Edge Perspectives with John Hagel

Stupidity and the Internet

Nick Carr has a talent for stirring debate.  I’ve been drawn in to such debates in the past and, once again, I find that I cannot resist.  This time, in an article in The Atlantic, suggesting that the Internet might be making us stupid, Nick set off a firestorm of debate and discussion in the blogosphere as the digerati piled on in defense of the Internet. Some of the best responses (including some rejoinders by Nick) are available at the Edge and the Brittanica blog.  But what was not said was often more interesting than what was said.

As might be expected, much of the debate focused on Nick’s core contention: the Internet is subtly molding our minds to favor brief snippets of information rather than the nuance and complexity that can only be communicated in much longer forms such as books.

Content became the battleground.  Are snippets superior to more in depth writing and analysis?  Some came to the defense of books while a surprising (to me) number of participants celebrated the passing of books from our consciousness – especially since many of the latter had written books themselves. Those who came to the defense of books then divided into two camps - those who agreed that books were endangered by the Internet and those who took a more optimistic view of the ability of earlier generations of media to co-exist with newer forms.

But two things were common across much of the debate.  First, it centered on content.  Second, it took the Internet in its current form as a given.  Perhaps it is time to challenge both of those assumptions and re-frame the debate.

Is content all there is?

To be fair, Nick is primarily concerned about the impact of the Internet on our reading habits.  This is to be expected from someone who is a fine editor (having worked with him) and author. But it is an interesting sleight of hand that Nick performs very early in his article: “I’m not thinking the way I used to think.  I can feel it most strongly when I’m reading.”  Thinking collapses to reading and then the rest of the article focuses on our reading habits.  This sets up the debate about content – short vs. long.

But if the concern is about intelligence, thinking and the mind, then isn’t content just one small piece of the puzzle?  Nick and many of the digerati who line up against Nick have one thing in common – they are content junkies.  They consume content voraciously and care deeply about the form that content takes. 

In the heat of debate, they seemed to often lose sight of the fact that most people are not content junkies.  Most people use the Internet as a platform to connect with each other.  Sure, they are exchanging information with each other, but they are doing a lot more than that.  They are learning about each other. They are finding ways to build relationships that expand their understanding of the world and enhance their ability to succeed in their professions and personal lives.

Now, there’s certainly a lot to debate about the impact of the Internet on this level as well. Are virtual relationships shallower than face to face relationships?  Do virtual relationships enrich or detract from face to face relationships? What is the trade-off between quantity and quality in relationships? To what extent can virtual relationships support the communication of tacit knowledge? Do we seek out virtual relationships that merely reinforce our existing points of view or that expand our perspectives? 

But it is interesting is that very few sought to expand the terms of debate to address these questions.  Yet, if the debate is really about the impact of the Internet on intelligence, aren’t these just as important, if not far more important, than narrow debates about the forms that content will take?

Where is the Internet headed?

The debate also largely took the Internet, and specifically the World Wide Web, in its current form as a given.  This is a dangerous assumption given the speed of change in the underlying technology foundations of the Internet. 

As one small example, we are seeing rapid evolution of both social network platforms and physical presence tools that will lead to a much more complex interweaving of physical and virtual environments. Sensors and imaging tools will give us much greater visibility into the world around us.

Today, navigation on the Internet is heavily shaped by search tools – but these search tools are geared to locating (surprise!) content. We are just now beginning to see tools emerge to help us find people and more effectively learn who they are.

We are also at the earliest stages of figuring out how to create environments that enhance serendipity and make visible the relationships and patterns that today lurk behind the cascade of events and snippets of information. The World Wide Web that was designed by content junkies for content junkies to more rapidly locate more snippets of content is already giving way to much richer platforms that will help people to connect with each other and engage together in sustained efforts to create new knowledge.

Tacit knowledge – that which cannot be readily expressed in published content of any length, whether snippets or books – has always been our most valuable knowledge. You can read all the books you want on brain surgery, but that alone will never qualify you to perform brain surgery. At an even simpler level, no book can teach you how to ride a bicycle.

The ultimate impact of the Internet on our intelligence will hinge on its ability to support the creation and sharing of tacit knowledge. Again, we are at the earliest stages of tapping into this potential.

Stories offer potential to communicate some elements of tacit knowledge.  They help to provide enough of a sense of context to reconstruct and extend parts of the tacit.  Stories, properly told to communicate the richness of context, do not reduce to snippets.

In the end, though, tacit knowledge will only flow through shared practice and the deep relationships that build up around shared practice.  Some examples of shared practice can already be found on the Internet in such diverse arenas as open source software and online games like World of Warcraft. This is one more area that the Internet will likely evolve to support much more effectively in the years ahead.

Snippets versus books?

OK, so maybe it is unfair to change the terms of the debate.  Maybe we should just take Nick on the terms that he has defined for the debate.  If it is about content, will snippets trump books and will we all be dumber for it? As someone who has never mastered the art of the snippet, let me proudly count myself as one who still sees profound value in the long form where texture and nuance can be teased out and explored.

But let me also align myself with those like David Brin who bridle at the zero sum nature of the debate.  It makes for good copy to proclaim that the book is dead or that snippets rule.  But the truth as always is in that textured middle.  Snippets of information, loosely coupled, have enormous value in enhancing peripheral awareness and provoking new ideas.

At the same time, snippets of information alone are deeply dangerous.  They distract us with never-ending waves of surface events, spreading us ever thinner and obscuring the deeper structures and dynamics that ultimately are shaping these surface events.  Those of us who stay only on the surface, swimming in a sea of snippets, will ultimately lose sight of land. 

We need books, or whatever the digital long forms of content are that will replace the book, to help us penetrate the surface and explore the deeper structures and dynamics that make sense of the changes around us.

Rushkoff is right – we need to develop a better understanding of the strengths and limitations of each medium available to us and find the right mix to give us the greatest insight. Larry Sanger also makes an important point – Nick is adopting a technological determinist view, ignoring the fact that we each have a choice in terms of what media we use.  I, for one, will continue to buy and read (and occasionally write) books while still actively surfing the Net.

Evolution favors those who can make sense out of evolving landscapes. Those who figure out how to navigate both media worlds will tend to survive and thrive relative to those who either abandon books or ignore the power of loosely coupled information.

Innovation on the Edge

I’ve played on the edge throughout most of my professional career, whether it was doing deals in the Sultanate of Oman back in the 1970s, building a start-up around a new technology called the microprocessor in 1980, building a new Internet-focused practice for McKinsey in 1993 or spending more time in places like Bangalore, Shenzhen and Shanghai in the early part of this decade (my first visit to Shenzhen was actually in 1982 when I led a major manufacturing offshoring initiative there).

The emergence of a theme

Instinctively, I have been drawn to various edges because of the opportunity and challenge they represent. Over time, I have focused more sharply and explicitly on the importance of the edge as a source of value creation and strategic advantage – hence the title of my blog “Edge Perspectives,” the title of my most recent book (co-authored with JSB), The Only Sustainable Edge, and the name of the new research center that JSB and I lead at Deloitte – the Center for Edge Innovation.  See a pattern here?

The Business Week column

About six months ago, JSB and I launched another edge initiative. We signed on to do a monthly column on the Business Week website called – are you ready? – “Innovation on the Edge.” Business Week has now made available a repository of our columns here (an RSS feed is also available at this location).

As a brief overview, here are the columns that have gone up on the Business Week website to date:

• Embrace the Edge -- or Perish – our opening salvo on the importance of the edge
• Phoning from the Edge – exploring Google’s edge innovation in telecommunications
• Catching the Innovation Wave – discussing insights from innovation in big wave surfing
• Learning from Tata's Nano – highlighting what was not discussed in the publicity surrounding the unveiling of this new automobile
• Life on the Edge: Learning from Facebook – analyzing some innovation initiatives on the Facebook platform
• Institutional Innovations – exploring an innovative approach to pursuing medical research

Why edges matter

From our perspective, edges take many forms.  They describe and define the edge of a company, the edge of markets or industries, geographic edges like emerging economies, demographic edges (either new generations or older generations) or the edges of specific domains of knowledge.

Most executives scratch their heads when I start talking about the edge.  Why bother about the edge when everyone knows that all the profit is in the core? Besides, edges are risky. Modest revenue, high risk, low return – isn’t the edge just a distraction?

