Adding Coherence to Capitalism

This post is inspired by my two favorite business readings of 2010: (1) “Creating Shared Value” by Michael Porter and Mark Kramer (Harvard Business School), and (2) “The Essential Advantage: How to Win with a Capabilities-Driven Strategy” by Paul Leinwand and Cesare Mainardi (Booz and Company).

I’ll risk doing a huge injustice to both of these contributions to the literature on business strategy and development and attempt to boil down the crux of each as follows.  The essence of “Creating Shared Value” is that “Companies can create economic value by creating societal value” in three key ways: reconceiving their products and services, redefining productivity along the value chain, and building supportive industry clusters at each of the company’s locations.  In other words, we need to move beyond giving lip service to calls for corporate social responsibility, adopt a long-term perspective, and pursue the real returns on investment in the community.

The essence of “The Essential Advantage” is that companies succeed, “not because of what they own or how big they are or because they are positioned in the right industries.  Their advantage lies in what they do and how everything fits together to create value. They succeed because they are coherent.” High relative coherence is what gives a firm the “right to win” in a given market, and coherence refers specifically to the “resolute, clear-minded focus in a company on three critical elements”, i.e. its unique value proposition, its system of distinctive capabilities, and its lineup of products and services.

The arguments articulated in “Creating Shared Value” and “The Essential Advantage” overlap and complement one another in several key respects.  First, both are about building virtuous circles of value creation whereby improving value in one area gives rise to opportunities in the others.  Second, both posit that a firm can create the most value, for both shareholders and society, by doing what it does best, that is leverage its most distinctive capabilities. Charitable monetary donations, for example, are a weak contribution to social welfare in comparison to the deployment of a firm’s core competences for the same purpose.  Third, Porter, Kramer, Leinwand and Mainardi have composed complementary pieces in that the former two authors offer an inspiring new sense of purpose for businesses, and the latter two authors offer a practical framework for setting priorities and coherently reflecting that purpose in a firm’s capabilities, product and service portfolio, and day-to-day operations.

Now to the point of this post: after these two readings, I was left wondering how, more generally, any firm’s value proposition might reflect both its contribution to social welfare as well as its distinctive capabilities. I wondered how, specifically, a firm might position itself vis-a-vis other firms or institutions as the champion of one discrete approach to shared value creation or another or as the champion of some combination of approaches. Porter and Kramer offer some examples of paths toward shared value creation — i.e. improving water and electricity efficiency, enhancing employee skills, health and safety, and promoting supplier access and viability — but I see these and other stated examples as less than fully representative of the full array of paths.  Reconceiving products and services, redefining productivity, and building supportive industry clusters are three, but they are among others, and “building supportive industry clusters” is awfully broad as it encompasses everything from public-private partnerships to shared infrastructure. Likewise, after reading “The Essential Advantage”, I was left wondering what is the list of most commonly used approaches for creating shared value that would supplement what Leinwand and Mainardi identify as 15 mutually exclusive value propositions that they see companies combining most frequently to compete and win (in the traditional sense of turning a profit).

An hour and three cups of coffee later, I came up with a list of seven mutually exclusive “shared value propositions” — or what Leinwand and Mainardi would call “puretone ways to play” (and I would be delighted to highlight others that anyone might suggest).  I phrase each in terms of the basic approach to creating shared value in a particular market, in a way that differentiates the company.

(1) Human capital developer. These companies invest in and advocate for local education, health services and social diversity (e.g. gender equality) to enhance labor market conditions, for their own benefit and for all.  3M, for example, actively contributes to the University of Minnesota’s highly competitive chemistry program.

(2) Resource steward. These companies maximize the productivity of their resources, ensuring minimum environmental impact and maximum health of their employees and their families, thereby minimizing resource costs and employee absences and lost productivity.  They also advocate for the protection and enhancement of these resources in general for the sake of national economic competitiveness and well-being.  Paperless companies save trees and money.

(3) Infrastructure provider.  These companies invest in infrastructure (I mean this in the broadest sense to include networking platforms, electricity and water utilities, transport infrastructure, etc.) that unlocks growth in their supportive industry cluster and the local economy in general.  De Beers has made significant contributions to utilities and transport infrastructure in some parts of Africa where both the firm requires that infrastructure for diamond mining and the community requires infrastructure in general.

