Market-Based Management®

Close Shave or Cut Throat? The Imperative of Creative Destruction

One of the hallmarks of Market-Based Management is creative destruction, which is when old processes are destroyed and replace by better, newer ones. It is not difficult to think of examples: ipods replaced CDs, which replaced cassettes, which replaced eight tracks, which replaced vinyl, which replaced wax cylinders.

However, one of the concerns about creative destruction is what to do when one’s business is sitting pretty? As the saying goes, “if it ain’t broke don’t fix it,” and what if pursuing creative destruction might result in a temporary (or even longer) dip in profits? Indeed, there are all sorts of crank conspiracy theories about mysterious firms and organizations unseen paying to keep superior products off the market, but logic would dictate that there is likely more money in bringing a superior product to market than paying money to hold it back.

I recently came across a great example of this while shaving. I finally purchased one of the powered safety razors and have been very happy. Not only do I enjoy a great shave, but I have noticed that the blades last a lot longer. Perhaps the sawing dulls the blades less or ensures that the whole surface wears evenly, but, whatever the reason, I am getting a lot more bang for my razorblade buck. So why would the razor manufacturers do such a thing, when it means they will sell me less razor blades this year? While I am sure they have their reasons, I would venture that they believed that enough new customers will take to the razor to more than offset the fewer blades per capita. At the same time, I wonder if some in the firm fought the introduction of the new razor, but someone must have realized that although the firm already sold plenty of razor blades, it would have to embrace the new product or be destroyed when someone else did.

The lesson is that the firm must drive creative destruction always—especially when it looks as if it doesn’t have to—and even when doing so will cause it to take a hit. No firm is untouchable, and the hard-won lesson of modern business is clear: creatively destroy or be creatively destroyed.

Something to sink your teeth into...

Last week an old friend relayed the following anecdote:

He said that several years ago the Polish division of Wrigley (the chewing gum company) had somewhere on the order of 70% market share of chewing gum sales in that country, almost none of it was the sugar-free variety. 

Part of their sales and operations planning process was to document assumptions and revisit them at each planning cycle.  One of the assumptions they documented was that as people grew older their preference would shift from sugar-based products to sugar-free products, and demographics suggested that the population was aging.  At some point in the future they decided they'd have to change their mix of sugar / sugar-free products, but that time would be many years in the future.

Charles Koch's Science of Success quotes George Will as saying, "the future has a way of showing up unannounced."  And it seems to show up a lot faster than we expect. 

Wrigley began seeing small but meaningful deviations to their expected sugar-free gum sales numbers.  Because they were revisiting their assumptions each month, they got curious and began testing whether the sugar-to-sugar-free preference shift was really as far out as it they'd assumed.  The result of their analysis caused them to recognize an opportunity: people in Poland were looking for sugar-free products, but not many companies were supplying them.

This information caused them to re-think their strategy and they immediately shifted their product mix almost entirely to sugar-free gum.  They captured 90%-plus of the market.

Innovation - identifying opportunities to recognize and take full advantage of changes that can better meet people's wants and basic human needs - is more often the stuff of disciplined, systematic analysis than it is the "big idea" out of the blue or the output of all-night brainstorming by sequestered employees.   Wrigley's innovation wasn't capitalizing on the demographic trend.   The innovation was in the management process: the discipline to document and revisit key assumptions in their S&OP process to recognize and pounce on a change.

Big is Beautiful

If you like train wrecks of the intellect, Nick Douglas has got a doozy for you over at Slate.com in which he demonstrates an astounding ability to simultaneously misunderstand the market economy and undercut his own arguments.  His thesis?  YouTube (not online video, just YouTube) is way too popular.  (All emphases in quotations are my own.)

Web video isn't an oligarchy, it's a dictatorship. You're either on YouTube or nobody's watching.

...

YouTube ... gets 60 percent of all online video traffic—that's up from 43 percent a year ago.

First, I wasn't aware that 40 percent of video traffic is equivalent to "nobody's watching."  Second, I was under the impression that most dictators enforce their wills through force and fear.  Contrast that to YouTube, which is a website that people are free to use or not at their own pleasure.  That is to say, online video is a democracy, and YouTube is winning in a landslide.  To me, that suggests that YouTube is doing something that a lot of people like.  And, it turns out, Mr. Douglas' article spells out exactly what that is:

Until recently, file formats and bandwidth costs made sharing video online a gigantic pain. ... In order to watch videos in your browser, you had to download all sorts of plug-ins. Mac-made videos often didn't work on PCs, and vice versa. Then, in 2005, YouTube launched, fixing all of those annoying problems.

YouTube wasn't the first site to host online video, but it was the first to do it well. YouTube instantly trumped sites like Vimeo, Veoh and Grouper by converting all uploaded videos into universally viewable Flash videos—so long, browser plug-ins!