In our first column for Business Week here, JSB and I explained why the edge matters in terms of innovation:

Edges are powerful sources of business innovation because they are places of potential and friction, where traditional products and practices are no longer adequate to address unmet needs or unexploited potential. Much tinkering and experimentation occurs on the edge, as well as heated debate about the most promising options to address emerging needs, intensified by the diverse backgrounds, skill sets, and perspectives of participants gathering on the edge. By playing a part in this experimentation, companies participate in rich flows of new knowledge, flows that are the primary sources of innovation.

Edges tend to be risky places: There are no well-established road maps. Order, to the extent it exists, routinely dissolves into chaos, only to reform again in a very different pattern. Market meltdowns and business failures are commonplace. Relationships form quickly on the edge, because people have less confidence in going it alone and are more inclined to seek out others to help them sort through the challenges and share the risks and opportunities created by edges.

A couple of other factors make edges particularly fertile grounds for innovation.  Edges tend to attract risk-takers, so there are a lot of people on the edge who are not only open to ideas, but more willing to act on them, even if they haven’t been tested yet.  At the same time, there are few entrenched interests or legacy assets on the edge, so there are few resistance points ready to impede those who want to try something different.  Bottom line – there’s less inertia on the edge.

Edges have always been a seedbed for innovation, but there is something different now.  Edges are folding back in on the core much more rapidly than ever before. Think of the telecom industry – it wasn’t so long ago that wireless networks were a minor edge to the wireline networks.  Now, many younger customers only own a cell phone and are somewhat puzzled about why anyone would own a fixed line phone.  Voice communication used to be the core of all telecom networks but now data has become the core of network traffic.

So, there is an even more compelling reason to participate on the edge.  If the edge becomes the core, edge advantage soon becomes core advantage. Those who remain focused on the core risk being blindsided by new forms of advantage that emerge first on the edge.  To use another meaning of edge, participating successfully on the edge will be essential to developing and sustaining a strategic edge.

The bottom line

To reduce this to a simple formula:
Edge = Innovation = Edge

Shift Happens – The Future of Advertising

In a world of rapid change, shift piles upon shift.  One can get thoroughly confused and draw the wrong conclusions by focusing on one change while losing sight of the shifts that are coming up.

Advertising is a case in point.  Seismic shifts are shaking up the world of advertising big time. But which shift is most relevant?  And what are the implications for executives?

Understanding the shifts

In the advertising world, multiple shifts are piling on top of each other and it is often hard to keep track of them, much less understand their implications. Let’s look at just some that are re-shaping the advertising world:

• Shifts from advertising placed in digital content to ads placed in social networks and applications
• Shifts from digital advertisements delivered through conventional PC’s to a growing array of mobile devices, with an increasing ability to target messages based on the physical location of the person
• Shifts in the behavior of digital users in their responsiveness to advertisements online
• Shifts in the way that companies connect with and build relationships with stakeholders (e.g., blurring boundaries between customers, partners and suppliers)
• Shifts in the revenue models for businesses, as online businesses in particular become more and more dependent on advertising as a key revenue source (e.g., is there any Web 2.0 start-up that doesn’t blithely answer “advertising” when asked about their revenue model?).
• If that isn’t complicated enough, we also have broader macro-economic shifts like potential near-term recessionary pressures

Whew! No wonder it’s easy to get confused, especially since one set of changes can offset or even reverse the impact of another set of shifts.  So, how do we make sense of all this?

In essence, three fundamental shifts are piling on top of each other.

• Advertising is migrating to digital media because it is far more effective in targeting and reaching relevant audiences than most traditional media.
• Aggregate advertising spend in the US is likely to experience a cyclical downturn as the economy softens
• People are confronting a proliferation of sources competing for their attention and becoming less receptive to advertising messages, even when they are very well targeted

Here’s the danger: we may become so focused on the recent growth in online advertising that we dismiss any short-term slowdown in spending growth as a purely cyclical phenomenon. In the process, we may miss the longer-term, and ultimately far more profound, impact of the diminishing returns that online advertising is already beginning to experience.

This is particularly relevant in the Internet space. Virtually everyone seems to be zeroing in on advertising as the basic revenue model. Titanic battles among Internet gorillas, including mega-acquisitions, are at least in part motivated by a desire to occupy choke-points in the advertising value chain. 

The likely evolution of Internet advertising

The basic paradox of the Internet can be framed very simply:  The very platform that makes advertising both more relevant and more measurable is the same platform that longer-term will challenge and ultimately undermine the basic role of advertising in communicating with customers. 

Why will the Internet ultimately undermine advertising?  A number of factors come into play:

• The Internet proliferates resources, all competing for the attention of people.  Even the most targeted and relevant ads over time will have a harder and harder time rising above the noise.
• The Internet creates powerful options for people in terms of how they become aware of new products and services and how they obtain information about the products and services that are relevant to them.
• The Internet offers increasingly powerful tools to filter and block advertisements (and, yes, product placements will be an interesting alternative for a while, until even that space becomes so cluttered that people will mentally filter out the products)

On the second point, social network sites provide increasingly robust platforms for us to learn about what our friends are interested in and purchasing (although in many cases still trying to figure out the appropriate balance between privacy and attention). In this context, Esther Dyson wrote a great op ed piece in the Wall Street Journal on February 11 on “The Coming Ad Revolution” (a longer version is available at her blog here) highlighting the “walled gardens” that users themselves are cultivating to connect with each other and with favored vendors.

Amazon continues to represent a leading edge example of how a trusted third party intermediary can help filter and present information about the interests and purchase patterns of others in ways that are very helpful in discovering new products. We are still a long way from the infomediaries that I wrote about almost ten years ago in Net Worth. However, the proposition of a trusted advisor who can help us sort through the growing array of resources and discover those that are truly relevant and valuable becomes ever more compelling.

As we find richer and more diverse ways to connect with friends and trusted advisors who can help us discover what we need, conventional advertising – even with all of the best behavioral targeting algorithms - will become viewed at best as marginal value and at worst as an increasing nuisance. People want to connect with vendors, especially vendors that can address unmet needs, but they will increasingly want to do it on their terms.

Advertisers are wrestling with this shift in user preferences.  Recent declines in online click-through rates and the especially dismal click-through rates experienced on social network sites like Facebook should be an early red flag regarding the challenges ahead.

Implications for advertisers

For advertisers, the key message should be to build the skills required to genuinely engage people around their products and services in such a compelling way that people seek them out – and keep coming back because they have received so much value. The old game of paying for placement of messages, no matter how targeted, will yield diminishing returns. The long trajectory that will shape the advertising business is the move from random interception to targeting intention to seeking attention and ultimately to attracting attention. 

The end game is collaboration marketing where advertising, meaning paid placements of messages, becomes more and more marginal. The focus shifts to becoming more helpful by creating rich, serendipitous environments that people will actively seek out (there’s a lot more to be said on this front, but this is a blog after all, so the details will be left to the imagination of the reader).

I want to be clear: while I am skeptical about the long-term future of advertising as paid placements of messages, marketing becomes more and more important in an era of abundance.  Companies of all kinds will wrestle with growing challenges in terms of connecting, and building deep relationships, with key stakeholders.  I also understand that advertising does far more than convey information; it also excites and engages people in imagining how their lives could be improved with the vendor’s products.  Marketing will still need to address this emotional and psychological mission – my only point is that advertising in online environments will be increasingly marginalized as the vehicle for accomplishing this mission. Will advertising go away?  Hardly, but it will move from the core of marketing to the edge, challenged by diminishing returns and more robust options for engaging people.

Implications for revenue models of businesses

If advertising is likely not to be a sustainable revenue source, it means that online businesses must find other sources of revenue to support their businesses long-term.  What might be some of those revenue sources? Well, one option is to get customers to pay. In this regard, Kevin Kelly has an interesting post on “Better Than Free”.  Observing that the Internet is a vast copy machine that makes copies of everything super-abundant and free, he concludes that “when copies are free, you need to sell things which can not be copied.” Kevin highlights eight uncopiable values that can in one form or another be sold – immediacy, personalization, interpretation, authenticity (meaning here certification of authenticity), accessibility, embodiment, patronage and findability. It is a thought provoking piece and, for my money, it begins to shine the light on the key question: what will people continue to pay for in this digital networked world?

Kevin’s perspectives are largely framed in the context of digital goods and services that are the core of the Internet today.  More broadly, until fab labs become consumer items, physical goods that cannot be reduced to digital code will still command a price, although we need to be ever watchful about the extent to which these goods will be transformed into services (look at what’s happening to computers as they get sucked into the cloud). 

