August 2006 Archives

In one more example of financial innovation and the monetization of a previous intangible, it looks like California may be creating a new market in green house gas emissions, according to this morning’s Wall Street Journal:

Leaders of the state legislature and Gov. Arnold Schwarzenegger announced a deal yesterday under which California will mandate a reduction in the state's emissions of gases contributing to global warming to 1990 levels by 2020. The cut would target the state's biggest industrial emitters of greenhouse gases, such as power plants, oil refineries and cement factories. California already has passed a law requiring greenhouse-gas-emission cuts from cars and light trucks sold in the state.
. . .
The measure still must pass both houses of the state legislature to become law, but the agreement by Gov. Schwarzenegger and the majority leaders of both houses all but ensures that outcome. "We can now move forward with developing a market-based system that makes California a world leader in the effort to reduce carbon emissions," Gov. Schwarzenegger, who is running for re-election this year, said yesterday, when the agreement was announced.

The emphasis, however, is on "may":

Business representatives wanted a guarantee that the state would include a mechanism allowing companies to buy and sell carbon-dioxide-emission permits among each other as needed, to soften the potential financial blow. But some environmentalists argued that would make it too easy for California businesses to avoid cleaning up their own operations. The final legislation says the state "may" include such a trading mechanism in its final plan.

I would think that they could create a market involving credits for reductions only within California. This would satisfy the environmentalist concern and be true to the Governor’s goal of a market-based system.

Stay tuned.

The Veterans Administration hospital system has engineered an amazing turnaround, according to TIME.com: How VA Hospitals Became The Best:

Until the early 1990s, care at VA hospitals was so substandard that Congress considered shutting down the entire system and giving ex-G.I.s vouchers for treatment at private facilities. Today it's a very different story. The VA runs the largest integrated health-care system in the country, with more than 1,400 hospitals, clinics and nursing homes employing 14,800 doctors and 61,000 nurses. And by a number of measures, this government-managed health-care program--socialized medicine on a small scale--is beating the marketplace. For the sixth year in a row, VA hospitals last year scored higher than private facilities on the University of Michigan's American Customer Satisfaction Index, based on patient surveys on the quality of care received. The VA scored 83 out of 100; private institutions, 71. Males 65 years and older receiving VA care had about a 40% lower risk of death than those enrolled in Medicare Advantage, whose care is provided through private health plans or HMOs, according to a study published in the April edition of Medical Care. Harvard University just gave the VA its Innovations in American Government Award for the agency's work in computerizing patient records.

. . .

The roots of the VA's reformation go back to 1994, when Bill Clinton appointed Kenneth Kizer, a hard-charging doctor and former Navy diver, as the VA's under secretary for health. Kizer decentralized the VA's cumbersome health bureaucracy and held regional managers more accountable. Patient records were transferred to a system-wide computer network, which has made its way into only 3% of private hospitals. When a veteran is treated, the doctor has the vet's complete medical history on a laptop. In the private sector, 20% of all lab tests are needlessly repeated because the doctor doesn't have handy the results of the same test performed earlier, according to a 2004 report by the President's information technology advisory committee.

Another innovation at the VA was a bar-code system, as in the supermarket, for prescriptions--a system used in fewer than 5% of private hospitals. With a hand-held laser reader, a nurse scans the bar code on a patient's wristband, then the one on the bottle of pills. If the pills don't match the prescription the doctor typed into the computer, the laptop alerts the nurse. The Institute of Medicine estimates that 1.5 million patients are harmed each year by medication errors, but computer records and bar-code scanners have virtually eliminated those problems in VA hospitals.

Private hospitals, which make their money treating people who come to them sick, don't profit from heavy investments in preventive care, which keeps patients healthy. But the VA, which is funded by tax dollars, "has its patients for life," notes Kizer, who served in his post until 1999. So to keep government spending down, "it makes economic sense to keep them healthy and out of the hospital." Kizer eliminated more than half the system's 52,000 hospital beds and plowed the money saved into opening 300 new community clinics so vets could have easier access to family-practice-style doctors. He set strict performance standards that graded physicians on health promotion.

Technological innovation (IT) - organizational innovation (performance standards) - innovation in the business model (shift from treatment to prevention). A winning combination.

I guess some times even dinosaurs can dance.

As Business Week points out, get ready for the Chinese:

The 2008 Beijing Olympics will doubtless be a gloriously defining moment for China—an international image blast underscoring the mainland's arrival as an economic power. And perhaps more important for Chinese companies selling everything from booze to bank accounts, it is shaping up to be the marketing opportunity of the decade.

And if you don't think they are ready, take a look at BW's 20 Best Chinese Brands. Many of these brands are positioned mostly for the local Chinese market, such as Bank of China, China Construction Bank, China Merchants Bank, insurance giant Ping An, China Mobile, China Telecom and Internet/on-line gaming leader NetEase. But others, such as mobile phone makers ZTE and Gree Electric Appliances (already the world's largest air conditioner manufacturer), are actively pursuing global markets. Others that didn't make the top 20 cut, such as Tsingtao Brewery, appliance-maker Haier, DongFeng Motors and Shanghai Automotive Industry, are also moving into the global market. Haier is already becoming a design leader in the US with what Business Week calls a "line of eco-friendly, tech-rich appliances."

China and other "developing" countries are moving up the value chain - including in design and innovation. Those who think that the US can survive economically simply by living off the royalties from our past great ideas, think again. The I-Cubed Economy is one of relentless innovation. And other nations are working hard to prove they are as good at that game as we are.

BEA revised its estimate of 2Q GDP up slightly this morning. As the Wall Street Journal reported - GDP Is Revised Up to 2.9% Rate On Stronger Inventory Building:

The U.S. economy didn't brake as hard last spring as first thought, said the government, raising its estimate for second-quarter growth partly because of stronger inventory building by businesses.

Wait a second. This is a good thing? In the old business cycle models, rising inventories was a sign of an impending recession as productive capacity outstripped demand, unless inventories were excessively low. And in today's just-in-time production process, what is an excessively low inventory level? Just because we are putting more things into warehouses doesn't mean the economic is doing better.

And what about all those intangibles which can’t be warehoused? How do we account for them in this model?

Too many questions, not enough answers.

Just so people don't think that the idea I talked about yesterday of environmental marketing is just wishful thinking, here is a story from today's Wall Street Journal - "Biggest-Ever Emissions Trades: $1 Billion Deal Benefits Beijing":

The World Bank and 11 utilities, banks, trading firms and others have put together the largest greenhouse-gas emission trades in history, a $1 billion deal that will help two Chinese chemical companies reduce emissions believed to cause climate change by the equivalent of 19 million tons of carbon dioxide a year.

A billion dollars -- that is real money!

But the creation of this market requires government action:

Seventy-five percent of the money is coming from European and Asian corporations, many of which are hurrying to buy emissions credits that can be used to meet the terms of the Kyoto Protocol. The treaty, ratified by 164 countries, requires 35 participating industrial nations to reduce emissions of carbon dioxide and five other so-called greenhouse gases by 5.2% below 1990 levels between 2008 and 2012.

Since the US does not recognize the Kyoto Protocol, this US companies are not interested in this type of international deal through the World Bank’s Carbon Finance Unit. But not to worry, one of the major players in this market is Natsource, a New York based asset management firm. Natsource reports that greenhouse gas market transactions in 2005 were valued at $10.9 billion.

Now that is really real money.

The group Business for Social Responsibility has identified a key intangible asset - environmental marketing:

How much are well-functioning environmental services like flood control and climate regulation worth to a company's bottom line? BSR has released a new Environmental Markets Trends Report in conjunction with launching an initiative that will help companies assess the risks and opportunities of emerging markets in carbon, water quality and biodiversity. Companies taking the lead in this field are seeing increased real estate value, consistent and high-quality supplies of raw materials, more cost-effective environmental management, cheaper cost of compliance and regulatory "goodwill."

This is not just feel-good advertising, or even brand protection (see the Christian Science Monitor story Stopping the outcry before it starts). BSR is referring to the increasing monetization of environmental services:

The emergence of market mechanisms to protect environmental services promises new business approaches to these issues. Efforts already underway are pricing environmental services, based upon the value they represent to corporations, communities and individuals. Environmental market mechanisms, already a success story in the U.S. in the 1990s, are evolving and are now trading in environmental services.
. . .
As hard, tangible value is assigned to environmental services, companies will be well served by exploring potential investments, as well as their exposures associated with them. Some companies are beginning to see increased value for their real estate, a new ability to ensure consistent and high-quality supplies of raw materials, more cost-effective environmental management, cheaper cost of compliance and regulatory “goodwill.” It is likely that in the foreseeable future, attention to these services will become similar to the attention companies give to other corporate assets, such as infrastructure. In this case, the “infrastructure” is the environmental services upon which the company relies.
(Emphasis in original)

Assigning a tangible value to intangible assets is the key. Monetization is one way of doing this (and something that Athena Alliance is looking more closely at). Non-financial reporting requirements is another (see our working paper, Reporting Intangibles). The combination should give us better tools for managing intangibles and the I-Cubed Economy.

The annual Fed confab is underway at Jackson Hole, with this year's focus on the topic of globalization. To start off, Fed Chairman Ben Bernanke assumed his old role as professor and delivered a history lesson - Global Economic Integration: What's New and What's Not?.

