When innovation yields efficiency

Much of the innovation we’ve seen lately hasn’t led to growth but instead to efficiency – that is, shrinkage.

I’ve been mulling over Mike Mandel’s cover story in last week’s BusinessWeek, in which he tried to puncture another bubble: the belief that we’ve had a rich decade of American innovation. He argues that there’s actually an “innovation shortfall” and he uses economic stagnation to plead his case. Now I’m not economist (that’s a straight line) and so I won’t argue about the impact of other events on growth – starting with the so-called financial crisis.

But as I thought through the major innovations of the last decade, many of them have not led to economic growth; they haven’t added money to the economy but left it in the economy. Thus measuring innovation’s impact in the revenue, growth, productivity, and market cap of large companies may not be valid. Instead, we are seeing innovation take money out of their pockets, leaving it with their customers. What they, in turn, do with that extra money and what impact it has on the economy is an entirely different question – and that impact is likely seen in any case not in large companies but in individual consumers and in small businesses. But I think the proper measure of the changes in the last decade is the innovation dividend. See:

* craigslist is blamed for destroying (that’s from the publishers’ perspective) $10 billion in classified ad value annually**, replacing it with its reported $100 million revenue. Newspapers act as if that was their money – as if they had a God-given right to it – but, of course, it wasn’t. When Craig Newmark spoke with my students at CUNY, and they asked him why he didn’t maximize revenue at craigslist and sell it for billions and then use that money for philanthropy, he told them that he thought he was doing more good for the country and the economy by leaving more money in the pockets of the people who were doing the transactions he now enabled. He cut out a gross inefficiency born of the monopoly that newspapers held over the means of production and distribution. If you try to measure his innovation’s impact on the economy with old methods and metrics – built on the assumptions of the old economy – you can’t see it. He didn’t make companies grow or become more productive. He added efficiency.

* Amazon, eBay, and the internet as a whole are blamed for destroying large swaths of the retail marketplace. But again, they brought efficiency in a number of ways: price transparency, which leads to lower prices for customers; critical-mass efficiency; the reduction of brick-and-mortar and staff costs; and I’d imagine a reduction in distribution and warehousing costs. The net result is fewer jobs, less rent, less waste (that is, books on shelves that get pulped; now they’re made just in time), and lower prices. Again, more money is left in the pockets of the transcators. The impact of innovation on retail is seen in shrinkage and efficiency, not growth.

* Google is blamed for destroying media but, of course, all it did was give advertisers a better deal. It dared to compete. Google did this not just by creating abundance rather than selling scarcity born of control of those means of production and distribution. This created a more efficient – read: less expensive – marketplace for advertising. More important, Google revolutionized advertising by selling performance, proving a return on investment. So the money that didn’t stay in the pockets of people buying and selling cars and homes, thanks to Craig, now stayed in the pockets of retailers and manufacturers thanks to Google. More efficiency. In What Would Google Do”, I argue:

We have shifted from an economy based on scarcity to one based on abundance. The control of products or distribution will no longer guarantee a premium and a profit. . . . We are entering a post-scarcity economy in which Google is teaching us to manage abundance, challenging the bedrock rule of economics, first written in 1767: the law of supply and demand.

Old rules and measures and analyses can’t track that.

* Web 2.0 is credited with making it much faster, easier, and far less expensive to start new companies. That is the other innovation dividend – the innovation that happens on the back of innovation. But this is happening, again, not at a large-company level but at a small-company level. Measuring spending on innovation, then, becomes another unreliable metric. The economics of innovation itself have changed.

The reliability of the standard metrics and analysis matters greatly because profound – and expensive – policy and economic decisions are being made on the basis of them and I’m not at all sure they’re valid anymore, or at least as valid. They miss too much of the change and impact and value and dynamics in this new economy. They lead us to bail out GM and Chrysler. One could argue, as George Will did in yesterday’s Washington Post, that that the bailout violates even old rules:

The administration’s deepening involvement in designing and marketing automobiles through two crippled companies ignores this truth: Capitalism is a profit-and-loss system, and the creative destruction it produces is supposed to clear away failures such as Chrysler, freeing capital for more productive uses.

