April 20, 2016, 12:39 pm
Has the net benefit of trade changed in today’s global secular stagnation?
Economists argue that trade is good, essential in fact to growing an economy. If you excel at growing tomatoes, and I carrots, we will each have a healthier and more plentiful diet by bartering carrots for tomatoes. Once you add in far more people (across the globe no less), more goods (beef, cars, iPhones), services, and a monetary system that converts the value of any item to a price, gains in our simple local barter example grow exponentially. The world benefits when people trade, exporting what they are uniquely good at and importing what others are more efficient at making. We end up with more goods and services at a lower price when trade crosses city, state, regions and national boundaries.
But what is true in theory is not always true in fact. The theory of trade assumed scarcity of labor in developed countries. Importing frees up workers to move into domestic industries needing labor. But we do not live in a world of full employment. In fact, we have globally deficient demand. So we need to think more carefully about trade.
Welcome to the “bad” of trade.
If one country artificially manages its currency to keep its exports cheap and its imports expensive, a trade deficit arises in the importing country. Because Gross Domestic Product depends on exports less imports, an increase in the US trade deficit reduces US growth. This pattern – of imports growing faster than exports until imports exceed exports – happened in the US with China for most of our trading years.
If one country imposes restrictions on trade, be they tariffs or other barriers to trade, trade is not fair, and we may import far more than we should be exporting under fair trade. The Chinese requirement to share IP and have a local partner as part owner of your business to sell in China is but one example. Dumping, a situation in which a country artificially under-prices its exports, creates a similar problem – you import far more than is justified by efficient markets.
Another problem-in-fact arises because labor is not fungible. The displaced manufacturing worker may not be able to switch occupations (to being a data analyst, for example) or move to locations where manufacturing jobs are growing. The slums of Milwaukee, Pittsburgh, Cleveland, and other Rust Belt cities reflect the loss of jobs initially to the South and then to other nations.
Another problem is that prices do not reflect total costs. The prices of Chinese goods do not incorporate the environmental damage caused by China’s weak environmental protection laws. When you read that the Beijing Airport is closed for three days due to smog, think about the unfair price advantage of the Chinese and the true cost (in Chinese lives and global warming) of our cheaper goods from China.
A final problem is a lack of economic resiliency when entire industries leave the US. Innovation emerges from the interaction of researchers, developers, and makers. When entire manufacturing output leaves a nation, as many parts of the electronics industry have done in the US, our innovation potential is at risk.
What about the ugly side of trade?
It emerges from our political system. Economists have always recognized that some people will benefit, and others will be hurt by trade. But, we argue, the net gains should be more than enough to compensate the losers. Unfortunately, we have not managed our unemployment system or labor policies to recognize this fact. Retraining due to trade-induced losses is neither uniform nor adequate.
Finally, today’s trade agreements like the Trans-Pacific Partnership are far more about managing trade than creating more trade. The agreement limits trade-based competition for pharmaceuticals, healthcare providers, Intellectual Property owners, and others while making lower-skilled markets easier for those wishing to export to the US. We already trade with most of the countries in the TPP, so there will be limited net gains in trade from this agreement.
Trade issues cannot totally account for the gap between our full-capacity Gross Domestic Product and today’s level and the resulting under-employment of US labor. We must take into account of forces such as automation, failures in our educational system, an archaic unemployment compensation system, mobility-reducing home ownership patterns, and growth in other nation’s capabilities. But there is no doubt that our continued trade imbalances mitigate growth and lower real wages in occupations and communities heavily influenced by trade. Estimates range around 3 million jobs or more lost due to trade inbalances.
I’m an economist and I am for trade. But Trump and Sanders are right to say we need fairer trade, although Trump’s solution – raising tariffs to 45% – is as ridiculous as his hair. Making trade fairer must be part of parcel of a smarter approach to creating middle-class jobs in a dynamic global economy.
January 25, 2016, 10:42 pm
What is the role of government in creating a successful economy?
It’s not possible to resolve political debates such as “Should we raise taxes to revitalize our aging transportation infrastructure?” without first achieving consensus on the role of government. The role debate, at least in my mind, is far less divisive than “how.” So, as we enter elections to determine the next US President and Congress, I thought it would be a good time to share an economist’s perspective on the role of government.
There would be no role for government in our economy if – in our roles as citizens, business owners, shareholders, employees, and consumers – we acted in the best interests of society as a whole. Rather, we act out of real or perceived self-interest.
