Can Dinosaurs Dance?
The rise of nimble Asian competitors and the accelerating pace of technological innovation are putting established companies in a double bind. For the storied multinational giants of the rich world, this is a battle for survival. Some of the dinosaurs of the old economy will fall by the wayside, but others may yet adapt and flourish. Some such firms are fighting the forces of change, but others making everything from consumer products and cars to colas are frantically figuring out the new tools and rules of global innovation.
The best of the breed are finding ways to turn the disruptive forces to their advantage. Some are experimenting with reverse innovation, through which Western firms bring innovations developed in emerging markets back to their home turf. Another weapon in their arsenal is the stealthy but sure spread of software, information technology, and related hardware into every nook and cranny of industries such as steel, cars, and energy. By becoming more like information businesses, which harness the Internet-fired explosion of customer data through advanced analytics and business intelligence strategies, traditionally stodgy companies hope to have a fighting chance.
Learning the tricks of frugal engineering now emerging from developing countries is essential for survival, but will Big Data really save Big Business? Actually, history shows that most companies die off over time—IBM, which celebrated its centenary in 2011, is a rare exception—and the pace of such creative destruction is accelerating. If big firms want to flourish, they need to combine scale with agility. To do so, they need to experiment and learn much faster than in the past, thereby speeding up the “knowledge turns” in their business.
That is because the digital revolution turns out to be a double-edged sword. The transformation of slow-moving, bricks-and-mortar industries into knowledge businesses does give them a renewed lease on life but it also exposes them to disruption from anywhere—meaning everyone must innovate faster today. This chapter highlights the successes achieved by nimble incumbents and plants red flags on the pitfalls that have befallen the insular and lethargic as dinosaurs learn how to dance to a new tune.
Vinod Khosla and Larry Page, two giants of the New Economy, are plotting to save the old economy. The two Silicon Valley stars were chatting one evening several years ago at the Googleplex. The crisis that Khosla was concerned about was caused by carmakers’ addiction to oil and the implications of that for national security and the environment. “The energy and car industries have not been innovative in many years because they have faced no real crisis, no impetus for change,” he insisted.
The two were plotting what they hoped would be the next great technological revolution: the convergence of software and smart electronics with the grease and grime of the oil and car industries. This was an audacious goal, given that the entrenched incumbents of asset-heavy industries such as the car business tend to move slowly indeed. Khosla was kicking around his plans for getting “chip guys” together with “engine guys” to develop the clean, software-rich car of the future. Such breakthroughs happen only when conventional wisdom is ignored and cross-fertilization encouraged—“managed conflict,” in his words.
Page had earlier hosted a gathering of leading environmentalists, political thinkers, and energy experts to help shape an inducement to get things moving: the Progressive Automotive X Prize, unveiled in early 2008. The organizers offered $10 million to whoever came up with the most efficient, affordable, and sexy car to obtain very high fuel economy using any form of energy. The winner, announced in 2010 after an exciting global competition, was the Edison 2, an incredibly aerodynamic vehicle that got over 102 miles per gallon of gasoline-equivalent energy. The charitable arm of Page’s firm even shamed the established carmakers into investing in electric cars by taking hybrid gasoline-electric vehicles, such as the Toyota Prius, and proving that they could easily be turned into safe and supergreen plug-in versions that can be topped up from an electric socket.
Such pushes were necessary, as the dinosaurs initially refused to budge. Khosla believes that clean cars, using advanced biofuels or other alternatives, will come about only through radical innovation of the sort that Big Oil and the Big Three automakers avoid. Risk and acceptance of failure are central to innovation, he argues, but these goliaths typically avoid both. “Big companies didn’t invent the Internet or Google, and much of the big change in telecoms also came from outsiders,” he adds.
But these men are from Silicon Valley, and Silicon Valley is not America. It is tempting to dismiss such breathless talk of revolution as just more hype from people who are seeing the world through Google goggles. After all, go beyond the rarefied air of northern California and the rules of gravity are no longer suspended. The well-established industries they mock still move at their usual but reliably glacial pace, right?
