The case for manufacturing – and the need to understand the transformation

In New York Times op-ed yesterday, Susan Hockfield, the President of MIT, made the case for manufacturing. Central to her piece (“Manufacturing a Recovery”) is a description of some advanced manufacturing companies:

Like the jet aircraft made by Boeing, one of the country’s largest exporters, products like these require sophisticated manufacturing equipment, operated by skilled workers, and benefit from the tight integration of design and production. With goods like these, the United States can reassert an economic advantage. If we can find ways for companies of every size to exploit the possibilities of nanofabrication, advanced materials, robotics and energy efficiency, we can create networks of innovation, joining lab research to new production processes and business models.

That tight linkage between product creation and product manufacturing has been highlighted by a number of others, most notable Gary Pisano and Willy Shih at the Harvard Business School in their HBR piece “Restoring American Competitiveness”.
I would go one step further and stress the tight linkage between product manufacturing and servicing. As I have noted many time in this blog, the difference between “manufacturing” and “services” are eroding. Service activities are increasingly linked manufacturing activities. In fact, companies such as the German Mittelständler companies are successfully competing in “old” industries based on that linkage. They offer knowledge — not low cost. Knowledge is what gives them a superior product and knowledge is what makes their services so valuable. But is it not just generic knowledge. They are selling their knowledge as a means to create solutions for their customers. Their customers want the knowledge to be specifically applied to them – not some abstract concepts. That is the “service” part of the equation. So, all of the activities described above for helping manufacturing should recognize that these manufacturing companies are already in the “service” business.
The fusion of product and service is part of the overall shift of manufacturing. As I pointed out in the Athena Alliance Policy Brief–Intellectual Capital and Revitalizing Manufacturing, manufacturing is in the process of being transformed into a much more knowledge-intensive activity. The process is analogous to the transformation of agriculture in the early 20th century. Farming did not simply move to other nations with lower-cost producers using the traditional techniques. Agriculture was mechanized–or industrialized, if you prefer. That transformation led to efficiencies that revolutionized the production of commodities and contributed to U.S. economic growth.
As manufacturing is transformed into a much more knowledge-intensive activity, it will require attention to all the inputs to the production process — technology, worker skills, and cooperative/collaborative organizational structures. All of which are key intellectual capital and intangible assets.
Embracing the role of intellectual capital and intangible assets in manufacturing requires going beyond the narrow view of formal intellectual property. Scientific and creative property are valuable assets that include product development activities beyond the patent, new architectural and engineering designs, and social and organizational sciences research. Computerized information, including customized software and databases, are other important company assets that go beyond our definitions of intellectual property. Specific business models, organizational structures, and organizational capabilities are key elements of any company’s ultimate success. Worker skills and tacit knowledge–both general and firm-specific–are assets that managers describe as leaving the company every evening and returning every morning. Brand equity, reputation, and relationships with customers and suppliers are all important. All of these forms of intellectual capital need to be explicitly developed and managed by successful manufacturing companies.
The policy question, therefore, is how do we position American manufacturers to make the transformation. It will not be an overnight leap, but a gradual process that will require sustained attention. At the heart will be helping companies understand the transformation and how to best utilize their intellectual capital.
There are a number of specific actions that could be taken to support the transformation. We should expand the Manufacturing Extension Partnership (MEP) services to explicitly include assistance in indentifying and managing their intellectual capital. Likewise, we should include intellectual capital management in Small Business Administration (SBA) training programs and Economic Development Administration (EDA) business incubator programs. We could also create a specific award and assessment program similar to the Baldrige Award.
Assistance for on-the-job training should be expanded. We should also create a program to allow businesses to use their intangible assets, specifically their intellectual property, as collateral on loans. This could provide an important source of capital to help companies finance the transformation. The government could also do more to promote innovative manufacturing through its procurement process and through the establishment of demonstration and technology diffusion programs.
Research on the manufacturing transformation should also be undertaken. But this should go beyond the traditional advanced manufacturing concept to embrace the entire transformation. For example, the concept of “design thinking” is becoming increasingly important in product development. Just like we have created Engineering Research Centers in a number of areas (including advanced manufacturing), we should create one for design thinking. Likewise, research need to be continued on new manufacturing business models and the linkages between services and manufacturing.
Next, it should be recognized that all of the activities described above for helping manufacturing also apply to services. Service industries are becoming more knowledge-intensive and need to understand and better their intangible assets. MEP could be further expanded to a offer assistance to service providers — just as the Baldrige Award was opened up to service businesses. Promoting innovative service delivery activities the government procurement process and through the establishment of demonstration and technology diffusion programs is also just as important as in manufacturing. Likewise, research on the organizational and business model aspects of service delivery should be undertaken.
Thus, it is not just a movement to advanced manufacturing in the sense that Hockfield describes that concept — as important as that is. What we face is a transformation of the entire production system. Companies are already in the middle of that transformation. Our public policy needs to catch up.

