Irving Wladawsky-Berger

The carnage underway in the financial sector reminds me of one those near-mass-extinction events that seem to strike industries and markets from time to time.  What can a company do to maximize its chances of survival at such times?

Most everyone will agree that a strategy based on diversification is the best way to reduce risks in a very complex system, especially one whose components are interconnected and undergoing rapid changes, thus causing the overall system to be intrinsically unpredictable and emergent.

Nowhere are the benefits of diversification more apparent than in biology.  Biodiversity is one of the best indicators of the health of a biological system.  The biodiversity in our planet today is the result of a few billion years of evolution.  It is evolution's way of improving the chances that as many forms of life as possible will continue to survive and thrive in spite of drastic changes in their environments, including periodic mass extinction events.  It is estimated that 99% of the species that ever lived are now extinct.  Thankfully, we are still among the 1%.

In dealing with your personal finances, a particularly timely subject, financial analysts generally advise that a diversified portfolio is the only reasonable strategy for managing your long-term investments - that is, a mixture of  stocks, mutual funds and bonds spread across different industries, countries and risk levels.  Given the impossibility of predicting the financial performance of any one item in the portfolio, diversification is the only prudent strategy to follow, so that losses in one area are offset by gains in others.   

But along with diversification comes complexity, whether in biology or financial portfolios.  Managing a pure-play portfolio with a small number of investments is a lot simpler than managing a mix of investments to try to achieve a well balanced portfolio.  But the risks are much higher.  If your pure-play investment does poorly, your portfolio could be essentially wiped out. 

In biology, the massive diversity in genetics, species and ecosystems that has evolved over billions of years has resulted in very robust, but extremely complex biological systems. 

This link between diversification and management complexity raises some key strategic questions for companies.  How diversified does a company need to be in order to survive major technological, market and geopolitical changes?  And how diversified can a company get before it is too complex to manage effectively?

A new company is typically started around a new idea -- that is, a specific product or service offered to a specific set of customers.  In its first few years, it needs to remain sharply focused on getting its offerings to market.  Many do not make it.  A recent study from the US Bureau of Labor Statistics found that 66% of establishments were still operating two years after they started, while only 44% were operating after four years.

Once successfully established, many of those companies will now begin to look for opportunities to diversify and grow by developing new products and services, as well as going after new customers and markets.  This is usually the time when the management of the company needs to transition from a single focus to managing multiple tasks at once.

The company now has products and services, customer relationships, employees, business partners and financial obligations - all of which need lots of operational attention.  But, at the same time, it needs to formulate a strategy for its future offerings, customers and markets.  Standing still is not an option, as competitors - startups as well as established companies - will all want a slice of its hard-fought market share.

This tension between diversification and complexity is particularly pronounced with large, global companies that are leaders in their field.  They achieved their leadership position by successfully managing this delicate balance between operational excellence for the present, and sound strategy for the years ahead.  But day-in and day-out, these companies are constantly facing the challenges of managing the kind of diversified, complex business that has enabled them to survive and grow, while making sure that the business does not become too complex to manage effectively.  Let me illustrate some of these challenges by talking about the company I am most familiar with - IBM.

IBM started doing business almost one hundred years ago.  By the time the computer industry was born in the 1950s, IBM was already a successful company selling tabulating machines around the world.  IBM then became the dominant vendor in the nascent computer industry, a position it solidified over the next few decades with the introduction of the highly successful System/360 family of mainframe computers.  By the mid 1980s IBM was the most profitable company in the Fortune 500, as well as at the top of the most admired companies lists.

You would expect that a company like the IBM of the mid ‘80s, selling the most successful products in the computer industry to clients around the world, would be resilient enough to ride out just about any changes in its environment.  But, as we know, that was nearly not the case.  IBM's business model was too hardware-centric and too focused on a single family of products - its mainframe family.  The principle of survival of the fittest applies just as dispassionately to companies and markets as it does in biology.  You are never too strong or too big to be wiped out, whether you are a dinosaur or a powerful, global corporation.

Mainframe profits and market share started to decline sharply in the late ‘80s and early ‘90s with the advent of powerful, inexpensive microprocessors, as well as the distributed client/server computing model based on relatively inexpensive personal computers and small servers.  This was a kind of marketplace mass extinction event that wiped out many industry leaders across IT.

IBM was nearly one of them.  Because of its reliance on hardware and mainframes for the bulk of its profits, IBM came very close to disappearing in the early ‘90s.  Plans were under way to split the company into a series of individual units.  In "Who Says Elephants Can't Dance?", Lou Gerstner wrote ". . . keeping IBM together was the first strategic decision, and I believe, the most important decision I ever made - not just at IBM, but in my entire business career."

