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Forces of change

Forces of change

Competition erodes established sources of advantage. Capabilities and incentives, connectivity and transparency have all increased competition, and therefore erosion. They also offer the potential for much faster renewal: the identification of options and the deployment of the vast toolkit of capabilities now available in the industrial economies. The balance between erosion and renewal set the tone of the times: how capital markets view the future, how we are employed, how we think about economic and non-economic policy.

This section explores three main topics.

De-integration and outsourcing.

Firms once had to perform almost all tasks for themselves. Henry Ford smelted his own steel and grew his own rubber trees. Companies had to do this because there was no-one to do it for them. The were 'vertically integrated'.

Much the same is true in poor nations today. Elsewhere, however, firms can focus on what they do well. They can 'outsource' other things which they need. They can, for example, look to others for their security, their clean laundry and their software. Equally, they can occupy only one layer in a 'value chain'. This is a flow of goods and services which start from primary goods and end up as a product bought by the final consumer. All of these steps had, perhaps, once been carried out by a single firm. Now, it tends to be done by a vast web of intermediaries and regulators, often acting across national boundaries. In 1960, about a fifth of trade consisted of manufactured intermediates: car engines and the like. Today, finished goods represent only about a fifth: all of the rest consists of components and contributions to value. These webs of value and dependency often sprawl across political boundaries, particularly in regions such as the European Union.

They also sprawl across industrial sectors. General software vendors or security providers do not, on the whole, need to care greatly about the business in which their customers engage.

The extent to which de-integration has proceeded is very great. The figure shows the level of US outsourcing

Figure 1: Levels of outsourcing in the USA

This has a number of powerful consequences. Competitive forces are increased, but options are also expanded. We shall see why this is the case in a moment. The way in which organisations interact with each other changes. Business-to-business electronic commerce plays an important role in this. Indeed, firms were engaging in 'B2B' long before the internet, and the success of stand-alone technologies such as EDI and SAP attest to the readiness of the system for a simple form of integration. Indeed, the telegraph supported strong e-commerce a century ago.

Increased competition.

Intensified competition will, of course, continue to increase as long as nations lower trade barriers, discourage monopoly and seek good value for their citizens. The scenarios discuss situations in which these trends may be weakened. In addition, however, internal commercial forces add a potent impetus to events. De-integration and outsourcing, in particular, give rise to three unusual forces

First, smaller and more modular businesses are easier to emulate (and value chains are easier to enter) than were vertically-integrated activities. It is thus easier to enter a profitable activity and also easier to leave it.

Second, focused activities of whatever scale are easier to assess and rank against each other than are conglomerate structures. Capital markets carry out this assessment from one angle, but suppliers and customers add a new dimension within a value chain. New forces such as electronic commerce allow mass purchasing in formerly niche markets. In general, information is more symmetrically available and decisions are taken which punish under-performance. Despite what has been said above, there is still limited 'globalisation' of commerce. Trade grows rapidly, but is still a minority part of the economy for most countries. Nevertheless, the expectation of best practice is thoroughly global. Customers will never knowingly choose second best, and their agents - retail purchasers and pension funds, for example - strive to supply the best.

Third, there are many more minds at work, and the level of management education is much higher. Processes are subjected to dissection and critique (through re-engineering and the like) and management information systems are increasingly effective. Gaps are spotted and new ideas replace less effective systems.

The acceleration of competition has driven managers to seek further simplification of what they do and what the have to 'sell' to capital markets. The logic which takes us to more intense out-sourcing will continue to run.

Options and innovation.

These developments greatly extend the range of options that are open to most organisations. There are three central reasons why this is so.

First, the economy can now be visualised as something of a tool kit. Almost anything which can be specified will be met by a specialist supplier, and these tools and components can be used to assemble new things.

Second, the flexibility which is offered by access to external resources allows risk to be laid off, whether this be in capital markets or through partnership.

Third, the support structures around primary value chains have grown, creating the service economy. These agencies all strive to deliver innovative or cost-effective legal, conceptual, technical or other support to the value chains and to each other. This extra dimension in the economy has greatly increased the choices open to managers.

A number of potent consequences flow from this. Focused organisations are able to explain themselves to others. Their own staff know what is needed, and can recognise a good thing when they see it. These staff are much more externally-oriented than they were a generation ago, not least because they are working in loose arrangements where previously they were buried in the heart of an integrated organisation. They are likely to see many more such opportunities present themselves. Further, the staff are more mobile between organisations than hitherto, benefiting the economy (if not individual firms!) Ideas and skills are carried around.

Indeed, many related capabilities tend to cluster together in physical locations, in so-called 'milieux'. Technology generators and aerospace companies, entertainment centres and design houses, arts and government all tend to find that they work well when the necessary facilities are closely co-located. With this clustering comes a social connectivity which research shows to be critical to innovation and the confidence to take chances.

