How productive is our economy really? Are things getting better or not?
You could try to answer that question in the traditional fashion by looking at changes in the nation’s GDP. But if you thought about it, even for a bit, you would realize that the GDP is a jumble of the real goods and services that are produced, along with a lot of other stuff that frankly isn’t very relevant. Its accounting of “benefits” to the economy include, as the FT pointed out recently, the soaring costs of health care and education, the speculative shenanigans of the financial sector that makes money out of money from things like flash trading and gambling in derivatives (risky), growing armaments and prisons (harmful), advertising (unproductive), and bloated government spending (tautological, since it is just recycled taxes).
GDP is thus an almost meaningless jumble of stuff. It includes everything going on, whether it is productive or unproductive. In fact, you shouldn’t be surprised to discover that, just last month, the UK GDP was suddenly 5 per cent bigger than previously thought. How come? Among other tweaks to the methodology, statisticians started counting the economic contribution of—get this—prostitution and illegal drugs. Check it out: I’m not making this up!
The fact that such a preposterous decision could be made—officially—shows us how far the concept of GDP has strayed from any sensible notion of the material well-being of society. What’s next? Including the earnings of terrorists and criminals? Could that give a nice bump to the GDP and further fuel an illusion of social progress?
In any event, the GDP is just a total. It doesn’t tell us anything about the efficiency or effectiveness of a country in taking inputs and turning them into outputs. Much of GDP growth has to do with population growth, which leads to more people in the workforce and the consumer base.
Upon reflection, you would realize, along with Diane Coyle in her book, GDP: A Brief but Affectionate History, that GDP is “a made-up entity” and “an artificial construct,” that is accompanied by “a regular fandango” with the quarterly release of GDP data. “Even though those numbers are often within the margin of error and routinely revised, we invest them with as much meaning as a priest does his liturgies.”
A dashboard approach?
Or you could try to answer the question by adopting the point of view put forward by the Nobel-Prize winning economists, Joseph Stiglitz and Amartya Sen in their report, Mismeasuring Our Lives: Why GDP Doesn’t Add Up (2010), by preparing a dashboard of supplementary metrics that focus on the impact of the economy on people’s lives. You could proceed by counting income and consumption as well as production per se, adding in wealth as well as income, and including a household perspective, the distribution of income and some non-market activities.
This approach might shed light on whether the nation’s citizens are getting much benefit from the jumble of economic activity going on, but it still wouldn’t tell you much about whether the productive sector was doing any better or not.
You would probably end up wringing your hands about the inequality of the distribution of income, and delivering political harangues to assorted villains for causing inequality, without asking the more fundamental economic questions: Is the economy producing enough real income to distribute?
Thus the Stiglitz/Sen approach doesn’t challenge or replace the basic logic of the GDP which includes “everything from nails to toothbrushes, tractors, shoes, haircuts, management consultancy, street cleaning, yoga teaching, plates, bandages, books and all the millions of other services and products.” Not surprisingly, the approach hasn’t displaced the GDP—with all its flaws—from its throne as the principal indicator of the health of the economy.
The Shift Index
Or you could try answering the question by taking look at The Shift Index, of which a new edition was issued just this week by Deloitte’s Center for the Edge.
In 2009, John Hagel and John Seely Brown created the Center for the Edge because they were frustrated by the endless stream of books, articles, reports, and business gossip about the deep changes taking place in the economy, with no sensible way to measure what was really going on.
They had a sense that gigantic changes were under way, in which everything we do is being reinvented—how we live, how we work, how we play, and how we communicate. They could see that exponential improvement in multiple technologies was fueling exponential innovation.
Yet there was no accurate method of characterizing the speed or acceleration of the changes or their impact on business outcomes. The measures that were available included a lot of noise (like armaments, prions, gambling on derivatives, advertising, bloated government and so on) and suffered from wilful distortion by financial gadgetry. Without time-series data and a methodology for integrating the elements affecting the productive sectors, business books often resembled the science fiction, or even the romance section, of the bookstore.
So Hagel and Seely Brown decided to develop a set of measures—a kind of X-ray photograph of business—that would tell us what is really going on. The result—the Shift Index—provided, for the first time, comprehensive insight into the underlying drivers of the performance of the productive components of the economy.