The press was quick to characterize the speech in the usual way:
New York Times - Bernanke Extols Perks of Globalization
WSJ.com - Bernanke Praises Globalization, Urges Broad Sharing of Gains
Washington Post - Bernanke Emphasizes Importance of Globalization
The outlier seems to the FT.com - Bernanke calls for fairer globalisation

But the speech was not just a standard paean to the benefits of free trade. It was also much more than an interesting tour of economic history, including a discussion of how opposition to greater economic integration arises out of the tensions it produces. Near the end of the speech Bernanke focused on the current situation with insightful precision:

What, then, is new about the current episode? Each observer will have his or her own perspective, but, to me, four differences between the current wave of global economic integration and past episodes seem most important. First, the scale and pace of the current episode is unprecedented. For example, in recent years, global merchandise exports have been above 20 percent of world gross domestic product, compared with about 8 percent in 1913 and less than 15 percent as recently as 1990; and international financial flows have expanded even more quickly. But these data understate the magnitude of the change that we are now experiencing. The emergence of China, India, and the former communist-bloc countries implies that the greater part of the earth's population is now engaged, at least potentially, in the global economy. There are no historical antecedents for this development. Columbus's voyage to the New World ultimately led to enormous economic change, of course, but the full integration of the New and the Old Worlds took centuries. In contrast, the economic opening of China, which began in earnest less than three decades ago, is proceeding rapidly and, if anything, seems to be accelerating.

Second, the traditional distinction between the core and the periphery is becoming increasingly less relevant, as the mature industrial economies and the emerging-market economies become more integrated and interdependent. Notably, the nineteenth-century pattern, in which the core exported manufactures to the periphery in exchange for commodities, no longer holds, as an increasing share of world manufacturing capacity is now found in emerging markets. An even more striking aspect of the breakdown of the core-periphery paradigm is the direction of capital flows: In the nineteenth century, the country at the center of the world's economy, Great Britain, ran current account surpluses and exported financial capital to the periphery. Today, the world's largest economy, that of the United States, runs a current-account deficit, financed to a substantial extent by capital exports from emerging-market nations.

Third, production processes are becoming geographically fragmented to an unprecedented degree. Rather than producing goods in a single process in a single location, firms are increasingly breaking the production process into discrete steps and performing each step in whatever location allows them to minimize costs. For example, the U.S. chip producer AMD locates most of its research and development in California; produces in Texas, Germany, and Japan; does final processing and testing in Thailand, Singapore, Malaysia, and China; and then sells to markets around the globe. To be sure, international production chains are not entirely new: In 1911, Henry Ford opened his company's first overseas factory in Manchester, England, to be closer to a growing source of demand. The factory produced bodies for the Model A automobile, but imported the chassis and mechanical parts from the United States for assembly in Manchester. Although examples like this one illustrate the historical continuity of the process of economic integration, today the geographical extension of production processes is far more advanced and pervasive than ever before. As an aside, some interesting economic questions are raised by the fact that in some cases international production chains are managed almost entirely within a single multinational corporation (roughly 40 percent of U.S. merchandise trade is classified as intra-firm) and in others they are built through arm's-length transactions among unrelated firms. But the empirical evidence in both cases suggests that substantial productivity gains can often be achieved through the development of global supply chains.

The final item on my list of what is new about the current episode is that international capital markets have become substantially more mature. Although the net capital flows of a century ago, measured relative to global output, are comparable to those of the present, gross flows today are much larger. Moreover, capital flows now take many more forms than in the past: In the nineteenth century, international portfolio investments were concentrated in the finance of infrastructure projects (such as the American railroads) and in the purchase of government debt. Today, international investors hold an array of debt instruments, equities, and derivatives, including claims on a broad range of sectors. Flows of foreign direct investment are also much larger relative to output than they were fifty or a hundred years ago. As I noted earlier, the increase in capital flows owes much to capital-market liberalization and factors such as the greater standardization of accounting practices as well as to technological advances.
(Emphasis added)

That is a good list of characteristics of globalization in the I-Cubed economy. For course, he left out the rise of intangible assets, although he did mention the rise of tradable services. It is the rise of intangibles and the spread of knowledge that, I believe, has undercut the core-and-periphery model. When knowledge becomes simultaneously local and global, there are many cores and few peripheries.

Last year, I worried whether Mr. Bernanke would understand the I-Cubed Economy the way that Alan Greenspan seemed to understand the "weightless economy". I'm still not sure. But today's speech was a positive sign.

In a little publicized (outside of sports news) case, a judge in St. Louis ruled earlier this month that certain information is not subject to copyright laws. The specific case involves baseball fantasy league. As the New York Times (Baseball Is a Game of Numbers, but Whose Numbers Are They?) noted when the case was first filed:

Like no other corner of American popular culture, baseball communicates in numbers. From .406 (Ted Williams's 1941 batting average) to 755 (Hank Aaron's record home run total) to countless digits bandied about water coolers every morning, statistics convey ideas and images that, even overnight, become inseparable from the players to whom they belong.

This relationship between players and numbers, so often romanticized, is now being stripped to its skeleton in a lawsuit with considerably wider ramifications. While the dispute focuses on fantasy baseball — in which millions of fans compete against one another by assembling rosters of real-life major leaguers with the best statistics — a real legal question has arisen: Who owns that connection of name and number when it is used for such a commercial purpose?

Many onlookers have cast this issue as a tiff over batting averages — as if children were squabbling over the backs of baseball cards — but legal experts are saying it could affect the wider arena of celebrity rights, freedom of the press and even how the press is defined as the Internet age unfolds.

The dispute is between a company in St. Louis that operates fantasy sports leagues over the Internet and the Internet arm of Major League Baseball, which says that anyone using players' names and performance statistics to operate a fantasy league commercially must purchase a license. The St. Louis company counters that it does not need a license because the players are public figures whose statistics are in the public domain.

. . .

Major League Baseball Advanced Media is not making a copyright claim to the statistics themselves; a 1997 decision in the United States Court of Appeals involving the National Basketball Association ruled sports statistics to be public-domain facts that do not belong to the leagues.

Rather, the central issue concerns celebrities' ability to control use of their names in commercial ventures, and how this "right of publicity," which has developed under state common law and statute over the last half-century, may commingle with Constitutional press protections under the First Amendment.

The term "right of publicity" was coined in 1953 when, in a case involving baseball, a court ruled that Topps Chewing Gum company could not print trading cards that featured baseball players' names and likenesses without their permission.

In 1970, in a case starkly similar to the CBC case, a Minnesota state court found that two baseball board games, each of which used only names and statistics, misappropriated the players' marketable identities and was subject to license.

But other subsequent cases have favored First Amendment concerns over the celebrities' right of publicity. Several courts have maintained that the dissemination of information, even for profit or for entertainment, cannot be curtailed by any state's right-of-publicity laws. In its court filings, CBC argued that it relied on baseball players' names and statistics "as their lifeblood in much the same way that the sports sections of newspapers do."

Major League Baseball Advanced Media, however, says that selling a service that helps customers pick and trade players crosses the line between reporting on games and running a nonjournalistic, commercial enterprise.

But, as the WSJ Law Blog notes, the judge ruled in favor of CBC - Fantasy Sports Leagues Hit Grand Slam With Court Ruling:

“The undisputed facts establish that the names and playing records of (MLB) players as used in CBC’s fantasy games are not copyrightable and, therefore, federal copyright law does not pre-empt the players’ claimed right of publicity,” wrote Judge Mary Ann Medler. Even if players have a claimed right of publicity, she added, “the First Amendment takes precedence over such a right.” The judge likened the names and stats of professional ballplayers “to the names, towns and telephone numbers in a phone book, to census data, and to news of the day.”

Major League Baseball has said it will appeal, according to AP - Baseball Appealing Fantasy Legal Victory

MLB Advanced Media spokesman Jim Gallagher said the league has distinguished that gray area from the beginning.

"We've agreed that the stats and names are in the public domain," Gallagher said. "But when you start to use teams logos and other images as CBC did, you need a license, it's that simple."

In this game, nothing is simple. Any one want to take bets on whether this one is headed for the Supreme Court?

Maybe some of the big dinosaurs are beginning to get it. For example, there is this story - Matsushita Electric Aims to Profit By Improving Design Efficiency:

Fumio Ohtsubo, the new president of Matsushita, which produces Panasonic brand goods, said in an interview that improving the design and assembly of its products is pivotal to raising profit margins.
Matsushita, the world's largest consumer-electronics maker by sales, last week said it will consider closing some of its 170 remaining plants in North America, Asia and Europe.
Mr. Ohtsubo's predecessor, Kunio Nakamura, was able to turn around Matsushita -- hit by a big loss in the fiscal year ended March 2002 -- by closing factories and cutting thousands of jobs. He also focused on a few major products, such as flat-panel plasma displays and digital cameras.
. . .
The 60-year-old Mr. Ohtsubo sees a focus on product-design improvements as central to pushing Matsushita into a new stage of growth. "I want to strengthen our cost competitiveness at the design level," Mr. Ohtsubo said.
He said his first step will be to head a new task force to break down the barriers between design teams. This will aim to get teams to share more information and design products that use fewer parts and are more easily assembled.

