Category Archives: The Firm

The future of retail: The need for a new trust architecture

Deloitte ran a series of breakfasts recently for the retail community, and they kindly asked C4tE to participate. My contribution, which you can find at Scribd or embedded below, sprang out of our recent report The Future of Exchanging Value: Cryptocurrencies and the trust economy(FoEV) when, during a chance conversation, Robbie (the left-brained person who leads the Spatial team) pointed out that that we were arguing for a new trust architecture in retail.

The nutshell explanation of the idea is:

  • The current retail model is a constructed environment and shopping a learnt experience. This model is a response to the creation of mass market products and supply chains.
  • The model is build on there pillars: customers identifying a need, searching for a solution to the need, and then transacting with a merchant that they may not know or trust. Money – cash – facilitates this, as it enables us to transact with someone we don’t know and may never meet again.
  • However, a number of trends we saw in FoEV suggest that this model might be breaking down. The mid-market dies, consumers seized control of the customer-merchant relationship, peers replaced brands, value is now defined by the consumer rather than the producer, payments are moving away from the till, and shopping is becoming increasingly impulse driven.
  • What will retail look like in a world where need is never fully formed, search is irrelevant, and transactions are seen as distasteful? What is the new trust architecture?

See what you think of the presentation and feel free ping us if you have any thoughts.

The two reports mentioned in the presentation are:

Future of Retail – a New Trust Architecture by Peter Evans-Greenwood

The Future of Exchanging Value: Cryptocurrencies and the trust economy

FoEV2_coverOur latest piece at Centre for the Edge is out: The Future of Exchanging Value.

This report started life as a followup to a report we published in 2012. As we say in the current report:

Our findings in that report centred on the realisation that we were reaching the end of the initial build-out
of a digital payments infrastructure. The task of provisioning the infrastructure merchants require to accept real-time digital payments, or for two individuals to settle a debt, was largely complete. Consequently, our focus had shifted to streamlining the buying journey – from the pieces and parts to the whole.

Our key point then was that the future of exchanging value would be shaped by social forces – how payments fit into the end-to-end consumer experience – rather than the technological challenge of deploying yet-another generation of payments solutions.

This new report, which was intended to be a short update, when in an entirely different and much more interesting direction.

Our key insight this time is that we’re all thinking about money the wrong way.

It’s common to assume that we use money (cash, currency…) to build trust relationships. This assumes that our adoption of money stems from the coincidence of wants. I need shoes. You have shoes. You want a fish. I have a chicken. We use money to bridge the gap.

The problem is that this assumption is incorrect. As David Graeber points out in Debt: The First 5,000 Years, debt came before barter and the coincidence of wants. Most folk in antiquity didn’t need money. They knew everyone they interacted with, and could rely on the community to enforce the collection of a debt if need be. Money’s first use was as a measure of value, typically to help calculate damages in a criminal or civil manner. Communities had carefully drawn up lists to capture exactly what you owed, in a convenient currency, someone if you destroyed their house, stole their food. In Somalia, for example, they use camels (commodity money). The other uses of money – as a medium of exchange and store of value – came later.

This is a fascinating fact, is it points out that we have the consumer-merchant relationship backward. We’re focusing on the transaction when we should be focusing on the relationship. The future of payments is not micropayments and tap-and-go. Indeed, the future of payments might be to use a loyalty scheme (a complimentary currency) to anchor the relationship and then move the transactions from the centre of the relationship to the edge. This ties is cultural preferences that we have, and which equate money and transactions as “dirty”. The future of payments might be not to have payments at all.

Bitcoin and the whole cryptocurrency thing is influenced by this too. There’s a huge amount of noise in this area at the moment, and everyone one is waiting for the killer app that will drive Bitcoin (or another cryptocurrency) into mass adoption. If, however, you view Bitcoin adoption as a cultural problem, rather than the search for a killer app, then you end up at the conclusion that no cryptocurrency will become much more than a large niche. The best equivalent in the current environment that we’re all familiar with would be a large frequent flyer scheme. It’s hard to scale trust, even with technology support, and these frequent flyer schemes seem to up near a nature limit.

There is one use case for currencies growing larger, though: when a sovereign nation mandates that you pay taxes in a specific currency. This trick is behind all the major currencies, and was used by the colonial powers to pull conquered land into their monetary system. Acquire currency to pay tax, or we send the bruisers around.

We conclude in the report that the best analogy for cryptocurrencies is rum and cigarettes. Rum was used in Australia’s early days when there wasn’t enough government issued currency to go around. Cigarettes were used by prisoners or war as they had few other options.

We can expect cryptocurrencies to see some adoption in countries where the population doesn’t trust – or can’t access – the national currency. Argentina springs to mind. Cryptocurrencies are mush less useful in other countries with mature and stable economies.

