Human Capital & Organization EffectivenessPerspectives from Leading Experts

SAMPLER

Inside this book samplerGary Hamel, What Matters Now } Table of Contents } Section 1.2: Learning from the Crucible of Crisis } About the Author

Chandran Nair, Consumptionomics } Table of Contents } Preface } Chapter 1: Asia Wants It All

Clint Laurent, Tomorrow’s World } Table of Contents } Chapter 5: The Evolving Labour Force } About the Author

Nik Kinley & Shlomo Ben-Hur, Talent Intelligence } Table of Contents } Chapter 1: Talent Measurement } About the Author

Gene Pease, Boyce Byerly & Jac Fitz-enz, Human Capital Analytics } Table of Contents } Chapter 1: Human Capital Analytics } About the Author

Seth Kahan, Getting Innovation Right } Table of Contents } Chapter 1: Pursue and Leverage Inflection Points } About the Author

CONTENTS

Preface ix

SECTION 1: Values Matter Now 1

1.1 Putting First Things First 3

1.2 Learning from the Crucible of Crisis 9

1.3 Rediscovering Farmer Values 25

1.4 Renouncing Capitalism’s Dangerous Conceits 29

1.5 Reclaiming the Noble 35

SECTION 2: Innovation Matters Now 39

2.1 Defending Innovation 41

2.2 Cataloging the World’s Greatest Innovators 45

2.3 Inspiring Great Design 55

2.4 Turning Innovation Duffers into Pros 61

2.5 Deconstructing Apple 73

v

vi Contents

SECTION 3: Adaptability Matters Now 83

3.1 Changing How We Change 85

3.2 Becoming an Enemy of Entropy 91

3.3 Diagnosing Decline 103

3.4 Mourning Corporate Failure 111

3.5 Future-Proofing Your Company 119

SECTION 4: Passion Matters Now 135

4.1 Exposing Management’s Dirty Little Secret 137

4.2 Putting Individuals Ahead of Institutions 145

4.3 Building Communities of Passion 153

4.4 Reversing the Ratchet of Control 163

4.5 Reinventing Management for the Facebook Generation 171

SECTION 5: Ideology Matters Now 179

5.1 Challenging the Ideology of Management 181

5.2 Managing Without Hierarchy 193

5.3 Escaping the Management Tax 207

5.4 Inverting the Pyramid 233

5.5 Aiming Higher 243

Appendix: The Half Moon Bay ‘‘Renegade Brigade’’ 259Notes 261Acknowledgments 267About the Author 269Index 271

LEARNINGFROM THECRUCIBLEOF CRISIS

1.2As I write this, the U.S. economy is sputtering. Though the Great Reces-sion technically ended two years ago, unemployment remains stubbornlyhigh and economic growth is distressingly feeble. The percentage of theU.S. population working is at a 25-year low and with 125,000 new jobseekers entering the workforce each month, it may take a decade for theUnited States to get back to prerecession employment levels. A numberof European states are in similar straits: property prices have tumbled,unemployment has soared, and growth has stalled.

What we are witnessing is the mother of all hangovers—theinevitable and entirely predictable outcome of an epically irresponsi-ble borrowing binge. Unfortunately, in this case, the boozers weren’thard-drinking college kids on a Fort Lauderdale beach. They were the

9

10 What Matters Now

captains of capitalism. Federal Reserve policymakers were the distillers,congressional legislators the rumrunners, and big bank CEOs the bar-tenders. Sure, a lot of ordinary folks bellied up to the bar of cheapdebt, but they were egged on by the ‘‘adults.’’ If you’re looking foran analogy, picture a high school dance where parents and teachers arepouring shots at an open bar.

It’s difficult to imagine grown-ups doing anything so reckless, butthen, a decade ago, it would have been difficult to imagine the world’ssmartest financiers and policymakers abetting financial idiocy on aglobal scale.

The worst economic downturn since the 1930s wasn’t a bankingcrisis, a credit crisis, or a mortgage crisis—it was a moral crisis, willfulnegligence in extremis. Few of us are surprised when we witness basebehaviors in lofty places (like a ‘‘sexting’’ congressman), but the implo-sion of America’s investment banking industry revealed Biblical scaletransgressions. One is reminded of the Exodus account in which theentire Jewish nation abandons Yahweh to bow before a golden calf.

Every institution rests on moral footings, and there is no forcethat can erode those foundations more rapidly than a cataract of self-interest. In The Radicalism of the American Revolution, Gordon Woodnotes repeatedly that the country’s founders regarded ‘‘disinterest’’ as anoble virtue. As they set about inventing the United States of America,that first crop of patriots endeavored to detach themselves from selfishconcerns over personal gain and loss. One would struggle in vain, Ithink, to find evidence of ‘‘disinterest’’ in the behavior of LehmanBrothers’ Dick Fuld, Merrill Lynch’s Stan O’Neal, or any of the otherbanking chieftains who pillaged the U.S. economy for personal gain.

While much has been written about the antecedents of the bankingdebacle (much of it opaque and tedious), it is worth taking a fewmoments to perform a quick moral autopsy. This will necessitate a briefrehearsal of the facts. The goal here is not to heap more blame onthe bankers (well, it’s not the only goal), but rather to understand whathappens when self-interest slips the knot of its ethical moorings. It iseasy to be contemptuous of the bankers and regulators who precipitatedthe crisis, but I am not so sure that you and I would have behaved

Learning from the Crucible of Crisis 11

much differently if we had been faced with the same temptations. Byall means let’s hold the bankers responsible (Someone? Please?), but let’salso use their calamitous misadventure to do a little moral reflection ofour own.

So, what happened? Let’s focus first on the proximate causes of thedisaster.

EASY MONEY

After the dotcom bust in 2000, the U.S. Federal Reserve, under theleadership of first Alan Greenspan and then Ben Bernanke, droveborrowing costs down to disastrously low levels. Dirt-cheap moneyencouraged U.S. consumers to gorge on debt, dramatically increasingthe risk of widespread mortgage defaults.

Asian savings also played a role. By pegging the yuan to the U.S.dollar, Chinese authorities kept exports high and internal consumptionlow, thus building up huge reserves. These had to be recycled, and a lotof that money went into buying mortgage-backed securities.

SECURITIZATION

By bundling mortgages into ‘‘collateralized debt obligations’’ and sellingthose CDOs to third parties, bankers were able to move dodgy loansoff their books. Between 2005 and 2007, more than 85% of all U.S.mortgages were securitized.

Historically, lending had been tied to deposit taking. By taking thebrakes off fund-raising, securitization led to an unprecedented boom inmortgage lending. The net result: a serious decline in lending standards.As banks competed their way to the bottom, they handed out loans tojust about anyone with a pulse.

As it turned out, securitization didn’t inoculate banks from the risksof subprime lending, since many banks built up large CDO holdingsvia off-balance sheet ‘‘Special Investment Vehicles.’’ Commercial banksalso lent billions of dollars to the biggest buyers of CDOs, investmentbanks and hedge funds.

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INSURANCE

Credit default swaps (CDS) made it possible for CDO investors toprotect themselves from a housing collapse—in theory. As with allinsurance products, underwriting prudence requires a rich seam ofhistorical data, but given the unprecedented growth of the subprimemarket, and the concomitant decline in lending standards, past defaultrates had no predictive value. As a result, CDO insurers like AIGseverely underpriced the risks of a default debacle. This error wasmultiplied when speculators dramatically upped the demand for CDScontracts. Amazingly, the world ended up with $62 trillion of creditdefault swaps and no organized trading exchange.

COMPLEXITY

The new financial instruments cooked up by the banks were mind-bendingly complex. Mortgages were packaged together, partitionedinto tranches, and then sold. Many CDOs were bundles of other CDOs.These convolutions made it hard for investors and ratings agencies todecipher the real risks.

It should be noted that all this complexity didn’t happen by accident.Bankers love complexity, as it creates the illusion of value-added andprovides a veil behind which they can hide their porcine fees. It’s evenbetter when a financial product isn’t publicly traded, as that makes itharder for a buyer to discern its real value. Unfortunately, as the worldcame to realize, complexity can also obscure risk.

LEVERAGE

In a bull market, the greater the leverage, the better the returns. That’swhy the biggest buyers of mortgage-backed securities borrowed heavilyto bulk up their portfolios. With leverage ratios of 30-to-1 and higher,most of the major investment banks made massive bets on a continued

Learning from the Crucible of Crisis 13

rise in U.S. home prices. While this unprecedented leverage amped theirreturns on the upside, it obscenely compounded risks on the downside.In their rush to profit from the subprime bonanza, many bankers seemedto forget that leverage is always a double-edged sword—sooner or laterit cuts both ways.

Unfortunately, much of that leverage came from loans made bycommercial banks. When defaults began to accelerate, those banksstarted calling in their loans, forcing investment banks and hedge fundsto deleverage in a down market. To do so, these institutions had todump other assets, which sent the stock market tumbling.

ILLIQUIDITY

Because of their complexity and novelty, there was no real secondarymarket for many CDOs, so when things started to go south, it was hardfor cash-strapped institutions to reduce their exposures.

Without a well-functioning secondary market, buyers had no way ofdiscovering the true value of the exotic instruments they held, nor was iteasy for investors and regulators to gauge the real threat to bank balancesheets. In the absence of reliable pricing data, bankers had no choice butto take punishing write-downs on their mortgage-backed securities.

Many senior bankers claimed that the subprime crisis could not havebeen anticipated—that it was, as the chairman of the Financial CrisisInquiry Commission scathingly put it, an ‘‘immaculate calamity.’’1 Idisagree. Anyone who was watching the unprecedented run up in U.S.house prices (see Figure 1.2.1) had to know that a crisis was looming.Indeed, in 2005 I bought a financial derivative from my broker that was,in effect, a bet against the housing market. The instrument was linkedto a stock index that tracked the performance of America’s largest homebuilders. For every 1 percent decline in the value of the index, the valueof my investment rose by 3 percent. The instrument expired in 2008and paid off handsomely. My only regret is that I didn’t bet bigger.

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Figure 1.2.1 S&P/Case-Shiller Index of U.S. House Prices*

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

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Jan-99

Jan-98

Jan-97

Jan-96

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Jan-90

Jan-89

Jan-88

Jan-87

0.00

50.00

100.00

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200.00

250.00

∗January 2000 prices are indexed to 100.

As I watched the crisis unfold, my initial reaction was disbelief. Howcould so many super-smart people be so wrong? Once the poop hit thefan, pundits of every stripe came forward with their preferred remedy(turn the Fed into a super-regulator, create living wills for the biggestbanks, dramatically raise capital reserves, limit banker bonuses, and soon). At the time, I wondered if the solution might not be simpler. Whatabout tattooing a few carefully chosen lines onto the forehead of everybanker who had received bailout money:

Alchemy doesn’t work. What was true for Isaac Newton all thosecenturies ago is still true: you can’t turn dross (garbage loans) intogold (triple A–rated securities) no matter how clever you are.

Things that can’t go on forever usually don’t. If an extrapolatedtrend produces ludicrous results (like million-dollar starter homes),it will soon reverse itself—so don’t bet it won’t.

Risks and returns are always correlated. Maybe there’s someoneout there who can produce a positive ‘‘alpha’’ year after year, but itprobably isn’t you or anyone you know.

Learning from the Crucible of Crisis 15

Stupidity is contagious. Reflect on the mad obsession with leverageand complexity that consumed you and your banking buddies. Smartas you may be, you’re every bit as vulnerable to silly fads as Japaneseschoolgirls.

The tattoos would have to be inscribed in reverse, so that every timea self-admiring banker glanced at a mirror, a teaching moment wouldoccur.

Tats or no, bankers do understand these simple truths, so why didWall Street’s finest fail to heed them? Or more pointedly, why didthey so completely abandon their responsibilities as the guardians ofcapitalism’s most important citadels?

As it unfolded, the subprime banking crisis revealed a Shake-spearian catalog of moral turpitude. It was a perfect storm of humandelinquency. Deceit, hubris, myopia, greed, and denial were all luridlydisplayed.

DECEIT

We now know that a good many mortgage bankers, the folks who madethose subprime loans, conspired with first-time borrowers to overstateincomes and understate debts. In addition, deceptive sales tactics and alack of disclosure encouraged many borrowers to take on loans they’dnever be able to pay off. In 2009, the FBI investigated 2,794 cases ofsuspected mortgage fraud, up from 721 cases in 2005.2 The simple lesson:any financial instrument that is built atop lies and misrepresentations willbe flimsy at its core.

HUBRIS

The Wall Street rocket scientists who were charged with packagingsubprime offal into marketable securities dramatically overestimated theirability to parse and partition risk. They would learn to their sorrow thatdistributing risk is not the same thing as eliminating it, particularly whenthat risk is compounded by nose-bleed leverage. Convinced of their

16 What Matters Now

own genius, they failed to distinguish between genuine sophisticationand mere sophistry.

MYOPIA

In creating and pricing all those brave, new ‘‘structured products,’’ WallStreet’s whiz kids relied on complicated financial models to estimatepotential risks. Because the models were based on recent trend data,covering a time frame when asset values had arced ever higher, theyfailed to anticipate the possibility of a major slump in asset values. Lendersand investment bankers could argue that the U.S. housing market hadnever been through a steep and prolonged nationwide slump, but thenagain, neither had there ever been a run-up in house values like the onethat occurred between 2000 and 2007. Again, there’s a lesson here: justbecause you can’t remember the last hundred-year storm doesn’t meanone isn’t headed your way.

GREED

It goes without saying that everyone on the subprime ship of folly wasearning big fees: the mortgage originators who approved all those ‘‘ninja’’loans (no income, no job, no assets), the Wall Street bankers who bundledthem into securities, the hedge funds who bought the new-fangledinstruments and charged their clients big bucks for delivering above-average returns, and the rating agencies whose thirst for new businesscompromised their once-hallowed objectivity. The lure of multimilliondollar bonuses turned sober-suited bankers into frenzied speculators. Asever, greed proved to be a tireless cheerleader of human folly.

DENIAL

Organizations are occasionally overtaken by truly unpredictable events.This was the case for the U.S. airline industry in the aftermath of the9/11 terrorist attacks. Usually, however, stupefaction is the productof denial. Companies get caught out by the future not because it’s

Learning from the Crucible of Crisis 17

unpredictable, but because it’s unpalatable. Unwilling to face facts, justabout everyone who was financially vested in the housing boom choseto ignore the inevitable. To a degree, the future is always opaque, butit’s a lot more so when you shut your eyes.

The subprime debacle revealed that America had a financial systemof the bankers, by the bankers, and for the bankers—consumers andshareholders be damned. To a large extent this is still true. No high-ranking banker is in jail, the biggest banks have grown even bigger,bonuses are once again setting records, and at this moment, more than3,000 banking lobbyists are hard at work in Washington trying to waterdown the reforms that were enacted in the wake of the crisis.3

This lack of accountability is baffling until one realizes that many ofthe watchdogs who were supposed to guard the economy from bankerlyexcesses—individuals like former SEC Chairman Christopher Cox andU.S. Representative Barney Frank, chair of the House Financial ServicesCommittee from 2007 to 2011—were ardent coconspirators.

Here, too, one witnesses Faustian sell-outs and a feckless derelictionof duty.

As taxpayers and citizens, we expected the government to protectthe economy from unsustainable booms and busts. Instead, it providedthe monetary fuel for an unprecedented housing boom.

As taxpayers and citizens, we expected the government to avoid cre-ating economically perverse incentives. Instead, it aggressively subsidizedsubprime mortgages. In the years leading up to the bust, Fannie Maeand Freddie Mac, government-sponsored entities that answered to con-gressional masters, bought billions of dollars of subprime mortgage loansfrom originators like New Century Financial Corp. and First FranklinFinancial Corp. With the implicit backing of the U.S. government, Fan-nie and Freddie were able to borrow at preferential rates and ultimatelyassembled a $1.4 trillion portfolio of mortgage-backed securities.

We expected the government to enforce prudent banking practices.Instead, it allowed investment banks to dangerously overextend them-selves. In 2004, with the housing boom well under way, America’s biginvestment banks were chafing under SEC restrictions that limited theirdebt levels. Eager to boost their returns by taking on more debt, Wall

18 What Matters Now

Street’s leading banks joined forces to lobby for regulatory relief. Upagainst the united front of the nation’s biggest investment banks, the SECcaved. Neutered by a belief in the omniscience of billionaire bankers, andblinded by their faith in industry self-regulation, the regulators failed toexercise the due diligence that would have prevented a financial Katrina.

As taxpayers and citizen, we expected the government to ensuretransparent and orderly markets. Instead, it abdicated its responsibilityto create a regulatory framework for credit default swaps and otherderivatives. Thanks to derelict legislators, the world ended up witha globe-spanning bazaar for mortgage-backed securities that was lesswell-organized than eBay’s market for snowglobes.

As taxpayers and citizens, we expected the government to indemnifytaxpayers against bank failures. Instead, it stood idly by while a mergerboom created banks that were ‘‘too big to fail.’’ In the 1990s, the bankingindustry led all others in terms of merger activity, and by 2004, 74% ofU.S. bank deposits were controlled by just 1% of America’s banks.

The truth is, America’s regulators had all the powers they needed tocurb the ‘‘irrational exuberance’’ that precipitated the banking crisis—but they didn’t. Again, this was a moral washout. Some of the mostegregious lapses included these:

Blind indifference to the human costs of ideological zeal. In theyears leading up to the crisis, there was a naive belief among manyregulators that banks could be trusted to police themselves. Thesefree market zealots failed to distinguish between the freedom to trade(generally a good thing) and freedom from oversight (generally a badthing). In October 2008, Christopher Cox ruefully remarked that‘‘The last six months have made it abundantly clear that voluntaryregulation does not work.’’ Duh. With the exception of Nazism andcommunism, it’s hard to think of another ideological infatuationthat has cost the world so dearly.

Public responsibilities abandoned for political gain. Wall Streetused its colossal profits to buy heavyweight political leverage, andfew legislators had the guts stand up to their Wall Street benefac-tors. Consider this: between 1990 and 2008, AIG provided morethan $9.3 million in campaign contributions and spent more than

Learning from the Crucible of Crisis 19

$70 million in lobbying efforts designed to batter down regulatoryobstacles, according to Time magazine.4 Virtually all of the gamewardens on Capitol Hill were taking the poachers’ money.

Milquetoast regulators more inclined to protect their backsidesthan raise an alarm. Undoubtedly there were officials in Washing-ton (at the SEC, the Fed, the Office of the Comptroller, the Depart-ment of Justice, the Office of Thrift Supervision, and the FDIC) whowere alert to the subprime contagion and who noticed the rapidlymultiplying pathogens in the regulatory crevices. Yet rather thanbark an alarm, the watchdogs rolled over and let the bankers scratchtheir tummies. Yes, there were gaps in regulatory coverage—butwhen you’ve been charged with protecting America’s economy,your responsibility is to find and fill those gaps, not to take refugein the sanctuary of a narrow regulatory remit. In the league table ofexecrable excuses, ‘‘it’s not my job’’ ranks near the top.

Fact is, America’s legislators and regulators were just as culpa-ble as its bankers. The bomb that blew up the U.S. economy mayhave been detonated on Wall Street, but it was manufactured inWashington, DC.

As with the bankers, we are still waiting for a mea culpa from the reg-ulators. None is likely to be forthcoming. (Among the powerful, blamedeflection is a core competence.) What we have gotten instead is a bar-rage of proposals for increasing the powers of those who were either toocowardly or too compromised to exercise the authority they already had.

We need to be clear: in the banking crisis it wasn’t capitalismthat failed us, but capitalism’s custodians. Those who should have beenfighting to protect the moral high ground laid down their arms andauctioned off their integrity to the barbarian bankers.

We are left, then, with two critical questions: What is it thatproduces such a disastrous lapse in collective moral judgment? And whatlessons are there for those of us who aren’t bankers or policymakers?Let’s take each question each in turn.

It seems to me that moral corrosion has its roots in the low-gradeegomania that afflicts us all. For each of us, on any particular day, thebattle between shameless self-interest and principled disinterest can be a

20 What Matters Now

close-run thing. Our better angels don’t always win. If it were otherwise,the notion of ‘‘sin’’ would have never gained currency.

Another contributing factor is the incremental nature of moral decay.Standards seldom tumble all at once; instead, they ratchet down graduallythrough a series of small, nearly innocuous compromises. That’s why thedeterioration is easy to miss, or dismiss. As with a slowly rusting bridge,no alarms sound until after the structure has collapsed. Faced with thecarnage, people scratch their heads and wonder, how the hell did thishappen? The answer: bit by bit.

Finally, there is a social dynamic which, if not challenged, levelsstandards down. As human beings, we often look to others for our moralbenchmarks. When we’re presented with a choice between self-servingexpediency and self-denying duty, we are typically relieved to find thatsomeone else has already lowered the bar for us. In other words, weare inclined to look for, and overweight, precedents that help us tonormalize our own ethical concessions. We’re scavengers for excuses;that’s why moral equivocation is infectious.

An example: In July 2007, just weeks before the debt bombexploded, Chuck Price, Citigroup’s chief executive, defended his bank’sgung-ho risk-taking in an interview with the Financial Times: ‘‘Whenthe music stops, in terms of liquidity, it will get complicated. But aslong as the music is playing, you have got to get up and dance. We’restill dancing.’’ The last time I heard an excuse that lame it came from a13-year-old: ‘‘But Dad, everyone’s doing it.’’

The freedom of every human being to pursue his or her self-interestis an essential prerequisite for an open economy, but it is not an adequatemoral foundation for capitalism. In The Wealth of Nations, Adam Smith,the patron saint of capitalism, made a compelling, if slightly depressing,case for self-interest:

It is not from the benevolence of the butcher, the brewer, orthe baker that we expect our dinner, but from their regardto their own interest. We address ourselves, not to theirhumanity, but to their self-love, and never talk to them of ourown necessities, but of their advantages.

Learning from the Crucible of Crisis 21

The moral superiority of capitalism rests on the fact that in a freemarket the only way to do well is to do well for others. Critically,though, the grocer doesn’t feed us because he is concerned about ourhunger—he feeds us because there is a profit in doing so. Capitalismis animated by self-interest, but when it’s not tamed by moral self-discipline, it can easily become mendacious. When that happens, thepowerless get abused and the ignorant get duped, legislators get boughtand safeguards get trampled. The ‘‘invisible hand’’ of the market is awonderful thing, but when not guided by a deep sense of moral duty, itcan wreak all sorts of havoc.

Though his acolytes seldom acknowledge it, Adam Smith’s philos-ophy was more nuanced than the previous quotation suggests. In TheTheory of Moral Sentiments, Smith begins thusly:

How selfish soevermanmay be supposed, there are evidentlysome principles in his nature which interest him in the for-tunes of others, and render their happiness necessary to him,though he derives nothing from it, except the pleasure ofseeing it.

Thankfully, there is benevolence in each of us. Compassion, though,can shrivel. For leaders, this happens in two ways. First, compassiongets lost in the pursuit of success. In our strivings, we start to seecolleagues, employees, shareholders, and customers as accessories topersonal ambition, as instruments to be used and abused as necessary.Second, we lose our compassion in the achievement of success. A positionof power, once attained, insulates us from the human consequences ofour actions. As a twenty-first-century leader, you must be alert to theserisks and consciously cultivate your compassion.

I don’t have a grand plan for a moral renewal of capitalism, thoughI will offer a few medium-scale ideas in later chapters. Because renewalhappens one soul at a time, a grand plan is, in any case, beside the point.

Nevertheless, we must face up squarely to capitalism’s shortcomings.To free market zealots I would say the following: One doesn’t haveto disown an economic philosophy to recognize its shortcomings. So

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stop being so defensive! There are things about capitalism as currentlypracticed that are by any standards indefensible. As a champion ofcapitalism, I’m worried when I see:

• An ever bigger share of the world’s wealth going to an ever smallerglobal elite.5

• Companies spending millions of dollars to tilt the regulatory playingfield in their favor.

• Three-hundred-to-one pay differentials between CEOs and first-levelemployees.

• Governance structures that are expressly designed to deflect share-holder concerns.

• Companies that treat employees as mere factors of production.• Executives who reap outsized rewards for mediocre performance.• Companies that award 90% of their share options to a handful of

senior executives.• Companies that resist calls for greater transparency and consumer

protection.• Corporations that compromise their values to do business with repres-

sive regimes.• Corporate PR campaigns that fudge the facts and demonize critics.• Executives who feel that society’s interests are somehow distinct from

their own.

If you can’t find within yourself a little righteous anger about theway your company fulfills its responsibilities, then you’re not going tobe very effective in helping to repair the moral fabric of capitalism.

All of us who have a stake in the future of capitalism have a non-delegable responsibility to make it better—and we must start by raisingour own ethical standards and by challenging others to do the same.

The rehabilitation of capitalism won’t come from top-down pro-grams of ‘‘corporate social responsibility.’’ While welcome, clever newstrategies for producing private and social gains in tandem are notenough. It’s great, for example, that in 2008, Coca-Cola’s then CEO,Neville Isdell, committed his company to becoming ‘‘water neutral’’ by

Learning from the Crucible of Crisis 23

2020—this after activists challenged the company to improve its steward-ship of scarce water supplies. But a grand top-down initiative, howeveradmirable or even profitable, will never be a substitute for a bottom-upsense of moral responsibility that informs every decision. Corporatemorality needs to be proactive and pervasive—too often it is neither.

Most of us don’t dump our trash out the car window, kick our pets,cheat on our taxes, lie on our CVs, or swear at telemarketers (well, fourout of five isn’t bad). It can be tough, though, to draw a line in the sandat work, particularly if those lines are regularly crossed by those at thetop. On the other hand, if being human means anything, it means beingethically accountable—in the way that a shoe-chewing canine will neverbe. It was that sense of accountability that led Deitrich Bonhoeffer, theGerman theologian, to join the Nazi resistance, a decision that cost himhis life. It was that sense of accountability that propelled civil rightsmarchers along the highway toward Selma, despite the tear gas andpolice batons. It was that sense of accountability that emboldened AungSan Suu Kyi to challenge the dictatorship in Burma.

Does the betterment of capitalism warrant the same sort of moralcourage? Perhaps not, but with the exception of democracy, there’sno other ideology that has done so much for so many. The ability tobuy and sell freely, to raise capital, to take a risk and get a return, tostart a new company, to invest where one wills, to expand or contractyour business, to import or export, to innovate or cut costs, to buyanother company or sell your own—these are extraordinary economicprivileges—and when they’re abridged, everyone loses.

But what, you ask, can one person do? Perhaps you’ve been told thata company’s values have to emanate from the top. That’s tosh. Just asturpitude compounds, so does virtue. E-mail, blogs and Twitter—theseare powerful amplifiers of moral conscience, as Egypt’s former presidentHosni Mubarak learned to his sorrow. In a networked world, whenone brave soul speaks up, it emboldens others. Yes, moral backsliding iscontagious, but so is moral courage—so exercise yours!