And then there is this Business Week interview with Bill Ford - Ford on Ford

Business Week: The truth about the auto business is that it takes years to bring new product to market, and there's little you can do to move the ball financially in the short term. Is the revised restructuring plan mostly meant to convey action—that you are digging deeper and faster to really change the company?
Ford: There's a large element to that. People need to see that we're attacking what we can attack. It's not just costs. It's also product. Most people focus on that we are too big and our costs are too high. It's about cutting costs. But it's very much a product-focused plan. We had already begun to diversify away from large SUVs and trucks well before the oil price spike. But we have to see how my product programs can accelerate and pull forward.

Or maybe not. Matsushita is talking about design-for-manufacturability and Ford is looks to simply catch up with the market.

Guess it takes a lot more to make dinosaurs dance.

Yesterday's announcement of the patent settlement between Apple and Creative Technology could be seen as a standard story of conflicting patents and how many patents can dance on the head of an iPod. As the WSJ Law Blog explains:

In May, Creative filed a patent infringement lawsuit against Apple. In addition to the federal lawsuit brought in San Francisco, Creative filed a trade complaint with the U.S. International Trade Commission to prevent Apple from importing its allegedly infringing iPod devices, which are manufactured in China.

Apple filed two countersuits, one in federal court in Madison, Wis., and the other in Texarkana, Tex., alleging that Creative infringed seven of Apple’s patents. Apple also filed a similar trade complaint with the U.S. ITC seeking to halt imports of Creative’s MP3 into the U.S.

The Washington Post captured what has become a routine part of these cases:

"From the point of view of Creative, their bitterness stems from the fact that when they approached Apple, they were arrogantly dismissive" about licensing their technology, said Phil Leigh, senior analyst with Inside Digital Media Inc., a Tampa-based market research firm. "Apple's point of view on this is, 'These guys are patent trolls,' " who are profiteering off of the technology patent process, he said

But, there is one element in this situation which caught my eye. According to the Journal's story today:

The deal will also allow Apple to recoup an undisclosed portion of its licensing fee if Creative is successful in licensing its patent to others. In fact, its agreement with Creative may lead to more such licensing deals. The agreement could strengthen Creative's patent in the eyes of competitors hoping to bring their own music players to market, spurring them to reach licensing agreements with Creative or giving the company a stronger hand in future licensing litigation.

"When you have a settlement with a large player, that sends a signal that this is a serious claim," said Allonn E. Levy, an intellectual-property attorney at Hopkins & Carley in San Jose, Calif.

In other words, the agreement with Apple may be just as valuable as the patent itself. And the value of the patent is now much higher than simply the value derived from the licensing fee. I realize that this is a standard dynamic in the industry -- validation of a technology by an industry leader raises the value. But I wonder how much a deal with Apple is worth compared to one with some other small fry? And how does that show up on the company books?

Yesterday, I talked about the importance of creativity in jurisdictional advantage. Clearly, communities need to understand the factors and forced that make their location a desirable place for economic activity. Some of those forces are internal - the creativity and entrepreneurship resident in the community. Others are external. And like a company's competitive advantage, jurisdictional advantage can (and does) shift.

An example of that shift can be seen in two case studies - both of which focus on energy costs and regulation.

The first is about an aluminum plant in central Maryland -- just north of Washington DC - "The Power of Rising Energy Prices":

For 35 years, the aluminum plant surrounded by fields of soybeans and corn in Frederick County has provided high-paying, reliable jobs that lured workers from faraway states.
. . .
Years ago, when companies chose locations to build aluminum plants, they did it to be close to the country's lowest-cost power providers. Eastalco long relied on cheap power provided by the Allegheny generating facilities that are close to cheap coal.

But with deregulation and nation-wide marketing of electricity, the price is the national price - not based on nearby resources:

If the market were still regulated, the company said, the price it pays would be more closely related to the price of coal, the dominant fuel for Allegheny's plants. But the company said that the PJM market establishes prices that are more heavily pegged to the price of natural gas. The most expensive unit of electrical generation, the company said, is used to determine the market rate. And that price is typically for power generated with natural gas, whose costs have increased much more rapidly than coal's.

So, with the disappearance of cheap local electricity, the plant is in trouble.

The second is the opposite set of regulations - an area that thought it would thrive because of cheap local power but was forced to export that electricity: the Columbia River basin. Tech Firms Go Mining for Megawatts:

There is cheap electricity here and lots of it. That is because the Columbia, the premier hydroelectric river in North America, flows nearby. Three publicly owned, local utilities own five large dams on the river, and they produce much more electricity than the sparse local population can use. With power prices soaring, the three utilities have become the hydroelectric emirates of the Pacific Northwest.
Until now, they have been obligated under 50-year-old contracts to sell about two-thirds of their power -- without profit -- to major utilities serving millions of people in Seattle, Tacoma and Portland. The arrangement helped keep monthly electric bills in the Northwest far below the national average.
Those old contracts, though, are expiring -- a development that will help push up residential electricity rates across the region. And the mid-Columbia utilities are scurrying to sell their newly unleashed power to the corporate giants of the Internet -- if they are willing to plant "server farms" in two-stop-light towns such as Quincy.
They do seem uncommonly eager.
Out in the bean field, Microsoft is rushing to complete what it says will be the largest data center it has ever built. It is scheduled to go online in February. Downstream in The Dalles, Ore., Google is building a data center that will go online within the next year and is reported by local officials to be scouring the region looking for other sites. Upstream in Wenatchee, Wash., Yahoo is expected to go online with another data center in the fall and is in negotiations for still others.

This was the original promise. The promoter of the Grand Coulee dam (local newspaper publisher Rufus Woods

boasted noisily in the pages of his newspaper that electricity from the dams would lure major industry to Wenatchee and the Columbia Basin. But the federal government broke his heart by stringing wires across the Northwest and setting up rules requiring dams to sell most electricity at a postage stamp rate, meaning that power had to cost the same in Wenatchee as it did hundreds of miles away in Seattle, Tacoma or Portland.
Although farming in the Columbia Basin boomed, thanks to irrigation water diverted by Grand Coulee, major industry, for the most part, ignored Wenatchee and towns such as Quincy for most of the past seven decades.
Companies could get plenty of cheap power in Seattle and Portland without having to build in the boondocks -- until now.

In both cases, external forces are shifting the communities' advantages - one positive and one negative. Those external forces may not be under the communities' control, but the internal forces will determine how each community copes with the changes.

In his paper, Why the Garden Club Couldn't Save Youngstown, Sean Safford talks about the social and political infrastructure needed for a community to respond to an economic shift. In this case, why Allentown was able to successfully respond to the shift and Youngstown was not. Often referred to as "capacity building," this institutional infrastructure is just as important a jurisdictional advantage as cheap electricity or a skilled workforce.

It is also the most intangible of intangible assets – one that is often defined more by its absence and not considered until too late. Capacity building should be at the top of our economic development concerns. Unfortunately, it is not as sexy as luring the next plant or setting up a high-tech oriented partnership. But it is the foundation of all that other work – and we need to start treating it as such.

I find myself in the strange situation of agreeing (somewhat) with the Editorial Board of the Wall Street Journal as they complain about companies now using the trade laws to bring patent infringement cases – see the poorly titled article Smoot-Hawley's Revenge:

The ITC was established in 1916 as the U.S. Tariff Commission. Smoot-Hawley gave it the authority to review claims of "unfair trade practices" based on patent infringement. If a company with U.S. operations believes a competitor is importing a product that infringes on its intellectual property, it can bring a Section 337 claim to the ITC. An administrative law judge then hears the case, and he can issue an exclusion order barring imports of the infringing product for the duration of the patent. The order is also subject to the review and approval by the six-member, bipartisan ITC board.

Incredibly, all of this takes place separately from normal judicial proceedings on patent infringement or validity. Most of the cell-phone cases mentioned above are also in court on patent-infringement grounds, but these cases can take years and are subject to lengthy appeals. The ITC tries to discharge Section 337 cases in about a year, and will not wait for the courts. Once the ITC votes on the judge's order, there is only one avenue of appeal: The President has 60 days to override the ITC's order. If he doesn't act, the import ban takes effect.

One would think that the Editorial Board would be all in favor of strong IPR and use of trade law to crack down on "the theft of intellectual property." In the past, they have complained about allowing developing countries to copy drugs under the guise of declaring a health emergency.

But on patents and copyright, the WSJ has been relatively consistent. In 2002, they urged the Supreme Court to overturn the 1998 Sonny Bono Copyright Term Extension Act which extended existing copyrights 70 years after the death of the creator. More recently, in their comment on the Blackberry case - "Patently Absurd", they stated,

Patents are supposed to protect intellectual property and spur innovation, and once upon a time in America they did. But like everything else the legal system touches nowadays, U.S. patent law has been hijacked so that it now operates nearly in reverse, deterring research and penalizing innovation.

My agreement with the Journal in this case is only partial, however. The Journal get the problem right -- concern over companies gaming the system -- but picks on the wrong target. The Journal apparently would like to throw out the Section 337 process -- thus depriving the US of its major tool to combat foreign counterfeiting. But the problem isn't the ITC and Section 337. As the Journal admits (but dismisses), there are three levels to the ITC process: an administrative law judge; the Commission; and Presidential review. Any one of these can throw out a bad decision.

