Managerial Economics

Pick one you like issue but try to make sure it has a management/econ approach.
Pick which ever is easy, simple english and understandble. also i’ll provide you link there is brief instructions. you have to watch it its about 25 minute. 

ECO 562/5Factors

FACTORS AFFECTING RIVALRY AMONG EXISTING COMPETITORS

To what extent does pricing rivalry or nonprice competition (e.g., advertising) erode the profitability of a typical firm in this industry?

 

Characterization (Current)

Future trend

Degree of seller concentration?

 

 

Rate of industry growth?

 

 

Significant cost differences among firms?

 

 

Excess capacity?

 

 

Cost structure of firms: sensitivity of costs to capacity utilization?

 

 

Degree of product differentiation among sellers? Brand loyalty to existing sellers? Cross-price elasticities of demand among competitors in industry?

 

 

Buyers’ costs of switching from one competitor to another?

 

 

Are prices and terms of sales transactions observable?

 

 

Can firms adjust prices quickly?

 

 

Large and/or infrequent sales orders?

 

 

Use of “facilitation practices” (price leadership, advance announcement of price changes)?

 

 

History of “cooperative” pricing?

 

 

Strength of exit barriers?

 

 

FACTORS AFFECTING THE THREAT OF ENTRY

To what extent does the threat or incidence of entry work to erode the profitability of a typical firm in this industry?

  

Characterization (Current)

Future trend

Significant economies of scale?

  

  

Importance of reputation or established brand loyalties in purchase decision?

  

  

Entrants’ access to distribution channels?

  

  

Entrants’ access to raw materials?

  

  

Entrants’ access to technology/know-how?

  

  

Entrants’ access to favorable locations?

  

  

Experience-based advantages of incumbents?

  

  

“Network externalities”: demand-side advantages to incumbents from large installed base?

  

  

Government protection of incumbents?

  

  

Perceptions of entrants about expected retaliation of incumbents/reputations of incumbents for “toughness”?

  

  

FACTORS AFFECTING OR REFLECTING PRESSURE FROM SUBSTITUTE PRODUCTS AND SUPPORT FROM COMPLEMENTS

To what extent does competition from substitute products outside the industry erode the profitability of a typical firm in the industry?

 

Characterization (Current)

Future trend

Availability of close substitutes?

 

 

Price-value characteristics of substitutes?

 

 

Price elasticity of industry demand?

 

 

Availability of close complements

 

 

Price-value characteristics of complements?

 

 

FACTORS AFFECTING OR REFLECTING POWER OF INPUT SUPPLIERS

To what extent do individual suppliers have the ability to negotiate high input prices with typical firms in this industry? To what extent do input prices deviate from those that would prevail in a perfectly competitive input market in which input suppliers act as price takers?

 

Characterization (Current)

Future trend

Is supplier industry more concentrated than industry it sells to?

 

 

Do firms in industry purchase relatively small volumes relative to other customers of supplier? Is typical firm’s purchase volume small relative to sales of typical supplier?

 

 

Few substitutes for suppliers’ input?

 

 

Do firms in industry make relationship-specific investments to support transactions with specific suppliers?

 

 

Do suppliers pose credible threat of forward integration into the product market?

 

 

Are suppliers able to price discriminate among prospective customers according to ability/willingness to pay for input?

 

 

FACTORS AFFECTING OR REFLECTING POWER OF BUYERS

To what extent do individual buyers have the ability to negotiate low purchase prices with typical firms in this industry? To what extent do purchase prices differ from those that would prevail in a market with a large number of fragmented buyers in which buyers act as price takers?

 

Characterization (Current)

Future trend

Is buyers’ industry more concentrated than industry it purchases from?

 

  

Do buyers purchase in large volumes? Does a buyer’s purchase volume represent large fraction of typical seller’s sales revenue?

 

 

Can buyers can find substitutes for industry’s product?

 

 

Do firms in industry make relationship-specific investments to support transactions with specific buyers?

 

 

Is price elasticity of demand of buyer’s product high or low?

 

 

Do buyers pose credible threat of backward integration?

 

 

Does product represent significant fraction of cost in buyer’s business?

 

 

Are prices in the market negotiated between buyers and sellers on each individual transaction or do sellers “post” a “take-it-or-leave it price” that applies to all transactions?

 

 

__MACOSX/ECO 562/._5Factors

ECO 562/Atoms Are the New Bits

http://www.wired.com/magazine/2010/01/ff_newrevolution/all/1

1.02

In the Next Industrial Revolution, Atoms Are the New Bits

• By Chris Anderson January 25, 2010 | 12:00 pm | Wired Feb 2010

In an age of open source, custom-fabricated, DIY product design, all you need to

conquer the world is a brilliant idea.

Photo: Dan Winters

The door of a dry-cleaner-size storefront in an industrial park in Wareham,

Massachusetts, an hour south of Boston, might not look like a portal to the future of

American manufacturing, but it is. This is the headquarters of Local Motors, the first

open source car company to reach production. Step inside and the office reveals itself as

a mind-blowing example of the power of micro-factories.

In June, Local Motors will officially release the Rally Fighter, a $50,000 off-road (but

street-legal) racer. The design was crowdsourced, as was the selection of mostly off-the-

shelf components, and the final assembly will be done by the customers themselves in

local assembly centers as part of a “build experience.” Several more designs are in the

pipeline, and the company says it can take a new vehicle from sketch to market in 18

months, about the time it takes Detroit to change the specs on some door trim. Each

design is released under a share-friendly Creative Commons license, and customers are

encouraged to enhance the designs and produce their own components that they can sell

to their peers.

The Rally Fighter was prototyped in the workshop at the back of the Wareham office,

but manufacturing muscle also came from Factory Five Racing, a kit-car company and

Local Motors investor located just down the road. Of course, the kit-car business has

been around for decades, standing as a proof of concept for how small manufacturing

can work in the car industry. Kit cars combine hand-welded steel tube chassis and

fiberglass bodies with stock engines and accessories. Amateurs assemble the cars at

their homes, which exempts the vehicles from many regulatory restrictions (similar to

home-built experimental aircraft). Factory Five has sold about 8,000 kits to date.

One problem with the kit-car business, though, is that the vehicles are typically modeled

after famous racing and sports cars, making lawsuits and license fees a constant burden.

This makes it hard to profit and limits the industry’s growth, even in the face of the DIY

boom.

Jay Rogers, CEO of Local Motors, saw a way around this. His company opted for totally

original designs: They don’t evoke classic cars but rather reimagine what a car can be.

The Rally Fighter’s body was designed by Local Motors’ community of volunteers and

puts the lie to the notion that you can’t create anything good by committee (so long as

the community is well managed, well led, and well equipped with tools like 3-D design

software and photorealistic rendering technology). The result is a car that puts Detroit

to shame.

It is, first of all, incredibly cool-looking — a cross between a Baja racer and a P-51

Mustang fighter plane. Given its community provenance, one might have expected

something more like a platypus. But this process was no politburo. Instead, it was a

competition. The winner was Sangho Kim, a 30-year-old graphic artist and student at

the Art Center College of Design in Pasadena, California. When Local Motors asked its

community to submit ideas for next-gen vehicles, Kim’s sketches and renderings

captivated the crowd. There wasn’t supposed to be a prize, but the company gave Kim

$10,000 anyway. As the community coalesced around his Rally Fighter, members

competed to develop secondary parts, from the side vents to the light bar. Some were

designers, some engineers, and others just car hobbyists. But what they had in common

was a refusal to design just another car, compromised by mass-market needs and

convention. They wanted to make something original — a fantasy car come to life.

While the community crafted the exterior, Local Motors designed or selected the

chassis, engine, and transmission thanks to relationships with companies like Penske

Automotive Group, which helped the firm source everything from dashboard dials to the

new BMW clean diesel engine the Rally Fighter will use. This combination — have the

pros handle the elements that are critical to performance, safety, and manufacturability

while the community designs the parts that give the car its shape and style — allows

crowdsourcing to work even for a product whose use has life-and-death implications.

Local Motors plans to release between 500 and 2,000 units of each model. It’s a niche

vehicle; it won’t compete with the major automakers but rather fill in the gaps in the

marketplace for unique designs. Rogers uses the analogy of a jar of marbles, each of

which represents a vehicle from a major automaker. In between the marbles is empty

space, space that can be filled with grains of sand — and those grains are Local Motors

cars.

Local Motors has just 10 full-time employees (that number will grow to more than 50 as

it opens build centers, the first of which will be in Phoenix), holds almost no inventory,

and purchases components and prepares kits only after buyers have made a down

payment and reserved a build date.

Local Motors CEO Jay Rogers combined the power of crowd sourced design and

professional experience to develop the Rally Fighter.

Photo: Adrian Gaut

Rogers was practically destined for his job. His grandfather Ralph Rogers bought

the Indian Motorcycle Company in 1945. When the light Triumph motorcycles began

entering the US after World War II, the senior Rogers recognized that his market-

leading Chief, a big road workhorse, was uncompetitive. The solution was to make a new

light engine so Indian could produce its own cheap, nimble bikes. He went bust trying to

develop the motor. It was just too hard to change direction — and eventually he lost the

business.

Today, Rogers’ grandson intends to do something even more radical — create a whole

new way of making cars — on a shoestring budget. His company has raised roughly $7

million, and he thinks that’s enough to take it to profitability. The difference between

now and then? “They didn’t have resources back then to enter the market, because the

manufacturing process was so tightly held,” he says. What’s changed is that the supply

chain is opening to the little guys.

The 36-year-old Rogers favors military-style flight suits, an echo of his time as a captain

in the Marines, including action in Iraq, and he boasts both a Harvard MBA and a stint

as an entrepreneur in China.

While at Harvard, Rogers saw a presentation on Threadless, the open-design T-shirt

company, which showed him the power of crowdsourcing. Cars are more complicated

than T-shirts, but in both cases there are far more people who can design them than are

currently paid to do so — Rogers estimates that less than 30 percent of car design

students get jobs at auto companies upon graduation. The rest become frustrated car

designers, exactly the pool of talent that might respond to a well-organized vehicle

design competition and community. Today, the Local Motors Web site has around

5,000 members. That’s a 500-to-1 ratio of volunteer contributors to employees. This is

how industries are reinvented.

Here’s the history of two decades in one sentence: If the past 10 years have been

about discovering post-institutional social models on the Web, then the next 10 years

will be about applying them to the real world.

This story is about the next 10 years.

Transformative change happens when industries democratize, when they’re ripped from

the sole domain of companies, governments, and other institutions and handed over to

regular folks. The Internet democratized publishing, broadcasting, and

communications, and the consequence was a massive increase in the range of both

participation and participants in everything digital — the long tail of bits.

Now the same is happening to manufacturing — the long tail of things.

The tools of factory production, from electronics assembly to 3-D printing, are now

available to individuals, in batches as small as a single unit. Anybody with an idea and a

little expertise can set assembly lines in China into motion with nothing more than some

keystrokes on their laptop. A few days later, a prototype will be at their door, and once it

all checks out, they can push a few more buttons and be in full production, making

hundreds, thousands, or more. They can become a virtual micro-factory, able to design

and sell goods without any infrastructure or even inventory; products can be assembled

and drop-shipped by contractors who serve hundreds of such customers simultaneously.

Today, micro-factories make everything from cars to bike components to bespoke

furniture in any design you can imagine. The collective potential of a million garage

tinkerers is about to be unleashed on the global markets, as ideas go straight into

production, no financing or tooling required. “Three guys with laptops” used to describe

a Web startup. Now it describes a hardware company, too.

“Hardware is becoming much more like software,” as MIT professor Eric von

Hippel puts it. That’s not just because there’s so much software in hardware these days,

with products becoming little more than intellectual property wrapped in commodity

materials, whether it’s the code that drives the off-the-shelf chips in gadgets or the 3-D

design files that drive manufacturing. It’s also because of the availability of common

platforms, easy-to-use tools, Web-based collaboration, and Internet distribution.

We’ve seen this picture before: It’s what happens just before monolithic industries

fragment in the face of countless small entrants, from the music industry to newspapers.

Lower the barriers to entry and the crowd pours in.

The academic way to put this is that global supply chains have become scale-free, able to

serve the small as well as the large, the garage inventor and Sony. This change is driven

by two forces. First, the explosion in cheap and powerful prototyping tools, which have

become easier to use by non-engineers. And second, the economic crisis has triggered an

extraordinary shift in the business practices of (mostly) Chinese factories, which have

become increasingly flexible, Web-centric, and open to custom work (where the volumes

are lower but the margins higher).

The result has allowed online innovation to extend to the real world. As Cory Doctorow

puts it in his new book, Makers, “The days of companies with names like ‘General

Electric’ and ‘General Mills’ and ‘General Motors’ are over. The money on the table is

like krill: a billion little entrepreneurial opportunities that can be discovered and

exploited by smart, creative people.”

A garage renaissance is spilling over into such phenomena as the booming Maker Faires

and local “hackerspaces.” Peer production, open source, crowdsourcing, user-generated

content — all these digital trends have begun to play out in the world of atoms, too. The

Web was just the proof of concept. Now the revolution hits the real world.

In short, atoms are the new bits.

Mark Hatch (standing center) and Jim Newton (far left, glasses) of Tech Shop, where

members pay for access to sophisticated prototyping tools.

Photo: Leon Chew

It all starts with the tools. in a converted brewery in Brooklyn, Bre Pettis and his

team of hardware engineers are making the first sub-$1,000 3-D printer, the open

source MakerBot. Rather than squirting out ink, this printer builds up objects by

squeezing out a 0.33-mm-thick thread of molten ABS plastic. Five years ago, you

couldn’t get anything like this for less than $125,000.

During a visit in late November, 100 boxes containing the ninth batch of MakerBots are

lined up and ready to go out the door (as a customer, I’m thrilled to know that one of

them is coming to me). Nearly 500 of these 3-D printers have been sold, and with every

one, the community comes up with new uses and new tools to make them even better.

For example, a prototype head delivers a resolution of 0.2 mm. Another head can hold a

rotating cutter, turning the printer into a CNC router. (CNC is short for computer

numerical control, which simply means that the machines are driven by software.) And

yet another can print with icing, for desserts.

Out of the box, the MakerBot produces plastic parts from digital files. Want a certain

gear right now? Download a design and print it out yourself. Want to modify an object

you already have? Scan it (a researcher at the University of Cambridge has developed a

technology that will allow you to create a 3-D file by rotating the object in front of your

webcam), tweak the bits you want to change with the freeSketchUp software from

Google, and load it into the ReplicatorG app. Within minutes, you have a whole new

physical object: a rip, mix, and burn of atoms.

Other tools offer additional tricks. The $18,000 ShopBot PRSalpha can work door-sized

pieces of wood. Or buy a smaller kit for $1,500 at buildyourcnc.com. If metal is your

material, try a CNC mill for around $2,000. Or, if you’re more into electronics, use the

free CadSoft Eagle software to create your own circuit boards, then upload the file to

have it fabbed in a few days at places like Advanced Circuits.

So, too, for CNC laser cutters, plasma cutters, water-jet cutters, and lathes. You can

make anything from fine jewelry to car chassis this way, and tens of thousands of people

are doing just that. We’ve already seen this DIY creation movement boom around such

simple platforms as T-shirts and coffee mugs, then expand into handcrafting

at Etsy (which did about $200 million in sales last year). Now it’s moving to more

complex platforms — like 3-D models and plastic fabrication — and open source

electronics hardware like the pioneering Arduino project.

With the tools in place, the second part of this new industrial age is how manufacturing

has been opened up to individuals, letting them scale prototypes into full production

runs. Over the past few years, Chinese manufacturers have evolved to handle small

orders more efficiently. This means that one-person enterprises can get things made in a

factory the way only big companies could before.

Two trends are driving this. First, there’s the maturation and increasing Web-centrism

of business practices in China. Now that the Web generation is entering management,

Chinese factories increasingly take orders online, communicate with customers by

email, and accept payment by credit card or PayPal, a consumer-friendly alternative to

traditional bank transfers, letters of credit, and purchase orders. Plus, the current

economic crisis has driven companies to seek higher-margin custom orders to mitigate

the deflationary spiral of commodity goods.

For a lens into the new world of open-access factories in China, check out Alibaba .com,

the largest aggregator of the country’s manufacturers, products, and capabilities. Just

search on the site (in English), find some companies producing more or less what you’re

looking to make, and then use instant messaging to ask them if they can manufacture

what you want. Alibaba’s IM can translate between Chinese and English in real time, so

each person can communicate using their native language. Typically, responses come in

minutes: We can’t make that; we can make that and here’s how to order it; we already

make something quite like that and here’s what it costs.

Alibaba’s chair, Jack Ma, calls this “C to B” — consumer to business. It’s a new avenue of

trade and one ideally suited for the micro-entrepreneur of the DIY movement. “If we can

encourage companies to do more small, cross-border transactions, the profits can be

higher, because they are unique, non-commodity goods,” Ma says. Since its founding in

1999, Alibaba has become a $12 billion company with 45 million registered users

worldwide. Its $1.7 billion initial public offering on the Hong Kong Stock Exchange in

2007 was the biggest tech debut since Google. Over the past three years, Ma says, more

than 1.1 million jobs have been created in China by companies doing ecommerce across

Alibaba’s platforms.

This trend is playing out in many countries, but it’s happening fastest in China. One

reason is the same cultural dynamism that led to the rise of shanzhai industries. The

term shanzhai, which derives from the Chinese word for bandit, usually refers to the

thriving business of making knockoffs of electronic products, or as Shanzai.com more

generously puts it, “a vendor, who operates a business without observing the traditional

rules or practices often resulting in innovative and unusual products or business

models.” But those same vendors are increasingly driving the manufacturing side of the

maker revolution by being fast and flexible enough to work with micro-entrepreneurs.

The rise of shanzhai business practices “suggests a new approach to economic recovery

as well, one based on small companies well networked with each other,” observes Tom

Igoe, a core developer of the open source Arduino computing platform. “What happens

when that approach hits the manufacturing world? We’re about to find out.”

Not long ago, all this was impossible. To see how it used to be back in the 20th

century, watch the movie Flash of Genius. The film, which is based on a true story, starts

in the mid-1960s and tells the sad tale of the invention of the intermittent windshield

wiper. A lone inventor — college professor Bob Kearns— tinkers in his basement until he

finally creates a working prototype. Rather than sell the technology to a big car

company, Kearns decides he wants to build his own company and make the wiper

himself. Ford signs on to install Kearns’ wipers in one of its new models. That means he

needs to build a factory. He leases a huge warehouse and starts outfitting it with

assembly lines, forklift loaders, and other heavy equipment — a classic industrial-age

scene.

How to Build Your Dream

In the age of democratized industry, every garage is a potential micro-factory, every

citizen a potential micro-entrepreneur. Here’s how to transform a great idea into a great

product.

� 1) INVENT Stop whining about the dearth of cool products in the world — dream

up your own. Pro tip: Check the US Patent and Trademark Office Web site to ensure no

one else had the idea first.

� 2) DESIGN Use free tools like Blender or Google’s SketchUp to create a 3-D digital

model of your invention. Or download someone else’s design and incorporate your

groundbreaking tweaks.

� 3) PROTOTYPE You don’t need to be Geppetto to crank out a prototype; desktop

3-D printers like MakerBot are available for under $1,000. Just upload a file and watch

the machine render your vision in layered ABS plastic.

� 4) MANUFACTURE The garage is fine for limited production, but if you want to

go big, go global — outsource. Factories in China are standing by; sites

likeAlibaba.com can help you find the right partner.

� 5) SELL Market your product directly to customers via an online store like

SparkFun — or set up your own ecommerce outfit through a company like Yahoo or Web

Studio. Then haul your golden goose to Maker Faire and become the poster child for the

DIY industrial revolution.

As Kearns is getting close to firing up his facility, Ford abruptly backs out of the deal.

With no revenue in sight, the factory shuts down before producing a single wiper.

Eighteen months later, Kearns is walking home in the rain and sees a brand new Ford

Mustang turn the corner. The windshield wiper sweeps, then pauses, then sweeps again.

His brilliant idea has been stolen. Kearns is ruined and will soon go mad, thus the rest of

the movie. (The real-life Kearns eventually sued Ford and Chrysler for patent

infringement and, after years of litigation, won nearly $30 million.)