There is nevertheless a huge advantage to individuals acting in their self-interest. It creates an invisible hand enabling a market-based economy. Adam Smith argued (correctly) that markets lead to better outcomes than a communist system’s centralized resource allocation. If you are old enough to remember, communism versus capitalism was a contemporary debate until the Berlin Wall fell and we all saw a real life experiment of how alternative economic systems worked. Even the communist Chinese have adopted a quasi-market system.
For markets to maximize total well-being, several critical conditions about markets’ operation would have to be met, including:
- Prices would incorporate true costs. We know this is not always true in today’s world. The price of manufacturing goods from China does not reflect the cost of environmental problems, which China’s residents are largely bearing. When there are externalities such as these (impacts on non-buyers), be they positive or negative, a free market creates too little or too much.
- Having multiple buyers and sellers on both sides of the market. Monopolies and their cousin oligopolies—situations with few sellers and many buyers—do not produce the most efficient outcomes as the seller can extract excess payments from buyers (called “rents” by economists). The only hospital and physician practice in town usually charge premium rates.
- Buyers would have reliable information. Enron succeeded until the true “facts” finally emerged.
Because these assumptions are rarely if ever met, we turn to government to correct the largest failures for the benefit of society at large.
First, governments create a legal system to make sure markets work efficiently and freely, including regulating monopolies. The impact of a well-functioning legal system on economic welfare is well documented. For example, it’s a key driver of differences in different African economies. In the U.S., security markets operate well (for the most part) because of government enforced accounting standards.
Second, government provides public goods. The invisible hand of self-interest leads markets to short-change vital areas such as national defense, transportation systems, clean water, federal R&D, and fire protection. So government invests in these public goods. We can and should debate the how: Do we use vouchers or publicly owned schools, for example, to educate our children?
Third, the government regulates and creates tax incentives. EPA regulations in the USA keep our air a lot cleaner than China’s. Again, we can have engaging debates about how we design regulations and whether economic disincentives offset benefits. But unregulated markets are fraught with problems far larger than disincentives. Tax incentives increase things like business investment in R&D, which creates a stronger economy, benefiting many.
I believe the role of government is becoming more imperative in four areas.
The US Department of Defense, which recognizes the human impact on climate, is on the record citing climate change as one of the top five risks to our nation’s national security. A basic principle of economics states: when irreparable harm might arise, act to reduce risk. Our debate should focus therefore on how we can reduce the risks posed by climate change. Taxing carbon, with proceeds used for infrastructure or for lowering payroll or income taxes, is the preference of most economists. Already many companies are incorporating carbon prices into their investment decisions and insurers are stepping away from climate change related risks.
Another role is campaign finance reform. The argument for reform is that when moneyed interests (be it unions, wealthy individuals, or corporations) influence politicians’ votes and proposals, elected officials no longer act in the interests of the whole but in the payers’ interests. A healthy market system requires strong government (note I did not say large), not a bought government. We call the former Main Street capitalism, the other Crony Capitalism or, at its extreme, an Oligarchy.
A third role is the social safety net: what it consists of and how to provide it in an age of economic disruption, freelance workers, and high underemployment. A final related role rests in addressing growing inequality of income, which data shows hurts economic vitality. Ford got it right: workers need to be able to afford cars for car producers to thrive. How do we best address a level of inequality worse than the roaring 1920s in our nation?
With my economist’s hat on, I’m hope we get Presidential candidates with the skill set and personality to be informed and insightful on these and other vital policy debates.
January 13, 2016, 9:45 pm
Kohl’s. Macy’s. JC Penny. Is there a difference? Kohl’s needs one.
Kohl’s Corporation, headquartered in Menomonee Falls, Wisconsin, started with a unique business model: just the soft goods. It offered consumers a comfortable buying experience at lower-than-department store prices. Some people, especially Midwesterners, swore by the brand. My sister-in-law— born, raised, still living in Milwaukee, and likely never to leave — visits Kohl’s regularly for good deals and an easy shopping experience.
As it grew, Kohl’s extended its geographic reach to about 1,200 stores, creating a publicly traded stock that made for a good story until it wasn’t. Along the way, the company added more design-driven merchandise, deploying its design center located in the heart of NYC. Kohl’s became omnichannel, as all good retailers must. (Read this report on the retail industry.)
Kohl’s. Macy’s. JC Penny. Is there a difference? How can you win in an environment of too much retail for a population shifting from goods to experiences and electronics? Not easily, if at all.
I shopped at Macy’s yesterday for cologne no longer carried by Nordstrom’s, my go-to department store destination. I had not been in Macy’s for over a year. No wonder. Crowded aisles. Very few sales representatives (and those I did see absorbed in conversation with each other). “Sale” signs posted everywhere, with merchandise carelessly placed. Were refrigerators nearby, I would’ve sworn I was at Sears.
