Economic Recovery? Don't Count On It.

You can’t open a newspaper these days without reading some headline about the economic recovery.  Hopes are rising that we may actually be turning the corner – consumer demand is growing, factory orders are increasing and the unemployment rate seems to have stabilized if not significantly dropped. Each day brings a new index number that we eagerly cluster around and struggle to interpret, much like tea leaves that are open to multiple interpretations.

While understandable, these efforts to read near-term indices also present very significant risks.  We continue to be seduced by near-term news, while losing any perspective on longer-term trends. These longer terms trends tell a very different story and suggest that we may be lulled into complacency by the short-term news of recovery.

Long-term performance deterioration

In our new book, The Power of Pull, we summarize the metrics that we developed for the Shift Index – the first attempt to quantify the longer-term trends that have been re-shaping the business landscape over the past four decades.  Of the 25 metrics in the Shift Index, one metric in particular stands out: return on assets for all public companies in the US.  Since 1965, return on assets has collapsed by 75% - it has been a sustained and substantial erosion in performance.  There is no evidence of any flattening of this trend, much less turning it around.

What does this mean?  It provides strong evidence that any “recovery” is merely a short-term relaxation of pressure and that there will be no “back to normal”. We often hear executives talk about the Red Queen effect where they feel they are running faster and faster to stay in the same place.  The actual situation is far worse: we are running faster and faster and falling farther and farther behind. There is absolutely no reason to believe that the long-term performance erosion will not continue.

The key question is what to do about it?  Market economies are generally successful in spawning innovative new approaches to overcome existing performance pressures.  That has not yet happened here. The fact that this trend has continued over such a long period suggests that the causes of the performance erosion are deeply embedded in our current management practices and institutions.

Shifts in the source of value creation 

The Power of Pull suggests that we are going through a fundamental shift in the source of economic value creation.  In the past, economic value creation depended on proprietary knowledge stocks.  The challenge for any company was to acquire some proprietary knowledge, rigorously protect it to make sure no one else had access to it, and then as efficiently as possible extract the economic value from this proprietary knowledge stock for as long as possible.  As change accelerates and uncertainty grows, though, knowledge stocks depreciate at a more rapid rate.  In this kind of environment, the key to economic value creation shifts to the ability to participate in a growing number of diverse knowledge flows to more rapidly refresh our knowledge stocks.

This shift calls into question our most basic assumptions about where and how economic value gets created.  Perhaps that is why firms have had such a difficult time responding to the deteriorating performance trends. Even more challenging, responding to this shift requires developing a whole new set of management practices and institutional arrangements.

Mastering the techniques of pull

We discuss these management practices under the broad rubric of pull.  Rather than trying to forecast demand and design push programs to ensure that the right people and resources are in the right place at the right time, a new approach is emerging.  This pull approach seeks to develop scalable pull platforms that amplify our ability to draw out the people and resources when we need them and where we need them. The pull techniques developed in lean manufacturing approaches are a promising first step, but they have only worked when there are a very limited number of participants. The leaders of a new generation of pull techniques are demonstrating the feasibility of aggregating thousands and even millions of independent and very diverse participants on global pull platforms.

As we begin to better understand these pull techniques and how they work, something interesting begins to happen.  For the first time, we have the potential to shift from our current pattern of diminishing returns performance improvement (as documented in the well-known experience curve) to a business environment where we can begin to unleash increasing returns performance improvement. We are already beginning to see some of the early indications of this potential on the edges of our economy, in such diverse areas as extreme sports, online gaming and software development networks.

The good news is that there is a pragmatic migration path that can move us from where we are today to where we need to be in a world of pull.  Small moves, smartly made, can in fact set big things in motion. To pursue this path, though, we will need a sense of direction, harness different forms of leverage and deploy platforms that can accelerate the pace of change.

Bottom line

Economic recovery?  Don’t count on it. We are just beginning to understand the challenges ahead. True recovery – in other words, sustainable, long-term recovery - will only come when we pull back from the near-term events that today consume our attention and re-focus on the less visible, longer term trends playing out around us. Those who refuse to be blinded by  short-term trends and focus on the longer term shift playing out in our global economy will begin to understand that the game is changing in fundamental ways. By harnessing the power of pull, they will create enormous wealth and leave those still struggling to read the tea leaves of short-term indices in the dust.

Comments

[Oaxaca]

Hello Rick. Actually your suspicions on growth being driven by small business (in the US)are not only valid but also fact. The Kauffman Research Foundation recently released a paper "that put simply, shows that without start-ups, there would be no net job growth in the U.S. economy."
See http://www.kauffman.org/research-and-policy/the-importance-of-startups-in-job-creation-and-job-desctruction.aspx

++++++

Hello John,

Really enjoy reading your work. Your statement;

"This pull approach seeks to develop scalable pull platforms that amplify our ability to draw out the people and resources when we need them and where we need them."

..is an area I've been working on for some time which I've described as "Fractional Work, The Next Small Thing"
http://winningbysharing.typepad.com/oaxaca/2007/02/fractional_cons.html

Odesk.com is probably the best example right now and could well become "an eBay for work".

IBM's recent announcement that it will lay off around 300,000 employees and shift to an 'on demand' workforce model should be taken very seriously because they realise that value can be created by any means necessary, no longer dictated by organisational relations, boundaries and out dated labour models.