Oh, so YouTube became popular by introducing an innovation that made mass online video sharing possible and started stomping it's competition?  Shocking!  But wait, there's more:

Once YouTube grabs a viewer, it doesn't let go. While the site got 43 percent of all visits to video sites in 2006, it earned 54 percent of page views—that means YouTube users stick around longer and watch more video than people who browse on competing sites.

YouTube will grab me and not let go?  How does it do that?  Spyware?  Viruses?  Hypnotism?  Oh, wait...

Next to every clip, YouTube lists up to 20 related videos, as well as other videos by the same creator and four "director videos," all promoted with an enticing thumbnail. With so many tempting links, it takes a lot of self-control not to veg out and clip-surf for hours.

So it keeps me watching by bringing up a lot of other entertaining material that I might want to see without my even having to ask for it?  I think most people would consider that a feature.  And maybe, just maybe, YouTube is such a big player because it's creating so much value for its viewers through such features.

Nevertheless, Mr. Douglas insists that YouTube's size is a problem because it stifles the artistic creativity of it's users:

...[N]ot everyone is welcome on YouTube. While the site has done a remarkable job building up the infrastructure that allows people to watch videos on the Web, it has also created a number of barriers to entry. The site bans nonpornographic nudity, places a 10-minute limit on most uploads, and has a resistance (so far) to including live streams.  And if you want live streaming video, you'll have to go to Ustream or Stickam.

Let's leave aside whether any of this constitutes "barriers to entry" as an economist would define the term.  What Mr. Douglas is pointing out is that there is still room for improvement in the online video business.  Which means that if YouTube's competitors address the shortfalls in its service (and apparently some already are), they can knock it from its current perch and reap the spoils. 

So let's recap.  YouTube dominates the online video market because it 1) introduced an extremely valuable innovation and 2) tries to offer its viewers more of what they want without their even having to look for it.  This has made it wildly popular and its competitors less so.  But YouTube's service isn't perfect, and there's plenty of money to be made by competitors who can innovate to offer a better service.  Mr. Douglas seems to find this all very vexing.  But as a consumer of online videos, I couldn't be happier.

Economists Heart the Planet

A new report from the Energy Information Administration (EIA) shows that U.S. emissions of carbon dioxide (CO2) declined by 78 million metric tons or 1.3 percent in 2006 (HT: Volokh Conspiracy). Meanwhile, according to the Bureau of Economic Analysis (BEA), the U.S. economy grew by around 3.1-3.2 percent in 2006. The confusion is already setting in, and everyone is pointing fingers at the weather. Indeed, I can think of few instances (if any?) where an economy grew rather robustly and experienced a fall in CO2 emissions.

One of my favorite topics in our recent Sustainable Economic Development course was the role of development and the environment. A lot of people think that there is a tradeoff between the two—a country can have either a developed, growing economy or a clean environment. However, most scholarship suggests that economic growth and environmental protection are linked. This is initially because as economic growth starts to satiate more peoples’ most pressing needs (food, water, shelter, work, etc.), folks can then concentrate on the things that are important but less so than basic needs—like the environment. Hence, a certain level of development is needed to have an environmental movement at all (ever wonder why environmental movements seem to be dominated by people from rich countries?). Secondly, as societies grow richer, they acquire the resources necessary to solve more environmental problems. They can then afford the new water treatment plant or finally manage to replace their old, dirty power plants with new ones. True, there is usually an uptick in pollution as economies get going, but environmental damage per unit of GDP actually starts falling at around $6,000 per capita GDP. For example, in the U.S. the economy has roughly tripled over the last 30 years, while the amount of pollution has halved. However, this is not a new trend. Pollution in the U.S. peaked in the 1920s—meaning that emissions of major pollutants actually started declining fifty years before the creation of the EPA. Nor is this trend due to some mistakenly perceived decline in manufacturing; U.S. manufactures are actually churning out more “stuff” than ever before.

The reason for this trend is simple progress. As people discover better ways to do things, they inevitably cause less environmental damage. New machines, cars, and appliances are almost always cleaner and use less energy than those they replace even in the absence of new regulations. The result in the U.S. has been a steady decline in major pollutants, such as nitrogen dioxide (NOX), sulfur dioxide (SOX), carbon monoxide (CO), etc. That being said, the emission of one particular gas (sorry there are differing legal and economic opinions as to whether it is technically a pollutant) has bucked this trend. This gas is carbon dioxide (CO2), and economies tend to produce more of it as they grow and demand more energy.

