Clarifying Disruption: Operations vs. Innovation


Part 1 of Series

The word disruption has multiple meanings in global business with the most commonly used definition some variation of “the act of interrupting continuity”.  Within the context of logistics, supply chain, manufacturing, IT, and other business operations, disruption is obviously an experience managers work diligently to avoid.  A good example of a recent operational disruption was caused by the Sendai quake and tsunami; a natural disaster which was unpreventable, but predictable and therefore can be mitigated with careful risk management planning.

In the context of innovation, however, and long-term economic survival, disruption can be paradoxical when “the act of interrupting continuity” of tightly controlled markets, stale products, and outdated business models is not an evil, but rather can be a savior to businesses, ecosystems, and economies, preventing eventual operational disruption, or as we’ve seen in many cases—complete failure.

Animal Instincts

Central to the theme of disruption in innovation is the nature of our species.  We humans tend to be creatures of habit even when presented with evidence that the behavior is self-destructive in the long-term.  In similar fashion, individuals and organized groups such as governments and corporations often refuse to change behavior even when continually presented with evidence that the cost of the short-term comfort zone may well be long-term survival, and of course fear and greed are ever present.

While resistance to change is often strongest in absolute monopolies, similar cultures are commonly found anywhere deep disequilibrium exists in the tension between security and progress, speaking to the need for competition.  Entire industries or regions can become static relative to the world quickly today, displaying little evidence of awareness in decision making.  Mix in a heavy dose of risk averse corporate cultures, conflicting (real and perceived) interests internally and externally, a bit of PR spin, and regional translation leakage between multiple native languages, confusion surrounding the issue of disruption becomes the norm rather than the exception.

History is overflowing with examples of the high costs of failing to intentionally disrupt the status quo with innovation.  A few recent cases that come to mind include:

Government

  • Failure to disrupt poor U.S. fiscal management and lack of accountability (in part with innovation) over a long period now threatens operational disruption

  • Failure to disrupt the U.S. healthcare and public educational system has greatly exacerbated the U.S. fiscal challenge, reflecting why prevention of negative spirals with continual improvement is so important

Mobile Technology

  • Nokia’s failure to maintain leadership in smart phones is now significantly impacting not just Nokia, but Finland’s national economy

  • Rim’s response to the iPad, which seemed unable to take the risk to cannibalize, failed to physically disrupt by tethering the Playbook with the Blackberry phone

  • Border’s failure to embrace disruptive digital publishing ended with liquidation

Offensive and Defensive Strategies

The need to disrupt static cultures, reform or replace decaying business models, and introduce competitive products is well known in management circles of course, so many kinds of offensive strategies, tactics, and systems have been crafted to overcome this age-old challenge, including motivational techniques, educational tools, recruitment practices, incentives, internal R&D, outsourcing, partnering, spin-offs, join ventures, acquisitions, IP licensing, and strategic venture capital. Quite a few companies have prospered through multiple business cycles employing a variation of all of the above in a persistent quest to achieve and maintain an optimal balance between growth and risk over the short-term and long.  The number of companies achieving mediocrity upon maturity is far greater, however.

One common method of defense is the formation of cartels, particularly with commodities or commoditized products that are susceptible to innovative new comers or companies moving into their markets.  Cartels and oligopolies can generate high margins for long periods of time and form very strong barriers to innovation, but eventually market and trade imbalances combined with innovation and conflicting interests of the members begin to fragment the cartel and erode market power, opening a window for competition that has proven to be healthy for incumbents, markets, and economies.  When economies stagnate, it’s generally a sign that incumbents have too much market power, usually achieved in part by manipulating the political processes, which is just one reason of many why corruption should be avoided.

The word cannibalism is sometimes used to describe what is often a difficult internal corporate process of intentionally replacing aging products that are still providing a significant portion of cash flow, with more competitive products. Another term used to describe disruptive innovation in the broader economy is creative destruction, popularized by Joseph Schumpeter in the 1940s, which describes the theory of replacing the old with the new in the entrepreneurial process. In the modern global economy, situations and cultures that allow progress without disrupting entrenched interests are quite rare.

In part 2 of the series, we’ll explore how innovation is beginning to revolutionize the innovation process in the digital enterprise.

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On Her 235th Birthday, America Desperately Needs Lean, Open, and Secure Governance


Baby boomers like myself clearly recall the tumultuous years leading up to the Bicentennial of the United States.  The world we grew up in was near the peak of the industrial revolution, dominated by the aftermath of the Great Depression, WW2, and the Cold War.  We were raised in a culture that had witnessed first-hand the power of a unified government, which led to the victory of fascism in our parent’s generation, followed by a round trip to the moon in our own. In the childhood of my generation, nothing was impossible with sufficient government power.