But on the margins, Macy has one difference. Macy’s has mastered marketing. Read a Macy’s catalogue and you might think you were looking at a Nordstrom’s catalogue. But walk into a Macy’s and experience the poor merchandise and service and the illusion disappears.
The difference between Kohl’s and JC Penny is that Kohl’s might become privately owned due to lackluster sales growth of late, little debt, and an attractive cash flow available to finance a leveraged buyout. JC Penny still has a stock story given its tumultuous fall under the Apple executive who thankfully exited his JC Penny CEO slot. Kohl’s appropriately worries about the arrival of activist take-over firms; Kohl’s board may therefore make a proactive move to privatize with investors of its selection.
Another option would be for Kohl’s to merge with JC Penny. The latter’s stores, I sense, are in different locations from Kohl’s (malls versus big box shopping areas). There would be considerable cost synergies. We’d also have one less retailer on the block competing on price, which would be good for the stores.
Another potential route to recovery and success for Kohl’s lies in Costco’s business model. Costco is, in essence, one huge co-op, focused on goods versus the credit union’s focus on finances. Costco generates its profit from customer membership fees, selling food and other products at an attractive discount and offering a highly regarded store brand (Kirkland).
In an era of commoditized clothes for the masses, could Kohl’s become Costco for soft goods? Why not? Kohl’s strong sense of community engagement supports this move. It certainly simplifies shopping for children’s gear and home goods for mid-income families: “We go to Kohl’s, kids. Period.” My guess is Kohl’s would steal a lot of market share from JC Penny.
Another route is to sell to Amazon, who will eventually be forced to be omnichannel to manage customer experience and shipping costs. Some big-box will sell out to Amazon. Why not Kohl’s?
Without some change like this, the most likely alternative for Kohl’s is bleak. Look for store closings across the country, significant cuts in headquarters staff, new wealth for private equity firms, and less wealth for Wisconsin.
Such is the nature of our economy today – differentiate or die, quickly or slowly, as all the value founders and associates created migrates elsewhere. I’m rooting for Kohl’s to do something wild and different, whatever that is.
How about you?
January 6, 2016, 1:49 pm
2016 – Become Fabulous
I opened the birthday card to find a silver metal cutout of the word FABULOUS glued to a background of shiny fuchsia ribbons. The message was wonderful to receive, for sure. Looking at the card days after my birthday, I realize the word FABULOUS is an important word for all of us as we begin a New Year in our organizations.
Competing on more than price is getting increasingly difficult. There is excess supply in many markets. Many customers face financial pressures and want a bargain. They find them as they have more buying power than ever, be they a consumer with access to the Internet, or a business offering large contracts that you do not want to lose. The only way past competing on price is to offer your target market benefits that are relevant, unique, and hard for competitors to copy.
Put simply, you need to be FABULOUS at something that matters to your customers.
Easier said than done, to be sure. But that is precisely why being fabulous at something is so important. If you are fabulous at something – or tremendous, wonderful, great, amazing, or any other synonym you choose to use – that something is often hard to copy.
Who is FABULOUS?
- Sunshine Laundromat in Brooklyn is fabulous in turning a mundane chore into fun by offering pinball machines, a bar, and a coffee barista complete with welcoming pictures of clients’ families and pets on its walls.
- BMW’s sense of design is so fabulous it was able to take its brand into a new category with the Mini Cooper.
- Tom Hanks in acting. Whatever the role, we forget it’s Tom Hanks on the screen and become immersed in the character he fully occupies. By comparison, think about Tom Cruise. He’s always Tom Cruise. (Go see Bridge of Spies, a great movie.)
- Mary Oliver in poetry. Her keen observation of nature reminds us to slow down and appreciate the nature of our lives. She’s a fabulous poet and worthy to have served as our nation’s poet laureate.
- Apple is fabulous at design — or, at least, was under Steve Jobs.
To become FABULOUS, you must choose not just where you will excel, but where you will not try to excel. The poet Mary Oliver, for example, will never excel as a CEO. Being all things to all people is a sure-fire recipe to be often considered, but rarely selected. Samsung’s phone products appear to me to be caught in this no man’s land, trying to win on low cost, design, and new features. Can someone tell me the core reason to buy Samsung?
Pull your team together and draw four circles on a flip chart or whiteboard:
- In the first, write down what you already excel at or could excel at versus your customers’ alternatives. Sunshine Laundromat’s owner had a fabulous collection of old pinball machines.
