Atomic: Reforming the Business Landscape into the New Structures of Tomorrow 9781841121161, 1841121169

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ATOMIC Reforming the Business Landscape into the New Structures of Tomorrow Roger Camrass and Martin Farncombe

ATOMIC

ATOMIC Reforming the Business Landscape into the New Structures of Tomorrow Roger Camrass and Martin Farncombe

Copyright © Roger Camrass and Martin Farncombe 2003. The rights of Roger Camrass and Martin Farncombe to be identified as the authors of this book have been asserted in accordance with the Copyright, Designs and Patents Act 1988. First published 2004 by Capstone Publishing Limited (a Wiley Company) The Atrium Southern Gate Chichester West Sussex PO19 8SQ www.wileyeurope.com All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except under the terms of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd 90 Tottenham Court Road, London, W1P 0LP, UK, without the permission in writing of the Publisher. Requests to the Publisher should be addressed to the Permissions Department John Wiley & Sons, Ltd, The Atrium, Southern Gate, Chichester, West Sussex PO19 8SQ, England, or e-mailed to [email protected], or faxed to (44) 1243 770571. CIP catalogue records for this book are available from the British Library and the US Library of Congress. ISBN 1-84112-116-9 Typeset in 11/15pt Goudy Old Style by Sparks Computer Solutions Ltd, Oxford, UK (http://www.sparks.co.uk) Printed and bound in Great Britain by T.J. International Ltd, Padstow, Corwall This book is printed on acid-free paper responsibly manufactured from sustainable forestry in which at least two trees are planted for each one used for paper production.

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Contents Foreword Preface Acknowledgements 1 The Countdown Begins

Part 1

Causes

2 New Wave Connections 3 Land of the Giants Discontinuity

Part 2

vii xiii xvii 1

17 19 39 55

Collapse

59

4 What is an Atom?

61

Part 3

Consequences

5 Winning Strategies on the Atomic Road 6 Atomic Me! 7 Industrial (R)evolution

81 83 101 117

vi

CONTENTS

Part 4

Changes

8 Relational Capital 9 Keep the Best and Ditch the Rest 10 Big Is Not Beautiful 11 Change IT! 12 Atomize Now!

Part 5 13

Corporate Re-formation

Corporate Re-formation

Index

139 141 164 183 196 213

233 235 243

Foreword by Chris Meyer, author of Blur and It’s Alive

For the past hundred years or so, the fastest growing economies have chosen to organize themselves into corporations as the most efficient means of production. And since most of us reading this book have grown up in that context, it’s easy for us to think it will always be so, just as feudal serfs, guild members and farmers did in their respective times. The technologies that have transformed value creation will likewise revolutionize economic organization, thereby shifting power from institutions to the talent they rely on. The most important innovation of the Industrial Revolution was not a technology such as the Bessemer steel-making process or the Newcomen steam engine – it was the legal creation of limited liability enterprises – corporations. Why? Because it mobilized the flow of capital, which was a scarce resource in the late nineteenth century.

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FOREWORD

A blacksmith might have started a business based on his family’s savings, or on what could be borrowed from the village he would serve. However, Andrew Carnegie needed financial capital on a different scale and it’s no accident that his name is connected to that of Paul Mellon, the founder of the bank that funded US Steel. The growth of the banking system and the ability to fund industrial-scale projects were enabled by the development of the corporate form of organization. The power of this new economic species proved almost too great. The industrial technologies that corporations developed on a mass scale – such as chemistry, electricity and mass production – created so much value and required so much capital that they eventually acquired enormous leverage. In fact, they accumulated power so rapidly that democratic societies had to create new institutions to curb it. First came the antitrust laws, then the labour movement and associated legal frameworks. Most recently, it has been consumerism that has again reduced the corporations’ room for manoeuvre. Even so, the corporation seems to be gaining ground as global enterprises take on capabilities that used to belong to governments. Few central banks, for example, can compete with Citicorp in currency markets. What could change this picture of growing corporate dominance? The traditional corporation got a bit of a frisson from the dot-com boom. Right now, of course, that fear has become a sneer as Aeron chairs, the emblematic furniture of Silicon Valley, can be picked up for next to nothing at auctions and individual ‘free agency’ looks more scary than liberating. But this does not mean the corporation is safe. Clayton Christensen1 has recently driven home a forceful point: when a technology with truly disruptive potential first emerges, it doesn’t work very well. It gets used only in niches where its specific advantages are strongest. The existing technology is generally too well developed and entrenched in the better-established applications to give way to the interloper in its early, crude state. Thus transistors were first popularized in tinny radios because, without the transistor’s low weight and power consumption, a portable radio wasn’t possible at all, never mind that the radio sounded horrible! But the new technology learns from its niche, improves and pretty soon names like DuMont, RCA, Philco and the other vacuum-tube dependent companies have disappeared. Christensen’s conclusion is this: successful corporations

FOREWORD

are generally managed according to the sort of rules that militate against investing in new and risky technology. The foregoing argument relates to product technologies but it applies equally to new forms of organization. The dot-com economy, comprising small companies and free agents, bound together by their shared mastery of new networking technology and an equally shared set of values about knowledge, relationships and competition, invented an economy perfect for the rapid proliferation of information-based, non-capital-intensive businesses – this was the early niche. The collapse of many of these businesses has not wiped out this way of working, only the recent approach to getting such companies funded. And ultimately the experiences of the dot-com cohort will lead to even more startling organizational innovation, as the transistor led to the microprocessor. The connected and fluid labour markets that bred the dot-coms still exist, just as Internet-based communication still exists among the Chinese intelligentsia even after Tiananmen Square. In fact this is the disruptive technology that will eventually weaken the corporation. The corporation’s last remaining monopoly power is created by the inefficiency of the labour market, which prevents individuals from seeking new jobs as easily as they do new cars. The Net is changing this rapidly, to the benefit of the most talented individuals. As Charles Handy says, ‘the big challenge for the elephants is that they don’t end up as the home for the second rate’. The corporation as we know it is now in trouble. There is nothing to prevent its demise given that what had previously been its advantages are becoming less and less important. In fact, its accumulation of power will come to be seen as a kind of historical aberration, like centrally planned economies. This is the big story for the next decade and it should already be capturing our attention. The technologies of communication and collaboration will drive economic power from the institution to the individual, and the decisions about how our resources fulfil our desires will be revolutionized. How? Roger Camrass and Martin Farncombe have done a courageous thing, and the right one. They have broken the corporation into its constituent elements, identified the forces that determine how these elements can and

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x

FOREWORD

will be put back together, and predicted the combinations that will thrive over the next ten years. Rather than picking this or that trend, declaring it universal and extrapolating it, they have created a chemistry of enterprise, allowing atomic engineers all over the economy to start making their own new compounds, testing them, and determining those that are the most promising. They have got the crucial drivers absolutely right: connectivity replacing many of the advantages of scale; financial capital giving way to human and intellectual capital; the emergence of new types of entities. But, above all, they have signalled a critical change in perspective, from an economy of monolithic and self-contained institutions looking at life from the top down, to a network of atomic entities constantly forming new relationships and creating value from the bottom up. In this their latest book, they lay out both the periodic table of elements and rules for this chemistry, and describe some of the new things that can be fashioned with it. No doubt, many more things will be created than anyone can foresee. But the process is essential: deconstruct the ways that value is added in corporations today, examine the forces that will alter this picture, and analyse the components that will support value creation in the future. This networked, bottom-up perspective parallels powerful currents in today’s economy (such as individual-based data mining and mass customization) as well as tomorrow’s, the focus being on value created at the molecular level through biotechnology, nanotechnology and advances in materials. The bottom-up view will prevail, and will up-end our views of resource management. Corporate power and its pathological cousin, the influence of financial analysts, will be eroded. As we find new ways to organize around our desires, including how we want to work and manage our own professional lives, we will create the kind of economic chemistry that Camrass and Farncombe describe. In the process, an economy of the people, by the people, and for the people will reappear. The corporation looks to be in full cry, with corporate executives not only highly paid but also lionized – Jack Welch got an $8 million book advance! But the bubble will burst as surely as it did for the dot-coms and,

FOREWORD

if corporations are to extract value from the assets they have built, they must understand the source of the power of the insurgents and the forms the alternatives may take. This book is a guide to transforming the value locked within the corporation into a new form, adapted to the connected economy and able to continue adapting on its own. It illustrates a challenge that will face every corporate leader in the decade to come.

Endnotes 1 Clayton Christensen, 1997, The Innovator’s Dilemma, Harvard Business School Press, ISBN 0875845851.

xi

Preface

The fundamental message of this book is that you are about to become more important than you can possibly imagine. In a few years from now, chances are that you will still be doing what you do today. You are, after all, presumably an expert in whatever your chosen career is. Whether you’re a lawyer or an accountant or a human resources manager, the odds are you will still be a lawyer, an accountant or a human resources manager in ten years’ time. It is quite possible (even likely) that the way you do your job (the tools you use, the methodology you employ) will not have changed either. After all, accounting, for instance, is not a field given to radical innovation or theoretical shake-ups! You may even be doing this same work in the same way for the self-same employer.

xiv

P R E FACE

Yet, in spite of all this, we predict that everything in your life (that’s right; and not just your professional life either) is about to change. Why? Let’s put it this way: for the better part of the two centuries since the Industrial Revolution, the business world has been governed by the underlying notion that ‘the sum is greater than the parts’. This has led to a theory of the firm that says that power and influence will concentrate in an ever-smaller roster of bigger and exponentially more influential companies, super-companies that would do it all, for whom scale would be everything. Cogs would have an identity only as invisible parts of the machine. Sea changes in the world of communications over the last half-dozen years (which, indeed, continue to take place as we write this book) are reshaping the world in which we live and work. In fact, they are revolutionizing it. The outcome of this fact is that the balance of power in the business world is shifting. In very short order, the theory of the firm is going to be turned on its head. The parts are about to become greater than the sum. And you are one of the parts. In the new corporate world, every part will be seen to have value and identity and, because each part can and will exist in its own independent orbit (connectivity being both the enabler and the inspiration behind this fact), each part will have a new relationship with the sum. We are not saying that all parts in the new world will be equal, or that the value of some of these newly empowered or respected parts will fundamentally improve their economic lot. But we are saying that all the parts will be valued and recognized for what they are. There will be no more ‘cogs’ (a description that damns by faint praise) because there will be no more ‘machine’. We call these parts ‘atoms’, and the seeds of the ‘atomic’ corporation are already growing. The huge, unwieldy companies of today are composed of atoms, just as companies in the future will be. But today, the atoms are aggregated in a complex corporate environment that serves to stifle their effectiveness and ability to innovate. In the future world, the world of the ‘Atomic Corporation’, the atoms are freed and in the process the corporation is redefined. Tomorrow’s atom, freed to achieve greater productivity, may be today’s individual employee, today’s small department within the company, or today’s contractor. In the future, the work itself won’t change … but the working relationships will.

P R E FACE

Furthermore, even though the parts are the important thing, the atoms of the future do form a whole. What is important here is that the value of the whole will amount to more than it does today. The atomic economy will function more effectively and more cost-efficiently, and it will be more responsive to changes, precisely because the focus will be on the parts. As mergers such as AOL-Time Warner have surely proved, we are reaching the point where increasing corporate size seems an end in itself, regardless of the consequences. Something has to give. It will. The atomic corporation will be the result. And you will be the winner. You will be the winner because the atomic world will be one in which quality overrides quantity, in which achievement is held in higher regard than paper-pushing, and in which you are valued for what you can deliver and nothing else. Today, work contracts and employee handbooks mostly amount to pointless collections of rules and regulations few of which have any direct relationship to the quality of work output. In future, employee/employer relationships will be defined simply through deliverables. Lithe, responsive and expert atoms (whether individuals or small companies) will focus on productivity and productivity alone. ‘Punching the clock’ will, not before time, be consigned to history. Ironically, most of us will achieve more in our professional lives while simultaneously having more to give to our families. This book is about the change, and the road on which we have already embarked to the ‘Atomic World’.

xv

Acknowledgements

Background and research Although the writing of this book was a compressed six-month project, it is the culmination of a thirty-year journey for the two authors. The journey starts in 1974, which, according to the Intel Museum in Santa Clara, California, is the dawn of the digital age – at which time the world’s first microprocessor was manufactured! To present a comprehensive snapshot of today’s digital revolution and to be bold enough to describe some order within the ensuing chaos requires more than a mere point of view. It calls for credible research and experience that goes well beyond the combined authority of just two individuals. To that extent, this book has its origins partially in a moment of inspired vision, but also in an extensive research project.

xviii ACKNOWLEDGEMENTS

With regard to the latter – our research – the foundations of this book are varied and all equally critical. They include the outcome of various studies that the authors have been involved with over a number of years with a variety of partners. They also include a study of the works of a number of our peers (such as the books/articles Blown to Bits; Unbundling the Corporation; and Break-up!) that have at once enriched and informed our own work and have thereby advanced our theory of the ‘Atomic Corporation’. Also, we are particularly indebted to several institutions and related individuals through which we have gained personal access to the knowledge and collective wisdom that provides reliable commentary on today’s profound events. We acknowledge in particular and with enormous gratitude the following people and organizations that have contributed the intellectual underpinnings to this book. The Center for Business Innovation in Cambridge, Massachusetts, and the associated work of its director Chris Meyer and his colleague Stan Davis have contributed much to our understanding of both the connected economy and the underlying financial metrics that determine corporate success in this new era. Two influential studies of the future have provided detailed research and evidence for our findings: • ‘Business in the Third Millennium’, undertaken from 1992–1998, brought together twelve global sponsors to navigate the new digital landscape. These included organizations such as Chevron, EPRI, GRI and the US Postal Service in the USA; BP, BT, Fujitsu/ICL and Barclays in the UK; The European Commission; NTT, DoCoMo and the Fujitsu Research Institute in Japan. The study was managed and supported by the Stanford Research Institute (SRI). • ‘Management in the Nineties’, undertaken by the Massachusetts Institute of Technology on behalf of twelve industrial sponsors, and the direct predecessor of ‘Business in the Third Millennium’. This programme led to the development of business re-engineering that was commercialized by consulting firms such as CSC Index and Gemini Consulting in the early 1990s. The authors acknowledge the particular work of colleagues such as James Champy, Michael Hammer and Fried Wiersema of CSC Index in the intellectual development of atomization.

ACKNOWLEDGEMENTS

Prior to these two programmes, Roger Camrass was intimately involved in one of the world’s leading CIO programmes. The Butler Cox Foundation undertook extensive research on behalf of over 500 major corporations across Europe. Projects covering every aspect of information technology from database design and distributed processing to IS efficiency and effectiveness were meticulously chartered through the 1980s and 1990s on behalf of the member organizations. The Foundation became one of Europe’s leading IT forums and is fondly remembered by its charter members.

Acknowledgements and thanks We do not claim to be the first or only exponents of atomization. Indeed, several other distinguished authors have described similar concepts over recent years. We stand on the shoulders of Chris Meyer and Stan Davis, authors of Blur. We also acknowledge the work of John Hagel III, author of Harvard Business Review article Unbundling the Corporation; Philip Evans and Thomas Wurster, authors of Blown to Bits; James Champy, author of Re-engineering the Corporation and David Sadtler, author of Break-up! and their respective co-authors. In researching new topics for this volume, we interviewed specialists from leading consulting firms and public institutions. We would like to acknowledge the help of the following individuals: Ian Brinkley, Chief Economist of the Trades Union Congress; Andy Mulholland, Chief Technology Officer of Cap Gemini Ernst & Young; Angus Knowles-Cutler, Partner of Deloitte and Touche; Jason Rabinowitz, Director, McKinsey & Company; Jacky Ross, Vice-President of IBM Global Services; Charles Snodgrass, Managing Director of Outsourcing Advisors Ltd; and David Sadtler, Fellow of Ashridge Strategic Management Centre. We are also grateful for the help and encouragement of our original publisher, Mark Allin, for being an instant believer, and his successor, John Moseley. Our editors, Sancha Dunstan and Keith Brody, brought our words to life in this new edition. And finally, we could not have produced this work without the active support of our wives and families. Thank you, Susi Camrass and Judy Farncombe, and sorry about the missed vacations!

xix

1

The Countdown Begins

Delta revolution Delta. That’s the word engineers use to describe change. Change in direction, change in speed, change in volume. But the volume of changes today is greater than at any time in recent history. We are facing huge, and huge numbers of, alterations in the geopolitical world, in our social environments, in our personal lives. Face it, our world is changing, and it’s changing dramatically. We all recognize that the world that we are used to is not, in its familiar form, going to be around for much longer. Most of us have yet to really grasp the nature and the true extent of the changes that we are about to experience, and that’s because we can only see a few pieces of the jigsaw – the picture is hidden from us.

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THE COUNTDOWN BEGINS

Moore’s Law, for instance, is one piece of this jigsaw of delta. It establishes the principle that the price/performance ratio of computer chips will roughly double every eighteen months. That’s a one thousandfold increase in power every ten years. Look at it another way: the $1000 laptop you use today is equivalent to the billion-dollar brain of thirty years ago. Big deal. It still just does email, right? Wrong. Moore’s Law (and its bastard child, the Internet) doesn’t just mean faster word processing. It means the downfall of the corporation you work for. Don’t believe us? The printing press nearly killed off one of the largest corporations in history – the Catholic Church. At the start of the sixteenth century, Martin Luther nailed his colours to his church door, fuelled by his revulsion at a money-raising scheme. This initiated a torrent of reform – the virtual atomization of the Church – not because of Luther’s zeal but because the printing press had made the Bible available to anyone who could read. The power of the priests had been broken (more on this in Chapter 13). In today’s world, the corporation and not the Church is the institution at the centre of most of our lives. And the corporate world is now embarking on a reformation of its own. Just like poor Pope Leo X back in 1517, today’s CEOs have little real grasp of the magnitude of the threat they face and the extent of the changes to come. This corporate reformation – like all radical changes – is not 100% predictable, but we can offer you a chance to adapt to the future before it buries you. This reformation also has a name: atomization. Our first book, The Atomic Corporation, was published during the first week of September 2001. The horror of the Twin Towers changed our outlook to an even greater extent than we could have ever predicted. Even apart from its geopolitical consequences – increasingly nasty and still unclear – we have seen a crisis of trust along with some of the largest bankruptcies in history. Enron (one of our previous case studies), Arthur Andersen, WorldCom, Marconi and a whole fleet of airlines have all hit the wall. Since then, we’ve taken our message to leading corporations and opinion formers all over the world – from BP, Henkel and Prudential in Europe to Coca-Cola, AT&T and American Express in the USA. We have experienced events first-hand that have shaken global confidence and challenged established wisdom. We are more convinced than ever that bloated

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and unresponsive corporate structures must be taken apart and rebuilt, and that our new atomic framework is the most plausible and compelling future scenario. This new book is not about theory, atomic or otherwise. Our first book was amply equipped in that department (although we do cover the main points once again in Chapter 4). This book is about outcomes. It’s time to look at the possible consequences for us as individuals and for the corporate and social structures we work in. And it’s time to ask what we have to do when the plane lands (see Chapter 13). First, let’s talk consequences. We will start this chapter by laying out some predictions on what we think might happen in the next twelve weeks, twelve months and twelve years.1 By the end of this book we hope you can anticipate the many changes that will affect your personal and working lives, and that you will be helping to make our predictions come true. Don’t fear the future. Be a part of it. After all, it’s not like you have a choice.

The next twelve weeks • Through a chance encounter on the World Wide Web you connect with someone you have not heard of or spoken to in twenty years. Despite the passage of time a new level of intimacy emerges between you both, and exciting business possibilities evolve. • Your son declines a graduate job offer with IBM in preference to a year of world travel. The staff at IBM are not surprised – despite the depressed employment market, even the best corporations find it difficult to recruit the best graduates. • Your father realizes that falls in the stock market means that retirement in his fifties is no longer an option. Instead, he invests all his surplus funds in bricks and mortar, bypassing traditional savings channels. • An old friend’s business unit is demerged from its parent company. He feels energized by the smaller management team and closer contact with customers and suppliers, and clocks up an eighty-hour week for the first time in his life.

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THE COUNTDOWN BEGINS

• A leading pharmaceuticals giant announces that it intends to withdraw entirely from R&D activities, currently exceeding $2 billion of investment a year. Its CEO stresses the need to focus on global marketing and sales in its drive to retain its number one position in the sector. It announces alliances with over eighty biotech and drug discovery companies to fill the R&D gap. • General Electric (GE) opens up its own stock market to trade over one hundred separately quoted companies within its own corporate portfolio. Investors, both institutions and individuals, are encouraged to swap their GE shares for a portfolio of GE securities ranging from power and lighting to finance and professional services. • AOL-Time Warner, one of the largest mergers in history, throws in the towel and announces its intention to break apart into five separate companies. This ends what many regard as the largest destruction of shareholder value in modern times.

The next twelve months • You are told that, due to the continuing harsh economic climate, your services to a Global 2000 firm are no longer required. You receive a handsome pay-off and the promise of part-time work that never transpires. After a few weeks of personal doubt and uncertainty, you fall into a new and more enjoyable pattern of portfolio employment by deciding what your real competencies are and applying them to the marketplace. • Ford sells off its premium brand car companies, including Aston Martin, Jaguar, Range Rover and Volvo to the French fashion and perfumes company LVMH. In an unprecedented bid to return to its core business, it continues to provide manufacturing and logistics services to LVMH, encouraging the new owner to concentrate on brand extensions and product innovation. • HP completes the world’s largest outsourcing deal with a Taiwan industrial consortium. It transfers all manufacturing and supply chain tasks to its Eastern partner in return for a 25% share of the new global manufacturing platform and a sign-on bonus of $5 billion cash to cover

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•

•

•

•

•

the asset value. Its workforce is reduced from 140,000 to less than 40,000 worldwide. Affected by the downturn in merger and acquisition (M&A) activity, Goldman Sachs decides to spin off all activities in this area and forms a joint venture with leading accountants Deloitte & Touche. The new entity takes equity positions in each of its M&A activities and draws on capital funds from a variety of investment banks. Nedcor, a relatively unknown South African bank, bids for and wins the outsourcing of Lloyds TSB’s core transaction processing platform, effectively gutting its retail operations. The deal takes the form of a new global vehicle based in South Africa’s low-wage economy that is soon touting for similar business from the leading retail banks in Europe and the USA. After almost fifteen years of relocation planning and deliberation, HSBC decides to abandon its new thirty-storey building in Canary Wharf in favour of smaller offices co-located with its business interests. As well as creating better connections to customers, this avoids the vulnerability of thousands of workers concentrated in one building. Shell makes an unprecedented announcement – it intends to spin off its global retail operations and to concentrate on oil exploration and production. McDonald’s registers interest in acquiring more than 30,000 filling stations – expanding its own footprint by a factor of two. Private equity house KKR is launched on to the New York stock exchange and becomes the second most valued stock after Microsoft. Its principals each become wealthier than Bill Gates and Larry Ellison put together.

And the next twelve years? • The average employment contract for staff working in California will come down from its current duration of eighteen months to less than thirty days – or one working month. The concept of permanent employment will be consigned to the annals of history.

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THE COUNTDOWN BEGINS

• Upwardly mobile professionals appoint personal agents to manage their careers. In return, agents take a share of annual wages and stock options as their fee. Other service companies step in to take charge of domestic obligations such as house cleaning, financial administration and holiday planning. • The first trillionaire is crowned. He has amassed his fortune in just under ten years as a result of applying intelligent agent technology to web-based search engines – his corporation finds what you need on the Internet. A PhD from Stanford University in 2003, he had no immediate expectations of making money from his research thesis. He is rapidly overtaken by the main investor of a biotech company that is the first to gain approval for a drug that arrests ageing. Neither of these corporations employs more than fifty people. • Will Smith, film star and singer, becomes the first black president of the United States, where public appeal and charisma are recognized as the essential differentiating qualities of a successful politician. In the UK the Conservative Party, bereft of personalities, slips into quiet obscurity. • Educationalists abandon fact-based learning in favour of discovery and experience. Virtual reality becomes as commonplace as personal computers in classrooms all over the USA and Europe. • The most eminent consultancy firm in the world (you know who we mean) closes after the partners refuse to provide any more working capital to keep the firm alive. The only saleable asset will be the research institute that generates more than sufficient equity funds to finance all existing partner pensions. • A global account team working for IBM undertakes a leveraged buyout, raising over $1 billion to purchase its profitable current customer relationship. This team consists of no more than twenty staff and exploits its new asset by forming multiple relationships with IT, HR and finance service providers. • Device-to-device traffic exceeds for the first time all other traffic across the World Wide Web. Much of our personal communication is delegated to software agents embedded in our hand-held terminals, laptops, clothes and other intelligent devices.

THE COUNTDOWN BEGINS

• Governments impose crippling taxes on organizations of five hundred or more people to discourage inefficiencies in their economic systems. They will also consider introducing laws to limit the size of government departments to fewer than two hundred staff as a means of convincing the electorate that they are serious about delivering value-for-money services. • Of all the professions and degree courses, Digital Arts becomes the most popular and highly remunerated of all careers in the Western world. Universities such as Cambridge and Harvard vie with each other to offer such training, but Thames Valley – once rated the worst UK university2 – excels above all of these worthy institutions, having been first in the field. Within our atomic view of the world, these predictions are all entirely plausible. But hold on, here. That kind of change requires nothing less than the rethinking of management science. Where did that delta come from?

Welcome to the 2% world Consider the economic pressures acting on your corporation. With inflation at its lowest point in fifty years (under 2% in many developed economies) and interest rates approaching zero, corporations are really under the microscope. Stocks should be more attractive than fixed-interest investments, but stock markets everywhere are down the pan. Many of the world’s largest corporations have seen their share prices halved and halved again. Why? According to the doyenne of the UK fund management community, Nicola Horlick, in such a low inflation world corporations have nowhere to hide. And even Warren Buffett said recently, ‘You don’t know who’s swimming naked until the tide goes out.’ The usual cures for stagnation are clearly not working. Traditional corporate restructuring programmes are as effective as rearranging the deckchairs on the Titanic. Acquisitions, once a popular mechanism to provide the illusion of growth, are increasingly seen as a very bad idea (we’ll have more to say on that in Chapter 10) and ambitious IT programmes look like spent

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measures. Firms that make their living supporting these remedies – consultancies, investment banks and IT service organizations – are slashing their workforces. In the 2% world, there’s nowhere to hide. To improve margins, corporations are undertaking ever more ruthless cost reduction exercises. Some have adopted strenuous outsourcing regimes to rid themselves of excess corporate fat, and in return are receiving generous pay-outs from businesshungry IT service organizations. And in lame-duck sectors, such as media and telecommunications, even more extreme measures are underway. Here, CEOs have run up huge debts to buy (comparatively) worthless assets and corporations are preparing to conduct ‘fire’ sales to meet their stringent debt repayments. And that’s your money they’ve thrown away. For the large majority of remaining corporate giants, the task of balancing the needs of all stakeholders has never been more difficult. Bloated marketing departments make a last-ditch attempt to create consumer demand for their products. Employees are tired of being abused and deceived by false promises, and shareholders are voting daily with their feet as they move the majority of their savings out of the equities market.

The changing customer The failing corporation has yet to take account of a much more powerful change taking place around it – in the nature of its customers. Consumers and business customers are entirely comfortable with using Internet-based portals to compare prices for goods and services from thousands of suppliers across the world. Already nearly a billion individuals are connected to the World Wide Web, comparing products and sharing new experiences. If you’re not the best, we already know about it. If your profitability is based on information asymmetry – you know something we do not – you can kiss it goodbye. We know what the other guy is paying! At the same time, there is no longer a corporate safety net to protect us through our careers. We are reaching a transactional economy where jobs will last for months rather than years. Nor can governments any longer afford to guarantee employment, welfare, pensions or lifelong learning. Each

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one of us has to take on absolute responsibility for our livelihoods and personal situations, leaving countless opportunities for new forms of personal services – from financial and career counselling to the basic outsourcing of domestic tasks. Even more dramatic events are unfolding as the millennium generation leaves school and sets out into the world. According to Malcolm Gladwell, author of The Tipping Point, this community has broken apart from its parents’ generation to become infinitely more diverse and independent.3 It connects together to form an almost indivisible network of consciousness through constant waves of text messages and mobile calls, and can create new fashions and fads at lightening speed. Comprehending and exploiting this affluent segment of consumer activity has never been more difficult for global companies run by forty- and fifty-year-olds. Those forty- and fifty-year-olds think that a computer is just a better sort of typewriter (does anybody still make typewriters?). They think that advertising is worthwhile. They just don’t get it. In little over a quarter of a century since the dawn of the digital revolution – which according to the Intel Museum in Santa Clara began in 1974 with the invention of the first microprocessor – nearly 6 billion microprocessors have been built. That’s one for every member of the human race. We can comfortably predict that by 2020 there will be almost a trillion intelligent devices connecting every element of our day-to-day existence, from cars and personal computers to refrigerators and hearing aids. Embedded intelligence and a corresponding rise in powerful communication systems that connect us together (humans and machines) will have a transformational effect on the way we live our lives. Interaction will become infinitely more important than the ‘stuff’ that dominates most of our lives today. In the next five to ten years we will enter a new world of information intimacy that is interdependent and ephemeral. In Chapter 2 we talk about the move beyond today’s verbal exchanges to the more visual and virtual realities of tomorrow (a picture is, after all, worth a thousand words). Do you remember your last visit to an electrical retailer to buy a digital camera or music centre? The breadth of choice has never appeared more extensive or dynamic. What Sony brings out this week, Canon, JVC and Philips will improve on the next. In essence the world has become a giant

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copying machine, producing ever more intricate and attractive products to tempt us into buying. But have these suppliers really understood our latent needs? It’s not just the death of information asymmetry. The nature of what we want is undergoing radical change. Many of us have acquired as much ‘stuff’ as we could ever need. The next generation is more interested in life experiences than product – knowing, doing and being, rather than buying.

The unchanging corporation Faced with the onslaught of improved connectivity, powerful new economic winds and the changing desires of the consumer, are corporations scrambling to respond? No, of course not. Most large corporations are caught in a spiral of inward-facing programmes aimed at staying alive rather than moving forward. True, they are trying to get sleeker and slimmer. They have reengineered themselves, they’ve installed massive enterprise-wide computer systems, and they’ve paid fortunes to management consultants to stay ahead of the pack. But all they have managed to achieve is equality with their major competitors – it’s a zero sum game. They have missed the big prize because they have been focusing on internal processes and information instead of grasping the prizes across the entire supply chain, from raw materials out to the end consumer. The external prizes are not just about increased intimacy with the customer. New trading mechanisms such as electronic marketplaces and portals mean radical reductions in the cost of doing business, and that necessarily undermines the need to be big (more on this in Chapter 3). Like most revolutions, the effects of the Internet will be greater than we expected, but will take longer to appear. We used to believe that the clarion calls of e-business would bring down the walls of the corporation on their own, but something got there first: outsourcing. The business of ‘transformational’ outsourcing is exploding. The IT service sector, deprived of lucrative systems integration and consulting contracts, has seized on radical corporate restructuring as its salvation.

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Companies in this sector offer to buy non-core assets such as finance, HR and IT from traditional corporations and perform an accelerated slimming regime on the body parts – a sort of corporate liposuction. Billion dollar cash advances have been offered by the services sector, to the delight of the soon-to-be former owners. This is a vast transfer of assets from the ‘old’ to the ‘new’ economy, with many surprising effects. As we will tell you in Chapter 9, the outcome is a dis-integration of the corporation, as so aptly described by John Hagel in his Harvard Business Review article ‘Unbundling the Corporation’,4 leaving behind a much-diminished set of core activities and piles of much-needed cash.

Checkpoint – a combination of causes These are some of the dramatic forces challenging today’s corporations. These cumbersome entities are facing a huge delta and it’s time for them to respond, but most are still too centred on their products and internal functions. They cannot recognize how the needs of all their stakeholders are changing – from the consumer who is being empowered by the effect of greater choice and price transparency, to the investor and the employee who want improved returns on their financial and intellectual capital. First and foremost, large corporations need to become more agile. But you can’t be big and agile at the same time – the internal cost of movement is too high – so fragmentation is looking more and more attractive. Smaller corporations are more responsive to consumer needs as well as being more innovative. Increasing connectivity means that the old economies of scale are disappearing fast. And let’s not overlook the force of the push from inside – from the CEO who needs to do something, no matter how radical, to deliver results to institutional shareholders. We have some ideas for him in Chapter 8. Taken together, these forces present a fundamental challenge to the structures of today’s mega-corporations. It’s not the first time the business world has undergone major upheaval – after all, the only corporation in the top one hundred list of 1900 that would see in the new millennium

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was General Electric – but we think this revolutionary cycle will be nasty, brutal and short.

Consequences – the atomic view Businesses have to make a fundamental choice between scale and agility. Already companies as diverse as General Electric and Nike have made this choice, as we will see in Chapter 5. In essence, we believe the businesses of today will explode into different atomic components. Some will be extremely small and adaptive. Others will continue to strive for scale and scope advantage, but often at an unacceptable price. We will see a polarization of structures into what Gill Ringland describes as ‘the Coral Reef populated by brightly coloured and diverse aquatic life, and the Deep Blue Sea populated by large creatures of the deep’.5 Let’s look more closely at the new atomic types that will emerge. The engines of the new economy will be small, knowledge-intensive ‘smart companies’ that create a constant stream of innovative new offerings. In the pharmaceutical sector we already see several thousand researchdriven biotech companies exclusively pursuing product innovation. The ‘smart companies’ will connect to the market through other distinct entities – ‘customer managers’, who understand the particular desires of the consumer, and ‘webspinners’, who create new types of business-to-business networks and derive value from their peer-to-peer interactions. Together such atoms will assemble the bundles of goods and services required to meet each customer’s individual needs. Most of these atoms will consist of tens or hundreds, rather than thousands, of employees and they will resemble the sorts of hi-tech boutiques to be found in the world’s most developed economies, such as California’s Silicon Valley. They may be biotech companies or specialist retailers but, in all cases, speed and agility will be their passport to successful survival. The analogy with the brightly coloured fish in Gill Ringland’s ‘Coral Reef’ scenario is an appropriate metaphor to describe such entities.

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At the other end of the scale, we have the global platforms that enable these small and innovative atoms to serve world markets. Someone still needs to manufacture detergents, grow the food and refine the crude oil. ‘Asset platforms’ will deliver global economies of scope and scale in areas such as manufacturing and transport, while ‘service platforms’ will manage process-related activities such as human resource management, information systems, procurement and financial control across a variety of sectors. We liken these to the whales and other enormous fish to be found at the bottom of the ‘Deep Blue Sea’. In a truly global economy specific regions of the world will take on particular platform activities – reflecting local skills and wage levels. Taiwan has already become the global manufacturing hub for electronics production. China is rapidly emerging as a multi-purpose manufacturing platform. Now India is on course to be the world’s largest hub for IT and related business process activities – making it a global service platform. The West will increasingly ‘offshore’ its manufacturing and back office activities to such hubs. The recent boom in business process outsourcing and third-party manufacturing and logistics confirms the trend towards a separation between design and operation. Those companies that excel in design must be ‘smart’ – small, agile and innovative – while those that wish to excel in operations must be large, stable and efficient. As the speed and intensity of economic and technological development continues to accelerate, so will this separation increase – a message that many of the integrated IT service organizations appear to have missed. Holding all these atomic entities together into a virtual corporation is the ‘portfolio owner’ – an atom that acts on behalf of the investor, holding equity in the atomic corporations that it has spawned or bought. The global corporations of the future will be small but powerful portfolio owners with elaborate sets of cross holdings, where access rather than ownership becomes the operating paradigm. Private equity companies such as KKR in the USA already adopt this approach, acting as investment banks rather than operators. As the hundred top executives of one of the world’s most successful companies, BP, decamp from their corporate head office in the City of London to a smaller venue in the West End, we see a real-life example of the portfolio owner mentality.

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These atoms may be individually small and incomplete, but they can combine together into value networks, or molecules, that are powerful, fast and immensely flexible, and still manage to fully meet their customer expectations. Value networks rather than mega-corps will compete together in the future for customer attention. The small particles comprising these networks will be our atomic entities, each flourishing in the more dynamic and richly connected environment. In later chapters we will see exactly how and from where these atomic entities emerge, but for now you may just have to take it on trust – the atomic economy will work.

The structure of the book Part 1 Causes In the next two chapters we explain why atomization is not only desirable but also inevitable. We look at the forces that are reshaping corporate structures and corporations’ relationships with their armies of stakeholders – from customers and shareholders to employees and suppliers.

Part 2 Collapse Chapter 4 sets out the core of our atomic theory – what corporations will look like in a truly connected economy and how they will coexist. As well as describing and giving examples of the atoms, we look at how they form the economic units of tomorrow – molecules.

Part 3 Consequences Having laid out the underlying theory, we progress to the principal consequences in Chapters 5, 6 and 7. We look then at how the individual – you the reader – will be able to adapt and flourish in this new environment and what options are open to today’s oversized corporations. We also describe how entire industries will evolve to cope with corporate atomization and how traditional sector boundaries might blur and eventually collapse.

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Part 4 Changes The broad consequences are interesting to understand, but most of us want to know how these will affect our day-to-day jobs and responsibilities, as well as our domestic and social environments. This is the section where we describe the impact of our atomic theory on the key elements of corporate life, from wealth creation, to mergers and acquisitions to outsourcing and organizational design. We also take a look at the IT services sector, where many of our readers are working today. Finally, we provide a field guide to atomization with two methods for spotting hidden atoms.

Part 5 Corporate Re-formation Atomization is not entirely new. The sixteenth century saw the break-up of the largest multinational corporation of the day – the Catholic Church, caused by drivers similar to many of those we have talked about in this first chapter. We end our journey with a call to arms for those in large corporations and for those who are thinking about their careers. Interesting times are ahead for us all. Now read on …

Endnotes 1 These are all hypothetical, by the way, and should not be taken as direct criticism of the firms concerned. 2 Thames Valley University was rated 123rd out of 123 entries in the Sunday Times University League Table, 15 September 2002. 3 Malcolm Gladwell, 2002, The Tipping Point: How Little Things Can Make a Big Difference, Abacus Press, ISBN 0349113467. 4 John Hagel III and Marc Singer, 1999, ‘Unbundling the Corporation’, Harvard Business Review, March–April 1999, p. 133 et seq. 5 Gill Ringland, 1997, Scenario Planning: Managing for the Future, John Wiley, ISBN 047197790X.

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A reformation always has its defining moment, though it’s inevitably one that can only be identified with certainty through the benefit of hindsight. Did Luther realize the impact his Ninety-five Theses, nailed dramatically to the church door in Wittenberg, would have on Western history? It’s unlikely that he understood, or that he would have liked, the changes his actions resulted in. Historical analysis is retrospective, defined by the phrase ‘that was the moment when …’. The moment is rarely obvious at the time it happens. Yet need that be the case? Can we not now anticipate the history books of future years and speculate about what will come to be seen as the atomic reformation’s Wittenberg moment? Perhaps that will one day be considered to be the chance conversation between the leaders of two of the world’s largest oil corporations that took

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place in early 2000. Or perhaps it will be deemed the moment the Internet really grabbed the public’s imagination and began to proliferate in earnest. We’ll have to wait and see. For now, let’s isolate what we can be certain about in the present: the factors now propelling us along the road ahead. In this chapter we look at the first and perhaps most consequential impetus behind the atomic drive – extended connectivity. How can this phenomenon incite major structural change in the corporate world? We look at the impact of increased connectivity on rigid industrial supply chains and corporate structures and then forecast the transformation that it will engender. We conclude the chapter by examining what improvements in communication capabilities will serve to accelerate these developments as we evolve from a verbal era to a ‘visual and virtual world’ of what some argue will be infinite richness.

Are we at the starting line? The months following the dawn of the new millennium are now just a fading memory for most of us. Not so for the CEO of one particular oil corporation. He remembers clearly the moment he received a telephone call from his most dogged competitor to ask if his firm would be interested in joining a new electronic procurement market. Surprised, he thought: ‘Why should procurement be a relevant issue at my level? Is this just a diversionary move, or is my competitor really suggesting something that will transform our entire industry?’ A week later, his questions were answered, and the answer to the latter question was a definitive ‘Yes’. In fact, that exchange was only the first step to an entire rethink of business in the new millennium. Within six months, fourteen of the world’s largest corporations assembled at the headquarters of the Coca-Cola Company in Atlanta and debated where electronic markets could ultimately take industrial collaboration. These major players, such as American Express, BP, Ford, General Electric and Morgan Stanley, concluded that developments would take them well beyond the domains of either the energy sector or the procurement function.

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This influential group was, knowingly or not, planning the probable demise and future reconstruction of the entire industrial complex.

From ethereal to ether … The organization of business has remained much the same for a hundred years or more. Production is focused around discrete products or service offers. Competition is based on three key linked factors – accessibility, quality and cost of goods. To succeed in all these areas, corporations have sought to dominate their supply chains right through from raw materials to manufacturing to distribution, direct to the end customer. Shell proudly states that it is offering runs ‘from the well head to the petrol pump’. Consumers are asked to take their pick from a dazzling array of products, either on the supermarket shelf or in the pages of a glossy magazine. But improvements in connectivity, especially through the Internet, are changing the supply-led pattern of business in a fundamental way. In the highly connected world, the structure of business will need to be reinvented. We anticipate the fragmentation of rigid supply chains and in their place the formation of flexible value networks. ‘From the well head to the petrol pump’ may no longer be something to be proud of. These improvements will open the way for the coming of corporate atomization. Meyer and Davis described several years ago how the changes were starting to transform our economy, in their book Blur.1 They forecast: • Real-time transactions: Every aspect of business in the connected organization operates and changes at great speed. • Electronic connectivity: Everything is becoming connected to everything else – products, people, corporations and countries. • Intangibles: Every offer has both tangible and intangible economic value. Of these, the value of the intangible elements are growing faster. In short, when the Internet and with it universal connectivity, enters the picture, everything changes. New e-enabled trading mechanisms, such as

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online portals and electronic markets, transform the way business is done across the entire length of the supply chain. Consider, for example, the experience of a traveller who wants to buy a plane ticket. He or she can instantly compare the price offers of all world airlines through an Internet-based search engine, thereby making a choice based on lowest cost or suitability. Using online auction techniques, the same customer can name a price or ask the airlines to bid for his or her business, as is the case with priceline.com. Such mechanisms are being deployed at every step of the supply chain to improve choice and efficiency. The power of such ‘intermediaries’ is breaking the stranglehold of players such as Shell, which dominated the traditional supply chains. Instead they are placing increasing power in the hands of the customer. The introduction of Internet-based techniques and the formation of electronic intermediaries will help to dissolve the stranglehold of large corporations on individual supply chains and instead enable a multiplicity of players to coexist. Let us explore how this works in practice.