There are risks, of course. You might piss off a few people, belabeled a malcontent, or get passed over for a promotion, but no one’sgoing to put you under house arrest. So ask yourself, within my sphere

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of leadership, what standards do I regard as inviolable? Where am Iunwilling to sacrifice my own integrity? What is my ‘‘moral signature’’?What values do I want others to infer from my actions? And, conversely,where have I fallen victim to greed, hubris, or power lust? When haveI shut up when I should have spoken up? Moral failings on a grandscale, of the sort observed in the banking scandal, are impossible withoutan epidemic of moral dereliction—so if you’re incensed by what WallStreet did to Main Street, and you should be, stand tall for the moralstandards you believe in.

And you know what? I think there’s even hope for the bankingelite. Redemption is possible. I think of Mikhail Gorbachev’s embraceof glasnost and perestroika in 1984, shortly before he was appointed thegeneral secretary of the communist party, or of F.W. de Klerk’s speechin February 1990 when, against all expectations, he announced thedismantling of apartheid. Anyone can reclaim their compassion.

My friend John Ortberg, a pastor, psychologist, and author, arguesthat if we’re going to have a world worth inhabiting, each one of us musthave the courage to do a ‘‘fearless moral inventory.’’ If you’re a leaderof any sort, in any organization, now would be a good time to start.

ABOUT THE AUTHOR

The Wall Street Journal recently ranked Gary Hamel as the world’s mostinfluential business thinker, and Fortune magazine has called him ‘‘theworld’s leading expert on business strategy.’’

Hamel’s landmark books, Leading the Revolution and Competing forthe Future (coauthored with CK Prahalad), have appeared on everymanagement bestseller list and have been translated into more than 20languages. His last book, The Future of Management, was selected byAmazon.com as the best business book of the year.

Over the past twenty years, Hamel has authored 17 articles for theHarvard Business Review and is the most reprinted author in the Review’shistory. He has also written for the Wall Street Journal, Fortune, TheFinancial Times, and many other leading publications around the world.

Hamel is on the faculty of the London Business School, where he iscurrently Visiting Professor of Strategic and International Management.

As a consultant and management educator, Hamel has worked withmany of the world’s leading corporations. His pioneering concepts suchas ‘‘strategic intent,’’ ‘‘core competence,’’ ‘‘industry revolution,’’ and

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270 About the Author

‘‘management innovation’’ have changed the practice of managementin companies around the world.

Hamel speaks frequently at the world’s most prestigious managementconferences and is a regular contributor to CNBC, CNN, and othermajor media outlets. He has also advised government leaders on mattersof innovation policy, entrepreneurship, and industrial competitiveness.

At present, Hamel is leading the world’s first open innovationproject aimed at reinventing management. The Management InnovationExchange (www.managementexchange.com) has been designed to rad-ically accelerate the evolution of management knowledge and practice.

Hamel is a Fellow of the World Economic Forum and the StrategicManagement Society. He lives in Northern California and can bereached at ghamel@managementlab.org.

Contents

Preface .......... 9

Introduction .......... 23

1. Asia arrives – and wants it all .......... 43

2. Clutching at straws .......... 61

3. Rethinking the future in Asia .......... 79

4. The Asian state .......... 97

5. Rewriting the rules .......... 119

6. Asia and the world .......... 139

Conclusion: Reshaping capitalism .......... 155

Afterword .......... 181

Notes .......... 185

Acknowledgements .......... 201

Index .......... 203

9

PrefaCe

Some twenty years ago, I found myself speaking more and more at a range of business and other forums on what I loosely called environmental issues. A recurring theme was the links between these

issues and a range of social, economic and political challenges. Over time, I became increasingly preoccupied by what would happen if Asia continued to develop along Western lines – in particular, if countries across this huge and disparate region were to adopt consumption-driven capitalism as both their goal and their means of reaching that goal. Often I found myself tempering my opinions, worried I would be accused of being unqualified or poorly informed on many of the issues I addressed. But as the speaking opportunities continued to arrive, I found myself testing more of my half-baked ideas to see how they were received. I discovered that some parts of my audiences, notably business leaders and policy makers, often looked uncomfortable with my suggestion that the current trajectory was unsustainable. But there were others who were broadly receptive, even if the more supportive comments were often made privately after a meeting had ended. I was curious. Who were the Brahmins deciding what topics were acceptable, which views could be expressed? Could I speak out more? Certainly, the opportunities to do so increased, as more and more forums began including an obligatory session – sometimes an entire event – on topics familiar to me, the ones I had spent years working on as a

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CEO and environmental consultant managing projects across Asia, from China and India to Indonesia, Thailand and Vietnam. Despite sparing no effort to avoid offence by being as polite and courteous as possible, I often found myself accused of being unwarrantedly negative and pessimistic – the last a charge I found difficult to accept, having long regarded myself as an incorrigible optimist. At one forum in Sweden, a senior United Nations official told me, albeit in a friendly manner, that I was a ‘demagogue’. I sensed that while he agreed with much of what I said, like many UN officials, he was worried that I had breached some unspoken protocol by throwing out a challenge to the business leaders, politicians, academics and others in the audience. At another meeting, a regional economic summit in Hong Kong in the mid 1990s, I was clearly the token ‘environmentalist’. I spoke about the dramatic deterioration of air quality in the Greater Pearl River Delta region, and questioned the conventional view that investment and growth would lead to a prosperity that, in turn and more or less automatically, would create the conditions for the environment to improve. I was told that my concerns about the environment were laudable but my fears were overblown; I should not worry as it would never get that bad, and before it did, business would respond. Fifteen years on, the pollution in Hong Kong and its neighbour, Guangdong, has worsened, and conference themes have expanded in scope – from how to be a better environmental citizen and green your operations to addressing global climate change and sustainability. A talk in the United States in 2008 drew a different response. Even though the audience was a largely liberal crowd – more Oprah/Obama than Sarah Palin/Tea Party – my suggestion that if Americans were serious about global warming then they might think about taking some action at home was not well received. Clearly, even floating the idea that consumption could be tempered – perhaps by restricting car ownership to one vehicle per household, introducing a carbon tax or possibly even eating less – was tantamount to foreign interference in US internal affairs.

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Nonetheless, as climate change moved up the political agenda and into the mainstream, I found myself encountering less direct rejection of what I had to say. The calls for corporate social responsibility increased, and more and more forums made room for inspirational speakers calling on their audiences to become more responsible eco-citizens and ‘be the change’ (watch the TED talks). Leadership remained in, but only if it took note of new social networks that were mobilizing citizens to take action. ‘Sustainable’ solutions replaced innovative ones, consumers became ethical, and companies were urged to reduce their environmental footprints because going green meant saving money – simultaneously benefiting the world, their customers, themselves and their shareholders. At least, however, the issues were being raised. And slowly – far too slowly – attitudes began to alter. In June 2009, speaking in Bali to a group of clients of one of the world’s oldest private wealth banks, I outlined the conundrum that consumption-led growth posed for Asia. I was surprised at the level of interest I generated. Several even accepted my throwaway lines that ‘bling is out’, ‘less is more’ and that constraints had to be put on consumption. In the audience was the CEO of a leading global publisher. I had expected to be dining alone, but instead I ended up hearing him suggest that I should expand and write down what I was saying. What you are reading is the result of our conversation.

Neither East nor West

The form of this book took a while to emerge. At its heart lies a discussion about the re-emergence of Asia as an economic power, and the dilemma this poses to itself and the world. But as I shared tentative outlines with a few friends, I was often told to make sure what I said could not be attacked or dismissed as an anti-West rant. These warnings troubled me. Why was it that these people liked the idea of having me air my views, but believed they should warn me about the likely reaction from the elite inhabitants of the well of conventional wisdom? Would it really be so dangerous to draw attention to what was clearly visible not just to me but to any reasonable being? After all,

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every day of the week it is possible to find articles and op-ed pieces in the international press critical of China and India, and it would not take long to find other articles criticizing the way in which every other country in the region is run. Anyway, to clarify matters, this book is far from being an attack on the West. It is not about how the West has got things wrong. Nor is it about how Asia will get them right. It is certainly not about this being the time for Asian ascendancy and how the West will now have to understand the new rules. There is a growing band of commentators, including many Asians, subscribing to these kinds of arguments – ones which I believe are dangerous. As far as it attacks anything, it is the path Asia is taking, and the unquestioning nature of the decision to go down this path taken by its leaders in the face of mounting evidence that doing so can only hurt their countries, not help them. This book does, however, advocate new rules. And it is not saying that the West is without responsibilities. Many people in Europe and America have taken their governments to task for not matching their rhetoric with actions, be it over development aid, climate change or military action around the world. It is vital that pressure continues to be maintained on these and other issues – however unlikely it may appear that results will be forthcoming. But what the West should do is not my subject. Rather, this book addresses the question of what Asian societies must do – most importantly, what their governments must do. As it became ever clearer to me that the direction Asia was taking had to change, I increasingly wondered why it was that so many Asian business leaders, many of whom had studied at what were commonly acknowledged to be the world’s best universities and business schools, so rarely addressed these issues of resource depletion, environmental degradation and backward governance. Why the silence? Were they so busy they had no time to think about them? Or were they convinced that really there was no problem: the costs would be short term, and beyond that prosperity would eventually trickle down?

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I began to wonder if they were just too scared to speak out, worried about what their companies or business partners might say. The more I got to know some of them and listened to their ever more frequent ‘green speeches’, the more I became convinced that, despite their power, they were too afraid to be more intellectually robust, except in private. For most of them, I suspect, the reason was simply not wanting to step out of line – after all, the system, whatever its contradictions, had rewarded them. Why question the Harvard Business School model of supply-chain management – a convenient way of shifting unwanted external factors, such as pollution, to developing countries – if they could rise to that ultimate point of professional recognition as the Asian representative on a multinational’s board? Other factors were also at play. More and more I noticed the ways in which the elite business schools of the world, most of them American, were shaping the thinking of their Asian students. It seemed to me that these young minds – some of the brightest in the region – were going to these schools not to be taught practical skills that would make them better, more responsible citizens, able to help the problems of their home countries, but rather to be schooled in an ideology. Learning how to manage and innovate within the limits and constraints imposed by our planet featured nowhere in their teaching. Instead they were told how, via its reliance on free markets, capitalism had emerged as the best means of creating prosperity. Governments had a role in all this, but principally to remove obstacles such as unnecessary regulations. Throw in democracy as the icing on the cake, and not only had the West succeeded in advancing civilisation to new heights of well-being and scientific achievement, but it had also, as Francis Fukuyama observed, arrived at the end of history. Such hubris, of course, almost inevitably precedes a fall. But even now I am still startled at just how self-assured this view of this world was, and how much it remains intact. I teach a course at an MBA School, and continue to marvel at how little its students – many of them Asian, but also from America and Europe, and almost without exception Western-

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educated – feel any need to question the assumptions on which they will base their careers and lives. Even today, despite the economic success of their home countries, most of them continue to play down their origins, preferring instead to aim for a high-flying career at an investment bank or multinational. They are smart, very smart, but intellectually neutered.

Governance

In considering the disparate but interlocked issues of silence and denial, I began to wonder about their possible connection with one other issue that was troubling me: why it was that the need for us to organize ourselves to live sustainably – fairly, equitably, and within constraints – had not kept pace with our ability to innovate technologically. Through the twentieth century, at an ever-accelerating rate, humanity proved able to increase its power over nature in the most extraordinary ways. Where we failed, however – and failed abysmally – was in our ability to govern our innovations. Our inventions sped ahead, but our ability to monitor and regulate their impact lagged dangerously behind. Typically action was taken only when something went badly wrong, as is happening in the wake of BP’s disastrous Gulf of Mexico oil spill. We have not found the means to integrate our technological and financial innovations with the need for limits and rules, where necessary draconian, to impose restraint on how we live. The evolving role of technology also provided the ingredients for yet another headache. Today, more than 2.2 billion people in Asia have access to mobile phones – far more than have access to potable water or sanitary toilets. I first noticed this gap between the availability of technology and that of basic necessities when I worked in Bangkok in the late 1980s. Friends who lived on the banks of the Chao Phraya River had televisions and video players, but they used the river as a sewer and its polluted waters for washing. Since then, even slum dwellers have migrated to mobile phones and iPods, but their refuse still pours untreated into the river. Similar sights can be seen across Asia, in Delhi, Jakarta and Manila. But how is it that, while mobile phones and other electrical goods

15

have become ever cheaper, lavatories are still a luxury item? Why is it that the best minds are helping companies make more iToys or banks rework their balance sheets, not shaping the governance that will determine our collective future? This book explores my answers to these questions – that we live in a world whose values are set by an economic system that incentivizes and rewards those who can generate growth for a select group of mostly Western institutions.

New values

To pre-empt suggestions that I am trying to revive the Asian values debate of the 1990s, nowhere in this book do I suggest that Asia will get it right because it has governments or cultures more suited to coping with the challenges of the twenty-first century than other parts of the world. This book does, however, argue that because of its sheer weight of numbers Asia faces an imperative to get things right that is less intense in other parts of the world. Thus it is about Asia’s responsibilities and obligations at this particular point in history. It seeks to contribute to the narrative about these issues in the region and therefore in the world too. I take seriously the fact that global debates are – alas – dominated by Western commentators, politicians and business leaders. Asian perspectives are badly needed (as are those of Latin America, the Middle East and Africa). It is both a challenge and an appeal to capitalism. One of capitalism’s strengths is its ability to adapt to new realities. And Asia is perhaps now, given its stage of development and the harsh realities it faces, most suited to freeing capitalism from being the captive it has become of free market fundamentalists and ideologues. This is not a book about climate change. Nor is it a doomsday book. But it is a book about the catastrophes – some of which are already upon us, and many more that lie ahead – if the world, and particularly Asia, continues on its current trajectory. Most of these will be of a creeping, insidious nature – those of people struggling to survive in depleted or disaster-struck environments, or being forced to give up farming and

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migrate to cities because they can no longer grow enough produce to feed themselves, or having to watch the forests they and their families have lived in and depended on for generations be felled and replaced with palm-oil plantations so we can all have cheap cookies. Possibly, further off into the future, worse fates may be in store for us. But my goal is not to spread fear by predicting dire outcomes. Rather, this book is a call for us to abandon the goal of realizing consumption-driven capitalism across Asia, and replace it with a different objective – of having an environment that we can pass on to future generations, one with rainforests, with biodiversity, with adequate resources, both renewable and non-renewable; one that is not poisoned, that has fish in its oceans; one with cities that are a pleasure to live in; and, of course, one with a climate that is not running out of control. This book will, I hope, make readers understand that without dramatic changes in our levels of consumption, the challenge of climate change cannot be meaningfully addressed. Of course, climate change plays a big role in this book, but at its heart is a call to embrace sustainable ways of living. As such, this is a book about realizing change, primarily in Asia – and possibly beyond. Doing so calls for questioning and redefining many ideas and concepts. The financial crisis prompted many in the West to suggest that it was time to question many of the core ideas that had guided countries through the last few decades. Asians must do the same. Rejection will be an important part of this – a critical first step. But rejection alone is not enough. We need to rethink policies, and political action, about how we define growth, wealth creation, what we can do and own, and how we should work and live. We must question the assumption that everyone in Asia should aspire to own a car, live and work in air-conditioned surroundings, and consume food and goods shipped from every corner of the world. But we must do all this in order to come up with something new. Doing this on the scale called for is a political task. The changes that will be necessary will require political action to determine their precise direction, to gain support and to overcome resistance. As I discuss further in the final chapter, this means that at its heart this is a

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political book, one about how people decide the rules under which they and others in their societies should live.

No silver bullets

When seeking feedback on my ideas, I was often told that stating problems without offering any suggestions for solutions would leave readers short-changed. I have borne this in mind, and this book contains proposals that I think governments could usefully follow. However, it contains no silver bullets. It refuses to take refuge in hopes that technology and finance, encouraged by markets, can see us through. If only it was that easy. But as well as asking questions, it looks for ways forward, attempting to move beyond feel-good solutions to identify some of the far harder decisions that will have to be taken. Many of these decisions can only be taken if we first accept that change will not all be win-win. Yes, there will be winners – but there will also be losers, most prominently some of those who have benefited most from the current institutional set-up. Tackling such vested interests will require willpower and – the biggest anathema of free market ideologues – strong states. As much of what people have bought into will need to be deconstructed if we are to live as many on a crowded planet, a strong and independent media would also be useful, as would robust civil societies. But if I were to prioritize one of these, it would be the force to devise and enforce the laws and regulations that our societies need. Consequently, this book is addressed above all to government officials and policy makers. These are the people who will have to draw up the agendas, build support and implement change. Policy success, however, will only come if it receives broad public backing. For this reason, I have striven to produce a book that is accessible to as broad an audience as possible. Among this number, I hope, are many business people – some of whom, perhaps, are genuinely willing to take seriously such often-repeated mantras as ‘creative destruction’, ‘innovation’, ‘change agents’ and ‘risk’. Harnessed properly, these could be forces that

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rework how people live. Almost all companies talk about the need to ‘think outside the box’. I hope the next few decades will show us that they can.

Definitions

It is in the nature of a book such as this to be reliant on sweeping generalizations. I apologise for this, while hoping that critics, before picking on the inevitable weaknesses or contradictions they are sure to find, first ask whether there is a greater question that it is better worth their time addressing. By Asia I mean the countries of east, south-east and south Asia. Australia and New Zealand are excluded, as are the central Asian states. Usually, but not always, I include Japan; I leave it up to the reader to decide when doing so is inappropriate. I refer often to the countries I discuss as developing nations, ignoring the fact that the wealthier parts of east Asia have more in common with Europe or even America than, say, with Myanmar or Afghanistan. In using the term ‘Asia’ I am conscious that many will question whether it is simply too big and diverse a collection of countries to be treated as a single entity – or, worse still, accuse me of adopting a Western reductionist construct for what are a hugely disparate group of countries. These are valid criticisms, but not ones I feel any great need to address in any depth. My reasons for this are twofold. First is that this book is not focused on a geographical cluster of nations, but on ones that for a host of reasons are home to a huge number of people living in economies that in recent years have realized sustained periods of economic growth. Thus, it is this part of the world that has the greatest potential to impose stress on our planet if it decides to opt for a consumption-driven model of growth. Second, it is a region that despite its political, cultural and social differences is increasingly being pushed closer together; many of its environmental challenges are cross-border. Combined, these two reasons make it a part of the world with great responsibility for finding new ways to navigate through what remains of the twenty-first century. More often than not, my discussions relate to the region’s two giants,

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China and India. Because of their scale, decisions and actions in these countries will affect the world in ways that those taken in most others will not. But other countries have vital roles. The fate of Indonesia’s rain forests is one of the pivotal issues facing the region; as is what happens in the Coral Triangle, a sea area of 2.3 million square miles embracing the Philippines, the eastern parts of Malaysia and Indonesia, the coast of northern Papua New Guinea and the Solomon Islands, nine-tenths of which is threatened by over-fishing, particularly that using explosives.2

And no country will escape the impact of environmental change. Pakistan was already one of the world’s most environmentally overstressed countries before devastating floods swept through it in 2010. Bangladesh will have more people affected by rising sea levels than anywhere else worldwide. In east Asia, Japan, South Korea and Taiwan may already have the wealth that allows them to look at environmental threats through developed-world lenses, but none will be able to escape the devastation that will follow if conflict over resources were to spill over into war. As for other parts of the world, I use the phrases ‘the developed countries’ or ‘the rich countries’ as shorthand for the nations of North America and Western Europe. Japan is sometimes included in this number, sometimes not. The United States features as the representative figure of the ‘West’, itself a word I use throughout this book, often imprecisely, but which I feel conveys that body of ideas embracing freedom and power that so many in Asia find both alluring and disturbing. Finally, Africa merits a brief note. I cannot claim to understand that vast continent, but having lived and worked there, I think I can say that the issues raised by this book have the utmost relevance to its countries. The timescale may be slightly different, but the questions people there will have to face will be the same as those now being raised in China, India and other Asian countries – whether adopting the Western consumption-driven model of growth can in any way aid their development, or whether it will have precisely the same impact as in

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Asia, eroding the possibilities of a flourishing future. Asians cannot have it all, and nor can the people of Africa.

Hong Kong, September 2010

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1asIa arrIves – and wants It all

Asia stands at the threshold of consumption. Across China, India and south-east Asia, hundreds of millions of people are buying mobile phones and refrigerators, eating in McDonald’s and KFC,

and drinking Coke and Pepsi. But these are just the advance troops. Over the next decade and beyond, they will be joined by two to three billion more consumers, buying motorbikes and cars, upgrading to iPhones and high-definition TVs, and moving to cities where they can buy their own homes. This is the dream that has kept Asia moving forward. Governments made fast-track growth a policy priority. They lowered barriers for multinational business. They told their populations that prosperity for all was achievable within a generation, maybe two at most. And the time to celebrate is almost here. The next few decades will see the most extraordinary jumps in the consumption of almost every product and service imaginable as Asia catches up. Take poultry. This year, Americans will eat nine billion birds. As of today, the whole of Asia – thirteen times as many people as in the United States – eats sixteen billion birds annually. But if by 2050 each Asian was eating the same amount of poultry as each American does now, the region would eat its way through more than 120 billion birds.1

Or take energy. Today, the average American uses 250 kilowatt hours of power a day. In China, the average is 40 kilowatt hours, and in India it

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is 20 kilowatt hours. If Asia’s population were to use as much energy per person as Americans, then they would consume fourteen times as much power as the United States does now. Even if Asia were to restrict itself to European energy levels – around 150 kilowatt hours per person per day – it would still use eight to nine times as much energy as America does now. This prospect of a prosperous Asia excites many – those in business most of all. Be they car makers or coal miners, in insurance or IT, it would seem that Asia’s huge market potential is finally materializing. Governments are also pleased. At last, after two centuries of Western dominance, their region is regaining its position as the globe’s economic centre of power. At the start of the nineteenth century, Asia accounted for over half the world’s economic output. Over the next 150 years, its share plummeted as Europe and America rode the industrial revolution. In 1950, it accounted for just 18 percent. But now it is back. Driven first by Japan, then China and now also by India, by 2025 Asia should have half of world output, and by 2050 it will be back to its eighteenth-century heights of around 55 percent. And then there are ordinary people. After decades of hard work and saving, hundreds of millions of people stand on the brink of middle-class abundance. Already enjoyed by Japan and the tiger economies of South Korea, Taiwan, Hong Kong and Singapore, now households across south-east Asia, China and India either have or have started acquiring the material trappings of affluence. For everyone, as Thomas Friedman puts it, the dream of living like Americans appears finally to be within reach. Or is it? Those who think about the world’s economic future – the World Bank, International Monetary Fund and other forecasters – see growth continuing uninterrupted. On current trends, they suggest world economic output is expected to grow between six and sevenfold between 2005 and 2050. (Jeffrey Sachs, for example, calculates that the world’s gross product – the value of everything the world’s economy produces – will rise by 6.5 times, or from $67 trillion to $420 trillion, between 2005 and 2050.2) Assuming that growth then slows in the second half of the century, it would end up between fifteen and twenty-five times bigger by

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the end of this century.3

A disproportionate share of the growth expected to come over that period would be in Asia. Currently, the countries of the region account for some $30 trillion of world product; by 2050, averaging real growth of just over 5 percent a year, that would be at least $230 trillion – between seven and eight times greater than now. These are astonishing numbers. But they demand scrutiny. According to Lester Brown, the president of the Washington-based Earth Policy Institute, an environmental research body, up until the middle of the twentieth century the world more or less lived within its means. Then it embarked on a three-decade growth spurt, expanding its economy eightfold. Around 1980, it passed the earth’s regenerative capacity – and now it stands at somewhere approaching 30 percent beyond our planet’s sustainable capacity.4

This does not mean that the world stands on the brink of collapse. It has enormous reserves that humanity can tap into for decades to come at current rates of extraction. But if we push the world’s economy towards being six or seven times bigger than now, or fifteen times, or twenty-five times, we can be sure that more and more of those resources will be driven to the point of collapse. The region where these collapses will have the most immediate and greatest impact will be Asia. Water is its most pressing resource issue. Almost without exception, countries across Asia are seeing the amount of water available to each of their citizens fall sharply. India’s per capita renewable water resources fell 7 percent from 2000 to 2005, China’s by 5 percent.5 Both country’s problems pale into insignificance compared with Pakistan’s. Agriculture is the economy’s biggest sector, employing nearly half the working population and accounting for a quarter of GDP – and 96 percent of all water withdrawals. This extraction is destroying the country’s water resources. According to the United Nations World Water Assessment Programme, per capita renewable water resources fell by more than half in the first five years of this century – from 2961 cubic metres in 2000 to 1420 cubic metres in 2005.6

asIa arrIves – and wants It all

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Across the region, countries find themselves with less water – and with more of what they do use being pumped out of aquifers faster than rain replenishes them. How can it make sense, then, to pursue ways of life such as replacing the vegetarianism traditional to much of India with eating beef and other meats that require much greater quantities of water to produce a meal? Current extraction rates have created a ‘water bubble’ economy, where consumption now will deny resources to the next generation. Other resources are equally threatened. Without a change of heart within the next decade, forests in Asia will be lost to the point where most people will never have the chance to see what covered most of the region’s tropical landscape just sixty years ago. Brazil’s deforestation of the Amazon is well known. But Indonesia’s clearing of its forests is far more advanced. In the last fifty years its rainforest cover has fallen from 82 percent of the country to less than half.7 Its impact on the world has been almost as great as that of Brazil. Between 1990 and 2005, the latter’s forest clearance contributed almost one third of all carbon dioxide emissions attributable to deforestation. Indonesia was not far behind – responsible for more than one quarter of all such emissions. Asia as a whole was responsible for nearly 36 percent of such emissions – a greater source than Brazil.8

And climate change eventually will outstrip even water shortages in terms of its impact on the environment. It is hard to know which country will be most affected, but Bangladesh, and its population of 160 million, will be a candidate. In its 2007 report, the UN’s Intergovernmental Panel on Climate Change estimated that by 2050 Bangladesh’s agricultural output could be sharply less than it is now, with rice output dropping 8 percent and wheat by 32 percent.9 Already the World Bank forecasts that developing countries will need to spend a total of $40 to $100 billion every year from now until 2050 on adapting to the effects of climate change on their farming sectors. Similar statistics as those for water, forests and food can be found for almost every other critical resource – from topsoil to rare earths, from greenhouse gas emissions to crude oil. Already, either sources are falling

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to dangerously low levels or exploiting them is having an environmental impact that threatens the livelihoods of huge numbers of people. Adhering to current policies of consumption-fuelled growth may bring middle-class affluence to many people across Asia – hundreds of millions, probably, perhaps more. But their ranks will be far outnumbered by the many more across the region, especially those living in rural areas or recent migrants to Asia’s ever-growing number of mega-cities, whose lives will be devastated by a lack of water and desertification, extreme weather, rising sea levels and the other impacts of climate change and environmental degradation. For them, the era of American consumption will never arrive.

