July 2009 Archives

The latest flash point in Wall Street rocket science is something called "high frequency" trading. The trick to this is using high-speed computers to exploit asymmetrical information. As the New York Times explains:

When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds -- 0.03 seconds -- before they are routed to everyone else. In that half-second, fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks, and can trade ahead of other market participants, pushing prices up or down.

Already Senator Chuck Schumer has called for an SEC ban while the financial services industry defended the practice. In his Washington Post column today, Steven Pearlstein (The Dust Hasn't Settled on Wall Street, but History's Already Repeating Itself) laments the practice:

But as far as I can tell, buying and selling huge volumes of securities in a matter of seconds is just another high-tech form of speculation that is only remotely connected to the fundamental purpose of financial markets, which is to raise and allocate capital efficiently for businesses that need it. Liquidity is certainly good for markets, but we recently learned from painful experience that it is also possible to have too much of it. And though sophisticated computer systems can be powerful tools in plotting trading strategies and managing risk, we also know that these systems have blind spots and can backfire when too many people try to pursue the same strategy at the same time.

I have a more fundamental question. I'm not a securities lawyer, but I thought the idea of one set of people having access to public information before others was forbidden. As Pearlstein notes:

Already, the Securities and Exchange Commission is preparing to clamp down on exchanges that, in return for special fees or guaranteed trading volume, provide certain hedge funds with access to some trading orders that come into its computers a fraction of a second before they are "posted" for everyone else. That's just enough time for the hedge funds' computers to detect patterns in the order flow and use that insight to trade ahead of other market participants.

It may be only milliseconds of access to the trading information before others have access to that information. But, in this case milliseconds can make a very big difference.

Welcome to the Information Age.

So, this mornings GDP numbers from BEA ended up better than expected - down only 1% rather than the 1.5% drop forecast by the Dow Jones Newswires. On the other hand, the 1Q of 2009 was a much steeper decline of 6.4% (rather than the "final" estimate of 5.4% in 1Q 2009 and 6.3% in 4Q 2008).

Today's numbers may be a good indicator -- they are not necessarily the light at the end of the economic tunnel for many people. As the New York Times reports:

"We're going from recession to recovery, but at least early on, it's not going to feel like one," said the chief economist at Moody's Economy.com, Mark Zandi. "For economists, this is a seminal part in the business cycle, but for most Americans, it won't mean much."

What is remarkable to me is the size of the revisions. Today's revisions essentially flip the story on economy over the winter. Before the data showed the biggest drop on 4Q 2008, with a smaller decline in 1Q 2009. Now the bigger drop is actually in 1Q 2009 with a smaller decline in 4Q 2008.

The revisions are even more striking when looking at the advanced and final estimate, compared with today's revisions. Advanced estimate of 4Q 2008 GDP was -3.8%; final estimate was -6.3%. Today's revised estimate is -5.4%. Advanced estimate of 1Q 2009 GDP was -6.1%; final estimate was -5.5%. Today's revised estimate is -6.4%.

These revisions are due to ongoing work by the BEA to improve the numbers.

As a side note, the terminology about the various releases will be changed, to better reflect the continued refinements of the data. As BEA notes:

The three vintages of quarterly GDP estimates are renamed "advance" (no change); "second" (currently known as "preliminary"); and "third" (currently known as "final").

So, treat the numbers with a bit of a grain of salt. Today's data is subject to revision as well. The direction of the trend is good however. The real question is not so much the specifics of the data, but how to create a sustainable, non-bubble growth path for the economy.

Here are some recent interesting articles:

Innovation in a Recession. Business Week's Special Report on "How companies are finding creative ways to come up with new products and services faster and more efficiently--with fewer resources."

Book Review: Learning from Apple's Design Consultant. A look at a new book on design from Hartmut Esslinger founder of the industrial design firm Frog -- complete with case studies.

How Washington Can Jumpstart Entrepreneurship - Washington Monthly Special Report. An interesting overview essay followed by articles on the areas of innovation policy focus of the Obama Administration: broadband, green tech, smart energy grid, and health care technology.

Effective Corporate Tax Reform in the Global Innovation Economy - Rob Atkinson, Information Technology and Innovation Foundation. An unabashed advocacy for using tax policy as an industrial policy toll to promote innovation -- including one of my favorite recommendations: the knowledge tax credit.

Creating a National Innovation Framework. Yet another call for an innovation policy -- with a nice description of the various federal technology and financing programs.

Using Design to Drive Innovation - Business Week. This article argues that "Designers must deliver the orchestration of the total experience with a brand, product, or service or face irrelevancy."

Bootstrapping High-Tech: Evidence from Three Emerging High Technology Metropolitan Areas - Brookings Institution. How cities without a major university can become high-tech nodes.

New Industry, New Jobs and Annual Innovation Report 2008. The UK's plan for economic recovery and the latest update on their innovation policy.

The Pink Prescription: Facing Tomorrow's Challenges Calls for Right-brain Thinking. An interview with the always insightful Dan Pink -- including why doctors should study art.

David Ignatius has an insightful column in Sunday's Washington Post - Life in the Rehab Economy. He talked about the slower rate of growth we can expect in the future as we move away the over-leveraged debt based consumption boom of the bubble:

It's an economy in rehab, you might say, working off the excesses and imbalances that created the crash of 2008. Savings rates will remain high, as people try to protect themselves and their families from another market collapse; the chronic trade imbalances of the past several decades will ease, as Americans reduce their consumption of everything, including foreign imports. It's a post-binge economy, cautious and careful -- with a lower tolerance for risk and correspondingly lower rewards.

He also talks about downside such a risk-averse economy:

The danger with this comfortable, slow-growth world was that it didn't adequately reward innovation and risk-taking. And that's the worry I have about our rehab economy. Without big incentives, will innovators come up with the world-changing ideas, and will capital markets be resilient enough to finance them? It's a good rule never to bet against America, and in the long run it's a certainty that America will innovate, grow and prosper. But over the next few years, America is likely to have stubbornly high unemployment, rising interest rates and disappointing investment returns in many sectors. I keep reminding myself that the rehab economy is good for us: Higher saving, less debt, lower imports, less risky financial behavior. But we should be honest about the drawbacks of this new paradigm and, where possible, ameliorate them.