But that capital, once freed, may not go to building huge new ventures. It may go to building small new ventures. It may stay in the pockets of people doing transactions and now instead of spending it on Toyotas, it may go to banks. You won’t see all the impact – except negatively – on the Dow Jones Average and the Fortune 500; those were the measures of the old economy. We need new measures.

** I had said craigslist and the internet replaced $100 billion in revenue in newspaper classified, which was an attempt to calculate over the life of the web, but that was difficult to calculate, so I changed the figure to $10 billion, the difference between classified revenue at its height in 2000 and in 2008.

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  • http://thepulse.ca shawnpetriw

    “Old rules and measures and analyses…”

    For more on how old rules don’t apply, and the move forward, I recommend the book “The Origin of Wealth” by Eric D. Beinhocker. It’s a great romp through economic history and a nice introduction to complex economics (vs “equilibrium”).

    http://www.amazon.com/Origin-Wealth-Evolution-Complexity-Economics/dp/1422121038/

  • http://www.download-not-available.com Jim McCarthy

    It seems like this kind of consumer surplus would express itself somehow in quality of life or perhaps material standard of living.

    I often think that when I hear stats about real wealth not growing much since the 70s or whenever. Yes, but people have and can do so much more with what’s roughly the same amount of money now.

    Surely that’s not the kind of measure that’s impossible to derive.

  • http://groundreport.com Rachel

    This all rings resoundingly true with GroundReport’s experience– we’re one of those ‘small, new ventures’ and have created a lean newsgathering & vetting system that allows us to compete with international outfits.

    In terms of efficiency, bigger is not better in this economy– focus, niche, vertical is the goal. As David Cohn acknowledges in this Mediashift interview on higher citizen journalism standards, platforms like GroundReport are voluntarily shrinking content to be better and more efficient: http://www.pbs.org/idealab/2009/06/citizen-journalism-networks-stepping-up-editorial-standards158.html

    Proof in the pudding? GR content output goes down 50% as our human network separates the wheat from the chaff, and traffic increases 10%.

    • Don

      During the great depression about a hundred auto manufacturers called the Great Lakes region home. Over the decades the hundred got eaten by three supersized behemoths. America really ought to just let the behemoths epic fail and disintegrate back into a hundred.

      The problems of auto manufacturing behemoths parallel those of mass media behemoths. Unfortunately control freaks find it infinitely easier to impose on behemoths.

      The last decade’s innovation enables my small business to easily do what was once unthinkable. Export to Canada and import from Hong Kong. Speaking of Hong Kong, this small business owner echoes my own economic beliefs.

      All Smiles in a Room Full of Frowns

      It is rare in the current recessionary climate to find small business owners in Hong Kong – or anywhere else in the world for that matter – who are not worried about the economy in one way or the other. However Ladda Kiatyungwalgri, a bubbly Thai woman with a round face, and the owner of a niche electronics export trading company run out of a messy workshop in the completely unglamorous district of Shampshipo, is one such singularity.

      Her company, DIY Electronics, has been struggling to keep up with the orders …

      “I am not worried about the economy. Maybe because I am just an ordinary working woman and a housewife …

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  • http://www.mercurynews.com Chris O’Brien

    @Jim:

    Your hunch is right. The stats on average pay can be misleading on this. Economist Michael Cox of the Dallas Federal Reserve established a measure of cost using “time” as the currency. In essence, he asks, “How much time does it take to earn the money to buy X?” The time, especially when it comes to digital goods, has dropped dramatically for a number of reasons (globalization, efficiencies, increased processing power). It’s why even though pay levels seem to be flat, the amount of gadgets people own has skyrocketed over the past two decades.

    The initial concept was outlined here:

    http://www.dallasfed.org/fed/annual/1999p/ar97.cfm

    • http://www.download-not-available.com Jim McCarthy

      Excellent, Chris. Thanks for coming up with actual information to support my completely unfounded guess. :)

      Even beyond gadgets, it seems like people live in more square footage, have air conditioners (I guess that’s a gadget), have safer cars, fly more and all the rest than they did in the past.