And there is judicial review (see ITC FAQ's), even if it appears to be more circumspect than in patent law cases -- as the law firm of Jones Day notes:

District courts are reversed by the Federal Circuit with regard to the meaning of patent claims from 38 to 50% of the time, depending on the statistical data gathered. See, e.g., Andrew T. Zidel, Patent Claim Construction in the Trial Courts: A Study Showing the Need for Clear Guidance From the Federal Circuit, 33 Seton Hall L. Rev. 711 (2003) (citing numerous studies showing the Federal Circuit’s high reversal rate on claim construction issues); Kimberly A. Moore, Are District Court Judges Equipped to Resolve Patent Cases?, 15 Har. J. Law & Tec. 1 (2001) ("The high reversal rate on claim construction is problematic. It creates uncertainty in patent cases and in patent claim scope analysis until the Federal Circuit review is complete."). The ITC's claim interpretations are, however, rarely reversed by the Federal Circuit. Thus, the uncertainty that accompanies claim construction rulings by federal district courts is greatly minimized in a Section 337 proceeding before the ITC where experienced, specialized judges conduct the investigations.

The real problem is our patent system -- especially with the presumption of the validity of a patent even in the face of evidence of problems with patent quality. There are provisions in pending patent reform legislation that would deal with that problem. Specifically there are proposals for a pre-grant opposition process and a post-grant review procedure. These mechanisms would help determine the validity of a patent well before the litigation or Section 337 process began.

The Journal has highlighted a problem. I hope they will now start advocating for the correct solution.

Bruce Nussbaum says, For Innovation, Forget Milan And Go To Santa Fe's Indian Market.

It has been over a decade since I visited the Indian Market (when I was working for Senator Jeff Bingaman) - but I still have some nice creative pieces I bought there. So I would second Bruce's suggestion that:

If you are interested in the method of combining the authenticity of tradition with the creativity of innovation, you need to go and talk to the artists at Indian Market. Awhile back, Xerox Parc experimented with bringing artists and engineers together to promote creativity. It's time to do this again--on a much bigger scale.

I would also second his second suggestion about bringing engineers and artists together. My impression is that this is one of the goals of some of the more innovative design school programs - like the Stanford d-School. That works for design students, but maybe we need a bigger program for working engineers and artists to meet on a regular basis.

Toronto has just released a new report on the future of the city, entitled Imagine a Toronto ...:

The goal of this project is to produce a strategy that addresses the current needs of Toronto's creative economy, that promotes its future growth and that leverages these creative assets to enhance economic and social opportunity.

The report sets out a "Credo for Creative Cities":

Creativity owns imagination. And imagination is what builds our cities. Creativity commands the allegiance and love of the creative person as a way of being, living, thinking. The imagination that comes of that allegiance is powerful, self-renewing, and tireless in delight. It permeates all aspects of civic life. It is the only limitless resource.
To know this is to release an industry in perpetual motion. Allegiance to true creativity defines imagination against the myopia of market greed. For the ethos of creativity left unchecked, by its natural genius, instructs all witnesses to the shared project of wonder. This is what makes a city great, a society great and, yes, even productive.
Creativity must become a way of life. It is not a question of sustainability but of survival, and the beauty that inspires it. And the kinds of risks that true creativity demands are crucial to that end.

The Toronto report has laid down an important marker. Energizing our cities is a key component of a national competitiveness strategy. As Business Week recently pointed out in Slicker Cities:

America is losing its competitive edge. That premise has been pounded into our heads so often by pundits, and reinforced with each report on the rise of China and India, that it's almost taken as a given. But can a nation that has averaged 3.4% growth for three years and keeps posting sterling productivity gains really have a competitiveness problem? Or is that problem much more local?

The BW special report Pushing For Growth: How Cities Succeed goes on to describe what a number of cities are doing:

Even with globalization, location still matters in economic competition. But it is more important than ever for communities to offer distinctive advantages.

Creating that jurisdictional advantage is something that we at Athena Alliance have been stressing for a long time - see our session on the topic with Professor MaryAnn Feldman.

Creativity is part and parcel of that advantage. But it is not necessarily the differentiating factor. All locations need to tap into their creative and innovative capabilities – but how they utilize those capabilities and the direction that their creativity takes them will provide that differentiation. It is not enough to simply say “be creative.”

As Business Week illustrates, cities can take different routes:

Stockholm shows how to succeed in the Knowledge Economy: It serves as a base for major companies and tech universities, it subsidizes broadband, and it offers a vibrant urban environment that lures young talent. Orlando has diversified its economy by nurturing a new industrial cluster: digital media. Singapore thrives by persuading multinationals to use it as a base for R&D and as regional headquarters, and even anticipates companies' needs five years out.

Edinburgh is an example of a city that has successfully taken the “creative route,” as Lorna Jack of Scottish Development International pointed out in a comment on the BW story:

I was interested to read that as the international marketplace becomes more globalized by innovative and competitive communities, regions are shaping unique infrastructures to meet the need. Edinburgh’s strong creative and digital media industry was built upon a hub of academia, an expert labor force, and the wildly creative Edinburgh Festival. Paired with support from economic development agencies within governments, it’s no wonder business flocks to these communities.

But this route – what I call the traditional arts path – is not for every location. Just as every city can’t be Silicon Valley, every city can’t replicate the Edinburgh Festival. Each location needs to understand and build upon its own strengthens and resources. The creativity of individuals, companies and communities is a part of that mix. “Creative industries” aka, the arts, may also be part of the mix depending upon the location. But the two are different.

As the Toronto report stated "creativity must become a way of life." Let us foster creativity in all its forms and manifestation – and in all industries and sectors. And let us help communities discover the creative forces in all of their economic activities.

According to this morning's New York Times, Tower Records Will Auction Its Assets. The action raises two questions:
1) is this the death knell for brick-and-mortar music stories, and if so 2) what value do those assets really have. As the story says:

Phil Leigh, a senior analyst for Inside Digital Media Inc., said that the Tower brand had value and would find a buyer, but that its stores were not likely to survive this latest bankruptcy. The company emerged from another bankruptcy in 2004. “I think they’ll sell off the name and liquidate the inventory,” Mr. Leigh said.

Tower Records, however, said it had seen “substantial interest among potential buyers” and hoped to find a buyer willing to continue operating its stores. The company said it was actively negotiating with one potential buyer and had received another offer on the eve of its bankruptcy filing.

It is “absolutely our intention to keep the Tower brand alive,” a spokeswoman, Lisa Amore, said.

There are two intangible assets here that may be of value: location of the stores and the brand. Interest by other major retailers in the stores is one thing; interest in actually operating those locations as record stores is something very different. Likewise with the brand: it is one thing to buy the brand to sell records, it is something else to buy the brand to morph it (and the stores?) into a different product line.

It will be interesting to watch what happens.

Check out Business Week's feature on the winners of ID Magazine 52nd annual design awards.

While this blog makes much of the shift to an intangible economy, it is good to remind ourselves that the tangibles - hard goods - will remain an important part of the economy. To keep this in perspective, I would point to the words of Toyota North America President Jim Press on the future of the automotive industry - as reported in Manufacturing & Technology News:

“If you ever wonder about the future of the auto business, you could do what I do on a Sunday. It’s kind of fun,” Press said. “Go to the hospital maternity wards. Do you ever do that, just go up there? You don’t know anybody. They’re all friendly, right? Everybody’s having a good time and big smiles and while you’re there in this happy place, just remember, each one of those little blue and pink baskets is 13 or 14 purchase cycles. It’ll cheer you right up. It’s a wonderful opportunity.”

Press is right: 13 to 14 purchasing cycles per new born -- that is a lot of cars to be sold over the next century or so.

To see Press's prepared remarks, see the Toyota website

Business executives and academics have been calling for an increase in government funded R&D as a key part of our competitiveness strategy (see "Rising Above the Gathering Storm" and the National Innovation Initiative - as I discussed earlier this year). Part of their reason has been the shift over the past 50 years in corporate spending from basic research to strictly applied research. One of the effects of deregulation has been to focus companies on the bottom line - and long term research does not pay off quickly to the bottom line. The shift is perfectly illustrated in today's Wall Street Journal story - WSJ.com - With Its Future Now Uncertain, Bell Labs Turns to Commerce:

Lucent Technologies Inc.'s Bell Labs, the birthplace of the transistor and the laser, has been through a decade of turmoil during which it was reduced to a third of its size. Now, some of its scientists are warily embracing a former submarine officer and entrepreneur as perhaps the laboratory's best hope of maintaining its relevance.

Jeong Kim took over last year with a direct plan for saving the storied laboratory: Make it profitable. Among his first moves, he set more of its scientific stars to work on breakthrough technologies that could turn quickly into businesses -- the opposite of the pure research many live for.

Each of these projects is expected to make back six times what it spends on research. Those with the biggest financial potential get the most funding. Researchers often condense their work into eight-minute PowerPoint presentations. Mr. Kim also seeks more government research grants and is aiming to speed the transformation of technology into products by seeking corporate partners and venture capital.

. . .

An example of the new approach involves metal detectors made of silicon the width of three human hairs -- technology for which Lucent long couldn't find a use. Under the new regime, Bell Labs is working with a small company to develop it into a device that could help the military detect snipers. Called a magnetometer, the device also could be used by doctors to measure blood flow through subtle changes in the heart's magnetic field.