By 1976, however,  America had endured the 1960s cultural revolution, the Vietnam War,  a serious energy crisis, stagflation, and Watergate.  We were experiencing the shocking end to the post war boom, with new revelations that success had a price, military power had limits, government was not always trustworthy, and our industrial economy had a soft underbelly leaking oil.

By the late 1970s, interest rates were skyrocketing, inflation seemed out of control, the Cold War was threatening to become white hot, and U.S. public debt had risen to the shocking level of $900 billion, representing one third of U.S. GDP.  During the next decade of economic expansion led largely by financial engineering and services, the U.S. debt more than tripled in dollar terms, rising to nearly 60% of GDP.

During the 1990s, with the commercialization of the Internet and exponential adoption of computer networking worldwide, the global economy began to shift, but the information revolution did not result in taming the industrial revolution—at least in the short-term, but rather acted as a catalyst in shifting heavy industry from West to East in our never ending quest for growth and scale. The dot-com bubble provided a very brief respite from accumulating debt in the form of capital gains, but it was a one-time gain.

By the late 1990s it became apparent that the unfettered Internet, in ironic contrast to the core message in The Wealth of Nations, offered such disruptive efficiency that many industries would be radically transformed, including the service economy that had become dominant in the U.S.

Meanwhile, global companies became too big to fail, increasingly divorcing themselves from U.S.interests in what became the primary global strategy for risk reduction and growth, which only compounded the challenges facing the U.S. economy.  By extension, regional and national economies dependent on the industrial revolution or services would also need to adopt the efficiencies offered by the new medium in order to avoid eventual bankruptcy.  In modern parlance, the trajectory of our national budget was increasingly in misalignment with the needs of our economy, the super majority of our citizens, and our collective future.

Rather than downsize to meet the new reality and future obligations, the post 9/11 economy witnessed increased liquidity that  “saved the economy” (Alan Greenspan), combined with post war guarantees in banking, systemic corruption, and ideological activism to enable the mega housing bubble, followed by the inevitable correction and almost certain economic depression if not for historic levels of Keynesian intervention. Rather than invest massive stimulus in converting to a sustainable trajectory, however, most of the spending was targeted at populist programs that continued to expand government overhead, thus increasing long-term liabilities, primarily in very temporary form that now leaves regional economies facing an even more challenging future, and citizens faced with much greater national debt; short, mid, and long-term.  The promises made by government during and after the Great Depression were obviously not only unfunded, but increasingly unfundable.

The most recent example of kicking the can down the road has been unprecedented life support from the FRB in financing 70% of the U.S. debt in QE2, while once again warning Congress and the White House to get its long-term fiscal house in order.  The result, once again, was to witness excess liquidity flow to the most speculative markets, not the fundamental investments required to transition to a sustainable economy, confirming that we have yet to address the underlying structural problems.  The cost of avoiding another Great Depression by stimulus and liquidity has been to advance U.S. insolvency by more than a decade; and quite probably more than two.

Port of Call in the Voyage of Fiscal Denial

Regardless of how one interprets the voyage, the destination that our culture is finally beginning to awaken to is tragic. Under what most believe to be an optimistic forecast, the Congressional Budget Office (CBO) warns us that public debt will rise from around 70% of GDP currently to 84% by 2035, with interest payments rising to 4% of GDP from 1% at current levels. This “extended-baseline” scenario is dependent upon a great many things that have not occurred in the past, however, nor are expected by most, including low inflation and a relatively disciplined Congress. The more consensus forecast, or “alternative fiscal scenario”, projects public debt to rise to 100% of GDP by 2021 and 190% by 2035. However, anyone observing financial crises can attest that these events do not occur on an even gradual basis, but rather reach a tipping point.

The warning I offer today is that economists have based their forecasting on comparable situations in very small economies relative to the U.S., not the world’s largest that also manages the global currency, not to mention the only global military power.  Every forecast, scenario, and metric I have observed in economics is based on a very different history than the situation we face today, all of which assumes the post war experience of a stable U.S. economy.

To capture the situation, consider that while each have proposed different remedies, the best economic forecasters of our time, to include investors, Nobel Laureates, current and past FRB chairs, and regardless of party or ideology, all essentially agree that this unsustainable trajectory has nearly reached its pinnacle.  All are raising red flags, and none can (or have to my knowledge) deny that when the herd finally changes course in bond markets, as we’ve seen most recently in Greece, the stampede is swift and brutal.

