As the article notes:

According to several employees and training manuals, sales associates are taught an unusual sales philosophy: not to sell, but rather to help customers solve problems. “Your job is to understand all of your customers’ needs–some of which they may not even realize they have,” one training manual says.

This last point may be the most important. Problem solving, rather than sell products (goods and services), is the hallmark of the I-Cubed Economy. Looks like Apple figured that out a long time ago.

Pandora IPO and intangibles

Follow up note to the earlier posting on Groupon and intangible accounting:
The latest internet IPO is that of Pandora Media, an internet radio company which went public today. A quick look at Pandora’s Form S1 filing with the SEC shows a different tactic. No use of adjusted CSOI — or any non-GAAP financial data at all. Sticking with GAAP reporting does seem to have hurt the stock sales — see Pandora shares surge in first day of trading as Internet IPO fervor continues.
Interestingly, the filing lists a number of intangible assets that the company feels are important to future success. These are discussed in terms of risks, but it is not hard to see the intangible asset underlying the risk:

Our failure to convince advertisers of the benefits of our service in the future could harm our business.
Unavailability of, or fluctuations in, third-party measurements of our audience may adversely affect our ability to grow advertising revenue.
We operate under statutory licensing structures for the reproduction and public performance of sound recordings that could change or cease to exist, which would adversely affect our business.
If we fail to accurately predict and play music that our listeners enjoy, we may fail to retain existing and attract new listeners.
Our ability to increase the number of our listeners will depend in part on our ability to establish and maintain relationships with automakers, automotive suppliers and consumer electronics manufacturers and consumer acceptance of the products that integrate our service.
Our business and prospects depend on the strength of our brand and failure to maintain and enhance our brand would harm our ability to expand our base of listeners, advertisers and other partners.
We depend on key personnel to operate our business, and if we are unable to retain, attract and integrate qualified personnel, our ability to develop and successfully grow our business could be harmed.
Failure to protect our intellectual property could substantially harm our business and operating results.
If we cannot maintain our corporate culture as we grow, we could lose the innovation, teamwork and focus that contribute crucially to our business.

Of course, the risk discussion includes a far larger list of possible problems. But this list is a good indication of the intangible assets powering this company. A positive take on the assets can be found in the filings section on “What we do.”
UPDATE:
It looks like the stock is not as hot as first thought. From the NY Times – Pandora Pares Its Gains After Its Debut Pop:

Pandora’s shares closed at $17.42, a gain of 8.9 percent over its initial public offering price of $16. The stock did open at $20 and spiked as high as $26 in the morning before trailing off.

Does Groupon endanger intangible asset accounting?

When Groupon floated its IPO, it had to report its financial data according to standard US accounting rules known as GAAP (Generally Accepted Accounting Practices). But, the company also touted an alternative metric called adjusted consolidated segment operating income (aka adjusted C.S.O.I.) (see filing with the SEC). Under this metric, costs such as marketing and acquisitions are not counted as expenses (see the NY Times Dealbook piece What is adjusted CSOI). The rationale for this is that they are temporary costs, not long term operating costs. Thus the company’s “real” income is what it would be exclusive of these costs.
Robert Cyran, Antony Currie and Rob Cox have pointed out the flaws in this approach in a NY Times piece Fuzzy Accounting Enriches Groupon. They imagine the same rules applied to other companies:

Take Netflix, which spends heavily on marketing. Use Groupon’s arithmetic and this cost can be ignored. Netflix also pays taxes and rewards executives with stock. Subtract these figures from its 2010 accounts, and it would have had around $600 million of adjusted C.S.O.I. Today, Netflix is valued around 48 times trailing operating profits of $284 million. Substitute C.S.O.I., and Netflix would be worth $28 billion.
Or consider an old-school enterprise like Johnson & Johnson. Last year it had multiple product recalls. Under adjusted C.S.O.I., costs associated with these may be treated as one-time expenses. Once a drug is invented, the formula is not forgotten, so research and development is a nonrecurring cost, too.
Do the numbers, and Johnson & Johnson’s C.S.O.I. would be about $10 billion higher than its 2010 operating profit line. At the same multiple of operating profit that the company now fetches, using C.S.O.I. would add $100 billion to its worth. If Groupon is to be believed, the entire investment world has got its accounting all wrong.

As it turns out, I happen to believe that the standard accounting using GAAP is all wrong. Most of the investment world already knows that. But, I have a concern over this development. We are finally making progress with the notion that investments in intangible assets are investments. That includes spending on marketing and R&D. The economists have now accepted this and soon R&D will be treated as an investment in the GDP data. However, the accountants are still skeptical of all this. In their view, an expense is an expense is an expense.
Now comes along a new strange notion that an expense is not an expense if the company doesn’t want it to be. This notion seems to be built upon (and may be used to try to sustain) the latest tech bubble. It is especially troubling that Groupon is so dismissive of its marketing expenses — a major intangible investment. Given this highly unorthodox view, does treating intangibles as an investment get tarred with the same brush?
Or is this an opening we have been looking for to push alternative measures? After all, Groupon was allowed to report adjusted CSOI in its SEC filing. Maybe other intangible based companies will adopt alternative metrics to tell their story to investors — measures that give a true picture of the company’s intangibles and their contribution to company profits. That would be a story worth telling.