I'm not sure I see the decline of an over-leveraged economy as an era of less innovation, however. In part, I disagree that we need "big incentives" such as we saw in recent years -- which in any event came in the form of the huge payouts to the financial sector not to business innovators. After all, Bill Gates didn't need an over inflated housing market to become a multi-billionaire. "Big incentives" can lead to bubbles -- dot-com, housing, etc. What we need are steady incentives - such as those that took a company like Washington DC based Blackboard from an idea of a couple of guys about education software in 1997 to one with over $300 million in revenues -- even through the dot-com bubble.

Second, I disagree because the culture has changed. Innovation is much more imbedded in company's operating procedures. The chance of returning to the day's of the "man in the gray flannel suit" as Ignatius mentions are rather slim.

Still, his warning about ensuring that innovation continues is timely. We need an innovation policy in this country. In December, we published an outline of such a policy with our Working Paper Crafting an Obama Innovation Policy. The recommendations of the paper still hold.

Chief among them was to re-establish the President's Council on Innovation and Competitiveness (PCIC). PCIC was created by Section 1006 of the America COMPETES Act of 2007 as a mechanism to "develop a comprehensive agenda for strengthening the innovation and competitiveness capabilities of the Federal Government, State governments, academia, and the private sector in the United States." The statutory Chair of the Council is the Secretary of Commerce and is made up of the heads of 16 departments and agencies (a nonexclusive list). However, the Council has never met. The Bush Administration relegated this responsibility to the Committee on Technology (CoT) of the National Science and Technology Committee (NSTC) in Office of Science and Technology Policy (OSTP) - which established it as a Subcommittee. Essentially, the issue of innovation and competitiveness was relegated to a subcommittee of a committee of a committee.

The Obama Administration should raise the issue of innovation and competitiveness back up to the Cabinet level where it belongs. That would an important first step in ensuring that the post-bubble economy is truly an Innovation Economy.

One of the hallmarks of the Intangible Economy is the shift in the innovation process. Central to that shift is the idea that innovation can come from anywhere -- including users. While standard example of user-generated is mountain bikes, the concept can be found almost anywhere including pipe-hanging fixtures, printed circuit boards and surgical equipment (see Eric Von Hippel's classic study The Sources of Innovation and his more recent Democratizing Innovation).

A new example comes from the fashion industry. Today's New York Times has a story about open innovation in design:

Polyvore is a user-generated fashion magazine filled with user-generated ads. The people who go to it play fashion editor and create collages featuring pictures of clothes, accessories and models from across the Web. Readers view the collages, which the site calls "sets," and if they click on a dress or necklace, they are taken to the Web site that sells it.

It has always struck me that fashion should be a prime area for user-driven innovation. After all, while top designers may dress the models, the day-to-day task assembling a wardrobe and of deciding what to wear is all user driven. Fashion pages (such as that in the Washington Post) often feature what is seen on the street -- put together by the average person (an average person with good taste, of course).

So the business model behind Polyvore makes perfect sense to me. It will be interesting to see how many of those fashion pages copy it. In part, the Washington Post already has, by having readers post their own fashion photos. But such user generated content is still based on a publication model. Polyvore seems to go well beyond that to a retail model.

It is also a data mining model. As the story notes:

Polyvore also plans to sell data on customer preferences it compiles on the site. It could potentially tell a retailer that a type of shoe is more popular in Manhattan than Los Angeles, so it would know where to stock the shoe. Or designers could upload images of new items before deciding to produce them to get input from fashion-savvy users. It could also give buyers information about trends in real-time, faster than monthly magazines, said Jess Lee, Polyvore's product manager. This fall, for example, watch for recent trends bubbling up on the site: exposed zippers, fingerless gloves and butterfly prints.

Like any good user-driven innovation model, the process connects users with producers. Sound like a winner to me.

Today, the National Design Awards is holding a Design in D.C. day, with top level participation from the Obama Administration. About time -- maybe next we can get them to focus on "design thinking" as well.

The session are at 10:00 am this morning and are being webcast live:

Details: Materials and their Effects
Francisco Costa (Fashion Design) and Calvin Tsao and Zack McKown (Interior Design) will discuss the role of material in their work, while sharing their visions, projects and inspirations with Ebs Burnough, White House deputy social secretary.

Community: Transform your Neighborhood
Neill McG. Coleman, general deputy assistant secretary, U.S. Department of Housing and Urban Development, will discuss how design can be used as a tool to create a sense of community with Christopher Sharples, Coren Sharples and Gregg Pasquarelli of SHoP Architects (Architecture Design) and Walter Hood (Landscape Design).

Information: Interpreting the Present and the Past
Anita Dunn, White House acting communications director, will discuss the relationship between current events and the design process with Boym Partners (Product Design) and The New York Times Graphics Department (Communication Design).

Experience: The Future of Interaction Design
Aneesh Chopra, U.S. chief technology officer, will discuss the future of interaction design with Jeff Han of Perceptive Pixel Inc. (Interaction Design) and Andrew Blauvelt of Walker Art Center (Corporate and Institutional Achievement).

Tomorrow: The Future of Technology and Sustainability
John Holdren, director of the Office of Science and Technology Policy in the Executive Office of the President, will discuss the future of technology and sustainability with Amory Lovins (Design Mind) and Bill Moggridge (Lifetime Achievement).

Joff Wild's blog has a run-down of the first day of the ICAP Ocean Tomo auction -- and the news is not good. Both sales and then number of patents auction are down significantly. Joff quotes Terry Ludlow of Chipworks summary:

If patents with clean provenance, limited licensing encumbrances and solid claim charts are offered, they still sell on the open market. But, no-one is buying speculatively. And, with the relatively high reserve bids published for the patents, most of the lots attracted no bids at all! The aggregators seem to have been entirely absent.

From what it sounds like, the bloom may be off the "IP-as-speculative-investment" rose. That may not be such a bad thing, however. If intangible assets can settle down as a solid asset class, then there is opportunity for sustainable growth in IA financing. But, as I worried about yesterday, if they remain "exotic" they are likely to remain a very small part of the financial markets. We need more vanilla and less Tabasco in this market.

