May 2012 Archives

1Q 2012 GDP revised

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The "second estimate" of the 1st quarter GDP is out, and as I noted in my earlier posting on the preliminary estimate, the number has significantly changed. According to the latest data, U.S. GDP grew at an annual rate of only 1.9%, compared with BEA's advanced estimate of 2.2%. GDP growth in 4Q 2011 was 3%.

Part of the reason for the downward revision was larger estimate of the declines in federal, state and local government spending. Clearly government cuts in spending continue to be a drag on GDP growth.

The good news concerns spending on equipment and software. The preliminary estimate had it growing by only 1.7%; this advanced estimate has equipment and software spending growing by a more health 3.9%. That is still below the trend line for the last two years but much better than the huge declines in the early part of the Great Recession.

And, as I have noted before, the data has a basic problem in that it does not give us any guidance on investment in intangibles other than software. So we do not know whether companies have increased or decreased their investments in important areas such as human and organizational capital.

Note: these are still estimates subject to potentially large revisions. The next revision will be released on June 28.


Innovation and non-R&D

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In an earlier posting , I referred to the Commission of Experts for Research and Innovation of the German Federal Government. In their 2011 report, they make an important point about innovation and R&D:

Non-insignificant numbers of innovating companies in Germany do not rely on research and development in the conventional sense. It can be useful to provide support for such companies in cases in which the support enhances use of existing knowledge, and in which it enables innovative companies without R&D to carry out research on an ongoing basis.
This finding tracks the U.S. experience as well. According to data from the National Science Foundation, only about 3% of the 1.5 million for-profit companies surveyed conducted any R&D (see "NSF Releases New Statistics on Business Innovation" and "Business Use of Intellectual Property Protection Documented in NSF Survey" and an earlier posting).

Case in point is an earlier posting where I described the re-cladding the National Gallery's East Building. To do the job, the construction company had to invent new components for anchoring the marble slabs. The technique and components were developed by engineers and perfected in a special training facility. Yet, I'm not sure that the construction company would report on a survey that it was doing R&D.

The construction example is what the UK's NESTA has called "Hidden Innovation." NESTA has identified four types of hidden innovation:
  Type I: Hidden innovation based on science and technology but excluded from traditional indicators for methodological reasons.
  Type II: Hidden innovation in nonscientific and technological forms such as new forms of organization and process.
  Type III: Hidden innovation from the novel combination of existing technologies and processes.
  Type IV: Hidden innovation that takes place 'under the radar' of many surveys - locally-developed, small-scale, incremental innovation.

There is another form of innovation (and "R&D" investment) that does not get picked up in the standard R&D measures. A couple of articles in the MIT Sloan Management Review on "The User Innovation Revolution" (The Age of the Consumer-Innovator by Eric von Hippel, Susumu Ogawa and Jeroen P.J. de Jong and an Interview with Eric Von Hippel) revealed an astounding statistic:

Recent research by Eric Von Hippel shows that spending on consumer innovation (creating and/or modifying consumer products) in the US is about $20 billion -- which is about 1/3 of the total level of company spending on consumer product R&D.
In the UK it is about $3.6 billion or almost 1.5x total company spending on consumer product R&D.
In Japan it is only $5.8 billion or 13%.

All of this leads to the same conclusion as the German Commission of Experts for Research and Innovation: we need to rethink how we view "R&D" and "innovation." In a our working paper Rethinking Innovation Policy (and earlier posting), we noted that "Innovation policy needs to catch up to the innovation process." Broadening our thinking from "R&D" to "knowledge creation and utilization" might be a good starting point. Now, how do we, as the German's suggest craft policies to match that broader view?




Select Tweets 5/21/12-5/27/12

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Select tweet and re-tweets from the past week:


Is Ikea the anti-Circuit City?

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In numerious previous postings, I have held up the now-bankrupt Circuit City electronics retail chain as the example of how not to foster your intangible assets. So here is an analysis from Strategy+Business about a retail chain that seems to be doing it right: "How Ikea Reassembled Its Growth Strategy" [registration required].