But he also wrote, "Keep in mind that all of this - hardware, software, sales, services - was dedicated and tied to System/360.  Despite the fact that IBM, then and now, was regarded as a complex company with thousands of products, I'd argue that, until the mid-1980s, IBM was a one-product company - a mainframe company - with an array of multibillion-dollar businesses attached to that single franchise." 

So, while reinventing the mainframe, it was critical to make IBM a truly diversified company.  In 2007 IBM's income had a very different distribution from what it was in those days that Gerstner wrote about:  40% software, 37% services, and 23% hardware and financing, with 43% of its revenues coming from the Americas, 36% from Europe, the Middle East and Africa, and 21% from the Asia Pacific region.  There is little doubt that the IBM of today is a significantly more diversified and robust company than the IBM of 1993.

In this regard, I had a strong sense of deja vu when I joined Citigroup earlier this year as a strategic consultant in innovation and technology.  Citi is one of the most diversified global banks in the world.  It is organized into four major segments - consumer banking, cards, wealth management and institutional clients.  It does business in more than 100 countries. 

Since being named CEO in December of 2007, Vikram Pandit had been under pressure to split the company.  Some analysts have claimed that each part of Citi could do better as a pure play, independent business than as part of a diversified, integrated global bank. Pandit has consistently responded that Citi's diversification across products and regions is a strong source of stability, especially in these times of rapid change in the financial industry.

There are considerably fewer critics of Citigroup's business model these days.  In the last few months we have seen bank after bank embrace Citi's diversified model as a way of weathering the ongoing financial crisis.  Pure play banks have been the most vulnerable to failure. 

We don't know how the present financial crisis will be resolved, let alone how banking will evolve into the future.  But we know that fundamental principles continue to apply.  Whether talking about biology, investment portfolios or large companies, diversification is the best, perhaps the only strategy to reduce risks and increase stability in a very complex system.

The recent events in the financial industry brought back memories of the Internet dot-com era of the late 1990s, only a short decade ago.

In the speculative dot-com bubble that developed during those years, a lot of people were talking about the rise of a new economy that rendered obsolete many business practices, including business models based on revenue, cash and profit.  They felt that in this new Internet economy, the emphasis should now be on increasing market share, clicks and eye-balls as fast as possible regardless of the impact on the bottom line.

There was a buzz in the air that in this new economy, "born-on-the-Net" startups had an inherent advantage over existing,” brick-and-mortar" businesses.  Because of their grounding in the physical world, it was thought that such old-fashioned companies could not possibly compete in this fast-moving digital space and were therefore headed for extinction.  Thus, many otherwise smart people rushed to invest in new Web-based companies regardless of their financial soundness, hoping to strike gold in this new economy.   

At the time, I was general manager of the IBM Internet Division.  Looking back at what we accomplished in those days, I am frankly almost as proud of what we did not do as I am of what we did.

All kinds of ideas for new Web-based companies were floating in the air.  Different groups within IBM wanted to start new projects.  Startups and VCs were asking us to invest in their new companies.  Established companies wanted to us to partner in the new Internet ventures they were starting. 

I have to admit that in many of those cases, I did not understand the business models they were presenting.  I just did not get it.  I know that when you start a new business, especially one based on a disruptive new technology or business model, it usually takes a few years for the business to start making money.  But in many of the proposals we reviewed, I did not understand how they could ever make money and turn into a real business. The proposals were generally very interesting, just not financially sound.

I am sure we missed a few good ideas we should have embraced.  But once the bubble burst, it became clear that many of those proposals were not well thought out and had no hope of ever turning into a real business. 

This was also the case with many of the dot-com companies that did get funded.  A number of these failed dot-coms were led by managers who had no idea how to build a real business, but were hoping to get very rich through a public offering or acquisition before anyone found out that the emperor had no clothes. 

By 2001, a majority of the dot-coms went under after burning through their venture capital.  The Internet and the Web were alive and well, but it was now back to the fundamentals. 

Then a few years later, we started hearing a new buzz in the air, this one coming from the financial industry.  Once more, we were asked to believe that there was a new world out there with a new set of rules quite different from those most of us had grown up with. 

We heard that borrowers can now get a mortgage regardless of their credit history, employment status, income level or ability to make a down payment, even though there is a high probability that they may not be able to keep up with their mortgage payments.  Lenders can now protect themselves from the risks that homeowners will default on their mortgages by distributing the risks using innovative securitization and financial instruments like derivatives.  And both borrowers and lenders will be fine because housing prices will keep going up with no end in sight.

