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Our learning programs help organizations accelerate growth by unlocking their people's potential. The board of a large European insurer was pressing management for answers. A company known mostly for its online channel had begun to undercut premiums in a number of markets and was doing so without agents, building on its dazzling brand reputation online and using new technologies to engage buyers. Others pointed to serious downtrends in policy renewals among younger customers avidly using new web-based price-comparison tools.
The board decided that the company needed to quicken its digital pace. For many leaders, this story may sound familiar, harkening back to the scary days, 15 years ago, when they encountered the first wave of Internet competitors. Many incumbents responded effectively to these threats, some of which in any event dissipated with the dot-com crash.
Robust attackers are scaling up with incredible speed, inserting themselves artfully between you and your customers and zeroing in on lucrative value-chain segments. The digital technologies underlying these competitive thrusts may not be new, but they are being used to new effect. Staggering amounts of information are accessible as never before—from proprietary big data to new public sources of open data. Analytical and processing capabilities have made similar leaps with algorithms scattering intelligence across digital networks, themselves often lodged in the cloud.
Smart mobile devices make that information and computing power accessible to users around the world. As these technologies gain momentum, they are profoundly changing the strategic context: altering the structure of competition, the conduct of business, and, ultimately, performance across industries. One banking CEO, for instance, says the industry is in the midst of a transition that occurs once every years.
To stay ahead of the unfolding trends and disruptions, leaders across industries will need to challenge their assumptions and pressure-test their strategies. Digitization often lowers entry barriers, causing long-established boundaries between sectors to tumble. New market entrants often scale up rapidly at lower cost than legacy players can, and returns may grow rapidly as more customers join the network.
Digital capabilities increasingly will determine which companies create or lose value. Eventually, what was once radical is normal, and unprepared incumbents run the risk of becoming the next Blockbuster. Others, which have successfully built new capabilities as Burberry did in retailing , become powerful digital players. The upshot is that digitization will change industry landscapes as it gives life to new sets of competitors. Some players may consider your capabilities a threat even before you have identified them as competitors.
Indeed, the forces at work today will bring immediate challenges, opportunities—or both—to literally all digitally connected businesses. Our research and experience with leading companies point to seven trends that could redefine competition. Digital technologies create near-perfect transparency, making it easy to compare prices, service levels, and product performance: consumers can switch among digital retailers, brands, and services with just a few clicks or finger swipes. This dynamic can commoditize products and services as consumers demand comparable features and simple interactions.
Some banks, for instance, now find that simplifying products for easy purchase on mobile phones inadvertently contributes to a convergence between their offerings and those of competitors that are also pursuing mobile-friendly simplicity. Third parties have jumped into this fray, disintermediating relationships between companies and their customers. The rise of price-comparison sites that aggregate information across vendors and allow consumers to compare prices and service offerings easily is a testament to this trend.
In Europe, chain retailers, which traditionally dominate fast-moving consumer goods, have seen their revenues fall as customers flock to discounters after comparing prices even for staples like milk and bread. These dynamics create downward pressure on returns across consumer-facing industries, and the disruptive currents are now rippling out to B2B businesses.
Digital dynamics often undermine barriers to entry and long-standing sources of product differentiation. Web-based service providers in telecommunications or insurance, for example, can now tap markets without having to build distribution networks of offices and local agents. They can compete effectively by mining data on risks and on the incomes and preferences of customers.
At the same time, the expense of building brands online and the degree of consumer attention focused on a relatively small number of brands are redrawing battle lines in many markets. Japanese web retailer Rakuten is using its network to offer financial services. New competitors can often be smaller companies that will never reach scale but still do a lot of damage to incumbents.
In the retailing industry, for instance, entrepreneurs are cherry-picking subcategories of products and severely undercutting pricing on small volumes, forcing bigger companies to do the same. Digital businesses reduce transaction and labor costs, increase returns to scale from aggregated data, and enjoy increases in the quality of digital talent and intellectual property as network effects kick in.
The cost advantages can be significant: online retailers may generate three times the level of revenue per employee as even the top-performing discounters. Comparative advantage can materialize rapidly in these information-intensive models—not over the multiyear spans most companies expect. Scale economies in data and talent often are decisive. Successful start-ups known for digital expertise and engineer-friendly cultures become magnets for the best digital talent, creating a virtuous cycle. These effects will accelerate consolidation in the industries where digital scale weighs most heavily, challenging more capital- and labor-intensive models.