A similar argument can be made against cryptocurrencies as internal reserve currencies. (And that argument is in the report.)

There’s a lot more in the report, and I’ve been told that it’s a bit of a ripping yard. Go grab a copy and read it.

The problem with platforms in the sharing economy

Platform_compressed-750x300

I have a new post up on the Deloitte Strategy blog.It’s the result of a chat I was having the other day with an economist colleague who opined that “platforms are an essential part of the sharing economy”.

As I point out in the post:

These platforms might be sufficient to kick-start the sharing economy, but they’re not necessary for its long term survival. There are alternative approaches to creating sharing economy solutions that do not rely on a centralised platform.

Platforms solve what we might call the discovery problem. When we’re creating a market it needs a mechanism for buyers and sellers to discover each other.

Rendezvous – where buyers and sellers meet at a common location – is probably the most common solution to discover. It’s also the one that firms prefer as it’s the easiest to monetise.

As I point out later in the post:

The recent emergence of blockchain – a distributed ledger solution – from the shadow of Bitcoin might be a sign that something has changed in the environment, something that is tipping the advantage away from centralised solutions and toward distributed ones.

This could be a big deal, as it blows a rather large hole in the business models of the sharing economy firms.

Check out the post and see the whole story.

Platforms are the new fool’s gold

Fools-Gold-750x300

I have a new post up on the Deloitte Strategy blog, which I wrote with Richard Millar.

Platforms are all the rage. In the modern digital economy many organisations are looking to create platforms, rather than simply building a traditional value-chain driven company (otherwise known as a ‘pipe’).

In this context, a platform is a business model designed to facilitate exchanges between interdependent groups; as opposed to a pipe, which is centred on the sourcing, production and distribution process. The successful companies of the past focused on controlling distribution (something which is increasingly difficulty in our highly-interconnected digital world), while it’s thought that successful companies in the future will focus on controlling access to customers (which they can do by creating a platform that attracts the best customers).

Platforms are where the smart money is going (particularly if your platform is seen as scalable). There’s even a Platform Strategy Summit where you can learn the tricks that will make your platform successful.

This recent obsession with platforms raises some concerns though, as it seems to confuse cause and effect.

You can find the entire text over at the Strategy blog.

The happy accident of profitable creativity

Fast Company has started a series on “profitable creativity” and the first article – How to achieve profitable creativity, the secret of exceptional companies1)Charles Day (11 May 2015), How to achieve profitable creativity, the secret of exceptional companies, Fast Company – is out now.

While interesting, the article – and the F.O.R.M. methodology behind it (named for Focus, Organisation, Resources and Measurements, the four principles behind the method) – follow the pattern of “if you implement these best practices then you too will dominate your chosen industry” that’s so common in business writing. Unfortunately life, and business, isn’t so simple.

Everyone is after the silver bullet, and there’s a long history of business writers and academics who pander to this. Some of the most revered business books – such as Good to Great2)Jim Collins (2001), Good to Great, Harper Business – are subject to these failings. Indeed, I’ve written about this before.3)The myth of sustainable competitive advantage @ PEG.

In this case it’s claimed that a particular type of creativity (represented by the best practices that the authors have uncovered) that is the secret to success. Creativity is all the rage at the moment. The article even leads with a quote on the importance of creativity from a captain of industry.

Capital is being superseded by creativity and the ability to innovate.
—Klaus Schwab, Founder of the World Economic Forum

Rather than pull apart the limited information the article provides on F.O.R.M. I thought it would be more productive to point out the questions that you need to ask to determine if what you’re seeing is snake oil or solid research whenever you come across yet-another claim for a silver bullet.

First you need to look for disconfirming research. It’s not enough to show that companies using these practices were successful. We need to see evidence that these practices are more strongly associated with successful companies than unsuccessful. Were these practices used by a significant number of companies that did fail? Or were they limited to successful companies? Can, therefore, we conclude that these practices were necessary for success? Or are just they just more noise in the crowded thought leadership marketplace and uncorrelated with success?

Consider, for example, if the CEOs of the successful companies we considered wore red socks on Tuesdays. We might conclude that wearing red socks on a Tuesday will give us the edge we need. Humans have a natural confirmation bias so when you reach a conclusion you need to ask yourself ‘What would it take to prove this conclusion false?’ Can you find a significant number of firms where the CEO religiously wears red socks on Tuesday and which were not successful? Did the CEOs of failed firms also wear reds socks? How do we know that the correlation they you’ve found isn’t just a happy accident, and that we’re reading a lot more into it than we should?