The electronic supply chain The Internet arrived, offering promises of untold opportunities for businesses and consumers alike. As the immense possibilities of the information superhighway began to penetrate the business community in 1996 and beyond, many corporations focused on purchasing over the Internet as the first ‘quick win’ in the new digital economy. Many leading industrial players (such as BP and Ford) were already well advanced in developing their own electronic procurement systems. These internal, Internet-based systems sought to take advantage of consolidated spend within a single corporation – and we’re not talking pennies here either. This could and often did amount to tens of billions of dollars. Each sector recognized that by combining its spend on direct and indirect products and services through electronic marketplaces made possible by the Internet, huge economies of scale could be achieved, as well as accompanying structural reforms to entire industries.

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In the automotive industry, much progress had already been made through the introduction of industry-wide trading standards and electronic links between the major car corporations and the multitude of component suppliers (15,000 or more). However, Internet-based electronic markets appeared to offer increased performance and trading efficiencies through online electronic catalogues and new market mechanisms such as electronic auctions. Suddenly competitors were sitting around tables discussing how their entire procurement spends could be amalgamated to produce huge electronic markets with combined purchasing powers often exceeding hundreds of billions of dollars. The additional attraction was the mouth-watering prospect of large equity windfalls arising from a share in a new commercial vehicle. Investment banks were quick to promote the opportunity, with companies such as Morgan Stanley earning millions of dollars in fees by bringing together key sector players. The number and intensity of market announcements taking place between 2000 and 2001 (shown in Figure 2.1)2 best illustrates the frenetic

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Figure 2.1 New e-marketplace announcements.

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interest generated. During this period almost every sector agreed on a new electronic procurement market to capture the numerous transactions taking place between suppliers and business customers. For example, Ford, DaimlerChrysler and General Motors created an integrated procurement market and Covisint mimicked this for vehicle parts and sub-assemblies. Thirteen of the largest global oil corporations combined their spend through a new market, TradeRanger, and sixty-two consumer product corporations, including old adversaries such as Pepsi and Coca-Cola, introduced Transora. As we predicted in our first book, many of the marketplaces shown in Figure 2.1 have by now failed. It’s one thing to have a huge combined spend and quite another to set up an industrial-strength marketplace. Integration of internal purchasing systems and processes has taken much longer to achieve than even we forecast, and many of the new markets are struggling to gain critical mass in terms of transaction volumes. However, some of the larger initiatives still survive, and the economic value of introducing Internet-based markets between the myriad of suppliers and customers in any industry has never been in doubt. Even a 1% saving in transaction costs would be more than ample to cover the costs of establishing these markets. However, after the initial frenzy of activity in creating online procurement markets in the early years of this decade, corporations have become aware that such mechanisms have a much broader scope and impact.

The wired customer What is happening at the vital customer-facing end of the supply chain? We know that electronic procurement is changing the relationship between large-scale manufacturers and the myriad suppliers doing business with them, but what of consumer relationships? To get things right, we have to start by looking at consumer desires. Let’s consider recent experience in the consumer products sector. The executive committee of one of the world’s most prestigious consumer products corporations – Procter & Gamble (P&G) – met over a weekend in its hometown of Cincinnati, Ohio in the late 1990s to discuss the perilous state of the corporation. Rarely in its history had such an influential group of executives come together with such a strong sense of common purpose. Despite being one of the most profitable corporations of its kind in the

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world, and the envy of major competitors such as Unilever and Henkel, the stock market had discounted its share price by 50%. The real shareholder concern was the clear absence of growth potential in an enterprise whose primary outputs are tubes of toothpaste and boxes of soap powder. Nobody expected the world market for such commodities to suddenly surge ahead beyond a modest 2–3% annual growth rate. But of equal concern to P&G was the silence from consumers themselves. Buffered by large retail groups such as Wal-Mart, which jealously guard customer information, managers of P&G had been unable to ‘connect’ with their end customers to understand how expectations and needs were evolving. Spurred on by video clips of new economy thinkers, one of the unique outcomes of the meeting was a radical initiative – an electronic beauty portal, reflect.com. This was to help P&G connect with its marketplace and learn at first hand what consumers actually thought. Reflect.com is about achieving consumer intimacy through the two-way interchange of very personal information. Visitors to the site are asked to input personal details of their skin and beauty needs in return for personal advice and products that address these needs. The challenge for the consumer is to part with this highly sensitive information. For its part, P&G had to assume the role of trusted adviser and reward its customers with relevant treatments based on this information. From being a mass-market producer of Pampers, Tide washing powder and Pantene hair care,3 P&G thus intended to become a one-to-one personal beauty counsellor to millions of women across the globe. The value for the consumer was obvious – an effective means of receiving personalized beauty care in the comfort and privacy of one’s home. P&G stood to benefit in two further ways. First, it could build up an intimate relationship with millions of consumers around the world, exchanging vital details of commonly experienced beauty conditions and being able to mine valuable information relating to geography, demographics, etc. The second, and perhaps most significant, benefit was the opportunity to launch and test new beauty products by short-cutting the traditional retail channels and working directly with the end customer. This could ultimately change the relationship between supplier and consumer from one of self-service to one of co-development.

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From customer to co-developer Reflect.com has had a relatively mixed reception due partly to problems of execution and also because of issues of consumer trust, although the concept is well understood and much admired. Of more prominence is the case of amazon.com. When Amazon launched the first online book portal, it created a unique retail destination. Unlike most high-street shops that might stock up to 50,000 books, Amazon offered an online catalogue of over 3 million books. Few, if any, shoppers on Amazon would encounter the familiar disappointment that their choice is not available. The catalogue offers almost infinite range at the touch of a button. However, as most of us know, choice alone is not necessarily the most important buying criteria. We consumers are seeking only a handful of books that will provide us with a unique and unforgettable experience. What we want most from Amazon is to identify the five or ten lifechanging titles in its near infinite range. Amazon is developing powerful techniques to help us navigate towards these titles but, as with health and beauty, it will require us as individuals to codify our unique tastes and personal characteristics as part of the matching process. As Davis and Meyer suggest in Blur,4 it is the exchange of emotional, intellectual and contextual information between both parties that enables the ultimate coincidence of interests to take place. We may be many years from achieving this ideal state, but these two examples illustrate how electronic portals can change the relationship between supplier and seller in many beneficial ways.

Connected corporations Combining developments at the procurement end of the supply chain, such as procurement exchanges, with those at the customer-facing side, such as electronic portals, we envisage a transformation of integrated supply chains into loose networks of trading parties. The once rigid relationships between each layer of the supply chain will become transient and subject to constant review and revision. Falling transaction costs, enabled by Internet-based mechanisms, will erode the traditional advantage of supply chain ownership (as we will see in the next

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chapter). Corporations are now starting to simplify their activities across the supply chain, becoming specialists at one stage of the chain. Improved connectivity encouraged newcomers to appear at each stage of the supply chain, both as providers of goods and services and as electronic intermediaries. As the networks of players continue to expand, the original chain begins to blur into a fuzzy cloud of trading entities. At the limit, only the end customer becomes the permanent anchor point in this evolving mass of electronic interactions (see Figure 2.2). We predict that as connectivity improves, new value networks will evolve into three layers focused on the end customer: • The customer management layer that encourages direct interaction with an individual about a particular need (for example, financial, educational, medical, domestic) and manages that part of his/her life. Reflect.com provides such a personal point of interaction in the sphere of beauty care. • The navigation layer, an electronic intermediary that enables individual need to be satisfied by facilitating the creation of a bundle of products and services from qualified suppliers. • The product layer, that is, the manufacturer or design shops that create the most compelling solution to a specific customer need, be it a physical product or more intangible offer.

Innovators and Makers Facilitators Customer Manager The End Customer

Figure 2.2 The end customer anchors the supply chain.

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Each is arranged in a concentric circle around the customer, and interconnected by electronic portal and market mechanisms. The product innovators out at the periphery provide an almost infinite choice of offers from which the network navigators and customer managers can choose. As we shall see later, this corresponds closely with the atoms in our postindustrial economy. Changes in the nature of the supply chain are apparent already and likely to become even more so as electronic intermediaries become more effective in mediating commercial relationships. What we are describing is in fact nothing less than the re-engineering of the entire industrial network. And as these changes progress, what is happening inside the corporate envelope?

Multiple points of connection Firms are linked via the supply chain to suppliers, customers and also, crucially, other critical stakeholders. These include employees, shareholders and other trading parties. The Global 2000 corporations may have as many as forty or fifty key stakeholders that influence the business on a day-to-day basis, from local communities and governments to media and pressure groups. Many of these relationships are conditioned by traditional and somewhat rigid means of communication, ranging from data and message exchange to face-to-face contact. The Internet and subsequent developments in broadband network technologies can intensify and transform these relationships through higher speed, two-way exchanges. We would agree with the premise of Blur,5 that any relationship in a connected world represents a complex exchange of financial, emotional and contextual information. According to this view of the world, a relationship consists of a six-lane highway where value is created through constant interactions (see Figure 2.3). In essence, the new information channels enable us to establish higher levels of intimacy between connected parties, whether corporations or individuals. Applying this thinking to the many critical stakeholder relationships that make up today’s complex corporation, we see how the Internet

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Buyer Figure 2.3 The six-lane exchange highway. Source: Blur by Stan Davis and Chris Meyer.

may be the vital mechanism to reshape traditional structures in ways that were once thought unimaginable. We’ve looked at customer relationships – let’s now look at how electronic markets, enabled by the Internet, could transform corporate structures and relationships: we see these as ‘connected employees’ and ‘connected shareholders’.

Empowering the employee Think of employees as stakeholders and you soon get the picture. A critical group of stakeholder that interacts closely with a corporation, payrolls may top tens or even hundreds of thousands of people. Each member of staff receives a regular salary, benefits and career opportunities that extend over many years. This flow of money alone can represent billions of dollars, and the combined purchasing power of this stakeholder community can be vast – for travel, banking, insurance and other services – absolutely anything in fact. Through a combination of cost reduction and service pressures, corporations are linking their employees into human resource (HR) portals

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to encourage a new self-service approach towards benefit management and career planning. One example is British Petroleum. It has introduced a global HR network service based on the software and support services of a firm called Exult. Using web-based connections, Exult has taken over the delivery of HR processes and administration throughout the firm. Employees can examine their benefits online, access tax and relocation information for foreign assignments and maintain current personal information. They can also review job opportunities within the firm and apply for new positions. Currently in its infancy, employees might argue that facilities of this new service are relatively sparse, and the absence of a friendly voice to solve personal problems is a step backwards, but consider how such connections may evolve in the future. The assembled gathering of fourteen Global 2000 corporations mentioned earlier in this chapter had much more ambitious ideas in mind. Imagine that the HR systems and networks of each non-competing corporation were connected together into a communal marketplace or universal employee portal. Brand managers working for Coca-Cola in Atlanta could access job opportunities with Nokia in Helsinki. Engineers on Alaska oilrigs could opt for employment with GE Power in Europe or Asia. HP product designers could apply to join innovation teams in Ford Motor Company. Loyalty and retention would then be issues for the broader community, not far removed from the notion of the European common market. Take this one step further and these corporations could use their combined community of one million employees to achieve remarkable trade discounts from suppliers of every kind of product and service. By extending the combined purchasing power of these corporations beyond the boundaries of the workplace into the domestic environment, employees could book hotels and air tickets at a small fraction of the retail price. Insurance companies already exert such leverage on consumer product suppliers when they replace damaged items such as TVs or cars. Such benefits could be passed on to employees as a perk of the job. The level of discount could be as high as 40–50% for a BMW, Marriott hotel room, or Virgin ticket across the Atlantic.

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These employee portals are not with us yet, but they could be commonplace in the coming years. The implications for job mobility and consumer power will be profound as communities connecting large firms swell into the millions, each member enjoying extended choice and improved purchasing power. In essence, employee portals will begin to blur corporate boundaries by encouraging job mobility. Over time, individuals could opt to divorce themselves from full-time employment and instead belong to freelance communities that contract with a firm for brief periods of employment – twenty days rather than twenty years. Just imagine the possibilities of this new connectivity – the possibilities are endless!

Choice and voice for shareholders The critical relationship between corporation and shareholder must also evolve to embrace new technology and the changing structure of business. How? The relationship between any corporation and its multiplicity of shareholders, both institutional and individual, is a crucial contributor to corporate well-being. It is also vital to the CEO, for the only guarantor of his job is the trust of his shareholders. But what does any corporation do today to foster this important relationship? At best, the majority of shareholders receive an annual report that is six months out of date the moment it goes to print. In a truly connected world, this point of connection can be improved dramatically to the benefit of all parties. In the case of General Motors, shareholders can now log on to the corporate website and receive almost real-time reports of news and financial indicators. General Electric (GE) has gone a step further by subdividing its shares into over a hundred classes of tracker stock, enabling investors to select from a wide portfolio of investment options within the firm. This greatly empowers shareholders who can, if they choose, invest in GE’s financial services arm, or focus on power and engineering. In effect, GE becomes a stock market of its own making – comparable to the entire stock exchange of many smaller countries. British Petroleum is moving one step further still

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in piloting a system that will enable shareholders to vote online about key corporate policy issues. In a truly connected world it is quite possible that millions of people across the globe could interact with and influence all key decisions within a major corporation. Corporations, like governments, will become democracies where employees, customers and shareholders participate daily in governance decisions and strategy development. What will this mean for the nature of corporate structures of the future? In such a widely connected environment the concept of a tightly bounded corporate structure loses all relevance. What is needed now is a whole new Theory of the Firm, where the ownership and management of the firm are recombined. Taken together, the revolution happening externally across the supply network and internally within corporate boundaries could reshape the entire industrial complex. The main questions today concern the pace of change and the destination point. However, all these developments depend on current Internet-based connections, which are undeniably limited in power. What if the capabilities of communication links were to improve by quantum leaps? How much further could such structural developments go then?

Revolutionizing connectivity for the new era Internet technology, as it is, will simply not do. We know that. Many of the opportunities described above depend on Internet technology dating back to the mid-1970s. However, most of us continue to think of such communication as a relatively mechanical exchange of voice, text and data – operating in what we might call the ‘verbal’ mode of information interchange. Such thinking is conditioned by almost a hundred years of gradual evolution in the telecommunications sector centred on telephony, facsimile and electronic mail. And just as we witness the new multimedia world of personal communication, we expect to see the universal connection of intelligent devices,

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from the cars we drive to the ovens we cook with. IBM looks forward to a world in which over a billion people are connected through multimedia devices, and over a trillion devices (a thousand billion) are linked together. Such devices can communicate together through wireless connections using standards such as Bluetooth. They are likely also to know exactly where they are by exploiting GPS satellite information. Tomorrow, our cars, our homes and even our clothes will become complex telematic devices with a wide range of multimedia services, delivered through the airwaves. The devices that we use to interact with information networks will continue to increase in scope and power, with software becoming increasingly personalized. Using intelligent agents, the ‘intimate’ computer will be able to carry out active negotiation on behalf of its owner, finding useful and relevant information from the increasing number of digital information sources and communications channels. Sometimes the negotiation will involve payment, sometimes a security check. Over time the intimate computer will be able to learn about its owner’s preferences, and actively provide him or her with a relevant diet of entertainment, information, education and home shopping offers. Alan Kay, father of the PC, sees this as a logical progression from the mainframe of the 1960s and 1970s and the personal computer of the 1980s and 1990s. Mobility will be a primary requirement for such a device as it offers individuals physical freedom to work and relax wherever and whenever. As the boundaries between the workplace, home and social settings begin to dissolve, the intimate computer will provide the single point of media access to support all these activities. Such devices will come in all shapes and sizes, from wall-mounted screens to wearable accessories. But however powerful these intimate computers become, they are limited in use without multimedia networks to support them. The rollout of high-speed digital switched networks, both fixed line and mobile, is a key priority for most telephone operators today. We anticipate a staged approach, taking us from today’s predominantly verbal networks to tomorrow’s visual and virtual networks.

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From verbal to visual and virtual communications Underlying the verbal-visual-virtual revolution (see Figure 2.4) is the proliferation of transmission and switching systems that are competing to provide low-cost broadband communications. Most nations are liberalizing their telecommunications markets to encourage investment in alternative network infrastructures. Coaxial and fibre optic cable systems are competing with twisted-pair copper wire to support telephony traffic as well as Internet and TV. Radio, or wireless, networks are competing with fixed networks to support voice and data traffic over the airwaves.

Towards the visual era Although one-way video broadcasting has been with us for over fifty years, two-way interactive visual communications remains in its infancy. But as personal computers evolve into fully multimedia devices, the over-abundance

Virtual Effectiveness of Communication

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Visual

Verbal

1900

1990

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Figure 2.4 The verbal-visual-virtual revolution.

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of broadband transmission and switching techniques will bring us close to a critical transition point in the development of visual communications. The visual era promises improvements in the quality and richness of personal communications that far outstrip those of the verbal era – ‘a picture is worth a thousand words’. The advances in two-way visual communication will be analogous to the transition from radio to TV in the entertainment world, and the effects will be as far reaching. In the same way that desktop publishing brought down the barriers for small business enterprises to enter various information-based markets, so streaming video has already encouraged, and will continue to encourage, new ways of interacting with stakeholders.

Surpassing reality – into the virtual era The virtual era promises extraordinary new communications services, such as tele-presence and tele-robotics, which could extend communications way beyond where we are today. Virtual reality (VR) techniques, some of which are already practicable, will dramatically augment communications by providing three-dimensional images of scenes and objects. The potential in the entertainment field is most obvious in electronic gaming. Video gamers will meet in cybercafes, at home, and ultimately in the electronic ether, to conduct global leisure wars in three dimensions. Beyond tele-entertainment lies virtual conferencing in which participants wearing VR headsets can link into a virtual conference room to explore computer-generated artefacts that can range from a whiteboard to a threedimensional product prototype. In the engineering sector, the concept of a virtual design team is already well established. Such virtual conference tools could enhance the effectiveness of these teams by integrating computeraided design and simulation modelling into a shared workspace. With tele-presence, stereoscopic vision and mechanical movement are transmitted between remote locations, enabling one person to be in two places at the same time. It enables a surgeon to conduct a remote operation on a patient by using stereoscopic vision to examine the patient, and robots to carry out the mechanics of the operation. Using new techniques, the surgeon can now experience full tactile feedback from the patient, giving a true-to-life experience.

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Because virtual technologies are digital, they are also scalable, which opens the door to a host of new applications. Tele-surgery, for example, could be applied to microscopic situations where miniature robots perform microsurgery.

Information intimacy empowers relationships With the increasing power of digital communications technology, information and the relationships it supports will become increasingly influential in every aspect of our professional and social lives. In the words of Blown to Bits, we will have both richness and reach.6 We are about to witness a further quantum change placing the individual, rather than the organization, at the centre of the emerging information web, and mastering information-based relationships will be the key corporate competency in the new economy. Business and government will need to build a new form of relationship with individual members of society, be they customers or employees, based on anticipation of need and reciprocity of information sharing rather than on one-way broadcasts. The individual will recognize these changes as heralding a new era of self-exploration, where successful partners will provide a better understanding of personal needs through individualized interactions. Power structures of all kinds have been unsettled by the redistribution of information and computing power. Much of these changes can be linked to information proximity. It has become the era of ‘Me’ rather than ‘Them’. With improved connectivity and the associated transparency of information, economic power moves away from the corporation, especially those that are internally focused, towards key external relationships. In a connected economy, customer power becomes a determining force in the transaction of goods and services. The concept of mass-markets diminishes in favour of markets-of-one, responding directly to individual need. But it is not only the customer relationship that will generate value in the new economy. As we have seen earlier in this chapter, a corporation has relationships with a multiplicity of stakeholders – the customer being an important but nonexclusive stakeholder.

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And the relationships with all stakeholders will be the central links of the extended organization upon which our atomized economy will be constructed. Instead of being product- or service-centric, tomorrow’s corporations will be relationship-centric. The nature of business will be focused on extracting value from each relationship through constant interactions and information sharing. As we shall see in the next chapter, this vision of the future is still far away from the current realities.

Summary The ‘steam-driven’ Internet has already started to change the ways that industries work (using electronic marketplaces) and how the main players interact with their customers (electronic portals, for example). New relationships with employees and shareholders are not far behind. And yet we have only just started to scratch the surface of the technology-driven changes in our society. New eras of visual and virtual communication present an ever more ambitious horizon for intimate transactions between individuals, as well as with corporations. In the new, networked economy, it is hard to contemplate the survival of rigid corporate structures or individual ties to single corporations. Instead, we anticipate a rich and continuously evolving web of relationships that brings us into a new atomic age. But is the corporation of today keeping up with these changes? In the next chapter we will look at the unchanging corporation and its prospects in the networked economy.

Endnotes 1 Stan Davis and Christopher Meyer, 1999, Blur: The Speed of Change in Connected Economy, Capstone Publishing, ISBN 1841120820.

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2 This diagram is taken from The Atomic Corporation, and is reproduced by kind permission of Cap Gemini Ernst & Young. 3 Pampers, Tide and Pantene are registered trademarks of Procter & Gamble Ltd and related companies. 4 Stan Davis and Christopher Meyer, Blur: The Speed of Change in Connected Economy, 1999, Capstone Publishing, ISBN 1841120820. 5 ibid. 6 Philip Evans and Thomas Wurster, Blown to Bits: How the New Economics of Information Transforms Strategy, 2000, Harvard Business School Press, ISBN 087584877X.

3

Land of the Giants

We were, not so long ago, full of hope and dreaming of untold wealth and prosperity. Now we have witnessed deep stagnation in the world’s stock markets, with many people wondering not only when, but if, economic recovery will come into view. It will – radical change is afoot. Soon, major reform will sweep through the economic sphere, altering its modus operandi forever. We are on the verge of the most fundamental change the world’s economy has seen in the last 40 years. Just one decade from now, the young observer will look back at the economic landscape of the new millennium in bewilderment and amazement and wonder why or how it ever could have worked. But why will tomorrow’s student be bewildered? For all to become clear, we need to observe the giants that roam the landscape today – yes, those

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mega-corporations that have been hitting the headlines (many of them infamously) of late. To understand what has gone on, we need to step back. We will discuss why businesses form, why they have grown to their current size, and why we think they have been going in the wrong direction. Then will we reveal to you why they will break apart. It will become evident in this chapter that atomization is not only desirable but also inevitable. We will show you the strong forces which motivated corporations to expand so spectacularly beyond the limits of their ability to exploit scope and scale, and consider the counterforces that will lead to their ultimate collapse and atomic renewal. We can already see some of these forces in action. Take Ford as a quick example. As the Ford Motor Company expanded to produce cars for customers across the globe in the twenties and thirties, it bought rubber plantations in Brazil and steel mills in the United States, thereby securing the base materials for its mass-produced vehicles. One of the world’s largest manufacturers today, Ford is no longer vertically integrated – it now owns neither the sources of its raw materials nor the means of distribution of its products. Indeed, less than 25% of the value of a modern Ford car originates from within the company. Taking this trend to its limits, Dell Computers neither manufacturers the components of its personal computers nor does it perform anything more than basic sub-assembly. Indeed, it never takes possession of some of the key components at all – Dell is a pure-bred information company. But when product manufacturers are abandoning the philosophy of vertical integration, what on earth possessed international media giants AOL and Time Warner to join forces in 2001? This enabled them to integrate content (films, magazines) with packaging and distribution (Internet and Cable TV) and perhaps they believed that the new ‘online’ and hi-tech industries are different from ‘on-land’ activities. They got it badly wrong, as opening any newspaper will confirm. AOL-Time Warner has achieved one of the largest destructions of shareholder value of all time. Well done, lads! And they are not alone – HP-Compaq has rushed headlong to follow this pursuit of financial ruination. Big companies can have small brains – welcome to the land of dinosaurs!

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Make or buy? In the early days of industrialization, the greatest barrier to corporate formation was the lack of financial investment for innovation and new plants. However, the wealth of the economy steadily grows and, as there is more money around to invest, the ‘capital barrier’ becomes less and less relevant. That said, in the early part of the twentieth century, capital scarcity dominated industrial logic, and companies expanded to gigantic proportions, often exceeding a few hundred thousand staff. Many companies now in the Global 2000 list have inherited structures that reflect conditions in the early to mid part of the last century rather than the present day. In the context of recent developments, many are struggling to overcome the constraints imposed by large concentrations of capital plant and labour. Received wisdom indicates that entrepreneurs start businesses when they believe they see an efficient way of converting inputs (raw materials, knowledge, labour) into more valuable outputs (products and services). The shape and boundaries of a business are governed by this single question: is it more efficient for us to make each component of a product or service or buy it in from outside? In other words, where do the inputs stop and the outputs start? The subsequent make-or-buy decision is governed by two factors: • Price – i.e. what is the price of this component on the open market? • Transaction cost – i.e. what does it cost me to buy this component in addition to the price I pay to an external supplier? The price factor is easy to understand (can he make it at a lower cost than I can?), and we can use the Ford example to illustrate the transaction cost element. From its inception, Ford Motor Company obviously needed tyres to produce its cars. However, as we mentioned earlier, the company had problems guaranteeing a low-cost and reliable source of rubber with which to make the tyres. Identifying potential suppliers, comparing prices and negotiating sourcing agreements consumed time and manpower for both Ford and its suppliers. This added to the overall cost of the car, and eventually Ford took ownership of the rubber plantations to eliminate the armies of

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bureaucrats involved in the sourcing transaction, including procurement people, accountants, lawyers and the like. Ford is not alone here. Every business incurs discovery, sourcing and contracting costs when procuring materials and subcomponents for its end products. There are clearly trade-offs between the price reductions obtainable from playing suppliers off against each other and the benefits of eliminating these transaction costs. This becomes especially compelling in a global marketplace, where large companies have access to resources (material and labour) from every part of the world. The next stage of the logic implies that it makes great sense to extend your reach up or down the supply chain if the cost of guaranteeing supply is high, or if you can raise capital more cheaply than your suppliers can. That is clearly the logic behind oil companies controlling everything from the wellhead to the fuel pump. However, doing everything yourself may not be cheaper. Just as there are discovery, sourcing and contracting costs when doing business outside the corporate boundaries, there are transaction costs associated with the ‘make’ decision as well. If you do decide to make rather than buy, you will need to hire layers of management to oversee the new activities. This increases further your costs, as you have to find a way (which we generally call ‘management reporting’) of overcoming the political infighting and the isolation from reality that these layers of management cause.1 Middle management is well known for whiling away the hours sending endless emails to colleagues, and while individually small, the combined effects are often catastrophic – the more the firm expands, the higher these internal costs get and the less agile the firm becomes. All of us who have worked for large firms know the frustration of getting things done internally, and have at some time probably gone to outside suppliers because it’s faster or cheaper than persuading someone to do the job in-house. It is often quite simply less hassle, isn’t it? The crucial point is this: organizations balance the ‘pain’ of trading and the ‘pain’ of doing things themselves.

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The insight that transaction costs balance out, though vitally important to our theory, isn’t particularly new: Nobel laureate Ronald Coase first published it in 1937.2 Since then, a whole school of transaction cost economics has been founded around it and other writers have extended Coase’s work to look at how other institutions,3 such as bank clearing houses and commodity markets, arise in order to economize on transaction costs. Firms expand until the costs of internal bureaucracy are equal to the cost of transacting externally. This equilibrium is illustrated in Figure 3.1. The importance of this is simple – the new forms of connectivity we discussed in the last chapter mean that the costs of connecting to your external stakeholders will fall much faster than internal costs. The conclusion is simple: large corporations are increasingly economically inefficient.

The corporate tug-of-war Our next theme is the ongoing struggle between scale and agility that still faces most businesses today. Since the recession of the early 1990s, companies have been drawn into a corporate tug-of-war.

External Transaction Costs

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• Discovery • Sourcing • Policing

• Bureaucracy • Politics • Co-ordination

Figure 3.1 The Coase equilibrium.

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See how it works. On the one side, senior executives see aggressive M&A programmes as pathways to scale efficiencies and stock market glory. Investment bankers with prospects of gigantic fees and commissions happily egg them on. On the other side, managers fight to rid their firms of unnecessary layers of management by successive bouts of downsizing and re-engineering, and introducing enterprise-wide information systems. The result is inevitably a constant battle between scale and agility that continues to this day, fought out on the fields of post-merger integration programmes. This drain on management attention is severe, and we contend that this is like navigating by looking through your rear-view mirrors.

Getting larger – full-fat mergers We talk about mergers in Chapter 10, but we can summarize that discussion by saying that the rush to consolidation usually destroys shareholder value and, at best, has limited merit. In a world of healthy inflation in the 1990s, the pressure to generate growth in revenues and profits was at an all-time high, as were expectations on Wall Street that activity of any kind spelled progress. Investment bankers were also very compelling in their logic and heavily focused on their Christmas bonuses, although they had little interest in outcomes once the transaction fee was extracted. And to make matters worse, corporate ego and greed escalated to new levels of excess – witness WorldCom, Vivendi, Marconi and the feeding frenzy that occurred in the telecommunications and media sectors. However, the ensuing effects were undeniable – over-valuation, over-leveraging and inevitable bankruptcies. The alluring promise of most mergers and acquisitions is based around economies of scale and the ability to control key distribution channels. By elevating itself to become the eight hundred pound gorilla in any sector, a company can purchase or supply materials at the lowest possible cost and raise capital on equally advantageous terms. This should give the company a commanding lead – subject to the necessary regulatory constraints. Equally, strength on the ground across the main channels of distribution (be they business-to-business or retail) can help suppliers to manage pricing to their advantage down the supply chain.

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However, the realities are often quite different to these lofty aspirations. First, in the majority of cases the benefits of consolidation have been underwhelming and leave behind mountains of debts that even the investment bankers that instigated the deals have difficulty in restructuring. The second consequence is the scale of the bureaucracy that frequently ensues, with political infighting for key positions and irreconcilable differences in cultures. Sound familiar? For many of you who have endured a major acquisition or merger, you will no doubt feel that we are understating the problems. There are of course notable exceptions to this rule. BP beat all stock market expectations with its successive acquisitions of Amoco, Arco and Castrol, and Cisco and WPP has built world-class companies on the back of carefully structured acquisitions. But the failures are equally visible and sadly much more numerous.

Getting smaller – the corporate re-engineering diet There’s a story that in an office at MIT’s Sloan School in 1990, a group of three people were reviewing the outcome of a five-year multi-client study, ‘Management in the Nineties’. Suddenly, one member of the team rushed out of the room and screamed down the corridor, ‘Let’s start to re-engineer the corporation.’ From this ‘eureka’ moment, Professors Michael Hammer and James Champy created the most powerful management consulting tool of all time – transformation on a grand scale. A whole new industry was created on the back of business re-engineering, and the effects can still be felt. The task of most companies, whether product manufacturers or service providers, can be divided into simple but significant activities. They must acquire and retain customers (the life-blood of any commercial enterprise), they must accept and process orders from these customers, they must develop new offers to satisfy changing customer needs (generating new sources of revenue), and they must manage the business enterprise and shareholder expectations. All these activities span several internal functional boundaries and they frequently fail because staff lack sufficient visibility of information to make effective decisions. Business process redesign (or ‘re-engineering’) emerged as the key tool to tackle and eliminate inefficiencies across the entire organization. In the words of Michael Hammer, this insight led to

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quantum improvements in performance – from the 10% improvement of Total Quality Management (TQM) to the times ten improvement of reengineering. Re-engineering is the latest in a long line of corporate fads, inspired by new management thinking and the desires of consultancy firms to extend the scale and duration of their client engagements. In the 1970s, consultants such as McKinsey & Company introduced the idea of the ‘standard business function’ and promoted certain corporate absolutes like standardized finance and accounting operations. This introduction of best practice led to shared service centres that helped eliminate bureaucracy and waste. The 1980s brought an increased focus on efficiency with TQM and similar techniques aimed at improving functional performance. However, it was not until the early 1990s that attention moved beyond functional boundaries to consider entire work processes. Despite the dramatic prospects of improvement held up to potential buyers of re-engineering services, the technique did little more than streamline systems and remove layers of middle management. Transformational benefits were hard to realize given the enormous task of trying to change culture, work flows and information systems in a single big-bang approach. Companies spent millions of dollars to achieve change, but in the end found marginal competitive benefit because everyone else was doing exactly the same thing. Re-engineering has left no sustainable advantage to date, and it has a failure rate that vies favourably with mergers and acquisitions. Cynics may argue that the real benefactor of the re-engineering revolution was the consulting sector itself.

The role of the consulting sector From modest beginnings early last century to a multi-billion dollar industry, consulting has become one of the most dynamic growth sectors in the new economy. Fuelled by technology-driven change, there is every prospect that the sector will continue to prosper and evolve for several decades to come, although we believe its form will change (see Chapter 11).

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In its early form, consulting emerged in the 1930s as a service to manufacturing industry. The main offering was work-study measurement, designed to identify and overcome inadequate work practices on the shop floor. A science based on improving factory performance emerged as a consequence, and several consulting firms, such as Urwicks and PE-International, grew to prominence. These techniques predated computer automation by two or more decades. By the 1960s a new group of influential firms emerged to focus on broader corporate policy and planning issues fuelled by structural changes taking place in the world economy. These included now familiar names such as McKinsey, A.T. Kearney and Booz Allen Hamilton. At the same time a further group of management advisers focused on technology-driven issues. These included names such as Arthur D. Little, PA Consulting and SRI International. With the explosive growth of information technology throughout the manufacturing and service industries in the 1970s, the major five accounting firms diversified into management consulting. Despite consolidations and spin-offs, these firms continue to occupy leadership positions in this segment of the consulting services market. In addition to IT, privatizations of national utilities and telecommunications companies gave these firms a welcome boost. In 1990, business re-engineering spawned yet a further wave of consulting boutiques, such as Index and Gemini, as well as a mainstream response by the larger houses. This wave has been followed by e-business almost a decade later, and a subsequent group of start-ups such as Sapient, Scient and Viant (referred to as the ‘fast five’ for their meteoric rise and equally meteoric descent). As the consulting business matures, the inevitable rounds of mergers and acquisitions have taken place, leaving a handful of full-service providers such as Accenture, CSC and IBM (which recently acquired PricewaterhouseCoopers’ consulting arm). Other global contenders include the remaining independent strategy houses and many niche players. The re-engineering revolution continues but under different guises. In the last five years we have been tearing down national rather than functional boundaries inside multinational corporations to pursue further economies

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of scale and globalization models. More recently we have started to see the introduction of web-based processes to further enhance efficiency and speed. The outcome of progressive waves of re-engineering has been a reduction in corporate size, and in some cases it has led to highly efficient structures with global reach and range. However, the emphasis has been purely internal and has had little impact on corporate effectiveness in a rapidly changing external environment.

There’s a world outside your window Ok, so all this corporate rewiring, streamlining, and redesign does reduce the costs of internal operations. And in turn this reduces internal transaction costs, which reinforces the structural status quo and should, in theory, help firms to survive and even grow larger. But as we all know, corporations don’t exist in a vacuum. Take the accounts payable function, for example: it spans not just internal boundaries but also extends into those of the corporation’s suppliers and probably into a bank or two – in the case of international trading, governments may be involved. An efficient process would, of course, extend information visibility to these entities as well. In the real world, even the links between the accounts receivable system of the supplier and the accounts payable system of the customer are almost always implemented using paper. Corporations implementing state-of-theart information systems increasingly became islands of automation in a sea of poor practice. Kicking management consultants for this omission, although tempting, is hardly fair – there was little choice but to take an internal focus. Apart from painful implementations of electronic data interchange (EDI),4 there was no mechanism to share information across corporate boundaries. In summary, re-engineering was a fine idea but it didn’t, and perhaps couldn’t, go far enough. Deeper efficiency could only have been achieved by extending the redesign beyond the corporation’s immediate identity. But now there is the opportunity to do just that. The new, richer interconnectivity between corporations means we can at last concentrate on the re-engineering of the entire supply chain.

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Causes and consequences Pulling the trigger for atomization The causes of atomization are changes to the nature of customer demand (which we covered in the last chapter) coupled with the collapse in the stock market. The trigger for atomization is the fall in external transaction costs, and that brings us back to the Internet. The formation of electronic markets and Internet-based portals represent two significant external developments that begin to challenge the status quo. Though currently limited in success, we expect rapid falls in the costs of doing business externally. This, according to the Coase equilibrium, negates the advantage of size but leaves behind a heavy administrative overhead. So we would expect to see a gradual and progressive erosion of corporate boundaries. Wholesale atomization of the corporate sector is coming, and it’s not going to be gradual and progressive. To understand why not, we have to look at two changes – one past (the Internet) and one present (outsourcing) in the economy.

Are the streets really paved with gold? Talk about follow my (blind) leader. Just when the large corporations began to feel sleeker and fitter in the late 1990s through years of downsizing and re-engineering, a new threat arrived. The advent of the Internet in the 1990s brought with it a new kind of lusty greed on the part of ambitious entrepreneurs. The dot-com era of small, agile start-ups, more able to exploit new technologies and business models, posed a more serious threat than established competitors. Some were genuinely good but many were simply a case of hotshots believing that ‘anyone can do it’. Spurred on by venture capitalists and consultants, senior executives began to leave the big corporations in the thousands to create new companies designed to destroy traditional players. By the start of the new millennium we were witnessing the largest migration of financial and human capital into start-up companies, each fuelled by the prospect of unimaginable wealth and success. NASDAQ reached the dizzy heights of 5,000 points. The promise was simple. The take-up of Internet connections, both commercial and domestic, was advancing at 15% monthly compound

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growth. That’s phenomenal by any reckoning. This growth implied that an increasing percentage of products and services would be bought directly online. Taking this to the limit would mean that established retailers and distributors would lose control of their customer base and the new electronic infomediaries would call the shots. In areas as diverse as financial services and pet foods, newcomers sought to acquire customers online, offering them cut-price bargains with flashy ads. Large corporations responded by liberating their own ‘intrapreneurs’ to engage in similar new ventures. There were successes, even in the sleepy UK, where the retailer Dixons, which launched an Internet Service Provider, Freeserve, and the Prudential Insurance Company, which created a new electronic bank, Egg. A lot of consultants made a lot of money. However, the dot-com boom didn’t last. Despite the energy and commitment of the founding fathers, this revolution was short-lived. The most obvious shortfall was the absence of established relationships among the new start-ups. Consider the online sports and footwear retailer FogDog, which arrived in Europe with a young chief executive and a well-proven US business model. The company planned to open up websites in seven countries in the space of six months, and build a catalogue of over 20,000 stock units. The reality facing FogDog and others like it was the need to acquire millions of customers, hundreds of employees and thousands of suppliers. Each represented a costly investment as well as careful design and execution. No amount of capital could pay for such a rapid expansion in reach and range of retail activities. In hindsight, it would have been cheaper to open up high-street stores across Europe than to recruit shoppers to FogDog’s website! When the NASDAQ collapsed in March 2000 the investment rug was pulled from under the many struggling dot-com start-ups, and the majority of them just disappeared from view. Survivors were those who had been fortunate enough to attract sufficient customers to achieve viability. For example, many of the search engines such as Yahoo! and Google were well-established brands with millions of customers and could continue to command advertising revenue and click-through income. Auction sites such as eBay generated enough trade to maintain their position. Retailers such as Amazon and e-Toys were beginning to bite into the high-street trade and are

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today highly acclaimed. But, if you remember back to the last chapter, they also offered something unique – help in navigating us towards life-changing experiences, not simply breadth of stock – a matching service if you like. Also, specific service categories such as travel, recruitment and finance offered the customer sufficient choice and value to be a viable alternative to established competitors. As Clayton Christensen observed in his book The Innovator’s Dilemma5, the arrival of a new disruptive technology, the Internet, was not in and of itself sufficient to erode the strong positions of the many incumbents (at least, not in a matter of months). It is a transmission technology, nothing more, an ‘enabler’. The corporate dinosaurs may have been wounded, but not terminated. What all this dot-commery did do was to force many to look once again at the customers’ role in the corporation, and to question whether the rigid old corporate structures were correct – roll on atomization!

Hauling out the trash The biggest threat to the traditional corporation today is not Internet startups, it’s outsourcing. We’ve talked already about make-or-buy decisions and the corporate re-engineering diet. Outsourcing is a logical extension of this, as large companies try to combine functional activities into shared corporate services to increase standardization of practices and reduce overall costs, or even to get rid of them altogether. That’s logical and financial sense. In many companies today, such as Procter & Gamble and Shell, functions such as finance, HR and IT are located in a few global ‘mega-centres’ serving hundreds of business units. The consolidation of such services has been so successful that senior managers are now considering what to do next – maintain the shared services in-house or look for suitable external partners. At the same time, what else is happening? Well, large IT service organizations, such as EDS, CSC and IBM, are beset by a declining IT spend among their major customers, and extreme pressures to find new sources of income. All have recognized that the outsourcing of non-core functions could yield vast new growth opportunities, and companies such as these have been offering powerful incentives to the large corporates to transfer

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such assets to their safe keeping, such as cash up-front and guarantees of operating cost reductions over periods of years and decades. With the large corporates in the throes of a deep recession and profit squeeze, such offers look too attractive to pass up. In addition, they enable businesses to simplify their internal operations down to the basic core. The decreasing real cost of telecommunications has another effect – the availability of highly skilled and very cheap labour in developing countries such as India and China means that an increasing number of CEOs are tempted to relocate large chunks of their corporate activity offshore. Service providers are also wise to this, and most are setting up vast brain farms in Asia to offer IT and business process outsourcing. Just as the West found it could not compete in manufacturing without protectionism (that means you, America), so we are starting to move into a post-service economy. We will talk at greater length about outsourcing in Chapter 9 and about the IT services sector in Chapter 11. In summary, though, we are witnessing a massive transfer of corporate assets from the ‘old economy’ companies, such as oil, finance and utilities, into the ‘new economy’ IT services sector. This process will accelerate as IT services companies learn to manage these assets in an efficient way – through the application of re-engineering techniques.