In our experience, banking, insurance, media, telecommunications, and travel are particularly vulnerable to these winner-takes-all market dynamics. Spending only modestly on traditional marketing, Free nonetheless has achieved high levels of customer satisfaction through its social-media efforts—and has gained substantial market share. As digital forces reduce transaction costs, value chains disaggregate.
Third-party products and services—digital Lego blocks, in effect—can be quickly integrated into the gaps. For many businesses, it may not pay to build out those functions at competitive levels of performance, so they simply plug an existing offering into their value chains. In the United States, registered investment advisers have been the fastest-growing segment 3 3.
By assets under management and other measures. With a license, individuals or small groups can be up and running their own firms. In the travel industry, new portals are assembling entire trips: flights, hotels, and car rentals. The stand-alone offerings of third parties, sometimes from small companies or even individuals, plug into such portals. These packages are put together in real time, with dynamic pricing that depends on supply and demand. As more niche providers gain access to the new platforms, competition is intensifying.
Software replaces labor in digital businesses. We estimate, for instance, that of the end-to-end processes in banks opening an account or getting a car loan, for example , about half can be fully automated. Computers increasingly are performing complex tasks as well. Digitization will encroach on a growing number of knowledge roles within companies as they automate many frontline and middle-management jobs based upon synthesizing information for C-level executives.
Such areas include digital skills like those of artificial-intelligence programmers or data scientists and of people who lead digital strategies and think creatively about new business designs. A key challenge for senior managers will be sensitively reallocating the savings from automation to the talent needed to forge digital businesses. One global company, for example, is simultaneously planning to cut more than 10, employees some through digital economies while adding 3, to its digital business. Moves like these, writ large, could have significant social repercussions, elevating the opportunities and challenges associated with digital advances to a public-policy issue, not just a strategic-business one.
They have come to expect payment systems that work across borders, global distribution, and a uniform customer experience. As the spread of the Internet and digital technologies reshapes the competitive landscape of industries, it is also revolutionizing the traditional flows of goods, services, finance, and people. All this is happening at breakneck pace exhibit , as we showed in a recent report, Global flows in a digital age: How trade, finance, people, and data connect the world economy.
The pace will only accelerate as global Internet traffic, which has expanded fold since , surges an additional 8-fold by Digitization transforms global flows by vastly reducing marginal production and distribution costs in three ways. The first is the creation of purely digital goods, in both the B2B and B2C realms. The volume of digital consumer goods, from music to movies, transported and reproduced around the globe continues to soar.
Apps that allow consumers to purchase virtual goods and digital services on mobile devices have become a significant industry. For businesses, digitization is transforming even physical flows of people into virtual flows, enabling remote work through tools for global collaboration. In some manufacturing sectors, it is now possible to ship a digital design file for 3-D printing and then make the product where it will be consumed instead of producing centrally and shipping the physical goods. Online reviews or customer ratings, for example, help consumers decide whether to purchase products.
Increasingly common digital tags and sensors connected by wireless communications can identify objects and collect information about transactions, the location of a product, and when it is used. Such wrappers greatly improve processes ranging from payment systems to supply-chain management. Imagine Apple trying to assemble the iPod, with parts from many different countries, without digital tracking and supply-chain-management tools. In ID, by contrast, technological change is viewed as a fundamental part of the industrial transformation process. Performance is judged in terms of static efficiency in IO and in terms of dynamic efficiency in ID.
Basic questions in industrial dynamics. The basic questions in Industrial Dynamics may be briefly stated as follows : What are the causes driving forces of industrial development and economic growth? What are the linkages between these processes and their micro foundations? That is to say, what are the characteristics of the systems within which the industrial transformation processes take place?
What is the framework within which we can best analyze the transformation and restructuring of world industry? It may be seen that these questions are fundamentally different from those dealt with in the traditional IO framework. Given this main thrust, there are four main themes of Industrial Dynamics which together constitute the analytical framework :. The nature of economic activity in the firm.
The boundaries of the firm and the degree of interdependence among firms. Technological change and its institutional framework. The nature of economic activity in the firm 1. The modern corporation is certainly far more complex than the standard notion of the firm in neoclassical theory as a production function which efficiently and under a budget constraint converts inputs into outputs.
This is illustrated in Figure 1, which shows that the physical transformation of inputs into outputs "goods processing" requires only slightly more than one-half of the total labor cost, at least in large Swedish manufacturing firms. Marketing and distribution make up a little more than 20 percent, and the remainder is distributed among a variety of other functions.