Lean, Open, and Secure Governance = The Semantic Enterprise

The Levin–Coburn Report found that the financial crisis was the “result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.”

The U.S. Financial Crisis Inquiry concluded that the crisis was caused by:

  • “Widespread failures in financial regulation, including the FRB’s failure to stem the tide of toxic mortgages”

  • “Dramatic breakdowns in corporate governance”

  • Key policy makers “ill prepared for the crisis, lacking a full understanding of the financial system they oversaw”

  • “Systemic breaches in accountability and ethics at all levels”

In early January of 2008, former GAO Director David Walker suggested that four types of deficits caused the underlying fiscal problem: budget, trade, savings, and leadership. While these four causal factors are without question, I suggest that all of our deficits depend upon the integrity of governance structure, including our increasing deficits in knowledge, competitiveness, security, and happiness.

The only reliable method to achieve a sustainable governance infrastructure in the network economy is with semantic enterprise architecture, which is based on many years of research and testing. For a brief video description of the semantic enterprise, see my elevator pitch, and for a more in-depth discussion, view this keynote at the recent SemTech conference by Dennis Wisnosky on the transformation of the DoD.

Is the customer’s customer a tipping point for enterprise IT?


In early 1996 we spun out a radical concept from my consulting firm on the newly commercialized web that attempted to level the playing field between small business and large. The vision was grander than the technical capabilities at the time, but despite our many weaknesses it became a niche market leader.

Even though we had recent experience representing clients who were competing with market leaders, I was still surprised by the response in some sectors. In our attempt to partner with multinationals, we found primarily fear and defense, including in finance. It was quite clear that the majority of leaders in the corporate world were not terribly thrilled with our efforts. From my perspective, however, given the advantages of incumbents, the long-term risk was far greater to most of their companies if such efforts did not succeed. Having been on all sides of this issue, I was closer to the challenges than they were (and had deeper intel).

Fast forward to 2008. During the initial wave of the global financial crisis I had a private email exchange with one of the leading economic editors, who is a respected centrist thought leader I had known for over a decade. While we have very different backgrounds and experiences, we were in agreement that the initial reaction to the crisis, even though understandable, were misguided. Due to a myriad of factors, including consolidation, centralization, internal financial conflicts, expediency, scale, political activism favoring large institutions, and technology, the small business engine was already in trouble in the west, buoyed primarily by easy credit and the housing bubble in previous years. Based on the evidence in previous recessions, we had very little confidence that the existing financial infrastructure could serve the needs of small business, particularly in current form. One need only travel in the rural U.S. or observe a few SME P&Ls to conclude in hindsight that we were correct.

Fast forward to the present day. On Meet The Press last Sunday, David Brooks sent a warning that I fear will go unheard in the very ivory towers that need to heed the message: “I was up on Wall Street the other day. I know political risk better than they do; they are vastly underestimating the source of political risk out there. We could have a massive problem in the next couple of years.” The source Brooks is referring to, of course, is the American citizen and consumer.

A headline on Wednesday (6/1) at CNBC echoes the disconnect: Wall Street Baffled by Slowing Economy, Low Yields. These are not isolated cases, but rather symptoms of a greater problem at work in the decision process found in every crisis over the past 15 years. I don’t know what data these analysts are consuming, or what tools they are using, but their systems and methods continue to fail them if these and other reports are true.

A glance at the quarterly reports of even the largest consumer companies would reveal a combination of inflation and weak spending that is beginning to negatively impact earnings. Given the massive scale and tight margins facing most of these companies, it should serve as a long over-due wake-up call that it’s time for the IT industry cluster to execute competitive, cost effective solutions to help the customer’s customers compete. This is not an immediate crisis begging for knee jerk reactions, but rather a trend long in the making, dealing with underlying structural problems in the economy that are essential to overcome.

One does not need to search far and wide to discover a variety of profitable methods and models to extend high-end functionality to the SME market, provided of course one is looking, not consumed with protectionism, and obstacles are removed. Regardless of what sector of the economy each serves, ultimately there is no escaping the impact of macro economic conditions, to include the impact of technology on customers of customers.

Innovation in the Enterprise


One of the better reports on innovation in the enterprise was published by PWC, so I wanted to share a link to it and provide a few comments.

Generally speaking this report supports most of the claims we’ve made at Kyield during our applied R&D journey, including knowledge systems, the power of semantic search, an integrated systems approach to the innovation challenge, and what the role of the CIO should be, among others.