At the limits

Of course, there are those who dismiss such forecasts as Malthusian fear-mongering. After all, predictions that the world would run into limits have turned out to be repeatedly false over the last two centuries. Instead, time after time, human ingenuity has come up with new ways of extracting more value – most obviously in agriculture, where the ‘green revolution’ of the 1960s and 1970s has provided food for billions of people in the developing world. And what about perhaps the most famous forecast ever that the world was running out of resources – The Limits to Growth report issued by the Club of Rome in the early 1970s? It, too, predicted that continuing growth in consumption levels combined with rising populations would inevitably lead to a resource-depleted world of shortages. But such constant predictions of ever more intense resource shortages leading to rising commodity prices have likewise been proven wrong – prices have consistently fallen. Our energy sources, especially oil, remain as abundant as ever, despite an unceasing series of ‘peak’ forecasts. But, while acknowledging that countless previous forecasts have turned out to be wrong, my point is different. Over the last 200 years, since Thomas Malthus was writing, limits have been surpassed time and time again, enabling the economic growth of the twentieth century. But

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to focus on shortages and depletion alone is to miss the bigger issue – the impact the use of those resources has had on our environment, and above all the fact that such environmental costs have been excluded from goods that use those resources. Thus industry was encouraged to develop products and use techniques for which it did not have to pay a true price. So, while I also believe that humanity will continue to come up with ideas and inventions that will allow us to produce enough food to feed everyone, the way in which we do this – and produce all the other goods and services we consume – will have to change. The ecological cost of human activity must now be taken into account. Where limits are being approached that threaten catastrophe for communities or populations constraints must be imposed, be it through outright bans or giving them a price via taxes or other charges. Malthus was not wrong when he said that if things continued as they were, limits would be reached. And the Limits to Growth report was not wrong in saying that on then-current consumption trends the world would run up against a range of limits. It is worth noting that the trends forecast by Limits to Growth have remained largely unchanged, and a recent analysis of its predictions found them broadly in line with events over the nearly forty years since the report was published.10

What is really strange, therefore, is the assumption that limits can always be overcome, and that the impact of using those resources can also be ignored. As with much else that has passed for conventional thought in today’s world, a good part of the responsibility for this can be laid at the door of market fundamentalism – in particular, its claim that at the heart of what markets do lies the notion of ‘efficiency’ by arranging for the best possible distribution of a finite amount of goods via a free market. In the short term, many possible arrangements can be made that make people better off – inventing machines that can pump water from ever deeper within aquifers, for example. However, if these ignore longer-term depletion issues, such as where the water will be found to raise crops for the next generation, Malthusian concerns have only been deferred, not solved.

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Off a cliff

But if putting a tricky problem off until later is at least understandable, what can be made of embracing a problem that can only get worse? In 1990, China had a negligible car industry, producing just a few hundred thousand vehicles. In 2009, it surpassed the United States to become the world’s biggest auto market, with some thirteen million vehicles sold. Growth is expected to continue, driven by an enormous expansion of factories built by almost every one of the world’s automotive companies. A study prepared for the US Department of Energy estimates that China’s total vehicle stock will catch up with that of the United States in the late 2020s, when both countries will have around 330 million vehicles. It will then rise to between 470 million and 660 million by mid-century – not far off the 820 million or so vehicles in the world’s total vehicle fleet today. What fuel will power all these vehicles? In 2005, China’s vehicle fleet used 109 million tonnes of oil; by 2050, it will need between six and ten times as much. Finding sources for this will be hard: ‘Considering the rapid depletion of the world’s oil reserve … and the geopolitical complications of global oil supply and demand, the study results suggest that unmanaged vehicle growth and only incremental improvements in vehicle efficiency will lead to an unsustainable and unstable transportation system in China.’11

Other studies come to the same conclusion. Another American report, produced for the Council for Foreign Relations, projected that if China’s per capita oil consumption were to reach that of South Korea’s now, the country’s share of world oil consumption would rise from its current 10 percent to 70 percent. Alternatively, if China’s share of world oil consumption were to peak at 22 percent – America’s current level – world oil output would have to rise by 13 percent a year for the next decade, or thirteen times the 1 percent growth rate averaged since 1975.12

Clearly the companies investing in China’s automobile industry hope something will turn up along the way that will change things. A taste of what that could be comes from Carlos Ghosn who, as head of both

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France’s Renault and Japan’s Nissan, is among those investors. Ghosn envisages massive growth for the automotive industry. Helped by China, India and other developing economies, he forecasts that by 2050 the world will have 2.9 billion passenger cars, more than four times its current figure.13 He acknowledges that those cars will be different from those of today – they will be zero-emission vehicles. But apart from this nod to sustainability, he has nothing to say about the other resource and environmental issues such an industry would create: the materials to make them, the infrastructure for them to be driven on, the fuel to run them, or the congestion and other external costs they would impose on the societies that had to endure them. Across Asia, similar short-term visions abound. The demands on resources, the stresses caused by pollution and the impact on climate are accelerating, and are likely to accelerate further. Technology may have helped the world feed itself, but it has created the means for companies to act without proper analysis of the consequences. Fishing and forestry technology allowing harvesting on hitherto unimaginable scales are two examples of this. But perhaps even more dangerous is the technology that has transformed the speed with which capital flows around the globe. High-speed financial transactions have encouraged the growth of consumption by offering new ways of spending to individuals, such as credit and debit cards and other forms of consumer debt, and providing an ever wider range of financial services to corporations. These have accelerated the speed at which decisions and actions can be taken to exploit resources.

Sustainable development

To meet the array of environmental and ecological challenges it faces, what Asia must find are ways of making its economies sustainable – ones that ‘meet the needs of the present without compromising the ability of future generations to meet their own needs’, to quote the UN’s defining statement in the Brundtland Commission report, published in 1987.14

An important point about sustainability is that it does not require

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things to remain unchanged. We have to preserve vital ecosystems. Resources can be depleted provided we ensure there are other things that can perform a similar function for future generations, either directly (there is something else that can be used in its place) or indirectly (via an idea or invention that makes a previous resource redundant). The key point is that rather than stimulating growth, countries should be looking at the sustainability of their productive bases. What impact will growth have? How is it possible to encourage forms of growth that maintain productive sustainability while barring those that undermine it? Understanding the relationship between these questions is helped enormously by a simple but elegant equation, I=PAT, first formulated in the early 1970s by biologist Paul Ehrlich and environmentalist John Holdren. I=PAT highlights how the impact of humans on the environment (I) is determined by multiplying population size (P), by affluence (A) and the level of environmental impact per unit of spending (T), otherwise known as the level of technological development. In Asia the size of P is enormous, but populations change only slowly over time, allowing us to bracket it for now and instead concentrate on the other elements affecting environmental impact – A, which we want to see rise, and T, which we want to fall. Basic maths suggests that if we want people’s affluence to double, and the environmental impact to remain unchanged, then T would have to halve. Currently, Asian consumption levels are around a twentieth of America’s. To raise them to, say, half of American levels, would mean raising A tenfold. To keep the environmental impact at current levels, therefore, would require lowering the environmental impact per unit of spending by 90 percent. Frankly, this is inconceivable. As industry expands, and cars, home appliances and other electrical goods become ever more commonplace, the environmental impact of rising affluence will only increase – regardless of the growing efficiency with which goods are made and electricity generated. A’s rise will far offset T’s fall.

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So if countries across Asia want to keep the impact on their environment within manageable limits, as well as addressing T they will also have to look at A, and ask whether there are other ways of being affluent than those assumed until now. In Chapter 3, I explore possible ways of finding alternative sources of affluence. For now, however, I want to explore one further implication of the difference in relationship between A and T in the developed world and in Asia. For the rich countries, the pressing environmental issue remains climate change, and what can be done to reduce greenhouse gas emissions without having to make any sacrifices in ways of life. As most of these countries have populations that are stable or falling, the challenge therefore is maintaining or slightly improving their current level of affluence while hoping that technology will allow them to lower T, so lessening their overall impact on the environment. Grasping this explains why Western countries still see little need to change their behaviour – for them, climate change is still a technological issue. But it also explains why Western countries have so great a difficulty in understanding what has to be done in Asia – quite simply, they still fail to grasp that Asia cannot use the same tools as them, nor that Asia will have to go down a very different path from the one they have taken. Failing to see this last point may partially explain why Western proposals on ways to help developing countries in Asia and elsewhere so often miss the point. If Asia were to find an alternative development route, the interests of many Western businesses would be severely affected. Western economic policy towards Asia may not be as explicitly aimed at exploiting the region as it was during the colonial era, but it remains focused on maintaining Western economic advantage, nowhere more so than in support of multinational companies. From the 1980s onwards, market fundamentalism’s international arm, globalization, prised markets open, allowing companies to sell more goods and transfer manufacturing operations to locations with lower-paid and usually non-unionized workers. Weaker regulatory systems also allowed for the offshoring of polluting and other environmentally costly facilities.15

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Companies often found the pickings richest in countries that had just liberalized their economic systems – in such places, markets preceded regulation, creating the conditions for a bonanza in the exploitation of natural goods such as forests or wildlife. Forests in south-east Asia, for example, have been felled more quickly in newly democratic countries than in authoritarian ones, precisely because once private companies were able to secure a foothold they had both the motive and usually the means, such as access to capital and equipment, to act as fast as they could.16

The financial crisis has done nothing to weaken the beneficiaries of globalization. Indeed, it probably had the opposite effect: with their home economies in recession, multinationals had even greater reasons for expanding their operations in countries where they expected growth, notably Asia. Foreign investment into India expanded each year through the crisis, while China’s held broadly steady at around $90 billion a year. Of course, this still leaves Western countries facing the dilemma that supporting their model of economic development in Asia simultaneously worsens the prospect of finding a solution to climate change. But then again, that might also be because the world is becoming increasingly aware that the planet’s climate future will be determined at least as much by Asia as by the rich countries. Indeed, what is decided in the capitals of North America and Europe will be irrelevant if China and India are not brought on board. And if Asia does opt to allow consumption-driven development to take precedence, they will have little say in the key decisions determining how high temperatures, and with them sea levels, will go. There is a certain irony in this. As little as fifteen years ago, few people in the West (or Asia) envisaged a world in which countries such as China and India might actually be rich. For sure, business executives would talk about the potential of such markets, but there was little expectation that it would be realized in anything but the long term. The speed with which these countries have grown their economies has caught many people off balance. Indeed, now they can see what impact this growth is having, many in the West are already ruing the rapid economic growth of these

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two countries. Some of the reactions to China’s re-emergence betray the underlying resentment of this new reality – because of the shift in economic power it represents, and because of the fears it brings about being forced to share the world’s resources. Assuming India follows in China’s footsteps, such resentment is likely to grow even more severe.

Fear of speaking out

So just why is it that no one wants to stand up and say to Asians that they cannot have it all? One reason was alluded to at the start of this chapter – the idea of having it all is very appealing. Pandering to people’s aspirations, however, is the easy way to go. The biggest reason for avoiding the truth is fear – fear of the terrible consequences of standing up and telling everyone that, quite simply, they cannot have it all. Even those with no vested interests appear to find it difficult to state the obvious. Among the various outpourings on the global financial crisis, one of the clearest-eyed commentators is Joseph Stiglitz. In Freefall, his analysis of what went wrong in America from the Reagan era onwards, he explicitly condemns his country’s way of life, and warns off others trying to emulate it: ‘The US lifestyle is not sustainable … If those in the developing countries try to imitate America’s lifestyle, the planet is doomed. There are not enough natural resources, and the impact on global warming would be intolerable.’17

He makes a strong case for markets being the wrong tools for achieving social objectives. Yes, they can help allocate resources efficiently, but the total failure of ‘efficient market theory’, as put into practice in the years before the financial crisis, starkly revealed how much America had used its power and influence at home and abroad to create an economic system that supported the self-interest of a small number of its institutions. And yet his arguments peter out. No substantive new thinking emerges on what the United States should do about this, let alone where this leaves the rest of the world. The problem is that better regulations, even ones that worked, would not confront the issues of America’s unsustainable lifestyle. But much as Jeffrey Sachs avoids talking about the need to transform

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lifestyles among the already well off in both the rich and the developing world, preferring to focus on the needs of the poor, so Stiglitz cannot move beyond an economics that remains essentially rooted in free markets, just with better regulation. In the final pages of his book, he nods to the possibility of there being other, greater goals that require attention: ‘The failures in our financial system are emblematic of broader failures in our economic system, and the failures of our economic system reflect deeper problems in our society.’ He then suggests that the rules of the game have changed globally, and that ‘Washington consensus policies and the underlying ideology of market fundamentalism are dead’. If only this were true. The unnerving thing about the financial crisis is not what happened, or even what it revealed, but just how much of what caused it remains intact. Why then, does Stiglitz claim the opposite? I suspect it has a connection with the fact that standing up and saying something as radical as that the people of Asia cannot have it all would open the way to saying that the people of the rich world cannot have it all either. Free market thinking allows those in the rich world to pretend that their lifestyles are OK because everyone else can aspire to them too. But if people in the developing world cannot have such lifestyles – because the demands they place on global resources are too great – then those in the rich world turn out to be no better than their colonial predecessors who believed in European superiority. It is for these reasons of supposed neutrality that the West, even at its more liberal end, continues to promote the idea that liberal democracy and liberal markets, whatever their shortcomings in practice, contain universal truths. For if these ideas hold true everywhere and so are applicable to all, then there is no reason to question the basis of their wealth, nor the right of their companies to go out and obtain more of it around the world. This is the ideology which is still being fed into Asia, via calls from newspaper commentators for open markets, via economists promising ever greater prosperity, and via officials calling for ever-increased consumption. It is understandable, therefore, that governments across Asia still fail to

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recognize – or refuse to accept – that the same free market thinking that pushed the economies of the United States and Europe into financial crisis is creating the conditions for a series of ecological and political crises whose long-term impact will far outstrip the market collapse of 2008. The costs will not be so instantly apparent as a sharp fall in stock market prices. But they are already being paid. With growing levels of affluence, hundreds of millions of Asians are enjoying a new life of abundance, but one steeped in over-consumption and wastage. In India, still home to a significant number of undernourished people, well over half the women between 20 and 69 years old are overweight. In China, approaching 90 million people are already clinically obese, with forecasts suggesting the number will rise to 200 million by 2015, and that within two decades two out of three people in the country will be overweight or obese, the same proportion as in the United States now.18 Governments continue to allow traditional practices, often frugal ones, to be pushed aside. In India, more and more people are replacing vegetarian diets with meat ones, much to the satisfaction of the food industry. Average meat consumption per person is currently six grammes a day; the Ministry of Food Processing Industries sees that rising to fifty grammes within a decade or so. ‘When such phenomenal increase in meat consumption occurs,’ says a ministry spokesperson, ‘the sector will witness a tremendous growth.’19

Governments are, however, finding it harder to ignore the almost inevitable conflicts that will arise over resources. Already, water flowing from the Himalayas is a major cause of tension. At one end, India and Pakistan are clashing over rivers flowing through Kashmir. At the other, Vietnam is becoming increasingly worried about Chinese, Lao and Thai plans to build dams along the upper Mekong that could severely affect water flow in the river’s lower reaches. In the East China Sea, Japan and China are arguing over oil and gas fields. Six countries contest ownership of parts of the South China Sea, with energy and fishing resources a major interest. East Asian nations fret about securing sea lanes across the Indian Ocean and through south-east Asia, vital links for the oil and gas they buy

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from Africa and the Middle East. Across the region, such disputes over resources, both real and potential, can only worsen if countries continue to make fast-track economic growth their principal goal.

Non-consumer choices

Wherever we look, therefore, wanting it all can only result in trouble. It is not that Asia stands at a turning point; too many difficult decisions lie ahead for any one to be singled out as vital. But the countries of the region must start paying more attention to the environmental and resource implications of their policy choices. For two centuries Asia did little choosing; the Western colonial powers dominated the region, exploiting its people and resources for their own benefit. After the Second World War, many countries found themselves choosing between capitalism and communism, though for many people the choice was forced upon them rather than freely taken. In the 1980s and 1990s, it seemed that finally countries could choose whether to embrace free markets. Except that this also was not really a choice; it was accepting orthodoxy. But despite the shortcomings of that orthodoxy having now been demonstrated, no one is proposing alternatives. After a brief pause for rhetoric, the countries of the West have resumed their old ways, struggling to cope with the economic fallout of the financial crisis. Europe has adopted austerity, with the implicit promise that as long as populations can endure several years of belt-tightening their way of life should be maintainable. The United States, despite Barack Obama’s promises of change, continues to search for ways of having it all. Under such circumstances, Asia can expect to hear more urgings to be responsible, reduce its emissions, enforce pollution laws and continue trying to grow its economies. The incoherent policy responses arising from this urging of growth on the one hand and restraint on the other will then be condemned as inadequate – either for governments failing to take the global challenge of climate seriously, or for not liberalizing their economies fast enough.

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Decisions, conflicts

Throughout history, humans have recognized that their individual rights are not absolute. In particular, people have accepted that at times of duress, they may have to surrender their freedoms and work for a common good. Even under normal circumstances, sacrifices and restraint may also be called for, as establishing and maintaining a stable society requires people to consider the impact their actions could have on others. Such notions have been replaced. Particularly in the West, entitlement rights and the pursuit of self-interest are the prevailing beliefs. No longer do people need to adapt themselves to the needs of society or others. Instead, things must be changed to suit them. Consequently, even under a threat so severe as climate change, there is no need for people to change their way of life. In a world where people’s wants are met by a market in which others benefit from meeting those wants, there are no limits, and so, no need for sacrifices. We must acknowledge that there are decisions which have to be taken – that there are not, despite the fervent wishes of so many people, only win-win outcomes. It is the blindness – wilful blindness, I would suggest – of those who only advocate win-win outcomes that I want to highlight. There are major conflicts that have to be resolved – between what we can expect immediately, and what we want in the longer term; that what countries in Asia have to do is different from what the countries of the West have to do; that what Asia does may impinge on some extremely powerful vested interests, most of which are Western in origin and have strong backers in Western-influenced bodies. As we discover what limits the world imposes on us, we must also ask what limits we must place on ourselves – and choose which limits we want. Nowhere has to choose more urgently than Asia. If the countries of the region are to create a future for themselves within ecological limits, then they must figure out what they should not be doing. The prerequisite for this is to stop looking to the West for inspiration. The rich countries are not ignoring the challenge, but their preoccupations are very different from those of developing Asia. The issue confronting

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the rich countries is whether they can reduce their ecological impact while broadly maintaining their current ways of living. The measures they eventually take may need to be drastic, but whether this will be the case remains unknown. Consequently their debates principally focus for now on mitigating their impact on the environment rather than radically changing the way people live. What these debates fail to address is what is happening in the rest of the world. They acknowledge that solutions to climate change will have to include the big developing countries – Russia and Brazil, as well China and India. And, particularly since the collapse of the Copenhagen climate talks, there is an awareness that these countries’ interests make coming up with a global answer an extremely difficult task. Perhaps because of this, when the issues facing the rest of the world are considered – which aside from demonizing China, is not often – the suggestions made are cosmetic. Asia must question the solutions that emanate from such bodies and interests, especially those that suggest that the world’s long-term future can be trusted to technologies and investments which posit the continuation of consumption-driven economies. This is still thinking in terms of the same kinds of outcome – a world in which the richer nations are a little constrained, but the poorer ones are brought up in the same model. Unfortunately, the way in which governments across the region think about such questions, when they consider them at all, remains rooted in conventional ways of thinking – the one that says that people across Asia can aspire to the same consumption-fuelled lifestyles now experienced by Americans, and that if they do, then their governments will benefit from the power and prestige of a re-emerged Asia. And yet neither of these are credible goals. Attempting to realize them can only end in environmental catastrophe. Those who suggest that technological and financial ingenuity will be able not just to avert disaster but allow people to move towards a consumption-fuelled lifestyle are living in a dream world, as the next chapter explains.

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1

2

3

4

5

1980 1985 1990 1995 2000 2005

Carbon dioxide emissions per capita Tonnes

World

East Asia

China

India

South Asia

Source: World Resources Institute0

1

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1980 1985 1990 1995 2000 2005

Carbon dioxide emissions per capita Tonnes

World

East Asia

China

India

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Source: World Resources Institute

Contents

Acknowledgments ixIntroduction xi

Chapter 1 The Present Demographic Scenario 1The Current State of Global Demography 2Where Is Everyone? 6Age Profile 7The Household 8Urbanisation 10Education 11Employment 13Household Income 16Summary 19

Chapter 2 Population Change by 2032 21Migration, Births, and Death Rates 22Death Rates 31The Implications for Total Population Changes 32

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v

The Changing Age Profile 34Summary 38

Chapter 3 Tomorrow’s Household 41The Modern Household 41The Changing Nature of Tomorrow’s

Households 45Employment and Dependency Ratios 48Household Dependency Ratios 49Summary 51

Chapter 4 Education and Productivity 53The Education Index 54The Future Demand for Education (and Standards) 56Education’s Impact on Society 60Can India Catch Up? 62Strategic Implications 63Summary 65

Chapter 5 The Evolving Labour Force 67Factors Influencing the Size and Value of the

Labour Force 68Strategic Implications 84Summary 85

Chapter 6 Where in the World Is the Money? 87Elephants in the Room 87Usefulness of GDP for Evaluating the Potential

of the Consumer Market of One CountryRelative to Another 89

What Is the Best Way to Compare Expenditureamong Countries? 91

So, Where Is the Money? 92Relative Average Household Incomes per

Capita in 2012 94Where Will the Money Be in the Future? 96The Future for Household Incomes 106Deciding Whether to Save or Spend 109Summary 111

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vi C O N T E N T S

Chapter 7 Distribution of Households by Income 113Introduction 114The Different Income Segments 116Who Are the Middle Class? 127Purchasing Power Parity (PPP): When Notto Use It 133

Strategic Implications 134Summary 135

Chapter 8 The Changing Pattern of ConsumerExpenditure 139The Basic Relationship between Consumptionand Affluence 140

Changes in Expenditure by Income Segmentand Region 148

Age Group and Expenditure—Where ShouldBrands Target Their Efforts in Future? 156

Strategic Implications 159Summary 160

Chapter 9 The Health Tsunami 163The Relationship between Ageing andDemand for Health Services 165

The Cost of Health Care 171Summary 179

Chapter 10 Behind the Hype: The Future forChina and India 181China: A Special Case 182The Future for India 195Strategic Implications 204Summary 205

Chapter 11 Conclusion 207The Old Affluent Regions 208Eastern Europe 212South America 213Developing Asia 215North Africa and the Middle East 217

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Contents vii

India 218China 221To Conclude 225

About the Author 227Index 229

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viii C O N T E N T S

Chapter 5

The EvolvingLabour Force

A t a national level, the trends in the size and capability (which is afunction of education) of the labour force significantly deter-mine the health of the economy and how it will grow. This in

turn impacts wages, household incomes, and expenditures. Therefore, itis important to understand the drivers behind the size and productivityof the labour force and their implications for the future size and capa-bility of the labour force. It is also important to have an appreciation ofhow the very nature of those drivers is changing and in particular, howan extended working age is changing the perceived ability of manycountries to develop their economy.

This chapter should also impact on perceptions about the futurecourse of some economies. A trick question is a useful starting point.Country A has a labour force which will shrink in absolute number ofworkers by 18 percent over the next two decades. Country B has a

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labour force that is 10 times more productive than that of Country A andwhose number of workers will increase by 13 percent over the next twodecades. Which one should be promoted as a good investment environ-ment? Which countries are they? Read on!

Factors Influencing the Size and Valueof the Labour Force

The size of the labour force, and how that will change, is driven by theage profile of the population which determines the number of persons ofworking age, and then their propensity to be employed, which itself is afunction of education (capability) and social norms (such as acceptanceof the involvement of women in the workplace).

The Working Age Population

The most important determinant of the size of the labour force is thenumber of people of working age, typically defined as being 15 years to64 years of age. However, this assumption needs to be modifiedto reflect the longer lifespan that is now evident in the affluent regionsof the world, and the consequent changes that are occurring in pro-pensity to work at older ages.

In many of the more affluent countries, including North America,most of Western Europe, and most of Affluent Asia, the improvedquality of nutrition combined with good and improving levels ofhealth care have led to people living significantly longer, and they arefitter and healthier for much of that time. In Japan, life expectancy hasrisen to 84 years—double that of the world’s least-developed nations.In many other developed nations, life expectancy is in the late 70sand early 80s.

This has two significant implications for older people’s desire andneed to find work. First, there are new, personal economic impera-tives. If an individual retires at age 65 and lives in a country with a longlife expectancy, they will need to fund on average an additional 15more years of life. Even as recently as 20 or 30 years ago, this was not

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68 T OMORROW ’ S WOR L D

the case. The existing pension and savingsfunds in these countries are insufficient toprovide for everyone to live a leisurely,retired life for an extended period longerthan originally intended—about 10 years.

Also, these people who are livinglonger are still physically active and intel-lectually able. Turning 65 does not switchoff the brain, and the prospect of beingstuck at home or playing golf every day isunappealing to many 65-year-olds. Thepoint of view held by many governments isthat this wish to remain in the workforceis desirable, as it reduces the pension liabilityon public funds. Most Western European economies are changing leg-islation right now to reflect this change in attitude as well as economicrealities, and in someWestern European countries, the actual (rather thanlegal) average retirement age of males is already over 65 years.

While this might seem like a fairly minor change at a nationaleconomic level, the reality is that, in these older countries, it increasesthe pool of individuals available to be in the labour force more signif-icantly than many realise. Japan is an interesting example, particularly asmany commentators focus on its potential inability to provide for itsageing population. If working age was not expanded from 15 to 64 to 15to 70 by 2032, then the working-age population would only compose59 percent of the Japanese people in 2032, limiting its productivecapacity. Adding an extra five years to working life increases theworking-age population from 63 percent of the total population in 2012to 67 percent in 2032. In absolute terms, this change would add another8.1 million people to the size of the working-age population. Thisextension of working-age definition expands the potential pool ofworkers in North America, Western Europe, and Affluent Asia. Theother regions at this stage do not have a life expectancy that would allowsuch a general social adjustment to be made.

Figure 5.1 shows the projected change in the number of personsthat are of working age in each of the regions between 2012 and 2032,

In many countries, pen-sions and savings havesimply failed to keep upwith changing economicrealities, personal circum-stances, and lifestyles.As a result, there is anincreasing pressure onindividuals to worklonger.

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The Evolving Labour Force 69

taking into account the longer working-age range in the older andmore affluent countries. In total, the number of people of working agein the 74 countries covered in this book is projected to increase from3.9 billion in 2012 to 4.2 billion by 2032. This means there will be anet increase of 349 million persons of working age over the next20 years, a growth rate of 0.5 percent per annum. Interestingly, Fig-ure 5.1 highlights significant differences in trends across the regions.In North America it increases, in Western Europe it is stable, and inAffluent Asia it declines. South America, North Africa and the MiddleEast, and Developing Asia, all having younger populations, are pro-jected to experience a significant increase in the potential pool oflabour. So too is India for the same reasons—but what a contrast India isto China. Whereas India is projected to have an additional 207 millionpersons of working age in the next two decades, China will have 138million less.