One of the aspects of the recent (ongoing?) financial meltdown that has concerned me is the possible backlash against intangible assets. Most of us recognize that intangible assets are real and have value. But to the rest of the world, looking superficially, these may look like very "exotic" assets indeed. As I commented about the recent Morgan Stanley transaction, they can seem (and be) very risky.

They need not be. Done right, an intangible asset backed loan or securitization can reduce risk and free up capital by providing security collateral not otherwise utilized. An IA-based securitization can be structured to be much more transparent than the massively complex synthetic securitizations of previous years.

However, to the extent that we don't have standards for ensuring transparency and guarding against the overly complex, intangible assets will be relegated to the "exotic", and therefore dangerous, category.

So why does this matter? Can't the market figure out the risk and act accordingly? From recent history, the answer is apparently not. This is where regulation comes in. And right now, the mood is anti-"exotic". For example, in last night's press conference President Obama went after these types of transactions. As the Wall Street Journal reports, (Obama Proposes New Transaction Fees for Financial Firms' Riskiest Investments):

President Barack Obama said for the first time that the government might assess new fees against financial companies engaging in what he labeled "far-out transactions," in order to protect taxpayers from future bailouts. Mr. Obama on Wednesday compared the possible fees to the assessments that more than 8,000 banks pay the Federal Deposit Insurance Corp. to guarantee deposits. He didn't describe what sorts of transactions might trigger the fees, though the way he described it suggests the proposal could cover exotic instruments such as credit derivatives that some believe played a key role in escalating the financial crisis. He also indicated that the fees might be levied against transactions the government wants to discourage.

It will be up to those of us who support the use of intangible assets in the capital markets to demonstrate that they are not "far-out transactions." And the best way to do that is with gold-plated underwriting standards.

Such standards are long overdue. Maybe this current crisis will be the spur to get this done.

From time to time, I have posted items about how the music business is changing in the face of digital technology. I have argued that the business needed to -- and has -- shift from recording to live performance as the means of raising revenue for artist. Today's New York Times has a story about how the recording model is changing as well -- Musicians Find New Backers as Labels Lose Power. The story describes the creation of a new intermediary to take the place of the record labels. The new company, Polyphonic, will market bands over the Internet:

Under the Polyphonic model, bands that receive investments from the firm will operate like start-up companies, recording their own music and choosing outside contractors to handle their publicity, merchandise and touring.
Instead of receiving an advance and then possibly reaping royalties later if they have a hit, musicians will share in all the profits from their music and touring. In another departure from tradition in the music business, they will also maintain ownership of their own copyrights and master recordings -- meaning they and their heirs can keep earning money from their music.

This is in sharp contrast to the 360 model adopted by some record labels -- whereby they handle all of the artists' promotions, including touring and merchandise as well as recordings (see earlier posting).

So after decades of a monolithic business model dominated by the record companies, we now have shifting and competing models. May the best model win. Or better yet, may diversity thrive.

Last week Ralph Gomory gave an interesting talk to the New America Foundation on the need for manufacturing. Gomory is the former head of R&D for IBM and former President of the Sloan Foundation. His major point is that we need a healthy manufacturing sector to have a balances economy. I completely agree. For more information on some of the data about manufacturing and services trade, see my earlier posting on Manufacturing in the Intangible Economy.

From Mary Adams on how to grow your business in the knowledge era using intellectual capital:





So get out those Legos and start building your knowledge business model.

During his life, Michael Jackson was able to leverage his intangible assets into huge up front financial payouts to sustain his lifestyle. That leverage was not enough to keep up with his expenses, however. In 2006, for example, he engineered a financing bailout deal with Fortress Investment Group based on his half ownership of the Sony/ATV Music catalog which includes a number of Beatles songs (see earlier posting). (As side note, apparently Jackson had stated that he wanted the Beatles songs to revert back to Paul McCartney upon his death. Given the debts, and the use of the collection as loan collateral, we will see if this will actually happen.)

Does this mean that the lenders made a big mistake financing Jackson's debt? Not necessarily. As a recent Wall Street Journal story noted, Jackson income potential provided a seeming cushion for lenders:

"You are talking about a guy who could make $500 million a year if he puts his mind to it," the billionaire investor Thomas Barrack, owner of Colony Capital, told The Los Angeles Times a month before Mr. Jackson's death. "There are very few individual artists who are multibillion-dollar businesses. And he is one."

Even with Jackson's death, that income stream continues. For example, now comes word that Jackson left a estimated 150 unreleased songs. In addition, Jackson memorabilia and other material (apparently including fashion items designed by Jackson) are hot items.

The question is who will control that income stream. The battle is just beginning -- and it is unclear as to the extent of the lender's rights. It all depends on the extent of the intangible collateral put up in the first place - and the breath of the lending contract. So stay tuned.

In the lighter side of the news, our friends over at GizMag have a wonderful example of why invention is not necessarily a step forward. I present to you - the iBum Chair. The iBum chair is a chair with a photocopies built into the seat so you can effortlessly engage in that ritual of every summer office intern -- making an ass of yourself by photocopying your ass.

It does however take away something from the process. As the reviewer notes:

Call me a traditionalist, but if it's not naughty, a bit dangerous and a blatant abuse of equipment, I can't see why you'd bother photocopying your bum at all. In fact, to me, the iBum chair seems to remove all fun from the act whatsoever.

Put me down as defining this as an invention - but not necessarily an innovation.

For some time, I have been asking the following question: Why do we assume that US will be the leader in the production of green technologies? Over the last couple of years I posted a number of items on how other countries are ahead of us -- and how at least some policy makers understand that.

However, a story in today's Washington Post (Asian Nations Could Outpace U.S. in Developing Clean Energy) illustrates the problem. In general, the story does a good job of describing the challenges. But it ends on this note with a quote from Mark Levine, director of the environmental energy technologies division at Lawrence Berkeley National Laboratory:

Levine said the United States is unlikely to "become the or even a leading photovoltaic manufacturer. But our scientific talent . . . has a good chance of developing the next-generation PV systems which we could either manufacture in China or another country . . . or license to foreign companies. . . . Even if the manufacturing is done abroad, this will lead to very real and large benefits to the U.S. from licensing fees, not to say sales in the U.S. and elsewhere."

