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AlterNet: Amid a Painful Economic Meltdown, Will Obama Be Bold Enough to Win?

Amid a Painful Economic Meltdown, Will Obama Be Bold Enough to Win?
By Joshua Holland, AlterNet
Posted on September 13, 2008, Printed on September 13, 2008
http://www.alternet.org/story/98495/

Voters may not follow every twist and turn of the election -- they may
not brush up on each of the candidates' policy proposals -- but they
know when they're hurting economically, and almost unprecedented numbers now say the country is on "the wrong track."

The Bush years have been bad. In fact, as economist Jared Bernstein noted,
when one compares the economic peak of the past cycle, in 2000, with
the high point of the business cycle that just ended in 2007,
households in the middle actually lost ground, earning $300, adjusted
for inflation, less than they did in 2000. The worst this group
had done in previous business cycles occurred during the 1970s, when
median income "only" increased by about $2,000. In comparison, the
income for a family in the middle rose by almost four grand during the
1990s.

It's the first time since they started keeping records of
family income after World War II that the economy has gone into a
recession before the middle class, those iconic "American families"
that dominate our political discourse, had rebounded fully from the
previous downturn. That represents an immensely painful double-dip for
those in the middle and at the bottom -- only those in the top fifth of
the economic ladder have seen any gains whatsoever
since the last recession (officially) ended in 2001. (The wages of the
bottom fifth fell by 6 percent, while those in the top 1 percent saw
their incomes rise by about 50 percent during what some conservative
pundits have called the "Bush Boom").

But
it's important to understand that Bushenomics only represents an
extreme iteration of the ideology that's prevailed since the 1973
energy crisis and the dawn of the "Reagan Revolution." The pain that
working America feels today is the culmination of a far longer trend.
An analysis by economists Thomas Piketty and Emmanuel Saez offers
perhaps the most compelling indictment of neoliberal economics. They
sliced and diced the American economy, going back to the beginning of
the last century, and they found that between 1973 and 2003, despite
several periods of healthy growth, the average real income of all but
the top 10 percent of the economic ladder -- 9 out of 10 American families -- actually fell
by about 4 percent over those 30-plus years. Meanwhile, the incomes of
the top 10 percent of American households increased by around
two-thirds.

It's a unique moment in history, with the country
facing a deep, structural energy crisis, with a tattered reputation and
dwindling influence abroad and a sputtering economy at home. But in
moments of crisis, there is often opportunity. The public now appears
to be uniquely receptive to a bold progressive agenda, more so than at
any other point in recent memory.

The question that will be
answered over the coming weeks is how aggressive the Obama campaign
will be in articulating such an agenda -- whether a campaign that has
moved to a steady but generic drumbeat of "change" can widen the
discussion from the failures of the Bush administration to the
disastrous consequences of the larger conservative project over the
past 30 years and offer the voters some concrete proposals to restore
Americans' tattered sense of economic security.

What Kind of "Change" Are We Talking About?

The
neoliberal project -- the idea that business, when largely unregulated,
has some sort of magical virtue that renders the idea of a healthy
social safety net a quaint but antiquated notion -- has failed, and
done so spectacularly over a long period of time.

Noam Chomsky
has said (and I'm paraphrasing) that for the adherents of
neoliberalism, the answer to each and every one of its failures is more
neoliberalism, and John McCain epitomizes that approach. His economic
prescriptions are as simple as they are familiar: Cut taxes for top
earners, privatize as many chunks of the public sphere as possible, and
let "the market" deal with whatever dislocations result. To keep the
masses from becoming unruly, throw some crumbs their way -- job
retraining, trade "adjustment assistance," maybe a grudging increase in
the minimum wage (actually, McCain has voted 19 times against raising the minimum).

McCain's
problem is that the American people aren't so ideologically rigid. Over
the past year or two, an extensive body of public opinion research has
shown that Americans -- including those crucial white working-class
voters who have been largely loyal to GOP candidates since their
benevolent Saint Reagan told them that government was the problem --
are hungry for real, substantive change in our nation's economic course.

That hunger runs deep. According to the American Dream Survey
-- a study of the non-managerial workers who make up about 80 percent
of the workforce -- released last month, Barack Obama, who's already
polling well among that group, "can capture even greater support
amongst working voters, including 'Reagan Democrats,' as well as the
emerging Obama Republicans with a program of economic populism."

The
study found that an overwhelming majority of working people -- about 8
in 10 -- think it's becoming harder and harder to attain the "American
Dream" -- defined as "jobs with pay that can support a family, access
to quality health care, chances for your children to succeed, and a
secure and dignified retirement." (Respondents were far more
pessimistic this year than they were last year, when I wrote about the annual survey in some detail.)

What's
most striking about the results is the degree to which these
working-class voters -- the subject of so much discussion on the TV gab
shows during this election season -- explicitly reject the Reaganite
economic principles that have held so much sway over both parties over
the past three decades. They say, explicitly, that they want the
government to take an active roll in protecting their interests;
according to the study, "Working Americans believe government can help
(them) achieve the America Dream but has failed to do so over the past
8 years." Eight out of 10 respondents said the best way to restore the
American dream is for the government to "guarantee access to health
care for all Americans"; a similar number says that "government
(should) make sure employers keep their promises to employees,
including protecting their pensions and health care."

One of the
crucial takeaways from the survey is that so-called "Reagan Democrats"
-- a constituency that has been easily swayed by conservative messages
on social issues -- are up for grabs in this election. As the authors
note, "A shift in voting behavior among Reagan Democrats could signal a
transformation in U.S. politics and the end of the conservative era
that Ronald Reagan began."

Those attitudes were confirmed by a poll of "middle-class families"
released by the Drum Major Institute last month. It found broad support
for key policies that might rebuild the working class, even among
Republicans and even among those who say they plan to vote for the GOP
ticket in November:

Despite media depictions of
a sharp red and blue divide, the nation's middle class displays broad
consensus on a range of public policies aimed at easing their economic
squeeze: They support a universal national health insurance plan,
requiring employers to provide paid family and medical leave, making it
easier for employees to join labor unions and allowing bankruptcy
judges to change mortgage payments to keep homes out of foreclosure. A
majority of middle-class adults -- whether they are Democrats,
Republicans or independents and whether they are supporters of John
McCain or Barack Obama for president -- believe that these policies
represent good ideas for the country.

Looking at
these trends, veteran Democratic pollsters Stan Greenberg and Andrew
Baumann released a memo in August that concluded that voters today see
parallels with the 1930s, and they want bold proposals, reminiscent of
FDR's New Deal, to restore their sense of economic security. Greenberg
and Baumann noted that the depth of dissatisfaction with our current
economic course is almost unprecedented, and that the country is
undergoing fundamental and historic changes. The key finding was that
voters are unmoved by proposals that tinker around the edges of the
problems America faces today. "This belief that the country is
undergoing fundamental change," they argued, "combines with the depth
of pessimism voters currently feel about the direction of the nation to
create an opening for candidates who can offer major changes and a bold
new direction for the country. Just 35 percent of voters say we can
solve America's problems with minor changes, while nearly two-thirds
believe it will take 'major changes' to bring about solutions."

According
to their polling, bold economic proposals can compete head-to-head with
McCain's emphasis on his heroic resume, his full-throated defense of
American power and his promise of protection in what he frequently
calls a "dangerous world." Greenberg and Baumann found that voters see
a clear and direct connection between restoring the economic strength
of the country and its standing as a shining "city on the hill" -- a
leader of the "free world."

A remarkable 82
percent find truth (nearly half finding a great deal of truth) in the
idea that America's greatness is waning because of the decline in the
middle class and that a "dramatic change" in our economic policies is
required to reverse the situation. Moreover, 85 percent find truth (43
percent a great deal of truth) in the idea that the decline of the
middle class is "reducing our standing in the world (and) leaving our
way of life under assault."

Can Obama Deliver?

Obama's economic prescriptions are significantly more far-reaching, and more progressive, than those ultimately enacted during the Clinton administration.

He
supports most of the key policy proposals cooked up in Democratic
circles in recent years, including calls for a shift toward "fair
trade," support of the Employee Free Choice Act, a bill that would allow workers to join a union without fear of reprisal from their bosses, and the cornerstone the "green jobs" program that advocates say would create millions of new, well-paying jobs while weaning the United States off hydrocarbons.

It
would be wrong to dismiss those proposals as just so much centrist
tinkering -- they're not -- but it's also true that with very few
exceptions, progressive thinkers outside the orbit of the Democratic
Party have criticized them as coming up short, either because of their
fundamental design or due to insufficient funding (and, in some
instances, their vagueness).

But in a political climate in which
perception often outweighs policy, the question remains whether Obama,
who is a genuine mediator at heart and firmly believes in bringing all
sides of an issue to the table to work out a compromise, can articulate
the kind of new approach for which Americans hunger right now.

There
have been some positive signs -- signs that the campaign gets it -- in
recent weeks. During his nomination acceptance speech, Obama referred
to "that old, discredited Republican philosophy -- give more and more
to those with the most and hope that prosperity trickles down to
everyone else. In Washington, they call this the Ownership Society, but
what it really means is: You're on your own. Out of work? Tough luck.
No health care? The market will fix it. Born into poverty? Pull
yourself up by your own bootstraps -- even if you don't have boots.
You're on your own. Well it's time for them to own their failure."

It
remains to be seen whether the campaign keeps hitting that message
consistently, and hard, and, if so, how that will play with Obama's
image as a "post-partisan" candidate. But it's clear that given the
choice between culture war and class war, there are a lot of
low-hanging votes out there that can be won over by unapologetically
opting for the latter.

Joshua Holland is an AlterNet staff writer.

© 2008 Independent Media Institute. All rights reserved.
View this story online at: http://www.alternet.org/story/98495/

September 13, 2008 at 04:15 PM in Business Models, Consumer trends | Permalink | Top of page | Blog Home

Which way now when the world has shifted? | Observer

Which way now when the world has shifted? | Business | The Observer

Ruth Sunderland looks at the causes and consequences of a 10-year boom imploding, leaving Britain at a dangerous economic crossroads

• 
  The Observer,
  
• Sunday December 23 2007

If
you landed in London from another planet this month and picked up the
Financial Times's glossy How to Spend It magazine, you would not
suspect for a nanosecond that there was a crisis on the world money
markets. In 120 pages of unabashed haute consumerism, ads for Tiffany
ran alongside features on record couture sales at Christian Dior, with
scarcely a hint at harsh realities such as multibillion-pound bank
write-offs, smaller bonuses and lost City jobs.

The truth,
however, is that in 2007 the financial world was turned upside down:
the credit crunch has toppled a golden decade of extraordinary
prosperity in the UK and accelerated a shift in the global balance of
economic power. One consequence is that banks in the City and Wall
Street, the engine rooms of capitalism, have been so desperate for cash
that they have sold large chunks of their equity to China or Middle
Eastern states.

The credit crunch has spawned plenty of soul
searching about financial regulation, debt risks and the like. But more
thoughtful financiers acknowledge it has also prompted broader
reflection on the City's role in modern Britain.

David Buik of
spread betting firm Cantor Index says: 'The day the queues formed
outside Northern Rock branches marked a sea change. It was the end of
the illusion that we - individuals, companies and governments - could
go on running up debt with impunity. It was a wake-up call,
particularly for a younger generation which has never known financial
hardship, negative equity, high unemployment, never known the economy
to be less than benign. It also revealed the truth about our system of
financial regulation, that was supposed to be so brilliant, but did not
work when put to the test.'

With hindsight, the first signs of
a gathering financial storm came early in the year, when HSBC, which
owns the former Midland Bank in the UK, admitted that it had written
off $10.5bn of bad debts, a large chunk of it on home loans to poor
borrowers in America. The bank came in for a huge lashing from its
shareholders, but few, at that stage, made the leap to realising it was
a much wider problem.

Loans made to cash-strapped American
homebuyers had been packaged up into fancy investment vehicles and sold
to investors around the world; banks are unsure of the extent of their
rivals' - even possibly their own - exposure, and therefore are
unwilling to lend to each other.

That matters because it has
hit our high-street banks: Northern Rock is being supported by the
taxpayer to the tune of £55bn and looks to be heading for
nationalisation. It could also hit the wider economy. Mervyn King,
governor of the Bank of England, who prides himself on being calm and
understated, warned last week of a 'palpable sense of fear' that could
send the economy into free fall.

The City has in the past
decade turned itself from a comparative backwater into a genuine rival
to Wall Street. But the credit crunch means jobs will be lost and
bonuses smaller. In Covent Garden, Portland Place and Berkeley Square,
the private equity barons, who menaced FTSE 100 companies with
audacious takeover bids in the first part of the year, have watched
their flood of deals dry to a trickle. On the high street, tills will
not be ringing so loudly and, on Acacia Avenue, homeowners are worrying
about their mortgages.

Some will see the crisis as an overdue
humbling of City arrogance. The past 10 years have been stunningly good
for the super-rich. The wealth of high-net-worth individuals (Henwis) -
those with at least $1m at their disposal, not counting their main home
- increased by 11.4 per cent last year to $37trn worldwide. In the UK,
the number of Henwis rose from 448,000 to 485,000; you now need £70m to
get into the 'Rich List' of the 1,000 wealthiest people. Much of that
wealth inflation has come from the City, with a record 155 financiers
making it into the table.

That has fuelled middle-class envy of
the very rich, or what Harvard economist Martin Feldstein calls
'spiteful egalitarianism' - the idea that the increasing fortunes of
the uber-wealthy are bad, because it makes others feel poor.

The
middle classes are resentful because they are being priced out of
things they consider their birthright, including homes in desirable
areas and good schooling. Private fees, for example, have soared by 41
per cent in five years, taking the average costs of a day school to
more than £9,600 a year. The rising costs of education and home
ownership, coupled with the urge to consume, has driven record numbers
into insolvency (see chart).

Robert and Lisa, a professional
couple in their late forties living in London with two sons, are
typical of the families caught in the middle-class squeeze. Although
prosperous by most standards, they are beset by financial anxieties.

'We
live in a five-bedroom terraced house in north London and it has shot
up in value since we bought it in 1996,' says Robert. 'But our elder
son will soon go to secondary school. To get him into a good one, we'd
have to move a short distance and pay an extra £250,000 for the
same-sized property near the school. We're thinking seriously about
sending both boys to an independent school because the fees are about
the same as moving.

'Foolishly, I failed to join company
pension schemes in my twenties and thirties and now regret it. We're
wondering how we are going to juggle all these financial
responsibilities at our age. My parents were not enormously wealthy,
but my dad had a good job in an accountancy firm and was always home
for supper at 6.30 in time to read us stories. I can't do that with my
kids because I have to work such long hours. He lived in London all his
life after retiring at 65 on a generous final salary pension scheme - I
will have nothing like that.'

Middle-class financial woes could
be dismissed as the bleatings of the privileged but, at the bottom end
of the economic scale, things are also arguably worse. The rich have
become richer, but the poor are still relatively poor. The Institute
for Fiscal Studies reported this year that relative poverty has risen
for the first time since Labour came to power, with 12.7 million people
- more than a fifth of the population - living in households with
incomes lower than 60 per cent of the median after housing costs. A
shocking 3.8 million children are classed as living in poverty.

Schadenfreude
may be satisfying, but a downturn in the City hurts us all, because of
the massive increase in its influence on the UK economy as a whole
during the golden decade. Financial services has grown from 5.5 per
cent of the economy to more than 9 per cent last year and, over the
past three years, it has been responsible for a third of overall GDP
growth. Manufacturing has gone in the opposite direction, declining as
a proportion of the total economy from 23 per cent in 1990 to 14 per
cent in 2005. Employment in industry has plunged by more than a
million, while financial service sector jobs have grown (see chart).

A
report by the Ernst & Young Item Club this year described the City
as a 'cuckoo in the nest', crowding out manufacturing and other
industries. While it is good to specialise, the report said, this
process should be carefully managed. David Frost, director-general of
the British Chambers of Commerce, says: 'The government has no option
but to nurture the City because it is a huge economic driver. But
manufacturing is still important. It is not an either/or situation. You
should be able to have both, as they do in Germany, where they still
have world-class manufacturers. The economy is like a tripod: you need
strong services, strong manufacturing and a strong public sector. Ours
is unbalanced, with manufacturing the poor relation.'

The credit
crunch has also prompted more soul searching about our high-consumption
lifestyle. Edward Bonham Carter, of fund manager Jupiter Asset
Management, says: 'In every economic cycle, there are excesses on a
local level. People have been much better off in the previous decade,
but are they happier? Material accumulation does not improve our sense
of well-being, and that is intersecting with the climate change debate,
where people realise that they have to consume less. It is part of the
zeitgeist.'

Not that he is advocating a hair-shirt backlash: 'The
more redistributive you are, the less incentive people have for
creating wealth. On the other hand, if you have a rampant capitalist
state and do not redistribute it at all, you get rich ghettos and
ultimately revolution.'

The other great upheaval of 2007 is the
shift in the balance of power from the West to the developing world,
seen in the rise of sovereign funds investing trillions of dollars of
excess savings from China and the Middle East, a trend that accelerated
strongly due to the credit crisis. While Northern Rock was bailed out
by the government via the Bank of England, others courted rescue from
the Chinese state. Morgan Stanley, for example, received a $5bn
injection from the China Investment Corp in return for securities that
will convert into as much as 9.9 per cent of its stock. Abu Dhabi's
sovereign wealth fund invested $7.5bn in Citigroup last month, and the
Singapore government and an unnamed Middle Eastern investor has
ploughed SFr13bn (£5.7bn) into Swiss bank UBS.

'When you have a
sector that is bombed out but with high growth potential, the smart
money piles in,' says one chief executive. 'I think it is a healthy
part of globalisation, but there will be more protectionist noise in
America about it, which could be harmful.'

Chagrined though they
are, leading bankers don't believe their game is up. The same chief
executive adds: 'If you take a 10-year view, there is every reason to
believe the financial services sector will be one of the fastest
growing. Nothing that has happened in the past six months will change
some of the big long-term trends, such as the privatisation of the
welfare state, or the demographic drivers, such as people living
longer. These are behind the development of the financial services
industry.'

He goes on: 'The conditions we have now were created
by the pursuit for yield by investors in a low-interest, low-inflation
environment. Some of the opaque instruments have gone, but the quest
for yield has not vanished and that will drive innovation. The
performance of markets over time is being pushed by those very big
demographic drivers - it is completely unstoppable.'

In the
past 10 years, the City has sealed its transformation from a soporific
club for paunchy Old Etonians to a magnet for brilliant young talent.
It has unleashed innovations on an uncomprehending world and the pace
of financial evolution has far outstripped ability of the relatively
underpaid, and sometimes intellectually underpowered, financial
regulators to keep up.

Sober critics have been questioning the
vertiginous rise of the City for some time. During the good times, this
was brushed aside by practitioners and politicians, content to bask in
the reflected glory of London's rise as a financial centre. After
Northern Rock, those inconvenient voices have grown to a clamour that
must be heard.

Are we prepared to live in a less equal and more
divided society if that is the price of a booming financial sector? Is
it OK for the City to play such an overweening role in our economy,
while manufacturing struggles? How else, other than in financial
services, might Britain compete in a global economy against emerging
nations with cheaper labour and raw materials? Is it desirable for the
sovereign funds of sometimes undemocratic foreign governments to gain
more control over the levers of capital? All of these are issues for
2008 as we ponder how best to move forward in this chastened new world.

December 23, 2007 at 06:00 PM in Business Models | Permalink | Top of page | Blog Home

From 0 to 60 to World Domination - New York Times - Toyota

By JON GERTNER 1. Here Comes the Tundra For most of the January morning, the reporters at the Detroit auto show crisscrossed the Cobo convention center like a herd of livestock, moving at least once every hour to feed sometimes literally, since Lexus offered fresh fruit. All the world's car companies were unveiling this year's models. Often, the back-to-back corporate announcements required everyone to scurry clear across the exhibit floor to get a seat at the next press conference. It was hard not to lose yourself in the scenery, however, as you passed by a dazzling showroom exhibit of Maseratis, for instance, or encountered some gleaming Infinitis. The event was a place untroubled by thoughts of traffic jams, long commutes or gas prices. It was also a place where C.E.O.'s like Rick Wagoner of General Motors showed off electric cars like the Chevy Volt that cannot yet be produced at least until battery technology improves but that can nonetheless be driven slowly across a stage toward a cluster of photographers. In this context, it seemed, G.M. was not a company that posted a $10.6 billion loss in 2005, nor was Ford a manufacturer that announced plans last year to shed more than 30,000 employees. There were no overwhelming pension and health-care burdens.

Source: From 0 to 60 to World Domination - New York Times

Shortly after noon that day, in a ballroom just off the convention center’s main floor, the crowd was waiting for Toyota to unveil the latest (and largest) version of its new full-size truck, the Tundra. From where I stood, pinned against a back wall in the darkened room, it was getting hard to breathe. At this point I had been following Toyota and the Tundra for months; I visited the company’s new Tundra plant in San Antonio, its sales headquarters near Los Angeles, its executive offices in Manhattan and its Camry plant near Lexington, Ky. Apart from some recalls of faulty parts (an unusual and humiliating occurrence for the carmaker), Toyota had seemed as close to a juggernaut as any corporation in existence.

By any measure, Toyota’s performance last year, in a tepid market for car sales, was so striking, so outsize, that there seem to be few analogs, at least in the manufacturing world. A baseball team that wins 150 out of 162 games? Maybe. By late December, Toyota’s global projections for 2007 — the production of 9.34 million cars and trucks — indicated that it would soon pass G.M. as the world’s largest car company. For auto analysts, one of the more useful measures of consumer appeal is the “retail turn rate” — that is, the number of days a car sits on a dealer’s lot before it is turned over to a customer. As of November 2006, according to the Power Information Network, a division of J.D. Power & Associates that tracks such sales data, Toyota’s cars in the U.S. (including its Lexus and Scion brands) had an average turn rate of 27 days. BMW was second at 31; Honda was third at 32. Ford was at 82 and G.M. at 83. And Daimler-Chrysler was at 107. The financial markets reflected these contrasts. By year’s end, Toyota would record an annual net profit of $11.6 billion, and its market capitalization (the value of all its shares) would reach nearly $240 billion — greater than that of G.M., Ford, Daimler-Chrysler, Honda and Nissan combined.

When the Tundra finally arrived onstage in Detroit, Jim Lentz, one of the company’s North American executives, told the packed ballroom that this vehicle “changed everything” for Toyota. It was researched, designed, engineered and built in America, Lentz pointed out; and it seemed, from his presentation, to be the toughest, brawniest and most iconically masculine pickup truck anywhere, ever. Such boasts were in keeping with the spirit of car-dealership hucksterism at the show. Still, 50 years after coming to the U.S., Toyota views the Tundra, which arrived in American showrooms earlier this month, not only as another big truck but also as the culmination of a half-century of experimentation, failure, resurgence and domination. And as anyone with even a passing familiarity with Toyota’s strategic history knows, the company never makes rash moves or false promises.

Whether Toyota has evolved into the world’s most sophisticated modern corporation — one whose example has challenged the American model of manufacturing and management — happens to be a common topic of conversation among business analysts these days. “It’s influencing just about every major company in the world, in that they’re asking the question: What can we learn from Toyota?” says Jeff Liker, an engineering professor at the University of Michigan who has written several books on the company. Indeed, what you can learn from Toyota is something that even Bill Gates has pondered publicly. And yet deconstructing Toyota means breaking down a corporation that uses all its resources, and more than 295,000 employees worldwide, to construct things that are not meant to come apart.

2. Kaizen Means Never Being Satisfied

One of the Toyota executives attending the Tundra’s debut was Jim Press. A tall, lean Midwesterner, Press is the president of Toyota Motor North America, making him the company’s highest-ranking American. Toyota is governed by a large corporate board, which is made up of top executives in Japan and senior managing directors spread around the globe; Press is one of 49 managing officers of the company just below that level. For most of his career, Press worked on the West Coast, at Toyota’s North American sales headquarters in Torrance, Calif. More than half of Toyota’s profits now come from the U.S.; its success here, and its success globally, are so closely related as to be indistinguishable. In the view of one longtime Toyota watcher, Press’s high standing reflects the fact that, more than any single manager, he delivered the American market to Toyota. His efforts helped make the Camry the best-selling car and the Lexus the most popular luxury brand in the U.S.

Press, who is 60, never had an ambition to be an auto executive. When I first met him in his Midtown Manhattan office in October, he told me that after college he took a job working for Ford. “My family was in retail,” he said, “and this was a foray into the manufacturing side to kind of learn what goes on in the industry before I went on and became a car dealer.” In 1970, his boss at Ford moved to Toyota and encouraged him to join up too. At the time, Toyota sold a few Land Cruisers and was known mainly for one car, the Toyota Corona. It seemed like a poor career move. “When you’re young and your head is full of ideas, you don’t let facts get in the way,” Press said. So he took a flier, gave up his company car (a new Ford Thunderbird) and went to work at Toyota.

When he started, the Big Three completely controlled car sales in the United States. The only foreign company of any prominence was Volkswagen, and as Press recalled, Toyota’s modest sales were lumped with various tiny carmakers as “Other.” Still, soon after he arrived, Press realized he liked the company’s intimacy: he could meet face to face with top managers and exert some influence over marketing decisions. And he liked Toyota’s obsession with customer satisfaction. When he told me about his first trip to Japan, he seemed to be recounting a religious experience. “As a young person, you are searching for this level of comfort, you don’t know what it is, but you’re sort of uncomfortable,” he said. In Japan, as he put it, he found a home, a place where everything from the politeness of the people to the organization of the factories made sense. On that first trip, at a restaurant one evening, he tried a rich corn soup and asked the waitress for the recipe. She checked with the chef, who explained that there was no recipe; it had been handed down from his mother. The next morning, the waitress came to Press’s hotel room: she had found a cookbook with a recipe for the soup. Press, apparently, was still her customer. “That blew me away,” he said.

It can be simplistic, and often a distortion, to accept a corporate executive as the personification of a corporation, especially one as large and varied as Toyota. Yet Press serves as an apt representative, and not merely because his career arc mirrors the company’s ascendancy. Like Toyota, he expresses himself in private with modesty and care, yet in public his speeches are bold, declarative and effervescent. In his office, he has an informal, relaxed presence and exhibits just a hint of an avuncular stoop; yet he loves to race cars and sometimes swims 5,000 meters a day. Press also has a fluency in the company’s arcane systems and history. Toyota is as much a philosophy as a business, a patchwork of traditions, apothegms and precepts that don’t translate easily into the American vernacular. Some have proved incisive (“Build quality into processes”) and some opaque (“Open the window. It’s a big world out there!”). Toyota’s overarching principle, Press told me, is “to enrich society through the building of cars and trucks.” This phrase should be cause for skepticism, especially coming from a company so adept at marketing and public relations. I lost count of how many times Toyota executives, during the course of my reporting, repeated it and how often I had to keep from recoiling at its hollow peculiarity. And yet, the catch phrase — to enrich and serve society — was not intended, at least originally, to function as a P.R. motto. Historically the idea has meant offering car customers reliability and mobility while investing profits in new plants, technologies and employees. It has also captured an obsessive obligation to build better cars, which reflects the Toyota belief in kaizen, or continuous improvement. Finally, the phrase carries with it the responsibility to plan for the long term — financially, technically, imaginatively. “The company thinks in years and decades,” Michael Robinet, a vice president at CSM Worldwide, a consulting firm that focuses on the global auto industry, told me. “They don’t think in months or quarters.”

Certainly the most obvious example of Toyota’s long view is the Prius hybrid. Press said he believes that every automobile in the U.S. will eventually be a hybrid. I asked how soon. Not in five years, he replied, “but I think at some point in the not-too-distant future.” I asked whether Toyota developed and marketed the technology years ahead of the other major automakers because it possessed better technical skills. Press instead framed the issue as a matter of philosophy. Ten years ago, he said, at about the same time the Prius made its debut, Ford rolled out the huge S.U.V. franchise. “Both of us had the same tea leaves, the same research,” he said. “One of us bet on hybrid, one of us bet on big S.U.V.’s.” In his view, the wisdom of making big S.U.V.’s — Press left unacknowledged that Toyota eventually brought out its own line of S.U.V.’s — seemed dubious: “First of all, long term, is fuel going to get cheaper or more expensive? Is oil going to become more plentiful or less plentiful? Is the air going to become cleaner or more polluted? And so, do you do something proactive and innovative, to be in tune with where society is going? Or do you hold on to where it has been, and then don’t let go, to the bitter end?” It was never a matter of altruism, he seemed to be saying, but an example of how corporations survive in society. “What’s the right thing to do to sustain the ability to sell more cars and trucks?” he asked. The Prius was not about a fast return on investment. It was about a slow and long-lasting one.

The Tundra is hardly green like the Prius, yet it, too, illustrates Toyota’s characteristic patience and belief that it should serve every kind of customer. The biggest-selling vehicle in the United States is not the Camry (448,445 sold last year) or the Accord (354,441) but Ford F-Series trucks (796,039). Not far behind in sales are the full-size trucks from Chevrolet. These are among the most lucrative consumer products around, yielding anywhere from $6,000 to $10,000 in profit for every unit sold. “To the American automakers, that’s their bread and butter,” Jeff Liker, from the University of Michigan, explains. “They break even on passenger cars, lose money on small cars. But all their profits come from large S.U.V.’s and trucks. For the American auto companies, this is the last hill that they dominate.” Several auto analysts pointed out to me that G.M. and Ford trucks not only have an extremely loyal customer base; they’re also widely regarded as extremely well built and engineered (often in contrast to their passenger cars). When I asked Jim Press how long the company had been thinking about creating a full-size truck, he said it had been a priority dating to the early 1990s, when Toyota failed with its first big truck, the T100. The company failed again in 2000 when its first (and smaller) Tundra came out; only 124,508 units were sold last year.

Within Toyota, there is a rare and secretive designation for certain development projects known as irei, which is roughly translated as “not ordinary” or “exceptional” and refers to vehicles that the company will spend any amount on and go to almost any lengths to engineer, market and perfect. In the early 1990s, the Prius had this designation. When it came time several years ago to begin redesigning the new Tundra, it received the classification, too. The success of G.M. and Ford suggested that it was a product that could eventually reap tremendous profits. It was also a vehicle that could conceivably cement Toyota’s reputation, once and for all, as an all-American company.

3. The Engineers Open the Window on the Big World Out There

It’s often noted that American carmakers are hobbled by their obligations to pay health care “legacy costs” to their ranks of retirees. Toyota has only about 1,600 retirees in the U.S., and many of its factories have never been successfully organized by a union. Yet Toyota has other strategic advantages too. For one thing, its enormous cash reserves allow it to spend billions on the pursuit of market share in the U.S. — designing a new car or significantly redesigning an old one usually costs $1 billion, and building a new plant costs between $1 billion and $2 billion — and at the same time to think deeply about where society will be in 20 years.

These two pursuits, which might appear contradictory, actually reinforce each other. “Toyota has always gone where the money is, and there’s money in trucks,” says John Casesa, an industry consultant and a former automotive analyst at Merrill Lynch. “This is a company that has, as its mission, to serve any customer. But the other reality is that you’ve got to make a lot of money to develop the research and development for hybrids.” Toyota spends $20 million a day, Jim Press told me, on research and factories. “They are outspending G.M. in R.&D., product development and capital spending,” says Sean McAlinden, an economist at the Center for Automotive Research, a not-for-profit consulting firm in Ann Arbor. “If that trend continues, we’re dead. The problem is, suppose we made a car” as good as a Toyota. “Then we only have a car as good as they do. It’s not just about catching up, or getting into the game. You’ve got to get ahead somehow. But how?”

Toyota itself keeps pushing ahead. Under its system, an engineer appointed to lead a new project has a huge budget and near absolute authority over the project. Toyota’s chief engineers consider it their responsibility to begin a design (or a redesign) by going out and seeing for themselves — the term within Toyota is genchi genbutsu — what customers want in a car or a truck and how any current versions come up short. This quest can sometimes seem Arthurian, with chief engineers leading lonely and gallant expeditions in an attempt to figure out how to beat the competition. Most extreme, perhaps, was the task Yuji Yokoya set for himself when he was asked to redesign the Sienna minivan. He decided he would drive the Sienna (and other minivans) in every American state, every Canadian province and most of Mexico. Yokoya at one point decided to visit a tiny and remote Canadian town, Rankin Inlet, in Nunavut, near the Arctic Circle. He flew there in a small plane, borrowed a minivan from a Rankin Inlet taxi driver and drove around for a few minutes (there were very few roads). The point of all this to and fro, Jeff Liker says, was to test different vans — on ice, in wind, on highways and city streets — and make Toyota’s superior. Curiously, even when his three-year, 53,000-mile journey was finished, Yokoya could not stop. One person at Toyota told me he bumped into him at a hotel in the middle of Death Valley, Calif., after the new Sienna came out in 2004. Apparently, Yokoya wanted to see how his redesigned van was handling in the desert.

When I spoke not long ago with the Tundra’s chief engineer, Yuichiro Obu, and its project manager, Mark Schrage, both of whom work in Ann Arbor, they characterized their research for the Tundra as quite unlike what was done for the Sienna. For starters, designing a full-size pickup truck for the American worker is more complex than designing a van for a soccer mom. The way a farmer uses a truck is different from the way a construction worker does; preferences in Texas (for two-wheel drive) differ from those in Montana (for four-wheel drive). Truck drivers have diverse needs in terms of horsepower and torque, since they carry different payloads on different terrain. They also have variable needs when it comes to cab size (seating between two and five people) and fuel economy (depending on the length of a commute). In August 2002, Obu and his team began visiting different regions of the U.S.; they went to logging camps, horse farms, factories and construction sites to meet with truck owners. By asking them face to face about their needs, Obu and Schrage sought to understand preferences for towing capacity and power; by silently observing them at work, they learned things about the ideal placement of the gear shifter, for instance, or that the door handle and radio knobs should be extra large, because pickup owners often wear work gloves all day. When the team discerned that the pickup has now evolved into a kind of mobile office for many contractors, the engineers sought to create a space for a laptop and hanging files next to the driver. Finally, they made archaeological visits to truck graveyards in Michigan, where they poked around the rusting hulks of pickups and saw what parts had lasted. With so many retired trucks in one place, they also gained a better sense of how trucks had evolved over the past 30 years — becoming larger, more varied, more luxurious — and where they might go next.

Obu’s team, which drew on hundreds of engineers, ultimately produced a pickup model with 31 variations that include engines, wheelbases and cabs of different sizes. Design engineers, however, cannot simply create the best truck they can; they need to create the best truck that can be built in a big factory. In other words, Tundra’s design engineers had to confer with Tundra’s manufacturing engineers at every step of the way to create a truck — or 31 trucks, really — that could be assembled efficiently and systematically. To that end, Toyota spent $1.28 billion to build its San Antonio plant; it has the capacity to produce about 200,000 vehicles a year. The company considers it one of the most advanced manufacturing plants in the world.

I visited San Antonio in late November, after the factory had just begun operating. Management theorists who study Toyota’s production system tend to say that it is difficult to replicate, insofar as the company’s methods are not simply a series of techniques but a way of thinking about teamwork, products and efficiency. Still, some aspects of the system were clearly visible in San Antonio. In the Tundra plant, there is no real inventory of parts, which is a hallmark of Toyota’s approach. Once a truck chassis begins its run on the factory line, an order goes out to, say, an on-site parts supplier that provides seats for the interior. At Avanzar, an independent company located in a large workroom adjacent to the assembly line, I watched workers build a car seat from scratch. They chose a raw steel frame with springs, put it on their own minifactory assembly line to add padding, then leather, and then they transferred it (via pulley, over a partition wall) to the Tundra assembly line, where it was installed in the truck. If the front seat had not been ordered 85 minutes earlier, it would not exist.

The idea of actually situating a parts supplier inside an assembly plant is wholly novel. But the methods of low inventory — or what’s known as “just in time” production — are hardly unique to Toyota; these have been emulated with great success by other automakers. The same goes for other processes at the San Antonio plant: the line stoppages and quality checks, the time spent by workers discussing hand and body movements in the hope of shaving a crucial half-second from their work. Over the years, Toyota has assisted competitors, especially G.M., in helping to adopt its system, believing it to be in its interest to share practices, especially in exchange for insights into a rival’s methods. Toyota’s true technological advances, however, are another matter. In San Antonio, for instance, recent innovations in the paint shop that significantly cut production time were considered proprietary and off-limits to journalists.

It is a challenge to convey the scale of the Camry plant in Georgetown, Ky., which comprises 7.5 million square feet, or the orchestral complexity of its shop floor, where 7,000 workers assemble some 5,000 parts into 2,000 cars a day. I couldn’t help wondering if a glitch in the flow of door handles, or a broken welding robot, would put a crimp in the entire enterprise. “But that’s what the Toyota Production System is,” Gary Convis, the head of the plant, countered. “You actually create the conditions where things have to work to make it work.” Convis, like most Toyota engineers, mostly wanted to talk to me about Georgetown’s ceaseless drive for improvement. When a plant changes over to a new car design, as Georgetown did for the 2006 Camry, production slows down as parts and systems are updated. The last time Georgetown overhauled the Camry, in 2001, 59 days were needed to fully convert the factory to new-car production; last year, the new model took 16 days. The extra cars probably meant additional revenue of about $100 million.

Improving efficiency in the factory, though, doesn’t necessarily lead to greater profits. Savings on the assembly line can mean a nicer dashboard without making the customer pay more for it. “If you’re efficient in the things the customer doesn’t see, then you can put it into the things the customer does see,” Ron Harbour, a consultant whose company rates the efficiency of auto plants, told me. A result is a car more popular with customers. Success on the assembly line, in this way, begets success in the showroom.

4. The Long Road From Rural Japan to California and Beyond

Over the past few years, in an effort to amass a physical record of its business experience in the United States, Toyota has been tracking down and collecting automobiles it has sold here since the late 1950s. The Toyota USA Automobile Museum, as it’s known, is located in an unmarked white-brick building on a side street in Torrance, Calif., a few blocks from Toyota’s corporate sales campus. When I visited in early December, I took a leisurely stroll through the museum’s main room, a spacious, high-ceilinged garage filled with Toyotas, Lexuses and Scions, all in immaculate condition, all parked aslant on a concrete floor. The museum is open only by appointment; there were no other visitors. Time was compressed into a few strides. I passed a Toyota Corona (1966), a Corolla built in California (the first Toyota made in the U.S., 1986), a Camry from Kentucky (1989), an early Prius (2000) and an early Tundra (2003). To walk along the rows undermines any notion that Toyota’s success has been sudden; the progression of cars — in styling, popularity and increasing Americanization — was methodical and incremental. “We don’t move in an unpredictable manner,” Jim Press told me a few weeks before my visit to the museum. “We move jojo, a Japanese term, meaning step by step.”

Toyota grew out of an entrepreneurial foray by the Toyoda family — which made a fortune building textile looms early in the last century — in the 1930s under the leadership of Kiichiro Toyoda. (That’s also when it was decided that the car company would be better served by replacing the family’s “d” with a “t,” in part because it was deemed easier to write and pronounce. The Toyoda loom works did not change its name.) Toyota’s success has often been attributed to a Japanese quality of persistence and ingenuity. One of the first Western academics to look deep inside the company, Michael Cusumano, now a professor of management at M.I.T., debunked that notion when he compared Toyota and Nissan in the early 1980s. “The founders and the managers created and refined Toyota company culture, which is far more powerful than Japanese culture,” he says. “It does build on many things that are Japanese — precision, quality, loyalty. But the Toyota culture dominates.” Cusumano adds that Toyota’s origins, in a rural prefecture, hours from the international influences of Tokyo, provided a beneficial insularity. The company began growing just after World War II, nurtured by government regulations that effectively shut out big American automakers. Still, the devastated postwar economy in Japan necessitated extraordinary resourcefulness: because there was a lack of materials and parts suppliers, for example, Toyota had to create them from scratch. Since the early 1930s, Toyota engineers have looked everywhere for inspiration while tearing apart American products to see how they work. Toyota’s systems and worldview derive from an economy of scarcity. In 1950, the company’s near-bankruptcy during a difficult year further defined its philosophy of frugality. Toyota soon began to focus obsessively on reducing muda — or waste — and building up a vast storehouse of cash for security.

If history teaches another lesson, it is that Toyota’s executives recognized early on that improving the process by which cars are designed and built is just as important as improving the vehicles themselves. In the 1950s and 1960s, this conviction was famously driven by Taiichi Ohno, an engineer who never earned a college degree but who revolutionized modern manufacturing. Ohno was in awe of Henry Ford, but he recognized that the market for cars in postwar Japan — the market for any modern consumer product, he later posited — required greater flexibility as much as the traditional means of mass production. For Toyota to compete with American companies, it had to make small batches of many models (think of those 31 Tundras) that could satisfy all kinds of customers. Ohno, who died in 1990, took an anthropomorphic view of raw materials: just as an employee shouldn’t wait around without a task, neither should sheet metal or molded plastic. And so, at his factories in Japan, parts were created only in response to demand. Every worker was to focus on improving his efficiency, too (along with that of his co-workers). There was no best way to do something, but there were always better ways. John Paul MacDuffie, a Wharton professor of management, points out that the system was a “cognitive reframing of what is possible.” It showed that quality and productivity were not mutually exclusive; Toyota could indeed produce a greater variety of more durable cars more quickly than anyone else. Some of Ohno’s and Toyota’s ideas also had a deeply subversive quality. It is human nature to cover up a problem rather than call attention to it. At a Toyota plant, the identification of a problem became imperative and exciting. Because then it could be addressed.

Toyota’s production system first gained wide notice in the U.S. in the early 1990s, after the publication of “The Machine That Changed the World,” which was written by James P. Womack, Daniel T. Jones and Daniel Roos and serialized in this magazine. According to Womack, whom I visited in his Cambridge office, creating a new product like the iPod or even the Prius is a far more modest achievement than developing a new process. The former are what we normally think of as inventions, of course. But the latter, at least in Toyota’s case, presents a novel way of thinking about work and the capabilities of human organizations.

Womack notes that Toyota’s managerial competence has extended well beyond Taiichi Ohno; the company has been fortunate that the Toyoda family’s descendants, especially the former chairman Eiji Toyoda, have demonstrated tremendous leadership abilities. “They got very lucky with genetics,” Womack says of Toyota. The company also benefited from the savvy of an early sales-and-marketing executive, Shotaro Kamiya. In the 1950s, when Toyota could barely sell its cars to the Japanese public, Kamiya decided Toyota could drive up demand by investing in Japanese driving schools. Kamiya also decided to send three employees to California in the summer of 1957 on a survey mission; a few months later, Toyota set up a small dealership in Hollywood to sell an austere, ugly and underpowered vehicle called the Toyopet Crown — “Toyopet is your pet!” its ads claimed. The car went on sale in 1958 for $1,995; only 288 were sold. That year, the Christmas party, held in the new company’s garage in Hollywood, consisted of about 30 people. The custodian’s wife cooked the food.