Today, Kearns would do it differently. As before, he would have made the first prototype

in his basement. But rather than building a factory, he would have had the electronics

fabbed by one company and the enclosure made by another. He then would have paid a

wiper manufacturer in China to create a custom assembly with these components. They

would have shipped straight to his customers, the car companies, and the whole process

would have happened in months, not years — too fast for big companies to beat him. No

factory, no lawsuits, no madness. He could have fulfilled his dream of turning his

invention into a company without tilting at windmills.

To see this model emerging in the real world, you need only visitTechShop, a chain of

DIY workspaces that offer access to state-of-the-art prototyping tools for around $100 a

month.

On a recent afternoon at the facility in Menlo Park, California, Michael Pinneo, a

successful former executive in the synthetic-diamond business, is machining a vapor-

deposition chamber for his newest approach to creating colorless diamonds. Over in the

corner stands the base of a rocket lander being developed by a team that’s competing in

the Google Lunar X Prize. At another table, Stephan Weiss, vice president of Interoptix,

and one of his colleagues are assembling circuit boards used to manage electricity grids.

They’re doing 50-unit runs, which Weiss describes as “too small for a factory but too big

for your garage.” The devices carry the badge of ABB, a giant engineering firm; the

utility customers may never know that they were made by hand in a hackerspace.

This is an incubator for the atoms age. When TechShop founder Jim Newton went

looking for an executive to run it, he quickly decided on Mark Hatch, a former Kinko’s

executive. The analogy is apt: In the same way that Kinko’s democratized printing and,

in the process, created a national chain of service bureaus, TechShop wants to

democratize manufacturing. It now has two additional locations, in Durham, North

Carolina, and Beaverton, Oregon, and has plans for hundreds more. One of the spots

being considered is San Francisco, within the facilities of the much-shrunken San

Francisco Chronicle. The irony is delicious: the seeds of tomorrow’s industry growing in

the ashes of yesterday’s.

Over lunch, Hatch reflects on the arc of manufacturing history. With the rise of the

factory in the industrial age, Karl Marx fretted that a tradesman could no longer afford

the tools to ply his trade. The economies of scale of industrial production crowded out

the individual. Although the benefits of such industrialization were lower prices and

better products, the cost was homogeneity. Combined with big-box retailers, the

marketplace became increasingly dominated by the fruits of mass production: goods

designed for everyone, with the resulting limited diversity and choice that implies.

But today those tools of production are getting so cheap that they are once again within

the reach of many individuals. State-of-the-art milling machines that once cost

$150,000 are now close to $4,000, thanks to Chinese copies. Everybody’s garage is a

potential high tech factory. Marx would be pleased.

Blogger Jason Kottke wrestled with what to call this new class of entrepreneurship,

these cottage industries with global reach targeting niche markets of distributed

demand. “Boutique” is too pretentious, and “indie” not quite right. He observed that

others had suggested “craftsman, artisan, bespoke, cloudless, studio, atelier, long tail,

agile, bonsai company, mom and pop, small scale, specialty, anatomic, big heart, GTD

business, dojo, haus, temple, coterie, and disco business.” But none seemed to capture

the movement.

So he proposed “small batch,” a term most often applied to bourbon. In the spirits

world, this implies handcrafted care. But it can broadly refer to businesses focused more

on the quality of their products than the size of the market. They’d rather do something

they were passionate about than go mass. And these days, when anyone can get access

to manufacturing and distribution, that is actually a viable choice. Walmart, and all the

compromise that comes with it, is no longer the only path to success.

For a final example of that, swing to the Seattle suburbs to meet Will Chapman

of BrickArms. Out of a small industrial space, BrickArms fills gaps in the Lego product

line, going where the Danish toy giant fears to tread: hardcore weaponry, from Lego-

scale AK-47s to frag grenades that look like they came straight out of Halo 3. The parts

are more complex than the average Lego component, but they’re manufactured to an

equal quality and sold online to thousands of Lego fans, kids and adults, who want to

create cooler scenes than the standard kits allow.

Lego operates on an industrial scale, with a team of designers working in a highly secure

campus in Billund, Denmark. Engineers model prototypes and have them fabricated in

dedicated machine shops. Then, once they meet approval, they’re manufactured in large

injection molding plants. Parts are created for kits, and those kits have to be play-tested,

priced for mass retail, and shipped and inventoried months in advance of their sale at

Target or Walmart. The only parts that make it out of this process are those that will sell

in the millions.

Chapman works at a different scale. He designs parts using SolidWorks 3-D software,

which can create a reverse image that’s used to produce a mold. He sends the file to his

desktop CNC router, a Taig 2018 mill that costs less than $1,000, which grinds the mold

halves out of aircraft-grade aluminum blocks. Then he puts them in his hand-pressed

injection molding machine, melts some resin beads, and pumps them through. A few

minutes later, he’s got a prototype to show to fans. If they like it, he gets a local

toolmaker to reproduce the mold out of steel and a US-based injection molding

company to make batches of a few thousand.

Why not have the parts made in China? He could, he says, but the result would be

“molds that take much longer to produce, with slow communication times and plastic

that is subpar” (read: cheap). Furthermore, he says, “if your molds are in China, who

knows what happens to them when you’re not using them? They could be run in secret

to produce parts sold in secondary markets that you would not even know existed.”

Chapman’s three sons package the parts, which he sells direct. Today, BrickArms also

has resellers in the UK, Australia, Sweden, Canada, and Germany. The business grew so

big that in 2008 he left his 17-year career as a software engineer; he now comfortably

supports his family of five solely on Lego weapon sales. “I bring in more revenue on a

slow BrickArms day than I ever did working as a software engineer.” Life is good.

In the mid-1930s, Ronald Coase, then a recent London School of Economics

graduate, was musing over what to many people might have seemed a silly question:

Why do companies exist? Why do we pledge our allegiance to an institution and gather

in the same building to get things done? His answer: to minimize “transaction costs.”

When people share a purpose and have established roles, responsibilities, and modes of

communication, it’s easy to make things happen. You simply turn to the person in the

next cubicle and ask them to do their job.

But several years ago, Bill Joy, one of the cofounders of Sun Microsystems, revealed the

flaw in Coase’s model. “No matter who you are, most of the smartest people work for

someone else,” he rightly observed. Of course, that had always been true, but before, it

hardly mattered if you were in Detroit and someone better was in Dakar; you were here

and they were there, and that was the end of it. But Joy’s point was that this was

changing. With the Internet, you didn’t have to settle for the next cubicle. You could tap

the best person out there, even if they were in Dakar.

Joy’s law turned Coase’s law upside down. Now, working within a company often

imposes higher transaction costs than running a project online. Why turn to the person

who happens to be in the next cubicle when it’s just as easy to turn to an online

community member from a global marketplace of talent? Companies are full of

bureaucracy, procedures, and approval processes, a structure designed to defend the

integrity of the organization. Communities form around shared interests and needs and

have no more process than they require. The community exists for the project, not to

support the company in which the project resides.

Thus the new industrial organizational model. It’s built around small pieces, loosely

joined. Companies are small, virtual, and informal. Most participants are not employees.

They form and re-form on the fly, driven by ability and need rather than affiliation and

obligation. It doesn’t matter who the best people work for; if the project is interesting

enough, the best people will find it.

Let me tell you my own story. Three years ago, out on a run, I started thinking about

how cheap gyroscope sensors were getting. What could you do with them? For starters, I

realized, you could turn a radio-controlled model airplane into an autonomous

unmanned aerial vehicle, or drone. It turned out that there were plenty of commercial

autopilot units you could buy, all based on this principle, but the more I looked into

them, the worse they appeared. They were expensive ($800 to $5,000), hard to use, and

proprietary. It was clear that this was a market desperate for competition and

democratization — Moore’s law was at work, making all the components dirt cheap. The

hardware for a good autopilot shouldn’t cost more than $300, even including a healthy

profit. Everything else was intellectual property, and it seemed the time had come to

open that up, trading high margins for open innovation.

To pursue this project, I started DIY Drones, a community site, and found and began

working with some kindred spirits, led by Jordi Muñoz, then a 21-year-old high school

graduate from Mexico living in Riverside, California. Muñoz was self-taught — with

world-class skills in embedded electronics and aeronautics. Jordi turned me on to

Arduino, and together we designed an autonomous blimp controller and then an aircraft

autopilot board.

We designed the boards the way all electronics tinkerers do, with parts bought from

online shops, wired together on prototyping breadboards. Once it worked on the

breadboard, we laid out the schematic diagrams with CadSoft Eagle and started

designing it as a custom printed circuit board (PCB). Each time we had a design that

looked good onscreen, we’d upload it to a commercial PCB fab, and a couple of weeks

later, samples would arrive at our door. We’d solder on the components, try them out,

and then fix our errors and otherwise make improvements for the next version.

Eventually, we had a design we were happy with. How to commercialize it? We could do

it ourselves, getting our PCB fab house to solder on the components, too, but we thought

it might be better to partner with a retailer. The one that seemed culturally matched

was SparkFun, which designs, makes, and sells electronics for the growing open source

hardware community.

The SparkFun operation is in a newish two-story building in an office park outside

Boulder, Colorado. The first floor is larger than three basketball courts, with racks of

circuit boards waiting to be sold, packed, and shipped on one side and some machines

attended by a few technicians on the other. The first two machines are pick-and-place

robots, which are available used for less than $5,000. They position tiny electronic

components in exactly the right spot on a PCB. Once each batch of boards is done,

technicians place them on a conveyor belt that goes into another machine, which is

basically just a heater. Called a reflow oven, it cements the parts into place, essentially

accomplishing what a worker could do with a soldering iron but with unmatched

precision and speed.

The PCBs arrive from SparkFun’s partner firm in China, which makes millions of them

using automated etching, drilling, and cutting machines. At volume, they cost a few

cents each.

That’s it. With these elements you can make the basics of everything from a cell phone to

a robot (structural elements, such as the case, can be made in low volume with a CNC

machine or injection-molded if you need to do it cheaper at higher volume). You can sell

these components as kits or find some college students on craigslist to spend a weekend

assembling them for you. (I conscript my kids to assemble our blimps. They rotate roles,

coveting the quality assurance task where they check the others’ work.)

SparkFun makes, stocks, and sells our autopilot and a few other products that we

designed; we get to spend our time working on R&D and bear no inventory risk. Some

products we wanted to make were too time-intensive for SparkFun, so we made them

ourselves. Now, in a rented Los Angeles garage, we have our own mini SparkFun. Rather

than a pick-and-place robot, we have a kid with sharp eyes and a steady hand, and for a

reflow oven we use what is basically a modified toaster oven. We can do scores of boards

per day this way; when demand outstrips production, we’ll upgrade to a small pick-and-

place robot.

Every day our Web site takes orders and prints out the shipping labels. Muñoz or one of

his workers heat-seals the products in protective electrostatic bags and puts them in

shipping envelopes. The retail day ends at 3:30 pm with a run to the post office and UPS

to send everything off. In our first year, we’ll do about $250,000 in revenue, with

demand rising fast and a lot of products in the pipeline. With luck, we’ll be a million-

dollar business by the third year, which would put us solidly in the ranks of millions of

similarly successful US companies. We are just a tiny gear in the economic engine

driving the US — on the face of it, this doesn’t seem like a world- changing economic

model.

But the difference between this kind of small business and the dry cleaners and corner

shops that make up the majority of micro-enterprise in the country is that we’re global

and high tech. Two-thirds of our sales come from outside the US, and our products

compete at the low end with defense contractors like Lockheed Martin and Boeing.

Although we don’t employ many people or make much money, our basic model is to

lower the cost of technology by a factor of 10 (mostly by not charging for intellectual

property). The effect is felt primarily by consumers; when you take an order of

magnitude out of pricing in any market, you can radically reshape it, bringing in more

and different customers. Lowering costs is a way to democratize technology, too.

Although it’s shrinking, America’s manufacturing economy is still the world’s largest.

But China’s growing production sector is predicted to take the number one spot in 2015,

according to IHS Global Insight, an economic-forecasting firm. Not all US

manufacturing is shrinking, however — just the large part. A Pease Group survey of

small manufacturers (less than $25 million in annual sales) shows that most expect to

grow this year, many by double digits. Indeed, analysts expect almost all new

manufacturing jobs in the US will come from small companies. Ones just like ours.

How big can these small enterprises get? Most of the companies I’ve described sell

thousands of units — 10,000 is considered a breakout success. But one that has

graduated to the big leagues is Aliph, which makes the Jawbone noise-canceling wireless

headsets. Aliph was founded in 1999 by two Stanford graduates, Alex Asseily and Hosain

Rahman, and it now sells millions of headsets each year. But it has no factories. It

outsources all of its production. And though more than a thousand people help to create

Jawbone headsets, Aliph has just over 80 employees. Everyone else works for its

production partners. It’s the ultimate virtual manufacturing company: Aliph makes bits

and its partners make atoms, and together they can take on Sony.

Welcome to the next Industrial Revolution.

Chris Anderson (canderson@wired.com) is editor in chief of Wired.

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Free exchange

Competition, hammered

The risks that cartels and collusion pose to auctions

Jul 12th 2014 |
From the print edition

PICKING the price at which to sell a public asset is a daunting task. The political stakes are high: this week Britain launched a review of such sales after claims that Royal Mail, the postal service, had been sold too cheaply. But the right price is hard to find, because privatisations are often one-offs. How much should, say, Portugal ask for TAP, the state-owned airline it has been urged to sell? Auctions are increasingly used to tease out the best price. Yet new research shows how collusion can corrupt auctions of public assets, so that the state is still short-changed.

Auctions have a simple aim: to reveal the bidders’ true valuation of the item being sold. Sellers then get the best possible price. By successfully revealing the maximum bidders are prepared to pay, auctions also allocate resources to those that value them the most. Auctions come in a wide variety. In a “Dutch auction”, often used to sell flowers and fruit, prices start high and gradually drop until a bidder is willing to pay up. A “Japanese auction” is a bit like poker: bids rise with each round and anyone who wants to win must bid every time. Vendors using auctions rid themselves of the headache of choosing prices and instead just pick the rules bidders must follow.

The choice matters, as a
paper published last year, by Hongbin Cai and Qinghua Zhang of Peking University and Vernon Henderson of the London School of Economics, shows. The authors examine sales of public land in China. In the 1990s dissatisfaction with the private negotiations that allotted land to developers grew. The processes were murky and the prices paid were often suspected of being too low as local officials siphoned off bribes. So in 2004 the government announced both a crackdown on corruption and a new policy of selling land by public auction.

Local officials choose the auction rules. In Beijing and Shanghai they plumped for a
zhaobiao or “sealed bid” sale. Across the rest of the country, two other types prevailed. One was a
paimai, a familiar “English” ascending-bid auction: rival developers try to outdo each another, pushing up the price until only one bidder is left. The other was a
guapai or “two-stage” auction. In the first stage, which lasts ten days, bidders can post bids anonymously on the internet. Rival developers see the current bid and the reserve price and decide whether to meet it, raise it or drop out. If after ten days more than one bidder is willing to pay more than the reserve, there is a second stage, in which an English auction is run between those who remain.

English and two-stage auctions produced strikingly different results. Collecting data for over 2,300 auctions covering 15 large cities between 2003 and 2007, the authors immediately spotted a suspicious pattern. In English auctions, bids were well spread, with some beating the government’s reserve by a big margin. But the first part of the two-stage auction clearly gave the bidders time to collude: in many there was little competition, with winning bids pitched at exactly the reserve price. If all the sales had been under English auction rules, government revenues would have been 30% higher.

Similar problems can arise when contracts are put out to tender. A
paper by Kei Kawai of New York University’s Stern School of Business and Jun Nakabayashi of Tohoku University examines Japanese public building projects. They collected data on over 40,000 tenders from 2003-06 worth $42 billion (around 3% of national tax revenue). The Japanese government uses a first-price sealed-bid auction: builders write down their best price, and the lowest bid wins the work. If none beats a reserve price that is known only to the auctioneer, the procedure is repeated until a bid beats the reserve.

To track competition, the authors honed in on auctions where the two best bids were very close but failed to beat the reserve price. These auctions were run again. Such close bids in the first round—suggesting firms had similar costs or appetite for the job—should mean both bidders had a good chance of winning at the second attempt. Instead, in the second and third rounds of auctions, the order of bids was exactly the same. This suggested a “bidding ring”, a type of cartel in which builders had predetermined who should win. Messrs Kawai and Nakabayashi identify 1,000 firms whose bids were suggestive of collusion. Those firms won 7,600 projects worth almost $8.6 billion.

Slicker sell-offs

Tweaking the rules can make collusion harder, as a
study in 2008 by Patrick Bajari and Jungwon Yeo of the University of Minnesota shows. Since 1994 America’s Federal Communications Commission (FCC) has run auctions to sell the spectrum used to transmit television, telephone and radio waves. To foster competition, it banned firms from discussing tactics. In response firms adopted a strategy called “code bidding”, using bids to signal their intentions. A bid of “$1,000,451” could mean, “I intend to go for licence 451. Don’t compete with me.” Other tactics used to deter competitors include “jump” bidding (raising prices by a big step rather than a small one) and “self bumping” (beating your own winning bid with a higher bid, as a display of strength).

Over time tinkering by the FCC has helped. The general rule is to restrict the information bidders have about their rivals. Restricting bidders to a small set of options (allowing bids to be raised by 1%, 5% or 10% per round, for example) prevents code bidding. Anonymous bidding creates a vacuum, breeding suspicion among cartel members. With these changes in place, pricing at FCC auctions has improved. In the 1995 auction of broadband spectrum over 6% of bids were suspicious; by 2008 less than 1% of bids were fishy. Auctions will never be perfect, but with the right rules they may be the best way for governments that are privatising assets to get closest to the best price.

Economist.com/blogs/freeexchange

From the print edition: Finance and economics

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·  

By
GORDON FAIRCLOUGH

TSOGT, Mongolia — Waves from the global economic downturn hit Sodnomdarjaa Khaltarkhuu when bank officials showed up at his tent on the edge of the Gobi desert and threatened to foreclose on his goats, sheep and camels.

Falling demand for cashmere among recession-hit shoppers in the West is cutting into earnings among nomadic herders in Mongolia, whose goats produce the soft fiber used in high-end sweaters, scarves and coats. The result: herder loan defaults.

Mongolian animal herders are being squeezed in this country’s version of a subprime lending crisis.

Mongolia Falls Deeper Into Poverty

View Slideshow

Josh Chin for The Wall Street Journal

Mongolians are calling the current situation a financial zud, invoking a local term for unusually harsh winters that devastate herds. After Mr. Sodnomdarjaa couldn’t pay back a $2,700 loan, he says bank officials pressed him to sell his livestock — which he used as collateral. The bank says he misrepresented the number of animals he owned, which he denies. Now a judge has ordered the seizure of Mr. Sodnomdarjaa’s family home — a tent — if he doesn’t come up with the rest of the money soon.

“We don’t have any animals,” says Mr. Sodnomdarjaa, sitting in his tent, heated by camel dung burned in a cast-iron stove. “How can we pay?”

Mongolian nomads’ troubles show that the ravages of the economic crisis have spread to even the most remote parts of the world. More than a quarter of the households in Mongolia — which has a population of about 2.6 million — earn a living raising animals.

The credit crisis on the steppe has root causes similar to those of the subprime mess in the U.S. Some herders, betting on continued strong cashmere prices, borrowed more than they should have, and spent the money on the Mongolian equivalent of conspicuous consumption: motorbikes and solar panels to provide electricity for their tents. Banks, looking to cash in on rural prosperity in the good years, didn’t pay enough attention to risk management and lent too freely, some bankers say.

Bankers say pressuring herders to sell animals and moving to foreclose on other collateral are last resorts. “We try our best to have flexible policies,” says Daimaa Batsaikhan, deputy chief executive of Khan Bank. He said the bank’s own forecasts for cashmere prices last year were “inaccurate” and that the bank has changed its risk-management practices.

He says his bank and other lenders have been working with herders. Khan Bank says it has restructured 7,000, or nearly 11%, of its outstanding herder loans, essentially extending the time borrowers have to repay. Ultimately, though, the money lent to herders is “money deposited by other Mongolians,” the banker says, and it is the bank’s responsibility to protect their interests.

Many banks have cut back on new lending. And a flood of forced sales has helped drive down prices for animals, skins and meat.

Munkhbat Tsedendorj, a 30-year-old animal dealer, based in Altai, the capital of the province where Mr. Sodnomdarjaa lives, says animals for sale in the city’s central market have been fetching about half of what they were before the downturn. “I’ve been in this business 10 years, and I’ve never seen anything like it,” he says, standing before a blue truck piled with skinned and frozen carcasses of sheep and goats. “They are bankrupting the herders.”

