Deloitte’s Shift Index aims to understand the long term transformations in the global business environment by tracking 25 metrics over more than 40 years. These metrics provide a comprehensive picture of the evolution and impact of advances in digital technologies and changes in public policy over that time span. The first Shift Index report came out in 2009 and has been updated three times since.
The 2013 version consists of five separate reports, each focused on a different topic. A few weeks ago I wrote about one of them, The burdens of the past, which dealt with the growing gap between individuals and institutions in their adoption of knowledge-sharing technologies. I now want to discuss another 2013 report, Success or Struggle?, which caught my attention with its provocative opening line: “Companies are broken and many don’t know.”
“The news today paints an upbeat picture on many fronts. Corporations report record profit levels. . . All aggregate signs point to positive outcomes for the time being,” notes the report, and then adds: “Yet, other metrics tell a different story, one of increasing pressures and stress for companies, executives, and employees. An increasing topple rate indicates that US companies are struggling to maintain their leadership positions as revenues and market share prove vulnerable. . . These pressures are felt by executives charged with pursuing profitable growth and workers who must stay relevant as technology and business models change.”
This contrarian report confirms my own anecdotal observations that many companies are feeling lots of pressures and stress despite their reasonably high profits and stock valuations. Fierce competitors keep appearing from all corners of the world. Advances in technology are eroding the prevailing business models in industry after industry, - including IT, media, retail and banking. Many of these companies have adopted a defensive posture in response to such unpredictable markets, - focusing on increased productivity and lower costs, which leaves little room for creativity and innovation. It’s a jungle out there, might well be a fair description of our current business environment.
Paradox 1: Many companies are reporting record profits, but longer-term trends suggest they are struggling.
One of the initiative’s major findings is that the profitability of US companies, as measured by their return on assets (ROA), has been steadily declining, and is now 75 percent lower than in 1965. Moreover, the decline is expected to continue into the foreseeable future. Deloitte believes that ROA is the most effective measure of fundamental business performance, capturing how well a company leverages its assets to earn a healthy return and create value. The fact that ROA is now a quarter of its 1965 levels shows how much the US economy has changed over the past several decades.
Another measure of market turbulence is the topple rate, which measures how rapidly companies lose their leadership position. The topple rate has increased by almost 40 percent since 1965. The tenure of companies on the S&P 500 was 61 years in 1958; it’s now 18 years. If these trends continue, 75 percent of the S&P 500 companies will have changed over the next 15 years.
Over seventy year ago, Austrian economist Joseph Schumpeter popularized the term creative destruction to describe the process of transformation that accompanies disruptive transformations. The Wikipedia entry succinctly observes: “Companies that once revolutionized and dominated new industries . . . have seen their profits fall and their dominance vanish as rivals launched improved designs or cut manufacturing costs.”
Creative destruction seems to be alive and well.
Paradox 2: Labor productivity is rising, but companies are still in trouble.
The output per worker is higher than ever. US labor productivity has risen almost 2.5 times between 1965 and 2010. Yet, “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.”
The intense competitive environment has been shifting the balance of power from companies to individuals, especially to well-informed consumers and to well-educated workers. Customers have been using that market power to find the best possible deals at the lowest possible prices. Similarly, the compensation for talented employees continues to rise as companies compete to attract and retain them. Thus, the increased productivity improvements are accruing, not to the firm, but to their customers and their more talented employees.
These well-connected individuals, - whether workers, consumers or citizens, - are being empowered by the knowledge flows made possible by digital technologies. Increased transparency helps people make better informed decisions. The traditional, industrial-age way of doing business is under siege and must evolve as social collaboration levels the asymmetry between individuals and institutions.
Paradox 3: Consumers have more selection and, in many cases, lower prices, but companies are still in trouble.
Consumers have more choices than ever in virtually every category of products and services as well as in the channels used to acquire them. Customers are taking advantage of all the information they can now access to make better decisions. But, this increased choice and transparency adds to the pressures on business.
“Consumers benefit from increased product selection with lower costs,” notes the report. “They compare products online, read reviews, go to the store to interact with the products, and then purchase through whichever channel meets their needs, from lower prices to immediate gratification to personalized service. . .”
“For firms, the increasing number of channels to serve consumers can lead to a higher cost to serve each customer. 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. . . 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.”
Paradox 4: The economy has been growing for years, but companies are still under pressure.
The US GDP has grown from $720 billion in 1965 to $15.7 trillion in 2012. A variety of reasons account for this huge growth. The US population has increased from 190 million in 1965 to around 320 million now, so there are considerable more people in the consumer base and in the workforce. Government spending has risen from $190 billion in 1965 to $6.2 trillion. Productivity improvements are enabling companies to deliver a lot more value at lower costs.
The economy has not only grown substantially over the past several decades, but it has also undergone a fundamental transformation, from a product-based to a service-based economy. Almost 80 percent of US jobs are now involved in services in one way or another.
Services are ubiquitous across many sectors of the economy, including finance, healthcare, retail, creative industries, business support, education, transportation and logistics. Moreover, as products are becoming increasingly standardized and hard to differentiate, companies are relying on service innovations to enhance and de-commoditize their products, as well as to develop new sources of revenues such as ongoing maintenance streams.
The industrial economy of the past couple of centuries brought us major innovations in products of all kinds. With industrial oriented R&D, the bulk of the design, development, testing and production of new ideas takes place in labs and factories. Product excellence and competitive costs are key to product innovation, which tend to focus on specialization, standardization and automation.
But companies are still learning how to apply innovation to services. R&D in services has to take place in the marketplace, and must focus on achieving a positive customer experience, - a much harder and less understood objective. Service solutions often involve sociotechnical problems that not only have to deal with large scale IT infrastructures but with the even more complex issues involved in human and organizational behaviors.
Many companies are still struggling with this historical transition to a 21st century customer-oriented, market-facing, service-based economy. They are still learning how to leverage digital technologies to best deal with their increasingly empowered customers, and how to best leverage their assets, - including talent and intellectual capital, - to improve their long term profitability. Their strategies and organizational structures are ill-suited for the world of technology-enabled knowledge flows.
Deloitte’s Success or Struggle? report raises many important questions, for which there are no easy answers. Lots to think about in 2014 and beyond.
on Paradox #1 - surely the reduction in Return on Assets is a direct result of the move to a service economy where people not machines are the key resource?
Posted by: David Birch | January 17, 2014 at 08:28 AM