Innovative milieux seem to have three key features. They have a specialised infrastructure (whether this be a supply of trained people or the existence of specialised transport systems.) They usually possess two or more major organisations, which act as an armature around which other, aspirant organisations assemble themselves. Third, they have an active 'social life', in the sense of there being much interaction between the organisations that goes beyond the merely competitive: they debate what might be, they exchange staff, they engage in joint ventures, the criticise legislation and in other ways create a common voice. Cities have always been the heartland of such milieux, although the past twenty years has seen the rise of suburban clusters such as the US 'edge cities'. Clusters mediated entirely through telecommunications have yet to arise in any convincing way.

De-integration brings with it the possibility of de-location. That is, most of what can be specified can, in theory, be done anywhere. (Clearly, ditches have to be dug where the drainage is needed, but many other activities - from some aspects of caring to software design - can, at least in theory, be done anywhere. An on-screen design can be sent to a CNC milling machine a continent away, and the resulting physical model freighted to a customer in yet another time zone. Most accounting houses have the routine aspects of document checking done in low wage areas. The highlands and islands of Scotland are making themselves a haven for English-speaking help lines. This could - and almost certainly, will - place pressure on the wages and conditions of those engaged in 'specified' tasks. Taken alone, it has major negative implications for the future of the cities of the wealthy nations.

The key balancing feature lies, of course, with the complexity of the task by which ideas come to be 'specified'. Figure 2 shows data for three countries. Manufacturing projects have three types of cost associated with them. First, there is the acquisition of materials and the steps involved making things from them. (These are a 'specified' set of processes, easily open to out-sourcing and the subject of much of the managerial emphasis of the past decades.) Second, there is the managerial processes of oversight and resource control; distribution and marketing to consider. Taken together, these make up around half of the life time costs of a manufacturing project. Third, however, are "issue definition costs", which consume half of the costs of the project. (When separated out from the value chain, they retain at least half of the profitability.) These are the non-specified tasks which require options to be spotted, ideas to be clarified, paths to practical implementation to be charted, permission to be gathered and legal protection assured.

Figure 2: The lifetime costs of manufacturing.

It is these tasks which it is hard to do 'down a wire'. It is these tasks which demand an innovative, focused milieu. They may well explain the high value which markets now place upon 'intangibles', those aspects for which a firm is valued that conventional accountancy cannot identify.

The "knowledge economy" consists less of a marketplace for data than it does a reserve of understanding, helping people to identify what might be possible and to steer towards their preferred option. It offsets the erosive forces to which we have already referred. The OECD have made a number of studies of the knowledge economy and estimate that is now represents over half of all value added in the industrial world. As Figure 3 shows, it is also growing faster than various the sectors to which it contributes.

Figure 3: Growth in the knowledge economy outstrips conventional sector growth.

These trends will continue unabated, insofar as many forces drive them and few oppose their development. Operating in this environment presents us with several cardinal requirements

How 'specified' projects are handled (managed, overseen, judged) is quite different from how latent options are to be undertaken. This has always been true, but the pace of change implies a much-increased pace of renewal if firms are not to see their base eroded. Managing for renewal has a number of implications, which are explored elsewhere.

Specified products embody considerable costs. It is hugely costly to define the molecule which will cure a disease, but often quite cheap to make it once this has been done. The theft of intellectual property is already an issue and it will grow. This is particularly the case in a world which is divided between the rich, compliant nations which generate intellectual property and the poor, potentially non-compliant nations which may well make the goods in question. This tendency will be accentuated in a world well-accustomed to electronic commerce. Handling intellectual property in such a world will be problematic. It may continue to be difficult to manage knowledge in milieux where it is necessary to contribute in order to extract knowledge, and where staff are highly mobile and where partnerships are fragile.

Commercial categories.

We have discussed the way in which firms have focused on their 'core', outsourcing 'non-core' activities to the marketplace. They have done this in order to reap many advantages, not least that of simplification. The can explain what they are about to their staff, to shareholders, to customers and to their regulators. Industrial segmentation - into financial services and aerospace, retailing and entertainment - have arisen from traditional categories which referred less to what firms did internally than to the things which they made. One went to a beer shop for beer and an armoury for weapons. Today, the 'beer shop' may be any of a myriad of categories - a retailer or a place of entertainment, a part of the transport system or a restaurant - and the means by which beer is put in its proper place may use transportation which is in no way focused on beer. Equally, sectors offer relatively poor guides to the performance and volatility of companies, despite this being the basis of man investment strategies. It is better to be a good scrap metal company than a poorly-managed organisation that uses high technology

Attempts to model companies suggest that there are a myriad of variables that are at play. Analysis of the future may well make use of the plethora of information that is available to assess companies in more complex, abstract terms. Smaller organisations which are currently lumped together may become increasingly seen as individuals through the power of, for example, data mining. This may be as powerful as the "junk bond" revolution of the Eighties.

This said, there are three important 'cuts' which we are likely to see develop over the next twenty years. These matter because they may well be the touchstone against which firms are judged. Early recognition by the reader may help to avoid category errors.

The traditional features - cash flow, return on capital employed, quality of management, the defensibility of the business idea, the intrinsic volatility to which the firm is exposed - will all influence investment views. However, as firms increasingly draw on a common pool of infrastructure for their software and talent, transport and communications, law and market presence, so these new sources of distinctiveness will become apparent, There is no New Economy, merely better ways of seeing the economy as it evolves

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