AFTERWORD
The 1990s and Beyond
The Changing World Economy
I begin with the remark that 1992 is after all not a terribly important date. Many things will be decided between now and then, but the important event has already happened, and it has nothing to do with governments. Governments are, alas, no longer performance centers, as they were in the nineteenth century. The main event is that the businessmen of Europe have already decided that there is a European economy. Has there ever been a precedent to guide us? Yes; and not so long ago, either.
When I first went to the U.S.A. as correspondent for five British newspapers in the late 1930s, it was just becoming a national market. It had been a political unit for 150 years, but there were very few national U.S. businesses: none of the big banks, none of the big insurance companies, only 3 of the then 10-12 automobile companies and a few of the steel companies (and then only because the U.S. navy required it) had national scale or coverage. All the rest were local or regional. Most of them were unfamiliar with other parts of the country—after all, it took six uncomfortable days in the train, without air conditioning, to reach Los Angeles from New York or Washington. Few people went there from the east except film stars.
Then, suddenly, in the mid-1930s every business had to learn to think national. Very few actually acted national. Contrary to what most foreigners think, the U.S.A. still has a tiny minority of companies that are fully national. The majority remain regionally based on the East Coast, West Coast, or in the Midwest to this day. Nevertheless, U.S. companies had to learn quickly to think and act in contemplation of the national market. This is what is happening in Europe.
Looking at this example will not, however, tell any business what to do in its own particular circumstances. Beware of prescriptions. A company must make up its own mind by examining its own business, its own market, its own competition and deciding where the new competition may arise—even though the CEO may never have been to Spain except on holiday, any more than many Americans have visited the West Coast. In any case, it must rethink strategy in contemplation of a fundamental change: location of markets, the need for expansion, alignment, and structure. This has to happen anyhow. Once it has been done, 1992 ceases to be a major event.
But New International Dynamics Do Matter
The European single market is, however, symptomatic of a capital change in the way the world economy functions. Whether you like it or not (and I for one do not), the world is very rapidly changing its form of economic integration. We are moving toward a world economy that is integrated not by free trade or protectionism, as in the past, but increasingly through a hybrid of the two which we can call reciprocity. What do I mean by reciprocity? International trade has evolved from a complementary exchange of goods and services to an adversarial exchange. In an adversarial trade relationship, if an attacking country excludes foreign competition and imports, as the Japanese did, in effect the defender is unable to counterattack. It cannot win; so what can it do?
One answer is to form an economic bloc or region, such as the European Economic Community scheduled for 1992. This gives smaller economies the larger market they need for competitive scale. At the same time, regionalism creates an entity that can deploy an effective trade policy transcending both protectionism and free trade. Thus reciprocity—in which, in principle, each bloc’s businesses would have the same degree of access to the other blocs’ markets—is rapidly emerging as the new guiding principle for the world economy. It may be the only way of preventing it from slipping into extreme protectionism.
We do not yet know exactly what reciprocity will entail in practice. Does it mean that European banks can do business in the U.S.A. on the same terms as U.S. banks, or on the same terms as those on which they do business in Europe? That is still up in the air. Questions such as these will be decided ad hoc, with endless friction and compromise, and in every case the answer will be slightly different. What is certain is that the EEC will adopt it as its main trade policy—and that is already having an effect elsewhere.
For example, the prospect of the European single market was the direct cause of the free trade agreement between the U.S.A. and Canada. In Europe it is impossible to comprehend the unlikeliness of this venture without the threat of the single market. It flies in the face of everything that Canada has ever felt important. Even now, Canadians are not enthusiastic; they simply had no choice but to throw in their economic lot with their dominating neighbor. After Canada, there is now an even bigger question: Does Mexico in its turn have any choice? There is no deeper cultural dividing line in the world than this unmarked border between two totally different civilizations and value systems. For 150 years the lodestar of Mexico’s policy was to keep as far away as possible from the huge and dangerous monster next door. Yet suddenly, despite tremendous politico-cultural tensions, the possibility of Mexico being forced to integrate itself into the North American economy is better than 50 percent. It is no longer absurd to contemplate it.
In the East Too
There are other emerging regions. In China, the pressure of enormous unemployment on one hand and the disparity between the energy of the coast and the lethargy of the interior on the other is beginning to split the country into rival economic warlordships once again. If, as is distinctly possible, a coastal belt containing all the commercial energy develops along a stretch from Tientsin to Canton, then very soon we shall see a new Far Eastern bloc organized around Japan. The Chinese cities are already in their economic orientation (although not yet politically or socially) pointing toward this new superstar and center, despite the tremendous Chinese fear and distrust of the foreigner, particularly the Asiatic foreigner. A Japan-centered Pacific Rim region is probably in the process of being formed.
A New International Economic Order Is Emerging
In the newly emerging world economic order—transnational, regionally integrated, and information intensive—two changes already stand out. First, tomorrow’s transnationals are unlikely to be manufacturing companies. The service economy is going transnational. Most of 256 public hospitals in Japan are today maintained and managed by a Chicago-based maintenance company. Virtually every big office building in Manhattan is maintained and managed by a maintenance company based in Aarhus, Denmark. Since Japan lacks business and engineering teachers, it is bringing the students to the faculty; and, inconceivable just a few years ago, three leading nongovernmental universities in Tokyo are building campuses on the West Coast of the U.S.A. for Japanese students. Banking and finance are more advanced still in transnational development. In large part because governmental politics are still focused on the concerns of the blue-collar factory worker, the service economy is going transnational much faster than manufacturing.
