You start. You struggle against initial inertia to gain velocity. You succeed. You grow. Your success breeds more success. Momentum is now your friend. But the world changes: technology, markets, society… And your hard won momentum keeps hurtling your (now large and profitable) company down the same trajectory. And momentum is now your enemy. Ah, the joys of…inertia.
The recent sensation caused by an ex-Microsoft insider’s NYT op-ed is just one more example of this seemingly inevitible ‘circle of (corporate) life.’:
Microsoft’s huge profits — $6.7 billion for the past quarter — come almost entirely from Windows and Office programs first developed decades ago. Like G.M. with its trucks and S.U.V.’s, Microsoft can’t count on these venerable products to sustain it forever. Perhaps worst of all, Microsoft is no longer considered the cool or cutting-edge place to work. There has been a steady exit of its best and brightest.
What happened? Unlike other companies, Microsoft never developed a true system for innovation. Some of my former colleagues argue that it actually developed a system to thwart innovation. Despite having one of the largest and best corporate laboratories in the world, and the luxury of not one but three chief technology officers, the company routinely manages to frustrate the efforts of its visionary thinkers.
Innovation is a new way of doing something or “new stuff that is made useful”
I’ve of course added my two cents to this discussion, with my thoughts on the subject drawing on my personal experiences (and those of friends and colleagues) of having tried (very hard) to sponsor a pro-active approach to disruptive innovation in a very large company. For those of you not familiar with my hypothesis on the question, I’ll save you the trouble of digging through my blog, it boils down to the complex weave of organizational and personal dynamics that unavoidably emerge when you assemble large groups of people in one organization:
Loss aversion dominates: most people (and sub-groups) fear loss much more than they enjoy gain. This is why the status quo is so closely guarded (at any level of resolution, from the individual through to the overall company.)
Dancing with the one that brought you: at any level of seniority, it is likely that the person in charge got to be that person in charge by being particularly skillful or adept at navigating the existing business and/or organizational model. It’s like the America’s Cup: the winner sets the rules (and has no incentive to adopt “new rules” for which they are probably less well adapted.
In fact, Machievelli eloquently summed it up 500 years ago:
It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than the creation of a new system. For the initator has the enmity of all who would profit by the preservation of the old institutions and merely lukewarm defenders of those who would gain by the new ones.
These principles form the core of the corporate immune system which considers any disruptive innovation as a threatening virus. So what is a big company to do? Should they accept the inevitability of decline (hopefully slow, profitable and graceful) or can they postpone or avoid this fate?
In some (most?) cases, I would suggest that they accept decline but this does not mean giving up. On the contrary it means aggresively (and even creatively managing the exisiting assets to create as much value as possible as the business model and or product ‘runs off’. This indeed was my prescription for Microsoft when I wrote two years ago that they should break-up the company and re-jig the capital structure, running the Windows/Office businesses for cash (with a debt financed balance sheet) and let a thousand new baby Microsofts bloom. A conventional view would see this as a failure of management and/or ambition. Obviously I think this attitude is ass backward: running the core products for cash while releasing enormous amounts of human and financial capital, which in turn could be used to create hundreds of new companies could – using any metric you like – only be considered a triumphant success. But convention, inertia and ego means that this path to success is rarely if ever taken by the leaders of market giants. Just in the last couple weeks the idea that Google might becoming the ‘next Microsoft’ has gained currency (at least in the valley.) I asked this same question (in May 2008:)
I know it has been asked a million times before but is Google the next Microsoft? (At least from a financial point of view…) At the start of 1996, MSFT traded at c. $6/share. Four years later they peaked at almost $60/share. GOOG IPO’ed at c. $85/share in 2004, and just over three years later peaked at over $700/share. Both moves of approximately 10x. Since 2000, MSFT has been more or less range bound at around $30/share, despite continuing to grow it’s top and bottom lines and produce prodigious amounts of cash. I’m not suggesting history will repeat itself exactly – perhaps we have not yet seen the peak in GOOG’s share price (sell at $850?), and I’m certain they will continue to grow their top and bottom lines and produce prodigious amounts of cast in the next 5-10 years. But…will the stock eventually settle at around $500 – 600/share…? Is it conceivable that Google, like Microsoft before it, will become the place where good companies are bought only to disappear?