Ikea has built its business around low prices and leveraged its customer loyalty into a strong brand. Ikea's founder Ingvar Kamprad had a reputation as a vigorous cost cutter. But it is not just about cutting cost, as Circuit City found out too late. Ian Worling of Ikea explained how the company coped with the recent economic downturn:

We didn't focus on cutting costs, because that's the easiest thing to do in retail. You just lay people off, and cut back some of your capital expenditure, and it reduces your variable costs. But it also weakens you. Instead, we decided to make structural changes -- to rethink our practices.
. . .
We did not cut back on our investment in retail stores. We own all of our buildings and land, and our stores are custom built and designed for efficiency and sales potential. We want people to feel at home in our stores, which is why we include the restaurants and child-care facilities. We decided to keep our investment, not just in new stores, but in extending and expanding our existing stores. We think it's just as important to improve the way we serve the customers we have today as it is to take on new customers
Note that there are two important intangibles at work here: customer relations (the "customer experience") and the technical know-how to design the store for efficiency and sales potential.

Investing in stores was one key to Ikea's strategy. Increasing volume and better managing the supply chain were also important. But it was also the workforce:

The fourth area involved empowering our co-workers. We try to keep the center of the company relatively lean, and not make too many decisions centrally that would be better made in stores or factories close to customers and suppliers. Therefore, we must have a strong group of co-workers who can make the right decisions to support our strategies.
. . .
Our biggest advantage was Ikea's culture and value. Culture is extremely important at Ikea, even more so than at other companies. We work hard to ensure that as new people come in, they understand who we are and what we're trying to do. The people who work here genuinely want to be here and share Ikea's core values of cost consciousness and humility. I suppose that we must do a lot of things reasonably well, but we never talk about that. We always talk about where we've disappointed people and how we can do better. When we have a particularly good triumph, you'll hear someone say: "Okay, we'll take one minute now for satisfaction, and then move on."

In summary, the key's to Ikea's success has been investing in its intangible assets: relations with customers, deep knowledge of store design/functionality, and its workforce. That makes it the anti-Circuit City in my mind.


Intangible assets work as loan collateral

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I have been arguing for a number of years that intangible assets can be valuable in securing a loan. In a number of reports (and posting on this blog), we have discussed examples of intangibles being used as loan collateral (for example, see Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance and Intangible Asset Monetization: The Promise and the Reality). In fact, I like to point out that this has been going on for a long time. The first trade secrets case in the United States involved the debt on a bond secured in part by a secret chocolate-making process in 1837. In 1884, Ara Shipman loaned Lewis Waterman $5,000 to start a pen-manufacturing business, secured by Waterman's patent.

One of the lesser know recent example was the use by Ford of its iconic blue oval logo to backstop a loan pacakage. Now come word, via a New York Times story, that Ford has met the terms of the 2006 loan and reclaimed the logo. No word in the story about what the logo was valued at.

Such deals, however, continue to be closer to "one-off" activities. Intangibles should be part of the routine loan evaluation. One important step would be developing sound, industry-wide, underwriting standards for intangible-backed debt. A step in that direction would be for the Treasury Department, the Small Business Administration (SBA) and other entities that administer government loans and loan guarantees to work with commercial lenders to develop standards for using intangible assets as collateral. Creating a common intangible-backed loan underwriting standard would go a long way to routinizing the use of intangibles.

OECD Skills Strategy

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Yesterday, the OECD released its new report on its Skills Strategy: Better Skills, Better Jobs, Better Lives: A Strategic Approach to Skills Policies.

Better Skills, Better Jobs, Better Lives | OECD Free preview | Powered by Keepeek Digital Asset Management Solution


The strategy is build around three parts:
  I. Develop skills
  II. Activate skills
  III. Putting skills to work

What especially like about the strategy is that it goes well beyond a focus on the individual's skill set. Yes, there is a discussion of education and training activities -- including on the need for both "hard" and "soft" skills and the importance of hands-on workplace training -- which goes beyond much of the narrow focus in the U.S. of STEM education and manufacturing-based skills. But what sets this report apart is its treatment of the organizational responsibility for utilizing the skills of the workforce. Some of the recommendations include:
  • Create financial incentives that make work pay
  • Discourage early retirement
  • Facilitate mobility
  • Help local economies move up the value chain
  • Foster entrepreneurship, and
  • Help employers to make better use of their employees' skills