Summary: get into shape! It’s now pretty clear that universal connectivity is rapidly changing our roles as individuals, either as individual employees or individual customers, from one of response to one of demand. We in the developed world finally have a way of expressing all of our demands, and those demands are to increase our experience rather than to consume your product. The fight is on between the big, powerful enterprises and the small, versatile ones. As corporations find further (unconvincing) reasons to increase in size and scope through mergers, acquisitions and global aspirations, other forces seek to disrupt their efforts. These forces include Internet-based

LAND OF THE GIANTS

electronic markets and dot-com start-ups as well as moves towards outsourcing non-core functions and activities into externally provided service platforms. The short-term effect appears to be a tug-of-war between the forces of scale and scope and those that encourage agility and simplification. It’s clear that most older corporations set in their ways are not ready to embrace this change in role, being too centred on their products and their internal functions. We want to shout, ‘Focus on agility: you can’t be big and agile at the same time, so make the changes and get in gear.’ Fragmentation is looking more and more attractive as the internal cost of movement is high. For many players in the economy ‘critical mass’ now translates as ‘critically ill’. However, as we will see in Chapters 4 and 5, the outcome will accommodate both sides, with an increasing polarization between small, agile entities that look after the interests of customers and product innovation, and the large-scale utilities that provide global scale and scope in production, logistics and key functional tasks. Each company has to accept its place in the bigger picture. This is the new universe of atomization, and the countdown has begun. Simultaneously, the market capitalization of traditional giants continues to drop, and corporations that are winning the battle for shareholder trust (the only real safeguard of CEO survival) are agile, inventive and relationship-focused. If the giants are to survive in any form, CEOs must find a way to realize and unlock the value tied up in their organization to ensure competitive advantage and, often, bare survival. The equilibrium between internal and external transaction costs has shifted. Sure, re-engineering and internal web-enablement will streamline process, but the costs of doing business with other organizations will drop further and faster. This challenges the old logic about corporate size at the most inconvenient time possible. Environmental changes are pushing an unstable system and the only possible outcome is radical change. For those who embrace it, the prize in terms of unlocked relational capital is enormous (see Chapter 8). The change will take time – it will be another ten years before its new shape becomes clear – but that doesn’t mean we won’t see it happening. We surely will, and soon.

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New atoms will take over as units of production and distribution, customized for all individual demands imaginable. The next decade will feel like snowboarding in front of an avalanche – be prepared and enjoy the ride!

Endnotes 1 Oliver E. Williamson, 1967, ‘Hierarchical control and optimum firm size’, Journal of Political Economy, 75, pp. 123–38. 2 Ronald H. Coase, 1937, ‘The nature of the firm’, Economica NS, 4, pp. 386–405. 3 Oliver E. Williamson, 1975, Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization, Free Press. ISBN 0029347807. Oliver E. Williamson, 1985, The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting, Free Press, ISBN 0029348218. 4 Electronic Data Interchange, an early form of e-commerce involving fixed-format messages defined by standards such as ANSI X12 and UN EDIFACT. EDI proved difficult and costly to install and maintain, although fairly efficient once operating. Modern standards such as Extensible Mark-up Language (XML) offer the same benefits and increased flexibility at lower cost. 5 Clayton Christensen, 1997, The Innovator’s Dilemma, Harvard Business School Press, ISBN 0875845851.

Discontinuity

Before we move on to the new theory of the firm, let’s take a look back over the last three chapters and simultaneously over the last hundred or so years of corporate development. In that time, corporations attained vast scale and scope. Some now approach the size of larger national economies. General Electric could, for example, reach the size of the French economy by the end of this decade if it continues to achieve its historic growth rates (or France continues along its current economic decline). For over forty years, academics have developed theories on how to manage scale and complexity effectively, and thus keep ever-expanding corporations alive. Peter Drucker invented the science of management in the 1960s and many great thinkers have emerged since then, covering every aspect of large-scale corporate activity, from strategy and governance to structure and control. A whole industry,

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consultancy, has developed and prospered by assisting large corporations to remain effective in changing economic circumstances. The advantages of scale have been numerous. They range from lower cost of capital and improved procurement leverage to global brands and well-stocked product portfolios. In a supply-driven world, large-scale production facilities – be they factories for producing goods or armies of skilled workers for delivering services – have returned a healthy profit for their owners. But we think that now the game has changed. Gone are the value and central importance of the unified corporate entity. Many forces are challenging the once indestructible corporation. These include: • Collapsing stock markets: The recent rapid decline of shareholder value illustrates the loss of faith of global stock markets and investment institutions. Shareholders are becoming increasingly sceptical about the ethics of large corporations and the managers who run them. • Over-provisioning of production capacity: In many sectors there is a glut of production capacity, for example in chemicals, steel and electronics. With ever more volatile patterns of demand, fixed production capacity has become a liability rather than an asset. • Inflexible sourcing arrangements: Long-term supply partnerships were considered an enduring asset in many sectors. With the gradual but inevitable growth of electronic markets and intermediaries (not to mention the destabilizing effects of rapid price shifts), rigid supply arrangements become costly and cumbersome. • Remote and insensitive customer service: The world today is plagued with remote and impersonal call centres as well as warehouse-styled retail outlets that offer reduced cost of operation at the expense of poor customer service. Corporations are clearly focused on their products, not on their customers. • Lack of genuine product innovation: Most large corporations have either disbanded their research labs or turned them into development centres geared towards incremental product enhancement rather than genuine innovation. Some large corporates now admit to having run out of innovation capacity altogether. All these factors might suggest a radical rethink of the traditional business model. In most respects, large is no longer beautiful. Instead it spells rigidity, remoteness

DISCONTINUITY

and inefficiency. In a connected world, new capabilities are required to compete effectively. Companies must be prepared to listen carefully to their customers through new interactive marketing channels. They must also be able to innovate more rapidly to reflect changing consumer attitudes and behaviours. They must also build more flexible and responsive supply relationships to respond to demand volatility. In subsequent chapters, our new corporate blueprint for a connected economy asserts that business success will come from excelling in just one of four dimensions. The first dimension is product and service innovation. Organizations engaging in these activities will become the engines of the connected economy. These organizations will need to be small and agile to anticipate and respond to changing consumer needs. We agree with Clayton Christensen’s assertion that large companies cannot introduce large innovations. Needless to say, we do not hold out too much hope for the mega-corps of today, which have not the culture, the agility or the market connectivity to succeed in this space. The second dimension is relationship management. Improvements in connectivity with customers, suppliers and other business partners will reward ever-greater know-how and the ability to extract value from relationships. They can be created and sustained by facilitating the two-way exchange of commercial, financial and personal information. The third dimension is risk management. As traditional industrial structures fragment, greater emphasis will be need to be placed on managing a portfolio of different industrial entities, each contributing specific competencies to a complex business network and each carrying its own set of rewards and risks. Many shareholders will look towards portfolio managers as their personal ‘front line’ in the battle for equity growth. The final and crucial dimension is industrial ‘heavy-lifting’ equipment. Small, agile atoms will need efficient yet flexible manufacturing and distribution capabilities to bring their new ideas to a global marketplace. To avoid the old mistakes of over-capacity, the product and service innovators will probably subcontract such activities to third parties who can balance variable demand across geographies, companies and sectors. They will also want to offload generic activities such as HR, IT and finance to third parties that can operate efficient and modern shared service centres.

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The glaring inadequacies of today’s bloated and lethargic corporations can be overcome by applying these new operating principles. Now let’s move on to the next chapter to understand how these ideas can be embedded into a new economic structure – that of the atomic corporation.

Part 2 Collapse

4

What is an Atom?

Small is beautiful By now, we should have convinced you that large, inflexible corporations are being shaken by earthquakes in the economic bedrock. In this chapter, we will introduce you to the entities that we think will replace them – the atomic corporations. Unlike today’s dinosaurs, atomic corporations can be both efficient and agile. They are able to meet very specific needs and desires in the new economy of individuality and customization. In this chapter, we will describe the organizational elements that will make up the economy until the middle of this century, and we’ve included some examples of emergent atoms at the end of the chapter. We will see two types of atom emerge: small and agile atoms, which are innovation and

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relationship driven; and larger asset and service platforms, which concentrate on scope and scale. Go on, ask if this sea change in the business landscape is really going to happen. Yes, it is. These basic units of production and distribution can organize and reorganize according to individual customer demand. Some of these atoms will be large, some small, but together they can unite to form systems that are powerful, fast and immensely flexible, and still manage to meet completely customer expectations. We predict that by the end of this decade we will be living in a society of atomic corporations. Those few behemoths that have yet to make the change will be still running at industrial-age speeds. You’ll find them clinging to their marketing departments like life jackets and watching tearfully as their margins wither away! If you think this scale of change is exaggerated, consider this example. There is an evolutionary precedent for the type of change we’re talking about. The dinosaur’s ascendancy on earth didn’t end overnight, although the moment an asteroid crashed into the Gulf of Mexico was the beginning of the end. The resulting long-term change in the environment meant it was no longer possible to find the tons of food that were needed to sustain their giant physiques. Smaller, smarter, faster creatures were better at exploiting the changed landscape. And just as the dinosaurs were wiped completely from the face of the earth, so with time the age of the corporate dinosaur will come to a brutal end. But now, with a roll of drums and a short fanfare, it is time to take a look at the components that we think will emerge to support the new economy. These are: • • • • • •

smart companies; webspinners; customer managers; asset platforms; service platforms; portfolio owners.

W H AT I S A N AT O M ?

Big ideas from small organizations – smart companies The first of our atoms are smart companies which serve a broad industrial base, knowledge-based businesses capitalizing on skills in innovation. This type of company may concentrate on science and technology (such as drug design/discovery or specialist software), or in more creative fields (such as graphic design or journalism). In some ways, these are the ‘engines of human endeavour’, the ways by which the economy moves itself forward. As we are starting to see service industries moving overseas in the same way manufacturing did decades ago, we cannot stress this strongly enough: the next industrial revolution will be about ideas. Can smart companies be spawned by existing corporations? Yes, but it will require a complete change in their mindset. The notion of releasing intellectual assets from their parent corporation – indeed, sharing them with competitors – seems to contradict all traditional business theory. However, each item of intellectual property has an asset value in its own right and, if a corporation has enough ideas, the market can probably find more to do with this portfolio of ideas than can one corporation. The portfolio can therefore be securitized and thus bring capital wealth or income to its parent corporation. Although BMW, Sony and Ford have all spawned independent design shops, most large corporations find it very hard to deal with major innovation,1 and we expect to see most smart companies to be formed from consultancies, consulting engineers, designers, architects, etc. For example, we see from the pharmaceutical industry that new start-ups are not only driving the pace of innovation but are also doing it more cheaply than Dinosaur Drugs, Inc. The agility of smart company atoms necessarily makes them far more able to innovate than large corporations, provided they stay small. Their value will be determined by the worth of their patents, their innovation and their knowledge reuse processes. As with many research and development operations (where for every successful drug there are ten, a hundred or a thousand unsuccessful ones), profits may depend on only one or two positive outcomes. Intangible worth will make up the principal element of the share price, with a solid long-term growth in capital worth to more than compensate for the frequent lack of profits.

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One of the earliest and most successful examples of a ‘smart’ atom is the Coca-Cola Company, and we profile it in the case study section at the end of this chapter.

Business catalysts – webspinners For the past hundred years, business-to-business relationships in the old production-centred world tended to be governed by preordained agreements: ‘We might buy so much of this kind of stuff from you, at this price.’ But in the new world, customers are increasingly capricious and what was an excellent source of supply yesterday may be irrelevant today. When coupled with the changes the Internet brings,2 we think these rigid chains are too inflexible to survive. When no two customer offers are likely to be identical, the elements of the offer that are to be assembled (and therefore the business-to-business bonds that need to be created) vary almost in real time. Recent and impending network innovations open up huge opportunities in the way we partner to do business. Making a market between those who want to sell goods or services and those who want to buy them is almost as old as commerce itself, but the rise of two-way, ubiquitous communications channels makes it much easier to establish the right partners, offering the option of creating alliances at the moment of trade. In a world where large, vertically integrated corporations and their supply chains are starting to fragment, many more business relationships will be needed and there will be many more potential offers to evaluate. Enter the webspinners! New e-commerce technologies reduce the sourcing and management elements of transaction costs but there are still issues around discovery – finding out whom you should be dealing with. That is where our webspinner atoms come into play. They will effectively own the relationships between suppliers and customers by improving the matching process across the value chain. They act as catalysts to ease the bond-making and bond-breaking processes. Trading with someone must involve price, trust and prior experience. Who can provide the goods or services you need? Are those available now? Can the potential partner be trusted to deliver? It will be the webspinner’s job to facilitate inventory visibility and complete description of the goods or services, and to provide an assurance of trustworthiness.

W H AT I S A N AT O M ?

That assurance of trustworthiness is the key to the webspinner’s value proposition. Generated from a combination of financial status, transaction history and rigorous review by previous trading partners, webspinners could offer anything from basic ‘trust ratings’ (consider Moody’s and Standard & Poor’s) to full guarantee of supply and payment. Webspinners need not be large, but their reputation must be unblemished. Webspinners are also the natural gateways for trade facilitation services such as insurance, procurement advice, protection against currency fluctuation and bankruptcy, import/export services, shipping, and advice on legal and cultural differences. It is the arrangement of these services that will generate most of their revenue rather than simple transaction or introduction fees. We are already familiar with some of the companies who play in this space, and we profile the well-known travel company Kuoni in the case study section at the end of this chapter.

Knowledge is power – customer managers Yahoo!’s stated vision has hardly changed since 1994: ‘… the only place anyone has to go to find something, connect to someone or buy anything’.3 Wow! If they were the only place that we needed to go on the Internet, where all of our news (from communities of interest or the wider world), shopping, finances, etc. came from, think of the capital value of those relationships! That’s a grand vision and equivalent to most of the business done by one billion people going through a single branch of Wal-Mart. But Yahoo!’s vision is perhaps too large. It’s more likely that capturing and satisfying customer desires will be focused around just some of the customer’s primary objectives – learning, health, personal wealth management, employability,4 entertainment, etc. – with bundles created, not to meet the typical customer’s need, but one particular set of preferences – yours. This idea of your preference is crucial. It’s all about ‘anticipation of need’ and personal insight into need – ‘help me better understand myself through my interaction with you’. Anyone who has used amazon.com frequently will know that they encourage customers to review goods bought from them so that they can provide better recommendations on what you might like in future. They are really asking customers to provide insider knowledge of

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their likes and dislikes in return for better service. The customer portal must capture, confirm, refine and constantly use the customer’s views and experiences (and those of other, seemingly similar, customers) in suggesting offers. This type of atom exists today but will become more advanced in time. There are some practical difficulties but none that can’t be overcome. In some European countries it is illegal even to mine customer data in this way, but if you can persuade customers to give you information about themselves (and that persuasion might be expensive), and if the information is used to improve their lives, then loyalty and a major share of their wallet is assured forever.5 That’s why we expect the best customer managers will have revenues measured in tens of millions of dollars per employee and solid growth in capital worth. Customers will benefit from atomization of large corporations. It will feel as if they are dealing with both a small company and a large one. The small company will be the customer manager atom, which, because it is concentrating on doing one or two things very well, will be very responsive to the customers’ needs. But there should also be the sensation of dealing with a large company because of the range of products and services and the depth of competence that are behind the atom, delivered through a web of alliances. We’re betting that customer manager atoms themselves will be reasonably large – to deliver the degree of personalization required at acceptable cost will require a great deal of investment. We would estimate that a customer manager would require 1,000–5,000 employees.6 That all said, it is far from certain that they will rise from today’s large corporations. Many organizations with large customer-facing operations (including utilities and banks) know staggeringly little about their customers and seem to have less idea what to do with that knowledge. So talk of them assuming management of the customer’s lifestyle is fanciful for the moment. The language gives it away – banks talk about their customers as ‘accounts’, telcos use ‘subscribers’ and utilities say ‘meter-clicks’. Large corporations don’t get the key point about customer relationships: it’s what customer intimacy can do for the customer that matters, not what it can do for them. One exception is the UK supermarket chain Tesco, and we profile them in the case study section at the end of the chapter.

W H AT I S A N AT O M ?

Getting physical – asset platforms The atoms above can only marshal and reorganize – they aren’t actually creating the physical goods that are probably going to be an element of the customer offer. Someone has to make the cars, grow the bananas and refine the oil. This will be the role of the fourth and largest type of atomic corporation, the asset-based business platforms (or asset platforms for short). What are the characteristics of this type of organization? Most are concerned with the manipulation and movement of matter on a grand scale within a particular industry, and here critical mass can play a part. We foresee these platforms being multinational and potentially global, either through direct ownership or by a franchising arrangement. Businesses in this category will require considerable capital and will be focused on operational excellence within a single industry, looking for economies of scale and scope in the manufacturing and distribution of products and services. They will be the largest players in our atomized economy in terms of numbers of people, capital employed and (probably) revenues and profit. However, they won’t dominate the supply chain – they are too far from the customer for that to happen and the customer will rarely, if ever, hear their names. Today’s stock market demonstrates that large-scale capital businesses tend to have stable (and low) market capitalizations, but they produce solid profits. Look at corporations such as Ford, General Motors, Dupont, agribusinesses, etc. these are corporations with price/earnings ratios often of less than ten, but which give good dividend yields – blue chip investments offering good returns at relatively low risk. All of that isn’t to say that there is no scope for the small, specialist refinery, the specialist farmer, the microbrewery, or the corner shop. They will trade efficiency for agility and play a role in providing customized services, albeit at higher cost than the global giants. Of course, many asset platforms already exist. The contract manufacturing sector consists entirely of asset platforms, not to mention thirdparty warehousing firms and logistics providers (trucking and shipping concerns, air freight etc.). Geographic regions, too, have begun to excel in this role – take Taiwan and its dominant position in third-party electronics

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manufacturing. Later in this chapter, we profile one of the best-known asset platforms, Celestica.

Perfecting the generic – service platforms Service platforms will take responsibility for organizing common ‘processes’ for all other atoms. Every business – large or small – needs to pay its staff, provide office space and computers, file their annual accounts, handle cash and carry out a multitude of pretty boring but necessary tasks. These do not differentiate them or directly provide income, but they do need to be done in order to stay in business. We definitely see a role for a fifth atom type to handle these processes – if you like, to specialize in the generic. Unlike the ‘vertical’ asset platforms, these generic processes and supporting platforms would not be specific to one industry, but would probably be tied to a geography or a legal system – an atom that provides HR support processes in the USA, for example, would not be viable in the European Union because of the differences between labour laws, tax structures and retirement planning mechanisms. How might these service platforms be created and how could they work? There are a number of examples. For instance, in procurement, the first Internet marketplaces were cross-sector, set up by banks and telcos to manage catalogues and the purchasing element of the process. Many of these had ambitions to support the payment and reconciliation processes as well. It is a short step to envisage the full life cycle of procurement being managed by such a service platform, especially for indirect items. The aggregated spend can be put to good use by specialist negotiators. Another example lies in office space, something that ties up a great deal of capital but adds little value to a business. It is hard to find, troublesome to maintain and difficult to get rid of. A specialist supplier with a large pool of quality office space could lease it and dispose of it quickly. Again, we profile one such supplier, Regus, in our case studies. Or take a third example, human resources. While most corporations would describe their employees as their most important asset, very few have a set of HR processes that really reflects that view. All too often, HR systems increase bureaucracy for the workers and block information that could allow them to do their jobs better. A door is open for entities with superb support

W H AT I S A N AT O M ?

infrastructures to sweep away most of the poor quality in-house organizations and serve many corporations within the same geography. BP recently signed a $600 million contract with Exult for all of its HR services, and Exult has gone on to service a number of other big-name clients. There are other potential areas for horizontal service platforms too. IT development, operations and maintenance are increasingly common outsourcing targets. What about marketing, publicity, lobbying and events management? Or management of call centres and customer insight processes (surveys, market research, demographics, etc.)? We predict that business finance (including insurance, audit and IPOs) and specialist international finance (forex markets, trade facilitation, letters of credit) will also be served by horizontal platforms in the new arena. As with asset platforms, certain geographic regions of the world are becoming compelling venues for service-based activities or processes. Take India and China. Both countries have highly skilled workforces that operate at a fraction of the cost of equivalent Western workers. Many companies – large and small – are choosing to relocate ‘back office’ functions, such as IT and finance, to such locations. Rather like the wholesale migration of Western manufacturing operations ‘offshore’ in the 1980s and 1990s, the same trend is becoming evident in service-based activities, and it is heralding in the ‘post-service’ economy for many developed countries such as the UK and USA.

Managing a risky business – portfolio owners We have painted a picture where our monolithic corporation splits into a number of potential atoms. But why would the CEO and the shareholders want to do that? Shareholders would need to be compensated for the loss of direct control over its assets. The mechanism is this – in place of those assets, the shareholders will initially own part of the atoms that are spun off. As we will demonstrate in Chapter 8, the sum of the parts should be worth considerably more than the original parent corporation. So our final type of atom is a portfolio owner that exists as a vehicle to retain the residual ownership of other atoms on behalf of the erstwhile shareholders. The principal competency of these atoms is risk-taking. Portfolio owners will manage their atoms as a set of investments that are expected

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to produce returns, maintaining a mix of types of atoms that produces the right profile of risk and reward. That is similar to the task of boards of directors of today’s conglomerates, and that is where most of the portfolio owners will come from, although we would also expect today’s venture capitalists and pension/mutual funds to acquire or part-own atoms. The corporate centre of today’s best-run organizations often acts as a portfolio owner, in that they mediate between the shareholders and the operating businesses. Tomorrow, such organizations may choose to invest in a specific area of the value chain rather than producing a specific product or service, although they may retain corporate brands and governance processes. These are the financial giants of the new economy. Portfolio owners will have large market capitalizations and their balanced portfolios will attract much of the direct investment by individuals. They will be the channels through which many of the atoms – too small to float directly on the stock market – will raise capital. We profile one of the world’s most successful portfolio atoms, KKR, at the end of this chapter.

Add it all together … atomic energy combined Molecules make the economy come alive So there you have the six elements that will make up the new economy. Look around, this change is already starting to happen. We can already see asset and service platforms and smart companies in abundance, with the other types starting to emerge. We will move to an economy of relationship-focused customer managers and webspinners, innovation-driven smart companies, and scale-driven service and asset platforms, all owned by capital- and riskowning portfolio owners. Now let’s put them together. We talked earlier about atoms combining into systems that are powerful, fast and immensely flexible. How will this happen? What links the atoms together into something capable of getting the goods and services to the customer? In the old world, it would be the supply

W H AT I S A N AT O M ?

chain. In our atomic future, ‘fixed links’ are a thing of the past and are substituted for something far more fluid. In line with our chemical analogy, we will call these molecules. Chemical molecules are made up of atoms and bonds7 that link them together, and so we would expect to see some type of bond in our business networks. These bonds are electronic (e-) marketplaces. Like their real-world equivalents, e-marketplaces are communications channels – places where buyers and sellers congregate, each with the intention of finding someone to trade with. Successful marketplaces are defined by strong liquidity,8 and this is determined largely by the size of the population that the market serves. The Internet, with its billion-strong community, was always certain to transform ways of doing business and the lower transaction costs that marketplaces bring are an important enabler of the atomization process as well. Another key take-away: in the twenty-first century, the principal unit of production will be the business network, NOT the corporation.

Breaking down the industry barriers One of the functions of webspinners will be to arbitrate between industries. Consider the case of the customer with no means of transport. The automotive industry will want to sell the guy a vehicle, finance houses will want to arrange a finance deal for him so that he can buy a car, and perhaps sell him some insurance, and customer managers will put the deal together. What he actually wants (and you’d know if you’d bothered to ask) is a way of moving his family and goods about the landscape with certain guarantees of availability, reliability, safety and comfort. The components of the offer (the vehicle, the finance and the insurance) are secondary to this. Sure, the transportation need as communicated by the customer manager could be met by owning a vehicle, but the best solution for him might be a rent-it-when-you-need-it deal from a service platform involved in aggregating car rental demand and providing global rental services. Both of these options meet the customer’s need, but they provide different combinations of availability, flexibility and cost.

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Summary So our atomic economy will consist of atoms working together to meet customer needs, all sitting on shared service and asset platforms (see Figure 4.1). Some atomic corporations – smart companies, webspinners and portfolio owners – will be small in terms of numbers of employees. Others, the asset platforms, service platforms and perhaps the customer managers, will be much larger. All, however, will be much more focused than today’s corporation and will have the benefits of being efficient and agile. As part of a network of other tightly targeted organizations they have access to a range of skills that they need not possess in-house. Whichever way you cut it, the new corporations will be much smaller than the current Fortune Global 100, where payrolls of 100,000–300,000 are typical. You may have noticed that our case studies include (currently) large companies. This is not inconsistent, as we predict that their profits will continue to grow, even as their size starts to decline. Some of the dominant players in the new economy will derive from today’s large corporations, but others will not. Yes, many large corporations will transform and survive (we look at strategies for survival in the next chapter), but many will struggle and perish. The next decade will brutally punish the mediocre. In the words of Evans and Wurster, authors of Blown to Bits, ‘Deconstruction is most likely to strike in precisely those parts of Vertical Marketplace

Generic Business Processes Virtual Infrastructure Physical Infrastructure Figure 4.1 Atoms on a sea of platforms.

Customer Manager

Smart Company

Webspinner

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the business where incumbents have most to lose and are least willing to recognize it.’9 A word of caution: atomization will be not be painless. It is inconceivable that so much energy and value could be released without some collateral damage. But that will not defer the inevitable.

Six case studies – atomic corporations Who’s already ‘atomizing’? Take a look at the following case studies (and the ones in Chapter 7) to see how all this works.

Molecular soda – the smart company The Coca-Cola Corporation is one of the most successful companies in the world. Its brand is a household name in every country in the world. Its P/E ratio is way above that of any other company in its sector and it is one of the most highly valued businesses of any kind. How can this be? Despite Coke’s revenues being only $20 billion per annum, sales of Coca-Cola products amount to over $200 billion each year. The Coca-Cola Corporation presides over and supports an enormous and complex molecular web of interrelated businesses that work to make this $200 billion figure happen. All of Coke’s manufacturing, bottling, and sales and delivery processes are handled by third parties, which are controlled through an ingenious cross-shareholding system. So despite the fact that the Coca-Cola Corporation itself actually has minimal involvement in the production and distribution, a large part of its value is driven by the power it wields over the global system of third parties that exist to make and handle the product it appears to own. It closely guards the product formulation secret, it aggressively protects the use of the Coke brand, and it closely manages the activities

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of the companies whose job it is to make and deliver the product. But it does not make or sell the end product itself. So Coke behaves like a smart company, albeit one which has not yet shrunk to its optimum size. It chose to outsource to this web of businesses all the lower-margin manufacturing and distribution elements of its operations in order to focus on being really good at a small number of highly profitable things. Those things are brand management, product design and relationship management. Compare this range of activities with that of Pepsi. While Coke sought to narrow the scope of activities it was involved in, Pepsi sought to open them up. Coke decided that it was in the beverages industry and that it would play a very limited number of high-margin roles within it. Pepsi targeted the whole food and drinks sector and played a wide range of roles, all with different margin potential. It is interesting to note that Coke’s P/E ratio is 12% higher than Pepsi’s. What all of this means for us is that our principles of atomization have first-class precedent. Eschewing contemporary trends for vertical integration and direct involvement with the physical product from very early in its history, Coke saw the value of operating as a small, smart molecule in a vast and atomized space.

Kuoni – spinning the perfect holiday Let’s take a look at Kuoni. We admit we could have chosen any of the better package constructors, but Kuoni consistently wins World Travel Awards as the best tour operator. The company was established in Zurich in 1906 by Alfred Kuoni, and still generates 30% of its CHF4 billion turnover in Switzerland. Today it is close to leading the market in Europe and has a strong presence in the USA and India. Tourism provides 85% of the corporation’s turnover, where it employs 7,000 people worldwide who create package holidays for the mid-to-upper price segment. That sounds easy, but it involves creation of a blend of flights, land travel, accommodation, food and leisure

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activities that will appeal to rich Europeans. Kuoni is not a customer manager – it knows little about the people it organizes tours for, but it is superbly efficient at that organization. Its tour operating division selects the most attractive destinations, contracts with hotels and other service providers such as transportation companies, buys charter quotas, identifies competent local agents and organizes transfers and excursions with them. It also establishes a local presence at major destinations. We see an increasing trend in this market segment towards custom holidays, where the client, often advised by a customer manager (travel agent), specifies their dream holiday, which the webspinner (package company) then constructs.

Tesco – towards a customer manager Although now the UK’s leading grocery retailer, Tesco has traditionally been at the lower end of the market. It pulled out of this position by learning about its customers and being prepared to use that knowledge, and through excellence in web-based customer service. The story begins a decade ago, when the company started to build a customer database around its loyalty card scheme. If you (loyally) present your card at the checkout you receive a 1% discount on your purchases. Fifteen million customers (about a third of the adult population) belong to this loyalty scheme, including one of our colleagues in the UK. Like most other UK supermarkets, Tesco has an ‘affiliate marketing’ deal with a number of non-competing organizations to provide financial services etc.10 During the later stages of his wife’s pregnancy, our colleague used the supermarket’s website to buy his son’s first disposable nappies, and shortly afterwards he received a mailshot from the supermarket’s banking affiliate about planning for school fees! This could be a coincidence, but in a time when some retailers see their loyalty card schemes bringing little benefit, we see this as an example of a corporation that can not only deduce information about

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its customers11 but that can also identify major lifestyle events from the individual’s purchasing patterns. Now that’s customer intimacy. But it’s Tesco’s web presence that particularly excites us. Tesco is the world’s largest Internet grocer, keeping 300 of its stores open overnight to fulfil orders. Items ordered online are delivered the next day for a £5 ($8) delivery charge. The service is popular with time-harried users, who still make up the majority of the UK surfing population, and its customers get good prices, discounts and (above all) increased convenience. The loyalty card scheme is used throughout to reward repeat buying and personalize the site. And Tesco, of course, increases its understanding of the customer with each purchase. The core grocery products are supplemented by non-competing products and services, and the range far exceeds that carried by Tesco’s physical stores. Some products (books, CDs, furniture, jewellery, gifts, ISP) are delivered from other providers but with the Tesco brand, while others are co-branded (financial services from the Royal Bank of Scotland and flowers from Interflora). This affiliate marketing means increased revenues for Tesco and decreased cost for all participants, with the best-known brand being used to promote the goods. Finally, Tesco’s brand and image is enhanced, and its product set moved from ‘groceries’ into ‘lifestyle’, a move supported by Tesco’s purchase of a large stake in the UK version of iVillage, a women’s lifestyle portal. Tesco is not yet an atom, but we see them as being one of the few companies likely to make the transformation from retailer into customer manager.

Celestica – assets for hire A search on the Internet for ‘contract manufacturing’ will reveal that there are already hundreds of asset platforms concentrated around the pharmaceutical, electronics and automotives industries. They can provide all of the facilities of an in-house manufacturing facility without the associated capital investment. They also claim to be faster to set

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up than in-house operations, and in these industries, time-to-market is one of the key determinants of profitability. Let’s look at one of the leaders: Celestica. Nearly two-thirds of its 2001 revenues of US$10 billion came from contracts with Sun Microsystems, IBM and Hewlett-Packard, but it serves a large number of OEMs in the IT and communications industries. Celestica is the third largest electronics manufacturing services company in the world, with more than 40,000 employees in both highand low-wage economies. It invests heavily in process improvements and communications, providing incredible amounts of real-time information on build and delivery. It’s not a pure manufacturing platform – it has an associated operation that assists its clients in designing for easier manufacture, and it also extends its services into delivery of goods to its clients’ customers. We think Celestica’s 2001 deal with Lucent points the way to the future for the in-house manufacturing plant. Celestica took over Lucent’s manufacturing operations in Oklahoma and Ohio in return for $600 million in cash and a five-year manufacturing deal worth about $10 billion. Lucent therefore obtained a radical improvement in return on capital employed (ROCE) and simplified its operations at a stroke.

Regus – walk in, sit down, start work It’s expensive to maintain branch offices in many locations. CEO Mark Dixon founded Regus in 1989 with operations in a single business centre in Brussels, selected to help international companies gain instant access to the European marketplace. Fourteen years later he had built Regus into the world’s largest operator of outsourced business centres, 80% of whose business is made up from global corporations such as GlaxoSmithKline and Merrill Lynch. The process for acquiring an international office for a day is fast (it based the rental agreement on a car hire form) and Regus offer

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business centres in more than 50 countries, where you can rent offices fully equipped with furniture, IT systems and support staff. It makes little business sense to maintain under-utilized office space in multiple locations just in case an employee or two needs to use it every now and again. One of the main drivers of the success of Regus is the fundamental shift in the relationship between workers and the workplace. Technological advances mean that workers are no longer tied to a single location but can (and do) move to wherever they are most needed. The rate of change in corporation size has also accelerated, with businesses expanding and contracting with alarming speed. The best corporate planning departments in the world are unable to meet in-house the demands for office space that are demanded by these accelerated life cycles. But perhaps the most compelling reason for Regus’s success is its ability to get the costly, capital-intensive premises off the balance sheet of large corporations. Although it sees itself primarily as a service provider, with its scale and expertise Regus probably manages offices better than most corporations anyway; they certainly claim to be able to do it cheaper on a fully loaded per user basis. If you do want to own the assets, Regus also provides an outsourced property management service, removing the need to maintain the skills inside corporations. In many ways Regus is the archetypal horizontal service platform (70% of its employees are customer-facing), operating on top of asset-based businesses (it leases most of its property), providing ways of overcoming geographical and temporal constraints to other corporations. Regus has announced that it intends to form alliances with other horizontal providers of support services such as bookkeeping.

Kohlberg Kravis Roberts – portfolio owners KKR is a marvellous example of an emergent portfolio owner. It buys and sells other corporations as assets, investing in them in order to

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increase their wealth. They are in the business of general risk management and minimization: KKR’s assets are not just corporations – they also invest in reinsurance and property. KKR has so far completed more than a hundred transactions since its foundation in the 1970s, involving in excess of $100 billion of total financing, $16 billion of which came from its own coffers. Each asset in KKR’s portfolio is independently managed and financed, meaning that it is a long way from the old Hanson-style conglomerates. Often, this management involves the break-up of large corporate parents into stand-alone, independent companies, highlighting the role of the portfolio owner as a catalyst for atomization. Although KKR stresses speed in acquisition and boldness in management, on average it owns assets for eight years, longer than many of its competitors. Although well known for its creativity in structuring transactions and excellence in due diligence, it is also an excellent corporate shepherd. KKR’s involvement in helping its assets enhance shareholder value is justly famous, and it is something of a role model of effective corporate governance. The reward mechanism for KKR’s staff is rather direct: they have a significant amount of their personal net worth invested in the assets they manage.

Endnotes 1 In the early stages of their life, disruptive ideas rarely work as well or as cheaply as the product they will replace. Large companies generally refuse to play in what they perceive to be a small market, leaving the ideas to the Darwinism of smaller companies. See Clayton Christensen’s excellent book The Innovator’s Dilemma for a more detailed explanation of this phenomenon. 2 The Internet affects business-to-business relationships in two ways. The first element, the effect on the discovery element of transaction costs (‘Who shall I trade with?) is obvious. We also believe that events such as Internet auctions introduce more of an element of supply and

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demand into goods pricing, and this tends to undermine stable supply chains. Quote from Tim Koogle, Chairman and CEO of Yahoo! in his FY2000 analyst briefing. We would definitely expect the best recruitment and executive search agencies to become customer managers. Philip Evans and Thomas Wurster have discussed at length what they describe as the logic of affiliation. At the moment, customer managers (they use the term ‘navigators’) affiliate with sellers because richness of content tends to be specific to suppliers, and because consumers are unwilling to pay for advice. They argue that the use of rich communications channels will see a shift to buyer affiliation as it represents a major competitive advantage for the customer manager. We would agree with that. See Blown to Bits, ISBN 087584877, p. 129 et seq. At the time of writing, Yahoo! has around 3,500 employees, generating revenues of $350 per employee. We expect this to increase substantially over the next decade (but do your own research before you invest in them!). Please don’t write to tell us that the interatomic bond is a fiction, and that atoms are really ‘joined’ by sharing or stealing electrons from each other – some analogies cannot bear too much examination. Liquidity is the ability to turn your assets into cash on demand. If there is not enough business going through a marketplace, it cannot work efficiently. This applies as much to stock exchanges as to indirect procurement marketplaces. Philip Evans and Thomas Wurster, 2000, Blown to Bits, Harvard Business School Press, ISBN 087584877, p. 222. Tesco is blurring the line between retailing and banking by allowing its customers to pay their household bills at the checkout. One of the authors is also a member of the same scheme. They send seemingly endless notification of special offers, and it is noticeable that the offers depend on your buying patterns – buy lots of vegetables and you will receive vouchers for money off iceberg lettuces, but switch to wine and caviar and the vouchers will be for champagne and other luxury items.

Part 3 Consequences

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Winning Strategies on the Atomic Road

All well and good so far, but how will corporations successfully atomize? This chapter lays out practical routes for corporate evolution and reviews the role of a corporation within the connected economy. We foresee at least four winning strategies that represent alternative pathways to a fully atomized economy. There’s definitely more than one way to skin a cat, in our view! Having considered the options, we can then imagine exactly how large corporates will shrink back to a few core activities. We can visualize how once-large corporates will depend for basic survival on a web of external alliances and partnerships to conduct their business efficiently and responsively.

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Traditions change as the status quo is challenged What traditionally defines a corporation? We have been throwing the word ‘corporation’ around without a thought but, according to the Oxford English Dictionary, it describes ‘a body of persons legally authorized to act as an individual’. In the industrialized twentieth century a corporation basically represents the ‘means of production’ – the way products and services are manufactured and brought to market. As you know, many corporations embody tens or even hundreds of thousands of individuals. These are complex entities. To deploy the ‘means of production’ efficiently, the modern corporation has a multiplicity of characteristics ranging from a ‘community of individuals’, held together by a common culture and purpose, to that of an ‘investment vehicle’ satisfying the needs of the shareholders. Today’s corporation represents many different stakeholder communities (trading partners, suppliers, employees and customers), with interests bound together by the common need to maximize shareholder value. The recent stock market gloom, coupled with the crisis over corporate governance, is a sad reflection of just how difficult such complex entities are to manage and control. As the global economy becomes ever more connected, the need for a rigid and integrated entity to fulfil the means of production and distribution becomes increasingly untenable and irrelevant. In the last chapter, we outlined the basic ‘atomic’ entities that will self-organize into efficient and highly responsive vehicles to meet customer needs. We have also described how such entities will interact through electronic markets that form the ‘glue’ of the connected economy. However, there is a big gap today between this idealistic vision and the realities of the modern corporate world. Our economy right now still predominantly persists with a few large players in each commercial sector. So how will we get from A to B?

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Connected strategies By now, you know about the forces promoting changes in traditional corporate structure and strategy, including those relating to the new economy. To recap, these are: • A dramatic shift in the prevailing Coase equilibrium (when external transaction costs drop sharply and no longer mirror internal costs, the advantage of scale reduces rapidly). • The rise of outsourcing (when qualified external parties offer attractive alternatives to internally operated processes, corporate unbundling becomes desirable). You will also be aware that large corporates are doing their damnedest to resist such pressures, using techniques such as business re-engineering and industrial consolidation.

Radical strategies for the connected economy In today’s recession-stricken markets the majority of corporate executives are struggling desperately to manage costs downwards to squeeze out pockets of corporate profitability. Many recognize that they are merely rearranging the deckchairs on the Titanic. One UK chairman told us these actions are symptoms of ‘arthritic management’, and he is probably right. But what are other feasible options? Given that the life expectancy of global companies is plummeting to as little as fifteen to twenty years,1 we expect that today’s philosophy of presiding over gentle but inevitable decline will soon lose favour with disillusioned investors. Instead, leaders who are prepared to take bold risks and challenge the status quo will begin to emerge in today’s besieged boardroom. As Andrew Grove described2 in his book Only the Paranoid Survive, there comes a time to confront the inevitable and take dramatic steps to avoid disaster. The other alternative is not worth thinking about. Applying our atomic view to the post-industrial world, provided such managers with new and radical strategies to embrace. These will stave off

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corporate collapse and instead build new sources of value and revenue growth. We’ll witness entirely new corporate structures with commensurate prizes going to the bold managers and companies that can shift away from the current ‘business-as-usual’ mentality. This is the biggest priority facing CEOs and boards across the world. The strategies described below are by no means exhaustive, but they do represent plausible new approaches for corporate development that reflect our atomic theory and the realities of an increasingly connected world. These are: 1 Customer champion: Companies start to focus exclusively on the needs of the customer and the supplier partnerships necessary to provide best-inclass solutions to those needs. Winners in this space must establish strong customer loyalty in defined categories of need and assemble the best product and service innovators under a ‘brand network’. This strategy focuses on product innovation and customer relationships and spawns smart company, webspinner and customer manager atoms. 2 Hollywood producer: Companies can excel at the co-ordination processes to support product and service delivery by orchestrating multiple partners within a virtual business network. This is the Hollywood style of production where the orchestrator operates with few assets other than finance and external relationships. This strategy takes account of new connected capabilities and the company becomes a webspinner. 3 Global utility: Companies can focus on building and maintaining largescale manufacturing and service capabilities to support those involved in the supply network (such as smart companies and customer managers). These operators resemble modern-day utility companies with stable environments and predictable shareholder returns. Success is based on operational excellence and incorporates the atomic categories of asset and service platforms. 4 Wheel of fortune: Companies can focus on managing investment risk to achieve certain pre-defined outcomes. These companies deploy shareholder funds to a range of companies and business activities to meet specific shareholder expectations. These companies correspond directly to the portfolio manager atoms described in Chapter 4.

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Each of these connected strategies presupposes a certain evolutionary path from today’s large integrated corporations towards a more loosely-knit federation of atomic entities. Notice that we have not included a product innovation route. Rather, we have bundled this under ‘customer champion’. We are convinced that few, if any, large corporates have the necessary skills or agility to compete purely on product or service innovation. This is likely to become the exclusive domain of the new atomic entity, the smart company. Already we see sectors such as IT and pharmaceuticals retreating from such activities, preferring to work in partnership with more agile start-ups and creative design firms.

1 Customer champion From its inception, Yahoo! has fostered a corporate vision of being the only Internet site that you will ever need to visit to satisfy every personal need. In an environment as diverse and confusing as the World Wide Web, this is a compelling proposition for the average surfer. However, it presupposes that Yahoo! will have sufficient knowledge of our personal circumstances that it can help navigate us to the best websites. Yahoo! is now embarked on a complex journey to evolve into our personal agent – able to anticipate personal needs and aspirations and make the connection to appropriate providers of services and experiences. Trust in me In a connected economy, one winning strategy will be to focus on the end customer’s needs and orchestrate the other players in the value network to satisfy these needs in the most effective and responsive manner. Developing a trusting relationship with each customer through repeated interaction and relevant brand promise creates the majority of commercial value here. This is all about identifying lifestyle expectations and bundling product/service offers to respond to consumer aspirations. Individual consumers will become loyal to those companies that can genuinely anticipate their needs and help develop deeper personal insights. As customer channels become highly interactive, the possibility of exploring new horizons will grow and with it the opportunity to merchandise compelling products and services.

