The End of Power (33 page)

The share of physical assets in the value of firms has plummeted across all industries. The material resources they control—factories and offices and all those other physical assets—bear a decreasing relationship to the price that these companies fetch when they offer shares on the market or get acquired. Today, scholars estimate, anywhere from 40 to 90 percent of a company's market value comes from its “intangibles,” a category that includes everything from patents and copyrights to the way the company is run and the brand premium and “goodwill” it commands among its customers. Not all of these intangibles can be easily measured—which has not stopped economists from trying.
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Of course, some industries are still predicated on very expensive operations, such as drilling for oil or building airliners. And some companies still have an immense advantage due to their access to desired assets: for instance, the Russian mining mammoth Norilsk controls 30 percent of the world's known nickel reserves and 45 percent of its platinum in Siberia. But even within these industries, the increasing importance of intangible assets holds true. Lorenzo Zambrano, the CEO of CEMEX, a Mexican cement company that has broken into the industry's top ranks and become a global player, told me that “knowledge management” was the crucial factor behind his company's ability to compete internationally with larger, more established rivals. Knowledge management, the “information systems, business models, and other ‘intangibles' which have to do more with knowledge than with cement,” explain the company's success, says Zambrano.
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CEMEX is another example of a new, innovative player from a country (Mexico) not known as a cradle of globally competitive companies that has upended the traditional power structure of an old, highly concentrated industry.

The logic of economies of scale has long been an axiom of the modern corporation: the larger the production capacity, the less it costs per unit to manufacture, and the harder for smaller competitors to match the cost and price structure of bigger incumbents.

This logic has extended to relying on the economies of scope gained in a given business to diversify into another where the skills and core competencies are used as a competitive advantage vis-à-vis existing or potential rivals in the new business. An example is PepsiCo, which owns the Gatorade brand, and by applying its marketing and distribution skills to the sports drink, has made Gatorade one of its top sources of revenue.

Managerially, the logic of scale and scope has extended to keeping any number of administrative and support functions in-house; entrusting them to others would threaten efficiency, accuracy, or trade secrecy.

Today there are still large-scale industries where sunk costs and other factors lead to the emergence of large companies with a propensity for tight central control. (Consider nuclear power, for instance, with its advanced technology, its safety and security issues, and the expenses involved in getting everything right the first time.) But these are exceptions. Many of today's business success stories come not just from industries where economies of scale are less salient but from companies that defied the axiom altogether.

As a result, the principles of economies of scale, scope, and corporate organization are being violated in any number of ways, to the benefit of the business heretics. One example is the small-batch production of massmarket goods. The Spanish apparel company Zara, which began as a cottage industry making bathrobes and only stepped outside of Spain in 1988, exceeded the sales of the American giant The Gap in 2007—and by 2012, in the midst of a global economic slowdown, its sales of almost 18 billion were almost 25 percent higher than The Gap's, having previously left in the dust its European competitor H&M.
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Operating in a broad-based, consumer segment of the fashion business, Zara (the flagship brand of Inditex, the holding company created by Zara's founder) is famous for producing apparel in small batches rather than farming out big production orders as its competitors do. It also tailors its retail strategy closely to its many overseas markets (more than 5,500 stores in close to eighty countries).
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Zara needs just two weeks to design and manufacture a new product and get it
to stores; the industry average is six months. Moreover Zara launches around ten thousand new designs each year.
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In Zara's business at least, it turns out that the advantage of speed—being sensitive to changes in customer taste and addressing them immediately—far outweighs the benefits associated with huge shipments of mass-produced goods.
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Zara is just one more example of a large and growing number of companies whose success is based more on speed than on scale—often in industries where large scale used to be the critical success factor.

Another violation of the axioms of scale and scope lies in the ability to set up a remote operation to perform services that once would not have been contracted out at all, let alone across long distances. Consider the activities encompassed under the rubric of “outsourcing.” At first, this simply meant contracting with outside vendors for materials or sending goods away for assembly or some other phase in the manufacturing chain. Then outsourcing spread to services—initially, the lower-skilled services like basic accounting or call centers for fielding basic customer issues. But now, the scope of outsourcing extends to telemedicine—doctors who issue diagnoses or laboratory experts who process tests or accountants in India who file tax returns for US companies.

A constellation of small firms whose geographic location is an increasingly less relevant factor turns out to be capable of delivering specialty and knowledge-intensive services at lower cost but equal quality to the in-house shops painstakingly cultivated by the old industry giants. And no country has a lock on the provision of such services. After opening a research center in India in 1998, IBM in 2010 opened one in São Paulo, Brazil, which has the most Java programmers in the world and the second-most mainframe programmers. In 2011, companies in Latin America and eastern Europe opened fifty-four new outsourcing facilities, versus forty-nine in India.
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The fact that the reasons for outsourcing are familiar does not make them any less powerful. Take the widespread availability of instantaneous, efficient communications. E-mail, instant messaging, and voice-over-Internet (VoIP) telephony do not just make our lives more convenient; they also dilute the traditional business advantage that used to reside in office buildings where colleagues saw each other in person, or in meetings arranged through in-house travel agents, inter-office mail, Centrex internal phone networks, Intranets and local area networks, and so on. Each of these once required its own hefty investment, amounting to many deterrents for start-ups or new entrants and discouraging contracting-out of
essential functions. That business advantage of incumbents is for all intents and purposes gone.