Debt is a main topic of conversation here in Tsogt, a settlement of tents, government buildings and a few shops. Sheriffs from the provincial capital delivered a new round of court orders in January, barring defaulters from disposing of their possessions until courts can rule on foreclosure proceedings.

Naranchimeg Sonom, 45, says she had to sell her herd of more than 300 animals to pay off her defaulted loan. Otherwise, she says, the bank would have foreclosed on her tent, known here as a ger, and on the decorative mirror that graces its back wall. She says bank collection officers said: “You are all beggars. Why did you take a loan if you can’t pay it back?”

In recent years, commercial banks started competing to extend credit to herders, who typically earn significant cash just twice a year — in the spring through cashmere and wool sales, and in the autumn through sales of animal skins and meat. The money helped families get through the times in between, usually at a cost of between 2% and 3% in interest per month.

Troubles began when demand for cashmere started falling after the U.S. slipped into recession in late 2007. By last June, the price for cashmere in Mongolia had fallen by more than 33% from a year earlier, hitting about 28,000 togrog, or $19, a kilogram. Prices have dropped further. “Everyone says now that we are just taking care of banks’ animals,” says Janchiv Nyambuv, a 65-year-old herder who borrowed 500,000 togrogs, or $350, that he must repay in May.

Herders who have sold their herds to repay loans have struggled to find other sources of income. Purevdelger Budkhuu, a 38-year-old widow, says she was forced to sell her family’s 128 goats and sheep after she couldn’t pay back a six-month loan of $1,270. Now, she and her two children live in a tent near Altai’s grimy central market. She says she has looked for work, to no avail, at shops, restaurants and hotels. “I don’t know what to do. I can’t go back to the countryside because I have no animals,” she says. “And I can’t stay here because I can’t find a job.”

Mr. Sodnomdarjaa says he went to a Khan Bank branch at the beginning of 2008 to get a loan to help repay those who had given him animals to start his herd and buy food and clothes for his wife and four children.

Mr. Sodnomdarjaa and his wife, Altantsetseg Tseyentsend, 38, say they intended to repay the loan by selling cashmere and other products from the 90 or so goats and sheep they owned, as well as from another more than 170 animals they were looking after for others. “We’d never taken a loan before” but, Mr. Sodnomdarjaa says, the bank officer he talked to seemed eager to give him money.

The bank says it checked government records of herders’ animals, which said Mr. Sodnomdarjaa owned 267 animals and had no reason to doubt their accuracy. The bank said that after Mr. Sodnomdarjaa defaulted, it discovered just 90 of the animals belonged to him. Bank officials said that if they had known that, he wouldn’t have qualified for such a large loan. Mr. Sodnomdarjaa denies any wrongdoing and says bank officials in Tsogt never asked him about the makeup of his herd.

When the loan was due, Mr. Sodnomdarjaa says he was unable to pay. He says the bank eventually pushed him to sell his animals. The bank says Mr. Sodnomdarjaa still owes more than 2.7 million togrogs, or about $1,900.

Mr. Sodnomdarjaa says he and his wife are determined to repay the loan and plan to look for construction or mining work. These days, the couple cares for other families’ camels. Their only regular compensation is the right to milk the herd. About half the milk, they drink. The other half they sell. Two months’ earnings are about enough to buy a sack of flour.

“The kids want to eat meat, but we have nothing to give them,” says Mr. Sodnomdarjaa.

Write to Gordon Fairclough at
gordon.fairclough@wsj.com

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our
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Free exchange

Pardon the disruption

When firms succumb to new forms of competition, inflexible organisation is usually to blame

Sep 6th 2014 |
From the print edition

DESTROYING the old to make way for the new is the essence of market economies. Karl Marx thought it one of the nastier qualities of capitalism whereas Joseph Schumpeter, an Austrian economist, cast “creative destruction” in more positive light, as the only route to sustained growth. In the 1990s Clayton Christensen, a professor at Harvard Business School, gave the notion a modern sheen with his theory of “disruptive innovation”. The term is now everywhere. Uber is said to be disrupting the taxi business, Cronuts are disrupting breakfast and Twitter is disrupting communication.

A disruptive innovation, in Mr Christensen’s work, is a very specific thing: a new technology that is inferior in certain respects to existing ones, but has other desirable attributes. He cites eight-inch floppy disks, which could store more data than smaller ones, but were nonetheless supplanted because they were too big and expensive for desktop computers. By the same token, publishers of music and newspapers were wrong-footed by the advent of online distribution, which was initially of lower quality. So was digital photography, but it nonetheless ended up displacing film.

Most studies that examine the size of a firm and its capacity to innovate fail to detect a relationship between the two. Yet that in itself is odd. Established firms ought to enjoy big advantages over would-be disrupters: skilled employees, infrastructure at the ready and the opportunity to share costs among products. At worst, incumbents should be as capable as new entrants of succeeding in nascent markets. Yet research by Rebecca Henderson of Harvard Business School finds that the money old firms in fast-evolving industries devote to research brings much lower returns than the research budgets of their younger rivals.*

Divining the reason for this poor performance is a challenge. Firms with straitened finances might be unable to invest adequately in a new business without cannibalising the old. That, in turn, might lead them either to decide not to invest in the new market, or to invest less than they should in both the old and the new. Yet the adjustment is often most difficult for firms that are wildly profitable in their established lines of business.

Profitable firms might underinvest in a competing technology for fear of hastening the end of their existing, successful business. Rational managers should be able to see that cannibalising their own sales and surviving is preferable to sticking to their knitting and falling prey to competitors. But bosses may not think much about the long term, or may be reluctant to write off sunk costs.

Yet even short-sighted or embarrassed managers should react when the threat from upstart technologies becomes clear. They do not, economists reckon, because of organisational rigidities. Ms Henderson suggests firms can be seen as giant information-processing organisations that evolve a structure and personnel to fit their respective business. Information on sales or production is efficiently filtered to decision-makers, who can then direct new research. When new technologies are no more than tweaks to old ones, this set-up is a competitive advantage. When innovations are more radical, however, the old networks are a hindrance.

In other research with Sarah Kaplan of the Wharton School of Business, Ms Henderson considers why older firms struggle to pursue new technologies. Many of them have systems in place to detect and respond to changing market conditions or new technologies. But they have also built up a system of incentives to ensure employees meet existing goals. Systems designed to encourage consistency and efficiency in the production of established goods or services might be a powerful deterrent to experimentation or creative thinking about new markets, regardless of what the corporate memos say.

One still might expect more adaptability given a serious enough threat, argues Ms Henderson in another paper along with Timothy Bresnahan of Stanford University and Shane Greenstein of Northwestern University. Established firms, they point out, can always set up loosely affiliated “entrepreneurial” divisions with the freedom to build a new business from the ground up. Yet even this will often prove difficult, they argue, thanks to assets like a firm’s reputation that cannot help but be shared between the old business and its internal rival.

IBM, for example, was initially a mainframe computing company that set up an internal unit devoted to developing personal computers. The PC business did well at first, thanks in part to IBM’s longtime reputation for quality. Yet this became a problem when the mainframe buyers became big consumers of PCs—an embryonic business in which kinks were still being ironed out. Customers began to interpret quality problems in the PC business as quality problems within IBM as a whole, undermining the existing mainframe business. When IBM resolved internal tensions by reabsorbing the PC unit, it in effect conceded the PC market to others.

Innovate or buy

Disruption need not be a death sentence, however. IBM remains a big, profitable firm. Work by Matt Marx of MIT, Joshua Gans of the University of Toronto and David Hsu of the Wharton School suggests that survival often comes down to what they call “co-operative commercialisation”. Once it becomes clear that start-ups have an edge in a new technology, incumbents can respond by striking deals with or purchasing their new rivals. The authors focus on the business of speech-recognition, but there are lots of other examples: Facebook, for instance, has gobbled up one competitor after another. To most, “If you can’t beat them, join them” has a more appealing ring than “Innovate or die”.

Sources

”
Dynamic Commercialization Strategies for Disruptive Technologies: Evidence from the Speech Recognition Industry”, by Matt Marx, Joshua S. Gans and David H. Hsu. NBER Working Paper Series, December 2013
”
Underinvestment and Incompetence as Responses to Radical Innovation: Evidence from the Photographic Alignment Equipment Industry”, by Rebecca Henderson. The RAND Journal of Economics, Summer 1993
”
Inertia and Incentives: Bridging Organizational Economics and Organizational Theory”, by Rebecca Henderson and Sarah Kaplan. NBER Working Paper Series, December 2005
”
Schumpeterian competition and diseconomies of scope; illustrations from the histories of Microsoft and IBM”, by Timothy Bresnahan, Shane Greenstein, Rebecca Henderson. Harvard Business School Working Paper
”
Dynamic Commercialization Strategies For Disruptive Technologies: Evidence From The Speech Recognition Industry”, by Matt Marx, Joshua S. Gans and David H. Hsu. NBER Working Paper Series, December 2013

From the print edition: Finance and economics

image1

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ECO 562/EcomNordic x

Special report:

The Nordic countries

In this special report

· Northern lights

·

More for less

·

The ins and the outs

·

Global niche players

·

If in doubt, innovate

·

Cultural revolution

·

The rich cousin

·

The secret of their success

Sources & acknowledgements
Reprints

Northern lights

The Nordic countries are reinventing their model of capitalism, says Adrian Wooldridge

Feb 2nd 2013 |

From the print edition
The Economist

THIRTY YEARS AGO Margaret Thatcher turned Britain into the world’s leading centre of “thinking the unthinkable”. Today that distinction has passed to Sweden. The streets of Stockholm are awash with the blood of sacred cows. The think-tanks are brimful of new ideas. The erstwhile champion of the “third way” is now pursuing a far more interesting brand of politics.

Sweden has reduced public spending as a proportion of GDP from 67% in 1993 to 49% today. It could soon have a smaller state than Britain. It has also cut the top marginal tax rate by 27 percentage points since 1983, to 57%, and scrapped a mare’s nest of taxes on property, gifts, wealth and inheritance. This year it is cutting the corporate-tax rate from 26.3% to 22%.

Special report

· Northern lights

·

More for less

·

The ins and the outs

·

Global niche players

·

If in doubt, innovate

·

Cultural revolution

·

The rich cousin

·

The secret of their success

Sources & acknowledgements
Reprints

Related topics

·

Private Education

·

Education

·

Think-tanks

·

Political policy

·

Government and politics

Sweden has also donned the golden straitjacket of fiscal orthodoxy with its pledge to produce a fiscal surplus over the economic cycle. Its public debt fell from 70% of GDP in 1993 to 37% in 2010, and its budget moved from an 11% deficit to a surplus of 0.3% over the same period. This allowed a country with a small, open economy to recover quickly from the financial storm of 2007-08. Sweden has also put its pension system on a sound foundation, replacing a defined-benefit system with a defined-contribution one and making automatic adjustments for longer life expectancy.

Most daringly, it has introduced a universal system of school vouchers and invited private schools to compete with public ones. Private companies also vie with each other to provide state-funded health services and care for the elderly. Anders Aslund, a Swedish economist who lives in America, hopes that Sweden is pioneering “a new conservative model”; Brian Palmer, an American anthropologist who lives in Sweden, worries that it is turning into “the United States of Swedeamerica”.

There can be no doubt that Sweden’s quiet revolution has brought about a dramatic change in its economic performance. The two decades from 1970 were a period of decline: the country was demoted from being the world’s fourth-richest in 1970 to 14th-richest in 1993, when the average Swede was poorer than the average Briton or Italian. The two decades from 1990 were a period of recovery: GDP growth between 1993 and 2010 averaged 2.7% a year and productivity 2.1% a year, compared with 1.9% and 1% respectively for the main 15 EU countries.

For most of the 20th century Sweden prided itself on offering what Marquis Childs called, in his 1936 book of that title, a “Middle Way” between capitalism and socialism. Global companies such as Volvo and Ericsson generated wealth while enlightened bureaucrats built the
Folkhemmet or “People’s Home”. As the decades rolled by, the middle way veered left. The government kept growing: public spending as a share of GDP nearly doubled from 1960 to 1980 and peaked at 67% in 1993. Taxes kept rising. The Social Democrats (who ruled Sweden for 44 uninterrupted years from 1932 to 1976 and for 21 out of the 24 years from 1982 to 2006) kept squeezing business. “The era of neo-capitalism is drawing to an end,” said Olof Palme, the party’s leader, in 1974. “It is some kind of socialism that is the key to the future.”

The other Nordic countries have been moving in the same direction, if more slowly. Denmark has one of the most liberal labour markets in Europe. It also allows parents to send children to private schools at public expense and make up the difference in cost with their own money. Finland is harnessing the skills of venture capitalists and angel investors to promote innovation and entrepreneurship. Oil-rich Norway is a partial exception to this pattern, but even there the government is preparing for its post-oil future.

This is not to say that the Nordics are shredding their old model. They continue to pride themselves on the generosity of their welfare states. About 30% of their labour force works in the public sector, twice the average in the Organisation for Economic Development and Co-operation, a rich-country think-tank. They continue to believe in combining open economies with public investment in human capital. But the new Nordic model begins with the individual rather than the state. It begins with fiscal responsibility rather than pump-priming: all four Nordic countries have AAA ratings and debt loads significantly below the euro-zone average. It begins with choice and competition rather than paternalism and planning. The economic-freedom index of the Fraser Institute, a Canadian think-tank, shows Sweden and Finland catching up with the United States (see chart). The leftward lurch has been reversed: rather than extending the state into the market, the Nordics are extending the market into the state.

Why are the Nordic countries doing this? The obvious answer is that they have reached the limits of big government. “The welfare state we have is excellent in most ways,” says Gunnar Viby Mogensen, a Danish historian. “We only have this little problem. We can’t afford it.” The economic storms that shook all the Nordic countries in the early 1990s provided a foretaste of what would happen if they failed to get their affairs in order.

There are two less obvious reasons. The old Nordic model depended on the ability of a cadre of big companies to generate enough money to support the state, but these companies are being slimmed by global competition. The old model also depended on people’s willingness to accept direction from above, but Nordic populations are becoming more demanding.

Small is powerful

The Nordic countries have a collective population of only 26m. Finland is the only one of them that is a member of both the European Union and the euro area. Sweden is in the EU but outside the euro and has a freely floating currency. Denmark, too, is in the EU and outside the euro area but pegs its currency to the euro. Norway has remained outside the EU.

But there are compelling reasons for paying attention to these small countries on the edge of Europe. The first is that they have reached the future first. They are grappling with problems that other countries too will have to deal with in due course, such as what to do when you reach the limits of big government and how to organise society when almost all women work. And the Nordics are coming up with highly innovative solutions that reject the tired orthodoxies of left and right.

The second reason to pay attention is that the new Nordic model is proving strikingly successful. The Nordics dominate indices of competitiveness as well as of well-being. Their high scores in both types of league table mark a big change since the 1980s when welfare took precedence over competitiveness.

Explore our

interactive guide

to Europe’s troubled economies

The Nordics do particularly well in two areas where competitiveness and welfare can reinforce each other most powerfully: innovation and social inclusion. BCG, as the Boston Consulting Group calls itself, gives all of them high scores on its e-intensity index, which measures the internet’s impact on business and society. Booz & Company, another consultancy, points out that big companies often test-market new products on Nordic consumers because of their willingness to try new things. The Nordic countries led the world in introducing the mobile network in the 1980s and the GSM standard in the 1990s. Today they are ahead in the transition to both e-government and the cashless economy. Locals boast that they pay their taxes by SMS. This correspondent gave up changing sterling into local currencies because everything from taxi rides to cups of coffee can be paid for by card.

The Nordics also have a strong record of drawing on the talents of their entire populations, with the possible exception of their immigrants. They have the world’s highest rates of social mobility: in a comparison of social mobility in eight advanced countries by Jo Blanden, Paul Gregg and Stephen Machin, of the London School of Economics, they occupied the first four places. America and Britain came last. The Nordics also have exceptionally high rates of female labour-force participation: in Denmark not far off as many women go out to work (72%) as men (79%).

Flies in the ointment

This special report will examine the way the Nordic governments are updating their version of capitalism to deal with a more difficult world. It will note that in doing so they have unleashed a huge amount of creativity and become world leaders in reform. Nordic entrepreneurs are feeling their oats in a way not seen since the early 20th century. Nordic writers and artists—and indeed Nordic chefs and game designers—are enjoying a creative renaissance.

The report will also add caveats. The growing diversity of Nordic societies is generating social tensions, most horrifically in Norway, where Anders Breivik killed 77 people in a racially motivated attack in 2011, but also on a more mundane level every day. Sweden is finding it particularly hard to integrate its large population of refugees.

The Nordic model is still a work in progress. The three forces that have obliged the Nordic countries to revamp it—limited resources, rampant globalisation and growing diversity—are gathering momentum. The Nordics will have to continue to upgrade their model, but they will also have to fight to retain what makes it distinctive. Lant Pritchett and Michael Woolcock, of the World Bank, have coined the term “getting to Denmark” to describe successful modernisation. This report will suggest that the trick is not just to get to Denmark; it is to stay there.

The final caveat is about learning from the Nordic example, which other countries are rightly trying to do. Britain, for example, is introducing Swedish-style “free schools”. But transferring such lessons is fraught with problems. The Nordics’ success depends on their long tradition of good government, which emphasises not only honesty and transparency but also consensus and compromise. Learning from Denmark may be as difficult as staying there.

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The Economist Magazine

Schumpeter

In praise of laziness

Businesspeople would be better off if they did less and thought more

Aug 17th 2013 |
From the print edition

THERE is a never-ending supply of business gurus telling us how we can, and must, do more. Sheryl Sandberg urges women to “Lean In” if they want to get ahead. John Bernard offers breathless advice on conducting “Business at the Speed of Now”. Michael Port tells salesmen how to “Book Yourself Solid”. And in case you thought you might be able to grab a few moments to yourself, Keith Ferrazzi warns that you must “Never Eat Alone”.

Yet the biggest problem in the business world is not too little but too much—too many distractions and interruptions, too many things done for the sake of form, and altogether too much busy-ness. The Dutch seem to believe that an excess of meetings is the biggest devourer of time: they talk of
vergaderziekte, “meeting sickness”. However, a study last year by the McKinsey Global Institute suggests that it is e-mails: it found that highly skilled office workers spend more than a quarter of each working day writing and responding to them.

Which of these banes of modern business life is worse remains open to debate. But what is clear is that office workers are on a treadmill of pointless activity. Managers allow meetings to drag on for hours. Workers generate e-mails because it requires little effort and no thought. An entire management industry exists to spin the treadmill ever faster.

All this “leaning in” is producing an epidemic of overwork, particularly in the United States. Americans now toil for eight-and-a-half hours a week more than they did in 1979. A survey last year by the Centres for Disease Control and Prevention estimated that almost a third of working adults get six hours or less of sleep a night. Another survey last year by Good Technology, a provider of secure mobile systems for businesses, found that more than 80% of respondents continue to work after leaving the office, 69% cannot go to bed without checking their inbox and 38% routinely check their work e-mails at the dinner table.

This activity is making it harder to focus on real work as opposed to make-work. Teresa Amabile of Harvard Business School, who has been conducting a huge study of work and creativity, reports that workers are generally more creative on low-pressure days than on high-pressure days when they are confronted with a flurry of unpredictable demands. In 2012 Gloria Mark of the University of California, Irvine, and two colleagues deprived 13 people in the IT business of e-mail for five days and studied them intensively. They found that people without it concentrated on tasks for longer and experienced less stress.

It is high time that we tried a different strategy—not “leaning in” but “leaning back”. There is a distinguished history of leadership thinking in the lean-back tradition. Lord Melbourne, Queen Victoria’s favourite prime minister, extolled the virtues of “masterful inactivity”. Herbert Asquith embraced a policy of “wait and see” when he had the job. Ronald Reagan also believed in not overdoing things: “It’s true hard work never killed anybody,” he said, “but I figure, why take the chance?”. This tradition has been buried in a morass of meetings and messages. We need to revive it before we schedule ourselves to death.