And, if Chris Anderson is to be believed in the preview to his forthcoming book, more and more things will be free in the economics of abundance. But even Chris ultimately circles around to finding money.  As he observes, “to follow the money, you have to shift from a basic view of a market as a matching of two parties — buyers and sellers — to a broader sense of an ecosystem with many parties, only some of which exchange cash.” While he acknowledges advertising as one source of cash, Chris offers a much more nuanced view, tapping into a number of other cash reservoirs.

So, where’s the money?  Here’s my answer: to find the money, seek out scarcity.  Abundance in some areas inevitably creates scarcity in others. Attention, reputation and talent become relatively scarce in economies of abundance.  Businesses will be well positioned to charge for their services if they can deliver one or more of the following values:

• help amplify attention through more effective advice/recommendations
• foster and protect reputation
• help amplify talent development through rich learning environments

The real winners will realize that amplifying return on attention, building reputation and developing talent are deeply and intricately related – the most valuable platforms will address these needs in powerful new ways.

Bottom line

Bottom line, if entrepreneurs want to build hot properties that can be flipped quickly, relying on advertising as the primary revenue source in the near-term may be OK – it will position you for a robust exit as long as investors stay focused exclusively on the first shift (I can hear a lot of my entrepreneurial colleagues breathing a deep sigh of relief at this point). 

On the other hand, if entrepreneurs want to build enduring businesses that will change the world, resist the temptation to become too dependent on advertising. It’s OK to offer many products and services for free (in fact, that will be essential for success) but just be sure you understand your role in a broader ecosystem where someone (even if it is not directly you) is making a ton of money with platforms and services that people will pay for. In particular, look for ecosystems with platforms and services that generate increasing value as the number of participants expands.

(PS – I appropriated the title of my posting from a great YouTube video of the same name – the video, created by Charles Frisch, looks at globalization and information trends and is well worth viewing. I believe it was Jean-Louis Gassee, a Silicon Valley entrepreneur, who first used the term.)

Addendum: Here's another great YouTube video that captures the dilemma of many advertisers (hat-tip to Max Bleyleben).

The Service Economy Made Tangible

Everyone knows that we now live in a service economy much more than an industrial economy.  But sometimes it helps to see some statistics to drive this point home.

Here are some that I came across in a recent article on “Old School Economics” by Christopher Caldwell:

• “the U.S. now has more choreographers (16,340) than metal-casters (14,880)”
• “more people make their livings shuffling and dealing cards in casinos (82,960) than running lathes (65,840)”
• “there are almost three times as many security guards (1,004,130) as machinists (385,690)”

According to a chart accompanying the article, there are also more fashion designers (15,670), landscape architects (22,130) and meeting and convention planners (42,510) than metal-casters (14,880).

We're not in Kansas any more.  It will unfortunately take a bit longer for economic analysis and management practices to catch up to all the implications of this transition.

Innovating on the Edge of Big Waves

On Saturday, January 12, surfers from around the world converged on Maverick’s to challenge each other on the big waves that have made this a legendary surfing destination. The sixth Maverick’s Surf Contest had been announced only forty-eight hours earlier to ensure optimal wave conditions for the contestants. Surfers from as far away as Australia, Brazil and South Africa scrambled to make their way to this invitation only competition at Pillar Point, just a few miles away from San Francisco. It was magical to watch these athletes challenge twenty foot waves with an ease and grace that made it all seem so natural.

Beneath the surface, though, there is a different story here, one that contains important lessons for business executives. While all attention was on the athletes riding their surfboards, the technology and techniques used to master big wave surfing have evolved over decades, driven by dedicated, perhaps even obsessed, groups of athletes and craftsmen. Executives can gain significant insight into the innovation process by looking in unexpected places like the big wave surfing arena.

Innovations in big wave surfing

Surfing has a long and distinguished history.  The activity had been pursued for centuries by the Hawaiians, where it was a central part of their daily life.  Surfing was pursued with great rituals and it served a key role in Hawaiian culture to strengthen the status of the king and nobility relative to commoners. The surfboards used by the king and nobility were made of fine woods,  and were long and very heavy, measuring up to 25 feet long and weighing up to 175 pounds. Surfing fell into disrepute and became virtually extinct in the 19th century under the pressure of newly arrived Western missionaries, who disapproved of the state of undress and mixing of sexes associated with surfing at the time.

Surfing slowly regained a following in the early part of the twentieth century but it was not until the early 1950’s that big wave surfing began to attract attention.  Ten foot single-finned surfboards with a balsa core and wrapped in a new material coming out of the aerospace industry – fiberglass resins - were introduced in the early 1950’s specifically to tackle big waves – at the time considered to be 10 to 20 foot waves. Along with new materials like Styrofoam and polyurethane foam, surfboard shapers were able to cut the weight of the surfboard in half while increasing the strength of the board. These advances made the sport accessible to a much broader group of younger enthusiasts.  Surfing enthusiasts in southern California developed a distinctive lifestyle and culture on the margin of 1950’s button-down culture.  Known disdainfully as “surf bums”, one of the early participants indicated that “surfing was not something you did, but something you became.”

In 1953, a group of these southern California surfers, including Greg Noll, inspired by newspaper photos of surfers tackling fifteen foot waves, boarded flights to Hawaii and made the trek out to Oahu’s Makaha Beach. There, the warm water and gently tapered waves proved to be a fertile ground for the next stage of big wave surfing. A couple of years earlier, a mainland transplant by the name of George Downing, one of the early pioneers of big wave surfing, had come up with the idea of adding a changeable stabilizing fin to his surfboard to provide greater control. Known as an “elephant gun”, later shortened to just “gun”, these boards helped surfers to tackle 15 foot waves with ease.

In 1957, Greg Noll, one of the California émigrés, headed to the North Shore of Oahu where famed Waimea Bay became the next test bed for athletes seeking to push the boundaries of big wave surfing. In the isolation of the North Shore, dedicated surfers spent 8 – 10 hours each day, every day, challenging themselves and each other on the big waves of Waimea Bay. Using the skills and techniques mastered there, Noll succeeded in riding a 35 foot wave at Makaha in 1969, the largest wave ridden until that time, staying that way for another 20 years. In his autobiography, Noll described “looking over the . . . edge at the big, black pit. . . . I didn’t think so at the time, but in retrospect I realize it was probably bordering on the edge.”  Noll had a magnetic personality and was instrumental in generating interest and publicity in big wave surfing, helping to build a very large surfboard business - Greg Noll Surfboards was the largest surfboard maker at the time.

It wasn’t until the early 1990’s that another surfing pioneer, Laird Hamilton, working with a couple of other surfing greats, came up with the innovations that would finally allow big wave surfers to tackle waves significantly greater than 30 feet.  Hamilton and his team looked for inspiration to wind surfing where sails helped windsurfers to achieve the speeds required to tackle really big waves and flat water freeboarding where boats were used to tow surfers much like water skiers. From these arenas, Hamilton and his team latched on to the idea of towing surfers into big waves with inflatable Zodiacs and then jet skis. Harnessing a sling shot effect made it possible for surfers to gain the speed required to catch and ride larger and larger waves.

Tow-in surfing, as it became known, was further helped by insights from snowboarding.  Working with leading surfboard shapers, Hamilton and his team challenged the conventional wisdom that longer boards were required to surf big waves and instead introduced much shorter boards with straps for the feet to provide much greater control in coping with the speed and turbulence of really big waves.

Pursuing these new practices and design ideas, Hamilton and the others working with him recognized that challenging larger and larger waves required a team effort.  Honing their craft at Jaws, a break off Maui, these surfing teams by the end of the decade were regularly riding 50 foot waves with ease.

While many of the surfboard design breakthroughs and towing techniques were first developed on the relatively remote north shore of Oahu, groups of dedicated surfers around the world at big wave sites like Maverick’s in California and similar breaks in places like Western Australia and South Africa worked closely with each other locally to perfect the practices required to fully exploit the potential of these new technologies and designs. Practicing in isolation, these surfers would regularly convene to test their capabilities and learn from each other in big wave competitions in places like Maverick’s, Waimea, Todos Santos and Pico Alto.

Bottom line for business executives

So, what can business executives learn from the experiences of these intrepid surfers?  First, if you want to push your performance levels, find the relevant edge.  In the case of big wave surfers, there has been an ever-expanding search for the breaks that would produce bigger and rougher waves to test new board designs and surfing practices.  Major breakthroughs in performance did not occur in the milder surf of Malibu, but in the pounding surf of Waimea and Jaws or the notorious Teahupoo break of Tahiti.