Next we have to consider survivorship bias. Someone has to win, but coming out on top does not imply that you were more skilful. There’s a lot of dumb luck in business; it’s not enough to be good at what you do, you need to be at the right place in the right time with the right product(s) and you still need a healthy does of luck.

Did the successful companies survive because they were good at what they do? Or is their success the result of happy accidents that took down their competition, or lucky coincidences that enabled them to leap ahead? Were they in the right places at the right time, moving into Asia when their competitors moved into South America, for example? Where they part of a rapidly growing industry were a rising tide raised all boats? Someone must survive, but there’s no rule that says that their skill was the only determinant of their survival.

Next we have the unknown unknowns. How do we know that the practices identified are the right practices?

Perhaps the successful companies that we’re looking at were more financially savvy and managed their cash flows more effectively, something which is hard at the best of times and even more challenging in the current turbulent environment, but which is inherently boring. Or perhaps they made a couple of astute (or just plain lucky) bets on which sectors to play in, nudging them past their competition. How do we know the survey or practices was complete? What was the framework used to identify these practices, and link them to changes in the environment. Correlations don’t cut it.

Ultimately, identifying a common set of practices for a group of companies that performed well over a given time period does little more than confirm that over the last time period these companies did well. That was already obvious.

What we, as practitioners, need to know is which practices can make a difference, and which are just fashions peddled by thought leaders who need to sell another book, who are trying to build an audience for the conference circuit, or are looking for consulting work.

Image: Split Shire.

References   [ + ]

1. Charles Day (11 May 2015), How to achieve profitable creativity, the secret of exceptional companies, Fast Company
2. Jim Collins (2001), Good to Great, Harper Business
3. The myth of sustainable competitive advantage @ PEG

The benefits of being big are shrinking

Pumpkin-750x300Centre for the Edge AU is looking at how long-term trends are changing the composition of the business landscape: the change in the mix of large verses small firms, and how they relate to each other.

The work is developing nicely, but we’re still a long way from putting something formal out. However, one conversation (between Richard Miller and myself) was worth blogging about, which is the dynamic between a long-term trends for consolidation (markets becoming increasingly dominated by a smaller number of larger firms) and one of fragmentation (large markets breaking into many smaller, niche, markets). The result is over on the Deloitte Strategy blog as Market trends: The benefits of being big are shrinking. I even managed to coin a nice visual image that I think sums the post up nicely:

It’s as if our efforts to rip operational costs out of business have incrementally worked their way from left to right across the value chain – from sourcing through to marketing and distribution – only to bounce off the customer and start working their way back, from right to left, fragmenting the business landscape in the process.

The car you just bought is the last car you will ever own

How long until it doesn’t make any sense to own a car? What if you considered a car an accessory for your phone, rather the considering a phone something you plug into your car? With decent smart phone integration (via CarPlay from Apple, and Android Auto) and for-profit car clubs (from ZipCar, FlexCar through Daimler’s Car2Go and BMW’s DriveNow to Hertz on Demand and Avis On Location by Avis) allowing you to only pay for the hours you use, that time might not be too far away.

Cars are status symbols. They’re expensive, typically the single most expensive item that most folk will buy other after a house. Since the around the 1930s your car has also been something of a fashion statement.

The car we buy is an extension of our personality. Agreeable individuals seem to prefer brands like Toyota or Nissan while Peugeot owners are extroverts and Volvo is associated with safety.1)Press release (2013), What Your Car Says About Your Personality, Veryday. Black is the colour of luxury and status, while the owner of a silver or grey car driver doesn’t want to stand out; owner of blue cars want stability, truthfulness and serenity; a brown-car buyer wants value and a long life in their purchase, and doesn’t care about trends or fads; while yellow car owners exude joy and a positive attitude.2)Lora Shinn (2014), What Your Car Color Says About You, Fox Business.

If a car is a status and fashion symbol then why don’t we change our cars when we change our moods? The zippy little commuter (or perhaps the impressive black executive conveyance) for the commute to the office, something fun and red for the weekend, or reliable blue people-mover for ferrying the kids to weekend sport.

The main problem for many folk is that we can only afford to own one (or perhaps two). Having a car for every occasion is just not financially viable. For-profit car clubs are changing that though. At the moment you can pay by the hour for something reliable but boring to get you from point A to point B and back again. What’s to stop the same services from offering something more exiting, or something with a little more room?

Then there’s the problem of carrying your preferences – the selection of radio stations, GPS settings, seat hight and so on that we’re dialled in – from car-to-car. If, however, we think of cars as smartphone (or even smartwatch) accessories, rather than the other way around, then it’s not hard to imagine hopping into the car club car you’ve just picked up and dropping your phone into the dock, only to find the seat hight adjusted, radio stations tuned and a route to your mother’s house out in the suburbs plotted by the time you mange to get the car started.