Well no, actually. Rapid and disruptive change is now happening across new and old businesses. Innovation is becoming both more accessible and more global. This is good news because its democratization releases the untapped ingenuity of people everywhere, and that could help solve some of the world’s weightiest problems. This will force the dinosaurs to dance in order to survive—and, just maybe, provide a renewed lease on life for the ones that come up with world-changing new ideas.
The seditious scene from the Googleplex also captures the challenge this presents to established firms and developed economies. For ages innovation has been a technology-led affair, with most big breakthroughs coming out of giant and secretive research labs, such as Xerox PARC and AT&T’s Bell Laboratories. It was an era when big corporations in developed countries accounted for most R&D spending.
North America still leads the world in research spending, but the big labs’ advantage over their smaller rivals and the developing world is being eroded. And research has found that companies are getting diminishing returns on in-house corporate research. Above a minimum threshold determined by the particular industry in question, spending more on in-house research and development has no correlation with any metric of the firm’s financial success. This suggests that for most companies in most industries, merely pouring pots of money into in-house research will not help in staving off disruptive innovations: they must open up and radically reinvent their innovation process.
However, for those companies with sufficient scale and long-term planning horizons, there may be an argument for doubling down on the traditional corporate research model. Bill Gates, ever the contrarian, remains a big believer in this traditional approach. He argues that open approaches are fine for incremental improvements, but that if a firm is aiming to develop breakthrough innovations such as the next generation of nuclear plants—something Terra Power, a nuclear energy firm in which he has a stake, is attempting—it needs serious in-house research, patience, and deep pockets.
Visit the storied Bell Labs, now owned by the telecom equipment manufacturer Alcatel, and you still find lots of scientists and well-equipped laboratories on its leafy campus in northern New Jersey—but these days they are mostly chasing ideas that will produce winners in the marketplace, not Nobel Prizes. GE has doubled its research and development spending over the past few years, despite the global economic downturn, and dramatically increased its spending on software. All this is aimed at preparing the firm for the coming convergence of the old economy and the New Economy.
That points to several of the big lessons emerging from the experiences of established companies trying to cope with today’s Great Disruption. Large firms must find ways of retaining their ability to scale good ideas—Immelt likes to say his firm isn’t the best at invention, but it is terrific at turning $50 million ideas into billion-dollar businesses—while becoming much more agile. That means bosses must push internal bureaucracies and hierarchies to experiment more readily, failing faster and learning from mistakes more gracefully. They must also be much more open to ideas, including ones that are threats to existing business lines, coming from unexpected quarters outside the firm.
What’s more, it is not just stodgy industrial firms that must learn to dance to a new tune: even high-technology firms that just a few years ago were themselves disruptive innovators will soon find that their comfortable perch is threatened by new and hungry upstarts. A good example is Intuit, a California firm that shot to prominence with TurboTax, Quicken, and other easy-to-use financial software. Scott Cook, the firm’s founder and current boss, saw the inefficiencies, high costs, and customer frustrations evident at traditional tax preparation businesses. By building a simple, affordable, self-service tax preparation package, he did for personal finance what Ray Kroc did for restaurants with McDonald’s.
That propelled Intuit into the ranks of billion-dollar businesses, but Cook was not satisfied. In the mid-2000s, he decided he needed to accelerate the firm’s organic growth and cast a wider net for new ideas lest his firm grow vulnerable to disruption. To do this, he decided to move toward an open innovation model of the sort long advocated by UC Berkeley’s Henry Chesbrough. This is easier said than done, he has discovered. Early efforts at collaboration with outsiders hit snags because employees were fearful of sharing intellectual property (company lawyers had advised them that patent applications might get “polluted” if outsiders were involved). Some collaborators, for their part, thought Intuit was flirting with them as a prelude to an acquisition bid. The firm’s internal R&D teams worried their jobs were about to be outsourced, and some managers adopted a “not invented here” attitude.