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One company that has made a concerted effort to respond to consumer expectations is Unilever. Having spent over a century manufacturing commodity products such as toothpaste and household detergent it is embarking on a more consumer-centric strategy. Through its recent brand innovation programme, it has focused its many products and brands towards a few lifestyle offers under such headings as ‘Making day-to-day tasks easier’ and ‘Age-defying skin and beauty treatments’. No one can deny the obvious appeal of such offers. The affluent baby-boomer generation of consumers has come to expect such modern-day conveniences and solutions. Unilever sees current and future product and brand innovation as bringing life to such aspirations. Innovation is external Customer champions will rely more heavily on supply-side innovation to satisfy their consumers. In turn, this will require more frequent innovation in available offers and improved matching to individual customer context. Most large corporations have an abundance of products and associated brands in their portfolios, but few have the capacity or mentality to achieve step-change innovation. Instead they are geared to incremental improvements that sustain their product or service range. Today’s consumer has growing expectations about the speed of product innovation. Small incremental improvements are no longer enough to sustain interest, unless we are talking of pure commodities such as salt or sugar that return unattractive margins to the producer. Customer champions will need to deliver step-change innovation as well as incremental change if they wish to escape the commoditization trap (see Figure 5.1). Here’s the problem: step-change improvements require creativity and the ability to take risks. Despite how they see themselves, there isn’t a large organization in existence that exhibits both of those characteristics. Ironically, most step-change ideas come from large corporations but, when the idea reaches the all-important customer test, either the marketing department cannot explain the idea or the financial people cannot grasp the size of the market. What happens? They redirect their R&D money to yet more incremental innovation, leaving the Big Idea to be picked up by spin-offs or new market entrants. In time, if the idea is big enough, it

Consumer Expectations

Su s Inn tainin ova g tion

Ste p Inn -cha ov nge ati on

Functionality

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Time Figure 5.1 Consumers expect step-change product innovation.

becomes the new status quo and the big corporation is forced to jump on someone else’s bandwagon.3 We expect many of today’s leading corporations such as Unilever to leverage their many established customer relationships by partnering with smaller, innovative design companies that can provide more compelling offers. The large, established suppliers will continue to invest in incremental product development to exploit their existing portfolio, while leaving step-changes to newcomers (frequently venture-backed). In the case of age-defying treatments these will be the new biotech companies located in regions such as Silicon Valley (California) and Silicon Fen (Cambridge, UK). This strategy is widely adopted already in many hi-tech sectors such as information technology and biotechnology, and it is likely to spread to other low-tech sectors such as consumer goods and financial services. The role of the network Large companies wishing to pursue the customer champion strategy will need to focus their capabilities around the customer interface, currently in the ghetto of a customer relationship management (CRM) team, while

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leaving genuine product and service innovation to networks of competing smart companies and webspinners. Infrastructure providers such as asset and service platforms will undertake the manufacturing and distribution functions. The customer champion is also expected to carry brand responsibility for the entire supply network. This represents the customer promise – connecting perceived need, such as refreshment or mobility, with a set of discrete commercial offers, e.g. beverages or automobiles. Retailers today maintain a close relationship with consumers to the point where many can successfully ‘white label’ third-party products and services. Tesco and Marks & Spencer are leading suppliers of financial services, although they do not manufacture the products. Expect to see ongoing competition within the value network as to who is the dominant brand sponsor. In consumer electronics, it is likely that the designers will retain control over the brand (e.g. Sony, Philips and Nokia). In many service sectors, however, consumers will buy on trust, favouring respected retail brands instead of product suppliers – this is particularly true for services such as banking, insurance, telecommunications and entertainment.

2 Hollywood producer If you visit the technical design centre of France’s largest car company, located south of Paris, you will be struck by the scale and complexity of the site. Renault employs over 15,000 staff ranging from scientists and engineers to designers and software programmers. Such a facility is large enough to cater for the needs not only of Renault but also every car company in Europe. So why not convert this technical centre into a Hollywood design studio for cars rather than movies, and produce blockbuster products for all the major automotive manufacturers? Joining forces The customer champion model depicts a strategy for creating networks around enduring customer relationships. That’s a large element of the modern economy, but we also observe economic activity in other parts of the value

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chain. Some of this activity is centred on large design programmes ranging from film production to system integration and construction projects. Take, for example, the Hollywood film industry. Film producers will select an appropriate script for a new movie, raise finance and bring together a film cast. They will also negotiate contracts with film distributors to bring the product to market. Most film producers are self-employed, relying heavily on their networks and reputations to source the best ideas, actors and funding. The construction industry is somewhat different as it employs large numbers of design engineers and accountants to support large projects. That said, it still depends on hundreds of subcontractors to carry out the work during a project, and acts as prime contractor to the customer and overall design authority. It may also bear the financial risk, requiring well-proven processes and procedures for ‘on time and on budget’ programme delivery. As these models rely on good communications, you can see that they will have far wider applications in a connected economy and may well compete against more formal and enduring supply structures. Consider, for example, the launch of a new car. Companies such as Renault, Ford or BMW bring together hundreds of different parties to help with the design and manufacture of a new vehicle. They become the design authority and owner of the production process, but they may well prefer to subcontract many of the launch activities to reduce the number and range of skills in their own organization. It is conceivable that, over time, such companies will achieve major global product launches with hundreds rather than thousands of internal staff. We see ‘Hollywood producers’ taking control of large-scale industrial processes and programmes, while offloading many of the design and technical tasks to external parties. As such they become ‘orchestrators’ rather than producers and take on the characteristics of webspinners. Many ally with large design studios, such as Renault’s Techno-Center in France, but they will share these facilities with other parties to defer costs and expand shared capabilities. We, the consumers, are not strangers to this way of operating. Many of us will hire an architect to undertake a home refurbishment such as a new kitchen. The architect is qualified to undertake the design and project

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management processes but will employ different subcontractors at various stages of the project – bricklaying through to decoration and fittings. As our personal needs become more sophisticated we may well seek other ‘business networkers’ or webspinners to execute our ideas. This will range from lifestyle planning (e.g. holidays, entertainment, fashion and sports) through to education and career planning. Over time this strategy – that of the ‘Hollywood producer’ – will expand rapidly in favour of large-scale manufacturers and service organizations. Talented individuals will develop business production companies with minimal staff but powerful external relationships. We will see such webspinners appearing in every creative commercial sector, causing further atomization of the large and unresponsive incumbents. Such a strategy will favour new design parks catering for a multiplicity of organizations and sector interests. Soho in London today contains a diverse community of design and production houses that respond to the needs of the media sector. New centres will emerge to cater for every type of design activity, from cars and consumer products to leisure and media activity. These will be the new ‘industrial parks’ of the twenty-first century – the ‘ideas factories’, where production lines will be geared towards ideas rather than physical goods.

3 Global utilities With growing specialization within the value network around design, business networking and customer management, who will manufacture and deliver products and services? Well, the current trend towards third-party manufacture, distribution and support services will accelerate as we enter the new economy. This is based on the factors required to compete in this area – scale and scope as well as efficient processes and use of assets. Achieving operational excellence requires superior processes and a specific culture and skills set quite different from other elements of the value network. Historically, one of the world’s most successful IT manufacturing companies, IBM, has negotiated successfully the transition from dominant mainframe supplier to the leading IT service provider. Through IBM Global Services it employs hundreds of thousands of staff worldwide that build and operate networks and data centres on behalf of third-party companies such

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as J.P. Morgan Chase, Shell and American Express. It provides IT utility services in much the same way as power and electricity companies provide energy. Scale brings massive advantage here in terms of lower costs and higher performance. We envisage that IBM could easily grow to a million or more staff in the coming decade as it continues to suck in IT operations from the Global 1000 companies and elsewhere. So, how does this fit into our ‘atomic’ world? A modernized utility Despite a sharp rise in terrorism, 1776 was a good year for the global economy. Adam Smith4 observed that reorganizing operational processes could deliver huge improvements in productivity and efficiency. It was these ideas – as much as the development of the steam engine – that led to the first Industrial Revolution and the concentration of the ‘means of production’. Smith observed that pin-makers working on a production line were able to produce 2,400 times more pins per worker per day than those doing the whole job. Since then, of course, we have added layers of management and support services that consume resources but don’t make any pins! The ‘asset’ and ‘service’ manager of the future will need to be significantly sleeker and more focused than its progenitor, the integrated corporation, which will in turn lead to greater productivity (and reduced waste in terms of transaction cost). We expect leading corporations that decide to pursue the customer champion route to club together to share production and service platforms (see Chapter 9) thus reducing further the cost of supply, be it in the manufacturing of goods or the delivery of services. For example, the Wall Street Journal has been discussing a shared printing facility with its major competitor, the Financial Times. We have already mentioned examples of third-party manufacture in product and process industries in earlier chapters, for example in automobile, IT and consumer goods sectors. We also expect to see large service organizations from sectors such as telecommunications, banking and insurance share common platforms for transaction processing and routine back office tasks. Further examples are given in Chapter 7.

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Although there are some additional co-ordination costs involved in employing third-party asset and service platforms, the advantages of shared facilities and superior techniques far outweigh the extra transaction cost. While these additional costs are often as high as 10% of the total cost of operation, they will diminish as electronic markets really start to bite. By far the largest advantage is that the outsourcing of such activities leaves corporations to focus on what they are best at – creating new offers, understanding customers and building business networks. In addition to the recent rise in third-party manufacturing and logistics, the development of shared services in areas such as IT, finance and administration and HR is growing apace. This is linked to the trend to outsourcing non-core business processes to qualified suppliers – described further in Chapter 9. We envisage a time in the not-so-distant future when global manufacturers such as Unilever or Ford will switch their efforts away entirely from making and distributing products to being customer champions and ‘Hollywood producers’. They will depend heavily on global utilities, such as Flextronics and IBM, to undertake the ‘heavy lifting’ activities, such as manufacture, and support services, such as IT, finance and administration. The Coca-Cola Company has already moved down this path, as we discovered in Chapter 4. For those who focus on this strategy, the prospects are strong, given the likely consolidation of these activities to just a handful of qualified players. Platform operators are likely to enjoy relatively stable demand compared to the many smaller atomic companies operating across the value networks. Investor returns are likely to be unspectacular but more predictable than from other strategies, and these companies will come to resemble the ‘utilities’ of tomorrow’s connected economy.

4 Wheel of fortune As the few remaining industrial conglomerates such as ITT, Hanson and Invensys fade into obscurity, the role of the holding company lives on – albeit under a different banner, that of the venture capitalist or investment bank. Names such as KKR in the USA and Apax in the UK have assumed a new level of importance as financial sponsors of a broad range of business activity ranging from entrepreneurial ventures to classic management buy-outs.

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These companies are constituted to take managed risk on behalf of investors, carefully balancing their portfolios to produce extraordinary returns. This model can be easily transferred to corporate holding companies – portfolio managers – in the diverse and multi-faceted atomic universe. Hogging the purse strings All organizations need access to sources of funding to purchase and periodically replace equipment, premises and intellectual assets. For most traditional organizations, this invested capital is the most important means of production. The majority of the ‘work’ that goes into manufacturing cars, appliances and clothing is undertaken by fixed assets in the form of machinery and software, not by the workforce. You would expect that organizations of 100,000 people can raise capital more efficiently (i.e. at lower rates) than organizations of a hundred people. This is generally the case even in today’s gloomy capital markets. But let’s look at a lesson from history: Hanson. For three decades, from 1964 to 1992, the Hanson Corporation systematically acquired business after business until it was one of the world’s largest conglomerates. In its heyday, it was a multinational concern with interests from chemical factories in the US to electricity supply in the UK and gold mines in Australia. Hanson produced cigarettes and batteries, timber and toys, golf clubs, cod liver oil capsules and cranes. Hanson’s strength was tight financial management, in other words being able to spot a poorly run company and apply tough financial controls to the operation. By so doing it was able to generate attractive returns for shareholders and thus had access to low-cost capital. Warren Buffett continues to operate in this fashion through his holding company Berkshire Hathaway. In the mid-1990s the climate in which Hanson operated began to change as investors looked beyond the large conglomerates towards companies focused on single sectors and specific activities. Investors were reluctant to advance further funds to Hanson so the cost of capital reached a point where prospects of returns were limited. As a result the company was broken up. One explanation for the break-up5 is that Hanson’s primary role had been to act as a banker for the businesses within the Group but, with the increasing sophistication of capital markets, such a role, and Hanson,

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had little extra value to offer. Today most conglomerates are discounted to reflect such inefficiencies. Capital markets will continue to entrust funds to specialist investors – our portfolio managers – who have specific knowledge of sectors and value network activities. These financial intermediaries will acquire a range of holdings that best match the investor’s appetite for risk and return. In an increasingly atomized economy, specialist investors will be even more important to maintain a healthy return for the shareholder. The choice of investment will be much greater than in today’s heavily consolidated industrial economy. Portfolio managers may choose to invest in cash-producing global utilities such as asset and service platforms to offer their investors stable profits at lower P/E ratios. Alternatively, they may prefer to specialize in more speculative investments such as smart companies and webspinners where returns could be much higher, but at greater risk to the investor. Others may invest in a wide portfolio to produce a balanced risk and return. We expect these different types of portfolio manager to coexist, reflecting the differing needs of the investors. Key characteristics of a successful ‘wheel of fortune’ strategy will be strong relationships with the capital markets and a trusted brand, earned through the achievement of above-average returns for the shareholder. Such entities must also be adept in assessing and managing risk across a range of ‘atomic’ equity investments and possess the associated business skills to analyse business strategies and ongoing performance. These are attributes of any successful corporate head office within today’s corporation and will continue to be in demand within the atomized economy. Even focused corporations such as BP are adopting a ‘wheel of fortune’ approach as they condense their head office functions into financial strategy boutiques. The staff of BP’s new head office concentrates exclusively on managing shareholder funds rather than drilling for oil or operating service stations. One may well ask (GSK shareholders, take note) why GlaxoSmithKline has a head office of several thousand staff compared to the eighty-five people occupying AstraZeneca’s corporate headquarters in London. One is focused on running a global operation, while the other is placing financial

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bets on new drugs and marketplaces. Which do you think has the agility and strategic focus to win in such a high-risk sector?

And the winner is … The first step towards atomization is a decision. Do you want to be a visible brand, or a third party operator hidden from public view – the ‘no name’ company? Branded companies will reside in the consumer product or service space and be well known to the end customer, and while that is attractive there are no prizes for second place here. Some companies such as Intel may seek to gain recognition here, although they do not touch the consumer directly (note the ‘Intel inside’ advertising campaigns). Most corporations already strive to be competitive in most of the above endeavours, and excellent in at least one area. Take Sony, which has global leadership in design and product innovation, but also manufactures and distributes its product worldwide, and employs countless staff to undertake basic corporate functions such as IT, HR and finance. In the connected economy, such companies will make deliberate choices about where they want their prowess to be, and which activities they must dispose of. BMW is already moving out of manufacturing to focus on design and technology leadership. The key strategic debate in corporate boardrooms is whether a company’s destiny is in the traditional strengths of customer intimacy, product innovation or operational excellence. Many pharmaceutical companies recognize that they will be unable to compete in the product innovation space against small and agile biotech companies. No matter, they can extend their marketing capabilities and withdraw from drug discovery. Companies who excel in product design and innovation will consider withdrawing from all manufacturing and distribution activities – as are many of today’s technology companies (such as Dell, Cisco and HP). Those who operate global manufacturing and service platforms may choose to withdraw from end customer markets and open their doors to smart companies. Finally, some companies could sell off the majority of their operating companies and retain an investment portfolio – the wheel of fortune approach.

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Break-up has never been higher on the corporate agenda. What we are suggesting is a different form of break-up, where corporate assets (e.g. manufacturing plant) rather than discrete business units are sold off.

Remains As companies dissolve progressively into atomic components, some form of residual activity will persist at the core, as boards continue to administer shareholder funds. These transitional activities are likely to include classic corporate functions such as: • Corporate governance and strategy: In an atomized economy this function is likely to differ strongly from that employed in a tightly integrated organization, and it will be focused less on internal matters such as operations and more on corporate alliances and investment strategies. BP’s move towards a small corporate head office focused on strategy is a recent case in point. • Brand positioning: If a corporation is pursuing a customer champion strategy, we expect brand positioning to be of central importance. Such companies will work to optimize their brand portfolios. They will also pay attention to the promise that underpins these. Unilever has taken a firm hold of its brand strategy and consumer promise. • Community support: As companies shift their emphasis from internal to external skills and partnerships, increasing effort will be required to secure loyalty and advantage from such relationships. Common communities of interest will need to be created and sustained. • Infrastructure support: Connectivity and support services are a critical part of the modern corporation – enabling its members to function efficiently, anytime, anywhere. Harmonization of these services helps to unite the workforce. It may also become a powerful tool in supporting external communities of interest. • Risk management: This becomes a core element of financial management as equity investments extend into external alliance and partners. Exposure to risk is a key performance indicator in loosely knit organizations.

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Summary Life-changing decisions are the order of the day. You don’t have to preside over a steady but inevitable decline in corporate position if you instead make a choice. Continuing to be a jack of all trades means you’ll end up a master of none. The gap between a self-organized economy composed of tiny atomic entities and today’s bloated and rapidly consolidating corporations appears depressingly wide, and recent consolidations such as AOL-Time Warner and HP-Compaq would appear to widen the gap even further. But the stock markets of the world are voting with their feet after three years of decline and demanding new strategies and structures that offer more favourable prospects of equity returns. Today’s corporates must respond to spiralling investor doubts by enacting radical changes in strategy. A progressively atomized economy requires different winning strategies to previous eras and large corporations need to select one of our four connected strategies in the early phases of atomization. So, taking this to its ultimate conclusion, we are left with microcorporations investing billions of dollars on behalf of capital markets and individual investors but employing only handfuls of staff. The main economic activity has at this time disseminated to atomic entities that populate the new economy and self-organize around customer-centric markets. This has all sorts of implications for industry sectors and individuals, as we shall see in the next chapter.

Endnotes 1 In 1998 the annual turnover rate of S&P firms was nearly 10%, implying a corporate lifetime of only ten years. From Creative Destruction, Richard N. Foster and Sarah Kaplan of McKinsey & Co., Financial Times Prentice Hall, ISBN 0273656384. 2 Andrew Grove, Only the Paranoid Survive, Profile Business, ISBN 1861975139.

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3 For more on the failure of innovation in large companies, see Clayton Christensen’s excellent The Innovator’s Dilemma, (1997), Harvard Business School Press, ISBN 0875845851. 4 Adam Smith, An Enquiry Into The Nature And Causes Of The Wealth Of Nations, ISBN 0679783369. 5 We are grateful to Professor Paul Stonham of the EAP European School of Management, Oxford, for this insight.

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Atomic Me!

Destiny’s child ‘But what about me?’ we hear you cry. We’ve talked about the changes the corporation will be undergoing, but so far neglected the impacts on the individual. Those impacts are largely very positive, if you keep your wits about you and exploit your real talents to the full in the Brave New World. But in this Darwinian regime, you will need to network, know your value and be prepared to bargain with it, and shy away from being one of life’s plodders. Popular ‘plodding’ will no longer be an option for the masses anyway – at least not for those want to succeed. The nanny state and the nanny corporation will become, for the most part, things from the past. There are no more jobs for life.

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The following pages explore the individual’s role within an atomized world. How can you and I exploit our varied personal assets to build a more flexible and enduring way of life? As always, the pessimist will see a dark future and the optimist a sparkling one – but both will have the same thing happen to them. The impact of the coming change will be breathtaking and the forces of reform so profound that repercussions will be felt well beyond just the corporate orbit. So let’s apply our atomic thinking to the individual and speculate about what it will mean for us – what will be nature of the ‘atomic me’. When corporations start blowing apart into smaller, more agile units – as we believe they will – our careers and personal lifestyles will be drastically transformed forever. Humans have long sought the comfort of institutional support. In the Middle Ages it was the Church that offered cradle-to-grave security for individuals and their families, often more emotional than physical. In the more secular society of the twentieth century, national governments stepped into the picture by creating a welfare state to provide free education, healthcare and pensions. More recently, large corporations have established similar benefits for their staff, often on a more lavish scale. However, we already see the cracks appearing in both the welfare state and corporate lifetime support. Governments simply can’t raise sufficient taxes – albeit not for want of trying – to sustain the necessary levels of spending on health, pensions and education to match growing lifestyle expectations. Nor can companies in today’s turbulent stock markets guarantee lifelong employment or generous pension schemes. Instead, individuals find themselves faced with the task of managing their own destinies with little help from such once-trusted sources. Is this a frightening glimpse of the Armageddon to come, or can we be reassured by the opportunities that atomization will provide for us?

Know thyself Our atomic model predicts that corporations will fragment into lots of different pieces, from ‘smart companies’ consisting of a handful of creative

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engineers and designers to ‘asset platforms’ involving global operations and billions of dollars of capital. These ‘atomic’ structures will be bound together by webspinners whose role is to connect many commercial partners together into infinitely variable value networks. The atomic model strongly reflects corporate competencies such as product design, customer management, deal-making and operational support. One size does not fit all, and companies will need to select a specific area of competence or focus if they are to develop a valuable role in the connected economy. The same arguments could be applied to the individual, who is the most vital and flexible atomic component of any economic system. Living and working in an atomized economy will involve individuals making more choices. Establish exactly where you think your specialization lies and where you fit into the new atomic structure. It won’t necessarily be an easy decision, but there will be some comfort in the scale of reward that will be offered by association with atomic corporations.

Welcome to the new trillennium In our view a more appropriate name for the new millennium is ‘trillennium’ because we predict that within the next ten years the world will see its first trillionaire. It won’t be Bill Gates or Larry Ellison. In fact, it won’t be anyone featured on the pages of today’s Fortune magazine, the Financial Times, or the Wall Street Journal. Instead, we think our first trillionaire is now completing high school, still blissfully unaware of his or her brilliant prospects. Where will this mega-wealth come from? At the turn of the last century, people of great personal wealth were involved in banking and the creation of the manufacturing industry. It was the J. P. Morgans, Rockefellers, Henry Fords and Thomas Edisons of the new industrial age who provided a mix of capital and intellectual brainpower to build transport infrastructures and manufacturing complexes to satisfy the materialistic Western populations. Wealth was all about creating good and plentiful ‘stuff’. Fifty years on, the game changed out of all recognition. By the 1950s and 1960s, a new generation of entrepreneur had emerged, one skilled in

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squeezing hidden value out of the sprawling industrial giants. These included asset strippers and stock market speculators who could sense and exploit capital inefficiencies in the now mature industrial system. Well-known names like Buffett, Slater and Hanson spring to mind. As we enter the twenty-first century, the list of the very rich makes interesting reading. Across the top ten categories in the USA or Europe are cult figures such as sportsmen (Michael Jordan and David Beckham) and rock stars (Madonna and Sir Paul McCartney), along with a sprinkling of self-made entrepreneurs and media icons. Nobody ever gets rich working for somebody else, and the CEOs of Europe’s largest companies rarely make the top 200 richest people (according to the annual lists published by the Sunday Times). Recognizing that wealth stems today from consumer appeal and personal branding, within another twenty years or so the top earners will be individuals who can make complex subjects more accessible to the mass population. Such figures could be so-called ‘Tele-Dons’ – academics with excellent screen presence and the ability to breathe life into their subjects – such as Simon Schama1 and Sir David Attenborough. They will also include health and fitness gurus such as Andrew Weil, MD.2 We have moved from mastery of industrial assets (means of production) to mastery of the intellectual and emotional assets (guides to human experience). The power of the Internet coupled with new visual and virtual communications channels enhance and exploit the impact of individuals who have something relevant to say about the human condition as it evolves and changes in the volatile years ahead. There is a law of increasing returns – rewards will escalate with size of audience and richness of interaction.

The winds of change Most prosperous parents of the post-war, baby-boomer generation hoped that their children would become ‘professionals’, entering safe (now oldfashioned) careers such as medicine, law or accountancy. Others may have anticipated a lifetime career for their children in one of the world’s large corporations such as GE, Shell or DuPont.

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Fifty years on and the answer is no longer so simple. The whole playing field has changed and so has the game. For a start, there are hundreds of occupations that now offer returns equivalent to the traditional professions or corporate postings, whether it be management consultancy, IT systems design or alternative healthcare. Also, the half-lives of large corporates have diminished to the point where span of career is likely to exceed the longevity of several employers. However, more importantly, this upsurge in choice and uncertainty brings with it greater individual responsibility. There may be more variety in today’s job market but there is correspondingly less security. And that diminution of job security will accelerate in the future. After all, one defining feature of the atomic corporation is its adaptability, and an inviolably tenured workforce is antithetical to its capacity to withstand the winds of change. So don’t expect the atomized corporations to have your welfare at heart. It is still the case that employment contracts in Continental Europe average sixteen years – thanks to the region’s more enduringly traditional social protection laws. Compare that to Silicon Valley, where the average employment contract is now down to eighteen months. We expect that in years to come employment contracts will average thirty days, based on a continuous process of renegotiation between employer and employee. This is a world where individual competencies, and the ability to deploy them effectively, will make the difference between poverty and prosperity.

Wealth accumulation – aspiration or necessity? The industrial age saw careers measured in continuous periods of thirty to forty years. Indeed, many pension schemes today still reflect this legacy. However, another dimension that has changed distinctly since the last century is the time constraints on earning capacity. The extraordinary demands of tomorrow’s business and professional life could further truncate full-time employment to the point where the millennium generation should plan to leave permanent employment at forty, with some twenty further years spent in portfolio occupations.

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Charles Handy spoke with great authority about portfolio careers in The Elephant and the Flea.3 However, his assumption is that such a career begins at fifty, following a long period of stable employment with a handful of large employers. In the atomic world, such assumptions may no longer be valid, and many school leavers may need to adopt a portfolio career from the start rather than at the end of their careers. Ian Brinkley, senior economist at the Trades Union Congress, points out that one of the major shifts in the patterns of work is that self-employment is moving from labouring to professional occupations. It sounds daunting but there’s an upside. Remuneration has outstripped inflation for most jobs in the last twenty years to the point where real incomes are at least double those of our parents. The prospect of a million-dollar salary is not unrealistic for anyone reading this book. One might well enjoy rewards in excess of this figure for sustained periods of ten or more years. That cash flow will be used differently too. It will not just finance today’s living expenses but tomorrow’s leisure time. In effect, we will need to build a personal investment engine to cover our entire life cycle needs. Don’t expect anyone to be looking after your interests – stay on the ball, keep your finger on the pulse. Even Europe’s more leftist governments have begrudgingly acknowledged the unsustainability of wide-scale public pension provision. It’s up to you, and you alone, in the new atomic world. Even the family unit is tenuous. According to US government statistics in 1960, the average household consisted of salaried male, housewife and two children. Today less than 5 per cent of US households conform to that description. Similarly, in the UK single people undertake a third of all house transactions. Each individual must take charge of his or her own destiny. The process of individualization is well and truly underway.

One basket for all your eggs It is often said in the professions such as law, accountancy or consultancy that the long climb to partner status is based on a combination of the many key attributes. To succeed in claiming a top job in tomorrow’s arena, the good news is that you don’t need to ‘have it all’. But you do need to ‘have even

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more’ in a smaller domain. Look at the types of people we are below and ask yourself: ‘Which am I?’ Therein lies the first step toward ‘atomic me’. • The rainmaker: Someone who can drum up exceptional business opportunities even in the most unlikely circumstances. An hour spent in an airport lounge talking to a perfect stranger may lead to a million- dollar sales opportunity! The winning characteristic here is charisma and creativity. Rainmakers are also consummate networkers, with numerous personal contacts and business associations. • The relationship manager: An expert at creating and sustaining working relationships with clients that are built on trust and personal chemistry. They often turn out to be the most productive means of generating new business. This requires commitment and focus. For many firms, client relationships today can be measured in the tens of millions of dollars. • The programme manager: Someone masterfully organized who can be trusted to undertake complex and risky projects. If the programme manager says it’s Christmas tomorrow, you better believe it! • The subject matter expert: A leader and an expert in a field based on literally years studying an industry or technology to minute detail to become a recognized thought leader and expert in the subject. It was said of one famous IBM watcher that he kept track of what the CEO of IBM had eaten for breakfast – and could relate this to share price fluctuations during the day! We can’t excel in all these areas – of course we can’t – many of them are mutually exclusive. The secret to atomic success lies in recognizing and building on strengths while complementing weaknesses. Strong professional practices will employ a combination of the above skills – embodied in different individuals but carefully orchestrated by the senior partner. The most important thing, if you face corporate atomization, is to work out what combination of skills you excel in: are you an innovator by nature, or do you prefer to follow well-established paths? Do you excel at delivering processes and managing assets, or would you say that building and maintaining relationships is your key skill? Answering these questions will direct you to the resulting atoms you will be happiest in.

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This, then, is individual atomization, the personal counterpart to the corporate phenomenon.

Matching the atom Can you now see the close correlation between the individual characteristics described above and our corporate atoms? The relationship manager is obviously the ‘customer manager’ in our corporate universe, able to develop an intimate understanding of an individual client, be it a business or an individual (for example, a physician or independent financial adviser). The value created here can be exceptional in personal equity terms, and has lasting impact. The subject matter expert corresponds to the ‘smart company’ category, and is an accumulator and broker of intellectual capital, rather like a successful design shop. Sensitivity to change in the external environment is a critical dimension here, and we can expect such individuals to ride the crest of several waves in their careers. The rainmaker is also closely linked to the smart company, given that success in creating new relationships and business ideas depends on personal creativity and agility. The programme manager is the webspinner or ‘orchestrator’ who knows how to bring together resources to undertake a complex assignment and achieve a stretched target. This is best illustrated in the construction sector, where one person can initiate and manage a large project by employing many different organizations and skills on a temporary basis. Relationships are important here, but the skill of teaming together a diversity of skills to achieve a result is the critical underlying competence. The programme manager would also be able to contribute to the running of asset and service platforms where operational excellence is the overriding skill. In the dynamic and rapidly changing future our focus will be on achieving excellence in one or at most two of the above categories. We may, for example, gain academic qualifications and practical experience in one specific area for many years to become a thought leader and world-class practitioner. But whichever course we choose to take, one thing is abundantly clear about the road ahead – it will require years of intense effort

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and fierce competition to reach a sustainable level of proficiency, and the huge bundles of dollars that go with it. Those who thrive as successful independent investors or as venture capitalists will clearly fit well into the portfolio owning atoms. Although few in number, these individuals may become very wealthy.

Role models and soul models: the atomic individual arrives Today, the power of modern communications and the appetite for wider personal experience has spawned an ever-expanding range of individual ‘rock stars’ who can respond to public interest in subjects as far ranging as pets, diet, keep fit, history and death. The success of sport and entertainment has always been linked to talented and famous individuals – whether in the Hollywood studios or sports venues such as Madison Square Gardens or Highbury (home to the UK’s Arsenal Football Club). Individual contracts amount to many millions of dollars for a film role or club transfer – far exceeding perks at the top of the world’s largest corporations. Even ‘experience’ in death can produce fame! When Professor Gunther Von Hagens followed an exhibition of human bodies by undertaking a public autopsy in London – the first in the UK for 170 years – he established himself as an authority on death. In 2002 alone he has earned £45 million from these activities, confirming that he has generated strong public interest. By broadcasting the autopsy to an audience of millions, Von Hagens has been elevated towards ‘rock star’ status. We expect many more stories such as this to emerge in the coming years. He is a pure example of the atomic individual. Public curiosity in ‘the self’ is partly fuelled by higher levels of education and media influence, but also intensified through the quest for new experiences as a substitute for material possessions. It may also reflect a greater insecurity implanted into our psyches by an atomic society where church, company and nation-state are vanishing from view. So what are the issues that we seek personal guidance on? How will these translate into roles for new economy ‘rock stars’?

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Here are some of the categories under which we expect to see emerging gurus with massive earning capacity: • Health and well-being: All of us will admit that good health is central to our lives. But where are the sources of practical knowledge to help us achieve such ends? Certainly the medical profession and related drugs sector have little to offer us here – other than expensive cures to established illnesses. Expect to see many more gurus emerge in this space who offer a blend of philosophy and practice to help us achieve peak performance of the body. • Financial security: Again, most of us are becoming deeply concerned and challenged by issues such as personal pensions, home purchasing and education costs for our children. Apart from those fortunate enough to still earn a predictable and secure salary, most need relevant financial advice to help manage the peaks and troughs as well as provisioning for old age or ill health. Expect to see personal champions emerge in this space to compensate for the remoteness of retail financial institutions whose primary contact is through a call centre or Internet portal. • Lifelong education: For most people, history, science or geography classes were moments of extreme boredom and irrelevance in early life. We leave school or university with little or no grasp of subjects that can influence important moments of our lives. Some TV channels such as Discovery and the BBC have helped to fill these gaps, but public appetite is growing for individuals who can translate complex subjects into common language. Expect to see multi-million dollar contracts for books, TV programmes and games relating to subject matter experts. Many new economy ‘rock stars’ will come from academia and media backgrounds rather than conventional corporate jobs. They will combine intellectual depth and creativity with first-class communication skills. Stephen Hawking may just be the archetype of this strange new generation. But how will a world populated by mega-rich individuals cohabit the commercial space with atomic corporations?

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Feet on the ground Robbie Williams signed an £80 million deal with EMI in 2002, demonstrating that rock stars can coexist comfortably with large corporations. Mr Williams brought his personal brand and unique singing talent to the table, while EMI offered the channel to market and a supporting infrastructure to help promote and sustain his brand. The two are remarkably synergistic and set a strong precedence for new economy alliances. In the atomic world, large companies will foster portfolios of talent in ways well understood in the media and publishing sectors, but less so elsewhere. Many will seek alliances with individuals who generate novel ideas and inventions, treating them as ‘smart companies’. The industrial sponsor will contribute large-scale marketing and production platforms to leverage talented ideas and derive massive returns. As many more channels to market emerge, in the form of two-way electronic links, the power of network economics (as defined by Metcalf’s Law)4 will work in favour of both parties. In extreme cases, large companies will adopt and promote individuals’ brands in favour of their own – preferring to bask in reflected glory. This is equivalent to consumer goods conglomerates, such as Unilever, that seek to promote branded products in preference to their own names. Financial institutions and drug companies will establish links with gurus in order to help promote complex products and ideas to the general public. It may be a few more years before GlaxoSmithKline forms a joint marketing agreement with Professor Gunther Von Hagens (there may be an issue about mutual trust and integrity), but such alliances will emerge as subject matter gurus connect strongly with public interest!

Have the goalposts moved? Back to the nitty-gritty then. Just how rich can we expect to become in the new atomic age? Is this really as important as it was in the heady days of the 1990s? Ask an entrepreneur of the 1980s what his or her wealth expectations were and you would have heard the word ‘millionaire’ mentioned frequently.

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At the height of the dot-com boom, wealth expectations had escalated into the billions rather than millions. Being a player in Silicon Valley in 2000 required a personal wealth of at least $1 billion. Do we expect new economy entrepreneurs of the 2010 period to talk in terms of trillions rather than billions? The answer is both yes and no. At one end of the spectrum we do expect to see individuals accumulate financial wealth comparable to or exceeding that of the largest corporations on earth. Perhaps the top ten Standard & Poor’s company list will include a few individual names as well as corporations by 2010. This will have dramatic consequences for the new economy – because individuals will be able to use their personal wealth to effect change on scales unknown to corporations. Bill Gates, for example, could eradicate many major diseases in the world. Some members of the bin Laden family, in contrast, can destabilize Western democracies through the financing of international terror. There is undoubtedly responsibility tied up with wealth, although that issue itself is a subject for an entire new book! On the other side of the equation, people of great talent and public fame may choose to accumulate different forms of wealth. For example, Princess Diana used her global status and appeal to help pursue world issues such as the clearance of minefields – without extracting financial gain. We believe that future generations will redefine wealth as the process of creating wellbeing for themselves and broader members of society. Well-being will have more than one component: • Financial wealth that enables human beings to pursue their own interests and avoids being tied to the commercial rat race. Realistic expectations may run to tens of millions, but cannot justify the billions that past entrepreneurs have sought. • Intellectual wealth that requires time and education to comprehend the environment we live in and to acquire wisdom about the destiny we aspire to. This may well deflect us away from the single-track pursuit of money. • Emotional and spiritual wealth and well-being that requires commitment to relationships, community interests and the service of others. Again, such wealth acquisition may erode the time and space for intellectual and financial endeavours.

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Seems familiar? Sounds rather like body, mind and soul! However, the most pressing need for the majority is to accumulate sufficient financial capital to ensure comfort and freedom throughout our lives. Few of us are fortunate enough to achieve this until a late age – if ever. Others may opt for a life of simplicity and intellectual or emotional pursuits that negate the need for financial well-being. However, as the rewards for individual effort prosper in the emerging atomic universe, more of us will be able to excel across all three dimensions as our quest for self-realization expands away from the world of ‘stuff’ to the more varied universe of ‘experience’. There is a tradition among Jewish people to leave an ‘ethical will’ to one’s children – describing how to apportion time and effort between work, family and charitable acts. Interestingly enough, such practices date back several hundred years, indicating that our case for a balanced wealth portfolio is nothing new. In the age of such individualism, who will provide the necessary guidance and leadership to help us grasp value from our relatively short and hurried lifespan?

‘My shrink’ Many large corporations have already recognized a latent need to guide aspiring individuals on their way up the ranks and have appointed mentors. But given that companies may only employ individuals for months or years rather than decades in the future, how can we transpose these practices into a broader social context, i.e. beyond the corporate boundaries? A new graduate entering the wider world for the first time needs direction but the chances are his or her parents are ‘pre-atomic’ and have little grasp of the opportunities and pitfalls of the new economy. Peers may be more in tune with the current environment but are struggling with their own career choices and prospects. Our graduate has probably cautiously rejected the prospect of a career for life with one of the mega-corporations, not expecting it to be around that long. Who can provide intelligent advice and guidance?

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Many of us would prefer to resort back to an independent person or community of interest for individual guidance and points of connection. In this respect we see the re-emergence of bodies of professional interest comparable to the guilds of medieval times. However, there will also be a mushrooming of personal agents and counsellors that will advise us on every aspect of our professional, social and domestic lives – we welcome the era of the personal guru, a business that is beginning to flourish and receive its share of public exposure. And if so much attention is focused on exploiting our intellectual and emotional assets to develop a sustainable and rewarding career, how will we cope with the everyday aspects of our existence?

Who will prop me up? The COO of the household is an endangered species! How do we expect to manage our lives in this demanding atomic world? Or, for that matter, once we have climbed to the dizzy heights of personal success? Some of us may be lucky enough to acquire a life partner who is prepared to accept the role of being the Chief Operating Officer of the household. That said, as the gender barriers throughout business are gradually eroded further, these will become an endangered (and no doubt much sought after) species. The answer is to outsource our back office to credible partners such as financial organizations. We’ll want support at several levels, and in each area we can foresee lucrative service platforms emerging to cater for individual need. What are these basic needs? • Accommodation for life: Too much of our time and energy is spent today purchasing, fitting out and managing our domestic environment. How about a Regus office approach to home dwellings? We buy a timeshare that entitles us to a roof over our heads – anywhere, anyplace, anytime across the world. We then alternate between capital cities while at work and country homes during leisure periods.

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• Mobility for life: Again, much is made of acquiring and owning a car, be it a Ford or a Ferrari. For many city dwellers a car is as much a liability as an asset. Many of the world’s leading car manufacturers are planning to provide mobility on demand as a more convenient solution to car ownership. This would enable us to choose different models for various times in the week, from a four-wheel drive or family saloon to a soft-top sports car. • Career for life: Managing our own personal capital is far too important to be left in non-specialist hands – and that includes our own. Some of the more progressive search firms are already piloting new schemes where they will contract talented individuals for life, and lease them to attractive employers – to extract a high return both in income and capital gains. Already talent agencies ranging from fashion models to business gurus have adopted a similar approach, where they take ownership of an individual’s intellectual output in its many guises. • Health for life: One of the most important dimensions of life in the fast track is personal health and well-being. There is an exploding industry that offers us keep-fit and body overhauls. However, the majority of expenditure today is geared towards fixing problems once they have occurred, as per the medical profession. Who visits a doctor in full health? Again, we will see personal well-being outsourced to experts who will carry out continuous programmes of self-improvement and disease prevention. Maybe we can look forward to a new generation of designer drugs to control appetite, slow down ageing and increase energy levels. But we digress … The commercial opportunities presented here feed well into our atomic economy. Service providers need to form one-to-one relationships with individuals to deliver on the above promises. They must employ webspinners to collect together the numerous products and services necessary to realize these personalized offers. In turn, each needs to trust the provider sufficiently to exchange personal and confidential information on their intimate life patterns. We will come to regard such information exchanges as an investment of personal intellectual property from which we will expect ample rewards.

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No pain, no gain The rewards for ‘getting it right’ will be enormous. But the penalties for failure, both in our work and domestic lives, will also never be greater. So how can we best prepare for the atomic world ahead? We must identify and build on our core competencies as individuals from an early age, and receive guidance from experts to help us to maximize our personal wealth – be it financial, intellectual or emotional. We should also engage with complementary talents and skills to create effective teams both in our work and social settings. These may include small enterprises or large corporations in search of trusted brands and valuable expertise. And we will need to place our trust in external agencies that will take on an ever-increasing proportion of our day-to-day existence – our personal back office. To avoid the trap of today’s increasingly hurried pace of life we need to substitute long hours, hard work and intrinsic ability with a new combination of courage, creativity and connectivity. ‘Atomic me’ is just another piece in the jigsaw, so make sure you are the right shape to fit into the puzzle!

Endnotes 1 Professor of History at Harvard University, author of a series of books and presenter/writer of the BBC’s A History of Britain. 2 Author of a set of books on alternative health – for example, Natural Health, Natural Medicine (1997), Time Warner Paperbacks, ISBN 0751517658. 3 Charles Handy, 2002, The Elephant and the Flea, Arrow Books, ISBN 0099415658. 4 Robert Metcalf’s law states that the ‘value’ or ‘power’ of a network increases in proportion to the square of the number of nodes on the network.

7

Industrial (R)evolution

The macro lens We said some pretty radical things in Chapter 1 … and we meant them. Hold tight – we’re going to continue that radical thought process here. Corporations can no longer expect to be all things to all people. You’ll recall from Chapters 4 and 5 that corporate fragments will concentrate on the one activity that best reflects their strategic intent and core competencies – we used phrases such as operational excellence, product innovation and customer intimacy. Although it won’t happen overnight, atomization will sweep across the world, leaving no corner untouched. We’ve described the strategies that corporations can adopt and how people will mould themselves into ‘atomic individuals’ to adapt to the new work set-up.

