“Crisis” would be the appropriate word to describe the troubled state of the economy in recent years. But what is the crisis, exactly?
To pull out of difficult times, public and private institutions need to be careful in how they define the crisis so that they respond appropriately and avoid repeating mistakes that may have worsened the difficulties. They also need to adjust to long-term trends driven by the global adoption of the digital infrastructure rather than simply respond to the short-term pressure of meeting quarterly numbers. These views and more were expressed by panelists at the opening plenary session on Day Two of the Supernova conference held in December in San Francisco. The panel featured a range of expert views on how organizations need to redefine themselves and develop strategies to meet the challenges of a connected world.
Supernova is an annual technology strategy event hosted and produced by Kevin Werbach, assistant professor of legal studies and business ethics at The Wharton School, which serves as partner. Werbach moderated the panel session, which addressed a variety of topic threads, including the impact and potential of social networks.
If the panelists were in agreement about one thing, it was that organizations run the risk of becoming so set in their ways that they see only the threats posed by major changes such as networking and social media and miss opportunities to leverage their full potential. Telecommunications companies, for example, largely missed the opportunity to extend customer relationships by creating applications that could integrate communications, scheduling and contact directories. Software providers such as Microsoft beat them to the punch.
By hunkering down in protective mode, many organizations do not employ new technology effectively to achieve a critical but often ignored measure of overall success: a high rate of return on assets. Panelist John Hagel III, co-chairman of the Deloitte Center for the Edge and author of several best-selling books on technology and business strategy zeroed in on this point during his remarks. “We are in the middle of a profound shift in terms of how we do business,” said Hagel. “However, the metrics we typically use to understand the economy and business performance do very little to shed light on long-term changes. Return on assets (ROA) is the best bottom-line measure of how companies are doing over the long term.”
Deteriorating ROA: Indicator of Crisis
During the plenary session, Hagel discussed key points from “The Shift Index,” a major research report released in 2009 by the Center for the Edge. The report was written by Hagel, John Seely Brown, Lang Davison and their research team at Deloitte. The Shift Index assesses long-term public company performance trends using three indices and 25 metrics, including ROA; however, what is garnering the most attention is the report’s analysis of ROA trends since 1965. The ROA rate offers a view of how successfully companies are earning money from assets and investments. Hagel noted that the research discovered “an overall sustained and significant deterioration of [ROA] performance of 75 percent” over the course of 40 plus years, with even the top performing companies just barely hanging on. “This is the real crisis: and there is no evidence that the deterioration is leveling off or that there will be a turnaround any time soon.”
Companies in the technology, telecommunications, media and automotive industries are under the most extreme corporate performance pressure, according to the report; they are experiencing both increases in competitive intensity and declines in asset profitability. “These three industries are closest to the changing digital infrastructure that is emerging around us,” Hagel explained. At the other end of the spectrum, companies in the health care, aerospace and defense industries are the most stable in terms of ROA erosion. The heavily regulated nature of these industries could be a major reason for their relative stability, Hagel noted.
Panelist JP Rangaswami, chief scientist of BT Group and chairman of BT’s recent acquisition, Ribbit, described how the turbulence is impacting telcos. “Infrastructure is at the same time both commoditizing and changing,” he said. “Your infrastructure is no longer something that’s going to differentiate you, even though you have to continue to invest in improving it.” Rangaswami said that BT had to look elsewhere in its traditional three-layer model of infrastructure, enabling technologies and services on top. “The economics of managing a telco have become much more complex, requiring us to work a lot harder on the enabling technologies layer of our model. The choice we made was to create the enabling environment as a multi-sided platform; we threw caution to the wind and put APIs in place that allow people to create and derive value over the top of our services. We have had to learn the ‘pull’ aspects of our environment, where power of choice has really passed to the customer.”
To improve performance, many organizations focus on labor productivity. But can increasing productivity improve companies’ ROA? Evidently not, in Hagel’s view. “There is absolutely no correlation between labor productivity and ROA; some of the industries that have shown the most dramatic improvements in productivity have suffered the most severe deterioration of ROA.” What about innovation? “At least as defined as product, process and service innovation,” Hagel said the report discovered that “it is not sufficient” to reverse ROA deterioration.
One of the report’s key insights – and one which may help companies see a way out of the downturn – focused on the competitive intensity metric. While debate continues in economics circles about how to define this metric, Hagel noted that standard concentration ratios used miss “the real action, which is that customers are becoming your competitors. They are extracting more value out of companies at lower costs to satisfy their needs.” The other constituency benefiting is creative talent – “knowledge workers” – who have significantly increased their total cash compensation since 1965.