As we now know, these and other flawed assumptions led to a housing bubble, with prices rising to unsustainable levels.  Once the bubble burst and home prices started to come down, borrowers, lenders and the whole economy found themselves in the middle of the huge subprime mortage crisis.  We still don't know how it all will play out.

We know we are living in times of profound change.  The Internet and Web are fundamentally transforming all aspects of business, society and our personal lives.  Many, perhaps most of the predictions made in the heady dot-come bubble days of the late 1990s are coming to pass.  We are indeed building an integrated, global, digital economy.  Billions around the world are able to access all kinds of information and applications over the Web, as well as communicate and collaborate with each other.  Whole industries, like media and entertainment, are being transformed in front of our eyes. 

But it is all based on classic, fundamental principles.  All these advances have to be grounded on solid science, technology and engineering, not wishful thinking - which is why they are taking a lot longer to come to pass than originally predicted.  More than ever, you need very competent managers with strong leadership skills, who can understand and deal with the complex systems, markets and organizations all around us.  New companies are emerging with all kinds of highly innovative, disruptive business models, but to succeed, those models must have sound financial underpinnings based on revenue, cash and profit. 

As the subprime crisis works itself out, the financial industry is poised to undergo its own massive transformation based on sound technology, management, innovative ideas and business models.  It is time to ask fundamental questions:  How will banks evolve in our emerging knowledge economy?  What does it mean to be a global, mobile 21st century bank?  How can we make it easier for people to deal with money in their everyday lives, as well as make sound financial decisions for their future and the future of their families? 

Sometimes you need a bubble, followed by a crisis, to help us all sort things out and get everyone's feet back on the ground.  As we learned with the Internet, only then can the real hard work and innovation finally start.  My hope and expectations are that something similar will now happen in the financial world.

There is general agreement that the corporation is going through dramatic changes in the 21st century, driven by a combination of advances in information technologies, the Internet, the fast-changing market environment, and the heightened competitive pressures brought about by globalization.  Business strategist and author Don Tapscott, whose research and writings have focused on the changing nature of companies, said it nicely in this article:

"We came to the conclusion that the corporation is arguably going through the biggest architectural change in a century.  Throughout the 20th century we created wealth through vertically integrated companies that did everything from soup to nuts. . . . But the rise of the Internet means that boundaries are far more porous.  A new model is emerging, enabled by IT and networks.  Vertically integrated companies are unbundling into business Webs, or what I call the open networked enterprise.  These are companies that think and act differently, that take a new approach to doing business in a highly networked world."

Companies are embracing a more distributed organizational style.  The foremost reason is the need to become more flexible and adaptable in response to changing market conditions.  A highly centralized organization may have worked well when markets changed slowly.  It was then possible to have a command and control approach to management, where authority and information flowed down from small groups of executives back in headquarters.

But, as we know, this does not work so well today, especially for global companies that operate within complex supply chains and industry ecosystems and need to react fluidly to dynamic market conditions all over the world.  The expertise is out in the field, where the rubber meets the road, as it were.  That is where people know what is really going on and what they should do about it.

It is hard for people back in headquarters, no matter how competent and committed they might be, to stay on top of what is happening all over their company.  Their own development labs and manufacturing plants are generally located all around the world.  It is even tougher for them to have the proper understanding of the changes underway in all the various cities, countries and communities where they do business.  The experts in the organization are those people closest to their products and services, their clients and their markets.

But, for a distributed organization to work effectively, it must adopt a culture of collaboration across its most important tasks.  As you distribute leadership and responsibilities, your employees should not feel that they are being asked to solve complex problems all on their own.  They should be encouraged to reach out to colleagues across the company, especially those with the proper skills and resources to be of help, - subject matter experts as well as managers.  Collaboration is particularly important when facing new kinds of problems from those you usually deal with – the kinds of problems where truly innovative approaches are typically most needed.

In our increasingly networked world, collaboration also extends beyond the firm.  A key finding in the IBM 2006 Global CEO Study is the link between external collaboration and innovation.  An increasing number of CEOs stressed the importance of collaborating beyond company walls, with business partners and clients as top sources of innovative ideas.  This is very different from previous organizational models that assumed innovation was too critical to involve outsiders. 

Turning from business to government: Can we envision a parallel move from a centralized style toward a more distributed, collaborative style?  Could such a shift in style help governments derive the benefits that have been working so well for companies and other societal institutions?