That last point is of special interest to me. Too often we hear about companies who claim that "workers are our most important asset" and then act as if workers are just another cost. I have long argued that we need policies to help foster the development of high performance work organizations that promote the utilization of worker's skills and knowledge. In that regard, the report specifically highlights the efforts of the Nordic countries in developing programs and policies to promote workplace change and innovation. [BTW - the Skills Strategy also directly references the OECD Innovation Strategy (see earlier posting)].

Let us hope that policy makers in the U.S. will take a hard look at the OECD report and embrace its broader message. One of America's greatest competitive advantages is the skill and knowledge base of its workforce. We need to maintain and improve that intangible asset. Doing so will require looking beyond just the individual to the organizational utilization of those skills as well.


Select Tweets 5/14/12-5/20/12

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Select tweet and re-tweets from the past week:


Deep knowledge and manufacturing

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Earlier this week I was at an Aspen Institute event on "Manufacturing, Innovation & Workforce Training - What Works in Germany and the US". In addition to all of the interesting comparisons, there was one statement that stood out. Dietmar Harhoff, Chairman of the Commission of Experts for Research and Innovation of the German Federal Government noted that what German manufacturing were selling was their "deep knowledge." Patent policy doesn't apply to this level of knowledge -- thus a policy model for manufacturing may be different from what is needed in patent intensive sectors. Yesterday, at a US Chamber/NAM meeting on manufacturing, a similar point was made by Jamie Regg from GE Aviation. He noted that one of the factors they look at very carefully in picking a supplier is the skill and expertise (knowledge-base) of that company. [In an earlier posting I discussed how GE is an example of a company that is seeking to develop deep knowledge.]

Prof. Harhoff's remark reinforces what I have said previously about German manufacturing: They use their knowledge and intangible capital for competitive success. And it is not just the knowledge of their workforce. It is relational capital as well. As the Economist noted in an article last year:

Mittelstand companies have long relied on the enviable network they already have at home. German universities work hand in glove with researchers at local firms. Suppliers cluster round big manufacturers. Owner-managers rub shoulders with workers.

Thus, I was pleased to hear an emphasis on supply chain relation and other forms of intangible capital at both of this week's manufacturing conferences [although they didn't phrase it that way]. Now we need to translate that attention into policy.

The cost of losing human capital

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In his column this morning, David Wessel takes on a key economic question: "Job Market's Vanishing Act: Seeking the Missing Five Million Workers". The issue is the factg taht population has grown but the labor force (those employed or seeking employment) has not. There are a number of reasons why: more retirees, young people delaying entering the workforce, and people waiting for better times before looking. All of these play a factor, but Wessel gets quickly to the heart of the matter:

But the falling participation rate could signal a more worrisome dynamic: More jobless and disheartened workers turning to disability benefits or reluctant retirement, or otherwise leaving the workforce for good.

Not only is this a waste of human potential, but it diminishes the rate at which the U.S. economy can safely grow. It also creates a growing cadre of Americans who will need the support of the working population and makes the government budget deficit worse because there will be fewer workers to pay taxes. There's no precise way to measure the size of this contingent. Official estimates of "discouraged workers" understate the problem; they count only those who say they want to work and have looked for a job in the past 12 months.

One thing is clear: The longer people remain out of work, the more risk they will fall out of the workforce altogether. Getting them back to work--or keeping them tied to the job market through training or volunteering or collecting unemployment compensation--would have long-lasting benefits.

Amen! Which is why I support a work-sharing arrangement - especially one ties to a skills improvement/training component. As I explained in an earlier posting, rather than reduce their hours, we should use those hours for training. It can be on-the-job training or classroom training.

This would have the dual effect: It would increase our human capital -- a major input to the innovation ecosystem. And it would immediately increase consumer demand as companies would use the funds to pay workers to take classes (thereby creating more employments slots for others to fill the working hours of those in the classes).