However, like with human life, I think there are probably a number of recipes to extend the natural corporate life (and the quality of those extra years) and to leave a more valuable legacy when and if the company ultimately disappears. Starting with investing some of their excess capital in the innovation ecosystem that surrounds them. As I have found however, this idea is anathema to most large companies. And with some reason. The history of ‘corporate venturing’ is indeed (as Azeem Ahzar eloquently writes) riddled with failure. My view is that this is because it is exceeding hard to do this in house: the corporate antibodies as described above will almost always do their job and sabotage any in-house venture program. And yet just investing as an LP in an outside venture fund – even if one that happens to focus on markets relevant to the company – is an understandably unsatisfactory and probably equally ineffective alternative.
But we think there is a third way: a focused, strategic innovation program run independently from, but in close collaboration with the company. Maybe we can help your company. You know where to find us: where innovation grows.
A couple of months ago, I had the privilege to have been invited to speak at eComm 09 in Amsterdam. I have posted on this previously but recently the video of my talk was posted and perhaps will make it easier to understand my accompanying presentation. If you can spare 20 minutes (there is an additional 10 minutes of q&a at the end) and are interested in understanding how Nauiokas Park defines our opportunity space, please have a look as it is probably the most succinct expression of the worldview we bring to investing and analyzing potential investment opportunities.
And here is the presentation again, in case you would like to follow along as you listen to the video:
Well-built developer platforms are the future of every industry. (-ReadWriteWeb)
Note: Their is a small glitch around 7:40 where the video skips over a few seconds; funnily enough (for the conspiracy theorists out there) this is exactly where I say that had ZSIN’s existed, the extent of the disasters that occurred in the mortgage securitization markets would have been at least an order of magnitude smaller…)
Using the tried and tested TED 20min format, it was a great opportunity for me to collect my thoughts into (what I hope was) a coherent overview of how I think technological and economic forces will shape the optimally adapted ‘industrial stack’ for the sixth paradigm. It’s a great summary of the prism through which we look at potential investment opportunities and I hope will help us articulate this more powerfully to entrepreneurs and prospective investors.
I’d love to hear any feedback (good, bad and ugly) from any of the eComm delegates who saw my presentation and hope to continue the conversation with you and others here. You can also follow me on twitter @nauiokaspark.
Thanks to Paul and Lee for inviting me and especially to those of you who took the time to respond to my call for input – it was tremendously valuable in helping me to shape and refine my thinking and in building the presentation; just a few years ago, assembling this kind of distributed brainpower would have been impossible, and I hope I never lose my ‘childlike sense of wonder’ at the boundless possibilities that technology enables.)
You would think that the current problems facing mega-financial institutions (with Citigroup being the obvious poster child, but to be fair by no means the only example) that the CEO’s and Boards of large banks would think twice before thinking about pursuing large ‘industry-consolidating’ acquisitions. Don’t get me wrong, I can see how this current downturn could be seen as a seductive opportunity for anyone with a strong(er) balance sheet – not only are targets potentially cheap (at least by historical standards – setting aside concerns about visibility of future earnings) but they are possibly available which isn’t always the case (irrespective of price.) Furthermore, given the current labor market environment, the potential to actually realize efficiencies by consolidating and downsizing must indeed seem tantalizing to experienced industry leaders. And yet…
…and yet, at the risk of oversimplifying, it all just seems to underline a lack of creative strategic thinking at the top. Is the strong buying the weak, the big buying the less big, really the best or the only long term strategic choice faced by global financial services giants? Isn’t there a viable plan B? or C? At times like these, one can be forgiven for asking the question (from Here is the City news):
One upshot of the credit crunch is that some of the smaller or troubled banks look vulnerable to takeover. Only last week Bank of America CEO Ken Lewis said that he thought it will be more difficult for stand alone investment banks (like Goldman, Lehman, Merrill and Morgan Stanley) to survive, and that they may be swallowed up by commercial banking rivals with bigger balance sheets, better capital-structures and deeper pockets. Well, it didn’t take long for the rumour mill to kick into life.