This question has been debated in one form or another ever since the birth of the Republic.  The early days of the US government saw fierce political battles between the Federalists, led by Alexander Hamilton, who advocated a strong national government, and the Democrat-Republicans, led by Thomas Jefferson and James Madison who favored states' rights and a strictly limited federal government. 

In the years between the Civil War and the Civil Rights Movement of the 1960s, states' rights became closely associated with segregation, with the federal government as the chief protector of civil rights for all, especially with the passage of the 1964 Civil Rights Act.

Fortunately, those days are behind us.  But the governance debates continue.  For example, New Federalism has emerged as a political philosophy which aims to devolve back to the states some of the autonomy and power which they lost to the federal government in the decades since the New Deal in the 1930s.  Supporters of New Federalism and related initiatives have generally been conservative politicians like presidents Richard Nixon and Ronald Reagan.

More recently, this philosophy has been embraced by people across the political spectrum.  As I was doing research for this blog, I came across the writings of Jonathan Taplin, a Professor at USC's Annenberg School of Communications.  In this entry of his blog, he writes:

"I have come to the conclusion that we have to use the same devolutionary technology that has transformed business to transform our republic.  I call the movement, The New Federalism and its principles come from Thomas Jefferson’s belief that 'The true theory of our Constitution is that the states are independent as to everything within themselves, and united as to everything respecting foreign nations.'”

In another entry in his blog, he writes, "The basic economic problem we will face in the next few years is that the Federal system no longer works correctly.  In the same way that giant corporations like G.E., News Corp and Berkshire Hathaway have flattened their organizations and shrunk their corporate staff, we need to redesign the way we govern, tax and spend.  The States are without sufficient taxing power to provide basic services for their people, as every single state government is in a fiscal crisis, exacerbated by the inability to keep capturing falling property tax revenues from county governments."

He further adds, "Since most of the concerns of citizens are local matters: Schools, Police, Housing, Power & Water, Public Transportation, and Health Care, these should be funded at the local level.  Even though the Federal Government provides block grants to the States for these concerns, much of the tax revenue gets wasted in the Federal Bureaucracy."

He then uses California as an example.  “In four years the state has passed laws on auto emissions, CO2 levels, stem cell research, personal data privacy and appliance energy standards all of which have clashed with the neoconservative agenda of the Bush administration.  As the governor pointed out, the power and size of the California economy has allowed the state to create de facto national standards that the corporate sector has been forced to follow.  And although both the auto, oil and banking industries have joined with the Bush administration to sue for relief from the California standards, to date the courts have not struck down any of the state laws."

New Federalism might give us a framework around which to apply the principles of distributed, collaborative leadership to government, especially in important areas that are naturally the province of state and local governments more so than of the federal government, such as economic development and education, along with major issues like healthcare and infrastructure which are closely related to economic development.  These are not only critically important areas to the country, but also areas where we are badly in need of fresh thinking. 

In healthcare, for example the states and the private sector are ahead of the federal government in experimenting with new ideas.  Over the last few years we have seen Massachusetts and other states enact or propose comprehensive health care reform plans and universal coverage.  We have also seen new private sector initiatives like miniclinics, which hold great promise for delivering "entry-level" primary care at reasonable prices.

Support of fundamental research has long been the province of the federal government through key agencies like the National Science Foundation and the National Institute of Health.  However, we are now seeing states taking the lead in certain areas of economic importance in partnership with the private sector.

In 2004, California voters approved the creation of  $3 billion in state funds over ten years for human embryonic stem cell research.  This led to the establishment of the California Institute for Regenerative Medicine, whose mission is “to support and advance stem cell research and regenerative medicine under the highest ethical and medical standards for the discovery and development of cures, therapies, diagnostics and research technologies to relieve human suffering from chronic disease and injury.”      

Another example is the leadership of New York State in establishing the College of Nanoscale Science and Engineering at SUNY Albany, doing so by working closely with IBM and a number of other industry partners.  This has enabled SUNY Albany to be recognized as the top university in the world for nanotechnology, and has transformed Albany and the mid-Hudson valley into the worlds leading region for nanotechnology, with all the economic benefits that implies.      

We need to get beyond the tired ideological debates of the past.  In effect the governance debates have been framed as: Do you want a centralized, authoritarian government, or a weak, incompetent one?

That is no longer the right question.  In business, you need very strong and competent leadership at the top to effectively implement a distributed, collaborative model.  Such leaders understand the limits of their power.  They know they must hire the best possible people, listen to their advice, empower them to act and truly delegate responsibilities.  The best leaders know that they must foster a spirit of innovation and collaboration across the organization.