Wrong! Licensing fees are good. But a licensing out strategy will not help the US economy. The US economy can not live on licensing fees alone if we have to import the products. As I and others have repeatedly pointed out, we need to make the green/clean technologies here.

In addition to a green technology strategy, we need a manufacturing strategy. Along that line, special kudos to my old boss Senator Jeff Bingaman for adding provisions to both the stimulus and the climate change bills to encourage US production of clean technologies. But we need to do more -- much more.

And a major first step is to get right of the business model of "invest it here; make it there." That may be fine for an individual company. But collectively, it is a national policy that will lead us eventually to what Warren Buffet once called the Sharecropper Society.

This recent story in the FT (Morgan Stanley unveils $250m securitisation) got a lot of people's attention -- at least from those of us who are interested in intangible asset financing. According to the story:

Morgan Stanley has launched a new intellectual property securitisation in the latest sign of life for structured products and a revival of investor interest in even the most cutting-edge corners of the market.
The bank has launched a $250m deal for Vertex Pharmaceuticals, a US biotech company that would see investors repaid from contractual milestone payments on a drug still in development.

(See also a companion story -- Intellectual property trade stirs up interest)

The Reuters story provides more detail:

The payments would come from Johnson & Johnson (JNJ.N), which licensed European rights to the drug, telaprevir, three years ago from Vertex.

Interesting that J&J licensed the right so long ago. It would be interesting to see what its projections are on the eventual revenues and therefore what are the royalty flows back to those Morgan Stanley investors. A risky proposition, which as Joff Wild points out, may have a huge upside. Still, as Joff notes, "Just as long as none of my pension pot goes anywhere near any deal."

So, we will see if this is a breakthrough in intangible asset monetization that will revive the market -- or a one-off risky deal that will end up sinking it. Personally I would like to first see a relatively plain vanilla patent securitization where the royalty flow has already been established. That might do more to entice investors back into this game. ."

Still, the idea of using securitization as an alternative method of financing product development is one that I find strongly appealing.


UPDATE -- see also the Vertex press release

Ed Glaeser has an interesting article in Forbes on the history of New York City -- and its economic dynamics. The title of the piece - The Reinventive City - makes the central point. Over its history, NYC has shifted its economic focus from shipping and commerce to manufacturing to finance and 21st Century activities. Glaeser tells the story of these shift - but with emphasis on one key element: human capital.

Today, Gotham's strengths--competition, diversity, access to the world, and, most of all, human capital, made even more potent through proximity--will enable the city to reinvent itself, as it has done several times in the past, and survive the current economic storm.

It is a great story -- including how winning independence from Britain was not good for NYC:

During the Revolutionary War, New York became the center of English operations and a haven for loyalists. But after Cornwallis' defeat at Yorktown led to the Treaty of Paris in 1783, the loyalists and redcoats evacuated, and New York's population declined by roughly 60%.

But New York bounced back. In part this was due to the China trade, where US grown ginseng was exported to the Far East. Later a huge government sponsored project -- the Erie Canal (which Glaeser does not mention) -- made NYC the port for export of MidWestern farm products.

Glaeser also points to the Caribbean sugar trade as a turning point in NYC's rise as a manufacturing power. That manufacturing might manifested itself in the garment industry -- still a force today. Curiously, Glaeser does not even mention the human capital element that powered the garment industry: the fact that NYC was the major entry point for European immigrants.

He does go one to tout how the wizards of Wall Street (including the so-called Masters of the Universe) brought NYC back from the dark days of decline during the 1970s. Personally, I think he give them too much credit for the revival of the city. There are far too many other things going on in the creative sectors to place finance on too high a platform.

Likewise, I'm not sold on his implicit "if we just keep taxes low and keep government out of the way everything will be ok" message. The story is far too complicated to be reduced to a simplistic formula of entrepreneurs will save us.

But his underlying point is strong --and one he shares with Jane Jacobs (whom he cites repeatedly in the article). The diversity of human interests, skill and talents -- which we loosely lump together under the rubric of human capital -- is what makes for economic dynamism.

But we have known that for some time. Just remember that it is human capital that Adam Smith touted as "The Wealth of Nations."


PS - For a history of New York City in the same vein, I would also recommend Thomas Kessner's Capital City: New York City and the Men Behind America's Rise to Economic Dominance, 1860-1900.

This just in over at the National Journal's Tech Daily Dose: PTO Puts The Brakes On Patent Project:

A Web-based governmental social networking project aimed at improving patent quality by connecting the Patent and Trademark Office with outside scientific and technical experts has effectively shut down after a two year test run and accolades from the White House. The Peer-to-Patent project, a joint effort between the PTO and New York Law School's Center for Patent Innovation has stopped accepting new applications but will continue processing those already in the system. The PTO elected to close Peer-to-Patent to new applications "until it can complete a full evaluation of the impact the project has had on the patent examination process," according to a NYLS press release.

I'm all for proper evaluation, but if the program seems to be working that evaluation should take place while the program is ongoing. There is something seriously wrong here.

I have great admiration for Andy Grove -- not just for his previous leadership of Intel but for his business insight. But his piece in today's Wall Street Journal (What Detroit Can Learn From Silicon Valley) gets it wrong -- and right at the same time. His main argument is that the government intervention in the auto industry represents a effort to prop up a failing business in a effort to protect jobs. He compares what is needed to the transformation of the PC industry in the 1980's:

Imagine if in the middle of the computer transformation the Reagan administration worried about the upheaval and tried to rescue this vital industry by making huge investments in leading mainframe companies. The purpose of such investments would have been to protect the viability of these companies. The effect, however, would have been to put the brakes on transformation and all but ensure that the U.S. would lose its leadership role.

I think he is right on what would have happened. But Grove strangely omits the history of what did happen. In the middle of the Reagan administration the government did make major investments that shaped the future of the industry. One was the creation of Sematech -- one of the first public-private partnership that has defined technology policy for the last two decades -- and led by Grove's old boss Robert Noyce. The second was the massive research and procurement support that created (and then opened up) the Internet.