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  • David

    The growth vs. efficiency story isn’t anything new; in fact, it’s probably been around since modern man improved the efficiency of transportation by inventing the wheel. Examples in recent history include agricultural efficiencies leading to only requiring 10% of the population to farm, to feed an entire nation, versus 80% … in a very short period of time. There is also the industrial revolution; which allowed companies like Ford to reduce the cost of cars (manufacturing efficiencies) to bring them within reach of common folks.

    One of the last major efficiency changes happened in the 90’s … nope, not the Internet, rather the Walmart-ization of retail, whereby retailers eliminated zero-value-added middlemen, and worked directly with manufacturers (often in lower cost countries) to fill their own warehouses. This resulted in households keeping a much larger share of their paycheck … unless you were a zero-value-added middleman (a.k.a. reseller/distributor) or a manufacturer who couldn’t compete with cheaper manufacturers in lower cost countries.

    The hardest thing for people (especially policy makers) to do; is to sit on the sidelines and do nothing when these tectonic shifts happen …hoping that as people have more money in their pockets; from spending less on food in the 1880’s; from spending less on cars in the 1920’s; or from spending less on their household purchases in the 1990’s … that their new savings (and spending thereof) will result in new jobs being created.

    The primary difference between the Walmart effect and Chrysler, GM, Citibank, etc; is that 1) it’s much easier to identify those affected (and likely to lose their jobs) and 2) there is more political power to ask for handouts (because it’s so concentrated). If 3-4 manufacturers and 3-4 distributors provided Walmart with 90% of their goods, you can bet there would have been some bailouts for distributors and manufacturers.

    Alas, this isn’t anything new … efficiency gains are what got us out of the business of hunting-and-gathering … and they will hopefully be what continue to allow us to improve our standard of living for a very long time.

  • http://www.hurlbutassociates.com Ted Hurlbut

    The computer revolution of the 60’s and 70’s led directly to the emergence of retail titans like Walmart in the 80’s and the mass-commoditization of just about every concievable consumer product category ever since. (Clearly, the GM/Chrysler story is a parallel story, following as it does the decline of the domestic steel industry before it.)In the productivity/growth cycle, we thought that the growth in service sector employment was the great benefit arising from the decline in inflation-adjusted prices. Now, with this downturn, we’re not so sure. I’m inclined to believe that it’s a momentary blip ( or bubble-bursting, if you prefer) and that we’ll continue the evolution to a service based economy once the current excesses have been worked through.

    • Don

      Wal-mart contracts with my small company to provide casual IT support. Working on a local store’s IT infrastructure makes me feel like Sam’s spirit endorses me as a true entrepreneur.

      Although company bigwigs attribute Wal-mart’s success to many things, the actualization of Sam Walton’s Calvinistic work ethic makes the most sense to me. “We make no bones about the fact that we believe in G-d, that we think everybody should.” – Jack Shewmaker speaking for Wal-Mart as President in 1983. It seems to me that Wal-mart’s everyday low prices do more to ease the misery of poverty than all the government programs in the world.

      Wal-mart encourages and empowers vendors such as me to “own” infrastructure. For instance, it personally offends me to see other apes messing with “my” store mainframes. LOL.

      While Wal-mart encourages a competitive friendly rivalry between its vendors Citibank enforces a big city mobster whack them before they whack you IT culture. G-d help Obama when those sharks come calling. I speak from experience.

  • http://wyman.us/ Bob Wyman

    You wrote: “Thus measuring innovation’s impact in the revenue, growth, productivity, and market cap of large companies may not be valid.”
    +1. Precisely correct.

    Back in the early 80’s I spent a great deal of time trying to get companies to switch from secretaries, typewriters and postal mail to using Office Automation, email, etc. I did this as product manager of Digital’s “ALL-IN-1″ office product which grew to take a 54% market share in the mid-80s. One of my biggest challenges was explaining to potential customers (and sales people) what the impact of the technology would be. Most people assumed the benefits were obvious: By improving “efficiency” they would be able to fire a large number of workers (particularly secretaries) and thus make higher profits with a smaller workforce. I fought to argue that this was not the case…

    What we consistently saw was that companies that adopted the new technology did not get smaller. Often, they didn’t even see much of a growth in their profit margins. The key effect of the technology was not to allow people to do the same work with “less.” What we mostly saw were people doing “more” and “different” work with the same resources used earlier and we often saw them selling that “more and different” product for much the same that they had sold the old product. (Note: The reason they couldn’t raise prices was obvious: because all players in similar industries were converting to the new technology at the same time, doing “more” and “different” didn’t and couldn’t lead to any real change in pricing power.) As a result of this, economists and pundits would complain that office and commercial computing didn’t actually improve corporate productivity. And, they were right as long as you only measure productivity in terms of “market value produced per unit of input.” However, if you measure productivity using non-economic measures like “quality of life produced per unit of input” then you end up with a very different set of conclusions.