It should be no different in government.  We must do everything possible to find the organizational models that will best help us address and make progress on our critical issues.  This is one of the most important innovations we need to step up to, to safeguard our country’s (and our world’s) future.

With few exceptions - support for research and education, diversity and immigration policy - my blog does not touch on political subjects.  But it is hard not to be thinking about politics, given our upcoming US presidential election, and in particular, the recently concluded Democratic and Republican conventions.

Beyond the relatively straightforward question of how I am going to vote, I have been struggling with how best to put into words my feelings about this coming election.  What are the key concerns of individuals, families and communities?  What are some of most important problems facing our nation as a whole?

There is clearly no single answer to these questions.  The conflicts in Iraq and Afghanistan, the war on terror, healthcare reform, energy, immigration and the financial crisis are clearly among the most important issues facing the next president.  But I wonder if, in the end, the most critical questions people are asking themselves around the country are less grand in scope but much more relevant to their daily lives.  How are our families generally doing financially?  Where will the good jobs come from that are needed to preserve and hopefully increase our standard of living?  How about our children?  Are they getting the proper education so they, too, can aspire to a decent, well paying job and a good standard of living?

These are the kinds of questions that bring to mind an old fashioned phrase from the 1930s,  “The American Dream,” even as we transition from the industrial to the knowledge economy and the 21st century.

In its essence, The American Dream refers to the opportunity for achieving greater material prosperity and a decent standard of living based on one’s ability and work ethic, as well as the hope that one’s children will receive a good education so they, too, can aspire to a good job and standard of living.  The term was coined by historian James Truslow Adams, when he wrote:

“The American Dream is that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement.  It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it.  It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position."

These words and the feelings they embodied captured the hopes and aspirations of people across the US, as they were struggling in the midst of the Great Depression.  But they continued to resonate beyond the 1930s, not just in the US, but around the world, because they reflected the most basic of human aspirations – a decent life and standard of living for oneself and one’s children.  The association of The American Dream with the US went a long way toward establishing the positive image that our country enjoyed around the world for decades, as the land of life, liberty and the pursuit of happiness.

What’s the current state of the American Dream?  I believe the answer is very mixed, perhaps more than it has been in a long time.  Not surprisingly, given the knowledge economy in which we increasingly find ourselves, it primarily depends on one’s skills, education and consequent ability to get a good job.  Let me elaborate.         

A recurrent message in my blog has been the critical importance of human capital - that is, the stock of skills and knowledge that enables individuals to produce economic value.  Talented, well educated individuals are more needed than ever in our global, highly competitive, knowledge economy.  Countries and regions endowed with that kind of human capital will be in a much better position to cope with, adjust to and thrive in our fast-changing, emergent world. 

Education is good for the nation, but it is particularly critical for individuals and families.  Every single study shows that per capita and household incomes go up significantly with education.  In fact, a major reason for the income inequalities over the last thirty years has been the demand - and corresponding higher wages - for individuals with high skills.

Furthermore, there is even growing evidence of a so called divorce divide.  The divorce rate appears to be measurably lower for households with college degrees than for those without.  Such a divorce divide could further add to the income inequality of future generations, as the children of higher educated, higher income families will enjoy even more opportunities, because of the additional support with which their families can provide them.

These major economic development issues are the primary reasons why innovation has become so prominent in the US and just about every other country in the world. 

In December of 2004, the National Innovation Initiative issued its final report, Innovate America.  It succinctly concluded, “Innovation will be the single most important factor determining America’s success through the 21st century,” because “the legacy America bequeaths to its children will depend on the creativity and commitment of our nation to lead a new era of prosperity at home and abroad.”  It further stated that “America’s challenge is to unleash its innovation capacity to drive productivity, standard of living and leadership in global markets.”

The report went on to make recommendations, which it organized into three broad categories:  Talent – the human dimension of innovation, including knowledge creation, education, training and workforce support; Investment - the financial dimension of innovation, including R&D investment, support for risk-taking and entrepreneurship and encouragement of long-term innovation strategies; and Infrastructure, the physical and policy structures that support innovators, including networks for information, transportation, healthcare and energy.

As I was watching the two conventions, and in particular the debates on social issues and the culture wars that the election seems to be degenerating into, my mind kept turning back to that old-fashioned concept of the American Dream. 

We have succeeded, beyond our wildest imaginations, in convincing nations around the world to turn to their own version of the American Dream.  It would be ironic, if not downright tragic, if at this historical juncture we spend our times in debates of limited relevance to the future of the nation, instead of reaffirming the American Dream through a renewed commitment to innovation and everything that it implies for jobs, education and our standard of living.