Despite the rise in CO2 emissions common to economic growth, some have postulated that these emissions will eventually follow the major pollutants and decline. The thought has been that CO2 simply will just begin to decline at a much higher level of GDP than other gases. Well, the EIA’s numbers could very well indicate the beginning of this trend. Of course, it could be the weather, or a strange combination of circumstances, rather than the beginning of a long-term trend. However, CO2 emissions don’t fall outside of recession very often (if at all?). Let us hope that this is the beginning of a long-term trend and not unusually pleasant weather; but rather the fact that as Americans grow ever wealthier they are replacing their older, less efficient homes, cars, appliances, and machines with newer, more environmentally friendly ones.

What Can You Learn from a Jar of Spaghetti Sauce?

Who is Howard Moscowitz, what did he have to do with the Spaghetti Sauce revolution, what insights might it provide about subjective value, profitably anticipating and satisfying customer needs, and appreciating the value of diversity? Watch this 20 minute talk by Malcolm Gladwell and see for yourself.

Who Will Create the Jobs?

The reading for my Sustainable Economic Development course this week includes an article assessing the effects of economic development programs for the states. Written for Economic Review in 1990 by two veteran economists then working for the Federal Reserve Bank of Kansas City, the article wisely points out that, despite a few high-profile successes, states’ efforts to attract or poach manufacturers from other states with subsidies and other incentives are probably not worth the effort. Rather, the authors, Tim R. Smith and William F. Fox, suggest that if states are really serious about “creating” jobs, then it is far better to concentrate on fostering a good climate for entrepreneurship – one that allows people and businesses already in the state to startup and expand.

The article is clear, well-written, and, of course, right on target, so it pains me to pick on the authors a little. However, near the end the authors predict, “Although high technology businesses will create a relatively small share of new jobs over the next decade …” Remember the article was written in 1990, but anyone who lived through the 90s observed that the economy created a lot of high technology jobs during the decade and continues to do so. Working from the best information available, even professionals, such as Smith and Fox, had no way of predicting the impending tech boom. Therefore, the article serves as a double-edged indictment of the folly of state economic planning, as the authors first (correctly) point out the shortcomings of past state economic planning and then proceed to discount the looming job creation in high technology.

Anyway, the lesson is that the next best thing or the instigator of the next decade of job growth is not going to come from the legislature, the Federal Reserve, or the boardroom. It will come from somewhere out there – in the great entrepreneurial ether made up of millions of minds and almost as many converted garages. Yet again, we are reminded that the firm must encourage the entreprenuers within or perish at the hands of the innovators from without. 

Long Live the King?

Roger Ehrenberg has an interesting post about the newly crowned king of the auto world, Toyota. Ehrenberg evokes Schumpeter's creative destruction model to suggest that even a successful company like Toyota faces the danger of being made obsolescent by its competitors. In fact, maybe Toyota faces even greater danger than other companies, Ehrenberg suggests, because of its size and success. We forget that in the past, companies now viewed as dinosaurs (or at least stumbling giants) -- Montgomery Ward, Sears, Kmart -- were feared to be unstoppable juggernauts who would crush all competitors.

If a company's very success can be its undoing (a thesis advanced more recently in Clayton Christensen's The Innovator's Dilemma, among other places), then is there any hope of surviving creative destruction? Only by internalizing a creative destruction mindset, so that we continually view all of our activities, processes, systems, and products with the eyes of the hungry competitor, the demanding customer, and the unsentimental investor. Making onself obsolete, as Drucker noted, is far cheaper than waiting for the competition to do it.

So will Toyota be able to continually renew itself from within? That's the question its customers, owners, and employees are hoping it will get right. It certainly seems to focus rigorously on cultivating the creative destruction mindset within. We'll see if it's enough to overcome size and success.

Eying the Prize!

Sir Richard Branson is my third favorite billionaire (easy guess who numbers one and two are).  I like him because the British have a tendency to view success as some sort of embarrassment, and he has done much to resurrect the acceptability of their entrepreneurial heritage.  Sir Richard recently took a page from Ye Olde English playbook, when he offered a $25 million prize for the development of an effective means of removing carbon-dioxide from the atmosphere. 

The use of prize money to spur innovation is often thought of as a daring new concept – consider the recent $10 million X Prize for a privately build spacecraft.  However, prize money was the original source of government sponsored research and development.  Long before governments could afford to fund labs and R&D bureaucracies, they sought answers to technical challenges by offering prizes.  The most famous of these was the British government’s 18th century Longitude Prize, which offered the then astronomical sum of £20,000 to whoever could develop a means for ships to calculate their longitudinal position (miscalculating positions and running into things was a major problem).  The prize resulted in the development of reliable sea clocks or chronometers, which have since saved the lives of thousands of seafarers and thousands more people through the extension of more reliable commerce.