(4) Alliance coordinator. These companies orchestrate partnerships between firms and institutions of government and civil society for the sake of correcting “coordination failures” (in the market failure sense). Specifically, these firms improve their own coherence through sharing of market, technology and resource access among strategic allies (i.e., other organizations in their supportive industry cluster). The strategic alliance between General Motors (GM) and Shanghai Automotive Industry Corp (SAIC) in 1997 involved substantial knowledge transfer to local Chinese employees and market access for GM.

(5) Policy influencer.  These companies know how to navigate regulations and transparently advocate for policy changes that create value for both the firm and for society.  A good example is Google’s success in influencing ICT sector deregulation in North Africa by drawing attention to implications for poverty reduction and development. These firms are essentially capable of “changing the game” by affecting change in the business climate itself.

(6) Consumer educator.  These companies view their current and potential customers as partners in collaborative product and service improvement.  Open-source software development (i.e. crowdsourcing) is one great example of the way in which these companies succeed.

(7) Social value player.  These companies motivate customers to embrace products and services that create societal benefits, like healthier food or environmentally friendly products.  These companies also serve disadvantaged communities and developing countries — customers at the bottom of the pyramid — that have not been recognized as viable markets; to do so, they redesign their products, services or distribution methods, offering them at very low or even zero cost.  Also, by learning-by-doing these companies thereby trigger capability improvements that often have application in traditional markets.

After producing this list, I realized that several could be captured under the large umbrella of “building supportive industry clusters”, but I find it more helpful to disaggregate the notions of alliance coordinator and infrastructure provider, for example, as they tend to reflect very different capabilities.  I also include areas concerning factor conditions (human capital developer), government (policy influencer), and demand conditions (consumer educator) because they help to reflect the ways in which a firm can strengthen what Professor Porter himself coined as the “Diamond of National Advantage”, and because they, again, reflect very different capabilities.

With due consideration and incorporation of the above seven Shared Value Propositions, and while guided by the roadmap articulated in “The Essential Advantage”, a firm can learn to build and leverage its unique system of distinctive capabilities to achieve a sustainable edge over the competition and simultaneously serve the basic needs of society.  As firms increasingly do so, we will see the emergence of a more coherent form of capitalism, in which the basic aim of businesses is to mobilize people around solving our shared social, environmental, and economic problems, and to do so as productively as possible.

Towards a Learning-based Economy

Earlier this year, I encountered this interesting article by Stuart Kauffman, an American theoretical biologist and complex systems researcher (thank you Wikipedia). I was reminded of it after seeing The Social Network, which I highly recommend.

Offering the origins of Facebook and Silicon Valley as examples, Dr. Kauffman argues that we cannot know in advance how growth in an economy will occur.  Consequently, policymakers alone cannot fathom in advance how they ought to adjust the millions of pages of legislation and the thousands of public entities necessary to facilitate and accompany the process of change. In his concluding remarks, he offers what I find is an good summary of the likely way forward: “Probably, the solution involves thinking of the meta-structure whereby policies co-evolve with capabilities and production.”

I’ve had the privilege of working on several quite interesting consulting projects in the Middle East focused on building better institutions of economic development, and I believe that they are exactly what Dr. Kauffman has in mind.  Through work in UAE and more recently in personal conversation with Professor Hausmann at Harvard Kennedy School, I found that two of the most important of these institutions are development banks and industrial cluster authorities (like Mubadala and ZonesCorp in Abu Dhabi).  The latter incubate social networks and bring people together to diagnose binding constraints on growth, which development investments can help to relax and remove.  The former channel savings into development investments, while providing a competitive arena for incubating good ideas.

That brings me to the point of this post.  If industrial clusters are one key source of information that entrepreneurs and policymakers in an economy can leverage for continuous improvement, then a third set of institutions, those focused on export promotion, are another key source, albeit typically broken and misunderstood.  What I mean to say is why don’t more countries have export marketing agencies instead of export promotion agencies?

In one of the best business books I’ve read (up there with Chasing the Rabbit and The Fifth Discipline), the authors of Blue Ocean Strategy explain how listening to the right customers can unlock new market spaces.  Southwest Airlines listened to bus and rail commuters in order to better understand consumer demand for point-to-point air travel.  The key word is listen — the “right” customers will “pull” in the right direction.  Now let’s take a look at export.gov, the online window for American firms to seek help in promoting or “pushing” their exports.  Options available on the site are: promote my products overseas, protect my IPR, file a trade complaint, get USG advocacy, attend trade shows, and participate in trade “missions”, to name a few.  The mission statement is more telling: “We promote and protect U.S. commercial interests abroad and deliver customized solutions to ensure that U.S. businesses compete and win in the global marketplace”.  Quite a far cry from the “listening” approach… more like “We’re gonna smoke ’em out!”