The most obvious beneficiaries of leaning back would be creative workers—the very people who are supposed to be at the heart of the modern economy. In the early 1990s Mihaly Csikszentmihalyi, a psychologist, asked 275 creative types if he could interview them for a book he was writing. A third did not bother to reply at all and another third refused to take part. Peter Drucker, a management guru, summed up the mood of the refuseniks: “One of the secrets of productivity is to have a very big waste-paper basket to take care of all invitations such as yours.” Creative people’s most important resource is their time—particularly big chunks of uninterrupted time—and their biggest enemies are those who try to nibble away at it with e-mails or meetings. Indeed, creative people may be at their most productive when, to the manager’s untutored eye, they appear to be doing nothing.

Managers themselves could benefit. Those at the top are best employed thinking about strategy rather than operations—about whether the company is doing the right thing rather than whether it is sticking to its plans. When he was boss of General Electric, Jack Welch used to spend an hour a day in what he called “looking out of the window time”. When he was in charge of Microsoft Bill Gates used to take two “think weeks” a year when he would lock himself in an isolated cottage. Jim Collins, of “Good to Great” fame, advises all bosses to keep a “stop doing list”. Is there a meeting you can cancel? Or a dinner you can avoid?

Less is more—more or less

Junior managers would do well to follow the same advice. In “Do Nothing”, one of the few business books to grapple with the problem of over-management, Keith Murnighan of the Kellogg School of Management argues that the best managers focus their attention on establishing the right rules—recruiting the right people and establishing the right incentives—and then get out of the way. He quotes a story about Eastman Kodak in its glory days. A corporate reorganisation left a small division out in the cold—without a leader or a reporting line to headquarters. The head office only rediscovered the division when it received a note from a customer congratulating the unit on its work.

Doing nothing may be going too far. Managers play an important role in co-ordinating complicated activities and disciplining slackers. And some creative people would never finish anything if they were left to their own devices. But there is certainly a case for doing a lot less—for rationing e-mail, cutting back on meetings and getting rid of a few overzealous bosses. Leaning in has been producing negative returns for some time now. It is time to try the far more radical strategy of leaning back.

Economist.com/blogs/schumpeter

From the print edition: Business

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Forecasting the present

Taking the economic pulse

How to gauge the current state of the economy

Jul 5th 2014 |
From the print edition

IT IS hard to predict the future: witness forecasters’ failure to foresee the financial crisis. Indeed, even ascertaining the current state of the economy is tricky. The first official estimates of quarterly GDP are generally published between four and six weeks after each quarter has finished. Interpreting them can be fraught since they are frequently revised. Such delays and uncertainties have led economy-watchers to search for other gauges.

Simply asking business-folk what they think is a venerable tradition—Britain’s
Industrial Trends for example dates back to 1958—but such surveys are flourishing as never before. Among the most influential are purchasing-manager indices (PMIs). Every month managers in both manufacturing and private services are asked whether their firms’ output, employment, orders and the like have expanded or contracted (compared with the previous month). An index based on the net balance of their answers shows expansion above the level of 50 and contraction below it.

These findings can in turn be used to estimate the current rate of growth, given the previous relationship between the indices and GDP. For example, Markit, a research group, reported this week that their composite index for manufacturing and services in the euro zone stood at 52.8 in June. The survey suggests the euro area should grow by around 0.4% in the second quarter, twice as fast as in the first, says Chris Williamson, an economist at Markit.

Markit’s estimate of second quarter euro-zone GDP growth appeared six weeks before the first official estimate. Such surveys have other benefits: the method is transparent and easy to grasp. And the findings are not revised once the final reports emerge a week after the “flash” estimates.

Some data providers go further, seeking to exploit all relevant statistics, such as official figures for new passenger-car registrations. This requires a sophisticated model to extract a common signal for GDP from the welter of data that become available. This is the approach adopted by Now-Casting Economics, a firm whose founders include two economists, Lucrezia Reichlin and Domenico Giannone. In the case of the euro zone, their model gobbles up 50 monthly variables and uses their past relationships with GDP to calculate an estimate for the current quarter. At present the firm, whose clients are hedge funds and other asset managers, is expecting growth of 0.26% in the second quarter—somewhat more sluggish than Markit’s estimate.

In principle, the model-based approach might appear superior because it exploits more information. On the other hand, it is more of a black box. Since surveys are themselves an important source of information for the nowcasts this suggests that the two methods will co-exist.

From the print edition: Finance and economics

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Four Key Issues From

Managerial Economics

1. Boundaries of the Firm:

· What should the firm do?

· How large should the firm be?

· What business should the firm be in?

2. Market and Competitive Analysis:

· What is the nature of the market in which the firm competes?

· What is the nature of the competitive interaction among the firms in those markets?

3. Position and Dynamics:

· How should the firm position itself to compete?

· What should be the basics of its competitive advantage?

· How should the firm adjust over time?

4. Internal Organization:

· How should the firm organize its structure and systems internally?

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Drake Bennett: A freelance work force
04:24 PM CST on Friday, February 5, 2010 

As of last week, a company called Txteagle became the largest employer in Kenya. The firm, 
started in its original form in 2008 by a young computer engineer named Nathan Eagle and 
soon to be based in Boston, has 10,000 people working for it in Kenya. Txteagle does not 
rent office space for these workers, nor do the company’s officers interview them, or ever 
talk to most of them. 

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What’s The Big Story? Find out atdallasnews.com/opinion 
Blog: Opinion 

And, in a sense, the labor that the Kenyan workforce does hardly seems like work. The jobs 
–  short  stretches  of  speech  to  be  transcribed  or  translated  into  a  local  dialect,  search 
engine  results  to be  checked,  images  to be  labeled,  short market  research  surveys  to be 
completed – come  in over a worker’s own cellphone, and the worker responds either by 
speaking  into  the phone or  texting back  the  answer. The workers  can be  anyone with  a 
cellphone  –  a  secretary  waiting  for  a  bus,  a  Masai  tribesman  herding  cattle,  a  student 
between  classes,  a  security  guard  on  a  slow  day  or  one  of  Kenya’s  tens  of  millions  of 
unemployed. The  jobs  take at most a  few minutes and pay a  few cents each (payment  is 
sent by cellphone as well), but a dedicated worker can earn a few dollars a day in a part of 
the world where that is a significant sum. 

The  Txteagle  story  is  a  variety  of  things:  a  tale  of  savvy  social  entrepreneurs  taking 
advantage of the proliferation of cellphones in much of the developing world, an example 
of the ability of clever programming to chop big jobs up into tiny, discrete chunks and to 
assess  reliability  by  checking  the  answers  of  different  workers  against  each  other.  But 
Txteagle is also, at the most basic level, a story of how people are rethinking what work can 
be. 

The  United  States  Government  Accountability  Office  has  estimated  that  so‐called 
contingent  workers  –  everything  from  temps  to  day  laborers  to  the  self‐employed  to 
independent  contractors  –  make  up  nearly  a  third  of  the  workforce.  And  forecasters 
believe  that proportion will  rise. The growth  is being driven partly by economic  factors, 
with the uncertain economic climate making short‐term contract workers more attractive 
to firms than full‐time employees, but of course broader technological changes are at work 
as well;  cellphones,  PDAs  and broadband make  it  easy  to  farm out work,  even  complex, 
interactive tasks that previously only made sense to do in‐house. 

This shift has begun to trigger a more fundamental examination of what a job is and what 
we expect to get from it. Despite the vast diversity of the work people do, the traditional 
notion of a job has tended to be a standard bundle of responsibilities, roles and benefits: 
We do our work  for  an employer  to whom we owe our primary professional  allegiance, 
and  that employer pays us and provides us health  insurance and  a sense of professional 
identity. In the United States, many of the laws that shape health insurance, retirement and 
tax policy are structured around this model. 

But  in a  few realms, people have begun to unpack that bundle and reassemble  it  in new, 
surprising and potentially important ways. As it becomes easier for companies to plug in 
on  the  fly  to  the  constantly  shifting  network  of  freelance  labor,  freelance workers  have 
begun to think not  in terms of having a  job, but of having a collection of different  jobs at 
any one time. Some companies,  like Txteagle, are unbundling work in more radical ways, 
using technology to “crowdsource” labor, to divvy it up into micro‐jobs that can be farmed 
out to unaffiliated masses of remote workers. 

At  the same  time, others have begun  to  think about  the broad social  implications of  this 
reshuffling,  and  to  create  institutions  to  fill  the  gaps  that  it  is  opening  up.  These  new 
institutions,  whether  clubs,  unions  or  something  more  like  a  medieval  guild,  seek  to 
provide those benefits – everything from a dental plan to a place to socialize to a sense of 
identity – that traditionally have simply come with the job. 

“In the long term, what we’re doing is building the next safety net,” says Sara Horowitz, the 
founder of Freelancers Union, a leading such organization with 130,000 members. “In the 
short  term, we’re  picking  up  the  pieces  of what  people  need,  like  health  insurance,  and 
helping members have the political clout to make the new New Deal happen.” 

The middle of the 20th century was the age of the great employer: Mainstream success was 
a  stable  job  at  a  single  company,  steadily  ascending  from middle  to upper management. 
That  began  to  change  in  the  1970s  and  1980s,  for  reasons  that  were  social  as  well  as 
economic: American conglomerates began to face stiff foreign competition, and the country 
accustomed itself to – and even began to celebrate – a more mercurial, less cosseted brand 
of  capitalism. The Organization Man was  replaced by  the worker  as  free agent,  one who 
might with little regret leave a job when a competitor gave a better offer, or who might be 
left  jobless  when  his  company  merged  with  another.  The  arc  of  the  average  career 
trajectory grew more fractured. 

What  we’re  seeing  today,  says  Thomas  Malone,  a  professor  at  the  MIT  Sloan  School  of 
Management  and  author  of  the  2004  book The  Future  of Work,  is  a  further  shift.  The 
growing freelance workforce, he argues,  is made up of people who see themselves not as 

having  a  single  job  so much  as  having  several  at  once.  To  describe  the  current  change, 
Malone borrows an image that the sociologist Alvin Tofflerused to describe the earlier one. 

“One of  the  things  [Toffler] said was  that we should move  from  the  idea of a career as a 
linear progression up the ranks in a single organization to that of a career as a portfolio of 
jobs that you hold over time in a series of different organizations,” says Malone. “What I’m 
just  now  realizing  is  that  many  people  today  see  their  career  portfolio  including  a 
combination of jobs at the same time.” 

Malone believes that new forms of freelancing will help drive this change. Companies like 
iStockphoto (a stock photograph and image site containing the work of more than 70,000 
artists),  Threadless  (a  T‐shirt  design  company  where  anyone  can  submit  designs  and 
evaluate  others)  and  Elance  (an  online  source  of  skilled  freelance  labor)  are models  of 
companies  where  not  just  secondary  jobs  but  the  core  function  of  the  business  is 
outsourced  to  a  diffuse  online  workforce.  All  are  helping  connect  client  companies  and 
freelance laborers to each other easily, without a traditional intermediary and with stricter 
standards than online marketplaces like Craigslist. 

These  sites  allow  freelancers  to  field  and  respond  to  far  more  offers  than  they  would 
previously have been able  to, and to create a  far  larger and more diverse slate of  jobs at 
any one time. Successful Elance workers often have nine or 10 projects going at any one 
time. 

“You can aggregate all these different jobs and clients, and create a portfolio of employers 
rather  than  one,”  says  Fabio  Rosati,  Elance’s  CEO.  “The  independent  professional 
freelancer has access  to many, many more opportunities and can  evaluate  them without 
getting in the car or picking up the phone.” 

The smaller the job, of course, the more voluminous the portfolio of work has to be. In this 
sense,  the most  radical  form of  freelancing  is  crowdsourcing, where  jobs  that previously 
might have been done by one person are instead “chunked” into much smaller tasks that 
can  be  taken  up,  one  by  one,  by  a  far‐flung  army  of  online  workers.  The  best‐known 
crowdsourcing  application,  Amazon.com’s  Mechanical  Turk,  pays  pennies  for  tasks  like 
tagging photos or transcribing speech. 

A few programmers have started to look at how to expand the possibilities of what sort of 
work  can  be  chopped  up  and  farmed  out  in  a  crowdsourcable way.  A  team  led  by  Greg 
Little  at  MIT  created  a  software  toolkit  called  TurKit  that  allows  the  Mechanical  Turk 
crowd workforce to be enlisted to perform more complex tasks like composing text, copy 
editing  or  deciphering  illegible  handwriting  by  using  crowd  members  in  an  iterative 
manner to go over each other’s work, replicating real‐world collaboration. 

In  computer  science  and  other  fields,  Little  believes  crowdsourcing  could  allow  the 
creation of a whole new category of worker, one with far greater specialization than what 
professionals have now but who could work on a much  larger number of projects, being 
called in to contribute a much smaller part of the whole. 

“Right now I can’t hire a bunch of programmer experts in lots of different domains because 
I can’t afford to keep them on hand all the time,” he says. “But if I could hire them just for 
the  five minutes  I need them,  individual people would have the power to create projects 
that  require  lots of  expertise,  and  the potential  for people  to  innovate  and  create  things 
would increase.” 

How much a person can make as a member of the “crowd” remains to be seen, of course. 
Txteagle – along with another company called Samasource that connects Kenyan refugees 
to crowdsourcing work – has found a population for whom a couple dollars a day is truly 
helpful. But it’s hard to imagine making a living off of that in, say, Boston. 

Other  distributed  labor market  firms,  however,  follow  a  somewhat  different model,  and 
one that’s far more lucrative for the individual freelancer. Elance offers professional work 
for  professional  pay  in  fields  from  programming  to  design  to  finance  to  law.  Another 
example  is  InnoCentive, which  allows  firms  in  fields  like  software,  pharmaceuticals  and 
engineering  to  post  problems  they  want  solved  –  requests  for  everything  from 
“Biodegradable, Bioderived Elastomers  for Medical Applications”  to “a novel design  for a 
male showering accessory” – and how much they’ll pay for a solution – usually something 
in the tens of thousands of dollars – and lets interested parties go at it. Successful solvers 
can make real money. 

Some of  iStockphoto’s  contributors,  too, are able  to make a good  living. One of  the more 
successful  artists  on  the  site  is  Nicholas  Monu,  a  medical  school  student  at  Brown 
University who, according  to  iStockphoto, earns a  low‐six‐figure  income  from his photos 
and  illustrations  on  the  site.  “It  pays  for med  school;  it  pays  for my  car.  IStock paid  the 
down payment on my condo, and it’s paying the mortgage,” he says. 

To Malone this shift is, in and of itself, an overwhelming good. 

“It’s now possible, for the first time in human history, to have the economic benefits of very 
large  organizations  –  things  like  economies  of  scale  –  but  at  the  same  time  to  have  the 
human benefit of very small organizations: creativity, motivation, flexibility and so forth,” 
he says. 

Jobs  provide  more  than  a  paycheck,  though.  For  most  workers,  their  employer  is  their 
source of health and retirement benefits, and for many, the workplace gives a structure to 
their social life and a shape to their sense of themselves. 

A shift is already under way with health care: The legislation before Congress could make 
it easier to get health insurance without relying on one’s employer. But the more workers 
there  are  outside  traditional  workplaces,  the  more  people  will  have  to  figure  out 
alternative sources for all of those things. 

One of the most basic benefits of a steady job, of course, is a measure of job security. Full‐
time jobs can always be terminated, as millions of Americans have been recently reminded, 
but  with  freelance  work,  potential  unemployment  lurks  at  the  end  of  every  short‐term 
contract. A world in which people have more smaller jobs rather than one big one would 
go some way toward addressing this, smoothing out the ups and downs that losing any one 
of them would bring. 

But  to  provide  a  greater  level  of  stability,  freelance workers may  require  a  new kind  of 
institutional  ally.  Malone  predicts  that  the  growth  in  freelance  work  will  necessitate  a 
different breed of  labor union  to provide  some of  the benefits  the  employer now offers. 
Today’s unions are largely defined by their role in collective bargaining – negotiating with 
employers for better benefits, conditions and pay. But many early unions actually arose in 
industries like construction or the garment trade where workers didn’t work for the same 
employer for very long, so the longstanding relationship wasn’t with the employer but the 
union. 

These unions were more like guilds: organizations, united by a common set of specialized 
work skills,  that combined elements of a social club and a mutual aid society. And rather 
than pressuring employers to provide benefits, they provided them directly. Malone argues 
that this sort of guild would be well‐suited to a work landscape in which more workers are 
freelance.  Such  organizations  might  even  see  fit  to  offer  income‐smoothing  insurance 
policies where freelancers can in good times pay into a fund that then helps them through 
leaner periods. 

Freelancers Union,  founded  in  1995  in New York City, models  itself  along  these  lines.  It 
provides medical and dental benefits, a retirement fund and life insurance. It lobbies state 
governments for freelancer‐friendly policies – among its causes right now is a proposal for 
a tax‐advantaged unemployment insurance plan for freelancers. 

And  it also  tries  to address some of  the  less quantifiable difficulties of  freelancing. Many 
freelancers  complain  that  one  of  the  great  difficulties  of  the  work  is  its  solitary  nature. 
Some of the online freelance companies try to tackle this. Most have online forums through 

which they try to recreate some of the dynamics of an actual workplace. IStockphoto goes 
further,  organizing  “iStockalypses”  for  select  groups  of  its  photographers:  weeklong 
gatherings  in  exotic  locales  worldwide  that  are  part  party  and  part  photo  shoot.  And 
iStockphoto photographers have begun organizing regional “Minilypses” on their own as a 
way to pool resources for photo shoots, to share information and simply to socialize. 

Freelancers Union’s attempts to knit its members together socially are more conventional. 
Last  month  the  organization  held  a  holiday  party  in  New  York,  and  150  or  so  people 
showed up. It was, says Horowitz, an enthusiastic crowd. 

“These people hadn’t been to a holiday party because they had been freelancing for years,” 
says  Horowitz.  “They  want  to  feel  connected;  they  want  to  feel  that  they’re  part  of 
something.” 

Drake  Bennett  is  a  staff  writer  for  the  Boston  Globe,  where  a  version  of  this  essay  first 
appeared. His e­mail address isdrbennett@globe.com. 

 

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ECO 562/Froeb3rdEd x
Most importantly, manage yourself.

Here are some things that worked for me.

· At the beginning of each day, write down on a card what you want to accomplish. Keep the card in your pocket and try to get at least half way through the list. .

· Figure out what you can do that no one else in the organization is capable of doing, and then do it. If you find yourself doing something that your subordinates can do, stop. .

· Do not let your “ In” box run your life. Answer e- mail only once each day— otherwise, you’ll soon find yourself glued to your computer, putting out fires instead of making progress toward your goals. .

· When you find yourself becoming frustrated or angry with subordinates, recognize that the problem is likely with you, not with them.

This was written by Luke Froeb as the Epilogue chapter to the third edition of “Managerial Economics”

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ECO 562/future forecsast

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ECO 562/GermanMiddle x

Schumpeter

German lessons

Many countries want a Mittelstand like Germany’s. It is not so easy to copy

Jul 12th 2014 |
From the print edition

GERMANY’S midsized manufacturers, collectively known as the
Mittelstand, are often praised as a group for providing the backbone of the world’s fourth-largest economy. Individually, they are world leaders in hiding their light under a bushel. They tend to be family-owned, tucked away in small towns and familiar only to the businesses that buy their specialised machinery and components. “We are not digging for gold,” says Joachim Kreuzburg, the boss of Sartorius, a maker of laboratory equipment. “We are selling shovels to the gold-diggers.”

Increasingly, though, Germany’s hidden champions are enjoying a measure of international celebrity. Officials and businesspeople from the world over are making pilgrimages to Germany to learn from the
Mittelständler, much as they flocked to Japan in the 1970s to study Toyota. Mario Ohoven, president of the BVMW, a trade body for the
Mittelstand, says that wherever he goes these days, he is pressed to explain the secrets of his members’ success. Recent suitors include Iran and Egypt.

Germany’s economic strength in recent years is the most obvious reason why other countries want to emulate it. But the
Mittelstand also appears to offer a solution to some of the biggest worries haunting the capitalist system. One is about inclusiveness: some countries worry that too much economic activity is becoming concentrated in a small number of giant companies and in a few megacities. Another is youth unemployment: millions of young people remain idle while bosses complain of skill shortages. Winfried Weber, a professor of management at the University of Mannheim, explains that the combination of medium-sized companies with deep local roots and a strong apprenticeship system means that in Germany only 7.8% of those aged 25 or under are unemployed, compared with 22.1% in Sweden and 54% in Spain.
Mittelstand firms inspire extraordinary loyalty in their workers: on average only 2.7% of them leave each year, compared with the 30% turnover at some big American companies.