As I have said over and over again, rather than pay workers to stand in unemployment lines or stay at home, let's pay them to sit in a classroom.

Thoughts on the JOBS Act and policy experimentation

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The recently passed JOBS Act continues to draw commentary. Below is a sampling of some of the various views (some old, some new). Frankly, I remain skeptical of both the praise and dispraise. As I noted before, JOBS Act should be viewed as a regulatory experiment. The SEC is in process of writing the guidelines to implement that Act. I am sure that all sides of the debate will be weighing in on these regulations. As that process moves forward, there is an opportunity for the entrepreneurial community to step up and change the way Washington (and government in general) works. Think of the Act as a start-up. Let's create some new mechanisms for measuring success and for learning from (and correcting the problems created by) any failures. That, in and of itself, would be a major accomplishment.

HBR Blog: two sides:
The Road to Crowdfunding Hell
Don't Abandon Crowdfunding -- Manage It

NY Times Deal Professor: From Congress, a Law Befitting a Sausage Factory.

Fast Company: The JOBS Act: Misconceptions And Motives Behind Crowdfunding For Startups

ComputerWorld: Tech chief says JOBS Act 'renews faith' in Washington

Wall Street Journal: Investors' Prying Eyes Blinded by New Law

TIME: The JOBS Act Signing: A Giant Step for Entrepreneurship in America


Select Tweets 5/7/12-5/13/12

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Insights on intangibles in small manufacturing

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Yesterday and today, the NY Times blog "You're the Boss" blog had pieces by a small furniture manufacturer (Paul Downs of Paul Downs Cabinetmakers) about his look at German manufacturing ("I Have Seen the Future of Manufacturing" Part 1 and Part 2). What I found especially interesting were the comments that reveled the importance of intangible assets in manufacturing (a point we made in an Athena Alliance Policy Brief--Intellectual Capital and Revitalizing Manufacturing).

In Part 1 of the piece, there was this setup comment on the linkage between design and production:

I have done wholesaling in the past. It worked best when we were allowed to design the work, which ensured that we could produce it efficiently.

Then, there was this about the importance of localized knowledge:

We were asked to design variations on some of their existing products that would work better in the American market. In particular, they were finding that their existing table-base designs didn't work well with American wiring. The semirandom placement of floor boxes that is so typical of American construction often missed the small openings in the bottom of their bases. Apparently, German electricians are better at putting the plugs where the plans specify. That's a problem we deal with daily, and it didn't take long for me to design a new base style to go with one of the company's existing top designs.

So in Part 2 he goes off to visit the German factory as part of this new project. There he comments on the vacuum lifters on the shop floor, "These are special machines that allow a single person to take a heavy panel off a cart and load it into a machine." (A video is included in the article).

The lifters made it possible for a single person to load and unload machines, and they probably cut down on injuries as well. The profusion of these lifters was emblematic of the way the plant was laid out in general. Wherever possible, tasks were arranged in such a way that machines do as much work as possible. Not that this was an assembly line -- the things that couldn't be done by machine required hand skills or human judgment. The workers weren't drones or button-pushers. They handled complex tasks that take years to master.
Three intangibles here: "In each area, skilled workers were surrounded by fantastic machinery in a spotless, logically arranged factory."

But he adds a very important caveat on the new machinery, specifically the lifters -- that they might be useful only in limited circumstances. Even more interesting was this insight:

It's also worth noting that machines don't ever think of new ways to do the work. They provide no opportunity for fruitful interaction between the shop floor and the engineers -- information flows only one way in an automated process. And they change the atmosphere within the company. They don't help each other and create a fellowship of workers mastering difficult tasks. They don't say hello, or ask about the wife and kids, or bring in cookies, or tell a joke, or go back to their town and coach a Little League team. One of the things I like best about owning a factory is the atmosphere created by a group of skilled, congenial people doing great work together. The machines we do have definitely help us make this happen, but there may be a tipping point where they start to suck the life out of the shop floor.

Here is a key insight that get often overlooked -- especially in manufacturing that has been driven by the Taylorist/Fordist model for a century. The knowledge of the front line workforce and the flow of information among the workers and engineers is critical.