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But what of the macro view? What will be the snowball effect of all this on entire industries? This chapter outlines the key opportunities for the biggest sectors of our economy, and demonstrates where the process has already begun to manifest itself today. As with re-engineering in the 1990s, we expect to see industry sectors transform at different rates, governed by the urgency for radical change. Naturally, we expect the earliest transformations to be in industries in the midst of major technological, economic or regulatory disruption – therefore, IT, telecoms, media and financial services are likely to be first. We also look at the energy and utilities, consumer goods and pharmaceuticals sectors. But first, an important and surprising observation …

No more vertical integration So how will the new economy look? Will these new atoms be contained within traditional sector boundaries, or will we see these boundaries (broadly) collapse? Consumers of the atomic age want to be able to specify broad ‘feelings’ – desires that can be translated into goods and services by an intermediary such as the customer manager described earlier. Mundane, product-focused shopping may, in many cases, become purely routine (via Internet access) or a thing of the past, as we are able to move from single point solutions (e.g. a tube of toothpaste) to broader consumer propositions (say oral hygiene or, more broadly, physical well-being). In turn, this necessitates a move away from tight sector boundaries towards new ‘macro-processes’ centred on the individual rather than the supplier. So we would expect atomization to reduce sector-specific boundaries in favour of consumer-centric activities that pull capabilities from across sectors. Let’s test that by taking each type of atom and following the logic through:

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• Customer managers serve customer needs, which will naturally cross traditional industry boundaries. For example, my motoring needs can only be met by the combined output of the automotive, oil and financial service industries. I don’t care about these sector boundaries, so neither should the customer managers. • Webspinners trade on and in relationships, so expect to see more sector specialization than with webspinners. The smarter ones, however, will look for game-changing opportunities from other geographies and industries. • Smart companies, as with webspinners, will probably need a degree of sector specialization, but again the smarter ones will also look outside their traditional sectors for new opportunities. Consider the way the consulting industry carried ideas such as re-engineering, lean manufacturing and six sigma from one industry into another. • Service platforms such as accounting, HR, IT and legal services will pay no attention to industry boundaries. They are governed by statute or common practice, not by the industry that their clients will be working in. Consequently, service platforms will be cross-sector, even if they may not be cross-border. • Asset platforms such as third-party manufacturing will rarely cross industry boundaries, as large capital investments tend to be for meeting specific needs, e.g. hi-tech assembly. The exception will be those asset platforms that offer generic support services (e.g. a truck-owning company supporting a logistics outfit). • Portfolio owners may be either industry-specific or not. They will not be dissimilar to today’s investment management firms, some of whom specialize in industry sectors while some remain more general. We do expect, therefore, a considerable degree of cross-sector interest among portfolio owners. Are traditional boundaries lost, then, or not? The answer is that the further we get from exploitation of physical assets, the more we expect sector boundaries to break down. The implications are clear – this is the end of vertical integration.

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Retail financial services – a lost cause? Companies in the retail financial services (RFS) sector provide finance and cash-based transaction services to consumers and small businesses. Though these are essential services, the industry that provides them is, largely speaking, broken. It’s not a pretty picture. The banking sector in Japan refuses to tackle its structural problems, there are just too many retail banks in the USA, and many of their European counterparts are fragmented into small national organizations shying away from cross-border competition. Oh, and the insurance industry everywhere is obscenely inefficient. This is an industry populated by the walking wounded. They are not even efficient at providing their core products and services – they run hugely expensive and labour-intensive back office operations. Expense-to-income ratios remain high because every RFS player builds and runs its own systems. This is madness, as the systems are not differentiators – there is ample opportunity for retail banks to migrate on to common transaction-processing platforms based on new digital architectures. We predict that leading banks and insurance groups will share investment in these platforms, probably hand-in-hand with IT service companies. Even more controversially, we think that most retail banks should dump their retail front ends. Let’s face it – despite their self-proclaimed focus on consumers, genuine customer understanding in this sector is patchy at best. RFS providers know less than supermarkets and entertainment retailers about the lifestyles and related financial needs of their customers. Their brands mean little in this context, and today we have as much if not more trust in non-typical banking facilitators such as Marks & Spencer or WalMart. High-street branches waste valuable resources and retailers can fulfil this function better. Even excluding the bricks and mortar on the high street, most retail banks have a significant asset base ranging from call centres to Internet portals, but rarely have the skills to extract high returns on this capital investment. We expect new ‘lifestyle’ entrants (e.g. Virgin Money) to reshape the way people look at banking, followed by the forced transformation of

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the traditional branch network. There is also no reason to assume that the operation of the transaction platforms will remain in their original country. Indeed, given the ratio of wages to education levels in India and China, we expect outsourcing to be the norm rather than the exception. The opportunity for atomization in this sector is therefore immense, if RFS players ignore the looming trap of trying to be a customer champion on their own. We foresee: • Ownership of the customer: Expect increasing encroachment by retail companies such as Wal-Mart, Tesco and Carrefour in the banking and commodity insurance sectors – alliances and new ventures will result, building on the bank’s production capabilities and the retailer’s customer knowledge. Look for major growth in webspinner atoms capable of bundling together a broad range of financial and non-financial services to meet customers’ experiential needs. There might be one exception to our rule that RFS players have no place here – more complex insurance products could stay with specialist brokers such as Aon and Marsh & McLennan. • Product innovation: Because large corporations inherently cannot innovate, newly spawned atoms will specialize in the creation and rapid launch of innovative financial products and services, especially in the pensions and insurance industry. For an interesting exception, see the National Savings and Investments case study below. • Managing your assets: The key remaining asset in the RFS industry is intangible: customer trust. When you pay cash into your account, you can rely on it to get there. An obvious evolutionary step for RFS players is to exploit this trust by concentrating on low-cost transaction processing and services such as claims processing. • Portfolio owners: Retail banks and insurance companies have a lot of their customers’ cash, and do understand risk and can aggregate it better than any retailer. RFS organizations will be counted among the new portfolio owners, holding a range of assets from atoms (their own and others) and a variety of business assets (e.g. insurance risks).

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National Savings and Investments – an unlikely atom Created by Gladstone a century and a half ago to provide the working Victorian with a way to save money (and to provide the Government with a cheap source of funds), National Savings and Investments today is a retail provider handling 10% of the UK’s savings and providing 18% of national borrowings. It also, staggeringly, has the largest customer base of any financial services organization in the UK, with almost half of the population holding an NS&I product. Yet this huge enterprise employs just 125 people, concentrating on the design, management and marketing of products. Most of the value chain is delivered by partners: the Post Office handle a large proportion of the customer interface and all of the transaction processing is carried out by Siemens Business Services (SBS). Hang on … this is a public sector organization, and yet it matches the future shape of the retail financial service (RFS) industry! How did this happen? Five years ago, NS&I examined everything it did and compared it to its private sector competitors. It decided that it was among the best in the industry at product design and management, but that it was merely average at transaction processing. In a tremendously brave step, it outsourced 97% of its 4,300 employees. Delivering the degree of change required was not easy, and most of NS&I’s current top team were bought in from outside. The deal was constructed to allow for innovation, with SBS supporting a number of new product introductions each year. Operating costs have come down (staff number have reduced by 50%) freeing funds for product and channel investment, but NS&I is keen to point out that this is a fringe benefit – ‘the key thing is efficient management of £63 billion of customer funds, not in saving a few million pounds on operations’. A virtual organization like this could not survive without a Chief Relationship Officer, and we spoke to NS&I’s Steve Owen: ‘My title is Partnerships and Operations Director and that about sums it up. I

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do all of the things that a COO would do, only by ensuring that our partners deliver on our behalf.’ His team works hard to ensure that the strategic objectives of all of the partners are aligned. ‘If this alignment slips,’ he points out, ‘the relationship degrades into a straightforward contractual deal.’ But how does NS&I maintain the integrity of its brand when it plays such a small part in the value chain? ‘We specify, in considerable detail, how each interaction looks to the customer. We may not be delivering the customer experience ourselves, but we make sure we stay in control of it.’ Finally, how does it feel to be an atomic corporation? Owen again: ‘Wonderful! We can get a lot more done as an organization of 125 people than we ever could with 4,000-plus staff.’

To summarize, the future shape of the RFS sector will be based principally around trusted service (or transaction processing) platforms and portfolio ownership, with some smart company atoms (usually from outside the sector) providing the genuine innovation that drives individual wealth. While some banks may be able to mutate into or spawn customer managers, we believe this will happen under the umbrella of traditional retailers, and that most banks will die trying.

Corporate financial services – happy disintegration? Corporate banks originate and manage loans to large corporations and sometimes to smaller businesses and the very wealthy. They also provide fee-based services such as merger and acquisition (M&A) support, fund-raising and flotation, etc. and clearly risk management is a key competency. Today, there is a trend for the sector to consolidate horizontally and vertically. As the large corporations become increasingly global, cross-border banks become more common. At the same time, banks are offering a wider range of services. This vertical integration is perhaps a step too far – market perception is changing and regulatory concerns are being expressed

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that the increasing integration of the banks is not in the interest of their customers. Financial products have always been bundled with high-quality research because this has been seen as necessary to sustain customer interest and loyalty. However, the independence of this research is increasingly in question, and the obvious solution is to split the research arm from the product arm. Corporate banking has been, and will always remain, relationship driven, with highly paid and knowledgeable staff manning the front line to the customer (both for businesses and high net worth individuals). It’s pretty clear that the quality of these relationships is strategic to the banks, although there is a case for saying that they can be blended with other corporate services – accountants, lawyers, tax advisers and the like. Let’s cut to the chase. We foresee the following movements in this sector: • Ownership of the customer: The ‘Customer Champion’ strategy is viable here and we foresee both the re-growth of the independent corporate finance unit and the rise of financial gurus that preach a doctrine of wealth to their clients. • Research: Customers will only be prepared to pay for ‘independent’ research, so the research arms will eventually need to be spun off (see the Salomon Smith Barney case study below). They will broaden their research base to rival traditional information providers such as Gartner and Forrester, as well as the more obvious competitors such as Standard & Poor’s. We also expect the research to become more customer-specific, rather than product-specific. • Webspinning: Large commercial transactions such as underwriting new flotations involve high elements of risk, and syndication is a key competency for successful players, just as it is in the making of a movie. This means that wholesale banks will incorporate, or spawn, financial webspinner atoms. • We predict that the principal type of service platforms in this sector will arise from the continuing consolidation of financial markets. It’s no revelation that a market such as NASDAQ is only a settlement service platform with an e-market on the front end. These entities need little or no physical

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presence and cross-border mergers will create service platforms handling transactions on a huge scale. We expect some dramatic developments here as major players pool their trading assets to expand liquidity and reduce transaction costs. We also expect the number of markets to diminish rapidly as the old national bourses die out or are absorbed – a nation no more needs a stock exchange than it needs a national airline. • Finally, finance houses make a good proportion of their profits buying and selling assets (shares, currencies, commodities), and we expect them to exploit their insights and become portfolio owners, trading in ownership of atoms in competition with venture capitalists and mutual fund managers.

Salomon Smith Barney – an unwilling atom? At the end of April 2003, ten of Wall Street’s largest investment banks signed a $10 billion settlement with the US Securities and Exchange Commission, after the regulators determined that there had been fraud in three major banks and ‘conflicts of interest’ in many more. The banks are also facing billions of dollars in private lawsuits brought by aggrieved investors. But Citigroup Inc., the world’s largest financial services firm, came in for the harshest punishment from the regulators, who forced it to pay $400 million after finding that its Salomon Smith Barney subsidiary had issued ‘fraudulent research reports’ to investors, and had awarded stock in ‘hot’ initial public offerings to executives in a position to steer their companies’ banking business back to Citigroup. We think that splitting its research branch from its investment banking arm is both a more fitting punishment and a better fate for Citigroup. We think that such a split is not only inevitable (the industry smells rotten to the public as well as the regulators) but also entirely beneficial. In the next chapter we’ll talk about the new ART of shareholder value, but for the moment you’ll have to trust us when we say that the first organization to establish a smart company as an independent arm will benefit from a trust bonanza.

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Non-industry Players

Customer Channel Operations

Customer Managers

Web spinners

Service Platforms

Product Innovation Portfolio Manager Smart Companies Figure 7.1 Evolution of financial services.

Figure 7.1 shows how we think both the retail and commercial financial services industries will evolve.

Energy and utilities Private investors regard most energy companies as defensive stocks, with relatively low P/E ratios but high dividends. Almost the sole exception in the last two decades was Enron, which doubled and then destroyed its share price in consecutive years by a combination of flair, imagination and fraud. Government organizations continue to dominate the supply side. Consolidation has taken place in recent years, but these industries remain highly fragmented – look at the oil and gas sector where Exxon Mobil is the market leader. Its market share of global oil revenues is only about 7%!

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Fluctuations in price of crude oil, both regular and unpredictable, lead to high volatility in profits, as well as political and social sensitivities. In the oil sector, the majority of profit is derived from upstream activities – exploration, where quality of capital and asset management determines stock market valuations. To offset the high cost of these speculative activities, much of the capital investment is shared among the major players, for example, in the North Sea and Alaska. Oil majors have historically favoured vertical integration to guarantee market access, linking wellhead to petrol pump. Although this means that many of the oil majors are global retailers with tens of thousands of outlets, institutions have difficulty valuing this activity alongside upstream assets. Sceptics would argue that downstream operations add little to overall shareholder value – indicating a strong opportunity for atomization. Energy companies have an inbred managerial culture linked closely to their upstream exploration activities. Long-term success in the oil sector frequently relates to exploration (picking the best sites) rather than production and distribution. Retailing activities lie far from these core competencies and are candidates for divestment, although the retail operations do offer a buffer against oil price fluctuations. You would expect us to say that the customer champion strategy is not a realistic option, but that all other options are open to the oil giants. So, what will a post-atomization oil industry look like? • Ownership of the customer: While corporations are reasonably good at servicing business customers, retailing energy products is a commodity business where customer loyalty is almost non-existent. Energy retailers know little about the majority of their customers, even though several of them (think of Exxon, BP, Texaco and Shell) are among the biggest retailers on Earth. Already, high-street retailers have stepped into this sector, buying oil on the open market (Sainsbury’s and Tesco being the obvious examples). Expect further entrants from outside the sector, as in our Nectar case study below. • Innovation is something that genuinely differentiates energy companies, that and intensive sector knowledge. This reflects the complex processes surrounding energy extraction, production and distribution that could

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be spun off into smart companies. The most obvious skills are those in nuclear power, seismic analysis, drilling, refining and distribution. Shell has stated publicly its goal of transforming itself from an asset-rich to a knowledge-rich corporation. For example, its Global Services arm is a knowledge-based division, housing broad process know-how and R&D. • Asset management: The production of energy is incredibly capital-intensive, with joint exploration fields providing a good example of how oil and gas companies have worked together with service providers to share investment and spread risk. For us, by far the most exciting opportunity is to aggregate downstream assets such as refineries, pipelines and storage depots into a sector-wide asset platform serving the whole industry. Given the relatively small market share of even the largest majors, this sharing of large-scale production assets makes strong economic sense. • Portfolio owners: There will be further atomization in upstream activities as some majors choose to become portfolio owners of exploration properties, and migrate away from operational responsibilities and associated physical assets. And of course, owning a portfolio of upstream and downstream atoms also buffers against price shocks. One type of atom we have not mentioned in this sector is the webspinner. Oil companies are constantly under pressure to escape the commodity trap, and trading on the strength of their sector knowledge is an obvious way forward. Corporations such as Enron led the way in energy trading, and although its disgrace dealt a severe blow to the webspinners, they will rise again. Let’s look at some market-making atoms created by the oil majors: • LevelSeas is an atom, originally created by Shell, but now with a much wider ownership, to link those who have freight to carry with ship owners who have spare capacity (see www.levelseas.com). • Ocean Connect is an exchange for marine fuel, originally centred on Shell’s storage and distribution facilities. It conducted over $250 million in business in 2001, and has expanded its shareholder base considerably. Equity owners now include buyers, suppliers, and traditional brokers and traders (see www.oceanconnect.com).

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• There is also scope to utilize industry-specific assets to create service platforms. Eastman Chemical effectively outsourced its logistics arm (which handled the specialized carriage of oil and chemicals) in March 2000. Now called Cendian, this is a joint venture with a supplier of logistics and transportation software, G-Log. It is based on the backbone of the Eastman logistics network, but it relies on the Internet to gather its customers and co-ordinate its network of partners, providing optimization, management, tracking and payment management for specialist multimodal shipping (see www.cendian.com). Figure 7.2 shows how we think the oil and gas industry will evolve.

Upstream

Governance

Exploration

Portfolio Owners

Extraction

Downstream

Smart Companies

Refining Distribution

Asset Platforms

Retail Customer Managers Non-industry Players

Figure 7.2 Evolution of the oil and gas industry.

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Nectar – cross-sector customer management Some retailers introduced retail loyalty schemes and then withdrew them when sales failed to increase. Others, such as Tesco, invested heavily in their schemes and used the information to up-sell and crosssell. The reason this case study is here in the energy section is Nectar – a loyalty programme launched in late 2002 and part-founded by BP. Nectar was founded by some of the UK’s best known companies – retailers Sainsbury’s and Debenhams, financial services company Barclaycard, and oil giant BP. Backed by a £40+ million launch marketing campaign, the Nectar consortium predicts that it will sign up over half of UK households in the first year, with an eventual target of over 70%. The benefits for the sponsors, in addition to increased customer loyalty in famously promiscuous markets, include cross-marketing opportunities and a chance to share those high operating costs. In fact, the programme was created by the man behind the popular (and competing) Air Miles scheme and is backed by venture capitalists Warburg Pinkus. In return for increased loyalty and loss of privacy, the benefits to consumers are centred on experience – meals, entertainment, holidays – or a straightforward reduction in their grocery bills. It’s too early to say whether or not this ambitious programme, based on cross-industry schemes popular in Canada, will succeed, and whether it will migrate into a full-blown customer management atom in the way that Tesco’s scheme appears to be. However, for BP it at least represents a way of finding out who their customers are!

Telecoms In the 1990s, the telecoms industry underwent what could accurately be described as a revolution; in reality, multiple, simultaneous revolutions. In little more than ten short years, the industry was deregulated globally, the basic network reinvented, and a parallel, mobile telephone market sprang

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into life. Suddenly, more operators offering more services over different backbones were competing for the customer’s dollar and, as a result, the customer became king. The telecoms industry (and phone companies with it) suddenly ceased to be an ‘engineering game’, and rapidly metamorphosed into a customer service business. The key tools were knowledge of the customer, network operations or service innovation.1 Well, that sounds OK. So why is the sector in such a parlous state? It may be that the people running the telecoms industry appear to be completely insane. It’s hard to believe, but read on:2 • Overgearing: Between 1996 and 2001, US telecoms companies borrowed $1,800,000 million. Half of European bank lending in 1999 was to telecoms companies. Credit agency Moody’s estimates that about 80% of all the junk bonds issued in the USA involved telecoms operators • Merger madness: Five of the ten largest mergers or acquisitions in history have involved telecoms companies, and much of the value of these has already been written off. • Absurd capital spending: In this period, the telecoms giants laid down 100 times more bandwidth than the world currently needs. Auctions of licences to operate new technology either failed, or reached absurd prices.3 As a result, the costs to the customer are huge, take-up is extremely slow and the chances of recouping these investments are remote. • Collapse: The DowJones telecommunications index has lost 75% of its value from its December 2000 peak. Many of the biggest names in the industry have gone broke, or seem to be about to do so. Maybe this shocking implosion might provoke some new thinking … Many of the larger operators, such as AT&T and BT, publicly announced an intention to break up when the market collapsed but this was often not going far enough, or fast enough. Others, such as WorldCom, had been effectively ruined by dishonest accounting practices during their halcyon days. Elsewhere, most national telecoms operators are still vertically integrated, owning both core network assets and the channels to customer (including local connection, billing and customer support services).

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Our atomization model could take industry thinking a lot further. We envisage the following: • Ownership of the customer: Atoms from this sector have a high potential value given the growing impact of telecommunications on our lives and the linkage to lifestyles – unlike the banks, telecos know where you are and what you are doing every hour of the day. However, new attitudes to the customer and new mechanisms for unlocking value are needed; with pricing based on application rather than simple line usage (most telecoms companies still look at their customers as ‘subscribers’). Just as with the banks, we expect to see branded companies with retail expertise (such as Virgin) providing stiff competition to the incumbents. • Service platforms that provide billing and maintenance could be very valuable; if the opportunity to bill for services other than telecoms is included (you can already use your mobile handsets instead of cash in Australia, Indonesia and parts of Europe). Specialist knowledge is needed and investment in new tools will be high, and we would expect these service platforms to be created in collaboration with IT service companies. In the corporate sector, we see continuing opportunities to trade excess bandwidth capacity, coupled with a range of secondary instruments based on variable demand patterns. • Innovation is the lifeblood of the telecoms corporations, but they seem curiously unable to make the most of their opportunities. Perhaps we will see more ventures with players emerging from other sectors (e.g. automotive, media, consumer goods, banking), which are all interested in exploiting new interactive channels to the customer. • Asset platforms: The glut of bandwidth and high levels of investment needed to construct new networks implies a strong case for industrywide consolidation towards a small number of global and local network operators. These could be co-owned by major telecoms operators, reflecting the fact that bandwidth provision is no longer a sustainable competitive advantage. The current situations – where small nations such as the UK have several competing mobile networks – are neither sane nor sustainable. Expect to see one, or at most two, network owners per country/region with shared ownership by the various telcos.

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So, in short, we expect to see the fragmentation of this industry as well. Some telcos, especially from the mobile operators, have the potential to exploit the customer champion strategy even if they do not have the right attitude. There is a strong global utility play, and room for more innovation by spawned and new entrant smart company atoms. We think this is a set of strategies that the telecoms industry will rush towards, not least because separation of operations from customer management and innovation should improve analyst ratings!

Consumer goods As with the oil sector, consumer products companies are seen as defensive stocks with low historic revenue growth and considerable product maturity. In a world that is becoming increasingly interactive, questions have also been raised about whether toothpaste and soap powders can be made into sexy brands or valuable consumer propositions. These companies are burdened with large-scale manufacturing units and complex processes, deeply embedded in electronic concrete (often referred to as ERP systems). There are a few corporations that we admire in this sector – in particular, smart companies such as Coca-Cola demonstrate the value of lean thinking (see case study in Chapter 4). Many of the larger companies are preoccupied today with the search for added value – Unilever is focusing on improving our ‘day-to-day’ activities such as domestic laundry, diet, skin care and body care – not just producing boxes of detergents. This means broadening their brands and extending products into full-blooded offers – such as household laundry and cleaning services. It also means reaching out directly to the consumer and thus bypassing the retailer. With stock values falling by up to 50% in recent times, the case for atomization in this sector has never been more compelling. In contrast to the oil and telecoms industries, we would counsel CEOs in this sector to concentrate on your customers and their needs, rather on your products and your means of production (see ‘customer champion’ strategy in Chapter 5).

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Other mechanisms to unlock value in this sector include: • Innovation: Atoms that focus on brand and product innovation and employ highly skilled designers and technologists will command high equity values. The concept of an innovation factory that accelerates new product development is being explored by a number of leading players. • Asset and service platforms: Consumer product companies employ vast infrastructures (e.g. manufacturing, logistics, finance and administration and IT) that add little value to the core business. Many have chosen to outsource IT and accounting, but have benefited little from these moves in equity terms. Transora is an industry experiment that could be the forerunner to many more co-operative schemes, ranging from shared financial services to employee portals. The latter would be held as either private or quoted stock, thus retaining value among key customers.

Webspinners ‘R’ us This sector was the first to spawn webspinners acting on behalf of the industry as a whole. The two leading players are: • Transora, which was established by members of the Grocery Manufacturers of America in mid-2000 to reduce costs and streamline trading relationships among manufacturers, suppliers and retailers. Transora’s investors include more than 50 of the world’s largest consumer goods manufacturers. • GlobalNetXchange (GNX) was designed to help retailers and manufacturers streamline the processes at the core of their business and drive down costs across the entire supply chain – services include auctions, collaborative development forums and logistics support. GNX equity partners include many of the world’s largest retailers, including Carrefour, Sainsbury and Sears Roebuck.

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Pharmaceuticals Oh dear. Pharmaceutical corporations, which have always been slow to learn from examples outside their industry, still seem intent on global domination. Their route, along with that of a long list of wannabe mega-corps, is usually through acquisition and merger. In Chapter 10, we will tell you why that is a bad idea, but the short version is that it usually destroys, rather than creates, shareholder value. But today pharmaceutical corporations try to cover all the bases of the old economy – R&D, manufacture, distribution and customer management. As an investment vehicle, they have the volatility of a high-risk stock without the accompanying growth – if you don’t believe us, open your newspaper. What should they do instead? For us, corporations like GlaxoSmithKline (GSK) need to make some simple choices – are they to excel in drug discovery, or manufacturing, or product sales and marketing? No corporation, however smart, can seek to be world class in all three areas. Let’s take drug discovery first. Professor Agamemnon Epenetos, former Chief Scientific Officer of one of the UK’s leading biotech companies, told us that ‘large pharmaceutical companies such as Glaxo take twice the time, and spend four times the money, to bring new drugs to market as they should’. We demonstrated in the last chapter that small is beautiful in the innovation business, so pharmaceutical corporations would be well advised to dismantle their bureaucracies in favour of selective licence deals with the thousands of biotech research boutiques across the world. Figure 7.3 shows our views on the future of the pharmaceutical industry. And how about other supply chain activities? The choice between manufacturing and marketing is an easy one to make. We’ve seen how the Coca-Cola Company made a choice many years ago to focus exclusively on brand and product management. It has outsourced bottling and distribution to third parties but maintains a tight quality control across the entire supply chain. As a consequence, it has achieved a remarkable track record as one of the world’s most highly capitalized companies – with price-to-earning ratios consistently double those of its competitors. Surely there is a lesson here for GSK and its peers? Rather like a Hollywood studio, it could select and promote a handful of blockbuster drugs.

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Non-industry Players

Distribution Manufacture Drug Discovery

Customer Managers

Web spinners

Service Platforms Asset Platforms Smart Companies

Figure 7.3 Evolution of the Pharma Industry.

Value would then be derived through rapid exploitation of multiple marketing channels before patents expire and commoditization sets in. Above a certain hygiene factor, manufacturing and logistics are irrelevant to competitive performance, and can be easily outsourced to competent third parties that offer global scope and scale. But perhaps the biggest opportunity is to adopt the strategy of customer champions, although it is a hard road to walk. If GSK really cares about our health, why does it wait until we become ill before offering us expensive drugs? Should it not be joining forces with companies whose new mantra is ‘Well-being’? How much more would we pay to stay well rather than remedy our illnesses?

Summary The path is now wide open for atomization across all major commercial sectors, but the main incumbents will need to choose the roles they want to take. The world’s top 10,000 companies must choose one of our main

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strategies – customer champion, Hollywood producer or global utility. Those that make the wrong bet, or (more likely) overestimate their own competencies, will not survive. The message: focus on your core competence – the things you do better than anyone else within and outside your industry – and structure your existing business accordingly. Atomization is going to change most industrial sectors radically. They will each have their different pressures and will evolve in subtly different directions. But the common theme will be a reorientation around the newly empowered customer. There are clues to the future in some sectors, where outstanding corporations have already begun the process of atomization or been organized along sympathetic lines for some time.

Endnotes 1 For more analysis of the telecoms industry, see The Great Telecoms Swindle by Keith Brody and Sancha Dunstan, 2003, Capstone Publishing Limited, ISBN 1841124672. 2 Figures mostly taken from the Financial Times, 4 September 2001. 3 Auctions held in 2000 and 2001 in several European countries lumbered telcos that wished to operate 3G (third-generation mobile) services with very high licence costs, while licence auctions in other countries effectively failed due to lack of bidders. Although Europe is perhaps two years ahead of the US in mobile communications, the introduction of 3G appears to be facing a period of uncertainty.

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Relational Capital

New sources of shareholder wealth This chapter is about wealth: in it we look at how corporations are valued and how their value increases as a result of the process of atomization. The drivers in that process, and the currency in which atoms deal, are innovation, agility, relationships and trust. It’s often idly said that modern man is always motivated by one of three things: sex, money and sport. Two of those are outside our scope (at least, as far as this book is concerned) but the third – the creation and distribution of wealth – is absolutely key to our arguments. It’s ironic that money – the bedrock of the commercial world – is so poorly understood. Ask yourself how shareholder value is measured, for

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instance. You may be surprised that you need to ask in the first place, yet it’s now widely realized that traditional measures based on accounting fundamentals are only useful up to a point. Newer methods of measuring wealth based on the inclusion of intangible value and future options are now, finally, coming into play. Not only do they factor in innovation and agility but they also reveal the principal source of untapped value in corporations – their relationships – and we believe that value can only be released in an atomizing world. Atomization in the corporate world is nothing more than the physical manifestation of the inexorable march of progress. Atomization is neither ‘an’ idea nor ‘our’ idea. In this book, we are simply recognizing and describing a new reality. But back to money. Any board of directors exists to increase shareholder wealth. In other words, their target is to improve the dividends the shares bring and to oversee growth in the value of those shares. In the good old days (say thirty years ago) boards thought in terms of long-term value and set about the job of making and selling things. The successful twentieth-century investor, characterized by Warren Buffet, selected stock portfolios based on corporations offering strong future profit flows from well-established businesses, backed by solid assets. These included product manufacturers and service corporations operating in the traditional publishing, branded goods, insurance and financial sectors where prudent management ensured healthy cash flows and strong returns. For a long time, this plan worked fine. Then, a few years ago, the Internet revolution arrived. Almost overnight, investors became euphoric about the value connectivity could bring. Future growth options became the new ‘name of the game’ and few people worried that the vehicles they were investing in were not making a profit at the time. In fact, some didn’t even seem worried that those corporations would never make money at all. Unsurprisingly, those people took a bath when the cash ran out. In the midst of this recent feeding frenzy a few corporations, including respected ones that really didn’t need to, ignored business management rule number one and sadly resorted to fraud to increase their apparent earnings. Rule one? When in a hole, stop digging. We’ll return to this theme later.

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And now? The stock market has over-corrected. Today we sit in the financial doldrums, with Buffetteers looking smug and the concept of increasing shareholder wealth a distant memory. There is a way out. The CEOs that will shine in the new post-boom economy are those that break the old trend and find new sources of value that can be released. And make no mistake – those sources are there to be found. Turning the clock back is not the way ahead. Atomization is first and foremost a sure method of releasing value, and we can prove it.

Financial alchemy In the process of writing our first book on atoms, we came across a neat little chemical serendipity: the basis of the global economy has moved from carbon to silicon in the last three decades! Carbon-based companies (oil, gas, chemical and the like) are valued on the basis of their tangible assets, while IT-related silicon companies are largely valued on the basis of their intangible assets. It will not have escaped your notice that IT has been repeatedly applied to every aspect of industry, with ever-shorter wavelengths of change. IT industry leaders have, unsurprisingly, gained a near monopoly within the top fifty of the world’s most valuable corporations (see Figure 8.1) and the sector has seen a unique combination of high profitability and rapid growth as a result. In the process, the old industries have been eclipsed. During the 1980s, for example, the IT industry achieved a compound rate of 30% growth and double-digit profits. To illustrate, in 1999 Microsoft achieved a market value five times greater than General Motors (the world’s largest car manufacturer) despite having just one-fifth of the revenues. The main losers have been the oil companies which, despite continuing profit growth, have failed to demonstrate where they will go when the oil runs out. Let’s look further at valuation methods, and why it’s time to change them again.

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Carbon 53%

Carbon 5%

Silicon-based industries include IT hardware, software and Internet-based companies Carbon-based industries are primarily oil, gas and chemical Iron-based industries are traditional industrial manufacturers Service companies were primarily in the financial services sector

Figure 8.1 Comparison of market values, 1970 and 2000.

Iron 26%

The US Economy in 2000 – $5,273 billion

Silicon 54%

Service 15%

Figures are for top 25 companies in the US economy at year end 1969 and 1999.

The US Economy in 1970 – $275 billion

Iron 16%

Silicon 29%

Service 2%

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Measuring corporate value Tangible and intangible value Until recently, corporations were valued primarily on their estimated current and future cash flows predicted from income, assets and pattern of investments. However, those measures did not keep up with developments in the nature of investors and investment. Previously, shares were owned by the very rich or by banks, often for dividend income rather than growth. Today, share ownership is the new opium of Western populations, and most people buy shares for growth opportunities as well as steady income. While the new economy bubbled away, the old one quickly became stale as investors moved away from corporations highly rated by asset-based valuation models. Modern investors wondered what the corporation would do to keep pace with increasingly fast changes in the world. ‘What’s coming next?’ they wanted to know. ‘Where are the new ideas to generate new sources of incremental value?’ It was this shift in perception that drove the dot-coms forth as much as the exciting opportunities offered by the new economy. Profits in the new economy appear inversely proportional to market sentiment1 – or to put it another way, if you return good profits to your owners, you can expect the value of your shares to fall. Procter & Gamble’s market capitalization fell by 50% in the last years of the 1990s because its toothpaste just isn’t sexy. So the question is begged, is the decline in traditional industries sound economics or unsound fashion? The answer, to a degree, is both. In one of the century’s sillier economic fashions, investors wrongly looked to corporations that hadn’t a prayer of making money, but what’s interesting is that they correctly recognized that the staid, solid industries of yesteryear won’t produce long-term value gains. Smart investors identify corporations that possess a certain je ne sais quoi – something that can only be described as ‘intangible assets’ that will not show up in traditional yardsticks such as return on investment (ROI) or discounted cash flow (DCF). These companies might (or might not) be worth

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large sums of money in future years, and the investors factor in a degree of undetermined future growth options as well as guaranteed profit flows. Analysts often measure the value of these future growth possibilities by using real options theory. Put simply, this theory states that in the future, things will happen (management decisions, changes in market conditions) that cause intangible items to obtain a real value. By understanding the flows of probability across time we can say now what the cash value of these intangibles might be in the future. A simpler, but less mathematically worthy, way of measuring the value of intangibles was developed by Ernst & Young’s Center for Business Innovation. Its net future expectations model measures shareholder wealth as the sum of two equally significant components. The first component is the actual generation of income for the shareholders, the net present value of guaranteed current and future profit flows or the cash flow you can be certain to get. The second component of shareholder wealth is the projected profits of future growth opportunities where significant investment and experimentation is being committed by management.

The value of future opportunities The Center for Business Innovation’s net future expectations formula is as follows: Net future expectations = discounted cash flow + net future opportunity The net future opportunity (NFO) element is comprised mainly of the ‘intangible’ assets of a company. In the Center for Business Innovation’s view, the NFO of a business is made up of three parts: its capacity for innovation, the flexibility with which it is able to adapt to changes in the marketplace, and its ability to execute a given strategy: • A company’s capacity for innovation can best be understood in terms of its R&D leadership, its technological expertise and its ability to deliver quickly new products and platforms to a market

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with ever-changing needs. It can be measured by assessing, among other things, the company’s R&D spend, new product pipeline and cycle times, and intellectual property portfolio. • A company’s flexibility can be quantified by (for example) the percentage of revenue that comes from new products and services each year, its number of strategic partnerships and its cost of capital. • Executional ability is evidenced in a company’s market share, customer satisfaction and retention scores and brand value.

Whichever intangible valuation method you favour (net future expectations or real options), clearly the most successful corporations now manage the balance between the here-and-now and ‘jam tomorrow’. Corporations still focusing exclusively on current profitability and associated cost-cutting measures have incurred substantial market discounts – of up to 50% – as demonstrated in the stock market revaluations of the old economy corporations in the late 1990s. That lost wealth has never been recovered. However, this is a poor excuse for the mass hysteria and insanity of the dot-com era, where investors backed businesses that had spectacularly over-valued their intangible assets. These dot-com lemmings were never likely to generate profit, yet alone a decent cash flow, and the lesson has been sharply administered to their backers. The picture is not complete, though we would argue that none of the traditional valuation methods include the key component of atomic success – relationships.

It’s not what you know, it’s who you know We’ve looked at traditional valuation methods to evaluate the assets of a corporation, and at those that apply equal weight to intangible value. However, neither of these is adequate in the economy of the twenty-first century. We want to turn now to a valuation model that looks at the value of a corporation not as a free-standing entity but as part of a wider economy. This model builds in the value created internally but released by connectivity,

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and it must therefore include innovation and relationships as key elements. We’ve added one new factor to this equation: trust.

The value of relationships From the beginning of time, relationships and trust have dominated business value. The age of mass production marginalized these factors but, as increasing connectivity destroys the trade-offs between richness and reach, they will return to predominance. Our work, both recently and as part of a global multi-client programme (Business in the Third Millennium), has identified three main factors that contribute to shareholder wealth: • a focus on stakeholder relationships, the anticipation and awareness of stakeholder needs (both articulated and latent), especially those of the customer; • the development of inter-business value networks, including suppliers to the business and other trading partners – even traditional competitors; • high levels of agility and creativity – what we call innovative capacity. The subject of innovation is explored elsewhere in this book, so here we concentrate on the other two factors identified by Business in the Third Millennium, the identifying and nurturing of relationships.

Business in the Third Millennium Following closely in the footsteps of MIT’s Management in the Nineties programme, Business in the Third Millennium was initiated by Gill Ringland, group director of strategy with Fujitsu Services, to create a global forum for strategic research into the broader social and economic effects of the digital economy. Under SRI International’s stewardship (and subsequently that of FirstMatter LLC, the futures consultancy spin-off of SRI), the programme brought together a further eleven

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sponsors from Europe, America and the Far East. These included public and private organizations such as Barclays Bank, BP, Chevron, EPRI, the European Commission, the Gas Research Council, NTT and the US Postal Service. A central theme of the programme was the blurring of relationships between individuals in society, major corporations and national governments, brought about by the widespread adoption of the Internet. Early areas of focus included evolution of digital infrastructures, digital literacy, changing market segmentation, and new sources of shareholder value. The programme took advantage of scenario-planning techniques developed jointly by SRI and Shell in the 1970s. This scenario planning exercise reviewed changes in the world economy influenced by digital technology. Watts Wacker, the Resident Futurist of SRI International and co-founder of FirstMatter, provided much of the thought leadership for the programme. Roger Camrass was the programme director from inception in 1992 to completion in 1998.

Spinning a web Any large organization has a multiplicity of relationships that are sustained over time – the four most obvious are with customers, suppliers, employees and shareholders. Much of the infrastructure of any organization is concerned with building and maintaining these associations through core functions such as sales and marketing, procurement, human resources and investor relations. Each of these stakeholders is probably a customer, employee, shareholder or supplier of another corporation, and so we have a web of relationships forming a potential source of value in the new economy (see Figure 8.2). In addition to these primary relationships, large corporations have as many as forty or fifty links with other key stakeholders, such as like governments, alliance partners, local communities, the media and other interest groups.

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Employees

Customers

Corporation Shareholders

Suppliers

Figure 8.2 Relationships with key stakeholders.

One of the most valuable relationships is that with the customer. A key process of any corporation is the acquisition and retention of its key customers – those that contribute to business profitability. The cost of customer acquisition can be high both on the ground and in cyber-space, as dot-com corporations have found to their cost. Media and incentive spends of up to several hundred dollars per new consumer are commonly built into business plans for those corporations using the World Wide Web as its primary channel for customer acquisition. Further, many alternative channels, on-land and online, have been employed in the last ten years to sustain these relationships, ranging from direct sales and telemarketing to web-based techniques such as websites and portals. The importance of this customer acquisition process is reflected in the capital value of the remaining online corporations. Amazon.com’s market valuation is based on a multiple of the total number of acquired customers. These multiples have ranged from $5,000 to $20,000 per customer, valuing Amazon.com in the tens of billions of dollars. A similar metric is used to

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value cable franchises where a home passed contributes $3,000 to $5,000 to total capital value. The cost of acquiring talented employees can be even higher than that associated with customer acquisition. For many service organizations, the total cost of acquisition and profitable deployment of new staff can equal between two and three years of pay and benefits. This may be as high as half a million dollars for a professional services organization, where the employees are, in essence, the products. Again, this provides a legitimate way of calculating the value of a services corporation based on the multiple of employees and their individual market valuation. Amazingly (to us at least), traditional approaches to improving business performance are often based on minimizing the cost of building and supporting key stakeholder relationships. Re-engineering focuses on corporate downsizing, which reduces the number of employees and simplifies supplier and customer arrangements. These efforts aim to cut the cost of doing business rather than increasing the non-financial benefits arising from established relationships.

Richness and reach In the bad old days (say until 1995), you had to choose between information-rich interactions with a few people through talking or meetings, or low-bandwidth links to many people via one-way media (print, television, radio, etc.). The new, two-way, media based on the Internet destroys that trade-off between richness and reach, making it possible to have many high-quality relationships.2 Managers can now form new customer relationships, and extract additional value from established relationships, through the use of interactive channels. Other mechanisms for enhancing value have emerged from marketplaces, such as Covisint – the electronic market that sits between leading car manufacturers, such as GM and Ford, and the many thousands of component suppliers that serve these corporations. These markets exploit web-based trading and collaboration mechanisms to increase the economic value flowing between suppliers and customer organizations.

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Each transaction reduces costs and increases intangible value for all participants, even excluding the potential capital value of the marketplace vehicle to its owners. Both of these factors represent new value that did not exist before the creation of the e-marketplace. The transactional information gathered within the e-marketplace will also have value within the sector and could spawn secondary markets based on derivatives. These, in turn, will further increase value opportunities such as those that exist in financial exchanges. Introducing web-based techniques to generate new value opportunities is now broadening out from customers and suppliers to include additional classes of stakeholder such as employees. Service platforms will provide a range of services, financial and other, to employees of several different corporations using electronic portals. They might, for example, offer insurance, investment, banking and home shopping in addition to those applications (e.g. HR and finance systems) sponsored by the employers. The spending power of the audience brought together by these worksite marketing opportunities promise tremendous value for their operators. Think of this as yet another new source of wealth that will be shared with the portal operator, the employer and employee. As with any corporate scheme, such as healthcare, the e-HR portal can aggregate demand across many thousands of staff to produce mutual benefits of scope and scale. Extending these portals across corporations could also lead to career secondment in addition to the usual aggregation opportunities. This may even shift employee loyalty from the employer to the wider group, again changing the nature of employment. As the connected economy expands, so the majority of stakeholder interactions will migrate towards electronic channels such as web-based portals. This is not so much because they are orders-of-magnitude cheaper than traditional channels, but because of the richness they can bring. CISCO, for example, has already evolved beyond this point, and could well claim to have become an entirely virtual organization where the Web is the single point of contact for internal and external parties alike.

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Cisco Systems Cisco Systems is a world leader, and perhaps the world leader, in the use of virtual technologies and web-based systems in its everyday business. It realized earlier than most that transaction costs could be reduced, and quality improved, by using the Internet to shape every encounter with its customers, employees, partners and suppliers. At the heart of Cisco is an intricate Internet-based network linking all aspects of its value web, and which it claims provides annual savings of over $800 million. This is in addition to a range of other upside benefits such as increased customer satisfaction, reduced product development times, inventory reduction and increases in productivity. Cisco rebuilt itself around three virtual networks, which drive web-based systems and processes into the core of every commercial activity. The first deals with customer-facing processes, using the Internet as a collaborative platform to improve customer service around the world. More than 80% of Cisco’s technical support for customers and resellers is delivered in this way, saving it $200 million annually. In some ways, this mirrors atomic customer managers. Second, Cisco has created an extranet for its manufacturing, supply and logistics functions. This makes available real-time manufacturing information for all the members of its supply web, internal and external, allowing it to run a network of manufacturing atoms. Information made available in this way includes forecast data, inventory, and purchase orders, as well as all necessary approvals and alerts from a host of individual manufacturing systems. Third, its intranet deals with all internal employee self-service initiatives, with applications to deal with engineering, sales, marketing, training, finances, HR, facilities and procurement. This provides the basis of service platform atom(s) and allows Cisco to scale its workforce and absorb other companies rapidly without incurring unnecessary overheads.