- In the second, capture what your customers (or potential customers) need. Sunshine Laundromat’s commercial laundry machines must work well.
- In the third, describe what customers can’t find in the market — compromises they take for granted with the current alternatives. Laundromats are boring, and usually too noisy for reading. Wasted time, that’s the compromise in using commercial do-it-yourself laundry services.
- In the fourth, write down what you feel passionate about or love to do as an organization. The owners of Sunshine Laundry were passionate about pinball back in college.
When you’re done, step back and look at all four circles. Is there any overlap, any intersection, between them? If not, you’re going to have a hard time being rewarded for being FABULOUS in the marketplace. Try creating different circles for different types of customers. Stay at this exercise until you find an area where you can excel, serve a fundamental customer need, fill a gap in the marketplace, and be passionate about it!
The final answer must meet three criteria:
- Your target customers and prospects benefit.
- You’re better or can design your systems to be better than the competition on this dimension.
- You can charge more than it costs you to be fabulous in this area.
Capture what you’re fabulous at in a value promise that will appeal to current and new customers. Duluth Trading (disclosure: I own stock) is fabulous in designing, testing, and telling the story of their products. Their value promise: ingenious gear that solves problems for people who work out of doors, covered by our “no-bull guarantee.”
2016 – make it the year of becoming FABULOUS.
December 9, 2015, 8:08 pm
Hail Mary passes in American football are named after a prayer for a reason. The chances of the quarterback connecting to a receiver over a long distance make this kind of pass look like an act of desperation when the clock is close to Game Over.
Preparation won the game for Green Bay.
Picture from ESPN
Did prayers miraculously come true for Aaron Rodgers’ last-chance effort to win their Green Bay Packer’s second game against the Detroit Lions? No. The final pass was not entirely an act of desperation requiring heavenly intervention. Rather, practice made the play part of the Green Bay arsenal; and practice made perfect.
There is a lesson in that for all of us as organizational leaders.
Apparently Rodgers and his teammates regularly practice long passes, and did so at least three times the practice before the Lions game. Green Bay’s preparation for the final attempt to score also included placing a former basketball rebounding star downfield. His ability to track Roger’s throw and jump at the right time and in the right place won the game.
Preparation on one side met an unfortunate assumption on the other. The Lions assumed the Packers would pass the ball back and forth down the field and lined their talent up accordingly. It was a reasonable assumption given previous Packers games. But it was far from the only option that the Packers had, and the Lions’ assumption turned out to be false.
How often do we prepare our organizations for unlikely events? Have we thought what we would do in a recession (which may be around the corner if the US Federal Reserve’s interest rate hike is ill-timed)? If not, we may unwisely make reactive cuts that can hurt the long run versus respond strategically. P&G cut too much of its innovation talent during a recession and paid the price in the upturn.
Do we prepare ourselves to be disrupted by an organization not even in our market space? BlackBerry thought it had a stranglehold on the business market, and never saw Apple moving into its market space.
Have we anticipated and acted on how we will hold onto our talent if the early signs of stronger recovery prove sustainable? Have we protected the knowledge each sales representative holds about our customers? Have we imagined a younger generation not caring about famous Baby Boomer branded categories, like fancy refrigerators and cars?
No, you cannot anticipate all risks. But you can identify those most likely to occur or those of greatest consequence, or both. And you can figure out in advance, before panic interferes with sound thought, what you would do.
Like cross training that makes muscles strong for any movement, not just those needed for your favorite activity, anticipating and preparing for unlikely events builds the strong strategic musculature for today’s uncertain times.
As a leadership group, you can and must challenge your hidden assumptions about competitors, suppliers, and customers. What do you mindlessly take as fact? The Lions’ coach I am sure wished he’d planned for more than one potential Packers play to get points on the board before the game ended. He’d have placed better talent in the end zone.
The New Year is about to begin; for many organizations, a fiscal year as well. Delineate your key risks. Mentally prepare. Engage in preparing responses that make sense for the business. Invest in those that make sense for other reasons even if the risk never materializes.
Something rare or unexpected will happen next year. Exactly what may not be certain. But, like Rodgers, you’ll thank preparation, and not the Virgin Mary, that you were ready.
September 29, 2015, 12:03 pm
Was the US Central Bank right to delay a planned rise in interest rates? The increase was anticipated to beat down inflation before it got out of hand. Instead, Chairwoman Yellen and her team “wimped out.”