Regulations as an innovation forcing function

In earlier postings, I’ve argued that, done right, regulations can be a driver of innovation by creating demanding customers. Here is one small example from today’s Wall Street Journal — “A GM Redesign Achieves Higher MPGs”:

After rising just 10 mpg in the last 30 years, the nation’s fuel economy regulations are poised to rise at least an average of two miles a gallon a year for the next decade. By 2025, the average new vehicle is required to get 54.5 miles per gallon.
Those increases are forcing companies to rethink how they design their vehicles. Honda Motor Co.’s 2012 Civic has specially coated engine pistons that reduce friction. The result is a 2% improvement in fuel economy. The 2012 Toyota Motor Corp. Camry weighs 150 pounds less than this year’s model. Chrysler Group LLC put a more fuel-efficient, eight-speed transmission in its 300 sedan. The car will get more than 30 miles a gallon, compared to 27 mpg in the current model.
In the case of the Chevrolet Malibu, GM engineers spent three years on changes that eked out at least five miles a gallon, creating a car that will go at least 92 more miles on a tank of gasoline compared to the current model. Slicker aerodynamics were just part of their bag of tricks. Lighter materials, such as an aluminum roof, and computer-controls that shut off the engine when idling and open and close grille vents also were part of the mileage boosters.

The story goes on to describe numerous other changes to improve fuel efficiency. None of them are “breakthough” innovations. Rather, they constitute a steady stream on incremental innovations. But they are the type of innovations that are easily overlooked. Without the forcing function of higher goals — in this case in the form of regulations, they are innovations that may not have even been thought of, let alone implemented.
That may the real power of regulations as a forcing function: not necessarily the breakthrough but the smaller, incremental steps. Either way, good regulations can foster innovation – just as bad regulations can inhibit it. Our task is to know the difference.

Bernanke on the near- and longer-term prospects for the U.S. economy

This morning Fed Chairman Ben Bernanke gave his annual address to the Fed policy symposium in Jackson Hole. This year, the topic of the conference was Achieving Maximum Long-Run Growth. In his remarks, Bernanke focused on fiscal, rather than monetary policy. While discussing the state of the economy and the deficit, he also focused on the need for improving US productivity and competitiveness:

Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs. To the fullest extent possible, our nation’s tax and spending policies should increase incentives to work and to save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development, and provide necessary public infrastructure. We cannot expect our economy to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face.

These remarks echo his comments earlier this year at Athena Alliance’s conference on New Building Blocks for Jobs and Economic Growth. In those remarks (see earlier posting on highlights, transcript and video), Bernanke noted:

The topics you will address today and tomorrow, bearing on innovation and intangible capital, are central to understanding how we can best promote robust economic growth in the long run.