The Singaporean equivalent of export.gov is IE Singapore; see the difference in rhetoric: “With a global network in over 30 locations and our 3C framework of assistance – Connections, Competency, Capital, we offer products and services to help enterprises export, develop business capabilities, find overseas partners and enter new markets […] IE Singapore’s global presence and extensive network of key business and government contacts offer companies the necessary connections to venture overseas.”

The quotes are cherry-picked, sure, and the improvement over the rhetoric of export.gov is perhaps only subtle, but I think the point is clear and the implications are tremendous.  The American institution that serves demand for American export promotion services sounds protectionist because it is.  Why don’t they take a longer view?  Why not make it their mission to “build relationships with potential customers to understand real needs in a fast-changing global marketplace”?  Why not view the energy efficiency improvement needs of China as an opportunity?  Or the hunger needs of India and Bangladesh?  Or the basic medical goods and health services needs of Sub-saharan Africa?  Maybe we just have a geographic problem, being physically located far away from the rest of the world.  Or maybe we just need to get on the metric system, teach more Spanish in schools, encourage kids to study abroad and develop a global perspective… okay, deep breath.

If a knowledge-based economy is the destination, then a learning-based economy is the journey.  Business School 101: promotion is merely the process of notifying customers for your product or service of your availability to serve them; marketing is a process of building relationships and mutual learning between a firm and its current and potential customers in order to create, capture and deliver value.  In the context of institutions of economic development, I think of that process of learning as taking place among introverts on one hand — the domestic industrial clusters that self-discover constraints on growth and advocate for change — and extroverts on the other hand — the export marketing authorities that should serve to build relationships, empower international consumers to self-identify, and educate local firms on the great many global causes worth serving to create value for all.

Why America needs more than Venturesome Consumers

I encountered a subtle but deeply disconcerting idea in a recent book entitled, “The Venturesome Economy”: America will prosper as long as American consumers are venturesome.  I’ll try to balance brevity with justice and summarize the author’s main points as the following:

First, more wealth is created by recombining technologies (building our capacity to benefit from them) than by making new technological breakthroughs.  Therefore, government should get out of the way, avoid distortionary and inefficient subsidies for pure scientific R&D, and allow firms to take greater risks with more freedom from over-regulation.
• Second, outsourcing and offshoring are no causes for alarm because our venturesome economy will create new jobs through a process of “nondestructive creation,” i.e., innovation that creates new jobs without eliminating existing ones, especially in the nontradeables services sector where jobs tend not to migrate overseas.  Protectionism is the wrong approach.
• Third, the American consumer is assertive, adventurous and capable – in a word, venturesome.  The author asks where else do customers exist who have been so anxious to buy products such as the iPod, willing to pay prices that justify significant upfront investments in R&D, and open to being ‘guinea pigs’ in the innovation process.  Innovative firms thrive in the U.S. because new ideas are given a chance; in fact, the social, cultural, psychological and historical roots for America’s venturesome consumption run so deep that they will nourish innovative activity for many years to come.

I can agree, in part, with the first point.  A growing body of economic literature does indeed find that “countries tend to converge to the level of income dictated by the complexity of their productive structures, indicating that development efforts should focus on generating the conditions that would allow complexity to emerge to generate sustained growth and prosperity” (Hidalgo and Hausmann, 2009).  In other words, wealth is created by deploying a distinctive and sophisticated combination of capabilities to satisfy human needs.

Beyond that, how visionary or inspiring is venturesome consumption?  Why not just say, “The key to prosperity: keep buying new toys, and he who dies with the most toys wins.”  But wait a sec…

• Were Americans being “venturesome” when Wall Street engineered innovative new financial products to provide loans to anxious and willing consumers in Sarasota that would inevitably default?
• Were Americans being “venturesome” when the Detroit Big Three discovered innovative new designs for wasteful, high-end automobiles and sold them to eager consumers?  What is “non-destructive creation” if not the discovery and deployment of clean technologies in auto manufacturing, and why do we lag so far behind?  Isn’t it the utter failure of these firms that makes it necessary for the DOE alone to spending more than $40 billion in loans and grants to encourage private firms to develop green technologies, such as electric cars and new batteries?
• Is it wise to assume that the demand stemming from venturesome American consumers will sustain our national competitive advantage?