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Trust and ideas My word is my bond Trust has long been the core to all successful relationships. Long before electronic means of communications, the handshake represented a mutual commitment to a commercial transaction. With the scale and complexity of modern business, opportunities to develop personal relationships over a long period are less frequent. Instead, corporations develop brand promises to reinforce their commitment to mass communities, be they customers, employees or shareholders. The credibility of a brand is based on the ability of a corporation to repeatedly deliver its promise. In the words of the American futurist Watts Wacker, ‘trust is a promise kept’. In many non-Western economies, trust is often a more important factor than cost.3 Consider the ways in which customer–supplier relationships are built and sustained in the Arab world, or how Far Eastern companies work within extended pre-existing networks such as the Korean chaebol or the Japanese keiretsu. In a digital economy built on myriad electronic connections, a fourth source of value – managing trust in the brand – will become critical for all businesses. Unless you can actively manage your brand – corporate or personal – the added value that you bring will not be recognized by customers. This is also the case for stakeholders who view a corporation mainly through its brand promise. Employees will place their loyalty with a corporation whose brand they respect, such as Disney, Nokia or Coca-Cola. In many cases brand reflects a statement of lifestyle, or personal aspiration, as in the case of BMW where the brand communicates the ‘ultimate driving experience’. Trusting relationships will become an essential ingredient of successful value networks. Competition in the future may be less between individual firms and more between the value networks in which they participate – perhaps between temporary virtual keiretsu. Increasingly, participants in the network will also co-ordinate, co-operate, and co-create new opportunities. Glass and ceramics manufacturer Corning Glass, for example, has always maintained a brisk rate of product and technology innovation by creating

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marketing alliances with other corporations to penetrate new markets. It does what it knows best, but it will not encroach on the marketing competencies of its partners in order to help facilitate collective growth.

Enron – a failure of trust In the last edition, we wrote about Enron in glowing terms. We stand by that review, and we’ll tell you why below, but there are further lessons to learn from the Enron story. In mid-1999 Enron sold its core oil and gas subsidiary in order to concentrate on ‘distribution, wholesale and energy-related services’. In October 1999 Enron launched its first Internet marketplace, EnronOnline, trading energy derivatives and emissions credits. While there are many such marketplaces nowadays, this was revolutionary in its time. Its purpose was to connect buyers and sellers together to trade specialist items, sometimes with Enron making the market. For example, to build a new power station you would not use your current emissions credits, although you might forecast you needed excess credits in ten years’ time. EnronOnline connected you with someone with the opposite profile to arrange an emissions swap, or perhaps to trade the credits for some electricity. EnronOnline then moved into trading specialist shipping, credit risk, pipeline capacity, metals, chemicals and a host of other products. By the end of 2000, EnronOnline claimed to be handling $3 billion of transactions, with something like 60% of Enron’s own transactions going through the marketplace. EnronOnline also spawned a number of specialist marketplaces. For example, in 1998, a heatwave in the US Midwest increased the shortterm price of electricity 500-fold. Enron’s response was to set up a derivatives marketplace (with the marvellous slogan ‘Buy the weather you want’) where distributors, farmers and companies could buy weatherrelated options to minimize their risk (www.weatherdesk.com). By

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Enron’s figures4 its wholesale services division was worth $50 billion in January 2001, making up 45% of Enron’s total valuation. As well as setting up derivatives markets for the water and paper industries, it created EnronCredit, which facilitated trade by allowing corporations to buy what is effectively insurance against their trading partners going bankrupt. But the market wasn’t there, and it seems that Enron started to accept the risk itself – it was now acting as a bank, but without the checks and ethical standards that industry uses. It was also heavily trading in commodities on its own account, creating an ever-increasing need for credit. Enron had doubled its share price in a year, partly by overstating revenues but partly through a genuinely innovative business model. What Enron had done was to spawn a host of webspinners, connecting parties together for the good of the industry, even in industries in which it was not particularly active. But in the next year, three failures of trust destroyed 99% of the value of the corporation. They admitted booking trades as sales (not uncommon in the Internet industry but unacceptable for a bank), trading with companies owned by some of its directors, and transferring $1 billion of assets to one of the directors in return for a piece of paper. They had the agility, they formed the relationships, but they blew the most important part of the ART equation – the trust element. Banks trade on trust, and when Enron betrayed that trust, they destroyed one of the shining examples of the new economy.

Innovation as a source of value The third factor in our new equation for shareholder value – alongside relationships and trust – is innovative capacity. Related to internal agility and creativity, this implies speed and originality of thought and action. An innovative organization is one that quickly recognizes significant changes in the external environment and imaginatively reconfigures its resources to exploit them. It may well use the intelligence derived from the value networks that surround it as its primary stimulus, but the core of its success will be the knowledge and creativity that reside within.

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We described such entities – our smart companies – in depth in Chapter 4, so suffice it to say here that knowledge-based relationships depend on complex human interactions. The most important attribute of effective knowledge management is a cultural one, and that is the commitment that individuals have to share their own knowledge within a common community. Again, the desire to do so is based entirely on trust and reciprocity, encouraged by a culture where transferring knowledge, rather than controlling it, is the basis of power.

The new ART of shareholder value Most businesses know that competitive survival depends on factors such as effective cash management, stock control and distribution efficiency, product and process innovation, and product quality – what one might call ‘ hard’ management issues. They are, and will continue to be, important in the atomized economy. But these alone are not enough to differentiate one business from another in a future global world where products, processes and markets become increasingly similar. Trust in the brand, trust between business partners, and internal trust will become essential in building healthy ecological competitive business relationships. To reiterate, drivers of shareholder wealth in the future will be agility and creativity, a focus on stakeholder relationships (including the development of inter-business value networks) and trust. We do not play down the tangible, current elements of corporate valuation but we believe that Future Value is equal to the product of the value of Agility and Relationships, accelerated by the power of Trust. Total shareholder value is clearly the sum of the usual tangible measures of physical value (asset and stock value, plus the discounted cash flow of the current revenue lines) and the future value described above (see Figure 8.3). Some managers feel uncomfortable with what they regard as a ‘soft issue’. Nonetheless, trust is an asset of business like any other. It should therefore be treated as a hard management issue – perhaps the hardest of all. The ability of a business to create and maintain trust will determine its unique

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Shareholder Value

Relational Capital Agility

=

=

Tangible Value

=

(Agility

Innovation Capacity

Relationships

+

×

+ Relational Capital

Relationships)

Trust

Speed to Adjust

= Customer Intimacy

+

Value Networking

Figure 8.3 The new ART of shareholder value.

identity as a business, and that is where the source of future competitiveness will lie. Break your trust and the value of your company will rapidly diminish to zero, as Enron clearly proved.

Money makes the world go round Releasing relational capital Our Crusade for Atomization will only gain adherents if it creates value. The sum of the atoms must be worth more than the original corporation. So we have to demonstrate that there will be a release of financial energy when atomization occurs. How can we use these new ideas to identify the value of our atoms? As part of an atomizing corporation and as individual elements? Clearly, our atom types will differ by primary source of value – the value of smart companies will be based on their innovation capacity, whereas customer managers will be composed mostly of the value of their relationships. Figure 8.4 shows the relative proportions of traditional, physical value, intangible value (based on agility) and relational value in the new atom types. The failings of large corporations are manifest – they stifle innovation, decide and act too slowly, and do not allow the full value of relationships to be extracted. So when we free the atoms from that corporation, we will

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% value per $ of total market capitalization

100

80

Relational Value Intangible Value

60

Physical Value

40

20

er in n eb sp W

M an ag er

C us to m er

C om pa ny

ce Se rv i

Sm ar t

Pl at fo rm

ne r w O Po rt fo l io

A ss et

Pl at fo rm

0

Figure 8.4 Unreleased relational value.

witness an uplift in the total value of the corporation as the relational (and, to a degree, the intellectual) capital elements of the atoms are released (see Figure 8.5). It should come as no surprise to anyone in an operational unit that the corporate centre makes things worse. Indeed, Sadtler, Campbell and Koch5 estimated that the existence of a central control function in a corporation depresses its value by between 10% and 50%, because of a number of factors including cost addition, demotivation, misinformation and (accidental) mismanagement.

Specific valuations We can be more specific, and predict the profitability of atoms and what their likely market capitalization will be. Amidst the sound of polishing crystal balls, let’s choose two measures to describe these factors and make an attempt to estimate them for our atoms: • From a shareholder’s perspective, then, we can measure profitability using dividend yield, a measure of the profit per share that the company returns to its owners (i.e. gross dividend) divided by the share price.

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180 160 140 120

% value per $ of total market capitalization

100 80

Relational Value Intangible Value Physical Value

60 40 20

er in n eb sp

W

M an ag er

C om pa ny

C us to m er

ce

Sm ar t

Pl at fo rm

ne r w O Se rv i

Po rt fo l io

Pl at fo rm

0

A ss et

16 0

Figure 8.5 Freeing the atoms increases P/E.

Investors concerned with regular, safe income would choose industries that tend to return high dividend yields. • We will get market capitalizations using the Price/Earnings ratio, which is usually described as the ratio of the share price to the per-share earnings, where earnings are calculated after taxes, depreciation, interest, etc. have been deducted.6 Alternatively it can be measured as the total market capitalization of the company divided by its after-tax (etc.) profit. The P/E can also be looked at as how many years the investor would have to hold the shares to get his money back. Since there is little or no relational capital element in the valuation of today’s corporations, the first part of our method for calculating the average dividend yields and P/E ratios of our atoms is to identify companies that are similar to the atom types. To do that, we have used averages for

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baskets of today’s industries that most closely match the atom type (see www.atomiccorporation.com for the exact methodology).7 Compared to today’s corporations, valuations are likely to be: Atom

Average Two-thirds div. yield between (%)

Average Two-thirds Volatility P/E ratio between

Customer mgr. Asset platform Service platform Webspinner Portfolio owner Smart company

3.7% 4.1% 3.3% -2% 2.5% 2.3%

14 17 19 30 39 73

3.5% and 3.9% 3.0% and 5.2% 2.2% and 4.3% 1.5% and 2.5% 1.6% and 3.2% 1.7% and 2.9%

13 and 15 12 and 22 14 and 23 20 and 50 30 and 50 0 and 170

Low Low Low Medium High Very High

We are the first to admit that comparing atoms to baskets of existing corporations is an empirical method for calculating market caps and profits, but given the manifold uncertainties surrounding equities markets, the errors inherent in it are, in our opinion, acceptable. But, of course, this does not take into account the value of the increased agility of the atoms and their ability to capitalize on their relationships. When we take into account the effects of freed relational capital, as shown in Figure 8.5, we can expect an increase of P/E along the following lines: Atom

Relational capital as % of total worth

Average P/E ratio now

Average P/E ratio once fully formed

Likely range

Customer mgr. Asset platform Service platform Webspinner Portfolio owner Smart company

60 10 25 70 20 15

14 17 19 30 39 73

22 19 24 51 47 84

21 to 24 13 to 24 19 to 28 43 to 59 37 to 57 0 to 200

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Summary To conclude, shareholders are no longer content with traditional valuations. Investors rightly want a company to demonstrate its ‘preparedness’ for future developments. The market’s rough treatment of long-time strong performers with few growth options has made that painfully clear. However, for all this to happen effectively it needs a reawakening to the virtues of an antique business emotion. Trust. Trust will be the key differentiator in the context of an increasingly commoditized business environment. It affects every stakeholder relationship and will have to be treated with unprecedented seriousness. Trust will and should be a ‘hard’ management issue. The difference in wealth between a bag of atoms and the corporation they came from is considerable. This new wealth will come from the increased agility of the atoms and their ability to capitalize on their relationships.

Endnotes 1 If you want to validate this, take a large selection of companies (say fifty) and plot pre-tax percentage earnings against the P/E ratio – you will find there is a near-inverse relationship. 2 Not a new insight – for more details, see Blown to Bits, (2000), by Philip Evans and Thomas S. Wurster of Boston Consulting Group, Harvard Business School Press, ISBN 087584877X. 3 Of course, fans of Transaction Cost Economics (see Chapter 3) will recognize keiretsu as a trade-off between contracting and policing costs. 4 Enron’s shareholder briefing, January 2000. 5 Break-up! (1997), Sadtler, Campbell and Koch, ISBN 1900961008. 6 Don’t send us nasty emails telling us that the P/E ratio is a flawed measure (e.g. it misrepresents the value of companies that are debt-ridden or that operate tax-minimization schemes) – we know. It’s here because it is the ratio the market tends to use.

R E L AT I O N A L C A P I TA L

7 In brief, the method involves selecting an index which represents a basket of similar industries, e.g. steel, chemicals, oil extraction, automotive, etc. for asset platforms. These calculations are conservative, as they were made November 2002, at the low point of the financial markets (to date).

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Keep the Best and Ditch the Rest

A trillion dollar bonanza Outsourcing is a central pillar of our atomization proposition and this chapter examines its rise, subsequent development and its role in the growth of the atomized economy. We look at the origins of the outsourcing business and how it has expanded in recent years to become one of the world’s largest industries. We then review the outsourcing proposition specifically through our atomization lens and describe effective new mechanisms to deal with the unbundling of non-core assets. The doctrine of atomization is simple. Stick to what you do best and reap the rewards. Take this a step further and the corollary is obvious: get rid of those things at which you do not excel. The quest by large companies to divest non-core assets means that outsourcing is fast becoming one of

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the world’s largest markets, one to rival automotive, healthcare, electronics and pharmaceuticals. According to IDC, the value of outsourcing is forecast to exceed a trillion dollars by 2005, with big names such as Accenture, CSC, EDS, HP, IBM and Fujitsu focusing their growth ambitions around this trend. Since the late 1970s outsourcing has moved on from zero-visibility tasks such as facilities management, building security and catering. The current wave, which is rapidly emerging, encompasses critical functions such as IT, HR, finance and administration. The next trend is around business process outsourcing to dispose of the generic business elements layer of the business (see Chapter 12), and after that, who knows? And will this rush to outsourcing continue? Absolutely. The benefits in terms of cost reduction are clear and it’s one of the key mechanisms by which atomization will take place. Do we believe that the end result will be as expected? Absolutely not. We see new shared service arrangements between large companies, harnessing scale and scope advantage while simultaneously retaining knowledge and asset value within the family. Service providers such as IBM and EDS will be relegated to operators rather than owners as shareholder appetite for mega-deals begins to collapse. All will benefit, however, from this new alliance approach.

Origin of the species Today, few if any large companies would ever consider running their own canteen, facilities management department, or even their own communications network, preferring to hand these tasks over to expert third parties. But it was not always the case … In the early 1980s an enterprising facilities manager, responsible for several million square feet of office space belonging to IBM, walked into the company’s UK boardroom and proposed a management buy-out. He had a very attractive proposition.

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First he argued that facilities management (the administration of all property-related services, from arranging leases and development schemes to the day-to-day cleaning and servicing of the space) was not IBM’s core competency. Second, by relocating several hundred staff into a new company, where IBM would be the anchor customer, he could grow a new type of third-party services business and help IBM to capitalize on a hidden asset. John Jacks presented a compelling story and within months a new company, Procord, was created in which IBM had a 25% equity stake. Procord acquired a string of blue-chip customers and was finally incorporated into US facilities management giant Johnson Controls. Around the same time, Unilever reviewed its global telecommunications arrangements. For over ten years, Unilever had operated a private telecommunications network serving its main lines of business such as Lever Brothers, Birds Eye Walls, Van Den Bergh and Elida Gibbs. The existing network technology had exceeded its sell-by date so the board was keen to take advantage of new digital capabilities to reduce costs and improve services. The network modernization proposal offered to the board was compelling, and a decision was made to adopt the new scheme – but with one significant modification. No one wanted to continue with an in-house network operation. Instead, the board suggested offering this business to an external party. British Telecom and EDS were shortlisted, and EDS was awarded a ten-year outsourcing contract for both global networks and head office computing. For EDS it was the first big win in the UK and heralded a serious overseas expansion that took the company from an office of 10 people in London to over 20,000 in the UK alone. These case studies illustrate examples of ‘first-generation’ outsourcing deals where non-core operations have been transferred to third parties such as IBM and EDS for extended periods, often as long as ten years – on fixed price contracts. At the time, few recognized how profound this development might become as a mechanism for wealth creation and industrial transformation.

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A new source of equity value? Generating wealth from service platforms The benefits to the outsourcer are evident from the examples above – guaranteed business for ten or more years. Investors and IT service providers delight in such ‘quality revenues’. But what was in it for the customer? Consider the growth of EDS and its long association with General Motors (GM). Roger Smith, former CEO of GM, won’t be remembered as the greatest automotive executive of all time but his contribution to the growth of IT services and outsourcing has been quite unique. Like other executives, Smith realized that his IT department was sluggish, not coping with new technology, and had a spiralling budget. The cost of internal IT support was escalating at 20% per annum – an unacceptable rate for a cost-competitive industry. Consequently, he approached several IT services organizations, including EDS, to elicit a classic ten-year fixed-cost outsourcing proposal. During the selection process, Smith realized that EDS was both well suited for this challenging task and could also provide a new and exciting growth path for GM itself. In June 1984 he awarded the global IT services contract to EDS and bought that company for $2.6 billion. He recognized that other multinationals would have similar needs to GM, and that EDS was well served to meet these needs. This meant that GM could participate directly in the high growth IT sector. However, it would be fatal if EDS were run like GM so, accordingly, EDS retained its independence, its aggressive and militaristic culture, and was given a separate NYSE listing through the first ‘tracking stock’ ever issued. Transplanting the EDS culture into moribund GM did prove culturally difficult for both parties, but what transpired was as beneficial for EDS as it was for its new parent. At the first GM board meeting following the acquisition, the CEO of EDS put forward a capital request for half a billion dollars to develop a network of global data centres, thereby increasing EDS’s footprint, from a largely US domestic player to a global service provider. In EDS’s context this was a massive investment in much-needed infrastructure. The CEO of EDS was astonished at the rapid acquiescence of the GM board. But, as Roger

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Smith explained at a cocktail party that night, half a billion dollars was a small price to pay to gain global leadership in the IT sector. In the context of GM’s other investments, it was little more than the cost of a paint shop! Over the next few years the synergies between EDS and GM progressed well beyond pure IT activities. EDS was already established in the US medical insurance industry, with links into all the major private health insurers. GM recognized that one of the highest components of cost in car manufacture is healthcare coverage for employees. EDS assumed responsibility for running the healthcare benefits programme within GM, and saved GM $500 million a year through improvements in process efficiency (including the elimination of fraud). Encouraged by a healthy stock market appetite for IT service companies in the 1990s, GM relaunched EDS on to the US stock exchange in 1996 and received a $15 billion return on its $2.6 billion investment, including a $500 million cash payment from EDS. Value had been exchanged both ways – through the amalgamation of GM’s IT support services worldwide and expansion of the associated IT footprint, EDS made the successful transition to a global company, while GM had pegged its IT spending to a fixed price contract and received a capital gain of $12 billion in the space of only a few years. Basically then, a large corporation used a (relatively) small service platform – EDS – to take over and transform its IT function, in turn acting as the portfolio owner of the old and new parts of the organization. Both the corporation and service provider realized substantial benefits in profits and equity growth from the deal.

Generating wealth from asset platforms The GM/EDS story and others like it raised artificial hopes among investors in the late 1990s that outsourcing would generate entirely new sources of wealth. The outsourcing of the BBC transmission network showed just how high the stakes had risen. In a deliberate move to strip itself of non-core activities (in atomized terms, selling an asset platform to those better placed to manage it), the

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BBC offered its national broadband transmission network to competitive tender in 1997. The network consisted of a series of high-capacity lines that transported TV programmes to over 700 transmission masts across the UK. The lines themselves were owned and operated by a telecommunications newcomer, Energis, then part of the electricity distributor, National Grid. Several UK companies prepared responses to this tender, hoping to capture a long-term and lucrative outsourcing contract. The most promising of these was Securicor, which believed that it could use the BBC transmission network to advance its own telecommunications services – progressing into a multimedia world of voice, data and video. As the tender documents were being evaluated, a new and unexpected party entered the bidding process. This was a US telecommunications company, Castle Tower Inc., which had no current operations in the UK. The local competition, Securicor, was surprised to learn that as well as matching their keen operating costs, Castle Tower was prepared to offer the BBC a capital sum of half a billion dollars to acquire the transmission ‘assets’. This was the trump card that won Castle Tower the deal – despite the valiant efforts of the local contenders. The BBC and the British public benefited massively from the transaction. The extra money helped to underwrite the launch of digital services in the UK at no additional cost to the taxpayers. Castle Tower acquired an ‘anchor’ tenant for its move into the UK’s multimedia telecommunications services, and hit the jackpot as mobile telephone operators queued to buy space on its newly acquired transmission masts.

All is not rosy Traditional outsourcing will not do Although substantial in scale and scope, these outsourcing deals, and many others taking place through the 1990s, merely transferred non-core assets from ‘old economy’ corporations to rapidly expanding ‘new economy’ IT service organizations. The benefits from these deals and the general growth in value of the service provider’s shares (see Figure 9.1) added credence to the idea that

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IT Products IT Services +300 +250 Media % change in FTSE 09/99 to 02/00

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Food Water Figure 9.1 Transfer of wealth from old to new economy stocks.

outsourcing would enrich the ‘new economy’ suppliers to the point that they could consider giving something back to the ‘old economy’ customers – to compensate them for the transfer of assets. First-generation outsourcing organizations acquired multi-million dollar contracts extending over many years that represented ‘quality revenue’ to the stock market. The bad news was that, all too often, these deals had transferred inefficient operations over to the service operators, who then had to fight to keep the lid on spiralling costs. In most cases, these exchanges did little to enhance overall profitability of the ‘new economy’ sector. The consequences in recent times have been massive reductions in shareholder value – bringing companies like EDS close to bankruptcy. In many cases this reflected in the poor quality of deals done. With the crash of NASDAQ in 2001 shareholder enthusiasm for megadeals began to run dry. The collapse of a $7 billion outsourcing deal between Procter & Gamble and EDS is a case in point. ‘New economy’ companies rapidly lost their capacity to trade over-priced equity for ‘old economy’ assets. The death knell for first-generation outsourcers was beginning to ring loud.

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A cynic’s (and our) view In addition, the relationship between the corporation and the service provider does not always run smoothly, especially in the case of rigid, longterm contracts. Business today moves at a pace that undermines long-term fixed-price relationships. Agility is the name of the game. The outsourcing cycle below demonstrates that something is fundamentally wrong with firstgeneration outsourcing.

The outsourcing marriage There are four stages in an outsourcing relationship, generally each lasting 2–3 years: • Infatuation: Initially, both the corporation and the service provider see nothing but benefits, and both enthusiastically embrace the deal. • Disenchantment: Two years on, the service provider has failed to get the costs down as fast as they anticipated, and the projected profit margin is looking thin. As it struggles to cut costs, the corporation starts to complain about a lack of responsiveness. • Separation: Sadly, the gulf between the parties gets larger and they move towards litigation. As with any married couple, only the lawyers benefit, but no alternative is identified. • Reconciliation: As the renewal date for the contract approaches, the parties realize they cannot live without each other. The service provider foresees a huge loss of revenue, and the corporation realizes that they just cannot run the service on their own any more. A deal is done, and the cycle starts again …

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Case study: Xerox and EDS Take one of the earliest outsourcing marriages – between EDS and Xerox. Xerox has a long and distinguished history in IT, having invented many concepts we take for granted today – mice, icons, GUIs etc. – and then failed to exploit them. Industry analysts had predicted for years the writing on the wall for Xerox’s IT department.1 In 1994, Xerox agreed to a ten-year deal with EDS to the tune of $3.2 billion. They released optimistic statements about partnership and benefits, with 2,000 staff being transferred to EDS. Within two years, sources inside the two companies were hinting darkly that things were not running smoothly – in particular, the liberal and creative Xeroids were not thriving in the EDS culture.2 Then came the litigation. In the early years of the relationship, Xerox engineers had been using EDS-supported notebook PCs at discounted rates. In 1999, Xerox was to start to pay full fees but instead found a cheaper method – by supporting the machines themselves. EDS had to write off $200 million – almost half its 1998 revenues – attributing it to ‘billing disputes’.3 In April 1999, EDS filed a suit against Xerox, claiming breach of agreement and demanding full fees for support dating back to 1996. It looked as if the deal was heading the way of that with American Express Bank, which in 1999 took back application development, maintenance, help-desk and desktop services, claiming poor performance on the part of EDS.4 Then came the crunch. Xerox reorganized its sales and marketing function late in 1998 and the billing system failed to keep up.5 Reconciliation was inevitable and late in 2001, with new management in both companies, Xerox signed an extension worth $1.5 billion to EDS to provide hosting and applications development until 2009. As a sweetener, EDS agreed to buy $50 million of printers from Xerox on behalf of one of its clients.6 EDS and Xerox are the best of friends again – for now, at least.

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Get your house in order Moving to internal shared services Large corporations have long recognized the operational advantages of aggregating routine business activities into shared service centres within their own enterprises – in short, creating internal service platforms. The advantage here over outsourcing is that a large company can achieve substantial efficiency improvements that drop directly to its bottom line – rather than sharing them with IBM or CSC. For example, Procter & Gamble has concentrated several thousand staff into three administrative mega-centres across the globe. These centres undertake the back office tasks of several hundred different companies operating under the P&G umbrella. To effectively consolidate these functions, companies have imposed common operating standards and processes throughout their divisions. As Global 2000 companies adopt global shared service centres as an effective means of providing key functions such as HR, finance and IT, new options present themselves. These include divesting the service platforms by the wholesale outsourcing of such centres to external parties – as P&G has done recently with HP. It also opens up the more interesting possibility of creating joint ventures between other like-minded multinationals, where service centres from different non-competing companies are combined to form shared business platforms. We describe mechanisms for doing this shortly.

Exploiting global promise In addition to the structural changes, such as shared service centres, taking place within organizations, improved telecommunication links between continents have opened up exciting new possibilities for sourcing skills externally at a fraction of the cost of local resources. These have a coincident effect with the other structural developments described above. Of most significance recently has been the opening up of the Indian and Chinese subcontinents, which have highly educated labour pools at rates 60–80% lower than their European equivalents. With widespread development of institutes of higher education and technology, India in particular provides equality of skills to that of the West and it has created

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world-class software companies such as Reliance, Infosys, Wipro and Tata Consulting Services. A growing proportion of corporate IT development is now located offshore (for example, that of American Express and National Grid Transco), as are the resources of leading system integrators and outsourcing organizations such as IBM, Accenture and Perot Systems. Essentially, the management of the service platform is retained in the home country, but the actual work is done in low-cost locations. This trend will increase under efficiency pressures to the point where only high-level IT programme management and project definition skills need be retained locally in Europe and the USA. Shared service centres, from finance and administration to call centres, are prime candidates for ‘off-shoring’. The leading UK insurance group, the Prudential, has moved thousands of jobs to India by relocating its customer care centres overseas. Almost all UK banks and many European ones are now looking at overseas outsourcing, and airlines such as British Airways have long since depended on such offshore staff to operate reservation centres. Surely this damages the home economy, doesn’t it? Not necessarily. Ian Brinkley, Senior Economist at the UK’s primary labour organization, the Trades Union Congress, told us: ‘Moving jobs offshore is not a problem as we have effectively full employment here, and it therefore increases the net wealth of both the UK and the Third World. The numbers we are talking about at any one time are not large compared to the total numbers employed. Industries come and go – consider the rise and fall of the UK’s textile industry in the last 150 years – but our overall net wealth increases.’

Further home improvements In addition to shared service centres and off-shoring, large corporations have become increasingly adept at fixing their internal operations before handing them over to external service providers. We are all familiar with the waves of re-engineering that have washed across corporate shores in the past decade. Much of this work has been focused on improving core functions and processes such as procurement, finance and administration, HR and IT. Today, business re-engineering or ‘transformation’ is becoming a key part of the outsourcing process.

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‘The CEO’s transformational outsourcing checklist’ provides one way of assessing current activity and deciding on the right course of action.

The CEO’s transformational outsourcing checklist The transformation of most businesses today is hampered by the lack of an IT infrastructure that can respond to rapid transformational change of the business. Transformation must be business-led, with a strong and supportive IT transformation.

Questions about business transformation (using a retail example) • Does your business have an e-enabled supply chain with just-in-time deliveries, low inventories and acquisition costs below the industry average? • Are the range and space for your products flexible for individual outlets? • Do you have ‘one view of the truth’ (i.e. are databases synchronized)? • Is your days sales outstanding (DSO) below industry averages? • Can you provide ‘mass customization’ to your customers? • Can promotions be rapidly targeted to small demographic groups? • Does your website permit one-click shopping? • Can your IT infrastructure accommodate acquisitions and disposals or is IT a barrier to M&A?

Questions about IT transformation • Is your internal IT function helping you achieve strategic advantage or is IT a barrier to strategic transformation? • Is the IT function supporting truly transformational change or only incremental change? • Are IT projects delivered on time, within budget and with the expected functionality?

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• Are your IT specialists businessmen first and technologists second? • Is there a rapid turnover in your IT staff with consequent losses in ‘corporate memory’ and extra recruitment and training costs? • Are you asked to approve large IT-related capital purchases that you don’t understand? • Is IT a large fixed cost rather than an incremental cost that waxes and wanes as projects are completed? • Does IT ‘cost too much’? • Are your IT costs out of control with a compound annual growth rate in excess of 20%? • Are you asked to approve large incremental IT expenditures without clear business benefits? Source: Charles Snodgrass, Managing Director, Outsourcing Advisors Ltd

Just two years ago a chance conversation between a partner of Accenture and the recently appointed CEO of a leading UK retailer, Sainsbury’s, led to one of the largest transformational outsourcing contracts of all time. This transaction illustrates how a major consultancy firm working in partnership with its client can tackle internal inefficiencies and embark on a long-term outsourcing relationship, with high returns for both parties. The Sainsbury’s deal heralds in the ‘second generation’ of outsourcing provider that combines business transformation and operating skills to deliver a combination of dramatic performance improvement and longer-term cost benefits. Many companies today will engage external organizations to carry out such ‘home improvements’ ahead of full outsourcing. Others will prefer to make these changes as part of an ‘operate’ deal. What is clear to both sides is that the era of ‘tossing non-core assets over the wall’ is vanishing. Instead, continuing transformation and refinement need to be applied to ensure that outsourced operations align with and contribute to organizational efficiency over long periods of time.

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Sainsbury’s and transformational outsourcing Sainsbury’s is one of the UK’s leading food retailers. In recent years it has faced an increasing threat from close rival Tesco – a company that has focused heavily on exploiting IT for competitive advantage. Sainsbury’s own IT organization was rated as one of the worst performers in the sector and suffered from low-quality management, high costs and low service levels. The prospects of a complete transformation of the department executed from within were considered remote by the board, and the incoming chairman, Sir Peter Davies, was well disposed to the offer of external help. All aspects of the Sainsbury’s IT activity required attention, from the back-office administrative systems and networks to in-store point of sale terminals. The scale of transformation required a combination of financial investment and management excellence that was clearly out of reach for the company, given the many competing priorities for capital and human resource. Accenture approached Sainsbury’s with a radical proposal. It suggested taking over all IT operations, and providing both cash injection up-front (for assets received) plus guaranteed operational savings over a seven-year period. At the heart of the deal, however, was an understanding that, together, Sainsbury’s and Accenture could outperform other retailers through process and IT excellence. The deal was readily accepted. Sainsbury’s is now one of Accenture’s largest consulting and IT outsourcing clients worldwide. To realize the necessary transformational changes, Accenture deployed over 800 IT consultants, and has taken over all applications development, maintenance and infrastructure management – employing over 1,200 operational staff. The Accenture-led IT transformation was based on transitioning from bespoke applications to industry-standard packages within a rigorously enforced IT architecture. The use of both creative financing – arranged by Barclays Private Equity – and the infusion of new levels of capability have given Sainsbury’s a step-change in operational performance, and Accenture a highly profitable long-term client relationship.

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Outsourcing is dead, long live outsourcing What’s the deal then? The outsourcing proposition sounds compelling enough, and some case studies show huge benefits, but the deals themselves do not always run smoothly. Consequently, companies have been looking at the alternatives. In today’s world of turmoil and instability, which organization would seriously engage in a fixed-price, ten-year contract, even with a promise of ongoing transformation and business alignment? The head of digital business at BP, John Leggate, recommends a maximum term of two years. And some large companies are choosing to bring external contracts back in-house, such as Halifax Bank of Scotland, or appoint multiple vendors to maintain competition and flexibility. The days of ‘sweeping it all away’ into the arms of the global IT giant may be fast disappearing. In our atomized universe a new outsourcing model is needed. Just how do we expect to see global service platforms emerge and gather support?

Third-generation outsourcing: atomic fusion Asset divestment with a difference Despite early setbacks, the rationale for divesting non-core assets remains strong, and looks even more compelling under the atomic lens. We have already presented the advantages of separating asset and service platforms from other parts of a corporation. To recap, this provides the more agile atoms such as smart companies with greater freedom to adapt and respond to changing market conditions. However, the temporary shortage of financial capital to do outsourcing deals and the continuing misalignment between the needs of large corporate customers and external operators implies that traditional outsourcing models may have limited life left in them. At the turn of the millennium, small groups of highly influential corporations met to discuss different and more radical models for asset divestment – based around closed partnerships. Having recently established electronic procurement marketplaces within their respective sectors, these companies were keen to seek further opportunities to collaborate more broadly. Outsourcing seemed to have an immediate attraction to these consortia.

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One such group was convened by the authors while at Ernst & Young, and included such companies as American Express, AOL-Time Warner, BP, Eli Lilly, Procter & Gamble, HP, Kellogg, Ford Motor Company, GE Power, Morgan Stanley, Nokia and UPS. The group adopted the name Internet Services Venture Vehicle (or ISVV).

What might the initial offerings be? The early collective experience of developing vertical procurement markets such as Trade Ranger (energy) and Covisint (automotive) have to an extent validated the partnering model. Steps taken were relatively modest, and mostly occurred inside the boundaries of the procurement function. Discussions among the influential ISVV group focused on a wider range of shared services. The goal was to convert current business expense and know-how into shareholder value, without threatening perceived competitive differentiation. Examples of propositions that emerged included: • Shared HR services: Creating a common HR portal for employees across the partner organizations by integrating a range of HR services from ‘best in breed’ suppliers. Each partner in this consortium would customize the portal for its own purposes while enjoying the scope and coverage of a global capability. With the backing of five or more major corporates in the ISVV, one million employees could be connected to this service, thus expanding scale and scope well beyond an individual partner’s capability. In addition to established HR facilities such as benefits management, new possibilities include possible job secondments between organizations within the consortium. • Shared customer care services: This would establish common call centres across geographic regions through which all consumer contact would take place. For many major corporates, most customer contact today takes place with business customers rather than end consumers. The aggregation of such consumer contact brings scale efficiencies as well as new prospects for data mining and direct marketing. Although they start as horizontal service providers, if the data were efficiently mined and re-used, these entities would have tremendous potential value as customer managers.

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• E-finance services: Some ISVV members were well advanced in separating back office services into global units that integrated the needs of different business divisions. These e-services could be developed further into a service platform that supports other corporate customers. Through aggregation of demand, large ‘lights off’ processing centres (e.g. largely unmanned facilities) could be created to serve the needs of the partners and other corporations, achieving new economies of scale and added value services. • E-knowledge in global trading: To exploit valuable knowledge in international trading, the ISVV partnership envisaged the formation of a network able to assemble, chronicle and disseminate relevant commercial know-how. Most global corporations are experienced in dealing with over 200 different national environments, and have amassed knowledge of local laws, regulations and business conditions. A smart company such as this could be extended into other relevant knowledge domains. By creating powerful and exclusive partnerships among Global 2000 corporations, these companies hoped to exploit shared economies of scale to mutual advantage. For example, the ISVV consortium represents nearly one million employees. This is a very attractive starting point for a shared HR service! The diversity and strength of their collective skills – or digital capital – in areas such as brand management, sales, HR, technology and process re-engineering could ensure word-class outcomes in each new shared business platform.

And the pay-off is …? Private ‘service’ partnerships such as ISVV require corporate members to commit their own internal assets – for example, financial transactions or call centre activities. The capital requirements to aggregate such shared facilities are relatively modest and can be secured easily from external parties. But such partnerships open up unique opportunities to play in the connected economy. In the case of the ISVV, each corporate member subscribes $2 million a year of seed capital to fund a joint incubator. As new joint venture possibilities emerge, each participant has the option to make a further investment

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to develop a specific shared service platform, be it an HR portal, shared F&A platform or call centre. By creating such options, each organization benefits in up to four ways: • Secures early mover access to new transformation techniques and shared services that incorporate best-in-class thinking from across many different industry sectors. • Converts ‘internal expense to value’ through the development of shared services that transfer internal non-core assets and processes to an external vehicle. • Generates valuable equity investments in new commercial ventures that will expand well beyond the charter members’ combined internal markets. • Develops a ‘halo’ effect in the eyes of the world’s stock markets through unique association with prestige brands and business entities. As stated earlier, there are few such ventures currently in operation. We expect many to emerge in the course of the next few years as corporations seek to securitize relationships and other assets through collaborative schemes. With the dearth of M&A opportunities around in today’s markets, expect to see a rush of investment banks, such as Morgan Stanley and Goldman Sachs, entering this area – each able to stimulate and execute connected economy deals among its many corporate clients; in effect, a webspinner that brings about new outsourcing activities. In the context of the outsourcing market, such private partnerships, or consortia, will supersede the first- and second-generation supplier–customer model by encouraging asset owners to retain a share in the new joint ventures. Major outsourcing firms such as IBM, EDS and Accenture will be invited to operate the new ventures but not to own the assets. This may come as a disappointment to these companies, but the operating incomes could be huge, and the need for equity capital almost non-existent. Their embattled shareholders are likely to endorse this third-generation epoch!

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Summary Outsourcing has emerged from humble roots to become a mainstream corporate activity over the last twenty years. Few companies, large or small, should consider owning and managing all the complex tasks necessary to remain in business. Atomization will become the new driver for outsourcing. As it continues to increase in pace, and companies examine more radical divestitures, the need to retain some ownership and control of these non-core assets may induce larger corporations to adopt consortia models such as the ISVV. If you are not already thinking about outsourcing, you should start now!

Endnotes 1 2 3 4 5 6

See Paul Strassmann, 2000, ‘The Xerox Tragedy’, Computerworld. ibid. ibid. Information Week, 26 April 1999. See Paul Strassmann, 2000, ‘The Xerox Tragedy’, Computerworld. Information Week, 3 December 2001.

10

Big Is Not Beautiful

Killing the sacred cow On the evidence, you might think that the world doesn’t (yet) agree that getting smaller is the right direction to go. Old-style CEOs of giant (and not-so-giant) organizations everywhere are still trying to buy other corporations – are they are all insane? Well, it certainly looks like it to us. OK, that’s too strong. They’re not all insane. But most mergers are failures that destroy the wealth of those that invest in, or work for, the merging corporations and it’s hard to avoid the conclusion that insanity has spread throughout the world’s boardrooms. In this chapter we look at several key factors driving companies to merge, and decide whether those factors are important and/or relevant in

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the twenty-first century. We also consider alliances as an alternative. And what about the logical assumption that if mergers burn shareholder value, demergers generate it? We have tuned in to the opinions of experts in this field. David Sadtler, Fellow of the Ashridge Strategic Management Centre, and Angus KnowlesCutler,1 Partner with corporate finance experts Deloitte & Touche, provide an interesting insight into the ‘bigger is better’ claim and we talk to them extensively in this chapter. As believers in an atomic economy, we the authors look back at the Merger Mania of the 1990s with horror and disbelief. The annual value of merger and acquisition (M&A) transactions around the world increased from $400 billion in 1991 to $3,400 billion by the end of the decade. Eightyfive deals a day were being signed!2 Most of these corporate marriages have ended, or will end, unhappily. The rate of mergers has slowed down sharply in the USA in 2001 and 2002, but we’ve seen the trend transferring to the UK, with Europe and Japan not far behind.3 The sectors involved are changing from media and telecommunications to utilities, retail and the public sector.4 The telecoms market alone provides a visceral example. It is now characterized by a long chain of epic corporate failures whose roots lie in the twin evils of an ill-conceived M&A activity and an abject failure to manage debt. Shareholder value has been destroyed by fattening the franchise while paying no heed to either the cost or quality of the diet required to do so. The inevitable process of regurgitation continues to cause immense pain. AOLTime Warner is an obvious example. France Telecom/Orange is another. Lucent/Agere is a third. And what about HP-Compaq in the IT sector? Yes, there will be mergers in an atomic economy – some atoms need scale – but we will no longer see the wholesale insanity of today.

Does size really matter? A cynic might suggest that the real driver behind merger mania is simply ego. Nobody ever got a boost or executive bonus by making an empire smaller.

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Knowles-Cutler of Deloitte & Touche concurs: ‘To an extent acquisitions, flawed as they are, still provide a surer route to top-line growth than the introduction of a new product. And while CEO bonuses continue to be based on growth, M&As will continue.’ Look at the reasons usually quoted by those pursuing mergers. In the words of David Smith and David Sadtler,5 mergers and acquisitions: • provide potential for operating synergies (e.g. elimination of duplicated cost through staff reductions); • can increase control over the target market by absorbing potential competition; • allow small companies to reach critical mass;6 • provide a route to a critical skill or technology (assuming the ‘skills’ don’t walk out of the door); • can ensure access to new markets or to a global production base; • appear to de-risk the business by balancing the asset portfolio (e.g. by buying corporations in different stages of maturity, geographies and industries); • guarantee a means of supply or distribution by vertical integration; • can be used to fend off an acquisition threat (the ‘Poison Pill’ defence). These reasons provide quite a rationale, and some appear sensible. But does this rationale hold true in the twenty-first century?

Mergers don’t work Before we turn to this question, let’s ask if mergers add value to the corporation. You will be expecting us, as ‘atomists’, to say that they do not, and we will not disappoint you!