At this point the only thing tying you to owning a car is the golf clubs that you store in the boot (trunk), and the strange iconic role that buying your first car has in your formative years.

While the baby boomers have a strong attachment to owning a car, this is not true for Gen Y, who are ambivalent about car ownership. Studies have shown that fewer young adults have driver’s licenses, that they hate the traditional car-buying process, and that they prefer urban living and socialising online and consequentially have less need for cars.

Why invest a large chunk of your personal wealth in a single asset that is worth nothing when you finally sell it, when you can access cars on on-demand, picking the car that fits your mood and needs at that particular time, and have the car magically become “yours” when you drop your smartphone into the dock?

This creates an interesting dilemma for the car manufacturers. On one side that have younger cohorts coming through who don’t automatically assume that they need to own a car, and who are consequentially harder to market to. On another side they have the emergence of fractional car ownership: what’s happened to private jets3)NetJets has provided a fractional ownership service for private jets since 1986. and handbags4)You can fractionally own, or rent, depending on your point of view, a designer handbag from services such as Bag Borrow or Steal. is now happening to automobiles. And finally, on the last side, they have new approaches to manufacturing such as iStream5)iStream is a new approach to car manufacturing that reducing the cost of tooling by around 80%, enabling new car models to be profitable in much shorter production runs. that slash the investment required to design and manufacture a car, potentially making all your expensive factories irrelevant overnight.

It’s not hard to imaging a time in the near future where you can have the car you want, when you want, without owning it. While it’s not an option at the moment, it doesn’t look like it’s to far in the future. The car you just bought could well be the last car you ever own.

Image source: Alden Jewell

References   [ + ]

1. Press release (2013), What Your Car Says About Your Personality, Veryday.
2. Lora Shinn (2014), What Your Car Color Says About You, Fox Business.
3. NetJets has provided a fractional ownership service for private jets since 1986.
4. You can fractionally own, or rent, depending on your point of view, a designer handbag from services such as Bag Borrow or Steal.
5. iStream is a new approach to car manufacturing that reducing the cost of tooling by around 80%, enabling new car models to be profitable in much shorter production runs.

90% of sales are in bricks-n-mortar stores, but many are dying anyway

The stats are in and the rush to declare bricks-n-mortar retail dead appear to be a bit premature. While online commerce appears to be growing at a fairly impressive rate (of somewhere around 15% to 20%1)NAB Online Retail Sales Index, depending on where you are) that growth rate is on a very low base. This means that somewhere are 90% of retail sales still occur in a bricks-n-mortar store, and that figure floats up to 95% if you include bricks-n-mortar stores with an online presence.2)Chris Lund (April 2014), “Reports of bricks and mortar’s demise have been greatly exaggerated”, Strategy.

The problem with this point of view is that it ignores that fact that while the future might be here, it’s still unevenly distributed.

At a whole of economy level retail might be growing, and most purchases still occur in a bricks-n-mortar store, but when you dig into the details a different story emerges.3)Winners and losers in retail @ PEG What we’re witnessing is the incremental destruction of small (and some not-so-small) areas of the retail market as consumer behaviour changes and makes them irrelevant.

The first wave of online retail – Web 1.0 as it’s called these days – was moving catalogues online. This enabled consumers, for the first time, to search for what they wanted from the comfort of their own home, rather than need to head out on a shopping mission. This created a distinct change in what consumers purchased, as they could now use the power of Google to find the best product at the best price, or the cheapest product at the lowest price, and make their purchase directly with the retailer (local or online) who offered precisely what they wanted.

This had two interesting effects. The first was the destruction of mid-market brands.

Historically consumers were forced to compromise, their choice limited to what the merchant around the corner chose to stock. Confronted with three options – a cheap option, a middle quality option, and a good option – the consumer was forced to compromise. They would pick the best that they could afford or the cheapest that the merchant chose to offer. Web 1.0 meant that if they they could find something better, possibly at a lower price in another country, then they could would avoid the middle quality option and go directly to the best. Many mid-market brands collapsed as a result.

The second effect was the destruction of many local retailers. Most of these local retailers – the small clothing shop on the high street, or the department store in town – were little more than the end point of someone else’s supply chain. Their value lay in the fact that they were convenient, being close to home. Web 1.0 enabled consumers to reach around these local retailers and source the products themselves. Unable to compete on price, quality or convenience, many local retailers collapsed (or are collapsing).

So while retail might be growing overall, some roles in the retail market are no longer sustainable. Typically this means firms that trade in easily transportable, durable goods, such as books, CDs, video games, clothing, jewellery and the like and offered little more than convenience shopping.