The advantage of prizes is that they unleash the creativity of human beings.  Often when governments or businesses conduct research and development, they place bets on specific solutions or technologies.  This narrows the range of possible solutions.  Furthermore, when you pay people to research and develop, they do just that – research and develop.  If anyone ever actually develops anything, then they often lose their funding!  It is also common for the best connected political groups to gain government funding for their own particular solution, which leaves out the less connected and backyard tinkerer with the novel, effective solution.  Not only does the promise of a prize give heart to the little guy, but it creates an incentive for entrepreneurs to search him out and support him – for a cut of the prize of course. 

I cannot wait to see what comes out of Sir Richard’s contest.  If the prize is ever given, then I am sure the $25 million will have unleashed more creativity than ten times as much in government expenditure.  I myself, have my own entry.  It is a highly complex biomechanical hybrid constructed from advanced alloys.  Actually, it is a fern decorated with tinfoil in a titanium pot; but one has to start somewhere.

Entrepreneurship [Updated]

I've heard the following line attributed to several different famous people: "The problem with the French is that they don't have a word for Entrepreneurship." It's funny, of course, because "Entrepreneur" is a French word - there is no word in English.

Some writers and speakers on the subject will translate Entrepreneurship into English as "to undertake something," and Entrepreneur as "undertaker," explaining that undertaker in French doesn't have the same meaning as undertaker in English (which is silly, since the French don't say "undertaker," they say, "entrepreneur" -- you might recall the Steve Martin line: "Those French have a different word for everything!").

A better translation might be "between-taker" - but that too lacks the fullness of the term. There is no English translation. At best we can approximate it and, as with poetry, hope that its fuller meaning comes out not just in the lines written, but "between the lines" as well.

Entrepreneur is built on two words: Entre ("To be in") and Prendre ("To take").

"Preneur" is straightforward - the noun version of the verb "Prendre." A sound translation is "Taker."

"Entre," is often (correctly) translated as "between" -- as in "entre chien et loup", which literally translates as "between dog and wolf". That phrase is French idiom. It describes dusk, or that time of day (just before nightfall) when you wouldn't be able to distinguish between a dog and a wolf trotting towards you at that level of light. It is also used to describe the tension between habit - what is comfortable, familiar - and the discomfort of the unknown.

With "entre," it doesn't seem to be as much about being in between two things - physically or metaphorically - as it does to be "inside" or "within" the situation. To be in.

Entrepreneurship is perhaps better understood as pouring yourself into something that takes hold of you in the attempt to take a profit. It is a process of deep immersion into a specific opportunity - an attempt (based on a hunch informed by personal knowledge and market signals) to efficiently fill an unmet need or want in society. If you're right (customers want it) and you're good (faster than your competition, execute well), you are rewarded with profit, and profit is very good - because it means you've created real value for society.

In an MBM company we strive to create and maintain a culture of Principled Entrepreneurship™ - Each of us striving to maximize the long-term profitability of the company by creating real value for society while faithully conducting all affairs lawfully and with integrity.

It requires virtue and talent so that you can pour yourself into the opportunities that arise based on your comparative advantage. It demands a sense of urgency, discipline, accountability, judgment, initiative, economic and critical thinking skills and a risk-taking mentality.

To do all of the above equally and exceptionally well is an ideal to be strived for - to actually pull it off would, perhaps, be superhuman. But then, to me at least, the Principled Entrepeneur is the penultimate superhero.

Creative Destruction - Best Buy style

There was an interesting article on Best Buy in last weeks Fortune (no subscription required). For the last decade Best Buy has been the clear leader in consumer electronic sales, with 30 billion dollars a year in sales and 17 percent of the consumer electronics market. What caught my attention was the following excerpt.

Wander around the executive suite at the Minneapolis headquarters of Best Buy, and near the CEO's office you'll encounter a strange tableau.

It's a mock "retail hospital"--including a row of truncated beds in which effigies of stricken retailers like Kmart and Woolworth, the old five-and-dimes, lie with their corporate logos propped up on pillows and with their abysmal financial results displayed on bedside charts. Declares a sign nearby: THIS IS WHERE COMPANIES GO WHEN THEIR STRATEGIES GET SICK.

But the mock hospital is a reminder that in the volatile, low-margin retailing realm, complacency brings doom. Because of that awareness, Brad Anderson (CEO) has been willing to roll the dice again and again throughout a legendary retailing career, junking perfectly good business models in favor of high-risk innovations.

"When most of us say, 'Well, I'm more comfortable where I'm at,' " says CFO Darren Jackson, "Brad pushes us around the next corner."

Whatever the business it is essential that each employee looks for better, or more effective, products or ways of doing things.  The only way to truly beat your competitors is to drive creative destruction internally faster, and more effectively than your competitors.  In our increasingly globalized marketplace the rule is simple -- innovate or die. To be clear, innovation by itself doesn't guanantee survival, but failure to innovate will lead to certain death.