Of the stream of pilgrims who come to study Germany’s midsized marvels, the most devoted are from South Korea. Moon Kook-hyun, a former boss of Yuhan-Kimberley, a maker of disposable nappies, has argued for years that his country is too dependent on a handful of giant conglomerates, the
chaebol, and must focus on improving its small and medium-sized family firms. He is so passionate about his cause that he set aside his business career to serve in parliament and, in 2007, to run for president. He got only 5.7% of the vote. But his message that companies do not have to be big to be world-class is resonating. South Korea’s current president, Park Geun-hye, recently took a group of would-be
Mittelständler to visit their role models in Germany. South Korea has also set up German-style
Meister schools, to teach bright youngsters to become masters of a technical trade.

Mr Moon is now taking his crusade to China. Every year he lectures to thousands of heads of Chinese family firms that Germany has more than 1,000 companies that have been in the same family for generations but can compete with the world’s best. Again, his message is hitting home, and China is also now sending delegations to Germany. However, some of its canny capitalists have concluded that the best way to understand the
Mittelstand firms is to own one. Among those recently bought by the Chinese are Putzmeister, a maker of concrete pumps, and Preh, which makes various electronic innards for cars.

Before announcing the triumph of the
Mittelstand, it is worth bearing two things in mind. The first is that business models can never be transported lock, stock and barrel. The German system depends on delicate relationships between schools and companies, and capital and labour. It is hard to see this being reconstituted in South Korea, with its adversarial industrial relations, or the United States, with its enthusiasm for labour mobility. The British have been trying to learn from the German apprenticeship model since the late 19th century, with limited success.

The second is that the
Mittelstand is changing rapidly: just as the world is trying to learn from its companies, they are busy learning from the world. The Freudenberg Group, a maker of filters, seals and lubricants, has been owned by the Freudenberg family for eight generations. But its chief executive, Mohsen Sohi, is an American who spent his first 20 years in Iran.
Mittelstand firms are realising that they can no longer just stay in small-town Germany. To stay competitive they need to produce their goods globally and service them wherever their customers are—and to help them with this, they are hiring growing numbers of foreigners. Sennheiser, which makes headphones and microphones, recently passed to a new generation of Sennheisers, Andreas and Daniel, who stress the importance of “being global in everything we do”. They want to learn from “innovative customers” around the world: the Japanese are particularly demanding when it comes to sound, and Americans when it comes to fashion.

Mix and match

However, this does not mean that the pilgrims are visiting Germany in vain. It is a vivid example of the fact that manufacturers in rich, high-wage countries can prosper from globalisation if they invest in human capital and focus on sophisticated products. The West’s industrial companies learned from lean manufacturing without importing Japan’s system of managed capitalism. German companies such as Freudenberg are embracing globalisation without losing their roots: Mr Sohi has learned German and praises his company’s “
Mittelstand spirit”. Management science has always progressed by picking up ideas from all over the world and remixing them into more productive combinations. Germany is assuming its rightful role as one of the world’s leading laboratories for this mixing.

From the print edition: Business

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ECO 562/Global Developing Markets Issue x
Global Developing Markets Issue

Background:

Much of how you have been trained in you management and economic education has centered around the American market place. That means one is selling products to a market that has relatively high income by world standards. Another way of saying this is that the majority of Americans simply are not poor.

However, assume your firm has decided to concentrate on the markets in say India, China, Brazil etc in which something along the lines of 80% of the population have very low incomes.

So here is your question:

Given the tools we have learned this semester, how would you have to modify them (or not) to be successful in these low income high volume markets. Think about issues of market structure, pricing, costs etc. If we mean low cost, then the issue of min average costs and scale are key issues. Yet in most the developing world respect for patents and copyrights are questionable. Thus you may indeed produce at low cost product, but what must you do to keep your share and margins.

Further, it seems to me you would like to grow your market and go upmarket, you would want to see higher incomes from you strategies also.

What are your thoughts? No more than two pages.

I suggest you pick one concept and concentrate on it alone.

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ECO 562/goalsetapp

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ECO 562/Here are two questions to think about and discuss on Weds x
Here are two questions to think about and discuss on Weds.
1.  We have often heard that if it is worth doing at all it is worth doing well.  What would economics say?
2.  Is is wrong the profit from the “pain” of others?  What would economics say?
Have fun and let’s talk about these Weds.
Dr. Shwiff

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ECO 562/Innovation pessimism x

Innovation pessimism

Has the ideas machine broken down?

The idea that innovation and new technology have stopped driving growth is getting increasing attention. But it is not well founded

Jan 12th 2013 |

From the print edition

BOOM times are back in Silicon Valley. Office parks along Highway 101 are once again adorned with the insignia of hopeful start-ups. Rents are soaring, as is the demand for fancy vacation homes in resort towns like Lake Tahoe, a sign of fortunes being amassed. The Bay Area was the birthplace of the semiconductor industry and the computer and internet companies that have grown up in its wake. Its wizards provided many of the marvels that make the world feel futuristic, from touch-screen phones to the instantaneous searching of great libraries to the power to pilot a drone thousands of miles away. The revival in its business activity since 2010 suggests progress is motoring on.

So it may come as a surprise that some in Silicon Valley think the place is stagnant, and that the rate of innovation has been slackening for decades. Peter Thiel, a founder of PayPal, an internet payment company, and the first outside investor in Facebook, a social network, says that innovation in America is “somewhere between dire straits and dead”. Engineers in all sorts of areas share similar feelings of disappointment. And a small but growing group of economists reckon the economic impact of the innovations of today may pale in comparison with those of the past.

Related topics

·

Europe

·

Massachusetts Institute of Technology

·

United Kingdom

·

Paul Romer

·

United States

Some suspect that the rich world’s economic doldrums may be rooted in a long-term technological stasis. In a 2011 e-book Tyler Cowen, an economist at George Mason University, argued that the financial crisis was masking a deeper and more disturbing “Great Stagnation”. It was this which explained why growth in rich-world real incomes and employment had long been slowing and, since 2000, had hardly risen at all (see chart 1). The various motors of 20th-century growth—some technological, some not—had played themselves out, and new technologies were not going to have the same invigorating effect on the economies of the future. For all its flat-screen dazzle and high-bandwidth pizzazz, it seemed the world had run out of ideas.

Glide path

The argument that the world is on a technological plateau runs along three lines. The first comes from growth statistics. Economists divide growth into two different types, “extensive” and “intensive”. Extensive growth is a matter of adding more and/or better labour, capital and resources. These are the sort of gains that countries saw from adding women to the labour force in greater numbers and increasing workers’ education. And, as Mr Cowen notes, this sort of growth is subject to diminishing returns: the first addition will be used where it can do most good, the tenth where it can do the tenth-most good, and so on. If this were the only sort of growth there was, it would end up leaving incomes just above the subsistence level.

Intensive growth is powered by the discovery of ever better ways to use workers and resources. This is the sort of growth that allows continuous improvement in incomes and welfare, and enables an economy to grow even as its population decreases. Economists label the all-purpose improvement factor responsible for such growth “technology”—though it includes things like better laws and regulations as well as technical advance—and measure it using a technique called “growth accounting”. In this accounting, “technology” is the bit left over after calculating the effect on GDP of things like labour, capital and education. And at the moment, in the rich world, it looks like there is less of it about. Emerging markets still manage fast growth, and should be able to do so for some time, because they are catching up with technologies already used elsewhere. The rich world has no such engine to pull it along, and it shows.

This is hardly unusual. For most of human history, growth in output and overall economic welfare has been slow and halting. Over the past two centuries, first in Britain, Europe and America, then elsewhere, it took off. In the 19th century growth in output per person—a useful general measure of an economy’s productivity, and a good guide to growth in incomes—accelerated steadily in Britain. By 1906 it was more than 1% a year. By the middle of the 20th century, real output per person in America was growing at a scorching 2.5% a year, a pace at which productivity and incomes double once a generation (see chart 2). More than a century of increasingly powerful and sophisticated machines were obviously a part of that story, as was the rising amount of fossil-fuel energy available to drive them.

But in the 1970s America’s growth in real output per person dropped from its post-second-world-war peak of over 3% a year to just over 2% a year. In the 2000s it tumbled below 1%. Output per worker per hour shows a similar pattern, according to Robert Gordon, an economist at Northwestern University: it is pretty good for most of the 20th century, then slumps in the 1970s. It bounced back between 1996 and 2004, but since 2004 the annual rate has fallen to 1.33%, which is as low as it was from 1972 to 1996. Mr Gordon muses that the past two centuries of economic growth might actually amount to just “one big wave” of dramatic change rather than a new era of uninterrupted progress, and that the world is returning to a regime in which growth is mostly of the extensive sort (see chart 3).

Mr Gordon sees it as possible that there were only a few truly fundamental innovations—the ability to use power on a large scale, to keep houses comfortable regardless of outside temperature, to get from any A to any B, to talk to anyone you need to—and that they have mostly been made. There will be more innovation—but it will not change the way the world works in the way electricity, internal-combustion engines, plumbing, petrochemicals and the telephone have. Mr Cowen is more willing to imagine big technological gains ahead, but he thinks there are no more low-hanging fruit. Turning terabytes of genomic knowledge into medical benefit is a lot harder than discovering and mass producing antibiotics.

The pessimists’ second line of argument is based on how much invention is going on. Amid unconvincing appeals to the number of patents filed and databases of “innovations” put together quite subjectively, Mr Cowen cites interesting work by Charles Jones, an economist at Stanford University. In a 2002 paper Mr Jones studied the contribution of different factors to growth in American per-capita incomes in the period 1950-93. His work indicated that some 80% of income growth was due to rising educational attainment and greater “research intensity” (the share of the workforce labouring in idea-generating industries). Because neither factor can continue growing ceaselessly, in the absence of some new factor coming into play growth is likely to slow.

The growth in the number of people working in research and development might seem to contradict this picture of a less inventive economy: the share of the American economy given over to R&D has expanded by a third since 1975, to almost 3%. But Pierre Azoulay of MIT and Benjamin Jones of Northwestern University find that, though there are more people in research, they are doing less good. They reckon that in 1950 an average R&D worker in America contributed almost seven times more to “total factor productivity”—essentially, the contribution of technology and innovation to growth—that an R&D worker in 2000 did. One factor in this may be the “burden of knowledge”: as ideas accumulate it takes ever longer for new thinkers to catch up with the frontier of their scientific or technical speciality. Mr Jones says that, from 1985 to 1997 alone, the typical “age at first innovation” rose by about one year.

A fall of moondust

The third argument is the simplest: the evidence of your senses. The recent rate of progress seems slow compared with that of the early and mid-20th century. Take kitchens. In 1900 kitchens in even the poshest of households were primitive things. Perishables were kept cool in ice boxes, fed by blocks of ice delivered on horse-drawn wagons. Most households lacked electric lighting and running water. Fast forward to 1970 and middle-class kitchens in America and Europe feature gas and electric hobs and ovens, fridges, food processors, microwaves and dishwashers. Move forward another 40 years, though, and things scarcely change. The gizmos are more numerous and digital displays ubiquitous, but cooking is done much as it was by grandma.

Or take speed. In the 19th century horses and sailboats were replaced by railways and steamships. Internal-combustion engines and jet turbines made it possible to move more and more things faster and faster. But since the 1970s humanity has been coasting. Highway travel is little faster than it was 50 years ago; indeed, endemic congestion has many cities now investing in trams and bicycle lanes. Supersonic passenger travel has been abandoned. So, for the past 40 years, has the moon.

Medicine offers another example. Life expectancy at birth in America soared from 49 years at the turn of the 20th century to 74 years in 1980. Enormous technical advances have occurred since that time. Yet as of 2011 life expectancy rested at just 78.7 years. Despite hundreds of billions of dollars spent on research, people continue to fall to cancer, heart disease, stroke and organ failure. Molecular medicine has come nowhere close to matching the effects of improved sanitation.

To those fortunate enough to benefit from the best that the world has to offer, the fact that it offers no more can disappoint. As Mr Thiel and his colleagues at the Founders Fund, a venture-capital company, put it: “We wanted flying cars, instead we got 140 characters.” A world where all can use Twitter but hardly any can commute by air is less impressive than the futures dreamed of in the past.

The first thing to point out about this appeal to experience and expectation is that the science fiction of the mid-20th century, important as it may have been to people who became entrepreneurs or economists with a taste for the big picture, constituted neither serious technological forecasting nor a binding commitment. It was a celebration through extrapolation of then current progress in speed, power and distance. For cars read flying cars; for battlecruisers read space cruisers.

Technological progress does not require all technologies to move forward in lock step, merely that some important technologies are always moving forward. Passenger aeroplanes have not improved much over the past 40 years in terms of their speed. Computers have sped up immeasurably. Unless you can show that planes matter more, to stress the stasis over the progress is simply a matter of taste.

Mr Gordon and Mr Cowen do think that now-mature technologies such as air transport have mattered more, and play down the economic importance of recent innovations. If computers and the internet mattered to the economy—rather than merely as rich resources for intellectual and cultural exchange, as experienced on Mr Cowen’s popular blog, Marginal Revolution—their effect would be seen in the figures. And it hasn’t been.

As early as 1987 Robert Solow, a growth theorist, had been asking why “you can see the computer age everywhere but in the productivity statistics”. A surge in productivity growth that began in the mid-1990s was seen as an encouraging sign that the computers were at last becoming visible; but it faltered, and some, such as Mr Gordon, reckon that the benefits of information technology have largely run their course. He notes that, for all its inhabitants’ Googling and Skypeing, America’s productivity performance since 2004 has been worse than that of the doldrums from the early 1970s to the early 1990s.

The fountains of paradise

Closer analysis of recent figures, though, suggests reason for optimism. Across the economy as a whole productivity did slow in 2005 and 2006—but productivity growth in manufacturing fared better. The global financial crisis and its aftermath make more recent data hard to interpret. As for the strong productivity growth in the late 1990s, it may have been premature to see it as the effect of information technology making all sorts of sectors more productive. It now looks as though it was driven just by the industries actually making the computers, mobile phones and the like. The effects on the productivity of people and companies buying the new technology seem to have begun appearing in the 2000s, but may not yet have come into their own. Research by Susanto Basu of Boston College and John Fernald of the San Francisco Federal Reserve suggests that the lag between investments in information-and-communication technologies and improvements in productivity is between five and 15 years. The drop in productivity in 2004, on that reckoning, reflected a state of technology definitely pre-Google, and quite possibly pre-web.

Full exploitation of a technology can take far longer than that. Innovation and technology, though talked of almost interchangeably, are not the same thing. Innovation is what people newly know how to do. Technology is what they are actually doing; and that is what matters to the economy. Steel boxes and diesel engines have been around since the 1900s, and their use together in containerised shipping goes back to the 1950s. But their great impact as the backbone of global trade did not come for decades after that.

Roughly a century lapsed between the first commercial deployments of James Watt’s steam engine and steam’s peak contribution to British growth. Some four decades separated the critical innovations in electrical engineering of the 1880s and the broad influence of electrification on economic growth. Mr Gordon himself notes that the innovations of the late 19th century drove productivity growth until the early 1970s; it is rather uncharitable of him to assume that the post-2004 slump represents the full exhaustion of potential gains from information technology.

And information innovation is still in its infancy. Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of “the second half of the chess board”. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in total—the whole world’s annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go.

Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book “Race Against the Machine”. By the measure known as Moore’s law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined.

The other side of the sky

As an example of this acceleration-of-effect they offer autonomous vehicles. In 2004 the Defence Advanced Research Projects Agency (DARPA), a branch of America’s Department of Defence, set up a race for driverless cars that promised $1 million to the team whose vehicle finished the 240km (150-mile) route fastest. Not one of the robotic entrants completed the course. In August 2012 Google announced that its fleet of autonomous vehicles had completed some half a million kilometres of accident-free test runs. Several American states have passed or are weighing regulations for driverless cars; a robotic-transport revolution that seemed impossible ten years ago may be here in ten more.

That only scratches the surface. Across the board, innovations fuelled by cheap processing power are taking off. Computers are beginning to understand natural language. People are controlling video games through body movement alone—a technology that may soon find application in much of the business world. Three-dimensional printing is capable of churning out an increasingly complex array of objects, and may soon move on to human tissues and other organic material.

An innovation pessimist could dismiss this as “jam tomorrow”. But the idea that technology-led growth must either continue unabated or steadily decline, rather than ebbing and flowing, is at odds with history. Chad Syverson of the University of Chicago points out that productivity growth during the age of electrification was lumpy. Growth was slow during a period of important electrical innovations in the late 19th and early 20th centuries; then it surged. The information-age trajectory looks pretty similar (see chart 4).

It may be that the 1970s-and-after slowdown in which the technological pessimists set such store can be understood in this way—as a pause, rather than a permanent inflection. The period from the early 1970s to the mid-1990s may simply represent one in which the contributions of earlier major innovations were exhausted while computing, biotechnology, personal communication and the rest of the technologies of today and tomorrow remained too small a part of the economy to influence overall growth.

Other potential culprits loom, however—some of which, worryingly, might be permanent in their effects. Much of the economy is more heavily regulated than it was a century ago. Environmental protection has provided cleaner air and water, which improve people’s lives. Indeed, to the extent that such gains are not captured in measurements of GDP, the slowdown in progress from the 1970s is overstated. But if that is so, it will probably continue to be so for future technological change. And poorly crafted regulations may unduly raise the cost of new research, discouraging further innovation.

Another thing which may have changed permanently is the role of government. Technology pessimists rarely miss an opportunity to point to the Apollo programme, crowning glory of a time in which government did not simply facilitate new innovation but provided an ongoing demand for talent and invention. This it did most reliably through the military-industrial complex of which Apollo was a spectacular and peculiarly inspirational outgrowth. Mr Thiel is often critical of the venture-capital industry for its lack of interest in big, world-changing ideas. Yet this is mostly a response to market realities. Private investors rationally prefer modest business models with a reasonably short time to profit and cash out.

A third factor which might have been at play in both the 1970s and the 2000s is energy. William Nordhaus of Yale University has found that the productivity slowdown which started in the 1970s radiated outwards from the most energy-intensive sectors, a product of the decade’s oil shocks. Dear energy may help explain the productivity slowdown of the 2000s as well. But this is a trend that one can hope to see reversed. In America, at least, new technologies are eating into those high prices. Mr Thiel is right to reserve some of his harshest criticism for the energy sector’s lacklustre record on innovation; but given the right market conditions it is not entirely hopeless.

Perhaps the most radical answer to the problem of the 1970s slowdown is that it was due to globalisation. In a somewhat whimsical 1987 paper, Paul Romer, then at the University of Rochester, sketched the possibility that, with more workers available in developing countries, cutting labour costs in rich ones became less important. Investment in productivity was thus sidelined. The idea was heretical among macroeconomists, as it dispensed with much of the careful theoretical machinery then being used to analyse growth. But as Mr Romer noted, economic historians comparing 19th-century Britain with America commonly credit relative labour scarcity in America with driving forward the capital-intense and highly productive “American system” of manufacturing.

The view from Serendip

Some economists are considering how Mr Romer’s heresy might apply today. Daron Acemoglu, Gino Gancia, and Fabrizio Zilibotti of MIT, CREi (an economics-research centre in Barcelona) and the University of Zurich, have built a model to study this. It shows firms in rich countries shipping low-skill tasks abroad when offshoring costs little, thus driving apart the wages of skilled and unskilled workers at home. Over time, though, offshoring raises wages in less-skilled countries; that makes innovation at home more enticing. Workers are in greater demand, the income distribution narrows, and the economy comes to look more like the post-second-world-war period than the 1970s and their aftermath.

Even if that model is mistaken, the rise of the emerging world is among the biggest reasons for optimism. The larger the size of the global market, the more the world benefits from a given new idea, since it can then be applied across more activities and more people. Raising Asia’s poor billions into the middle class will mean that millions of great minds that might otherwise have toiled at subsistence farming can instead join the modern economy and share the burden of knowledge with rich-world researchers—a sharing that information technology makes ever easier.

It may still be the case that some parts of the economy are immune, or at least resistant, to some of the productivity improvement that information technology can offer. Sectors like health care, education and government, in which productivity has proved hard to increase, loom larger within the economy than in the past. The frequent absence of market pressure in such areas reduces the pressure for cost savings—and for innovation.