So to recap, the articles highlight a number of intangible assets:
  • Link between design and production
  • Localized knowledge of customer needs
  • Skilled workers
  • Advanced machinery (and the knowledge embedded therein)
  • Logically arranged factory
  • Information flows among all levels of the workforce

Many kudos to Mr. Downs for both understanding the role of intangibles (although he probably doesn't use that term) and for illustrating them for the rest of us to better understand.

March trade in intangibles

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This morning's release of the March trade data from BEA was not good news. The deficit rose sharply by $6.4 billion to $51.8 billion. Exports increased by $5.3 billion in March but imports surged by $11.7 billion. The deficits in both petroleum and non-petroleum goods increased. But while some of the increase in the deficit is due to higher oil prices (and imports), the deficit grew much more in the non-petroleum goods. Both capital goods and consumer goods saw significant jumps in imports and auto related imports reached a record high.

In some good news, the trade surplus in intangibles continued to grow in March, increasing by $173 million to $14.119 billion. Imports and exports increased for both royalty payments and business services, with exports rising faster than import in both categories. As I noted last month, the trade surplus in business services had declined in the Nov-Jan time period. So, the continued increase in the business services surplus is especially good news. However, we must continue to remember that the intangibles surplus is a fraction of the goods deficit. The size of the goods deficit is 4.8X the size of the intangibles surplus. The increase in the goods deficit was almost 60X the increase in the intangibles surplus. If we are to bring trade back to a more balanced position, we cannot rely solely on trade in intangibles. We must use our advantage in intangibles to the strengthen the competitive position of our goods manufacturers and thereby both increase exports and reduce imports.

Symptomatic of the challenge we face in knowledge (intangibles) intensive goods is that fact that the deficit in Advanced Technology Products also shot up in March to $7.2 billion. The decline was due almost exclusively to a $3.8 billion surge in information and communications technology (ICT) imports -- which swamped increases in aerospace and ICT exports. 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.

Intangibles trade-Mar12.gif

Intangibles and goods-Mar12.gif

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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.



Talk on reinventing the research university

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Interesting talk by Jim Duderstadt, former president of the University of Michigan, at the April meeting of the Coalition for Networked Information (CNI). [Disclaimer: UM is my Alma Mater - both undergraduate and graduate.] [And spoiler alert: it gets really interesting about half way through at minute 34 when he switches to the speculative longer term and larger view.]




Summarizing a complete innovation strategy

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Earlier this year, OECD Secretary-General Angel Gurría gave a speech to the China Development Forum on "Promoting Technological Innovation for New Sources of Growth." That talk essentially summarized the OECD's Innovation Strategy (see also earlier posting). What caught my eye was the following description of an expansive view of innovation:

The Strategy goes beyond R&D to describe the broader context in which innovation occurs. Let me briefly share with you some of its insights:

First, innovation is about extracting value from existing, traditional or emerging technologies to develop new services and business models. For example, the emergence of information and communications technologies (ICT) - like cloud computing - holds the promise of productivity gains. They help companies avoid heavy, upfront investments in IT infrastructure and staff in exchange for a sustainable, pay-as-you-go model, which can enable them to grow faster.

Second, knowledge assets - research, design, marketing, networks, software, data analytics - will increasingly drive growth and competitiveness. Today, companies often invest more in software alone than in machinery and equipment. According to sources in the car industry, these knowledge assets make up the majority of development costs for a new Volvo truck.

Other "intangible" elements, like design, branding and marketing, can also account for a huge share of a product's value-added. These are some of the reasons why the world buys Apple phones, Ikea furniture or Nespresso coffee. Smart companies know that, when they invest in intangibles, they can better capture value from global trade.

Third, innovation is a key pillar of green growth. It helps to decouple growth from natural capital depletion. It addresses knowledge gaps and fosters new technologies that can help the transition towards greener growth. It is absolutely central in enabling green and growth to go hand-in-hand.

Last, but not least, innovation depends on people: on their knowledge, creativity and skills. Your recently-launched human resources strategy acknowledges that a better educated workforce is critical to move up the global value chain, and to ensure a more inclusive economic and social progress for China's citizens.