More recently the emergence of social media and smart phones (the information comes to us, rather than us going to the information) means that we no longer rely on brands or firms for the information that drives a buying decision. The tangible effect of this is a dramatic decrease in brand loyalty. Fast food chains have already seen this effect, as everyone from travellers to teens started using recommendation services (Urbanspoon, Yelp, etc.) rather than trusting the brand, and were heading to local bistros rather than the outline of some national or global chain.

This effect is causing consumer facing parts of the market to fragment. This is a second knife in the back for many retailers – such as department stores – as their “sell to everyone” model doesn’t work in a market that’s fragmenting into a range of niches. The firms that are successful in this space are those that use a range of media (face-to-face stores, pop-up stores, social media, mobile apps, web sites…) to build a relationship with the consumer, and/or which are focusing on niches. The balance of power has tipping into the hands of firms that are agile enough to address these niches, “sell to niche” rather than “sell to all”.

So, taking all that together, we can see that 90% of purchases are through physical stores is not surprising. The problem is that:

  1. retail sectors that are moving online will be seeing more the 10% of transaction leaving bricks-n-mortar (let’s assume 20%), which is enough to drive many firms out of business
  2. spend in many sectors is moving to the cheapest and the best, eliminating many local businesses and mid market brands
  3. mobile and social means that many niche firms are now successfully competing with larger firms, causing significant problems for the larger firms

While the top line number might seem quite benign, the terror for many firms is in the details.

Image source: Chris Talbot

References   [ + ]

WhatsApp wasn’t overvalued

WhatsApp-Facebook

I have a new post up over at the Deloitte Digital blog, ‘WhatsApp wasn’t overvalued’. I’d been watching the debate around Facebook’s purchase of WhatsApp 1)Media Release (19 February 2014), Facebook to Acquire WhatsAppFacebook. and I was struck how many analysts and journalists were stuck in the past, trying to value WhatsApp based on the assets it holds (user base and ad inventory) when clearly the firm’s value lay in the information flow it controlled (~1,000 messages per month, per subscriber). It’s true that it you do asset-based valuation that the deal doesn’t make sense, but if you do an information-flow base valuation then the deal is a no brainer.

On of the big ideas behind the Shift Index 2)Peter Evans-Greenwood & Peter Williams (2014), Setting aside the burdens of the past, Deloitte. is the shift from stocks to flows: it’s not the stocks that you hold (assets, information, etc.), but the flows that you can tap into (partner networks, information, etc.) that drive your competitive advantage. Put another way, in a world where everything you need is available on demand and the world is awash with information, it’s your ability to tap into whats happening in the environment and react that defines your competitive advantage, and not the assets and data you hold.

Facebook’s purchase of WhatsApp is a great example of this difference.

Look assets that WhatsApp holds and the deal doesn’t make sense. WhatsApp’s user base of around 450 million active monthly users, many of whom will already be using Facebook, doesn’t seem to be worth the effort, especially since the company is only making US$1 per year (with the first year free). Nor is the advertising revenue of interest, since there isn’t any and WhatsApp has a public position of ‘no ads, no games, no gimmicks’. That user base, with WhatsApp as a standalone service, is not worth what Facebook paid.

Since the deal doesn’t stack up based on a standard valuation most of the pundits are calling the acquisition a ‘strategic’ move. That’s usually code for ‘we’re not sure why they did it’. However, what if we value WhatsApp based on the information flow that the firm controls?

As I point out in the article:

The average WhatsApp user sends more than 1,000 messages every month, and receives more than 2,000 messages. That’s over 30 messages a day, few of which are the spam which dominates email. It’s also a user base where over 70% of the population is active on any given day.

Facebook as a fairly low click through rate, somewhere around 0.09%3)Miranda Miller (23 October 2012), Facebook Click-Through Rates Increase, Costs Per Click Down 20-40% in Q3Search Engine Watch. What if Facebook could use the information flow from WhatsApp to double it’s click through rate? They would double the firm’s revenue, making the 16 billion for WhatsApp look like a bargain. This seems quite possible since Google is running at a click-through rate of about 0.4%, over four times that of Facebook. Google gets there by snooping on your private communications (web searches, email, instant messages) to work out what you might buy. As I point out in the article:

WhatsApp might just provide Facebook with something like that Google Search box, as WhatsApp gives Facebook a big, fat data stream that tells them what their user base is about to do. WhatsApp might not grow Facebook’s user base, and it won’t be a direct source of ad revenue. It will, however, allow them to watch what you’re saying – privately – to your friends and relatives, and then use that information to tailor the ads presented to you on the firm’s various web properties. Tell your best friend that you’re test driving a car tomorrow, and expect to see ads from car manufacturers when you’re browsing another friend’s timeline later that night.