Thus, physical production is only one aspect of the firm's activity, albeit an important one. The technical efficiency of physical production assumed in the conventional production function is certainly also important, but it cannot be taken for granted. Indeed, the competence required to achieve technical efficiency is but one aspect of the firm's overall competence. The notion that firms vary in the degree of competence which they bring to bear on their various activities is one feature which distinguishes industrial dynamics from the neoclassical tradition.
Economic competence may be defined as the ability to identify, expand, and exploit business opportunities. It is useful to distinguish between four types of capabilities which together determine the firm's economic or business competence :. Strategic selective capability : the ability to make innovative choices of markets, products, technology, and organizational structure ; to engage in entrepreneurial activity ; and especially to select key personnel, resources, and competence.
Organizational integrative, coordinating capability. Technical functional ability relating to the various functions within the firm, such as production, marketing, engineering, research and development, finance, as well as product-specific capabilities ; and. These capabilities may be thought of as a hierarchy of competence, illustrated in Figure 2.
The operational level at the bottom of the pyramid represents the various functions ; this is where physical work is done. The functions need to be coordinated and integrated ; this is the task of middle management. The top of the pyramid represents the control exercised by top management on all the activities of the firm. This is manifested primarily in the organization, allocation, and upgrading of human competence learning in the organization. Thus, the choices made and the selection mechanisms used serve the dual function of exercising control while at the same time facilitating organizational learning.
The neoclassical model treats knowledge and competence as fully tradable information. There is no need for firms hierarchies and therefore no room for differences in firm behavior. The various functions are coordinated by the market. But in the presence of bounded rationality and tacit knowledge, two things happen. First, trading of information is no longer sufficient ; much of the required knowledge is not tradable. Secondly, organizing economic activities is not simply an act of coordination but rather the art of combining functional activities and integrating them with information activities to achieve synergistic effects, or scale effects, at the level of the entire firm.
Selective Strategic Capability. Choices have to be made at all levels of the firm. This is done through formulation of overall business strategy what to produce and where to sell, what technology to use, etc. Innovative or creative ability is a special form of selection : the ability to organize the firm so as to generate and take advantage of new business opportunities. Thus, the innovative capability of the firm determines how the firm interacts with the opportunity set. Firms differ in their ability to perceive opportunities, in their willingness to take risks, and in their ability to take advantage of opportunities.
They also differ in their ability to expand the opportunity set for themselves as well as others through their own inventions and innovations. Organizational Capabilities. Coordination is the capacity of the firm to integrate and organize its activities so as to achieve synergy effects at the firm level. Specifically, it refers to the ability to put together the various functional abilities of the firm such that it beats the market in minimizing coordination costs.
Since the market achieves coordination through a decentralized organization, the visible hand must achieve synergies from coordination, making total production greater than the sum of its constituent parts. This integrative ability is largely tacit. It is imbedded in persons and organizations and cannot be easily articulated or transferred to other persons or organizations.
Such organizational competence does not usually come about through explicit once-for-all choices but through experimental learning Eliasson b. Technical Functional Capabilities. This competence refers to the management of the current operations i. We are now at the level of well-defined, separable activities that constitute the everyday operations of the firm.
Strategic tradeoffs in competitor dynamics on adaptive networks
This is the notion of the firm underlying the production function and productivity analysis in static theory. The essential point here is that this represents only a fraction of what business activity is all about.
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Functional capability is necessary but not sufficient for superior economic performance ; other more dynamic aspects of economic competence selective, organizational, and learning are also important. Learning Capabilities. The learning capability of a firm is a form of adaptive ability : the firm's ability to learn from success as well as failure, to identify and correct mistakes, to read and interpret market signals and take appropriate actions. Generally, organizational learning includes the capacity to create new competence internally through innovations and to acquire knowledge in external markets.
It also includes methods of efficiently diffusing new knowledge throughout the organization, while keeping the knowledge within the organization. Learning is a major part of the competitive process and draws significant although not easily measured resources. There is a good deal of evidence that there are systematic differences in firm performance over extended periods of time.
For example, in a previous study Eliasson , pp. Ericsson, MoDo, and Sandvik was examined. The real rate of return on total capital before taxes in these firms was compared to that in Swedish industry as a whole for the period See Figure 3. Three of the four firms have consistently outperformed Swedish industry in general during the postwar period, while MoDo a forest products firm with a large share of its business in the paper and pulp industry has generally performed worse. While some of these differences are undoubtedly due to fact that these firms belong to different industries, some may also be due to differences in economic competence.