To the firm’s great credit, observes Chesbrough, Intuit stuck with its efforts to open up its innovation process. When the effort started, the firm took months to develop new ideas; recently, it produced in a matter of weeks an Android app with Google for online payments. When several new employees grew frustrated a few years ago at the internal silos and lethargic pace of cross-functional communications, they used the “10 percent time” granted them by the company to pursue any project they want (3M and Google let their employees have 20 percent off for pet projects) to create their own online tool. Not only does the entire company now use Brainstorm, the resultant software, for collaboration and knowledge sharing, but Intuit also sells this serendipitous invention to such customers as GE, Netflix, and the Wharton Business School.
Reflecting on his firm’s progress, Cook says the hardest part of teaching his dinosaur to dance was changing corporate culture: “It requires a change to the standard process of development, relying less on secrecy and IP protection and more on collaboration—and no longer retreating to the old ways.” In short, even firms that were paragons of New Economy disruption a few short years ago (think Google today, Facebook tomorrow) will, like Intuit, confront the same forces that are now forcing wrenching changes at the icons of the old economy.
Into the Looking Glass
Two decades ago, David Gelernter saw the coming convergence of the old economy and the New Economy. In his visionary tome Mirror Worlds, he predicted that “you will look into a computer screen and see reality . . . some part of your world—the town you live in, the company you work for, your school system, the city hospital—will hang there in a sharp color image, abstract but recognizable, moving subtly in a thousand places.” That sounded like something out of Orwell or the dystopian Matrix movies to some, which perhaps explains why the Unabomber tried to blow him up.
Thankfully, the neo-Luddite terrorist failed, and the curmudgeonly Yale professor continues to crank on. And Gelernter’s forecast that the digital world would converge with the real world is fast coming true. The rise of intelligent infrastructure and smart systems, which embed sensors into everything and link up using wireless communications networks, is indeed creating a digital version of reality. This raises important questions about security and privacy, but it also means that stodgy, asset-based industries such as steel, cars, and shipbuilding are turning into information industries—and therefore companies in those fields must innovate much faster than in the past.
The embedding of intelligence into dumb systems is nothing new, of course. For several decades, logistics firms and retailers such as Walmart have been putting RFID tags and related technologies into many products. This has made it possible for them to track everything from the location of specific cargoes on the freeways to identifying which specific size and variety of Jif peanut butter has just gone out of stock in which aisle of your local supermarket. But now, argue technology experts at McKinsey, this trend is accelerating toward what has been called the “Internet of things.” “Embedded with sensors, actuators, and communications capabilities, such objects will soon be able to absorb and transmit information on a massive scale and, in some cases, to adapt and react to changes in the environment automatically.”
Why does this matter? Because, argue the McKinsey futurologists, the spread of smart software and sensors into every nook and cranny of traditional, unsexy industries will make processes more efficient, give products new capabilities, and spark novel business models. For example, heart patients using implanted or wearable sensors now have a real-time guardian angel monitoring them all day and night, reporting to doctors if there is any cause for concern or if a medication needs to be modified. Insurers in Europe are offering to install sensors in cars to monitor behavior, so they can offer rates based on actual performance rather than demographic guesstimates. And luxury carmakers are putting in elaborate sensors that will automatically take evasive action when the car senses danger if the driver is asleep or distracted.
Stepping on the Gas
“A BMW is now actually a network of computers,” declares Ulrich Weinmann. That may seem like an exaggeration until you step into a sleek Hydrogen 7 BMW sedan. Push the pedal to the metal on the autobahn and the car responds as every BMW should, cylinders growling enthusiastically as the ultimate driving machine races past slower vehicles. But this car is not like any other made by BMW. Press a button on the steering wheel and it seamlessly switches from burning gasoline to consuming hydrogen.
The key to this advance, says Weinmann, an innovation expert at BMW, is smart software. Electronics have been in cars for decades, but those were isolated “dumb systems,” he adds. Now cars are crammed full of networks of computers, with smart software controlling and monitoring things. New BMWs were among the first to synchronize seamlessly with Apple’s iPhone and download maps and directions from Google while you drive.
As the knowledge component of industries continues to grow, it will lower even further the barriers to entry in many businesses. Yet the same democratization of innovation that empowers the new firms can be used to generate much greater and faster innovation from within established companies. Some multinationals are already doing this in Asia to keep up with their local competitors.