I think that covers a number of key points: innovation is more that new tech and intangible play a big role. I know the Chinese audience was paying attention to Gurría's comments. I hope American policymakers were listening as well.

Disney benefits from Marvel

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Speaking of intangible assets, here is another story on company's assets -- this case, Disney and Marvel comics from the IP Value blog ("Disney's release of Marvel's The Avengers will begin an informative case study on IP as a value-driver").

With today's [Friday May 4th] U.S. introduction of the film, Marvel's The Avengers, we will see the Disney hydra-headed marketing machine in action.
Tying the Marvel name to the movie title is working. Almost all of the movie theaters and web move-time-listings services are adding the Marvel name to the title of the movie;
Licensees are lining up, from the logical (Hasbro,) to the not-so-likely, Wyndham and Harley Davidson;
Disney expects licensing revenues to exceed box-office revenues (a look into ktMINE, the license and royalty rate database, reveals 9 pre-Disney Marvel licensing agreements with an average royalty rate of a hefty 8.3% of net sales);
International sales are expected to set records.
Disney paid $4.2 billion for Marvel. We will see how quickly and much that investment pays off. Already in its weekend debut, the film broke box office records and is predicted to gross over $1 billion in global box office sales. Disney clearly recognized that Marvel was an addition to its asset base that could be used to could be used to leverage its existing assets -- and be leveraged by them.


Facebook's intangible capital

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An interesting piece in the Financial Times (Lex in depth: Facebook) that, as its title implies, takes a close look at the upcoming Facebook IPO. The article raises a number of questions about the possible valuation of the company, based on questions about the business model. What it really raises are questions on Facebook's intangible capital:

Vulnerable strategic capital - in contrast to Microsoft and Google:

It is hard to quit using Microsoft's software or Google's search engine, not just because of network effects but also because almost everyone needs to do things those tools make possible. Competitors are more expensive or not as good. Facebook simply is not essential to life or work in the same way.

Vulnerable relational capital - based on the balancing act between customer wants and advertisers needs:

Advertisers could end up offering stuff people actually want. And privacy protection features will be put in place. But the issue is whether what Facebook does to increase the value of the data it collects makes users enjoy Facebook less and use it less. Users might start to think they are the product not the customer. Not a fun feeling.
The contrast with Google is striking. If Lex types "HP 12C calculator" into Google, it is setting itself up to see a certain kind of ad alongside search results. Indeed, users often have commercial intentions when they search. This is absolutely not the case on Facebook. And if the company cannot target ads without turning off users, revenue growth will slow, and soon.

In other words, Google's strategic capital is grounded in the irreplaceable function of its product (i.e. the need for a search engine). As long as its product continues to be the best in meeting that function, it has strong strategic capital. Google's relational capital is based on the complementarity of user needs (i.e. customers and advertisers are using the product for similar purposes). Facebook has neither of these strengths.


Select Tweets 4/30/12-5/6/12

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April employment

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The BLS employment data for April is out and many will see it as a disappointment. Employment increased by 115,000 jobs while, once again, the unemployment rate dropped by 0.1% to 8.1%. Economists had expected up to 168,000 new jobs (with some low predictions of 125,000 to 89,000). April's job growth came closer to that figure if you count just private sector jobs, which grew by 130,000. But continued government jobs cuts -- a lose of 15,000 jobs in April -- drove the total down.

In some good news, the jobs numbers for February and March were revised upwards.

Unfortunately, the number of involuntary underemployed increased, both the number of workers who could only find part time work and the number of individuals working part time because of slack work or unfavorable business conditions. The biggest increase was with those who could only find part time work. This may be a worrisome indicator that companies continue to be reluctant to hire full time workers.