Second, in the new world economy investment is growing much faster than trade. Classic economic theory says that investment follows trade. In the nineteenth century that was true. In the twentieth century it is the other way around. To take a topical case, look at the Japanese automobile companies and their suppliers in the U.K. No sooner does Honda, Nissan, or Toyota establish a factory in the U.K. than it imports its own suppliers as well to provide it with components. This is in part because the Japanese do not find it natural to buy from an independent supplier. In Japan a company is either a master or a servant, and the supplier which sells to more than one master is not to be trusted. But consider a less obvious example of the same phenomenon. Why did U.S. exports not collapse in the years of the overvalued dollar in the mid-1980s? For a similar reason: in spite of the price penalty, Japanese subsidiaries of U.S. companies kept on buying machinery, spare parts, and materials from their tried and trusted suppliers back in the U.S.A.
Yet in an investment-led world economy, a strategy based on exports is out of date. One of the factors that lost the U.K. its economic leadership in the nineteenth century was, ironically, its mastery of exporting. This meant that in every port in the world, the main importer was a Scot, and a Scot who bought almost exclusively from Manchester and Glasgow. Since they could not penetrate their key markets by the traditional route of exports, U.S. and West German companies were obliged to establish factories there instead. They had to invest before they could trade. In this kind of world, proximity to and feel for markets have become decisive, and these require market presence and market standing. So now, one of the accepted facts that economic history (rather than the economic textbook) teaches is that a company cannot hold a leadership position in a key market unless it manufactures there. The Japanese have taken 20 percent of the U.S. automobile market, compared with the 30 percent captured by foreign manufacturers in all. Yet only half of the Japanese share has been taken from the U.S. Big Four. The rest has been stolen from the Europeans, notably Volkswagen, which had no less than 12 percent of the market in 1969. Alas, the unions barred Volkswagen from manufacturing in the U.S.A. the first time round. In 1973, when the oil shock struck, VW was not in the market as a manufacturer, and it misread the signs. When it did try to come back and manufacture, it was too late.
Once again, investment is the economic driver. The real economy of goods and services no longer dominates the transnational economy. The London interbank market daily turns over 10–15 times the amount of eurodollars, euromarks, or euroyen which are needed to finance world trade in goods and services. No figures exist for the foreign exchange markets, but they are certainly bigger still; far greater than needed for commercial trading purposes. These flows finance capital movements and investments. If the corporation does not maintain its investments in its key markets, it will have no sales.
In the transition, of course, these arrangements hold some difficulties for the wealth-creating sectors of national markets. We still hold the nineteenth-century assumption that there is a shortage of liquid funds. The reality today is that there is a surplus. One reason is that the economies of the developed world are becoming steadily more knowledge intensive and less capital and labor intensive. Another is the enormous amounts of money accumulated in small savings accounts and large pension funds. So instead of rationing, their traditional function, now the large investors are looking for places to put their money. The results are not necessarily always economically optimal, except in the very short run.
Look at junk bonds. In effect, junk bonds are simply another form of equity financing, the main purpose of which is to give industry and the takeover specialists very cheap money (because it is debt and the interest is tax-free) at a high yield to the lender. Not surprisingly, the banks have rushed to participate in a miraculous market that gives them 15 percent at a cost to the borrower of 6 or 7 percent. It is doubtful whether this is in the interests of the economy. Where there is excess liquidity there is a risk of making investments guided by short-term speculation, whether it is lending money to Zaire or to the latest takeover artist.
Finance, a Model for the Future: Adapt or Die
As this suggests, of all the changes so far, the fastest and most extensive are those which have transformed the world financial system. Money, like information, knows no fatherland, with the practical consequence that financial systems in countries at similar stages of economic development are strikingly similar irrespective of legislation or social habits. We can therefore look at what happens in one part of the developed world and see what it tells us about where the rest of the world is going. The U.S.A. has gone the furthest: partly because it was most severely regulated and partly because the markets, less dominated by a few very big units, were most flexible.
When the financial revolution began around 1960, we all predicted the imminent triumph of the financial supermarket: a money continuum, from total liquidity and minimum risk at one end, to minimum liquidity with very high risk at the other, all at a suitably graded price. We were wrong for two reasons. First, to most people money is not a commodity. U.S. retailer Sears Roebuck has always prided itself on being the buyer for the U.S. family. It looked at the investment demand on the part of the masses and bought a major brokerage house. For many years it was a total disaster. Very few of us are willing to buy our investments, even in government bonds, next to where we buy our children’s underwear. It is not right. It is not becoming. Money is, if not sacred, at least different.
The second reason for the failure of the financial supermarket is that in every developed country there are two separate markets with entirely different characters: retail and institutional. Whether one institution can serve both of them is still unclear. The retail market is a strange beast. When I worked in the City of London more than 50 years ago, my very wise boss said to me: “Mr. Drucker, never forget that in the richest country in the world only one family out of every 20 can lay aside more money than is needed for the funeral of the head of the family.” Today probably at least half the families in all developed countries lay more aside than is required for a funeral. Not enormous sums: most people only spend less than they make once they are past the age of 50. Except in Japan, where compensation follows the life curve, income patterns are skewed so that rewards really begin to climb when the children are grown up and the spending needs begin to go down. At that stage people are too old to change. Suddenly they have a little money individually—and those small individual sums collectively add up to an almost unbelievable total.
Almost everyone has radically underestimated these amounts, as companies have found that dared to bring out new financial products. The U.S. saving rates are some of the lowest in the world, yet sales of mutual funds boomed in 1983–87, in two years actually exceeding the official total savings. And all this without affecting other forms of saving. Clearly, something is wrong with the figures. However, for companies the great challenge is how to service this formidable reservoir of money. For a start, do the big life insurance companies have the right distribution system? To be sure, there are several life insurance agents in every little town. They have their lists of customers, some of whom are the right age, 50+, which is where the money is. Yet most life insurance companies still stubbornly insist on selling the one product that is guaranteed not to survive this century, the whole life policy. In an affluent economy, whole life makes absolutely no sense. For anyone who is not poor, it is the worst buy on the financial market. Term insurance or group life provides more protection for one-sixth of the premium, but even that is a hopeless investment. If it can be unbundled, the same sum will provide twice as much life insurance and 50 percent more investment. And yet in Europe, at least, these terrible buys still flourish. But they will not survive even a mild bout of inflation. People are not that stupid. So far not one life insurance company has succeeded using agency channels. The agency system has not responded to the great challenge of serving the retail finance market.