The other part that Grove omits from his story is the parts of the automotive strategy which are geared toward the transformation of the industry. If the take over was only a massive jobs program, then why is the Administration taking all the heat from the dealers? And for other down-sizing activities?

Grove is right on one part. The nature of the value added drivers is changing from the current internal combustion engine drive train assembly to the battery technology electric motor combination (as I have noted before). But he fails to even acknowledge any of the US effort in that area.

Grove is also right that China is making its' bet on battery technology - although I think any China watcher would be assumed over Grove's statement that "It's not clear precisely how the Chinese government influences industrial strategy." It is clear to almost all that Chine has an industrial policy.

But the current situation is not due to the Obama Administration's actions. Rather there are the result of decades long denial that the US should have an industrial policy as well.

Finally Grove offers a very interesting analysis of industrial structure. He thinks the auto industry needs to adopt a more horizontal structure similar to the PC industry. It is interesting to speculate what the auto industry would look like if it did so. Would a quasi-monopoly emerge similar to the Microsoft-Intel (Win-tel) dominance of the PC industry? Would we see more offshore production, as was perfected in the "cross border production networks"? We may already be headed that way given the situation in battery technology. It is also interesting to speculate where such a system would be any different from the system that has already evolved - with its vast independent (but captive) supplier base.

In short, I too believe that there may be lessons to be learned in Silicon Valley. But there are lessons to be learned elsewhere as well. And the lessons from Silicon Valley may not be the same ones as Andy Grove thinks there are. Correction: The text has been modified to the correct spelling of Mr. Grove's name -- Grove not Groves. We regret the error.

In many businesses, companies either understand, or at least give lip services to the saying that "our employees are our most valuable asset." The big exception apparently is retail. This has become clear as the retailers (in the form of the National Retailers Federation) have ganged up on one of their own -- Wal-Mart -- for supporting mandatory health insurance coverage. A story in today's Wall Street Journal explains why:

Health-care expenses are a sensitive topic in the labor-intensive retail sector, where low-paid workers and high employee turnover are a standard feature. Many companies have typically offered minimal benefits, partly because their workers don't earn enough to share much of the cost of premiums, and because employers haven't seen much advantage in extending coverage to workers who were unlikely to stay long, benefits experts said.

Only 45% of retail sector workers are covered by employer health care -- as compared to 63% in "service" industries and 79% in manufacturing.

So the model in retail is pay low wages -- and expect high turnover. But that may be changing, according to the story:

While retailers have typically opted for the bare minimum in health benefits, firms including Wal-Mart, Toys R Us Inc. and Home Depot Inc. have begun tinkering with more expansive programs in hopes of reducing employee turnover, said Shub Debgupta, who conducts benefits research for more than 300 large companies as part of Corporate Executive Board Co.
. . .
Costco Wholesale Corp. for years has enjoyed a reputation for generous health benefits -- more than 90% of its workers have coverage with the company -- and executives have defended their strategy as a boon to productivity.

It seems to me that I remember stories of a similar issue 100 years ago in mass production manufacturing. Wages were ok - especially compared to life on farm. But turnover was high. Then a young entrepreneur who had built a hugely successful company came up with a way to solve his turnover problem. Henry Ford started paying his workers the unheard of sum of $5 a day. The turnover rate dropped dramatically to a point where Ford said he was no longer measuring it.

I realized that the retail sector is not suffering from the same magnitude of a turnover problem facing Ford (where he had to hire 52,000 maintain a 14,000 man workforce). But I think the retail industry might learn something from him. And health care may be the place to start.

The May trade figures were released by BEA this morning and there is some good news. Exports increased, imports dropped and the overall deficit declined by $2.8 billion to $26.0 billion. Economist has expected that the deficit would widen slightly due to rising oil prices. As the Wall Street Journal reports, the news on the energy front was mixed:

The U.S. bill for crude oil imports fell to $13.41 billion from $13.63 billion the month before despite a continued rise in oil prices. The average price per barrel climbed $4.61 to $51.21. Crude import volumes fell to 261.89 million barrels from 292.60 million.
The U.S. paid $17.70 billion for all types of energy-related imports, up from $17.40 billion in April.

Our intangibles trade surplus moved ever so slightly in the wrong direction, however. The surplus was $11.62 billion in May compared to $11.67 (revised) in April. Both exports and imports of private business services were up while both inflows (exports) and outflows (imports) of royalty payments were down. The intangibles trade surplus has been essentially flat for the past 6 months.

Our deficit in Advanced Technology Products improved somewhat after surging in April. The May deficit was $3.6 billion - down from April's $4.7 billion but still higher than in the first three months of the year. Of course, that is still half of the over $7 billion monthly deficits we were running last summer. Imports were generally down and exports up - a good sign. The major exceptions, however, were in information and communications technologies and opto-electronics, where exports dropped, imports grew and the deficit got worse. This data is however subject to revision as a footnote in the BEA tables discusses - due to non-disclosure requirements. The level of exports may be overstated by $455 million. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

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.

Lucian Bebchuk of the Harvard Law School has an insightful analysis over at the Wall Street Journal's Real Time Economics blog on The Fall of the Toxic-Assets Plan:

The plan for buying troubled assets -- which was earlier announced as the central element of the administration's financial stability plan -- has been recently curtailed drastically. The Treasury and the FDIC have attributed this development to banks' new ability to raise capital through stock sales without having to sell toxic assets. But the program's inability to take off is in large part due to decisions by banking regulators and accounting officials to allow banks to pretend that toxic assets haven't declined in value as long as they avoid selling them.
. . .
What happened? Banks' balance sheets do remain clogged with toxic assets, which are still difficult to value. But the willingness of banks to sell toxic assets to investment funds has been killed by decisions of accounting authorities and banking regulators.
Earlier in the crisis, banks' reluctance to sell toxic assets could have been attributed to inability to get prices reflecting fair value due to the drying up of liquidity. If the PIPP program began operating on a large scale, however, that would no longer been the case.
Armed with ample government funding, the private managers running funds set under the program would be expected to offer fair value for banks' assets. Indeed, because the government's funding would come in the form of non-recourse financing, many have expressed worries that such fund managers would have incentives to pay even more than fair value for banks' assets. The problem, however, is that banks now have strong incentives to avoid selling toxic assets at any price below face value even when the price fully reflects fair value.