The Daily Telegraph has come out Tuesday and reported that Barclays President Bob Diamond is trying to twist his board’s arm to make a bold bid for an investment bank. And, according to the newspaper, top of his wish-list is Lehman Brothers and under-fire UBS.
As the newspaper points out, Lehman would bolster investment banking arm Barclays Capital’s presence in the US (something Diamond is keen to do), but there is significant overlaps in terms of jobs in fixed income and huge job losses are likely in the event that a deal is done. Over at UBS, of course, a large proportion of fixed income staff have been (or will be culled), so Diamond and the BarCap team won’t need to do as much axe wielding. And UBS’s equities, wealth management and private banking businesses would make a deal for the Swiss bank highly attractive.
Rumours are also swirling that Ken Lewis himself, despite his much-regretted comments last year about having about as much ‘fun’ as he could stand in investment banking, might be mulling over a run at Merrill Lynch. Although busy putting to bed the Countrywide deal at present, the smart money says that once that is sorted, Lewis might pounce (he is said to have long-coveted Merrill’s brokerage network).
I’m sure there are some good ‘consolidation’ deals out there to be had in the next 12-18 months, but I would further suggest that they will be the exceptions that prove the rule. The biggest risk in my opinion, will be when CEOs and Boards think like traders and not business leaders when considering these deals. In the majority of cases, they would be better off buying out-of-the money calls on firms they think are cheap and (if they are right) reaping the financial rewards of a good trade, rather than buying one firm lock-stock-and-barrel and having to valiantly try to manage through the (probably non-linear) increase in corporate complexity that this would engender.
I’ve been thinking about how to point you in the direction of a fantastic post by Going Private and despairing of just putting up a link saying ‘Read this’, or alternatively lamely regurgitating an executive summary, I am pleased to connect the dots in the context of the question posed above. Going Private blames the strategic ineptness of many businesses on Michael Porter and his Five Circles of Hell:
I blame Michael Eugene Porter. Not that Porter is a dipstick, (well not only that) but because the majority of his modern adherents certainly are.
The eager and almost rabid application of Porter’s “Five Forces” (Supplier Power, Customer Power, Threat of New Entrants, Threat of Substitute Products, Industry Rivalry) to technology products and services has bred an entire generation of MBAs in marketing positions dedicated to developing and maintaining closed systems and closed hardware platforms. This is particularly egregious in the case of business models that are effectively based on distribution channels. In conventional analysis there is nothing wrong with making your living on distribution channels. Remember, that in 1979, when Porter developed the Five Forces framework, distribution channels were highly expensive to create and maintain and, owing to these costs, constructing them effectively presented a significant barrier to entry. Your product didn’t even have to be particularly good, because the threat of substitutes was reduced via the difficulty and expense of the competition actually getting those substitutes (however good they might be) to your customers. Suppliers, if they wanted access to your customer base as a proxy to sell their raw materials, had to go through you. New entrants had to build an entirely new distribution channel. Customers were stuck. You owned the market. But you had to guard this distribution channel carefully. And you had to make sure you hadn’t forgotten something simple and critical. That’s not part of a conventional Porter analysis. But why would it be? Conventional distribution channels are quite physical, antique and boring.
In this post, Going Private makes the point by looking at a variety of businesses such as entertainment (videos, music), telecommunications and consumer electronics: “…particularly egregious in the case of business models that are effectively based on distribution channels.” (emphasis added) Now I would posit that this describes remarkably well much of the business of modern financial services as well. (Indeed some readers may recall my penchant for comparing the business models and the impact of technological changes thereon of the telecommunications industry and financial services…) (Mixing metaphors liberally…) bolting unreconstructed, 20th century, distribution platforms together ad infinitum, might get you a more efficient horse-and-buggy, but I sincerely doubt it will get you a car.