[tartle]

The Red Queen effect only plays out positively if you are running in the right direction. Getting the vector right requires 'thinking'. I remember sitting in a bankrupt aeroengine company [that 40 years on is one of the top global aero-power providers] and being told we could have as many people as we liked to start work on a better engine (for Boeing as it happens). Our boss said "no, I want to sit with my 3 section managers (I was one) and figure out how we do it faster and better." Two weeks later we started to ask for support services to get their act together and collaborate/coordinate and we did our project almost right first time and in 1/3 less time.
So to get out of this incredible mess I suggest we need to think for a while and then move, in what we think is, the correct direction and be prepared to change the vector (slow down, move north, speed up on the turn, etc.). It is that OODA effect again.

[pankit]

I completely agree. Recover? not too soon...
here's my take - supported with facts

I see dead companies...

http://witstroll.wordpress.com/2010/04/16/i-see-dead-companies/

[Darrell Kent]

Hi John,

I really thought the last two posts were unfair.

I'm just a regular guy trying to make my way in the (as you point out, increasingly competitive) world - your book is proving to be of tremendous help.

There often aren't easy answers. Feeling sorry for oneself - and blaming the parasite class - I suspect will be the answer for few if any.

[Richard Leon]

I think it's fascinating to see words like 'passion', 'change', 'creativity' and 'pull' coopted into an Orwellian newspeak where they mean - well, who knows what they're supposed to mean now.

Obviously, it's Very Important, whatever it is. But equally, it's clearly not what they've meant for the last few centuries in English like what she is usually spoke.

I realise this is SOP for the upper levels of corporate industries, which are fundamentally driven by drama, self-importance, perpetual crisis and superficial egotism, and not so much by the ability to do a job quietly and well.

But that's no reason to make the rest of us suffer through this kind of nonsense.

Oh, and *please* learn to write English.

"Small moves, smartly made, can in fact set big things in motion. To pursue this path, though, we will need a sense of direction, harness different forms of leverage and deploy platforms that can accelerate the pace of change."

You realise that's almost entirely empty of any real meaning, don't you?

I suppose it reduces to 'Hire me to tell you to do clever stuff which only I understand and you don't.'

Not a bad strategy in a market economy where everyone is a brand and we're all synergistically competing with each other.

But still. Meh.

[Ormond]

One more smart guy makes up a concept to hide the real reason for the failure of Return on Capital.

The answer is, of course, as Darwin would predict, that the aging and static system of capitalist engorgement on the output of the lower/working classes is a form of parasitism. Look for financialisation as a form of bunco game, rather than a real output optimisation technique.

This article is puffery and fraud, onanism of the parasite class.

[Carmen Medina]

As Rick Burnes suggests, there are many ways you can have economic growth even as the return on assets for corporations declines. The fact of the matter is the world economy has grown 3-4 times in size since 1965 and while Asia is the largest share of that growth, the US was no piker. The new economy developing around the principles of Pull also gets captured in economic indicators.

[Mike Speiser]

I just started reading your book, so this comment is based only on this post.

When the world goes through significant technological transitions, might capital get "stuck" in the last generation's industries / companies for too long -- only after persistent economic under-performance finally getting freed up to pursue better uses? Is it reasonable to expect some extended period of inefficient allocation and the pain associated with these inefficiencies before we have the will to get rid of the old and bring in the new?

Do you know if the same ROA compression has existed in previous transitions in the US? Internationally?

I love the idea of pushing (or pulling) decision making down to where knowledge exists rather than destroying knowledge by pushing it up a hierarchy. But perhaps this is as much about capital inertia as anything else?

[Dticoll]

John,

I think your analysis on the downside is powerful, essentially that technology and innovation inevitably exert deflationary pressure, and that information technologies are more powerful in this respect than physical technologies. It's probably occurred to you, JSB and Lang D. that Marx pretty much predicted this a long time ago.

What I find harder to grasp is how knowledge flow and pull will change this. I can see why this would be true in the case of an individual firm that takes a lead in these new of achieving productivity. But as these techniques inevitably become generalized across the economy the impacts on margins and returns will spread. Unless you believe that a handful of monoliths will rule these roosts. What we are seeing today is a lot of both. Massive deflation in specific markets (like media) and quasi-monopolies like Google and Apple that have managed to capture point positions.

This raises some questions:
- is the dominance of these quasi-monopolies sustainable?
- if so, don't they do so at the expense of ROC across the rest of the economy (which means that average ROC will continue to decline)
- if not, won't average ROC decline anyway, as the methods of the knowledge-stock pioneers become generalized?

[George]

It's good to see someone make this connection. One area that I cover in my blog has to do with open innovation. Companies are engaging in this practice in order to identify what the market really wants as opposed to dictating what the market needs.

[Michael Gusek]

This is going to be one wild ride...

Geriatric Command and Control holding on to the 1950's Game Theory Intelligence model like an addict being told to give up their God Smack...All supported by an aging centralized Reductionist infrastructure and an inflated Baby Boomer vote.

Will we survive? Stay tuned for the next episode of "Regaining Balance in the System"!

[Rick Burnes]

What if, as many hypothesize, a recovery is being driven by small businesses? The return on assets for public companies may not be recovering, but it could be that smaller companies are generating quite a healthy return -- in fact, anecdotally, I'd say it's far easier for small companies to position themselves to take advantage of knowledge flows, and thus begin to grow.