It is worth noting that overall for the countries covered in thisbook, in 2012 an estimated 68 percent of the populations are of

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Number of Persons (Mns) of Working Age

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2012

Figure 5.1 Number of Persons (Millions) of Working Age in 2012 and 2032Source: Global Demographics Ltd.

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working age and this decreases marginally to 66 percent by 2032. Alsothere is, with the exceptions of North Africa and the Middle East andChina, relatively little variation around this global average. North Africaand the Middle East are relatively low at 61 percent and 62 percent in2012 and 2032, respectively, and China is relatively high at 73 percentand 66 percent, respectively.

The vital challenge for all economies is how far they will be able toconvert this additional human capital, as a result of an increasing numberof persons being of working age, into greater productive capability—that is getting and keeping them employed.

Participation Rates

The relative similarity across countries and regions in terms of the shareof the population of working age means that the key driver of theeconomies is not what proportion of their populations are of workingage but, rather, their ability to engage them in employment. That is thepropensity of working-age persons to be employed. The reader isreminded that this is very different from unemployment rates. Unem-ployment rate is the proportion of persons seeking work who cannot findwork. However, not all persons of working age are seeking work. So theemployment rate is the proportion of people of working age who areseeking and who found work. It is necessary to use this approach as datais not generally available on the proportion of those of working age whoare seeking work. It is also a more robust measure and therefore moreappropriate for international comparisons.

The percentage of working age that is employed is called theparticipation rate and it is a function of many factors, including how longpeople spend in education (the better the education system, the latertheir entry into the labour force), attitudes toward female participation,and, finally, the availability of work (which effectively determines theunemployment rate).

The participation rate can vary as a result of multiple external factors.However, an analysis of the last two decades suggests that participationrates vary around a clear trend line for each country and region, and thattrend is what is used for the forecast in 2032.

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The Evolving Labour Force 71

When looking at the workforce participation rate, it is important tobreak the analysis down by gender, as there are significant differencesbetween them. Figure 5.2 shows the participation rate of men andwomen for each region in 2012. In most countries, the male partici-pation rate is close to the overall average of 77 percent, meaning thatslightly more than three out of every four males of working age areparticipating in the labour force—that is, employed. In Eastern Europethis figure is 67 percent; in Developing Asia it is 81 percent and China at83 percent. Contrast this with female participation rates. By a substantialmargin China has the highest female participation rates at 71 percent.The next highest region is North America at 63 percent. This isfollowed by Affluent Asia, with 58 percent, and Western Europe with57 percent. Perhaps, unsurprisingly, female participation rates are by farthe lowest in North Africa and the Middle East at around 30 percentfor a variety of reasons, notably social and cultural, but also genderdifferences in educational opportunities. It is also worth noting that inDeveloping Asia there is a significant dichotomy. In Thailand and

77%

73%

70%

78%

73%

67%

76%

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81%

75%

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0% 20% 40% 60% 80% 100%

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North America

Western Europe

Affluent Asia

South America

Eastern Europe

North Africa/Middle East

China

Developing Asia

India

Percentage of Working Age That Is Employed

Females 2012

Males 2012

Figure 5.2 Participation Rates by Gender in 2012Source: Global Demographics Ltd.

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72 T OMORROW ’ S WOR L D

Vietnam the female participation rate is over 70 percent whereas inIndonesia, Malaysia, and the Philippines it is around 47 percent and forthe others it is below 30 percent.

As the size of the total labour force is substantially determined bythe proportion of the working-age population that is employed, thesepercentages are crucial and what is particularly significant is how thetrend will develop over the next two decades. For men, the generalconsensus is that the participation rate will remain relatively steady, butwith a marginal decline in some countries where the access to educationis improving and thus delays their entry into the workforce. This con-trasts with the female participation rate, which is expected to increasemarginally as more women gain equal access to education and as socialattitudes change towards women working. However, it is interesting tonote that the trend in female participation between 2000 and 2010provides no evidence of significant change, even in countries wherethere is no difference in educational outcomes by gender. So only agradual increase can be planned for.

The exception to this is Japan. There is a significant change inbehaviour happening there, and female participation rates have increasedsignificantly over the last decade, reflecting a change in attitudes tofemale participation (there has been relatively little difference in gendereducation profile for some decades so that is not the cause of thechange). This trend of the older working age empty nester femaleentering/returning to the workforce is expected to continue for the nexttwo decades and has a significant impact on the size of Japan’s totallabour force.

Finally, with respect of participation rates, it is important to note thesituation in China. With male participation rate of 83 percent and afemale rate of 71 percent it can be stated that China is operating at fullcapacity in terms of its labour resources. While it might be overstatingthe participation rate in the rural areas, the point remains that it isunlikely that any society can expect a higher proportion of working-ageadults to be employed. Consequently, China has no spare labourresource and the trend in working age population is critical to deter-mining the future size of its total labour force, and that (working-agepopulation) is projected to decline from 988 million in 2012 to aprojected 850 million in 2032.

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The Evolving Labour Force 73

Implications for Existing Labour Force Size

The size of the labour force in 2012 can be estimated by applying theparticipation rates to the working-age population. The resulting esti-mated employed population is considered to be quite reliable andprovide a good basis for economic planning.

In 2012, the global workforce is around 2.54 billion people.Understanding where these people are located, however, reveals aninteresting picture that is highlighted in Figure 5.3.

Given its large population, it is not surprising that China accounts for30 percent of the global workforce. In contrast, India, with almost thesame total population as China, accounts for just 17 percent of the globaltotal. Its total labour force is little more than half the size of China’s. Thisis due to differences in age profile of the population and in femaleparticipation rates. In terms of working age female population, forIndia only 39 percent are employed whereas for China it is 71 percent.The other factor influencing the difference is age profile. India is muchyounger, as explained in Chapter 1, and as a result has a lower pro-portion of its population falling within working age band. That is

North America7%

Western Europe7%

Affluent Asia5%

South America8%

Eastern Europe7%

North Africa/Middle East

5%

China30%

Developing Asia14%

India17%

Figure 5.3 Regional Share of Global Workforce in 2012Source: Global Demographics Ltd.

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74 T OMORROW ’ S WOR L D

64 percent. For China the working-age population as a proportion oftotal population is 73 percent.

Finally, in respect of the 2012 scenario, slightly under two out ofthree workers in the world are located in Asia (India, China, DevelopingAsia, and Affluent Asia).

The Future Labour Force

The total global labour force is expected to increase by 176 millionpeople by 2032. However, there are significant differences in the trendand absolute amount of change by region.

Figure 5.4 shows the absolute size of the labour force in each regionin 2012 and as projected for 2032, taking into account the changing sizeof the working-age population and the likely (marginal) trends in pro-pensity to be employed. There are some clear patterns in the changesexpected. Basically, the young regions are all expected to have significant(greater than 18 percent) increases in the size of their labour forces overthe next two decades. This applies to Developing Asia, India, North

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Employed Persons (Millions)

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Figure 5.4 Total Employed Persons (Millions) in 2012 and 2032Source: Global Demographics Ltd.

c05 31 January 2013; 12:15:38

The Evolving Labour Force 75

Africa and the Middle East, and finallySouth America. Not surprisingly, at 54percent, the largest increase will be in theNorth Africa and Middle East region. Evenmiddle-aged South America is expected tohave an 18 percent increase in total labourforce. This does raise the question as towhether there will be enough jobs for allthese young people entering working ageand seeking work. The trend in propensityto be employed assumes that employmentopportunities grow in line with it. Obvi-ously under this scenario (supply of labourpotentially exceeding demand), that couldbe tested. At the very least, it will placecontinuing downward pressure on wagesin these areas as there is a real probabilitythat supply will exceed demand—especiallyif the export markets of these regions aremoderating their demand for physicalgoods and moving more to experienceexpenditure, as discussed in Chapter 8.

In contrast, the older regions of theworld are projected to have quite stabletotal labour force size with the exception ofNorth America which, with its youngerpopulation and growth through migration,is expected to increase its total labour forceby 13 percent in absolute size over the next20 years. This contrasts significantly withthe scenario in China.

China’s labour force will inevitably shrink, and quite rapidly. Giventhe country’s ageing population and the resulting decline in the numberof people of working age, and that it is already fully utilising its working-age adult population, it is expected that the number of employed peoplein China will decline from 761 million people to 626 million by 2032.

Keep in mind the fact thatthe costs of manufacturingwill change dramatically asa result of robotics, 3Dprinting, and other inno-vations that will have aprofound effect during thenext 20 years. This willhave a major impact on thedemand for low-skilledlabour. It’s worth remem-bering that the IBM PCwas introduced in1984—just 28 years ago.At that time nobodyhad a desktop computer—today, most peopledo—and this has dis-placed many low-end jobs.Robotics is now probablyat the equivalent of 1990in terms of computeradoption.

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76 T OMORROW ’ S WOR L D

That is a reduction of 135 million people in 20 years from China’slabour force. It is a decline in size of 18 percent and is an interestingjuxtaposition against North America, whose labour force is projected togrow by 13 percent over the same period.

This decline in the absolute size of the labour force has interestingimplications for China’s total economic growth and where it might be infuture. There can be few, if any, societies in human history that haveever experienced such a rapid decline in the number of workers as Chinainevitably will. It is inevitable because the two parameters driving it arethe number of persons of working age and propensity to work. The firstof these is closely defined as most of the people that will be working ageby 2032 are already alive today so it can be forecast with some accuracy.The only possible variable is propensity of those people to be employed.In this respect, China already has one of the highest rates for propensityto be employed in the world and effectively has no spare capacity. It isunlikely the propensity to be employed can be higher than its presentlevel. Therefore, there is the certainty of the decline in the total size ofChina’s workforce.

This does have significant implications for economic forecasts forChina. For the last two decades up to 2010, China has been addingapproximately six million workers every year to its labour force which,combined with increased productivity per worker and massive fixedcapital investment, has helped China enjoy a period of rapid growth intotal GDP. However, in future, the Chinese labour force will begin todecline at an average rate of 6.7 million workers per annum over thenext two decades.

For China’s total economy to continue to grow at the rate it has forthe last 10 years, China’s productivity per worker will have to increasesignificantly. As we saw earlier in Chapter 4, China’s overall standard ofeducation is approaching the point where productivity per worker couldimprove significantly. However, the reader is reminded that growth intotal GDP is less important in a country that has a declining (or even flat)total population. What is more important is that the per capita GDP isgrowing—and in China’s case the prognosis is good as a result ofimproving education of the workforce. So perhaps one can be skepticalabout the very optimistic headline growth rate forecasts of some for total

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The Evolving Labour Force 77

GDP but, nonetheless, remain positive about the overall well-being ofChina’s population.

There is one other vital question to consider: That is the trend inlabour forces in the countries which are able to extend working age, asdiscussed in the previous section of this chapter. Before looking at aspecific example in respect of this, it is worth noting the headline sta-tistics. For North America, the total employed labour force will grow by13 percent in absolute size in the next two decades, aided by an extra25 million persons being working age and with a slight increase in thepropensity of these persons to be employed (although the 65- to 69-year-olds are at 50 percent of the average rate for propensity to be employed).The same factors mean that in Western Europe the labour force isprojected to grow by 3 percent. In the case of Affluent Asia, it is pro-jected to decline by 5 percent over the next 20 years—this declinetaking place particularly in South Korea and Taiwan and, to a muchlesser extent, in Japan.

Japan is an interesting specific example in this respect, as manycommentators have been saying that its economic future is dismalbecause the aging population will inevitably result in a decliningworkforce relative to the overall population. However, there are twofactors at play which give a different outcome from the obvious one.The first is the extension of working age, which is not really a matter ofchoice but rather economic necessity, as the average individual other-wise faces the prospect of funding a 20-year retirement. The implicationof this is that by 2032, there are an additional 7.5 million persons ofworking age—an 11 percent increase on what would have otherwisebeen the case.

In addition, there is in Japan the unusual situation of increasing par-ticipation rates. Female participation rate is expected to increase from60 percent of the female working age population to 68 percent. In part,this is the result of older, well-educated women (aged 40 years plus)entering the labour force for the first time as a result of the unusualcombination of capability (Japanese females have been as well educated asmales for some considerable time now) and changing acceptance of femaleparticipation. Taken together, these factors suggest that Japan’s totallabour force will decline from its current level of 62.8 million people to59 million in the years to 2032, contrary to the traditional case, which

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would have it declining to 56 million by 2032. Basically, while the totalpopulation will decline by 9 percent, the portion of the population that isworking will increase, and the total labour force will decline only 6 per-cent in size. So, rather than being a weakened economy, it is actuallystrengthening its position—high productive capacity and very lowdependency ratios—which (as discussed next in this chapter) mean greatercapability to both save and engage in discretionary spending.

Twin Challenges: Dependency and Productivity

The number and proportion of the population that is employed are,however, just the first step in understanding changes in the labour force.The number of employed persons has to be examined in two furtheraspects. The first is dependency rates, how many people are supported byeach worker, as that directly impacts consumption patterns. The secondis productivity trends, as this determines the value of the worker andultimately the economic value of the society and its ability to consume.

Understanding Dependency Ratios Having analysed the numberof employed people in the population and the implications for size ofthe labour force, we can now return to the number of dependent peoplewho are relying on each worker, a figure known as the dependency ratio.As we saw in Chapter 3, this vital economic statistic determines eachhousehold’s ability both to save and to consume. Clearly, if fewer peopleare dependent on each worker, then the average household is effectivelyricher in that it has a higher income per capita. Figure 5.5 shows thedependency ratios for each region and how this is expected to changebetween 2012 and 2032.

The first point to note is that there are considerable differencesbetween each of the regions. In 2012, China, at 0.77, has by far thelowest dependency ratio. North Africa and the Middle East have thehighest ratio, at 2.04. To appreciate the consequences of this, consider aworker in each region earning $3000 per annum. In China, that equatesto $1,694 per person (one worker and 0.71 dependents). In the MiddleEast or North Africa, the same earnings provide $983 per person(US$3,000 divided by 3.04, being one worker and 2.04 dependents).

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The Evolving Labour Force 79

The forecast reveals diverse trends in the dependency ratio in theyears to 2032. In China, with a declining working age population,the dependency ratio rises to 1.08. In comparison, India’s dependencyratio falls from 1.73 to 1.61 and it is also expected to fall in North Africaand the Middle East, from 2.04 to 1.83, and in South America from 1.38to 1.33. As in these cases, the proportion of the population that isworking age increases and with that (hopefully) employment. Generally,though, for most of the 74 countries considered in our analysis, thedependency ratio is projected to increase marginally.

Once again, the situation in Japan provides an interesting andunexpected trend—one that also extends to many of the countries inWest Europe and Affluent Asia. As we mentioned earlier, greater lifeexpectancy, combined with the increasing desire and ability of the 65-to 69-year-old age group to work and with increasing female partici-pation in the workforce, means that the total Japanese labour force isexpected to decline by 6 percent from its present level of 63 millionpeople to 59 million over the next 20 years. This will happen at the same

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Number of Persons Supported by Each Worker

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Figure 5.5 Number of Persons Supported by Each WorkerSource: Global Demographics Ltd.

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time as the population of Japan declines from 127.4 million peopleto 115.7 million. The obvious result is that Japan’s dependency ratiowill actually improve from 1.03 to 0.96dependents per worker—a figure whichactually makes Japan a country with one ofthe lowest dependency ratios in the worldin 2032. Crucially, this means that Japanhardly needs to be concerned about theeconomy’s ability to provide for the agedpopulation.

The popular misconception is thatJapan’s low birth rate and ageing popula-tion will greatly worsen the country’sdependency ratio, potentially resulting inan economic, political, and social crisis.This is clearly not going to be the case.Commentators have failed to take intoaccount the realities of Japanese life, inparticular an increased lifespan, extendedwork life and greater use of robotics, and the implications of all ofthese issues for Japan’s dependency ratio. Finally, it is worth notingthat the trend for dependency ratios to reduce is also accompanied bythe trend for household incomes to increase, as discussed in the nextchapter. Combining the two means that, in Japan, overall per capitaincome, and consequently people’s standards of living, can be expectedto improve.

And Productivity per Worker Finally, to understand the globallabour force, we need to examine the cost effectiveness of employingsomeone in each country, and how this might develop in the years to2032. Given that we know average household income and the averagenumber of workers per household, we can determine the average wageper worker. Similarly, because we also know total GDP and the totalnumber of workers, we can determine, with a high degree of reliability,the gross productivity per worker. While a crude measure of produc-tivity, it is reliable and not subject to fudging. Following this analysisthrough, by dividing GDP per worker by the average wage we can then

The trend for dependencyratios to reduce in Japanis also accompanied by thetrend for householdincomes to increase.Combining the twomeans that overall percapita income, andconsequently people’sstandards of living, can beexpected to improve inthat country.

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The Evolving Labour Force 81

estimate the return to the economy (and, on average, to the employer)on every dollar of wage paid to a worker. Figure 5.6 highlights thesituation in 2012 and 2032.

Looking at the 2012 data, the obvious issue is the high returns gen-erated inChina. For every $1 inChinese wages there is an output of $1.83.The next highest return on wages is in North Africa and the Middle East,at $1.46 of output per $1 paid followed by South America at $1.40. Thesenumbers explain why China attracted so much investment inmanufacturing. This situation also reflects the fact that China’s salaries arequite low as a proportion of total economic activity. We’ll return to thisissue when we consider household incomes in Chapter 6, but for now it isenough to know that the private consumption component of GDP,which is a reliable measure of total household expenditure (and incomes),is just 33 percent of GDP in China in 2010 (latest published), whereas formost countries it is over 60 percent and for many it is over 70 percent.

The situation in which Chinese workers receive a disproportionatelysmall share of the total economic activity matters for two importantreasons. Firstly, relative to the size of GDP, the proportion of the total

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Return per Dollar of Wages

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Figure 5.6 Return per Dollar of WagesSource: Global Demographics Ltd.

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economy in China that is available for the consumer is significantlylower than in most other countries As such, the GDP is not a goodindicator of the value of the consumer market in a country, and par-ticularly China. Secondly, this situation will inevitably change. As wehave already seen, the number of employed persons in China willinevitably decline. Given the already high participation rates of theChinese labour force, there is little spare capacity, putting an inflationarypressure on wages. It is already evident along China’s eastern seaboardthat incomes are rising—and factories in central and western China aremoving in the same direction. Furthermore, it is the Chinese govern-ment’s stated intention to increase the share of the economy that goesback to the worker by steadily increasing the minimum wage paid in thestate-owned enterprises (who are the largest employers in China),which, in turn, impacts on the cost of labour in the private sector.

As a result of these changes, it is projected that the return perdollar wage in China, in real terms, will decline by 2032 to $1.30 forevery $1.00 spent on wages. This is a significant economic develop-ment, as there are many other countries already near or above thatlevel of return and will close the gapfurther by 2032. For example, in 2012the return per dollar spent in Indonesia isUS$1.45, in Brazil $1.57, Azerbaijan $1.9,Czech Republic $1.56, Romania $1.73and Malaysia $1.63—and they are all likelyto improve on this dimension.

This matters because China will becomea less-attractive destination for investmentinmanufacturing and increasingly importantas an exportmarket for other countries as thedomestic market grows as a result of higherwages. In addition, with some countriesbecoming increasingly competitive as areasin which to invest, this will attract produc-tion out of China.While, on the one hand itwill constrain China’s total GDP growth(negative trade balance being one factor), itwill also impact on the cost of labour in the

As a result of thesechanges, it is projectedthat the return per dollarwage in China, in realterms, will decline by2032 to $1.30 for every$1.00 spent on wages.This is a significant eco-nomic development, asthere are many othercountries already near orabove that level of returnand will close the gapfurther by 2032.

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The Evolving Labour Force 83

other developing countries (e.g., Indonesia) as the demand for labourthere will increase and, with that, the potential for real wage increasesand increased consumer demand.

Strategic Implications

First it is important to understand that, while the global labour force willcontinue to grow in size, albeit now relatively slowly, technologywill have an enormous impact on the demand for that labour and whereproduction is located. We will see many important changes over thenext 20 years, including the continuing development and applicationof robotics and 3D printing, as well as a quickening pace of innova-tion. Taken together, these developments will profoundly affect thecosts of manufacturing and will decrease the demand for low-skilledlabour and increase the capability of older, more experienced labour.It could well foretell the shift of manufacturing back to the older,better-educated economies with potentially disastrous implicationsfor the developing world. India’s demographic dividend could wellbecome its demographic liability—thus, the importance of the ability ofcountries like India to raise their education standard rapidly. Otherwise,robots will take the work that would have been done by the unskilledlabour forces.

The second major strategic issue to flow from this analysis is thatChina’s labour costs will inevitably increase simply as result of shortageof supply. It will, however, be further encouraged by the government’sstated intention to rebalance the economy to consumption and to dothat by encouraging the increase of real wages. This will impact China’scompetitiveness and will probably result in the movement of lowerskilled (and perhaps even higher skilled) labour demand to othercountries such as Indonesia and some Eastern European and SouthAmerican countries, where the cost is now competitive with that ofChina. So expect some movement of manufacture and also perhapsmore rapid growth of these economies as the cost of their labour is bidup by increased demand for it. Eastern Europe, with its closer access tothe large Western European market, as well as its own markets (in termsof total consumer spending it matches China), is expected to benefit

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significantly from this change in relative cost efficiencies given its logisticadvantages as well. It could not compete when China is over $1.77return per $1 wage, but it can at $1.30. The same argument can beadvanced in terms of South America (and particularly Mexico), given itsaccess to the large North American consumer market.

Finally, reconsider the older countries, particularly Japan. Theirlabour forces are not shrinking relative to the total population andtheir education standard and productivity per worker are very high.These economies are not under threat and actually have growthpotential—the extreme case being North America. The expectation thatthey will be overtaken by the large population but low income econ-omies does not bear scrutiny.

Summary

With the exceptions of Affluent Asia, Eastern Europe, and China, thetotal employed labour force of the regions will grow over the next twodecades—driven by a combination of an increased proportion of thepopulation being of working age and increased propensity to beemployed. The major anomaly will be China. Its capacity for growth is,in one important respect, going to be constrained: The number ofpersons of working age has gone into decline and, as the country isalready at full employment (it has very high participation rates already),this means the total labour force will also decline. China’s situationcontrasts with many other countries, such as India, that are younger (interms of population age) and poorer. For these countries, an ability toincrease female participation in the labour force provides a majoropportunity to stimulate economic growth. To date, these countrieshave not shown much inclination to increase female participation andthe forecasts here assume only slow increases. However, if these countriescould change this attitude more quickly than has been apparent, wholecountries and regions could be transformed economically—from India tothe Middle East and North Africa—assuming there is work for them.

A major factor leading to the growth of the labour force (or lack ofdecline in the case of specific countries such as Japan) is the changingpractice in terms of what is retirement age. It is extending beyond

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The Evolving Labour Force 85

60 years and by 2032 it will not be unusual for a person aged 69 to be inemployment. This change in attitude is a function of improved life span(a function of health) and is still largely constrained to the affluentregions of the world. China and much of Developing Asia, for example,have not reached the same life expectancy yet (for adults aged 50 today).They will start to catch up in the subsequent two decades.

Finally, to answer the question at the start of this chapter, Country Ais China and Country B is the USA, yet how often is the USA describedas the investment opportunity of the next decade, and how often is thattitle given to China?

In the next chapter we continue with the theme of economicdevelopment and spending—so vital for individuals, businesses, societies,and the future—and ask: Where in the world is the money?

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About the Author

Dr. Clint Laurent is the founder and managing director of GlobalDemographics Ltd., formerly Asian Demographics Ltd. Dr. Laurentmoved to Hong Kong in 1976, initially with Hong Kong Universityand then as a director of Price Waterhouse, where he built up a marketresearch and consultancy group. In the following years, Dr. Laurentfounded and subsequently sold two leading regional research companies,Asia Market Intelligence Ltd. (now Synovate) and then Asia Studies Ltd.,before launching Asian Demographics in 1997.

Asian Demographics developed substantial historical databases of thedemographic and socioeconomic profile of the countries of Asia,including China down to county level, and using modelling techniques,provided long-range forecasts of the changing nature of populations,labour force and households, and their income and expenditure pat-terns. In 2006, Asian Demographics became Global Demographics, andthe databases and models were expanded to cover 75 countries,including South and North America, Eastern and Western Europe, andthe Middle East, in total representing 79 percent of the world’s popu-lation and 90 percent of its GDP. Through its Healthcare Subsidiary,

babout 31 January 2013; 12:31:38

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the company provides forecasts for disease incidence and treatmentaffordability. Global Demographics’ reports and databases are now usedby a wide range of companies throughout the world to assist with theirmarket planning.

Dr. Laurent has a PhD in Marketing and Statistics from BathUniversity in the United Kingdom.

babout 31 January 2013; 12:31:38

228 A B O U T T H E A U T HOR

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2 TALENT INTELL IGENCE

The Hidden Role of Talent Measurement

Talent measurement is the use of various methods and tools to gather and use information about individuals ’ talents. There is no one way of doing it. Some organizations rely on the intuition of their leaders and simple interviews; others employ sophisti-cated online tests. Both, though, have the same purpose: to identify whether job applicants and current employees have the abilities, expertise, and characteristics they need to help both them and their businesses thrive and be successful.

As a task, talent measurement is often hidden away, part of bigger and broader processes. Yet it is there. It is key to recruit-ment, promotion, high-fl ier identifi cation, restructuring layoffs, organizational design, individual development, competence as -surance in technical roles, and due diligence for mergers and acquisitions.

Unsung it may be, but talent measurement is a fundamental foundation of modern talent management. It is a basic building block in successfully managing workforces, helping identify who adds value right now, and who could do so going forward. And although it may have been a low-profi le activity to date, it is about to have its day in the sun.

Why Talent Measurement Matters More Than Ever Before

Talent management is changing, and as it does so, it is leading businesses increasingly to focus and rely on talent measurement.

Almost fi fteen years ago, McKinsey declared that a “war for talent” was coming, and it seems they got it right. 1 Globalization and shifting population demographics are causing competition for talent to rise steadily and persistently and making it harder than ever before for businesses to fi nd the talent they need.

In the West, only 18 percent of fi rms say they have enough talent in place to meet future business needs, and more than half

TALENT MEASUREMENT 3

report that their business is already being held back by a lack of leadership talent. 2 Worryingly, 75 percent of businesses report diffi culty in fi lling vacancies too. 3 The temporary increase in available workers created by the downturn is not helping either, as there is evidence that all the choice is making it more diffi cult to spot the best people. 4

The situation is generally not as critical in emerging markets, but this will change. In China, for example, the predominantly manufacturing base of its economy has largely protected it from these concerns up to now. Yet as service industries and the use of knowledge workers grow and the impact of the country ’ s one-child policy is felt, China too will face these challenges. The war for talent is going global.