In addition to the changes in accounting, Bebchuk points to the failure of the bank stress test to look at the value of longer term assets.

So, with the introduction of "mark-to-myth" accounting, what should have been a program of price discovery has become an irrelevancy.

However, Bebchuk points out that the problem could resurface later this year.

While the market for banks' toxic assets will remain largely shut down, we are going to get a sense of their value when the FDIC auctions off later this summer the toxic assets held by failed banks taken over by the FDIC. If these auctions produce substantial discounts to face value, they should ring the alarm bells. In such a case, authorities should reconsider the policies that allow banks to pretend that toxic assets haven't fallen in value.

At that point, look to see whether the mark-to-myth model can hold up.

The talk in Washington and in the blogsphere has already turned to the next stimulus package (which would actually be our third stimulus package - remember the $152 billion package in the summer of 2008). Before everyone starts getting excited, let me state for the record that I think the talk is premature. I don't think the previous stimulus funds have yet started to do their macroeconomic job. But, if policy makers are going to put together another economic package, there are a number of things that should be in it.

First, let me reiterate what I have said before. Any economic package needs to be transformative. Simply reflating the bubble is unacceptable. Thus I reject any ideas that only spur consumption. We need to be investing and rebuilding, not buying more consumer goods from abroad.

Here are some of the ideas. First and foremost, invest in workers. Put in place a knowledge tax credit to spur companies to send workers to training, rather than unemployment lines. There are ideas floating around about giving workers government paid time off. I think that is a bad idea. Rather than paying them to do nothing, pay them to upgrade their skills to make themselves, their companies and the nation more competitive. As I've said before:

If we can give companies a tax break for a new piece of equipment (as we did in the first stimulus package), surely we can give companies a tax break to upgrade their most valuable asset: their workers.

Next invest in the creation of the infrastructure needed to foster other intangible assets. We need programs to stimulate innovation. Not just in energy, health care and use of IT in government -- as the Administration seems to be doing -- but across the board. We need programs to stimulate entrepreneurship. We need programs to help companies, especially small and medium size businesses embrace design thinking -- and the 21st Century linkage between manufacturing and services.

Finally, we need to invest in creating an economic strategy. As I mentioned last November, there are numerous calls for a new strategy. Since then, more and more respected business and economic leaders have joined in the call. Back in November I noted that Michael Porter ended his Business Week article Why America Needs an Economic Strategy - with the following:

We will need some new structures to govern strategically. I served on the last public-private President's Commission on Industrial Competitiveness--in 1983! This time we need one that is less politically motivated. Congress would benefit from a bipartisan joint planning group to coordinate an overall set of priorities.

We had such a group. It was a bipartisan Congressionally created organization - the Competitiveness Policy Council. It was created in the 1988 Trade and Competitiveness Act and operated from 1991 until 1997, when the GOP-controlled Congress cut off its funding. There was also legislation submitted in 2004 by Senator Lieberman to create a Commission on the Future of the US Economy -- which Athena Alliance consulted on and supported. It is time to invest in this strategic process as part of any new economic package.

So it is Google versus Microsoft:
Bing, the Imitator, Often Goes Google One Better
Google Plans a PC Operating System
True competition - or are we all just the grass?

It is often assumed by many that brands are an independent and positive intangible asset of a company. The truth is that brands are a much more fragile asset - and are highly reliant on a multitude of other intangible assets - such as customer statisfaction, quality, etc. Brands are the outward manifestation of many of those intangibles.

Now comes new study at Strategy+Business warning that brand value may not be all that it is reported to be. According to the authors of The Trouble with Brands:

When all the facts were put together, we discovered that, yes, there was an increasing expansion of the value that financial markets are attributing to brands, but this value growth is actually attributable to fewer and fewer brands. Sure, for financial juggernauts like Google, Apple, and Nike, brand value continues to increase powerfully, but the number of these kinds of high-performance, value-creating brands is diminishing across the board, while the actual value created by the vast majority of brands is stagnating or falling.
This overall mismatch between consumer attitudes toward brands and the market values of the universe of companies that produce and own them is, we believe, a recipe for disaster at two levels. At the macroeconomic level, it implies that the stock prices of most consumer companies are overstated: A "brand bubble" is implied in their stock prices, and once it deflates -- or worse, pops -- it could further drive down valuation multiples and stock prices around the world. Meanwhile, for leaders of consumer-related corporations, the mismatch points to a serious, continuing problem in brand management.

Not only may brand values be overstated, but companies need worry about the negative value of some brands. The problem of negative brand value is illustrated by a story in today's Washington Post - In the Chevy Malibu, GM's Pride and Its Challenge. The story relates how Troy Clarke, president of General Motors North America, experience with a focus groups:

Standing behind mirrored glass, Clarke watched as the facilitator listed the raves the car had won from critics. The participants grew increasingly enthusiastic, and they still didn't know it was a GM product.
"The facilitator said, 'What do you think of this car?' and they said, 'Whoa, that's really nice.' He said, 'What if I told you this was North American car of the year?' And the group would nod and say 'I can understand why.' He said 'What if I told you it got the best fuel economy in its segment and it was recommend by Consumer Reports?' And I mean people were reaching for their checkbooks.
"Then we say this is the new Chevrolet Malibu, and then boom."
The enthusiasm vanished.

Not a good sign for those who might be thinking of investing in the Chevy (GM) brand.

I wonder if this was taken into account in the bankruptcy valuation?

The Commerce Department's Manufacturing Extension Partnership has set up a new open innovation marketplace system as part of Planet Eureka. The goal is to help small and medium size businesses share ideas and find partners. Check out Ben Franklin's introduction, including his description of the importance of open innovation.