For some, though, the opposite outcome is the one to worry about. Messrs Brynjolfsson and McAfee fear that the technological advances of the second half of the chessboard could be disturbingly rapid, leaving a scourge of technological unemployment in their wake. They argue that new technologies and the globalisation that they allow have already contributed to stagnant incomes and a decline in jobs that require moderate levels of skill. Further progress could threaten jobs higher up and lower down the skill spectrum that had, until now, seemed safe.

Pattern-recognition software is increasingly good at performing the tasks of entry-level lawyers, scanning thousands of legal documents for relevant passages. Algorithms are used to write basic newspaper articles on sporting outcomes and financial reports. In time, they may move to analysis. Manual tasks are also vulnerable. In Japan, where labour to care for an ageing population is scarce, innovation in robotics is proceeding by leaps and bounds. The rising cost of looking after people across the rich world will only encourage further development.

Such productivity advances should generate enormous welfare gains. Yet the adjustment period could be difficult. In the end, the main risk to advanced economies may not be that the pace of innovation is too slow, but that institutions have become too rigid to accommodate truly revolutionary changes—which could be a lot more likely than flying cars.

From the print edition: Briefing

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·
OPINION

· OCTOBER 27, 2008

The Age of Prosperity Is Over

This administration and Congress will be remembered like Herbert Hoover.

By
ARTHUR B. LAFFER

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About a year ago Stephen Moore, Peter Tanous and I set about writing a book about our vision for the future entitled “The End of Prosperity.” Little did we know then how appropriate its release would be earlier this month.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent. This process is the topic of Nassim Nicholas Taleb’s book “Fooled by Randomness.”

David Gothard

When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can’t afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house’s value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.

But here’s the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn’t create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don’t believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they’ll do with Wall Street.

Some 14 months ago, the projected deficit for the 2008 fiscal year was about 0.6% of GDP. With the $170 billion stimulus package last March, the add-ons to housing and agriculture bills, and the slowdown in tax receipts, the deficit for 2008 actually came in at 3.2% of GDP, with the 2009 deficit projected at 3.8% of GDP. And this is just the beginning.

The net national debt in 2001 was at a 20-year low of about 35% of GDP, and today it stands at 50% of GDP. But this 50% number makes no allowance for anything resulting from the over $5.2 trillion guarantee of Fannie Mae and Freddie Mac assets, or the $700 billion Troubled Assets Relief Program (TARP). Nor does the 50% number include any of the asset swaps done by the Federal Reserve when they bailed out Bear Stearns, AIG and others.

But the government isn’t finished. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid — and yes, even Fed Chairman Ben Bernanke — are preparing for a new $300 billion stimulus package in the next Congress. Each of these actions separately increases the tax burden on the economy and does nothing to encourage economic growth. Giving more money to people when they fail and taking more money away from people when they work doesn’t increase work. And the stock market knows it.

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan’s tax cuts, Paul Volcker’s sound money, and all the other pro-growth, supply-side policies.

Bill Clinton and Alan Greenspan added their efforts to strengthen what had begun under President Reagan. President Clinton signed into law welfare reform, so people actually have to look for a job before being eligible for welfare. He ended the “retirement test” for Social Security benefits (a huge tax cut for elderly workers), pushed the North American Free Trade Agreement through Congress against his union supporters and many of his own party members, signed the largest capital gains tax cut ever (which exempted owner-occupied homes from capital gains taxes), and finally reduced government spending as a share of GDP by an amazing three percentage points (more than the next four best presidents combined). The stock market loved Mr. Clinton as it had loved Reagan, and for good reasons.

The stock market is obviously no fan of second-term George W. Bush, Nancy Pelosi, Harry Reid, Ben Bernanke, Barack Obama or John McCain, and again for good reasons.

These issues aren’t Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren’t.

I was on the White House staff as George Shultz’s economist in the Office of Management and Budget when Richard Nixon imposed wage and price controls, the dollar was taken off gold, import surcharges were implemented, and other similar measures were enacted from a panicked decision made in August of 1971 at Camp David.

I witnessed, like everyone else, the consequences of another panicked decision to cover up the Watergate break-in. I saw up close and personal Presidents Gerald Ford and George H.W. Bush succumb to panicked decisions to raise taxes, as well as Jimmy Carter’s emergency energy plan, which included wellhead price controls, excess profits taxes on oil companies, and gasoline price controls at the pump.

The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again. Yikes!

Then we have this administration’s panicked Sarbanes-Oxley legislation, and of course the deer-in-the-headlights Mr. Bernanke in his bungling of monetary policy.

There are many more examples, but none hold a candle to what’s happening right now. Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity.

Mr. Laffer is chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy — If We Let it Happen,” just out by Threshold.

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Schumpeter

Over the horizon

Three issues that should preoccupy managers in the next 50 years

Sep 6th 2014 |
From the print edition Economist

FOR most people a 50th anniversary is an excuse for a party. For the men and women of McKinsey it is an excuse for a conference. Earlier this year the consulting firm decided to celebrate half a century of the
McKinsey Quarterly by arranging a gathering of some of the world’s leading business thinkers and asking them to look forward to the next 50 years of management. The resulting special issue of the
Quarterly is inevitably a mixed bag. A discussion on strategy inadvertently demonstrates the parlous state of the discipline that has provided McKinsey with its bread and butter. A puff-piece on eBay’s policy of recruiting female executives demonstrates that you should never let companies write about themselves (“Gender diversity has long been a passion of our CEO…”). But there are three issues that stand out.

The first is that the rise of smart machines will have a dramatic impact on the role of executives. Andrew McAfee of the Massachusetts Institute of Technology points out that the first machine age gave rise to the modern discipline of management: companies hired armies of managers to co-ordinate the workers who operated the machines, and to organise supply chains and distribution systems. The second machine age will reconfigure the discipline: much of the work of bosses, from analysing complex data to recruiting staff and setting bonuses, will be automated.

Some companies have already begun delegating management decisions to machines. Google’s “human-performance analytics group” uses algorithms to decide which interview techniques are best at choosing good employees, and to optimise pay. Deep Knowledge Ventures, a Hong Kong-based venture-capital firm that specialises in drugs for age-related diseases, has even appointed an algorithm to its board of directors. Its name is Vital, and it gets a vote on which companies the firm invests in.

Senior managers will have to rethink their roles dramatically if they are not to become latter-day Luddites. They will have to hand some of their functions to intelligent machines, which will always be better at data analysis than humans, and some to the heads of business units, who will be in a better position to make use of the crunched data. Executives will increasingly focus on the two things that humans can still do better than machines—motivating the troops and producing game-changing thoughts. Mr McAfee says, “I’ve never seen a piece of technology that could negotiate effectively. Or motivate and lead a team.” Tom Peters, a veteran American management guru, reckons the best leaders of the future will spend half their time reading books.

The second idea is a new twist on a familiar worry about productivity. Economic growth has traditionally been fuelled by two things: higher productivity and more workers. But productivity growth has been disappointing in recent years, and, more important, the population is beginning to age: the United Nations predicts that, for the world as a whole, the number of people employed will increase by just 0.03% a year over the next 50 years compared with 1.8% in the past 50.

McKinsey argues that there are good reasons to be optimistic about improving productivity. The IT revolution is turbocharging what once looked like mature management technologies such as lean production and supply-chain management. Cloud computing lets small startups harness computing power that was once reserved for big firms. But the biggest potential gains will come from focusing on areas of the economy that have either been overlooked, because of a lack of imagination, or have stagnated, because they are protected by powerful interests.

There is considerable scope for boosting productivity in the use of industrial materials: first, by greatly expanding the recycling and reuse of metals and other matter; second, by replacing suboptimal materials with better ones (eg, carbon-fibre composites to replace metal in cars and planes) and third, by using “virtual” materials rather than physical ones, as with digital books and records. John van Reenen of the London School of Economics also notes that many developing countries, particularly India, have a long tail of badly managed companies. Productivity would improve significantly if these laggards were subjected to greater competition: Alibaba is already shaking up the Chinese retail industry in the way that Walmart shook up America’s in the 1990s, and India’s productivity would be similarly boosted if it opened up its archaic retail sector to foreign companies.

Obscure cities of the future

The third idea is also a twist on a well-known worry, about globalisation. Understanding emerging markets will no longer be enough. Managers will have to familiarise themselves with a mind-boggling number of mid-level cities in the developing world if they are to ride the next wave of globalisation. McKinsey notes that almost half of the world’s GDP growth between 2010 and 2025 will come from 440 cities in emerging markets: managers will have to learn about big, obscure places like Tianjin (China), Porto Alegre (Brazil) and Kumasi (Ghana).

These cities could be homes to competitors as well as consumers: McKinsey thinks that by 2025 no less than 45% of businesses on
Fortune’s Global 500 list of the world’s biggest companies will be based in emerging markets, compared with just 5% in 2000. Given these changes, strategists at multinationals will no longer be able to think in terms of a set of national markets, each divided into a handful of income brackets. They will have to learn to “zoom out” to produce a coherent global approach and then “zoom in” to tailor their strategies to the idiosyncrasies of particular cities and the taxonomy of consumers in each.

Such growing complexity hardly supports Mr Peters’s idea that the managers of the future will be able to devote half of their time reading books. But it certainly suggests they will need all the help they can get—and maybe smart machines will turn out to be better guides even than management consultants.

From the print edition: Business

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Business education

Change management

The MBA is being transformed, for better and for worse

Oct 12th 2013 |
From the print edition of The Economist

THE master of business administration is one of the success stories of our time. Since it was first offered by Harvard Business School (HBS) in 1908, the MBA’s rise has seemed unstoppable. Having conquered America, it reached Europe’s shores in 1957 when INSEAD, a French school, launched a programme. In the past couple of decades, Asia, South America and Africa have succumbed. Today, it is the second most popular postgraduate degree in America (after education).

Whereas 40 years ago, American colleges graduated similar numbers of lawyers and MBAs, nowadays nearly four times as many students pass out with a business-school master’s degree than with a law-school one (see chart). Although demand among Americans is plateauing, the slack has been taken up by emerging markets, particularly in Asia. India now has around 2,000 business schools, more than any other country. China has fewer, but their numbers are growing quickly. It has an estimated 250 MBA programmes, graduating around 30,000 students each year. This is less than half the number it will need over the next decade, according to Hao Hongrui of DHD, a consultancy.

Yet for all its success, these are demanding times. For a start, MBA candidates are beginning to question the return on investment of such expensive programmes. Business schools claim their graduates are less concerned than they once were about earning fabulous salaries. Instead of trumpeting the number of students who get high-paying jobs in finance, they now reel off examples of those who join non-profits or launch social enterprises. This fits the socially-aware image they wish to portray after the financial crisis.

However, there is a whiff of post-hoc rationalisation in this. Data from our latest ranking of full-time MBA courses (see
article), show that the average basic salary of graduating students is now $94,000, around $1,500 less than it was five years ago. And yet our survey of business-school students suggests that they are more focused on the size of their pay-packets than those who enrolled before the crisis.

As salaries have fallen, tuition fees have risen. At Chicago, our top-ranked school, two years’ tuition costs $112,000, an increase of around $17,000 since 2008. Harvard’s prices have risen by nearly $25,000. A degree that once let the brightest students name their starting salaries now warrants a careful cost-benefit analysis.

Concentrate!

The MBA is changing in other ways, too. The days in which students study a broad set of management skills, with little specialisation, are numbered. Most business schools now encourage students to concentrate on one area, such as finance. An increasing number of MBA courses are tailored to particular industries, such as health care, luxury goods or, in one case, wine and spirits management.

This is partly because students now have to have a clear career plan before they apply to business school. Competition for plum summer internships, the most common route to a post-MBA job, begins on the first day of school. Such is the focus on finding the right job, laments Sunil Kumar, dean of Chicago’s Booth School of Business, that students sometimes forget to savour the academic experience.

Business schools are expanding in other ways too. University administrators are wont to view them as cash cows and allow them to graze on other faculties accordingly. For years, they have been poaching professors from economics departments. Now they also woo psychologists and sociologists to teach softer subjects such as leadership and organisational behaviour. And their scope seems to be expanding.

“Big data” is currently one of the hottest study areas. York University in Canada, for example, recently launched a Master’s in Business Analytics. It recruits students with solid quantitative backgrounds, such as mathematicians and engineers, who spend half their time poring over mathematical models and half taking MBA classes. It is not enough to be a top-notch statistician nowadays, says Murat Kristal, director of the programme. Firms want people who can also understand the business implications of their analysis.

Perhaps the most disruptive influence on MBAs will be educational technology. Many institutions, from leviathans such as the University of Pennsylvania’s Wharton school to relative tiddlers such as Grenoble in France, now make some of their courses available free of charge as “massive online open courses”, or MOOCs. It is uncertain what long-term effect this will have. Roger Martin, the recently departed dean of Toronto’s Rotman school, clearly remains unconvinced: “Giving away your product? In what way is that a business?”

Instead, it is more likely disruption will be from better distance-learning technology. Demand for mass-market, paid-for but cheap online MBAs, delivered by institutions such as the University of Phoenix, is not new. However, it has been rarer for prestigious, traditional universities to offer distance-learning MBAs. This is changing. Top-ranked schools are spending heavily to equip themselves for this. Chicago, for example, has built video studios at its American campus so that students on its foreign campuses, in London and Singapore, do not miss its best tutors’ lectures.

The University of North Carolina at Chapel Hill (UNC) has gone further. It is one of the first top-ranked schools to offer a full-time MBA programme entirely at a distance. It has just enrolled 500 students in the second intake of its MBA@UNC programme, an online MBA that can be completed in 18 months. This is close to double the number it enrolls for its campus-based version. Interestingly, it typically costs a little more than attending Chapel Hill, partly because the technology has not come cheap. Yet students are signing up because they prefer not to give up their jobs, or because they cannot move to the campus for other reasons.

The tipping-point

Douglas Shackelford, the programme’s director, says that online classroom technology has now reached a tipping-point, whereby it is at least as good as a real classroom. Classes on the programme are limited to 15 students, spread across the globe, all of whom can interact. It has also allowed UNC to employ the best tutors whether or not they are in North Carolina. Professors lecture from India, France and across America. All lectures and class discussions are available in perpetuity, to be rewatched before exams or even after students graduate. Yet Mr Shackelford thinks he is only scratching the surface: “In 10 years we will look back and be embarrassed it was so simple.”

This may come at a cost, however. As students get more choice, so business schools, perhaps for the first time, will be forced to compete on price, says Clayton Christensen, the Harvard professor who coined the idea of disruptive innovation. Many will find they do not have the resources, so there could, thinks Mr Christensen, be many casualties. Students might celebrate; business schools may prefer to keep the champagne on ice.

From the print edition: Briefing

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Special report:

Outsourcing and offshoring

In this special report

· Here, there and everywhere

·

The story so far

·

Coming home

·

Staying put

·

Herd instinct

·

On the turn

·

The next big thing

·

Rise of the software machines

·

Shape up

Sources & acknowledgements
Reprints

Here, there and everywhere

After decades of sending work across the world, companies are rethinking their offshoring strategies, says Tamzin Booth

Jan 19th 2013 |

From the print edition

EARLY NEXT MONTH local dignitaries will gather for a ribbon-cutting ceremony at a facility in Whitsett, North Carolina. A new production line will start to roll and the seemingly impossible will happen: America will start making personal computers again. Mass-market computer production had been withering away for the past 30 years, and the vast majority of laptops have always been made in Asia. Dell shut two big American factories in 2008 and 2010 in a big shift to China, and HP now makes only a small number of business desktops at home.

The new manufacturing facility is being built not by an American company but by Lenovo, a highly successful Chinese technology group. Founded in 1984 by 11 engineers from the Chinese Academy of Sciences, it bought IBM’s ThinkPad personal-computer business in 2005 and is now by some measures the world’s biggest PC-maker, just ahead of HP, and the fastest-growing.

Lenovo’s move marks the latest twist in a globalisation story that has been running since the 1980s. The original idea behind offshoring was that Western firms with high labour costs could make huge savings by sending work to countries where wages were much lower (see

article
). Offshoring means moving work and jobs outside the country where a company is based. It can also involve outsourcing, which means sending work to outside contractors. These can be either in the home country or abroad, but in offshoring they are based overseas. For several decades that strategy worked, often brilliantly. But now companies are rethinking their global footprints.

The first and most important reason is that the global labour “arbitrage” that sent companies rushing overseas is running out. Wages in China and India have been going up by 10-20% a year for the past decade, whereas manufacturing pay in America and Europe has barely budged. Other countries, including Vietnam, Indonesia and the Philippines, still offer low wages, but not China’s scale, efficiency and supply chains. There are still big gaps between wages in different parts of the world, but other factors such as transport costs increasingly offset them. Lenovo’s labour costs in North Carolina will still be higher than in its factories in China and Mexico, but the gap has narrowed substantially, so it is no longer a clinching reason for manufacturing in emerging markets. With more automation, says David Schmoock, Lenovo’s president for North America, labour’s share of total costs is shrinking anyway.

Second, many American firms now realise that they went too far in sending work abroad and need to bring some of it home again, a process inelegantly termed “reshoring”. Well-known companies such as Google, General Electric, Caterpillar and Ford Motor Company are bringing some of their production back to America or adding new capacity there. In December Apple said it would start making a line of its Mac computers in America later this year.

Choosing the right location for producing a good or a service is an inexact science, and many companies got it wrong. Michael Porter, Harvard Business School’s guru on competitive strategy, says that just as companies pursued many unpromising mergers and acquisitions until painful experience brought greater discipline to the field, a lot of chief executives offshored too quickly and too much. In Europe there was never as much enthusiasm for offshoring as in America in the first place, and the small number of companies that did it are in no rush to return.

Firms are now discovering all the disadvantages of distance. The cost of shipping heavy goods halfway around the world by sea has been rising sharply, and goods spend weeks in transit. They have also found that manufacturing somewhere cheap and far away but keeping research and development at home can have a negative effect on innovation. One answer to this would be to move the R&D too, but that has other drawbacks: the threat of losing valuable intellectual property in far-off places looms ever larger. And a succession of wars and natural disasters in the past decade has highlighted the risk that supply chains a long way from home may become disrupted.

Third, firms are rapidly moving away from the model of manufacturing everything in one low-cost place to supply the rest of the world. China is no longer seen as a cheap manufacturing base but as a huge new market. Increasingly, the main reason for multinationals to move production is to be close to customers in big new markets. This is not offshoring in the sense the word has been used for the past three decades; instead, it is being “onshore” in new places. Peter Löscher, the chief executive of Siemens, a German engineering firm, recently commented that the notion of offshoring is in any case an odd one for a truly international company. The “home shore” for Siemens, he said, is now as much China and India as it is Germany or America.

Companies now want to be in, or close to, each of their biggest markets, making customised products and responding quickly to changing local demand. Pierre Beaudoin, chief executive of Bombardier, a Canadian maker of aeroplanes and trains, says the firm used to focus on cost savings made by sending jobs abroad; now Bombardier is in China for the sake of China.

Lenovo, as a Chinese company, has its own factories in China. The reason it is moving some production to America is that it will be able to customise its computers for American customers and respond quickly to them. If it made them in China they would spend six weeks on a ship, says Mr Schmoock.

Under this logic, America and Europe, with their big domestic markets, should be able to attract plenty of new investment as companies look for a bigger local presence in places around the world. It is not just Western firms bringing some of their production home; there is also a wave of emerging-market champions such as Lenovo, or the Tata Group, which is making Range Rover cars near Liverpool, that are coming to invest in brands, capacity and workers in the West.

Such changes are happening not only in manufacturing but increasingly in services too. Companies may either outsource IT and back-office work to other companies, which could be in the same country or abroad, or offshore it to their own centres overseas. Software programming, call centres and data-centre management were the first tasks to move, followed by more complex ones such as medical diagnoses and analytics for investment banks.

As in manufacturing, the labour-cost arbitrage in services is rapidly eroding, leaving firms with all the drawbacks of distance and ever fewer cost savings to make up for them. There has been widespread disappointment with outsourcing information technology and the routine back-office tasks that used to be done in-house. Some activities that used to be considered peripheral to a company’s profits, such as data management, are now seen as essential, so they are less likely to be entrusted to a third-party supplier thousands of miles away.