Clearly a focus on product innovation should be a priority for companies like Lucent. But changing that focus requires someone else to fill in the gap in basic research. Hence the push for greater government investment in basic science. Hence also companies' expanded search for research results from whatever source. As other nations improve their scientific capabilities, companies will logically look to tap into those resources.

A key to US competitiveness is whether that basic scientific activity needs to be physically nearby the applied work that Bell Labs is now doing. Or does formal scientific knowledge easily transfer in this wired and networked economy. It has been a standard answer that world class basic research facilities are needed locally to produce the applied spin-offs. But if scientific knowledge is easily transferred, then a more important goal is having a local workforce with the education and ability to absorb and utilize that scientific knowledge rather than a goal of having the top creators of basic research.

While basic research will always be important, it becomes a matter of finding the right allocation of resources. Finding that balance will require us taking a hard look at how the innovation and technology creation process really works. As companies move further and further away from basic research, we need to clearly understand what it takes to keep that pipeline of scientific knowledge flowing. We can no longer simply assume it works the way it worked in the past – especially clinging to the linear factory-type flow of knowledge from new science to new product. We need a new understanding. But our understanding of innovation lags the changes occurring in the economy.

We need to do better.

I ran it to the following short article from a week or so ago on stock market indexes - Ellen Simon: New indexes aim at old benchmarks - Examiner.com. The article describes how financial companies are trying to create indexes to mirror the market, and then sell exchange traded funds (ETFs) to track those indexes. But what caught my eye were the following two statements:

The emphasis on stock price in most indexes is “how a stock like Google can become the 20th largest position in the S&P 500 even though its current revenue, earnings and book value wouldn’t even place it among America’s top 200 companies,” the July issue of “The No-Load Fund Investor” explained.
. . .
The other big player in fundamental indexing is Research Affiliates LLC. Its indexes weight companies according to earnings, revenue, dividends and book value.

Book value? Someone is still using book value as a measure of anything?

As Investopedia says in Value By The Book:

Thanks to conservative accounting rules, book value completely ignores intangible assets like brand name, goodwill, patents and other intellectual property created by a company. Book value doesn't carry much meaning for service-based firms with few tangible assets.

Given that much of our economy is based on intangible assets that don't necessarily show up on the accounting books, how could anyone be still be using book value to weight stock indexes?

For more on the problems of accounting for intangibles, see the Athena Alliance working paper Reporting Intangibles: A Hard Look at Improving Business Information in the U.S.

The Chair of the National Governors Association is making innovation the focus during her term with an Innovation America initiative. Incoming NGA Chair Arizona Gov. Janet Napolitano announced the initiative at the NGA's annual meeting earlier this month. Goals for the initiative include to:
   • raise national awareness of the urgent need to embrace innovation as the U.S. path to maintaining competitiveness;
   • share examples of best practices and provide a "tool box" of effective policies and strategies;
   • present each governor with an economic profile specific to their state, including high growth innovation centers and science and math proficiencies;
   • host regional learning labs and workshops to help states improve education in the areas of science, technology, engineering and math; and
   • create new science and math academies to improve student achievement and grow a workforce in emerging occupations.

Most important the initiative seems to realize the need for a broad view of innovation. According to the brochure:

The term “innovation” is defined broadly. In the 1990s, innovation was about technology, but today it involves much more. Innovation is about reinventing strategies, products and processes and creating new business models and new markets. It also is about selecting the right ideas and executing business strategies quickly and efficiently.

Unfortunately, when it comes to solutions, they fall back on the old stand-bys: math & science education and R&D hot spots:

The Innovation America initiative will highlight two areas that are critical to our future success. First, we will focus on increasing student proficiency in math and science by modernizing the teaching force, benchmarking academic standards and aligning assessments and creating new models for math and science education. Second, we will strive to enhance innovation by implementing state wide strategies as well as those that target existing high growth regional centers of innovation; together these approaches will reduce existing barriers to innovation, support entrepreneurship, fund research and development and create 21st century university systems.

The seeds of a breakthrough to a full-blow innovation agenda are in the NGA proposal. Over the next year, they have a golden opportunity for creative thinking and policy making. That is the challenge facing Governor Napolitano. The states have been very active in new approaches to innovation-led economic development. The Innovation America initiative would do well to catalog and evaluate those new approaches, rather than fall back on the old stand-bys. Such a compilation of state activities would be a great help in moving innovation policy forward.

Are American's more or less satisfied with their products and services? Depends on who you ask. According to the most recent American Customer Satisfaction Index, things are looking up. As Money magazine reports - Survey: Consumers more satisfied with many brands - Aug. 15, 2006:

Americans are more satisfied with a broad range of products they use, from autos to personal computers, according to a survey of consumers.

The University of Michigan's American Customer Satisfaction Index (ACSI) increased to an overall 74.4 score in the second quarter out of 100. That's a gain of 2 from the first quarter, and the fifth consecutive quarter at its highest level since 2004.

But while overall customer satisfaction is up, satisfaction with customer service is down. As the blog Economic Development Futures Journal, states - Company Customer Service Lacking:

Despite the flood of new service-friendly technologies, nearly half of U.S. consumers were driven away from retailers, banks, and other businesses in the past year by lousy customer service, a new survey shows.

Of more than 1,000 respondents to an online poll in May, a full 46% said poor service had turned them off of at least one business this year, according to a survey released earlier this month by Accenture, a New York-based management consulting firm.

About 18% cited retailers as having the worst customer service, followed by Internet service providers, banks, home and cell phone companies, and cable and satellite television companies. Utility companies, life insurance firms, airlines, and hotels were cited the least, the survey found.

Now, granted, the two studies are not strictly comparable -- different time frames, coverage of different industries, different underlying questions. But, they do point out that consumers can be happy and dissatisfied at the same time.

What is most troubling to me is the dissatisfaction with customer service. Talk about how to destroy an intangible asset! So I hope that companies don't get to complacent about the latest ACSI findings. There seems to still be a lot of room for improvement in the delivery of those goods and services that we seem happy to have.

As a follow up to my previous posting (on the Crate), here is a story from Business Week about the life-or-death role of functionality in design (literally) - How Hospital Design Saves Lives

Forget fancy entrances, healing gardens, and feng shui—more aesthetic elements of building design whose impact on patient health is easy to suppose but difficult to prove. Over the past seven years, hospital architects have increasingly awakened to the possibilities for design to save lives. To do that, they are taking a page from medicine's playbook.

. . .

The opportunities for using design to improve hospitals range from the subtle to the mundane, the environmental to the ergonomic. Increasing natural light and reducing noise, for instance, lower stress levels for both patients and staff (see BusinessWeek.com, 08/15/06, "Seeing the Light").

Standardizing operating rooms within a hospital minimizes the likelihood of wrong-site, wrong-side, or wrong-patient surgery (a not uncommon occurrence). Arranging nursing stations to improve access to both patients and charts reduces errors and fatigue. And perhaps most important, providing private rooms improves infection control, allows families to help with care, and minimizes environmental stressors such as noise and light.

According to the story, such changes not only save lives, they reduce heath care costs. That is a design story that we can all (pardon the pun) live with.

In case you missed it, Britain is in the midst of a heady controversy - over a crate. According to the International Herald Tribune - Inspired design? Or just a crate?

The story began when Established & Sons commissioned a piece from Morrison, one of Britain's most influential product designers. Setting out to design a bedside table, he played with various ideas only to conclude that he could not improve upon the old wooden wine crate in which he stored books beside his bed. "Nothing else seemed to do the job as well," said Morrison, who decided to produce a replica of that crate.

That simple statement of functionality set off a firestorm. As the Tribune goes on to note:

The Crateoversy is still rumbling in the blogosphere, and the opposing views go like this. The pro-Crate camp - to which I should confess I belong - praises it as an inspired exercise in conceptual design; a wry critique of the seemingly unstoppable production of yet more superficially striking, but purposeless, new objects at a time of environmental crisis; an interesting addition to the design history of the found object; and something that looks good and might be quite useful. The anti-Crate camp accuses it - and Morrison - of everything from laziness, cynicism, pretension, arrogance, exploitation and vacuity to wasting wood.

Entertaining though the debate has been, it is more interesting to consider why The Crate has provoked such extreme reactions.

. . .

One is the question of how an industry whose commercial viability depends on persuading people to buy new things can justify doing so in a saturated consumer culture with dwindling natural resources. Deciding that he could not invent a better type of bedside table than a wine crate is Morrison's way of proclaiming that new is not necessarily better.

Then there is the equally tricky issue of what constitutes "new." Designers often re-use existing materials and symbolism. Would The Crate have caused such a stir if it had been made in the same shape from one of the advanced types of plastic that Morrison often uses? Probably not. But by remaking the old crate in slightly posher wood, he has been both praised for honesty and panned for exploitation.

Did it make a difference that he copied a cheap, anonymously designed object? Quite possibly. The economics of the furniture industry depend on persuading consumers to pay more for signature products by well- known designers like Morrison. But if you ask those designers what they consider to be well designed, they are as likely to name unsung triumphs, like the humble paper clip or Bic biro (both of which were chosen by Morrison and the Japanese designer Naoto Fukasawa for the Super Normal exhibition in Tokyo this summer) as they are to cite expensive pieces by famous names.

I also have to admit that I probably fall into the pro-Crate faction (although my significant other would have a fit if she even thought that I was considering bringing one of those into our bedroom). Innovation for innovation's sake has never appealed to me. I guess I am still just an engineer at heart, but functionality is important to me along with aesthetics. And how can you beat the simple clean lines of the Crate? Form and function together – a winning combination.