Institutional Finance Must Change Too
On the other side of the financial markets are the enormous institutions of capital, the pension funds, which in every developed country will soon be the only true capitalists left. How will we organize them for constructive investment? Currently by their constitution the interests of the pension funds are purely financial. If they can make money by buying or selling, then they have no choice but to do it. The trouble is that, as any businessman knows, the short-term financial view is not enough to build a business. How therefore can we get the pension funds to be owners, and thus business builders, rather than investors? What tools shall we need? What instruments? These are crucial questions.
The final critical question about the financial system is whether the commercial banks can survive when they can no longer make a living out of interest differentials. The public has become too sophisticated, the costs of capital are much too high, and borrowers have so many different ways of raising money that the traditional commercial loan is the least attractive alternative. One bank, Citicorp, already makes 60 percent of its money in fees, compared with 20 percent at the most for the majority. Can banks switch from being paid for money to being paid for information? Assets in a bank are increasingly a liability. The bank of tomorrow will have no assets. It will be a market arbitrageur rather than an interest arbitrageur. This challenge is particularly acute for the European banks that bestride the Netherlands, Belgium, Austria, and Spain like giants, but which are pygmies on the world scene. In terms of serving their countries, these have been the best banks of all, successfully building their domestic economies precisely because they were big enough to do everything and small enough to know what was required. Can they survive, and in what form?
These are some of the questions thrown up by the changing world economy. Nineteen ninety-two has caused them to be directly posed, but they were there all along. They will all be answered, by my best guess, before 1993, not by the process of thinking them through, but by acting on events.
The Knowledge Society
Information Matters
Just as modern money penetrated the whole world within less than a century and totally changed people’s lives and aspirations, we can safely assume that information now penetrates everywhere. On my last and longest trip to China, I spent almost three weeks looking at factories and cotton plantations in the interior. The biggest cotton plantations are in the most remote province, near the Mongolian border in the extreme north. It was hard to get there, and the plantations were very poor and primitive: only the meeting halls had electric light, for example. At one site we held a meeting, and at 6 o’clock the 22 plantation managers got up, asked to be excused for a short period, and disappeared. After half an hour they came back, and we resumed the discussion. Why the interruption, I inquired, another meeting or a party of visitors? “No,” they replied. “It was Dallas on television.”
Information Means a New Type of Management
Thus information moves everywhere. And its effects are everywhere pervasive. In the case of the corporation, any business that has tried to organize itself around information has rapidly reduced its number of management levels by at least half, and usually by 60 percent. The first and most spectacular case was Massey Ferguson. Virtually bankrupt, the world’s largest farm equipment and diesel manufacturer required radical surgery. It was a complex business in organizational terms, with headquarters in Canada, production primarily in Europe, and 60 percent of its markets in the U.S.A. Because it was managed by people who had previously worked at General Motors and Ford, it was organized like a U.S. automobile company, with 14 layers of management. Today it has 6 and the number is still coming down.
Massey Ferguson thought about the information it needed to run its business. The moment it did so, it discovered a great truth: many levels of management in fact manage nothing. They make no decisions. In reality they are only boosters, amplifying the very faint signals that come up and down through the organization. If a company can organize itself around its information needs, these layers become redundant.
There are good reasons why large organizations will have to become information-based. Demographics is one. The knowledge workers who increasingly make up the work force are not amenable to the command-and-control methods of the past. Another reason is the need to systematize innovation and entrepreneurship, quintessentially knowledge work. And a third is the requirement to come to terms with information technology. Computers turn out data—vast amounts of it. But data is not information. Information is data endowed with relevance and purpose. A company must decide what information it needs to operate its affairs, otherwise it will drown in data.
To organize in this way requires a new structure. Although it is perhaps too early to draw an organization chart of the information-based organization, we can set out some broad considerations.
One hundred and twenty-five years ago, when large enterprises first came into being, the only organizational structure they had to model themselves on was the army: hierarchical, command-and-control, line and staff. Tomorrow’s model is the symphony orchestra or the football team or the hospital. Mahler’s symphonies require the presence of 385 instrumentalists on stage, never mind the singers. If it were to organize itself the way we organize our big companies today, a modern orchestra would have a chief executive officer plus a chairman conductor flanked by two nonexecutive conductors, six vice-chairman conductors, and countless vice-president conductors. Instead of which there is one conductor to whom every specialist instrumentalist plays directly, because everyone has the same score. In other words, there are no intermediaries between the specialists and the top manager, and they are organized as a gigantic task force. The organization is totally flat.
There is a famous 1920s joke about the then-new discipline of industrial engineering which takes on fresh meaning today. The story concerns a (needless to say) German engineer who attends a symphony concert on which he writes a report. He points out that most of the musicians sit around doing nothing most of the time: Would it not be more efficient if they played the Rossini, Beethoven, and Brahms simultaneously rather than in sequence, thus occupying the players all the time? Well, the orchestra still functions by playing one work at a time. Indeed, one of the lessons of organizing around information is the importance of concentration to prevent people from becoming fatally confused. The orchestra can perform precisely because all the players know they are playing Mozart, not Haydn. A medical team performing an operation also has a score, although an unwritten one. But the performance of a business or a government agency creates its own score, or many scores, as it goes along. An information-based organization must therefore structure itself around goals that clearly state expectations and objectives both for the enterprise and for each specialist. There must be strongly organized feedback so that every member can exercise self-control by comparing expectations with the actual outcome.