Clearly, I’ve got issues.  In particular, I’m also disturbed by the notion that somehow pure scientific inquiry pales in comparison to entrepreneurship.  Technologies come from somewhere!

And regarding the overtones of free-market fundamentalism, aren’t “perfect storms” becoming the norm?  Don’t we need publicly elected stewards of economic activity to help guard against market failures (including inter-industry coordination failures) more now than ever?  While the author’s repeated expressions of anti-industrial policy sentiment are loud and clear, let’s not forget some of the great successes of industrial policy, like the Internet, a DoD research project dating back to 1969.  Last summer, Dani Rodrik reminded us in an online debate that the Chilean government has played a crucial role in developing every significant new export that the country produces, South Korea’s POSCO is possibly the world’s most productive steel firm (state-owned until 2000), and Dubai’s Jebel Ali port is one of the largest and most successful ports in the world.  Go figure.

Of course, absolute protectionism is not the answer, but at the same time, we need more than just venturesome consumers.  Why is it so hard to hold two competing ideas simultaneously and still retain the ability to function?  A better path to prosperity involves lengthening our time horizon for investment and entrepreneurship; it involves both intellectual curiosity and genuine empathy; and it involves a process of de-bottlenecking along the way.  If we truly believe and spread the idea that the venturesome American consumer can sustain innovation across the U.S. economy, then we are doomed to wander a dark path toward more perfect storms, armed only with our hopeless optimism.

On the other hand, if the goal is to create a better world for both ourselves and the next generation, then firms, governments and civil society need to think hard about the co-evolution of scientific inquiry and human needs, not only in our own venturesome economy, but all around the world.  After all, “As American consumers spend a little less and save a little more, it has never been more important to connect U.S. businesses to the 95 percent of the world’s consumers who live outside our borders” (U.S. Commerce Secretary Gary Locke, Sep. 16, 2010).

The Velocity of Economic Diversification

As a total newb to blogging, I suppose I’ll begin on a productive note and publish my recent thesis, submitted to fulfill the graduation requirements of the Master of International Business (MIB) program at The Fletcher School.  The topic reflects my long-held personal and professional interests in the evolution of economic complexity and the controversial roles of institutions of economic development.

ABSTRACT

Is there a speed limit to productive diversification?  What does rapid diversification entail in terms of resource requirements for economic governance? Complementing existing literature on the benefits of diversification for economic development, I examine the public sector labor requirements associated with the diversification of output across economic sectors.  Evidence from time-series and panel data for 16 countries, as well as the case of Abu Dhabi’s economic transformation since 1975, suggests that aggressive diversification may lead to problematic imbalances between public and private sector employment.  In view of these potential imbalances, I argue that policymakers should be less aggressive and more deliberate in their pursuit of productive diversification and adopt priorities to optimize the pace of achieving their economic development aspirations.

Full text: MIB Thesis – Fabyanske – 2010.

A Network Analysis of the Global Financial System

The following was submitted to fulfill the requirements of coursework in finance with Professor Jacque at The Fletcher School at Tufts and coursework in networks and complexity with Professor Hidalgo at Harvard Kennedy School of Government.  The network visualizations were created using gephi, an open source graph viz platform that rocks my world.

ABSTRACT

What implications has the U.S. sub-prime mortgage crisis had for international financing?  Are banks more or less exposed to systemic risk in the global financial system now than before?  This paper explores recent developments in the web of cross-border bank exposures and, treating these exposures as a “directed network”, investigates the changing statistical measures of network topology.  These measures suggest a stark departure from historical patterns of globalization in banking.  Historically, trends toward higher connectivity and diversified exposure were continuous and unhampered by disturbances or crises between 1985 and 2006.  More recently, these trends have been substituted for an apparently steady state of constant connectivity, with lower levels of average exposure, lower bank appetites for risky lending to less developed countries, and greater concentration on lending between “culturally similar” countries.  Looking forward, key implications of this departure include lower levels of systemic risk, but also lower levels of efficiency in international financial markets.

Full text: 0420 – Exposures Network – Fabyanske – FINAL

PowerPoint: Bank Exposures Network Analysis