Following the lead of big wave surfers, business executives need to find relevant edges that will test and push their current performance.  For example, companies making diesel engines and power generators should be actively engaged in finding ways to more effectively serve lower income customers in remote rural areas of emerging economies. These demanding customers could prompt significant innovation in both product design and distribution processes in an effort to deliver greater value at lower cost. The innovations resulting from these efforts on the edge could lead to significant improvements in their product lines more broadly.

Second, attract motivated groups of people to these edges to work together around challenging performance issues.  There are great stories about Jeff Clark who surfed Maverick’s solo for fifteen years before the “break” was discovered by the broader surf community, but the real advances in surfing technology and practices occurred at the breaks where surfers gathered and formed deep relationships over extended periods of time.  They learned rapidly from each other and pushed each other to go to the next level.

Large companies have become very adept at establishing remote outposts in places like Beijing, Hyderabad, Haifa and St. Petersburg to attract local talent and push challenging research and development projects. Often, though, these outposts either become disconnected from their parent companies or fail to establish deep linkages with other leading edge participants in the local area.  The key challenge is to connect these company-owned facilities more effectively with their local environments as well as with each other through challenging and sustained innovation initiatives that build long-term trust based relationships.

Performance improvement generally comes first in the form of tacit knowledge that is difficult to express and communicate more broadly. You literally have to be there to gain access to this tacit knowledge.  Big wave surfers who watched Laird Hamilton tackle the Teahupoo break in Tahiti for the first time in 2000 noticed that he put his right hand into the wave on a left breaking killer wave, something unheard of in surfing. It was an instinctive move on Hamilton’s part; he had never done it before and he was not even aware of doing it, but it was enormously effective in coping with the distinctive power of these waves. Those who were there to observe this and who had deep understanding of the practice of big wave surfing realized immediately that a powerful new practice was being developed.

Third, recognize that the people who are likely to be attracted to the edge are big risk-takers. Greg Ambrose, a surfer, observed that "When surfing Waimea it is essential to have the proper crazed attitude that implies a certain reckless disregard for personal safety. If you paddle out thinking you are going to get hurt, you will. If you think you can't make the drop, you won't. If you begin to wonder what in the world you're doing out among those menacing waves, it's time to be thankful you're still alive and head for the beach."

This is a key reason why the edge becomes such a fertile ground for innovation.  It attracts people who are not afraid to take risks and to learn from their experiences. They have a different disposition, relentlessly seeking out new challenges. Executives need to be thoughtful about how to attract these people, provide them with environments to support risk-taking and reward them for both successes and failures.

The natural response is to create highly segmented organizations – one part of the company focuses on the core business while separate organizational units focus on highly innovative (and more risky) business initiatives.   The challenge with this approach is to bring the edge back into the core.  The innovations spawned in the edge organizations are often critical to the continued success of the core business, yet the different cultures, mindsets and skill sets create significant barriers to learning.  Executives need to balance organizational focus with aggressive performance challenges and incentive structures that reward collaboration across these organizational units.

Fourth, recognize that the edge fosters not just risk-taking, but very different cultures that are also “edgy”.  The advances in big wave surfing did not come from the casual surfers, but those who developed an entire lifestyle and culture, fostered by intense and even obsessive concentration on pushing the envelope.  The early big wave surfers in Waimea were so obsessed they lived in close quarters right on the beach and relied on the sea and the occasional stolen chicken or pineapple for food. Dismissed as “surf bums” by mainstream society, they developed their own distinctive identity.  Executives need to find ways to protect and honor these edgy cultures, whether it is the tattooed web designers or the next generation of employees who learned how to innovate as members of guilds in World of Warcraft.

Fifth, find ways to appropriate insights from adjacent disciplines and even more remote areas of activity.  The aerospace industry could not be further removed from surfing, yet early advances in surfing technology came from this industry, because some of the employees in this industry were also avid surfers.  Some of Laird Hamilton’s greatest insights came from his experiences as an expert windsurfer and his colleagues’ experiences with snowboarding. By attracting diverse backgrounds and experiences to the edge, executives can foster creative breakthroughs.

Sixth, bring users and developers of technology closely together at the edge.  It is no accident that the most innovative surfers also tended to be expert shapers of surfboards. These folks not only designed surfboards but shaped the materials into the finished product and then took them out to life-threatening breaks to test them and refine them. They were relentless tinkerers, integrating experience, intuition and craft making skills to come up with creative new boards. Downing and Noll were both proficient shapers, driven by their experiences in using their own surfboards, and Laird Hamilton is the adopted son of one of the most renowned surfboard shapers, Billy Hamilton.  Eric Von Hippel has written extensively about this phenomenon in other extreme sports arenas and the same pattern plays out here – technology and product innovations critically depend upon deep and extended interaction with leading edge users.

Technology and practice are intimately linked.  Very little performance improvement comes directly out of the technology itself.  It is only when seasoned practitioners engage with the technology, especially in close-knit communities, and evolve their practices to better use the technology that the real performance breakthroughs occur. One of the big wave surfers watching Laird Hamilton first getting towed into a big wave said the wave was no bigger than the waves that had been paddled before, but the technique was clearly different. It set the stage for a new “S-curve” of performance improvement. Evolving practices in turn generate insight to the product designers for future waves of design innovation.

Finally, executives could profit from understanding the loose practice network that evolved around big wave surfing.  Key individuals like Greg Noll, Laird Hamilton and Jeff Clark have played pivotal roles in shaping and growing this network.  They certainly have not applied the traditional management techniques that most executives use, but they have been very effective in attracting world-class talent, focusing that talent on challenging performance goals and helping to disseminate the learning that came from these efforts. Complex and shifting relationships among athletes, commercial enterprises and competitions shaped the advances we have seen in big wave surfing. These new management techniques, or perhaps more accurately, orchestration techniques will increasingly determine who creates value and who destroys value when seeking to innovate on the edge.

(Note: This is a longer version of a column that John Seely Brown and I have written for Business Week. JSB and I have written a working paper on Creation Nets that focuses more explicitly on the management techniques required to deliver business value from the kind of collaboration described above. Also, for other examples of innovation on the edge of other extreme sports, check out Eric von Hippel's Democratizing Innovation and The Sources of Innovation). Finally, for those really energized about this brief description of the history of big wave surfing, check out the fantastic documentary Riding Giants or just go ahead and buy  Riding Giants (Special Edition) at Amazon.  There's a clip from the documentary at Youtube that highlights the tacit knowledge example of Laird Hamilton surfing in Tahiti (hat tip to Ethan Eismann.  For those who want to learn even more about the history of surfing, check out Matt Warshaw's excellent The Encyclopedia of Surfing.)

Fractal Spikes and Global Competition

In my last blog posting, I mentioned the increasing value of place.  At a time when information technology is supposed to make location irrelevant, we need to wrestle with the paradox that location is becoming more, rather than less, important. In fact, place is becoming an ever more critical dimension of competition in global markets. Executives who dismiss the value of place are likely to find themselves marginalized.

Microclusters

In this context, Steve Lohr wrote a fascinating article in the New York Times on December 20 entitled "Silicon Valley Shaped by Technology and Traffic" making the case that Silicon Valley actually consists of multiple “microclusters”.  Geographically, the microclusters array as follows:

While there are plenty of exceptions, it is generally true that hardware clusters – semiconductors, disk drives and network equipment, for example – are in the South Valley, around San Jose and Santa Clara. . . . . Moving farther north in the Valley typically means moving farther away from the guts of the machine and climbing up the tiers of computing – from chips and layers of business and consumer software and then into San Francisco, home to people with online advertising and digital design skills.

Lohr might have also mentioned emerging microclusters around biotech in South San Francisco and nanotech in the Menlo Park/Palo Alto area.

These microclusters are defined by skills, but they also generate cultural friction as well.  Lohr writes:

There is a certain visual identity to the clusters, and a hint of cultural tension among them. The clearest schism, perhaps, separates Valley dwellers from San Francisco residents.

The hard core in the Valley jokes that San Francisco, with its Internet advertising and design cluster, has a “high P.I.B. coefficient,” for People in Black.  The city’s companies also have more women than those in the Valley.  San Franciscans regard Valley engineers as denizens of a style-free suburban zone for whom being well-dressed means wearing jeans and a T-shirt with a company logo.