It is not actual war, of course, but there will be casualties and there will be winners. We know that businesses that are better at talent management and better able to fi nd and keep the best people tend to outperform their industry ’ s average return to shareholders by around 22 percent. 5 In fact, making good hiring and promotion decisions can have a bigger impact on market value than creating a customer-focused environment, improving benefi ts, or having good union relationships. 6 And amid stronger competition for talent, these performance advantages for com-panies that are effective at identifying and managing talent are likely to increase.

Realizing this, alert organizations are turning to talent man-agement for solutions and investing in it too A recent U.S. Department of Labor report predicted that over the next ten years, the number of people in human resources (HR) and talent management professions will grow at more than double the rate of the general workforce. 7

Driven by all this attention and investment, talent manage-ment is changing. Perhaps most notable, and arguably long overdue, it is becoming far more data led. People data have become currency, and workforce analytics is the buzzword of the moment. The idea is simple and compelling: to manage talent

4 TALENT INTELL IGENCE

and make good personnel decisions requires knowing what you need, what you have, and what is available. And to make this possible, new software systems have emerged that promise to help you gather, manage, and use talent information more effectively than ever before.

You might assume that talent measurement would be at the heart of this analytical talent management revolution, but, oddly, this has not typically been the case so far. Instead, these talent systems tend to use data such as demographics and distributions—that is, workforce composition. This type of administrative infor-mation does have uses, but it is limited in terms of what you can do with it and the value you can add with it. So while many of these new talent management tools are undeniably impressive, they are, like all other systems, only as good as the data you put into them. And in this respect, they are lacking.

A few larger companies have sought to rectify this by putting talent measurement at the heart of these systems. Google, pre-dictably, is ahead of the curve when it comes to people data. Unsure of whether it was hiring the best applicants, the company started developing a comprehensive database that captured information about current employees ’ attitudes, behaviors, per-sonality, biographical information, and job performance. This database has allowed Google to develop an algorithm for predict-ing which applicants are most likely to succeed at the company. 8 It is too early to judge how effective the algorithm is, and this kind of approach would not be suitable for all businesses. Yet it is clearly more sophisticated in its approach than mere demo-graphics and has the potential to yield far more value.

Other organizations are following suit. For example, a major UK retail bank recently linked the results of its employee engage-ment survey to administrative data on people, measurement data, and customer service feedback scores for individual bank branches. As a result, it was better able to understand what the business and branch managers needed to do to improve the cus-tomer experience.

TALENT MEASUREMENT 5

So businesses are beginning to realize the potential of mea-suring talent systematically and combining talent data with other information to produce insights of real business value. This may sound like good news and a great opportunity. And it is. But it can be seized as an opportunity only if talent measurement works and produces good-quality intelligence, which is where things get worrying.

The Ineffectiveness of Most Talent Measurement

Unfortunately, the vast majority of organizations are ineffective in how they measure talent. Even among companies that are measuring talent effectively, most are using the information it provides in ways that mean they derive only a small margin of the real value it can deliver.

For example, surveys show that less than one-third of busi-ness leaders rate their company ’ s selection processes as effective. 9 Indeed, while they see selection as the most important task of talent management, they also view it as the least effective. 10 This is not limited to just hiring either. The results for other talent identifi cation processes—such as promoting, benchmarking, or identifying potential future leaders—are not much better. This may be hard to hear, and your fi rst instinct may be to dismiss it or rationalize it away. But it gets worse.

Over the past thirty years, businesses have invested heavily in trying to fi nd the best people, to the extent that this period has witnessed the development of a global talent identifi cation indus-try. There is the corporate recruitment market—the headhunting fi rms whose collected annual revenues prior to the downturn were estimated to be in excess of US$10 billion worldwide. And then there is the specialist talent measurement market, estimated to be worth more than US$3 billion per annum globally.

With all this investment, you might expect to fi nd that busi-nesses had signifi cantly improved their ability to identify talent and hire the right people. Yet when we compare research from

6 TALENT INTELL IGENCE

thirty years ago into how well new employees do with research from today, this is not what we fi nd. Instead, the rate of failure among new employees seems to have risen. Thirty years ago, it was estimated that about one-third of all new employees failed. 11 Today, reported failure rates range from 30 to 67 percent, with an average of about 50 percent. 12

What is shocking about this is not so much the high rate of failure or even the rise in failure rates over the past few decades, but that the measurement industry has had no discernible impact on these rates. Somehow, despite massive investment in mea-surement and the widespread adoption of sophisticated methods and tools, we do not appear to have achieved meaningful im -provements in failure rates. There is no shortage of case studies showcasing individual organizations that have done great work in this area, but across the board, this success is just not shared.

In almost any other area of business, investing that kind of money and not making a dent in failure rates would be unacceptable—or at least it should be. As a number of commen-tators have noted, in a world where organizations are placing an unerring focus on results, they seem to tolerate surprisingly low success rates when it comes to hiring and promoting people. 13 Indeed, it is hard to think of any other area of management where such poor performance would be tolerated. 14

That is not to say that the task is easy. The sheer complexity and number of variables involved is often understated, and some of the reasons and circumstances that cause people to fail are not predictable. 15 For this reason, we are unlikely ever to reach 90 percent of our people decisions being highly effective. But we should be doing better than we are.

So what is going on? One obvious possibility that springs to mind is that current talent measurement methods do not work or even that “talent” cannot be measured. But decades of research have unequivocally demonstrated that some measurement methods and tools are better at predicting both overall perfor-mance and individual elements of it than the traditional, basic

TALENT MEASUREMENT 7

selection procedure of using just unstructured interviews. 16 In fact, study after study has driven this point home until it is no longer a matter of debate. Moreover, if accurate talent measure-ment were not possible, then no one would be making any progress. But that is not what we see. Instead, there appear to be pockets of excellence surrounded by a general lack of progress.

Studies show, for example, that effective talent measurement in recruitment and promotion processes can lead to reduced turnover, improved performance levels, and faster integration and time to full productivity. Indeed, effective talent measure-ment in hiring executives has been shown to result in companies being eight times more likely to hire someone they keep and go on to later promote. 17 And it is not just success rates that good measurement can have an impact on. The use of some measure-ment tools has been shown to be able to cut absenteeism and decrease both accidents at work and employee theft.

So measurement can work and the growing use of it over the past thirty years should have had a greater impact. Somehow, somewhere, something has gone wrong. And it is a critical issue, because if businesses cannot make talent measurement work, the rest of their talent management activities are likely to come up short.

Why Talent Measurement Is Not Working

In our work with organizations around the world looking at the issues they face in talent measurement, we have found fi ve common challenges:

1. Talent measurement is unavoidably complex.

2. It is hard to know what works.

3. Measurement methods do not always meet business needs.

4. Implementation gets overlooked.

5. Businesses lack expertise.

8 TALENT INTELL IGENCE

Each challenge by itself can signifi cantly limit the ability of measurement to have the sort of impact we would expect. But in our experience, most organizations are struggling on all fi ve fronts.

Talent Measurement Is Unavoidably Complex

It is diffi cult to do something well if you do not fully understand it, and talent measurement is a highly technical business. Indeed, it has its own subareas of expertise, such as the math-ematics of test design, which many measurement professionals themselves do not fully understand. Not everyone needs to know all the technical details, of course, but even at an opera-tional level, measurement can be complex.

For starters, you need to know what you want to measure. Companies usually know this at a broad level—for example, they want to know if someone is a potential leader for the future. Yet knowing what specifi cally to measure can be a lot harder. Is it behavioral competencies and, if so, which ones? Should you look for intelligence? Personality? Ambition? And how do you know which qualities make the biggest difference in which situations?

Moreover, what if the best test to use in order to predict future performance also happens to be the one that shows most bias against some racial groups? Or what if an organization wants to use one consistent measurement tool across all its offi ces around the world, but some countries have regulations control-ling which measures can be used? These, in fact, are some of the most common complexities that businesses encounter, and they can create signifi cant problems.

The complexity does not end once you have worked out what to measure. You then have to choose the right tool for the task, and here you encounter the thorny issue of how to ensure that you are accurately measuring what you set out to assess. For example, we encountered a major global bank

TALENT MEASUREMENT 9

that in its Singapore offi ce used a respected test to assess the intelligence of all job applicants. Yet it was assessing all of the candidates, no matter what their background, using tests written in English. The logic was simple enough: it wanted to be able to benchmark candidates ’ intelligence with that of people in the UK head offi ce. The complexity the fi rm did not grasp, however, was that it was not getting a true, accurate reading of intelligence because candidates ’ language abilities were affecting how well they did on the test. What the company should have done was to use intelligence tests in candidates ’ native language, and if it wanted to assess their English ability as well, then it should have also administered a separate lan-guage skills test.

Of course, complexity in itself is not a problem. It becomes problematic only when the complexity is not recognized or is underestimated. So it is unfortunate that many vendors, in an effort not to scare potential customers away, tend to downplay the complexities and keep the inner workings of measurement out of sight. It is commercially understandable and, from a cus-tomer ’ s viewpoint possibly, preferable. After all, we live in a world in which convenience, keeping things simple, and “just-do-it” solutions are valued. But understanding complexity can sometimes be necessary for things to work effectively, and this is certainly true for measurement. Measurement is a complex issue, and if it is to be done well, it needs to be treated as such. Failure to do so will mean that whatever you do, the chances are it will not work.

It Is Hard to Know What Works

Adding to the complexity is the fact that fi nding the right solu-tion can be diffi cult. The measurement market is awash with a mass of different methods and tools, and the choice can be bewil-dering. Information about which tools should be used when and which work best tends to come from one of three sources:

10 TALENT INTELL IGENCE

1. Academic researchers —who are not always interested in the same issues as organizations and whose fi ndings often need translation for nonacademic readers

2. Vendors —whose commoditization of measurement methods creates a confl ict of interest in terms of objectively reporting their effi cacy

3. Colleagues in other organizations —whose interests, like those of the vendors, are not served by reporting negative fi ndings

In theory the best source of information should be academic research because it is the only reliably objective source. Yet surveys show that HR professionals and business leaders alike rarely read academic journals and often consider research con-tradictory or irrelevant. 18 And who can blame them? The research literature can be hard to access and even harder to understand. As preparation for this book, we read over a thousand articles, so with some authority, we can confi rm that they can be diffi cult to understand and downright mind numbing.

The result is that businesses tend to be relatively uninformed about measurement research and have to rely instead on what vendors tell them. Yet without objective sources of information, HR and business leaders often report feeling intimidated by the apparent expertise of vendors—or at least unable to question or challenge what vendors tell them.

The importance of this is that organizations need to question and challenge what they hear. Some excellent vendors, services, and tools are on the market, but there are estimated to be over two thousand test publishers in the United States alone, and only a minority of them engages in any proper validity studies. 19 So only a small percentage of vendors can say with any objective authority that they know that their measurement methods genu-inely work.

Moreover, even when they do have evidence of the quality of their tools, this information cannot be taken at face value.

TALENT MEASUREMENT 11

The reason lies in the worrying trend of reporting bias: the ten-dency for people to publish only positive results or ones that further their arguments or products. Measurement is, of course, a business, and we understand that in this commercial environ-ment, vendors need to present themselves well. But recent research shows that reporting bias is far more prevalent than you might expect in an industry that professes to be grounded in science.

At a broad level, for example, there is evidence that aca-demic research fi ndings are less favorable about the success of measurement than research produced by vendors. 20 More spe-cifi cally, studies have identifi ed reporting bias by some very well-known psychometric test publishers. 21 The publisher of one of the most globally used personality tests, for instance, states that the tool has great validity, yet a review by a respected independent body has concluded that “the test suffers from questionable reliability and unknown validity. Its use is not recommended.” 22

Probably the most public example of the issue is the tale of emotional intelligence. In the mid-1990s psychologist and author Daniel Goleman brought to the fore the idea that emotional skills are important for leadership success. On the back of the book came a number of tools claiming to measure emotional intelligence, and with them came claims that they could account for 80 percent of the factors that determine success.

Almost twenty years on, however, there is now overwhelm-ing independent research showing that emotional intelligence measures are actually some of the less effective predictors of success. This does not mean that emotional intelligence is not important for leadership. It simply means that measures of it are nowhere near as good at predicting success as initially claimed. Yet if you Google these measures, you will fi nd the same original weighty claims still being made by some big-name vendors selling them, without mention of the decades ’ worth of independent research fi ndings to the contrary. 23

12 TALENT INTELL IGENCE

This prevalence of biased validity fi gures makes the recent actions of one of the biggest test providers in the world all the more concerning. It appears to have changed its contractual terms to prevent independent research into the validity of its tests without its approval and permission. In our view, this throws any kind of pretense about objective science straight out of the window.

So not only is measurement a complex, technical, and all-too-often impenetrable fi eld, but knowing who and what to trust is not easy. Little wonder that when recently asking for our help in setting up a new talent measurement process, one of the biggest companies in the world said that it felt “vulnerable” to the market.

It may feel at this point that there is no easy way to determine if measures and tools actually work. But all you need to know is which questions to ask and what to look out for in the answers. And businesses have the opportunity here not just to fi nd out which tools work, but also to change how the measurement market works and make it easier to navigate. For example, if they stop using vendors who do not provide proper validity informa-tion, those vendors will either start producing it or disappear. And if fi rms simply refuse to use vendors that prohibit indepen-dent research into their tools, then these vendors will soon revert to allowing it. Far from being hopeless, the reality of the situation is that armed with just a little knowledge, you can make a big difference.

Measurement Methods Do Not Always Meet Business Needs

The choice of what measures and tools to use is complicated by the fact that they have traditionally been developed without considering how organizations use them. As a result, researchers and vendors have sometimes developed measurement methods that look great in theory and are strongly able to predict perfor-

TALENT MEASUREMENT 13

mance, but have not been used or are not much liked by businesses.

The biggest example of this can be seen in the academic articles expressing surprise that businesses so frequently ignore one of the most accepted fi ndings in measurement research: that structured interviews tend to be far better able to predict perfor-mance than unstructured interviews. This surprise betrays a lack of understanding that the purpose of interviews for businesses is not just to predict performance. Interviews also need to leave candidates with a positive impression of the company and give managers a chance to gauge what their working relationship with candidates might be like. Yet proposals to heavily structure inter-views, which in the strictest sense does not allow for any unscripted questions, clearly do not acknowledge these addi-tional objectives. Some researchers have suggested that the reason structured interviews are not used more is that their ben-efi ts have not been clearly communicated. 24 The reality is that they simply do not meet business needs.

Furthermore, researchers and test developers for the most part have taken the objective of measurement to be predicting job performance. At present, the yardstick for whether a measure is viewed as valid or effective is if it can predict who receives the best overall performance ratings. This certainly sounds reason-able, and indeed it is, in that this kind of information can be important in making people decisions. Yet the emphasis on pre-dicting performance has been so strong that it has come at the expense of also trying to develop tools that can predict other factors that may affect a person ’ s success.

For example, hiring managers are usually not only interested in who is the most able or could theoretically perform best. They also tend to be interested in factors such as whether potential new employees will get along with them, fi t with the company ’ s values, or work well with their coworkers. These issues may not sound as immediately compelling as candidates ’ likely overall level of performance. Nevertheless, they are critical to

14 TALENT INTELL IGENCE

individuals ’ longer-term success and are some of the most fre-quent reasons people eventually “fail” in a role, despite consider-able apparent ability. Let ’ s face it: if your manager does not like you, then chances are that you are not going to succeed no matter how good you are on paper.

To be fair, there has been a shift in recent years. Vendors are beginning to produce more user-friendly tools and are starting to look at a broader range of factors that lead to success. And, of course, some vendors are better at this than others. But in general, the move has been late, slow, and minimal, and it has some way to go.

Implementation Gets Overlooked

Knowing what to measure and how to measure it may be the most obvious challenges facing businesses when it comes to gauging talent, but they are not the biggest ones. In fact, in spite of everything we have said about how hard it is to know what works, the choice of measurement processes is usually the easiest thing to get right. It is everything else that is much harder for businesses to do effectively—things such as how they use mea-surement outputs to make decisions, how well they integrate measurement activities with other processes, and the degree to which they use measurement data to inform their broader people strategy.

The importance of these implementation issues is that if insuffi cient attention is paid to them, they can fundamentally limit the value and usefulness of the intelligence that talent measurement produces. Yet insuffi cient attention is exactly what these issues typically receive.

Working both within organizations and as external consul-tants to them, we have lost count of the number of times we have been asked to help set up a new measurement process or identify the best tool to use. But rarely have we been asked about how to make more use of measurement data or how to develop

TALENT MEASUREMENT 15

a company ’ s attitudes and approach to using the data. Yet in our experience, it is such seemingly peripheral issues that all too often constrain and limit the potential impact and value of mea-surement processes.

For example, one of the easiest wins with measurement data collected in recruitment processes is to use this information to help tailor initial developmental support for new joiners. Yet research shows that only 19 percent of fi rms do this. 25 It is cer-tainly common enough to hear talk of how important such issues are, but the reality is that all too often, they are an afterthought and so not implemented effectively, if at all.

The shame in all of this is that measurement can do so much more than merely guide and support individual people decisions and development. Indeed, not doing more with the results is probably the single biggest missed opportunity that exists with measurement. With the advent of talent analytics, the situation is changing as businesses look more closely at what they can use measurement data for, but they have a lot of catch-ing up to do.

Businesses Lack Expertise

Finally, to meet the fi rst four challenges successfully, you either need to have measurement expertise yourself or access to someone who does. Unfortunately, the people who make decisions about measurement issues and manage vendors frequently have little such expertise themselves and little independent expertise avail-able to them. 26 As a result, they often either use the wrong measurement processes for their needs or use them in ways that limit their impact.

An increasing number of companies do employ experts to help them navigate the market and manage processes. Yet these roles are typically at a fairly junior level and predominantly tactical in nature. As a result, they can have little infl uence on measurement strategy. Of course, many smaller fi rms cannot

16 TALENT INTELL IGENCE

afford or justify employing specialists and so have to fi nd and rely on external experts and vendors. In itself, there is nothing wrong with this. But with little knowledge of the fi eld, it is not easy to be effective in choosing and managing vendors.

In an effort to navigate the fi eld, fi rms often resort to what Peter Saville, one of the fathers of modern measurement, calls faith validity . This is the tendency to become attached to parti-cular tests or vendors that are familiar instead of objectively considering what works best. 27 Yet surveys show a large diversity of opinion among HR professionals on which measurement methods work best. 28 And wide gaps appear to exist between what research tells us is the best approach and what practitioners and businesses believe and in fact do. 29

For example, the highly popular Myers-Briggs Type Indicator (MBTI) continues to be used in selection processes, even though the test distributors repeatedly assert that it should not be applied in this context. 30 As a more general example, there is the con-tinued use of graphology in places like France despite a mass of evidence demonstrating its lack of effi cacy. 31 And we recently came across a business that claimed that the measure it used to help identify which candidates to hire was right 95 percent of the time. Yet this belief in the tool appears to be unfounded. The company has never evaluated it, and in the tool ’ s technical manual, the vendor suggests that it could account for only 3 percent of the reasons that people succeed. Something does not add up.

This is not to say that businesses need to know everything about measurement—far from it. Of course, the more access to expertise they have, the better. But we are convinced that even smaller fi rms without access to independent expertise can successfully manage measurement and make it work for them. All they need is a basic understanding of the challenges, knowledge of what fundamental questions they should always ask, and an awareness of how they can make the most of measurement.

TALENT MEASUREMENT 17

The Purpose of This Book

From these fi ve issues, it is obvious why getting measurement right can be diffi cult and why both measurement and the talent intelligence it produces appears to be having little impact.

The purpose of this book is to show how organizations can overcome these challenges. It is thus not about how to do measurement—how to run an interview or the various algo-rithms for sifting candidates. It is about how to implement measurement in ways that produce good talent intelligence and have a genuine impact on the bottom line.

Moreover, one of the key messages of this book is that the solutions required to make measurement work lie within organi-zations. As much as vendors are trying to produce and promote shinier, shorter, and smarter new tools and tests, it is organiza-tions that hold the key to progress. In fact, there are some simple things that all businesses can do that have the potential to trans-form the effi cacy of talent measurement and thus the quality of their talent intelligence.

In the chapters that follow, we guide you through the three basic things that businesses need to know and get right to make measurement work:

• They need to know what to measure. • They need to know how to measure it. • They need to know how to implement measurement and

use the results.

Chapters 2 and 3 are all about what to measure. We begin in chapter 2 by looking at the standard measures of talent—some of the common factors that businesses look at to try and gauge people ’ s talent—things like experience, competencies, intelli-gence, and personality. And we present an accessible summary of what the very latest research has to say about which—if any—of these factors can genuinely be used to identify talent. In

18 TALENT INTELL IGENCE

chapter 3 , we explore some simple things that all fi rms can do to dramatically improve their chances of accurately predicting who is most likely to succeed.

Chapters 4 and 5 are about how to measure. Chapter 4 describes the various methods and tools that can be used, and chapter 5 focuses on how businesses can best choose which to use: the basics they need to know and the questions they need to ask.

Chapters 6 , 7 , and 8 are about how to implement talent measurement and use the results. In chapter 6 , we look at the foundations that talent measurement needs to be built on to be effective—the things that need to be in place for it to have the impact it should. Chapter 7 is about how companies can ensure that the output of measurement, the intelligence pro-vided, is used to best effect. And in chapter 8 , we go on to explore how fi rms can source the expertise needed to do all these things, as well as how best to choose and manage mea-surement vendors.

In chapter 9 , we draw some conclusions about the state of the market and give pointers for the future. We end on a practi-cal note with an appendix that provides answers to some frequently asked questions that we hear from HR and business leaders.

More than anything else, this book is a call to arms, a plea for action. Businesses themselves—not just outside vendors or expert consultants—need to act to make measurement work because only they can do so. If they do not, the current failure rates will remain as fi xed for the next thirty years as they have been for the past thirty. And without progress in these rates, talent management as a whole will remain intrinsi-cally limited in what it can achieve, and businesses will be missing an opportunity for better performance and shareholder value.

Companies may not have taken action yet, but the growing talent challenges and need for reliable talent intelligence provide

TALENT MEASUREMENT 19

How to Read This Book

This book contains a lot of information, some of which is quite technical and some of which is very practical. We believe that having a basic understanding of technical issues is important for making good practical decisions about how to use talent measurement. So the earlier chapters of the book focus more on these technical issues, before we then move on to practical matters from about chapter 6 onward.

We hope that readers will go through the chapters in order. However, we are aware that different readers will be interested in different elements of the book, and that almost all readers will be very busy people. So:

• If you are mainly interested in reading an accessible summary of some of the latest technical research about how to measure talent, you could start with chapters 2 and 4.

• If you are more interested in understanding some of the practical considerations involved in choosing which measure, method, or tool to use, you could start with chapters 3 and 5 and the relevant sections in the appendix.

• If you are primarily interested in how best to implement and use talent measurement in your organization, you could begin with chapters 6 , 7 , and 8.

a compelling reason to do so now. Firms that do not act will not, of course, collapse overnight or notice a sudden drop in profi ts. Yet slowly and insidiously, their competitors who do act will gain ground on them. Big or small, global or local, organizations need to get this right. It is time to make measurement work.

xiii

About the Authors

Nik Kinley is a London-based independent consultant who has specialized in the fi elds of measurement and behavior change for over twenty years. He has worked with CEOs, factory-fl oor workers, life-sentence prisoners, government offi cials, and chil-dren. His prior roles include global head of assessment for the BP Group, head of learning for Barclays GRBF, and senior consul-tant with YSC, the leading European assessment and develop-ment consultancy.

He began his career in commercial roles, before spending the next decade working in forensic psychotherapy. Ten years ago, he returned to working with organizations and since then has worked with over half of the top twenty FTSE companies, iden-tifying and developing talent across the globe. He now specializes in consulting with businesses to help them build their talent intelligence and enhance the performance of their people, and consulting with vendors to help them develop talent and learning-related products and services. He holds a master ’ s degree in systemic psychotherapy and a bachelor ’ s degree in psychology from the University of London.

* * *

Shlomo Ben-Hur is an organizational psychologist and a profes-sor of leadership and organizational behavior at IMD business school in Lausanne, Switzerland. His areas of focus are the psy-chological and cultural aspects of leadership and the strategic

xiv ABOUT THE AUTHORS

and operational elements of talent management and corporate learning. In addition to teaching leadership on two of IMD ’ s top programs for senior executives, he creates programs for and con-sults with a wide variety of organizations across the globe.

Prior to joining IMD, he spent twenty years in the corporate world, most recently as vice president of leadership development and learning for the BP Group based in London and earlier as chief learning offi cer of DaimlerChrysler Services AG in Berlin. He earned his doctoral degree in psychology from the Humboldt University of Berlin. He holds a master ’ s degree in industrial/organizational psychology and a bachelor ’ s degree in psychology and political science from Bar-Ilan University in Israel.

* * *

Contact the authors at inbox@measuringtalent.com or check out their blog with the latest news, information, and advice on talent intelligence at www.measuringtalent.com .

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Chapter 3 The Measurement Plan ...........................................61

Defining the Intervention(s) 62

Measurement Map 63

Hypotheses or Business Questions 66

Defining the Metrics 67

Demographics 68

Data Sources and Requirements 70

Summary 77

Note 77

Chapter 4 It’s All about the Data.............................................79

Types of Data 80

Tying Your Data Sets Together 86

Difficulties in Obtaining Data 89

Ethics of Measurement and Evaluation 90

Telling the Truth 92

Summary 97

Notes 98

Chapter 5 What Dashboards Are Telling You:Descriptive Statistics and Correlations ...............101

Descriptive Statistics 102

Going Graphic with the Data 103

Data over Time 104

Descriptive Statistics on Steroids 106

Correlation Does Not Imply Causation 108

Summary 115

Notes 116

Chapter 6 Causation: What Really Drives Performance .......117

Can You Create Separate Test and Control Groups? 120

Are There Observable Differences? 121

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viii ⁄ C O N T E N T S

Did You Consider Prior Performance? 121

Did You Consider Time-Related Changes? 122

Did You Look at the Descriptive Statistics? 123

Have You Considered the Relationship between the Metrics? 123

A Gentle Introduction to Statistics 123

Basic Ideas behind Regression 125

Model Fit and Statistical Significance 126

Summary 130

Notes 131

Chapter 7 Beyond ROI to Optimization .................................133

Optimization 134

Summary 143

Notes 144

Chapter 8 Share the Story .....................................................145

Presenting the Financials 147

Telling the Story and Adding Up the Numbers 148

Preparing for the Meetings 152

Summary 152

Notes 153

Chapter 9 Conclusion .............................................................155

Human Capital Analytics 156

Alignment 156

The Measurement Plan 157

It’s All about the Data 159

What Dashboards Are Telling You: Descriptive Statisticsand Correlations 159

Causation: What Really Drives Performance 161

Beyond ROI to Optimization 162

The Ultimate Goal 164

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C O N T E N T S¥ IX

What Others Think about the Future of Analytics 164

Final Thoughts 169

Notes 169

Appendix A: Different Levels to DescribeMeasurement 171

Appendix B: Getting Your Feet Wet in Data:Preparing and Cleaning the Data Set 181

Appendix C: Details of Basic Descriptive Statistics 193

Appendix D: Regression Modeling 199

Appendix E: Generating Soft Data from Employees 205

Glossary 209

About the Authors 225

Index 227

ftoc 24 September 2012; 13:1:40

x ⁄ C O N T E N T S

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Predictive analytics is being successfully applied in the private,

public, nonprofit, educational, and government arenas. Organizations

that apply analytics to their human capital generally outperform their

competitors. In a 2010 study of 179 large companies, those organiza-

tions adopting “data-driven decision making” achieved productivity

gains that were 5 to 6 percent higher than those that did not.2

This work has been perfected in many industries and organiza-

tional areas during the last 30 years. Davenport shows many areas

where advanced analytics are being applied. The financial services

industry uses advanced analytics for credit scoring, fraud detection,

and underwriting. The retail industry uses analytics for marketing

promotions, inventory replenishment, and demand forecasting.