I believe, therefore, that we are moving toward more concentrated organizations and units of organizations, based on much clearer business and individual goals, on self-discipline and on systematic feedback. If this is truly the case, businesses will have to learn that they must build their communications system on information up rather than information down. Information becomes communication only if the recipient understands and accepts it. If information only moves down, that cannot happen. The structure must be based on the upward communication of information that enables those at the top to know what goes on at the bottom, at the sharp end.
Changing Society: The Decline of the Servant …
Some of the greatest changes in social structure in the history of the human race have taken place this century. These changes have been nonviolent, which is perhaps why few people pay them any attention. Yet had any of the great economists or sociologists of the last century been apprised of them, they would have laughed in disbelief. Consider the cases of the domestic servant and the farmer. The first scientific census, the British census of 1910, famously defined lower middle class as the family that could not afford more than three servants. How many people have spotted even one servant lately, other than at Madame Tussaud’s? Servants antedate history by millennia, and in 1913 they were the largest single employee group in any developed country. Thirty percent of all wage earners were domestic servants. They are all gone.
… the Farmer …
So, almost, are farmers. There is now no developed country in the world in which farmers form more than 8 percent of the population. The political power of the farmer has evaporated. In the 1988 U.S. election the farmer became a nonperson. Both candidates went to Iowa for two hours, but that was all. They could not care less how the 3 percent of the U.S. population who are still farmers cast their vote. Politicians have good antennae. They know that the farmers’ power has become the smile on the face of the Cheshire cat. In Japan, there is one farm vote for seven city votes; but one-third of all the money for the war chest of the Japanese politicians comes from the Farmers’ Cooperative Bank. This power is likely to be broken as a result of the Recruit scandal. Farmers’ power will soon be over, even in Japan.
… and the Worker
The blue-collar industrial worker is going the same way. No century has seen anything like his rise and his decline. A very short time ago it seemed that this group was ineluctably controlling society, politics, and markets. To test market a new product in the U.S.A. in the 1950s, a company went to the solid blue-collar communities that would make or break it. Not today; not even in the U.K. By the end of the century in every developed country, blue-collar workers will be no more important or numerous than farmers. Their numbers have declined by a full third in the past 20 years.
It is not only the numbers that have fallen, however. There are now few manufacturing companies where blue-collar labor costs rise above 15 percent. A country such as Spain has five to seven years during which its reservoir of highly trained, cheap labor will remain an asset. By the end of the century, if its manufacturing has not evolved to the point where labor costs are below 15 percent, that labor force will have become a liability. No Western country can compete with Shanghai, where $1 a day is an excellent wage, and only the top 10 percent of the work force makes even $1.
The answer for Western manufacturing is not necessarily automation. Information is not the same as automation, or even information technology, and no firm should start by buying a machine. Rather, the first step is to rationalize the process in order to identify what machines are necessary. A company that begins by buying robots or automating its existing process will almost certainly waste monstrous amounts of money and become less productive in the process. General Motors proves the point. GM spent the not inconsiderable sum of $30 billion on robots, with the result that labor costs went up, not down. GM’s blue-collar labor costs are now 28 percent compared with Ford’s 15 percent and Toyota’s 16 percent (in the U.S.A.). At the new Honda plant, built in a high-wage area, the figure will come down to 11.5 percent. Cars, remember, are a relatively ancient industry. In the new industries labor costs should be even lower.
Most people believe that the favorite child of capitalism was the owner of capital: the capitalist. A better candidate is the blue-collar industrial worker. In 1850 he was still a laborer hired by the hour, paid a few pennies, without social standing or political power. He was neglected and despised. By 1950 he belonged to the dominant social class. He enjoyed health insurance, pensions, job security and political power that would have seemed unthinkable only two generations before. He still has the benefits, of course. But the brief moment of dominance is suddenly over. And all this without real social convulsions.
The Learning Society Is Taking Over
In the place of the blue-collar world is a society in which access to good jobs no longer depends on the union card, but on the school certificate. Between, say, 1950 and 1980 it was economically irrational for a young American male to stay at school. In three months a 16-year-old school leaver with a job at a unionized steel plant could be taking home more money than his university-educated cost accountant brother would make in his life. Those days are over. From now on the key is knowledge. The world is becoming not labor intensive, not materials intensive, not energy intensive, but knowledge intensive.
Japan today produces two and a half times the quantity of manufactured goods as 25 years ago with the same amount of energy and less raw material. In large part this is due to the shift to knowledge-intensive work. The representative product of the 1920s, the automobile, at the time had a raw material and energy content of 60 percent. The representative product of the 1980s is the semiconductor chip, which has a raw material and energy content of less than 2 percent. The 1990s equivalent will be biotechnology, also with a content of about 2 percent in materials and energy, but with a much higher knowledge content. Assembling microchips is still fairly labor intensive (10 percent). Biotechnology will have practically no labor content at all. Moreover, fermentation plants generate energy rather than consume it. The world is becoming knowledge intensive not just in the labor force, but in process.
Knowledge is always specialized. The oboist in the London Philharmonic Orchestra has no ambition to become first violinist. In the last 100 years only one instrumentalist, Toscanini, has become a conductor of the first rank. Specialists remain specialists, becoming ever more skillful at interpreting the score. Yet specialism carries dangers, too. Truly knowledgeable people tend by themselves to overspecialize, because there is always so much more to know. As part of the orchestra, that oboist alone does not make music. He or she makes noise. Only the orchestra playing a joint score makes music. For both soloist and conductor, getting music from an orchestra means not only knowing the score, but learning how to manage knowledge. And knowledge carries with it powerful responsibility, too. In the past, the holders of knowledge have often used (abused) it to curb thinking and dissent, and to inclcate blind obedience to authority. Knowledge and Knowledge people have to assume their responsibilities.