The first years in the U.S. were in fact a disaster. Toyota sold a few Land Cruisers but eventually withdrew the Toyopet from the market. Meanwhile its engineers in Japan tried to create a passenger car that American customers would actually want. The result was the 1965 Corona, an air-conditioned and modestly priced vehicle. After that, sales grew steadily. A variety of factors helped — currency differences often made Japanese car imports cheap (for consumers) and profitable (for Toyota). Labor costs in Japan were lower, too. But perhaps the most important factor was timing. A few years after Jim Press began working at Toyota Motor Sales in California, the gas crisis of the early 1970s brought legions of customers to Toyota’s more fuel-efficient cars. By the time the company began setting up factories in the U.S. in the mid-1980s (just over half of the Toyota cars sold in North America are now built here), it was gaining respect for the quality as well as the gas economy of its vehicles. Then came the success of Lexus in the early 1990s. “When they really went at the U.S. market seriously, in the late 1970s and 1980s, the product they brought out was far superior to what the Big Three were producing,” Ron Harbour, the efficiency expert, says. “They created this impression and reputation early on. And in the ensuing years, Ford and G.M. have made great strides to make it up. They’ve narrowed a lot of those gaps. But when you lose that reputation, it’s very hard to recover.” Catching up is even harder, moreover, when Toyota’s cars, like those from Honda and BMW, have consistently higher resale values.

Let’s go back in time and say you’ve got a guy who in 1985 bought a Camry, Harbour says. That Camry buyer was surprised to find he never had to get his car fixed at the dealership. “That guy never, ever looked back,” he adds. “G.M., Ford, Chrysler — they’ve basically lost a whole generation of Americans.”

You might figure that Toyota is elated at the way things have gone lately: its market share in the U.S. has risen in the past couple of years while American automakers like Ford (and to a lesser degree, G.M.) have been in a tailspin. But this assumption is probably only partly correct. “We want them to be strong,” Jim Press says, referring to Ford and G.M. “When you play a ball game, you don’t want to win by errors.” Jim Womack puts it more bluntly: “The last thing Toyota wants is for any of those guys to collapse.” For one thing, it could be politically disastrous for the Japanese company if it were considered responsible for the death of a grand American institution. “But it’s also completely worthless to Toyota in the market,” Womack adds. “They’re selling all the vehicles they can make already. What they actually want is just continuous, slow decline — decline at the same rate that they have the ability to organically expand. That’s the ideal world for them.”

5. Toyota Has It Made in America

McAllen, Tex., is a small city in the state’s southernmost tip, which has among the highest numbers of pickup-truck sales in any U.S. market, according to Toyota’s research. That made it an ideal location for focus groups and marketing research: What did these people need? What did they think of Toyota? And what would actually get them to drive a Tundra? Toyota ultimately decided to pursue customers it calls “true truckers.” True truckers aren’t ordinary pickup owners; rather, these men are the Platonic ideal of truck-driving authenticity. They might work on the ranch or the construction site; they might fish for bass every weekend. “They’re the taste makers, the influentials,” Ernest Bastien, a vice president of vehicle operations, told me in San Antonio. “I think all consumers are influenced by professionals. The professional uses a certain tool, and then they want it, too.” What Toyota needed was to find the true truckers, get them behind the wheel of a Tundra and then hope that Obu and Schrage’s engineering would take care of the rest. If the true truckers bought it, their followers would, too.

Toyota expects that some buyers will be moving up from its smaller truck, the Tacoma; others will be trading in their weaker, older Tundra for the new model. Still other buyers may be families that view pickup trucks with big back seats (so-called double cabs) as an alternative to an S.U.V.’s But building a new factory in the U.S. for the truck, locating the plant in the heart of Texas pickup country and then flying the Texas flag outside all speak to the company’s focus on severing truck owners’ blood ties to Ford and G.M. These loyal owners are the hardest to woo. Indeed, they may be beyond reach. Just as G.M. and Ford may have lost a generation of car buyers, Toyota may have put off a generation of full-size truck buyers with the T100 and the first Tundra.

The company doesn’t think so. In recent years, Toyota has successfully marketed cars like the Prius and brands like the Scion through grass-roots endeavors, which often meant showcasing the Prius to an audience of influentials. With Scion, the company wanted to get the cars in the hands of hipsters who would make them seem desirable and rare to young drivers, a strategy backed by limiting production this year to 150,000 vehicles, even as demand will probably exceed that amount. Some of these techniques seemed appropriate for the Tundra too. “There are so many of these buyers that probably will feel uncomfortable going into a Toyota dealer because they don’t see a Toyota on the construction site and never have and they don’t want to be the first one to show up with one,” Brian Smith, the head of Toyota’s truck operations, told me. So for the past year, the company’s marketers have tried to “soften” resistance to the brand. “Street teams” drive Tundras to big construction sites with water in the summer and coffee and doughnuts in the winter. “We say: ‘Hey guys, you ever been in a Toyota before? Just take a moment to sit in it and tell us what you think,’ ” Smith says. Already Toyota has sent its street teams on hundreds of runs.

Toyota focused the marketing of the Tundra on what Smith calls five “buckets”: 1) fishers and outdoorsmen; 2) home-improvement types; 3) Nascar fans; 4) motorcycle enthusiasts; and 5) country-music lovers. Anyone wondering why Toyota has become a major booster of Nascar or a sponsor of bass-fishing tournaments can see the logic. It’s also why Toyota is sponsoring Brooks and Dunn, the country-music duo. And dealers are taking new Tundra trucks to Nascar events, country-music concerts, fishing tournaments and the like. “Parking lots tend to be a long ways away from where the events are,” Smith explains, referring to motocross competitions, “so we have our dealers setting up shuttles.” The plan is to pull up in a Tundra, offer visitors a ride but have them drive to the event on a slightly indirect course (laid out by a Toyota dealer). “At the end,” Smith says, “we say, ‘Thank you, you’re guests of Toyota, here’s a bottle of water, take a lanyard.’ ”

Based on the company’s track record, it’s tempting to predict a resounding victory — if not a quick one, then a slow and steady one. But Toyota is by no means infallible. It failed in the large-truck market in the 1990s, and it faltered in the youth market until it came up with the Scion strategy. Its vehicles are sometimes outranked in Consumer Reports in safety and customer satisfaction by other automakers, especially Honda. The company’s growth has sparked tremendous internal concerns about quality-control problems.

And Toyota has worries abroad too. Many auto analysts wonder if Toyota has the ability to succeed in emerging markets. “Toyota is fairly weak in what we see as the second-largest growth market in the world, which we consider India,” Ashvin Chotai, a London-based auto analyst for Global Insight, told me. In China, the largest growth area, Toyota expects to have 10 percent of the market by 2010, but the company faces intense competition, from both its American and Asian rivals. Jim Press often says that Toyota is not doing as well as the headlines suggest. The trustworthiness of this claim is debatable — Press also says that G.M. is doing just fine — but it’s undeniable that the company will soon assume leadership in a market that’s both global and brutal.

However the Tundra does in the next few months, the company’s history suggests that it never relinquishes a goal before reaching it. And what’s striking is that if Toyota succeeds, it won’t necessarily be because the company has done anything different this time. Toyota has never really caught the Big Three by surprise. Its marketing strategists have been trying to establish an aura of American authenticity since the early 1970s, when Toyota’s TV ads featured four Dallas Cowboys squeezing into a Corolla. When I asked Takahiro Fujimoto, a management professor at the University of Tokyo and a longtime Toyota observer, whether the company’s victories — or the fact that it is now the world’s largest automaker — were hard to envision, he said no: “Since almost everything that happened to this company in the past several decades has been evolutionary rather than revolutionary, there have been few surprises.”

Toyota’s triumphs are often reduced to spare inventory and just-in-time productivity, but that’s too simplistic; there are many factors at work. Among management theorists, success derives from what they call the Toyota Way — the company’s culture of efficiency and problem-solving. Among historians, Toyota’s supremacy is a product of happenstance, specifically its early years in the rural precincts of ravaged, postwar Japan. For those in the marketing world, Toyota has triumphed in its packaging of brands like Lexus and Scion. On Wall Street, its success is defined by huge profits and driven by low retiree costs and close relationships with parts suppliers. Toyota’s prosperity also owes a large debt to its dealers, the true links to the consumer, who are very good at letting company executives know what customers like and don’t like. And to the fact that Toyota does not award huge stock-option grants or bonuses to its executives. Our culture of excessive compensation has never really caught on there.

All this doesn’t make Toyota virtuous. But it does make Toyota different — in some deep, cellular way — from many American companies. Nothing in its DNA, to borrow a fashionable term among business-school academics, is focused on short-term gains. What’s more, the long view as a business outlook seems to link so many aspects of the company’s success. The long view took Toyota to California, and to its most important market, in 1957 and kept it in the United States even after the Toyopet failed miserably. The long view allowed Toyota to understand the need for improvement and the potential rewards of meeting a higher standard. And when it met higher standards, the company looked ahead at the evolution of its American customers, marshaled its resources and tried to figure out what should come next.

6. Getting the Carbon Out of Cars

Toyota’s president, Katsuaki Watanabe, who like all of the company’s top executives is based in Japan, recently declared that his dream for Toyota is to build a car that does not hurt anyone and cleans the air when it’s running. This is not quite as fantastical as it sounds. Several automakers are developing cars with sensors that literally prevent them from crashing (though not from being crashed into). And in the heavy intersections in Tokyo where air quality is poor, Takahiro Fujimoto told me, part of Watanabe’s vision is already real: “The emission gas of some advanced cars is in fact cleaner than the intake air.” The most vexing challenge, though, is what fuel cars will run on in a future where oil is too scarce or tailpipe emissions too dangerous on account of global warming. About 10 percent of global carbon emissions come from cars, S.U.V.’s and pickup trucks. Many automakers, Toyota included, now trumpet their vehicles as “clean,” but this label, while by no means unimportant, refers to engine technology that reduces smog-forming emissions like nitrogen oxides or unburned hydrocarbons. But every gallon of gas burned still produces more than 19 pounds of CO2.

What I found within Toyota is that its engineers and executives all take environmental issues seriously, but on their own terms. For many consumers, of course, Toyota’s hybrid innovations established a green halo over the company. Yet the environmental community is more wary of the company’s lauded progressivism than you might expect. Many environmental advocates are dismayed by Toyota’s participation (as a member of the Alliance of Automobile Manufacturers) in a suit to block California’s new laws curtailing greenhouse-gas emissions. And some view Toyota’s strenuous efforts, especially in the U.S., to sell gas-guzzling trucks and S.U.V.’s as counterproductive. “I think the reality is that Toyota’s focus on the truck market has been to make them look as American as possible, rather than be the global environmental leaders they are on the car side,” Jason Mark, the former head of the vehicle program at the Union of Concerned Scientists, told me. As Mark sees it, Toyota’s activities matter more than any other automaker’s. “First, they’ll be the biggest car company very soon,” he says. “Second, they’ve demonstrated a knack for innovation with the Prius. And third, they’ve demonstrated a commitment for stewardship that I don’t think one could attribute to the domestic automakers.”

When I spoke with John DeCicco, an automotive specialist at Environmental Defense, a New York-based advocacy group, he said that in the near term, at least, it’s better not to count on a silver bullet — a drastic changeover to hydrogen-powered vehicles, for instance. There are many reasons that this will remain a long-term goal. One is that cars, especially ones of good quality, last a long time. Another is that automakers are profit-driven public corporations, and any new technology has to be competitive in the marketplace. To see just how long that can take, consider that Toyota began developing the Prius at a time, 1991, when gas was plentiful and cheap. Today, seven years after its introduction in the U.S., it has less than 1 percent of the car market. Higher gas prices or gas taxes may alter this. But for now, environmental advocates like DeCicco urge carmakers to focus on making modest changes to popular vehicles (making S.U.V.’s lighter, for example, thereby increasing fuel efficiency), which could have a more significant environmental impact than a sophisticated new technology. When DeCicco began analyzing total greenhouse-gas emissions from each car company’s American fleet, he noticed that in 2003, for instance, there was a significant change for the better in Toyota’s rate. This wasn’t because of its hybrids but because of its redesign of the Corolla. “When you make a small change in efficiency in a high-volume product like that,” DeCicco told me, “it can have a bigger net effect in your carbon than a major change in a small-volume seller.”

Still, more economical cars for the short term cannot solve the long-term problem. Toyota expects to be in business 100 years from now, one person in the company’s West Coast office told me, long after oil has been depleted or rendered unusable because of its carbon content, and for that reason it has placed all its bets on hybrid technologies. Indeed, Toyota created its hybrid systems not so much with the current era in mind, but because it views hybrids as more practical and energy-efficient. Whether the future is in biodiesel, ethanol or hydrogen doesn’t seem to matter; the hybrid system could be adapted to any of those fuels, says Bill Reinert, Toyota’s U.S. engineer in charge of advanced vehicle planning. Reinert also told me that the current Toyota system already has the ability to accommodate the larger battery capacity of a plug-in hybrid, which would use electric power for local trips and fuel only for longer excursions. But those large batteries don’t yet exist. Was that extra capacity put there on purpose? “Hell, yes,” he says. “This company is not stupid.”

Reinert adds that every Toyota engineer designing a new car gets an environmental-impact budget as well as a financial one. Designers must consider the total amount of carbon dioxide produced in the design, production and lifetime operation of a new vehicle. This sounds both encouraging and socially responsible. But you have to wonder too if it’s really an equation for sustainability. Right now, Reinert says, there are about three-quarters of a billion cars worldwide; by 2050, if market trends continue, “we could conceivably have 2 billion or even 2.5 billion cars.” Accommodating those cars will entail building new roads and new factories and spending vast amounts of energy to make shipments. All those activities will create enormous emissions on their own. So even with giant strides in clean-vehicle technology, just doubling the number of vehicles could increase the overall environmental effect by a factor of three.

To their credit, engineers at Toyota like Reinert do not soft-pedal the immensity of the challenge. And they argue, sometimes convincingly, that Toyota will be a large part of the solution. Jim Press does, too, but his is a different kind of optimism. A few days after the new Tundra made its debut, Press gave a speech to the Society of Automotive Analysts in Detroit in which he seemed confident that this would be Toyota’s century. New technologies are on the way, he promised. And the demographics of the American market look good: boomers are buying more cars. Americans are living longer. And the growth rate of the U.S. population is greater than China’s. Even in the face of what looks like a difficult year for car sales, the industry is on the verge of a golden era. “This is one of the few countries on earth where we have more cars per household than drivers,” he said. “Isn’t that great?”

At the beginning of his speech, Press joked to the audience that he was about to reveal the secret of Toyota’s success. He never really did, except to look ahead with relentlessly bright expectations.

Jon Gertner, a contributing writer, last wrote for the magazine about the economics of making comedy movies in Hollywood.

February 27, 2007 at 12:06 AM in Business Models | Permalink | Top of page | Blog Home

Apple - Thoughts on Music

Steve Jobs February 6, 2007

With the stunning global success of Apples iPod music player and iTunes online music store, some have called for Apple to open the digital rights management (DRM) system that Apple uses to protect its music against theft, so that music purchased from iTunes can be played on digital devices purchased from other companies, and protected music purchased from other online music stores can play on iPods. Lets examine the current situation and how we got here, then look at three possible alternatives for the future. 

To begin, it is useful to remember that all iPods play music that is free of any DRM and encoded in open licensable formats such as MP3 and AAC. iPod users can and do acquire their music from many sources, including CDs they own. Music on CDs can be easily imported into the freely-downloadable iTunes jukebox software which runs on both Macs and Windows PCs, and is automatically encoded into the open AAC or MP3 formats without any DRM. This music can be played on iPods or any other music players that play these open formats.

Source: Apple - Thoughts on Music

The rub comes from the music Apple sells on its online iTunes Store. Since Apple does not own or control any music itself, it must license the rights to distribute music from others, primarily the “big four” music companies: Universal, Sony BMG, Warner and EMI. These four companies control the distribution of over 70% of the world’s music. When Apple approached these companies to license their music to distribute legally over the Internet, they were extremely cautious and required Apple to protect their music from being illegally copied. The solution was to create a DRM system, which envelopes each song purchased from the iTunes store in special and secret software so that it cannot be played on unauthorized devices.

Apple was able to negotiate landmark usage rights at the time, which include allowing users to play their DRM protected music on up to 5 computers and on an unlimited number of iPods. Obtaining such rights from the music companies was unprecedented at the time, and even today is unmatched by most other digital music services. However, a key provision of our agreements with the music companies is that if our DRM system is compromised and their music becomes playable on unauthorized devices, we have only a small number of weeks to fix the problem or they can withdraw their entire music catalog from our iTunes store.

To prevent illegal copies, DRM systems must allow only authorized devices to play the protected music. If a copy of a DRM protected song is posted on the Internet, it should not be able to play on a downloader’s computer or portable music device. To achieve this, a DRM system employs secrets. There is no theory of protecting content other than keeping secrets. In other words, even if one uses the most sophisticated cryptographic locks to protect the actual music, one must still “hide” the keys which unlock the music on the user’s computer or portable music player. No one has ever implemented a DRM system that does not depend on such secrets for its operation.

The problem, of course, is that there are many smart people in the world, some with a lot of time on their hands, who love to discover such secrets and publish a way for everyone to get free (and stolen) music. They are often successful in doing just that, so any company trying to protect content using a DRM must frequently update it with new and harder to discover secrets. It is a cat-and-mouse game. Apple’s DRM system is called FairPlay. While we have had a few breaches in FairPlay, we have been able to successfully repair them through updating the iTunes store software, the iTunes jukebox software and software in the iPods themselves. So far we have met our commitments to the music companies to protect their music, and we have given users the most liberal usage rights available in the industry for legally downloaded music.

With this background, let’s now explore three different alternatives for the future.

The first alternative is to continue on the current course, with each manufacturer competing freely with their own “top to bottom” proprietary systems for selling, playing and protecting music. It is a very competitive market, with major global companies making large investments to develop new music players and online music stores. Apple, Microsoft and Sony all compete with proprietary systems. Music purchased from Microsoft’s Zune store will only play on Zune players; music purchased from Sony’s Connect store will only play on Sony’s players; and music purchased from Apple’s iTunes store will only play on iPods. This is the current state of affairs in the industry, and customers are being well served with a continuing stream of innovative products and a wide variety of choices.

Some have argued that once a consumer purchases a body of music from one of the proprietary music stores, they are forever locked into only using music players from that one company. Or, if they buy a specific player, they are locked into buying music only from that company’s music store. Is this true? Let’s look at the data for iPods and the iTunes store – they are the industry’s most popular products and we have accurate data for them. Through the end of 2006, customers purchased a total of 90 million iPods and 2 billion songs from the iTunes store. On average, that’s 22 songs purchased from the iTunes store for each iPod ever sold.

Today’s most popular iPod holds 1000 songs, and research tells us that the average iPod is nearly full.  This means that only 22 out of 1000 songs, or under 3% of the music on the average iPod, is purchased from the iTunes store and protected with a DRM. The remaining 97% of the music is unprotected and playable on any player that can play the open formats.  Its hard to believe that just 3% of the music on the average iPod is enough to lock users into buying only iPods in the future.  And since 97% of the music on the average iPod was not purchased from the iTunes store, iPod users are clearly not locked into the iTunes store to acquire their music.

The second alternative is for Apple to license its FairPlay DRM technology to current and future competitors with the goal of achieving interoperability between different company’s players and music stores. On the surface, this seems like a good idea since it might offer customers increased choice now and in the future. And Apple might benefit by charging a small licensing fee for its FairPlay DRM. However, when we look a bit deeper, problems begin to emerge. The most serious problem is that licensing a DRM involves disclosing some of its secrets to many people in many companies, and history tells us that inevitably these secrets will leak. The Internet has made such leaks far more damaging, since a single leak can be spread worldwide in less than a minute. Such leaks can rapidly result in software programs available as free downloads on the Internet which will disable the DRM protection so that formerly protected songs can be played on unauthorized players.

An equally serious problem is how to quickly repair the damage caused by such a leak. A successful repair will likely involve enhancing the music store software, the music jukebox software, and the software in the players with new secrets, then transferring this updated software into the tens (or hundreds) of millions of Macs, Windows PCs and players already in use. This must all be done quickly and in a very coordinated way. Such an undertaking is very difficult when just one company controls all of the pieces. It is near impossible if multiple companies control separate pieces of the puzzle, and all of them must quickly act in concert to repair the damage from a leak.

Apple has concluded that if it licenses FairPlay to others, it can no longer guarantee to protect the music it licenses from the big four music companies. Perhaps this same conclusion contributed to Microsoft’s recent decision to switch their emphasis from an “open” model of licensing their DRM to others to a “closed” model of offering a proprietary music store, proprietary jukebox software and proprietary players.

The third alternative is to abolish DRMs entirely. Imagine a world where every online store sells DRM-free music encoded in open licensable formats. In such a world, any player can play music purchased from any store, and any store can sell music which is playable on all players. This is clearly the best alternative for consumers, and Apple would embrace it in a heartbeat. If the big four music companies would license Apple their music without the requirement that it be protected with a DRM, we would switch to selling only DRM-free music on our iTunes store. Every iPod ever made will play this DRM-free music.

Why would the big four music companies agree to let Apple and others distribute their music without using DRM systems to protect it? The simplest answer is because DRMs haven’t worked, and may never work, to halt music piracy. Though the big four music companies require that all their music sold online be protected with DRMs, these same music companies continue to sell billions of CDs a year which contain completely unprotected music. That’s right! No DRM system was ever developed for the CD, so all the music distributed on CDs can be easily uploaded to the Internet, then (illegally) downloaded and played on any computer or player.

In 2006, under 2 billion DRM-protected songs were sold worldwide by online stores, while over 20 billion songs were sold completely DRM-free  and unprotected on CDs by the music companies themselves. The music companies sell the vast majority of their music DRM-free, and show no signs of changing this behavior, since the overwhelming majority of their revenues depend on selling CDs which must play in CD players that support no DRM system.

So if the music companies are selling over 90 percent of their music DRM-free, what benefits do they get from selling the remaining small percentage of their music encumbered with a DRM system? There appear to be none. If anything, the technical expertise and overhead required to create, operate and update a DRM system has limited the number of participants selling DRM protected music. If such requirements were removed, the music industry might experience an influx of new companies willing to invest in innovative new stores and players. This can only be seen as a positive by the music companies.

Much of the concern over DRM systems has arisen in European countries.  Perhaps those unhappy with the current situation should redirect their energies towards persuading the music companies to sell their music DRM-free.  For Europeans, two and a half of the big four music companies are located right in their backyard.  The largest, Universal, is 100% owned by Vivendi, a French company.  EMI is a British company, and Sony BMG is 50% owned by Bertelsmann, a German company.  Convincing them to license their music to Apple and others DRM-free will create a truly interoperable music marketplace.  Apple will embrace this wholeheartedly.

February 6, 2007 at 06:58 PM in Business Models | Permalink | Top of page | Blog Home

Living a Second Life

Virtual online worlds | Living a Second Life | Economist.com

Sep 28th 2006 | SAN FRANCISCO
From The Economist print edition
A Californian firm has built a virtual online world like no other. Its population is growing and its economy is thriving. Now politicians and advertisers are visiting

PETER YELLOWLEES, a professor of psychiatry at the University of California, Davis, has been teaching about schizophrenia for 20 years, but says that he was never really able to explain to his students just how their patients suffer. So he went online, downloaded some free software and entered Second Life. This is a “metaverse” (ie, metaphysical universe), a three-dimensional world whose users, or “residents”, can create and be anything they want. Mr Yellowlees created hallucinations. A resident might walk through a virtual hospital ward, and a picture on the wall would suddenly flash the word “shitface”. The floor might fall away, leaving the person to walk on stepping stones above the clouds. An in-world television set would change from showing an actual speech by Bob Hawke, Australia's former prime minister, into Mr Hawke shouting, “Go and kill yourself, you wretch!” A reflection in a mirror might have bleeding eyes and die.

When Mr Yellowlees invited, as part of a trial, Second Life's public into the ward, 73% of the visitors said afterwards that it “improved [their] understanding of schizophrenia.” Mr Yellowlees then went further. For about $300 a month, he leases an island in Second Life, where he has built a clinic that looks exactly like the real one in Sacramento where many of his students practise. He gives his students “avatars”, or online personas, so they can attend his lectures inside Second Life and then experience hallucinations. “It's so powerful that some get quite upset,” says Mr Yellowlees.

Second Life, as Mr Yellowlees illustrates, is not a game. Admittedly, some residents—there were 747,263 as of late September, and the number is growing by about 20% every month—are there just for fun. They fly over islands, meander through castles and gawk at dragons. But increasing numbers use Second Life for things that are quite serious. They form support groups for cancer survivors. They rehearse responses to earthquakes and terrorist attacks. They build Buddhist retreats and meditate.

Many use it as an enhanced communications medium. Mark Warner, a former governor of Virginia who is considered a possible Democratic candidate for president in 2008, recently became the first politician to give an interview in Second Life. His avatar (also named Mark Warner) flew into a virtual town hall and sat down with Hamlet Au, a full-time reporter in Second Life. “This is my first virtual appearance,” Mr Warner joked, “I'm feeling a little disembodied.” They then proceeded to discuss Iraq and other issues as they would in real life, with 62 other avatars attending (some of them levitating), until Mr Warner disappeared in a cloud of pixels.

By emphasising creativity and communication, Second Life is different from other synthetic online worlds. Most “massively multi-player online role-playing games”, or MMORPGs (pronounced “morpegs”), offer players pre-fabricated or themed fantasy worlds. The biggest by far is “World of Warcraft”, by Blizzard Entertainment, a firm in California, which has more than 7m subscribers. These worlds are the modern, interactive, equivalents of Nordic myths and Tolkien fantasies, says Edward Castronova, a professor at Indiana University and the author of “Synthetic Worlds: The Business and Culture of Online Games”. They allow players to escape into their imaginations, and to take part by, say, joining with others to slay a monster.
Making, not slaying

Second Life, by contrast, was designed from inception for a much deeper level of participation. “Since I was a kid, I was into using computers to simulate reality,” says Philip Rosedale, the founder of Linden Lab, the San Francisco firm that launched Second Life commercially three years ago. So he set out to construct something that would allow people to “extend reality” by building a virtual version of it, a “second life” not unlike that envisioned by Neal Stephenson in “Snow Crash”, a science-fiction novel published in 1992.

Unlike other virtual worlds, which may allow players to combine artefacts found within them, Second Life provides its residents with the equivalent of atoms—small elements of virtual matter called “primitives”—so that they can build things from scratch. Cory Ondrejka, Linden Lab's product-development boss, gives the example of a piano. Using atomistic construction, a resident of Second Life might build one out of primitives, with all the colours and textures that he would like. He might add sound to the primitives representing the keys, so the piano could actually be played in Second Life. “Of course, since these are primitives, the piano could also fly or follow the resident around like a pet,” says Mr Ondrejka.

Because everything about Second Life is intended to make it an engine of creativity, Linden Lab early on decided that residents should own the intellectual property inherent in their creations. Second Life now allows creators to determine whether the stuff they conceive may be copied, modified or transferred. Thanks to these property rights, residents actively trade their creations. Of about 10m objects created, about 230,000 are bought and sold every month in the in-world currency, Linden dollars, which is exchangeable for hard currency. Linden Lab estimates that the total value (in “real” dollars) this year will be about $60m. Second Life already has about 7,000 profitable “businesses”, where avatars supplement or make their living from their in-world creativity. The top ten in-world entrepreneurs are making average profits of just over $200,000 a year.
By emphasising creativity and communication, Second Life is different from other synthetic online worlds

Second Life's total devotion to what is fashionably called “user-generated content” now places it, unlike other MMORPGs, at the centre of a trend called Web 2.0. This term usually refers to free online services delivered through a web browser—for example, social networks in which users blog and share photos. Second Life is not delivered through a web browser but through its own software, which users need to install on their computers. In other respects, however, it is now often held up as the best example of Web 2.0. “It celebrates individuality,” says Jaron Lanier, who pioneered the concept of “virtual reality” in the 1980s and is now “science adviser” at Linden Lab. And it connects people, he says, because “the act of creation is the act of being social.”

The Web 2.0 crowd also extols Second Life for its highly original business model. Most Web 2.0 firms try to build audiences around user-generated content in order to sell advertising to them. This assumes the availability of unlimited advertising dollars, a notion that is increasingly ridiculed.

Linden Lab does not sell advertising; instead it is a virtual property company. It makes money when residents lease property—an island, say—by charging an average of $20 per virtual “acre” per month. Only about 25,000 residents, or about 3% or the population, lease property, but that already amounts to 53,800 acres, which, in real life, would be bigger than Boston. This works out to monthly revenues of $1m, not counting the commissions that it takes on currency exchanges between Linden dollars and hard cash. As a private company, Linden Lab does not disclose its exact revenues, although Mr Rosedale says the firm is “close to profitability”.

A common reaction to such numbers is astonishment that anybody should pay anything at all for something that exists only in a metaphysical sense. But “there's actually no economic puzzle in this; all kinds of things derive their economic value only from the realm of the virtual,” says Indiana University's Mr Castronova. The American dollar, for instance, is virtual (aside from the value of the paper used for the bills) in that it requires consumers to have faith in its worth. In the context of online games, virtual economies much bigger than Second Life's have existed for years. Many people in poor countries, called “gold farmers”, play games such as “World of Warcraft” professionally to score weapons, points or lives to sell to lazier players in rich countries. But Second Life is unique in that residents conceive what they sell. As such, says Mr Lanier, it is “probably the only example of a self-sustained economy” on the internet.

For all these reasons—its ability to change the real lives of its residents, its innovations in technology and in its business model—Second Life has become a darling of Silicon Valley. It promises to be “disruptive”, says Mitch Kapor, the inventor of the Lotus spreadsheet that played a big role in the personal-computer revolution of the 1980s and 1990s. He is now chairman of Linden Lab. To him, Second Life is comparable to both the PC and the internet itself, which started as something “quirky” for geeks, and then entered and transformed mainstream society. “Spending part of your day in a virtual world will become commonplace” and “profoundly normal,” says Mr Kapor. Ultimately, he thinks, Second Life will “displace both desktop computing” and other two-dimensional “user interfaces”. As “a hothouse of innovation and experiment,” he says, Second Life may even “accelerate the social evolution of humanity.”
Back to this reality

It is bold and early to make such predictions. After all, Second Life is still a relatively small virtual world—only about 9,000 residents are usually logged in at any one time, for example. About two-thirds create content from scratch, but mostly they customise things that they find or browse passively. And a lot of the wares on offer are banal. Whereas a few residents choose very innovative bodies for their avatars, most have shapes, male and female, that hew to the default templates and look, predictably, like cosmetically enhanced porn stars. Among the artefacts, there is some genuine art but quite a bit of junk.
Endless possibilities: Donna Meyer, a grandmother from New York, and her avatar

Is Second Life a nirvana where unknown talent can prove its creative mettle and make it in the real world? “You can create your own island and people come to it,” said Bill Joy, a co-founder of Sun Microsystems and now a prominent venture capitalist. But “I don't see any correlation between that and what it's going to take to be a designer and have a skill set to succeed in the world.”

Mr Castronova also cautions against overestimating the depth and breadth of Second Life's economy. Yes, people do create clothes and games and spacecraft in Second Life and then sell them. But most of the big money comes from the virtual equivalent of land speculation, as people lease islands, erect pretty buildings and then rent them to others at a premium. Tongue in cheek, Mr Castronova compares Second Life's in-world boom to America's house-price bubble. In artistic terms, there is not always much difference between building an in-world house and designing a personal web page.

There are also stirrings of discontent among some of the “older” (if one can use that term in a three-year-old metaverse) and more purist residents of Second Life about what they see as a menacing trend toward commercialism. One avatar, for example, has created “MetaAdverse”, a network of advertising billboards inside Second Life to which property developers can feed images of their creations. More controversially, Second Life is also attracting the attention of corporations and advertisers from the real world hoping to attract the metaverse's residents. Publishers now organise book launches and readings in Second Life. The BBC has rented an island, where it holds music festivals and parties. Sun Microsystems is preparing to hold in-world press conferences, featuring avatars of its top executives. Wells Fargo, an American bank, has built a branded “Stagecoach” island, where avatars can pull Linden dollars out of a virtual cash machine and learn about personal finance. Starwood, a hotel and resort chain, is unveiling one of its new hotels in the virtual world.

Toyota is the first carmaker to enter Second Life. It has been giving away free virtual vehicles of its Scion brand and, in October, will start selling all three Scion models. The price will be modest, says Adrian Si, the marketing manager at Toyota behind the project. Toyota really hopes that an “aftermarket” develops as avatars customise their cars and sell them on, thus spreading the brand “virally”. Toyota will be able to observe how avatars use the cars and might, conceivably, even get ideas for engineering modifications in the real world, he says.

Those Scion cars have “great driving performance for in-world physics,” says Reuben Steiger, the boss of Millions of Us, a company he founded this year to bring companies like Toyota into Second Life for marketing and brand-building. “How it corners and makes sounds when it changes gears is great.” So Toyota, which is a client of his, along with Sun Microsystems and even Mr Warner, shows that Second Life is “perfect for creating experiences around a brand,” says Mr Steiger. “We don't think that conventional advertising will be very prevalent,” he says, because it would “be badly received culturally”. Advertising in Second Life is not about “trapping people” but about captivating and stimulating them. A good campaign in Second Life costs about $200,000 dollars, he reckons, of which only a tiny part is property leases and most goes to paying the talented designers to create great virtual stuff.
Virtual strip mall?

Inevitably, this sort of thing turns some residents off. Will Second Life, that realm of individualism and pure creativity and spontaneity, get plastered over by the same mega-brands and mass culture that have, arguably, made the physical world such a homogenous place? In real life, many avatars argue, big business tends to push out small artisans. If the same happens in Second Life, the metaverse will lose its raison d'être.

Mr Rosedale, Linden Lab's founder, empathises with the concern, but thinks it is misplaced. “That is a fear which comes from the real world that is not likely to be borne out in Second Life,” he says. His arguments are all economic. In the physical world land is scarce, so big brands can buy up much of it; in Second Life, Linden Lab simply allocates more computer-processing power and makes even more islands available. The world is infinitely expandable, in other words. If one patch did become homogenous and drab, avatars would simply fly off to the next.

Another economic difference, says Mr Rosedale, is the lack of economies of scale in Second Life. In real life, a shoemaker, say, can reduce the average cost of making a pair by producing huge amounts, and the average cost of marketing by buying advertising in bulk. In Second Life, however, scale means nothing. There is no manufacturing cost to minimise. Gimmicks, such as giving away free shoes, are useless because nobody actually needs shoes at all. Nike, say, has no inherent competitive advantage over a hobbyist who likes to design shoes (or feet, paws, wings or claws) for fun. Thus, says Mr Rosedale, whereas the physical world has relatively few things that are sold in huge numbers, Second Life has huge numbers of things that are sold in relatively small quantities. In the statistical jargon, Second Life's economy trades in “the long tail” of things.

This is why, for the time being, Mr Rosedale prefers to rule Second Life with Adam Smith's “invisible hand” only. To him that means treating every resident the same, whether it happens to be Toyota or “an 80-year-old woman from India.” Both will pay the same price for their acres; what they do with it is up to them. If it ever became necessary, he adds, Linden Lab could “become a regulator and break up monopolies”, but this does not seem likely to come about.

How, then, is one to make sense of Second Life? For those new to it, it appears to be too mind-boggling to have much relevance to real life. For those who spend time inside, however, Second Life ironically tends to resemble the real world even as its obvious differences become clear. Mr Kapor, Linden Lab's chairman, is the first to agree. “People bring all their karma” into the world, he says. Alongside benevolence, there is harassment. If Second Life were ever to become truly mainstream, there is no guarantee that residents would not pollute it with racism and hatred. Perhaps crime too: residents had to reset their passwords after a recent hacking attempt.

These things may be a criticism of human nature, but it cannot be blamed on Second Life. Henry Jenkins, a professor of media studies at the Massachusetts Institute of Technology, thinks that Second Life deserves credit as “a world of hypotheticals and thought experiments.” From new approaches to corporate branding to education, Second Life is a petri dish for innovations that may help people in real life. Already, therapists are using Second Life to help autistic children, because it is a safe environment to practice giving signals to others and interpreting the ones coming back. Other organisations are using Second Life for long-distance learning. Overall, says Jaron Lanier, the veteran of virtual-reality experiments, Second Life “unquestionably has the potential to improve life outside.”

November 1, 2006 at 09:11 PM in Business Models | Permalink | Top of page | Blog Home

Word of web makes British writer US bestseller

Word of web makes British writer US bestseller - Sunday Times - Times Online

Richard Brooks, Arts Editor
AN unknown British author has topped America’s fiction bestseller lists after news of her debut novel spread over the internet.

Diane Setterfield, 42, a former university lecturer, took six years to write The Thirteenth Tale after she gave up her career teaching French.

The mystery, published just three weeks ago in America, has beaten established US authors such as James Patterson and Anna Quindlen as well as the latest Frederick Forsyth to top the bestseller lists of The New York Times, The Wall Street Journal and Publishers Weekly.

Setterfield, who lives in Harrogate, North Yorkshire, is the first debut British novelist to reach number one in America since Nicholas Evans in January 1996 with The Horse Whisperer. That book had already been bought in a film deal by Robert Redford before publication, giving it a significant headstart.

The Thirteenth Tale had few reviews in conventional media and seems to have taken off because bloggers recommended it. “I suppose it’s a new form of word of mouth,” said Setterfield, who tomorrow leaves for a book tour of America.

Despite the book’s success in America, where it has sold about 70,000 copies, it has had a less enthusiastic reception in Britain, selling 600 last week.

The development of Setterfield’s fan base on the internet is similar to that which gave a kick-start to musicians such as the Arctic Monkeys, Lily Allen and Sandi Thom. Setterfield has gone from a tiny income to deals worth nearly £1.5m.

She became a lecturer in the 1990s at the University of Central Lancashire in Preston. “In the end I hated it,” she said. “Not the students but the whole admin thing. So I moved with my husband to Yorkshire. I knew I had a book in me.”

After giving up teaching in 1999, she began The Thirteenth Tale, which tells the story of a novelist who employs a biographer to write her life story, resulting in the unearthing of family secrets.

September 24, 2006 at 09:48 AM in Business Models | Permalink | Top of page | Blog Home

Universal backs free music rival to iTunes

FT.com / Companies / Media & internet - Universal backs free music rival to iTunes

y Joshua Chaffin and Aline van Duyn in New York

Published: August 29 2006 05:02 | Last updated: August 29 2006 05:02

Universal Music, the world’s largest music company, is backing a start-up that will allow consumers to download songs for free. It will rely on advertising for its revenues, offering a different business model from that of Apple Computer’s popular iTunes music store.

The move reflects music companies’ willingness to experiment as they try to capture some profit from the boom in digital distribution still dominated by illegal file-sharing networks.

ADVERTISEMENT

The service, SpiralFrog, represents a departure from Apple’s 99 cents-a-song business model and other legal download services which charge a subscription fee by being completely free. It is due to start up in December.

A report released last month by the International Federation of Phonographic Industries revealed there were still 40 illegal downloads for every legal one.

Although Apple’s iPod and its iTunes music download service has 80 per cent of the market for legally downloaded music, competition is expected to hot up in the run-up to Christmas.

This year, the IFPI has predicted that 60m music players will be sold worldwide, many of them MP3 players not compatible with Apple’s services.

As well as start-ups such as SpiralFrog, established companies are getting ready to flex their muscles. Microsoft is to launch Zune, which will offer music players and a music download store. MTV has launched Urge, a service that has downloadable music and music videos via subscription.

“Offering young consumers an easy-to-use alternative to pirated music sites will be compelling,” said Robin Kent, SpiralFrog’s chief executive and the former head of the Universal McCann advertising agency.

Mr Kent has held talks with labels Warner, EMI and Sony-BMG and hopes they will be lured by the surge in online advertising.

Merrill Lynch last week raised its forecast for the sector’s growth, predicting it would expand by 35 per cent this year in non-US markets to $11.6bn (£6.1bn). US growth is expected to increase by nearly 30 per cent to $16bn.

Perry Ellis, the fashion company, said it would advertise on SpiralFrog. Levi’s, Aeropostale, Benetton and others have expressed interest. “Our audience is into music and can be more easily reached on the web,” said Oscar Feldenkreis, president of Perry Ellis International.

Other music services are looking to advertising for their revenues. The new Napster allows consumers to listen to up to five tracks for free while they view advertising. Meanwhile, video-sharing sites, such as YouTube, have held talks with music companies about showing music videos, which would then be supported by advertising.

Mr Kent said his research revealed that young consumers would be willing to endure advertising as long as the brands and products were relevant to them.

Copyright The Financial Times Limited 2006

August 29, 2006 at 09:48 PM in Business Models | Permalink | Top of page | Blog Home

The Power of Productivity (McKinsey)

Poor countries should put their consumers first.

William W. Lewis

2004 Number 2

After the Second World War, a vast array of international and national institutions—the United Nations, the World Bank, the International Monetary Fund, and a host of nongovernment and government aid organizations—was created to better the lot of the world's poor. Conventional wisdom came to hold that improvements in infrastructure, technology, capital markets, education, and health care would eliminate the stark distinctions between rich and poor nations.¹ Fifty years and billions of dollars later, this wisdom has proved wrong.

At the beginning of the 1990s, the Soviet Union's fall precipitated a new conventional wisdom. This "Washington consensus" focused heavily on macroeconomic policies, such as flexible exchange rates, low inflation, and government solvency, while also embracing microeconomic elements—for instance, price decontrol, privatization, and good corporate governance and market regulation. Market reform swept through the world, including countries as diverse as Argentina, Brazil, India, Mexico, New Zealand, Poland, and Russia. Most were thought to be doing virtually everything needed to spark rapid growth.

But once again the results were disappointing. By the end of the 1990s, most of these countries' growth rates had returned to levels so low that the profile of the global economic landscape wasn't changing at all. Today more than 80 percent of the world's people still get by on less than a quarter of the average income in rich countries, much as they did 50 years ago.

Even worse, only a handful of countries, having moved out of dire poverty into the middle ground, enjoy a real prospect of joining the rich ones (Exhibit 1). This failure is worrisome because it means that today's poor countries will probably be poor 20 years from now. Economic development is a slow process. Even if poor countries grew at the extraordinary rate of 7 percent a year, it would take them 50 years to catch up. At current rates, it would take them a couple of centuries—if they ever did. As the tenacity of oppressive regimes and the rise in terrorism in these poor countries amply demonstrate, this gap between rich and poor is a major threat to global stability.

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Conventional solutions have failed because they don't address the real causes of persistent poverty. The Washington consensus, like the 50 years of development economics before it, is grounded in an analysis of economies at the aggregate level. But that's like trying to learn about the physical universe by using only the telescopes of astronomy; most real understanding in physics has actually come from studying the interaction of the tiniest particles in the universe. In economics, it is necessary to understand why individual companies operate as they do, since they are the ultimate sources of growth and job creation. Most economists can't afford the time and resources needed to look, in detail, at the way an entire country's economy works. They rely instead on broad national data sets and complex econometric tools that yield qualified answers at best.