Marc Andreesen, co-founder of three Silicon Valley companies, sums up the culture clash best with this quote from the article:

“ . . . in general, the nerds with minimal social lives like me are well down in the Valley, and the cool kids with the trendy glasses and Prada shoes who like to go to parties are in San Francisco.  You can guess who has the leg up in building companies.”

Some companies like Google need to access talent from multiple microclusters, leading to solutions like Google's 32 shuttle buses that help ease the commute to its campus for some 1,000+ employees.  There is no word about the culture clashes that surface as the buses from San Francisco discharge their people in black on campus (perhaps they don camouflage before boarding the buses).

(For the record, I live in the mid-Peninsula area, close enough to drop in on the cool San Francisco parties, but far enough away to get some serious work done.)

Why Place Matters

Lohr's article provides compelling evidence that geographic proximity still matters, even down to the neighborhood level, even in the most technologically sophisticated talent pool in the US.  Why is this the case?

It is all about talent development.  No matter how talented any of us are these days, our talents must be continually and quickly refreshed and augmented if we are to thrive in this rapidly changing global economy.

The best way to refresh and augment talent is not to attend some training course.  In this fast-moving world, by the time knowledge has been expressed and packaged in a form that can be used in a training course, it is probably out of date. We all need to find ways to connect with people who are at the leading edge of relevant talent pools. 

The most valuable knowledge these people have is tacit knowledge – especially the knowledge that is so new that they have difficulty in articulating it, much less abstracting and codifying it. This is a key point for business strategy – when the pace of change accelerates, the balance of value between explicit knowledge and tacit knowledge shifts profoundly. Strategies focused on developing and protecting explicit knowledge fall when confronted with effective strategies to tap into and leverage tacit knowledge.

This is exactly why talent spikes become so strategically important in times of rapid change.  They provide rich opportunities to connect with people at the leading edge of relevant talent pools and more effectively access the tacit knowledge that is so valuable. These connections can take many different forms.  It starts with the casual encounter at the soccer game as described by Steve Lohr in his article. It could be connections that are made possible by a rich infrastructure of specialized service providers, including financers, lawyers, marketing firms or even real estate firms.  One of the key roles of good venture capitalists is to serve as a talent hub, making introductions helpful to their entrepreneurs in accessing relevant talent.

These connections can be very helpful in terms of exposing someone to a new idea or story that sparks some creative insight.  For many, including myself, it is about the patterns that emerge from countless encounters and conversations.

But the true richness of talent spikes comes from the opportunity they provide to engage in real work with other people who are at the leading edge of their fields.  It is one thing to have a casual conversation at a party or even a business meeting.  It is a completely different thing to engage in a challenging work project where all the participants are pushing their skills to the limit and learning deeply from the experience and expertise of others.  It is here that tacit knowledge becomes the most visible and accessible. JSB and Paul Duguid did a masterful job of highlighting this role of talent spikes in their essays “Mysteries of the Region: Knowledge Dynamics in Silicon Valley” and "Local Knowledge: Innovation in the Networked Age."

Talent spikes differ in terms of their ability to provide this opportunity.  Annalee Saxenian, in her historic work, Regional Advantage, captured the advantage of Silicon Valley relative to Route 128 outside Boston as a high tech talent spike precisely in these terms.  In the Route 128 corridor tech companies tended to operate as self-contained and relatively secretive entities with limited flows of employees across enterprise boundaries.  Silicon Valley companies in contrast were much more prone to collaborate with other companies. Among employees, rapid changing of employers became a badge of honor.  Staying too long with one company was viewed with some suspicion. The opportunity to engage deeply with diverse collaborators and access tacit knowledge was far greater in Silicon Valley. 

Silicon Valley further enhanced this advantage by emerging as a more effective global talent magnet, attracting skilled and entrepreneurial engineers from around the world. People often overlook this aspect of Silicon Valley in seeking to uncover the “secret sauce” driving SV’s success, yet it has been central to the innovation that has been a hallmark of this talent magnet.  The ability to attract and retain talent from around the world drives the continuing success of Silicon Valley.  Current patterns of talent flows have been impressively documented in Joint Venture Silicon Valley Network’s Index of Silicon Valley 2007. Its report notes that “Silicon Valley’s population is increasingly more global in character than in California or the U.S.”

A New Basis for Competition

Now, as we move into the 21st century, a new dynamic is beginning to play out.  As captured by Annalee Saxenian in her more recent book, The New Argonauts: Regional Advantage in a Global Economy, Silicon Valley capitalized on globalization to build a rich network of personal and institutional connections with emerging talent spikes in Israel, Taiwan, China and India.  In many cases, these connections arise as successful entrepreneurs in Silicon Valley who came here from abroad return to their home countries to participate in local spikes.

Saxenian does a great job of describing the connections that are emerging and evolving across these talent spikes but, from my perspective, this is just the first step in the next wave of global competition.  We need some profound institutional innovation to more effectively harness the capabilities that are developing in spikes around the world. 

On this dimension, I fear that Silicon Valley companies are falling behind more innovative Asian companies. A number of Asian companies are mastering the management techniques and institutional architectures of process networks required to access and mobilize talent across hundreds or thousands of business partners on a global scale.  While many Silicon Valley companies participate in process networks, very few have successfully organized and orchestrated these process networks.

The Bottom Line

Place still matters in shaping talent development and competition. Place matters because density matters. Density increases opportunities for serendipitous encounters and sustained and rich collaboration. Place not only matters; it is becoming even more important and much more complex. 

Depending on whether you zoom in or zoom out, relevant spikes emerge at the neighborhood, metropolitan or global level.  In fact, they are fractal, down to the level of corridors and work areas within specific buildings. Some companies have developed explicit location strategies, seeking to locate facilities in key spikes in an effort to attract local talent.  Far fewer companies have successfully tackled the challenges of effectively connecting talent across geographic spikes in ways that accelerate learning and talent development.  Technology tools can help support these efforts, but the real opportunity is to define new environments that foster productive friction on a global scale. In a flat world, where you stand really does matter.

Restoring Balance in the New Year

A new year is upon us and it is time to make those resolutions, promising ourselves that we will do better this year.

In keeping with this time-honored tradition, let me start with a firm resolution to up my game on this blog.  Over the past six months, my postings have tended to be few and far between.  I have been consumed with the challenge and excitement of building a new research center for Deloitte & Touche USA LLP here in Silicon Valley.  We are now up and running (well, at least walking quickly but still in stealth mode) so I feel comfortable devoting a little more time and attention to these postings. Of course, I continue to be hampered by my inability to master the art of the pithy blog posting – once I get started on one of these, it is really hard to stop.

This posting won’t be any different. In the spirit of New Year’s resolutions, I’d like to offer a set of resolutions regarding some of the themes that I want to explore in the year ahead.  Many of these resolutions offer a contrarian take on some of the conventional wisdom floating around these days, especially in the Internet world.  Without revealing too much (at least not yet), this posting will offer a preview of some of the perspectives that will shape this blog over the next year.

I will explore the growing value of stability.  As I venture into the dot com corridors of Silicon Valley these days, I get more than a whiff of those heady days in the late 1990s when all moorings were cast aside and we plunged into the strong currents of change, celebrating the fact that “nothing will ever be the same.”  In the process of embracing change, though, we often lose sight of the paradox that stability becomes ever more valuable as more and more of our surroundings are put into play.  Institutions and individuals that understand where and how to offer stability will create enormous value in the changing times ahead.

I will explore the diminishing value of transactions.  Many of us have become enamored with the ease of doing transactions on the Internet.  One click shopping is deeply seductive.  The transaction mindset has even made headway on social networking sites where the ease of “inviting” friends has drawn many of us into an escalating game of building ever larger social networks of “friends.”  We talk glowingly about relationships on the Web, but too often when we take a closer look, we find that many of these “relationships” are simply transactions under a different guise. Focusing on transactions will guarantee diminishing returns. Deep relationships become increasingly valuable in times of widespread change (and, yes, I know that “weak ties” are also important, but not as a replacement for deep relationships – in fact, deep relationships are essential to capture the full value of weak ties).  Once again, institutions and individuals that understand where and how to build these deep relationships will have a significant advantage.