These new competitive intensity pressures are forcing corporate performance to withstand “a pincer move,” Hagel said. “On one side, customers are getting more powerful and are pulling out value; on the other side is creative talent, also pulling out value. Companies do not want to pull back that value. So, the challenge is to rethink the institutional environment; companies must rethink their rationale – their reason for being.”
The Big Shift: Source of Instability
Such a rethinking is imperative because of what Hagel and his Deloitte colleagues have termed, “The Big Shift.” The panelists discussed many aspects of this shift, including the move from static knowledge to a flow of knowledge, and from discrete transactional interactions with customers to fuller, more extended and trusted relationships. “But how do we value relationship information?” asked Rangaswami. “This crisis shows that we don’t know how to value the right things. In the telco industry, we are just beginning to grasp the importance of things that could be of value going forward, such as relationships, conversation, information flow and tacit human knowledge.”
Panelist Umair Haque, director of the Havas Media Lab and strategic advisor to investors, entrepreneurs and other organizations, said the problem was that “our building blocks are not fit for a networked world; they weren’t built for it.” He offered examples how this mismatch brought about consequences such as the tremendous trade imbalance between the U.S. and China and instability caused by the largely unregulated explosion in securities day trading. “Our institutions have been built on economics suited for a non-networked world. We don’t know how to build economics for a hyper-connected world. Just as a radical example, if we had the right building blocks that could fuel perfect trust among us, there would be very little need for money. We don’t have that.”
Hagel noted that in other eras, revolutionary infrastructure changes in electricity, telephony or steam power brought bursts of innovation that were followed rapidly by stabilization. “This is not happening with the digital infrastructure. We need a different way of thinking about how to organize and access resources and to connect with people to draw them out as needed.”
Social Networks: The New Platform
Could social networks begin to provide a degree of stability amid such change? Panelist Ellen Levy, vice president of Corporate Development and Strategy at LinkedIn, described the company’s professional network of “53 million self-registered individuals” as a way for people to build long-term relationships even as the institutions they work for change. “When you look at crowdsourcing, malleable boundaries and other models of how the world is changing, they all rely on a set of assumptions that should be called out,” Levy said. “You have to be able to find out about people outside your organization. You have to believe that the information is accurate, authentic and valid. You have to be able to trust reputations. And finally, the person on the receiving end has to be interested in receiving your inquiry. When the floodgates are open and everyone can reach out to everyone, there has to be a model for why you start to do business with someone you haven’t known before.”
This makes context important, Levy noted. She described how the professional context of LinkedIn makes it different from a purely social network, and how that context can become the basis for filtering information so that overload is not a barrier to building relationships. “With filters, I can make inferences based on hypotheses about people around you who are part of your professional relationships or express similar goals and objectives,” Levy explained. LinkedIn could then fill out the context and even provide recommendations not only about people but also about things like books to buy because of what is known about professionals in the network who share your interests. “This is how we are trying to build the underpinnings of a connected world,” Levy said.
A member of the audience voiced some concern that “if you introduce any kind of monetization to a relationship, it can sully that relationship.” Levy agreed that LinkedIn and other networks have to be careful. “Motivations can’t be ignored,” she said. “However, our founders’ vision is of a system that is not transactional; you are not getting anything from it except relationship capital, which is the asset we should be measuring.”
Unleashing the Passion
Hagel offered that the best way for organizations to build value and break the downward trend is to locate and connect to passionate people. “Too often, organizations keep creative, passionate people behind closed doors; they shove a pizza under the door every once in a while, but don’t expose them to senior management – and senior management is usually not very passionate.” Haque agreed: “What we need today is a purpose and a passion.” He saw these as critical to creating value that can offset or counterbalance the negative effects that networking brings to institutions not built for a connected world and in the process of adjusting to it.
To Levy, connecting passionate people is a key value of social and professional networks, both inside and outside of organizations. “All of a sudden, the passion of people in charge of their own professional life can be harnessed, utilized and built into the story of a company,” she said. She noted that companies such as Best Buy use social networks to harness ideas and collaboration to improve how the company works. Rangaswami noted that with network platforms, “for the first time, in an environment where collaboration is real, its value can be measured and quantified.” Panelists agreed that the valuation can happen both inside and outside organizations, such as among partners.
With the collaborative potential of networks growing, Hagel suggested that it was time for executives and managers to ask themselves, “Do I have a long-term, trust-based relationship with the 20 smartest people not just in my organization, but in my industry?” With the connected infrastructure evolving through social and professional networks, it is possible, perhaps as never before, to develop those relationships – and spark the passion and creativity to drive economic growth.
[Note: I wrote this report for The Wharton School.]