Most Education Does Not Deliver Knowledge …
The advent of the knowledge society has far-ranging implications for education. Schools will change more in the next 30 years than they have since the invention of the printed book. One reason is modern learning theory. We know how people learn, and that learning is not at all the same thing as teaching. We know, for instance, that no two human beings learn in the same way. The printed book set off the greatest explosion in learning and the love of learning the world had ever seen. But book learning was for adults. The printed book is basically adult-friendly. In contrast, the new learning tools are child-friendly, as anyone with a computer-using eight-or nine-year-old child will know. By the age of eleven most children except the freaks begin to be bored with the computer; for them it is just a tool. But up to that age, children treat computers as extensions of themselves. The advent of such powerful tools alone will force the schools to change.
… So Organizations Must Do It Themselves
But there is another consideration. For the first time in human history it really matters whether or not people learn. When the Prince Regent asked Marshal Blücher if he found it a great disadvantage not to be able to read and write, the man who won the battle of Waterloo for Wellington replied: “Your Royal Highness, that is what I have a chaplain for.” Until 1914 most people could do perfectly well without such accomplishments. Now, however, learning matters. The knowledge society requires that all its members be literate, not just in reading, writing, and arithmetic, but also in (for example) basic computer skills and political, social, and historical systems. And because of the vastly expanding corpus of knowledge, it also requires that its members learn how to learn.
There will—and should—be serious discussion of the social purpose of school education in the context of the knowledge society. That will certainly help to change the schools. In the meantime, however, the most urgent learning and training must reach out to the adults. Thus, the focus of learning will shift from schools to employers. Every employing institution will have to become a teacher. Large numbers of American and Japanese employers and some Europeans already recognize this. But what kind of learning? In the orchestra the score tells the employees what to do; all orchestra playing is team playing. In the information-based business, what is the equivalent of this reciprocal learning and teaching process? One way of educating people to a view of the whole, of course, is through work in cross-functional task forces. But to what extent do we rotate specialists out of their specialties and into new ones? And who will the managers, particularly top managers, of the information-based organization be? Brilliant oboists, or people who have been in enough positions to be able to understand the team, or even young conductors from smaller orchestras? We do not yet know. Above all, how do we make this terribly expensive knowledge, this new capital, productive?
The world’s largest bank reports that it has invested $1.5 billion in information and communications systems. Banks are now more capital intensive than the biggest manufacturing company. So are hospitals. Only 50 years ago a hospital consisted of a bed and a sister. Today a fair-sized U.S. hospital of 400 beds has several hundred attending physicians and a staff of up to 1,500 paramedics divided among some 60 specialities, with specialized equipment and labs to match. None, or very few, of these specialisms even existed 50 years ago. But we do not yet know how to get productivity out of them; we do not yet know in this context what productivity means. In knowledge-intensive areas we are pretty much where we were in manufacturing in the early nineteenth century. When Robert Owen built his cotton mills in Scotland in the 1820s, he tried to measure their productivity. He never managed it. It took 50 more years until productivity as we understand it could be satisfactorily defined. We are currently at about the Robert Owen stage in relation to the new organizations. We are beginning to ask about productivity, output, and performance in relation to knowledge. We cannot measure it. We cannot yet even judge it, although we do have an idea of some of the things that are needed.
How, for instance, do famous conductors build a first-rate orchestra? They tell me that the first job is to get the clarinetist to keep on improving as a clarinetist. She or he must have pride in the instrument. The players must be craftsmen first. The second task is to create in the individuals a pride in their common enterprise, the orchestra: “I play for Cleveland, or Chicago, or the London Philharmonic, and that is one of the best orchestras in the world.” Third, and this is what distinguishes a competent conductor from a great one, is to get the orchestra to hear and play that Haydn symphony in exactly the way the conductor hears it. In other words, there must be a clear vision at the top. This orchestra focus is the model for the leader of any knowledge-based organization.
Innovation and Entrepreneurship
I turn now to crucial issues for managers in the knowledge society: innovation and entrepreneurship.
It is not a coincidence that these necessary concepts are back in fashion. For a long period they were neglected, to the point where for all intents and purposes they vanished from the list of corporate concerns. Only in the last 15-20 years have these two practices —for that is what they are, neither science nor art—come to the fore again.
On neither side of the Atlantic is the record of the new entrepreneurial companies exemplary. It is probably better than those of the nineteenth century, but it is still not nearly good enough. By now we know pretty much what is needed for those companies to survive and to prosper: the practice of entrepreneurship, like the practice of management, has its rules and knowledge base. But to confine the focus of innovation and entrepreneurship to the new individual entrepreneur is too narrow. If start-ups and new businesses were the main or only locus of innovation, our societies could probably not survive.
Lessons from the Nineteenth Century’s Innovative Climate
There is one great difference between the innovative climate of the last 20 years and the late nineteenth century. Our rate of innovation (social as well as technical, that is just as important) is equally rapid. But practically all the institutions, business or other, of the nineteenth century were new: they emerged in the 50 or so years between 1865 (the year of Perkins’s first aniline dye, Siemens’s first dynamo) and 1914, when the First World War paralyzed the entrepreneurial energies of the West. During that period a new institution, a major invention or innovation emerged on average more often than once a year. Some of them led to the founding of new industries. But they did not displace existing institutions. They emerged, as it were, into a vacuum. Thus, the Home Office set up British local government in 1856 from scratch. In the same decade the first modern U.S. university was founded. Today the task is different: we have to learn to make existing institutions capable of innovation. We know what is needed, and it is relatively uncomplicated, although that does not mean it is easy. But if existing institutions cannot learn to innovate, the social consequences will be almost unbearably severe.