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We don’t expect you to take our word for it, so read what others say about the effects of mergers on shareholder value, profitability and overall corporate health: • In a study by Michael Porter of thirty-three corporations and more than 3,700+ merger transactions,7 the vast majority of acquired corporations had been sold off after a few years, leading to the conclusion that the acquisitions had been failures. Porter said the effect was clearest where businesses had strayed into areas they did not understand. • Figures from consultancy A.T. Kearney8 showed that only around 30% of the companies in their study of global mergers realized any increase in aggregate profitability, with 57% becoming less profitable. • Figures from Business Week showed that far less than one-fifth of mergers created substantial returns for shareholders, and a half actually destroyed shareholder value. • Professor Robert Bruner of Darden School of Business, University of Virginia, polled fifty executives who had been involved in mega-mergers, and only 37% of them believed that the deals created value for buyers.9 • Research by Hans Schenk at Tilberg University in the Netherlands has shown that merged companies typically perform 17% worse than their independent rivals in terms of productivity, profitability, innovation and growth in market share. He estimates that only 35% of mergers (by value) created economic wealth.10 • Finally, McKinsey estimates that only 12% of mergers in 1995 and 1996 managed to grow faster than their industry rivals in their first three years of operation.11 Get the picture? While the actual proportion of failures varies from study to study, it’s pretty clear that most M&As not only fail to deliver benefits, but the majority also actually destroy shareholder value. Not everybody loses, of course. Investors in the acquired company may see a short-term price hike, and the investment banker that has just

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pocketed 2–3% of the merger value will be gloriously happy. Other winners are the financiers who raise billions to pay for the deal, as the capital value of the company, and much of its future profits, switch from shareholders to debtholders. Whatever the cause, the consequences of failure are serious. KnowlesCutler of Deloitte & Touche says: ‘We looked at the last forty companies that we had reorganized in the UK. More than half of those had a failed acquisition as the chief cause of their problems. In 40% of cases, that acquisition had to be sold as part of the restructuring.’ But why do so many of these mergers go wrong?

Going bananas Some mergers are sensible but badly executed, while others are, well, just plain stupid. Sometimes acquirers pay too much. In the last years of the twentieth century Marconi, a corporation with a great history and a £3 billion cash mountain, went on a buying spree. In one of the most extreme examples of value destruction in British corporate history, investors who collectively bet £35 billion were left with £1.5 billion. In 2002, Marconi was forced to give 99.5% of its equity to its debtholders. The days of the Hanson-like conglomerate are past, but companies still buy things that are outside their competency to manage. As Professor Michael Porter points out,12 cross-industry acquisitions seem to be particularly good at burning investors’ cash. Again, some mergers are the result of outdated thinking. Mergers to achieve vertical integration – buying companies further up or down the supply chain – are particularly baffling in an increasingly connected world. Ford no longer feels the need to own its own steel mills or rubber plantations as it used to in the 1930s, so why did Time Warner and AOL need to shove together two almost incompatible cultures in an attempt to forge a virtual supply chain between content and customers?

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AOL-Time Warner Time Warner, founded in 1923, owned some of the best media assets in the world, including HBO, CNN and a thriving movie portfolio, not to mention Time, People and Sports Illustrated magazines. In early 2000, Internet upstart AOL offered $160 billion for the business. The principal reasons for the deal, completed in January 2001, were (in a nutshell) convergence and income – providing an Internet outlet for Time Warner’s content, while providing a sound revenue stream for AOL’s shareholders. Our commentator Sadtler was unimpressed by this argument:13 ‘It was a typical piece of lazy vertical thinking. Tying the means of production to the means of distribution limits, not liberates, both parties.’ The merger was not well executed either. Time Warner’s culture and management team was conservative and gentlemanly, while AOL’s was one of the most aggressive in an aggressive industry. Time Warner found AOL autocratic and arrogant, and AOL’s top management were contemptuous of their older partner’s fiefdoms, long lunches and interdepartmental warfare.14 If AOL did one thing right, it provided a common enemy for Time Warner to unite against, but the fighting continued unabated. By mid-2002, the dream had turned into a nightmare. Most of the original management team had left, and Time Warner shareholders were furious that their company had been swapped for AOL paper at its ephemeral peak, which had now lost over 80% of its value. Meanwhile, AOL has sacrificed its agility and sharp focus by swallowing a whale. At the time of writing, there was no sign that the corporation was ready to demerge, but this may come to be seen as the optimum result for the biggest waste of money in business history.

Getting it wrong Few corporations make a success of the M&A process. To do so requires making the right decision about what to buy, and then flawlessly executing the post-merger integration programme.

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The merger integration process should start before the deal is announced. There is a short period (maximum 180 days) to make the necessary organizational and cultural changes after the deal. After that, the return to ‘business as usual’ will slowly defeat the merger integration programme. In the words of General George S. Patton, ‘A good plan violently executed now is better than a perfect plan next week.’ But why does the implementation need to be so speedy? Well, because post-merger uncertainty reduces the efficiency of those in the corporation. It reduces effective productivity from 70% to 25%, and the longer the uncertainty lasts, the greater the damage to profitability. That 180-day limit is significant, says Knowles-Cutler, because experience demonstrates that if the merger is not demonstrably delivering benefits by that point, the CEO’s days are numbered. The principal warning sign of impending disaster is prevarication. If the mission of the merged company is not clear, and the occupants of the top two or three layers of the management not decided by the close date, the merger will probably fail. At the onset, the CEO should have laid out his ‘non-negotiables’ and indicated from where the principal benefits will come. If you get to Close Day without a coherent integration plan for the two businesses, formulated in reasonably rich detail and with clear responsibility for each phase, then unhappiness and dissatisfaction are in store. All too often, especially in a merger of equals, the first few months are spent on pointless political infighting, which squanders the window of opportunity and increases internal costs. In this situation, key ‘assets’ of the companies often take jobs somewhere else. Knowles-Cutler told us that you can ‘expect to lose 35% of your key managers even after a friendly merger, with that figure rising to 50% if the process was piratical’. One proven winner at the M&A game is Cisco Systems, which has a well-established process for acquisitions. Cisco avoids the trap of increasing internal costs by ruthlessly imposing its own processes and systems on the acquired company. At the other end of the spectrum, we’ve worked for a merged insurer that changed the name of the corporation but took integration no further than re-engineering the letterhead. We later saw the equity of that corporation lose 70% of its value in a few months.

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It’s said that a positive benefit of getting larger (and one not always grasped) is that it increases bargaining power with suppliers. Demerging or atomizing corporations do lose the benefits of scale (especially around indirect procurement) when it comes to negotiating with suppliers, but we expect to see a rise in aggregating electronic marketplaces (effectively buying clubs) to overcome this.

Friend or foe? OK, so mergers are difficult. But is there a realistic alternative for a corporation that needs access to fresh knowledge or new markets? Yes. Most of the benefits of mergers can be achieved through alliances, with far fewer potential problems. We have demonstrated that being big and agile at the same time is not possible – the internal cost of movement is too high. Alliances, on the other hand, present a way of gaining scale without increasing in size. They also represent an option to do business rather than a commitment – partnerships are easily dissolved if circumstances change. Also, as electronic connectivity progressively reduces the cost of doing business with other companies, ‘virtual corporations’ become technically more feasible as well as beneficial. Of course, some organizations will be better at alliances than others; those with strongly autocratic traditions (such as in France) will find it hard to trust their potential partners. Other cultures, especially in the Far East and parts of Continental Europe, will find that alliances come much more naturally. Formal alliances are common in the fast-moving IT industry and in capital-intensive businesses such as oil exploration, but are less common elsewhere. There seems to be a fear of alliances among large corporations, perhaps because the partners, while co-operating in one venture, are competing in others. In an atomic world, decreased scope and increased focus mean less competition and greater interdependency, and as corporations get smaller, we expect alliances to be more plentiful and more important to the shape of the economy.

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That said, today, few companies seem to have developed the skills needed to manage alliances. Both partners need to see a clear strategic rationale, agree an unambiguous set of rules, take care of each other’s interests, and understand certain conditions under which the alliance will be dissolved. A successful alliance can turn into industry domination (think Microsoft and Intel), but how many companies even have a Chief Relationship Officer? The answer demonstrates the lack of due consideration for this advantageous corporate strategy.

M&A in the atomizing world We do foresee mergers in an atomized economy. Small is not beautiful for three types of atom: • Customer managers require scope: the economics of finding and developing relationships with customers generally means a big up-front investment.15 While customer managers need not be large in terms of staff, they will need to be large in terms of the customer bases they satisfy. We will therefore see some aggregation of these companies. • Asset platforms are, by their nature, capital-intensive. Profitability will depend on how much sweat they can get out of their assets, and economies of scale definitely apply. We will therefore see a fair amount of merger activity in this sector. • Service platforms need to be as efficient as possible, and in some cases that may mean broad scale or scope. Our instincts suggest that service platforms will be formed by outsourcing and the amalgamation of the back office processes of existing companies rather than by traditional M&A activity. And just as we expect the number of mergers to decrease, we expect the success rate to rise. The post-merger integration process in an atomized economy will be much simpler, as smaller and ‘purer’ companies will be involved.

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Reason to merge

Validity in an atomic economy

Potential for operating synergies

Valid, if difficult to achieve. Largely offset by increases in internal transaction costs and decreased flexibility

Increased control over the target market by absorbing potential competition

Valid, although usually restricted by regulation. Alliances are generally a better option

Allow small companies to reach critical mass

Valid, but only where critical mass is important (asset and service platforms, and possibly customer managers)

A route to a critical skill or technology

Alliances provide a better option, with less risk and at less cost.

Again, alliances provide a better option. May have Access to new markets or to a global production some applicability for asset platforms base Reducing business risk by balancing the asset portfolio

Portfolio owners can more efficiently reduce this risk

Guarantee means of supply or distribution by vertical integration

Increasingly seen as a fallacious idea – again alliances provide flexibility without the integration costs

The ‘Poison Pill’ defence Always a bad idea – it may represent the political interests of managers, but rarely meets the economic interests of shareholders!

Let’s look again at the reasons we quoted earlier for M&As, and see how they stack up in an atomizing world: The traditional reasons seem rational in a world where external transaction costs will forever remain high, but they don’t look so convincing in the context of our radically changing business environment.

Demerging – the route to value If creating a larger company usually destroys shareholder value, will breaking the corporation up increase it? This is the question underlying much of this book. The answer to that would appear to be a positive yes, but listen to our experts again.

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It should come as no surprise to anyone in an operational unit that having a corporate centre makes life more difficult, and the economic effects appear to be manifest. The overall cost of management rises, and the ability to change decreases as the corporation gets larger. Breaking the organization into smaller parts decreases this ‘corporate friction’ and thus reduces the relative cost of running the business. Indeed, Break-up! by Sadtler, Campbell and Koch16 estimates that the existence of a central control function in a corporation depresses its value by between 10% and 50%, due to a number of factors including cost addition, demotivation, misinformation and (accidental) mismanagement. Removing the influence of this centre by demerging the operational units should have an uplift effect on the efficiency and valuation of the spawned units. Knowles-Cutler agrees. ‘We conducted a study of the 118 largest demergers worldwide between 1990 and 1999, all above $2 billion in value. There was an immediate drop in share price of the parent after the announcement, but it was only of the order of 2–10%. This is more than compensated for by a dramatic turnaround within a year of the demerger. The share price of the parent company increased from 12% for a median performer to 52% for upper-quartile performers. The separated business, the child, also fared well, with share price rises of 13% for a median performer to 46% for upper-quartile performers relative to IPO prices.’ Scale is lost for both separating companies, but this is far outweighed by increased clarity of focus. Managers in demerged units often feel as if they have a new lease of life – decision-making is easier, motivation rises with the greater sense of ownership and there is a shared sense of direction. We just don’t observe the same loss of productivity that is evident after a merger. Even if the rationale is sound, many mergers are undone by delays in the integration process. These problems are not echoed in the demerger deals, which by their nature require a ‘hard’ close. Each company must be self-sufficient on the day the deal closes, so the number of loose ends must be much smaller. Naturally, this means the demerger process has to be more aggressively managed, but the reductions in scale mean that the problems to be overcome are likely to be correspondingly smaller.

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Summary Most acquisitions are a waste of money, and most of the money they waste belongs to the investor in the acquiring company. Other mergers fail because they were a bad idea in the first place, and yet others fail because of poor integration. These failures are entirely avoidable. Investors should tell companies to consider an alliance instead as a viable alternative. Alliances offer most advantages of mergers without any of the inbuilt disadvantages, and a good alliance can do far more for a company’s fortunes than an average merger. There will still be mergers in an atomic economy, but they will be limited to those atom types that require scale – asset platforms, service platforms and possibly customer managers. Demerging is particularly attractive, as the freedom to trade allows each component of the new structure to maximize its value. As the decade progresses and electronic communications become better and better, demerger and flotation may well take over from mergers and acquisitions as the next major corporate trend.

Endnotes 1 Angus Knowles-Cutler has worked on thirty mergers and ten demergers, both as an adviser and as a line manager. He focuses on integration or separation planning prior to deal completion and then the initial execution of the plan. Angus has advised on both the UK’s largest merger and demerger. His experience covers energy, utilities, telecommunications, financial service and manufacturing transactions. He co-leads the Deloitte & Touche Merger Integration Services group. 2 Karen Lowry Miller, ‘The Giants Stumble’, Newsweek, 8 July 2002. 3 Global merger value $1,700 billion for 2001, predicted $980 billion for 2002. Goldman Sachs, quoted in the Financial Times, 28 October 2002, p. 25. 4 Interview with Angus Knowles-Cutler, July 2002.

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5 This list of reasons for merger is taken from Successful Business Acquisition, Smith and Sadtler, Delta Sierra Publishing, 2000, ISBN 0953916200. We are grateful for their kind permission to reproduce this list. 6 Sometimes corporations are too small on their own. For example (source: ibid.), an automobile corporation must produce about 2 million cars per year for efficient operation, forcing Volvo, which made 400,000 cars per year, to find a buyer. 7 Michael Porter, Harvard Business Review, May–June 1987. 8 Investors Chronicle, December 2001. 9 See http://faculty.darden.virginia.edu/brunerb/index.htm for a description of Professor Bruner’s work. 10 See Note 2. 11 See Note 2. 12 See Note 7. 13 Interview, September 2002. 14 Financial Times, 19 July 2002. 15 This insight is from John Hagel III and Marc Singer, both of McKinsey & Company, in ‘Unbundling the Corporation’, Harvard Business Review, March–April 1999, p. 133 et seq. 16 Sadtler, Campbell and Koch, 1997, Break-up! ISBN 1900961008.

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Y2K – the promise that broke an industry The information technology or ‘IT’ sector (covering hardware, software and services) has enjoyed unprecedented success over the last thirty years. As we demonstrated in Figure 8.1, from a standing start it has superseded petrochemicals as the world’s largest industry sector. However, in the words of Andy Mulholland, the Chief Technology Officer of Cap Gemini Ernst & Young, ‘something failed to go terribly wrong at the dawn of year 2000’. The traffic did not stop. Aeroplanes did not fall out of the sky. The hype and rumours of the IT suppliers, many of whom had made gigantic profits from Y2K programmes, were thoroughly, embarrassingly and publicly disproved. Since that time, senior managers have become more sceptical about overblown IT claims, especially about IT-related productivity improvements,

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and have slashed spending in this once-protected area. Consequently, some IT service providers have seen their share prices tumble to a tenth of pre2000 high points. Telecommunications providers have suffered even more seriously, as a glut of transmission capacity has provoked a global price war. The ghosts of WorldCom, France Telecom and Marconi now haunt the international stock markets. In the broader perspective of the changing economy, we are witnessing only a temporary setback in a continuing expansion of IT supply and demand. According to our atomic principles, the role of IT – especially the Internet and whatever follows it – will become ever more pervasive. Individuals and small, agile corporate entities will engage in a new and more intricate business dynamic based on interactive commerce and pervasive computing. IT is becoming the ‘glue’ of the connected economy. Set against this changing picture of requirements, both internal IT shops (IT organizations within corporations) and the IT supply sector itself will not be immune from the forces of atomization. We are currently witnessing a major consolidation of the supply side of the IT sector. Mega-mergers such as IBM and PwC Consulting, or HP and Compaq, demonstrate a classic pattern of industrial rationalization. Although such consolidation will almost certainly reduce the net worth of corporations (see Chapter 10) this trend will continue, despite shareholder and customer protests, until at most four or five players are left in the primary segments of hardware, software and services. Watch out for a merger between Accenture and Microsoft! While this supplier consolidation continues, their business customers will be atomizing. This will in turn drive the IT supply industry to stop growing and to start fragmenting, providing at least some relief for the shareholders! In this chapter we ask (and answer) some important questions. What changes are needed to bring about a fully connected economy? How do IT suppliers and their customers need to adjust to the new realities? How will these changes affect IT professionals and service organizations within the sector? And how can we best prepare for the changes? We will also review the implications of atomization and connectivity on traditional IT architectures

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and supply-side structures, and consider appropriate new models for IT support organizations and their staff.

Connecting the atoms IT is the glue of the new economy We have already described the emerging digital economy. Companies and individuals form an intricate web of commercial interactions enabled by advanced communication techniques. Visual technologies will enhance the richness of these interactions, bringing face-to-face dialogue and enticing imagery. The inclusion of intelligent and constantly communicating devices in every aspect of our daily lives – from our cars and clothes to our homes and offices – will increase the scope and coverage of these interactions. In such a connected world, the information processes and IT infrastructures that support business will extend well beyond the boundaries of the corporate enterprise into every aspect of our lives. The customer will become the central feature of the digital marketplace, rather than today’s intermediaries such as distributors and retailers. Commercial success will require intimate knowledge of each and every customer’s personal habits, physical location and individual context. This extends well beyond the current horizons of customer relationship management (CRM) systems, which are little more than sales administration tools. Within the corporate confines themselves, traditional systems that linked commercial processes, such as order entry and customer management, need to adjust to the new realities of an atomized universe where today’s rigid boundaries dissolve away into loosely coupled networks of collaborating business entities. The progressive impact of outsourcing of generic business processes, such as manufacturing and logistics, and the intervention of electronic markets will infringe on today’s enterprise-based systems and network infrastructures, rendering them increasingly irrelevant in a connected economy.

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Towards the world of information intimacy As all-pervasive Internet and multimedia mobile devices extend to billions of people worldwide, we are stepping out from a world of ‘information isolation’ (restricted to large sophisticated organizations) to a new era of ‘information intimacy’ (focused on the individual). Until recently, large corporations needed to communicate only with their suppliers and business customers (e.g. distributors and retailers) in a stable supply chain. Today, they must engage with a much more complex and rapidly changing value network, reaching out to the end consumer as well as multiples of business partners and alliances. According to Andy Mulholland, the concept of rigid and fragmented IT systems supporting a supply chain will be horrifying. The prospect of interaction with the end consumer brings an almost infinite range of commercial possibilities, exploiting contextual information such as physical location and personal disposition. New Internet-based architectures will help fuse offerings from different suppliers into compelling consumer propositions. They will also focus on real-time events rather than static relationships. Think for a minute about possible developments in the automotive sector. By the time you read this, new generation cars, equipped with communication links and multimedia devices, will be able to order and download a variety of information and entertainment services through the airways. These will be sourced from different suppliers such as content providers (e.g. the BBC), telecommunications operators (e.g. Vodafone), credit card companies (e.g. Visa) and motoring organizations (e.g. Automobile Association). Car manufacturers (e.g. Ford) and consumer electronics companies (e.g. Sony) will provide the devices. The benefits go way beyond downloading movies into automobiles. Upmarket vehicles are today able to report on their ‘health’ to service engineers, and tomorrow they will be able to diagnose their ailments, order their own replacement parts, and check the owner’s diary to book service slots. Meanwhile, they will be locating (and probably paying for) fuel, restaurants, hotels and anything else to make the driver’s life easier. And all that’s not far off!

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Event-driven IT architectures Such commercial partnerships are predicated on new-generation IT architectures and standards that enable multiple business partners to work together seamlessly around real-time events and individual customers. At the heart of these collaborative architectures will be an all-pervasive IT infrastructure that reaches into every organizational unit within the business network. The characteristics of this new IT environment differ sharply from traditional enterprise-based systems: • Commercial processes will operate in real time and extend across the entire business network. New IT architectures must offer transparency across corporate boundaries and bespoke enterprise resource planning (or ERP) systems. • Such commercial processes will span the entire buying cycle from discovery and proposition development to transaction and fulfilment. Again, new links will carry out seamless interactions at every stage of this cycle. It will become difficult to distinguish where one business partner’s system begins and the other’s ends. • The new information infrastructures will be ‘always-on’ and accessible to a wide range of mobile – and intelligent – devices. Emphasis will be on ‘ease of use’ rather than efficiency and cost-effectiveness. As usual, IT suppliers have assembled into different camps to develop and promote such universal capabilities. For example, Microsoft has launched dot.net as the platform for inter-company working, while Sun is promoting the J2EE standard. Much of the effort is designed to promote web-based services that use Internet standards to enable inter-working between different applications and devices. Intelligent agents will populate the new infrastructures, carrying out critical tasks close to the end consumer rather than in traditional mainframe-centric systems. It’s worth summarizing the differences between tomorrow and today. Today, ERP systems form the core of most IT architectures, managing information within tight corporate boundaries. In such a fragmented world information leaks sporadically and painfully out to other organizations. Tomorrow, as much, if not more, information will flow between corporations

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as within them, and the ERP system will be discarded or maintained as an unpleasant-but-necessary legacy system. Commercial flexibility, not efficiency, will be the key. In essence, the IT world needs to turn itself inside out, placing greater emphasis on events and processes outside the corporate boundary than within. This will, of course, require a complete change of mentality within internal IT organizations.

IT ‘lite’ In a continuous effort to align with changing business needs, internal IT organizations have evolved from centralized bureaucracies, characteristic of the 1970s and 1980s, into more devolved support units, frequently embedded in the operating companies they serve. But atomization is biting here too! In many cases, large elements of IT departmental responsibilities have been outsourced to external service providers such as IBM and EDS, leaving behind business consultancy and application development competencies and resources. Even these capabilities are being competed for by outside contenders such as Accenture and IBM/PwC who are often more closely aligned with the needs of the business divisions than the internal provider. Increasingly, the whole IT function (including business consultancy and application development) is being disposed of. In 2002 alone, Sainsbury’s, American Express, GM, Deutsche Bank (and others) took the step of outsourcing large components of their IT organizations to third parties.

Technical skills need to change In contrast to the gradual decomposition of the IT organization, the underlying enterprise systems and network infrastructures provided by vendors such as Microsoft, Oracle and SAP have become larger and more integrated. The recent wave of enterprise resource planning (ERP) systems has endeavoured to embed the many internal business processes into one all-embracing information resource. Yet not one of these implementations has succeeded without massive internal tailoring to fit the organization structure. This might have been appropriate in a world of mega- corporations

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that continue to conduct all activities under one roof – or in the IT context, ‘one firewall’. But in the post-atomic economy, the concept of ERP is outmoded and constraining. For a large majority of corporations, IT comprises a ‘virtual infrastructure’ (see Chapter 12) which – although necessary – does not add real value. Corporations must decide between core competencies (those elements to be retained) and generic activities (those elements to be externalized). And, in most cases, it is not just the ERP systems but also the processes they support that must go. Even for manufacturing organizations, it may be easier to throw out all of the ‘electronic concrete’ rather than try to untangle it. If you have just spent $100 million on implementing an ERP system, start polishing those excuses now! Fortunately, the growing emphasis on Internet services, connecting large organizations to loosely coupled networks of suppliers and customers, is shifting attention away from monolithic ERP systems to new web-based infrastructures. Many companies have implemented a range of Internetbased applications alongside heritage ERP systems but are having difficulty co-managing these fundamentally different resources. Few standards yet exist outside the corporate firewall to guide system development across the emerging value networks. For all these reasons, IT organizations must evolve even more rapidly in the near future than in the three or four preceding decades. The first generation of IT shops were embedded cost centres, and the second generation were more commercial IT shared service centres. Now it’s time for a new ‘third-generation’ approach. What will be the operational principles guiding such an evolution? We believe that to handle progressive atomization of the host organization and to align with a constantly evolving IT supply sector, the internal IT organization will need to restructure into a more adaptive and highly connected entity. It, too, will need to atomize. In an atomic universe, the IT organization’s domain of influence will extend well beyond the corporate firewall and will thus need to influence and assimilate IT standards and architectures common to the entire business network in which its host business participates. The consequences for those

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employed within these units will be even more profound. New skills will be needed and career choices devised to sustain atomic structures.

The cloverleaf IT organization The internal IT organization is going to need to restructure into a more adaptive and highly connected entity. Why? Partly to handle progressive atomization of the host organization, and partly in response to an atomizing, and therefore more effective, IT supply sector. In response, we see the emergence of a new ‘cloverleaf’ IT organization that has the flexibility to deal with the impending revolution – on both the supplier and customer sides of the line. To show how this functions, take a leading oil major that has inherited a large and highly bureaucratic IT organization of several thousand staff. This centralized organization provided a broad range of services to the various business units within the corporation, from business consultancy and applications development to data centre and network operations. The options for the board were either to sell the entire entity – following the example of many other companies such as Philips (which founded Origin as a separately quoted company) – or to devolve the IT activities to the main businesses (another well-trodden route among decentralized multinationals). The company assessed the options and recognized that a central IT group has some compelling advantages as well as suffering the usual issues of size and relative detachment from its primary customers. The advantages include the raw ‘buying-power’ associated with a multi-billion dollar budget and the ability to define and police IT standards across all internal company boundaries (and, by implication, beyond into the supply chain). It also can impose uniformity on infrastructure services such as ‘desktop’ amenities across the entire business – helping to standardize the corporate working environment. A new organizational approach was proposed that preserved the scale advantages, but dramatically reduced bureaucracy. This approach consisted of a cloverleaf structure to reduce the staffing levels by a factor of ten, while strengthening delivery capability through powerful external alliances (see Figure 11.1).

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Service Delivery

Relationship Management

Offer Development Figure 11.1 The cloverleaf IT organization.

The ‘cloverleaf’ includes: • Relationship management: Small teams of consultants facing the main business units to help identify and define new IT applications that deliver value to commercial operations. These consultants are more familiar with the businesses than they are with IT and act as mediators between service supply and demand. They work closely with external agencies that specialize in specific IT innovations. Many of the day-today service support activities are embedded in web-based portals that provide users with advice and guidance over the internal intranet. • Service delivery: Programme and contract managers oversee external providers of services ranging from infrastructure (data centres, networks and desktop support) to applications development and management (including a growing number of web-based services). In the latter case, much real work is conducted offshore by companies in India and China. Tight service management implies relatively small numbers of core resources – backed up by armies of external ‘asset and service platform’ providers. • Offer development: IT sector specialists explore new industry partnerships and service innovations on behalf of the service delivery and customer manager units. The constant explosion of new products and services

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generated by entrepreneurial activity requires constant surveillance of the supply sector and discussions with innovative new companies. Architectural skills are needed here to place such innovations within the broader strategic context of the organization and its evolving business network. The use of the web becomes central in pinpointing new innovations. To reiterate, the consequence of the new format is to reduce the staffing levels by a factor of ten, while strengthening delivery capability through powerful external alliances. The organization preserves its authority on key strategic and tactical issues, such as IT architectures and service level agreements, but reduces the size of its fixed-cost base in favour of more flexible external arrangements. You can see the similarities to the atom types we presented in Chapter 4. In essence, it ‘atomizes’ the IT structure in favour of small, highly skilled units that can leverage their capabilities through external partnerships and extensive use of web-based services (see Figure 11.2).

Broader account penetration

Access to external skills Service Delivery

Relationship Management

Offer Development

Wider choice of offers and services

Figure 11.2 Extending the cloverleaf organization.

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The other popular approach, devolving IT management to individual business units, loses the advantages of large-scale partnerships with external parties and architectural alignment across the organization. Business structures are often a reflection of national characteristics, and many European multinationals prefer the light touch corporate approach against a more centralized philosophy adopted by many US companies. However, in a connected world, decisions concerning IT can be as critical to the health of a large corporate as financial policies and are thus better executed under board guidance than through a multiplicity of localized decisions.

Splitting the (IT) atom Increasing pressures on the supply side As IT architectures undergo a fundamental rethink, so too will the IT supply sector itself. Sure, ‘nobody ever got fired for buying IBM’ but, as the IT sector continues to melt down under economic pressures and credibility issues, CIOs can gain little comfort or support from their traditional allies among the supplier base. The Y2K problem was just one episode of a continuous series of promises and scare tactics that made IT the fastest growing sector in commercial history. Suppliers vied with each other to dream up ever more compelling propositions to corporate customers, from the early days of mainframe computing and cost displacement to distributed processing, re-engineering, ERP systems, network computing, e-commerce, Y2K, CRM and the recent dot-com boom! Rock stars such as Michael Hammer and James Martin have enthused global CIO audiences with memorable sound bites such as ‘Less is More’. Hype aside, few such offers have delivered demonstrable benefits and experienced customers are increasingly weary of the demands of their internal IT departments. Instead, many companies facing recessionary pressures have taken the axe to the IT budget and associated pipeline of new IT projects. We have seen IT spending in global companies (such as BP) fall by up to 40%, heralding gloom and doom for a sector fuelled by continuous growth.

CHANGE IT!

Set against this background of failed supplier promises and reduced customer spending, the sector is undergoing a classical consolidation, while cost pressures encourage the aggregation of production and distribution. The attractive economics of developing countries such as India and China also encourage structural changes. Despite the recent moves towards consolidation, stock markets have reacted badly to many of the announcements, and continue to underrate many key players. The telecommunications sector is in turmoil, with heavy debt and almost stagnant growth. IT suppliers have seen similar falls in recent fortunes, with companies such as EDS and Cisco trading at historic ten-year lows. With every prospect of flat or declining revenues, these companies must adopt radical approaches to enhancing shareholder value. Get that atomic thinking cap on.

IT sector reformation To generate the sort of returns shareholders have come to expect in this high-performing sector, larger players in the IT sector will atomize into different elements, each with its own stock market profile. Such elements may include: • Customer managers (account-focused service organizations): Many IT service organizations have invested heavily in building strong customer relationships on a global and regional basis. These help to elevate the role of technology on the corporate agenda and stimulate higher value service opportunities – remember, customers will have greater freedom of choice, and quality of service will become a core differentiator. We predict, for example, that many of the key account teams operating today within IBM Global Services, and EDS will atomize into specialist boutiques aligned more closely with their clients than their parent companies. Such companies might have a micro-workforce of, say, fifty staff but a revenue base of hundreds of millions of dollars. Customers will choose from among these specialist houses (customer manager atoms) that understand their unique needs as organizations and sectors, and can call on the best resources worldwide to meet particular requirements.

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• Smart company (product innovators): Most big breakthroughs in IT come from small, venture-backed technology companies. These companies will exploit the raft of consultancies and system integrators to bring their products to market. Return on equity investment will continue to be high as and when the larger players acquire these companies. • Webspinners (system and service integrators): Complex customer needs require myriad IT products and services. These in turn have led to a network of alliances and partnerships across the sector. Many large IT service firms have 300 or more such alliances on their books. Developing and managing these alliances demands specific skills. We will start to see smaller boutiques emerging, with exceptional value linked to their ‘relational’ capital. • Asset and service platforms: IT manufacturers are beginning to unbundle manufacturing and logistics to third-party operators in an effort to simplify their structures and increase flexibility of supply in highly volatile markets (CISCO has become a model for third-party manufacturing, preferring to specialize in design and marketing. These manufacturers will use asset platforms – large and stable atoms, frequently owned by large consortia and government agencies. Service platforms, or global IT utilities, will enjoy similar scale and scope to ensure lowest cost production. The stock market will view such platforms as utilities with stable and positive returns. It is entirely feasible, for example, that Taiwan – today’s largest electronics manufacturing hub – will become an independent asset platform serving all the hardware vendors, while India becomes the dominant software platform for the IT services sector. Set within our new industrial taxonomy, the atomized economy will comprise myriad smaller, high-value boutiques – innovators and customer managers, coexisting with large global manufacturing and service platforms. Companies such as IBM and HP will break apart into their constituent elements, laying to rest the ideal of a total service IT supplier. Internal IT organizations will have the choice of dealing with consulting firms that can advise on new applications and techniques, or going straight to asset and service platforms for low-cost solutions and operational support.

CHANGE IT!

The shake-up of the late 1980s and early 1990s saw the disappearance of once-established names such as Burroughs, Digital Equipment Corp and Data General, while others such as IBM only just survived. Atomization will further damage today’s established names, as dead-weight corporate cultures are broken up or just plain out-evolved. And so the shape of the IT supply sector changes yet again.

Vertical disintegration of IT consultancies The current fad for consolidation within the consulting sector – with large IT firms buying consultancies – introduces internal conflicts resulting from cultural incompatibility. Although the concept of a full service IT organization has a popular ring to it, consider the problems of integrating a high-level consulting partnership such as Ernst & Young, PwC or A.T. Kearney into a large corporate structure such as Cap Gemini, IBM or EDS. The ethos, economics and management styles of the different elements of the firm are inherently incompatible. In many respects, external IT service organizations encounter similar issues of style and flexibility to internal IT organizations, although the scale and resulting problems are even larger – in May 2003, IBM had a payroll of 315,000 employees! The largest players, operating everything from strategy consultancy to routine IT operations, look similar to vertically integrated corporations, and by now you must have worked out what we think of them. Applying atomization principles to these integrated IT service organizations suggests the following business models for this sector: • Niche consulting firms: Specializing in the needs of a few large corporate customers where industry and process knowledge is crucial as well as customer intimacy. The CIO of BP once commented to an account manager of an IT services group that his team had a better understanding of BP than the internal IT team. We have observed the rise of niche outsourcing specialists and even foresee the rise of atomization advisers!

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• Systems integration and application development organizations: Other small boutiques that bring together world-class methods and approaches with top-level programme management skills to undertake large projects with a multiplicity of external contractors, frequently offshore. This is comparable to the models evident in the construction and movie industries and has the merit of flexibility to market conditions (see the Hollywood producer strategy in Chapter 5). • Product design shops: Companies that apply state-of-the-art thinking and technologies to product innovation, both hardware and software. These companies will remain small and highly agile to reflect the innovative nature of their business and supporting culture, and will depend heavily on third-party manufacture to achieve global scale and scope. This is a similar trend in car companies such as BMW and Porsche, which are moving towards design and engineering rather than manufacturing. • Operations and infrastructure platforms: The industry needs a few largescale service operations that concentrate on data centres and network operations. These players are capable of absorbing the operations of many different companies and provide high levels of efficiency and back-up. They are the IT equivalent of power utilities. You will not be surprised to see that this list is very similar to the characteristics of the customer manager, webspinner, smart company and service platform atoms we described in Chapter 4. This change will not happen overnight. The current trend of rationalization and the creation of full-service organizations will continue to run its course, at least until managers, professionals and shareholders give the thumbs down sign – just observe the departures of partners from recently acquired consulting firms. But the real determinant of future structures will be the corporate customer who recognizes growing inefficiencies in today’s IT supply sector and is currently voting with his feet – as demonstrated by dramatic reductions in IT spend.

CHANGE IT!

IT or digital business? Career choices for the IT professional Perhaps you are a young IT professional or an IT manager, contemplating the new environment described above? Alternatively, you may be a generalist intrigued by the connected economy and the numerous opportunities it might open up. Or you may still be at college evaluating your career options. Either way, the same questions are likely to jump out at you. Will IT continue to hold the promise and rewards of earlier years? What skills and training will be required to succeed in this field? Is a career with the suppliers more exciting than within the confines of an internal IT function? Our picture of an emerging IT supply sector, and its associated functional structure, is dramatically different to the heyday of the 1980s and 1990s when size mattered. Today, many of the more accomplished IT professionals and managers are working for small boutiques or internal functions with hundreds, rather than thousands, of people. This trend will accelerate as large units are atomized into many small pieces. We predict that in the future the majority of professionals will be either small teams or freelancers – managing a portfolio of skills and relationships. To survive and flourish in a more volatile and transient work environment, managers and IT professionals will need a mix of competencies and experience that is easily transferable and regularly updated. Some of the key ingredients will be: • Relationship building: With much time invested in maintaining contacts and awareness with business customers and key suppliers. • Partnering and alliances: Learning how to initiate and sustain loose business networks and working arrangements. • Business consultancy and process innovation: Applying new techniques to traditional work patterns to achieve efficiency and effectiveness improvements. • Programme management and cultural change: Being able to orchestrate large and complex projects with strong emphasis on the human as well as the technical dimension. • Technical competency: Developing familiarity with the many new aspects of IT as a business and innovation tool.

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Naturally, individuals will not be able to excel in all areas (you know by now that is not how atomization works!) and will have to build a personal checklist of a few core competencies. Some will err on the side of change management and business consultancy while others will prefer to acquire deep technical know-how or long-term relationships. The key to success for any corporation or ‘atom’ will be to identify a network of like-minded individuals who have complementary skills – either within an organization or, more frequently, outside. Such networks will evolve into the atomic corporations of tomorrow and should provide both the stimulation and reward that more hierarchical organizations do today.

Summary Just because IT suppliers continue to get bigger does not mean that this trend is sensible, or that it will continue. Even if the cultural incompatibility of full-service IT organizations does not finish them off, the economic logic of atomization will. Atomization will involve a rapid reversal in growth of IT suppliers, which will slim down sharply to concentrate on customer understanding, product creation, innovation or operations. New IT supply atoms will remove the need for large in-house IT organizations, which too will slim down sharply to concentrate on customer understanding, alliance cultivation and delivery management. If you run an in-house IT function, you have perhaps five years to break it up before someone else does it for you. So go on – change IT!

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Atomize Now!

It’s D-Day So what will happen if you don’t atomize your corporation? Let’s spell out what will happen once your competition consists of networks of atoms: • Their internal costs will be much lower than yours: they don’t have whole reams of management to play politics, and the non-value added services (HR, IT, finance, etc.) will be bought in. Consequently, they can undercut your prices and shred your margins. • They will be significantly more agile and innovative – you can forget about being first to market – not to mention being more able to move with the shifting tides of customer demand.

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• They will be marvellously empowering places to work when compared to your dinosaur of a corporation. The war for talent? You’ve lost it. • As word gets around that atomizing corporations become more profitable and have rising P/E ratios, your investors will desert you – sending your share price into a death spiral. Do we have to spell out what will happen then? Enough already. We’re sure you get the message. In this penultimate chapter we will help you avoid this death by ossification by showing you how to find the atoms hidden in your corporation. First, we’ll look at how you can identify and separate the layers of value within the corporate model. If your organizational structure blocks that route (history and politics, as ever, defeat common sense), what we present is a second, bottom-up view of atomization starting with the current organization chart. Once we have demonstrated that there are superior alternatives to the current structure, we will ask whether your current organizational structure gets in the way of change. Prepare your banners now, saying, ‘Down with the SBU’, as we’ll be rushing to the barricades later on. Having decided on an atomic structure, we’ll look at the skills needed to manage individual atoms and offer some pointers on where you might find them. Finally, we will look at an alternative organizational model to atomization – often described as the competency-based organization – and ask if this is really an alternative to atomization or just a step along the road.

The corporate pineapple Take a look at the organization you work for, not in terms of geographic boundaries or the pre-arranged strategic business units (SBUs), but as a set of components that add value to each other and to the shareholders. Envisage those components as a set of horizontal slices, as demonstrated in Figure 12.1. Some organizations might not possess all of these layers (e.g. banks will possess little in the way of value-adding physical assets), but let’s consider them all to be complete.

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Governance e.g. Strategy, alliances

Specific Business Elements e.g. New product development

Generic Business Elements e.g. Procurement, HR, Finance & Administration

Virtual Infrastructure e.g. IT services, employees, offices

Physical Infrastructure e.g. Property, logistics, refineries

Figure 12.1 Layers of the corporation.

Heart and soul The soul of a large corporation does not lie in the units that make the products of the corporation. Nor is it in the layers of middle management. The latter are often focused on end results (or politics) and are the tools by which strategy is implemented, rather than a part of the strategy-setting process. The strategy definition part of even the largest corporation probably does not exceed 10–100 people who perform the governance functions of the corporation. These governance functions consist of strategy, alliance management and oversight: • Corporate strategy decides why the corporation exists, what it will set out to do and, in the broadest terms, how to do it. • Management of strategic alliances involves controlling relations with a few key stakeholders, such as major investors, governments, sometimes the trades unions, and key business partners. • Oversight ensures delivery of the strategy, with the lightest touch possible. This is perhaps the least crucial of the three functions. Day-to-day operational details (quite rightly) rarely intrude into this level except where decisions on corporate policy are needed.

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Essentials The second layer of our apple contains key differentiators. These elements that provide competitive advantage make a positive difference to the success of the corporation. Such elements may seem obvious to all (think of Coca-Cola’s famous ‘secret recipe’ and the marketing that promotes it) or far more subtle (Wal-Mart’s excellence in supplier management, or Cisco’s virtual manufacturing processes). Differentiators vary from industry to industry, but one would commonly see items such as: • Process knowledge: How to build that better mousetrap, or how to make the same mousetrap faster, better, cheaper than your competitors. • Knowledge management: How to generate and harvest knowledge. • Product design and specification: Think Coca-Cola. • Intellectual property: Management of specific items of knowledge or expertise (e.g. mathematical understanding of stock markets, drugs, patents, etc.). • Human inventory: In some industries, the staff of the organization constitute its products, for example in academia, journalism, consultancies, merchant banking, advertising and other forms of prostitution. • Brand management: Especially for consumer products corporations. • Good relationships: Either with customers or within supply chains.

Run of the mill The majority of corporate functions, however, are generic. You would find the same processes within competitors and probably even in different industries. These functions maintain business-as-usual rather than contribute towards the corporation’s products. For example, all corporations have (at least) one procurement function, HR function and IT function. The role of these functions is seldom strategic to the corporation, despite their pleas to the CEO during the budget allocation cycle! They rarely make an outstandingly positive contribution to success because there is so little room for them to differentiate the corporation or add real value. Such functions, however, cannot be ignored – disastrous marketing, lousy IT or sloppy cash management can kill a corporation faster than poor strategic vision.

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Functions that are differentiators – Wal-Mart’s supplier management processes, and IT in the wholesale banking industry – and that are clearly major contributors to the corporation’s success belong in the layer above. This layer consists of all the other processes: look at some examples: • Finance and accounting: Cash and treasury management, accounts payable and receivable processes, financial reporting, etc. are processes that all corporations deploy. These underlying processes are so similar that they are often externally regulated. Professional services such as tax and legal advice also fall into this layer. • IT development: While the types of systems that IT functions produce differ from industry to industry, the processes used to produce them are generally pretty indistinguishable. • Human resources: Recruitment and retention of staff, benefits management (including payroll), health and safety, discipline and firing, etc. are all processes that tend to differ by geography rather than by industry.