At the McKinsey Global Institute (MGI) we have had, since 1990, the luxury of studying the dynamics and evolution of a representative group of industries in 13 countries: Australia, Brazil, France, Germany, India, Japan, the Netherlands, Poland, Russia, South Korea, Sweden, the United Kingdom, and the United States. In each, we analyzed the performance of 6 to 13 industries and compared it with the performance of the same industries in a handful of other countries. Our work is thus based on detailed studies of individual businesses, from state-of-the-art auto plants to black-market street vendors. It builds an understanding of the economy from the ground up, not the top down—a grassroots rather than a bird's-eye view.

This research has produced a new and unexpected understanding of the persistence of income disparities among nations. Economic progress depends on increasing productivity, which depends on undistorted competition. When government policies limit competition, even unintentionally, more efficient companies can't replace less efficient ones. Economic growth slows and nations remain poor.

It's productivity

GDP per capita is widely regarded as the best single measure of economic well-being.² That measure is simply labor productivity (how many goods and services a given number of workers can produce) multiplied by the proportion of the population that works. This proportion varies around the world—though, interestingly, not by much.

Economists must understand how individual companies—the sources of job growth—function

Productivity, however, varies enormously and explains virtually all of the differences in GDP per capita (Exhibit 2). Thus, to understand what makes countries rich or poor, you must understand what causes productivity to be higher or lower. This understanding is best achieved by evaluating the performance of individual industries, since a country's productivity is the average of productivity in each industry, weighted by its size. Such a micro approach reveals the important fact that the productivity of industries also varies widely from country to country.

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This approach yields two crucial insights. First, to understand why some countries are mired in poverty, it is necessary to look beyond broad macroeconomic policies, such as interest rates and budget deficits, and also consider the myriad zoning laws, investment regulations, tariffs, and tax codes that hold back the productivity of industries and thus a nation's prosperity. Of course, macroeconomic stability is necessary. MGI's studies of Brazil, India, and Russia show that without it companies concentrate on making money by exploiting the instability rather than by raising their productivity. Yet a stable economy alone isn't enough to make countries prosper and grow: Japan has had a stable economy for decades but has suffered from ten years of stagnation.

The second insight is the realization that the income level of a country is determined, above all, by the productivity of its largest industries. High productivity in the unglamorous "old-economy" sectors—retailing, wholesaling, construction—is most important, since more people work in them. The fabled high-tech enclaves and financial markets are less so. MGI's study of rapid US productivity growth in the 1990s found that it was caused by just six industries, including retailing and wholesaling, not by the vaunted "new economy."³ IT investments played a modest role. In India, the fast-growing IT industry has yet to raise the living standards of more than a minuscule part of the population.

Differences in productivity also explain the persistence of disparities in wealth among rich nations. Twenty-five years ago, the economies of the United States, Europe, and Japan were generally expected to converge because technology, capital, and business practices flowed freely among them and their workforces were healthy and well educated.

In fact, significant disparities of wealth remain even among rich countries. Despite Japan's world-class automotive and consumer electronics industries, for example, its average per capita income⁴ is about 30 percent below the US average. Japan has followed a path different from that of the United States and Europe (Exhibit 3): economic growth during the past 30 years has been generated more by massive increases in the number of hours worked and the amount of capital equipment used than by an increase in the productivity of the workforce. South Korea has followed a similar path. But there is a limit to the number of hours that can be worked, and massive inputs of capital that don't earn an economic return eventually lead to diminished growth. Since 1990, Japan's real per capita income has barely grown. South Korea's tiger economy is running out of steam as well.

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Barking up the wrong tree

Many economists still attribute differences in the productivity of countries to differences in their labor and capital markets. These economists therefore believe that big investments in education and health and generous development loans and grants are the keys to economic growth. MGI's research, however, found that these factors explain few, if any, differences in economic performance.

Consider education. In the early 1990s, Germany and Japan seemed to be passing the United States in economic performance. One of the principal reasons cited was the poor education of the US workforce. Since then, Japan's carmakers have built US factories that achieve 95 percent of the productivity these companies enjoy at home. Whatever the faults of the US education system, on-the-job training clearly compensates for them.

This truth holds for poor countries as well. Some of Brazil's private retail banks are as efficient as any in the world. South Korea's POSCO (formerly Pohang Iron & Steel) may have the highest productivity of any integrated steel producer. Carrefour operates with nearly the same efficiency in emerging markets and in Europe. Poor education systems haven't hindered these companies. If illiterate Mexican immigrants can reach world-class productivity levels building apartment houses in Houston, illiterate Brazilian workers can do so in São Paulo.

Similarly, MGI found that a lack of capital to finance investment isn't the main constraint on growth in poor economies. If local businesses organized and managed themselves as the world's best companies do, they would unleash rapid productivity growth. About 20 percent of India's people work in companies that are structured somewhat like those in the developed world, but their average labor productivity is only 15 percent of what their US counterparts achieve. MGI calculated that these companies could increase their productivity to about 40 percent of the US average without any additional capital investment,⁵ just by reorganizing the way they conduct work. In 1983, the high-performing Japanese auto company Suzuki Motor invested in a joint venture to make cars in India. Suzuki, which had operational control, built plants like the ones in Japan, organized the work as it is organized in Japan, and trained employees to work as they do in Japan. As a result, the productivity of these facilities is 55 percent of the US auto industry average.

Poor nations don’t have to wait to build school systems and educate a whole generation of workers

Poor countries thus don't have to wait until they build bigger and better school systems and educate a whole generation of workers. Nor do they need to wait for more development aid from rich countries. If local businesses followed the proven approaches for organizing production and managing a workforce, poor countries could grow much faster than most people realize. Domestic savers and foreign investors hungry for good returns would also supply these countries with plenty of capital for new investments.

Competition is the key

If differences in labor and capital markets don't matter, what does? In each of 13 country studies, MGI found that the primary answer was the nature of competition in product markets.

Competition is the mechanism that helps more productive and efficient companies expand and take market share from less productive ones, which then go out of business or become more efficient. Either way, consumers benefit as companies offer better goods at lower prices, and this may in turn unleash a burst of new demand.

But government policies sometimes stand in the way of competition and prevent innovation from spreading. Such policies might exclude potential competitors, such as start-ups or foreign companies, or might favor particular classes of companies, such as mom-and-pop retailers. Often, policies (zoning laws, for example) have unintended consequences for business. When they do, competition is less intense and inefficient companies aren't pressured to change. Productivity growth is slower and countries remain poor.

The Washington consensus of the 1990s profoundly underestimated the importance of a level playing field for competition. Over and over again, MGI found industries in which more productive innovators were excluded and less productive companies favored. In much of Europe, for instance, zoning laws prevent large retailers from expanding as fast as they could and therefore from replacing less efficient small retailers. Because retailing is one of the largest sectors in most economies, it has important ramifications for a nation's standard of living. For instance, Tesco, the United Kingdom's largest food retailer, has failed to obtain planning permission to build a modern supermarket on the site of a derelict hospital—broken windows and all—near central London because the building is over 100 years old. The result of such failures is lower productivity for the UK economy and higher food prices for consumers.

In Japan, a combination of zoning laws, tax policies, and government subsidies has allowed the smallest, most inefficient retailers to thrive. Today they account for slightly over half of all retailing employment, compared with less than 20 percent in the United States. In one small shop in central Tokyo, I have seen the same hat sit unsold on a store shelf gathering dust for the past 15 years. Every time I'm in Tokyo, I check to see if the hat is still there. It is. The proprietors don't have to sell it to stay in business, since they get subsidized loans. Their shop sits on some of the world's most valuable land, so they know their estate will repay the loans.

Even the United States isn't immune to policies that limit competition. The 2002 steel tariffs, which have since been declared illegal by the World Trade Organization and withdrawn, protected US steel producers from lower-cost foreign competitors. The recent increase in US agricultural subsidies does the same.

Poor countries, however, have adopted much more severe market-distorting measures. After the Soviet Union's fall, a flurry of new business activity took place in Russia. It was assumed that more productive companies would replace the unproductive Soviet ones and that Russia would rapidly become rich. But MGI found that the new Russian companies were no more productive than their Soviet predecessors. Why? More productive companies either tried to enter the market and failed or didn't bother to try. For instance, Carrefour, perhaps the best international retailer, concluded that it couldn't make money in Russia. Like virtually all multinationals, Carrefour pays taxes. The competitors it would face in Russia—the open-air markets—don't and thus have a decisive tax advantage. Before the ruble crashed in 1998, open-air markets also sold smuggled or counterfeited goods at prices Carrefour couldn't match.

A similar situation exists in Brazil. About 50 percent of its workers aren't registered with the government. Although many of these people are poor and wouldn't be taxed heavily, the total revenue forgone is substantial because of the number of workers involved. As a result, Brazil must collect twice as much in profit, employment, value-added, and sales taxes from corporations as the United States does to finance its government.⁶ When taxes are included, it costs more productive companies as much to do business as it costs less productive, informal ones, which don't pay taxes. Modern, productive enterprises can't easily take market share from their unproductive counterparts, and the economy's natural evolution is stymied.

Meanwhile, in India the government has directly limited competition by insisting that several hundred consumer goods can be manufactured only in small-scale plants. As a result, Indian consumers pay higher prices than they should, and India, unlike China, hasn't become a global center of low-cost manufacturing. (China actually exports to India.) Moreover, in housing construction, competition among developers and construction firms is based not on cost and productivity advantages but on gaining control of scarce parcels of land with clear ownership titles. Over 90 percent of land titles in India are subject to dispute, and nobody is going to invest in land someone else might claim.

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If poor countries eliminated the policies that distort competition, they could grow rapidly. India's government, for instance, abandoned many of the limits on foreign investment in the country's automotive industry during the early 1990s. Subsequently, prices fell, demand for cars exploded, and output nearly quadrupled (Exhibit 4).

The barriers to growth

The main obstacles to economic growth in poor countries are the many policies that distort competition. Why are they so pervasive?

For one thing, most people favor the social objectives that inspire high minimum wages, small-business subsidies, and other business policies. They may not be aware of the unintended adverse consequences that create major barriers to growth. Instead of attempting to achieve social objectives by limiting competition, countries should allow fair competition and thereby generate more national income, which can then be redistributed through taxes and government subsidies for the desperately poor.

Countries follow bad policies, above all, because they benefit powerful or well-connected people

Even more important, countries have bad policies because they benefit certain people. In rich countries, special interests generally aren't allowed to have their way so much that they can significantly undermine the common good. Most poor countries lack these limits. Moscow's government officials, for instance, allocate housing contracts to their cronies in the old Soviet construction companies. As a political favor to small companies that can't pay their bills, local governments in Russia prevent energy companies from cutting off their power. India's domestic retailers are wholly protected from foreign direct investment by global best-practice retailers.

In poor countries today, every domestic firm is a potential special interest that stands to lose from more competition. These unproductive firms' workers often think, mistakenly, that they too stand to lose. Certainly, the prospect of finding new work in an economy where most jobs pay near-subsistence wages is frightening. But to have healthy economies, countries must allow unsuccessful owners and managers to fail so that more productive ones can take their place. In that healthier economy, workers will find a better job market.

Think consumer

Undoubtedly, dismantling barriers to economic growth is difficult. Some firms must be allowed to go out of business, thus forcing workers to find new jobs. Industries must be opened to foreign competition, and the enforcement of tax codes and other regulations must be strengthened. And governments must stand up to special interests.

How can countries muster the political will to do all these things? The answer lies in focusing on consumers, not producers. Many people think that production itself creates economic value—an idea that sometimes makes governments protect businesses regardless of their performance. This approach is mistaken. Such people and governments fail to understand the link between production and consumption. Goods have value only if consumers want them. Otherwise sheer production does little to raise standards of living.

Most poor countries are far from having a consumption mind-set. Their governments and leaders, like those of the former Soviet Union, focus instead on output. A consumption mind-set requires some notion of individual rights, including the right to buy what you want from anybody who wishes to sell it to you. Consumers want to patronize companies that offer better products and services or lower prices. Those are the companies that survive if competition is equal. Thus, consumer interests are served when competition isn't distorted.

If policy makers in poor countries—and the many development experts who advise them—can accept this overlooked fact, those countries could unleash rapid growth. Only then will the shape of the global economic landscape begin to change for the better.

About the Authors

Bill Lewis, a McKinsey alumnus, was the founding director of the McKinsey Global Institute. This article was adapted from chapter 1 of his new book, The Power of Productivity: Wealth, Poverty, and the Threat to Global Stability (Chicago: University of Chicago Press, 2004).

Notes

¹ For more on the failure of development economics, see William Easterly, The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics, Cambridge, Massachusetts: MIT Press, 2002.

² Some people argue that indicators of health, life expectancy, and social well-being are just as important, if not more so. But men and women the world over want more than a subsistence living, and that is why millions of them emigrate from poor countries to rich ones, even doing so illegally and risking their lives in the attempt. The Soviet Union achieved military power but ultimately collapsed because it didn't provide enough consumer goods.

³ See William W. Lewis, Vincent Palmade, Baudouin Regout, and Allen P. Webb, "What's right with the US economy," The McKinsey Quarterly, 2002 Number 1, pp. 30–40.

⁴ Measured at purchasing power parity, not current exchange rates. PPP compares standards of living in different countries more accurately because it measures the amount of goods and services different currencies can command in their home markets.

⁵ Because of low labor rates, the lack of automation would prevent them from matching US productivity.

⁶Brazil's bloated government contributes to the high tax burden and thus is an obstacle to growth. It currently spends 39 percent of the nation's GDP, compared with 37 percent in the United States. Back in 1913, when the United States had the same per capita income Brazil has now, the US government spent only 8 percent of the country's GDP.

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August 16, 2006 at 11:27 AM in Business Models | Permalink | Top of page | Blog Home

The green machine

The green machine - August 7, 2006

Lee Scott is no tree-hugger. But Wal-Mart's CEO says he wants to turn the world's largest retailer into the greenest. The company is so big, so powerful, it could force an army of suppliers to clean up their acts too. Is he serious?
FORTUNE Magazine
By Marc Gunther, Fortune Magazine
July 31 2006: 2:00 PM EDT

(Fortune Magazine) -- "Doesn't it feel good to have this kind of commitment made by the company that you are part of? Don't you feel proud?"

The 800 Wal-Mart Stores employees gathered in the home office for an all-day meeting were used to this kind of rah-rah talk. Top executives from Fortune 500 companies regularly trek to Bentonville, Ark., to pay homage to one of the world's most powerful companies and to shout out the Wal-Mart (Charts) cheer.

This time, though, the cheerleading was coming from an unlikely source: Al Gore.

Wal-Mart had invited America's most famous environmentalist to show his movie, "An Inconvenient Truth." "Having the former Democratic Vice President was a shock" to some people at the company, chief executive Lee Scott told the crowd. "At least based on a couple of my e-mails."

But as the credits rolled, Gore strutted onto the stage to a standing ovation. Dressed in a blue suit and cowboy boots, he joked with the audience, answered questions in his best Southern drawl, and coyly denied that he had any plans to run for President again. (This wasn't exactly his base: He took just 32% of the vote in Benton County in 2000.)

Before heading off to dinner with Wal-Mart chairman Rob Walton and Scott, Gore delivered a parting thought: As Wal-Mart embarks on a far-reaching plan to adopt business practices that are better for the environment, he said, the world will learn that "there need not be any conflict between the environment and the economy."

Wal-Mart, you see, has decided to help save the earth.
Environmental values

Just listen to Scott. "To me," he says, "there can't be anything good about putting all these chemicals in the air. There can't be anything good about the smog you see in cities. There can't be anything good about putting chemicals in these rivers in Third World countries so that somebody can buy an item for less money in a developed country. Those things are just inherently wrong, whether you are an environmentalist or not."

In a speech broadcast to all of Wal-Mart's facilities last November, Scott set several ambitious goals: Increase the efficiency of its vehicle fleet by 25% over the next three years, and double efficiency in ten years. Eliminate 30% of the energy used in stores. Reduce solid waste from U.S. stores by 25% in three years.

Wal-Mart says it will invest $500 million in sustainability projects, and the company has done a lot more than draw up targets. It has quickly become, for instance, the biggest seller of organic milk and the biggest buyer of organic cotton in the world. It is working with suppliers to figure out ways to cut down on packaging and energy costs. It has opened two "green" supercenters.
Credibility questioned

Plenty of people won't buy it - or anything else from Wal-Mart. To labor leaders, left-wing elites, and the small-is-beautiful crowd, the $312-billion-a-year retailer stands for everything that's wrong with big business.

They see the company in a race to pave the planet and turn it into a giant emporium of cheap goods built on the back of cheap labor. The union-funded website walmartwatch.com dismisses Wal-Mart's environmental push as a "high-priced green-washing campaign."

Wal-Mart, though, has a whole lot more to worry about than convincing a few ideological critics that its eco-intentions are pure. Its business, for starters.

Its same-store sales growth has slowed down, trailing Costco's (Charts) and Target's (Charts). Its stock price is another big concern. After rising 1,205% during the 1990s, the stock has fallen by 30% since Scott took over as CEO in January 2000.

It's no wonder that inside Wal-Mart some veteran executives grouse that Scott's green crusade will be a costly distraction. Many remember the last time Wal-Mart set out an initiative this broad: founder Sam Walton's 1985 "Made in the U.S.A." campaign.

That move burnished Wal-Mart's red-white-and-blue image, but it wasn't long before critics noted that Wal-Mart continued to seek out goods from the absolute lowest-cost supplier- and typically that meant "Made Anywhere but America."

Indeed, Wal-Mart's single-minded desire to save its customers money has been its raison d'être for 44 years. Which raises two questions: Why is the world's largest retailer so determined to become the greenest? And how green can a company that operates 6,600 big-box stores really get?

Rob Walton, his son Ben, Pearl Jam guitarist Stone Gossard, and conservationist Peter Seligmann were scuba-diving off Coco Island, a lush, uninhabited Costa Rican national park populated by manta rays, dolphins, and sharks.
High-level influence

During a ten-day trip in February 2004, Seligmann, co-founder and CEO of Conservation International, a big Washington, D.C., environmental organization whose mission is to protect the world's biologically rich habitats, had been pointing out fleets of fishing boats that were destroying the delicate Costa Rican marine habitat. Toward the end of the trip, Seligmann looked Walton in the eye: "We need to change the way industry works. And you can have an influence."

Like all Sam Walton's children, S. Robson "Rob" Walton, 60, grew up in the Ozarks with a love of the outdoors. "All our family vacations were camping trips," he says in a rare interview. His younger brother John, who died last year in a private plane crash, was a conservationist. And his son Sam, who worked as a Colorado River guide, sits on the board of Environmental Defense, a nonprofit group.

About four years ago, after a trip to Africa, Rob Walton began to think about ways his family could help preserve wilderness areas through its foundation, which has assets of about $1 billion. (The Walton family's 40% stake in Wal-Mart is worth about $80 billion.)

A mutual friend then introduced Walton to Seligmann. Over the next two years the preppy ex-biologist guided Rob and his two sons on a series of adventures. They hiked in Madagascar. They took a boat trip through the world's largest freshwater wetland, in Brazil. They went diving in the Galápagos Islands.

"We spent a lot of time diving and talking," says Seligmann. The family foundation eventually made a $21 million grant to CI for ocean-protection programs, and Walton joined the group's board.

But Seligmann had another agenda, one that he finally put on the table in Costa Rica. Whatever money the foundation could contribute would pale in comparison to what Wal-Mart the corporation could do. "I suggested to Rob that Wal-Mart could be a driver of tremendous change," Seligmann says.
Huge footprint

He wasn't exaggerating. The company is the biggest private user of electricity in the U.S.; each of its 2,074 supercenters uses an average of 1.5 million kilowatts annually, enough as a group to power all of Namibia.

Wal-Mart has the nation's second-largest fleet of trucks, and its vehicles travel a billion miles a year. If each customer who visited Wal-Mart in a week bought one long-lasting compact fluorescent (CF) light bulb, the company estimates, that would reduce electric bills by $3 billion, conserve 50 billion tons of coal, and keep one billion incandescent light bulbs out of landfills over the life of the bulb.

If Wal-Mart influenced the behavior of a fraction of its 1.8 million employees or the 176 million customers that shop there every week, the impact would be huge. And because of the extraordinary clout Wal-Mart wields with its 60,000 suppliers, it could make even more of a difference by influencing their practices.

Walton was intrigued, but he had taken himself out of an operational role at Wal-Mart years ago. He didn't want to overstep his bounds. "We are really, really careful about mixing personal interests and the business," he says. Still, he agreed to introduce Seligmann to Lee Scott.
PR play

The timing was fortuitous. Scott had just undertaken a review of Wal-Mart's legal and PR woes - and it wasn't a short list. A lawsuit alleging that Wal-Mart discriminated against its female employees had been certified as a federal class action. Opponents blocked new stores in the suburbs of Los Angeles, San Francisco, and Chicago.

A study found that Wal-Mart's average spending on health benefits for its employees was 30% less than the average of its retail peers. The company's environmental record was nothing to boast about either: It had paid millions of dollars to state and federal regulators for violating air- and water-pollution laws.

For years Wal-Mart simply brushed off such criticism. "We would put up the sandbags and get out the machine guns," Scott recalls. After all, business was good. They were saving their customers billions, fighting for the little guy.

But as the upstart rural retailer grew into one of America's biggest companies and clashed with unionized competitors, it made powerful enemies. Expectations of business were rising, and Wal-Mart was failing to meet them.

A McKinsey & Co. study leaked to the press by walmartwatch.com found that up to 8% of shoppers had stopped patronizing the chain because of its reputation.

Scott wondered, "If we had known ten years ago what we know now, what would we have done differently that might have kept us out of some of these issues or would have enhanced our reputation? It seemed to me that ultimately many of the issues that had to do with the environment were going to wind up with people feeling like we had a greater responsibility than we were, at the time, accepting."

In a drab Bentonville conference room, Scott, Rob Walton, Seligmann and Glenn Prickett of Conservation International, and a friend of Seligmann's named Jib Ellison, a river-rafting guide turned management consultant, convened a pivotal meeting in June 2004. For a presentation to the man who is arguably the most powerful CEO in the world and the man who is inarguably one of the richest, the pitch was surprisingly informal.

The five men chatted about the environment and about ways Wal-Mart could improve its practices. Seligmann and Prickett talked about their work with Starbucks (Charts), which developed coffee-buying methods to protect tropical regions, and about McDonald's (Charts), which was helping to promote sustainable agriculture and fishing.

Their argument was simple: Wal-Mart could improve its image, motivate employees, and save money by going green.

If there was any group that could deliver such a message to Scott, it was CI, whose board members include former Intel (Charts) chairman Gordon Moore, BP chief executive John Browne, and former Starbucks CEO Orin Smith. CI works closely with corporations, and about $7 million of its $93 million in 2005 revenues came from such consulting arrangements.
Accepting responsibility

Scott hired CI and Ellison's management consulting firm, called BluSkye, and asked them to measure Wal-Mart's environmental impact. The assessment would include not just Wal-Mart's operations, but the impact of growing or producing all the products it sells and shipping them to stores.

Wal-Mart was defining its responsibility broadly, in a way that would bring its vast supply chain - where its environmental impact is greatest - into the picture.

About a dozen people from BluSkye, CI, and Wal-Mart spent nearly a year measuring the company's impact. Fairly quickly, the environmentalists spotted waste that Wal-Mart's legendary cost cutters had overlooked.

On Kid Connection, its private-label line of toys, for instance, Wal-Mart found that by eliminating excessive packaging, it could save $2.4 million a year in shipping costs, 3,800 trees, and one million barrels of oil.

On its fleet of 7,200 trucks Wal-Mart determined it could save $26 million a year in fuel costs merely by installing auxiliary power units that enable the drivers to keep their cabs warm or cool during mandatory ten-hour breaks from the road. Before that, they'd let the truck engine idle all night, wasting fuel.

Yet another example: Wal-Mart installed machines called sandwich balers in its stores to recycle and sell plastic that it used to throw away. Companywide, the balers have added $28 million to the bottom line.

"Think about it," Scott said in his big speech to employees last fall. "If we throw it away, we had to buy it first. So we pay twice - once to get it, once to have it taken away. What if we reverse that? What if our suppliers send us less, and everything they send us has value as a recycled product? No waste, and we get paid instead."

That was talk any Wal-Mart executive could understand, even if few knew it came straight from the pages of Natural Capitalism, an influential book by Paul Hawken, Amory Lovins, and Hunter Lovins that lays out a blueprint for a new green economy in which nothing goes to waste.

Not coincidentally, Lovins and his Rocky Mountain Institute were also hired as consultants by Wal-Mart to study a radical revamp of its trucking fleet.
Casting a wide net

Wal-Mart was pulling ideas from everywhere-consultants, NGOs, suppliers, and eco-friendly competitors such as Patagonia and Whole Foods (Charts). This open-source approach worked so well that the company decided to form "sustainable value networks" made up of Wal-Mart executives, suppliers, environmental groups, and regulators; they would meet every few months to share ideas, set goals, and monitor progress.

Today there are 14 networks, each with a focus: facilities, internal operations, logistics, alternative fuels, packaging, chemicals, food and agriculture, electronics, textiles, forest products, jewelry, seafood, climate change, and China.

Experts from the World Wildlife Federation, the Natural Resources Defense Council, and even Greenpeace have made the pilgrimage to Bentonville. "I can honestly say I never expected to be at Wal-Mart's headquarters watching people do the Wal-Mart cheer," says John Hocevar, a Greenpeace campaigner. Environmental Defense announced plans to open a satellite office in Bentonville.

Though hundreds of people are in the networks, only five Wal-Mart employees, led by corporate strategist Andy Ruben, work full-time on the initiative. Key decisions are decentralized. "If you are a buyer, sustainability is going to be your business," says Scott.

Some environmentalists who are part of the networks worry the initiative is understaffed. They say that the Wal-Mart people responsible for keeping the networks going, all of whom already had full-time jobs like running truck fleets or buying jewelry, are stretched thin.

Still, getting tree-huggers and Wal-Mart lifers in the same room led to some unexpected benefits. "Sustainability helped us develop the skills to listen to people who criticize us and to change where it's appropriate," Scott says.

His managers are learning "not to be so afraid of venturing out there, thinking that if people see our warts, they're just going to castigate us." It also gives them another reason to feel good about Wal-Mart, a sense of working for a "higher purpose," he says.

Scott, too, was filled with the zeal of the newly converted. "I had an intellectual interest when we started," he says. "I have a passion today." As a lifelong angler from Baxter Springs, Kan., Scott, who is 57, was particularly worried about pollution in the world's rivers and oceans.

He visited Mount Washington in New Hampshire, where he chatted with a maple-sugar producer about the impact of global warming. And he traded in his Volkswagen Beetle for a hybrid Lexus SUV.

Hurricane Katrina, after which Wal-Mart employees mobilized to deliver vital supplies to victims, deepened Scott's resolve. "We stepped back from that and asked one simple question: How can Wal-Mart be that company - the one we were during Katrina - all the time?"

The environmental campaign that Scott admits started out as a "defensive strategy" was, in his view, "turning out to be precisely the opposite." His people were feeling better about the company. They were saving their customers money. That was one of Wal-Mart's strengths. Another was twisting the arms of suppliers - who would soon learn all about Wal-Mart's new crusade.
Sustainable agribusiness

In the cold waters off Kodiak Island, Alaska, where the sockeye salmon are running in early June, a 45-year-old third-generation fishing-boat captain named Mitch Keplinger is having a disappointing day.

Operating under Alaska's strict regulatory regime, Keplinger and his crew labor for more than 12 hours to haul in about 1,000 pounds of sockeye, which they sell for 70 cents a pound to Ocean Beauty, a Seattle-based processor and Wal-Mart supplier. They catch another 500 pounds of pink salmon, which sells for 35 cents a pound. That's $1,050 before expenses, to be shared by the four of them - barely worth the effort.

What does that have to do with Wal-Mart? Keplinger - and fisherman like him who play by the rules - are getting killed by competition from unregulated fisheries and farmed salmon. In February, Wal-Mart announced that over the next three to five years it would purchase all its wild-caught seafood from fisheries that, like Alaska's salmon fishery, have been certified as sustainable by an independent nonprofit called the Marine Stewardship Council (MSC).

The company is working on a similar certification system for farmed fish, and it hopes consumers will come to value "brands" like MSC-certified as they do the organic label. Says Rupert Howes, chief executive of the MSC: "It's supply-chain pressure of the best kind."

Keplinger and his buyers at Ocean Beauty are watching Wal-Mart closely. Says Tom Sutherland, Ocean Beauty's vice president of marketing: "When Wal-Mart hiccups, it's all we can talk about."

It's not just Alaskan fishermen who are talking. So are corn farmers in Iowa (who want to sell more ethanol through Wal-Mart), coffee growers in Brazil (who are being promised higher prices for their beans), and factory bosses in China (who are being told to cut their energy and fuel costs).
Organic clothes, too

Wal-Mart's campaign has already turned the small world of organic cotton upside down, thanks in part to Coral Rose, a ladies' apparel buyer for Sam's Club. In spring 2004 - just before Wal-Mart held its first meeting with CI - Rose ordered a yoga outfit made of organic cotton for Sam's Club; the tops sold for about $14, the loose-fitting pants for $10. The 190,000 units sold out in ten weeks

That got Scott's attention. Sales of organic food had grown at Wal-Mart; he wondered if organic cotton could do as well. With Scott's encouragement, Wal-Mart's buyers visited organic cotton farms. They learned about the environmental risks posed by conventional cotton farming, which uses more chemical pesticides and synthetic fertilizer than any other crop.

Wal-Mart's purchases of organic cotton have eliminated millions of tons of chemicals, Scott says. Today, Wal-Mart and Sam's Club stock a range of organic-cotton products - baby clothes under the Baby George brand, teenage fashion, and a line of bed sheets and towels.

The organic-cotton industry had found its best customer. Five years ago global production of organic cotton amounted to about 6,400 metric tons, and some farmers who converted to organic methods, which can cost more, could not find buyers willing to pay a premium.

In 2006, Wal-Mart and Sam's Club alone will use 6,800 metric tons, and they've made a verbal commitment to buy organic cotton for five years, giving farmers an assurance that there will be a market for their crops.

Wal-Mart is also increasing the amount of organic food it sells, but some even find fault with this, assuming that it buys only from massive corporate organic farms. Not true. Wal-Mart buys locally in two dozen states, striving to reduce "food miles" to save shipping costs and increase freshness.
Peer pressure

Scott, meanwhile, is personally pushing his cause with Fortune 500 CEOs. He has talked with Jeff Immelt at GE about LED lighting for Wal-Mart's buildings. He's talked with Tom Faulk, the CEO of Kimberly-Clark, about "compressed toilet paper," which squeezes three rolls into one. Steve Reinemund, PepsiCo's CEO, just sold Wal-Mart on a massive recycling contest involving Aquafina water.

Wait a minute. Recycling's great. But why consume Aquafina in the first place? Bottled water is bad for the environment, period. But neither PepsiCo nor Wal-Mart will stop selling it as long as consumers want to buy it. This is one place where tensions arise between what's good for business and what's good for the planet.

Packaging is another thorny issue. On my grocer's shelf are a bulky, 100-fluid-ounce, orange plastic jug of Procter & Gamble's bestselling Tide and a slim 32-ounce aqua plastic bottle of Unilever's "small and mighty" All.

Both contain enough detergent for 32 loads of wash, but the smaller package, made possible by condensing All, saves energy, shipping costs, and shelf space - a big win all around, right?

Not quite. Bigger packages command more shelf space, provide more surface area for advertising, and suggest to consumers that they're getting more for their money. Unilever executives voiced all those worries when they went to see Scott. He agreed to make "small and mighty" All a VPI (that's Wal-Mart code for "volume-producing item," and it means that Wal-Mart will promote it heavily). "That helps to increase their confidence," he says. You can now find "small and mighty" All in supermarkets everywhere.

And guess what? This fall Procter & Gamble will replace the bulky plastic jugs with condensed, slimmed-down versions of all its liquid laundry detergents - Tide, Cheer, Gain, Era, and Dreft - in a test in Cedar Rapids, Iowa, to prepare for a likely national rollout.

We wondered if Wal-Mart had anything to do with that. "We've been doing sustainability for quite some time," replied a P&G spokeswoman. "And we're pleased to work with all our distributors, including Wal-Mart." You figure it out.

This is why Wal-Mart's eco-initiative is potentially more world-changing than, say, GE's. GE sells fuel-efficient aircraft engines and billion-dollar power plants to a few customers. Wal-Mart sells organic cotton, laundry soap, and light bulbs to millions. When shoppers see a display promoting "the bulb that pays for itself, again and again and again," they'll be reminded of their own environmental impact.

By buying CF bulbs they'll also save money on their utility bills, leaving them more money to spend at, you guessed it, Wal-Mart. The bigger idea here is that poor and middle-income Americans are every bit as interested in buying green products as are the well-to-do, so long as they are affordable.

Plenty of places sell fair-trade coffee, for example. Only Wal-Mart sells it for $4.71 a pound. "The potential here is to democratize the whole sustainability idea--not make it something that just the elites on the coasts do but something that small-town and middle America also embrace," says CI's Glenn Prickett. "It's a Nixon-to-China moment."
Eco-stores

Several weeks ago a dozen Japanese supermarket industry executives flew halfway around the world to visit a store in a suburb of Denver that is unlike any they had ever seen. They snapped pictures of wind turbines and solar cells and listened as a tour guide explained how dirty cooking oil from the deli and used motor oil from the lube department are recycled to heat the store.

They ran their fingers across jewelry cases built of renewable bamboo and peered into the dairy case at the superefficient light-emitting diodes that illuminate rows of organic milk.

The visitors wandered among shelves stocked with tuna certified by the Marine Stewardship Council and coffee endorsed by the Rainforest Alliance. They learned that spoiled food was composted into fertilizer and resold. They walked on sidewalks that are - no joke - made of recycled airport runways.

This is Wal-Mart Store No. 5334, which opened last winter. It's one of two experimental stores the company built to test ways to cut energy and reduce waste.

It sounds terribly futuristic, but this isn't totally new ground. In 1993 the company debuted a Bill McDonough - designed eco-store in Lawrence, Kan., with great fanfare. Two more stores followed, but the concept quietly died.

Wal-Mart's more serious now, but skeptics remain. Jeffrey Hollender is president of Seventh Generation, a Burlington, Vt., maker of nontoxic household products. Though Scott met with Hollender in Bentonville and offered to carry some of his line, Hollender declined. "We might sell a lot more products in giant mass-market outlets, but we're not living up to our own values and helping the world get to a better place if we sell our soul to do it," he says.

Scott understands there are some critics he will never win over. He knows that not everyone at Wal-Mart shares his vision. But he's quite certain that one person would.

Midway through the daylong sustainability summit, the one where Al Gore showed his movie, Scott did what Wal-Mart executives always do when they want to get people's attention: He invoked the name of Sam Walton.

"Some people say this is foreign to what Sam Walton believed, that Sam Walton focused solely on the customers, driving prices down so the average person can have a higher standard of value," Scott said.

"What people forget is that there was nobody more willing to change. Sam Walton did what was right for his time. Sam loved the outdoors. And he loved the idea of building a company that would endure. I think Sam Walton would, in fact, embrace Wal-Mart's efforts to improve the quality of life for our customers and our associates by doing what we need to do in sustainability."

Then he posed a challenge to the audience: "What other company in the world could do this? This company is uniquely positioned. But we will not be measured by our aspirations. We will be measured by our actions." Of that there's no doubt. This is Wal-Mart, after all. The whole world will be watching.

Reporter associates Doris Burke and Jia Lynn Yang contributed to this story. Top of page

August 13, 2006 at 02:08 AM in Business Models | Permalink | Top of page | Blog Home

Brits to spend £1.7bn on downloads by 2010

Netimperative - Brits to spend £1.7bn on downloads by 2010

By Staff
24-03-2006 04:27 PM
Related:
UK consumers will spend £1.7bn a year on downloading music, films and ebooks from the internet and on mobile phone content by the end of the decade, according to research.

The study, from online payments system PayPal, shows that spending on internet and mobile phone downloads and online gaming could account for as much as 10% of all online retail spending in the UK by 2010.

The biggest growth areas for digital downloads are the mobile and music industries, which will account for nearly nine in ten (89%) of all consumer spending on digital content.

However, by 2010, film downloads and online gaming will have become substantial markets and the e-book sector is also expected to be showing early signs of development.

Consumer spending on online music downloads will total £379m in 2010 according to the research.

The market in the UK was worth £35m in 2005, but is expected to grow ten-fold in the next five years as legal download sites such as iTunes gain greater traction.

The growth in value of legal music downloading will mean that Internet music will account for around 15% of all music sales by 2010.

The report predicts that the average UK web user will download 25 tracks and spend £15 on Internet music content in 2010 – average per-track prices will come down to around 60p as record companies continue to embrace the Internet and levels of competition between service providers increase.

Increased content and flexibility of packages are also likely to encourage more people to download more music, the research found.

Carl-Olav Scheible, general manager, UK Merchant Services for PayPal Europe said: “Consumers are going to shift more of their music purchasing to online services as devices change and digital storage becomes more prevalent and CD-use becomes less widespread.

“It will also be interesting to see what the mobile players and established online content portals do in the music arena – driving greater mass-market take-up of digital music downloads.“

Mobile services including music, movie clips and mobile TV services will create a market for digital content worth £1.14b by 2010, the report predicted, going on to say the market will grow three-fold from £380m in 2005 as the rise of 3G mobile will spur consumer spending on mobile services.

In 2005, ringtones, realtones and screensavers accounted for around two-thirds of mobile content spend, with games accounting for the majority of remaining revenues.

However, full-track music will account for an increasing proportion of content spending – UK consumers will spend over £200m mobile music in 2010. Video downloads will also increase in popularity, accounting for around 11% of mobile content spend within the next 4 years.

Meanwhile, eBooks and online gaming will be areas where substantial growth will be seen, according to the report.

The UK online film download market will be worth £109m by 2010, rising from virtually nothing today. PayPal expects online downloads in the large part to supplement rather than replace traditional means of obtaining film content (DVD purchase, DVD rental and subscription/digital TV).

However, it is likely that services such as iTunes film download will create a market for film download and that new players offering streaming “film on demand” will have started to make inroads by 2010.

UK gamers will spend £67m online in 2010, which represents 70% growth from today. The market is currently worth £39m, derived in the main from subscriptions to PC-based online services.

However, by 2010 spend on services within games – buying new levels and characters – is likely to increase to around £9m. Subscriptions for console-based services such as Xbox Live are also likely to rise dramatically.

Brits will spend £8.9mlion on eBooks in 2010 – making it the smallest of the digital content markets in five years’ time.

The Digital Content research was conducted in March 2006 for PayPal Europe by Datamonitor

April 8, 2006 at 06:02 PM in Business Models | Permalink | Top of page | Blog Home

The next revolution in interactions

The McKinsey Quarterly: The next revolution in interactions

Successful efforts to exploit the growing importance of complex interactions could well generate durable competitive advantages.

Bradford C. Johnson, James M. Manyika, and Lareina A. Yee

An introductory note

Scott C. Beardsley, James M. Manyika, and Roger P. Roberts

Economists have long tended to describe the critical shifts in the European and North American labor markets over the past 200 years as movements between broad sectors—from agricultural to industrial jobs and from manufacturing to service ones. While this assessment is certainly true, the big picture obscures important nuances in what workers and professionals actually do. The finer details of the employment landscape hold important lessons for the way companies organize to manage their talent and technology, for competition within industries, and for public policy in developed nations.

In today's developed economies, the significant nuances in employment concern interactions: the searching, monitoring, and coordinating required to manage the exchange of goods and services. Since 1997, extensive McKinsey research on jobs in many industries has revealed that globalization, specialization, and new technologies are making interactions far more pervasive in developed economies. Currently, jobs that involve participating in interactions rather than extracting raw materials or making finished goods account for more than 80 percent of all employment in the United States. And jobs involving the most complex type of interactions—those requiring employees to analyze information, grapple with ambiguity, and solve problems—make up the fastest-growing segment.

This shift toward more complex interactions has dramatic implications for how companies organize and operate. In the mid-1990s, McKinsey studied the growing impact of interactions on the way people exchange ideas and information and how businesses cooperate or compete. In 1997, "A revolution in interaction" presented the findings of that research.

Over this past year, we looked closely at different kinds of interactions. Companies in many sectors are hiring additional employees for more complex interactions and fewer employees for less complex ones. For instance, frontline managers and nurses—who must exercise high levels of judgment and often draw on what economists call tacit knowledge, or experience- are in great demand. Workers who perform more routine interactions, such as clerical tasks, are less sought after. In fact, companies have been automating and outsourcing jobs that involve many of these transactional interactions.

The article that follows, "The next revolution in interactions," shows that the shift from transactional to tacit interactions requires companies to think differently about how to improve performance—and about their technology investments. Moreover, the rise of tacit occupations opens up the possibility that companies can again create capabilities and advantages that rivals can't easily duplicate.

Finally, "Mapping interactions by industry," a Web-exclusive series of interactive exhibits, examines the way tacit workers are deployed. In some industries, for instance, they create products and services, while in others they are concentrated largely in noncore areas such as administration, finance, and IT. In addition, each industry uses a different mix of tacit and transactional workers to manage its interactions with customers.
About the Authors

Scott Beardsley is a director in McKinsey's Brussels office, James Manyika is a principal in the San Francisco office, and Roger Roberts is a principal in the Silicon Valley office.

Like vinyl records and Volkswagen Beetles, sustainable competitive advantages are back in style—or will be as companies turn their attention to making their most talented, highly paid workers more productive. For the past 30 years, companies have boosted their labor productivity by reengineering, automating, or outsourcing production and clerical jobs. But any advantage in costs or distinctiveness that companies gained in this way was usually short lived, for their rivals adopted similar technologies and process improvements and thus quickly matched the leaders.

But advantages that companies gain by raising the productivity of their most valuable workers may well be more enduring, for their rivals will find these improvements much harder to copy. This kind of work is undertaken by, for example, managers, salespeople, and customer service reps, whose tasks are anything but routine. Such employees interact with other employees, customers, and suppliers and make complex decisions based on knowledge, judgment, experience, and instinct.

New McKinsey research reveals that these high-value decision makers are growing in number and importance throughout many companies. As businesses come to have more problem solvers and fewer doers in their ranks, the way they organize for business changes. So does the economics of labor: workers who undertake complex, interactive jobs typically command higher salaries, and their actions have a disproportionate impact on the ability of companies to woo customers, to compete, and to earn profits. Thus, the potential gains to be realized by making these employees more effective at what they do and by helping them to do it more cost effectively are huge—as is the downside of ignoring this trend.

But to improve these employees' labor performance, executives must put aside much of what they know about reengineering—and about managing technology, organizations, and talent to boost productivity. Technology can replace a checkout clerk at a supermarket but not a marketing manager. Machines can log deposits and dispense cash, but they can't choose an advertising campaign. Process cookbooks can show how to operate a modern warehouse but not what happens when managers band together to solve a crisis.