If we value WhatsApp based on the information flows that it has, then the deal starts to make a lot of sense.

I’d greatly appreciate it if you head over to the article and leave your thoughts.

Image: Tsahi Levent-Levi

References   [ + ]

1. Media Release (19 February 2014), Facebook to Acquire WhatsAppFacebook.
2. Peter Evans-Greenwood & Peter Williams (2014), Setting aside the burdens of the past, Deloitte.
3. Miranda Miller (23 October 2012), Facebook Click-Through Rates Increase, Costs Per Click Down 20-40% in Q3Search Engine Watch

The myth of sustainable competitive advantage

I’ve mentioned to a few people that I was unimpressed with The End of Competitive Advantage by Rita Gunther McGrath. I’ve even be so impolitic as to call it ‘crap’ a few times, after which I’m usually asked why I think this, and I then spend time shooting over references and explaining how I came to my conclusion.

Rather than doing this yet again, I thought I’d compile some notes here which I can then point people at.

The End of Competitive Advantage claims to provide key insights into how business strategy needs to change, moving on from the foundations laid down by Michael Porter all those years ago. A few even called it an ‘important’ book, as they see it as the first proof that sustainable competitive advantage is a thing of the past.

My problem with the book is in three parts:

  1. The book provides insufficient argument and data to prove its thesis.
  2. The book ignores the fact that Porter’s work was shown to be lacking at least as far back as 2006.
  3. The simple analysis and lack of research into what is driving the shift results in trite recommendations.

The usual response to these points is are along the lines of:

  • ‘But everyone is using Porter still’ – which is an observations and not an argument.
  • They point out that the book is from a professor at Columbia Business School and published by HBR – which is just appealing to credentials.
  • ‘But the book is based on lots of analysis’ – which it is, but the analysis is riddled with holes.

Let’s handle the second point first.

Do Porter’s theories still work?

Porter’s work on competitive strategy might be one of, if not the most, cited works by business academics. This doesn’t mean that it’s any good.

Academia is riddle with frameworks that either have little or no evidence behind them, or which have been proved to be irrelevant in the modern context. This hasn’t stopped them being used as the foundation for new work.

Abraham Maslow and his pyramid of needs, for example, has been shown to have no basis in fact1) William Kremer & Claudia Hammond (31 August 2013), Abraham Maslow and the pyramid that beguiled businessBBC World Service. – it’s just something Maslow made up one day – and yet it’s taught in every b-school in the world. There’s similar problems with business value, technology adoption, and a whole range of topics.

Just because everyone uses Porter’s five forces doesn’t mean it works or has any basis in fact.

As Matthew Stewart pointed out in 2009 in his book The Management Myth2)Matthew Stewart (2009), The Management Myth: Management Consulting Past, Present & Largely Bogus, W. W. Norton & Company., the idea of being able to locate and explot a sustainable competitive advantage was ‘lacking any foundation in fact or logic’. It’s rent seeking of the worst form. There’s an earlier article by the same author from 2006 that points out many of the same flaws3)Matthew Stewart (June 2006), The Management Myth, The Atlantic.. Even earlier in 2000 Pankaj Ghemawat conducted a survey of the history of business strategy which found that ‘In the case of the five forces, a survey of empirical literature in the late 1980s—more than a decade after Porter first developed his framework—revealed that only a few points were strongly supported by the empirical literature generated by the IO [industrial organisation] field.’4)Pankaj Ghemawat (April 2000), Competition and Business Strategy in Historical Perspective, HBS Comp. & Strategy Working Paper No. 798010. The report he drew this from (and which I don’t have in my hands yet) is from 19895)Richard Schmalensee, ‘Inter-Industry Studies of Structure and Performance’, in Richard Schmalensee and R. D. Willig, eds., Handbook of Industrial Organization, vol. 2 (Amsterdam: North-Holland, 1989)..

The market even rejected Porter’s theories conclusively in November 2012 when Monitor Group, the firm that Porter founded to consult around his theories, filed for bankruptcy. As Steve Denning over at Forbes commented6)Steve Denning (20 November 2012), What Killed Michael Porter’s Monitor Group? The One Force That Really Matters, Forbes.:

Monitor wasn’t killed by any of the five forces of competitive rivalry. Ultimately what killed Monitor was the fact that its customers were no longer willing to buy what Monitor was selling. Monitor was crushed by the single dominant force in today’s marketplace: the customer.

It was Drucker who pointed out that the whole point of a company is to create a customer, not to try and squat in some magical place that would allow a firm to extract rents without any effort. Porter appears to have ignored this.