In an earlier posting, I mentioned how manufacturing companies, such as Deere, more and more see themselves as providing "integrated customer solutions" rather than building products. I recently came across a study by Deloitte on The Service Revolution: Manufacturing's Missing Crown Jewel that explores this trend. Their findings "point to a large untapped market for the manufacturers that can master the elements of superior service."

Services are already a major part of many larger manufacturers. As the report notes, "Across the manufacturing companies that we studied, service revenues average more than a quarter of total revenues but deliver 46 percent of the profits." They cite a number of examples, including the the now classic example of Rolls-Royce jet engines.

One of the example used is that of Siemens:

Leading providers such as Siemens AG Medical Solutions make service central to their corporate strategy, designing the service business around customer requirements in order to create customer satisfaction, loyalty, and business performance.
Siemens' customers increasingly expect to pay for equipment uptime. To achieve this, Siemens harnesses sophisticated technology and advanced processes and workflows, combining online, real-time repair information, inventory management, pricing and invoicing with advanced logistics systems to give service technicians the right information and parts when and where they need them. For example, the company is using simple lockboxes to store parts near customers, reducing the travel time for high-cost and highly valued service technicians. The best way to assure high efficiency of field service engineers, they have learned, is to synchronize closely the arrival of a part at the drop-off point with the scheduled service job of the engineer at the client site.

Another is Caterpillar:

Caterpillar Inc . is a master of the service game, with an inventory of more than half a million spare part numbers and a huge worldwide installed base of earthmovers, engines, excavators, and other equipment that in some cases needs service for 40 years or more. Yet Cat can ship its customers exactly what they want within 24 hours, 99.7 percent of the time.
Cat has done so well on the service front that it has extended its capabilities in service parts management and logistics to external customers. Forming Cat Logistics in 1987, the company set out to build a global growth business and to capture more of the available market for service parts management. Today, Cat Logistics counts among its customers blue-chip companies such as Ford, Saab, Toshiba and Honeywell. It employs more than 9,000 logistics professionals across 25 countries and six continents, managing more than 18 million stock-keeping units (SKUs) and shipping more than 160 million orders and 16 billion pounds of freight each year.

But both of these are examples of after sales services and subsidiary operations. Neither are about the elusive "integrated customer solution."

A better (and also now classic) example is the iPod where a product (a MP3 player) was married to a service (easy downloading of music via iTunes) to provide a seamless customer experience.

Unfortunately, the report leaves unstated (and unanswered) one of the biggest question of all: why manufacture at all. After all, in the case of subsidiary services, such as the example of Cat Logistics, there is no connection between the service and the manufacturing. In the case of the iPod, Apple does not feel the need to actually make the iPods themselves but rather have suppliers make the product.

The reason to still make things is found in the after sales service support model, such as Rolls and Siemens. The report mentioned a number of companies who thrive in the after market of service and parts where there a direct linkage between service and manufacturing. This is a variation of the old "give away the razor and sell the blades" approach.

However, too many manufacturers apparently still don't get this. According to the report, "only a few companies effectively include service management issues when making decisions about product innovation and product life cycle management." Companies seem still fixed in the industrial age mentality of turning out a large volume of a commoditized product. Reducing cost is everything -- which leads to the never ending hunt for the lowest cost production location, even if it ends up costing more in terms of supply chain management, quality and other factors.

Here is a case where government policy can help. We need more research on the service-manufacturing linkage. That would be an excellent part of the "services sciences" agenda. We also need to instill this notion of the fusion of manufacturing and services into the Manufacturing Extension Partnerships. The MEPs were on the front lines helping small and medium size companies during the quality revolution. They need to be on the front lines of the innovation and "customer solution" revolution.

The bottom line is that there is no reason why manufacturing can't flourish in the United States. But it has to be a manufacturing sector that is different from the past. a few companies have understood and exploited the linkage between manufacturing and services. Our public policy needs to be geared to helping more make that transformation.

During the GM bankruptcy case, it was argued that the case needed to move quickly in order to protect GM's assets. As a story in the Washington Post last week noted:

In closing arguments, attorneys for GM, and the governments of the United States and Canada, which has also provided funding, urged Judge Robert Gerber to approve the sale quickly. Speed, they said, was of the essence, because GM's assets -- as well as consumer confidence -- are fragile.

What were those fragile assets? Their intangibles, of course. Consumer confidence was cites as key. In Sunday evenings court order approving the reorganization plan, Judge Robert Gerber expressly noted the need for speed:

Even if funding were available for an extended bankruptcy case, many consumers would not consider purchasing a vehicle from a manufacturer whose future was uncertain and that was entangled in the bankruptcy process.

Not explicitly mentioned as part of the "need for speed" but implied throughout is the relationship with the supplier base, which could also crumble during an extended period of uncertainly.

It is also interesting to note that the Court implicitly recognized the additional value of an ongoing concern versus the sum of the value of the assets:

Bankruptcy courts have the power to authorize sales of assets at a time when there still is value to preserve--to prevent the death of the patient on the operating table.

In other words, the concept of the intangible value of an entity - above and beyond the value of the assets - is enshrined in bankruptcy laws.

Missing from the order, however, was any recognition of the value of hard intangible assets, such as intellectual property. The order speaks to the book value of GM's assets -- without recognizing that the company's intangible assets are only carried on the books. However, the liquidation analysis prepared by AlixPartners does explicitly state:

Technology and trademarks are generally not carried on the balance sheet of the Debtors: my analysis assumes a recovery range of approximately $980 million to $1.19 billion.

In contrast, property, plant and equipment was valued at between $1.3 and $2.1 billion. Thus, the ratio of of GM's real property to intellectual property is approximately 1.3-1.7 to 1.

The true worth of that intellectual property is subject to debate. As we noted in a previous posting, 42% of its patent portfolio made up of grade A or B quality patents, which does suggest strength in potential licensing revenues. But GM lags its competitors in green technology patents.

(Note the largest asset value for GM is in various financial assets, including equity in its subsidiaries.)

Whether the "new GM" can capitalize on its intangible assets remains to be seen. At least the reorganization process recognized their importance - explicitly and implicitly.