Machines can help managers make more decisions more effectively and quickly. The use of technology to complement and enhance what talented decision makers do rather than to replace them calls for a very different kind of thinking about the organizational structures that best facilitate their work, the mix of skills companies need, hiring and developing talent, and the way technology supports high-value labor. Technology and organizational strategies are inextricably conjoined in this new world of performance improvement.1

Raising the labor performance of professionals won't be easy, and it is uncertain whether any of the innovations and experiments that some pioneering companies are now undertaking will prove to be winning formulas. As in the early days of the Internet revolution, the direction is clear but the path isn't. That's the bad news—or, rather, the challenge (and opportunity) for innovators.

The good news concerns competitive advantage. As companies figure out how to raise the performance of their most valuable employees in a range of business activities, they will build distinctive capabilities based on a mix of talent and technology. Reducing these capabilities to a checklist of procedures and IT systems (which rivals would be able to copy) isn't going to be easy. Best practice thus won't become everyday practice quite as quickly as it has in recent years. Building sustainable advantages will again be possible—and, of course, worthwhile.
The interactions revolution

Today's most valuable workers undertake business activities that economists call "interactions": in the broadest sense, the searching, coordinating, and monitoring required to exchange goods or services. Recent studies—including landmark research McKinsey conducted in 19972—show that specialization, globalization, and technology are making interactions far more pervasive in developed economies. As Adam Smith predicted, specialization tends to atomize work and to increase the need to interact. Outsourcing, like the boom in global operations and marketing, has dramatically increased the need to interact with vendors and partners. And communications technologies such as e-mail and instant messaging have made interaction easier and far less expensive.

The growth of interactions represents a broad shift in the nature of economic activity. At the turn of the last century, most nonagricultural labor in business involved extracting raw materials or converting them into finished goods. We call these activities transformational because they involve more than just jobs in production.3 By the turn of the 21st century, however, only 15 percent of US employees undertook transformational work such as mining coal, running heavy machinery, or operating production lines—in part because in a globalizing economy many such jobs are shifting from developed to developing nations. The rest of the workforce now consists of people who largely or wholly spend their time interacting.

Within the realm of interactions, another shift is in full swing as well, and it has dramatic implications for the way companies organize and compete. Eight years after McKinsey's 1997 study, the firm's new research on job trends in a number of sectors finds that companies are hiring more workers for complex than for less complex interactions. Recording a shipment of parts to a warehouse, for example, is a routine interaction; managing a supply chain is a complex one.

Complex interactions typically require people to deal with ambiguity—there are no rule books to follow—and to exercise high levels of judgment. These men and women (such as managers, salespeople, nurses, lawyers, judges, and mediators) must often draw on deep experience, which economists call "tacit knowledge." For the sake of clarity, we will therefore refer to the more complex interactions as tacit and to the more routine ones as transactional. Transactional interactions include not just clerical and accounting work, which companies have long been automating or eliminating, but also most of what IT specialists, auditors, biochemists, and many others do (see sidebar, "About the research").

Most jobs mix both kinds of activities—when managers fill out their expense reports, that's a transaction; leading workshops on corporate strategy with their direct reports is tacit work. But what counts in a job are its predominant and necessary activities, which determine its value added and compensation.

During the past six years, the number of US jobs that include tacit interactions as an essential component has been growing two and a half times faster than the number of transactional jobs and three times faster than employment in the entire national economy. To put it another way, 70 percent of all US jobs created since 1998—4.5 million, or roughly the combined US workforce of the 56 largest public companies by market capitalization—require judgment and experience. These jobs now make up 41 percent of the labor market in the United States (Exhibit 1). Indeed, most developed nations are experiencing this trend.

enlarge exhibit

The number of jobs that involve relatively complex interactions is growing at a phenomenal rate

The balance is tipping toward complexity, in part because companies have been eliminating the least complex jobs by streamlining processes, outsourcing, and automating routine tasks. From 1998 to 2004, for example, insurance carriers, fund-management companies, and securities firms cut the number of transactional jobs on their books by 10 percent, 6.5 percent, and 2.7 percent a year, respectively. Likewise, a more automated check-in process at airports makes for smaller airline check-in staffs, automated replenishment systems reduce the need for supply chain bookkeepers, and outsourcing helps companies shed IT help desk workers. Manufacturers too have eliminated transactional jobs.

Meanwhile, the number of jobs involving more complex interactions among skilled and educated workers who make decisions is growing at a phenomenal rate. Salaries reflect the value that companies place on these jobs, which pay 55 and 75 percent more, respectively, than those of employees who undertake routine transactions and transformations.

Demand for tacit workers varies among sectors, of course. The jobs of most employees in air transportation, retailing, utilities, and recreation are transactional. Tacit jobs dominate fields such as health care and many financial-services and software segments (Exhibit 2). But all sectors employ tacit workers, and demand for them is growing; most companies, for example, have an acute need for savvy frontline managers.

enlarge exhibit
A new path to better performance

The demand for tacit employees and the high cost of employing them are a clear call to arms. Companies need to make this part of the workforce more productive, just as they have already raised the productivity of transactional and manufacturing labor. Unproductive tacit employees will be an increasingly costly disadvantage.

The point isn't how many tacit interactions occur in a company—what's important is that they ought to add value. This shift toward tacit interactions upends everything we know about organizations. Since the days of Alfred Sloan, corporations have resembled pyramids, with a limited number of tacit employees (managers) on top coordinating a broad span of workers engaged in production and transactional labor. Hierarchical structures and strict performance metrics that tabulate inputs and outputs therefore lie at the heart of most organizations today.

But the rise of the tacit workforce and the decline of the transformational and transactional ones demand new thinking about the organizational structures that could help companies make the best use of this shifting blend of talent. There is no road map to show them how to do so. Over time, innovations and experiments to raise the productivity of tacit employees (for instance, by helping them collaborate more effectively inside and outside their companies) and innovations involving loosely coupled teams will suggest new organizational structures.

The two critical changes that executives must take into account as they explore how to make tacit employees more productive are already clear, however. First, the way companies deploy technology to improve the performance of the tacit workforce is very different from the way they have used it to streamline transactions or improve manufacturing. Machines can't recognize uncodified patterns, solve novel problems, or sense emotional responses and react appropriately; that is, they can't substitute for tacit labor as they did for transactional labor. Instead machines will have to make tacit employees better at their jobs by complementing and extending their tacit capabilities and activities.

Second, a look back at what it took to raise labor productivity over the past ten years shows that the overall performance of sectors improves when the companies in them adopt one another's managerial best practices, usually involving technology. In retailing, for instance, Wal-Mart Stores was a pioneer in automating a number of formerly manual transactional activities, such as tracking goods, trading information with suppliers, and forecasting demand. During the 1990s, most other general-merchandise retailers adopted Wal-Mart's innovations, boosting labor productivity throughout the sector.4

But in the world of tacit work, it's less likely that companies will succeed in adopting best practices quite so readily. Capabilities founded on talented people who make smarter decisions about how to deploy tangible and intangible assets can't be coded in software and process diagrams and then disseminated throughout a sector.
Tacit technology

Companies have three ways of using technology to enhance and extend the work of tacit labor. First, and most obviously, they can use it to eliminate low-value-added transactional activities that keep employees from undertaking higher-value work. Pharmacies, for example, are using robots to fill prescriptions in an effort to maximize the amount of time pharmacists can interact with their customers. Meanwhile, The Home Depot is trying out automated self-checkout counters in some stores. The retailer isn't just automating and eliminating transactional tasks; its chairman and CEO, Robert Nardelli, believes that automated counters can reduce by as much as 40 percent the time customers spend waiting at cash registers. Just as important, the new counters mean that people who used to operate the old manual ones can be deployed in store aisles as sales staff—a much higher-value use of time.

Furthermore, technology can allocate activities more efficiently between tacit and transactional workers. At some companies, for example, technology support—traditionally, tacit work undertaken by staff experts on PCs and networks—has been split into tacit and transactional roles. Transactional workers armed with scripts and some automated tools handle the IT problems of business users; only when no easy solution can be found is a tacit employee brought in.

Second, technology makes it possible to boost the quality, speed, and scalability of the decisions employees make. IT, for instance, can give them easier access to filtered and structured information, thereby helping to prevent such time wasters as volumes of unproductive e-mail. Useful databases could, say, provide details about the performance of offshore suppliers or expanded lists of experts in a given field. Technology tools can also help employees to identify key trends, such as the buying behavior of a customer segment, quickly and accurately.

Kaiser Permanente is one of the organizations now pioneering the use of such technologies to improve the quality of complex interactions. The health care provider has developed not only unified digital records on its patients but also innovative decision-support tools, such as programs that track the schedules of caregivers for patients with diabetes and heart disease. Although it is hard to determine quantitatively whether physicians are making better judgments about medical care, data suggest that Kaiser has cut its patients' mortality rate for heart disease to levels well below the US national average.

Finally, new and emerging technologies will let companies extend the breadth and impact of tacit interactions. Loosely coupled systems are more likely than hard-coded systems and connections to be adapted successfully to the highly dynamic work of tacit employees. This point will be particularly critical, since tacit interactions will occur as much within companies as across them.5 Broadband connectivity and novel applications (including collaborative software, multiple-source videoconferencing, and IP telephony) can facilitate, speed up, and progressively cut the cost of such interactions as collaboration among communities of interest and build consensus across great distances. Companies might then involve greater numbers of workers in these activities, reach rural consumers and suppliers more effectively, and connect with networks of people and specialized talent around the world.6
Competitive advantage redux

Technology itself can't improve patient care or customer service or make better strategic decisions. It does help talented workers to achieve these ends, but so, for example, do organizational models that motivate tacit employees and help them spot and act on ideas. These kinds of models usually involve environments that encourage tacit employees to explore new ideas, to operate in a less hierarchical (that is, more team-oriented and unstructured) way, and to organize themselves for work. Most of today's organizational models, by contrast, aim to maximize the performance of transactional or transformational workers. Tacit models are new territory.

The rigidity of traditional organizational models too often limits innovation and learning. See "From push to pull: The next frontier of innovation"

As a result, it won't be easy for companies to identify and develop distinctive new capabilities that make the best use of tacit interactions—new ways to speed innovations to market, to make sales channels more effective, or to divine customer needs, for instance. But at least such capabilities will also be difficult for competitors to duplicate. Best practices will be hard to transplant from one company to another if they are based on talented people supported by unique organizational and leadership models and armed with a panoply of complementary technologies. If it becomes harder for performance innovations to spread through a sector and thereby to boost the performance of all players, it will once again be possible to build operating-cost advantages and distinctive capabilities sustainable for more than a brief moment.

During the past few years, advantages related to costs and distinctiveness have rarely lasted for long: they eroded quickly when companies built them from innovations in the handling of what are essentially transactional interactions. E*Trade Financial, for instance, gained tactical advantages by optimizing transactional activities to create more efficient and less expensive ways of making trades but then watched its unique position evaporate when other discount brokers and financial advisers embraced the new technology and cut their trading fees. Cheap trades were no longer a sufficient point of differentiation.

By contrast, advantages built on tacit interactions might stand. A company could, for example, focus on improving the tacit interactions among its marketing and product-development staff, customers, and suppliers to better discern what customers want and then to provide them with more effective value-added products and services. That approach would create a formidable competitive capability—and it is difficult to see how any rival could easily implement the same mix of tacit interactions within its organization and throughout its value chain.

enlarge exhibit

enlarge exhibit
Looking forward

As companies explore how to expand the potential of their most valuable employees, they face more than a few challenges. For one thing, they will have to understand what profile of interactions—transactional and tacit—is critical to their business success and to allocate investments for improving the performance of each. Some companies will have to redeploy talent from transactional to tacit activities, as Home Depot did. Others, following the example of companies such as Toyota Motor and Cisco Systems, may find it necessary to redeploy their available tacit capacity to transformational and transactional activities, thus bringing a new level of problem solving to many kinds of transformational jobs. At the same time, it will be necessary to guard against becoming overly reliant on a few star tacit employees and to manage critical tacit or transactional activities undertaken by partners or vendors.

On the human-resources side, companies will need a better understanding of how they can hire, develop, and manage for tacit skills rather than transactional ones—something that will increasingly determine their ability to grow. Certain organizations must therefore learn to develop their tacit skills internally, perhaps through apprenticeship programs, or to provide the right set of opportunities so that their employees can become more seasoned and knowledgeable. What's more, performance is more complex to measure and reward when tacit employees collaborate to achieve results. How, after all, do you measure the interactions of managers?7

Companies will also have to think differently about the way they prioritize their investments in technology. On the whole, such investments are now intended largely to boost the performance of transformational activities—manufacturing, construction, and so on—or of transactional ones. Companies invest far less to support tacit tasks (Exhibit 3).

So they must shift more of their IT dollars to tacit tools, even while they still try to get whatever additional (though declining) improvements can be had, in particular, from streamlining transactions. The performance spread8 between the most and least productive manufacturing companies is relatively narrow. The spread widens in transaction-based sectors—meaning that investments to improve performance in this area still make sense. But the variability of company-level performance is more than 50 percent greater in tacit-based sectors than in manufacturing-based ones (Exhibit 4). Tacit activities are now a green pasture for improvement.
About the research

The next wave of performance improvements—to raise the effectiveness of tacit workers—will be far more difficult than the improvement efforts of the past. But companies that can innovate to make their complex, higher-value business activities deliver what their customers care about most will probably gain significant (and not easily duplicated) advantages in distinctiveness, quality, and cost.

We looked at the range of business activities involved in more than 800 occupations in the United States. Building on McKinsey's 1997 study, we placed every job in one of three categories: transformational (extracting raw materials or converting them into finished goods), transactional (interactions that unfold in a generally rule-based manner and can thus be scripted or automated), and tacit (more complex interactions requiring a higher level of judgment, involving ambiguity, and drawing on tacit, or experiential, knowledge). While any kind of work clearly involves activities in all three of our categories, we placed each job by determining its predominant activity. This occupational segmentation allowed us to develop a macroeconomic view of employment and wage shifts and to isolate trends in tacit interactions. We cross-checked the results with the 1997 activity-level analysis and with other economists' findings on interactions.

Then we linked the occupational analysis to the US government's industry classifications and quantified the mix of tacit, transactional, and transformational activities within and across industries. In addition, we used data from the International Labour Organization, the World Bank, and other sources to analyze these trends on a global basis. Finally, interviews with economists and with functional and industry experts throughout McKinsey helped us to identify and understand the key enablers of tacit and transactional interactions in today's companies.

Return to reference
About the Authors

Brad Johnson is an associate principal in McKinsey's Silicon Valley office, and James Manyika is a principal in the San Francisco office, where Lareina Yee is a consultant.

The authors wish to acknowledge the contributions of their colleagues Scott Beardsley, Lowell Bryan, Luis Enriquez, Dan Ewing, Diana Farrell, Sumit Gupta, Lenny Mendonca, Navin Ramachandran, and Roger Roberts, as well as of John Hagel, Professor Hal Varian of the University of California, Berkeley, and the Cisco Thought Leadership Team.
Notes

1 Lowell L. Bryan and Claudia Joyce, "The 21st-century organization," The McKinsey Quarterly, 2005 Number 3, pp. 24–33; and Lowell L. Bryan, "Getting bigger," The McKinsey Quarterly, 2005 Number 3, pp. 4–5.

2 Patrick Butler, Ted W. Hall, Alistair M. Hanna, Lenny Mendonca, Byron Auguste, James Manyika, and Anupam Sahay, "A revolution in interaction," The McKinsey Quarterly, 1997 Number 1, pp. 4–23.

3 Douglass C. North, "Institutions, Transaction Costs, and Productivity in the Long Run," Washington University at St. Louis economics working paper, economic history series, number 9309004, September 1993; Douglass C. North, "Transaction Costs Through Time," Washington University at St. Louis economics working paper, economic history series, number 9411006, November 1994; and Douglass C. North, "Institutions and Productivity in History," Washington University at St. Louis economics working paper, economic history series, number 9411003, November 1994. All are available online.

4 Brad Johnson, James Manyika, and Lenny Mendonca, US Productivity Growth 1995–2000: Understanding the Contributions of Information Technology Relative to Other Factors, McKinsey Global Institute, October 2001; Diana Farrell, Terra Terwilliger, and Allen P. Webb, "Getting IT spending right this time," The McKinsey Quarterly, 2003 Number 2, pp. 118–29; and Diana Farrell, "The real new economy," Harvard Business Review, October 2003, Volume 81, Number 10, pp. 104–12.

5 John Seely Brown and John Hagel III, "Flexible IT, better strategy," The McKinsey Quarterly, 2003 Number 4, pp. 50–9.

6 Scott Beardsley, Luis Enriquez, Carsten Kipping, and Ingo Beyer von Morgenstern, "Telecommunications sector reform—A prerequisite for networked readiness," Global Information Technology Report 2001–2002: Readiness for the Networked World, World Economic Forum, Oxford University Press, June 2002, pp. 118–37.

7 Lowell L. Bryan, "Making a market in knowledge," The McKinsey Quarterly, 2004 Number 3, pp. 100–11.

8 As measured by revenue or EBITDA (earnings before interest, taxes, depreciation, and amortization) per employee.

January 23, 2006 at 02:43 PM in Business Models | Permalink | TrackBack (64) | Top of page | Blog Home

New strategies for consumer goods

The McKinsey Quarterly: The Online Journal of McKinsey & Co.

The industry has already extracted much of the benefit to be had from improving productivity and concentrating on core brands. Meanwhile, its dynamics are changing. What comes next?

Peter D. Haden, Olivier Sibony, and Kevin D. Sneader

Web exclusive, December 2004

At first glance, the leading consumer goods companies' strategy for handling the fierce competition of the past ten years looks robust enough to carry them through the next ten. Indeed, with the industry still caught between price-sensitive consumers and powerful retailers, some of the challenges facing it remain the same.

In the 1990s the industry's executives developed strikingly similar strategies to address these issues: focusing rigorously on the strongest brands and pursuing productivity gains. The results confounded those who forecast the demise of brands and the industry's rapid consolidation. Remember "Marlboro Friday," the day in 1993 when Philip Morris slashed the price of its core cigarette brand by almost 20 percent? A business weekly wrote, "Many brands will perish or never be so profitable again."1 But such pessimists were wrong. Anyone who invested every year since 1993 in the top 50 consumer goods companies (minus the tobacco companies, whose shares were affected by liability lawsuits) received a 12 percent annual return over ten years—results that outperformed those of most industry sectors. Eight of the top ten companies of 1993 (ranked by sales) were still in the list of leaders in 2003, and roughly in the same order.

But the strategy that worked so well might have run its course. A string of recent profit warnings at big consumer goods companies hints that the industry's dynamics may be shifting in important ways. The surge of discount retailing and the spread of private-label products are putting ever greater pressure on the price of branded goods. Companies have extracted much of the financial benefit from restructuring their portfolios and concentrating on core brands. And though managers doggedly pursue further improvements in productivity, most of the obvious gains have already been achieved.
The glory days

In confronting the challenges of the past ten years, big consumer goods companies all chose much the same strategy. They began by reshaping their product portfolios through mergers and acquisitions, with the aim of becoming global leaders in a few core categories. Danone, an extreme case, went from a dozen categories to three in just a few years. These companies made acquisitions to fill geographic gaps (L'Oréal in Asia) or to strengthen a specific category (Procter & Gamble's hair-care business).

Then, most companies focused on their core brands, where they concentrated marketing and other resources, and eliminated weaker ones. Strengthened brands made it more difficult for retailers to insist on price cuts. Even the cross-category heavyweights—Kraft Foods, Nestlé, Procter & Gamble, and Unilever—concentrated on fewer brands.

Next, to reduce costs and finance growth, most companies in the industry went after productivity gains. Large savings came from global purchasing and from centralized supply chains facilitated by information technology. But plant closures were the most visible sign of the push for higher productivity: Nestlé and Unilever each disposed of more than 100 manufacturing sites in the past few years alone.

For many companies, this strategy created a virtuous circle. Productivity gains financed investments in marketing and product innovation. Brands gained market share and expanded internationally. Their growth unleashed further productivity gains as burgeoning companies generated new economies of scale. Contrary to conventional wisdom, it did not take a unique, creative strategy to win; companies of different sizes successfully applied the same approach. The key lay in how well, and how quickly, they executed it.

Their results were impressive. A composite index of the top 50 consumer goods companies, excluding tobacco, shows that over the past decade gross margins improved by an average of five percentage points and earnings before interest, taxes, and amortization (EBITA) by four percentage points. The strategy has weaknesses, however.

First, it is proving difficult to propel the virtuous circle beyond portfolio restructuring and core brands. Acquisitions did make up for the lack of organic growth and helped increase margins as companies reaped the benefits of postmerger synergies. But they were costly: the industry-wide return on capital has been flat since 1998 as the amortization of billions of dollars in intangibles and goodwill absorbed from these acquisitions weighed on corporate balance sheets (exhibit).
Chart: Margins rise while returns fall flat

Another worry is that the easiest savings from improvements in purchasing, logistics, and manufacturing have already been pocketed. The move to centralized purchasing, for example, saved plenty of money but can take place only once; furthermore, the savings were achieved in a decade of favorable raw-material costs. The industry's strategic position is also troubling. Retailers continue to consolidate, adding to the bargaining power of the bulked-up survivors, and discounters continue to grow, especially in Europe, where chains offering inexpensive private-label and branded goods are gaining strength.
Where now?

Given this list of concerns, senior management could be excused for wondering how companies will grow. In our view, they must accelerate the pace at which they build capabilities in core functions, because day-to-day execution is—and will remain—an important factor for success. They must also serve emerging markets better, respond to the growing emphasis on value in advanced countries, and reap the benefits of scale and scope. Finally, we believe, some companies will strike out in bold new directions: outsourcing, entering new service businesses, or developing product categories that others have shunned.
Improving execution

Discipline in execution is nothing new, but it remains a top priority, despite the likelihood of decreasing returns. The important point is that big differences in the performance of companies persist; in other words, superior capabilities can be built and exploited. In the coming years, success will require ever sharper capabilities in the four main areas that sustain consumer goods companies: brand marketing, sales, innovation, and the supply chain. Average performance and best practices have improved spectacularly in each area compared with a decade ago. Tomorrow's winners will be the companies that not only adopt and roll out best practices more quickly but also introduce new approaches, often borrowed from other industries.

Marketing effectiveness remains a big source of gain for consumer goods companies; most, for example, are still struggling to maximize the value of trade spending—the money passed on to retailers to promote sales. Given how much money these companies invest in marketing, and the declining productivity of traditional advertising in many markets, managers will be under increasing pressure to allocate resources wisely across not only brands but also marketing tools and consumer segments. In sales, managing relations with retailers and the customer interface they control will be particularly important for the biggest multicategory companies, which will seek to take advantage of scale and scope.

Although every consumer goods company views innovation as vital, few are happy with what they have accomplished in this respect, especially compared with pharmaceutical and consumer electronics companies. The most successful consumer businesses will treat innovation as a strategic and organizational challenge, striving particularly to blur the distinction between home-grown and external ideas (obtained through acquisitions or partnerships) and tailoring their approaches to different types of innovation.

Some leading companies will also find ways to squeeze more efficiency from their supply chains by offshoring some of their operations, employing new technologies (such as radio frequency identification tags to track inventories), or redesigning processes to reduce waste and variability, as manufacturers in other sectors have done.
Winning in emerging markets

Although almost all consumer goods companies are active in countries such as Brazil, China, and India, few take advantage of their full potential. Many concentrate on the minority of the population that can afford expensive, Western-style goods, leaving local competitors to target the overwhelming majority of consumers with modest means. The locals have the edge in supplying neighborhood stores, which global companies find harder to reach, and have held off the big players by selling some products at very low prices while nonetheless generating profits. The Peruvian soft-drink maker Kola Real, for example, has gained ground not only in Peru but also in the large and profitable Mexican market.

It is hardly news to senior executives that big consumer goods companies must tailor their products to meet local needs; indeed, companies such as Procter & Gamble in China and Unilever in India have had some success with that formula. But many others still find it hard to come to grips with the big changes required in branding, distribution, and manufacturing strategies. Competing for the mass market in developing countries means rethinking the way things are done—not easy for huge, successful organizations. Those that do well there will become truly global corporations and will shake up the industry's balance of power.
The value conundrum

Serving value-conscious consumers in mature markets is also increasingly necessary. This notion might seem counterintuitive, since many companies have focused on introducing expensive innovations at the premium end of their markets. Nonetheless, though the premium segment is growing in many categories, the shift toward value is a more important trend for companies that mainly target the mass market. Retreating to a narrow premium segment might make sense in categories such as vodka but would prove self-defeating in household cleaners. In addition, price competition stalks the premium segment: a growing number of retailers, such as the United Kingdom's Tesco, excel at offering consumers premium private-label alternatives.

The growth of discounters has accelerated the trend toward private-label goods and split companies into two camps. A few hard-liners continue to make and market only branded products and deploy marketing and sales skills to defend their share at the low end of the market. Many other manufacturers, in a spirit of "if you can't beat them, join them," supply retailers with private-label products, at least in some categories and countries. A number of paper-product companies, for instance, have developed a sizable private-label business outside their home markets while retaining a strong branded domestic business.

To decide which approach to take, companies must weigh their strengths and weaknesses. Those whose brands are below second or third place in market share and don't occupy a clearly defined niche might find making private-label goods the most attractive option. The same goes for companies that can't sustain the advertising and research spending needed to keep brands on top.

But underestimating the risks would be dangerous: private-label supply is no longer an amateur sport. The skills required to stand out in that business are different from the core know-how of a supplier of branded products—not just in manufacturing but also in product development, logistics, and sales. The decision to develop those new skills must be a conscious, strategic one, not an afterthought.
Exploiting scale and scope

The biggest companies are still trying to figure out how to wring a competitive advantage from global scale and broad scope. The aggregate financial and economic performance of industry heavyweights such as Kraft, Nestlé, Procter & Gamble, and Unilever, for example, hasn't been markedly different from that of the category champions, which compete in a more focused range of products. We can imagine two extreme scenarios.

One is that single-mindedness, responsiveness to consumer needs, and the ability to move quickly will continue to help category champions match or beat the giants' performance. Some of these champions will continue to consolidate fragmented categories—a trend that has already affected categories such as beer and some segments of personal care, among others. A handful, aiming to defend their independence, might join forces in mergers of equals, thereby avoiding the acquisition premiums that have hurt the industry's performance in the past. Others will seek to defend their independence by entering into alliances and joint ventures to find new avenues for growth (as PepsiCo and Unilever have done in tea-based drinks). Ultimately, new category champions will emerge as the heavyweights spin off some of their categories or break themselves up into several companies. This development would represent the final triumph of the focused category champion model.

In the alternative scenario, the heavyweights would find creative organizational solutions to the traditional trade-offs between the global management of a number of categories and brands, on the one hand, and local responsiveness, on the other. These companies would harness their considerable resources, for example, to pioneer breakthroughs in fundamental technologies. The payoff from using electronic identification tags to track inventories more efficiently would make it easier to swallow that technology's high cost. And they and some retailers would develop strategic partnerships leveraging scope advantages based on better insights into shoppers' preferences. Companies that succeed with these strategies will be in a good position to justify acquisitions—prompting a new wave of industry consolidation and challenging the prevailing orthodoxy that favors category champions.
Try unorthodox strategies

Some companies now limited by the orthodox approach might consider quite different strategies to spur growth. They have several innovative options.
New business models

Traditionally, consumer goods companies have been vertically integrated: they design, make, market, and sell their products. Increasingly, however, they will depart from this model and outsource some or all of their production to third parties—a trend that has already started in apparel and consumer electronics. The final form these consumer goods companies take will differ markedly from one category to another, but a range of business models could replace the integrated monoliths that now dominate. Contract manufacturers that make but don't brand products, for example, will coexist with pure branding companies that do no manufacturing. Often the former will build capacity by acquiring and restructuring assets from the latter.

This approach is less radical than it sounds. Coca-Cola and many other beverage companies routinely outsource bottling operations. High-end perfumes often come from contract manufacturers. And in some segments, such as home and personal-care products, the outsourcing strategy is steadily gaining ground: the contract manufacturer Budelpack, based in the Netherlands, recently announced its acquisition of manufacturing assets from Colgate-Palmolive, Henkel, Sara Lee Corporation, and Unilever.

Where brands continue to rule, the rationale for outsourcing is simple: management can concentrate entirely on dealing with customers and consumers—the main engines of growth. Indeed, many companies find that they can think more creatively about developing new products and stretching their brands into new categories when they no longer have to worry about keeping factories occupied. This approach would also promote a great leap in a company's return on capital employed.

The supply company too can create value. A management team focusing 100 percent on operations is better placed to build skills and generate improvements than the management of an integrated company. Operational excellence has a direct impact on profits; our evaluation of the best pure private-label suppliers shows that their profitability is on par with that of their average-performing branded counterparts. Moreover, the prospects for growth are better, since supply companies can produce goods for a variety of customers and tap into the growing market for value-oriented products.

Not every maker of branded goods should play this game. In some cases, proprietary manufacturing expertise is a source of competitive advantage that cannot be risked, even with watertight contracts to protect products and processes. In other categories, margins are too slim and the potential to cut costs is too slight for profits to be shared with a contract manufacturer. Concerns about product safety or the sourcing of ingredients are also easier to address with in-house operations. To decide whether outsourcing makes sense, companies need to assess each product and category in individual geographic regions—and, of course, evaluate possible suppliers.
Venturing into services

Nestlé's Nespresso system—gourmet coffees individually packaged for use in special espresso makers and sold through the mail and boutiques—is a service that extends a product. Another example: the drinking fountains and bottled water supplied by Danone Waters' home- and office-delivery division to 1.7 million residential and business customers in the United States.

These businesses and other successful forays into the world of services share several important characteristics. They have real consumer appeal and avoid head-on competition with mainstream retailers. They are managed separately from the core of the enterprise to avoid stifling them with big-company controls, costs, and attitudes. Most important of all, their senior executives understand that developing new businesses takes time and that nascent ones cannot be measured by the same yardsticks applied to established brands.

The move toward services is challenging. It requires new skills and runs the risk of damaging core brands by stretching them into territory that is hard to control. Moreover, during the initial growth phase, returns are paltry compared with those from a core business. Still, as consumers everywhere demand more service, some companies will find ways to provide it. In principle, any corporation, whether large or small, could enter this new arena, but the bar is high: you need not only creativity to invent attractive concepts but also determination to realize them.
The forgotten categories

A handful of companies might gain an advantage by focusing on product categories, such as traditional grocery products and canned foods, that global operators have forgotten. While multinational companies were busy consolidating, a new breed of consumer goods player stealthily gained ground: private equity firms that acquired local businesses in categories that multinationals were divesting or ignoring.

So far, the evidence suggests that firms such as BC Partners and Hicks, Muse, Tate & Furst have been highly successful in the industry. Their formula is well-known: acquire a stand-alone business, either from independent shareholders or from a multinational reshaping its portfolio, add financial leverage consistent with predictable cash flows, and give management the incentives and authority to improve the performance of the acquisition. After spending a few years building it up, such firms sell it—to a trade buyer, another private equity firm, or the public through a stock offering.

This approach provides a template for some consumer goods companies searching for growth. They can optimize a portfolio of local businesses—concentrating on categories that are too small or fragmented for the giants—without much regard for the synergies among them. Usually, these categories (which include some canned foods, breads, fresh-and-ready meals, and seafood) are relatively small, sensitive to local tastes, or dependent on local supply chains.

The industry's largest companies might have difficulty playing such a game: after all, they have spent the past decade getting rid of small brands and would have a hard time explaining an about-face to investors. But some midsize consumer goods companies could make this a viable strategy. They have little hope of becoming global category champions, because they lack the brands, the marketing capabilities, and sometimes the financial wherewithal. Rather than mimicking the global giants, they could adopt a different mind-set and organizational model, taking the private equity firms as their inspiration.

Ever greater price competition means that the pace of change in consumer goods is likely to accelerate. The companies best placed to thrive will be those prepared to take their quest for growth into new arenas.
About the Authors

Peter Haden is an associate principal in McKinsey's London office, Olivier Sibony is a director in the Paris office, and Kevin Sneader is a director in the New Jersey office.

The authors wish to acknowledge the contributions of Christian Barker, Peter Freedman, and Nicola Calicchio Neto.
Notes

1 "Brands lose shelf space," Economist, June 5, 1993.

January 23, 2006 at 02:40 PM in Business Models | Permalink | TrackBack (28) | Top of page | Blog Home

Boosting government productivity

The McKinsey Quarterly: Boosting government productivity

To pay for the care of the elderly, developed societies face plummeting levels of public services for everyone else—and soaring taxes. Productivity could be the answer.

Thomas Dohrmann and Lenny T. Mendonca

2004 Number 4

The costly retirement of 76 million US baby boomers will swell the ranks of the elderly to more than 20 percent of the population of the United States during the next 20 years. In Europe and Japan, the elderly will come to account for more than 30 percent of the population during the same period. This transformation is about to create a new sense of urgency to get the most from every government dollar. Public services beyond health care and pensions for seniors will face epic squeezes, and officials will struggle to balance the needs of retirees and younger citizens while still holding taxes to politically acceptable levels. Boosting the government's performance will be an imperative no country can ignore.

To be sure, attempts have been made before. In the United States, former Vice President Al Gore's efforts to "reinvent government" in the early 1990s scored some successes. The administration of President George W. Bush has made efforts to reform civil service rules that inhibit some sensible management practices. The Government Accountability Office (formerly the General Accounting Office) has shown perennial leadership in prodding government departments to address their management challenges. In the United Kingdom, Peter Gershon's recent review of government efficiency1 has galvanized work to improve productivity across the public sector, with a target of £20 billion in savings by the end of 2008.

But veterans of reform efforts agree that they have barely begun to scratch the surface of the government's performance potential. One reason is that reforms take sustained attention—often rare when they become caught up in partisan or interest group politics. What's more, political cultures remain oriented to legislation, not to executing and managing programs. Few people make their name by improving the way government runs.
Chart: A large share

Nonetheless, the coming era's extraordinary fiscal pressures will force leaders to overcome these obstacles. In the developed world, the state commands a large share of the economy, so improving the performance of government departments can generate hundreds of billions of dollars of value (Exhibit 1). Our experience working with public institutions in 50 countries has shown us that the opportunity, though hard to capture, is large enough to take some of the sting out of the hard choices that aging societies face. With the first baby boomers becoming eligible for retiree health and pension benefits in just a few years, there is no time to lose.
The size of the prize

Layoffs often lead to poorer service and thus to lower productivity; boosting productivity can bring both cost savings and better service

Productivity lies at the heart of government performance. Although many people think that improving productivity is synonymous with cost cutting and layoffs, this misconstrues its real meaning: the amount and quality of the goods and services that can be generated with a given set of inputs. Improved productivity can certainly be achieved by reducing inputs, but it can also come from increasing the quality or quantity of the output. In fact, layoffs often lead to poorer service and thus to lower productivity; perhaps paradoxically, boosting productivity can bring both cost savings and better service.

Either way, rising productivity—whether in the public or the private sector—is the key to rising living standards. In the US semiconductor industry, for instance, productivity growth averaged 75 percent a year from 1993 to 2000 because of advances in processing speed. The price of chips stayed roughly the same, but since they were more powerful and valuable to consumers, the industry's productivity increased. In the public sector, improving educational outcomes or reducing recidivism among criminals could likewise raise productivity even if more money was spent to do so. Collecting a higher percentage of the taxes owed by people and companies would improve the productivity of tax departments.
Chart: The rewards could be great

Huge potential savings or quality improvements could come from raising government productivity, which in ten years could increase by at least 5 percent in the United States and perhaps by 15 or 20 percent—estimates that are almost certainly conservative. The potential gains in other countries are equally impressive (Exhibit 2).

Admittedly, estimating the public sector's productivity is problematic because some of the data are sketchy at best. From 1969 to 1994, the US Bureau of Labor Statistics (BLS) experimented with productivity measures for key government functions, only to stop because of budget cutbacks and the waning interest of policy makers. The BLS metrics used results reported by government agencies and, in some areas, were not adjusted for the quality of services and value added. Yet even imperfect information offers a basis for assessing the value at stake.

To estimate the potential productivity gains, we start by comparing the productivity growth rates of the private and public sectors. For the United States, we use national-accounts data for the private sector and data from the Federal Productivity Measurement Program for the public sector. Of course, these two data sets use different selection and measurement methods, so it isn't possible to compare absolute productivity levels. But we can use the data to compare each sector's productivity growth rates and thereby to produce at least a rough estimate of the value at stake from improving government productivity.2

The data show that productivity in the public and private sectors rose at roughly the same pace until 1987, when a gap appeared (Exhibit 3). The private sector's productivity rose by 1.5 percent annually from 1987 to 1995 and by 3.0 percent annually thereafter. In contrast, our best estimates show that the public sector's productivity remained almost flat, rising by just 0.4 percent from 1987 to 1994, when the BLS stopped measuring it. No evidence suggests that since then it has experienced the growth spurt enjoyed by the private sector. A similar and growing gap appears in the United Kingdom as well.3 Data on government productivity in other countries are not available. If the US public sector could halve the estimated gap with the private sector, government productivity would be 5 to 15 percent higher in ten years, generating $104 billion to $312 billion annually.
Chart: The public sector lags

Is it fair, though, to compare productivity growth in the public and private sectors? The economist William Baumol famously noted in 19674 that services may lag behind manufacturing in productivity because their labor-intensive nature makes it hard to apply cost-saving technological innovations: it will always take the same amount of time for a teacher to read a story, for instance, or for a nurse to give a shot. In this view, since the public sector largely provides services such as education, health care, and law enforcement, there is little scope for productivity improvements.

Most government activities have private-sector analogs; processing Social Security payments resembles processing insurance claims

Yet Baumol's reasoning may not be as conclusive for government today as it seems. Technology is just beginning to change the nature of service delivery in health care and education fundamentally. Moreover, most government activities have direct private-sector analogs. Processing Social Security payments or tax returns resembles processing insurance claims. Managing logistics and real estate is much the same in the public and private sectors. So is procurement. Private enterprises have found ways to boost their performance substantially in each of these areas, and there is little reason to think that the public sector can't.

Our estimate of the size of the opportunity is also in line with work done by other credible researchers. John Wennberg and his colleagues at Dartmouth College, for instance, found that productivity in health care could increase by up to 25 percent.5 Their work shows that the substantial regional variations in US Medicare costs are not associated with differences in access to health care, its quality, or health outcomes. Reducing costs in all regions to those in the lowest quintile (adjusted for differences in the prevalence of illness, medical prices, age, sex, and race) would cut annual Medicare spending by about 20 percent without affecting the recipients' standard of care.6 Such a transformation implies a productivity increase of 25 percent. Furthermore, David Brailer, the new national coordinator for health information technology at the US Department of Health and Human Services, estimates that widespread modernization of the IT infrastructure will eventually reduce national health costs by 10 percent through administrative and clinical savings. Business Executives for National Security found that the Pentagon wastes up to 10 percent of its budget compared with more efficient private-sector organizations in functions such as housing, inventory management, payroll processing, and travel. Whatever the precise figure, all evidence points in the same direction: the opportunity to improve government productivity is huge.
Boosting the performance of government

Let us be clear: calling for a new focus on government productivity isn't meant to serve as a justification for thoughtless cuts in government spending or for "union bashing" inspired more by ideology than by a quest for effectiveness. Nor is it meant to induce complacency in the face of the hard budget choices that aging societies will face.

Instead, our call to action is meant to promote a necessary conversation on the role that government productivity can play in making the coming fiscal challenges more manageable and humane. In an era of permanent fiscal pressure, liberals should welcome a more efficient government to assure that more money is available for social needs. Conservatives should welcome it to help keep taxes at levels consistent with strong economic growth. Rightly understood, better performance by government can become that rare arena in which common ground is possible.

Over the past decade, a handful of public-sector organizations around the world—schools, public-welfare agencies, health care systems, postal and transit systems, and militaries—have improved their performance by 5 to 30 percent or more. Often they have chosen among three classic management tools to raise productivity: organizational redesign, strategic procurement, and operational redesign. In the most effective cases, these tools were part of a broader program of cultural change that transformed the organization's performance and measured it rigorously.7
Organizational redesign

A redesign that focuses on the end "customer," eliminates duplication, and streamlines processes can improve both the cost and the quality of services (see "Organizing for effectiveness in the public sector"). Consider the experience of the US state of Illinois. In 1997 it put public-aid programs from six separate departments under a single roof. Previously it had been necessary to approach each of them separately and to give them the same information, even though more than half of their 1.8 million customers received more than one service. The new Department of Human Services is a one-stop shop ensuring that recipients get all of the services they need—in the past many of them hadn't—and eliminating the duplication of programs and back-office processes. As a result, the department has redeployed money and staff to new programs, such as an early-intervention initiative.

The German Federal Employment Agency (Bundesagentur für Arbeit) is also reorganizing, amid a controversial and often bitter public debate about the future course of German social and labor policy. Headquarters have been shrunk down to 400 staff members, from 1,100, and operational responsibilities have in effect been decentralized to ten regional divisions. The radical redesign of local agencies and their service offerings has been successfully prototyped and now gives customers tangible benefits, such as halving waiting times and doubling the amount of time available for counseling. These changes have led to much higher customer satisfaction levels.
Procurement

Improving supplier-management and purchasing operations can help organizations cut their expenditures while raising the quality of the goods and services they buy. Governments mounting such efforts usually standardize and consolidate orders, designate preferred suppliers, reward them for meeting delivery and quality targets, and collaborate with them on ways to improve production processes and reduce costs. Government regulations sometimes make revamping public-sector procurement difficult, but enormous progress can still be made: Illinois saved more than $100 million in fiscal year 2004 and expects to save more than $200 million in fiscal year 2005 (see sidebar "How Illinois cut its purchasing bills"). For many items, the state is getting better quality.

Sometimes procurement officials cut costs dramatically by understanding the suppliers' economics. A US federal agency, for example, recently renewed an IT contract with outside vendors. By building a detailed model of the suppliers' costs and benchmarking their individual components, it negotiated prices that were more than 60 percent lower than the first set of competitive bids it received and will save several hundred million dollars over the term of a five-year deal.

These are not unique opportunities: Most government agencies could improve their procurement processes. The state of Tennessee, for instance, is projected to save more than $300 million annually in Medicare and Medicaid costs, without any changes in health outcomes, by purchasing the cheapest drugs available rather than name-brand ones. Schools throughout the United States have saved 10 to 35 percent on food, janitorial services, textbooks, and transportation by purchasing them more astutely. (Large school systems can save $30 million to $40 million a year in this way.) Military and security spending is an even bigger opportunity, in part because it accounts for more than 70 percent of total government contracting. The United Kingdom is trying to capture this opportunity through its Smart Acquisition program, a set of reforms designed to reduce bureaucracy, cut procurement costs, and speed up the delivery of equipment.
Operational redesign

Redesigning operational processes to reduce waste, eliminate unneeded effort, and correct mistakes quickly can also raise productivity to an astonishing extent. Consider the experience of the United States Postal Service (USPS). Since 1999, the number of addresses it serves has increased by seven million—nearly equivalent to the number of addresses in the entire Chicago metropolitan area. Nonetheless, the USPS has saved $5.5 billion by replicating the best practices of the best sorting plants and by improving its delivery and counter operations. In this way, it cut its full-time workforce to 69,000, mainly through retirement and normal attrition, and increased its productivity by 6 percent. Customer satisfaction ratings and other service-quality metrics are at all-time highs (see sidebar "You have mail, efficiently").