The effects of this have become increasingly clear in heavy engineering. Reinhold Achatz, of Siemens, claims the German giant has undergone a hidden electronics revolution. “We have more software developers than Oracle or SAP, but you don’t see this because it is embedded in our trains, machine tools, and factory automation,” he says. Achatz calculates that as much as 60 percent of his firm’s sales now involve software. Some 90 percent of the development in machine tools is in electronics and related hardware, and the figure is similar for cars.
The steady conversion of engineering into yet another knowledge-based industry forces the pace of innovation for all industries. “We are a quite mature industry, but customers now expect change faster,” adds Weinmann. The demand for change is fastest in Asia. Several hundred new mobile phones are launched every year in China, and customers there now expect their new BMWs to be able to synchronize perfectly with each new handset, he sighs.
New competitors are emerging from unexpected quarters, which makes things difficult for established firms. One of them is Elon Musk, who is challenging incumbents in not one but two old-time industries. Musk made his fortune during the Internet boom by selling PayPal, an online payments system, to eBay for $1.5 billion. He now heads Space Exploration Technologies, known as SpaceX. This is a start-up offering private space launches. In 2010, it fired a rocket successfully into space, the first to be designed, paid for, and launched entirely with private money. Later that year, it managed to send the company’s Dragon reusable space capsule into orbit and back to the surface of the earth safely, heralding a new chapter in private-sector-led initiatives at NASA.
SpaceX is the vanguard. Many private-sector newcomers, fed up with the overbearing ways of NASA and the big defense contractors, are working furiously to commercialize space. The X Prize Foundation and Google decided to fuel the fire by announcing a $30 million prize for the first private sector team to land and operate an unmanned rover on the moon. Peter Diamandis, the foundation’s chairman, believes the old guard is no longer able to innovate. “Real breakthroughs require risk and the ability to absorb failure, and large organizations are incapable of such risk taking,” he insists.
Musk is not waiting to win any prizes. Besides SpaceX, he has also started Tesla Motors, which has devised an electric sports car capable of accelerating from zero to 60 mph in four seconds and has a top speed of over 130 mph. More impressively, thanks to its advanced lithium-ion batteries and lightweight carbon-composite construction, the Tesla Roadster has a range of perhaps 200 miles on an overnight charge, less if driven fast and furious. The cars cost a pricey $110,000 or so, and the global recession hit the start-up firm’s finances hard, but Musk managed to take Tesla public in one of 2010’s most successful IPOs.
Can established corporate giants hope to compete against such disruptive innovators? The dinosaurs certainly are not giving up without a fight. Visit Walmart’s headquarters in Bentonville, Arkansas, and you will be greeted by a large plaque in the lobby that says: “Incrementalism is innovation’s worst enemy! We don’t want continuous improvement; we want radical change.” These are the words of Sam Walton, the firm’s founder. And to his credit, Walton did radically change the general store with his innovative approach to low-cost, high-volume supermarket retailing. But ask Linda Dillman, a senior official at the firm, about innovation at Walmart today and she concedes that radical thinking was easier when the firm was young. Size and scale offer many advantages, but they also carry with them the seeds of the firm’s own destruction: lethargy and legacy. The bigger you are, suggests corporate history, the harder you may fall.
Ideas at Double Speed
That explains why many executives feel that the heat is on and that they must innovate faster just to stand still. In part due to the spread of information technology in traditional industries, product cycles are undeniably getting shorter. Gil Cloyd, the former chief technology officer at P&G, studied the life cycle of consumer goods in America from 1992 to 2002 (way back before the Internet’s full impact was felt) and found that it had already fallen by half. It has surely accelerated further with the arrival in full force of the Web. That, he concluded, means his firm now needs to innovate at least twice as fast.
The American company famous for inventing the Post-it sticky note, 3M, also believes the world is moving much faster. Andrew Ouderkirk, one of the firm’s celebrated inventors, thinks that is in part because many things that his company used to do in-house are now done by outsiders. To keep up, 3M carries out “concurrent development,” which involves talking to customers much earlier in the process to try to shorten development times.