Let’s provide some context first. Following the banking crisis that resulted in the 2008 recession, The US Federal Reserve engaged in unprecedented monetary stimulus through buying bonds, driving real and nominal interest rates to historic lows. Most GOP commentators forecasted high inflation because all else equal that much monetary stimulus should have driven inflation into the double digits. Many business leaders accepted these projections as fact. The fear still hangs over us.
Those inflation projections were flat out wrong. Why? Because the “all else equal” condition did not hold true. Banks used extra reserves to build up capital rather than lend, preventing the Fed’s bond-buying action from increasing the money supply and stimulating inflationary forces.
The bankers’ response was rational. Bank capital needed replenishing. Loan demand had fallen, and remaining applicants looked riskier than in the past. Inflation was not just unlikely; the recession planted deflationary seeds. Yellen appears to believe these seeds may sprout if she raises interest rates too soon. She delayed raising rates at the last Fed meeting as a result.
The one part of economics that cannot lie is its algebra. Gross Domestic Product (GDP) (a universal measure of economic activity, closely aligned with National Income) is the sum of underlying components. To increase GDP requires growth in consumption, investment, government spending, or exports net of imports. Think of our economy as a biker on a GDP hill with these four components creating the strength in our lungs and legs. Monetary policy is wind – at our back if expansionary or in our face if contractionary. At first, steady wind from behind helps us up the hill. We avoided Europe’s economic woes thanks in large measure to the Fed’s monetary stimulus.
The bicyclist tires when businesses, facing too little demand and too much uncertainty, hold back on investments. He stalls when consumers face stagnant wages, unemployment, school debt, and credit issues. In response, they reduce their spending on housing, durable goods, clothing and fun evenings out. Add in our worsening trade imbalances, where import growth exceeds export growth, and the biker has a hard time holding ground, much less returning to pre-recession GDP levels. (See Chart which shows shortfall of economy from its potential.)
With far more supply of goods and labor than there is demand, there’s no price or wage-setting mechanism for inflation; expansionary monetary policy does nothing. In these situations, the real risk is deflation – a decline in prices. It exists in Europe where monetary policy remained tight until recently. When prices fall, worrisome events follow.
First, purchases are delayed in anticipation of lower prices. Second, debtors face crises, as loans established at higher price levels are harder to pay back. Bank reserves fall with higher levels of defaults than usual, so banks are forced to reduce lending. Finally, because employers rarely cut wages, real wages go up in deflationary periods. The rise reduces demand for labor and exports, creating yet more deflationary forces.
In essence, deflation loads the biker with a 100-pound weight in his pack and going backward becomes a real risk. A recession turns into difficult-to-reverse stagnation, as Japan has experienced. The US Federal Reserve, thankfully, has kept us from this danger.
Where are we now? The economy has improved. Unemployment is down, and our biker on the hill has some momentum. Does the biker still need the wind? The no voters argue a failure to raise interest rates will create asset bubbles and make it hard to arrest inflation. The yes voters point to the following arguments.
First, China’s economy is slowing down considerably. Second, our exports are slowing as nations depreciate their currency against the US dollar to increase their exports and reduce ours. Third, with recent global stock market declines, asset bubbles are unlikely. And finally, there’s little sign of inflationary pressure in wages or prices. So why create a headwind when a weak biker is trying to move up the hill?
People are still fear-struck by 2008. Any downward momentum can, therefore, produce a quicksand of slow growth and deflation. I for one think the Fed made the right call.
The experience has also taught us a lesson as business leaders: facts are often assumptions disguised as facts.
September 10, 2015, 4:47 pm
Apple steps up its Apple TV offering.
“Apple is finally getting serious about pushing into our living rooms,” according to New York Times reporters Kate Benner and Brian X. Chen. Apple’s already in our bedroom, bathroom, subway ride, vacations and, if we’re not diligent, meals with family. Why not the living room? What else is left?
Apple might not be in everyone’s living room, but it’s already in mine. It’s a box that sits next to my cable box that transforms my TV screen into something equivalent to my iPad screen, full of apps such as Public Radio podcasts, movies, TV shows, the HBO channel, etc. (Amazon and Roku are competitors.) Because Netflix streaming has very few of our favored old movies, my husband and I opted for Apple TV as our streaming solution. I will also use Apple for my music once I take the time to download my CDs onto my computer. (Writing that last sentence I realize I never will – so I’ve now contacted Madison’s Murfie Music to do the job for me.)
“Getting serious,” according to the article, is adding gaming to Apple’s TV platform and turning it into a developers’ software tool. Critics say this move won’t upset the apple cart for the game box market that Sony and Microsoft control. But they said the same thing about the Blackberry “monopoly” when the iPhone first came to market. “Serious cell phone users”—business people using Blackberry for e-mails—would never change, or so the story went.