"E-government" initiatives too can radically improve service and customer satisfaction while reducing costs by 25 percent or more.8 In Singapore, an export license that formerly required 21 forms and took three weeks to process now involves one online application that can be approved in 15 seconds. The US Internal Revenue Service can process an online tax return for just $0.40, compared with $1.60 for a paper return, and the Arizona Department of Transportation can renew a driver's license online for $1.60, compared with $6.60 at a branch office. Combining online delivery with a redesign of the back-office processes supporting it can realize cost savings of 35 to 40 percent—while customer satisfaction soars.
Overcoming the barriers

If governments could improve their performance easily, they would have done so already. In fact, they face unusual challenges. Competition is the most important missing element. More than a decade of McKinsey Global Institute research around the world shows that monopolies, businesses protected by government regulation, and other private-sector companies without competitors nearly always have very low productivity.9 Without competition, managers have little incentive to take risks on new techniques.

For governments, the solution is creating competition to provide services and giving citizens the ability to choose among these alternatives. Charter schools, for example, create competition in public education. Outsourcing back-office services such as procurement, real-estate management, and payrolls and benefits creates competition in these functions. Allowing private-sector companies to bid on social-service contracts lets them compete with government providers.

When creating competition in the public sector isn't possible, its leaders can devise other incentives. For one thing, managers can be prodded to meet targets if governments budget in expected performance improvements; in the United Kingdom, the Gershon review of the public sector's efficiency has given each government department three-year productivity targets covering financial savings and head count reductions while at the same time ensuring that services will continue to be provided. Making the performance of governments more transparent by publishing the results of customer satisfaction surveys, benchmarking surveys, and service-quality metrics also helps citizens to take an active role in demanding change.

If the execution challenges are daunting, the principles and prerequisites for success are clear. When public-sector operations become more transparent, accountability increases. Benchmarking and tracking performance help managers to raise their game. Exposing activities to competition improves service and cuts costs. The keys are committed leadership, a critical mass of talent, processes that budget for productivity targets, and citizens who know that they have a stake in a better outcome and hold officials accountable for achieving it. One way of building public confidence and media support and of stoking the appetite for change is to design the reform effort so that it delivers high-profile early victories.
If not now, when?

Given the magnitude of the opportunity, there are only two paths forward. The first—government as usual—ensures that in the decades ahead citizens will pay higher taxes and receive fewer, lower-quality services while financing the baby boomers' retirement. Public alienation seems likely to deepen just when governments already face a talent crisis as a generation of managers heads toward retirement.

The other path—developing a serious and sustained agenda to boost performance throughout the government—won't be easy. But as part of a broad national effort to meet the challenge of an aging population, it could draw new talent to public service at a crucial moment. Today governments at all levels face an unprecedented loss of talent and institutional knowledge. Nearly three-quarters of all senior federal executives could retire in the next few years; in California, nearly a third of the state's entire workforce could. To inspire a new generation capable of filling the shoes of these retiring leaders, government must transform itself.

The public sector has guided some of history's most extraordinary management feats, from the Manhattan Project to space flight

If leaders of governments started to think differently about how they do and could work, the results would surprise the cynics. The public sector, after all, guided some of history's most extraordinary management feats, from the Manhattan Project to space flight to bullet trains to smallpox eradication. An agenda to revitalize government could make citizens more engaged with it, initiate a virtuous cycle of continual improvement, and ease the impact of an aging society (see sidebar "A part of the answer for aging populations?").

Even without a broad mandate, visionary government executives can begin making real progress on productivity in their own organizations. The leaders of the German Federal Employment Agency, Illinois, and the USPS have shown the enormous gains that can be made. By starting with less politically charged areas, such as procurement, government leaders can gain the experience and credibility to tackle more sensitive ones, including education and health care.

Unprecedented fiscal pressures that are only a few years away should promote a new kind of national conversation, in which shibboleths can be rethought. Leaders at all levels of government must consider how their own organizations can immediately start to plan and implement the performance improvements that advanced nations will desperately need. The time for action is now.
A part of the answer for aging populations?

If sustained growth in public-sector productivity began now, it could contribute to some easing of the looming fiscal crisis that will accompany the rapid aging of the populations of developed countries. The Organisation for Economic Cooperation and Development (OECD) estimates that by 2050 public expenditures will have increased by an average of 6 percent of GDP to accommodate the needs of retirees.1 But the Center for Strategic and International Studies (CSIS) argues that these projections are too optimistic and that increases in spending could amount to more than 12 percent of GDP by 2040.2 Using assumptions lying somewhere between those of the OECD and the CSIS, we estimate that spending will increase by 8 percent of GDP in the United States, where higher birth and immigration rates are expected to make the impact of aging less dramatic than it will be in other advanced countries, and by more than 10 percent of GDP in Germany, where the aging trend is more pronounced.

The usual options for controlling the massive expenditures that will soon be needed to accommodate the elderly are reducing the level or growth of government benefits for them, cutting public services for the rest of the population, and raising taxes. Enhancing public-sector productivity could make any of these options less painful. In fact, raising it by an extra 1.4 percent a year in the United States and by an extra 1.6 percent in Germany would let their governments sustain current levels of public services and social-welfare benefits, without additional taxes or borrowing.

These are undoubtedly very large improvements, but they might be possible. After all, from 1987 to 1994 the private sector's productivity growth rate in the United States was 1.0 percent higher than the best estimate for that of the public sector. In the United Kingdom it was 1.8 percent higher from 1995 to 2001. Even if reducing the gap doesn't eliminate the fiscal impact of aging populations on its own, it could take some of the sting out of the hard fiscal choices societies will face coping with them.
Notes

1 Pablo Antolin, Thai-Thanh Dang, and Howard Oxley, Fiscal Implications of Ageing: Projections of Age-Related Spending, OECD Economics Department working paper number 305 (2001). (Acrobat PDF 181Kb)

2 Neil Howe and Richard Jackson, The 2003 Aging Vulnerability Index, Center for Strategic and International Studies and Watson Wyatt Worldwide, Washington, DC, 2003 (Acrobat PDF 470Kb); and Richard Jackson, The Global Retirement Crisis, Center for Strategic and International Studies and Citigroup, Washington, DC, 2002 (Acrobat PDF 2.4Mb).

Return to reference

Two sidebars to this article show how public agencies have boosted their productivity:

How Illinois cut its purchasing bills
By centralizing procurement processes, the state realized benefits from volume discounts, renegotiated contracts, and a more accurate picture of its long-term costs of ownership.

You have mail, efficiently
When the US Postal Service discovered that its best mail-sorting plants were twice as productive as some of the others, it implemented improvement targets and incentive programs to spread best practices throughout the organization.
About the Authors

Thomas Dohrmann is an associate principal in McKinsey's Washington, DC, office, and Lenny Mendonca is a director in the San Francisco office.

The authors wish to thank Paul Callan, Diana Farrell, and Pamela Keenan Fritz for their thoughtful input into this article.
Notes

1 Peter Gershon, Releasing Resources to the Front Line: Independent Review of Public Sector Efficiency, July 2004.

2 For a full description of the challenges of comparing the two data sets, see Donald Fisk and Darlene Forte, "The Federal Productivity Measurement Program: Final results," Monthly Labor Review, 1997, Volume 120, Number 5, pp. 19–28.

3 The UK Office of National Statistics is revising its metrics, and the public-sector productivity numbers may rise, although there are no indications that they would equal or surpass those of the private sector.

4 William J. Baumol, "Macroeconomics of unbalanced growth: The anatomy of urban crisis," American Economic Review, Volume 57, Number 3, pp. 415–26.

5 Elliott S. Fisher, Daniel J. Gottlieb, F. L. Lucas, Étoile L. Pinder, Thérèse A. Stukel, and David E. Wennberg, "The implications of regional variations in Medicare spending," Annals of Internal Medicine, 2003, Volume 138, Issue 4, pp. 273–87. John Wennberg, the director of the Center for the Evaluative Clinical Sciences, at Dartmouth Medical School, pioneered research into regional Medicare patterns. The paper cited in this footnote has David Wennberg, another researcher, as one of its authors.

6 Elliott Fisher and Jonathan Skinner, "Regional disparities in Medicare expenditures: An opportunity for reform," National Tax Journal, 1997, Volume 50, Number 3, pp. 413–25.

7 Emily Lawson and Colin Price, "The psychology of change management," The McKinsey Quarterly, 2003 special edition: The value in organization, pp. 30–41; Jennifer A. LaClair and Ravi P. Rao, "Helping employees embrace change," The McKinsey Quarterly, 2002 Number 4, pp. 17–20; and Jonathan D. Day and Michael Jung, "Corporate transformation without a crisis," The McKinsey Quarterly, 2000 Number 4, pp. 116–27.

8 Gassan Al-Kibsi, Kito de Boer, Mona Mourshed, and Nigel P. Rea, "Putting citizens on-line, not in line," The McKinsey Quarterly, 2001 special edition: On-line tactics, pp. 64–73.

9 William W. Lewis, "The power of productivity," The McKinsey Quarterly, 2004 Number 2, pp. 100–11.

How Illinois cut its purchasing bills

Chip W. Hardt and Ravi P. Rao

With huge swaths of the labor market set to retire in the coming years, the public sector will soon face intensifying pressure to top up its coffers in order to provide services for aging citizens. More people living on fixed incomes mean that state governments can't rely on the personal income tax and other traditional revenue boosters to fill budget gaps. Alternative revenue generators, including casinos and lotteries, are already showing their limitations.

To stanch the red ink, it will be necessary to take a hard look at the other side of the equation: cost-management and procurement policies. Increasingly, governments will have to borrow best practices from the private sector and alter them to suit agencies that often not only don't enjoy the degree of managerial freedom that prevails there but also face strong resistance by employees to change. Such obstacles may have prevented the earlier adoption of private-sector practices, even as the dot-com bust and the economic downturn of 2001 upended the budgets of states, local governments, and school districts, making more efficient management necessary.

Purchasing is one area in which states can innovate successfully despite these barriers. Last year, Illinois transformed its procurement system, a patchwork of agencies stitched together over the past 175 years. In the process, it saved roughly $110 million out of the $15 billion spent each year on goods and services, such as prison food, phone calls, and copy machines. For fiscal year 2005, the state is on track to save twice as much.

The way Illinois achieved these savings provides lessons for other state governments. By the time it began its transformation process, in 2003, it had become a conglomerate of more than 100 agencies, departments, and commissions, which in all spend more than $50 billion a year. If the state were a private-sector business, "Illinois Inc." would rank in the Fortune 100. Each agency or department has its own budget and determines its own spending needs—the notion being that the missions and corresponding strategies and operations of different agencies vary greatly, so they require as much flexibility as possible. The state's decentralized model, however, creates some predictable difficulties, such as the signing of a number of contracts for the same items and a failure to leverage the state's purchasing power or to share learning across agencies. A "silo mentality" reinforces these difficulties. The all-too-familiar results are financial deficits, poor service levels, project delays, budget overruns, and low organizational morale.

Illinois set out to transform its purchasing culture by promoting a new, centrally led, One State model to help it procure goods and services as a single entity. Hundreds of employees throughout the state helped plan new purchasing strategies and in the process gained training in the new approach.

Amid these efforts to shake up the state's purchasing culture, Illinois designed a two-pronged effort to drive down spending. The first was a "quick-sourcing" initiative that used benchmarked prices as a tool to renegotiate contracts with vendors. The second was a total-cost-of-ownership (TCO) approach focusing on two major spending questions—what to buy and how to buy it—which help determine all of the long-term cost elements of an item and all of the drivers of those costs.

Quick sourcing relies on the premise that vendors will renegotiate their contracts in the state's favor when confronted with benchmarking data showing that they may have overcharged for goods or services in the past. It helped Illinois to identify $30 million in annual savings, including $3 million a year for telephone bills alone. The benchmarking information has been included in a new online database, so that future negotiators—no matter what their agency, department, or commission—can take advantage of the work already completed.

In addition to the price cuts earned through quick sourcing, Illinois deployed TCO methods to find an additional $80 million in savings during the initiative's first year. By focusing on what to buy, for example, the state Department of Corrections saved $2 million a year on prison food, in part by eliminating costly items (such as tuna and grapefruit) from the menu and replacing them with less expensive but comparable items, such as ground beef and oranges. In most cases, the challenge came in convincing officials that the substitutions and cuts wouldn't result in inferior services.

After looking at how to buy—the other major aspect of the state's TCO approach—a team from a number of agencies recommended, among other things, that Illinois attempt to consolidate all of its contracts for temporary services. The decentralized hiring of clerical workers had been an attempt to accommodate the divergent needs of different agencies but meant that the state had not been able to leverage its size to get better prices. By combining contracts, it saved $2 million during the first year. In this case, changing how the state bought services involved coordinating the needs of agencies that had rarely collaborated in the past. The change also posed a new political challenge: fewer contracts mean that the state has fewer opportunities to expand the amount of business it does with companies owned by members of minority groups and by women.

The experience of Illinois shows that state and local governments adopting best purchasing practices can achieve big savings. Clearly, however, for these procurement approaches to succeed, states must transform their cultural DNA.
About the Authors

Chip Hardt is a principal in McKinsey's Chicago office, and Ravi Rao is a consultant in the Cleveland office.

You have mail, efficiently

Thomas Dohrmann and Stephen K. Sacks

Ever since Henry Ford came up with his revolutionary assembly line, manufacturing companies have constantly sought to raise their efficiency by redesigning operations. More recently, public-sector organizations have found that they too can boost productivity by reducing waste, eliminating unneeded effort, correcting mistakes quickly, and encouraging workers to suggest ideas for improvement.

A variety of challenges inspired the United States Postal Service to begin considering such an operational redesign in 1999. The number of addresses the USPS served was growing by 1.8 million every year, without corresponding increases in the revenue it generated or in mail volumes, which were projected to stop growing or even decline. Like many public-sector organizations, it faced regulations that, combined with its powerful labor unions, made it nearly impossible to close plants or to lay off workers. Moreover, largely as a result of having prices pegged to costs by the government, the USPS had developed a culture in which managers were rarely expected to improve productivity. In this environment, merely maintaining service levels and raising the price of stamps by rates at (or even below) the inflation rate counted as a success. Productivity had therefore been essentially flat for ten years, growing at only 0.2 percent annually, compared with the 3 to 5 percent expected in the private sector.

An initial analysis of the problems indicated that the best mail-sorting plants and delivery units were twice as productive as the least productive ones—and that potential opportunities to improve productivity were substantial. To pursue them, the postal service's leadership decided to launch what it called a "breakthrough productivity initiative."

A team of 15 people handpicked by senior management led the charge. The first finding was that performance data were murky at best: it was hard to tell with any real precision how well plants and delivery operations were performing or to compare performance across plants or delivery units. To remedy this problem, the team decided that detailed performance data should be captured by an information system and distributed through an intranet site where USPS employees could monitor the performance of every plant and delivery unit. Grouping all of the plants into seven categories, each with similar characteristics (such as size or layout), provided for meaningful comparisons.

First, the team used the data to set improvement targets for each plant and delivery unit and to lock them into budgets. While there was resistance initially, the organization began to accept the new approach after a few budget cycles, and managers soon came to expect that they would be asked to increase productivity each year. A new incentive and recognition system rewards those who do. Second, to help managers meet their budget targets, the team used the data to reveal best practices throughout the organization. A sorting plant in New York City, for example, processed only 5 percent of its total mail by hand, versus a nationwide rate of 10 percent. The approach of the New York plant was simple: its workers quickly looked through mail containers destined for manual sorting and decided which of them could go onto its automated equipment. When the USPS applied this practice across all plants, it generated several hundred million dollars a year in cost savings, since manual sorting is actually ten times more expensive than automated sorting.

After the productivity improvements kicked in, a simple scheduling tool revealed that the USPS had more workers than it needed overall, even at peak times. The team therefore suggested ways of matching the organization's staff levels to its variable workloads. Nonetheless, throughout the whole labor-reduction process, the USPS leadership fully cooperated with the unions, avoiding layoffs entirely. Natural attrition, the use of fewer temps, and less overtime for some workers cut full-time employment levels by 15 percent, thereby creating a much leaner organization.

Although the breakthrough productivity team finds and disseminates best practices across the organization, the nine area vice presidents across the country are ultimately responsible for deciding how to meet their productivity targets. As this kind of accountability has taken hold across the organization's 380 mail-sorting plants and 27,000 delivery units, it has reduced the variability of performance among branches, standardized processes, and spread best practices to the worst performers. These achievements have in turn decreased the USPS operating budget by more than $5.5 billion—close to 10 percent—in four years' time.
About the Authors

Thomas Dohrmann is an associate principal and Steve Sacks is a principal in McKinsey's Washington, DC, office.

January 23, 2006 at 02:31 PM in Business Models | Permalink | TrackBack (27) | Top of page | Blog Home

The demographic deficit: How aging will reduce global wealth

The McKinsey Quarterly: The demographic deficit: How aging will reduce global wealth

To fill the coming gap in global savings and financial wealth, households and governments will need to increase their savings rates and earn higher returns on the assets they already have.

Diana Farrell, Sacha Ghai, and Tim Shavers

Web exclusive, March 2005

The world's population is aging, and as it gets even grayer, bank balances will stop growing and living standards, which have improved steadily since the industrial revolution, could stagnate. The reason is that the populations of Japan, the United States, and Western Europe, where the vast majority of the world's wealth is created and held, are aging rapidly (Exhibit 1). During the next two decades, the median age in Italy will rise to 51, from 42, and in Japan to 50, from 43. Since people save less after they retire and younger generations in their prime earning years are less frugal than their elders were, savings rates are set to fall dramatically.

enlarge exhibit

In just 20 years, household financial wealth in the world's major economies will be roughly $31 trillion1 less than it would have been if historical trends had persisted, according to new research by the McKinsey Global Institute (Exhibit 2). This study examined the impact of demographic trends on household savings and wealth in Germany, Italy, Japan, the United Kingdom, and the United States. (The full report, The Coming Demographic Deficit: How Aging Populations Will Reduce Global Saving, is available for free online.) If left unchecked, the slowdown in global-savings rates will reduce the amount of capital available for investment and impede economic growth.

enlarge exhibit

No country will be immune. For the United States—with its relatively young population, higher birthrates, and steady influx of immigrants—the aging trend will be relatively less severe. Still, its savings rate is already dismally low, even before the baby boomers have started to retire. To finance its massive current-account deficit, the United States relies on capital flows from Europe and Japan, but they too face rapidly aging populations. Even fast-growing developing countries such as China will not be able to generate enough savings to make up the difference.

Finding solutions won't be easy. Raising the retirement age, easing restrictions on immigration, or encouraging families to have more children will have little impact. Boosting economic growth alone is not a solution, nor is the next productivity revolution or technological breakthrough. To fill the coming gap in global savings and financial wealth, households and governments will need to increase their savings rates and to earn higher returns on the assets they already have. These changes involve hard choices but can offer a brighter future.
Growing older, saving less

In just two decades, the proportion of people aged 80 and above will be more than 2.5 times higher than it is today, because women are having fewer children and people are living longer. In about a third of the world's countries, and in the vast majority of developed nations, the fertility rate is at, or below, the level needed to maintain the population. Women in Italy now average just 1.2 children. In the United Kingdom, the figure is 1.6; in Germany, 1.4; and in Japan, 1.3. Meanwhile, thanks to improvements in health care and living conditions,2 average life expectancy has increased from 46 years in 1950 to 66 years today.

As the elderly come to make up a larger share of the population, the total amount of savings available for investment and wealth accumulation will dwindle. The prime earning years for the average worker are roughly from age 30 to 50; thereafter, the savings rate falls. With the onset of retirement, households save even less and, in some cases, begin to spend accumulated assets.

The result is a decline in the prime savers ratio—the number of households in their prime saving years divided by the number of elderly households. This ratio has been falling in Japan and Italy for many years. In Japan, it dropped below one in the mid-1980s, meaning that elderly households now outnumber those in their highest earning and saving years. Japan is often thought to be a frugal nation of supersavers, but its savings rate actually has already fallen from nearly 25 percent in 1975 to less than 5 percent today. That figure is projected to hit 0.2 percent in 2024. In 2000, the prime savers ratios of Germany, the United Kingdom, and the United States either joined the declining trend or stabilized at very low levels. This unprecedented confluence of demographic patterns will have significant ramifications for global savings and wealth accumulation.

How the decline in prime savers will affect total savings depends on how these people's savings behavior changes over the course of a household's life. Germany, Japan, and the United States have traditional hump-shaped life cycle savings patterns (Exhibit 3). In these countries, aging populations will cause a dramatic slowdown in household savings and wealth. In contrast, Italy has a flatter savings curve, resulting in part from historical borrowing constraints that forced households led by people in their 20s and 30s to save more. Thus an increase in the share of elderly households will have less impact on the country's financial wealth.

enlarge exhibit

In some countries, the relatively lower savings rates of younger generations in their peak earning years will exacerbate the slowdown in savings and wealth. In the United States and Japan, where we analyzed generation-specific savings data, several factors contribute to this pattern: a tendency to rely more on inheritance than past generations did, the good fortune to avoid the economic hardships that prompted earlier generations to be more frugal, and the availability of consumer credit and mortgages (which, in the case of Japan, have become more socially acceptable).
The coming shortfall in household wealth

Most of the public discussion on aging populations has focused on the rapidly escalating cost of pensions and health care. Little attention has been paid to the potentially far more damaging effect that this demographic phenomenon will have on savings, wealth, and economic well being. As more households retire, the decline in savings will slow the growth in household financial wealth in the five countries we studied by more than two-thirds—to 1.3 percent, from the historical level of 4.5 percent. By 2024, total household financial wealth will be 36 percent lower—a drop of $31 trillion—than it would have been if the higher historical growth rates had persisted.

Of course, changes in savings behavior by households and governments or increases in the average rate of return earned on those savings could alter this outcome. Without such changes, however, our analysis indicates that the aging populations in the world's richest nations will exert severe downward pressure on global savings and financial wealth during the next two decades. The United States will experience the largest shortfall in household financial wealth in absolute terms—$19 trillion by 2024—because of the size of its economy. The growth rate of the country's household financial wealth will decline to 1.6 percent, from 3.8 percent. Since the aging trend is less severe in the United States, reduced savings rates among younger generations are responsible for a large part of the decline.

In Japan, the situation is much more serious. Household financial wealth will actually start declining during the next 20 years: by 2024 it will be $9 trillion—47 percent lower than it would have been if historical growth rates had persisted. Japan's demographic trends are severe: the median age will increase to 50, from 43 (for the US population, it will rise to 38, from 37), and the savings of elderly households fall off at a faster rate in Japan than in the United States. Even more important, household financial wealth in Japan is almost exclusively the result of new savings from income rather than of asset appreciation; therefore, the falloff in savings causes a bigger decline in wealth.

The outlook for Europe varies by country. Italy will experience a large decline in the growth rate of its financial wealth—to just 0.9 percent, from 3.4 percent—because of the rapid aging of its population. Its relatively flat life cycle savings curve will mitigate the impact, however, resulting in an absolute shortfall of about $1 trillion, or 39 percent. The projected decline in the growth rate of financial wealth in other countries will be less dramatic: to 2.4 percent, from 3.8 percent, in Germany (because of its higher savings rates) and to a still-healthy 3.2 percent, from 5.1 percent, in the United Kingdom (because of its stronger demographics).
Global ripple effects

This slowdown in household savings will have major implications for all countries. In recent years the United States has absorbed more than half of the world's capital flows while running a current-account deficit approaching 6 percent of GDP. Japan has historically enjoyed a huge current-account surplus, which has allowed it to be a major exporter of capital to other countries, notably the United States. The expected drop in Japan's household savings will make this arrangement increasingly untenable.

In all likelihood, the United States also won't be able to rely on European nations, with their aging populations, to increase capital flows. Nor can it expect rapidly industrializing nations, such as China, to fill the gap. Even if China's economy continued to grow at its current breakneck pace, it would need approximately 15 years to reach Japan's current GDP. In any case, if China is to sustain this growth, the United States must continue consuming at its current level—something it cannot do if capital flows from abroad decrease. Even if China did have savings to export, it would have to confront the obstacles posed by its current exchange rate and capital controls regime.

Although an increase in global interest rates and the cost of capital may seem inevitable, it is not. On the one hand, as global savings fall markets can adjust through changes in asset prices and demand; which of these will predominate is unclear. Some economists forecast less demand for capital: fewer households will be taking out mortgages and borrowing for college, governments will invest less in infrastructure to keep pace with population growth, and businesses won't have to add as much capital equipment to accommodate a labor force that will no longer be growing. On the other hand, the demand for capital is likely to remain strong if emerging markets and rich countries seek to boost their GDP and productivity growth by increasing the amount of capital per worker. Likewise, while a drop in global savings could drive up asset prices, opposing forces will also be at work, as retirees begin selling their financial assets.3

One thing is certain: as household savings rates decline and the pool of available capital dwindles, persistent government budget deficits will likely push interest rates higher and crowd out private investment. The rising cost of caring for an aging population in the years to come will force national governments to exercise better fiscal discipline.
No easy solutions

Many policy changes suggested today, such as increasing immigration, raising the retirement age, encouraging households to have more children, and boosting economic growth, will do little to mitigate the coming shortfall in global financial wealth (Exhibit 4).

enlarge exhibit

Our analysis shows that an aggressive effort to increase immigration won't solve the problem, simply because new arrivals represent only a tiny proportion of any country's population. In Germany, for instance, a 50 percent increase in net immigration (to 100,000 people a year) would raise total financial assets just 0.7 percent by 2024. In Japan, doubling official projections of net immigration would have almost no impact on the number of households or on the country's aggregate savings. The same is true even in the United States, which had the highest historical levels of immigration in our sample.

Since households don't reach their prime saving years until middle age, promoting higher birthrates through policies such as child tax credits, generous maternity-leave policies, and child care subsidies will also have only a negligible effect by 2024. This approach could actually make the situation worse by adding child dependents to a workforce already supporting a larger number of elderly.

Similarly, raising the retirement age won't be particularly effective in most countries. In Japan, efforts to expand the peak earning and saving period by five years (a proxy for raising the retirement age) would close 25 percent of the projected wealth shortfall in that country. In Italy, however, this approach would have little impact because households do not greatly reduce their savings in retirement.

After the IT revolution and the jump in US productivity growth during the late 1990s, it may be tempting to think that countries might grow themselves out of the problem. Without changes in the relationship between income and spending, however, an increase in economic growth won't generate enough new savings to close the gap. The simple reason is that as incomes and standards of living rise, so does consumption. For instance, raising average income growth in the United States by one percentage point—a huge increase—would narrow the projected wealth shortfall by only 10 percent.
Navigating the demographic transition

The only meaningful way to counteract the impending demographic pressure on global financial wealth is for governments and households to increase their savings rates and for economics to allocate capital more efficiently, thereby boosting returns.
Boosting asset appreciation

The underlying performance of domestic capital markets varies widely across countries, resulting in significantly different rates of return.4 Since 1975, the average rate of financial-asset appreciation in the United Kingdom and the United States has been nearly 1 percent a year, after adjusting for inflation. In contrast, financial assets in Japan have depreciated by a real 1.8 percent annually over the same period (although the ten-year moving average is now near zero). Real rates of asset appreciation have been negative in Germany and Italy as well.

UK and US households compensate for their low savings rates by building wealth through high rates of asset appreciation. Their counterparts in Continental Europe and Japan save at much higher rates but ultimately accumulate less wealth, since these savings generate low or negative returns. From 1975 to 2003, unrealized capital gains increased the value of the financial assets of US households by almost 30 percent. But in Japan the value of such assets declined. European countries fell somewhere in between.

Raising the rates of return on the $56 trillion of household savings in the five countries we studied could avert much of the impending wealth shortfall. In Germany, increasing the appreciation of financial assets to 0 percent, from the historical average of -1.1 percent, would completely eliminate the projected wealth shortfall. The opportunity is also large for Italy, since its real rate of asset appreciation has averaged -1.6 percent since 1992; raising returns to the levels in the United Kingdom and the United States would fully close the gap. For the latter two countries, the challenge could be more difficult because their rates of asset appreciation are already high.

Achieving the required rates of return will call for improved financial intermediation so that savings are funneled to the most productive investments. To achieve this goal, policy makers must increase competition and encourage innovation in the financial sector and in the economy as a whole,5 enhance legal protections for investors and creditors, and end preferential lending by banks to companies with political ties or shareholder relationships.

For some countries, such as Japan, where households keep more than half of their financial assets in cash equivalents, diversifying the range of assets that individuals hold is an important means of increasing the efficiency of capital allocation.6 To promote a better allocation of assets, policy makers should remove investment restrictions for households, improve investor education, and create tax incentives for well-diversified portfolios. New research in behavioral economics has shown that offering a balanced, prudent allocation as the default option for investors can improve returns because they overwhelmingly stick with this option.7
Increasing savings rates

In many countries, today's younger generations earn more and save less than their elders do. This discrepancy is an important driver of the wealth shortfall in the United States and, more surprisingly, in Japan. If younger generations saved as much as their parents did while continuing to earn higher incomes, one-quarter of Japan's wealth shortfall and nearly a third of the US gap would be closed by 2024.

Persuading young people to save more is difficult, however, and tax incentives aimed at increasing household savings have yielded mixed results.8 Contrary to conventional wisdom, too much borrowing is not the culprit in most countries. Although household liabilities have grown significantly faster than assets have across our sample since 1982, keeping consumer borrowing in line with asset growth would close $2.3 trillion, or just 7.5 percent, of the projected wealth shortfall.

The key to boosting household savings is overcoming inertia. When companies automatically enroll their employees in voluntary savings plans (letting them opt out if they choose) rather than requiring people to sign up actively, participation rates rise dramatically.9 A study at one US Fortune 500 company that instituted such a program found that enrollment in its 401(k) retirement plan jumped to 80 percent, from 36 percent; the increase among low-income workers was even greater.10 In addition, a substantial fraction of the participants in the automatic-enrollment program accepted the default for both the contribution rate and the investment allocation—a combination chosen by few employees outside the program.

Of course, governments can also increase the savings rates of their countries through the one mechanism directly under their control—reducing fiscal budget deficits. Maintaining fiscal discipline now is vital if governments are to cope with the escalating pension and health care costs that aging populations will accrue.

If policy makers take no action, the coming slowdown in global savings and the projected decline in financial wealth could depress investment, economic growth, and living standards in the world's largest and wealthiest countries. The future development of poor nations could also be in jeopardy. A concerted, sustained effort to increase the efficiency of capital allocation, boost savings rates, and close government budget deficits can avert this outcome.
About the Authors

Diana Farrell is director of the McKinsey Global Institute, where Tim Shavers is a consultant; Sacha Ghai is a consultant in McKinsey's Toronto office.

The authors wish to thank Ezra Greenberg, Piotr Kulczakowicz, Susan Lund, Carlos Ocampo, and Yoav Zeif for their contributions to this article.

An abridged version of this article appears in The McKinsey Quarterly, 2005 Number 2.
Notes

1All figures given in this article are valued in 2000 US dollars, and all growth rates indicate real terms.

2The State of World Population, 1999 and 2004, United Nations Population Fund.

3Empirical analyses on the impact of demographic changes on financial-asset prices and returns are inconclusive. See Barry P. Bosworth, Ralph C. Bryant, and Gary Burtless, The Impact of Aging on Financial Markets and the Economy: A Survey, Brookings Institution, July 2004; and James Poterba, "The impact of population aging on financial markets," National Bureau of Economic Research working paper W10851, October 2004.

4In this article, the terms "financial-asset appreciation" and "returns" refer to the unrealized capital gains on financial assets, not to interest and dividends paid. By convention, interest and dividends are treated as household income, a portion of which may be saved.

5For a good synthesis of MGI's research, see William W. Lewis, The Power of Productivity, Chicago: University of Chicago Press, 2004.

6Moving households closer to the efficient frontier of risk and returns serves to make asset pricing more precise and forces companies to practice greater capital market discipline.

7Brigitte C. Madrian and Dennis F. Shea, "The power of suggestion: Inertia in 401(k) participation and savings behavior," Quarterly Journal of Economics, November 2001, Volume 116, Number 4, pp. 1149–87.

8B. Douglas Bernheim, "Taxation and saving," Handbook of Public Economics, Volume 3, Alan J. Auerbach and Martin Feldstein (eds.), New York: Elsevier North-Holland, 2002.

9James J. Choi, David Laibson, Brigitte C. Madrian, and Andrew Metrick, "Defined contribution pensions: Plan rules, participant decisions, and the path of least resistance," National Bureau of Economic Research working paper W8655, December 2001.

10Brigitte C. Madrian and Dennis F. Shea, "The power of suggestion: Inertia in 401(k) participation and savings behavior," Quarterly Journal of Economics, November 2001, Volume 116, Number 4, pp. 1149–87.

January 23, 2006 at 02:28 PM in Business Models | Permalink | TrackBack (15) | Top of page | Blog Home

Ten trends to watch in 2006

The McKinsey Quarterly: Ten trends to watch in 2006

Macroeconomic factors, environmental and social issues, and business and industry developments will all profoundly shape the corporate landscape in the coming years.

Ian Davis and Elizabeth Stephenson

Web exclusive, January 2006

Those who say that business success is all about execution are wrong. The right product markets, technology, and geography are critical components of long-term economic performance. Bad industries usually trump good management, however: in sectors such as banking, telecommunications, and technology, almost two-thirds of the organic growth of listed Western companies can be attributed to being in the right markets and geographies. Companies that ride the currents succeed; those that swim against them usually struggle. Identifying these currents and developing strategies to navigate them are vital to corporate success.

What are the currents that will make the world of 2015 a very different place to do business from the world of today? Predicting short-term changes or shocks is often a fool's errand. But forecasting long-term directional change is possible by identifying trends through an analysis of deep history rather than of the shallow past. Even the Internet took more than 30 years to become an overnight phenomenon.
Macroeconomic trends

We would highlight ten trends that will change the business landscape. First, we have identified three macroeconomic trends that will deeply transform the underlying global economy.

1. Centers of economic activity will shift profoundly, not just globally, but also regionally. As a consequence of economic liberalization, technological advances, capital market developments, and demographic shifts, the world has embarked on a massive realignment of economic activity. Although there will undoubtedly be shocks and setbacks, this realignment will persist. Today, Asia (excluding Japan) accounts for 13 percent of world GDP, while Western Europe accounts for more than 30 percent. Within the next 20 years the two will nearly converge. Some industries and functions—manufacturing and IT services, for example—will shift even more dramatically. The story is not simply the march to Asia. Shifts within regions are as significant as those occurring across regions. The United States will still account for the largest share of absolute economic growth in the next two decades.

Further reading:
China and India: The race to growth
Mapping the global capital markets

2. Public-sector activities will balloon, making productivity gains essential. The unprecedented aging of populations across the developed world will call for new levels of efficiency and creativity from the public sector. Without clear productivity gains, the pension and health care burden will drive taxes to stifling proportions.

Nor is the problem confined to the developed economies. Many emerging-market governments will have to decide what level of social services to provide to citizens who increasingly demand state-provided protections such as health care and retirement security. The adoption of proven private-sector approaches will likely become pervasive in the provision of social services in both the developed and the developing worlds.

Further reading:
The demographic deficit: How aging will reduce global wealth
Boosting government productivity

3. The consumer landscape will change and expand significantly. Almost a billion new consumers will enter the global marketplace in the next decade as economic growth in emerging markets pushes them beyond the threshold level of $5,000 in annual household income—a point when people generally begin to spend on discretionary goods. From now to 2015, the consumer's spending power in emerging economies will increase from $4 trillion to more than $9 trillion—nearly the current spending power of Western Europe.

Shifts within consumer segments in developed economies will also be profound. Populations are not only aging, of course, but changing in other ways too: for example, by 2015 the Hispanic population in the United States will have spending power equivalent to that of 60 percent of all Chinese consumers. And consumers, wherever they live, will increasingly have information about and access to the same products and brands.

Further reading:
Premium marketing to the masses: An interview with LG Electronics India's managing director
New strategies for consumer goods
Social and environmental trends

Next, we have identified four social and environmental trends. Although they are less predictable and their impact on the business world is less certain, they will fundamentally change how we live and work.

4. Technological connectivity will transform the way people live and interact. The technology revolution has been just that. Yet we are at the early, not mature, stage of this revolution. Individuals, public sectors, and businesses are learning how to make the best use of IT in designing processes and in developing and accessing knowledge. New developments in fields such as biotechnology, laser technology, and nanotechnology are moving well beyond the realm of products and services.

More transformational than technology itself is the shift in behavior that it enables. We work not just globally but also instantaneously. We are forming communities and relationships in new ways (indeed, 12 percent of US newlyweds last year met online). More than two billion people now use cell phones. We send nine trillion e-mails a year. We do a billion Google searches a day, more than half in languages other than English. For perhaps the first time in history, geography is not the primary constraint on the limits of social and economic organization.

Further reading:
The next revolution in interactions
The McKinsey Global Survey of Business Executives, July 2005

5. The battlefield for talent will shift. Ongoing shifts in labor and talent will be far more profound than the widely observed migration of jobs to low-wage countries. The shift to knowledge-intensive industries highlights the importance and scarcity of well-trained talent. The increasing integration of global labor markets, however, is opening up vast new talent sources. The 33 million university-educated young professionals in developing countries is more than double the number in developed ones. For many companies and governments, global labor and talent strategies will become as important as global sourcing and manufacturing strategies.

Further reading:
China's looming talent shortage
Sizing the emerging global labor market

6. The role and behavior of big business will come under increasingly sharp scrutiny. As businesses expand their global reach, and as the economic demands on the environment intensify, the level of societal suspicion about big business is likely to increase. The tenets of current global business ideology—for example, shareholder value, free trade, intellectual-property rights, and profit repatriation—are not understood, let alone accepted, in many parts of the world. Scandals and environmental mishaps seem as inevitable as the likelihood that these incidents will be subsequently blown out of proportion, thereby fueling resentment and creating a political and regulatory backlash. This trend is not just of the past 5 years but of the past 250 years. The increasing pace and extent of global business, and the emergence of truly giant global corporations, will exacerbate the pressures over the next 10 years.

Business, particularly big business, will never be loved. It can, however, be more appreciated. Business leaders need to argue and demonstrate more forcefully the intellectual, social, and economic case for business in society and the massive contributions business makes to social welfare.

Further reading:
What is the business of business?
The role of regulation in strategy

7. Demand for natural resources will grow, as will the strain on the environment. As economic growth accelerates—particularly in emerging markets—we are using natural resources at unprecedented rates. Oil demand is projected to grow by 50 percent in the next two decades, and without large new discoveries or radical innovations supply is unlikely to keep up. We are seeing similar surges in demand across a broad range of commodities. In China, for example, demand for copper, steel, and aluminum has nearly tripled in the past decade.

The world's resources are increasingly constrained. Water shortages will be the key constraint to growth in many countries. And one of our scarcest natural resources—the atmosphere—will require dramatic shifts in human behavior to keep it from being depleted further. Innovation in technology, regulation, and the use of resources will be central to creating a world that can both drive robust economic growth and sustain environmental demands.

Further reading:
Preparing for a low-carbon future
What's next for Big Oil?
Business and industry trends

Finally, we have identified a third set of trends: business and industry trends, which are driving change at the company level.

8. New global industry structures are emerging. In response to changing market regulation and the advent of new technologies, nontraditional business models are flourishing, often coexisting in the same market and sector space.

In many industries, a barbell-like structure is appearing, with a few giants on top, a narrow middle, and then a flourish of smaller, fast-moving players on the bottom. Similarly, corporate borders are becoming blurrier as interlinked "ecosystems" of suppliers, producers, and customers emerge. Even basic structural assumptions are being upended: for example, the emergence of robust private equity financing is changing corporate ownership, life cycles, and performance expectations. Winning companies, using efficiencies gained by new structural possibilities, will capitalize on these transformations.

Further reading:
Strategy in an era of global giants
Loosening up: How process networks unlock the power of specialization

9. Management will go from art to science. Bigger, more complex companies demand new tools to run and manage them. Indeed, improved technology and statistical-control tools have given rise to new management approaches that make even mega-institutions viable.

Long gone is the day of the "gut instinct" management style. Today's business leaders are adopting algorithmic decision-making techniques and using highly sophisticated software to run their organizations. Scientific management is moving from a skill that creates competitive advantage to an ante that gives companies the right to play the game.

Further reading:
Do you know who your experts are?
Matching people and jobs

10. Ubiquitous access to information is changing the economics of knowledge. Knowledge is increasingly available and, at the same time, increasingly specialized. The most obvious manifestation of this trend is the rise of search engines (such as Google), which make an almost infinite amount of information available instantaneously. Access to knowledge has become almost universal. Yet the transformation is much more profound than simply broad access.

New models of knowledge production, access, distribution, and ownership are emerging. We are seeing the rise of open-source approaches to knowledge development as communities, not individuals, become responsible for innovations. Knowledge production itself is growing: worldwide patent applications, for example, rose from 1990 to 2004 at a rate of 20 percent annually. Companies will need to learn how to leverage this new knowledge universe—or risk drowning in a flood of too much information.

Further reading:
The 21st-century organization
Making a market in knowledge

Companies need to understand the implications of these trends alongside customer needs and competitive developments. Executives who align their company's strategy with these factors will be the best placed to succeed. Reflecting on these trends will be time well spent.
About the Authors

Ian Davis is worldwide managing director of McKinsey & Company and Elizabeth Stephenson is a consultant in McKinsey's San Francisco office. A shorter version of this article was published in the Financial Times on January 13, 2006.

January 23, 2006 at 02:27 PM in Business Models | Permalink | TrackBack (5) | Top of page | Blog Home

Plot your course for the new world

McKinsey & Company - Plot Your Course For the New World

The Financial Times
Ian Davis
January 13, 2006

Those who say that business success is all about execution are wrong. Choice of product market, technology and geography are critical components of long-term economic performance. Bad industries usually trump good management.

In sectors such as banking, telecommunications and technology, almost two-thirds of quoted western companies' organic growth can be attributed to being in the right markets and the right place. Companies that ride the currents succeed; those that swim against them usually struggle. Identifying these currents and developing strategies to navigate them is vital.

What are the currents that will make the world of 2015 a very different place in which to do business from the world of today? I would highlight five trends that will change the business landscape.

First, centres of economic activity will shift profoundly, not just globally but regionally. As a consequence of economic liberalisation, technological advances, capital market developments and demographic changes, the world has embarked on a massive realignment of economic activity.