This is an area worthy of further inquiry. Source : Eliasson , p. There is a growing literature on the changing role of small business in the economies throughout the industrialized world. For example, as shown in Figure 4, the share of manufacturing employment in plants with less than employees fell in many countries until about but has increased since then. This change has been pervasive, regardless of whether the country is large or small or has relatively large or relatively small plants. The differences among countries in the share of small business persist, i.
Source : Loveman and Sengenberger What are the reasons for this shift towards small business? This is a question which fits under the second main theme in Industrial Dynamics. An example of the type of analysis that can be carried out in this area is provided in what follows 2. In Carlsson I have argued that there are two primary forces at work which have caused the shift towards small business in recent years.
One set of driving forces has to do with changes in the world economy. Intensified global competition has forced firms to specialize in their core businesses, shedding lines of business outside the core. In addition, within each line of business, many firms have decentralized their operations and increased their reliance on subcontracting and. Increased uncertainty reflected in high interest rates, volatility of exchange rates, and high rates of inflation in conjunction with increased specialization means a need for increased flexibility which is more easily achieved in small units than large.
During the first three decades of the postwar period, firms tended to diversify in order to reduce their exposure to risk. But with the events of the s oil shocks, the breakup of the Bretton Woods system, the emergence of Newly Industrializing Countries, etc. Hence, diversification was no longer the strategy of choice ; building defensible positions was. See Carlsson, b. This is done by an intensified watch for threats and opportunities, actual or potential, and by building up flexibility to respond when necessary.
Another set of driving forces has to do with technological change. This transition has been facilitated by the diffusion of numerically controlled NC machine tools. The diffusion process was slow as long as NC machine tools were expensive and difficult to program. They were used mainly in large plants manufacturing complex products or a closely related family of products. The typical users were firms in the aircraft, construction machinery, and engines and turbines industries. But after the introduction of microcomputer-based NC controllers in the mids, prices were sharply reduced ; the machine tools were mass produced particularly by Japanese firms , and a vast new market was opened up : small and medium-sized plants.
One of the consequences of this diffusion process was a sharply increased ability to handle product differentiation. Another result was a new division of labor between large and small plants. Large plants tended to move away from mass production into batch production, using the new, flexible equipment. At the same time they were specializing on fewer products, causing them to shrink, while small ones tended to grow as they became suppliers to larger plants.
Often the user- supplier relationships evolved into close collaboration in the form of networks Saxenian The third main theme of inquiry in Industrial Dynamics is technological change and its institutional framework.
Strategic Competition, Dynamics, and the Role of the State
This may be captured under the heading of technological systems. They consist of dynamic knowledge and competence networks.
In the presence of an entrepreneur and sufficient critical mass, such networks can be transformed into development blocks, i. Development block refers to a set of interconnected and interdependent factors which are only partially reflected in price and cost signals and which give rise to new combinations techniques, products, organizations, markets, sources of supply. It is a disequilibrium concept : incomplete development blocks generate both difficulties and opportunities for firms.
This tension generates progress. When equilibrium is reached, the development block ceases to be a dynamic force. Thus, technological systems have many dimensions space, subject area, etc. Therefore, their characteristics vary from one techno-industrial area to another. An important aspect of technological systems is the varying economic competence of the agents within the system. Thus, technological systems differ from so-called National Systems of Innovation cf. Freeman and Nelson in three ways : 1 they refer to specific techno-industrial areas whereas the latter refer to the economy as a whole ; 2 the boundaries do not necessarily coincide with national boundaries ; and 3 by emphasizing such microeconomic aspects as the role of economic competence and development blocks rather than institutional infrastructure alone , they bring into focus the problem of adoption and utilization of technology as contrasted with that of generating and distributing knowledge.
An implication of this is that if economic competence is a scarce and unequally distributed resource, creating more knowledge within a nation or region does not necessarily result in improved economic performance. The institutional infrastructure of a technological system refers to a set of institutional arrangements both regimes and organizations which, directly or indirectly, support, stimulate and regulate the process of innovation and diffusion of technology. The range of institutions involved is very wide. The political system, educational system, patent legislation, and institutions regulating labor relations are among many arrangements which can influence the generation, development, transfer, and utilization of technologies.
The role of public policy 3. The fourth main theme of Industrial Dynamics deals with the role of public policy. In conventional neoclassical theory, market failures give rise to govern-. In a dynamic framework, market failures are much more difficult to define and therefore cannot serve as readily to justify public policy.
