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Tue 12 Aug 2008 10:07 AM

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Business on the edge - the new rules

Innovation may be important - but what is it and how can you do it? David Westley provides the tool kit.

Last week Arabian Business magazine published an intriguing column by Sam Palmisano, the CEO of IBM, about the rise of what he termed the global commons, and what everyone else calls globalisation and the flattening of the world.

Palmisono used his column to argue that companies need to become ever more innovative if they are to succeed; that just being low cost, or in a growing market would no longer be enough.

Unfortunately IBM's CEO was not so clear as to what exactly he meant by innovation - where, how, when, in what way? I don't know about you but when I read business books and columns what I like to do is look for the prescriptions I can use. Being made aware of a problem, but not the solution is a bit of a tease.

So I thought I would add a second part to Palmisano's column as to how companies can use the flat world to be innovative. These are my own thoughts - so don't blame Mr Palmisano.

As a company IBM deserves huge credit for seeing the opportunities of the flattening of the business world. Big Blue and open source may sound like oil and water, but the company made what can only be described a courageous and as it turned out genius move in marshalling its suits and software engineers behind Apache and Linux, in favour of its owns proprietary server systems.

IBM did not do this out of a sense of altruism. Every company would like to have a monopoly, and proprietary software that locks you in is essentially just that.

However, IBM realised early on that between Microsoft and growing grass roots support for open source, it may win a few battles, but the war was already over - and it was on the wrong side. It was better to focus its efforts on what it did best, and where it made most of its margins: providing solutions, services and support to the enterprise.

Essentially what IBM did was recognise the world had changed, and rather than fight it, it adapted to it and redrew the boundary of what the company was, and was not.

The just realeased Wikonomics by Don Tapscott and Anthony Williams goes into some detail as to how IBM did this - and is recommended reading for why IBM serves as an example to all companies faced with a rapidly changing market dynamic.

One of the anchors of the book was a paper published by Ronald H. Coase in 1937.

Coase was puzzled how economists could argue that Stalin was wrong to run the Soviet Union as one large company, when the most successful business leaders in the West at the time - Henry Ford and Alfred P. Sloan - were effectively in control of companies the size of countries.

According to traditional economics, the most efficient form of the economy is when a company deals with multiple suppliers who compete to provide the best price. However, the likes of Ford practiced vertical integration - owning the suppliers that fed its factories - and therefore locking out the benefits of competition.

Coase's explanation to the problem was that traditional economics ignored transaction costs - the cost of finding suppliers, negotiating prices and meshing production and processes with suppliers. At the time these costs were so high it made sense to own as much of the supply chain as possible.

Coase's law still applies to day: a firm should expand until the costs of organising an extra transaction within the firm become equal to the costs of organising that transaction on the open market.

What has changed is the transaction cost - which has been decimated.

The innovation Palmisano refers to, I believe, concerns a company's boundaries - what is and what is not included within your company.

At its simplest level this involves working out what value your business adds, and then outsourcing anything with a transaction cost above the market price.

However, that's a very limited view of the opportunities that lie ahead. In IBM's case it was not a question of outsourcing - it was a question of tapping into the minds of some of the brightest people on the planet, who worked indirectly for them for nothing.

More examples - these are just initial thoughts, so they would need considerable fleshing out.

For events companies, it's not necessarily about outsourcing logistics but building online communities whose discussions indirectly provide the research you need to build the next multi-million dollar summit.

For banks it's not necessarily about outsourcing call centres, but making a parallel (and safely disconnected) internet banking site open source, and letting unknown programmers build services for your customers you had never thought of. They may do it for free - you may want to pay a licence fee to those who produce something you use...

For large pharma companies who hold millions of patents they do nothing with, it's not necessarily outsourcing the study of research, but outsourcing the patents themselves for other companies to take on and develop. Why hold onto something earning you nothing, when you can share in something? Build a marketplace for partners to bid for your products

For Web companies - use open source as a means to get thousands of developers to create solutions and new services for you.

For publishing companies - outsource editorial, design and production. Own the brand, the marketing and the sales - or vice versa. Don't fight citizen journalism, build it into what you do - it's free copy, and if set up in the right way, written by real experts in their field.

I could go on... but I hope you get the point. To be innovative today, companies need to:

1. Think about what they can move outside their boundaries2. Do so in ways that have not been thought up yet and may offer unique advantages to your business and/or industry.

Doing so may be a painful process - but as I am sure Mr Palmisano would tell you, that just makes the long term gain all the more rewarding.

Sanjay 11 years ago

One of the best things I have read in a long time. How would I apply this to a manufacturer though. You've got me thinking...