Innovation Matters Because Ours Is a Knowledge-Based Society
Knowledge changes extremely fast. But that in itself is not new; knowledge has always changed fast. What is new is that knowledge matters. In a crafts society, which ours essentially was until late in the nineteenth century, major changes occurred perhaps every 80 years. In military technology, between the disappearance of the longbow in the reign of Elizabeth I and the launching of the Dreadnought in 1906, a significant innovation took place every 60 years. Today, courtesy of the Pentagon, it is probably every 60 days. We have learned to innovate because we cannot expect that the accumulated competence, skill, knowledge, product, services, and structure of the present will be adequate for very long. The change is not so much that the pace of accumulation is so much more rapid. It is rather that the center of gravity of knowledge is constantly on the move.
I have talked about institutions rather than businesses. This is intentional. In a market economy, innovation comes easier to businesses. In fact it is equally important in every other field of endeavour. But although the principles of innovation and entrepreneurship apply just as well to government institutions or universities, the practice is different. There is nothing more reactionary that a liberal faculty in a university. It is the ultimate in reaction. It is the motto of the U.S. universities that when a subject becomes totally obsolete, then a required course should be built around it. To survive and be useful, they must learn how to innovate.
Innovation Means Abandoning the Old
What do we know about innovation? First, it has very little to do with genius. It has very little or nothing to do with inspiration. It is hard, systematic work. The myth is that an owner-entrepreneur can depend on a flash of genius. I have been working with owner-entrepreneurs for 40 years: the ones who depend on the flash of genius also go out like one.
Innovation depends rather on what we might call “organized abandonment.” When the French economist J. B. Say coined the word entrepreneur 200 years ago, he meant it as a manifesto and a declaration of intent: the entrepreneur in his scheme was someone who upsets and disorganizes. Later Joseph Schumpeter, the only modern economist to take entrepreneurship seriously, described the process as “creative destruction.” To get at the new and better, you have to throw out the old, outworn, obsolete, no longer productive, as well as the mistakes, failure, and misdirections of effort of the past. To put it another way, think of the old medical saying: “As long as the patient eliminates there is a chance. But once the bowels and the bladder stop, death does not take long.” If organizations cannot get rid of their waste products, they poison themselves. They must organize abandonment, a most difficult thing to do, because most organizations develop a strong emotional attachment to the products they make.
Take a typical case. He is the head of a company that makes writing instruments. When he was 25 years old, he had an idea for a mechanical pencil. Everybody ridiculed the notion, but he put his job on the line and fought for it, and it turned out to be a successful product. He is now the head of the company that makes it, and as a consequence he has seen much more of it than he saw of his wife and children and is deeply emotionally involved with this company and this object. And then some eager young whippersnapper comes along as he did 30 years ago with an idea which makes the old product obsolete. He has very little love for that young man and he will not encourage him to persist with his idea, unless he builds organized abandonment into the company.
If innovation is not genius, nor is it necessarily, or even primarily, technical. There was not much technology involved in moving a lorry body off its wheels and putting it on a ship. But containerization roughly quadrupled the productivity of the oceangoing freighter and made possible the colossal expansion of world trade over the last 40 years. Similarly, few technical innovations can compete for impact with the humble textbook, newspapers, or insurance. Installment buying, invented by a U.S. maker of farm implements to enable poorly off farmers to buy his equipment, literally transforms economies. And so the list goes on. For all its visibility and glamour, science-based innovation is actually less reliable, less predictable, and probably less likely to lead to company profits than almost any other sort.
The Zero-Based Audit
So now we know what innovation is not. More positively, we also know what is needed to put it into action. The key to innovation is to sit down every three years and systematically put every aspect of the company on trial for its life: every product, service, technology, market, and distribution channel.
Here is a clue: nothing is changing quite so fast today as distributive channels. Very few economists or newspaper commentators seem to realize that the service economy, which is expanding so fast, does not operate in contradiction to, or grow at the expense of, the goods economy. It is a distributive channel for the goods economy. And the fastest-growing segment of the channel is leisure. There is no developed country in which people now work more than half the hours they worked in 1910. Economists may not consider leisure part of the economy, but it is responsible for a huge amount of goods distribution. The same sort of growth is visible in other service institutions such as hospitals and schools. Sixty years ago, health care took less than 1 percent of developed GNP or consumer spending. Now, health care, and especially hospitals, account for 7-11 percent of enormously expanded national products. To repeat: the service economy is a distribution channel for goods, economically speaking, and distribution channels change faster than goods or services themselves. So examine them closely.
The zero-budgeting exercise also demands that managers look at every process and procedure, not to mention every staff activity, inside the organization and ask, “If we did not do this already, given what we now know, would we do it the same way?” If the answer is no, do not say, “Let us call in a management consultant to make a study.” Say, “What do we do?” Sometimes the right thing to do is to make minor changes, sometimes to reposition the company entirely. Sometimes the answer is to simplify. Where there are six product lines, perhaps they should be cut to one or two. Sometimes they should be abandoned altogether. But the important thing is to do something. At that point the organization is open to innovation. Dr. Johnson said that nothing so concentrates a man’s mind as the knowledge that he is to be hanged in a fortnight. Nothing quite so sharpens a manager’s mind as the knowledge that his mechanical pencil will be taken away from him—then he starts to innovate.
Innovation Means Looking on Change as an Opportunity
Systematic innovation requires a willingness to look on change as an opportunity. Innovations do not create change. That is very rare. They may if successful make an enormous difference, but most of the innovations that aim at changing society, or market, or customer, fail. Innovations that succeed do so by exploiting change, not attempting to force it.