What I do not see discussed is the importance of meritocracy, although to be fair to PWC they discuss it elsewhere in detail; nor is there much discussion on the need to protect the ideas of the best and brightest in social environments, without which those ideas are likely to exit and become disruptive.

In the digital world, despite the needs of individual members of the ecosystem, one cannot (nor should not attempt to) silo innovation from crisis prevention or meritocracy, meaning also the need to embrace management of internal cannibalism. Let’s not forget our important lessons of the broader needs of the economy with respect to creative destruction, or we will indeed likely continue to see a continuation of jumping from one systemic crisis to another. So while they have done better than most revealed publicly, it does not appear that they have completely mapped the innovation genome.

That said, this report by PWC is worth serious time and reflection. Their domain is after all, like thousands of other market leaders, frequently found in our web logs.

Mark Montgomery

Regulatory Failure on the Web; Consequences and Solutions


I have argued consistently since the mid 1990s that the global medium (combined Internet and Web) increasingly reflects the global economy and that rational, functional regulation is essential. I started this journey then with a very similar ideology to Alan Greenspan’s before the financial crisis; that self-regulation should be sufficient to prevent systemic crises, but unfortunately in practice it has failed to do so.

Most of the actual regulation in computer networking today is accomplished via manipulation of architecture in one form or another, but technical standards on the web are voluntary, as the Tech Review article The Web is Reborn highlights, which was apparently in response to the article The Web is Dead at Wired earlier in the year. In the U.S. we are really reliant primarily on one form of regulation on the web, other than proprietary architecture and voluntary standards, which is social. Social regulation has evolved with the consumer web, occasionally demonstrating some power—as was recently demonstrated with Facebook security issues, but social regulation has also proven to be self-destructive at times, particularly regarding sustainable economics and jobs. Few if any consumers can see how their actions on the web are impacting their own regional economy or industry, meaning that the blind is often leading the blind towards dangerous hazards in a similar fashion to the housing crisis. Ignorance is being exploited.

Two eras, opposing needs, yet same reaction

In order to provide some context with continuity let’s begin with the PC revolution about 30 years ago when the lack of interoperability allowed Microsoft to extend its growth from the operating system into productivity, communications, and eventually networking, forming one of the strongest strategic partnerships and business ecosystems in history.

During the PC era regulation was essentially outsourced to industry which employed a combination of proprietary computer code, strategic alliances and the failure of others to work together in a competitive manner to establish the standard, which of course led to a monopoly. The political, social and cultural dynamics at play were very interesting at the time, dominated by the view still common today that the only other option was government which couldn’t be relied upon to regulate technology.  It turns out that many other forms of regulation exist that can be learned from in natural sciences, physical sciences, social sciences, and architecture, among others.

Among the most important business lessons in the PC era was that Microsoft bet against the abilities of others to work together which when combined with strong execution was rewarded at historic levels. At the time I clearly recall arguments from investors, customers, government officials and even competitors agreeing with Microsoft that the PC revolution was too young for external regulation (which I heard again this week regarding the web), so “let the best man win”.  I myself said much the same then—not having the benefit of observing this case (and many others) in what is a very complex, quickly evolving environment.

In hindsight I believe we were correct regarding regulation in the PC era, but only for a very brief time—less than a decade; that’s how fast the big innovation door opened, scaled, and began to close. Our society cannot respond that quickly. This was new territory, just as the web would be a decade later.

In a very similar manner to the PC era the lack of regulation on the early web fostered a highly innovative environment during the very early days, but the era peaked much quicker on the web due to the toxic flood of capital during the inflation of the dot-com bubble; and the web was very quickly taken over by entrenched interests.  Opportunity still exists of course, but the dirty secret few discuss is that the failure rate for new IT ventures is very likely at an all time high—no credible statistics exist on the entire ecosystem to my knowledge; only portions thereof.  Of course knowledge, experience, relationships, resources and luck play a big role on outcomes, as usual, but lack of effective regulation generally favors and rewards predatory behavior.

The PC was sustaining innovation; the web is disruptive innovation

It’s important to understand that in the pre-network era economic alignment in desktop computing was primarily positive for everyone except direct competitors to Microsoft (or Intel in semiconductors), which was managed masterfully by a brilliant entrepreneur who became the world’s wealthiest human, and supported by many other brilliant people.  The world needed a standard for interoperability, and since few were negatively impacted the increases in productivity from authoritarian rule were viewed largely as positive within the social regulation realm, even if only for a brief time.  In hindsight government regulation failed not only to prevent the monopoly but also in resolving it. Government was then and still is today complicit in the creation and protection of  monopolies, regardless of how they form, particularly in the U.S. and EU within the IT cluster, which is I think driving future industry leaders to other countries.