Today, excluding Japan, Asia accounts for 13 per cent of world gross domestic product while western Europe accounts for more than 30 per cent. Within the next 20 years, the two will nearly converge. Some industries and functions - manufacturing and information technology services, for example - will shift even more dramatically. The story is not simply the march to Asia. Movements within regions are as significant as those across regions. The US will still account for the largest share of economic growth in the next two decades.

Second, the consumer landscape will change and expand significantly. Almost a billion new consumers will enter the global marketplace in the next decade as growth in emerging markets pushes them beyond the threshold of $5,000 (£2,800) annual household income - a point at which people generally begin to spend on discretionary goods. By 2015, annual consumer spending power in emerging economies will increase from $4,000bn to more than $9,000bn - nearly the current level in western Europe.

Shifts within consumer segments in developed economies will also be profound. Populations are ageing, but changing in other ways, too. For example, by 2015, the Hispanic population in the US will have spending power equal to 60 per cent of all consumers in China. And consumers will increasingly have information and access to the same products and brands, wherever they live.

Third, technological connectivity will transform how we live. The technology revolution is at an early stage. We are learning how to make the best use of IT in the design of processes and in developing and accessing knowledge. New technologies such as bio-technology, laser technology and nano-technology will also have a huge impact on products and services.

More transformational than technology itself is the shift in behaviour that it enables. We work not just globally but instantaneously. We are forming communities and relationships in new ways (12 per cent of American newlyweds last year met online). More than 2bn people now use cellphones. We send 9,000bn e-mails a year. We do a billion Google searches a day, over half not in the English language. For perhaps the first time in history, geography is not the primary constraint on the boundaries of social and economic organisation.

Fourth, the battlefield for talent will shift. Changes in the nature of labour and talent will be far more profound than the widely observed movement of jobs to low-wage countries. The shift to knowledge-intensive industries highlights the importance and scarcity of well trained talent. The increasing integration of global labour markets, however, is opening up vast new talent sources. The 33m university-educated young professionals in developing countries is more than double the number in developed countries. For many companies and governments, global labour and talent strategies will become as important as global sourcing and manufacturing strategies.

Finally, the role and behaviour of business will come under increasing scrutiny. As businesses expand their global reach, and as the economic demands on the environment intensify, the level of societal suspicion about big business is likely to increase. The tenets of current global business ideology - for example, shareholder value, free trade, intellectual property rights, profit repatriation - are not understood, let alone accepted, in many parts of the world.

Scandals and environmental mishaps seem as inevitable as the likelihood that these will be blown out of proportion, fuelling resentments and creating pressure for political and regulatory backlashes. The increasing pace and extent of global business and the emergence of truly giant global companies will exacerbate the pressures over the next 10 years.

Business will never be loved. It can, however, be more appreciated. Business leaders need to get on the front foot. They must demonstrate more forcibly the case for business in society and the massive contributions it makes to social welfare.

Companies need to understand the implications of these trends alongside customer needs and competitive developments. Those that align their strategies to them will be best placed to succeed. Time spent reflecting on the trends will be time well spent.

Ian Davis is Managing Director of McKinsey & Company.

January 23, 2006 at 02:26 PM in Business Models | Permalink | TrackBack (11) | Top of page | Blog Home

But making those applications talk with one another isn't easy. One way to solve this problem is to migrate to an integrated enterprise application integration (EAI) suite from vendors such as SAP AG, Oracle Corp. or PeopleSoft Inc. These products have pr

Quiet Revolution in the North

While many countries have loudly proclaimed they will use technology to transform government, Canada has quietly accomplished what others are still talking about.
By Kathleen Sibley
November 2003
So often overshadowed by its large neighbor to the south, Canada has learned how to do things its own way, without a lot of fanfare.

Take electronic government. For three years in a row, Canada ranked No. 1 out of 22 countries in a global survey, which is startling news to many. Canada achieved this success not by showcasing Web portals or high-profile applications, but by building trust among its citizens.

Canada Post, the Canadian postal system, created the world's first electronic post office, and is part of a consortium of vendors and service providers who are building the Canadian government's technology infrastructure, called Secure Channel, to allow citizens to access government services securely over the Internet.

"We realized a long time ago that people might not like us, but they trust us," said Dean Pope, general manager of electronic/Internet services and products for Canada Post. "What we have been working off as a strategy is building on that trust."

Canada Post, said Pope, has developed an electronic postmarking service. Much like the postmark on a letter provides an origin, date and time stamp, "Our role is to validate the transactions that took place and put our stamp to prove it," said Pope.

Canada, a nation of about 31 million people, is divided into 10 provinces and three territories. It is the only country in an Accenture E-Government Leadership survey to have reached what Accenture calls the service transformation stage -- using a customer relationship management (CRM) approach to deliver transactional e-services citizens want, and integrating those services seamlessly across many departments and agencies.

The federal government committed approximately $660 million to the initiative. Most of the 130 e-services slated for completion by 2005 are up and running, although many are still being fine-tuned and developed into more sophisticated offerings. According to the June 2003 Government On-Line Annual Report, the available e-government services get their share of use. In 2002, more than 400,000 Canadians applied for employment insurance online and 9 million (43 percent) filed their tax returns electronically.

"What most impressed us about Canada is the amount of collaboration and discussion that has gone on, and not just at the federal level," said Graeme Gordon, a partner with Accenture. "It really is another factor that differentiates it. Canada understands this is about more than simply the Internet, it's about service transformation and really focusing on customer service."

While the impetus for providing e-services comes largely from a citizenry that has become accustomed to conducting much of its daily business online -- Canadians are highly enthusiastic about online banking, for example -- it also is driven by the goal to improve delivery of government services overall and achieve efficiencies, he said.

"E-government is a lightning rod for service transformation," said Gordon. "Government is under pressure to continue improving, yet budgets aren't increasing, so they're having to learn how to do things more effectively."

Doing things more efficiently means applying some private-sector practices -- particularly CRM -- that have helped large enterprises improve their customer service. Banks, for example, routinely use CRM to understand which customers make them the most money and which cost the most to service.

While governments such as Canada's have embraced the CRM theory -- at least the better service part -- they're reticent to wholeheartedly apply a private-sector practice to public-sector organizations. "Governments are afraid when you start talking segmentation, that it means some people will be treated differently. Some people are worried CRM will lead to treating certain citizens with kid gloves," said Gordon. "But that's not what it's about. It's about understanding what people want and providing good, consistent service."

Efficient Transitions
For Michelle d'Auray, CIO for the Canadian government, CRM is citizen, not customer, relationship management. The government uses CRM, she said, not so much as a marketing tool, but as a way to help citizens move from channel to channel with the least effort possible.

"If a citizen asks for a service over the phone and then goes to the Net, they should not have to repeat their information over and over again just because the people on the other end of the line have changed. And they should expect to get the same answer on the Web site as they do on the phone," said d'Auray. "For us, citizen relationship management is also about looking at ways to offer the benefits to which citizens are entitled to automatically, rather than requiring the citizen to figure it out. Its also means doing a better job at coordinating our efforts across levels of government, so we only send one, rather than three, government officials into a senior's home, for example, to do an assessment of the benefits they might be entitled to."

D'Auray is clear that focus on the citizen has been the key to Canada's e-government success. To find out what citizens want in terms of e-government, the government established an Internet user-based panel of 4,500 people to better understand their service preferences and expectations. The government also conducts multiple focus groups on a range of e-government issues, and participates in a number of syndicated studies, such as the Citizens First series research on client satisfaction with government services.

"We do an enormous amount of focus group testing and adjustment based on the results because it's not just about putting the right information and services up once, it's also critical that we regularly change in response to changing use patterns and changing preferences," said d'Auray.

That approach appears to be working. The most recent Citizens First report (January 2003), which collected responses from 9,000 Canadians across the country, indicates an increase in citizen satisfaction with government services across all three levels of government. According to the report, satisfaction with federal services was 56 percent, up from 47 percent in 1998. Satisfaction with municipal services was 59 percent, compared to 53 percent in 1998.

The American Customer Satisfaction Index, in contrast, reports no significant increase in satisfaction ratings for U.S. federal government services since 1999.

The government also reaped the benefits of taking a whole government approach, so the same tools and services are available across all delivery channels, whether the user is in line or online, said d'Auray. While the online channel is growing, the latest survey from May 2003 shows the phone, at 41 percent, remains the preferred channel for contacting government. The Internet was favored by 34 percent; snail-mail by 17 percent; and in-person, 7 percent.

While Canada has celebrated many e-government successes, it still has a ways to go to move to full-service transformation. The government has yet to overcome the challenge of streamlining its internal operations to support "seamless" services to citizens and business -- across departments, across delivery channels and eventually across jurisdictions.

The Unexpected ROI of E-Government
One of Canada's biggest e-government success stories, however, is of the Canada Customs and Revenue Agency (CCRA), which offers a range of Internet and telephone applications, such as its cargo release and invoice information system, and its e-filing applications for businesses and individuals.

CCRA Deputy Assistant Commissioner Roderick Quiney said while the cost of building and maintaining systems that are "100 times more complex" than earlier systems has not rendered any savings, there is another kind of payback -- one that is perhaps far more valuable, at least for a tax collection agency.

For example, he said, the CCRA now gets 15 times fewer errors with Goods and Services Tax (GST) returns filed over the phone than when the tax was filed on paper. In Canada, there is a 7 percent tax levied on all goods and services, paralleling the provincial taxes of six provinces. Brought in by the Conservative government in the 1980s to replace a previously hidden federal tax, the tax has never been popular -- not just because of the cost it imposes, but because it requires many more businesses to keep track of it than the tax it replaced.

"If we and the client make fewer errors, it's good for both of us," said Quiney. "Whoever causes the error, there's always a bad feeling at the end of the day, and it's more difficult to explain why we didn't understand the error and correct it than to have a system that is nonjudgmental and nonargumentative automatically correct it."

According to Quiney, there are many new Canadians, as well as young entrepreneurs, entering the labor market every year with little or no knowledge of the tax system. Because it's less expensive in the long run to provide self-serve options -- the CCRA handles about 24 million calls to its call centers every year -- the agency developed an interactive Web information system with answers to the 400 most common questions people ask over the phone.

"We found our biggest problem dealing with inquiries over the phone is just getting the right question," said Quiney. "People will call up and say, 'Is my dog taxable?'"

Call center agents are trained to ask questions until they understand what the client wants, but it would take a lot less time -- so the theory goes -- if clients were to use the call center as a last resort, once they have exhausted the Web site's interactive information system. That's where answers are structured as decision trees, which users can follow until they are satisfied. They are also provided with references for further information as well as technical bulletins.

"You can spend hours with it," said Quiney. "It's an interesting machine, and it's got infinite patience. In the end, you may want to talk to a human being, but by then you're very well informed."

However, he adds, "We still have some work to do on making an Internet site replace a human being."

Although the CCRA was motivated by benefits of moving to e-service delivery, it could theoretically have continued to function as it always had -- processing all returns manually.

Postal Service E-Enabled
Not so for Canada Post, which processed 9.8 billion pieces of mail in 2002. "For us, it was do or die," said Pope of the corporation's move into the electronic world. "We realized the Internet was going to significantly impact the core business, and we couldn't just sit back and do nothing, or we would have become irrelevant in time as that impact had a greater and greater impact on our volumes."

But building a new business model takes time, he said, and while e-services "in the scheme of things in a company the size of Canada Post are not a big business area yet, it's a strategic business area and one that's looked at as having high-growth potential."

To maximize that potential, Canada Post underwent a business transformation initiative four years ago to help it become more process-oriented, rather than function-oriented, he said. All the business's core processes have been re-engineered using SAP technology.

"We used to be an organization that was very stovepipe-oriented, with hundreds of databases, most of which didn't talk to each other," he said. "That's gone. It has been a very difficult, challenging time changing the way we work. But we've re-engineered every process and extracted anything that doesn't add customer value."

Adding customer value is key to all government online projects, in terms of citizen acceptance and take-up. But key to long-term success is measuring that value, said Brian Freeman vice president of single window government initiatives at CGI Group.

Freeman cites a recent IDC study that measured the economic impact of New Brunswick's e-government services. New Brunswick has a population of about 750,000.

According to the study, Service New Brunswick (SNB), the self-funding corporation owned by the province that delivers 160 e-services, realized approximately $108 million in net economic benefits to the province in 2002. That figure is based on estimated savings to citizens in productivity costs by using e-services ($44.5 million), as well as to businesses ($54.5 million) and to municipalities ($4.8 million), aggregated processing and labor savings to municipalities ($3.8 million) and a one-time cost avoidance to the provinces ($.7 million).

"While intrinsically people in public administration knew electronic service delivery was a good thing, there was no hard measure they could point to and say, 'This is of economic benefit to the jurisdiction,' largely because there weren't many examples that were mature enough," said Freeman. "With New Brunswick, they have been able to look at long-term changes and make some measurements."

Overcoming Investment Obstacles
New Brunswick CIO Lori MacMullen explains that SNB was created in 1990 as a means of consolidating the province's 1,700-plus points of contact for government services. "That's kind of ridiculous, especially for transactional services," she said.

The province decided to create a separate corporation because it allowed SNB to do something governments can't -- invest and wait for payback over a number of years. "Governments are not set up to carry money," she said. "They're not able to invest now and get the benefits over time. That's not the way it works. Governments are measured on debt and cash flow in a year."

SNB is run by a board of directors much like a private-sector organization. It was built, said MacMullen, on a "spin the terminal" model. "The delivery of the service was designed in such a way it doesn't matter if you do it over the phone, over the Web or at an SNB center. The person at the desk uses the same tool to deliver that service as the person who takes your call at a call center or on the Web site."

Despite Canada's apparent maturity in e-government at all government levels, it still faces challenges. Accenture's Gordon points to another study it conducted, called E-Government: The Citizen's View. "In this one, Canada didn't fare as well. It was actually third in usage, behind the U.S. in the number of Internet users that have actually visited a government Web site."

What that indicates, he said, is that Canada, like all governments, must learn to market its e-services better, perhaps through incentives. "In some cases that's a great idea," he said. "We're seeing some innovative practices all over the world."

D'Auray agrees. "That's why the government launched niche marketing campaigns specific to the type of service," she said. "We have a challenge to break the barrier to completing transactions online, whether in the private or public sector, because of concerns around information sharing and privacy. Security of transactions is still top of mind among a lot of Canadians."

But if past successes are any indication, that barrier is one Canada will soon overcome.
Kathleen Sibley
Contributing Writer

January 20, 2006 at 11:47 AM in Business Models | Permalink | TrackBack (37) | Top of page | Blog Home

CRM opens up

CIO - CRM opens up

Marc L. Songini
09/05/2003

As customer relationship management (CRM) technology has matured, users have begun looking for bigger payoffs by enabling better integration with other enterprise applications. For instance, companies that want to let their customers view the status of their orders in real time might need to connect their call center or e-commerce applications to supply chain or manufacturing systems.

"The notion that CRM is largely a stand-alone sales force automation function is no longer valid," says Joshua Greenbaum, an analyst at Enterprise Applications Consulting in Daly City, Calif. "[Users] realize that CRM is central to many supply chain functions, such as order tracking and management, logistics and service."

But making those applications talk with one another isn't easy. One way to solve this problem is to migrate to an integrated enterprise application integration (EAI) suite from vendors such as SAP AG, Oracle Corp. or PeopleSoft Inc. These products have prebuilt integration hooks that ease application-sharing headaches. They also include tool kits or adapters to hook the suite applications to other vendors' modules. By using the suite vendors' tool sets and prepackaged processes, you can cut integration costs involved with custom coding and consulting. But even if you're willing to invest in such a migration effort, individual suite applications might not always have the features you require.

Users who go the best-of-breed route and use applications from companies such as San Mateo, Calif.-based Siebel Systems Inc. can use built-in integration capabilities, says Erin Kinikin, an analyst at Cambridge, Mass.-based Giga Information Group Inc. For instance, Siebel is rolling out its Web services-based Universal Application Network framework to connect applications and allow business-process integration.

Other CRM software vendors, including Menlo Park, Calif.-based Kana Software Inc., Cupertino, Calif.-based Chordiant Software Inc. and Cambridge, Mass.-based PegaSystems Inc., also offer products that enable integration at the business-process level.

"These vendors tend to do best at customer-facing or partner-facing applications, where there's lots of integration required and processes change frequently," Kinikin says.

Suite Connections

Ottawa-based Canada Post Corp. took the suite route after dealing with the aggravation of linking multiple applications. "In the pre-Y2k world of our systems landscape, we had best-of-breed and custom-developed interfaces tying it together, and it was a real mess," says Aaron Nichols, general manager of business transformation at Canada Post. "It was tough to manage and hard to make changes."

Integrating disparate applications was possible, but it was complex and expensive because the software was passing information related to orders, pricing and contracts, he says. Because of this and the challenges of business-process re-engineering and change management in the organization, Canada Post decided to install SAP's CRM and enterprise resource planning (ERP) modules.

Using Web services, Canada Post has also connected its Web site to the SAP system so it can take orders and connect them directly to the ERP system. The mail carrier also built an interface to its legacy tracking software to let customers track parcel deliveries.

When Canada Post went live with SAP CRM 2.0, the technology was immature, Nichols says. And there were many questions to sort out, such as whether the master customer profiles should reside in the CRM system or the R/3 system. Nichols plans to move to Version 3.0, which he says is a more mature product with a broader range of CRM features.

The CRM system has both prebuilt and homegrown interfaces. The connectors between the SAP CRM and R/3 applications that handle workflow came out of the box, but they required a bit of tuning. "We had to spend some time understanding them," Nichols says. The connectors allow call center workers to access a customer's case history from the back-end systems by entering a phone number. They also allow the system to route individual cases into the human resources system to determine whom to send them to for resolution.

Canada Post's order-taking system isn't an SAP product, but it ties into the back-end R/3 software by way of eGate EAI software from Monrovia, Calif.-based SeeBeyond Technology Corp.

EGate handles all data going in and out of the SAP system. Nichols says business-process designers crafted each interface to select the requisite data that needed to be mapped and passed back and forth, and they developed error-handling routines. Once the designs were finalized, they were given to an integrator, who built, tested and deployed the architecture.

Nichols says the integration project has resulted in a consolidated set of systems with tightly linked business processes and a common view for all customers. "We eliminated over 80 legacy systems and reduced labor costs by eliminating duplication and waste in processes," he says.

Siebel in the Middle

Suites may claim easier integration, but Jay Gardner, CIO at BMC Software Inc., says mixing and matching different CRM and ERP applications wasn't a big deal. "There is definitely value to an integrated application, but I don't think I have to have [all applications] from a single vendor," he says. Although Gardner says he wouldn't want to link together five different systems, two front- and back-office suites are manageable, he says.

BMC recently connected its Siebel sales force automation system to its Oracle financials backbone to automate order processing on the Web. The Houston-based maker of management applications has also connected a Siebel installation to its call system from Vantive Corp. (now part of PeopleSoft). The Siebel system also pulls information from a document management system, which allows support workers to view images of customer contracts. Information sharing among the Web team and the inside sales, direct sales and support staffs has generated a faster turnaround on potential sales leads, Gardner says.

BMC initially wrote its own custom interfaces for these applications but now plans to use EAI software from WebMethods Inc. in Fairfax, Va., to simplify future connectivity. The WebMethods system, in pilot since June, provides more extensive coding capabilities than BMC's legacy systems allow, Gardner says.

For instance, it enables a "publish and subscribe" model that lets BMC connect applications that need to share data with WebMethods without having to write separate point-to-point interfaces for each one. BMC also plans to configure its Siebel application to generate XML as its common CRM document format, so that the WebMethods XML adapter can parse it. BMC will then use Web services to establish data synchronization between applications, Gardner says.

Going forward, both suite and best-of-breed CRM vendors point to their support for Web services as the glue that will hold disparate systems together. But, says Giga's Kinikin, "the reality is that Web services is a five- to 10-year evolution, not a magic answer. We're at the very beginning of a new journey."

And even after Web services are established, she says, IT will still need to incorporate process flows, metadata and semantics-based standards such as electronic data interchange.

Vendor Approaches to CRM Integration

Oracle Corp.

Oracle touts the value of its integrated business application suite, but it also offers integration with competitors' products using prebuilt transformation adapters. These adapters allow data to be exposed for use with standard Web services technologies such as XML, Simple Object Access Protocol (SOAP) and Universal Discovery Description and Integration. But "[Oracle] still is largely interested in just keeping users vanilla with its products," says Steve Bonadio, an analyst at Meta Group Inc. in Stamford, Conn.

PeopleSoft Inc.

PeopleSoft claims to offer easy integration for its CRM customers through its AppConnect data integration broker, data warehouse and portal middleware tools. The vendor has a "pure technology" approach, relying on its portal as the presentation aggregator, says Bonadio. The company also offers support for XML-based Web services connectivity.

SAP AG

SAP takes a similar tack by offering its own application server product and portal to facilitate CRM data integration. It relies on the SAP Web application server, mySAP Portal and messaging exchange technologies to permit users to map CRM documents to general business documents using SOAP and XML technologies.

Siebel Inc.

With its newly announced Universal Application Network (UAN), Siebel appears to be the most forward-thinking in viewing integration as a way to craft business processes, Bonadio says. UAN is a series of Web services and XML-based business-process library specifications that, according to the company, make it easier to connect Siebel's CRM applications to homegrown systems and other packaged applications.-- Computerworld (US)

January 20, 2006 at 11:45 AM in Business Models | Permalink | TrackBack (24) | Top of page | Blog Home

The business transformation journeyCanada Post focuses on people and processes

The business transformation journeyCanada Post focuses on people and processes

By: Blair McQuillan
CIO Governments' Review (09 Jun 2003)

Increased demand from customers to deliver better service is not unique to government - or para-government, for that matter. Take Canada Post for example. In 1999, the agency found itself with poor customer service satisfaction, a high level of employee frustration and a number of silo-based legacy systems that were responsible for both problems.

The solution, according to Cal Hart, Canada Post's vice-president of business transformation and product management, was to start a business transformation initiative.

"Our customers were demanding more and we couldn't service them," Hart said. "We knew we had to improve our customer satisfaction and our employee satisfaction. We knew we had to get a more modern technology platform in place to enable us to move into new business opportunities, and that our costs at the time were not sustainable going forward."

The transformation vision

Hart knew from the beginning that most business transformation projects fail, and he didn't want Canada Post's venture to suffer a similar fate. As a result, everyone involved in the business transformation process made sure there was a clear understanding of what needed to be done and how each goal was going to be achieved before any changes took place.

"We spent six months doing an assessment of whether this was the best thing for us to do, what areas we would target, [and] what kind of business outcomes we were looking for," he said. "Before we started, we detailed what we wanted the customer experience to look like at the end of the day. Everyone had that vision and worked towards it as we built our CRM solution."

In order to ensure that Canada Post customers were served in a more streamlined, cost effective and timely manner, a number of changes had to take place and a three-year business transformation project was laid out. The project included altering Canada Post's Web site, retooling key business processes, replacing more than 80 legacy systems with an integrated ERP system, implementing a revised organization structure along a process enterprise model and launching a major change management program.

"It's all about people, process and technology," Hart said. "The trick is to get them all to work in harmony."

The transformation begins

The quest for harmony began to take shape in June 2001, when Canada Post launched a revamped Web site. The new site allows customers to conduct e-business and saves Canada Post the cost of completing transactions over the phone through call centres.

As for the call centres, they were outfitted with a CRM module in September 2001 that was part of one enterprise-wide ERP system. With the new system, call centre agents can now access information in different departments as well as a customer's case history.

For example, following the implementation of the new infrastructure, Hart watched as one call centre agent in Ottawa spoke with a woman in Toronto who had closed a mail box at a postal outlet, changed addresses twice and then wanted to know what had happened to her $50 refund check from the original mail box.

"The agent called up the information in the system and told the customer the day she closed the box," Hart said. "The agent was also able to tell her that the check had been sent out, but was returned to Canada Post because she had not notified us of her move. Then, since she was calling again, the check was cut and sent out the next day."

Hart said that prior to the installation of the ERP system, the agent would have had to call the postal outlet in Toronto where the customer closed the box, then access the financial records to find out who had issued the check and what had happened to it after it was sent and then take the matter up with the customer.

"With this implementation of CRM we have more information on the customer's history, we have more information between departments and other functions that work to resolve customer issues," said Marsha Creary, a customer service training and field support officer with Canada Post. Creary added that call centre agents can now take care of a customer's request on first contact 86 per cent of the time. "It's empowered the employees and reduced their level of frustration."

In order to ensure that its employees were empowered, the corporation, which handles 5 million calls from customers annually, launched a vigorous change management program prior to the launch of its new technology. Training specialists like Creary were brought up to speed on the system and then tasked with training the 280 call centre agents nationwide. At the regional level, call centre agents attended information sessions and had information booths detailing the different stages of the rollout. Canada Post even implemented a virtual system where employees could go after training to hone their new skills.

"The employees really liked that," Creary said of the virtual system known as the sandbox. "It was really engaging."

The new system - and the manner in which Canada Post implemented it - was so successful that the corporation was recently honoured with a CRM excellence award from Gartner Inc., a research and advisory firm based in Stamford, Conn. The award, in part, recognized Canada Post's dedication to people and processes during its business transformation initiative.

The transformation advantage

On the human resources front, Canada Post also realized it is facing a major loss of staff in the next five years as baby boomers get set to retire. Hart and his team knew this during the planning stages of the business transformation project and wanted to take advantage of it. The decision was made to change the organization's work process in order to utilize the natural attrition in a proactive manner.

"In 2002, our plan was to take out a little over 700 full-time [positions] and we exceeded that by 11 people," Hart said. "We're streamlining the processes at our back end. Those people that were formerly pickers and packers are now electronically taking orders."

While the initial business transformation project was completed in April 2002, Hart said Canada Post is still completing upgrades and the Crown corporation shows no sign of slowing down.

When you sit back and look at where we are today and where we were in January 2000, we really delivered a complete modern infrastructure in 18 months," he said. "We maintained our profitability while doing it, [and] we're now conducting e-business with our commercial customers.

"I know we've done the right thing for Canada Post going forward, because where we were was just not sustainable. But it's a journey. We're not there. We can only stop changing when our customers stop wanting us to change."

Blair McQuillan is assistant editor of CIO Governments' Review

Copyright © 2005
ITworldcanada.com

January 20, 2006 at 09:36 AM in Business Models | Permalink | TrackBack (17) | Top of page | Blog Home

The Northern Irish approach to IT commercialization

IT Business

A Belfast research centre provides some strategic blueprints that Canadian universities could learn from. Experts discuss the "spin-in" concept, partnerships with industry and the role of government
12/16/2005 5:00:00 PM
by Neil Sutton

The pride of Belfast’s research community is right next door to the former home of one the world’s better known disasters.

The Institute of Electronics, Communications and Information Technology is the brainchild of Queen’s University, based in Belfast. The facility, known as ECIT, is located just outside the city and overlooks the dry dock where the Titanic was built.

“(The Titanic) was fine when it left Belfast” is a common local phrase, says Godfrey Gaston, ECIT’s operations director. Gaston and his team are attempting to launch a series of projects – hopefully with happier endings than the infamous vessel – by increasing the level of collaboration between Queen’s University and industry in order to successfully turn research into actual marketable products.

The facility, which opened earlier this year, focuses on digital communications, high-frequency electronics, speech and language processing, and imaging systems.

ECIT follows a set of guidelines designed to make sure all interested parties are getting what they want out of projects. In the past, the private sector tried to tip the scales in its favour, according to Gaston.

“There’s a tendency to say, ‘Let’s go to the university, they’re cheap,’” he says. “There’s a mindset around some companies that they want to own everything and pay nothing.”

ECIT takes on companies on a case-by-case basis and determines the ownership of any resulting IP depending on the level of funding and participation they bring to the table. ECIT employs 130 staff, including 20 full-time engineers with real-world experience. “It’s not normal you’d have so many engineers in an academic institution,” says Gaston.

Research could result in spin-off companies, but it is just as likely that companies could “spin in,” i.e. small firms would become part of ECIT on a contract basis in order to share research with the institution. ECIT is also open to working with other universities to collaborate on projects. One of those is Halifax’s Dalhousie University.

David Gough, president of GINI University Services, visited ECIT in Belfast earlier this year. GINIus is a wholly-owned subsidiary of Dalhousie and is mandated to help support the university’s faculty of computer science. One of its goals is to help the university commercialize IP.

What Gough learned from ECIT is that Dalhousie and other universities across Canada could be doing more to support commercialization efforts.

“I think the main thing that they showed is that we could do better over here is the co-operation between universities and the private sector in a tangible form,” he says. “There’s applied research versus basic research, which doesn’t produce what is needed these days.

“What we’re finding here is that there’s very little commercialization going on. A lot of the professors can’t get over the fact that 10 per cent of something is a lot more than 100 per cent of nothing.”

The onus should also be on businesses to seek out academic partners, says James Milway, executive director of the Institute for Competitiveness and Prosperity, based in Toronto.

“True commercialization is done by business people who have to figure out, ‘How do I connect market needs with what’s going on in academia?’ That’s where we need to think about how to get businesses more compelled to innovate.”

The situation is improving in Canada, says Gough. The creation of organizations like Springboard – a government-supported effort to commercialize research in Atlantic Canadian universities – is a step in the right direction. But what Canadian universities should focus on is ties to business. Queen’s and neighouring institution Ulster University “could show the majority of our universities here a better way of doing things because of their aggressive and proactive linkages with industry,” he says, adding that ECIT is helping to attract industry participation by focusing on very specific areas of technology research.

Industry partnership is not a sure thing when it comes to turning research into products, says Ron Venter, interim executive director of Toronto’s Innovations Foundation, but is a good place to start.

The Innovations Foundation is affiliated with the University of Toronto and recently moved into the MaRS Centre (Medical and Related Study), a new research facility located in the heart of the city.

Venter says that the Innovations Foundation is currently revising its approach to industry partnerships to avoid what he calls a “disconnect” between university and private sector interests.

A lot of private sector companies thumb their noses at university research since it’s often raw and a long way from a marketable product, he says.

“Industry would love to have products with bows on them where there’s no risk. They would love us to give them the best stuff we have,” he says. “They would like to get it as cheap as possible. There’s always got to be this tug of war. The real truth lies in: what is the real value of this product?”

In a sense, pairing university research with business savvy “isn’t rocket science” says Gaston, but ECIT is still figuring out the right mix to make it all work properly. ECIT currently relies on public sector funding to keep its operation and up running. Assuming it can it hit upon a winning formula, Gaston wants the facility to be funded entirely through the proceeds of its commercialization efforts by 2008.

Most universities are looking for the same formula, but it can be elusive and change over time, said Ventive.

“Belfast may have all these good ideas, but they’re no different from U of T or McMaster or Waterloo,” he says. “The key thing is, nobody is right in this business.”

And after all, before she set sail for New York, even the Titanic was thought to be unsinkable.

December 16, 2005 at 05:42 PM in Business Models | Permalink | TrackBack (53) | Top of page | Blog Home

Google: Ten Golden Rules

Google: Ten Golden Rules - Issues 2006 - MSNBC.com

Getting the most out of knowledge workers will be the key to business success for the next quarter century. Here's how we do it at google.

By Eric Schmidt and Hal Varian
Newsweek
Updated: 11:33 a.m. ET Dec. 2, 2005

Issues 2006 - At google, we think business guru Peter Drucker well understood how to manage the new breed of "knowledge workers." After all, Drucker invented the term in 1959. He says knowledge workers believe they are paid to be effective, not to work 9 to 5, and that smart businesses will "strip away everything that gets in their knowledge workers' way." Those that succeed will attract the best performers, securing "the single biggest factor for competitive advantage in the next 25 years."

At Google, we seek that advantage. The ongoing debate about whether big corporations are mismanaging knowledge workers is one we take very seriously, because those who don't get it right will be gone. We've drawn on good ideas we've seen elsewhere and come up with a few of our own. What follows are seven key principles we use to make knowledge workers most effective. As in most technology companies, many of our employees are engineers, so we will focus on that particular group, but many of the policies apply to all sorts of knowledge workers.

* Hire by committee. Virtually every person who interviews at Google talks to at least half-a-dozen interviewers, drawn from both management and potential colleagues. Everyone's opinion counts, making the hiring process more fair and pushing standards higher. Yes, it takes longer, but we think it's worth it. If you hire great people and involve them intensively in the hiring process, you'll get more great people. We started building this positive feedback loop when the company was founded, and it has had a huge payoff.
* Cater to their every need. As Drucker says, the goal is to "strip away everything that gets in their way." We provide a standard package of fringe benefits, but on top of that are first-class dining facilities, gyms, laundry rooms, massage rooms, haircuts, carwashes, dry cleaning, commuting buses—just about anything a hardworking engineer might want. Let's face it: programmers want to program, they don't want to do their laundry. So we make it easy for them to do both.
* Pack them in. Almost every project at Google is a team project, and teams have to communicate. The best way to make communication easy is to put team members within a few feet of each other. The result is that virtually everyone at Google shares an office. This way, when a programmer needs to confer with a colleague, there is immediate access: no telephone tag, no e-mail delay, no waiting for a reply. Of course, there are many conference rooms that people can use for detailed discussion so that they don't disturb their office mates. Even the CEO shared an office at Google for several months after he arrived. Sitting next to a knowledgeable employee was an incredibly effective educational experience.
* Make coordination easy. Because all members of a team are within a few feet of one another, it is relatively easy to coordinate projects. In addition to physical proximity, each Googler e-mails a snippet once a week to his work group describing what he has done in the last week. This gives everyone an easy way to track what everyone else is up to, making it much easier to monitor progress and synchronize work flow.
* Eat your own dog food. Google workers use the company's tools intensively. The most obvious tool is the Web, with an internal Web page for virtually every project and every task. They are all indexed and available to project participants on an as-needed basis. We also make extensive use of other information-management tools, some of which are eventually rolled out as products. For example, one of the reasons for Gmail's success is that it was beta tested within the company for many months. The use of e-mail is critical within the organization, so Gmail had to be tuned to satisfy the needs of some of our most demanding customers—our knowledge workers.
* Encourage creativity. Google engineers can spend up to 20 percent of their time on a project of their choice. There is, of course, an approval process and some oversight, but basically we want to allow creative people to be creative. One of our not-so-secret weapons is our ideas mailing list: a companywide suggestion box where people can post ideas ranging from parking procedures to the next killer app. The software allows for everyone to comment on and rate ideas, permitting the best ideas to percolate to the top.
* Strive to reach consensus. Modern corporate mythology has the unique decision maker as hero. We adhere to the view that the "many are smarter than the few," and solicit a broad base of views before reaching any decision. At Google, the role of the manager is that of an aggregator of viewpoints, not the dictator of decisions. Building a consensus sometimes takes longer, but always produces a more committed team and better decisions
* Don't be evil. Much has been written about Google's slogan, but we really try to live by it, particularly in the ranks of management. As in every organization, people are passionate about their views. But nobody throws chairs at Google, unlike management practices used at some other well-known technology companies. We foster to create an atmosphere of tolerance and respect, not a company full of yes men.
* Data drive decisions. At Google, almost every decision is based on quantitative analysis. We've built systems to manage information, not only on the Internet at large, but also internally. We have dozens of analysts who plow through the data, analyze performance metrics and plot trends to keep us as up to date as possible. We have a raft of online "dashboards" for every business we work in that provide up-to-the-minute snapshots of where we are.
* Communicate effectively. Every Friday we have an all-hands assembly with announcements, introductions and questions and answers. (Oh, yes, and some food and drink.) This allows management to stay in touch with what our knowledge workers are thinking and vice versa. Google has remarkably broad dissemination of information within the organization and remarkably few serious leaks. Contrary to what some might think, we believe it is the first fact that causes the second: a trusted work force is a loyal work force.

Of course, we're not the only company that follows these practices. Many of them are common around Silicon Valley. And we recognize that our management techniques have to evolve as the company grows. There are several problems that we (and other companies like us) face.

One is "techno arrogance." Engineers are competitive by nature and they have low tolerance for those who aren't as driven or as knowledgeable as they are. But almost all engineering projects are team projects; having a smart but inflexible person on a team can be deadly. If we see a recommendation that says "smartest person I've ever known" combined with "I wouldn't ever want to work with them again," we decline to make them an offer. One reason for extensive peer interviews is to make sure that teams are enthused about the new team member. Many of our best people are terrific role models in terms of team building, and we want to keep it that way.

A related problem is the not-invented-here syndrome. A good engineer is always convinced that he can build a better system than the existing ones, leading to the refrain "Don't buy it, build it." Well, they may be right, but we have to focus on those projects with the biggest payoff. Sometimes this means going outside the company for products and services.

Another issue that we will face in the coming years is the maturation of the company, the industry and our work force. We, along with other firms in this industry, are in a rapid growth stage now, but that won't go on forever. Some of our new workers are fresh out of college; others have families and extensive job experience. Their interests and needs are different. We need to provide benefits and a work environment that will be attractive to all ages.

A final issue is making sure that as Google grows, communication procedures keep pace with our increasing scale. The Friday meetings are great for the Mountain View team, but Google is now a global organization.

We have focused on managing creativity and innovation, but that's not the only thing that matters at Google. We also have to manage day-to-day operations, and it's not an easy task. We are building technology infrastructure that is dramatically larger, more complex and more demanding than anything that has been built in history. Those who plan, implement and maintain these systems, which are growing to meet a constantly rising set of demands, have to have strong incentives, too. At Google, operations are not just an afterthought: they are critical to the company's success, and we want to have just as much effort and creativity in this domain as in new product development.

Schmidt is CEO of Google. Varian is a Berkeley professor and consultant with Google.
© 2005 Newsweek, Inc.

December 6, 2005 at 09:15 AM in Business Models | Permalink | TrackBack (25) | Top of page | Blog Home

Another desperate attempt to discredit Massachusetts OpenDocument adoption

Another desperate attempt to discredit Massachusetts OpenDocument adoption

It was on the front page of the Boston Globe newspaper today, and the lead article on their web site--an investigation that normally would be buried in the City & Region section of the paper. So you can't miss it: IT manager Peter Quinn of the Massachusetts state government is criticized for not fully reporting trips he took during his promotion of the OpenDocument format.

Microsoft, after a late start (like most technology companies) has poured millions into lobbying over the past decade. Rumors even suggest that several government IT managers who dared to consider open-source alternatives to Microsoft heard promptly from both the company and their own bosses to pull back. So it would be highly gratifying to Microsoft and those trying to maintain the status quo if someone could turn the tables and try to smear the proponents of open source and open standards with similar influence.

Because the whole thrust of choosing an open document standard is to improve transparency in government, one could hardly find a cleverer complaint than to accuse the proponents of lack of transparency.

A nice side effect of the controversy is to intimidate government staff and punish them for doing what they should be doing: going out into public forums and exchanging ideas with the communities affected by their decisions. Especially in a major paradigm shift, and especially when dealing with open standards that have far-flung communities.

People opposing change have claimed that moving to an open standard would raise costs, playing up the obvious observation that any investment in the future requires a temporary increase in short-term expenditures. Then representatives for the disabled raised the concern that tools providing the OpenDocument format don't support all the accessibility options that Microsoft Office contains; this gap is being addressed surprisingly fast.

Pamela Jones of groklaw pointed out that representatives for the disabled were demonstrating an unseemly helplessness in raising their complaint. Because several open-source tools support OpenDocument, anyone who wants accessibility added can pay someone to do the job rather than complaining about it.

So they're running out of FUD, and it became time to shoot the messenger. The Boston Globe article is short on details--suggesting that there isn't much legal basis for the whole complaint to start with--but the argument goes like this; state officials have to receive written authorization for trips paid by outsiders, and have to give a detailed estimate of the costs of travel. Quinn, as director of IT for the state government, made a dozen trips during the last two years, receiving written authorization for some. It is not clear whether he received verbal authorization or written authorization for the others. He paid for some trips himself and accepted payment from the conference sponsors, duly reporting these payments.

Now someone in state government is claiming Quinn should have listed all the companies that sponsored the conferences, to allay fears that these companies were trying to gain underhanded influence. By this standard, a speaker who gets free admission to a conference such as LinuxWorld Expo or O'Reilly's Open Source conference would have to list that his trip was paid for by Intel, Sun, Dell, and any other of the one or two dozen companies listed as sponsors--even Microsoft!

Yes, companies are involved in open source. Contrary to the critics, open source does create markets, and companies will rush in to make money there. So the publicity around this investigation may inadvertently weaken another form of anti-open source FUD.

Attending a conference, however, does not necessarily mean one comes in contact with a company representative. Usually, to actually interact with that company, an attendee has to take the deliberate step of arranging a meeting; otherwise he's unlikely even to get a demo at a booth. A speaker at a conference is likely to come in, deliver a speech, and leave without ever seeing a company representative.

I managed to reach Quinn's former boss, Eric Kriss, which the Globe did not. (Choosing to break a story over Thanksgiving weekend, when protagonists are on vacation and government offices that could answer questions are closed, definitely does not contribute to clarity.)

Kriss, whom I know because he's contacted me with a book idea earlier, pointed out that:

*

Most of Quinn's trips occurred after Massachusetts made the decision to adopt OpenDocument. There is no possibility that the trips would influence the decision that had already been made.
*

While some two-way communication occurs at any conference--and is beneficial to the public--the primary purpose of the trips were to let Massachusetts government tell the rest of the world what it was doing.
*

Far from being junkets, these trips were normally squeezed in on weekends around his normal duties and represented a contribution of his free time to the community.

I'm not going to express an opinion on the law, which is none of my business, particularly because I err on the side of supporting more information rather than less. Lapses in authorization and reporting should be investigated by the state, and the Globe should report the investigations. But it seems that their fundamental misunderstanding of the dynamics of technical conferences has threatened to create an unwarranted hysteria. Sponsorship of a technical conference does not mean the sponsor is paying the speakers, or has any influence over them.

What we're left seeing is a lot of scurrying to transform an important issue of government documentation into a spurious issue of staff documentation, with publicity flourishes to warn that anyone trying to open up government has to be ready for every kind of backlash.

Andy Oram is an editor for O'Reilly Media, specializing in Linux and free software books, and a member of Computer Professionals for Social Responsibility. His web site is www.praxagora.com/andyo.

November 27, 2005 at 02:55 PM in Business Models | Permalink | TrackBack (23) | Top of page | Blog Home

Building a Better Boom

Building a Better Boom - New York Times

By JOHN BATTELLE
Published: November 18, 2005

Kentfield, Calif.

IT sure feels like a bubble, doesn't it? Let's tick off the signs: a red-hot market for Internet stocks (Google, for example, has more than quadrupled since it went public in 2004); fawning articles celebrating entrepreneurs; a glut of venture capitalists elbowing one another to invest in companies with no plans on how to make money past some hand waving about "advertising" and plenty of vague claims about how their technology will "change the world."

The Internet is exciting again, and once again folks are rushing in. In some categories - like search or social networking, for example - there are scores of start-ups vying for pretty much the same market, and it's certain that, just like last time, most of them will fail.

But regardless of all this déjà vu, we are not in a bubble. Instead we are witnessing the Web's second coming, and it's even got a name, "Web 2.0" - although exactly what that moniker stands for is the topic of debate in the technology industry. For most it signifies a new way of starting and running companies - with less capital, more focus on the customer and a far more open business model when it comes to working with others. Archetypal Web 2.0 companies include Flickr, a photo sharing site; Bloglines, a blog reading service; and MySpace, a music and social networking site.