Ways and means The fourth layer holds the ‘fixed’ infrastructure items used to support the generic processes of the business – items such as office space, computer and communications hardware and software. Unlike the capital assets of the business, managers see the virtual infrastructure as ancillary corporate operations and are willing to take make-or-buy decisions on where they come from. For most corporations, this layer would also include the workforce. Sufficient numbers of people, with sufficient training, could deliver the same results regardless of whether they are contractors or permanent employees. Of course, it matters to the employees (that’s why we have labour laws) but to the employer the question is again one of the balances between internal and external costs. So management makes rent-or-hire decisions where the workforce is concerned. Temporary hires are no longer restricted to typists and administrative support, and there are even some industries (healthcare, construction) where the workforce feels more allegiance to the profession as a whole than to any particular employer.

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Assets Most corporations, with the exception of those purely in the service industries, have considerable amounts of capital tied up in physical infrastructure such as assembly lines, refineries, trucks, warehouses, etc. They are not strategic to the corporation nor are they directly used in the production of goods. Unlike the layer above, this stuff is important. Profitability of some industries is almost entirely based on this physical infrastructure layer. Corporations in these industries tend to use principal performance measures related to the assets – such as mean time between failures, production output, return on investment, or return on capital employed – and these corporations are often characterized by good profit margins but low P/E ratios. These organizations have always been regarded as the engines of capitalism. However, many have fallen into an asset trap. Most traditional managers see these physical things as their strategic assets and as barriers to entry for the competition. Capital assets certainly can be the strategic base of a corporation, if it does not fool itself that it is customer-focused. And yes, capital assets certainly are barriers to entry. Building these assets requires considerable access to funds and expertise in their design and operation. More importantly though, they are barriers to change, because they impose an inflexible mindset on the corporation and make it concentrate on its operations rather than its customers.

Parting the layers Concentrate! The role of the corporate strategist is to ask: what should we do? The answer is staggeringly simple and should be ingrained in everything you do: Only do those activities that directly add value to the shareholders. If an asset or a process represents the core of what the corporation does, then it should be retained. If it represents something that is part of the mechanism of how it does it, then get rid of it now. What! Get rid of it? Why? Because management attention is one of the scarcest commodities in the world, and it should not be squandered on

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non-core components of the business. Reductions in external transaction costs means that it is possible to unbundle these things from the corporation, either saving cost or releasing a potential source of capital worth. This is a radical vision. To accept it, CEOs must ask themselves what it is that their empire does better than anything else, and then declare the rest of that empire independent and/or redundant! Let’s take an example: the choices facing a chemicals corporation: • If its cost of capital is low and its asset base strong, then it could become an asset platform, concentrating on bulk production for other people. • Alternatively, it could sell its assets and use its business expertise to take over the webspinning role of managing the supply of feedstocks and routes to market. • If it has a strong intellectual pedigree, perhaps it should shrink back to a smart company – such as a research team and a set of protected intellectual property. • Or if it is good at all of these things, then a loose association of atoms, each free to exploit its own specialism and to trade on the market, will be worth more than the current, bundled version of the corporation. We used that example because it’s far from certain that the corporate elements that were of value 30 years ago are still of value today, and maybe the things that you think are core can really be disposed of. One can also be creative with support services. It is entirely possible that our chemicals corporation has the area’s best-run HR department. This is an untapped source of capital, and they can make use of it by floating it off as a separate business, either retained under direct control or used as a cash generator via an IPO. But if their HR department is not the best in the area, why are they still running it? There is probably a corporation nearby with a better one. Coming to an arrangement with them could reduce fixed costs and increase services to the employees, thus increasing productivity. Under either situation, everyone wins (except the worst of the two HR departments). Next key message: If it isn’t key, sell it. If you can’t sell it, dump it.

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Atomizing by layer You should have figured out how the atom types we presented in Chapter 4 correspond to the layers of the corporation: • The physical infrastructure layer, if it exists, will clearly become a set of asset-based business platforms. • The virtual infrastructure and generic process layers will become, or be replaced by, service platforms, probably through a process of outsourcing. • Specific business elements, if they truly have the power to differentiate, will be the basis of valuable smart companies, webspinners or customer managers. • The governance layer will be the core of a portfolio owner that retains a financial stake in the other atoms. With the exception of corporations dominated by their asset layer, the core of a corporation lies in the governance and specific business element layers – everything else is potentially saleable (or should be dumped) – see Figure 12.2.

Core to Business Governance Specific Business Elements Generic Business Elements Virtual Infrastructure Physical Infrastructure Saleable Assets? Figure 12.2 Unbundling the corporation.

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So we can see a corporation in (say) the financial services industry reorganizing as shown in Figure 7.1 (on page 126), where once-large corporations are de-layered to specialist atoms floating on a sea of lowerlevel platforms.

Bottom-up atomization It’s time to consider the second method of identifying atoms. This is not as clear-cut, but the structure of most corporations has developed over decades and it is very often impossible to divide them into neat layers. In these cases, a bottom-up approach to redesigning the organization will be needed. The place to start is with the organization chart. Figure 12.3 shows an idealized organization structure for our fictional example corporation, Monolith, Inc. Bottom-up atomization is simple to understand – take each of the boxes on the chart, identify the core competence required to run it and then match those competencies to the atom type. For example, the ‘USA sales’ branch of the tree contains a sales function, which can either be retained or sold (depending on how good it is), a loyalty programme, which should be core to the business, and two financebased businesses (leasing and insurance), which can be seen as potential portfolio owners. If you find it hard to clearly identify which atom type the box belongs it, it’s probably because it is too complex and it needs to be split up. Having identified the atom which best represents each element of the organization chart, group them into atom types requiring similar competencies and management ethos, giving you something like Figure 12.4. We still have the same old, fat, bloated corporation we always had, so it’s time for some corporate liposuction! Take a look at the organizational units which represent each of these potential atoms and ruthlessly take out anything and anybody that doesn’t fit its competencies – either relocate them into an adjacent atom (e.g. a service platform) or dump them. This will give you a hyper-efficient version of your current structure, ready for atomization.

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Vehicle Sales

Loyalty Programme

Insurance

Leasing

Finance Co

International

Domestic

Logistics

Buying Club

Procurement

Vehicles

Sales

Alliance

JVs/Alliances

JV Planning

Automotive

Commercial

Admin

Components

Manufacturing

Figure 12.3 Organization chart for Monolith, Inc.

Sales

USA

Strategy and Planning

Head Office

Distributors

Customer Club

Testing

Vehicle Design

Lab Services

Glass Products

Research

Europe

Admin

Facilities Managemt

Marketing/ PR

Finance

Central HR

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JV Planning

Buying Club

Distributors

Loyalty Programme

Customer Club

Alliance Marketing/PR Procurement

Testing Planning Central HR

Facilities Management

USA Logistics

International Logistics

Service Platforms

Glass R&D

Vehicle Design

Laboratory Services

Smart Companies

Figure 12.4 Potential atoms from Monolith, Inc.

Webspinners

Customer Managers

Component Manufacture

Truck Manufacture

Automotive Manufacture

Asset Platforms

Financing

Insurance

Leasing

Strategy and Planning

Head Office

Portfolio Owners

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Sketch the new corporation We advocate atomization of the current corporation, but not its obliteration. The current organization exists to convert inputs (raw materials, knowledge and labour) into more valuable outputs (products, services, etc.). Unless the corporation is in terminal decline, the market still has a need for those outputs, and the next step is to work out how they will continue to be created by the corporation in its new atomized form. For each of the atoms, we must list what it consumes (its inputs) and what it produces (its outputs). Then, starting from the ‘output’ end of the existing corporation, we sketch out the molecules that will be used to create the corporate output, remembering that some of the services might in future be sourced from outside. This sketch of how the atoms fit together should demonstrate the viability and workability of the deconstructed corporation. Figure 12.5 is one high-level solution corresponding to our worked example above.

Burning down the SBUs The shift of focus from agility to short-term profitability over the last two decades has led most corporations to create quasi-independent and highly accountable strategic business units (SBUs). These SBUs are often designed around geography or product, and ignore the realities of an increasingly interconnected economy. Current conditions are worth looking at in greater detail, as different forms of organizational structure require slightly different remedies: • By function (e.g. accounting, sales, manufacturing, shipping, etc.): Legacies of 1970s thinking, these functions are not really SBUs as they do not concentrate on a business segment. Function-based structures are rarely observed these days but, if you do come across one, it’s ripe for atomization! • By industry sub-sector (e.g. extraction/refining/retail in the oil business): Corporations sometimes organize themselves like this, often (as is the case of the oil industry) to offset cyclical losses in one business unit against

Bought-in Services

Insurance

Leasing

Central HR

Manufacture Components

Manufacture Automotive

Marketing/PR

Administration

Ownership

Strategy and Planning

Head Office

Knowledgebased Businesses

Alliance

Procurement

Testing and Metrology

Vehicle Design

Glass Products

AP/AR/Finance

Domestic & Int. Logistics

Facilities Mgt

Sales Channel

Alliance Planning

Manufacture Commercial

Import/Export Businesss

Asset-based Businesses

Figure 12.5 Monolith as an atomic corporation.

Supply Chain

External

Internal

Service Businesses

Risk-based Businesses

Relationship Management

Customer Club

Distribution

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profits in the other. They can be atomized, and holding them under the same portfolio owner will continue to provide cyclical protection. • By customer segment (e.g. in many retail banks): These SBUs always contain the germ of a customer manager atom, often sitting alongside inefficient support processes. Atomization will probably yield considerable benefits. • By geography: Geographic structures have the advantage of being able to reflect local cultural values and management structures, but otherwise have nothing to commend them. You are likely to find mini-SBUs under the geographic umbrellas matching one of the other structures – get rid of them. • By product: Organizations structured by product line are clearly more interested in what they make than in what their customers want – break them up immediately! We should bear in mind that efficiency and agility are mutually exclusive. Remember the hummingbird that was so specialized its beak was designed to fit one type of flower? As the rate of change in the economy accelerates, efficiency is a luxury corporations can no longer afford. It is possible that the new atomic structure aligns neatly to the existing structure, in which case the atomization process will be relatively easy. But it’s more likely that your new atoms transcend your current SBU boundaries. This is a difficult situation to unpick (especially while maintaining some semblance of business as usual) but it’s imperative that you do so, as you have just demonstrated that your current organizational structure is not viable in anything other than the short term. Moving from an SBU-based structure to a horizontal layer-based structure is not going to be painless. SBU chiefs will not appreciate the fiefdoms they have worked so hard to dominate being broken down. But there is no choice – your corporation will either live as a set of atoms or die as a set of SBUs.

Managing the zoo New tactics The skills needed to manage an atom vary from type to type (managing a herd of creative innovators requires very different skills from managing a

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refinery), but we can say that guiding an atom involves managing customers, managing knowledge and managing relationships. These skills are in addition to those needed to survive as middle-to-upper management in a large corporation (which often seems to be finessing the complexity of the organization, budgeting and politics). Consequently, many of today’s managers will need to rethink their value proposition. Atomizing your business may present you with some interesting issues on where the new management teams will come from. In some cases, there may be no viable in-house management team, especially in corporations where staff turnover is low, and it may be time to think of bringing in an external team. But most of the time, it is likely you will find that the business units are full of star performers with ideas on how the business could be improved, if only you got out of their way!

Atomic skills It’s currently popular, especially in the UK, to cultivate generalists by moving staff around between dissimilar posts every couple of years. In the new economy there will be far less diversification of skills. Why? One of the oldest maxims of economics is that ‘the division of labour is limited by the extent of the market.’1 In other words, the likely size of the audience determines the degree to which the players can afford to specialize (think of the variety of specialist restaurants in a city as compared to a small town). Since the new web-enabled global market is very large, we would expect considerable specialization among the atoms that service it. Let us consider the competencies that our atoms will need:

Customer managers

Marketing, particular ‘life need’ experience (e.g. employment, parenting, learning), consumer interaction skills (e.g. anthropology, design), data mining, knowledge management

Webspinners

Ability to form relationships, broad range of contacts, alliance management, legal expertise, collaboration

Service platform Process expertise, efficiency focus, probably considerable IT skills Asset platform

Industry expertise, asset management focus

Smart company Innovation, subject specialization (either creative or analytical), knowledge management Portfolio owner

Financial acumen, good risk management skills, financial acumen

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Relationship management – the missing skill There is one specific skill that will be needed in all atoms and one likely to be in very short supply – relationship building. In a world where relationship capital is one of the major sources of intangible value, people who can build value into these relationships will be at least as useful as someone with superb operational skills. In the mid 1980s, 5% of all revenue earned by Fortune 1000 companies derived from alliances. By the end of the 1990s, the figure had jumped to around 20%.2 By the end of this decade (the noughties?) we expect that to be approaching 100%. As we described in Chapter 9, alliances offer a number of benefits over ownership – they are faster, (generally) don’t require as much capital, they don’t increase internal transaction costs and they represent an ‘option’ to do future business rather than a firm commitment. Apart from having a clear strategic vision and the ability to find partners, the key skills in alliance management will be flexibility over how the relationship is managed. That requires both forethought and formal processes governing the ways in which exceptions and problems are handled, and the conditions under which the alliance be dissolved.

A step on the road Atomization is a radical vision for corporate structure, and we are often asked if there are ways that corporations can get some of the benefits of smaller, more focused structures without going through such a major transition. Well, there is a way …

The competency-based organization To get to this halfway house, take a traditional, monolithic organization and lead it through the bottom-up atomization process described above, but stop at the point where you have identified the atoms and ruthlessly taken out the non-contributing elements. What you have is a set of proto-atoms, each with a single core competency, inside the boundaries of the corporation. You now have a choice – either to liberate the atoms to trade with whomever

AT O M I Z E N O W !

they like, or to keep them inside the corporate boundary and force them to trade with tight contractual arrangements between them. Let’s look at two types of captive atom.3 First are those whose business rotates around customer need and, second, those whose core competencies are in the provision of goods and services at the lowest unit cost possible. Due to the economics of customer management, the first type of atom needs to provide as many services as possible to its customer group. Thus, they must be motivated to seek out customer desires and to provide them, but from within their corporate boundaries if possible. The second type of atom tries to offset its investments by providing goods or services to as many customer manager atoms as possible, with a minimum of tailoring or customization. We can even foresee the existence of atoms whose job it is to explain to atoms the economics of the other guy’s business model! Our traditional corporate structure would end up looking something like the diagram shown in Figure 12.6, where atoms whose core competency was customer management create market-facing offers based on goods and services from within the corporate boundary, and possibly from outside it. The other set of atoms provide goods and services to the corporation’s offers, and possibly to those of other organizations as well.

Remind me: why atomize at all? Good question. The type of structure described above and pictured in Figure 12.6 has many advantages but severe limits too. It preserves the coherence Corporate ‘Boundary’ Offer 1

Offer 2

Offer 3

Offer 4

Service A

Service B

Services provided to other players

Service C Service D

Services imported from other players

Figure 12.6 Competency-based organization structures.

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of the CEO’s (note, not the shareholder’s) empire, and forces each component of the corporation to concentrate on what it is best at. It also provides a semi-porous boundary to the corporation to allow goods and services to flow in and out, but under tight control. However, we see this competency-based structure as a step in the transition to atomization rather than an end-point because: • The customer-facing elements, and to a degree the service elements, will be too parochial. Customer-facing elements need a broad scope if they are to capture and retain the customers’ imagination, and while they are forced to stay within the parent corporation they will be unable to expand their scope enough.4 • There will be insufficient freedom to shop around. In-house elements linked by internal contractual arrangements are likely to see internal transaction costs go up without a corresponding decrease in costs. There is always a tendency to take internal customers and suppliers for granted. In the words of David Sadtler,5 this structure is ‘the curse of vertical integration with added bureaucracy’. • The total financial value of the atoms to the shareholders will exceed those of their parent corporation by a significant amount (see Chapter 8). Such a release of relational capital cannot be achieved while the corporate boundaries remain. Shareholders will force atomization. Make no mistake, this idea of a competency-based organization6 does have some merit and it is a stepping-stone. It provides a way of breaking down SBU structures and forming the atoms without creating unpalatable amounts of change within an organization. It can also lead to a progressive atomization, as customer-facing and service-based elements are sold off or floated. It’s a nice place to visit, but you wouldn’t want to live there.

Summary We’ve travelled along several roads with our current organizations, with all roads leading (of course) to atomization. Traditional corporations can be

AT O M I Z E N O W !

seen as a set of layers that reflect the value-adding elements of the corporation, with outsourcing being the most recent and radical way of removing those layers. It’s easy to see how some of the non-value added parts of the organization can be cleaned out. We have also taken a bottom-up view where elements of the current corporation can be sorted and grouped into (somewhat bloated) atoms, and then stripped down to be fit for the new economy. Finally, we’ve seen how organizations can be arranged by competency elements, giving us a stepping-stone, but not an alternative, to atomization.

Endnotes 1 Adam Smith, An Enquiry Into The Nature And Causes Of The Wealth Of Nations, ISBN 0679783369. 2 Quotation from Mainspring Consulting’s paper, ‘New skills for the new economy: a primer on partnerships and alliances’, September 2000. 3 This is similar to the ideas portrayed by John Hagel III and Marc Singer, both of McKinsey & Company, in ‘Unbundling the Corporation’, Harvard Business Review, March–April 1999, p. 133 et seq. 4 This argument is taken from John Hagel III and Marc Singer, ibid. 5 A Fellow of the Ashridge Strategic Management Centre, and major contributor to Chapter 10. We are grateful for his kind permission to reproduce his views. 6 For a full description of how such a corporation might work, see Rebuilding the Corporate Genome, by Aurik, Jonk and Willen (Wiley 2002), in addition to the earlier works of Hagel and Singer.

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Part 5 Corporate Re-formation

13

Corporate Re-formation

In this chapter, we reach the end of our journey. Let’s look back on where we have travelled, and summarize our progress.

The downfall of Indulgences, Inc. We started our journey with an unusual comparison – that of the modern corporation with the sixteenth-century Church. But it’s actually not that far off the mark.1 The history of the Catholic Church throughout the Middle Ages and Renaissance is filled with spiritual and artistic triumph. It was forcibly downsized, not because of the horrors of the Inquisition or even a long list

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of doctrinal stupidities, but because it became obsessed with its own power and structure. At the start of the sixteenth century, the multinational corporation that we know as the Church of Rome still held sway over Europe, with compulsory weekly attendance at corporate meetings. This corporation was the dominant force in European politics, actively repressing the emerging nation-states. The old vows over poverty (not to mention chastity!) had been forgotten, and the corporation had grown immensely rich. The core product of the corporation was forgiveness. One of the central sales messages of this corporation was the promise that, if you confessed and genuinely repented your sins, they would be forgiven. External proof, such as penance or the conduct of good works, was seen as an essential part of your commitment to the corporation. Although widespread use of interchangeable money was fully two hundred years old, the corporation was pretty conservative, and it had taken a while for it to see just how useful cash was, not least because of the need to raise large amounts of the stuff to upgrade corporate headquarters in Rome. But where could the cash come from? Well, from the sinners, of course. The CEO at the time, Pope Leo X (better known as Giovanni de Medici) argued that clergy were doing more good works than they needed to, and that they had the time if you had the money! You could pay these clergy to do your penance for you and be issued a certificate of indulgence as confirmation. This was not popular with a section of the middle-management class – the priests. They felt the corporation should be concentrating on supplying its core product (forgiveness) to its core customers (the poor) and that the new concentration on the high net worth individuals (or fat cats) had more to do with gilding the walls of the Vatican than with serving the populace. Meanwhile, an emerging new medium – printing – was dis-intermediating the priests, as everyday-language translations of the Bible shifted power into the hands of the consumers. This could even be seen as a radical reduction in religious transaction costs!

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If you recall our messages in Chapters 2 and 3 of this book, you should be able to predict what happened next – the break-up of the corporation. It wasn’t planned that way. On 31 October 1517, one of the middle managers – a priest called Martin Luther – posted a note on the door of his church in Wittenberg that called for an end to the selling of indulgences and a return to the simpler values for the Church. His actions opened the floodgates. The newly empowered consumers, led by the princes whose nation-states were suffering under the corporation’s monopolist tendencies, revolted. What started as a simple protest by an angry priest led to a series of spin-offs and management buy-outs (most spectacularly, 17 years later by England’s Henry VIII). The power of the Catholic Church was broken in much of Europe and the result was the rise of the new Protestant ‘atomic’ churches.

The need for corporate puritanism Can the Popes of today’s secular corporations avoid a similar fate? Should they even try, or have we approached another turning point? For two centuries, corporations have concentrated on the creation of products, and on maintaining the organizational structures needed to create and distribute them. It’s only human nature to expand empires, so it’s no surprise that these corporations have grown in size so dramatically. However, over the last five years, and increasingly over the next fifteen, we can observe the rise of a new medium – the Internet. Intrinsically different from the old, one-way media of television, radio and print, this medium allows for the free exchange of information. This puts power into the hands of the consumers and radically cuts costs of doing business. Just as the printing press marginalized the Catholic Church (Luther was just the fulcrum), so the Internet will overthrow the corporation. Let’s review the forces that are acting on the poor CEO: • The nature and inherent wealth of consumers is changing – they want experience, not product. What’s more, they now have a means to demand it.

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• Corporations are not responding to this change – they still organize themselves into product silos and continue to cling to their marketing departments. • The drive for growth through merger mania has not only failed, it is increasingly seen to have failed. • Falling transaction costs have left large corporations looking dangerously wobbly. • The world is a less stable place than it used to be, and the gaps between economic, political, social and technological changes are getting smaller. Agility is essential for survival and, as we’ve always said, you can’t be big and agile at the same time (the internal cost of movement is just too high). • CEOs still need to provide results for shareholders, and the old sources of wealth are just about tapped out. These guys need some new ideas, and fast. In fact, it’s entirely possible that the stock market pressures of recent years will act as the fulcrum, forcing CEOs to disband their corporations before their competitors do it for them! Staying still is not an option – corporations have to change. The new corporation has to be simpler, smaller and purer.

Living with implosion The new corporate puritanism can be formed around four things – innovation, relationships, excellence in delivery, and risk management. This is reflected in the six types of atomic corporation we introduced in Chapter 4. Of these routes to puritanism, existing corporations will struggle most with innovation. Although large organizations are great at small, incremental innovations, they find it almost impossible to introduce major changes in their product ranges (see The Innovator’s Dilemma for more details).2 This necessary innovation can be in products or in markets, but we expect few of the webspinner or smart company atoms to emerge from the giant corporations.

C O R P O R AT E R E - F O R M AT I O N

This leaves today’s giants with three main routes to atomization: concentration on delivery through creation of service platforms or asset platforms, concentration on customer relationships (leading to our customer manager atoms) or concentration on managing a portfolio of business and other risks (our portfolio manager atoms, of course). We are already seeing rapid growth in asset and service platforms through trends such as contract manufacturing and outsourcing. These trends will be the major drivers to atomization throughout these first few years of this decade. We expect to see more, and more radical, outsourcing and this will lead to changes in the nature (and location) of our service industries. While mergers are not yet dead (scale is important for some atoms), we expect to see the trend shifting firmly towards demergers. The giant multinational, multi-product corporation is dead in its current form. It will shrink down to the smallest feasible unit – ranging from dozens of people in a smart company to a few thousand in asset and service platforms – with consequent rises in profitability and shareholder value. We’ve also demonstrated that getting smaller through demergers increases capital worth, just as getting larger destroys it. This is key. In the case of the corporation, the sum of the parts is far greater than the whole. It’s hard to say exactly when the atomic bomb was dropped on today’s corporations, but we expect to see the effects of the fallout for some years to come.

When the plane lands – a call to arms If the clichés about business books are to be believed, you are probably reading this on an aeroplane. While you’ve been enjoying that marvel of modern society known as in-flight catering, the world has changed around you. Let’s take a look at what you should do when the plane lands.

The CEO Although your bonus may be based on top-line growth, your shareholders really do not care how large your empire is. They want to see continued

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growth in profitability and resumption in capital growth. We’ve shown you how to deliver both – what’s stopping you? If you remember the 1980s, you will recall how the pioneers adopted Business Process Re-engineering early on, and took the benefits while their competitors scrambled to catch up. Tomorrow’s leaders will start to atomize today. Start with those elements of the corporation that do not generate profit, and here we’re not talking about SBUs or subsidiaries. Think of your empire as a set of layers spread across your current business boundaries (see Chapter 12 if you need a reminder). Most of this stuff – generic business processes, the virtual infrastructure, and probably most of the assets – holds you back. It can be outsourced, or even bought in from lower-wage economies at a fraction of the cost. Then get radical – look at the layers of the corporation that do add value. Are they worth more to you inside the current corporate boundaries, or could their value be increased if you floated them? Remember the figures we gave you in Chapter 10 on the value uplift coming from demergers. It’s true that atomizing your corporation cannot be done overnight – any organization worth breaking up will have thousands of people in it that need to be convinced – but you can start today by planning its future shape. Think about what you are in business to do. Ask yourself which parts you really need to retain. Then get rid of everything else.

The middle manager You have the most to lose but also the most to gain from atomization. If you pride yourself on your political and budgeting skills, honed on the way up the corporate ladder, we have bad news for you: the scrapheap looms. This will be a time of great liberation for most corporate managers. Look at your real skills – your knowledge of the core business and your relationships with suppliers, partners and customers. Now look at yourself in a new light – as the CEO of a new, atomic corporation. Start planning how your little but crucially important atom would work as part of a larger network. There is enough information in this book and in your head to produce a business plan for your new fiefdom. Why not send the plan, with a copy of this book, to your CEO?

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Mr Everyman For the rest of us, how we survive in the new atomic economy depends on how true we are to our natures. Are you a rainmaker, a relationship manager, a programme manager or a subject matter expert? While your skills will change as you go though life, if you find the atom type that most closely fits to your talents, you will always feel at home and you will prosper accordingly. But whatever you do, do not expect stability. The old concept of the ‘job for life’ has everywhere collapsed (except possibly Germany) and shorter and shorter terms of employment face you. This is to be embraced, not feared. You may have to take responsibility for your own pension and your own career plans, but wealth and satisfaction are yours if you follow the atomic path (happiness is your own problem!). The future is yours – take it from us.

Endnotes 1 The authors are indebted to the work of Richard Hooker of Washington State University for his insight in the preparation of the section on the Reformation. 2 Clayton Christensen, 1997, The Innovator’s Dilemma, Harvard Business School Press, ISBN 0875845851.

2 41

Index

Accenture 47, 165, 174, 175, 177, 181 amazon.com 26, 50, 65, 150 American Express (Amex) 20, 93, 174, 179, 201 AOL-Time Warner 40, 99, 179, 184, 187, 188, 199 Aon 121 Apax 94 Arthur Andersen 2 Arthur D. Little 47 Ashridge Strategic Management Centre 184 asset platforms 13, 67–8, 103, 239 case study 77–8 consumer goods 134 energy/utilities 128–9 IT 208 macro view 119 mergers and acquisitions 191

retail financial services 121 telecoms 132 AstraZeneca 96 AT&T 131 atomic corporation 61–2, 72–3 case studies 73–9 components 62–70 linkages 70–1 atomization bottom-up 221–4 consequences 14, 83–137 empowerment 214 increased agility/innovation 213 investment 214 lower internal costs 213 desirable/inevitable 14, 19–57 impact on key corporate elements 15, 141–230 old idea updated 15, 235–41

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INDEX

in practice 14, 61–79 reasons for 229–30 Attenborough, Sir David 104 Automobile Association (AA) 199 automobile industry 23, 24, 90, 91, 199 Beckham, David 104 Berkshire Hathaway 95 bin Laden family 112 BMW 63, 91, 97, 154 Booz Allen Hamilton 47 brand management 216 positioning 98 responsibility 90 trust 154 Brinkley, Ian 174 British Broadcasting Corporation (BBC) 168–9 British Petroleum (BP) 2, 13, 20, 22, 30, 31–2, 45, 69, 96, 130, 178, 179, 206 British Telecom (BT) 131, 166 Bruner, Robert 186 Buffett, Warren 7, 95, 142 Burroughs 209 business process re-engineering (BPR) see re-engineering Business in the Third Millennium 148–9 Cap Gemini Ernst & Young 47, 146, 196, 209 capital markets 96 Carrefour 121, 134 Castle Tower Inc. 169 Catholic Church 2, 235–6 Celestica 76–7 Cendian 129 Center for Business Innovation 146–7 chaebol 154 Champy, James 45 change corporation 10–11 delta revolution 1–3 effect of low interest rates 7–8 nature of customers 8–10 predictions 3–7 turning points 19–20 chief executive officer (CEO) 2, 8, 20, 31, 53, 69, 86, 104, 133, 143, 167, 237–8, 239–40 Chief Operating Officer (COO) 114

China 13, 69, 121, 173 Christensen, Clayton 51, 57 CISCO Systems 45, 97, 152, 153, 189, 207 Citigroup Inc 125 cloverleaf organisation 203–5 Coase equilibrium 43, 49, 85 Coase, Ronald 43 Coca-Cola Corporation 20, 30, 64, 73–4, 135, 154 communication 9, 91 virtual era 35–6 visual era 34–5 competitive advantage brand management 216 good relationships 216 human inventory 216 intellectual property 216 knowledge management 216 process knowledge 216 product design/specification 216 connected corporation choice/voice for shareholders 31–2 empowering of employee 29–31 multiple points of connection 28–9 transformation of supply chains 26–8 value networks customer management layer 27 navigation layer 27 product layer 27 connected employees 29–31 connected shareholders 31–2 connectivity electronic 21, 22–6 extended 20 improvements 21 information intimacy/empowerment of relationships 36–7 intangibles 21 integrated supply chains/loose networks of trading parties 26–32 real time transactions 21 revolutionizing 32–3 consultants 46–8, 50 niche 209 vertical disintegration of IT sector 209–10 consumer goods 133 atomization asset/service platforms 134 innovation 134 webspinners 134 Corning Glass 154

INDEX

corporate financial services 123–4, 236 atomization innovation 124 ownership of customer 124 portfolio owners 125 service platforms 124–5 webspinning 124 case study 125 evolution 126 corporations 21, 83 atomization 12–14 bottom-up 221–4 reasons for 229–30 skills 227 bankruptcies 2 breaking down industry barriers 71 breaking-up 98 burning down SBUs 224–6 challenges 11–12, 55–6 competency-based 228–9 competition 21 connected strategies 84–99 definition 84 dot-com era 49–51 expansion 40 flexible manufacturing/distribution 57 governance functions 215 inward-looking 10 layers assets 218 essentials 216 heart and soul 215 parting 218–21 run of the mill 216–17 ways and means 217 make-or-buy decision 41–3 new operating principles 56–71 new tactics 226–7 reformation 2, 235–41 relationship management 228 scale/agility relationship 12, 43–4, 52–3 consulting sector 46–8 internal/external equilibrium 48, 53 mergers & acquisitions 44–5 re-engineering 45–6, 49 step-change ideas 88 Covisint 24, 151 CSC 47, 51, 165 customer champion strategies see strategies customer managers 12, 65–6 case study 75–6 IT 204, 207

macro view 119 mergers and acquisitions 191 customer ownership corporate financial services 124 energy/utilities 127 retail financial services 121 telecoms 132 customer relationship management (CRM) 89, 198, 206 customers accept/process orders from 45 acquire/retain 45 changing nature 8–10 expectations 87–8 greater choice/price transparency 8, 9–10, 11 loyalty 87 relationship with supplier 24–6 satisfy needs 45 wired 24–5 Daimler-Chrysler 24 Data General 209 Davies, Sir Peter 177 Davis, Stan 21, 26 Debenhams 130 Dell Computers 40, 97 Deloitte & Touche 184, 185, 187 Deutsche Bank 201 Diana, Princess 112 Digital Equipment Corp 209 Disney Corporation 154 Dixons 50 dot.coms 112, 150 Drucker, Peter 55 Dupont 67, 104 e-marketplace 22–4, 152 e-Toys 50 Eastman Chemical 129 eBay 50 EDS 51, 165, 166, 167–8, 170, 172, 173, 181, 201, 207, 209 Egg 50 electronic intermediaries 22 electronic market 22–4 customer/co-developer change 26 customer/supplier relationship 26–9 employee 29–31 shareholder 31–2 wired customer 24–5 electronic portals 25, 26, 30–1, 65–6, 152

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Eli Lilly 179 EMI 111 employment 8–9, 241 contracts 105 IT career choices 211–12 job mobility 31 length of time 105–6 energy/utilities 126–7 atomization asset management 128 innovation 127–8 ownership of customers 127 portfolio owners 128 webspinners 128–9 case study 130 evolution 129 Enron 2, 155–6 enterprise resource planning (ERP) 200–1 entrepreneurs 104, 111–12 Epenetos, Agamemnon 135 Evans, Philip 72 Exult 30 Exxon Mobil 126 finance see corporate financial services Flextronics 94 FogDog 50 Ford Motor Company 20, 22, 24, 30, 40, 41–2, 63, 67, 91, 151, 179, 187, 199 France Telecom 184, 197 Freeserve 50 Fujitsu 165 future predictions next twelve months 4–5 next twelve weeks 3–4 next twelve years 5–7 gas industry see energy/utilities Gates, Bill 112 General Electric (GE) 12, 20, 30, 31, 55, 104, 179 General Motors (GM) 24, 31, 67, 143, 151, 167–8, 201 Gladwell, Malcolm 9 GlaxoSmithKline 97, 111, 135 Global 2000 companies 20, 28, 30, 41, 173, 180 GlobalNetXchange (GNX) 134 Goldman Sachs 181 Google 50 Grove, Andrew 85

Hagel, John 11 Hammer, Michael 45, 206 Handy, Charles 106 Hanson Corporation 95 Hawking, Stephen 110 Henkel 2 Hewlett Packard (HP) 30, 97, 165, 208 horizontal-layer organization by function 224 customer segment 226 geography 226 industry sub-sector 224, 226 product 226 Horlick, Nicola 7 HP-Compaq 40, 99, 184, 197 human resource (HR) system 29–31, 68–9, 94, 152, 165, 173, 174, 179, 180, 181, 216, 217 IBM 33, 47, 51, 92, 93, 107, 165–6, 174, 181, 197, 201, 206, 208, 209 Index 47 India 13, 69, 121, 173 individuals 101–2 acquisition of wealth 103–4, 111–13 advice/guidance 113–14 atomic model 102–3, 108–9 basic needs accommodation 114 career 115 health 115 mobility 115 building on strengths not weaknesses 106–8 characteristics programme manager 107, 108 rainmaker 107, 241 relationship manager 107, 108, 241 subject matter expert 107, 108, 241 corporate links 111 earning capacity 105–6 employment contracts 104–5 Jewish ethical will 113 responsibility/power 112 rewards/penalties 116 role models/soul models 109–10 financial security 110 health/well-being 110 lifelong education 110 support 114–15 well-being balance 113

INDEX

emotional/spiritual 112 financial 112 intellectual 112 industrial parks 92 information asymmetry 8–10 exchange 26, 28–9, 48 intelligent agents 33 intimacy 36–7 verbal mode 32 information technology (IT) 52, 69, 93, 94, 105, 143, 216, 217 atomization 201–3 asset/service platforms 208 customer managers/account-focused service organizations 207 smart company/product innovators 208 career choices 211–12 cloverleaf organization 203–6 corporate restructuring 7–8, 10–11 event-driven architectures 200–1 expansion/consolidation 196–8 glue for new economy 198 mergers and acquisitions 190 outsourcing 167–8, 173, 174, 177 splitting sector reformation 207–9 supply side pressures 206–7 technical skills 201–3 vertical disintegration of consultancies 209 application development organizations 210 niche firms 209–10 operations/infrastructure platforms 210 product design shops 210 systems integration organizations 210 world intimacy 199 Infosys 174 innovation 56–7, 88–9, 97, 156–7, 238 consumer goods 134 corporate financial services 124 energy/utilities 127–8 IT 204–5 retail financial services 121 telecoms 132 Intel 97, 191 Intel Museum (Santa Clara) 9 internal costs 42, 43, 48 Internet 21–2, 24, 26, 37, 129, 199, 237

customer relationships 29–32 promise of 49–51 Internet Service Providers (ISPs) 50 Internet Services Venture Vehicle (ISVV) 179–81 intimate computers 33 ITT 94 Jacks, John 166 Jordan, Michael 104 J.P. Morgan Chase 93 Kay, Alan 33 AT Kearney 47, 186, 209 keiretsu 154 Kellogg 179 knowledge-based businesses see smart companies Knowles-Cutler, Angus 184, 185, 187, 189, 193 Kohlberg Kravis Roberts (KKR) 13, 78–9, 94 Kuoni 65, 745 Leggate, John 178 LevelSea 128 Lucent/Agere 184 Luther, Martin 2, 19, 237 McCartney, Sir Paul 104 McKinsey 46, 47, 186 macro-processes consumer goods 133–4 corporate financial services 123–6 end of vertical integration 118–19 energy/utilities 126–30 move towards 118 pharmaceuticals 135–6 retail financial services 120–3 telecoms 130–3 Madonna 104 Marconi 2, 44, 187, 197 Marsh & McLennan 121 Martin, James 206 mergers and acquisitions (M&A) 7, 44–5, 123, 131, 181, 183–4, 197 alternatives 190–1 atomization asset platforms 191 customer managers 191 reasons 191–2 service platforms 191

2 47

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INDEX

consequences 187 demerging 192–3, 239 failure 185–7 getting it wrong 188–90 size of company 184–5 Metcalf’s Law 111 Meyer, Christopher 21, 26 Microsoft 143, 191, 200, 201 middle manager 240 Moody’s 131 Moore’s Law 2 Morgan Stanley 20, 179, 181 Mulholland, Andy 196 multimedia services 33 NASDAQ 49, 50, 170 National Grid Transco 174 National Savings and Investments (NS&I) 121, 122–3 Nectar 130 Nike 12 Nokia 30, 90, 154, 179 Ocean Connect 128 off-shore activities 13 oil industry see energy/utilities Oracle 201 Orange 184 outsourcing 8, 10–11, 51–2, 57, 85, 94, 164–5, 182, 239 alternatives 178 asset platforms 168–9 case study 172 failure of traditional 169–71 first-generation 165–6 internal shared services 173 marriage fatigue 171 infatuation 171 reconciliation 171 separation 171 off-shore 173–4 second generation 176–7 service platforms 167–8 third generation asset divestment with a difference 178–9 benefits 180–1 customer care services 179 e-finance services 180 e-knowledge in global trading 180 HR services 179

transformational 10–11, 174–6 Owen, Steve 122–3 PA Consulting 47 Patton, George S. 189 PE-International 47 Perot Systems 174 pharmaceuticals 135–6 Philips 90, 203 Porter, Michael 186, 187 portfolio careers 105, 106 portfolio managers 96, 239 portfolio owners 13, 69–70 case study 78–9 corporate financial services 125 energy/utilities 128 macro view 119 retail financial services 121 priceline.com 22 PricewaterhouseCooper (PwC) 47, 197, 209 Procter & Gamble (P&G) 24–5, 51, 145, 170, 173, 179 procurement market see electronic supply chain product copying 9–10 Prudential Insurance Company 2, 50 re-engineering 45–6, 47–8, 49, 53, 118, 151 reflect.com 25–6 Regus 77–8 relational capital 158–61 relationship management 57 Reliance 174 Renault 91, 92 research and development (R&D) 88–9 retail financial services (RFS) 120–1 atomization managing your assets 121 ownership of customer 121 portfolio owners 121 product innovation 121 case study 122–3 future shape 122 lifestyle entrants 120 Ringland, Gill 12, 148 risk management 57, 69–70, 98 rock stars 109, 110, 206 Sadtler, David 184, 185, 193 Sainsbury’s 130, 134, 175, 177, 201

INDEX

Saloman Smith Barney 125 SAP 201 Sapient 47 Schama, Simon 104 Schenk, Hans 186 Scient 47 Sears Roebuck 134 service platforms 13, 68–9, 93, 152, 239 case study 76–7 consumer goods 134 corporate financial services 124–5 IT 204, 208 macro view 119 mergers and acquisitions 191 telecoms 132 shareholder value 141–3, 157–8, 186 dividend yield 159–60 price/earnings (P/E) ratio 160–1 Shell 21, 51, 93, 104, 128 Silicon Fen (Cambridge, UK) 89 Silicon Valley (California) 89, 112 Sloan School 45 smart companies 12, 13, 63–4, 89, 102, 238 case study 73–4 IT 208 macro view 119 Smith, Adam 93 Smith, David 185 Smith, Roger 167–8 Sony 63, 90, 97 SRI International 47, 149 strategic business units (SBUs) 214, 224–6 strategies 85–6 customer champion 86, 87 innovation is external 88–9 role of the network 89–90 trust in me 87–8 decision-making 97–8, 99 do activities that add shareholder value 218 global utilities 86, 92–3 modernized utility 93–4 Hollywood producer 86, 90 joining forces 90–2 sell/dump suppport services 219 wheel of fortune 86, 94 hogging the purse strings 95–7 subcontractors 57, 91 Sun Microsystems 200 supply chain changes in 21 electronic 22–6

extending reach 42 ownership 26–7 transformation 26–32 Tata Consulting Services 174 telecommunications 130–1, 197 atomization asset platforms 132 innovation 132 ownership of customer 132 service platforms 132 future 133 problems absurd capital spending 131 collapse 131 merger madness 131 overgearing 131 Tesco 66, 75–6, 121, 130, 177 third-party manufacture 90–2, 93, 94 Total Quality Management (TQM) 46 TradeRanger 24, 179 transaction costs 26, 42–3, 53, 236 transitional activities 98 brand positioning 98 community support 98 corporate governance/strategy 98 infrastructure support 98 Transora 24, 134 trust 2, 26, 64–5, 87–8, 115, 154–6, 162 Unilever 88, 94, 133, 166 UPS 179 Urwick 47 utilities see energy/utilities value carbon/silicon change 143 comparison of market 144 innovation 156–8 measuring shareholder wealth 141–3, 157–8 tangible/intangible 145–7 new model 147–8 new sources 143 relationships agility/creativity 148 customer 150–1 employee 151 inter-business value networks 148 richness/reach 151–3 spinning a web 149–51 stakeholder 148

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INDEX

releasing relational capital 158–9 specific valuations 159–61 trust 154–5 value networks 14, 27–8, 89–90 verbal-visual-virtual revolution 34–6 Viant 47 Virgin Money 120 virtual reality (VR) 35–6 Visa 199 Vivendi 44 Vodafone 199 Von Hagens, Gunther 109, 111

wealth measurement see value webspinners 12, 64–5, 90, 92, 115, 238 case study 74–5 corporate financial services 124 macro view 119 relationships 149–51 Williams, Robbie 111 Wipro 174 World Wide Web 8, 87, 150 WorldCom 2, 44, 131, 197 WPP 45 Wurster, Thomas 72

Wacker, Watts 149, 154 Wal-Mart 121 Warburg Pinkus 130

Xerox 172 Yahoo! 50, 65, 87