Admittedly this line of thinking is somewhat self-serving given that my business is predicated on helping large financial institutions develop a ‘Plan B’ and to helping them embrace new business ideas and approaches that are adapted to the new techno-economic paradigm. I am sympathetic however (see my previous post) to the institutional reality that it is often easier for a Chief Executive and his team to convince the Board to spend $10 billion on a ‘linear’ acquisition than it is to convince them to spend $10 million on an unproven ‘non-linear’ venture. We think we’ve found a way to help mitigate this behavioral paradox and plan to spend the next few years trying.
If we don’t succeed, I fear the future giants of banking will need a new mascot…
I don’t know these gentlemen, and obviously I am not privy to the internal workings of the financial behemoths that they were charged with piloting, but I wonder if the problem isn’t so much who is at the helm but the ship they were trying to steer. As Mr. Prince said, taking personal responsibility was the “honorable thing to do” as a leader (I’m reminded of the immortal words of Hopper – “The first rule of leadership: everything is your fault”) and I would tend to agree. And there is no reason to cry for these men – they were amply rewarded for their efforts and will – I’m sure – land on their feet so to speak, so don’t misunderstand what is to follow as sentimental apologia for their failings (real or perceived.) However I wonder if these giant firms are manageable at all – at least under the current constructs of managerial science – and ask honestly if any one individual however smart, charismatic or experienced (Mr. Rubin would seem to have all these qualities in excess) can realistically succeed in steering the turn-of-the-21st-century financial megafirm through the oceans of Extremistan (Mr. Taleb’s metaphorical “province where the total can be conceivably impacted by a single observation.”)
For some years now, I have been interested in trying to understand how the corporate ecosystem would change under the effects of the onslaught of accelerating social and economic change driven by the revolution in information and communication technologies. Applying Coase’s Theory of the Firm to a world where communication and transaction costs move unrelentingly towards zero (at least in many contexts) must in my mind lead to a fundamental – quantum – shift in the optimal organizational dynamics of companies and the economy more broadly speaking. The vision I seem to be ineluctably drawn towards is one that looks like the classic map of a network, containing millions (or billions) of nodes and interconnections, with a fractal geometry. So yes I do think that ’super-nodes’ (read mega-corporations) will continue to exist and even grow, but I think that complexity will migrate away from any particular node to the network. So in my mind, bigger is only sustainable if ’simpler’. Today’s financial behemoths are anything but ’simpler’.
If we look back from a vantage point twenty years hence, I suspect that the period between 2002 and 2012 (or so, I’m not hung up on exact dates…) will be seen as a transitionary period – when the one wave (of linear giganticism) crested, and another of specialization and the migration of organizational complexity to the network (the “edge”) emerges. Will the takeover of ABN Amro be the last of the mega-mergers (although and perhaps fittingly the 3-way break-up involved added an element of deconstruction to the transaction…)? If I had to guess, probably not but it will more likely be ‘one of’ the last of its kind. Of course, I am far from alone in wondering if these giants have passed the point of diminishing returns on scale (from the BBC article on Mr. Prince’s resignation:)
“The actual structure of Citigroup is broken – it’s too big, it’s too bloated and we think it should be broken up into three of four pieces,” added Bill Smith from Smith Asset Management in New York.
Ronald Coase, the economist, famously observed that private companies are different, because they are not the only place to do business. An alternative to costly and complex banks is an atomised market, where individuals and institutions do business without a large financial intermediary. Banks may merge to survive this inevitable transition; but in the long run many of their functions will disappear…the core functions of any Wall Street Bank cannot remain inside the same complex and costly shell forever.
Given this is probably a topic worthy of a doctoral dissertation (and if done well perhaps a Nobel prize in 25 years), there is no way I can even start to do it justice in a short blog post, but I hope I have been able to give at least a taste of how I think this might play out and why it is likely to be a core consideration in any investment thesis for financial services over the coming two or three decades.
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