Over long spans of time, economic growth and the associated improvements in living standards reflect a number of determinants, including increases in workers’ skills, rates of saving and capital accumulation, and institutional factors ranging from the flexibility of markets to the quality of the legal and regulatory frameworks. However, innovation and technological change are undoubtedly central to the growth process; over the past 200 years or so, innovation, technical advances, and investment in capital goods embodying new technologies have transformed economies around the world. In recent decades, as this audience well knows, advances in semiconductor technology have radically changed many aspects of our lives, from communication to health care. Technological developments further in the past, such as electrification or the internal combustion engine, were equally revolutionary, if not more so. In addition, recent research has highlighted the important role played by intangible capital, such as the knowledge embodied in the workforce, business plans and practices, and brand names. This research suggests that technological progress and the accumulation of intangible capital have together accounted for well over half of the increase in output per hour in the United States during the past several decades.

Unfortunately, as I’ve noted before, many of the policy prescriptions coming out of Washington focus on the generalities and not on any specifics that would foster investment in and utilization of intangibles. When they do look at innovation and intangibles, they focus almost exclusively on technology (as did even Mr. Bernanke, although he did mention other intangibles at the end). If we are to ramp up economic growth, we need to ramp up our attention to intangibles.

End the Doha Round

I don’t often agree with Claude Barfield over that the American Enterprise Institute. But on this one, I think he is completely right — “It’s Time to Dump the Doha Development Round.” (FYI — something that trade attorney Bob Lighthizer proposed over a year ago “Stifling the Economy, One Argument at a Time”.) As I’ve written a number of times before, the Doha Round has outlived its usefulness.
In fact, I’m not sure that the Doha Round wasn’t outmoded from the beginning. Back in 2001, I wrote a paper on After Doha: What The WTO Is Not Talking About. In that piece I speculated that the Uruguay Round might have been the last major comprehensive round of multilateral trade negotiations. During my Senate staff career, I was involved in the beginning and the end of the Uruguay Round. When we finally passed the implementing legislation, I mused out loud that I thought this would be the last global round of trade negotiations. None of my colleagues agreed – and some of the old hands seemed taken aback at such heresy. They argued that you can only get an agreement by linking everything in a big package. (In diplomacy – this is known as “linkage.”)
But the Uruguay Round may have sown the seeds of Doha’s failure. The Uruguay Round changed the internal dynamics of trade negotiation. Global trade talks have become too complex and overarching to succeed in one mega-negotiation. The dynamics that made these trade rounds work is no longer present. Trade talks aren’t about just trade any more. They are talks about the harmonization of economic rules. As such, the old trade-offs no longer apply.
In previous negotiations, the focus was on tariff reduction. I’ll reduce my tariffs on steel if you reduce your tariffs on autos. This allowed for a win-win (from economists point of view) situation that pushed for lower and lower tariffs. Everyone agreed that the end point was lower tariffs. The question was how to get there.
Now it is unclear how the trade-offs work, and in what direction the dynamics points. I’ll lower my tariffs on steel if you increase your patent protection to 100 years? I’ll allow you to subsidize your aircraft industry if you don’t ban my genetically-modified beef? I’ll decrease my agricultural subsidies if you reduce regulations on investment banking?
We don’t have any agreement on what the end point should be. We have a general idea – “open economies” – but we differ dramatically on what that means and on the specifics.
My 2001 piece also made the point that for all the various issues being raised in the Doha Round, a major piece is missing:

Not on the table is a comprehensive look at policies toward information and other intangibles. We are moving to a knowledge economy. Knowledge is both an increasingly important input into the production process and an end-use commodity in and of itself. As the role of information increases in both our economic and social systems, issues of control of information will become increasingly central to our policy and political debates. Parts of the issue are included in the WTO agenda, such as: Trade-Related Aspects of Intellectual Property Rights (TRIPS); the work program on electronic commerce; trade and investment; and the proposal for a new discussion on technology transfer. Missing from the discussions is the recognition of the interconnection between these areas.