The lesson is clear: Watch out Microsoft and Sony. Given Apple’s ergonomic expertise I would expect them to reinvent the gaming controller once Apple’s designers get deeper into gaming.
Peter Csathy, chief executive of Manatt Digital Media, a media-consulting firm, captures Apple’s move perfectly in referring in the NYT article to the new Apple TV as a Trojan horse. It will open the door to everything electronic in the home.
Why rely on a refrigerator screen when the TV screen can manage that, your thermostat, and set the time for the dishwasher to start? The Apple TV software development platform, like that for the iPhone, will encourage development of new, useful apps that we’ll access through our TV.
Were I luxury kitchen appliance company SubZero/Wolfe’s product development director, I’d seek out the Apple TV and iPad operating platforms ASAP. Why create a SubZero-specific operating system and fight the challenge of screen size when an Apple-compatible app could get remote-controlled kitchen devices to the market faster with a screen experience that is likely better? Apple has a successful track record of making our “digitized” lives more manageable. My bet’s on Apple to win the home control center battle.
Apple’s move is consistent with its existing business models, which are individually and collectively among the best in the world. Why are they best?
- All Apple products work well together – creating benefits that further differentiate each product.
- All products share a common value promise, which enhances the credibility of Apple’s brand. Apple promises, “We’ll simplify your life and eliminate frustrations of electronic gear, while enhancing your capacity to do things.” Each new product (well maybe not the watch….yet) reinforces the promise.
- Apple’s been smart to partner when partnering added deeper layers of value. Here I am referring to its app store and music partnerships. Look for many more with the new Apple TV.
- Apple’s business models leverage superb core competencies, calling into question Columbia University Professor Rita McGrath’s argument that core competencies do not last.
- Apple grooms leaders and exits leaders who do not rise to Apple’s level of aspiration. I for one am a great fan of CEO Tim Cook who is leaving his own mark on Apple.
There’s a lot more Apple could do in the area of corporate social responsibility. I hope Cook will take Apple down that path. He should, if the company wants to attract and retain future talent to continue this remarkable company’s market leadership. A place to start: with Intel no longer sponsoring America’s top high school science fair, The Science Talent Search, Apple should step up and in.
September 2, 2015, 8:21 pm
Like Eve’s apple, is creative destruction a good or bad thing?
Economist Joseph Schumpeter called waves of industry change “creative destruction.” He argued disruption of the current industry structures and companies built a nation’s wealth. Most economists agree, viewing creative destruction as a necessary ingredient for economic growth.
But Schumpeter was writing in 1942. Is creative destruction still a positive force in today’s world? Or are the benefits of creative destruction more nuanced and the costs far greater than Schumpeter argued?
As I reflect on this question, I observe three types of disruptions to markets: new-to-market capabilities, reshaping of the industry value chain, and consolidation. While all three create winners and losers, the net benefits to society differ.
New-to-market capabilities disruptions include examples like the steam engine, the telephone, the electric bulb, genetic profiling, and personal computers, creating industries that allow us to do things previously impossible. When an entrepreneur brings new-to-market capabilities to an industry, especially ones that solve costly problems or enable major increases in productivity, society wins alongside the innovator.
The second example – reshaping of an existing industry’s value chain – has occurred many times in recent years. Walmart and Amazon transformed retail. Google disrupted advertising. Uber and Lyft are more recent examples of value chain disruption. Consumers, in these cases, benefit through cheaper prices and convenient transport. But by replacing (versus adding to) an industry’s capabilities, dead bodies appear. Uber and Lyft hurt cab and town car business owners just as Walmart and Amazon hurt wholesalers, Main Street business owners, and the employees both treated as family members.
My observation is that when an innovation reshapes an existing industry, it often (but not always) gains its initial scale through some twist of the law, network effect, or another advantage. Uber bypassed regulatory costs and employer contributions to social security. Airbnb bypassed hotel taxes, at least for a while. Amazon did not pay local sales taxes for a long time. Walmart grew to dominate when its scale enabled it to import from China and squeeze manufacturers, increasingly dependent on Walmart’s order size. No other retailer could or (in Sears’ case) chose to do the same. Google dominated advertising, shifting dollars from print media, due to network effects.
Without these advantages, would these industry disruptors have gained the scale that enabled them to invest in yet other advantages? Because of the magnitude and speed of their disruption, my hypothesis is that entrepreneurs and investors gain a lot more value than the consumer, workers, or society at large. The situation is akin to an unfair monopoly – which economists cite as bad for society. Look at America’s wealthiest people (Walmart Waltons, Jeff Bezos, Google founders, etc.) to gain a sense of the wealth that industry value chain disruption creates for the disruptors.