These sites all came into their own in the past two years, and all of them have been sold for handsome sums to major media or technology companies. What do they have in common that proves that this time, we're not heading for a fall?

First, this time the Web is ready for the dreams of both its innovators and its public. The first version of the Internet - call it Web 1.0 - was long on vision but short on execution and audience. The technology was rudimentary, precious few had broadband connections and starting a business that "scaled" - one that could deal with success and the traffic it brought - was extremely expensive.

The Web has since become a platform, and building new businesses on that platform is no longer a multimillion-dollar proposition. Most new Web businesses nowadays are started with less than half a million dollars, and it's rare to find one that wants to use money from an initial public offering to get to profitability.

The reason? Start-ups are leveraging nearly a decade's worth of work on technologies that are now not only proven, but also free, or very nearly so. Open-source software can now do nearly everything that Oracle, I.B.M. and Microsoft specialized in back in the 90's. And the cost of computing and bandwidth? You can now lease a platform that can handle millions of customers for less than $500 a month. In the 90's, such a platform would have run tens of thousands of dollars or more a month.

I should know. It cost me millions to build my Web 1.0 business's Web site. My current business is based on blogging, where the average cost to start a site is about $100.

Or just ask Joe Kraus, a founder of the once high-flying Excite portal. Excite ran through millions in venture capital, then tens of millions of I.P.O. money, before its spectacular demise (Mr. Kraus had left before then). His latest start-up, JotSpot, is built on open-source software, and cost less than $200,000 to begin.

Mr. Kraus exemplifies the second reason I believe we are not in a bubble: this time, the financiers aren't driving. Instead, the entrepreneurs and geeks - often one and the same - are. The lessons of Web 1.0 are never far from their minds, and the desire to create something cool that might foster some good in the world is often equally paramount with the desire to make money. The culture of Web 2.0 is, in fact, decidedly missionary - from the communitarian ethos of Craigslist to Google's informal motto, "don't be evil."

Ah, yes, Google. That brings us to the third reason we are not in a bubble: vastly improved search technologies. Recall that the demise of Web 1.0 was predicated in large part on the collapse of the Internet advertising business - people were spending millions buying billboard-like ads that, it turns out, nobody was paying attention to.

But effective search engines - and what they enabled - changed all that. Right as the bubble burst, the Internet became a mainstream medium - a majority of Americans were now online. At about the same time, Google turned its first profit, as did Overture, a similar company now owned by Yahoo. These two companies made money by reinventing advertising. Using their services, advertisers paid only when people actually clicked on their ads, and it turned out, millions did just that - once the ads were matched to searches and therefore actually useful.

Search has provided the business models for countless companies, which use search to find new customers (eBay and Amazon are two of Google's largest advertisers) or which run Google or Yahoo's advertising networks on their own sites (a process called syndication). In fact, syndication has become the de facto business model of many start-ups: if you build a new service that garners a decent audience, syndication can provide enough revenue to give you time to refine your services and find your true business model.

Which leads me to the final reason I believe we are not in a bubble: the relative lack of public offerings. Most companies this time around are taking the path of acquisition, finding homes at large, stable and profitable companies like Yahoo, Google, News Corporation or Barry Diller's InterActiveCorp. The era of the hot Net I.P.O. is over, and good riddance.

So sure, there are too many start-ups, and sure, some venture capitalists are trying to get in on as many as they can. In the meantime, far more companies are starting that just might change the world, or at least interesting parts of it, and thanks to the lessons of the past, we now have an ecosystem that may enable them to make a serious go of it.

John Battelle,a co-producer of the Web 2.0 conference, is the author of "The Search: How Google and Its Rivals Reinvented Business and Transformed Our Culture."

November 19, 2005 at 02:54 AM in Business Models | Permalink | TrackBack (26) | Top of page | Blog Home

Office 2003 vs. OpenOffice.Org

Office 2003 vs. Openoffice.Org

April 26, 2004
By Jason Brooks, eSeminars

In recent years, open-source alternatives to Office have matured to the point where IT managers are beginning to investigate the viability of moving from the Microsoft Corp. suite to a license-free alternative. So when eWEEK Corporate Partner Ed Benincasa shared his desire to perform a user-based comparison between the OpenOffice.org project's OpenOffice.org suite and Microsoft's Office 2003, we saw a perfect opportunity to compare the suites under real-world conditions.

Benincasa is vice president of MIS at precision machining manufacturer FN Manufacturing Inc., in Columbia, S.C. Microsoft Office 97 and Office 2000 are deployed to the 300-plus users at the site, and Benincasa is evaluating whether to move to Microsoft's latest suite, Office 2003, or the open-source OpenOffice.org 1.1.1.

Benincasa is looking to upgrade because Microsoft has discontinued distribution of new licenses for Office 2000 and Office 97. Benincasa is exploring his office application suite options because he is concerned about the high cost of an upgrade to Office 2003. He also wants to prevent Microsoft's product release and support road map from dictating FN Manufacturing's upgrade timetable.

"I'm not an anti-Microsoft person, and I think Office is a good product," said Benincasa. "However, we are cautious with our IT budget, and I'd prefer to spend money that directly relates to our business, like investing in things like hardware. Office 97 does everything we want it to do, and we would stay on that suite if we could. It pains me to have to spend money for features and functions most of my end users won't even begin to need."

eWEEK Labs traveled to FN Manufacturing to put the two office suites to the test. We worked with Benincasa and members of his IT staff, as well as several representatives of the user population at FN Manufacturing and its related companies—Browning Arms Co., in Ogden, Utah, and parent company Fabrique Nationale (National Weapons Factory), in Herstal, Belgium.

Also participating in the testing were Corporate Partner Kevin Wilson, product line manager of desktop hardware at Duke Energy Corp., in Charlotte, N.C., and Jeff Worboys, Duke's product line manager of desktop productivity applications.

For a complete list of eVal participants, click here.

We worked with three groups of users, all of whom currently use Office 97 or 2000 for productivity tasks. We tested OpenOffice.org and Office 2003 with sample documents provided by eWEEK Labs and with the testers' own files. We concentrated our tests on the applications' capability and compatibility, as well as on user training requirements.

During tests, most users had little or no trouble moving from their current suite to OpenOffice.org. However, for more advanced users—especially advanced users of Excel—OpenOffice.org did not fare as well.

"The advanced users already push Microsoft Office to the limits and are constantly looking for more functionality, which OpenOffice. org may not be able to provide," said Tina Sanzone, application analyst at Browning. "For other users, however, we can easily customize OpenOffice.org to make it look pretty close to what they already have."

Users who tested Office 2003 found the suite more polished and easy to use than Office 97 and 2000. However, only a few testers—again, mostly advanced users of Excel—said an upgrade to Office 2003 would provide them significantly more useful functionality.

Benincasa said that he has rolled out OpenOffice.org on shop-floor computers for basic document viewing and that the application works well there.

Those who participated in this eVal seemed, for the most part, receptive to a move to OpenOffice.org, but it's important to keep in mind that they volunteered for the test and, therefore, may be more open to a move than the bulk of Benincasa's users.

Next page: Sum of their parts

In any case, all testers liked Office 2003 and said staying with Office would likely provide the smoothest upgrade path. "It'll be easier to introduce Microsoft Office 2003 to users here at FN Manufacturing than OpenOffice because it's a lot more user-friendly than OpenOffice," said Joan Curfman, business systems supervisor at FN Manufacturing. "Training will definitely be more detailed and will take a lot longer on OpenOffice.org because the interface isn't that friendly. Users here have problems using what we already have. They'll probably find OpenOffice.org even more difficult to use and learn."

Benincasa said training on OpenOffice.org would be conducted in-house, leveraging the OpenOffice.org knowledge developed within the organization through this eVal and FN Manufacturing's previous tests of the suite.

A move to OpenOffice.org could be just the beginning of FN Manufacturing's open-source journey. Benincasa has been pondering a move from Windows to Linux for some of the company's desktop systems, a path the multiplatform OpenOffice.org would help clear.

Sum of Their Parts

We tested the word processor, spreadsheet and presentation applications in OpenOffice.org 1.1.1 and Office 2003 separately, but some of the testers' assessments applied suitewide.

Almost every person who tested Office 2003 expressed appreciation for Office's Task Pane—an interface feature that lets users carry out operations related to the document at hand, such as using the thesaurus while working on a Word document. Testers also said they valued Task Pane as an interface to Office's help system, which they found to be effective.

As for OpenOffice.org, most testers said they liked being able to launch any of the suite's document types from the application they were using. Testers also said they appreciated having all their OpenOffice.org application instances available from the Window tool bar menu item. The Window item in Office's apps, in contrast, shows only open instances of like applications.

Word vs. Writer

All the eVAL testers said they create and work with Word documents every day.

The testers who worked with Office 2003 said there were few differences between Word 2003 and earlier versions of the Microsoft word processor. In a comment echoed by many of our testers, Rick Miller, an engineer at FN Manufacturing, said, "Most tasks I perform are the same or similar [whether in Word 97 or 2000 or in Word 2003]."

That's not to say that there weren't issues: One tester, for example, complained that a key combination had changed and that Microsoft's context-sensitive smart-tags feature got in the way during testing. By and large, however, users were agreed that their familiarity with Word would minimize the time required to get up to speed with Office 2003.

However, the testers who worked with OpenOffice.org said the suite's word processor application, Writer, seemed familiar as well.

FN Manufacturing Validation Engineer Doug Shaffer said that Writer's "layout and command locations are similar to Microsoft Word's" and that it was "very easy to perform the standard basic tasks in Writer."

Browning's Sanzone, who tested OpenOffice.org in addition to Office 2003, said that documents took longer to open in Writer than they did in Word. This can be attributed to the fact that Writer must carry out an import operation when it opens documents saved in Microsoft's Word format. For short documents, there's no noticeable difference, but for large files with complex formatting, Writer can take as much as 10 seconds longer than Word to open the same document.

In general, though, of the OpenOffice.org applications we evaluated, Writer presented the fewest file-format-compatibility problems.

Several testers said they were impressed with the ability of Writer to save documents as PDF files, a feature they believe would save money as well as time because PDF export for Word requires a Microsoft add-in that must be purchased separately.

Next page: Suite considerations

Another Writer feature that stood out for testers was the application's word-complete function, similar to the auto-complete function of many Web browsers. Writer attempts to complete words being typed based on words previously typed in a particular document. Deborah Hordych, a buyer at FN Manufacturing, liked this feature but said that users would have to be careful that Writer was suggesting an appropriate word.

With a Belgian parent company, FN Manufacturing users were, not surprisingly, interested in Word 2003's translation capabilities. Using a document he created, Kevin Patten, a controller in FN Manufacturing's finance department, was able to use Word to effectively translate specific phrases from English to French, something Patten said he does frequently during his daily work routine.

"Extras like the translation feature are a really nice touch because they cut down on the amount of time I have to spend on a document," said Patten. "Every minute I save on something like this is a minute I can spend working on something else."

Suite considerations

OpenOffice.Org 1.1.1

Pros

# No licensing costs As a free-software project, OpenOffice.org has no licensing.

# Good integration among suite applications eValuation testers said, for example, that they appreciated being able to create new spreadsheet documents from within the word processor application.

# Variety of export options OpenOffice.org ships with PDF export capabilities, as well as support for saving presentations in Flash format.

Cons

# File-format compatibility issues Although OpenOffice.org does a good job of handling Microsoft Office file formats, small formatting inconsistencies will require reworking of complex documents.

# Lack of traditional support Office suites typically do not require much vendor support, but the fact that OpenOffice.org is an open-source project means software support must come from the community, generally spread out across various Web sites and newsgroups.

# Interface differences OpenOffice.org is similar to Microsoft Office in its design, but users will need some time to grow accustomed to differences between the two.

Office 2003

Pros

# Familiarity Most knowledge workers use some version of Microsoft Office already, and an upgrade to a new version of Office presents the flattest learning curve.

# File-format compatibility Microsoft Office file formats are de facto standards, and no rival suite handles these proprietary formats as well as Office does.

# Advanced features Office 2003 has more features and capabilities than competing suites. Although many users do not require or use much of this functionality, advanced users, particularly of spreadsheets, often find it vital.

Cons

# High licensing costs Microsoft Office licenses are priced at a few hundred dollars each—a cost that can be difficult to justify when your users require only basic productivity suite functionality.

# Advanced features require latest versions Some of the most compelling features added to the last two versions of Office—such as extensible smart tags, document protection and Smart Document creation—are not backward-compatible with earlier versions of the suite.

Next page: Excel vs. Calc

Excel vs. Calc

eVAL testers were split between those who use spreadsheets very little or for fairly simple tasks and those who are accustomed to using Excel 97/2000 as an analysis tool.

The latter group includes some of FN Manufacturing's finance and engineering personnel. They leverage Excel's statistics capabilities, among others, and appreciated the improvements made to the Pivot Table feature in Excel 2003. OpenOffice.org's Calc offers a similar feature, called DataPilot, but testers had trouble locating it because of the differences in the way Calc and Excel are organized.

Our advanced testers also were interested in Excel's Watch Window feature, something Microsoft added to the application in Office XP. A Watch Window is a separate, small window that remains "on top" and enables users to monitor a selected set of cells. Calc does not have a similar feature, but this wouldn't likely be a deal breaker for FN Manufacturing users because the versions of Excel they currently use don't offer this functionality.

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Among the more casual spreadsheet testers, the differences between the spreadsheet applications were less jarring. Romuald Dufour, an IT manager at Fabrique Nationale, said of Excel 2003: "There was not much difference between Office 2000, OpenOffice.org and Office 2003 for my use."

Melinda Vause, who works in finance at FN Manufacturing, said Calc felt "similar to Excel, and it would be easy to learn the slight differences."

Most of the Excel spreadsheets we used during testing were not heavily formatted, but we did experience compatibility issues between Excel and Calc. For the most part, these problems related to charts.

OpenOffice.org tester Vause noted that "graph names were converted to row numbers in some cases, and some formatting was dropped."

The severity of these issues differed from document to document, and the significance differed from tester to tester.

FN Manufacturing bookkeeper Suzan Widener reported that the Excel-formatted spreadsheet she used during the eVal was compatible with Calc. However, Joan Curfman, who tested Office 2003 during the eVal but who had been part of an earlier OpenOffice.org test group, estimated it would take weeks to convert FN Manufacturing spreadsheets from Office 97 and 2000 to OpenOffice.org.

Next page: PowerPoint vs. Impress

PowerPoint vs. Impress

eVAL testers said they use the PowerPoint presentation app less than any other Office application. However, a move to either PowerPoint 2003 or OpenOffice.org's Impress would require significant training because PowerPoint 2003 is the Office application that's changed the most since its 97/2000 incarnations and Impress is the OpenOffice.org application that differs most from Office in its design. Shaffer said of Impress: "Its icons and commands are not very similar to PowerPoint."

FN Manufacturing produces its fair share of complex presentations, and it was with one such presentation that we experienced several compatibility problems between PowerPoint and Impress.

The FN Manufacturing presentation we were testing made heavy use of embedded Word and Excel objects, a result of the heavy collaboration among the groups that produced the document (a common scenario in many organizations). The upshot was that the small formatting snafus testers encountered in Writer and Calc tended to collect in the test presentation. FN Manufacturing would definitely have to rework this presentation—and likely others it has already produced—if it moved to OpenOffice.org.

What's more, Impress and PowerPoint handled transition animations differently, and certain Impress capabilities, such as three-dimensional text in presentations, did not carry across to PowerPoint.

However, Philippe Nemery, an IT manager at FN's parent company in Belgium, said he's used Impress for some time now and has come to prefer the way that the application is organized.

Senior Analyst Jason Brooks can be reached at jason_brooks@ziffdavis.com.

November 6, 2005 at 03:44 PM in Business Models | Permalink | TrackBack (16) | Top of page | Blog Home

A market for ideas

A market for ideas | Economist.com

Oct 20th 2005
From The Economist print edition
Intellectual-property protection can be good for the technology industry as well as for its customers, says Kenneth Cukier (interviewed here). But it requires careful handling

“The granting [of] patents ‘inflames cupidity’, excites fraud, stimulates men to run after schemes that may enable them to levy a tax on the public, begets disputes and quarrels betwixt inventors, provokes endless lawsuits...The principle of the law from which such consequences flow cannot be just.”

The Economist may have put it rather strongly in 1851, but its disapproval of patents represented conventional wisdom at the time. A century earlier, Adam Smith had described them as necessary evils, to be handed out sparingly, and many other economists have since echoed his reservations. Patents amount to temporary monopolies on useful new inventions.

In recent years intellectual property has received a lot more attention because ideas and innovations have become the most important resource, replacing land, energy and raw materials. As much as three-quarters of the value of publicly traded companies in America comes from intangible assets, up from around 40% in the early 1980s. “The economic product of the United States”, says Alan Greenspan, the chairman of America's Federal Reserve, has become “predominantly conceptual”. Intellectual property forms part of those conceptual assets.

In information technology and telecoms in particular, the role of intellectual property has changed radically. What used to be the preserve of corporate lawyers and engineers in R&D labs has been speedily embraced by the boardroom. “Intellectual-asset management” now figures as a strategic business issue. In America alone, technology licensing revenue accounts for an estimated $45 billion annually; worldwide, the figure is around $100 billion and growing fast.

Technology firms are seeking more patents, expanding their scope, licensing more, litigating more and overhauling their business models around intellectual property. Yet paradoxically, as some companies batten down the hatches, other firms have found ways of making money by opening up their treasure-chest of innovation and sharing it with others. The rise of open-source software is just one example. And a new breed of companies has appeared on the periphery of today's tech firms, acting as intellectual-property intermediaries and creating a market for ideas.
Mind the keep-out signs

At the same time, however, the legitimacy of many patents granted is in question as patent offices struggle with the huge increase in demand. Over the past decade the number of patent applications has nearly doubled and continues to climb. Much of that growth has been in the IT and telecoms field: in America alone, that sector's overall share of patents has increased from around 30% in 1990 to almost 40% today. Also climbing, alas, is the number of lawsuits over patent infringement, the cost of litigation, and the amount of money plaintiffs are winning.

Meanwhile, emerging technology powerhouses such as China and India are competing to move up from lower-end work such as hardware manufacturing and software coding to more sophisticated projects requiring their own innovation. This could pose serious challenges to today's incumbents. The number of patents granted at China's patent office has trebled in the past four years alone.

“Intellectual property has become more central to the industry,” says Greg Papadopoulos, chief technology officer of Sun Microsystems. “I don't know if that is a function of a mature industry, or simply a confused one.”
Licensed to make money

The facts and figures speak for themselves. IBM alone now earns over $1 billion annually from its intellectual-property portfolio. HP's revenue from licensing has quadrupled in less than three years, to over $200m this year. Microsoft is on course to file 3,000 patents this year, when in 1990 it received a mere five. Earlier this year it set up an entirely new corporate division to exchange its technology for cash or equity in start-up firms. Nokia has recently started licensing its technology to other firms and plans to do more. And some companies, such as ARM, a British firm that designs the blueprints for microchips used in wireless devices, do little other than create and sell intellectual property.

According to a survey of business executives last year by McKinsey, a consultancy, 54% of companies saw growth in licensing of 10-50% between 2000 and 2002. Almost 75% of executives say they expect to buy as well as sell more licences over the next two to five years, and 43% expect a dramatic increase in their licensing revenue. And they think the market is still embryonic. “Many companies generate a lot of intellectual property and do not capture the value from it,” says Jay Jubas of McKinsey.

The new predominance of intellectual property in technology industries is fed by a number of broader industry trends. First, IT and telecoms have become so complex that there is a greater willingness to accept the innovations of others. Gone are the days when vertically integrated firms handled every step of a product, from initial design to final sale. Now, a small army of specialist firms focus on narrow portions of technology, using intellectual-property rights to protect their inventions when they are licensed out.

Second, as many new technologies quickly turn into commodities, firms increasingly rely on innovation to remain competitive. Yet the return on investment in R&D is short-lived because more people innovate at a far faster pace than before. That means margins have shrivelled, explains Ragu Gurumurthy of Adventis, an IT and telecoms consultancy. “How to recoup the cost of innovation? By licensing the technology,” he says.

Third, customers are demanding “interoperability” and common standards rather than proprietary systems, which means different firms' technologies must work together smoothly. This often requires pooling patents or cross-licensing agreements.

Fourth, generating intellectual property is less capital-intensive than other aspects of the IT businesses because it relies mainly on people rather than bricks, mortar and machinery. That makes it attractive to many start-up firms. Venture capitalists often demand that firms patent technology, both to block rivals and to have assets to sell in case the firm flounders. This was particularly apparent during the internet boom in 2000. “In addition to the dotcom bubble, we had a patent bubble,” says Mark Webbink of Red Hat, a firm that sells Linux, an open-source operating system.

Companies cannot simply turn their back on what is happening in intellectual property. Even if they refuse to play the game, they may be unwittingly infringing someone else's patents because there are so many more of them around. Unless firms have patents of their own to assert so they can reach a cross-licensing agreement (often with money changing hands too), they will be in trouble. Thus many companies are acquiring large numbers of patents for purely defensive reasons, for use only to keep others' patent threats at bay.

Legally, the intellectual-property system covers four areas: copyrights (used to protect artistic, musical or literary works); trademarks (for things like brands); patents (for inventions); and an ill-defined category of “trade secrets”, for practices that are kept confidential. The system provides legal protection against counterfeiters and copiers and is vital to many fields, such as biotechnology and nanotechnology. And it matters not only to companies: universities, too, have recently become big patent holders and licensers.

In IT and telecoms, the area of intellectual property that is creating particular upheaval is patents (see article). This is because patents confer a “negative right” to exclude others from using the same technique; yet information technology and telecommunications rely on “network effects”, meaning that as more people use a system, it becomes that much more useful. To make the most of such network effects, interoperability between different technologies is essential. This can be achieved either by a single standard set by a dominant firm (which tends to generate resistance from customers and competitors), or by using a mixture of different technologies, with the patent system providing legal protection for inventions.
The more the merrier

As the system of intellectual property evolves, the ethos seems to be that if a little is good, then more is better. That is to say, if some property rights on inventions are beneficial, then increasing those rights—in scope, strength or duration—will increase the benefits. But that is a large assumption. There is even a body of evidence to suggest it is flatly wrong.

The technology industry faces the question of whether today's abundance of patents, rather than lubricating the gears of innovation, may be clogging them up. Already, businesses are having to negotiate with other firms in order to do basic things such as reading files from different proprietary formats; and the design of new technology products now involves lawyers as well as engineers. The proliferation of patents might prove a serious encumbrance to businesses, just as travellers along the Rhine in medieval Europe were slowed down by having to pay a toll at every castle.

James Boyle, a legal scholar at Duke Law School in North Carolina, claims that the current increase in intellectual-property rights represents nothing less than a second “enclosure movement”. In the first enclosures, in 18th- and 19th-century Britain, the commons—open fields used by many, belonging to all, owned by none—were fenced in, and nearly all land became private property. By analogy, the granting of property rights on ideas, to the extent it is happening today, is plundering the intellectual commons of our public domain.

Others see the expansion of intellectual-property rights as hugely beneficial, leading not only to more innovation but to more openness. The standard justification for the patent system is that it provides an incentive for innovation, allowing the inventor to reap rewards by protecting the work from imitators who would otherwise hitch a free ride on the investment. But that is a simplification. The initial intention was in fact to make inventions available to the public as well.

Before the 18th century, innovations were mainly kept secret through trade guilds. Sometimes monarchs capriciously granted indefinite exclusive rights to someone they favoured. Intellectual-property law was meant to remedy this by requiring the invention to be vetted by experts, limiting the right to a set period and making knowledge more widely accessible through public disclosure. Its development was part of the drive towards democracy and capitalism and the abolition of royal privileges and monopolies.

In principle, patents open up innovations in two ways. First, they confer only temporary rights; once patents expire or are abandoned, the intellectual property they are designed to protect passes into the public domain. Second, they require the details of the invention to be disclosed so they can be replicated. This permits follow-on innovation, which is essential for industrial progress.

More recently, as the patent system has evolved, it has been seen to provide other benefits. It leads to a degree of economic specialisation that makes business more efficient. Patents are transferable assets, and by the early 20th century they had made it possible to separate the person who makes an invention from the one who commercialises it. This recognised the fact that someone who is good at coming up with ideas is not necessarily the best person to bring those ideas to market.

Such specialisation is now so common that it is taken for granted. Semiconductors, the silicon chips that power digital devices, are typically designed by specialist firms that are good at engineering, but physically produced by other firms whose expertise lies in manufacturing. As the patent system has matured and licensing has become much more widespread, these transfers are turning business relationships on their head. Some economists argue that the growth of patent transactions is establishing a proper “market for technology”. The creation of any market takes time and trouble. When such an institution develops, those outside the system feel threatened by it and condemn it. Yet just as the banking system created a market for capital and the insurance industry created a market for risk, the growth of the patent system may be creating a market for innovation.

This provides a sort of “liquidity” to knowledge that did not previously exist, argue Ashish Arora, Andrea Fosfuri and Alfonso Gambardella in their 2001 book, “Markets for Technology, the Economics of Innovation and Corporate Strategy”. Seen that way, the evolution of the patent system in IT and telecoms is simply part of a broader movement to create an institutional mechanism for the transfer of ideas to fuel economic progress.
Mutually assured destruction

That is the context in which commercial battles are taking place in the technology industry today. The convergence of IT and telecoms is forcing companies to work together in new ways in order both to protect and exchange their technology. “How do you create a marketplace for ideas in that converged marketplace?” asks David Kaefer, director of intellectual-property licensing at Microsoft. “That is really the big question. In the past, two parties would haggle over a pound of wheat. Today, they haggle over the patent of the week.”

These markets for technology are expanding. For instance, 60% of technology and telecoms firms report an increase in licensing compared with the previous decade, and 70% report fewer obstacles to reaching such agreements, according to a survey by the Organisation for Economic Co-operation and Development in 2004. “Intellectual property is the next asset class. Companies are creating a market,” says Eric Gillespie, the co-founder of ipIQ, one of the new crop of firms that are fuelling patent transactions.

But when talking to executives in the technology firms themselves, the language you hear most often is that of “the arms race” and “mutually assured destruction”. Companies amass patents as much to defend themselves against attacks by their competitors as to protect their inventions. Many technology companies have recently championed reform of the patent system to deal with spuriously awarded patents, licensing extortion and massive lawsuits. “There is a broad recognition in the US that the patent system, if not reformed, will...begin to impede American competitiveness around the world,” says Bruce Sewell, general counsel of Intel, the world's biggest chipmaker.

This survey will argue that, despite such adjustment problems, the huge changes in intellectual property currently taking place in the IT sector will in time produce more efficient markets. But what do the IT firms themselves make of it all?

October 29, 2005 at 10:29 PM in Business Models | Permalink | TrackBack (17) | Top of page | Blog Home

Top 100 Global Brands Scoreboard

BusinessWeek Online: Top 100 Global Brands Interactive Table

The table that follows ranks 100 global brands that have a value greater than $1 billion. The brands were selected according to two criteria. They had to be global in nature, deriving 20% or more of sales from outside their home country. There also had to be publicly available marketing and financial data on which to base the valuation.

Click column heading once to reorder from highest to lowest. Click twice to reorder from lowest to highest.
2005
Brand
Rank
2004
Brand
Rank
2003
Brand
Rank
2002
Brand
Rank
2001
Brand
Rank
Brand Name
Parent Company
Country
2005
Brand
Value
($Mil)
2004
Brand Value
($Mil)
Change in
Brand Value
(%)


1 1 1 1 1 Coca-Cola Coca-Cola U.S. 67,525 67,394 0

2 2 2 2 2 Microsoft Microsoft U.S. 59,941 61,372 -2

3 3 3 3 3 IBM International Business Machines Corporation U.S. 53,376 53,791 -1

4 4 4 4 4 GE GE U.S. 46,996 44,111 7

5 5 5 5 6 Intel Intel U.S. 35,588 33,499 6

6 8 6 6 5 Nokia Nokia Finland 26,452 24,041 10

7 6 7 7 7 Disney Walt Disney Company U.S. 26,441 27,113 -2

8 7 8 8 9 McDonald's McDonald's Corporation U.S. 26,014 25,001 4

9 9 11 12 14 Toyota Toyota Motor Corporation Japan 24,837 22,673 10

10 10 9 9 11 Marlboro Altria Group U.S. 21,189 22,128 -4

11 11 10 10 12 Mercedes-Benz DaimlerChrysler AG Germany 20,006 21,331 -6

12 13 NR NR NR Citi Citigroup U.S. 19,967 19,971 0

13 12 12 14 15 Hewlett-Packard Hewlett-Packard U.S. 18,866 20,978 -10

14 14 15 15 17 American Express American Express U.S. 18,559 17,683 5

15 15 16 19 18 Gillette Gillette U.S. 17,534 16,723 5

16 17 19 20 22 BMW Bayerische Motoren Werke AG Germany 17,126 15,886 8

17 16 17 16 NR Cisco Cisco U.S. 16,592 15,948 4

18 44 45 41 38 Louis Vuitton LVMH Mo・ Hennessy Louis Vuitton France 16,077 NA NA

19 18 18 18 21 Honda Honda Japan 15,788 14,874 6

20 21 NR 34 42 Samsung Samsung S. Korea 14,956 12,553 19

21 25 29 31 32 Dell Dell U.S. 13,231 11,500 15

22 19 14 11 8 Ford Ford U.S. 13,159 14,475 -9

23 22 23 45 44 Pepsi Pepsi U.S. 12,399 12,066 3

24 23 21 22 23 Nescaf・/TD> Nestl・/TD> Switzerland 12,241 11,891 3

25 26 27 25 19 Merrill Lynch Merrill Lynch U.S. 12,018 11,499 5

26 24 22 24 26 Budweiser Anheuser-Busch U.S. 11,878 11,846 0

27 28 24 23 25 Oracle Oracle U.S. 10,887 10,935 0

28 20 20 21 20 Sony Sony Japan 10,754 12,759 -16

29 33 37 NR NR HSBC HSBC Britain 10,429 8,671 20

30 31 33 35 34 Nike Nike U.S. 10,114 9,260 9

31 29 28 28 30 Pfizer Pfizer U.S. 9,981 10,635 -6

32 NR NR NR NR UPS UPS U.S. 9,923 New New

33 27 26 26 NR Morgan Stanley Morgan Stanley U.S. 9,777 11,498 -15

34 30 NR NR NR JPMorgan JP Morgan Chase U.S. 9,455 9,781 -3

35 35 39 43 41 Canon Canon Japan 9,044 8,055 12

36 34 35 42 43 SAP SAP Aktiengesellschaft Germany 9,006 8,323 8

37 37 41 39 33 Goldman Sachs Goldman Sachs U.S. 8,495 7,954 7

38 NR NR NR NR Google Google U.S. 8,461 New New

39 36 38 40 39 Kellogg's Kellogg's U.S. 8,306 8,029 3

40 38 36 36 31 Gap Gap U.S. 8,195 7,873 4

41 43 50 50 49 Apple Apple U.S. 7,985 6,871 16

42 40 43 44 46 Ikea Ikea Sweden 7,817 7,182 9

43 NR NR NR NR Novartis Novartis Switzerland 7,746 New New

44 45 NR NR NR UBS UBS Switzerland 7,565 6,526 16

45 39 NR NR 98 Siemens Siemens Germany 7,507 7,470 1

46 41 44 NR NR Harley-Davidson Harley-Davidson U.S. 7,346 7,057 4

47 42 40 37 37 Heinz H. J. Heinz Company U.S. 6,932 7,026 -1

48 47 46 47 40 MTV Viacom U.S. 6,647 6,456 3

49 59 53 52 50 Gucci Gucci Group N.V. Italy 6,619 NA NA

50 46 32 32 29 Nintendo Nintendo Co., Ltd. Japan 6,470 6,479 0

51 50 52 53 NR Accenture Accenture Ltd. U.S. 6,142 5,772 6

52 49 47 54 NR L'Oreal L'Or饌l SA France 6,005 5,902 2

53 65 59 60 55 Philips Philips Netherlands 5,901 NA NA

54 51 48 51 45 Xerox Xerox Corporation U.S. 5,705 5,696 0

55 60 NR NR NR eBay eBay Inc. U.S. 5,701 4,700 21

56 48 42 38 35 Volkswagen Volkswagen Germany 5,617 6,410 -12

57 52 55 57 57 Wrigley's Wm. Wrigley Jr. Company U.S. 5,543 5,424 2

58 61 65 67 59 Yahoo! Yahoo! Inc. U.S. 5,256 4,545 16

59 58 57 62 60 Avon Avon Products, Inc. U.S. 5,213 4,849 8

60 56 56 59 56 Colgate Colgate-Palmolive Company U.S. 5,186 4,929 5

61 54 49 49 51 KFC YUM! Brands, Inc. U.S. 5,112 5,118 0

62 53 34 30 27 Kodak Eastman Kodak Company U.S. 4,979 5,231 -5

63 55 51 48 47 Pizza Hut YUM! Brands, Inc. U.S. 4,963 5,050 -2

64 57 54 55 54 Kleenex Kimberly-Clark Corporation U.S. 4,922 4,881 1

65 64 61 64 61 Chanel Chanel S.A. France 4,778 4,416 8

66 62 60 61 NR Nestl・/TD> Nestl・S.A. Switzerland 4,744 4,529 5

67 63 62 66 NR Danone Groupe Danone France 4,513 4,488 1

68 66 74 80 76 Amazon.com Amazon.com, Inc. U.S. 4,248 4,156 2

69 67 63 65 65 Kraft Kraft Foods Inc. U.S. 4,238 4,112 3

70 68 75 79 NR Caterpillar Caterpillar Inc. U.S. 4,085 3,801 7

71 69 67 68 70 adidas adidas-Salomon AG Germany 4,033 3,740 8

72 70 68 69 69 Rolex Montres Rolex S.A. Switzerland 3,906 3,720 5

73 76 81 74 66 Motorola Motorola, Inc. U.S. 3,877 3,483 11

74 71 76 58 52 Reuters Reuters Group PLC Britain 3,866 3,691 5

75 72 69 76 74 BP BP p.l.c. Britain 3,802 3,662 4

76 74 NR NR NR Porsche Dr. Ing. H.c. F. Porsche AG Germany 3,777 3,646 4

77 NR NR NR NR Zara Industria de Diseno Textil, S.A. Spain 3,730 New New

78 77 79 81 72 Panasonic Matsushita Electric Industrial Co., Ltd Japan 3,714 3,480 7

79 81 NR NR NR Audi Volkswagen AG Germany 3,686 3,288 12

80 80 71 75 62 Duracell The Gillette Company U.S. 3,679 3,362 9

81 75 NR 72 NR Tiffany & Co. Tiffany & Co. U.S. 3,618 3,637 -1

82 79 73 NR NR Hermes Hermes International France 3,540 3,376 5

83 78 78 77 71 Hertz Ford Motor Company U.S. 3,521 3,411 3

84 NR NR NR NR Hyundai Hyundai Corporation S. Korea 3,480 New New

85 90 89 NR NR Nissan Nissan Motor Co., Litd. Japan 3,203 2,833 13

86 83 82 NR NR Hennessy LVMH Mo・ Hennessy Louis Vuitton France 3,201 3,084 4

87 88 NR NR NR ING ING Groep N.V. Netherlands 3,177 2,864 11

88 86 85 84 78 Smirnoff Diageo plc Britain 3,097 2,975 4

89 91 NR NR NR Cartier Compagnie Financiere Richemont SA France 3,050 2,749 11

90 84 83 83 77 Shell Royal Dutch Petroleum Company Brit./Neth. 3,048 2,985 2

91 87 86 85 NR Johnson & Johnson Johnson & Johnson U.S. 3,040 2,952 3

92 89 88 87 79 Mo・ & Chandon LVMH Mo・ Hennessy Louis Vuitton France 2,991 2,861 5

93 95 87 86 NR Prada I Pellettieri d'Italia S.p.A. Italy 2,760 2,568 7

94 NR NR NR NR Bulgari Bulgari S.p.A. Italy 2,715 New New

95 93 NR 100 91 Armani Giorgio Armani S.p.A. Italy 2,677 2,613 2

96 85 77 73 67 Levi's Levi Srauss & Co. U.S. 2,655 2,979 -11

97 NR NR NR NR LG LG Electronoics Inc. S. Korea 2,645 New New

98 97 92 91 87 Nivea Beiersdorf AG Germany 2,576 2,409 7

99 98 93 93 88 Starbucks Starbucks Corporation U.S. 2,576 2,400 7

100 99 90 88 82 Heineken Heineken N.V. Netherlands 2,357 2,380 -1

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October 27, 2005 at 02:04 AM in Business Models | Permalink | TrackBack (27) | Top of page | Blog Home

Tripling of digital revenue offsets decline in CD sales

The Globe and Mail: Tripling of digital revenue offsets decline in CD sales

By ADAM PASICK

Tuesday, October 4, 2005 Page B2

Reuters News Agency

LONDON -- The music industry cheered a tripling of digital music sales in the first half of 2005 that was spurred by mobile phone "ringtunes" and on-line services, and offset persistent declines in sales over all.

Digital music now makes up 6 per cent of total sales, or about $790-million (U.S.), according to first-half figures released yesterday by the International Federation of the Phonographic Industry (IFPI) trade group.

Sales of CDs and other physical formats continued a long decline, which the music industry has mainly attributed to piracy, falling to $13.2-billion from $13.4-billion a year earlier.

"It feels as if the decline is lessening," said John Kennedy, IFPI chairman and chief executive officer, who has predicted full-year sales will be roughly flat.

The IFPI said lower CD prices, flagging DVD music video sales and competition from other entertainment sectors also contributed to the decline. The music industry has used a carrot-and-stick approach to reverse flagging music sales by promoting digital music services such as iTunes, Napster and Rhapsody, while aggressively targeting illicit downloaders with lawsuits.

"Without the legal crackdown, it would be a different situation," Mr. Kennedy said. "You certainly have to have the legal services to make it all work."

Despite the success of the market-leading iTunes service, Apple and the music labels may be heading for a showdown when licence agreements expire in the spring. The labels are pushing for the ability to charge different rates for different songs, while Apple is insisting that its flat-price model be maintained.

In recent months the music industry has also won legal victories against peer-to-peer services such as Grokster and Kazaa, and is trying to force other P2P companies to block copyrighted material that is traded on their networks.

In Canada, physical sales were up almost 1 per cent, driven by releases from Michael Bublé, 50 Cent, Coldplay and Il Divo, but fell 4.6 per cent in value primarily because of retail discounts.

In the United States, which is the world's biggest music market, physical sales fell 5.3 per cent by value and 5.7 per cent by units. In Japan, the second-biggest market, physical sales were down 9.2 per cent in value and 6.9 per cent in units.

Discounts in France led to a 2.7-per-cent decline in value but a 7.5-per-cent increase in unit sales.

Singing the CD sales blues

Sales of CDs and other physical music formats continued a long decline in the first half of 2005, falling to $13.2-billion from $13.4-billion a year earlier. The industry has attributed the slide mainly to illegal downloading.

Canada's best-selling albums

Michael Bublé, It's Time; 50 Cent, The Massacre; Green Day,

American Idiot

U.S. best-selling albums

50 Cent, The Massacre; Mariah Carey, The Emancipation

of Mimi; The Game, The Documentary

Coming soon

Bon Jovi, David Gray, Franz Ferdinand, Jamie Cullum, Kanye West, Korn, Madonna, OutKast, Paul McCartney, Pink, Ricky Martin, Robbie Williams, Rolling Stones, Sean Paul, Sheryl Crow, System of a Down

Why sales are down

Lower retail prices affected revenues. Sales of CDs were down 6.7 per cent in value but with a much more modest unit decline of 3.4 per cent. However, a few markets posted growth in CD sales value, namely France, Russia, India and Mexico.

There was a small decline in DVD music video sales, which fell 3.1 per cent in value and 1.6 per cent in units. Despite falls in continental Europe and Asia, DVD music video sales value grew in parts of Latin America, U.K. (18.3 per cent), U.S. (3.7 per cent) and France (3.9 per cent). Globally, DVD music video accounts for 7.2 per cent of sales value.

The continued impact of illegal downloading and CD burning.

October 4, 2005 at 06:55 AM in Business Models | Permalink | TrackBack (37) | Top of page | Blog Home

Sales of Digital Music Triple

Sales of Digital Music Triple

The Associated Press
Monday, October 3, 2005; 9:11 AM

LONDON -- The market for music downloads and other digital forms of music has tripled in a year, helping offset a continuing decline in sales of CDs and other physicial formats, an industry report said Monday.

The International Federation of the Phonographic Industry estimated that digital music sales totaled $790 million in the first half of this year, equivalent to 6 percent of industry sales, compared to $220 million in the same period a year earlier.

Recorded music sales fell 1.9 percent to a retail value of $13.2 billion in the first half of 2005, compared to $13.4 billion in the same period of 2004.

IFPI said the digital boom, which now exceeds the value of the global singles market, was largely driven by sales in the top five markets _ the United States, Britain, Japan, Germany and France.

Sales of physical formats fell 6.3 percent by value in the period to US$12.4 billion, the report said.

That partly reflected pressure on prices: CD sales were down 6.7 percent in value by 3.4 percent in unit volume. DVD music video sales fell 3.1 percent in value and 1.6 percent in units.

The IFPI has had some success recently in shutting file-swapping operations.

"There is a long way to go _ digital and physical piracy remain a big threat to our business in many markets," said IFPI Chairman and CEO John Kennedy.

"Our industry's priorities are to further grow this emerging digital music business while stepping up our efforts to protect it from copyright theft."

The report said digital sales helped compensate for a fall in disc sales in Germany, with single track downloads growing to 8.5 million in the first half of 2005 compared to 1 million a year ago. Physical retail sales dropped 7.7 percent in units.

France had the small fall in physical sales among the big five markets, down 2.7 percent in value but up 7.5 percent in units. French CD album sales were up 9.5 percent in units and 1.2 percent in value. helped by a changing product mix, but due to falling Digital sales in France grew to 4 million single-track downloads, compared to 1 million in the previous year.

October 3, 2005 at 09:33 AM in Business Models | Permalink | TrackBack (13) | Top of page | Blog Home

Sony takes aim at Apple's iPod

Sony takes aim at Apple's iPod - Yahoo! News

Thu Sep 8,12:48 PM ET

TOKYO (Reuters) - Sony Corp (NYSE:SNE - news). said on Thursday it would sell advanced Walkman portable music players later this year, aiming to move out of Apple Computer Inc.'s shadow in a market the Japanese company created a quarter of a century ago.

The announcement comes hours after Apple unveiled the pencil-thin "iPod nano" digital player and a long-anticipated mobile phone that plays music in a bid to extend its domination of the market.

"Our previous models have been well accepted by customers in Japan and the United Kingdom. But we are not at all satisfied with where we are now," said Koichiro Tsujino, co-President of Connect, a Sony unit which makes portable music players and offers online music distribution services.