My gut reaction to the trade talks is that we will have to approach each of these economic regulatory issues separately – possibly in separate forums, such as the OECD and the G20. Yes, this being a negotiation, there will be linkage. But the complex web of links will not become so great as to bring the entire structure down.
I, for one would welcome, such as shift. As the I-Cubed Economy matures, these economic harmonization discussions need to be ongoing. We are still feeling our regulatory way – and the economy keeps shifting. It is not as simply a matter as hitting a zero tariff number or eliminating a trade barrier. It is an evolutionary process that we need to engage with other countries real-time and continuously.
That is much more difficult that negotiating a trade agreement – but also much more important.
So, if the Doha Round collapses, let us not take it as a sign of failure. Rather, it is an opportunity to build the new international framework for regulating the new global I-Cubed Economy.

2Q 2011 GDP revised downward

This morning, the BEA released the second estimate of the 2Q GDP. The rate of growth of the economy was revised downward slightly to 1% for the second quarter (from an “advanced” estimate of 1.3%). The downward revision was due to more complete data, including data that showed that exports were not as strong as first thought.
As I’ve noted in almost every previous posting on GDP, we need to remember that these numbers are only estimates based on incomplete data. And, as I have noted before, the data has a basic problem in that it does not give us any guidance on investment in intangibles other than software. So we do not know whether companies have increased or decreased their investments in important areas such as human and organizational capital. Work is underway in the UK to survey companies on their investments in intangible assets. We should be doing the same here.

Apple loses an intangible asset – maybe

With the announcement last night of Steve Jobs’ resignation as CEO of Apple, the importance of human capital as a key intangible asset has hit home. I don’t subscribe to the Great Man theory of history. But it is clear that Jobs made a difference. His key skill was in redesigning the industry – starting with Apple II and through to the iPod/iPhone/iPad. And it hasn’t been limited to products. And, as I have argued before, the big breakthrough was as much the business model of iTunes as it was the iPod design.
However, it is unclear what the final impact of yesterday’s announcement. Jobs will still be involved in setting Apple’s future course as Chairman of the Board. Jobs has also assembled a strong team, including Jonathan Ive, who some say is the real genius behind the design of the iPod. And Apple has built a strong culture of creating a “customer experience” that feeds customer loyalty. This relationship with its customers (aka fan base) is a strong intangible asset in and of itself (see earlier posting).
Of course, it was Jobs who pulled everything together. So the real question will the Jobs vision continue post-Jobs. Or will the team slowly fade away. We are not yet in that post-Jobs future. But is it is clear that an era may be ending.
UPDATE: One of the standard intangible assets is of course IP. Here is an interesting story from the Wall Street Journal on Jobs and Apple’s protection of its IP — “Controversy Surrounded Jobs’s Innovations”.

Job creation in start-ups

E.J. Reedy and Bob Litan at Kauffman Foundation have written a new report on start-ups and job creation — Starting Smaller; Staying Smaller: America’s Slow Leak in Job Creation. The report highlights the fact that the job creation slowdown predates the beginning of the Great Recession.
Interestingly, the problem has not been a lack of start ups. In fact, the report notes that the 2010 Kauffman Index of Entrepreneurial Activity was at an all time high. The reason for the job slow down has been a decrease in the average number of jobs being created by new firms:

BLS data show that new establishments opened their doors with about 7.5 jobs on average for much of the 1990s, a figure that has since declined to 4.9 jobs per new
establishment.
. . .
the most recent year of data shows a cohort of new business that was smaller in number and in jobs created than in any cohort since 1994 and, in most cases, than any previously measured cohort in data dating back to 1977.

And the problem is not just that new companies start out small. They also have stayed smaller.