Manufacturing organizations use analytics for supply chain optimiza-

tion and warranty analysis. The hospitality industry uses analytics for

pricing, customer loyalty, and yield management. The transportation

industry uses analytics for scheduling, routing, and yield optimization.

Drugs are tested and taken to market using advanced analytics.

Recently, this tool is being applied to the world of HR investments.3

It is one thing to be able to show the benefit of a human capital

investment by calculating the business impact and its return on

investment (ROI). But to gain insight into where the investment is

working and where it is not allows you to identify opportunities for

improvement. Building on the work from those thought leaders dis-

cussed in the introduction, we will show you the methodology behind

getting to an isolated business impact using your company’s data, rather

than relying on subjective opinions gathered through surveys.

Understanding how the investment is working, while isolating the

impact from all of the other variables internal and external to the

organization, is not the end in itself. There are many methodologies to

estimate the business impact and ROI of an investment. We will show

you the value of isolating the impact that allows you to evolve to

optimization by segmentation (job title, tenure, department, location,

business unit, region, and so on)—understanding where the invest-

ment is working and where it is not. Understanding where your HR

investments are having an impact and where they are not allows you

to predictively increase or decrease your investment in each area.

Isolating investments from all of the other variables is not simple, but

c01 24 September 2012; 11:58:41

14 ⁄ H U M A N C A P I T A L A N A L Y T I C S

we know it is the best way to achieve optimization. Accurate, isolated,

and precise impact provides optimization almost as a free benefit.

Generally, there are two types of HR investments: direct and

indirect. A direct investment has a clear, or direct, line of sight to the

business outcome you are trying to achieve. Sales readiness initiatives

most often are trying to increase revenue, gross margin, or new

accounts. Customer call center training strives to decrease average

handling time, or the number of calls escalated to the supervisor. An

indirect investment does not have a direct line of sight to the business

outcome. What are the business outcomes for a leadership develop-

ment program, a mentoring program, or a performance management

system? The outcomes are not so obvious, thus indirect. Our meth-

odology applies to both.

This book is not for those who want to merely justify your HR

investments, but for those who want to improve them. Relying on

average business impact is limiting and sometimes even misleading.

Consider these scenarios:

j Suppose in a retail organization your “customer first” program

was increasing overall same-store revenue, but it was not

working in the Northeast. Would you adjust anything?

j If your leadership development initiative was successfully

building the management pipeline, but you discovered it was

working only for men, what would you do?

j What if your new on-boarding program showed an increase in

initial performance, but the benefit disappeared after the first six

months. Would it still be worthwhile?

j Suppose your new call center training program successfully

increased sales, but also increased call handling time. What

would you need to know in order to see if the training was

responsible and whether the overall return was worthwhile?

If you could answer these questions, of course you would make

changes to your program. This is the power of optimization. You no

longer need to deploy programs using anecdotes and myths, but

rather evidence.

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This book has seven case studies that will show you how leading

organizations are using the power of analytics to improve their HR

investments. In this chapter’s case study, Lowe’s home improvement

stores will illustrate how advanced analytics is used to link employee

engagement with store performance. In Chapter 2, Rio Tinto, a leading

international mining company, shows how it aligned a safety program

to not only its employees but to more than 50,000 contractors as well.

In Chapter 3, we will show you how Sun Microsystems (since acquired

by Oracle) developed measurement plans for the introduction of a

social learning platform. In Chapter 4, U.S. Bank comes to terms with

locating and using complex data. In Chapter 5, both Chrysler and VF

Corporation (the world’s largest apparel company) show you how

they organized their existing data to provide insights into their

workforce. In Chapter 6, Chrysler isolates how much of the superior

performance, shown by trainees, was due to the training itself. And in

Chapter 7, ConAgra Foods and Chrysler use predicative analytics to

optimize their human capital investments.

Although the case studies we highlight are from large public

companies, the work we will show you in the book can be simplified

for smaller organizations.

HUMAN CAPITAL ANALYTICS CONTINUUM

Let’s begin with the human capital analytics continuum—a look at

how organizations collect and report data. Exhibit 1.1 shows our view

of human capital analytics. The continuum is based on what we have

seen in our work, starting with simple, commonly used techniques.

Viewing the continuum as a mountain, we suggest that similar to

mountain climbing, things become more difficult but the view

improves as you reach higher ground.

The ascent begins with anecdotes or storytelling. Brinkerhoff has

done some of the best work in this area, describing a mixture of eth-

nography and positive psychology in “Success Case Methodology.”4

This well-thought-out interview has important applications in clinical

psychology, anthropology, expert systems, and many other areas.

Scorecards and dashboards are other important areas. Scorecards,

most notably “Balanced Scorecards,” are a strategic performance

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management tool that can leverage automated surveys to track how an

organization executes strategy and the consequences arising from

business processes, most commonly referred to as activity metrics.5

Scorecards characteristically have a mixture of financial and nonfi-

nancialmeasures, each compared to its targets, allwithin a single concise

report. They are an important step on the continuum, because this is

where youmust lay out the basic assumptions: what are your strategies,

and what are the various ways in which you will measure them?

Dashboards share those characteristics. A dashboard is a distillation

of the most important key performance indicators of a company that

an executive can view at a glance. Dashboards might be an ad hoc

effort put together on spreadsheets or even lower-tech tools, or they

may involve special-purpose programming. Chapter 5, “What Dash-

boards Are Telling You: Descriptive Statistics and Correlations,” details

how basic descriptive statistics, such as those in dashboards, can be rich

sources of data.

Benchmarks are another step on the continuum. Benchmarking

has long been used as a standard tool; the idea is that studying the

best-run companies in a specific area can be very beneficial in terms of

Optimization

PredictiveAnalysis

Causation

TM

Correlations

Benchmarks

AnecdotesScorecards

& Dashboards

Exhibit 1.1 Continuum of Human Capital Analytics

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setting things such as salary, training levels, desired turnover rates, and

so forth. In our opinion, benchmarking needs to be taken with a grain

of salt, perhaps several grains of salt. First, our experiences in

understanding and acquiring corporate data have been humbling;

understanding accurately the data within one company is quite

enough of a job some days. Tying together data from a variety of

different companies does not produce a feeling of confidence. Take

turnover, for example. Within a given company, turnover data can be

split into regrettable and nonregrettable turnover and further split into

avoidable and nonavoidable varieties.6 Our experience tells us that

identifying the nature of the turnover is crucial to corporate strategy,

and this information may not be available or similar between com-

panies. Furthermore, companies are not always willing to accurately

report their data, for all sorts of reasons. Organizations also have very

different philosophies and practices. We have worked with call centers

that hired carefully and treated their employees well by offering

quality grooming and training; this philosophy resulted in expensive

employees, but ones who stayed with the company and performed at a

high level. Other call centers with whom we have worked hired

unselectively, paid low wages, cracked the whip, and hosed down the

decks when employees didn’t perform. Which of the two philosophies

is preferable depends on the business strategies of the organization.

Finally, there’s just something intrinsically contradictory to us about

aspiring to greatness by doing the same thing that everyone else does.

Correlations and causations are the next two stages in the con-

tinuum. We use these phrases in a way that we find comfortable but

may not entirely agree with standard usage. “Correlations” we use to

describe the descriptive statistics that might occur on a sophisticated

dashboard. Where are sales highest? Did the trained employees

outperform the untrained ones? These are rich data mines for

understanding business resources and human capital.

Causation is the next level beyond correlation. We would like to

have a nickel for every time we have repeated the phrase “correlation

does not imply causation” around our offices. We hope it will continue

to be repeated, to junior business analysts and freshmen, until the

Earth quits turning on its axis. Newspapers and books are full of cor-

relations, tying together every conceivable item to support policy

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decisions. Umbrellas need to be banned because it ends up raining

on days where everyone carries them. Ice cream sales and murder

rates leap together in the dog days of summer. We like Cascio and

Boudreau’s three-part criteria of causation:7

1. Two events must show a clear and statistically significant

connection,

2. One event must precede the other, and

3. All other plausible causes must be ruled out.

We view the final stage as optimization, the holy grail of HR

measurement. Optimization is having the intelligence to understand

where the impact is occurring. Optimization is intimately wrapped

up with causation. Without understanding all of the factors that control

impact, it is impossible to be sure that you have correctly assessed

impact. The really positive side of having assessed and measured the

different factors that control and mediate impact is that you can

use them to control future impact and improve outcomes. If you have

controlled and assessed the impact of the various factors, you are able to

use them prescriptively. If you know how much tenure controls per-

formance and how the various tenure levels benefit from training, the

logical consequence is that you can now specify where training should

be focused and what new programs need to be created for areas that do

not show the benefits.

When we speak at industry events, we typically survey the audi-

ence on where its members are on this continuum. Based on our

feedback, we believe most organizations are on the lower left of the

continuum, obtaining information from their dashboards and

scorecards. So, where is your organization on this human capital

analytics continuum? This book will show you how to move up the

continuum into the world of predictive analytics, enabling you to

optimize your human capital investments.

There are, of course, other ways to talk about the continuum of

human capital measurement. Several different measurement method-

ologies are particular to learning and development but have limita-

tions when we apply advanced analytics to them. In developing our

continuum, we are striving for a broader view of all human capital

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investments, independent of learning and development. We think a

broader view is necessary for HR.

The application of predictive analytics allows you incredible

insights into your workforce and enables you to improve your HR

investments, both financially and for your employees. In our first case

study, Lowe’s will show you the power of this work.

’

CAS

EST

UDY

CONNECTING PEOPLE INVESTMENTS ANDBUSINESS OUTCOMES AT LOWE’S: USINGVALUE LINKAGE ANALYTICS TO LINKEMPLOYEE ENGAGEMENT TO BUSINESSPERFORMANCE*The ability to formulate and implement strategy is one of the most importantand elusive enablers of sustained organizational success. Successful strategyexecution requires that the purpose and priorities of the organization bedefined and the strategy and tactics for achieving them be clearly aligned.

Aligning strategy and execution is a difficult task for most businesses.Research indicates that 70% to 90% of organizations fail to realize successfrom their strategies.8 Human resource leaders, in particular, often find itdifficult to strategically align and integrate their HR functional strategies,outputs, and measures to business priorities.

HR measures are typically cost-based, lagging metrics that either measureworkforce-related expenditures (for example, headcount costs) or efficienciesin the HR function itself (such as position fill rates). Most HR executives lackforward-looking data that help drive business strategy. This puts the peopleagenda at a significant disadvantage when HR engages in strategy andexecution discussions with other executives. Although there is generalrecognition that people truly are an organization’s greatest asset, there seemto be limited ways to measure their activities effectively.

During the last 20 years, employee engagement has become generallyaccepted as one indicator of business performance. Applied correctly,engagement data can act as an early warning system for revenue and profits.The statistical relationship between engagement

*This case study was written by Cedric T. Coco, senior vice president, Learning & OrganizationalEffectiveness, Lowe’s Companies, Inc.; Dr. Fiona Jamison, senior vice president, Research andConsulting, Spring International; and Dr. Heather Black, vice president, Research Analytics,Spring International. It was published in HRPS’s journal People & Strategy.

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and financial success has been shown in numerous studies. For example, inthe report Employee Engagement Underpins Business Transformation,companies with highly engaged employees outperformed those with less-engaged employees in three key financial measures—operating income, netincome growth, and earnings per share.9

However, there are two critical issues that are still keeping most orga-nizations from measuring the actual financial impact of engagement on theirbottom line. First, identifying the financial impact of engagement is, to date,mostly correlative—organizations know there is a connection but do not havesufficient cause-effect data necessary to make specific improvements forpeople or operational performance. Second, as a recent survey of HR leadersshowed, companies that statistically test these relationships typically onlyexamine relationships among different HR data points, rather than makinglinkages to non-HR data as well. In fact, only a handful of organizations linkHR to financial or other non-HR data.10

In order to show how HR helps drive business strategy, the relationships ofHR data point to other non-HR data metrics throughout the organization thatmust be measured. The statistical techniques must be sophisticated enough toshow cause and effect, while managing the complexity of the organization’sbusiness processes.

Importance of Integrating Data

For many organizations, integrating HR, customer, operations, financial, andother types of data can be daunting. Barriers to conducting this type ofanalysis can range from simply not knowing all of the types of data theorganization is currently collecting to dealing with incompatible or redundantsystems housing the data, to data quality issues (information gaps) andissues in working across organizational silos.

In 2007, Lowe’s began the journey to establish a data-driven, HR businessmodel to show causal linkages from HR to business outcomes. Lowe’sunderstood that employees are crucial to competitive advantage and couldnot accept that people were the largest single most unmeasured asset.Business leaders intuitively knew the relationships existed, but a provendecision model would help identify the people and HR priorities by showingwhich areas had the greatest business impact. Lowe’s collaborated with anoutside consultant to develop a systematic methodology for determining theimpact of people on financial results.

Lowe’s set out to create a value linkage decision model to define thecausal linkages between people measures and key metrics, such as retailshrink (a retail metric related to inventory loss due to shoplifting, employee

(Continued )

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theft, or supplier fraud), revenue, and customer satisfaction. Lowe’s used themethodology to link HR data (engagement surveys, turnover data, sick time,and so forth) to marketing data (customer satisfaction, loyalty, value, and soon), operations data (inventory shrink, safety, and so forth) and financialmetrics (sales per square foot, net income before tax, and so on).

Step 1: Establishing Buy-In

For Lowe’s, the first step was to establish executive buy-in. Human resourcesis the steward for many people decisions, but Lowe’s objectives went beyondmaking HR more efficient or effective. Lowe’s wanted to make better peopledecisions for the organization, not just better HR decisions. Lowe’s hadalready seen the impact of its engagement work, and the HR leadership teamchampioned linkage analysis as an extension of this work.

Yet from the beginning, Lowe’s had skeptics about its ability to create aviable model to show the impact of engagement on the bottom line. TheLowe’s HR team recognized early on in the process that a cross-functionalteam was required to build and achieve support for a linkage model. A cross-functional team was created with an emphasis on finance, market research,and operations to help build the model.

Beyond building the cross-functional project team, HR’s primary role inthe model development was to facilitate the process. HR’s larger role fororganization alignment would come after the model was built.

Step 2: The Discovery Process

The second step was to conduct a data audit and evaluation process startingwith the employee attitudinal data from Lowe’s employee engagementresults. Establishing quality metrics is essential before embarking on anylinkage analysis approach. For example, organizations cannot assume thatsimply conducting an engagement survey provides sufficient data to conducta linkage analysis. Many organizations collect only a sample survey eachyear, may use a limited response scale (less than a five-point scale), andmay not identify results by location or group or even distinguish results bymanager and nonmanager. These components have been found to be veryimportant for linkage analysis.

After assessing the employee opinion data and other data traditionallycollected by HR, the project team turned its attention to the non-HR data. Theteam initiated a discovery process with the key holders of data—finance,marketing, customer service, business development, and operations—to findthe metrics that are most relevant to the way Lowe’s business operates.

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Multiple meetings, facilitated by HR, were conducted during the course of asix-week period. In addition to gathering data, these meetings were importantto establish credibility and buy-in. In the meetings, data holders had theopportunity to ask questions about how their information interacts with datafrom other parts of the company. Each meeting was designed to sharepurpose, establish “what’s in it for me” for stakeholders, identify dataavailability, clarify outcomes, and, of course, address the skeptics. Even withleadership buy-in and HR as the facilitators, gathering all of the data frommultiple sources required both patience and persuasion.

At the conclusion of the discovery process, the cross-functional teamdeveloped a people value linkage blueprint to document the data that wereavailable, evaluate the quality of the data, and provide a road map for themodel (see Exhibit 1.2). This blueprint also captured all of the expectations,or hypotheses, from the key stakeholders. These expectations translated intovarious stakeholders’ perceptions. Some examples included the expectationthat there would be a causal linkage between engagement and customersatisfaction and the expectation that the level of employee engagementwould drive a reduction in accident and shrinkage rates. These expectationsbecame the first set of hypotheses that the resulting models would measure.

(Continued )

Assess. Ctr.Rating of Mgr.

Mgr.’sEngagement

Mgr.’s360 Degree

Avg. EmployeeEngagement

Shrinkage Rate

Age of StoreWeatherStore

Performance

LocalEconomicConditions

Competition

CustomerFocus

H6

(�)

H1

H2H3

H4H5

Exhibit 1.2 Lowe’s First Store Model BlueprintSource: Reprinted with permission from Lowe’s

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Step 3: Building behind the Firewall

Because most financial and operational data are too sensitive to take off site,the modeling itself took place within company firewalls with a two-partconsultant analysis team consisting of a statistician and a business strategist.The combination of these two minds ensured that relationships tested in themodel reflect both statistical accuracy and the reality of business.

The modeling process began with collecting all of these data from thevarious data holders in the several systems and cleaning it before merging itinto one cohesive system. Lowe’s included nearly 600 variables in the initialdata set to be analyzed. The team used a combination of correlations, factoranalysis, and regression to reduce the number of variables to the mostpredictive in each core area on the blueprint. For example, analysis deter-mined which observed variables had the most predictive impact to be usedto measure important metrics in retail, such as store performance andcustomer focus.

Structural equation modeling (a statistical technique that combinesconfirmatory factor analysis and path analysis) was then used to build andtest the model created in the blueprint. Structural equation modeling is adeductive technique that tests a predetermined model. Most organizationshave already chosen a structure and ways to interact within that structure tomaximize business results. Decisions are made within organizations withexpress purposes. Deductive models allow organizations to test how welltheir structure and processes are working.

The process allows for revisions to the blueprint as variables are added orremoved and for the testing of more than one model as new information ispresented. The final model is constructed through creating different versionsand testing each with different theoretical assumptions to look at newrelationships that make sense in the context of the company. The modelcontinues to be adapted until it reflects the best fit.

When the structural equation modeling process was complete, Lowe’s hadseveral core models that clearly delineated data correlations and causallinkages and the strength of those relationships (see Exhibit 1.3).

In this model, ovals indicate an item that is constructed of multiplevariables, and rectangles indicate individual variables. Lines with arrows onboth ends are co-varying relationships, meaning that the two items have animpact on each other. Lines with arrows pointing in one direction indicate thatone item is affecting the other. The numeric values are regression error termsthat show how much impact one item has on another (for example, if A affectsB with a score of 0.14, then when A moves one unit, B will move 0.14).Positive values indicate that when one item goes up, the other item will

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also go up. Negative values indicate that when one item goes up, the otheritem will go down.

Once the base models were established, Lowe’s was able to quantify theresults into tangible financial impact measures within the organization andthen further refine the models over time with additional metrics and insights.In this stage, the models are used to answer critical questions, such as

j Training increases cost, but it also should influence efficiency. How doesthat play out in reality, based on a company’s actual financial results?

j Leadership tenure and staffing levels should contribute to customersatisfaction, but do they?

j What is the most effective HR program or investment to increase cus-tomer satisfaction?

Step 4: Identifying Performance Themes with Executive Buy-In

On development of the initial models, the researchers and Lowe’s HR teamconducted a working session with the data holders to fully explore theimplications and refine the model. The team validated the model and theresults and then analyzed the data to make sure it was pulling out the rightinitial themes that existed across the enterprise.

Lowe’s was careful to focus on key strategic themes to ensure thatmanagement would focus on business priorities with the follow-upengagement action planning. Once the themes were understood from an HRperspective, they were shared with the executive team. Through dialoguewith the executive team, enterprise-wide themes were agreed on and thenshared with each function (finance, operations, and so on).

(Continued )

EmployeeEngagement

ManagementEngagement

Sales Ratios

Better ShrinkNumbers

CustomerSatisfaction

.32

.22

.17

�.13

Exhibit 1.3 One of Lowe’s First Core ModelsSource: Reprinted with permission from Lowe’s

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Although the executive team was supportive of value linkage’s objectives,some questioned whether models could establish the cause-effect rela-tionships. Because the models were built in concert with finance, operations,and research, the insights were acknowledged from functional stakeholders.This cross-functional design is essential to validity, as well as to acceptance.With this acceptance, Lowe’s was able to use the models to prove a directconnection between engagement and customer satisfaction and the linkagesto revenue, shrink rates, and a number of other areas.

Lowe’s started the review and buy-in process with the HR leadershipteam, then with the executive staff, including the CEO, the functional leadersacross the board, and then down to the workforce. The concept of working atthe enterprise level helped to get agreement and work across silos.

The models were used to identify areas with the strongest relationshipsand greatest impact on Lowe’s business priorities. These models became afoundation for prioritization of effort—influential in decision making for theHR team and operators within the organization. The models were thenfinalized, and the sharing and buy-in process across the organization began.

Step 5: Cascading Results and Taking Action

Many organizations find it difficult to disseminate value linkage data andresults. The impact on performance is measured over time and is often partof a larger change initiative. A key success factor at Lowe’s was sharing acombination of the visual models, simple charts and graphs and themes thatrepresented the findings of the complex statistical models, and then com-municating the findings in concrete financial measures that held meaning forkey operators.

There are two ways to approach data sharing and follow-up. A functionalapproach allows individual business units to choose their own focus. Anorganizational approach looks at themes across the enterprise and providesdirection to the functions. Lowe’s chose an organizational approach to allowthe time to educate the organization and business units on how to use thedata and enhance control of the change process. In retail-focusedoperations—where operational excellence is a top priority—the tendencyis to fix and deploy something as quickly as possible. Keeping the resultsat the thematic level within the enterprise ensured that the HR andoperations components were created simultaneously to drive systemic andholistic change.

During the last five years, Lowe’s has placed significant focus onemployee engagement, and now it has permeated across the entireorganization. Every business leader and each business unit believe in the

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importance of engagement and want to know how their workforce perceivesthem. Employees want to know how the decisions and investments theorganization is making affect not only themselves but customers and thecorporate infrastructure.

Now at Lowe’s, management teams are eager to receive their informationand, in the spirit of healthy competition, are energized to raise engagement.HR continues to partner with management teams to help maintain focus onkey areas with the greatest impact on both engagement and the business.

Step 6: Evolving the Model

Lowe’s conducted employee research to ask the workforce for input, bytheme, to determine what employees needed to drive engagement in thesepriority areas. Lowe’s used its employee communication platform to collectemployee input, as well as to communicate their engagement investments. Insome cases, employees wanted changes that Lowe’s would not be able toprovide, and it was important to be transparent and show that the engage-ment priorities were aligned to the business priorities.

After Lowe’s collected employee input for priorities and action planning, itcontinued to build out its linkage models with more data. Within Lowe’s, thefocus has also grown beyond employee engagement to begin testing theimpact of other HR programs that were determined to be essential toenhancing engagement. HR programs that support leadership development,enhance work-life balance, and foster diversity and inclusion can all be builtand tested within the existing models to see their impact on engagement andultimately on the bottom line. With each new data set, new hypotheses canbe tested and new relationships proved.

In addition, during the first year of modeling, Lowe’s conducted quarterlystratified sample surveys measuring employee engagement that mapped tofinancial quarters. This enabled the analytical team to create models thatcould account for lags and leads and to determine which drivers and rela-tionships stayed constant over time or weakened, based on changes in theeconomy and the market. For example, did increased engagement in quarter1 lead to improved customer satisfaction in quarter 1, or did it lag untilquarter 2? How long did the effects of increased engagement last? Thisquarterly approach to modeling throughout the operational and financial yearenabled the analytical team to test for seasonality and ebbs and flows ofsales that are common to the retail setting.

This approach helps determine questions that need to be explored furtheror new questions that need to be asked. The models are designed to be

(Continued )

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SUMMARY

Human capital is the most important differentiator of a modern

company. We are at a moment in time where theories about human

capital, the amount of data available, and the computing power nec-

essary to deal with the data are radically changing how business is

done. We present the continuum of analytics, based on what we see in

practice. All of analytics are useful: data ranges from anecdotes to hard

operational data interpreted with statistics. Anecdotes add stories and

context to your reports. Yet the rigorous analysis that provides true

impact and helps you optimize your investments is the most important

goal in the analysis of human capital. It is necessary to take your

company into the next century.

NOTES

1. “Gartner Recession,” The Register (October 18, 2011), retrieved April 2,2012, from www.theregister.co.uk/2011/10/18/gartner_recession.

adapted and improved to reflect the constantly changing economy, workenvironment, market demands, and employee relationships.

Future Role for Value Linkage at Lowe’s

Today, Lowe’s has captured the impact of employee attitudes and how thisaffects the business—this is a milestone step for the HR business function.Lowe’s is beginning to translate these models into forward-looking, pre-dictive analytics.

Value linkage is a key step in the journey toward predictive analytics.Lowe’s sees the next stage, which includes forecasting retention and pro-ductivity issues and the corresponding financial impact to make predictiveinvestments for ongoing improvements. To reach this stage, Lowe’s will needto continue to build out models with more details—market demographics,employee behavioral data, forecasts, and so on. Lowe’s wants to know with ahigh degree of probability how the workforce will behave and the levers topull for higher productivity—to predicatively analyze business from a humancapital perspective.

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2. E.Brynjolfsson,L.M.Hitt, andH.H.Kim,Strength inNumbers:HowDoesData-Driven Decision Making Affect Firm Performance? (April 22, 2011), retrievedJune 1, 2012, from Social Science Research Network, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1819486&http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=16&ved=0CFsQFjAFOAo&url=http%3A%2F%2Fpapers.ssrn.com%2Fsol3%2FDelivery.cfm%2FSSRN_ID1968725_code1376648.pdf%3Fabstractid%3D1819486&ei=Q.

3. T. H. Davenport, J. G. Harris, and R. Morison, Analytics at Work: SmarterDecisions, Better Results (Boston, MA: Harvard Business Press, 2010).

4. R. O. Brinkerhoff, The Success Case Method: Find Out Quickly What’s Workingand What’s Not (San Francisco: Berrett-Koehler Publishers, 2003).