This magisterial study measured the performance of 20,000 US firms from 1965 to date in great detail. It looked beyond merely cyclical events, and shed light on the deeper trends of longer-term change. It provided a clear, comprehensive, and sustained view of the dynamics changing our world, thus documenting and quantifying what it called “the Big Shift.”
It revealed the fundamental paradox facing business today. On the one hand, new technology is indeed creating vast possibilities for doing things better, faster, cheaper, smaller, lighter, more convenient, and more personalized. Per capita labor productivity is steadily improving.
On the other hand, businesses are by and large not capturing value from these new possibilities. This turned out to be a steady trend of long duration.
Core performance has been deteriorating for decades: The returns on assets and on invested income for US companies has steadily fallen to almost one quarter of 1965 levels.
Bad news for business
The resulting index is bad news for business: It shows that, behind the mirage of financial engineering, mergers and acquisitions, tax gadgets, share buybacks, seemingly rising profits fed by cheap government money and soaring executive compensation, the underlying reality is harsh: US business is in a long-term secular decline and has been so for decades.
The conclusion is inescapable: big hierarchical bureaucracies with legacy structures and managerial practices and short-term mindsets have not yet found a way to flourish in this new world.
The Shift Index 2009 thus anticipated the conclusion to which macro-economists are now reluctantly coming, namely, that an economy comprising mainly big hierarchical bureaucracies are undergoing a “Great Stagnation” (Tyler Cowen) or “Secular Stagnation” (Larry Summers).
The 2011 edition of the Shift Index covered industry-specific data for nine key sectors and provided a guide to the thought leadership, methodology, and data that drives the index’s metrics.
Highlights of the new edition
Now the new edition of the Shift Index takes the analysis to the next level. It updates and confirms the trends of earlier editions while opening up the discussion in new areas.
Among the highlights:
•It explores a key driver of an economy that is dependent on rapid innovation: worker passion. In recording that only 11 percent of employees are passionate about their work, the Shift Index shows how far big companies have to go in shedding legacy management practices.
•It examines why companies are broken, although many don’t know it yet: They are looking at the wrong measures. It explains why the rate of return on assets provides a more realistic picture of the underlying drivers of performance.
•It discusses the various contradictions that companies find themselves in as a result of the exponential pace of change and the increased power of customers to get more for less. It shows how integrative thinking can reveal win-win solutions. (For more on integrative thinking, see Roger Martin’s Opposable Mind: Winning Through Integrative Thinking and his website.
•It gives examples of what it takes to manage successfully in this different world, with lessons from the Amazon River, not just Amazon.com.
A set of paradoxes
The Shift Index reveals a set of paradoxes facing business today.
On the one hand, new technology is creating vast possibilities for doing things better, faster, cheaper, smaller, lighter, more convenient, and more personalized. Per capita labor productivity is steadily improving. On the other hand, businesses are by and large not capturing value from these new possibilities. This turns out to be a steady trend of long duration. Core performance has been deteriorating for decades.
The practical implications are significant. The big hierarchical bureaucracies of legacy structures and 20th Century managerial practices and short-term mindsets have not found a way to flourish in this new world. Meanwhile those firms in the Creative Economy that have mastered the dynamics of the Big Shift, such as Apple [AAPL], Amazon [AMZN], Starbucks [SBUX], Autodesk [ADSK], are growing rapidly, although they are still only a relatively small part of the overall economy.
The Shift Index thus changes our very conception of what the 21st-century economy is about. It reveals what’s going on in terms of fundamentals. It points to the need, not just for better management, but for different management.
A counter-intuitive story
The findings of the Shift Index “don’t fit with the stories commonly reported about firm performance and the business environment. Many economic and market indicators suggest everything is fine; it is tempting to believe that as the economy continues to recover, companies will find ways to thrive. However, beneath the surface, consumer needs, worker capabilities and expectations, and the very nature of work is changing. Companies, particularly large ones, have not yet addressed the impacts of these fundamental shifts. As institutions’ strategies, structures, and practices become increasingly ill-suited for the world of technology-enabled flows, they are confronted by contradictory evidence and short-term performance that makes it easy for leaders and investors alike to dismiss the indications of long-term performance deterioration.”