The third and last category contains companies that consolidate industries by acquiring their competition. Health insurers like Aetna are acquiring competitors. Fisher Scientific consolidated the biotech tools and services industry, its most recent move the acquisition of $4B Life Technologies.
Where is the value in this kind of creative destruction? Under the guise of “lowering costs to benefit the customer,” consolidators are often using cash to buy revenue that holds up share prices. This action also increases the value of stock options C-Suite leaders and board members hold. Banking executives made fortunes this way, going from local to regional to national then global banks. Often, when you peek behind the curtain of these consolidated companies, you find that the best leaders of the acquired companies left the organization shortly before or after the acquisition. Innovation skills in the remaining team usually plummet. Does it matter? From society’s perspective, I’d argue it’s a bad thing as large companies have capabilities smaller ones lack, and great jobs are destroyed in the process at a time when we lack enough good jobs. This type of consolidation also contributes to the growing inequality in income, which economists argue curtails our long-term growth.
Schumpeter felt (as did Marx) that creative destruction would eventually undermine capitalism’s institutional frameworks, including people’s support for capitalism. As someone who loves capitalism, I fear some days that Schumpeter was prophetic.
It may not be desirable (and would be impractical) to try specifically to limit this type of economic turbulence. But if society is going to foster more true innovation and value creation, then we should take moves to encourage the development of more new-to-market capabilities and technological innovations over consolidations and abuse of laws. As to monopolies from network effects, we need a stronger FTC.
Do you agree with my assessment?
July 8, 2015, 10:46 am
Inconsistency not only creates confusion for customers – it destroys brand equity.
My husband and I had two choices of hotels for our stay last weekend at a destination wedding—Hilton Garden Inn or Best Western. The choice was a no brainer. More on that decision shortly, but first, let’s take a diversion into the history of brands.
My parent’s honeymoon story was a family favorite. Married in Pittsburgh after WWII ended, Bill and Bernie drove to Miami for their honeymoon. The first night, they stopped at a hotel and dad unpacked the car, bemoaning that mom had not packed one (smaller) overnight bag. Mom entered the room, looked around, and then said, “It’s neither clean nor lovely enough.” Five stops later they found an acceptable motel. The process repeated itself the second night. Thankfully, the marriage survived.
It’s no wonder then why Dad rejoiced when Howard Johnson’s motels popped up along turnpikes across America. He always selected them for our family’s one-night stays en route to the family summer vacation rental cottage. As one of the first national brands in the hotel industry, Howard Johnson’s promised clean rooms, a restaurant kids loved, and ample space for roll-away beds. It delivered. To pick a local motel risked a “honeymoon repeat.”
Flash forward to 2015 and the economy is full of national, indeed, global brands. Drive the outskirts of any city and it’s hard to know which city you are in as you pass Trader’s Joe’s, Starbucks, Marshall’s, Macy’s, Marriot, Olive Garden, etc. National expansion resulted in a larger market and economies of scale, both beneficial to shareholders. And we, as consumers, gained simpler choices and lower prices.
But a lot has been lost. Travelers spending twenty minutes in line at Starbucks at the San Diego airport miss the local outlet, Pannikin, with its shorter lines and far better tasting coffee and meal options. Macy’s destroyed the heart of soul of Marshall Field’s and many other regional department stores. Macy stores increasingly look like Sears — disorganized with discount signs everywhere.
The hotel industry is packed with brand names. Many, including Starwood, Hilton, and Marriott, have sub-brands that carve out market niches. It’s a perfect recipe for competition on price among similar-class properties. If you want to win with a national brand – in hotels or any category – you must have a powerful brand promise and deliver on it consistently.
Which takes me back to our no-brainer hotel choice. Best Western’s brand issue is the huge variability around its properties. Some are new and modern, offering a terrific value. Others are old and worn. The local property owners and managers benefit from the brand, as they increase bookings. But we as consumers have no idea what we’re getting when there is so little control over quality. So we have to invest extra time in Trip Advisors to figure out the experience for a specific Best Western property.
Hilton Garden Inn, on the other hand, delivers a more reliable and higher value (despite higher price) experience. The service level is friendly, the properties always up-to-date and clean, the breakfasts fresh and filling, and the exercise room adequate.
The formula for the brand is clear. It’s articulated so well, you can imagine how the business model design, processes, and measures flow directly from promised amenities.