I will explore the diminishing value of advertising.  Ask the management team of any Internet business about revenue models and, more likely than not, you'll get the confident answer that advertising will provide the necessary revenue.  Even enterprise software businesses are beginning to consider advertising as a promising revenue source.  There’s no doubt about it, Internet advertising expenditures will continue to rapidly grow over the next several years. But I have more than a passing suspicion that advertising revenue streams are vulnerable in the longer term.  As the long tail of advertisers crowds onto the Internet and as customers become more protective of our attention, I suspect that online advertising will begin to run into seriously diminishing returns. Without developing the detail right now, let me suggest that traditional models of advertising where vendors pay for messages to be delivered to prospective customers will be challenged longer-term by various forms of collaboration marketing and advisory services where customers pay trusted advisors to recommend relevant products and services.  In the short-term, steadily improving algorithms for targeting ads will continue to draw advertisers onto the Internet and provide an attractive revenue source for Internet businesses. Unfortunately, this short-term advertising revenue growth has had a narcotic effect and made a lot of online businesses lazy. Longer-term, I anticipate that most businesses online will have to make money the old fashioned way – by offering products, services and experiences so valuable that people will actually pay money for them. Those who begin to develop this discipline today will profit in the long-term.

I will explore the growing value of place.  I have actually addressed this theme already.  As many of you know, I believe the world will become a lot more "spiky" , while paradoxically becoming flatter in terms of connectivity.  The much vaunted “death of distance” joins the “paperless office” as a too simplistic extrapolation of information technology. The more connected we become, the more intense our need to accelerate talent development will become.  People who come together in dense urban areas will be much more successful in developing their talent than those who remain isolated in remote rural areas, even if they have the best broadband connections.  Most people understand this.  That is why, on a global scale, the trend towards urbanization is accelerating rather than slowing down, even among the most wired digital elites in our younger generations. Place matters more than ever and where we choose to live will increasingly determine how successful we become.

I will explore the growing value of bold leadership.  In an era where the “wisdom of crowds” and empowerment are the watchwords of the digerati and where we generally have become increasingly cynical about the leaders of many of our largest institutions, we may lose sight of the importance of visionary leadership. We can take the notions of emergence and self-organization too far and dismiss the role of forceful leaders. In times of great uncertainty and rapid change, unprecedented opportunities arise to shape our environments to create even more value.  Shaping requires deep insight into the fundamental forces at work and powerful personalities to communicate conviction and persuade many who are on the sidelines that the rewards outweigh the risks. Even our most cited examples of collective intelligence, initiatives like Linux and Wikipedia, would have died stillborn (as most open source initiatives do) if it had not been for the forceful leadership of personalities like Linus Torvalds and Jimmy Wales. To be sure, this new generation of leaders employs a different set of techniques relative to more traditional leaders, but their leadership is essential to the success of these initiatives. Those who are able to exercise this forceful leadership and attract and mobilize others will reap significant rewards in the decades ahead.

I will celebrate length while appreciating brevity.  OK, this may be somewhat self-serving.  Having never mastered the art of the short form, I necessarily harbor a certain attachment to longer essays and, dare I say it, even the endangered book.  In times of rapid change, there is an understandable temptation to sample briefly and quickly from many sources, never lingering too long with any one idea or source.  As we race to keep up, we avoid or quickly discard anything that threatens to take up too much of our valuable time and attention.  But the risk is that we lose any sense of texture or deep structure that would help us to make sense of the changes going on around us and to make connections that might otherwise remain hidden in the whirlwind of events and distractions occupying our day. Vicious cycles begin to play out, where the more we surf from one source to another, the more sense of urgency we develop about falling behind amidst the rapidly proliferating long tail of resources available to us.  Those who invest the time to go below surface events and explore deep structures will be in a far better position to anticipate change and stake out positions that matter rather than simply racing to react to the latest unexpected event and spreading themselves precariously across to many fronts.

Before everyone jumps on me for the contrarian and somewhat retrograde views expressed above, let me hasten to add that I too appreciate the value of change, transactions, advertising, virtual connections, empowerment and brevity. Having recently returned from Vietnam, though, I have gained a renewed appreciation for the traditional Asian concept of yin and yang – two fundamentally opposing forces that come together to complete the world.  I simply want to restore some of the balance that we often lose when we get caught up in the events of the moment.  That’s the essence of my New Year’s resolutions – invest the time required to maintain balance in a time of great flux. I promise to be more frequent in my postings, but probably not a lot shorter.

Institutional Innovation

Executives spend a lot of time these days worrying about innovation.  Innovation is a key engine for growth and profitability yet few companies do it well and consistently.  Even more fundamentally, few companies think broadly enough about innovation.

Mention innovation and most executives immediately focus on product innovation.  Some will expand the scope to include process innovation.  But few venture beyond to explore other levels of innovation.

Seeking More Robust Forms of Innovation

Here’s the rub.  Product and process innovation tend to be event driven – someone comes up with a great new idea, applies it and reaps the rewards. But the rewards offer diminishing returns.  We all know that product life cycles are steadily compressing and markets are fragmenting into a long tail of endless niches.  Early growth from new product introductions rapidly peters out and then revenue begins to slide precipitously towards the inevitable (and increasingly near-term) product retirement.

Process innovation can yield longer-term returns.  Yet, even here, process life cycles are also compressing in the face of rapidly changing business environments.  In a much more connected world, processes can also be more readily copied. The ability to generate more value through process learning soon runs into the diminishing returns reality of the well-known experience curve - greater and greater effort must be invested to yield the same degree of performance improvement.

In a world where profitable growth is the key to value creation, companies need to find ways to sustain and amplify the rewards of innovation. To do this, executives will need to expand the scope of innovation well beyond product and process to a much broader terrain – institutional innovation.

What do I mean by institutional innovation?  It redefines roles and relationships across independent entities to accelerate and amplify learning and reduce risks. The next generation of institutional innovation will seek more productive ways to connect with talent wherever it resides and build relationships that foster and focus learning rather than taking the walls of the enterprise as a given.

Institutional innovation in the twentieth century focused on creating scalable institutions through standardized product design and design of business processes to cost-effectively serve mass markets. In the twenty first century, the focus of institutional innovation will shift to foster scalable learning across institutions.

What’s Different?

This is much broader than the current fad of open innovation.  Open innovation focuses narrowly on accessing third party resources to support product innovation initiatives.  The institutional innovation perspective expands the horizon to include all core operating processes of the enterprise – supply chain management, product innovation and customer relationship management.  Most of the prominent examples of open innovation tend to highlight transactional approaches to accessing existing third party resources, especially knowledge that can be codified.  The institutional innovation perspective focuses on approaches to build scalable, long-term trust based relationships that can accelerate learning on all sides by more effectively accessing tacit knowledge.

This is also quite different from the concept of “management innovation” that Gary Hamel first outlined in his Harvard Business Review article "The What, Why, and How of Management Innnovation" (see my review here) and more fully develops in his recently released book The Future of Management. For Hamel, the primary focus of innovation remains within the walls of existing institutions – he rightly points out that significant value can be created by re-thinking the management processes that drive these institutions but, as the examples he uses in his article and book demonstrate, he is largely concerned with different approaches to managing the resources within institutions rather than across large numbers of institutions.

The companies that excel at institutional innovation will lead the next wave of wealth creation.  We are only at the earliest stages of this kind of institutional innovation, so there is both a lot of opportunity and a lot of uncertainty regarding the approaches with the most promise. JSB and I have offered some early perspectives on this in our writing on The Only Sustainable Edge, Creation Nets and From Push to Pull.

Institutional Design Principles

In thinking about institutional innovation, it is useful to highlight promising design principles that offer the potential to accelerate learning:

Diversity.  As Scott Page and others have persuasively suggested, new insight and learning tends to increase with cognitive diversity. This principle highlights the importance of designing institutional arrangements that extend well beyond a single institution, with particular attention to the opportunity to connect to diverse pools of expertise and experience. Diversity can often be enhanced by connecting into spikes – geographic concentrations of talent – and by targeting “brokers” within social networks, creating a multiplier effect in terms of the number of participants that are potentially accessible.

Relationships.  It is not enough to have cognitive diversity.  By itself, cognitive diversity often breeds misunderstanding and mistrust, seriously limiting the opportunity for people and institutions to learn from each other.  Long-term trust based relationships, on the other hand, make it easier to engage in productive friction – the clash of diverse perspectives in ways that produces deep new insight and learning. The challenge is that these kinds of relationships often take a long time to develop and are hard to scale.  Innovative institutional arrangements can help to accelerate and scale the formation of these kinds of relationships.