So no one wanted to buy the sustainable competitive advantage snake oil from Monitor, nor was Monitor able to apply the theory to its own situation and save itself. The idea has no basis in fact, the market rejected it, and it doesn’t work. And all this happened well before The End of Competitive Advantage was written or published.

Let’s set aside the idea that Prof McGrath’s book is the first time that Porter’s theories have been shown to lack potency: clearly she’s a decade or so late to that party.

The analysis

The second problem I have with the book is the poor quality of the analysis. Generally, the approach used by The End of Competitive Advantage is of the same level as Good to Great, which is another business bible that typically can’t be questioned but is riddled with holes. A lot of data might have been used, but the process is clearly deeply flawed.

The End of Competitive Advantage is built on a set of ‘growth outlier’ companies which out-performed the market. As is stated in the book:

In 2010, my research team tracked down every publicly traded company on any global exchange with a market capitalization of over $1 billion US dollars as of the end of 2009 (4,793 firms). Then we examined how many of these firms had been able to grow revenue or net income by at least 5 percent every year for the preceding five years (in other words, from 2004 to 2009).

These firms were then compared with their top three competitors and then with each other to identify what made them different. (Comparing a firm with its top three competitors is not the same as controlling for natural industry or geography growth, but we’ll let that one slide. At least there was some attempt to normalise the results. We can also set aside the question of why a five year period was used, even though it seems completely arbitrary.) The rest of the book presents what was learned, and provides the reader with some advice and a simple framework that you too can use to copy these growth outliers’ success. (This is why some reviews think that the book is an extended ad for consulting services, as the information presented is not much more than a teaser.)

As the book states:

The major conclusion was that this group of firms was pursuing strategies with a long-term perspective on where they wanted to go, but also with the recognition that whatever they were doing today wasn’t going to drive their future growth. Interestingly, they had identified and implemented ways of combining tremendous internal stability while motivating tremendous external agility, particularly in terms of business models.

The first issue we can call out with the analysis is a lack of disconfirming research. Consider, for example, if the CEOs of all the growth outliers wore red socks on Tuesdays. We might conclude that wearing red socks on a Tuesday will give us the edge we need. Humans have a natural confirmation bias so when you reach a conclusion you need to ask yourself ‘What would it take to prove this conclusion false?’ Can you find a significant number of firms where the CEO religiously wears red socks on Tuesday and which are not growth outliers? How do we know that the correlation they you’ve found isn’t just a happy accident, and that we’re reading a lot more into it than we should?

Next we have to consider survivorship bias. Someone has to win, but coming out on top does not imply that you were more skilful. There’s a lot of dumb luck in business; it’s not enough to be good at what you do, you need to be at the right place in the right time with the right product(s) and you still need a healthy does of luck. Did the growth outliers survive because they were good at what they do? Or is their success the result of happy accidents that took down their competition, or lucky coincidences that enabled them to leap ahead? Were they in the right places at the right time, moving into Asia when their competitors moved into South America, for example? Someone must survive, but there’s no rule that says that their skill was the only determinant of their survival.

Next we have the unknown unknowns. How do we know that the practices identified by Rita and her team are the right practices? Perhaps some of the outliers were more financially savvy and managed their cash flows, something which is hard at the best of times and even more challenging in the current turbulent environment, and which is inherently boring. Or perhaps they made a couple of astute (or just plain lucky) bets on which sectors to play in, nudging them past their competition. How do we know the survey or practices was complete? What was the framework used to identify these practices, and link them to changes in the environment. Correlations don’t cut it.

Ultimately, identifying a common set of practices for a set of companies that performed well over a given time period does little more than confirm that over the last time period these companies did well. That was already obvious.

We need to build a model that allows us to feed in long term market trends (increasing competitive intensity, decrease in ROA – at least in the US – blurring of sectors, etc.) and ask questions like, ‘How would these companies have performed three or more periods back in the past, and how might they perform in the future as the market evolves?’. If we’re looking for a change in the market then there should be an earlier time period where these practices were counterproductive. It’s this sort of approach that makes Thomas Piketty’s new book so interesting7)Thomas Piketty (10 March 2014), Capital in the Twenty-First Century, Belknap Press..

If you’re going to write a book about what to do in the future than you need to do more than point out what worked in the past, even if it’s the recent past. The future, as they say, is a foreign country.

This is also the big mistake that Good to Great made: identify a group of profitable companies that have some shared characteristic, assume that what made them successful in the past will also make them successful in the future, and then call out the common elements from this set of companies. As Freakanomics, put it, a lot of the Good to Great companies went ‘From Good to Great … to Below Average’8)Steven D. Levitt (28 July 2008), From Good to Great … to Below Average, Freakonomics..