5. R. S. Kaplan and D. P. Norton, The Balanced Scorecard: Translating Strategyinto Action (Boston, MA: Harvard Press, 1996).

6. R. Griffeth and P. W. Hom, Retaining Valued Employees (Thousand Oaks,CA: Sage, 2001).

7. W. F. Cascio and J. W. Boudreau, Investing in People: Financial Impact ofHuman Resource Initiatives (Upper Saddle River, NJ: Pearson, 2008).

8. R. S. Kaplan and D. P. Norton, Strategy Maps—Converting Intangible Assetsinto Tangible Outcomes (Boston, MA: Harvard Business School Press, 2004).

9. Towers Perrin, “Employee Engagement Underpins Business Transformation”(September 2009), retrieved June 21, 2012, from www.towersperrin.com/tp/getwebcachedoc?country=gbr&webc=GBR/2008/200807/TP_ISR_July08.pdf.

10. A. Fink, “New Trends in Human Capital Research and Analytics,” People &Strategy 33, no. 2 (2010): 14–21.

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About the Authors

Gene Pease is the cofounder and CEO of Capital Analytics, a consul-

tancy revolutionizing the way companies evaluate their investments in

people. With more than 25 years of experience as a CEO, and under his

leadership, Capital Analytics has been recognized by Bersin and

Associates (2012 Bersin Learning Leaders), CLO Magazine (Learning in

Practice Awards in 2009, 2010, and 2011), Gartner (2009 and 2011

Hype Cycle for Human Capital Management “On the Rise Vendor” for

Workforce Decision Support and 2008 Cool Vendor of the Year), and

the ROI Institute (2011 First Place Recipient, Most Innovative Approach

toROI). Gene earnedhisMBAwithhonors in entrepreneur and venture

management from the University of Southern California. He holds a BA

in architecture from theUniversity of Cincinnati. Gene currently holds a

town council position in Chapel Hill, North Carolina.

’ ’ ’

Boyce Byerly, PhD, is the cofounder, chief scientist, and chief tech-

nical officer of Capital Analytics and has more than 20 years of experi-

ence designing and managing pure and applied research projects with

high technology firms in the Research Triangle Area of North Carolina.

He directed the Capital Analytics team that developed themethodology,

software, and analytical tools that are the core intellectual assets of

Capital Analytics. Boyce has published numerous articles and chapters

on human capital analytics, knowledge representation, and computer-

support cooperative work. Boyce earned his PhD from Duke University

for interdisciplinarywork in computer science and cognitive psychology,

using advanced statistical techniques to investigate how the represen-

tation of information affects memory and problem solving. In addition,

he holds an MS in computer science from Rutgers University and a

babout 24 September 2012; 12:43:1

225

BS from Duke University, double-majoring in English and computer

science and graduating cum laude. He is an active member of the

International Society for Performance Improvement and is a professor at

Bellevue University.

’ ’ ’

Jac Fitz-enz, PhD, is widely regarded as the father of human capital

strategic analysis and measurement. He founded the famous Saratoga

Institute and published the first HR metrics in 1978 and the first inter-

national HR benchmarks in 1985. HR World cited him as one of the top

five “HR Management Gurus,” IHRIM gave him its Chairman’s Award

for innovation, and SHRM chose him as one of the persons in the

twentieth century who “significantly changed what HR does and how it

does it.” He has authored 12 books and more than 350 articles and has

trained 90,000 managers in 46 countries on strategic management and

measurement. His 2010 book, titled The New HR Analytics, introduced

predictive analytics to human resources. Dr. Jac holds degrees from

Notre Dame (BA), San Francisco State (MA), and University of

Southern California (PhD) in organizational communications.

babout 24 September 2012; 12:43:1

226 ⁄ A B O U T T H E A U T H O R S

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Contents

List of Figures and Tables ixIntroduction xi

1 Pursue and Leverage Inflection Points 1Expert Input: Cindy Hallberlin of Good360.org on Getting

13tnioPnoitceflnInafodaehA

2 73yticapaCnoitavonnIdliuBExpert Input: Jeanne Tisinger o�he Central Intelligence

44yticapaCgnidliuBnoycnegAExpert Input: Paul Pluschkell of Spigit on Idea Management 59

3 56ecnegilletnItcelloCExpert Input: Ken Garrison of Strategic and Competitive

Intelligence Professionals on Competitive Intelligence 86

4 39evitcepsrePtfihSExpert Input: Roger Martin o�he University of Toronto’s

Joseph L. Rotman School of Management on�inking401yltnereffiD

vii

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viii Contents

5 Exploit Disruption 109Expert Input: William D. Eggers of Deloitte’s Public

Leadership Institute on Disruption and Government 124

6 Generate Value 147Expert Input: Mark Katz of Arent Fox LLP on Generating

Value 158

7 Drive Innovation Uptake 183Expert Input: Mark Hurst of Creative Good on Getting

Close to Customers 201

Appendix A: Sample Business Intelligence Contract 219

Appendix B: High-Level Outline of a TypicalBusiness Plan 223

Appendix C: Simplified Business Plan Financial Model 225

Notes 227Acknowledgments 233About the Author 235Index 237

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1

Pursue and LeverageIn�ection Points

An inflection point is a dramatic and decisive shi� in yourrelationship with the market for better or worse. It can bepositive, increasing your success, or negative, as you fall out

o�avor. Masterful leaders anticipate inflection points and use them totheir advantage, like using a wave’s energy to carry them to a new andbetter position or preparing for a setback in conditions to minimizedamage to their position. Because an inflection point springs from yourrelationship to the market, the change it brings comes about one ofthree ways: (1) youmove in relation to the market, (2) the market movesin relation to you, or (3) you move in relation to each other.

Most inflection points fall in the third category, simply becauseconditions are constantly changing—both yours and the market’s. Infact, you are a subset o�he market, so change on either side results inchange on both sides. But it is helpful to think in terms o�he first twoto get a handle on how to use market shi�s to your advantage. �is isdone either by anticipating a major change in conditions (the marketmoves) or by planning a decisive pivot that puts you in a better positionto succeed (you move).

An example o�he market moving in relation to an organization,generating anegative inflectionpoint, is the recent demise o�heVisitingNurse Foundation (VNF), a nonprofit that served stroke victims inPittsburgh. VNF, founded in 1989, had as its primary revenue source

1

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2 Getting Innovation Right

the administration of flu shots. In 2007 state legislators passed a lawpermitting pharmacists to give flu injections and the organization’smain source of funding dwindled severely.1 The legislative process wastransparent and the coming inflection point would have been visibleto anyone who was looking—apparently they were not looking. As aresult VNF failed to build other revenue sources and the change led totheir demise.

An example of an organization designed from the beginning tocreate a positive inflection point is Gazelle.com. As of this writing theyare the US leader in re-commerce,2 a business founded on buying oldor expired electronics so consumers can buy the latest and greatest.Re-commerce as a successful innovation was officially recognized in2005,3 andGazelle.comwas founded in 2006 to take advantage of it. Theyhave achieved dramatic and consistent success with 2011 year-over-yeargrowth of 65%.4

Discovering inflection points in their early stages is a powerful allyto successful innovation. But this is often easier said than done. It takesleaders who understand the power of inflection points, who invest theirtime and direct their staff to seek out the signals that portend significantchanges, and who direct their organizations to respond strategically.

One client of mine discovered how difficult it can be to cut throughthe mind-set that prevents sensing an emerging inflection point. Yet asyou will see, turning a potential negative into a positive inflection pointcan be done.

I had been hired to work with a large oil and gas operation inthe Americas to determine the value of new technology that hadbeen mandated by headquarters. This was the 2000s and every majorexploration and production company was putting technology downhole, deep in the ground, to better monitor and model what could beextracted.

The technology was a major innovation, a breakthrough in howoil and gas was identified and existing oil wells and gas fields wereoptimized to produce more. Further, this breakthrough was generatinga global inflection point. As underground digital technology became

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Pursue and Leverage Inflection Points 3

available around the world, oil and gas operations that adopted it gaineda financial edge—my client’s competitors among them.

Yet some of the folks in the Americas remained unconvinced ofits utility, and as the top-producing division of the company’s globaloperations, their resistance was significant. If they denied the inflectionpoint, not only would they lose the value of the innovation at the cashregister, they could also stall the enterprise’s progress around the worldand put themselves at a major disadvantage in the industry.

On the other hand, if they saw the inflection point and jumped on it,the new technology had the power to propel significant increases in theamount of oil and gas they retrieved from existing wells and fields, withgreat impact for the financial success of the entire enterprise, propellingthem forward as global leader.

The inflection point had been identified at headquarters, but thefolks in the Americas did not see it yet. To them, it seemed like justanother mandate from above.

Everything came to a head in a meeting I called, bringing the twogroups together. We assembled in New Orleans. Major players werepresent. The first two hours were civil even though it was clear thatthere was a rift. Slowly the two sides engaged and argued until finallywe reached a point where the tension was palpable.

I thought the guy from the Gulf of Mexico was going to jump outof his chair and throttle the analyst from headquarters. ‘‘You expect meto believe those numbers? I don’t trust those numbers and I don’t trustyou because you gave me those numbers. There is no way in hell thatyou can tell me you know what this technology will do. There are justtoo many variables at play. Is that what you believe? I mean do youbelieve these numbers?’’

The room was dead quiet. Everyone waited to see what the analystfrom headquarters would say.

It had been two years since headquarters had mandated the newtechnology that could produce exceptional results. But it had beenannounced with flashy brochures loaded with propaganda and unsub-stantiated claims. The guys in the Gulf didn’t like it then and they didn’t

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4 Getting Innovation Right

like it now. They had reluctantly agreed to do a pilot but made damnsure the rig they tested it on would demonstrate the new technology’sutter lack of utility. I had seen that before.

Sure enough, the trial proved the technology was not cost justifiedon that oil platform. Then Katrina hit. The whole issue was shelved,pushed to the back burner forwell over a yearwhile other,more pressingdecisions were made and while New Orleans began to recover.

But headquarters did not forget. They believed in the technology.It was already up and running in Africa. Indonesia and the North Seawere testing it on platforms, where it would do well. But the Gulf stillrejected the mandate. This was the single most profitable region andthey were not about to be told how to run their business. They had cloutbecause they led in generating profit. But was it worthmaintaining theirindependence if it meant missing the inflection point that could carrythem forward or leave them behind?

The analyst from headquarters caved. ‘‘You are right. We cannotsay this technology is solely responsible for those results.’’ But he wasquick to add, ‘‘In my gut I just know this is the right thing to do; this isgoing to change the whole industry and we have to be there, too!’’ Theguy from the Gulf joined him, ‘‘You know, I can respect that. Let’s takea closer look and see what this can do for us.’’

What brought them to agreement was the guy from headquartersshifting from the propaganda platform to saying that he knew in hisgut that an inflection point was on them. Down-hole technology waschanging the oil business.

I ended up taking a lead consulting position with the Americas divi-sion as they implemented the new technology. Two years later there wasa futuristic room in the Gulf of Mexico’s main office that looked like thebridge on Star Trek. But it was not its looks that made it innovative—itwas the value it brought to operations and the hydrocarbon they tookto the bank as a result. This company used the inflection point createdby down-hole technology and rode it to maintain and even increase itsposition as the most profitable energy company in the world.

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This is the story of a how one company rode an inflection pointinto a better future. But if you don’t see an inflection point for what itis and act decisively, it can take you out of the game entirely. I havesat in rooms with leaders who just don’t see them. The whole worldis changing and for some reason their radar is not picking it up. I amgoing to show you in the pages ahead how to make sure you never jointheir ranks.

I will lay out the four types of inflection points so that you canrecognize them as they are emerging. This way you will be able to seethem in advance more readily and then align your offerings to besttake advantage of them. You can also better prepare to drive your ownpositive inflection points, jetting your organization into growth mode.

Take for example the Human Resources Certification Institute(HRCI). Created as a separate organization by the Society of HumanResource Professionals in 1973, it is solely and independently responsiblefor developing and administering certification exams in the field ofhuman resources.

Initially growth was slow. By 1981, under the name of the Per-sonnel Accreditation Institute, they had certified around 2,500 humanresources (HR) professionals. In 1988 they established their two main-stay certifications, the Professional in HR® and the Senior Professionalin HR®. Growth was incremental, steady. But all that changed in themiddle of the first decade of the 21st century when the group introduceda sequence of game-changing products and services.

The time seemed ripe. Although companies had for years beengiving lip service to the idea that people are their biggest assets, the ageof the knowledge economy made that a reality, and HR deserved itsplace on the frontier of strategic talent development. People had becomethe primary competitive advantage for knowledge organizations.

The inflection point was the strategic use of HR; that is, developingandacquiring the talent explicitly todrive success in themarket.Globallyorganizations were moving from viewing HR as the birthday-benefitspeople to HR as the source of the leaders required for growth.

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6 Getting Innovation Right

HRCIdetermined itwouldbe at the forefront of this inflectionpoint,establishing itself as the midwife of professional standards required tosucceed in a global marketplace. Innovation would be their tool ofchoice. Here is a high-level timeline of HRCI’s tactical innovationsdesigned to drive a positive inflection point for the organization inrelation to their market:

2004—Global Professional in HR hits the market, establishinginternational HR certification standards.

2005—The exam is taken online–worldwide, one of the first certi-fications conducted via the web.

2007—Specialized exams for the state of California are introduced.2008—An online directory of approved preparation providers is

launched.2010—HRCI’s national conversation on strategic HR is launched.2011—The first symposia on strategic HR and innovation takes

place in Washington, DC.2012—Launchof the in-house publication,Certified, focusing exclu-

sively on the intersection of HR, strategy, and innovation.National symposia are held in Washington, DC, and New Yorkwith dates for 2013 in San Francisco, Chicago, Toronto, and Seoul.

Each of these innovations combined to increase awareness of HRCIamong its target clients at a time when HR was becoming more visiblycrucial to business success. They demonstrated that HRCI was movingaggressively into a new role as a thought leader at the forefront ofstrategicHR,not just a purveyor of certifications. The global certificationof 2004 was a huge step forward, providing practical guidance in acomplex world of increasingly multinational organizations. The onlineexam was one of the first to enable applicants to test electronically,ensuring HRCI’s leadership in an increasingly Internet-enabled world.And so on. Each of these accomplishments moved them forwarddecisively as a leader in their field.

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Pursue and Leverage Inflection Points 7

The combined result was a reputation for being at the forefrontat a time when strategic HR was a competitive advantage. The successof these efforts could be measured in certifications issued. By 2008 thecount was up to about 96,000. At the time of writing, summer 2012, theircertificant base had reached over 125,000 in 100 countries.5

This sequence of steps was intentionally designed and executed togarner a positive inflection point for the organization. You can feel theresults when you walk the halls of HRCI’s offices. The buzz is palpable.Leadership is on a roll. The level of productivity is off the charts, withsynergies being cultivated and harvested faster than any one person canorchestrate.

HRCI is on the ascent.They are anorganization towatch, appreciate,and join. They have changed the game from HR certification to HRleadership, and as a result their market success is on an upwardclimb. HRCI’s sphere of influence is expanding to include CEOs,business leaders, and other players who understand the need for talentmanagement as a critical component of organizational strategy andsuccess.

HRCI’s positive inflection point has resulted in a growing customerbase, increased purchases as individuals choose to take more than onecertification, loyalty during an economic downturn, and a real move upmarket, claiming and owning their niche.

Four Targets for Innovation Strategy

Recognizing and leveraging inflection points can make a real contribu-tion to four strategic targets:

1. Growing your base2. Getting a bigger buy3. Improving loyalty4. Increasing market prominence

Which of these targets best fits your current situation? Let’s considerthe gains that can result from aiming at each, and the tactics to do so inmore detail. I will use HRCI’s example to illustrate.

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8 Getting Innovation Right

Growing Your BaseExpanding your customer base depends on five factors:

1. Current customer satisfaction2. Desire for your offering3. Your reputation as a provider4. A value proposition you can deliver5. Effective outreach

Any one of these factors can significantly limit or enhance thedevelopment of new customers.Donewell together they create synergiesthat enhance, reinforce, and build upon each other’s capacity to growyour base.

Current customer satisfaction describes how content today’s cus-tomers are with you. The higher their satisfaction, the easier you’ll findit to build the base. Satisfied customers become evangelists, providepositive reviews, and refer people to your business.

Desire for your offering is an indicator of the pull for your productsand services; it tells you howmuch the market wants what you have andtherefore how likely it is to embrace your offering.

Your reputation as a provider contributes significantly to the trustthe market puts in your ability, which in turn accelerates acceptance.

A value proposition you can deliver is essential. If the other factorsare in your favor, customers will give you a try, and then it’s up to youto provide the goods. This is what makes your offering credible.

Effective outreach means that you are getting the attention of thepeople who matter; that is, you are in front of your target audiencedelivering messages they want to hear in media they prefer.

Bring these five factors together and you have the makings of asolid growth effort. For example, the HRCI activities rely on effectivecommunication to a base of satisfied customers who want the valueof certification and trust HRCI to deliver, with quality certificationand recertification keeping certificants relevant and up to speed in anever-changing field. Satisfied customers lend credence by recertifying,obtaining certification in more than one area, sharing their stories,

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Pursue and Leverage Inflection Points 9

attending events, and spreading the word to their peers. Each of thesestrengthens growth in HRCI’s market and contributes power to theirpositive inflection point.

Getting a Bigger BuyA bigger buy means that you are growing the amount of spend yourcustomers are giving you, as opposed to other providers they can choosefor the same services or products.

HRCI got a bigger buy from their audience by expanding thecertifications they provided,making it possible for individuals to pursuemore than one. Professionals in the field can expand their expertiseas they rise through the ranks from Professional in Human Resources(PHR) to Senior Professional in Human Resources (SPHR). If they areoperating in a global environment they can also become certified as aGlobal Professional in Human Resources. Those who already hold PHRand SPHR credentials and want to become expert in regulations andlegal mandates specific to the state of California can earn the additionalcertificates, PHR-CA and SPHR-CA. In this way HRCI has increasedthe spend clients can give them.

There is an important nuance to growing a bigger spend. I callit customer-centric competitive differentiation. Here is an example toillustrate. If you are a hardware store competing with two other storesin your locale, your customers are spreading their business acrossthree stores. Getting a bigger buy in this situation means differentiatingyourself from the other two in away that causes customers to choose youover them. Some of those you are courting are already your customers,but they go to the other two stores, too, for a variety of reasons. Yourjob is to figure out why and bring everyone to your store wheneverpossible. This is competitive differentiation.

If you are engaged in winning customers from others (that is,operating in a competitive environment), it’s helpful to think of thecustomer base as existing in three spaces, as in Figure 1.1.

On the far left inside Your Operation, you see theD-zone, so namedbecause this symbolizes your dedicated customers. These people have

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10 Getting Innovation Right

FIGURE 1.1 Customer Spaces in a Competitive Environment

Competitor AYourOperation

Competitor B

D-zone:Dedicated customers

D-zone A

D-zone B

C-zone B

C-zone A

C-zone AB D-zone AB

alreadydecided that you are theprovider for them.Yourprimary activityin this space is maintaining this group, ensuring they stay dedicated.This is your home base. There is no competition here. However, youalways want to be alert to any indication your customers are migratingto one of the other six zones.

On the far right are similar D-zones. These are your competitors’home bases. D-zone A represents all the customers who are dedicatedto doing business with Competitor A, and D-zone B is the same forCompetitor B. D-zone AB indicates those customers torn betweenyour competitors, but not considering you—in other words, they arededicated to A or B. Since you are not in the mix, this is not an areaof competition for you. You can only compete where customers are tornbetween you and another.

In the middle are the C-zones, named for competition. Here iswhere the battle rages. C-zone A represents those customers decidingbetween you and Competitor A. C-zone B represents those doing the

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Pursue and Leverage Inflection Points 11

samewith you andCompetitorB.C-zoneAB are thosewrestling betweenyou and A or B.

The key to competition is not just what distinguishes you from yourcompetitors. It is what differentiates you in the areas your customerscare about.

For example, you may have lower prices and feel this is yourunique differentiator. But customers may be looking for convenienceand willing to pay more for it. If stores A and B get their customers inand out of the store in less than half the time as you, you are misplacingyour resources to focus on price. Hire a few extra people to work thefloor, teach your cashiers to operate with speed even if it means youhave to raise your prices to pay for the extra staff. Conduct a marketingcampaign to highlight how you get your customers in and out of thestore more rapidly than your competitors.

It is critical that you understand what your competitors are pro-viding that is central to your customers. That is the front of the battle.To gain customers from the competition you must differentiate your-self and compete here. Thus the name, customer-centric competitivedifferentiation.

To compete successfully you must work hard to understand whatmotivates potential customers to choose you over your competitors.Then you are in a position to turn their behavior. If you only focus onwhat you offer, you miss the actual competition zone, the front in thebattle where customers are won.

Another look at our chart in Figure 1.2 and you will see the threeintersection zones that overlap with Your Operation form ‘‘the front’’of the battle. This is where you compete.

Youmay have customers whomove from your D-zone toward yourcompetitors. To do so they will have to cross through the front wherethey make their decision about who to patronize. If you are suffering anexodus you must fortify the front facing your own home base. You cando this by reinforcing what your dedicated customers value.

A positive inflection point is an excellent tool to capture theattention of your competitors’ existing customers and stimulate them

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12 Getting Innovation Right

FIGURE 1.2 The Front in the Battle to Win Customers

Competitor AYourOperation

“the front”

Competitor B

D-zone:Dedicated customers

D-zone A

D-zone B

C-zone B

C-zone A

C-zone AB D-zone AB

to make a decision about who they are going to buy from, thus movingthem into the front where they become available to you.

When Verizon launched FIOS, their bundle of home communica-tions services, they created an inflection point by bringing fiber opticsstraight to the homes of their customers. This grabbed the attention ofmany who went on to reevaluate their service providers and decidedto leave Comcast and other competitors to experience fiber optics athome. By so doing Verizon moved competitors’ customers out of theiropponents’ dedication zones and onto the front where many were thenacquired. ThenVerizonwas in a position to get a bigger buy by bundlingservices, which they did.

Improving LoyaltyOne of the biggest market challenges in recent decades was the 2008economic downturn. Many leaders found holding onto their client baseexceptionally hard. Any weakness in customer relationship becamestark as portfolios shrank and customers took a hard look at theirspending.

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What became apparent all too quickly in this dire market was howmany organizations were suffering from one of these three unfortunatecircumstances:

• Offerings were no longer competitive. Customers were able toget sufficient quality or, in some instances, better for less costelsewhere.

• Customer care became disconnected from value. In essence,customer care became a nice-to-have, not a must-have. Whentimes were hard, it was exchanged by the customers for costsavings where possible. This means that customers were quick tojump to another provider even when customer care was clearlyworse, as long as there were financial rewards.

• Customers were in trouble themselves, slashing their expensesseverely and sometimes indiscriminately. They made loyaltydecisions poorly, but made them nonetheless.

Creating an inflection point in this environment is an excellentsolution that revives loyalty and holds onto your existing base. Itcan reorient the customers’ mind-set from surviving to thriving. Ifcustomers believe that by sticking with you they will be able to getthrough the downturn successfully, their loyalty increases. They becomemore willing to tolerate challenges buoyed by the hope of a better future.

For example, HRCI increased loyalty at a time when others werelosing it by establishing their presence as a thought leader in strategicHR during the economic downturn of 2008. They associated theircertifications with job success. It was a way out of dismal prospects inthe minds of their customers. Certification is both a job security tacticand a job-seeking strategy. It became necessary in an environmentriddled with job loss and the resulting uncertainty, a buffer againstdifficult circumstances.

By embracing a downturn and associating yourself with a way out,rather than avoiding or hunkering down to weather the storm, you canreverse the trend of disloyalty and increase steadfast dedication amongyour customers.

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Increasing Market ProminenceWhen Avis, second to Hertz, adopted their slogan,We try harder, theywere not even making a profit. Within three years under the bannerof that slogan they became a credible force in the industry, a positionthey continue to hold to this day. They increased their prominencein the market by carving out a space that they were first in. Theyput in more effort, took their role more seriously than Hertz—or sothey claimed. The innovation in this case was making #2 the placeto be in the customers’ minds instead of #1. The inflection point waspositioning customer service as the defining value rather than marketdomination.With success riding on customer service, Avis moved fromunprofitability to solvency while growing their market share from 11%in 1962 to 35% in 1966.6

You need not be first in what appears to be your niche (for Avis itwas rental cars), but you must be first in something. Only then can youattract new customers, build your base, extend your profits, and moveup market.

HRCI shifted their position out from under their progenitor’sshadow to create a center of gravity all their own, establishing aglobal brand and attracting new clientele through their reputationas the thought leader for strategic HR. They increased their marketprominence significantly by using their inflection point to secure theirposition as global leader in HR certification.

Now that we have looked at the four targets of inflection points, let’stake a deeper look at what exactly an inflection point is, the differenttypes of inflectionpoints bothnegative andpositive so you can recognizeand discover them, and howmultiple inflection points can be combinedto generate a Turnaround.

Inflection Points Defined

HRCI leads today in supporting HR practitioners worldwide, liftingthem out of the ranks through certification, and facilitating a nationalconversation on strategy, innovation, leadership, and the contribution

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of HR to succeeding in business. As a result of a positive inflectionpoint, they changed their game and garnered market favor. That’show organizations get ahead, move out in front of others, repositionthemselves as leaders, and claim ownership of their niche.

My use of the term inflection point borrows from both mathematicsand economics but is a generalization not bound by the rules of either. Iuse the term to highlight an important business dynamic, a game changethat shifts circumstances forcefully. I am talking about a decisive changein the status of your organization with respect to its success in the market.This is not an independent phenomenon, but an event that takes placebetween you and themarket. It can be either negative, indicating a drop,or positive, demonstrating market success.

I illustrate with graphs that depict an organization’s path throughits inflection point. For these illustrations, time is always moving usforward into the future, left to right. The vertical axis shows how theorganization is doing in the market: up means success is on the rise anddown means it is in decline.

First I go through the negative inflection points (diagrammedin Figure 1.3) that show a turn for the worse. Each of these reflects a game

FIGURE 1.3 Negative Inflection Points

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16 Getting Innovation Right

FIGURE 1.4 Positive Inflection Points

Time

1

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change that shifts circumstances decisively against you: a trajectoryto avoid.

Then I discuss the positive inflection points (shown in Figure 1.4),highlighting a variety of increases in market success; that is, gamechanges that shift circumstances decisively in your favor. These, ofcourse, are the inflection points we pursue and leverage.

Negative Inflection PointsThere are two types of negative inflection points:

1. Vertical Drop: A downward fall levels and then falls again, this timedecisively.

2. Step Down: A shallow descent drops precipitously and then levelsout in shallow but ongoing decline.

While we strive for positive turns, it is good to have a thoroughunderstanding of the negative. Business, like life, is filled with its fairshare of both.