Modularity.  When activities are tightly specified and hard-wired together, the opportunities for experimentation and tinkering are very limited.  Segmenting people and activities into discrete modules with well-defined interfaces can help to create much more space and opportunity for distributed innovation and learning.

Federated decision-making.  To encourage distributed innovation and learning, it is helpful to distribute decision-making into self-governing units while at the same clarifying dispute resolution and escalation protocols to ensure that prompt action can be taken across business units when required.  If structured appropriately, these dispute resolution mechanisms can become fertile grounds for productive friction that in itself drives learning.

Reputation mechanisms.  As relationships scale, it becomes harder to develop a clear view of the full range of experience and expertise available to address challenging problems.  Reputation mechanisms can play a vital role in enhancing findability but also help to reinforce incentives to participate and contribute.

Feedback loops.  More broadly, there is enormous value to investing in performance measurement systems and structuring performance feedback loops so that participants can reflect on their practices and focus their efforts to improve performance.  This task becomes much more challenging when activities and participants are scattered across a large number of institutions and geographies, but the rewards in terms of learning are far greater given the opportunity to compare and contrast performance across a larger number of participants.

Incentive structures.  Focusing narrowly on near-term cash incentives undermines the ability to build trust and foster learning. By expanding incentives to include talent development and capability building, institutional innovators have the potential to turn zero sum games into positive sum games, where the prospects of expanding rewards encourage participants to adopt longer time horizons and invest more in collaborative undertakings.

Deployment Approaches

There’s a massive opportunity for institutional innovation building upon these design principles.  One of the key pitfalls, though, is the temptation to map out detailed blueprints of new institutional arrangements before deploying any changes.  In the highly specified, hardwired institutions of the twentieth century, this level of advance analysis and planning was critical.  These new design principles, however, make it possible to pursue a much more incremental approach to institutional innovation. New institutional arrangements consistent with the design principles above can be deployed in stages to facilitate learning and refinement.

Bottom Line

As executives start to focus on the opportunity for institutional innovation, they could begin by asking the following questions:

• What are the top one hundred companies with world-class capabilities that are complementary to our own?
• What, if any, relationships have we built with these one hundred companies?
• How could we re-design these relationships along the lines of the principles presented earlier to enhance the potential for learning on both sides?
• What relationship networks are these one hundred companies participating in and how could we begin to participate in relevant networks to further expand our opportunities for learning?

In thinking about innovation, executives would be well served not to focus exclusively on finding talented product design maestros or even process design experts, but rather creative institutional designers who can challenge and re-think their existing institutional arrangements from the ground up.

These institutional designers will unlock a steady flow of product and process innovations.  Without their help, executives will continue to struggle with isolated innovation initiatives that show great promise at the outset, but rarely deliver on their full potential.  Even when the full potential of these initiatives is realized, this potential is inherently limited.  Far better to re-think the innovation opportunity at a much more fundamental level – a level that keeps on giving.

For those who doubt the power of institutional innovation, reflect on what has been the single most wealth creating innovation over the past several centuries.  The steam engine? The telephone? Ford’s assembly line approach to manufacturing? Fuhgeddaboutit.  It was the development of the limited liability joint stock company – a profound institutional innovation.

Convergence or Divergence?

Convergence is re-shaping the technology, telecommunications and media industries. Paradoxically, though, divergence may actually be a more powerful theme in determining who creates value and who destroys value.

Read the business press and convergence is everywhere.  Devices are becoming more versatile, embedding functionality that cuts across computing, communications and consumer electronics.  Internet companies are bidding for wireless spectrum.  Network service providers are introducing devices.  Device makers are backward integrating into Internet services. 

Boundaries are not just blurring; they seem to be disappearing. As everyone seeks to get into everyone else’s business, it is easy to fall prey to a belief that all distinctions will fall by the wayside and we will confront an undifferentiated mass of competition. My own personal view is that this is a transitional phenomenon. New boundaries are forming and some of the emerging patterns are already discernable.

Where Convergence Matters

Stepping back from events over the past fifteen years, convergence has been most significant at the network platform layer – here we have seen a growing convergence of voice, data and video networks shaped by a shared set of technology standards.

The convergence of network platforms directly contributes to two other forms of convergence – convergence of market power at the customer level and greater collaboration among enterprises to deliver value to customers.

Converged networks systematically eliminate shelf space constraints, making it easier for customers to access a broader range of products and providers on a global scale. (As an aside, these converged networks paradoxically generate much greater diversity and fragmentation of markets into the myriad niches that populate the Long Tail). These converged networks also provide customers with much greater information about product/service offerings and vendors, including the ability of customers to connect with each other and compare their experiences with products and vendors.

As relative scarcity shifts from shelf space to attention, customers gain greater power and vendors experience increasing margin squeeze. The natural reaction is to cut costs but many companies lose sight of the fact that cutting costs alone is a losing game.  In increasingly competitive markets, cost savings are rapidly competed away and captured by customers.  The result is a steadily shrinking business.  The only way to continue to create value in this kind of environment is to find major new growth platforms.

Fortunately, converged network platforms also create an opportunity – they enhance the ability to collaborate across institutional and geographic boundaries. By providing an opportunity to access and mobilize complementary resources, they offer powerful platforms for leveraged growth (purchase required) – delivering greater value to customers by bringing together third party resources.

Where Divergence Matters

So, power is converging at the customer levels and providers have an opportunity to collaborate more effectively to deliver even more value to customers – these two forces of convergence are accelerating and intensifying a broad trend towards divergence in business models.

For those following my writings, you know what is coming next – my personal belief that most companies today are an unnatural bundle (purchase required) of three very different kinds of businesses.

• Infrastructure management businesses (IMB)  - high volume, routine processing businesses - think of contract manufacturers, logistics providers and call center operators as relatively pure play examples of these businesses
• Customer relationship businesses (CRB) – businesses that get to know individual customers extremely well and, based on that understanding, help to access relevant resources for these customers – relatively pure play examples of these businesses include large advisory firms that help large enterprise customers decide what form of IT outsourcing to pursue and help these large enterprises to evaluate and negotiate with the right mix of outsourcing service providers.
• Product innovation and commercialization businesses (PIC) – businesses that focus on developing innovative new products and services, getting them into market quickly and accelerating adoption of the products - think of semiconductor firms operating without their own fab facilities as relatively pure play examples of these businesses.

The Performance Penalty

While there are some pure play examples of these businesses as indicated above, they are exceptions. Most companies tightly bundle these three businesses together despite very different economics, skill sets and even cultures – leading to significant underperformance across all three:

• IMB – economies of scale, standardized operations skill sets and cost conscious cultures
• CRB – economies of scope, direct marketing skill sets and customer service oriented cultures
• PIC – economies of speed, product innovation skill sets and creative cultures

While economics differ radically across all three business types, each business type has the potential to be very profitable, provided management understands what is required for success and manages the business in a focused manner. Two of the business types – infrastructure management and customer relationship – are driven by economics that favor large scale or scope based operations, so there will be accelerating concentration and consolidation in these two business types. In these arenas, unbundling will be prelude to a much more focused process of rebundling, driving significant growth.  The third business type – production innovation and commercialization – is more likely to fragment over time given the importance of attracting and retaining the most creative talent and the importance of agility in the economics of speed.

Sound historical reasons explain why these businesses came to be bundled in the first place. But today’s converged network platforms now create the opportunity to unbundle them.

The process is well underway, although proceeding at different paces in each industry and geography. For example, the broad trend towards outsourcing and offshoring over the past decades can be understood as a systematic stripping out of IMBs from larger companies.

The next wave of opportunity comes from a systematic splitting of PICs and CRBs – a process already underway in certain industries, for example the rise of Original Design Manufacturers (ODMs) in high tech or the unbundling of research in the pharma industry.

Broader forces will accelerate this divergence of business models. As markets fragment, product companies will be under increasing pressure to broaden product reach as far as possible and not be constrained by their own distribution capabilities. As attention becomes scarcer, customer relationship businesses will need to be more helpful to customers by providing them with a broader array of options and not be constrained by their own product offers.