When a brand gets the operations consistently right, they secure an additional differentiated benefit — the prospect of offering a guarantee. Hilton Garden Inn seizes this opportunity by promising, “to do whatever it takes to ensure you’re satisfied, or you don’t pay. You can count on us. GUARANTEED™.” That statement is one powerful hotel value promise.
And our experience in selecting Hilton Garden Inn was exactly as we expected. We left delighted, as did the new bride and groom who wisely chose the same hotel. As to sisters, parents, and a brother at the Best Western, they felt their sore backs returning home after two poor nights of sleep.
June 25, 2015, 5:40 pm
Ignore facts and you place your business at risk.
One of the hardest challenges facing leaders is making decisions in the face of uncertainties. To deal with the discomfort of uncertainty, some leaders turn their assumptions and beliefs into “facts” in their mind. That’s unfortunate. Stick blindly to ill-informed thinking, as some prominent leaders have done, and you’ve doomed your company to decline. Let’s look at some examples.
Ironically, it was a Kodak engineer (Steve Sasson) who invented one of the first digital cameras in 1975. Three decades later, Kodak’s leaders made decisions seemingly based on a belief that digital photography would have a slow uptake, even though by that time digital cameras dominated the marketplace. Why? Digital technology made saving and sharing photos effortless.
Blockbuster believed stores offered the most convenient video rental and purchasing experience. Its CEO turned down an opportunity to purchase Netflix in 2000. “Netflix doesn’t do anything we can’t… do ourselves.” Even if that was true, the company failed to invest in a way that would mobilize or capitalize on that capability.
My observation is that the more confidence you have about your assumptions concerning the external environment, the more likely it is you will be blindsided. And I suspect climate change is creating a long line of business leaders at risk. Case in point: Milwaukee BizTimes recently asked its readers, “Do you believe humans contribute to the causes of climate change?” Only 55% in the poll said yes.
The correct answer is “Yes.” It doesn’t take complicated models to prove mass industrialization increases world temperature. Fourier (1768-1830) discovered the principles of the greenhouse effect from laws of physics. Centuries of actual and derived data trends document the correlation between industrialization, CO2 levels, surface temperatures and rising ocean levels and acidity. Climate systems do adjust to achieve equilibrium, but these natural adjustments work at a far slower pace than we are increasing greenhouse gas emissions (2.3% last year). So nature can’t be counted on to minimize the impacts of global warming. It’s why 97% of scientists (and 57% of adult citizens) believe human activity is the leading contributor to climate change over the last century. (45% of BizTime poll respondents deny human activity is even a contributor.)
Admittedly, climate scientists do not fully understand how clouds, sunspots, and other factors impact a complex system. And it’s fair to note there is a stellar MIT expert in the tiny slice of scientific doubters. Even he agrees that industrial activity is increasing the earth’s surface temperature but predicts a far lower temperature increase than his peers.
When you ignore the fact that your beliefs about your business may be wrong, and you deny facts, you make three mistakes.
First, you miss risks to your business. Surely the executives of Sears Holdings would have made different decisions about resource allocation and investments if they had recognized that maybe, just maybe, people no longer put a high value on finding everything from hardware to appliances to underwear in a single store. Taxes and insurance costs will rise as climate changes. Carbon taxes may be imposed. Are you prepared?
Second, you miss the opportunities the changing marketplace creates. Forward-looking companies like Unilever advance sustainability agendas that lower costs and attract and retain today’s younger talent and customers. Milwaukee’s ZBB Energies exists to address storage issues of alternative energy sources. Companies can make money by selling carbon offsets.
Finally, when we deny the realities around us, we elect politicians who wear blinkers, the headgear that force horses to only see what is right in front of them. House Committee on Science, Space and Technology Committee Chair Lamar Smith (R-Texas) is one. He spent more time in his first year on the job holding hearings on aliens than on climate change. Far worse, he has proposed drastic cuts to NASA’s Earth Sciences research programs. Our nation’s future economic opportunities and our ability to understand and address climate change align directly with our investments in science. And we’ve got a closed-minded leader in a top spot.
The role of a leader is to anticipate changes in the external climate and make sure the leadership team is evolving its business model in light of these risks. In adopting an open mind, you better defend your market position, retain attractive margins and surface profitable growth opportunities.
Believe whatever you want to as a person. One-quarter of the US population (according to a recent NSF survey of scientific literacy) doesn’t accept the earth revolves around the sun. Thankfully, they’re not part of landing a probe on Mars. But as a CEO and business leader, remember that your people, your customers, and I’d argue your grandchildren deserve a reasoned and open mind.