Coming full circle

Even General Electric is reversing its course in some important areas of its business. In the 1990s it had pioneered the offshoring of services, setting up one of the very first “captive”, or fully owned, offshore service centres in Gurgaon in 1997. Up until last year around half of GE’s information-technology work was being done outside the company, mostly in India, but the company found that it was losing too much technical expertise and that its IT department was not responding quickly enough to changing technology needs. It is now adding hundreds of IT engineers at a new centre in Van Buren Township in Michigan.

This special report will examine the changing economics of offshoring in the corporate world. It will show that offshoring in its traditional sense, in search of cheaper labour anywhere on the globe, is maturing, tailing off and to some extent being reversed. Multinationals will certainly not become any less global as a result, but they will distribute their activities more evenly and selectively around the world, taking heed of a far broader range of variables than labour costs alone.

That offers a huge opportunity for rich countries and their workers to win back some of the industries and activities they have lost over the past few decades. Paradoxically, the narrowing wage gap increases the pressure on politicians. With labour-cost differentials narrowing rapidly, it is no longer possible to point at rock-bottom wages in emerging markets as the reason why the rich world is losing out. Developed countries will have to compete hard on factors beyond labour costs. The most important of these are world-class skills and training, along with flexibility and motivation of workers, extensive clusters of suppliers and sensible regulation.

From the print edition: Special report

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Schumpeter

The silence of Mammon

Dec 17th 2009
From The Economist print edition

Business people should stand up for themselves

Illustration by Brett Ryder

HENRY HAZLITT, one of the great popularisers of free-market thinking, once said that good ideas have to be relearned in every generation. This is certainly true of good ideas about business. A generation ago Margaret Thatcher and Ronald Reagan did an excellent job of making the case in favour of business. Today it looks as though the case needs to be made all over again.

It is hardly surprising that business has fallen from grace in recent years. The credit crunch almost plunged the world into depression. The new century began with the implosion of Enron and other prominent firms. Some bosses pay themselves like princes while preaching austerity to their workers. Business titans who once graced the covers of magazines have been hauled before congressional committees or carted off to prison.

Business people have been at pains to point out that it is unfair to judge all of their kind by the misdeeds of a few. The credit crunch was the handiwork of bankers (who lent too much money) and policymakers (who fooled themselves into thinking that they had abolished boom and bust). Corporate criminals like WorldCom’s Bernie Ebbers and Tyco’s Denis Kozlowski were imprisoned for their crimes. Avaricious bosses like Angelo Mozilo, who pocketed more than $550m during his inglorious reign at Countrywide, are exceptions. The average American boss is actually paid less today than he was in 2000.

This is all true enough but hardly sets the blood racing. More ambitious defenders of business have advanced two arguments. The first is that many firms are devoted to good works. They routinely trumpet their passionate commitment not just to their various stakeholders (such as workers and suppliers) but to the planet at large. Timberland puts “green index” labels on all its shoes. GlaxoSmithKline makes HIV drugs available at cost to millions of Africans. Starbucks buys lots of Fairtrade coffee.

The second argument is more hard-headed: that businesses have done more than any other institutions to advance prosperity, turning the luxuries of the rich, such as cars a century ago and computers today, into goods for the masses. General Electric’s aircraft engines transport 660m people a year and its imaging machines scan 230m patients. Wal-Mart’s “everyday low prices” save Americans at least $50 billion a year.

The problem with the first argument is that it smacks of appeasement. Advocates of corporate social responsibility suggest that business has something to apologise for, and thus encourage its critics to find ever more to complain about. Crocodiles never go away if you feed them. The problem with the second argument is that it does not go far enough. It focuses exclusively on material well-being, and so fails to engage with people’s moral qualms about business.

This is doubly regrettable. It is regrettable because it has allowed critics of business to dominate the discussion of corporate morality. For all too many people it is now taken as a given that companies promote greed, crush creativity and monopolise power. And it is regrettable because it has deprived the business world of three rather better arguments in its defence.

The first is that business is a remarkable exercise in co-operation. For all the talk of competition “red in tooth and claw”, companies in fact depend on persuading large numbers of people—workers and bosses, shareholders and suppliers—to work together to a common end. This involves getting lots of strangers to trust each other. It also increasingly involves stretching that trust across borders and cultures. Apple’s iPod is not just a miracle of design. It is also a miracle of co-operation, teaming Californian designers with Chinese manufacturers and salespeople in all corners of the earth. It is worth remembering that the word “company” is derived from the Latin words “cum” and “pane”—meaning “breaking bread together”.

Another rejoinder is that business is an exercise in creativity. Business people do not just invent clever products that solve nagging problems, from phones that can link fishermen in India with nearby markets to devices that can provide insulin to diabetics without painful injections. They also create organisations that manufacture these products and then distribute them about the world. Nandan Nilekani, one of the founders of Infosys, put the case for business as well as anyone when he said that the computer-services giant’s greatest achievement was not its $2 billion in annual revenue but the fact that it had taught his fellow Indians to “redefine the possible”.

Enfranchising, not enslaving

A third defence is that business helps maintain political pluralism. Anti-capitalists are fond of arguing that companies account for half of the world’s 100 biggest economies. But this argument not only depends on the abuse of statistics—comparing corporate turnover with GDP (which measures value added, not sales). It also rests on ignorance of the pressures of business life.

Companies have a difficult enough job staying alive, let alone engaging in a “silent takeover” of the state. Only 202 of the 500 biggest companies in America in 1980 were still in existence 20 years later. Anti-capitalists actually have it upside down. Companies actually prevent each other from gaining too much power, and also act as a check on the power of governments that would otherwise be running the economy. The proportion of the world’s governments that can reasonably be called democratic has increased from 40% in 1980, when the pro-business revolution began, to more than 60% today.

Most hard-headed business people are no doubt reluctant to make these arguments. They are more concerned with balancing their books than with engaging in worthy debates about freedom and democracy. But they would do well to become a bit less reticent: the price of silence will be an ever more hostile public and ever more overbearing government.

Copyright © 2010 The Economist Newspaper and The Economist Group. All rights reserved.

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THE SATURDAY ESSAY

· October 12, 2013, 8:50 p.m. ET

Scott Adams’ Secret of Success: Failure

What’s the best way to climb to the top? Be a failure.

“Dilbert” creator Scott Adams talks to WSJ editor Gary Rosen about how to draw lessons, skills and ideas from your failures—and why following your passion is asking for trouble. Photo: Scott Adams

If you’re already as successful as you want to be, both personally and professionally, congratulations! Here’s the not-so-good news: All you are likely to get from this article is a semientertaining tale about a guy who failed his way to success. But you might also notice some familiar patterns in my story that will give you confirmation (or confirmation bias) that your own success wasn’t entirely luck.

Share Your Failures

Forget passion. Goals are for losers. Dilbert creator Scott Adams reveals his secret to climbing to the top: Suffer defeat. Lots and lots of defeat. Readers, we want to hear from you.
Share your best stories of failure and we’ll choose a few to feature in an upcoming blog post.

If you’re just starting your journey toward success—however you define it—or you’re wondering what you’ve been doing wrong until now, you might find some novel ideas here. Maybe the combination of what you know plus what I think I know will be enough to keep you out of the wood chipper.

Let me start with some tips on what not to do. Beware of advice about successful people and their methods. For starters, no two situations are alike. Your dreams of creating a dry-cleaning empire won’t be helped by knowing that Thomas Edison liked to take naps. Secondly, biographers never have access to the internal thoughts of successful people. If a biographer says Henry Ford invented the assembly line to impress women, that’s probably a guess.

But the most dangerous case of all is when successful people directly give advice. For example, you often hear them say that you should “follow your passion.” That sounds perfectly reasonable the first time you hear it. Passion will presumably give you high energy, high resistance to rejection and high determination. Passionate people are more persuasive, too. Those are all good things, right?

Here’s the counterargument: When I was a commercial loan officer for a large bank, my boss taught us that you should never make a loan to someone who is following his passion. For example, you don’t want to give money to a sports enthusiast who is starting a sports store to pursue his passion for all things sporty. That guy is a bad bet, passion and all. He’s in business for the wrong reason.

My boss, who had been a commercial lender for over 30 years, said that the best loan customer is someone who has no passion whatsoever, just a desire to work hard at something that looks good on a spreadsheet. Maybe the loan customer wants to start a dry-cleaning store or invest in a fast-food franchise—boring stuff. That’s the person you bet on. You want the grinder, not the guy who loves his job.

For most people, it’s easy to be passionate about things that are working out, and that distorts our impression of the importance of passion. I’ve been involved in several dozen business ventures over the course of my life, and each one made me excited at the start. You might even call it passion.

The ones that didn’t work out—and that would be most of them—slowly drained my passion as they failed. The few that worked became more exciting as they succeeded. For example, when I invested in a restaurant with an operating partner, my passion was sky high. And on day one, when there was a line of customers down the block, I was even more passionate. In later years, as the business got pummeled, my passion evolved into frustration and annoyance.

On the other hand, Dilbert started out as just one of many get-rich schemes I was willing to try. When it started to look as if it might be a success, my passion for cartooning increased because I realized it could be my golden ticket. In hindsight, it looks as if the projects that I was most passionate about were also the ones that worked. But objectively, my passion level moved with my success. Success caused passion more than passion caused success.

So forget about passion. And while you’re at it, forget about goals, too.

Just after college, I took my first airplane trip, destination California, in search of a job. I was seated next to a businessman who was probably in his early 60s. I suppose I looked like an odd duck with my serious demeanor, bad haircut and cheap suit, clearly out of my element. I asked what he did for a living, and he told me he was the CEO of a company that made screws. He offered me some career advice. He said that every time he got a new job, he immediately started looking for a better one. For him, job seeking was not something one did when necessary. It was a continuing process.

This makes perfect sense if you do the math. Chances are that the best job for you won’t become available at precisely the time you declare yourself ready. Your best bet, he explained, was to always be looking for a better deal. The better deal has its own schedule. I believe the way he explained it is that your job is not your job; your job is to find a better job.

This was my first exposure to the idea that one should have a system instead of a goal. The system was to continually look for better options.

Throughout my career I’ve had my antennae up, looking for examples of people who use systems as opposed to goals. In most cases, as far as I can tell, the people who use systems do better. The systems-driven people have found a way to look at the familiar in new and more useful ways.

To put it bluntly, goals are for losers. That’s literally true most of the time. For example, if your goal is to lose 10 pounds, you will spend every moment until you reach the goal—if you reach it at all—feeling as if you were short of your goal. In other words, goal-oriented people exist in a state of nearly continuous failure that they hope will be temporary.

If you achieve your goal, you celebrate and feel terrific, but only until you realize that you just lost the thing that gave you purpose and direction. Your options are to feel empty and useless, perhaps enjoying the spoils of your success until they bore you, or to set new goals and re-enter the cycle of permanent presuccess failure.

I have a friend who is a gifted salesman. He could have sold anything, from houses to toasters. The field he chose (which I won’t reveal because he wouldn’t appreciate the sudden flood of competition) allows him to sell a service that almost always auto-renews. In other words, he can sell his service once and enjoy ongoing commissions until the customer dies or goes out of business. His biggest problem in life is that he keeps trading his boat for a larger one, and that’s a lot of work.

Observers call him lucky. What I see is a man who accurately identified his skill set and chose a system that vastly increased his odds of getting “lucky.” In fact, his system is so solid that it could withstand quite a bit of bad luck without buckling. How much passion does this fellow have for his chosen field? Answer: zero. What he has is a spectacular system, and that beats passion every time.

As for my own system, when I graduated from college, I outlined my entrepreneurial plan. The idea was to create something that had value and—this next part is the key—I wanted the product to be something that was easy to reproduce in unlimited quantities. I didn’t want to sell my time, at least not directly, because that model has an upward limit. And I didn’t want to build my own automobile factory, for example, because cars are not easy to reproduce. I wanted to create, invent, write, or otherwise concoct something widely desired that would be easy to reproduce.

Scott Adams

My system of creating something the public wants and reproducing it in large quantities nearly guaranteed a string of failures. By design, all of my efforts were long shots. Had I been goal-oriented instead of system-oriented, I imagine I would have given up after the first several failures. It would have felt like banging my head against a brick wall.

But being systems-oriented, I felt myself growing more capable every day, no matter the fate of the project that I happened to be working on. And every day during those years I woke up with the same thought, literally, as I rubbed the sleep from my eyes and slapped the alarm clock off.

Today’s the day.

If you drill down on any success story, you always discover that luck was a huge part of it. You can’t control luck, but you can move from a game with bad odds to one with better odds. You can make it easier for luck to find you. The most useful thing you can do is stay in the game. If your current get-rich project fails, take what you learned and try something else. Keep repeating until something lucky happens. The universe has plenty of luck to go around; you just need to keep your hand raised until it’s your turn. It helps to see failure as a road and not a wall.

I’m an optimist by nature, or perhaps by upbringing—it’s hard to know where one leaves off and the other begins—but whatever the cause, I’ve long seen failure as a tool, not an outcome. I believe that viewing the world in that way can be useful for you too.

Nietzsche famously said, “What doesn’t kill us makes us stronger.” It sounds clever, but it’s a loser philosophy. I don’t want my failures to simply make me stronger, which I interpret as making me better able to survive future challenges. (To be fair to Nietzsche, he probably meant the word “stronger” to include anything that makes you more capable. I’d ask him to clarify, but ironically he ran out of things that didn’t kill him.)

Becoming stronger is obviously a good thing, but it’s only barely optimistic. I do want my failures to make me stronger, of course, but I also want to become smarter, more talented, better networked, healthier and more energized. If I find a cow turd on my front steps, I’m not satisfied knowing that I’ll be mentally prepared to find some future cow turd. I want to shovel that turd onto my garden and hope the cow returns every week so I never have to buy fertilizer again. Failure is a resource that can be managed.

Before launching Dilbert, and after, I failed at a long series of day jobs and entrepreneurial adventures. Here are just a few of the worst ones. I include them because successful people generally gloss over their most aromatic failures, and it leaves the impression that they have some magic you don’t.

When you’re done reading this list, you won’t have that delusion about me, and that’s the point. Success is entirely accessible, even if you happen to be a huge screw-up 95% of the time.

My failures:

Velcro Rosin Bag Invention: In the 1970s, tennis players sometimes used rosin bags to keep their racket hands less sweaty. In college, I built a prototype of a rosin bag that attached to a Velcro strip on tennis shorts so it would always be available when needed. My lawyer told me it wasn’t patentworthy because it was simply a combination of two existing products. I approached some sporting-goods companies and got nothing but form-letter rejections. I dropped the idea.

But in the process I learned a valuable lesson: Good ideas have no value because the world already has too many of them. The market rewards execution, not ideas. From that point on, I concentrated on ideas that I could execute. I was already failing toward success, but I didn’t yet know it.

Gopher Offer: During my banking career, in my late 20s, I caught the attention of a senior vice president at the bank. Apparently my b.s. skills in meetings were impressive. He offered me a job as his gopher/assistant with the vague assurance that I would meet important executives during the normal course of my work, which would make it easy for him to strap a rocket to my backside—as the saying roughly went—and launch me up the corporate ladder.

On the downside, the challenge would be to survive his less-than-polite management style and do his bidding for a few years. I declined his offer because I was already managing a small group of people, so becoming a gopher seemed like a step backward. I believe the senior vice president’s exact characterization of my decision was “[expletive] STUPID!!!” He hired one of my co-workers for the job instead, and in a few years that fellow became one of the youngest vice presidents in the bank’s history.

I worked for Crocker National Bank in San Francisco for about eight years, starting at the very bottom and working my way up to lower management. During the course of my banking career, and in line with my strategy of learning as much as I could about the ways of business, I gained an extraordinarily good overview of banking, finance, technology, contracts, management and a dozen other useful skills. I wouldn’t have done it any differently.

Webvan: In the dot-com era, a startup called Webvan promised to revolutionize grocery delivery. You could order grocery-store items over the Internet, and one of Webvan’s trucks would load your order at the company’s modern distribution hub and set out to service all the customers in your area.

I figured Webvan would do for groceries what Amazon had done for books. It was a rare opportunity to get in on the ground floor. I bought a bunch of Webvan stock and felt good about myself. When the stock plunged, I bought some more. I repeated that process several times, each time licking my lips as I acquired ever-larger blocks of the stock at prices I knew to be a steal.

When the company announced that it had achieved positive cash flow at one of its several hubs, I knew that I was onto something. If it worked in one hub, the model was proved, and it would surely work at others. I bought more stock. Now I owned approximately, well, a boatload.

A few weeks later, Webvan went out of business. Investing in Webvan wasn’t the dumbest thing I’ve ever done, but it’s a contender. The loss wasn’t enough to change my lifestyle. But boy, did it sting psychologically. In my partial defense, I knew it was a gamble, not an investment per se.

What I learned from that experience is that there is no such thing as useful information that comes from a company’s management. Now I diversify and let the lying get smoothed out by all the other variables in my investments.

These failures are just a sampling. I’m delighted to admit that I’ve failed at more challenges than anyone I know.

As for you, I’d like to think that reading this will set you on the path of your own magnificent screw-ups and cavernous disappointments. You’re welcome! And if I forgot to mention it earlier, that’s exactly where you want to be: steeped to your eyebrows in failure.

It’s a good place to be because failure is where success likes to hide in plain sight. Everything you want out of life is in that huge, bubbling vat of failure. The trick is to get the good stuff out.

Mr. Adams is the creator of Dilbert. Adapted from his book “How to Fail at Almost Everything and Still Win Big,” to be published by Portfolio, a member of Penguin Group (USA), on Oct. 22.

A version of this article appeared October 11, 2013, on page C1 in the U.S. edition of The Wall Street Journal, with the headline: Fail Your Way toSuccess.

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The future of universities

The digital degree

The staid higher-education business is about to experience a welcome earthquake

Jun 28th 2014 |
From the print edition

FROM Oxford’s quads to Harvard Yard and many a steel and glass palace of higher education in between, exams are giving way to holidays. As students consider life after graduation, universities are facing questions about their own future. The higher-education model of lecturing, cramming and examination has barely changed for centuries. Now, three disruptive waves are threatening to upend established ways of teaching and learning.

On one front, a funding crisis has created a shortfall that the universities’ brightest brains are struggling to solve. Institutions’ costs are rising, owing to pricey investments in technology, teachers’ salaries and galloping administrative costs. That comes as governments conclude that they can no longer afford to subsidise universities as generously as they used to. American colleges, in particular, are under pressure: some analysts predict mass bankruptcies within two decades.

At the same time, a technological revolution is challenging higher education’s business model. An explosion in online learning, much of it free, means that the knowledge once imparted to a lucky few has been released to anyone with a smartphone or laptop. These financial and technological disruptions coincide with a third great change: whereas universities used to educate only a tiny elite, they are now responsible for training and retraining workers throughout their careers. How will they survive this storm—and what will emerge in their place if they don’t?

Finance 101

Universities have passed most of their rising costs on to students. Fees in private non-profit universities in America rose by 28% in real terms in the decade to 2012, and have continued to edge up. Public universities increased their fees by 27% in the five years to 2012. Their average fees are now almost $8,400 for students studying in-state, and more than $19,000 for the rest. At private colleges average tuition is more than $30,000 (two-thirds of students benefit from bursaries of one sort or another). American student debt adds up to $1.2 trillion, with more than 7m people in default.

For a long time the debt seemed worth it. For most students the “graduate premium” of better-paid jobs still repays the cost of getting a degree (see
article). But not all courses pay for themselves, and flatter graduate salaries mean it takes students longer to start earning good money. Student enrolments in America, which rose from 15.2m in 1999 to 20.4m in 2011, have slowed, falling by 2% in 2012.

Small private colleges are now struggling to balance their books. Susan Fitzgerald of Moody’s, a credit-rating agency, foresees a “death spiral” of closures. William Bowen, a former president of Princeton University, talks of a “cost disease”, in which universities are investing extravagantly in shiny graduate centres, libraries and accommodation to attract students.

Politically, the mood has shifted too. Both Bill Clinton and Barack Obama have said that universities face a poor outlook if they cannot lower their costs, marking a shift from the tendency of centre-left politicians to favour more public spending on academia. Cuts made by state governments have been partly offset by an increase in federal “Pell Grants” to poor students. But American universities will soon receive more money from tuition fees than from public funding (see chart 1).

In Asia tuition-fee inflation, running at around 5% for the past five years among leading universities, has stoked middle-class anxieties about the cost of college. Latin American countries fret about keeping fees low enough to expand the pool of graduates. In Europe high levels of subsidy, coupled with lower rates of college attendance, have insulated universities. But fees are going up: in 1998 Britain introduced annual tuition fees of just £1,000 (then $1,650), which by 2012 had increased to a maximum of £9,000 ($13,900).