Implications for Specific Industries

That’s the broader trend towards divergence that paradoxically emerges from convergence. While I can’t develop here the full implications of this perspective for companies in industries like media, technology and telecommunications, let me be provocative and assert my personal view that companies in these three industries will face the following sets of choices:

Media industry – Most media companies today in their core genetics are product innovation businesses, even though they have the other two business types within their companies as well. Here’s the strategic challenge: long tail dynamics make product innovation businesses increasingly challenging in terms of building and sustaining scale. As niches proliferate and a growing array of media options competes for audience attention, it will be harder and harder to find the blockbusters that drove scale in most traditional media companies. For those who want to build large and scalable companies in the media industry, the key opportunity will be to focus on customer relationship businesses.  There’s a growing unmet need for pure play versions of this business type as content proliferates and customers seek to improve their return on attention. Infrastructure management businesses like running large scale printing operations and server farms will be increasingly farmed out to pure play providers that are likely to come from outside the traditional media industry.

Tech industry – Most tech companies today in their core genetics are product innovation businesses – run by engineers who get status and success by coming out with the latest and greatest product. Long tail dynamics again make building and sustaining scale in the tech industry as a product innovation business very challenging. On the other hand, as more and more tech products evolve into remotely delivered shared services, there are significant opportunities to build focused IMBs. Also, as customers continue to wrestle with the complexities of rapidly evolving shared services, there are increasing opportunities to build focused CRBs with a deep understanding of customer needs and the ability to evaluate and mobilize appropriate services for individual customers.

Telecommunications industry – Most telecom companies today in their core genetics are IMB’s running large scale, routine processing operations. These companies have two primary options:

• Learn to love commodity pipe businesses and recognize that there is an opportunity for substantial profitability as consolidation and concentration plays out in the classic IMB business.
• Leapfrog to becoming a CRB by developing a deep understanding of end users and becoming more helpful to them in sourcing appropriate telecom (and other) services. Extreme examples include a major wireless provider in India that outsourced its entire network infrastructure and the Mobile Virtual Network Operators (MVNOs) that have emerged in the wireless market in the US and other developed economies.

The Customer Focus Test

As I suggested in a previous blog, from my experience very few companies are truly customer focused in the sense of a CRB.  To test the degree of customer focus, I offer three questions:

• Who in the organization holds real decision-making power? Is it the organization that manages relationships with the customer or is it some other group?
• What are the primary measures of performance for the firm? Are the primary measures customer centric or product centric?
• What is the primary focus of the brand promise of the company? Is it a customer-centric promise or a product/vendor-centric promise?

When confronted with these three customer focus questions, most executives begin to realize the enormous distance they would need to travel to become a true customer relationship business. The companies that really succeed in the customer relationship business will have no trouble meeting this test.  All the rest had better decide which of the other two businesses they really want to focus on.

Are We Compromising on Performance?

In wrestling with the divergence of business models that inevitably follows the convergence of network platforms, executives would do well to focus on three questions:

• Where do we have distinctive and world-class capabilities today and where do we generate the most significant economic returns?
• Are we compromising those capabilities and returns by participating in the other two business types?
• Are we doing everything we can to access and leverage world-class capabilities in the other two business types?

Implications for Industry Boundaries

Will industry boundaries across technology, telecommunications and media still matter in this brave new world?  Well, it depends on what business type we are talking about.  Here’s my guess: industry boundaries will disappear first in the IMB arena, they will more gradually erode in the CRB arena and they will morph in interesting and unpredictable ways in the PIC arena as we move from a product to a service world.

The Bottom Line

As we wrestle with the challenges and opportunities of convergence and divergence, let’s not get too focused on the technology or product level, or even the industry level, and instead let’s invest the time required to sort through the implications for business types and business models.  At the end of the day, this is where the most value will be created and the most value destroyed. And here we may find that divergence matters more than convergence.

Tests for Customer Focused Companies

Most companies claim to be customer-focused, yet few are. In a world where customers (both end consumers and intermediate customers) are becoming increasingly powerful, all companies declare that they are “customer-focused”. At one level this is a truism – all companies must have some degree of customer focus just to survive in increasingly competitive markets.

But, let's move beyond this generic level and apply some real tests of customer focus. We'll find that the practice rarely matches the rhetoric. I apply three questions to determine whether companies are truly customer focused. These three questions zero in on the most fundamental elements of a firm – decision-making power, performance metrics and brand promise. It is surprising how few companies meet these tests.

Power

Who in the organization holds real decision-making power? Is it the organization that manages relationships with the customer or is it some other group?

In every firm, even in complex matrix ones, one set of executives typically holds the real decision-making power. More often than not, they are the executives managing major product groups rather than executives assigned with the responsibility of managing customer relationships.

Now, of course, executives with product accountability have to be focused to some degree on serving the needs of customers, otherwise their products would not sell.  But, at the end of the day, their primary loyalty is to the product, not to the customer. If products sales are flagging, they will aggressively seek to market and sell their products, even if they are not the most appropriate products for specific customers. In this case, who champions the customers needs?

In fact, many firms do not even have a senior executive accountable for building relationships with customers.  At best, these firms may have a marketing executive, sales executive and perhaps even a customer support executive, but these are functional silos leaving no single executive responsible for building and managing end to end relationships with customers. How can a company claim to be customer focused if they do not have an executive accountable for building relationships with customers? Even where such an executive exists, this executive rarely wields the greatest decision-making power within the firm.

Performance

What are the primary measures of performance for the firm?

Ask most executives about the performance of their firm and they will discuss in great detail their profitability by product or, perhaps if they are a retailer or asset intensive manufacturing company, their profitability by facility.  Ask them about their profitability by customer and you will more likely get a blank stare. 

Few companies systematically track profitability by customer.  They are usually not able to answer which 20% of their customers account for 80% of their profitability.  Even fewer could tell you about the life time value of their customers. And even fewer could tell you what share of an individual customer’s “wallet” they represent.

If a company is truly customer focused, it would seem natural that they would be closely tracking their customer economics.  If we accept that people generally focus on what gets measured, we would have to say that people in most companies are unlikely to put their highest priority on customer performance.

This lack of focus on customer profitability is not accidental.  Two factors explain the persistence and prominence of other metrics. Throughout most of the previous century, production economics or facility economics (e.g., retail stores or branch outlets) dominated the financial performance of most firms.  While the economics of the firm are shifting to the growing challenge of finding and retaining customers, our financial accounting systems continue to focus on what drove performance in the past.  A second factor involves the difficulty of tracking and measuring customer profitability for many companies.  Advances in information technology are making this task easier, but again our accounting systems are slow to catch up.

Now, I know that most companies closely track their overall market share and some even track it by customer segment. But, at best, this would mean they are market focused.  They have very little investment in tracking their customer performance.

And, yes, I know that many companies track customer satisfaction metrics.  These may play a role in the performance evaluation of individual contributors and perhaps even become a factor in some compensation decisions.  But in most companies these customer satisfaction metrics play a very modest role relative to product or facility profitability metrics.

Customer satisfaction metrics are certainly a key driver of customer profitability, but they are not the only driver.  In the absence of a broader focus on customer profitability, many of the actions required to serve customers effectively are likely to get little, if any, attention.

At the end of the day, money matters more than any other dimension in performance evaluations and compensation decisions.  Most companies keep track of their financial performance along dimensions other than customer profitability.  How can they claim to be customer focused if they do not systematically track financial performance along this dimension?

Promise

What is the primary focus of the brand promise of the company?

Most companies have a vendor-centric or product-centric brand promise – buy from me because I have great products or because I have a great company.  Very few companies have developed a customer-centric brand promise – buy from me because I know you as an individual customer better than anyone else and you can trust me to use that knowledge to configure the best products, services and experiences that meet your individual needs.

Bottom line

Choices need to be made.

Few companies are customer-centric in terms of these three basic dimensions of the firm. And perhaps they don’t need to be.  I have suggested in earlier writing that most companies today are an unnatural bundle of three very different kinds of businesses – infrastructure management, product innovation and commercialization and customer relationship management. 

Most companies are ultimately going to have to choose which of these three businesses they really want to be in, shed the other two businesses and aggressively grow the business they have chosen, aided by the enhanced agility and focus that they have achieved. If they do not make these difficult choices, they are likely to under-perform as they make the inevitable compromises required to accommodate the competing demands of three very different kinds of businesses.

When I pose this choice, most executives gravitate towards the third business type – the customer relationship business. In part, they do this because they genuinely believe they have a customer centric company. 

When confronted with the three customer focus questions, though, they begin to realize the enormous distance they would need to travel to become a true customer relationship business.  The companies that really succeed in the customer relationship business will have no trouble meeting this test.  All the rest had better decide which of the other two businesses they really want to focus on.