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Anti-servitization

I've write a lot about the fusion of manufacturing and services. In the most recent, I explicitly mention the concept of "servitization" -- where a company sells as product as part of a service. In many cases, this takes the form of a after-sales service contract. But here is the counter-case of a successful strategy that specifically eschews the servitization model, from a recent Strategy+Business article "China's Mid-Market Innovators":

China's rapid expansion of buildings and infrastructure has involved widespread subcontracting, with work on all sizable projects shared among a chain of hundreds or even thousands of small businesses. Most of these Chinese construction subcontractors think in the short term. They want equipment that is good enough to do the immediate job, and that will then be written off after five years or less. They are not interested in expensive, feature-rich products with a long life span supported by service contracts.
This type of segment is hard to penetrate for non-Chinese heavy equipment manufacturers, such as Caterpillar (U.S.), Liebherr (Germany), and Komatsu (Japan). These manufacturers follow well-established business models with buyers who, supported by long-term financing, think on a 10- to 15-year time span. Equipment must both last a long time and have the service needed to keep it operating with as few interruptions as possible.
Meanwhile, upstart construction equipment manufacturers have emerged to serve China's fragmented construction industry. They sell low-cost machines that typically do not get expensive servicing, but are replaced when they wear out. The manufacturers focus on only a small range of related products, and keep their prices ultracompetitive by restricting investment only to functions and features that are strictly needed. Their versions of multinational products might not pass muster in Canada or Denmark, but they are considered superior in China.
Having said that however, the article hints that this "throw-away" strategy may be just an interim phase as they move into other markets:
Already, some of these mid-market construction equipment companies are becoming global powerhouses. For example, Sany Heavy Industry Company -- founded in 1994 in Changsha, the capital city of Hunan province -- became the world's largest concrete pump manufacturer in 2009; its total revenues in 2010 approached $8 billion. In 2012, Sany announced that it would acquire the second-largest producer, the German company Putzmeister, and it has built plants in the U.S., Brazil, India, and Germany, as well as a major R&D center near Cologne. Other construction equipment manufacturers expanding outside China include ZoomLion (also based in Changsha), XCMG (a state-owned company headquartered in Xuzhou), and Shandong Heavy Industry Group. They all got their start by selling to China's fragmented construction industry.
Even if the companies eventually abandon the throw-away strategy, its success in China raises an interesting point. Will there always be a market for pure manufactured goods, not tied to services? I think there will be. After all, many people are happy to just buy a fire alarm/smoke detector without signing up for a security monitoring service. We need to keep in mind that the I-Cubed Economy runs on multiple strategic models.

What is common, however, is the role of intangibles. Even pure manufacturing as an output requires intangibles as an input. The reason why the Chinese equipment company strategy works is because they have a clear understanding of exactly what features their customers want -- and have the design and engineering capabilities to provide for that want. It may not be a high value added product compared to some of their competitors. But it is an appropriate value added product. And getting to that point of being appropriate takes a lot of knowledge (intangibles) inputs.

In yesterday's posting, I critiqued Imagine: How Creativity Works by Jonah Lehrer. One of my favorite parts of the book is a quote that comes not from the section of creativity and group interaction (as discussed in yesterday's posting). It comes from the first part of the book in the discussion of individual brain activity. The quote is from neurologist Marcus Raichle about his studies of brain activity when the subjects were not engaged in active tasks (i.e. when they are daydreaming):

"When you don't use a muscle, that muscle isn't doing much," Raichle says. "But when your brain is supposedly doing nothing, it's really doing a tremendous amount."
The same can be said for the intangible economy. There is a lot going on even when it looks like nothing is happening.

This below the surface activity of intangibles is what makes understanding and measuring the intangible economy so hard. A successful economic outcome in the industrial era was the production of X widgets. That was later refined to X widgets of a high quality standard of Y. Like a muscle, the economy was either producing or resting. But in the intangible economy, like in the brain, things are happening that don't automatically translate into an immediately visible activity. Relationships are forged or modified. Structural capital is created. Skills and knowledge are created -- including tacit knowledge being shared. All of which will ultimately contribute to economic success.

Lehrer's book tells the story of how psychologists and neurologists are using new tools and techniques to understand the functioning of creativity and the hidden pathways of the brain. Just as the neurologist seek to connect certain brain activity to certain outcomes, we need to connect the functioning of intangible assets to economic results. To do so, we need to develop new tools and techniques (including both macro and micro economic statistics) to better look at the not-so-visible world of the intangible economy.

    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


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