The recommendations

Given all this, the book introduces the idea of ‘areas’ as the basis for competition, rather than industries. Its a nice idea as it allows us to pull more context into our analysis of the market: industries modulated by a few different dimensions, such as geography, demographic, etc.

The concept falls down, though, as it ignores the fact that industry definitions have become fluid. (What? Apple is a PC maker, not a phone maker? And what’s this touch and apps store stuff?) This  means that areas must also be a fluid concept, but the book does not look into the dynamics of how areas change. (I expect that this is left as an exercise for the reader, or they assume that you use Porter’s model to evaluate opportunity.)

The model for managing change across areas is a simple launch, ramp-up, sustain, ramp-down, disengage process. This doesn’t account for the pace in the current market. If your competitor can launch a new product in two to six weeks from a standing start (as many companies now can) then, while your carefully thought out launch process taking six months might seem modern, it’s largely irrelevant. There is no insight in the recommendations on what the change in market pace means other than ‘the end of competitive advantage’.

The recommendations all but ignore the shift from stocks to flows9)Peter Evans-Greenwood (20 Feburary 2014), Setting Aside the Burdens of the Past, PEG., which has huge implications for how we think about, organise, govern and manage our business. There is, however, a brief mention to the idea of consuming services rather than building assets, and the book even name-checks Odesk. However, it doesn’t look into the implications that spring out of this. The coverage is only a few spare paragraphs and you’re left wondering if the author doesn’t really know what to make of the topic.

The rest of the book which follows is a fairly straightforward process of working through the stages of the model and providing a few points of sage sounding advice for each stage (‘Rotate you team through departments so that they don’t get comfortable’ type of thing). You’ll either nod and say yes to each of these (the Barnam effect10)From wikipedia: The Forer effect (also called the Barnum effect after P. T. Barnum’s observation that ‘we’ve got something for everyone’) is the observation that individuals will give high accuracy ratings to descriptions of their personality that supposedly are tailored specifically for them, but are in fact vague and general enough to apply to a wide range of people. This effect can provide a partial explanation for the widespread acceptance of some beliefs and practices, such as astrology, fortune telling, graphology, and some types of personality test. in action) or go ‘meh’. Your mileage might vary.

My review

So, as you can see, my opinion is based on the following pillars:

  • The main thesis that ‘sustainable competitive advantage is over’ is very old news.
  • The analysis is suspect, at least, and doesn’t prove the thesis.
  • The model and recommendations provided hold little value.

Calling it ‘crap‘ might be going a bit far, but for me the book was a waste of money. Use the money to buy a coffee for a friend that you haven’t spoken to in a while; you’ll learn a lot more.

While the content might come from a major b-school and has been written up in respected journals, that doesn’t change the fact that we live on the internet now and we need proof that we can see. As Jay Rosen pointed out the other day11)Jay Rosen (March 2014), “I want it to be 25 years ago!” Newsweek’s blown cover story on bitcoin, PressThink., appealing to credentials doesn’t work in this day and age.

Image: Peter Mooney

References   [ + ]

1.  William Kremer & Claudia Hammond (31 August 2013), Abraham Maslow and the pyramid that beguiled businessBBC World Service.
2. Matthew Stewart (2009), The Management Myth: Management Consulting Past, Present & Largely Bogus, W. W. Norton & Company.
3. Matthew Stewart (June 2006), The Management Myth, The Atlantic.
4. Pankaj Ghemawat (April 2000), Competition and Business Strategy in Historical Perspective, HBS Comp. & Strategy Working Paper No. 798010.
5. Richard Schmalensee, ‘Inter-Industry Studies of Structure and Performance’, in Richard Schmalensee and R. D. Willig, eds., Handbook of Industrial Organization, vol. 2 (Amsterdam: North-Holland, 1989).
6. Steve Denning (20 November 2012), What Killed Michael Porter’s Monitor Group? The One Force That Really Matters, Forbes.
7. Thomas Piketty (10 March 2014), Capital in the Twenty-First Century, Belknap Press.
8. Steven D. Levitt (28 July 2008), From Good to Great … to Below Average, Freakonomics.
9. Peter Evans-Greenwood (20 Feburary 2014), Setting Aside the Burdens of the Past, PEG.
10. From wikipedia: The Forer effect (also called the Barnum effect after P. T. Barnum’s observation that ‘we’ve got something for everyone’) is the observation that individuals will give high accuracy ratings to descriptions of their personality that supposedly are tailored specifically for them, but are in fact vague and general enough to apply to a wide range of people. This effect can provide a partial explanation for the widespread acceptance of some beliefs and practices, such as astrology, fortune telling, graphology, and some types of personality test.
11. Jay Rosen (March 2014), “I want it to be 25 years ago!” Newsweek’s blown cover story on bitcoin, PressThink.