In Innovation and Entrepreneurship (1985) I wrote that “systematic innovation … consists in the purposeful and organised search for changes, and in the systematic analysis of the opportunities such changes might offer for economic or social innovation.” I went on to identify seven sources to look out for as signs and sources of a chance to innovate. Four of these sources are within the enterprise (business or otherwise) or the industry in which they operate. They are basically symptoms of change. They are: the unexpected success or failure; the incongruity (the discrepancy between reality as it is and reality as it is assumed to be); innovation based on process need; and changes in industry or market structure that take people unawares. The other three sources involve changes outside the industry or enterprise, namely, demographics; changing tastes, perceptions, and meanings; and new knowledge, both scientific and nonscientific.
The most useful of the seven “windows” of innovation (which is why I list it first) is always the unexpected, especially the unexpected success. It is the least risky and the least arduous. Yet it is almost totally neglected. What is even worse, managers often actively reject it.
Consider for a moment that prime product of modern accounting: the monthly or weekly report. This was a tremendous eye-opener. Nobody had ever had systematic figures before. Most people see the first page that shows them they are over budget, but how many receive the other “first” page that shows where they are ahead of budget? They should order their accountants to produce it immediately. Without this information an organization becomes fixated on its problems. However, it is usually the case that the first indication of an opportunity is where a company is faring better than expected. Most of the figures and variations turn out to be not significant, of course, and managers can explain them immediately. But one out of every 20 might mean something. It might be pointing to something we did not know.
A leading hospital supplier launched a new line of instruments for clinical tests. The new products did quite well. Then suddenly orders started appearing from a quite different spectrum of customers: university, industry, and government laboratories. No one noticed that the company had tripped over a new and better market. It did not even send a sales person to visit the new customers. The result: a competitor has not only recognized and captured the industrial laboratory market; exploiting the scale of the new segment, it has seized the hospital market, too. This is a very typical story. The first firm had failed to understand the significance of an unexpected success. It has now been bought out by a pharmaceutical company.
Of the other sources of innovation, scientific and technical research is listed last because, although undeniably important, it is also the most difficult, has the longest lead time, and is the most risky. We know quite a bit about how to manage research. But, as with other change opportunities, the important part is systematically to look out of the windows and ask, is this an opportunity for the company? And if so, what kind of an opportunity? Most changes for most companies are not. Changes in population structure are very important for some businesses and totally unimportant for others. For a steel mill, except in so far as it affects the labor supply, there is almost no interest in demographics. On the other hand, changes in environmental awareness are of tremendous importance to a steel mill.
Innovation Is Work above All
Everyone knows the second law of thermodynamics: all work degenerates into heat and friction. Drucker’s first law is that everything degenerates into work, and if it does not degenerate into work, nothing gets done. A lot of it then becomes heat and friction, but first it has to be work. How we organize for work on innovation is a matter for the individual company. Very big and bureaucratic firms can be as innovative as small and nonbureaucratic ones. I am not actively proposing bureaucracy; the point is that it is a matter of systematic organization, clear strategy, and (again) hard work.
Du Pont, a notably bureaucratic company, has an enviable record as a successful and rapid innovator. 3M is not bureaucratic, but it is a very large company which has institutionalized innovation to the extent of incorporating it into the company’s goals: at any period, no less than 25 percent of its turnover must come from products invented in the last five years. It always meets this target. And the goals are internalized. At 3M nobody gets into upper middle management who has not innovated, and everyone knows it. Forty years ago we were not so sure how to do these things. Now there is no excuse. The common pretext of waiting for the genius with the flash of inspiration will no longer wash. Any enterprise, no matter what its function, can today organize itself to undertake systematic entrepreneurship and purposeful innovation.
Personal Effectiveness
We now come to the fourth and final part of our survey. In the light of the changing world economy, the advent of the information-based organization and the need to systematize innovation and entrepreneurship, what skills and abilities will an executive need to be effective in the next years? The old skills are, of course, required, but there are some new ones which are likely to become increasingly important. I can think of three.
Skill 1: Management by Going Outside
All managers are now In Search of Excellence. In that book Tom Peters preaches that managers should walk around. Walking around within the company is still to be recommended, but I believe that the emphasis has changed. The important thing now is to be enough on the outside of the company to be able to stand back and draw the right conclusions.
When everything around the company—markets, technologies, distributive channels, and values—is in a ferment of change, to wait in the office until the reports arrive on an executive’s desk may be too long. One paramount piece of advice to senior managers: the next time a salesman goes on vacation, go out and take his or her place. Ignore the returning salesman’s complaint that the customers are up in arms about the incompetent who took his place. The point of the exercise is that it forces you outside, into the marketplace, where results are. Remember that there are no results inside the firm. Up to the point where the customer reorders, there are only costs.
The external perspective might, for example, profitably prod companies to look at those who are not their customers but ought to be. A firm with a 22 percent market share is the market leader in most industries. Yet the more significant figure is that 78 percent of potential customers buy elsewhere. Why? That is usually the first indication of opportunities.
For several years I worked with the joint management and labor committees of our two largest automobile companies, General Motors and Ford. I could not persuade either unions or managements that what they mean by the word quality is not what customers mean. Ford and GM are very proud of the fact that when their cars come off the line they are “better” in quality terms than the Japanese. The trouble is that management and union people alike define quality as what is in the car when they deliver it. But it is the customer who defines quality, not the manufacturer. For example, I have a summer house in the Colorado Rockies, a 1,200-mile drive from my home in California. When something goes wrong with my car, I expect the local dealer in the next small town to have the part and fix the car. Yet GM and Ford have a compensation structure that rewards dealers for sales of new cars, not for service, and certainly not for keeping spare parts, so I have to wait a week for a spare part to arrive from a warehouse. Toyota, on the other hand, rewards service, so the dealer has the part in inventory and can replace it at once. Why can I not persuade Ford and GM that I am right? Because when I tell them to go outside, they simply talk to their own dealers.