"I understand a certain company made an announcement earlier today. We will accelerate our challenge with these new models," he told a news conference.

Sony, which created the portable music market 26 years ago with its now-legendary cassette-playing Walkmans, has lost out to Apple in the portable digital era as it focused on its mainstay CD and Mini Disc players.

Sony will offer two hard disk-based music players -- one with a storage capacity of 20 gigabytes (GB) and the other with 6 GB -- and three flash memory-based players that will keep the existing models' perfume bottle appearance.

The 6 GB model is Sony's first hard-disk player with a small capacity. Apple's iPod nano comes in 2 GB and 4 GB capacities.

Sony's new models will add the ability to automatically select and play the songs a user listens to most, and also to pick songs released in a certain year -- a function Sony calls the "time machine shuffle."

The new models will go on sale in Japan on November 19 and Sony, which introduced the first Walkman in July 1979, aims to launch them overseas by the end of the year.

The 20 GB hard-disk model, capable of storing up to 13,000 songs, is expected to retail at around 35,000 yen in Japan, Sony said.

Sony aims to sell a total of 4.5 million hard disk and flash memory portable music players in the year to next March, up from 850,000 units a year earlier.

Apple has sold about 22 million iPods worldwide since their introduction in October 2001, making it by far the most widely used player in a market that research firm In-Stat expects to nearly quadruple to 104 million units a year by 2009.

Apple last month launched its iTunes online music store in Japan, bringing the leading download service to the world's second-largest music market by album sales.

Some analysts have cited the lack of iTunes in Japan as a major reason Sony was able to secure 27 percent of the local market for flash memory-based players in May and June, knocking the iPod Shuffle to second place.

Shares in Sony closed up 0.26 percent at 3,930 yen, outperforming the Tokyo stock market's electric machinery index IELEC, which fell 0.42 percent.

September 8, 2005 at 09:50 PM in Business Models | Permalink | TrackBack (56) | Top of page | Blog Home

British Music Retailers Begin Digital War

British Music Retailers Begin Digital War

By JANE WARDELL
The Associated Press
Monday, September 5, 2005; 8:22 AM

LONDON -- In a clear sign the digital music revolution is here to stay, Britain's major music retailers are going head-to-head for a slice of the burgeoning _ and potentially very lucrative _ Internet downloading market.

HMV, the biggest specialist music seller in Britain, made a big splash with the launch of its new digital service Monday, employing the band Razorlight to showcase its library of around 1.3 million tracks for consumers to download from the Internet.

But some of its thunder has been stolen by Virgin Megastores, the country's second biggest music chain, which signed up the Dandy Warhols for an ambush launch of its own digital service on Friday.

Both outlets are fighting for a share of a market that, while still small in Britain, is expected to grow exponentially. A year ago, the total number of songs officially downloaded from the Internet in Britain was 500,000 _ the same number is now sold every week.

"The industry is moving on. Digital is here and it's here to stay," said Dario Betti, a new media analyst at IT consulting firm Ovum. "HMV and Virgin have been slower to get into the market but they recognize it's important to be there and not be left behind."

The digital download market in Britain has so far been dominated by Apple's iTunes music store, which offers consumers around 1.2 million tracks.

HMV and Virgin are aiming to break Apple's stranglehold by offering services that will work with several digital music players, allowing wider download possibilities and accessibility. Apple's iTunes software works only with the iPod music player.

"How many customers know that in buying an iPod, they're effectively locking oneself into a walled garden?" said John Taylor, HMV's director of e-commerce.

HMV and Virgin are both planning to offer a separate subscription service, where users pay 14.99 pounds ($27.72) a month to download as much music as they want - the catch being that if they stop paying, they lose all their music.

HMV, which has teamed up with Microsoft for its new service, has also stepped up the competition, making a special 39 pence (72 cents) offer for tracks by some new artists. It also plans to sell recordings of gigs and is formulating a film and computer game download service.

The two retailers are banking on further growth in an already booming market.

About 5 percent of Britons currently own a digital music player while legal digital sales account for less than 2 percent of the market. However, analysts expect online music sales to nearly double from 34 million pounds ($63 million) this year to 65 million pounds ($120 million) next, reaching 261 million pounds ($483 million) by 2010.

"We've taken our time to enter this new and exciting market. Our intention is to deliver a quality service that will...rival the best," said Steve Knott, Managing Director of HMV for the U.K.

Virgin founder Richard Branson is pegging his product's success on user-friendliness, compared to the more technical iPod. Like the HMV version, the Virgin product is compatible with the Windows Media Audio standard. Neither is compatible with the iPod.

"We have always felt that a company with music at its core rather than technology could do so much better for music fans," Branson said at the Virgin launch. "It is so user friendly that even I could use it."

Virgin Digital customers will get free music insurance which will provide a back-up service to replace downloaded tracks if their computer's hard drive crashes. It is offering around the same number of tracks as iTunes.

The HMV program features search and download capabilities, music transferring from a portable device onto the program, CD-burning, streaming radio stations, and HMV playlists. HMV plans to add video capabilities soon.

Knott said that while he has not seen the Virgin program, he's not surprised by the rival's interest in the emerging market.

"I think competition is very healthy," he said. "I would've expected Virgin to be in the game...and we'll compete with them in the same ways as we compete on the high street. I welcome the competition."

Knott said that he expected iPod also to upgrade its offering, but added that HMV plans to continue to sell Apple's iPod players in its shops and bank on its flexible pricing to win over customers.

Betti warned there will be a period of flux as each product is improved and upgraded, likening the situation to that of the Betamax-VHS video player wars in the early 1980s _ VHS eventually won out, making Betamax obsolete.

"At least back then you could have a Betamax player and a VHS player at home. Having two portables to carry around would defeat the purpose," he said. "My advice to any consumer is make sure you don't get too attached to whatever you buy right now. You might find later on that what you have has been surpassed."

September 5, 2005 at 05:29 PM in Business Models | Permalink | TrackBack (15) | Top of page | Blog Home

Piracy crackdown spurs shift in online file-sharing

Piracy crackdown spurs shift in online file-sharing - Yahoo! News

By Adam Pasick Mon Aug 29,10:30 AM ET

LONDON (Reuters) - Traffic in the popular file-sharing network BitTorrent has fallen in the wake of a crackdown on piracy, but file sharers have merely shifted to another network, eDonkey, new data released on Monday showed.

Popular movies like "
" /> Star Wars: Episode III - Revenge of the Sith" have surfaced on BitTorrent before they even appeared in theatres.

A study by the Cambridge-based Internet analysis firm CacheLogic found that eDonkey is now roughly on par with BitTorrent in the United States, China, Japan and Britain.

It is the dominant peer-to-peer file-sharing network in
South Korea, which has the world's highest percentage of high-speed Internet use, and also in Italy, Spain and Germany.

"This is almost assuredly a result of the increased legal action toward the once-ignored BitTorrent -- a game of P2P hide-and-seek," said CacheLogic's chief technology officer Andrew Parker.

Last year, BitTorrent was consuming up to a third of the Internet's total bandwidth as users traded huge movie and television files. Hollywood struck back with a slew of lawsuits to shut down Web sites that provided "tracker" links, which tell the network where to look for files.

The United States has also seen a surprising return to popularity of the
Gnutella file-sharing network, which had faded after an earlier crackdown by music companies.

"Gnutella was once seen as dead so may be off the radar" of the music and movie industries, Parker said. "It's proof that legal pressure from industry groups results in the mass migration of file sharers to an alternative network, whether old or new. This cat and mouse game will continue."

About 60 percent of the Internet's total bandwidth consists of P2P traffic, according to the CacheLogic study. P2P, which sends data from user to user, is often difficult to shut down because networks don't rely on a centralised server to distribute data.

In a precedent-setting ruling earlier this summer, the
U.S. Supreme Court ruled against P2P firm
Grokster, saying that because the company's intent was to encourage copyright infringement, it could be held liable for the movies and music traded on its network.

But any hopes from Hollywood that the Grokster ruling would result in less P2P traffic have not been fulfilled, according to CacheLogic.

"The Grokster case did not result in a rapid decline in P2P usage," Parker said.

August 29, 2005 at 10:45 PM in Business Models | Permalink | TrackBack (19) | Top of page | Blog Home

E-books' latest bid to send paper packing

TheStar.com - E-books' latest bid to send paper packing

Virtual textbooks offered cheaper than hard copies

But students worry about controls on access, expiry dates

RACHEL ROSS
TECHNOLOGY REPORTER

Move over hardcopies. Starting today, there's a new item on bookstore shelves.

Ten U.S. university bookstores are stocking digital versions of popular textbooks alongside the paper products. The digital version will sell for approximately 33 per cent less than a new, paper copy.

The pilot project will include approximately 200 titles from McGraw-Hill Higher Education, Thomson Learning, Sage Publications and Houghton Mifflin Company.

"We're interested in measuring student demand for digital content," said David Serbun, director of partnerships for Houghton Mifflin's college division. "We're also interested in offering students a choice."

Once a digital textbook has been downloaded to a student's computer, sections can be highlighted and pages can be printed. Students can also search their digital book for keywords.

Downloadable books have been available online for years, but according to Jeff Cohen, advertising and promotions manager for MBS Textbook Exchange Inc., this is the first time that digital books will be featured on stores shelves, right beside the traditional, bound versions.

It was essential to get the digital products into brick and mortar stores, Cohen said, because "the majority of textbook purchases still take place in a physical bookstore."

Cohen insists that no student will be forced to buy the digital version of a textbook. Bookstores ordered the same number of paper copies as they would have without the pilot project. The digital books are simply another option available to students.

Here's how the system works:

#
The digital books are represented by small, plastic cards that look much like credit cards. The cards are stocked on shelves, beside their paper equivalent.

#
Each book card has a unique bar code that identifies it.

#
The bookstore adds a sticker with a second bar code to the one that designates a particular textbook.

#
When someone buys the book, both bar codes are scanned at the checkout counter. The information is sent to a central computer system.

#
The buyer visits the DigitalTextbooks.net website and enters one of the bar codes into an electronic form so they can download the book to their hard drive and read it onscreen. (The downloading process will not work unless both bar codes have been scanned at the point of purchase, thereby thwarting thieves.)

Princeton University, University of Utah, Morehead State University, University of Oregon, Portland Community College, Bowling Green State University, Georgetown College, California State University-Fullerton, The Co-op Bookstore Inc. at Louisiana State University and The Book Exchange Inc. at West Virginia University are participating in the electronic book endeavour.

Shane Gerton, associate director of the University of Utah campus bookstore, said digital books should save the store money because they won't have to buy stock up front.

"We don't get charged for the book until it's purchased by the student," he said. "It's also just easier to maintain. All we have to do is put out a little card instead of shelving books."

Cohen said portability and price are the major advantages for students.

While the initial price of digital books will be lower than paper books, questions remain about the real value of the electronic product. Some stores offer as much as 50 per cent off the purchase price to students if they sell their paper books back to the store once they are done with the book. But the bookstores say they won't buy back the digital versions.

Digital rights management software also controls access to the books. Originally, the pilot project was set up so that the books would become unusable after 150 days. Students complained about the expiration dates in online forums, stating that a book with such a short life span wouldn't be useful. In response, three publishers extended the useable life of their books for the pilot project. Digital books by Thomson Learning will be readable for a year after purchase and buyers will have unlimited access to titles by Houghton Mifflin and McGraw Hill.

"The publishers are sensitive to what students feel they need to make this work," Cohen said.

He also pointed out that digital textbooks come with customer service. If a student downloads their book and their laptop breaks down a few weeks later, technical support people will help them reinstall their book on a new computer.

Chris Tabor, president of the Canadian Campus Retail Associates, said several Canadian bookstores have experimented with offering digital books on their websites and the amount of technical support required was sometimes "frightening." The CCRA is a consortium of Canadian university and college stores that come together to develop technology for their businesses.

"We were surprised at the number of calls we got for very simple problems," Tabor said, especially considering the purchases were made by what he'd thought was a tech-savvy demographic.

But, he said, the CCRA's experience with electronic books has been positive in terms of sales.

In 1998, the Queen's University bookstore started offering free downloads from the store's website of books in the public domain.

"What we've noticed is that after uploading or downloading thousands of titles, the sale of the ink and paper version actually goes up," Tabor said, adding that he couldn't quite explain why sales went up by more than 10 per cent that year. He admits though, that it might have had something to do with other features the website added at the same time, such as lists of competitor's prices.

Additional articles by Rachel Ross

August 15, 2005 at 08:39 AM in Business Models | Permalink | TrackBack (12) | Top of page | Blog Home

Best Live 8 Viewing to Be Found Online

Best Live 8 Viewing to Be Found Online - Yahoo! News

By DAVID BAUDER, Associated Press Writer Sun Jul 3, 5:52 AM ET

In Berlin, Green Day proclaimed its majesty with a cover of Queen's "We Are the Champions" as R.E.M. performed "Man on the Moon" in London. And R.E.M. hadn't left the stage before Tim McGraw began singing "Live Like You Were Dying" in Rome. These were just a few thrilling musical moments from Live 8 that you couldn't see on live television. For the ultimate viewing experience, you needed America Online.

Television seemed shockingly old-fashioned during Saturday's worldwide concert for poverty relief. AOL's coverage was so superior, it may one day serve as a historical marker in drawing people to computers instead of TV screens for big events.

Part of it was simply the way things were structured. Concerts held more or less simultaneously in 10 venues are next to impossible for television to get its arms around. Live Aid 20 years ago, with concerts only in London and Philadelphia, was much easier.

And part of it was also MTV's failure to really try. There were as many commercial breaks as performances, and MTV's stable of correspondents spent more time talking about what a fantastic event it was instead of showing it.

With a click of the mouse, AOL visitors could jump from a video feed of the London concert to one from Philadelphia, Berlin or Rome. The performances were shown in their entirety. AOL programming chief Bill Wilson claimed that 160,000 people were simultaneously viewing the video streams at any given time, and that more than 5 million people sampled the video at some point during the day.

While AOL could be faulted for failing to provide users with a comprehensive schedule ahead of time, it offered updates onscreen under an entry called "The Buzz." People watching Kanye West in Philadelphia, for instance, were flashed a message: "Brian Wilson is performing `Good Vibrations' in Berlin." Or they were told Snoop Dogg was about to take the stage in London.

It was utterly addictive. It tied the event together and gave fans a reason to stay glued to their computers.

AOL's "global feed" feature offered a chance to catch up with performances that just took place, with little chatter or interruption.

Meanwhile, MTV was playing catch-up on a whole different level.

When Destiny's Child took the stage in Philadelphia to sing "Survivor," MTV was showing a tape of Coldplay from three hours earlier in London. MTV also suffered from a maddeningly short attention span: It missed the opening of a Black-Eyed Peas song because of an interview with fans, then cut off the end for a commercial.

MTV simply had too many elements — interviews, personalities who needed their "face time" and all those performances — to give its broadcast any sense of coherence.

Overall, the day's events were magnificent in their sheer breadth and diversity. Organizer Bob Geldof promised to deliver "the greatest concert ever, and it was hard to prove him wrong. Most acts seized the moment with magnanimity, realizing it could well be the most-remembered moment from their careers.

After backing Paul McCartney on the concert-opening "Sgt. Pepper's Lonely Hearts Club Band," U2 cemented its status as the world's top rock band. It performed "Beautiful Day," "Vertigo" and "One" with ease and power.

Green Day — whose crowd-pleasing leader Billie Joe Armstrong has a future in Vegas — had a powerful four-song set. And after being critically discounted in recent years, R.E.M. was intent on proving its strength.

Carried out on a throne behind women spreading rose petals in his path, Will Smith gave a delightfully over-the-top show in his hometown of Philly. Madonna rose to the occasion with a stage full of singers and breakdancers all dressed in white.

The day's oddest trend? Masks.

R.E.M.'s Michael Stipe had an odd blue raccoon-like mask painted on his face, and Kanye West's violin players looked like they had black masking tape over their eyes.

By ending with the desultory "Fix It," Coldplay missed a chance to make a powerful statement for itself; cameras were busy in Coldplay's set with no less than three peeks at singer Chris Martin's wife Gwyneth Paltrow and their baby in the front row.

Dido seemed to be swallowed up by the large stage, her voice not up to the challenge. Maroon 5 needlessly broke an unspoken rule by covering a song by an artist scheduled to perform later, with Neil Young's "Rockin' in the Free World."

Pictures of the G8 leaders flashed on video screens as Sting sang the "I'll be watching you" refrain in "Every Breath You Take." The Who used the same pictures behind "Who Are You."

The day's most anticipated musical event, a reunion by Pink Floyd, felt ragged and a little sad. One could only guess whether formerly feuding Roger Waters and Dave Gilmour wondered about their wasted years as they looked across the stage at one another.

The London concert wrapped up with Paul McCartney singing "The Long and Winding Road" — a fitting end for Live 8's eclectic trip around the globe.

July 3, 2005 at 10:48 AM in Business Models | Permalink | TrackBack (4) | Top of page | Blog Home

Suspected file-swappers arrested in global raid

Suspected file-swappers arrested in global raid - Yahoo! News

By Andy Sullivan Thu Jun 30, 4:43 PM ET

WASHINGTON (Reuters) - Police in a dozen countries have seized computers and made arrests in a raid of groups that illegally copied more than $50 million worth of software, movies, music and video games, U.S. and Dutch authorities said on Thursday.

Investigators across the globe conducted 90 searches in an effort to disrupt the sophisticated "warez" groups that are responsible for the vast majority of copyrighted material that is available illegally online.

The 22 groups distributed "Star Wars Episode III: Revenge of the Sith," Adobe Systems Inc.'s (Nasdaq:ADBE - news) Photoshop software, and hundreds of other well-known titles that had been stripped of their copy protection, the U.S. Justice Department said.

Four people were arrested in the United States and three more in the Netherlands, authorities in those countries said.

More computers were seized in Australia,
Israel, Germany,
South Korea, Norway, France, Sweden, Denmark, Russia, Poland, Canada and Hungary, according to the Dutch Finance Ministry.

"We have shown that law enforcement can find and prosecute those who try to use the Internet to create piracy networks beyond the reach of law enforcement," U.S. Attorney General Alberto Gonzales said at a press conference.

Warez groups are responsible for 95 percent of the copyrighted material that ends up on Internet "peer-to-peer" networks, according to U.S. Customs and Immigration Enforcement.

Motivated by fun rather than profit, warez groups rely on industry insiders to steal movies, software and other works before they're released, then strip them of their copy protection and post them on secret server computers.

From there, the works spread quickly across the Internet and become available to millions through peer-to-peer networks like Kazaa, or are burned onto discs to be resold by unscrupulous retailers around the world.

U.S. officials broke up a warez ring called DrinkOrDie in 2001, and led an international effort in April 2004 that seized 200 computers.

"One may wonder whether or not this is simply scraping the tip of the iceberg, but we believe it is very, very important to show the community that we care very much about the protection of intellectual property rights," Gonzales said.

"We believe that actions such as this are going to have, we hope, a significant deterrent effect."

In many countries it is not illegal to download certain digital files such as music, but it is illegal to upload them and make them available to other computer users on the Internet.

Recording labels and movie studios sued thousands of people who distribute their material through peer-to-peer networks, and have sued several peer-to-peer software makers for copyright infringement.

On Monday, the
U.S. Supreme Court ruled that peer-to-peer networks can be held liable if they encourage users to copy protected works. (Additional reporting by Lucas van Grinsven in Amsterdam)

July 3, 2005 at 10:33 AM in Business Models | Permalink | TrackBack (9) | Top of page | Blog Home

File-sharing suffers major defeat

BBC NEWS | Technology | File-sharing suffers major defeat

The US Supreme Court has ruled that file-sharing companies are to blame for what users do with their software.

The surprise ruling could start a legal assault on the creators of file-sharing networks such as Grokster and Morpheus.

The case was brought by 28 movie and music makers who claimed that rampant piracy was denting profits.

The Supreme Court judges were expected to rule in favour of the file-sharers because of legal precedents set when video recorders first appeared.

Big win

he unanimous ruling is a victory for recording companies and film studios in what is widely seen as one of the most important copyright cases in years.

Andrew Lack, chief executive of Sony BMG, said his company would pursue those who failed to comply with the law.

"The court made it very clear that we can go after damages and that we can chase them out," Mr Lack told BBC World's World Business Report.

"We will do that if necessary but my hope is that we will find new bridges to legitimise a lot of services that formerly were confused about what was right and wrong, legal and illegal."

The legal case against Streamcast Networks - which makes the software behind Grokster and Morpheus - began in October 2001 when 28 media companies filed their legal complaint.

The complaint alleged that Streamcast was prospering on the back of the unfettered piracy taking place on the file-sharing networks.

However, the attempts to win damages suffered a series of defeats as successive courts sided with the file-sharing networks. The judges in those lower courts cited a ruling made in 1984 over Sony's Betamax video recorder.

In that case, the Supreme Court said that the majority of people using a video recorder for legal uses outweighed any illegal use of the technology.

Video tape cassette, BBC

Q&A on File-sharing ruling

But in this latest ruling the judges sets aside this precedent and the lower court decisions and means the makers of a technology have to answer for what people do with it if they use it to break the law.

In the ruling Justice David Souter wrote: "The question is under what circumstances the distributor of a product capable of both lawful and unlawful use is liable for acts of copyright infringement by third parties using the product."

He added: "We hold that one who distributes a device with the object of promoting its use to infringe copyright ... is liable for the resulting acts of infringement by third parties."

Reaction to the ruling was swift.

Dan Glickman, president of the Motion Picture Association of America, said: ""Today's unanimous ruling is an historic victory for intellectual property in the digital age, and is good news for consumers, artists, innovation and lawful Internet businesses."

John Kennedy, head of the International Federation of the Phonographic Industry said: "It quite simply destroys the argument that peer-to-peer services bear no responsibility for illegal activities that take place on their networks."

Andrew Lack, chief executive of Sony BMG, said the verdict

In other decisions on Monday, the Supreme Court:

* ruled against the display of the Ten Commandments inside two Kentucky courtrooms but approved a monument to the same in Texas

* declined to hear appeals by two US journalists facing a contempt ruling by a lower court over their investigation into an alleged White House intelligence leak

* overturned a ruling that cable operators' high-speed internet lines must be opened up to rivals.

The rulings came on the last day of the US Supreme Court's current judicial session. It now breaks for a three-month recess.

One expected announcement that did not appear concerned the retirement of 80-year-old Chief Justice William Rehnquist.

Justice Rehnquist is suffering from thyroid cancer, breathes through a tracheal tube and struggled to talk during a speech closing the current court term that thanked court workers.

Unseen effects

In its ruling the Supreme Court said there was "substantial evidence" that Streamcast Networks had "induced" people to use its software to illegally share copyrighted files.

It is unclear yet what action this ruling will prompt from movie studios and music makers who brought the original case. It could mean claims for substantial damages from Streamcast or moves to get the file-sharing networks shut down.

Ipod mini, Getty Images
It is unclear what effect the ruling will have on use of digital media
Wayne Rosso, former Grokster president and now head of legal file-sharing system Mashboxx, said: ""If I'm running the RIAA [Recording Industry Association of America], you're going to see lawsuits coming down like a Texas hailstorm. Don't be surprised to see an unusually large number filed immediately."

He said it would mean that users would have to get used to paying for music.

Michael McGuire, from analyst firm GartnerG2, said: "It's something of a surprise. It will be interesting to see how record labels respond. It could be argued that these peer-to-peer services were the most efficient way to deliver rich media."

The decision could also have an impact on any technology firm developing gadgets or devices that let people enjoy media on the move.

If strictly interpreted the ruling means that these hi-tech firms will have to try to predict the ways people can use these devices to pirate copyrighted media and install controls to stop this infringement.

The ruling could also prompt a re-drafting of copyright laws by the US Congress.

June 27, 2005 at 08:14 PM in Business Models | Permalink | TrackBack (11) | Top of page | Blog Home

File-Swapping May Be Here to Stay

File-Swapping May Be Here to Stay - Yahoo! News

By ALEX VEIGA, AP Business Writer 39 minutes ago

LOS ANGELES - Four years after it shuttered the original
Napster with a legal assault, the recording industry is taking a different approach to online file-swapping: If you can't beat 'em, join 'em.
ADVERTISEMENT

Recording companies have begun taking steps to legitimize the peer-to-peer technology that lets computer users share songs, video and other files with one another online.

However the
U.S. Supreme Court rules in a file-swapping decision expected as early as Thursday, the technology appears irrepressible.

In the last few months, major record labels have signed licensing deals with companies working to field file-swapping services that would block unauthorized files from being traded online.

"There's only two options here," said Michael Goodman, an analyst at The Yankee Group market research firm. "You either license it — and you find a way to license it and monetize it — or you don't license it and it gets traded anyway."

Some 330 million tracks were purchased online last year from online stores such as Apple Computer Inc.'s iTunes. But around 5 billion were downloaded from free file-sharing networks, he said.

Meanwhile, recording companies have sued 11,700 computer users for file-swapping. Of those, 2,500 cases have been settled, typically for about $3,000 each.

The Supreme Court is considering whether companies behind unrestricted file-sharing services —
Grokster and Morpheus — should be liable for copyright infringement. The case's outcome could speed the way for licensed peer-to-peer services.

Even so, it remains to be seen whether those industry-endorsed alternatives can attract people who now tap open file-swapping networks using such programs as eDonkey, BitTorrent and Kazaa.

"When it comes down to it, why is somebody going to pay for something they can get for free?" said Mac Padilla, 21, a student who lives in Los Angeles.

The industry may know the answer at least in part as early as next month, when Peer Impact, one of the licensed file-swapping services, is slated to launch.

Its software can be used to find and purchase tracks from an initial catalog of a half-million songs from all the major labels, said Gregory Kerber, head of Saratoga Springs, N.Y.-based Wurld Media Inc., the firm behind the service.

After a user buys a song from Peer Impact, future buyers get it from that member — or others who have gotten it in the meantime — instead of from a central server. Users have to pay for each track they download, but sharing songs they've purchased from Peer Impact earns them credits they can spend on the service.

At launch, at least, Peer Impact will not let users share songs from their own collections.

Another company to sign licensing deals with major and independent record labels is Snocap Inc., which was founded by Napster creator Shawn Fanning.

The company's software is designed to track songs being swapped online and notify record labels when someone tries to share a song that hasn't been licensed for free distribution. Snocap also has a deal with file-sharing software maker Mashboxx to block unlicensed tracks from moving through its network.

Mashboxx is set to launch a beta test version next month, said Wayne Rosso, chief executive for the Virginia Beach, Va.-based company. Rosso, who once headed the company behind the Grokster file-swapping software, says Mashboxx users will be able to search for tracks across peer-to-peer networks, upload them and share those that are not restricted by record labels using Snocap's software.

Through Snocap, the labels will be able to assign usage rules for each track, deciding whether users on Mashboxx or other peer-to-peer networks can listen to a track a few times before they must purchase it, or what sort of copy restrictions each file will have, for example.

Rosso claims Mashboxx users will be able to swap millions of tracks — such as concert bootlegs and other recordings — on which record labels have not applied restrictions.

That would help unsigned bands that use peer-to-peer networks to build their audience and established acts like Wilco that encourage their audiences to record their concerts and share bootlegs.

"If the content is not identified and registered in the database, then we can't be held responsible for it," Rosso said. "It's highly unlikely that any Mashboxx user is going to be sued."

Still, Rosso adds, once a record label finds that a bootleg recording or other track is being swapped, it can move to restrict it from being shared — or set up limited listens before purchase.

Privately, record label executives say they remain circumspect over how a licensed peer-to-peer service would actually fare in the marketplace.

Mashboxx has yet to announce licensing deals with the major labels, though it's been reported that Sony BMG Entertainment has agreed in principle to license its music.

Meanwhile, Microsoft Corp. is testing file-sharing technology of its own that one day could be integrated in the company's dominant Windows PC operating system.

The project, dubbed Avalanche, is supposed to improve on the speed of other file-sharing distribution systems, such as BitTorrent, while also preventing unlicensed content from being traded. For now, the company says it has no plans to release Avalanche or include it in future products.

If Microsoft develops its own peer-to-peer software, it could help boost the number of music fans using licensed file-sharing services, said Goodman, the Yankee Group analyst.

"They have the opportunity to integrate it into the operating system ... so you get large-scale adoption," Goodman said. "That would make it attractive to content companies."

June 22, 2005 at 09:50 PM in Business Models | Permalink | TrackBack (28) | Top of page | Blog Home

Branding game is not an easy one to win

Branding game is not an easy one to win

By BILL VIRGIN
SEATTLE POST-INTELLIGENCER COLUMNIST

Here are four local illustrations of the notion that the traditional elements used to establish and reinforce a brand no longer work.

Microsoft, Costco, Amazon.com and Starbucks have achieved national, even international prominence, without benefit of a catchy slogan, a universally identifiable symbol or an anthropomorphic spokesanimal, to build awareness in consumers' minds.

Here's the refutation of that notion: The Clydesdales are coming to Seattle starting today.

See, I don't even need to say whose Clydesdales, and already you not only know the name of the sponsor -- a certain purveyor of beer -- you're probably also recalling the commercials, hearing the jingles and seeing in your mind the horses pulling a red wagon (with Dalmatians riding on it) emblazoned with the name of the brewer.

That, friends, is one powerful branding image.

It's the sort of branding power that most companies would love to have, particularly in an era of increasingly fractionated media channels through which companies are trying to reach ever-growing markets. A powerful brand image can be expensive to establish, but once it's established, it can accomplish far more at less cost than expensive marketing campaigns for less well-known products or services.

But how do you get the brand power in the first place?

Celebrity endorsements are at best a temporary and risky fix. Celebrities' recognition or appeal may not cross borders or may be limited to certain demographic groups. Such careers can also be short-lived and subject to self-inflicted damage that cast celebrities (and by extension the products they endorse) in an unfavorable light. Do you think Pepsi is thinking "gee, what a swell idea it would be to bring Michael Jackson back as our endorser?" The Clydesdales, by contrast, are not likely to be caught in some sort of scandal.

Slogans, symbols and logos sometimes work. Most consumers could probably identify the mermaid logo as belonging to Starbucks even if the name were stripped off. But most consumers couldn't tell you the derivation of that symbol or the connection to the company, and the stores themselves might be more identifiable by the green awnings than the logo.

Click Here
For all of Microsoft's success in the PC software business, it would be hard to argue that its market position has been aided much by the flying Windows logo or the slogan, "where do you want to go today?"

Even the company with the horses and the wagon has a slogan -- "King of beers." At best that slogan is likely to inspire quizzical looks.

But horses, Dalmatians and an old-fashioned wagon -- that's the sort of stuff to inspire warm and fuzzy feelings even among those who don't drink beer.

How well-ingrained is that image? Clydesdales are not the only breed of very large workhorse. But the same people who couldn't tell you if a Percheron is a fish, bird or mammal can instantly conjure up a mental picture of a Clydesdale -- all because of the investment of time and money the sponsor has put into establishing that image as its image.

And how valuable is image recall? The proliferation of media channels and commercial messages pushed through them means marketers have to try ever harder -- and wind up failing more often -- to stand out from the clutter. The challenge increases with interchangeable products (like beer) and marketing approaches (even blimps, once the exclusive territory of Goodyear, have multiple imitators these days)

The Clydesdales (who will be at Qwest Field Events Center from 2-8 p.m. today through Sunday as part of a national "Here's to the Heroes" tour saluting American military personnel) don't have to be louder, brasher or flashier to stand out. The closest you can come is Wells Fargo and its stagecoach -- and that's for a bank.

The very trends -- erosion of audiences in mass-market channels, limited patience for establishing a brand -- that make a powerful brand image like the Clydesdales so desirable will also make them even harder to establish.

But the rewards of having a powerful brand image are so great that marketers can be expected to continue throwing ideas at consumers, hoping something sticks so deeply in the public consciousness that people recognize it -- even if, as with this column, the sponsor's name is never once mentioned.

June 18, 2005 at 08:46 PM in Business Models | Permalink | TrackBack (11) | Top of page | Blog Home

Coldplay's new single breaks sound barrier

Britain, UK news from The Times and The Sunday Times - Times Online

By Adam Sherwin, Media Reporter

THE rock group Coldplay have secured an international first for British music after their new single became the world’s fastest-selling download

Speed of Sound is available only in digital form, but already it has broken chart records held by the Beatles. The song entered the US Billboard Hot 100 at No 8, the first British group to debut inside the Top Ten since the Beatles in 1968.

Speed of Sound shot to No 1 on its day of release in all 15 worldwide Apple iTunes stores, achieving almost 100,000 sales last week.

The song is the first preview of the quartet�s hotly anticipated album X&Y, which is tipped to sell ten million copies.

However, the song is barred from tomorrow�s British singles chart. Although downloads now count in the Top 40, a song is ineligible if no physical version is available in stores.

The rule is designed to prevent established retailers from being frozen out of the singles market. Speed of Sound is not released as a British CD until May 23, when its combined sales will count.

Coldplay tonight will seal their status as the �new U2� when they headline the Coachella Valley Festival in the California desert, playing to 80,000 fans. The bill is dominated by British artists, including Keane, Snow Patrol, Razorlight, Jamie Cullum and even the million-selling Radio 2 favourite Katie Melua.

Coldplay have invited Franz Ferdinand to join them on a �best of British� summer tour of American arenas.

While Coldplay are happy to enjoy the benefits of paid downloads, EMI, their record company, is paranoid about the album leaking on to the internet before its June release.

Reviewers may preview X&Y only via an iPod locked in a glass case and surrounded by security guards. EMI Group shares fell 16 per cent in February after it blamed delays in releasing the Coldplay and Gorillaz albums for lower-than-expected profits.

Paul Richards, an analyst with Numis Securities, said: �This is the high-stakes album of the year for EMI. All eyes will be on the performance of X&Y.�

The pressure is intense on Chris Martin, the perfectionist Coldplay singer, whose marriage to Gwyneth Paltrow has placed his life under even greater scrutiny.

He called the making of the band�s third album �one of the most difficult experiences of my life� and even suggested that it may be Coldplay�s last.

EMI has planned a 12-month strategy for the band, which will see them playing to 150,000 British fans this summer, plus tours of Asia, Australasia, Latin America and a return to the US next year.

Coldplay have some way to go before they can truly equal the Beatles. When Lady Madonna reached No 4 in the Billboard chart in 1968, it sold one million vinyl singles. During the first week of April 1964, the Beatles held the top five positions on the Billboard singles chart and the Lennon/McCartney team were responsible for 32 No 1 singles.

Speed of Sound needed just 44,000 downloads to enter the US Top Ten, which is combined from downloads and radio airplay. Record companies have largely abandoned CD singles in the US.

# Tony Christie, the resurgent crooner, will join Franz Ferdinand, Scissor Sisters and Kaiser Chiefs at this summer�s V Festival. Christie, 62, has been added to the Chelmsford and Staffordshire rock festival after the million-selling reissue of (Is This The Way To) Amarillo.

COLD FACTS
# Chris Martin, Jonny Buckland, Guy Berryman and Will Champion met at University College London in 1996

# Parachutes (2000) sold 2 million copies. A Rush of Blood to the Head (2002) sold 10 million

# 2003 North American tour grossed �4.3 million

# David Martin, the singer�s uncle, is the Conservative candidate for Bristol West

May 1, 2005 at 09:37 AM in Business Models | Permalink | TrackBack (105) | Top of page | Blog Home

Downloaders face court as record bosses strike back

Downloaders face court as record bosses strike back - Newspaper Edition - Times Online

By Adam Sherwin, Media Reporter
THE biggest global clampdown on illegal file sharing was implemented yesterday by the music industry with 963 people across Europe and Asia facing legal action.

The British Phonographic Industry (BPI), the record industry�s trade association, initiated cases against 33 people in Britain as part of the campaign. The number of cases it has brought since October last year is 90.

It is the third time that the association has focused on music downloaders. The 26 people caught in the first wave, from a student and the director of an IT company to a councillor, have agreed to pay settlements totalling more than �50,000.

Last month it was announced that a further 31 people were being investigated. They will receive letters today after the disclosure of their identities by internet service providers.

The International Federation of the Phonographic Industry (IFPI) initiated actions in ten other countries including the Netherlands, Finland, Ireland, Iceland and Japan for the first time. The Japanese market has been badly damaged by internet piracy and other factors in recent years, losing 200 billion yen (�980 million) between 2000 and 2004.

Geoff Taylor, the BPI�s leading lawyer, said: �We have warned people time and again that unauthorised file sharing is against the law. Anyone engaged in this activity faces having to pay thousands of pounds in compensation. It�s now easy to get music online legally.�

Yesterday�s action brought the total number of cases to 11,552 worldwide. British singles sales have slumped by more than 50 per cent since 1999, when downloading took off. Illegal downloaders spend as much as 32 per cent less on albums and 59 per cent less on singles, according to BPI research. Yet sales of CD albums in the UK have risen, bucking the global trend.

Record labels are concerned that album sales will decline in the same way as singles, once broadband � which rapidly speeds the process of downloading � is more widely available. Yesterday�s lawsuits affect users of the popular KaZaA file-sharing network and newer file-sharing services including eDonkey and BitTorrent.

The BPI will go to the High Court next week to attempt to disclose the identities of those it believes have been uploading thousands of music files illegally. They face civil action seeking an injunction and damages.

This week sales of legal downloads, which have been incorporated into the Top 40, are set to overtake CD singles sales for the first time this year.

But taking illegal downloaders to court has proved controversial. The parents of Brianna LaHara, a 12-year-old American girl, paid $2,000 (�1,175) after she was accused of illegally swapping songs online.

John Kennedy, the IFPI chairman, said: �These lawsuits are not going to stop. We stop when piracy gets to zero.� The IFPI is sending out brochures to companies and universities in Britain making them aware of the risks of allowing their computer networks to be used for widescale downloading.

Smaller record companies last night gave warning that the new combined chart could be rigged by multiple download sales. Sales from iTunes, Napster and other leading online stores will be counted and 2,000 downloads bought for just 79p each could catapult a song into the Top 20.

April 12, 2005 at 09:17 PM in Business Models | Permalink | TrackBack (13) | Top of page | Blog Home

Grokster and StreamCast face the music

Economist.com | Illegal file-sharers under attack

Mar 24th 2005
From The Economist Global Agenda

The entertainment industry is taking its battle against illegal downloading to America’s Supreme Court. But attacking the technology behind file-sharing could stifle innovation without tackling the industry’s long-term problems

THE music business should have stuck by Thomas Edison�s technology if it wanted to avoid the threat of piracy. His wax cylinders could record a performance but could not be reproduced; that became possible only with the invention of the flat-disc record some years later. On Tuesday March 29th, America�s Supreme Court will begin to hear testimony in a case brought by the big entertainment companies that is intended to stop the illegal downloading of copyright-protected music and film. The industry�s target is the peer-to-peer (P2P) technology that allows the swapping of files directly over the internet. The defendants in the case are two firms that make file-sharing software: StreamCast Networks and Grokster.

The entertainment business has long been susceptible to copyright infringement�and it has usually blamed the electronics industry. The music industry first cried foul at the introduction of the cassette-tape recorder in the late 1960s. More recently, the digitisation of music has allowed �burning� of music tracks on to CDs with the help of a computer. The latest threat to the record companies is a copying technique of even greater speed, ease and scope. Every day some 4m Americans swap music files over the internet, according to figures from Pew, an independent research organisation. And now the swapping of new films online is gaining ground too, to the chagrin of the movie industry.

This comes at a particularly bad time for the music industry, which is struggling to reverse a long-term decline. According to the IFPI, a recording-industry umbrella group, worldwide music sales plunged in value by 22% in the five years to 2003�a drop of over $6 billion. In 2004, sales fell by 1.3%, though that decline looks less bad when revenue from legal digital downloads is added in. The music industry largely blames illegal file-sharers for its ills, noting that CD sales are dipping steeply in countries where broadband internet access is growing fast.

Some suggest that the latest attempt to curb illicit file-swapping�legal action against the technology that drives P2P networks�threatens the future of innovation. P2P software allows computers to talk to others running the same software without having to use intermediaries. Grokster and StreamCast argue that they are not able to control the use to which their software is put, whether it be searching, downloading or sharing.

In court, the two software firms will no doubt cite the case of Sony�s Betamax technology as a precedent. The home video-recording system, which was eventually superseded by VHS, faced a suit in 1984 in which Disney and Universal called for its ban. The entertainment firms feared that the ability to record on to video would allow considerable infringement of their copyright. America�s Supreme Court ruled that Sony was not liable because the equipment had �substantial� uses other than infringement, such as the recording of TV programmes for later viewing.

Similarly, the software produced by StreamCast and Grokster has significant non-infringing uses, such as sharing music that is not copyright-protected and internet-routed phone calls. In fact, some make the case that P2P technology could make the internet more robust and secure by avoiding the use of centralised servers, and that the entertainment companies� lawsuit is thus harmful to the web as a whole.

Napster, the first and best-known of the file-sharing businesses, was killed off by the music industry in 2001. Because it used central servers and so had the ability to block users who broke copyright laws, a judge issued an injunction ordering Napster to shut its servers down. At the time, it boasted some 14m users. Since then, the industry has ramped up action against file-sharing and widened its attack by going after individual downloaders as well.

At present, some 8,000 individuals around the world face lawsuits for illegal file-sharing. The industry has backed up its legal moves with a publicity offensive aimed at convincing the public that unauthorised downloading is theft. As well as cinema- and TV-advertising campaigns, 45m instant messages have gone out to users of P2P services, warning them to stop putting copyrighted material on the internet. America�s Department of Justice has weighed in too, even suggesting that P2P services could be used to support terrorism. Others have muttered darkly that the technology is a conduit for illegal pornography.

There are some signs that these measures are working: surveys suggest that internet users are becoming more wary of illegal file-sharing, for instance. However, according to the IFPI�s own figures, the number of unauthorised music files on the web has grown in recent months after falling sharply in the first half of 2004 (see chart). The number of users is also up, with 8.6m offering illegal files compared with 6.2m a year ago.

The music business has employed other defensive measures. Apart from a round of mergers and cost-cutting over recent years, the industry has tried to embrace legal downloading. Napster itself was reborn as a legal downloading service. And in 2004, according to the IFPI, the number of legal download sites increased four-fold to 230 and the number of legal downloads to over 200m (a figure that could double in 2005, according to forecasts). Apple�s iTunes, the largest legal download catalogue, has over 1m songs available and handles over 1m downloads a day.

But even if the entertainment business manages to coax more users into paying for legal downloads and succeeds in court against Grokster and StreamCast, its problems are unlikely to go away. True, a Supreme Court ruling in the industry�s favour would put paid to other P2P services. But it is not clear that curbing illegal downloading will translate into extra sales for the music business. A rush into legal downloading would hardly be good for sales of CDs: some cannibalisation is inevitable. And perhaps the decline in global sales is indicative of a far greater problem for the music industry�consumers simply think that many of its products are just not worth paying for.

March 29, 2005 at 07:50 AM in Business Models | Permalink | TrackBack (20) | Top of page | Blog Home