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Talking To John Hagel About Emergent Business Networks November 29, 2009

Posted by Bernard Lunn in capital markets, Globalization.
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John Hagel is one of the leading business strategists, author of The Only Sustainable Edge. I interviewed him back in July about the research he is doing at Deloitte into the dramatic and overlooked plunge in Return On Assets (ROA). When Deloitte contacted me again about some new data which dug deeper into ROA in different markets, I wanted to learn more about the background story. In conversation with John, the story emerged. The story is what big western companies can learn from Chinese companies about peer partnering in emergent business networks.

The Return On Asset Bombshell

The Big Shift research done by John Hagel and his team shows:

“U.S. companies’ return-on-assets (ROA) have progressively dropped 75 percent from their 1965 levels despite rising labor productivity.”

That is dramatic. If you had to select a single measure by which to judge the value delivered by a CEO, board, or management team, it would be return on assets. To quote from the Wikipedia entry:

“The return on assets (ROA) percentage shows how profitable a company’s assets are in generating revenue. This number tells you what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control.”

And here is the bit that matters:

“Return on assets is an indicator of how profitable a company is before leverage.”

If you want to understand the financial meltdown that happened at the end of 2008, just think leverage, i.e. debt. Companies juiced up their earnings using leverage. They have been doing this more and more in the last 30 years.

What happens when you take that away? You get the return on asset bombshell that the Shift Index reveals. It is like taking steroids away from an athlete and then saying, “Now, how fast can you run 100 meters?”

Give Your Lobbyist A Bonus

In their latest research the Shift Index team looks at how this is impacting different industries:

“While virtually every industry that Deloitte examined has been impacted by the “big shift”, the first wave of industries currently feeling the most pressure include technology, media, telecommunications and automotive.  They also represent a ‘canary in the coal mine’ for industries that have just started to feel the effects of the Shift Index, including banking, retail and insurance.  Finally, the report also reveals that heavily-regulated industries like healthcare and aerospace & defense are the most insulated, at least for the moment.

The take way for investors? Place your money in markets where the government has erected the barriers to entry through regulation. The take way for companies in that fortunate position? Give your lobbyist a bonus!

But what if you work in technology and don’t think that regulatory barriers are either desirable or practical? You certainly need to do something dramatic if you look at the ROA data in your industry:

“In terms of the technology industry, the report reveals that a decline in ROA of nearly 70 percent, despite the highest gains in labor productivity in the U.S. This industry is also experiencing a level of competitive intensity that has magnified almost four-fold since 1965 and is 30% greater than in the rest of the economy.”

What Companies Are Showing The Way?

This all sounded rather gloomy. Deloitte is in the business of advising large companies. So I assumed that John must have some role models, some tech companies that were prospering in this hyper-competitive economy. Surely the only answer was not just “work in a highly regulated industry and hire a good lobbyist”?

Yes, John had some role model of tech companies prospering despite hyper intense competition. But their location surprised me. In the past the role models brought out by management consultants were almost all American, with an occasional European or Japansese company thrown in for good measure.

The role models that Jon mentioned where Chinese tech companies.

As A Historian I Should Know About Quoting The Source

When he described how they were working, it reminded me of the Chinese motorcycle companies that I had written about in my original post on “Emergent Business Networks“.

I mentioned that I had written about this earlier having been impressed by the story about Chinese motorcycle manufacturers in Wikinomics by Dan Tapscott. Oops! John told me that Dan got the story from him. As somebody who studied History at college, I should know better. So, by way of an apology, here is a link to John’s book – The Only Sustainable Edge.

Peer Partnering vs PR Partnering & Platform Partnering

These Chinese tech companies are “partnering” to build products way more efficiently than they could by creating everything in-house. Nothing new there you might think. Partnering is what we all do, right?

Partnering is perhaps one of the most overused and abused term in the business dictionary.

There are two predominant forms of partnership today:

  1. “PR Partnerships”. These are designed to make both partners look good and to get press but they don’t involve much real work or create significant revenue.
  2. “Platform Partnerships”. These are when a big company sets the rules in order to get small companies to create products for niche markets or to sell their product in niche markets. This is like calling a landlord/tenant agreement a partnership.

By contrast, the Chinese model is more like “Peer Partnership”. Each company is genuinely independent and each partnership is mission critical to both parties. This involves some hard-nosed negotiation.

Keiretsu 2.0?

Cynics might say “we have seen this movie before”. In the 1980s it looked like the Japanese model was going to dominate. Their networks of companies were called Keiretsu. The term became popular in the start-up world; Kleiner Perkins called their network of contacts a Keiretsu.

I asked John if the Chinese model was simply “Keiretsu with a Chinese Face?” John had clearly considered this and responded that the Japanese model involved equity cross-holdings (that’s why the model appealed to VC firms). The problem with that is that the equity position outlives the usefulness of the partnership. Rather than re-negotiating or ending the partnership, cross-holdings tend to lock them in well past their “sell by date”.

Chinese Jiu Jitsu

Necessity is the mother of invention. Chinese companies have grown despite lacking two critical things that we take totally for granted in the West:

  1. Intellectual Property (IP) protection
  2. Well developed capital markets.

The Chinese firms turned these weaknesses into advantages through their approach to partnering – classic Jiu Jitsu.

Large American companies may need to learn some of these tricks. We are entering an era that looks a lot like emerging markets when:

  1. Intellectual Property (IP) protection is threatened by the “perfect copy machine” of the Internet and the consequent move to open source, open data and open everything else.
  2. Capital becomes more scarce as debt leverage declines and equity investors demand a greater real ROA.

StartUps Know That Partnering Has To Be A Core Competency

The 3 golden rules of a start-up are focus, focus and focus. Startups know that have to focus on the one thing that they do better than anyone else partner with other companies for everything else. Some entrepreneurs now consider the art of partnering as a core competency.

It is possible that we are facing an interesting inversion of the norm. It used to be that start-ups studied at the feet of managers who used to run large traditional companies. “Teach me to manage oh great suited one”.

Now the big cats in the corner office are being asked to think more like a scrappy bootstrapped start-up in a garage in cheap location in America or an equally scrappy start-up in a dusty corner of Western China. It’s enough to make you throw up your 3 martini lunch!