Robert Samuelson has been a "competitiveness" skeptic for decades and his latest column on the subject - Cooling Off About Keeping Up - clings to that thought process when he says "One problem with these debates is that competitiveness is a vague term. What does it mean?"

Apparently, he has not been paying attention. Back in the 1980's, when Samuelson was pooh-poohing the competitiveness notion, the term was very clearly defined by the President's Commission on Industrial Competitiveness (the Young Commission):

Competitiveness is the degree to which a nation can, under free and fair market conditions, produce goods and services that meet the test of international markets while simultaneously maintaining or expanding the real incomes of its citizens

What part of this does he have trouble understanding? When you are running a huge trade deficit it strains credulity to argue that your ability to meet the test of international markets isn't a problem.

In his column, he throws up a number of strawmen, which he proceeds to shoot down: keeping a lead in every industry and maintaining our share of world GDP. What distractions!

He does throw out this more interesting definition:

One possible "competitiveness" definition is the ability of countries to stay ahead in developing new industries. Economists once saw land, labor and capital as the basic inputs of any economy. But they've now added "knowledge," as David Warsh -- former economics columnist for the Boston Globe -- shows in his engaging book "Knowledge and the Wealth of Nations." It doesn't just matter how much countries invest or how many people they employ. What also matters is how smartly. Can they create gadgets and services that people want or that solve important problems?

By this standard the United States is still doing well. It's a leader in many industries -- aerospace, computers, biotechnology, investment banking and entertainment.

Doing well? Oh really? As I pointed out yesterday , our Advanced Technology Trade is in deficit (yes aerospace is doing well, but computers is deeply in deficit).

And a static definition of "doing well today" in innovation isn't very helpful. That is what the guy who jumped off the 20th floor said as he passed the 10 floor: "so far so good."

Samuelson falls back on the standard notion of productivity. But as he admits, "Unfortunately, economists don't understand why productivity has fluctuated so much."

Nor is productivity the best measure of those innovative industries he claims to admire. Doing old things more efficiently isn't what innovation is all about. One can have high productivity and low innovation - which ends up eventually at an economic dead-end.

For example, Samuelson goes on to state, "They [economists] tend to attribute the recent surge to information technologies -- but productivity actually improved after the dot-com crash." Of course, productivity usually increases in a recession as the least productive workers are laid off and the least productive facilities are closed. (How long has he been covering economics without understanding that?) And productivity is about the utilization of IT - not about its creation (that is innovation). So there is no mystery why IT using productivity shouldn't have increased after the dot.com crash.

Samuelson does get one point right:

We're really competing with ourselves to make the future better than the past.

Now there is a comment we can both agree on. Doing that, however, requires us to take innovation and the competitiveness challenge serious. Articles that down play that challenge and the need for government action undermine that shared goal.

FT.com / World / International economy - Melting of Greenland’s ice sheet quickens:

The melting of Greenland’s ice sheet is accelerating, threatening an increasing rise in sea levels.
Satellite measurements showed that the speed of ice-sheet melting had risen threefold in the last two years compared with the average for the previous five years, according to a paper published in today’s edition of the peer-review journal Science.

Maybe when the west front of the Capitol overlooks the National Tidal Basin (formerly known as the National Mall), then our political leaders will take climate change seriously.

On the positive side, the Washington Post ran this story today - Cities, States Aren't Waiting For U.S. Action on Climate:

With Washington lawmakers deadlocked on how best to curb global warming, state and local officials across the country are adopting ambitious policies and forming international alliances aimed at reducing greenhouse gases.

Justice Louis Brandeis called the states "the laboratories of democracy". That is even truer today in this age of information and ideas.

Just as states are moving ahead on climate change, they have been leading the federal government in crafting innovation-led economic programs. What is condemned at the federal level as “industrial policy” is seen as every governors and state legislators basic duty.

Let us hope that the state actions on climate change are not too little, too late.

In the I-Cubed Economy, women rule. Or at least that is the implication of a recent opinion statement ("leader") in the Economist - "La différence: How women won the sex war":

Men, studies show, are exceedingly good at rotating three-dimensional shapes in their head. Perhaps women once stared open-mouthed in wonder as their mates juggled pyramids of imaginary polyhedra. Such tricks are also quite handy for engineers who specialise in building large bits of machinery, digging tunnels or slinging bridges across rivers. But, now that the rich world has about as many tunnels and bridges as it needs, and the large bits of machinery which aren't made by computers and robots are made by the Chinese, their usefulness is limited.

Modern professional life is dominated by management, which these days sets high store by emotional intelligence, empathy and communication. Wise chaps seeking professional advancement should therefore spend their free time with groups of women, boning up on how to undermine somebody's confidence while pretending to boost it, and how to turn an entire lunch table against an absent colleague without saying a mean word. Such skills are likely to have a greater influence on their lifetime earnings than the ability to spin an icosahedron. It's a girlie man's world, as Arnold Schwarzenegger didn't say.

Ok - take that as slightly tongue-in-cheek. And the in-depth story - "Differences between the sexes" - reveals a more nuanced story. In fact, the stories header is "Men and women think differently. But not that differently." In a meta-analysis study 124 supposed difference between men and women only 22% showed real differences. And in one of the most widely held differences, aggression, it was a matter of tactics not the level of anger. Males were more likely to retaliate physically (direct aggression) while females used social retaliation (indirect aggression).

The story also goes not to talk about how women excel in supposedly "male" engineering and science skills. Although, it doesn't talk about how well successful men do with supposedly "female" social skills. As the story concludes:

Biology may predispose, but . . . it is not necessarily destiny.

So, all of us need to work on developing a complete set of skills to compete in the I-Cubed Economy. After all, it is that full set of skills which makes it so interesting.

The Commerce Department is setting up a "Measuring Innovation in the 21st Century Economy Advisory Committee."

From the Federal Register - FR Doc 06-6811:

     The U.S. economy is the fastest growing of the major industrialized countries. this growth is occurring as we shift to more knowledge-based and service-based industries. The high level of productivity that sustains this growth derives not only from innovations in the types of products and services we produce, but also from innovations in how goods and services are produced and brought to market. In a competitive global economy, policy makers need to understand the determinants of growth. Our data and analytic capabilities, therefore, need to be updated to keep pace with changes in the economy.
     To help address these issues, the Secretary of Commerce is establishing the Measuring Innovation in the 21st Century Economy Advisory Committee to be composed of leaders from business and academia who will be charged with recommending new and improved statistics to help policy makers understand the innovation process.
     Better metrics will help improve the understanding of how innovation occurs in different sectors of the economy, how it is diffused across the economy, and how it impacts economic growth and productivity. Definitions and methodological questions relevant for both government and private sector officials will be explored, therefore it is critical to have input from leaders in both the business and academic communities.

BRAVO!

But the real test will come when it come time to put funds behind the implementation of those new metrics. Past efforts at improving statistics has floundered on the budget shoals. Let us hope that this effort is different.

According to this morning's BEA trade data, our trade surplus in intangibles declined by 3.75% to $7.8 billion as imports rose and exports declined slightly. Much of the decline was do to higher royalty payments to foreigners and lower exports of business services (where exports failed to keep up with the growth in imports).

The increase in imports of business services is especially worrisome, as it has steadily increased in 2005 and 2006. On the bright side, royalty payments (exports) have also trended upwards while our payments to foreigners (imports) have fluctuated.

The overall trade deficit was essentially unchanged in June, falling by a mere $0.2 billion to $64.8 billion. As expected exports reversed themselves from last month and increased by $2.4 billion. But imports also rose by $2.2 billion. As the Wall Street Journal reports:

The June trade deficit came in precisely where Wall Street expected. The median estimate of 22 economists surveyed by Dow Jones Newswires and CNBC was a deficit of $64.80 billion.

The improvement was due to high enough exports of capitol goods to offset increased energy costs and higher imports of consumer goods.

The deficit in Advanced Technology Products improved slightly in June, falling to $2.5 billion from a deficit of $2.9 billion in May The improvement was largely due to increased exports of aerospace products.

Note: we define trade in intangibles as the sum of "royalties and license fees" and "other private services". The BEA/Census Bureau definitions of those categories are as follows:

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

According to two professors at Rutgers, even states which have been doing relatively well in the high-tech economy are at risk. James Hughes and Joseph Seneca at Rutgers School of Planning and Public Policy point out in their report
New Jerseys New Economy Growth Challenges that the state is in danger of slipping:

The economic dynamism and the ever more intense competition of the twenty-first century portend an emerging paradigm shift: No state (or nation) can rely on past success to continue to deliver sustained high levels of future economic growth. Jobs, investment, and public resources will all flow to the most efficient, most innovative, and the most strategically savvy businesses, states, and countries. New Jersey has a legacy of highly successful economic development that supported high levels of employment and income. Much of that success was the result of efficient and innovation-based export-led industries—first, in manufacturing in the first 70 years of the twentieth century, and more recently in advanced knowledge-based services and in science and technology over the last several decades. However, disturbing but clear evidence is mounting that the state’s competitive position in these sectors has eroded. New Jersey needs to pay sustained attention to its economic development policies and its business environment to recapture its former comparative advantages. No less than the future economic well-being of the state is at stake.