    The difference in perspective (i.e market-value vs. quality of life) can be seen in looking at the difference between the companies I was building products for in 1980 and those same companies today. Economists may argue about productivity, but, 29 years ago corporations maintained what was virtually a slave-class of women who worked at what were often mind-numbing jobs as secretaries, typists, copyists, filers, etc. Technology has eliminated the vast majority of those jobs but hasn’t resulted in unemployment for women. What has happened is that the women who used to waste their vitality on menial, mechanical work were released to become administrative assistants or to compete with men in the same corporations. At the same time, a vast number of secretarial training schools were run out of business — only to be replaced by “computer” training schools. Everyone is doing different stuff more stuff and more personally rewarding stuff, but the fact that they are doing so can’t necessarily be seen in any particular economic indices…

    Neither companies nor markets nor economies can “grow” forever. Just as we should be looking for when “Peak Oil” happens, it might make sense to start looking for “Peak Growth…” At some point, economic growth (as traditionally measured) becomes a zero sum game, but that is not a bad thing as long as we still have room to improve aggregate quality of life. Quality of Life is what we should be focused on, not growth, efficiency, etc…

    bob wyman

  • http://TheNumerati.net steve baker

    Very good comments. The common point seems to be that when industries and economies shift, it takes us time to figure out what to count. From what I can tell, we’re nowhere close. It might make more sense to resign ourselves to this economic blindness and get on with business.

    Incidentally, I wrote a story last week about a Stanford student who puts together health data networks in Africa using used cell phones and open-source software. It costs $150 to run them for six months, and saves $4,000 of motor bike fuel. So we have the wonder of an undergrad putting together a global business from his dorm room, lives saved in Africa, and unless you come up with an extremely sophisticated economic model, negative growth.

  • Evan Downey

    The problem isn’t that we haven’t seen technical innovation, it’s that business models and products haven’t adapted to new capabilities. In economic terms, companies think the marginal cost/benefit for maintaining the status quo still exceeds the marginal cost/benefit for driving innovation.

    Organizations have adopted cost reductions that new technologies offer, possibly because doing what you already do more efficiently is less threatening than giving up revenue. I think that’s the reason you’re seeing efficiencies, but no new products.

    Developing products and business models in the new economy is scary, and companies are not investing in projects that will cannibalize their existing business model. Instead of biting the bullet and making the change, they’re going to ride their doomed models all the way down.

    Eventually, the new economy will win out, but the old guard is dragging down the economy in the meantime. We’re starting to see companies pay the price for this miscalculation (auto industry, newspapers, etc.) We also see a variety of companies fighting for their old ways in Congress and the courts (record companies and telecommunications for example,) but their arguments boil down to “it’s not fair that our old assumptions aren’t true anymore.” Apparently, we’ll only see real innovation when the old companies die.

  • http://www.mano-studijos.lt Studijos

    It is un normuos money

  • Tex Lovera

    Excellent post and excellent comments.

    Chris O’Brien’s comment on “how much TIME does it take to buy item X” and Bob Wyman’s comment on “people doing more and different work with the same resources used earlier” are really two sides of the same coin. Both involve a reduction in time to achieve goal, but the “extra” time we gain does not necessarily translate directly to “material” wealth gain (which I think is what Bob was saying).

    And as a few folks said, the old metrics that government, etc. use to set policies may no longer hold. I posit that the government is now the biggest obstacle to growth (or perhaps a better term might be “evolution”) as it tries to maintain the status quo through the flailing use of bailouts to preferred actors. When will they learn that the invisible hand moves whether they want it to or not?

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