Even the firm that laid down the first long-distance telegraph lines thinks today’s innovation frenzy is unprecedented. Achatz, of Siemens, is adamant that innovation is happening much more quickly and that “access to information is so fast now that it allows much faster product development cycles.” His firm is convinced that there will be an explosion of medical know-how thanks to the advance of information technology into medicine.
Perhaps managers at firms everywhere should be both farsighted and paranoid in equal measure as they scan the horizon for unexpected competitive threats. Embracing the digital revolution, as Siemens and other industrial giants are doing, is one good way to prepare for a disruptive future. Another is to push into difficult emerging markets in hopes of disrupting one’s own business model.
Role Reversal
That challenging technique is what Vijay Govindarajan, an innovation expert at Dartmouth’s Tuck School of Business, calls reverse innovation. This, he explains, is the mechanism by which the gap between rich and poor drives innovation. One pillar of this theory, which echoes the arguments about disruptive innovation put forward by Clay Christensen, exploits the performance gap: firms need to learn how to come up with cheap and cheerful products that achieve 50 percent of the performance of their gold-plated offerings at 5 percent of the cost, just as Indian and Chinese rivals do. Another pillar relies on filling the infrastructure gap: because the developing world lacks the legacy infrastructure of the rich world, that is where most of the new roads, airports, and buildings are being built. Because this infrastructure is built with the latest technologies and energy-efficient designs, companies that compete successfully can leapfrog ahead of rich-world rivals that stay focused on stagnant domestic markets.
The sustainability gap in poor countries, where resource problems such as water scarcity are often much more immediate than in wealthy countries, also offers incentives for breakthrough innovations that can be profitably brought back home. A regulatory gap between rich and poor countries will also spur reverse innovation, argues Govindarajan: pharmaceutical companies will do more clinical trials in India, for example, and stem cell or gene therapies will take off sooner in South Korea and China.
The upshot is that by recruiting ingenious local engineers and designers in places such as Bangalore and Beijing, and by paying close attention to trends and practices in the market, forward-looking Western firms in some industries are coming up with products and services that can be sold in other parts of the world too. For example, Nokia’s engineers are finding that many Chinese and Indians access the Internet mainly through their mobile handsets. Such customers’ requirements for their handsets may therefore be quite different from those of Western users, many of whom have computers at home and at work.
Unilever has long had a strong distribution network in India, but it has expanded its efforts with a division called Shakti, which provides Indian women’s self-help groups with business education and the chance to earn a living selling cheap sachets of Unilever products. The effort has proved so successful that Unilever introduced a high-tech element: the Shakti entrepreneurs now run kiosks with personal computers that villagers can rent to send e-mails and browse the Web for things that can make a big difference to their lives, such as market prices for various commodities. Google has taken Wenda, a question-and-answer “knowledge community” product developed by its division in China (before the firm’s withdrawal from that market in 2009) to help overcome a lack of local content, and launched it in the Russian market.
A. G. Lafley, the former boss of P&G, says many Asian firms began imitating what foreign ones did but are now “very innovative, especially with business models.” Lafley sees Indian firms shaking up the way foreign companies operate, and not only with back-office services where many began. Hours after he uttered those words, Wipro, an Indian pioneer of software services, said it would open a new development center in Atlanta that will report back to its headquarters in Bangalore.
This is forcing P&G to innovate in other ways too. Lafley uses the example of detergents in China, where the company is using a low-cost manufacturing method that he likens to Coca-Cola’s syrup model, in which the company supplies a concentrate to local bottlers. P&G provides secret, high-value performance chemicals to Chinese partners, who add basic ingredients and packaging before distributing the products.
The notion of dinosaurs learning to dance to a new tune is not as ridiculous as it may first seem. When the personal computer first arrived on the scene some three decades ago, the computing world was dominated by big, bureaucratic firms peddling mainframes and other centralized solutions. IBM, Digital, Wang, and other giants of that era pooh-poohed the PC, considering it a toy—and they dismissed the unknown Taiwanese manufacturers building and assembling it too. “There is no reason for any individual to have a computer in his home,” declared Ken Olsen, boss of Digital Equipment Corporation, back in 1977.