Vertical Drop: This is what happens when an organization is onits way down and is not able to pull out and achieve a Turnaround. Theinflection point here portends demise. Success in the market is on a

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downward slope to begin with, but it starts to flatten out before takinga turn for the worse. Then performance plummets.

We see this kind of behavior when a leader makes a bad move justas the drop in market success is starting to slow, or other factors movein to impact an already-weak situation and seal its doom.

The way out of this is to go for a Turnaround, a tactic I detail laterin this chapter.

Step Down: Although this is a less-than-ideal scenario, it does notend in death. Instead the organization plateaus at a lower level of successthan it began. This is preferable to annihilation and can be engineeredinto a Turnaround somewhat more easily than a Vertical Drop.

Here you have an organization that was on its way down, too—seethe shallow descent turning steep at the midway point in the secondcurve in Figure 1.3. The inflection point actually reorients the path sothat it is heading off to the right rather than on to the bottom. Thismeans that some form of stability has staved off a nosedive and resultingobliteration. The stability is very important to understand, as it is likelyto be a primary asset in putting together a Turnaround.

While the way out of both the Vertical Drop and the Step Down isa Turnaround, a Vertical Drop has greater downward momentum andis thus more difficult to shift in direction. As a result, it is almost alwayseasier to first shift a Vertical Drop into a Step Down and then shift theresulting Step Down into a positive inflection point.

For example, if your company is in a free fall, out of market favor,and losing customers quickly, you may find a way to hold onto a certainsegment and be able to do so even if you cannot pull the organizationinto a climb right away. Securing a segment of your customers movesyou from the Vertical Drop into a Step Down. Then you can work withthat segment to shift to a rise in market prominence. By viewing theTurnaround process in two steps, it becomes easier to see the actionsteps that lead to your desired result, market success.

Now that we have seen the inflection points that spell trouble, let’smove to those we all desire: inflection points that signal market success.

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18 Getting Innovation Right

Positive Inflection PointsThe two types of positive inflection points are

1. Vertical Climb: A steep climb shifts to a plateau then a near verticalascent.

2. Step Up: A shallow ascent accelerates up and then levels out as aplateau.

Vertical Climb: Here is an organization that was on its way up,began to level out, and then shifted to an ascent. We see (from the zoomview in Figure 1.5) that the curve is heading off to the right in a plateaubefore it begins to ascend dramatically.

This pattern is typical of many organizations today. After a strongrun it is considered normal to flatten out, even decline. The traditionalinnovation S-curves (portrayed in Figure 1.6) suggest the need fora sequence of innovations to avoid plateaus and achieve continuousgrowth.

This is effective. But it is much more powerful when an inflectionpoint takes place that fundamentally shifts circumstances in your favor.This requires not a linear sequence of innovations, but a multiprongedapproach that includes building capacity, generating value, turning

FIGURE 1.5 The Vertical Climb

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Pursue and Leverage Inflection Points 19

FIGURE 1.6 Traditional Innovation S-Curves

Time

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Innovation 1

Innovation 2

Innovation 3

disruption to your advantage, and engaging your target customers forbest possible delivery. All of these are covered in detail in the chaptersahead.

The end of the Vertical Climb’s curve points almost straight uprather than at the flatter angle of the Step Up. Through this type ofinflection point you shift market success through a plateau into theaggressive climb of dramatic growth.

StepUp: Here (in Figure 1.7)we see a curvemoving fromanupwardtilting plateau through an ascent into another plateau.

Why would we want to stabilize rather than continue up? There arethree good reasons:

1. Resources are exhausted. You need to secure position and refuel.2. Timing is not right for the next level of growth. You need to reassess,

bring in different talent, or wait for the opportunity window to opento mount the next stage of growth.

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20 Getting Innovation Right

FIGURE 1.7 The Step Up

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3. You have achieved your target and now need to dedicate resourcesto other activity; for example, engaging the increased base you nowhave exposure to.

The Step Up is particularly effective when you have tapped a sourceof value that can provide an ongoing stream of profitable customersbut is pulling you in directions you don’t want to go. Let me give anexample to illustrate.

Roger Scheumann andCarolynWeinberg, owners of QuartermaineCoffee Roasters, started out as Peet’s Coffee & Tea proteges. I met themafter I wrote my first book in their coffee shop. It’s a great place to getlocally brewed coffee and write in Bethesda, Maryland.

When Peet’s Coffee & Tea decided to close down the Quartermainebrand Roger and Carolyn bought it. Their hard work produced sevenstores and a wholesale business that included an account withWalmart.By all accounts they were well on their way.

Then they created something new that propelled them into successrapidly.Workingwith local restaurant,Clyde’sRestaurantGroup,Rogerand Carolyn developed a customized roast, Clyde’s blend, that achievedgreat success among customers. But the wait staff did not always makea great cupof coffee, soRoger andCarolyndeveloped a training program

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to ensure that every cup was uniformly excellent, a monitoring processthat made it possible for Clyde’s Restaurant Group executives to detecthowwell their employees adhered to the procedures and a course correc-tion methodology that could be applied as needed to ensure customerswere getting the coffee experience they wanted. This quality control sys-tem, predicated on a quality coffee experience for customers, was theinnovation that launched them into a whole new level of success.

Their innovation required them to install and maintain the coffeemachines, train employees, develop and gather metrics, report to man-agement, and support employees when coffee quality went down. Theresult was a powerful coffee experience that grew their brand so welldemand moved first from restaurant to local stores. As a result of thepopularity a very large chain picked up the coffee. Their innovation hadspringboarded them from local roaster to national phenomenon. Theyhad created a Vertical Climb inflection point.

But Roger and Carolyn did not want to grow, grow, and grow. Theywanted a business lifestyle that matched their desire for fun, family, andother pursuits. They closed down all the retails shops except for one thatwas within easy driving distance of their homes. They sold the coffeewholesale, but let go of managing the stores. They concentrated on theirroasting facility, one retail shop, and building relationships with localrestaurants where the taste of their coffee was central.

Then they received an offer for a second location. It was close totheir homes but a different culture altogether from their one successfulstore. Not being in the heart of a small city like Bethesda, they wouldhave to adapt to a new clientele. After some examination they decidedthe new location fit their criteria and they decided to go forward.

Business didn’t come easy the first year. The landlord didn’t under-stand their style. The mall they were in had not had a community coffeeshop. They had to find innovative ways to attract the locals. As of thiswriting they are in their second year at the new location and things aregoing well, but they are not pursuing additional growth. Instead theyare stabilizing, creating a Step Up inflection point. They are working tolock in their success rather than secure new ground.

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22 Getting Innovation Right

Using Inflection Points to Create Success

Whenyoubegin topursue inflectionpoints, you start to look at theworldin a different way. Jeff Bezos sensed an inflection point when he learnedabout the rapid growth in Internet use through his job in a hedge fund.7

Hedetermined to get aheadof the curve andput together a business plan,incorporated in 1994, and turned his first profit in the fourth quarterof 2001.8 It took him seven years of aggressive driving to achieve theinflection point that buoyed Amazon.com to its current position.

With his knowledge of the coming changes in technology he wasable to brave years of investor losses and steer successfully toward theday when it would all turn around and he would achieve a positiveinflection point, a dramatic and decisive rise in success in his market.Today, the business he founded, Amazon.com, is the most profitableonline retailer in the world.9

Pursuing inflection points requires attention tomarketmovements,a clear understanding of emerging opportunities and challenges, theability to question basic assumptions, and skill at turning disruption toyour advantage. All of these are covered in the chapters ahead in detail.But once you understand the opportunities that circumstances aregiving rise to, how do you position yourself to harness those conditionsfavorably?

Three Inflection Point TacticsThere are several basic tactics that can be used to take advantage ofchanging market conditions. They can be executed independently orcombined to createmore complex responses such as a Turnaround. Thethree that I will elaborate on here are

1. Stop the Drop2. Shift to Ascent3. Soar

Inflection point tactics are simple moves that change your rela-tionship to an upward or downward trend. Each tactic is designed toaccelerate or stabilize your success in the market.

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Stop the Drop: This tactic, shown in Figure 1.8, is one of the mostimportant to learn, as it rescues you from impending disaster. It takes asituation in rapid decline and creates a plateau to stop the downturn. Itis the first stage of a Turnaround, covered in more detail after the threetactics.

When an organization is in free fall something dramatic is calledfor to stop the nosedive.

One of my CEO clients was in command of an old-school orga-nization that served an industry experiencing a significant transition,gasoline station owners. He was on top of his numbers and knew hisprofits were declining and leading him into the red.

The longstanding customers were all white males who believedknowledge-sharing was what you do at the bar after work with your bestbuddies. As they retired and left his organization, his numbers wentdown. The new clients were Asian, African American, and Hispanic,including women as well as men. Many were young, some just out ofcollege, with others even younger, helping their families run operations.

The new crowd appreciated an online approach. Many were immi-grants and worked long hours. Their culture was such that they would

FIGURE 1.8 Stop the Drop

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not take time out to get away from work. However, they were veryinterested in learning from others.

My client created a migration path from traditional strategies thatincluded annual meetings that were thinly disguised pleasure trips. Hemoved his organization to a suite of online communities that could beaccessed 24/7 from anywhere there was an Internet connection.

He did a rigorous accounting of the costs and revenues he hadto generate and intentionally took his organization from one mode ofoperation to the other. By shifting decisively away from leading the oldboy’s club and toward real value delivery online he stopped the drop.

Shift to Ascent: Aggressive growth is not always the aim, evenwhen growth is sought. Sometimes establishing a slow growth presencein the market is desired. This tactic (shown in Figure 1.9) yields a gentleincline as an outcome.

Slow growth can be good if infrastructure is an issue. Often it is thecase that a firm will use an investment to grow. If that growth takes off,the original investment may not be enough to build the infrastructurerequired to ensure the quality necessary for continued, rapid growth. Ifquality goes down as speed of growth goes up, sustainability is sacrificed.

FIGURE 1.9 Shift to Ascent

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You may even build up animosity in the market that will sabotage yourgrowth.

Another instance when slow growth can be helpful is when issues ofscale arise. Sometimes a businessmodel that works very well at one scalehas challenges associated with speedy growth. For example ’wichcraft,the New York, Las Vegas, and San Francisco sandwich shop that builtits reputation on fresh ingredients, has taken its time growing its first 14locations. This was necessary so they could work out the supply chainrequired to make the small batches of fresh preparations responsible fortheir success.10

Soar: This tactic, shown in Figure 1.10, shifts you from steady todramatic growth. The organization is already on the way up whenits success moves to another level, creating a Vertical Climb. This isa demanding transition, requiring excellence in execution to sustain.Although it appears at first glance to be a desired state, many are notprepared for the activity required to sustain it.

A primary area of concern is infrastructure. Your infrastructuremust be ready to handle a large spike in activity to achieve a Soarinflection point. An example of success in this regard is Animoto.com,a web-based video producer.

FIGURE 1.10 Soar

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The Animoto site will take photos, video, music, and sound files,and combine them into a short video you can download and share withyour friends. It’s a creative way to generate home movies and works forbusiness presentations, too.

Animoto launched in 2007 andwas receivedwell, attracting fundingand users at a significant pace. In 2008 they launched an applicationon Facebook and experienced a huge spike in new users, resulting in aneed for massive computing power fast.

They went from 25,000 customers to 750,000 in four days. Toprocess all the registrations and videos they required the use of upto 5,000 servers simultaneously.11 Brad Jefferson, one of the founders,said, ‘‘Without the ability to handle a spike like that, our businessdoesn’t exist.’’12

Animoto did it using cloud computing purchased from Amazon.As their need increased Amazon was able to dedicate the resources,and as their need diminished Amazon followed along, hugging demandclosely.

This type of arrangement makes it possible for companies workingwith cloud providers to experience huge spikes in computing power,both the climb and the drop, without sacrificing customer experience.Further, the close matching by Amazon ensures they stay in the black,never spending more than they need.

Not so long ago a company like Animoto would have had to buyservers, the facility to house them, and the staff to run them in advance.A huge expense like this is not justified unless a big increase in revenueis clearly coming. This is often something no one can predict accurately.And when the spike is over, what do you do with the servers, facility,and people?

The process of powering down, so to speak, has tremendousoverhead. But with the advent of cloud computing all that changes forthe better, enabling companies like Animoto to pull off the Soar tacticwhile they maximize their profits in the process.

Each of these three tactics is easier to talk about than to execute.These simple moves take an extraordinary amount of skill. Now that

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you have an understanding of what they are, I will show you how theycan be combined to create a more complex move, the Turnaround.

The TurnaroundThe Turnaround (illustrated in Figure 1.11) is one of the most difficultmaneuvers to manage, yet it is also one of the most important andlucrative when done successfully. As a result there are leaders whospecialize in it.

A Turnaround delivers three inflection points sequentially: (a) Stopthe Drop, (b) Shift to Ascent, then (c) Soar. Each requires its own effort.

First you have to pull out of your nosedive, Stop the Drop. Thisis all about steering the organization away from doom. It typicallyinvolves changing staff, implementing new and better systems, gettingreliable data, and sometimes slashing expenses beyond what can besustained in operations; for example, temporary salary cuts. The resultis a stabilization or plateau. Typically that alone does not improve yourstanding in the market. Instead it stabilizes the organization, averting anasty ending. But you cannot cut your way to success—and so there ismore to do.

Once you are no longer drowning, just treading water, you shiftto improving your market standing. The focus is less on cutting

FIGURE 1.11 Turnaround

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expenses and more on generating enough revenue for operations whileestablishing solid value for your customer base. You begin to earn yourkeep. This is the Shift to Ascent.

Finally, you put the pieces in place to take off with an eye towardsuccess. All the changes you have instituted are now put to the test:great staff, robust systems, rigorous financials, market aggression, andpartnerships. If successful you Soar, and you are not only back inbusiness, you are on your way to the top. I will share a story so you willsee the exceptional leadership necessary to execute this kind of dramaticchange.

I serve on the board of the Columbia Lighthouse for the Blind(CLB), a Washington, DC, nonprofit, and was privy to their recentTurnaround from the inside, providing strategy to CEOTonyCancelosipro bono. I read the financial statements before and after. I watchedCancelosi operate on multiple fronts to pull the organization out of anosedive and get it back in the community as a rising star.

Founded in 1900, CLB enables people of all ages who are blind,visually impaired, and deaf-blind to remain independent, active, andproductive in society. Their programs and services include trainingand consultation in assistive technology, employment marketing, skillstraining, career placement services, comprehensive low-vision care, anda wide range of counseling and rehabilitation services. While theirmission is to help the visually challenged population of theWashington,DC, metro region, they provide assistive technology and training in 83cities across the United States.

But in 2005 the century-plus-old CLB was going down, an outdatedinstitution in the red and plummeting fast. That year Cancelosi washired as CEO to get the organization back on track. The first thing hedid when he arrived was to review the bylaws, turn over the board, andimplement solid financial systems. He also reviewed and turned overstaff, took a cut in salary himself, and instituted a short furlough. All ofthis was intended to Stop the Drop, which he did successfully.

Cancelosi then focused on reinvigorating CLB’s presence in theWashington, DC, community by building an advisory board of movers

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and shakers, combining veteran business leaders with up-and-comingfirebrands. Simultaneously he focused efforts on improving servicesto the visually impaired and instituting innovations to resuscitate theailing organization. Central to his efforts is the program Bridge toWork, training for wounded warriors. Bridge to Work ensures thatveterans who are blind or visually impaired have the skills, resources,and training they need to succeed in the workplace. It does this bygiving them training in digital data scanning, computer skills, and jobinterviewing.

‘‘The disabilities groups within the different counties recognizedthe fact that our veterans were coming back through miracle medicalattention and had all the capabilities of survival,’’ he said to me. ‘‘Yetthey still needed to be reconstituted back into society at a level that theycould be earning a living andmaintain the quality of life they had beforethey went into the military.’’

Cancelosi envisioned an innovation. He wanted not only to trainthe veterans in skills they could market and use to gain employment.He wanted to match them with jobs. He wanted to provide a completeend-to-end solution, one that started with the veteran’s desire to reenterthe workforce and ended with secure employment. Cancelosi used CLBas an incubator to test the Bridge to Work program.

After three years and cross-county support, he built a matureprogram and began identifying corporate sponsors. This program,along with others that Cancelosi has put together, is now responsiblefor government funding that has taken the Lighthouse to a whole newlevel of operation. He successfully engineered a Shift to Ascent.

In 2011 CLB put on their first Light the Way 5k run. The goalof the run was to increase public awareness of CLB’s work restoringindependence to the visually impaired and open the way to newpartnerships thatwould amplifyCLB’s success.Throughmedia coverageand public participation hewanted people to learn howCLBwasmakinga difference.

Cancelosi recruited Charlie Plaskon to be spokesperson for theLight theWay 5k. Since 2003 Plaskon has completed eight half Ironman

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events, six full Ironman events, including the World Championship inKona, Hawaii in October, 2007. He has six Olympic distance triathlonsto his credit including the ITU World Championship representing theUnited States as part of TeamUSA in Lausanne, Switzerland in 2006. Hehas been featured in two Ironman documentaries carried nationally onNBC and the Outdoor Life Network. Charlie is in his late 60s and blind.

Cancelosi brought Plaskon in not just to speak about the Light theWay 5k, but to run and teach other participants how to lead runners whoare visually impaired. This way the visually impaired could participateand everyone whowas up for the challenge had the chance to be a guide.

The event netted $80,000, far more than most 5ks garner their firstyear. More importantly it established partnerships in the communitythat included the Washington Nationals and Safeway. It did this byinvolving the key members of their staff in the race as sponsors andparticipants. Steve Neibergall, president of Safeway’s Eastern Divisionand veteran marathoner, left me in his dust as I ran the course.

Once people experienced what CLB was all about firsthand, theywanted to deepen their involvement. The same year as the first raceCancelosi began a professional fundraising campaign and receivedseveral significant estate donations.

He poured energy into his grant acquisition program and garneredmillions of dollars in multiyear contracts from the federal government,including the Federal Bureau of Investigation, Internal Revenue Ser-vice, Department of Veterans Affairs, Andrews Air Force Base, andthe Department of Education. Many smaller grants were also acquired.He opened relationships with the Workforce Investment Boards ofthree local counties and the District of Columbia.

In 2011 not only was CLB in the black, it was garnering mediaattention and newmajor partnerships. All of these efforts were parlayedback into core services improving the quality of care to help the visuallyimpaired achieve independence. As of 2012 Cancelosi is in the earlystages of a Soar. CLB is no longer known as an old-school charity. Itis now a savvy business partner attracting top-level sponsors in theWashington, DC, community.

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With emotional intensity Cancelosi executed each of the threetactics that together generated a Turnaround. His is a perfect exampleof how to combine basic moves for a more sophisticated result.

The overarching innovation Cancelosi brought to CLB was hisability to run it like a business. Every step of the way his tactics wereengineered to lift the numbers. He ran the nonprofit with the rigor ofa business perspective. He never compromised on CLB’s core mission.But he pulled every lever at his disposal as a CEO, from salaries tosystems, from marketing to partnerships, to move CLB from the redto the black.

Seeing Around the Curve

Inflection points are important because they enable decisive shifts inmarket acceptance.Beingable to sense theminadvanceandprepareyourorganization to take advantage of them positions you for innovationsthat will succeed in the market—the only kind that really matter.

Looking for inflection points and detecting them in advance posi-tions you to win big in important areas. Without developing this sense,you will find it extremely difficult to get innovation right. Increasingyour ability to find inflection points and applying the tactics to turnthem to your advantage will help you grow your base, get a biggerbuy from existing customers, improve loyalty even in tough times, andincrease market prominence.

Every one of the chapters that follows teaches skills that will helpyou discover inflection points and take advantage of them when youspot them coming.

EXPERT INPUT: CINDY HALLBERLIN OF GOOD360.ORG

ON GETTING AHEAD OF AN INFLECTION POINT

Cindy Hallberlin, CEO of Good360.org, is a dynamo with a mission.She has a history of successfully tackling really tough business chal-lenges. As the chief ethics and compliance officer following a $1 billionfraud, she oversaw the cultural transformation of US Foodservice.

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Before that she developed and successfully managed the US PostalService’s REDRESS employment mediation program, which success-fully resolved more than 80% of discrimination claims and resultedin $60 million in cost avoidance.

An international nonprofit with nearly 30 years of experience inproduct philanthropy, Good360 is dedicated to helping people andcommunities in need by distributing corporate product donations toqualified nonprofits. On behalf of Fortune 500 consumer, retail, andtechnology companies, Good360 distributes products to a network ofmore than 30,000 prevetted organizations and is consistently rankedby Forbes as one of the top 10 most efficient charities in America.13

Good360has deliveredmore than$7 billion of donatedproducts totens of thousands of nonprofits and schools. Every Good360-registerednonprofit can access their online catalog to browse products donatedby America’s top brands such as The Home Depot, 3M, Hallmark,Bed Bath & Beyond, Crayola, Sears, Walmart, Life Is Good, andmany others. Registration is free and all a nonprofit needs is proof oftheir organization’s 501(c)(3) status, an active Form 990 provided tothe IRS or financial documentation that demonstrates how programsare funded, and a signedGood360 Product UseGuidelines agreement.

The inflection point Hallberlin wanted to get ahead of was thatof companies participating in product giving on a significant scale.It had already been established that product giving could be used asa brand element, helping a company to project an image of socialresponsibility. It became clear that scaling product giving wouldrequire a stronger and clearer financial case. Hallberlin’s job was notjust establishing the cost returns, but also ensuring Good360 was wellknown as the leaders in product philanthropy.When it comes to companies unloading product, we have learnedthat donating not only provides scalable impact to communitiesin need, but can also yield a better return on investment thanliquidating or disposing. This fact cannot be ignored. Strategicdonation efforts—benefiting the triple bottom line (people, planet,profit)—were an inflection point in the private sector I wanted to

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get ahead of and steer. The way that recycling has become a socialmovement over the last decade, we want to lock in and seal thedonation mind-set by publicizing the business case and simplifyingthe donation process.

To get ahead of the product giving inflection point, we knewwe had to do more than connect those who have with those whoneed—we had to become thought leaders. We commissioned Indi-ana University research that was released in January 2012 showingdonation to be the best financial choice over liquidation or disposal.The Business Case for Product Philanthropy, by economist JustinRoss, includes two worksheets companies can use to determinefor themselves (1) Cost-Benefit Analysis of Liquidate, Dispose, orDonate, and (2) Return on Investment.

Our vision also demands constant innovation and it was imper-ative that we leverage the latest technology to stay ahead of thecurve. For the product giving movement to truly catch on, we knewit had to be simple, manageable and customizable. We have theability to tailor a giving program to fit any company’s needs andstrategies—from innovative employee giving programs to one-timedonations to ongoing national retail initiatives.

A good example of an employee giving program is the onewe developed and manage with Hewlett-Packard (HP). We set uptheir giving website, manage the back end, and oversee all logisticalaspects. Employees are able to select HP products they want todonate through an online website, donate 25% of the cost (HP picksup the remaining 75%), and hand select which charity will receivetheir gift. When employees are asking more from their employersthan ever before, HP provides a fantastic benefit that not onlyempowers employees to give back to the community, but allowsselected nonprofits to receive new technology to aid their missions.

In June of 2012, the Committee Encouraging Corporate Philan-thropy (CECP) honored Good360 with its Directors’ Award as partof the organization’s 12th Annual Excellence Awards in CorporatePhilanthropy, for our exemplary partnershipwith TheHomeDepot

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34 Getting Innovation Right

on the Framing Hope Product Donation Program. Framing Hopewas created in 2008 out of The Home Depot associates’ desire todonate marked-down inventory, buy-backs, returnedmerchandise,and end-of-season items rather than shipping them back to distri-bution centers or placed in landfills. By partnering with Good360to manage all aspects of the program, The Home Depot was ableto distribute more than $100M in products to more than 1,000prequalified nonprofits across the country.

Influencing a powerful trend like corporate giving on a large scaleis a real challenge. Operations are massive and complex. But a keeneye for Good360’s inflection point indicated what was needed: (1) astrong financial case she could present to her customers, (2) easy-to-use tools her customers’ CFOs can apply to their organizations, (3)highly customizable and easy-to-implement employee participationprograms, and (4) a reputation for thought leadership in the fielddemonstrating that Good360 is the partner of choice. These are thetools Hallberlin plied to successfully achieve her positive inflectionpoint.

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Success Rules

• Create inflection points that drive you toward one or more offour targets:1. Growing your base2. Getting a bigger buy3. Improving loyalty4. Increasing market prominence

• Growing your base depends on five primary contributing factors:1. Current customer satisfaction2. Desire for your offering3. Your reputation as a provider4. A value proposition you can deliver5. Effective outreach

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• To get the bigger buy, exploit inflection points that bring oppo-nents’ customers into the competition-zone where they willdecide who they want to engage.

• Improving loyalty requires creating an inflection point thatreorients customers’ mind-sets.

• To increase market prominence, carve out a space you can befirst in.

• Inflection points, which can be negative or positive, and pre-cipitous or moderate, represent a change in the status of theorganization with respect to its success in the market.

• Inflection point tactics are simple moves that stabilize or accel-erate your success in the market. Combine the Stop the Drop,Shift to Ascent, and Soar inflection point tactics to create aTurnaround.

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About the Author

Seth Kahan is an executive strategy consultant who works withCEOs to lead change and develop business innovations thatimprove market performance. He teaches over 25,000 profes-

sionals every year in conferences and professional seminars. Seth hasprovided leadership for large-scale innovation initiatives at Royal DutchShell, World Bank, and the Peace Corps, among many other organi-zations. In addition, he works with the CEOs of a large number ofprofessional societies and trade associations to identify innovationthat generates success for members while improving the bottom line,including the American Society of Association Executives, the Cen-ter for Association Leadership; American Geophysical Union; and theHuman Resource Certification Institute.

He is the author of theWashington Post best-seller Getting ChangeRight: How Leaders Transform Organizations from the Inside Out.He writes regularly for Fast Company’s website (SethFast.com), and hiswriting is syndicated to thousands of readers worldwide.

Seth lives in Bethesda, Maryland, with his wife, daughter, andson. Besides his family and work, he enjoys solo wilderness camping,traveling, poetry, and storytelling around the campfire.

For more information and to download Seth’s articles oninnovation and change leadership, visit VisionaryLeadership.com orfacebook.com/GettingInnovationRight.

235

The chapters from this sampler are extracted from the following titles:

What Matters Now 978-1-118-12082-8, January 2012, Wiley

To view a wider selection of business and management titles, please visit

13-5

8167

Consumptionomics 978-0-470-82857-1 December 2010, Wiley

Tomorrow’s World 978-0-470-82471-9, February 2013, Wiley

Talent Intelligence 978-1-118-53118-1, May 2013, Wiley

Human Capital Analytics 978-1-118-46676-6, October 2010, Wiley

Getting Innovation Right 978-1-118-37833-5, March 2013, Wiley

www.wiley.com