Two points need to be made regarding market failures. First, market failures derive from marginalist economic theory which is concerned with static efficiency problems. As we move away from equilibrium analysis to seeing competition as an open-ended process Metcalfe and Gibbons , we need to analyze the consequences of market failures in the context of that process, or in the context of the workings of a technology system. Second, market failure per se is not sufficient to justify intervention.
Government failure Krueger may, for a variety of reasons, be even greater than the market failure and consequently, an intervention may not lead to a reduction or elimination of the market failure. Indeed, most governments may lack an ability to intervene "correctly " Pack and Westphal This inability to rectify market imperfections is not, however, inherent in government bodies ; economic competence is not a monopoly of managers of private business.
A Japanese corporate senior manager who begins work with MITI does not, of course, lose all his economic competence in transfering to the public sector. Certainly, the experiences of both Japan Freeman , Fransman and Korea Jones and Sakong , Jacobson , Pack and Westphal , Jacobs- son and Alam suggest that the state can have a very positive role to play in economic development 4. In periods of rapid technical change, involving a series of technological transitions based on new generic technologies, the state may have a particularly important role to play in the molding of technology systems.
However, as we move away from equilibrium analysis to analyzing dynamic problems in a technology system, it is not self-evident that the market failure approach with its clear policy conclusions is the appropriate one. Precisely how policy should influence the system is, in fact, unclear. Indeed, given the importance of networks in technology systems, it may not be unreasonable to suggest that technology systems and therefore the process of generating and diffusing new technology rest heavily on market imperfections.
Many of the external economies tend to become reciprocal in nature. In conventional economic theory, such external economies require some coordinated investment decision, inter alia by state intervention. However, in a technological system, the exchange of information may well result in a blending of visions technological expectations of the future among various actors Fransman Indeed, the technological system functions much like a large innovating firm which manages to internalize and integrate a variety of more or less unpredictable changes and thus to survive cf.
Pavitt , p. How well the technological system works is, in part, dependent on how well its constituent parts are connected. The argument here is that the mechanisms which generate variety and as well as those which select across variety both basic features in evolutionary economies are critically determined by the connectivity of the science and technology system. Metcalfe and Gibbons , p. The distribution of research funds between institutions, the existence of bridging mechanisms to connect industry to the public science and engineering base, and the degree of public investment in skill formation all play their role in raising creativity in general.
By enhancing the rate at which information flows through the technology system increasing the connectivity , the general awareness of the technological opportunity set is raised and the visions are blended. Both innovation and diffusion are affected. Moreover, the connectivity of the system affects how quickly learning from both failures and successes takes place at the level of the technological system.
Policy, it would appear, should therefore aim at enhancing the connectivity rather than correcting for individual market failures in terms of external economies. Economic Competence. Second, economic competence — the ability to identify, expand, and exploit business opportunities — is critical to the functioning of the technology system but is unevenly distributed among firms. Firms therefore operate with different knowledge bases and under different assumptions concerning technology, markets, competitors etc.
A particularly important subset of management's experience and competence refers to the firm's technology base. The technological and commercial opportunity set, as perceived by management, is presumably closely connected to this base 6. When new generic technologies become available, provi-. To a degree, a technological system may manage to blend the visions of some of its constituent parts in a socially optimal way, but in other cases, intervention may be required. The following observations by Freeman , pp.
The "Visions" of the future producted by They chart the broad direction of advance for the economy and for technology and give companies sufficient confidence in this vision to make their long-term investment in research, development, software, equiment and training Nobody believes that it is possible to eliminate uncertainty, but a thorough discussion serves to mobilize resources, to expose difficulties, and bottlenecks, and above all to energize the participants, secure consensus and heighten awareness".
Emphasis added. The role of MITI could thus, in part, be seen as helping firms to improve their economic competence and expand their perceived opportunity set, in particular in periods of rapidly increasing technological opportunities. Third, institutions matter. This refers to a whole set of features of a technological system. One of the more important institutions is the educational system, especially the training of engineers. In particular, the system needs to be pro-active and flexible : pro-active in order to be able to supply industry with specialized skills and new knowledge in emerging new technological fields ; flexible in order to adjust the orientation of education from old technologies e.
A second critical institutional aspect is that of "bridging" institutions which act as information exchanges within the technological system. These institutions may well need initial support to get started — once they function they can be financed by those who discover the usefulness of their "bridging" work. A third critical institution is, as always, the functioning of the financial market. This is of particular importance for innovative small firms which will eventually become the new industrial giants.
Factory automation in Sweden : an example of industrial dynamic analysis. In the following, an attempt will be made to summarize briefly some preliminary results of a larger, still on-going project 7 , the first phase of which focuses.