The average rate of employment growth from birth to age two and then age two to age five has been decreasing in all the data series, with only moderate yearly variation. So, while the levels might vary slightly in the different data series, the trends appear similar: Businesses that survive their early years of existence have been adding jobs at a slower pace than the historic norm in recent years. (emphasis in original)

So the problem is not start-up, but scale-up.
To me, this calls for a different approach to public policy. The recent focus has been on the start-up process, for example the President’s Startup America (see this posting on the Kauffman blog for an update of the program). This new look at the data tells me we need to focus more attention on the growth phase. There are a number of things we could be doing to help established business grow faster. For example, we could expand the Manufacturing Extension Partnership (MEP) programs to encompasses a broader range of business assistance services (including management of intangible assets) to a broader range of companies. We could also increase funding for high-growth intangible-rich companies by allowing intangible assets (such as patents and other IP) to be used as collateral for loans. Creating a pilot program on IP backing lending at SBA would be the first step.
Bottom line: entrepreneurship is good; scaling up from start-up to high growth is better. Time we start paying more attention to the latter part of the process.

Sic transit innovation – and the broader role of intangibles

Innovation needs to be a verb. Unfortunately, most people think of it as a noun. Innovation is a thing, an outcome. As Webster’s defines it: a new idea, method or device. But we also need to think of innovation as a process.
Case in point is the recent history of Motorola. As everyone now recognizes, the proposed takeover of Motorola Mobility by Google is based on access to the Motorola patent portfolio. The acquisition has little to do with Motorola’s hardware technology. In fact, as a story in today’s New York Times (“Motorola’s Identity Crisis”) points out, Google may have difficulties figuring out what to do with Motorola’s hardware activities. Google already has close relations with other hardware manufacturers, such as Samsung and HTC. Getting into the hardware business could disrupt those relationship.
This is far cry from Motorola’s reputation as an innovative leader. Motorola pioneered wireless communications, starting with the first “carphone” (a radiotelephone) in 1946 to the first commercial cellular phone (the DynaTAC 8000X) to the breakthrough flip phone StarTAC and the hot selling RAZR. Motorola also led in process technologies in the late 1980 with the development of the Six Sigma quality improvement program.
The acquisition could be a huge positive step for Google if it can find a way to harness the innovation processes in Motorola. Controlling the previous innovations (noun) in the form of the patents is far different from exploiting innovation (verb) capacity latent in the Motorola Mobility organization. That capacity in embedded in a variety of intangibles — from the innovation tradition and culture to the skilled workforce.
On the other hand, maybe all that changed with the split of the company last year into Motorola Mobility and Motorola Solutions. It could be that all that innovation capacity now resides in Motorola Solutions. If so, then Google has only bought itself some innovation-as-a-noun. Innovation-as-a-verb may continue somewhere else.

Understanding the patent boom

If you want to understand what is happening with the recent patent boom, here are two stories to read: Steve Lohr’s “A Bull Market in Tech Patents” in the New York Times and Jia Lynn Yang’s “Four titans of tech are racing to be king of digital age” in the Washington Post.
It is not as if companies just realized the value of IP and innovation.
It is about dominating the next technological platform.
Not that this is necessarily a bad thing if it brings greater attention to intangible assets. As a NY Times Dealbook story (“Quest for Patents Brings New Focus in Tech Deals”) relates:

“Before, nobody really paid attention to patents. Now patents are emerging as a new currency,” said Alexander I. Poltorak, chief executive of the General Patent Corporation, a patent licensing and enforcement firm. “I’ve recently received several calls from financial analysts and bankers who want to know how to value patents and what does it mean.”

Unfortunately, it may be a bad thing if it only feeds the litigation mindset. The concept of intangibles asset monetization easily be dismissed as only an innovation-blocking defensive strategy. Yet the utilization and management of intangibles can be a powerful positive and innovation-inducing business strategy (see earlier posting). It would be a major lost opportunity if we can’t make the positive case for intangibles right now.
And by the way, for the latest on the patent wars behind all this, check out these two stories in the Wall Street Journal — “Cellphone Patent Disputes Piling Up” and “Founder of Priceline Spoiling for a Fight Over Tech Patents”.