Nothing endures but change

It is a cliché to state that globalization has been a tremendous force of change in the last decades. Never before have economies, markets and supply chains in different parts of the world been so entwined. This has led to unprecedented growth of the world economy. It allowed China to lift around 500M people out of poverty since the country opened up in the late seventies. It turned India from a socialist, autarkic backwater into an economic power and helped another 122(!) countries to grow more than 4% in 2007.

But there is a flip side: the resulting interdependence has brought complexity and instability. The butterfly effect applies: “small variations of the initial condition of a dynamical system may produce large variations in the long term behavior of the system”.

When the financial markets collapsed the repercussions were felt around the globe and as a consequence most western countries will experience a shrinking economy in 2009. The causes are manifold. There were the financial managers, whose short term oriented decisions were guided by multi-million bonuses. Then the compulsive consumers on a spending spree, high on cheap credit, supported by the huge trade deficits with China. Lax regulation, opacity and complexity of markets also played a role. All was well until the bubble burst and the walls came crumbling down. For a brief period Europe was basking in schadenfreude and then quickly governments had to step in to rescue their local banks. Iceland’s financial products -too good to be true- turned out to be that way. Within a couple of weeks this pristine country’s stock exchange lost 90% of its value.

I guess by now everyone realizes that financial markets operate 24 hours a day, around the globe. They have become more dynamic and complex and evolve faster than most people can grasp. Nassim Taleb, who writes about what to do with a world we don’t understand in the Black Swan (published before the crash): “Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse.” Some of the world’s leading financial gurus, including Alan Greenspan and Warren Buffett, have openly admitted that they failed to see what was happening. Buffett states in his letter to shareholders: “I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.” On the theoretical front, Nobel Prize winner Paul Krugman puts it as follows: “much of the past 30 years of macroeconomics was spectacularly useless at best, and positively harmful at worst.”

Other industries may not show the same dynamics as the Financial Services, but acceleration of change is happening in IT, healthcare, automotive and media.

The IT industry has always been prone to change. What happened to Wordstar, Visicalc, Wang and DEC, just to name a few of the hundreds of brands that disappeared? Given the steady onslaught of open source and cloud services, where will the companies go that sell expensive software with outrageous maintenance contracts and the need for armies of specialists to install and keep it running? Successful product companies like Apple have focused on design and online services. They don’t own any factories. Google has built their business model around getting huge numbers of users and mining their data on the largest imaginable scale. Those providing software services can no longer depend on their proprietary knowledge, as there is currently more and better technology information in the public domain than in any of these companies. Those without a substantial workforce in emerging economies like India, China, Philippines or Argentina will soon find themselves out of work.

Oil prices have been fluctuating wildly. Last summer in a matter of weeks the price at the pump doubled. At the same time the discussion on global warming moved to the foreground. Gas guzzlers like the Hummer suddenly lost their coolness. Although years in the making, the decline of the Detroit Big Three became clear to all. Ford managed to fight its way back to profitability but Chrysler and GM had to be bailed out by the government. They didn’t act quickly and resolutely enough. Western car markets have shrunk by almost 20%. Meanwhile the car markets in India and China were alive and well. Tata launched a revolutionary $2,500 car that competes not only with low end cars but also motor bikes. Meanwhile countries like Australia and Israel are working on an electric car infrastructure. This is an industry in transformation.

The media industry is struggling. The sales of CDs is in terminal decline. Though paid-for downloads are increasing steadily, more and more kids are listening to personalized Internet radio and are no longer interested in owning songs. In the last year hundreds of newspapers went bankrupt, losing the battle with their online competition. Open source models are appearing to compete with traditional publishing and Google is putting millions of books online. Youtube is replacing television as the most important entertainment medium. Time to rethink business models in this industry.

Most companies react to change by reorganizations or mergers and acquisitions. It is harder to have the companies’ business models and processes adapt to new customer needs, competition or regulation. One of the reasons is that the key processes are supported by software applications and a technology infrastructure, suffering from change resistance. Business models also have the tendency to assume a linear world, rather than one in which sudden events and disruptions become more rule than exception.

The fashion industry always had to deal with fickle consumer tastes that could change on a dime. For most apparel companies it is hit or miss. In contrast, the Spanish company Zara has built their business model around customer insight and agility. According to the Harvard Business Review: “Zara has developed a superresponsive supply chain. The company can design, produce, and deliver a new garment and put it on display in its stores worldwide in a mere 15 days. Such a pace is unheard-of in the fashion business, where designers typically spend months planning for the next season.” Zara operates 1,500 stores in 71 countries. They aim to be as close as possible to the customer. Every day they collect sales data from all of their stores. These data are analyzed and related to inventories and other operational data. Slow moving inventory in one store can be moved to a fast moving store. They use a team-based approach in which designers and product managers work closely together to continually evolve their clothing lines, based on the information they receive about sales as well as input from store managers. Most products have very short life cycles. This gives their clothes a level of exclusivity and forces the consumer to buy today, because it may be gone tomorrow. Accurate forecasting is not required: they adjust as they go along. The company has a vertically integrated supply chain, keeping half of the work in-house, and a network of partners and subcontractors. Its supply chain is built around speed of operation. The CEO of Zara: “you need to have five fingers touching the factory and five touching the customer.”

Like Zara, who captures customer information in every store every day, companies that have a strong engagement with their customers tend to do better. They react faster and have more influence on customer needs. Many consumer goods and apparel companies who sell their products through distributors have to make assumptions about their client needs, as they lack a direct channel and timely data. But current technology allows these companies to get in touch with their clients directly, without the need to invest in a large retail network. They should set up highly interactive portals to promote information exchange between their stakeholders. Clients in different markets are prompted to share experiences. Forums on product customization or service improvement allow insight in customer needs. Events, both online and offline, can be organized to rally the fan base. All this interaction may be analyzed to glean information on current and future customer needs. While this will not generate the next breakthrough product, it gives input on product improvement and generally strengthens the ties between supplier and consumer. It will give the company an early warning system for changing behavior.

Successful companies constantly monitor the environment and assess the potential impact of changes on the company’s business. One of the largest Investment Banks has created online dependency maps of the companies they invested in, similar to the ones you can find at News Dots. It visualizes the most recent topics in the news as a giant network, highlighting “hot areas”, that may require action. So when GM got in the news about their issues it immediately showed which companies had substantial subcontracting relationships. New technologies that search large quantities of data and find patterns and associations, can highlight early warning for impending change. Obviously dealing the right way with that change is a matter of leadership and organizational agility. More on that topic in my next blog.