History shows how wrong they were, of course: not only did the personal computer transform business, but its arrival proved the calling card for the rise of flexible Asian manufacturing too. Unable to adapt to a world of networked and distributed computing, Digital and Wang went bust. However, IBM set up its own PC division as a hedge on its bet—and managed to come up with a personal computer offering, bundled in with lucrative service contracts, that corporate clients loved.
And when this business model itself was at risk of being disrupted by the software-as-a-service approach pioneered by Salesforce.com, IBM moved itself to a service-based approach and spun off its PC unit altogether. To whom did Big Blue sell its unwanted Lenovo division? Chinese investors, of course. That may seem ironic, but it was ever thus in the computer business, as the history of Intel reveals.
Lessons from a Master
Not too long ago, Andy Grove taught a class at Stanford Business School. As a living legend in Silicon Valley and a former boss of Intel, the world’s leading maker of computer chips, Grove could have simply used the opportunity to blow his own horn. Instead, he started by displaying a headline from the Wall Street Journal heralding the takeover of General Motors by the Obama administration as the start of “a new era.” He gave a condensed history of his own industry’s spectacular rise, pointing out that plenty of venerable firms—with names such as Digital, Wang, and IBM—were nearly or completely wiped out along the way.
Then, to put a sting in his tale, he displayed a fabricated headline from that same newspaper, this one supposedly drawn from a couple of decades ago: “Presidential Action Saves Computer Industry.” A fake article beneath it describes government intervention to prop up the ailing mainframe industry. It sounds ridiculous, of course. Computer firms come and go all the time; such is the pace of innovation in the industry. Yet for some reason this healthy attitude toward creative destruction is not shared by other industries. This is just one of the ways in which Grove believes that his business can teach other industries a thing or two. He thinks fields such as energy and health care could be transformed if they were run more like the computer industry, made greater use of its products, and dramatically accelerated the pace of innovation.
Though Grove’s scientific credentials are solid, he will probably be best remembered as a daring and successful businessman. Richard Tedlow, a historian at Harvard Business School, calls him “one of the master managers in the history of American business.” One reason is market success: under Grove’s tenure, Intel came to dominate the microprocessor industry and its market capitalization rocketed up (making it, at one point, the world’s most valuable company). A bigger reason lies in how exactly he managed to steer Intel to such spectacular success—a tale that shows how the fine American traditions of entrepreneurship, ambition, and sheer chutzpah can revive innovation at companies and countries alike.
One particularly risky decision he took is revealing. In Only the Paranoid Survive, Grove’s bestselling book, he argues that every company will face a confluence of internal and external forces, often unanticipated, that will conspire to make an existing business strategy unviable. In Intel’s case, such a strategic inflection point arose because its memory chip business came under heavy assault from new Japanese rivals willing to undercut any price Intel offered.
What could he do? The firm’s roots and most of its profits lay in making memory chips; Intel’s microprocessor group was just a small niche. The firm’s two founders and much of its engineering staff were too emotionally wedded to its past successes to make a break. But Grove decided to bet the future of the company on microprocessors, a move that saved his company and transformed the industry. He argues now that it is not only companies that face such an inflection point; so too do societies and countries. That echoes a central premise of this book: the world is at a strategic inflection point, and the policy and investment decisions this generation makes in the next decade will cast a long shadow over future generations.
At the time, the microchip business was producing such unreliable products that customers insisted that companies such as Intel always license new products to a secondary supplier in order to ensure reliability of supply. Grove’s efforts to tighten up quality control led to a commercial coup. When his firm introduced its widely anticipated 386 processor, he stunned the industry by declaring that Intel would not license any secondary manufacturers. This was a huge risk for computer makers, but such was their appetite for the new chip that they bought it anyway. Intel’s ability to deliver good enough chips in large numbers meant profits no longer had to be shared with secondary manufacturers.