Hughes and Seneca's analysis reveals that New Jersey's slippage is not unique. For the US as a whole, the employment in the sectors of Information, Professional and Business Services, and Financial Activities grew by 39.9 percent between 1990 and 2000, but increase only 0.7% from 2000 to 2005. Over the past half-decade, New England, Mid-Atlantic and Midwest and the Pacific states saw an actual decline. Growth in these sectors occurred in the South (except Georgia) and the Mountain West. (Note: In this analysis, Maryland is included in the South not the Mid-Atlantic region).

One of the changes they cite as placing New Jersey at risk is the changing model of research. As basic research shifts from corporate labs (such as Bell Labs) to universities, New Jersey loses:

This new model has worked to the detriment of New Jersey. Historically, the state has long been home to some of the world’s leading large-scale corporate research operations. Leading-edge research activities have now shifted from such facilities in New Jersey to locations near the major national research universities outside of the state, with the attendant loss of highpaying jobs and the economic spin-offs that typically accompany that research. At the same time, New Jersey has not been nearly as competitive in supporting its research universities. Thus, New Jersey is losing at both ends of the shifting paradigm of industrial R&D.
These new industrial R&D facilities are going to such locations in part because of the access they provide to university-based research “stars” and facilities, and the resulting leveraging of corporate resources from the large federal grants awarded to universities. This adds another dimension to the state’s economic losses stemming from the new business model. In general, new corporate research facilities are now being located outside of New Jersey.

While New Jersey may be special case because of its past concentration of corporate research facilities, it provides a limited insight as to what other states might do. I say limited because both Massachusetts and California – states with unquestioned star research universities – have suffered the same job lose as New Jersey (according to the author’s analysis).

The report offers no specific list of policy recommendations, but the authors do sound a warning:

the prosperity of the state and the sheer scale of its income and wealth levels have masked the risks to the state created by a profoundly changing world economy. This prosperity, perhaps understandably, also lulls public policymakers into expecting that the economic successes of the state’s past will somehow replicate themselves

Washington should heed that warning as well!

Sebastian Mallaby of the Washington Post has discovered intangibles, especially A New Brand of Power:

Not long ago, the value of a company consisted largely of its "book value": physical assets such as factories and equipment plus money in the bank. But today book value accounts for only about a third of the stock market capitalization of the top 150 U.S. companies, down from three-quarters two decades ago. In the new economy, corporate value lies in intangible assets: patents, databases, know-how -- and brands.

And brands now carry a lot of political importance:

If brands are both valuable and vulnerable, political consequences follow. Mighty companies have so much riding on their corporate image that they quiver in the face of customer opinion. And if they are mass-market companies, customer opinion is the same as public opinion, so corporate bosses become as sensitive to political and social shifts as elected officials.

Mallaby goes on to talk about the numerous cases where companies have gotten ahead of regulations to protect brand reputations, such as Nike and wages.

The next stage may be for companies not merely to outpace government but to pull government along. Howard Schultz, the chairman of Starbucks, broke the mold by offering comprehensive health benefits to part-time workers, but now he's even more ambitious: He's lobbying Congress to fix the health system. Meanwhile, companies such as BP and GE have enhanced their brands with enviro-friendly policies, and perhaps may now nudge governments to become greener as well.
But whether or not we get to that, something big is going on. At a time when Washington seems incapable of tackling serious policy challenges, brands are creating a sort of shadow government. They cannot replace the real one, not by a long shot. But they are better than nothing.

There is nothing new in companies pushing for regulations so that competitors will not gain an advantage. And corporations have been pushing for the government to fix the health care system (and get that monkey off their backs) for a long time. But Mallaby is right that pushing for regulations in areas that serve to solely protect the brand (as opposed to lower costs or raise profits) is something new.

Welcome to the new rules of the Intangible Economy!

The Boston Consulting Group has released two new studies on innovation:
   • Innovation 2006 - a survey of innovation practices and
   • Measuring Innovation 2006 - a study of innovation metrics.

The first study, BCG's third annual company survey on innovation, reveals that senior business executives plan on significantly increasing their levels of spending on innovation. But executives were dissatisfied with the return they were getting for that spending:

Reasons cited were numerous, ranging from difficulties in accurately gauging costs and, ultimately, returns, to cultural issues that stifle productivity and squander resources. By industry, dissatisfaction was highest
among industrial goods companies, with 56 percent of respondents saying they were unhappy with their return on investment.
Additionally, only 52 percent of respondents considered their company’s innovation capabilities—the people, processes, resources, etc., necessary to turn ideas into cash—to be superior to those of their competitors.

The BCG studies clearly show that innovation affects the bottom line. Executives were asked to name the most innovative companies. BCG then looked at the financial results of these companies:

Innovation, our research shows, translates into superior long-term stock-market performance: the 25 most innovative companies (as defined by our survey respondents) had a median annualized return of 14.3 percent
from 1996 through 2005, a full 300 basis points better than that of the S&P Global 1200 median. The driver of that outperformance was these companies’ ability to expand margins at a superior rate without sacrificing growth: innovators increased median profit margins by an annualized 3.4 percentage points per year over the ten-year period, versus 0.4 percent for the median Standard & Poor’s Global 1200 company. And they did this while keeping revenue growth on pace—9 percent per annum—with the index median.

One of the reasons why some companies do so much better than others may be the lack commitment to market-defining innovations by the majority of business executives. By an overwhelming margin, executives claim that breakthrough innovations are necessary for success. But they give priority to and spend most of their resources on improvements to existing products/services or new products/services for their existing customers. As the report notes:

Perhaps an implicit calculation is being evidenced here. Given the inherent difficulties of creating an entirely new product or service (cost, time to market, intellectual-property concerns, branding, etc.), let alone a winning one, companies may be quietly deciding to weight incremental innovations (the surer bets) more heavily, believing this the most practical choice on a risk-adjusted basis. Yes, everyone wants to develop, and pays lip service to developing, the next product that “defines a market,” the next iPod. But in the end, when it comes down to actually committing resources, most companies seem to be playing the percentages.

Part of that difficulty (and the reason for the dissatisfaction over returns) is captured in the second study, which reveals the sad state of innovation metrics:

Innovation is widely undermeasured, and few firms—even those that attempt to track innovation rigorously—are confident they’re doing it right.

Without good measures, it is easy to understand why executives will focus on short-term improvement and incremental innovations. As was described earlier, there is great interest in improving innovation metric - see my posting on the recent NSF workshop. But, as Rajesh Chandy pointed out that workshop, our understanding of the innovation process is still primate: Innovation is not what we typically measure, not done by whom we typically assume, and not done as we implicitly believe. When we can get a better handle on how innovation really occurs in the I-Cubed Economy, we can then craft metrics to help both business executives and government policymakers.

That is our most important research task.

According to the US Census Bureau:

The image of a typical “mom and pop” business is getting a makeover, according to new data on these burgeoning enterprises released today by the U.S. Census Bureau. Yesterday’s notion of a family-run corner store is giving way to Internet-based auctions, nail salons and even motorcycle dealerships, according to Nonemployer Statistics: 2004.

The nation added nearly a million businesses with no paid employees between 2003 and 2004 to reach 19.5 million, a growth rate of 4.7 percent over a one-year period. Businesses without a payroll make up more than 70 percent of the nation’s 27 million-plus firms, with annual receipts over $887 billion.

The report has data on 17 million individual proprietorships and on more than 1.3 million corporations and 1.2 million partnerships. Nonemployer firms may be run by one or more individuals, can range from home-based businesses to corner stores or construction contractors and are often part-time ventures with owners operating more than one business.

Among the fastest-growing: building finishing contractors (22.5 percent), Internet service providers (18.7 percent), nail salons (14.7 percent), electronic shopping and mail-order houses -- including Internet-based consumer trade (12.7 percent), lessors of real estate (9.7 percent), formal wear and costume rental stores (8 percent) and motorcycle dealers (7.4 percent).

While those may be the fastest growing self-employed areas, the largest remains the traditional areas:
   • construction with almost 2.4 millions establishments (especially specialty trade contractors - 1.7 million);
   • real estate with almost 2.2 million establishments;
   • professional, scientific, and technical services with 2.7 million establishments (heavy on lawyers, accountant, architects but also computer design services);
   • retail trade with 1.8 million establishments; and,
   • the catch-all category of "All other personal services" (NAICS code 81299) with over a million establishments.

(Have I mentioned recently how bad our statistics are in tracking the I-Cubed Economy?)

There are more non-payroll establishments in manufacturing (302,000) than in the "information" industries (283,000).

So, while self-employment may be up, it is unclear whether self-employment is more or less the form of choice in the intangible (as opposed to the tangible services – e.g. retail and personal services) portions of the economy.

Interestingly there are 1,405 "Lessors of nonfinancial intangible assets (except copyrighted works)" with revenues of $141 million. This is down from 1,264 in 2002 but an increase in revenues from $120.7 million in 2002. However, non-payroll establishments represented only 0.7% of all revenues in this sector in 2002 (but 34.6).
(See Industry Statistics Sampler: NAICS 533.)

As the Census Bureau describes it:

This industry comprises establishments primarily engaged in assigning rights to assets, such as patents, trademarks, brand names, and/or franchise agreements for which a royalty payment or licensing fee is paid to the asset holder.