Once monopoly power sets in it can be very destructive, including to the long-term company culture within the monopoly itself, which provides a strong case to manage market share very carefully.  The largest impact, however, is invisible, which usually manifests as aborted innovation within the specific market and industry, lack of adoption of competing technologies, and failed investment, which is evident today in most consolidated industries as reflected by very poor economic performance.

Failed regulation often leads to market failure, which is a real possibility for the web unless a sustainable economic structure is formed. This is essentially the argument behind the claim the “Web is dead”—with Chris Anderson suggesting that the Internet was moving over to wireless devices where a more viable economic structure is forming; customers are far more likely to pay for services rendered in the iPhone structure than the web structure.

As I have often argued since the commercialization of the web, the advertising industry is not nearly large enough to compensate for the economic displacement of industries from the disruption, particularly in the service dominated economies in the West.  Silicon Valley, Madison Ave, Wall St. and D.C. cultures still don’t seem to fully understand this reality and equation, or presumably policy would reflect it.  China and Germany on the other hand seem to understand the issue with abundant clarity, and are exploiting the situation brilliantly, as is India and others.  A nation does not want to be dependent upon a service economy within a global economy that is increasingly delivering services over an ad supported medium; particularly a nation deep in debt that is challenged educationally.

The often misunderstood lesson here is that the PC ecosystem was not a disruptive innovation but rather a sustaining innovation—meaning that it threatened very few. In direct contrast the web is very disruptive—not only to specific companies, but to entire industry clusters, regional, and national economies, which affects everyone on the planet.

Despite this extremely important difference, regulatory schemes reacting to the two very different situations are essentially the same, and will very likely result in a similar outcome unless regulation improves quickly, particularly relating to technical standardization.  As market share becomes more dominant in corporate cultures, so does hubris—the cultures become increasingly less influenced by voluntary standard processes or social regulation.  Eventually, as we’ve seen in our recent past, the monopoly cultures can even directly challenge the authority of sovereign governments with the potential exist for global companies to actually dominate national policy.  Currently Ireland provides a fine case study of why such a situation should be avoided.

I maintain that the winner-takes-all approach of the PC era would be catastrophic for the web and the global economy, perhaps even leading indirectly to civil disruption and conflict. Many wars have been fought over far less economic disruption so in a very real sense this issue is one of national and global security.

So is the web dead or reborn?

The web is primarily lost in a sea of confusion from lack of structure, which is largely due to the lack of effective regulation, which is in turn due to spin from those who benefit from the lack of regulation, and perhaps the impact of that spin on the ideology within our culture.  As in all previous standards wars free from effective regulation, a continuous battle rages, albeit somewhat more rational given the global nature of the beast than in previous sector or geographic standards wars.

In an invited letter to the editor in an upcoming issue of a leading publication, I will argue for functional regulation of the web relating to the creation and enforcement of technical standards, which are necessary to achieve security, privacy, and a host of other essential issues, including some degree of certainty for investors and entrepreneurs like myself.  It is far more important that credible independent standards exist than what the specific standards are, which is lost on the academic CS community almost entirely.  The current scheme is without power, glacial, and entirely without dependability, the latter of which is synonymous with credibility outside of academia.

I will save my detailed suggestions on how such a regulatory body might be structured for my book, but there is an emerging regulatory scheme on the web worth noting within the largest industry.  The U.S. health care legislation, as messy as it was, did empower the HHS to determine technical standards for electronic health records, which was tied to funding and reimbursement.  While substantially less than perfect, this standards process does appear to have the ability to gain traction due to a combination of initial funding, need for interoperable data, and leverage from other governments around the world to achieve a functional global standard.

Just one example of how this may occur is the relationship between life sciences, government regulation over drugs and devices, and the delivery of health care, all of which will require interoperability in order to function with any degree of efficiency.  In the current environment the health care technical standards process appears to be the most functional regulatory path towards adoption of a more intelligent web, aka the semantic web.

While we are all aware of the messiness of democracy, this alternate path towards regulation of standards on the web should not be viewed as a substitute for a rational, long-term solution.  Welcoming luck once it occurs is one thing; depending on it for survival quite another.  Our economy is too fragile and complex to depend on luck alone.  Conflicted interests simply cannot be trusted, whether corporate, academic, or otherwise.