With his reputation for ruthlessness in the marketplace and rigorous discipline inside his firm, Grove has much in common with another American business leader: Lee Raymond, the formidable former chairman of ExxonMobil. Both men were feared not just by rivals but also by many of their employees. Grove once even spearheaded a sales campaign against a superior chip made by Motorola in an effort dubbed Operation Crush. When asked about such bully-boy tactics, Grove remains unrepentant. He even likes the comparison with the unloved oilman: “I never knew Lee Raymond, but he did take Exxon to the top of the Fortune 500—and that’s OK with me.”
Personal admiration aside, however, Grove is convinced that Exxon and its Big Oil brethren are in a sunset industry. He has written and lectured widely on energy and environmental topics in recent years, arguing that oil and cars are heading for a divorce. He regards electricity as the most promising replacement fuel, and thinks battery technology has the potential to produce an Intel-like giant as the industry develops.
Another business he believes to be ripe for disruption is health care. He complains that the industry seems to innovate much too slowly. The lack of proper electronic medical records and smart clinical decision systems bothers him, as does the slow-moving, bureaucratic nature of clinical trials. He thinks pharmaceutical firms should study the fast “knowledge turns” achieved by chipmakers, so that the cycles of learning and innovation are accelerated. A knowledge turn, a term coined by Grove, is the time it takes for an experiment to proceed from hypothesis to results and then to a new hypothesis—around eighteen months in chip making, but ten to twenty years in medicine.
Given the coming perfect storm of global challenges confronting the world economy, Grove is surely right in calling for a dramatic acceleration in the pace of global innovation. But can companies in slow-moving industries such as health care and energy (two sectors that GE’s boss, Jeff Immelt, also thinks are the keys to his firm’s and America’s future) really respond to his call? The surprising answer is yes, as the experiences of Kaiser Permanente demonstrate.
How the Health Care Industry Can Save Itself
On a trip to America in early 2010, Nicolas Sarkozy, France’s president, could not resist the temptation to needle his hosts. Just before the visit, his American counterpart, Barack Obama, had secured congressional approval of a controversial but ambitious plan (dubbed “Obamacare” by its critics) to expand the country’s health insurance market dramatically. Observing that America is the only wealthy country to lack universal health coverage, Sarkozy sniffed: “Welcome to the club of states who don’t turn their back on the sick and the poor.”
Europeans have long thumbed their noses at the bloated U.S. health care system. It is true that parts of it are convoluted, cruel, and much too costly. But Richard Feachem, a health care expert and the former boss of the Global Fund to Fight AIDS, Tuberculosis and Malaria, argues that such a view ignores “nuggets of good practice.” The best such nugget, he reckons, is Kaiser Permanente (Kaiser), a not-for-profit health insurer and hospital chain that in 2009 took in $2 billion more than the $40 billion it spent.
Though there are plenty of dedicated doctors and nurses, the American health care system is dominated by cream-skimming health insurers and the myriad fee-for-service providers they do business with, which drive up costs by charging high prices for piecework. Kaiser’s business model integrates fixed-price health insurance with treatment at its own hospitals and clinics. This has led to big efficiency gains, making Kaiser one of the cheapest health care providers in most of the regional markets in which it competes. Thanks to Obama’s reforms, more than thirty million Americans will enter the health insurance market over the next few years—and Kaiser’s low prices should make it a big beneficiary.
Moreover, Kaiser’s medical results are as good as its financial ones. By many objective clinical measurements, it is the best-performing health care outfit in the regions it covers. The firm’s success obviously holds lessons for its American rivals, but given that Kaiser serves some 8.6 million patients—more than the population of Austria—and has come up with some world-beating innovations, Feachem believes that there is much that Europe can learn too.
At Kaiser’s Oakland Medical Center in northern California, Christina Ahlstrand, a lifelong customer, has come to see her doctor, Jennifer Slovis. Ahlstrand had been experiencing “very low energy,” so she e-mailed to see if she should get any blood tests done. After reviewing her electronic medical records (which include all her lab tests, prescriptions, e-mail exchanges, and notes from visits to all specialists), Slovis e-mailed her back saying she needed to see her in person.