As regular readers of this blog know, one of my pet peeves concerns the standard myths of innovation. Let me highlight a couple. Myth one is that innovation is all about technology. Myth two is that innovation proceeds in a linear fashion from scientific research to a fancy new product. The two are obviously interrelated. If it is only about technology, then model of the process is a linear deployment from lab to market (with occasional feedback loops.)

For a long time, I have argued that lead-edge companies understand that these are myths. That point jumped out at me when I was recently reading a book by the management consultant Tom Koulopoulos. The book, The Innovation Zone, is aimed at companies who want to become more innovative. But the points he makes are relevant for policymaker's understanding of innovation.

On the first myth, over and over he cites examples of how the most innovative companies go far, far beyond technology. He stress, with examples, that innovation is not invention and that business model innovations are just as important. Apple's iPod and Zipcar are classic cases in point.

He also points out the innovation is not a sole activity (myth three: the lone genius driving the process). Rather, collaboration is key to sustainable innovation in any organization.

On the second myth, he has this to say when discussing the failure of companies to be open to alternative sources of innovation:

This points to the flaw in the innovation model used today in most organizations, which is build to generate ideas from one place, R&D. An idea that starts there will be taken seriously, evaluated through some methodical process, and then tested and, if it makes it through the right gates, ultimately commercialized. But ideas that start elsewhere have no path to follow. In fact, they typically have nothing but obstacles to content with. In this respect we are stuck in a 1920s-style division of labor that is woefully out-dated for today's demands.
Just as central R&D had to be developed and institutionalized over the past two hindered years, we now need a new function to cultivate ideas from throughout the organization.

Amen to that.

And just as companies need a new organizational set-up, so too do we need a new innovation policy for the 21st Century. Our policy focus on R&D and IT is not enough. Business is starting to get it. Can policy makers?

The BLS jobs data for June saw a slight increase in the unemployment rate -- up 0.1% to 9.5% -- and a larger than expected increase in the employment decline (467,000). As the New York Times and the Wall Street Journal noted, the number had been expected to be around 365,000.

Once again, however, I do see one of those famous (infamous?) "green shoots" in the data on involuntary underemployed (part time for economic reasons). That number has been relatively stable for the past four months at around 9 million underemployed. As I said last month, not great news, but possibly an indicator of a bottom.

In an earlier posting, I noted that the "cash-for-clunkers" program might result in an increase in uncertainty for car buyers - and a temporary decline in sales while people wait for the program to be implemented.

Well, the June car sales figures are in, and as a story in the Washington Post relates:

Economists say consumers are warily making purchases again. Yet some held off last month, as Congress rallied to pass the "cash for clunkers" bill, which gives consumers vouchers to purchase new, more fuel-efficient cars and trucks when they trade in older models. "It certainly put some people on the sidelines," said Mark LaNeve, GM North America vice president of sales, service and marketing.

Don't get me wrong - I think the program is a good idea. And Congress is to be praised for enacting the program quickly. An extended debate would likely have hurt sales even more.

But it does speak to the need to carefully look at effects of the transition periods while new programs are being implemented. Another case in point is the new credit card regulations -- where companies are raising rates before the new law can take effect (see story in Washington Post).

As I said earlier, this is all a great opportunity for the behavioral economists to make an important contribution to economic policymaking.

Over at Idea Connections they have a great interview with Tom Kelley - General Manager and co-founder of IDEO (with his brother David Kelley) . There is far too much in the interview for me to try to summarize. Trust me - you just have to read the whole thing.

However, there are a couple bits I will highlight. One has to do with the importance of "being there." At lot was written years ago about how modern information and communications technology (ICT) would result in the "death of distance." IDEO uses a lot of collaborative technologies. They have operations spread across the globe. But this quote from Kelley is telling.:

We did an IDEO off-site recently where we had presentations from every office in the firm and, for the first time, we made extensive use of video conferencing. It's getting better, but even so we still believe that whenever possible at the beginning of a project, or at the time of the formation of a team, there still is no substitute for getting people together face-to-face. Even if only for the first week. The reason is friendships get made and bonds are formed when having dinner together after hours and during sidebar conversations about what people have in common - such as hobbies and other interests. In a videoconference participants are not likely going to be able to have those types of conversations.

. . .

The second bit is about the "abundance mentality."

The opposite of an abundance mentality is a scarcity mentality. If people have a scarcity mentality about their ideas, and we've all encountered people like this, they've usually got one favorite idea. They've been plugging at this one idea for the last decade, and are worried about not getting enough credit for it. They're defending their idea--even if it's weak they're defensive about it.
If you can have the opposite attitude - an abundance mentality - it goes a long way towards fueling a culture of innovation. With this mentality you are more likely to say, "I've got this idea, but you may take it and build on it." You and the other person go back and forth and when he or she says, "This part won't work", you are more likely to reply, "Okay, how can we make it work?" rather than, "No, I think it will". You are not defending your turf all the time.
In an abundance mentality, you are more generous with your ideas because you know you've got more. This allows you to blend and mix your ideas, and to get synergy. It's an important cultural value that contributes to innovation.

I think our current discussion about intellectual assets suffers from the scarcity mentality. This especially manifests itself in the focus on intellectual property -- which is based on a "its mine, you can't have it" argument. The standard idea is that unless you can prevent others from using this asset (which is by its very nature non-rival and non-excludible), there will be a serious free-rider problem which will distort the incentives to invest. Without investment, there will be no innovation.

Kelley's comments turn that concept on its head. Sharing and building on shared knowledge is the key to innovation. Without sharing, there is no innovation.

Obviously, the dynamic of innovation doesn't fall perfectly or exactly into either of these two arguments. Both sharing and protection to provide incentives are important. The trick - as is so often in live - is to get the balance right.

But first, everyone has to understand there is a balance to be reached -- something that I'm afraid is not always in evidence in discussions over IP.

. . .

The third bit is these snippets on the fusion of goods and services and the important of non-technological innovation. The first is this:

By the way, only about 30% of the innovations we do these days at IDEO are with products.

And then there is this point that I have been trying to make over and over and over again:

The iPod became the leading music player in the world because of the link between iPod hardware and iTunes. It became super easy to download music, and it's this design experience that's created billions of dollars of value for Apple.

. . .

As I said, a lot there.