“Part of the answer lies in a company’s ability to generate returns and turn a profit. The mass media tends to focus on income statement profits as the one true measure—after all, isn’t it the bottom line that matters? Absolute profits, however, matter little—at a minimum, profits should be considered relative to total revenue to get a sense of whether profits are rising faster or slower than revenue. But even that analysis overlooks a critical component of business activity: the assets required to run a business. Ultimately, companies need to earn a healthy return on those assets in order to stay in business.”
Aren’t workers becoming more productive?
How does the Shift Index square with the notion that workers are becoming more productive? As the Shift Index itself notes, “It’s true that in aggregate, workers are becoming more productive. The output per worker is higher than at any time in history. As a whole, the US economy has steadily improved its productivity for nearly five decades, growing from 45.3 in 1965 to 111.5 in 2010.”
But this hardly offers any reassurance to business. In fact, “this trend makes the decline in ROA even more worrisome. Companies seem unable to capture the benefits of labor productivity for themselves. Instead, cost savings are competed away in an effort to serve more, and more powerful, customers”.
One might also note here the explosion in executive compensation and the predatory activities of the financial sector which are additional drags on the capacity of firms to capture the benefits of productivity improvements. These are two dimensions that the Shift Index might usefully focus on, in future editions.
“To satisfy an ever-fragmenting consumer base, companies also must continually upgrade and introduce new products. This increases product development costs and compresses product lifecycles. As demanding customers chase the latest offer, more and more money is spent to develop new products that have shorter and shorter lives. In this environment, companies need close relationships with customers.”
“After all, it’s customers that turn a product or service into economic wealth for the business through their willingness to pay for a perceived benefit. Yet, the pressure to reduce benefits to customers in order to maximize shareholder returns can be immense. Efforts to reduce customer service or remove product features yield cost savings—a short-term boon for companies. However, the ease with which new competitors arise today means new businesses can quickly fill the void if companies fail to balance the evolving needs of customers with the short-term needs of shareholders.”
Radically different management is needed
“So, here’s the bottom line: Customers are benefiting from trends that increase access to flows of information and enable lower cost production. They are getting more value at lower cost from an expanding array of vendors. For companies, though, this poses a challenge. How will they maintain profitability when customers demand more for less? The long-term decline in ROA suggests that they aren’t, and they will continue to face mounting performance pressures as a result.”
“It’s a vicious cycle. Executives are increasingly reluctant to develop and communicate long-term strategic direction given the perception, and often a reality, of greater market uncertainty. In the absence of vision and guidance from company leaders, financial analysts and investors are left with little more than near-term financial results to judge a company’s potential. But as the investment community shifts focus to short-term financial metrics, executives also focus more on these same metrics. This type of self-reinforcing, short-term thinking leads to reactive behavior from management. Companies tend to hedge their bets by deploying resources in multiple areas with the hope that at least one bet will prove fruitful. These types of management practices do not differentiate among short-term events, and they have the tendency to spread resources too thinly. The result is suboptimal performance on all fronts and failure to achieve longer-term goals or chart a course for long-term viability.”
“A new mindset is needed. A longer-term view of performance, trajectory, and opportunities can help company leaders prioritize efforts while maintaining a focus on strategic directions and goals. Firms can build strategic conviction based on the macro trends that impact the market and their customers. Rapid prototyping can help companies test the market, as can engaging others in their ecosystems to gather real-time feedback—all while marching toward their long-term strategic goal. This approach can help companies avoid being distracted by the volatility of short-term events.”
“Those that can effectively tap into information and knowledge flows create advantages for themselves….The inability or unwillingness of the business community to adopt this mindset creates an economy where large portions are stagnating with very few consistent winners. Companies that can balance short- and long-term stakeholder needs will be best able to develop a vision and commitment to execution.”
Ignore this study at your peril!
Is there a more valuable business study than the Shift Index? If there is, I don’t know of it.
The latest edition of The Shift Index is another giant step toward understanding the new world into which we are willy-nilly being hurled.
The message for business leaders is clear: Ignore this study at your peril!
And read also:
The Phase Change to the Creative Economy
Christensen: Are Investors Bad For Business?
The dumbest idea in the world: maximizing shareholder value
How America lost the capacity to compete
The five big surprises of radical management
Follow Steve Denning on Twitter @stevedenning
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