Many health systems, including Britain’s National Health Service (NHS), have tried unsuccessfully to implement comprehensive computer systems; patients and doctors often hate them. But studies published in the journal Health Affairs and elsewhere show that Kaiser’s embrace of technology (its doctors conducted nearly nine million electronic consultations in 2010) has resulted in fewer frivolous visits, better medical outcomes, and soaring patient satisfaction. Patients can even send doctors photos of worrisome moles or slow-healing wounds by e-mail for remote diagnosis. In other words, Kaiser has managed to craft a learning system that meets Grove’s call for faster knowledge turns.
Ahlstrand, like many Kaiser patients, loves this system. She also likes Kaiser’s personal-health website, which gives her tips and points her toward classes on healthy living. Slovis, for her part, is pleased that her work is “nearly paperless” and that she can easily track the specialists treating her patients, “so I know exactly what’s going on.”
The ease with which Slovis tracks Ahlstrand’s interactions with specialists and any resultant test results is indicative of the sort of integration that is missing in most health systems. George Halvorson, Kaiser’s boss, argues that such coordination is all the more essential because of the dramatic rise of such lasting and expensive afflictions as metabolic syndrome, diabetes, and heart disease.
Kaiser also aligns incentives both to promote parsimony and to improve the quality, rather than merely the quantity, of the care it gives. Patients such as Ahlstrand use e-mail because it is free and convenient, whereas a personal visit can involve hassle and an out-of-pocket payment. Slovis and other Kaiser doctors are on fixed salaries, unlike America’s many self-employed physicians, so they have every incentive to share information with other specialists and no financial motive to order unnecessary procedures.
Kaiser’s third big advantage is that its integrated approach and incentive structure encourage investment in forms of long-term care such as the wellness classes that Ahlstrand enjoys. The firm is in the midst of a ten-year, $30 billion capital investment plan. It has now completed the rollout of its computer system—the biggest one in the world for private health care.
Many other insurers and health systems avoid making such investments because of “churn”: patients switch insurers frequently, so any spending on preventive medicine, aimed in particular at avoiding expensive hospital visits in the future, ends up benefiting a rival company. Kaiser says its churn rate is well below that of its rivals, so it can invest for the long haul. It even funds an innovation center located in California that perfected the telemedicine systems its doctors are now using for remote dermatology consultations, for example.
Clay Christensen applauds the firm’s culture of innovation. He notes that Kaiser’s dentists routinely apply a coating to children’s teeth that helps prevent cavities, a procedure that many other American dentists tend not to use. Why not? In an integrated system with incentives aligned properly, he argues, preventing future cavities saves the company money. In contrast, in a fee-for-service system, “future cavities represent future revenue.”
If Kaiser’s approach is so successful, why is it not more widely copied? A number of health systems from around the world, including Britain’s NHS, have sent emissaries to California to study its approach, but efforts to replicate it have met with only limited success. Within the United States, a handful of outfits such as the Mayo Clinic independently evolved into integrated systems, but the rest of the industry remains a fragmented mess.
The prevailing culture of health care in the country is difficult to overcome. Some American patients, used to having all the scans and consultations with exotic specialists they want, costs be damned, do not like Kaiser’s frugal ways. By the same token, some freewheeling American doctors do not like its rigid systems or fixed (albeit generous) salaries. Much the same applies in other countries: whether in politicized state-run systems or profiteering private ones, the incentives for doctors and patients are seldom as soundly aligned as they are at Kaiser. “Most of its success is explained by culture,” says Alain Enthoven, a health economist at Stanford University, “and that is simply not easy to replicate.”
If an American health care giant can learn to be so nimble, surely there is hope for many other big businesses now confronted with the threat of disruptive innovation. Reverse innovation will help steal the thunder of potential rivals from overseas, while investing in smart technologies and systems will help accelerate knowledge turns at home. The key lies in cultivating a culture that embraces change, experimentation, failure, and rapid learning.
If companies do that, they have a good shot at surviving, and perhaps even conquering entirely new markets. That is especially true because capitalists now have a powerful new ally in their quest for sustainable profits, as the next chapter explains: dynamic social entrepreneurs who want to harness market forces to save the world.