Rising costs could scarcely strike at a worse time. Around the world demand for retraining and continuing education is soaring among workers of all ages. Globalisation and automation have shrunk the number of jobs requiring a middling level of education. Those workers with the means to do so have sought more education, in an attempt to stay ahead of the labour-demand curve. In America, higher-education enrolment by students aged 35 or older rose by 314,000 in the 1990s, but by 899,000 in the 2000s.

Improvements in machine intelligence are enabling automation to creep into new sectors of the economy, from book-keeping to retail. New online business models threaten sectors that had, until recently, weathered the internet storm. Carl Benedikt Frey and Michael Osborne, of Oxford University, reckon that perhaps 47% of occupations could be automated in the next few decades. They find that the odds of displacement drop sharply as educational attainment rises.

iPad illuminatio mea

So demand for education will grow. Who will meet it? Universities face a new competitor in the form of massive open online courses, or MOOCs. These digitally-delivered courses, which teach students via the web or tablet apps, have big advantages over their established rivals. With low startup costs and powerful economies of scale, online courses dramatically lower the price of learning and widen access to it, by removing the need for students to be taught at set times or places. The low cost of providing courses—creating a new one costs about $70,000—means they can be sold cheaply, or even given away. Clayton Christensen of Harvard Business School considers MOOCs a potent “disruptive technology” that will kill off many inefficient universities. “Fifteen years from now more than half of the universities [in America] will be in bankruptcy,” he predicted last year.

The first MOOC began life in Canada in 2008 as an online computing course. It was 2012, dubbed the “year of the MOOC”, that generated vatic excitement about the idea. Three big MOOC-sters were launched: edX, a non-profit provider run by Harvard and the Massachusetts Institute of Technology (MIT); Coursera, partnered with Stanford University; and Udacity, a for-profit co-founded by Sebastian Thrun, who taught an online computing course at Stanford. The big three have so far provided courses to over 12m students. Just under one-third are Americans, but edX says nearly half its students come from developing countries (see chart 2). Coursera’s new chief executive, Richard Levin, a former president of Yale University, plans an expansion focusing on Asia.

For all their potential, MOOCs have yet to unleash a Schumpetarian gale of disruption. Most universities and employers still see online education as an addition to traditional degree courses, rather than a replacement. Many prestigious institutions, including Oxford and Cambridge, have declined to use the new platforms.

Nick Gidwani, the founder of SkilledUp, an online-course directory, compares the process to the disruption of publishing and journalism. Large publishers used to enjoy a monopoly on printing presses, subscriber bases and deals with advertisers. A proliferation of low-cost blogs, websites and apps means they no longer do. Even successful print products have had to take on aspects of their digital rivals’ model. Mr Gidwani sees “scant hope for 200 professors, all delivering the same lecture”.

Traditional universities have a few trump cards. As well as teaching, examining and certification, college education creates social capital. Students learn how to debate, present themselves, make contacts and roll joints. How can a digital college experience deliver all of that?

The answer may be to combine the two. Anant Agarwal, who runs edX, proposes an alternative to the standard American four-year degree course. Students could spend an introductory year learning via a MOOC, followed by two years attending university and a final year starting part-time work while finishing their studies online. This sort of blended learning might prove more attractive than a four-year online degree. It could also draw in those who want to combine learning with work or child-rearing, freeing them from timetables assembled to suit academics. Niche subjects can benefit, too: a course on French existentialism could be accompanied by another university’s MOOC on the Portuguese variety.

Some universities are already adding digital classes to their syllabuses. In Brazil, Unopar University offers low-cost degree courses using online materials and weekly seminars, transmitted via satellite. In America, Minerva University has entry criteria to rival the best Ivy League colleges, but far lower fees (around $10,000 a year, instead of up to $60,000). The first batch of 20 students has just been accepted for Minerva’s foundation year in San Francisco, and will spend the rest of their course doing online tutorials while living outside America, with an emphasis on spending time in emerging economies as a selling-point to future employers.

Error 404: Degree not found

Online learning has its pitfalls. A pilot scheme at San Jose State University in California, offering a maths and statistics course run by Udacity, was suspended last year. Whereas 30% of campus students passed an entry-level algebra course, 18% of those studying online did—and the gap widened as material became more complex. “MOOCs’ pedagogy needs to improve very quickly,” admits Udacity’s Mr Thrun. He thinks the San Jose experiment showed that students needed more personalised support to use a university-level online course. A survey of MOOC students in America found that 70% already had a degree. If they are to compete with ordinary universities, MOOC providers must get better at teaching newcomers to academia. EdX’s Mr Agarwal wants to offer more courses during vacation-time, when students could use them to earn extra credit or to catch up on missed topics.

Detractors point to high dropout rates: only about 10% of first-time MOOC subscribers finish their course. That may not reflect badly on what is offered: the negligible cost of enrolment means that many people sign up without the firm intention to finish the course. But since the providers make most of their money from the certificates they grant to completers, maintaining a reasonable completion rate is important. Some are refining their courses to make the early stages easier to follow. EdX discovered that most dropouts happen quite quickly, in the same way that first-year university students sample courses before deciding which to pursue for their degree credits.

Another worry is that students can cheat by getting someone else to sit online tests in their place. The iversity, a German online college founded last year, is trying to get around this by holding in-person exams with an invigilator present. Coursera offers paid-for identity-verification services, which involve recording students’ unique typing patterns.

Online courses have provoked opposition from academics, who fear that they will accelerate cuts to university staffing. When Michael Sandel, a Harvard politics tutor, agreed to deliver some of his popular undergraduate lectures for edX, he was criticised by a group of Californian academics for supporting a model which poses “great peril to our university”. Online courses, they argued, risked “replacing faculty with cheap online education”. Others fret that the main beneficiaries will be stars like Professor Sandel, widening the pay and prestige gap between them and their colleagues. They may be right: lively teachers have always attracted more interest than dull ones (Socrates delivered lectures at raucous Athenian drinks parties). The difference now is that more students can share access to them.

Credit where it’s due

So far, MOOC providers have wooed new students by using graduates’ testimonials, vouching for the fact that completing a course has helped them get a job. Many potential students are put off by the fact that there is no guarantee that their online labours will be accepted as credit towards a degree. This is starting to change, as digital courses become more intertwined with existing curriculums. Over half the 4,500 students at MIT take a MOOC as part of their course. The John F. Kennedy University in California, which educates mainly mature students, has started to accept edX MOOC credits towards its degrees.

But most universities still do not. An answer to this stand-off may lie in Europe. Under rules designed to promote student mobility between EU member-states, students can transfer course credits, at the discretion of universities, in any of the 53 countries that have signed the Lisbon Recognition Convention, “regardless of whether the knowledge, skills and competences were acquired through formal, non-formal or informal learning paths”. The catch is getting European universities to accept MOOC credits, in order to trade them. “Europe will not quickly take to new forms of degree delivery,” predicts Santiago Iñiguez, the president of Spain’s IE university. Others are more optimistic. Hans Klöpper, the managing director of iversity, points out that it is easy for students to assess MOOCs’ quality, since they are open for all to see. Once students start to complete them in large numbers and clamour for recognition, it will be hard for Europe’s universities to resist accrediting the best of them, he believes.

In the meantime, a second generation of MOOC is trying to mirror courses offered at traditional universities. Georgia Institute of Technology and Udacity have joined forces with AT&T, a telecoms firm, to create an online master’s degree in computing for $7,000, to run in parallel with a similar campus-based qualification that costs around $25,000. Mona Mourshead, who runs McKinsey’s education consultancy, sees a turning point. “If employers accept this on equal terms, the MOOC master’s degree will have taken off. Others will surely follow,” she says.

Although some companies have authored online courses (Google, for instance, has made a MOOC on how to interpret data), established universities still create most of them. To encourage them to spare their best academics’ time to put the courses together, online-learning companies must give them a financial incentive. EdX says it is “self-sustaining” but provides no details of its revenues. The
Chronicle of Higher Education reported last year that edX lets universities use its platform in return for the first $50,000 generated by the course, plus a cut of future revenues. An alternative model that it reportedly offers is to charge $250,000 for “production assistance” in creating a course, plus further fees every term that the course is offered. Coursera reveals only its revenue from certification—around $4m since its launch in 2012—for which it charges students between $30 and $100.

Some have struggled to make a business out of this. Last year Udacity underwent an abrupt “pivot”, declaring that the free model was not working and that from then on it would sell professional online training. Although web-based courses are much cheaper than on-campus ones, they will not retain ambitious students unless they replicate the interaction available in good universities. Making teachers available for digital seminars and increasing the level of interactivity could help. So would more detailed online feedback. Improvements like these raise costs. So a more varied MOOC-ecology might end up with varying price-tiers, ranging from a basic free model to more expensive bespoke ones.

You can’t do this online

The universities least likely to lose out to online competitors are elite institutions with established reputations and low student-to-tutor ratios. That is good news for the Ivy League, Oxbridge and co, which offer networking opportunities to students alongside a degree. Students at universities just below Ivy League level are more sensitive to the rising cost of degrees, because the return on investment is smaller. Those colleges might profit from expanding the ratio of online learning to classroom teaching, lowering their costs while still offering the prize of a college education conducted partly on campus.

The most vulnerable, according to Jim Lerman of Kean University in New Jersey, are the “middle-tier institutions, which produce America’s teachers, middle managers and administrators”. They could be replaced in greater part by online courses, he suggests. So might weaker community colleges, although those which cultivate connections to local employers might yet prove resilient.

Since the first wave of massive online courses launched in 2012, a backlash has focused on their failures and commercial uncertainties. Yet if critics think they are immune to the march of the MOOC, they are almost certainly wrong. Whereas online courses can quickly adjust their content and delivery mechanisms, universities are up against serious cost and efficiency problems, with little chance of taking more from the public purse.

In “The Idea of a University”, published in 1858, John Henry Newman, an English Catholic cardinal, summarised the post-Enlightenment university as “a place for the communication and circulation of thought, by means of personal intercourse, through a wide extent of country”. This ideal still inspires in the era when the options for personal intercourse via the internet are virtually limitless. But the Cardinal had a warning: without the personal touch, higher education could become “an icebound, petrified, cast-iron university”. That is what the new wave of high-tech online courses should not become. But as an alternative to an overstretched, expensive model of higher education, they are more likely to prosper than fade.

Correction: In an earlier version of this story, we incorrectly said that edX was a for-profit provider of MOOCs. It is a non-profit provider. Sorry. This was corrected on June 30th 2014. 

From the print edition: Briefing

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The Saturday Essay Wall Street Journal

Competition Is for Losers

By

Peter Thiel

Sept. 12, 2014 11:25 a.m. ET

Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits. Javier Jaén

What valuable company is nobody building? This question is harder than it looks, because your company could create a lot of value without becoming very valuable itself. Creating value isn’t enough—you also need to capture some of the value you create.

This means that even very big businesses can be bad businesses. For example, U.S. airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to
Google. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry’s profit margin that year. Google makes so much money that it is now worth three times more than every U.S. airline combined.

The airlines compete with each other, but Google stands alone. Economists use two simplified models to explain the difference: perfect competition and monopoly.

Monopolies are a good thing for society, venture capitalist Peter Thiel argues in an essay on WSJ. The PayPal co-founder joins Sara Murray to discuss his business philosophy, his take on Apple Pay, and what’s a deal breaker in pitch meetings.

“Perfect competition” is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand. Every firm in a competitive market is undifferentiated and sells the same homogeneous products. Since no firm has any market power, they must all sell at whatever price the market determines. If there is money to be made, new firms will enter the market, increase supply, drive prices down and thereby eliminate the profits that attracted them in the first place. If too many firms enter the market, they’ll suffer losses, some will fold, and prices will rise back to sustainable levels. Under perfect competition, in the long run no company makes an economic profit.

The opposite of perfect competition is monopoly. Whereas a competitive firm must sell at the market price, a monopoly owns its market, so it can set its own prices. Since it has no competition, it produces at the quantity and price combination that maximizes its profits.

To an economist, every monopoly looks the same, whether it deviously eliminates rivals, secures a license from the state or innovates its way to the top. I’m not interested in illegal bullies or government favorites: By “monopoly,” I mean the kind of company that is so good at what it does that no other firm can offer a close substitute. Google is a good example of a company that went from 0 to 1: It hasn’t competed in search since the early 2000s, when it definitively distanced itself from
Microsoft .

Americans mythologize competition and credit it with saving us from socialist bread lines. Actually, capitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition, all profits get competed away. The lesson for entrepreneurs is clear: If you want to create and capture lasting value, don’t build an undifferentiated commodity business.

How much of the world is actually monopolistic? How much is truly competitive? It is hard to say because our common conversation about these matters is so confused. To the outside observer, all businesses can seem reasonably alike, so it is easy to perceive only small differences between them. But the reality is much more binary than that. There is an enormous difference between perfect competition and monopoly, and most businesses are much closer to one extreme than we commonly realize.

The confusion comes from a universal bias for describing market conditions in self-serving ways: Both monopolists and competitors are incentivized to bend the truth.

Monopolists lie to protect themselves. They know that bragging about their great monopoly invites being audited, scrutinized and attacked. Since they very much want their monopoly profits to continue unmolested, they tend to do whatever they can to conceal their monopoly—usually by exaggerating the power of their (nonexistent) competition.

Google makes so much money that it is now worth three times more than every U.S. airline combined. Associated Press

Think about how Google talks about its business. It certainly doesn’t claim to be a monopoly. But is it one? Well, it depends: a monopoly in what? Let’s say that Google is primarily a search engine. As of May 2014, it owns about 68% of the search market. If that doesn’t seem dominant enough, consider the fact that the word “google” is now an official entry in the Oxford English Dictionary—as a verb. Don’t hold your breath waiting for that to happen to Bing.

But suppose we say that Google is primarily an advertising company. That changes things. The U.S. search-engine advertising market is $17 billion annually. Online advertising is $37 billion annually. The entire U.S. advertising market is $150 billion. And global advertising is a $495 billion market. So even if Google completely monopolized U.S. search-engine advertising, it would own just 3.4% of the global advertising market. From this angle, Google looks like a small player in a competitive world.

What if we frame Google as a multifaceted technology company instead? This seems reasonable enough; in addition to its search engine, Google makes dozens of other software products, not to mention robotic cars, Android phones and wearable computers. But 95% of Google’s revenue comes from search advertising; its other products generated just $2.35 billion in 2012 and its consumer-tech products a mere fraction of that. Since consumer tech is a $964 billion market globally, Google owns less than 0.24% of it—a far cry from relevance, let alone monopoly. Framing itself as just another tech company allows Google to escape all sorts of unwanted attention.

Non-monopolists tell the opposite lie: “We’re in a league of our own.” Entrepreneurs are always biased to understate the scale of competition, but that is the biggest mistake a startup can make. The fatal temptation is to describe your market extremely narrowly so that you dominate it by definition.

Suppose you want to start a restaurant in Palo Alto that serves British food. “No one else is doing it,” you might reason. “We’ll own the entire market.” But that is only true if the relevant market is the market for British food specifically. What if the actual market is the Palo Alto restaurant market in general? And what if all the restaurants in nearby towns are part of the relevant market as well?

These are hard questions, but the bigger problem is that you have an incentive not to ask them at all. When you hear that most new restaurants fail within one or two years, your instinct will be to come up with a story about how yours is different. You’ll spend time trying to convince people that you are exceptional instead of seriously considering whether that is true. It would be better to pause and consider whether there are people in Palo Alto who would rather eat British food above all else. They may well not exist.

In 2001, my co-workers at PayPal and I would often get lunch on Castro Street in Mountain View, Calif. We had our pick of restaurants, starting with obvious categories like Indian, sushi and burgers. There were more options once we settled on a type: North Indian or South Indian, cheaper or fancier, and so on. In contrast to the competitive local restaurant market, PayPal was then the only email-based payments company in the world. We employed fewer people than the restaurants on Castro Street did, but our business was much more valuable than all those restaurants combined. Starting a new South Indian restaurant is a really hard way to make money. If you lose sight of competitive reality and focus on trivial differentiating factors—maybe you think your naan is superior because of your great-grandmother’s recipe—your business is unlikely to survive.

The problem with a competitive business goes beyond lack of profits. Imagine you’re running one of those restaurants in Mountain View. You’re not that different from dozens of your competitors, so you’ve got to fight hard to survive. If you offer affordable food with low margins, you can probably pay employees only minimum wage. And you’ll need to squeeze out every efficiency: That is why small restaurants put Grandma to work at the register and make the kids wash dishes in the back.

A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world. Google’s motto—”Don’t be evil”—is in part a branding ploy, but it is also characteristic of a kind of business that is successful enough to take ethics seriously without jeopardizing its own existence. In business, money is either an important thing or it is everything. Monopolists can afford to think about things other than making money; non-monopolists can’t. In perfect competition, a business is so focused on today’s margins that it can’t possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

So a monopoly is good for everyone on the inside, but what about everyone on the outside? Do outsize profits come at the expense of the rest of society? Actually, yes: Profits come out of customers’ wallets, and monopolies deserve their bad reputation—but only in a world where nothing changes.

In a static world, a monopolist is just a rent collector. If you corner the market for something, you can jack up the price; others will have no choice but to buy from you. Think of the famous board game: Deeds are shuffled around from player to player, but the board never changes. There is no way to win by inventing a better kind of real-estate development. The relative values of the properties are fixed for all time, so all you can do is try to buy them up.

But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Creative monopolies aren’t just good for the rest of society; they’re powerful engines for making it better.

Even the government knows this: That is why one of its departments works hard to create monopolies (by granting patents to new inventions) even though another part hunts them down (by prosecuting antitrust cases). It is possible to question whether anyone should really be awarded a monopoly simply for having been the first to think of something like a mobile software design. Monopoly profits from designing, producing and marketing the iPhone were clearly the reward for creating greater abundance, not artificial scarcity: Customers were happy to finally have the choice of paying high prices to get a smartphone that actually works. The dynamism of new monopolies itself explains why old monopolies don’t strangle innovation. With Apple’s iOS at the forefront, the rise of mobile computing has dramatically reduced Microsoft’s decades long operating system dominance.

Before that,
IBM’s
IBM -0.23%
International Business Machines Corp. had a monopoly on telephone service for most of the 20th century, but now anyone can get a cheap cellphone plan from any number of providers. If the tendency of monopoly businesses was to hold back progress, they would be dangerous, and we’d be right to oppose them. But the history of progress is a history of better monopoly businesses replacing incumbents. Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and finance the ambitious research projects that firms locked in competition can’t dream of.

So why are economists obsessed with competition as an ideal state? It is a relic of history. Economists copied their mathematics from the work of 19th-century physicists: They see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that is what’s easy to model, not because it represents the best of business. But the long-run equilibrium predicted by 19th-century physics was a state in which all energy is evenly distributed and everything comes to rest—also known as the heat death of the universe. Whatever your views on thermodynamics, it is a powerful metaphor. In business, equilibrium means stasis, and stasis means death. If your industry is in a competitive equilibrium, the death of your business won’t matter to the world; some other undifferentiated competitor will always be ready to take your place.

Perfect equilibrium may describe the void that is most of the universe. It may even characterize many businesses. But every new creation takes place far from equilibrium. In the real world outside economic theory, every business is successful exactly to the extent that it does something others cannot. Monopoly is therefore not a pathology or an exception. Monopoly is the condition of every successful business.

Tolstoy famously opens “Anna Karenina” by observing: “All happy families are alike; each unhappy family is unhappy in its own way.” Business is the opposite. All happy companies are different: Each one earns a monopoly by solving a unique problem. All failed companies are the same: They failed to escape competition.

Adapted from Mr. Thiel’s new book, with Blake Masters, “Zero to One: Notes on Startups, or How to Build the Future,” which will be published by Crown Business on Sept. 16. Mr. Thiel co-founded PayPal and Palantir and made the first outside investment in Facebook.

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ECO 562/Ways Developing Market Firms are Changing the Rules of the Management Game x

Ways Developing Market Firms are Changing the Rules of the Management Game:

1. Contract out ever more work up to the point of all but core business.

2. Use existing technology in imaginative news ways to cut costs.

3. Apply mass production techniques in new and unexpected ways and areas.

All of this is driven by gaining access and making money from customers in the bottom of the income pyramid.

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