One can assume that the self-employed in this category includes (and is mostly) independent inventors. But given that broad coverage (by including brand names and franchises), it is impossible to tell what portion of royalties for patents are going to self-employed versus companies.

Can it be? Dilbert's point-haired boss understands a key to the Intangible Economy? Check it out for yourself at Dilbert!

Having just expressed my frustration with our political system's inability to deal with and go beyond the R&D tax credit issue, I have to now reverse course and give Congress credit for tackling another major issue: pension reform.

One of the characteristics of the I-Cubed economy seems to be a shift in financial choice and risk from institutions to individuals. Case in point is the shift from defined-benefits plans (where the company carries the risk/reward in that it needs to meet specific return on pension investments in order to payout the specified benefit) to defined-contribution plans (where the company is only on the hook for the specific contribution - not the final return). As David Wessel points out in his "Capital" column in the Wall Street Journal:

Perhaps the pension bill is best viewed as a funeral service for defined-benefit pensions. Employers don't want to be in this business, preferring to pass the risk of financial markets and longevity to workers, many of whom would rather have a 401(k) anyhow.

The shift to defined-contribution plans has been a long running trend. Back in the competitveness debates of the 1980's I worked on something called pension portability. It became clear that people were changing jobs more frequently -- and the inability of workers to transfer their pension was a deterrent to what economist call "labor market flexibility." But a portable defined-benefit plan was an administrative nightmare. Defined-contribution plans were much more mobile.

I do worry about the increasing trend toward placing all the risk on the individual - without a social safety network. Are we really going to throw Great-Aunt Tillie out on the street because she bet her retirement funds on AOL rather than Microsoft? This is why I opposed the social security privatization plan.

So there needs to be a balance. There are also provisions in the bill regarding defined-benefit plans: to strengthen the Pension Benefit Guaranty Corp. and closes loophole that allowed companies to underfund their pension plans.

Does this pension bill get the balance right? As Wessel states, is it unclear:

The quiet word from sober pension experts is that the bill does more good than ill for most workers and taxpayers, but is disappointing, given how much time Congress spent on it.

At least they move forward on an important issue in a thoughtful and bipartisan manner.

The R&D tax credit is being held hostage to estate tax. As the Washington Post explains:

Republican leaders in Congress have long wanted to eliminate or slash the taxes levied on estates left by wealthy people, but the Senate has repeatedly refused. Hoping to attract enough Democratic support, House leaders last week added a sweetener: the first increase in the federal minimum wage in nine years, plus an extension of several popular tax breaks for businesses. The House passed the complex measure -- dubbed "the trifecta" because of its three main facets -- and sent it to the Senate, which planned to vote before adjourning this weekend for the August break.

The R&D tax credit extension was one of those in the package. The bill would also have made permanent the prevision from last year's tax bill allowing the sale of songs to be treated as a capital gain rather than income – as I wrote about earlier.

However, last night the tactic failed as the Senate refused to vote to end debate on the legislation. (Interestingly, the failure may be due more to the issue of how to adjust or not adjust the minimum wage for tips than any other issue - as the Post story points out).

But even if the bill had passed, the issue of the R&D tax credit would be far from over. The bill includes only a two year extension retroactive to Dec 31 2005 - extending it to the end of 2007!

R&D tax credit is an example of how Washington can’t seem to get beyond the agenda of the 1980’s. It should have been made permanent decades ago. And we now should be conducting a review of its effectiveness – with an eye to crafting an incentive for innovation, not just R&D.

Instead, we are mired in a situation where the incentive is not a powerful as it should be because companies can’t plan on it being there from year to year. In addition, the nature of innovation has moved well beyond the types of activities that are rewarded under the law. The tax credit doesn't apply to many sectors of the economy where innovation is not the result of traditional R&D.

We need to move beyond the old ideas and address the competitive issues of today. Instead, we are replaying over and over again the fights of two decades ago.

Frustrating – really frustrating.

According to a new study by Deloitte Touche Tohmatsu - Innovation in emerging markets: Strategies for achieving commercial success, manufacturing companies need to stop relying on their existing products and innovate if they are to be successful in selling in emerging markets:

Global manufacturers are focused intently on the opportunities to source, develop, manufacture, sell, and service their products in emerging markets. But long-term success will take far more than simply making minor adjustments to existing products, lowering prices, or replicating existing sales channels. Instead, a new set of competencies and organizational structures will be required to generate a continuing stream of innovative products and services tailored to the needs of consumers and industrial buyers in emerging markets.

However, their survey shows that very few companies offer very different products in emerging markets: only 12%! Of the rest, 36% offer somewhat different products and 50% offer similar products. Instead of changing the product, they adjust their pricing, promotion/discounting and service.

The study appears to directly challenges the standard strategy (at least standard when I was teach International Business) of going global by modifying existing products to suit local markets ("glocalization" - also sometimes known as mass customization). The idea was to marry the advantages of mass production of a base product with customization to the specific market.

According to the study, the new strategy:

is a matter of customer knowledge. Companies should avoid assuming that what works or meets customer needs in developed markets will also work in emerging markets. Companies need to invest the resources required to gain a deep understanding of the requirements of customers in emerging markets. Each country is different, and the needs within a single country can vary widely.

By the way, this is the same message of CK Prahalad's influential book The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits. Prahalad is building a consulting firm The Next Practice specifically around the idea of innovation in emerging markets.

As a result of this new thinking, R&D is following manufacturing, as the Deloitte Touche Tohmatsu survey explains:

Manufacturers are increasingly locating and expanding their R&D operations in emerging markets. One important motivation is cost reduction, through lower costs for skilled engineers and also the potential for tax credits and other government incentives. But perhaps even more importantly, placing R&D close to suppliers and customers in emerging markets allows design by engineers who better understand their needs, facilitates collaborative product design, and simplifies the resolution of engineering-related problems. When it came to introducing new products in emerging markets, almost half of the executives surveyed said they had designed these products locally.

98% of the executives of large multinationals surveyed said they either had R&D facilities in emerging markets (66%) or were planning such facilities (32%)!

While obtaining a better understanding of the local market was cited as an extremely or very important reason for locating R&D facilities in emerging markets, lower cost was also a major factor (cited by 51% as an extremely or very important factor).

One especially interesting finding concerned the role of intellectual property. The report discusses how some firms cite key facilities due to a desire to protect intellectual property and trade secrets by not citing plants in certain areas or keeping the most advanced facilities close to home.

But the citing of key facilities is also a form of risk management:

Some companies are using “operational hedging”—distributing their operations across different countries—to minimize the potential impact of political, economic, and operating risks. For example, when a country accounts for five percent to six percent of sales, Emerson will relocate key manufacturing, labor, and sourcing operations to other locations to reduce its risk exposure.

This is an interesting twist on the concepts of comparative and jurisdictional advantage: a place's advantage is that it is not someplace else. I guess that is the ultimate differentiation in the I-Cubed Economy!

Thanks to Bruce Nussbaum for pointing out that Innovation Pays Off--P&G Gets Great Earnings.:

Evidence is piling up that innovation/design/creativity pay off on the bottom line and Procter & Gamble's latest earnings are but the latest proof.
. . .
In issue # 1 of IN--Inside Innovation, we ran a table by Peer Insight that showed companies focusing on consumer experience do better in the stock market than those that don't. Consumer experience is one of many expressions of innovation. P&G is good at it, good at design strategy and good at innovation. And don't forget, this is a packaged goods company. It isn't a hot, high tech startup.

The UK Design Council came up with a similar financial finding two years ago concerning companies which are design-oriented (see the Design Council website for more on the design index).

(As I pointed out earlier, the UK is ahead of the US in the area of understanding design and competitiveness.)

Clearly investment in intangibles pays off!

(By the way, for more on P&G's innovation process, see the Athena Alliance June event on Design and Innovation which featured a speaker from P&G)

In a posting over a year ago (Don't reform education, redesign), I mentioned the work of the Partnership for 21st Century Skills. The Partnership released its news report a couple of months ago - Results That Matter: 21st Century Skills and High School Reform continuing their work to redesign the high school:

The report presents three fundamental ideas about high schools that are not yet widely perceived:

* There are results that matter for high school graduates in the 21st century — and these results are different from and go beyond traditional metrics. Even if every student in the country satisfied traditional metrics, they still would remain woefully under-prepared for 21st century success beyond high school.

* Improving high schools requires the nation to redefine “rigor” to encompass not just mastery of core academic subjects, but also mastery of 21st century skills and content. Rigor must reflect all the results that matter for all high school graduates today. Today’s graduates need to be critical thinkers, problem solvers and effective communicators who are proficient in both core subjects and new, 21st century content and skills. These 21st century skills include learning and thinking skills, information and communications technology literacy skills, and life skills. Twenty-first century skills are in demand for all students, no matter what their future plans — and they will have an enormous impact on students’ prospects.

* The results that matter — 21st century skills integrated with core academic subjects — should be the “design outcomes” for creating high schools that prepare students for success in the 21st century. Only by setting clear goals that incorporate 21st century skills can high schools truly prepare students to succeed in postsecondary education, workplaces and community life.

These are powerful findings! What they say is that even our best high schools may not be doing their job of preparing young people for real world. Our educational standards are geared for the Industrial Era, not the I-Cubed Economy.

And until our policymakers, on every level, get that, we run the risk of falling further and further behind.