So the first imperative is to learn to be outside, where the results of the business take place. And the only way to be on the outside is to work, not to visit. Nothing is more wasteful than a visit to the Barcelona subsidiary. But work for two days, standing behind the counter, and it is surprising how much the manager will learn about that company.
Skill 2: Find Out the Information You Need to Do Your Job
Second, people must learn to take responsibility for their own information needs. Information responsibility to others is increasingly understood. But everyone in the information-based organization needs constantly to be thinking through what information he or she needs to make a valuable contribution in his or her own job. This may well be the most radical break with the present conventions of work. Even in the most highly computerized companies, perhaps especially in these companies, very few people have information. What they actually have is data, in such quantities that it causes information overload or blackout.
Information responsibility addresses another key problem. Most managers still believe that they need an information specialist to tell them what information they should have. But information specialists are providers of tools. They can tell us to use a hammer to bash an upholstery nail into a chair. But they cannot tell us whether we should be upholstering a chair in the first place. It is the manager’s job to figure out what information he needs to identify:
1. what he is doing now;
2. what he should be doing; and
3. how he can get from (1) to (2).
This is by no means an easy task. But only if it is carried out will information begin to be the servant and the tool, and MIS departments results centers rather than the cost centers which they are now.
Until very recently there was no such thing as information. There were only experience and anecdotes. Now, for the first time, there are data. To convert those data into information means asking what you need, from whom, when, and in what form, and making sure that those who can provide the information also know and understand their responsibilities. A manager must ask, too, what information others require from him or her.
In the information-based organization of tomorrow, people will very largely have to control themselves. This does not mean we shall all be working in free-form organizations. That is nonsense. A land animal on this earth cannot be more than six inches in size without having a skeleton. Companies are the same. Above a very small size, every company needs the skeleton of a formal command structure. But an animal does not perform work or feel through the skeleton. It has a nervous system and a musculature for that. In the same way, information systems enable a person to organize and integrate his or her own work. They are also what someone takes control of and responsibility for. At that point the apparently insurmountable task of operating in a form that requires an ad hoc team looms much less large. The cross-functional team is the key. No one begins with pure research, applied research, engineering, development, manufacturing, or marketing any more. It takes much too long and results in wonderful products that nobody buys.
Focus for Effectiveness
In the same vein, managers should spend a little time thinking through what their company should hold them accountable for by way of contribution and results over the next 18 months. “What is the one thing that I, and only I, can do that if done well will make a difference?” A clear priority is essential. Do not diversify, do not splinter, do not try to do too many things at once. Without priorities, managers will be pulled in 5,000 directions at the same time. This applies particularly to top managers. Textbooks dwell, quite rightly, on the need to delegate down. What they fail to mention is that the real delegation is always up. In the end, the problem always comes to rest on the boss’s desk. The buck stops there. That is his job, of course. But he above all needs to have time to do his own work; and he above all needs to know what his one, or two at most, contributions are to be.
As managers, we are not effective enough because we try to do too many things. The other great bane of organizations is that we believe that what we are trying to achieve is so obvious that we do not need to tell the person next door. Modern psychology began when Bishop Berkeley stated that because no two bodies can occupy the same space, nobody else could see what was obvious to one person. The people on whom you depend must understand what it is you are trying to accomplish, and you must communicate your priorities to them.
Skill 3: Build Learning into the System
The third element of effectiveness is building learning into the system.
One of the great puzzles of history has always been the sixteenth century. By 1560 Europe was dominated by two institutions which 25 years earlier did not even exist: the north by the Calvinist church and the south by the Jesuit order. Both came into being in 1535, and by the seventh decade of the century they had become dominant institutions. Most of their members worked by themselves, in considerable danger and under great pressure. What was their secret? With the benefit of modern learning theory, we can begin to see what happened. Calvin and Loyola applied the most important principle in learning: that of feedback. In any key activity area, the first step is to set down what you expect will happen. Nine months later, the actual results are examined and compared with original expectations.
As Loyola and Calvin discovered, feedback is the primary key to learning. Crucially, since no one is productive by putting weaknesses to work, feedback identifies the strengths. Learners need to know their strengths in order to find out where to improve. What bad habits inhibit those strengths? In what areas has the Good Lord simply not provided any ability at all? Most schools and most education are problem-focused; they concentrate on correcting weakness. Up to a point, that is necessary. Every student needs the basic skills. But real world-beating performance, like learning, is built on strengths. When it is so organized, learning is astonishingly rapid, for the simple reason that it has focus.
Learning, moreover, must be continuous. We have to recognize the unwelcome fact that the knowledge of those who are five years out of school is by definition obsolescent. The U.S. authorities now require physicians to take refresher courses and sit requalifying exams every five years. This caused initial grumbles from the examinees, which almost without exception gave way to wonderment at how much had changed and how much they had forgotten. The same principle should apply for engineers, and even more so for marketing. It should therefore be part of every manager’s practice to go back to school every so often for a week at a time. Many big companies are currently building their own in-house education facilities. I advise caution here. The greatest danger to the big company is the belief that there is a right way, a wrong way, and our way. In-house training tends to emphasize and strengthen that view. Skills, yes; teach them in-house. But for purposes of broadening the horizon, questioning established beliefs, and for organized abandonment, it is better to be confronted with diversity and challenge. For these, managers should be exposed to people who work for different companies and do things in different ways.
Those are some of the key things for an individual to know and do about making and keeping himself or herself effective as an executive in a challenging world. There are enormous opportunities, because change is opportunity. But there is no predictability. Turbulence—for those who still remember a little mathematics—is characterized by having no predictability. It is certain that the unexpected will happen; but it is impossible to predict where, when, or how. We live in a very turbulent time, not because there is so much change, but because it moves in so many different directions. In this situation, the effective executive has to be able to recognize and run with opportunity, to learn, and constantly to refresh the knowledge base.
[1990]