One term that has vanished from the economics lexicon is
natural monopolies.
This used to designate businesses with economies of scale so intense that it made no sense to have more than one provider. Electric power, fixed-line telephones, and water supply were prime examples. The only question was whether their monopolies should be state-owned or, instead, private and regulated. But now these industries are increasingly contestable, as economists put it: technology allows them to be organized in ways that let multiple providers compete for customers. The result is a dramatic expansion of choice. In Africa, Bharti Airtel, the region's leading mobile-phone service, has partnered with a pay-as-you-go solar micro-utility called SharedSolar to offer airtime and electricity to Bharti's 50 million subscribers on the continent.
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A consumer in Melbourne, Australia, can select among fifteen power suppliers. Heresy a generation ago; now standard practice.

As scale and scope have lost their competitive edge, other advantages have come to the fore. Speed used to be a benefit of scale. Now speed trumps scale, and equal access by smaller and new competitors to the tools that enable fast customer identification, product and service development, and fulfillment and delivery is helping to turn scale from an advantage to, if anything, a burden.

One classic way of gaining a comforting market position is by deploying and defending a brand. Branding—with a name, a logo, and all the advertising and associated campaigns that a well-known and alluring name permits—helps to protect a product from becoming an undifferentiated commodity, whereby it matters little or not at all who manufactured or delivered it, and to endow it with the possibility of becoming an emotion and an experience. Famously, an early revolution in branding came in 1947 when the United Fruit Company devised the name
Chiquita
to label its bananas.
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Previously, a banana was nothing more than a banana, no matter who grew it or where. All that differentiated two bananas was size, ripeness, and taste—factors seemingly independent of the producer. But the invention of a friendly name and logo allowed the creation of advertising stories around them. The success of the brand was so great that in 1990 it became the company's new name.

As this example illustrates, the whole point of branding is to deter competition. The more effective the brand, the more it contributes to the company's market power. And today, the ways to differentiate a product are more abundant than ever. They range from traditional tools such as logos, packaging, TV advertising, and sponsorships to new tools such as purchasing corporate naming rights, ensuring visible product placement, advertising across media platforms, and seeding viral marketing campaigns. The ways to tell a story about a product have proliferated, and they no longer require massive advertising budgets entrusted to the top New York or London agencies. As another illustration of how new and unexpected challengers succeed at eroding the dominance of long-established players, consider the example of a business that did not exist a few years ago—advertising through social media like Facebook, Twitter, and YouTube—and is poised to capture a large and rapidly growing share of the advertising dollars that for years went only to traditional media like TV, radio, newspapers, and magazines. Effective niche marketing—that is, marketing to soccer fans, Russian-speakers, videogame enthusiasts, wheat farmers, vegetarians, and so on—is available at prices that need not scare off new entrants. And a clever site can draw Web surfers to the name and products of a company they had previously never heard of half a world away.

A field has sprung up in economics to measure the component of a company's market value that can be attributed to its brand. In 2011 a study by Interbrand, a leading consulting firm in this area, found that the McDonald's brand—the name, product monikers, restaurant design, and golden arches—accounted for more than 70 percent of the company's valuation. Coca-Cola's brand was worth 51 percent of its value; Disney, IBM, and Intel derived from their brands 68 percent, 39 percent, and 22 percent of their value, respectively.
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The 2011 ranking of companies by the monetary value of their brands turned up a mix of old-economy stalwarts and newer technology-led players: Coca-Cola led the pack, followed by IBM, Microsoft, Google, GE, McDonald's, Intel, Nokia, Disney, and Hewlett Packard rounding out the top ten.
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Accordingly, it makes sense for companies to invest a huge amount of money in building up their brand. And smart ones are constantly evolving. IBM, for example, has recast itself from a maker of PCs, disk drives, and other computer equipment into a tech visionary that uses brainy consultants and analytics software to solve thorny global problems—an effort captured in its 2012 “Smarter Planets” ad campaign. But even brand advantage
has grown slippery. Some of the most dynamic brands whose contribution to the total value of their firms has grown the fastest in recent years are upstarts like Skype (now owned by Microsoft). Just as brands have surpassed physical assets as a component of company value, the brand advantage itself is becoming harder to hold on to as new players establish their name.

Few obstacles to enterprise are as crippling as the lack of access to capital. Rare are the entrepreneurs who have on hand the money they need to fund an idea or pilot a product. Typically, those with this luxury are large companies with money to invest in research and product development or enough spare cash to spend on a “loss leader.” The more limited and restrictive the channels for raising funds, the more closed the market is to new competitors. And around the world, access to capital has been limited indeed, requiring onerous applications to stingy banks for credit that comes with high interest rates. The United States was historically the greatest exception to this pattern, contributing to its leadership role as a hub of innovation for the world.

Today, the United States remains one of the easiest places in the world to obtain credit—but only the tenth easiest. According to the World Bank, the five countries where credit is easiest to get are Malaysia, South Africa, the United Kingdom, Australia, and Bulgaria. This surprising sampler of countries is evidence of large changes not only in the location of capital sources but also in their nature, as whole new sources of credit have opened up and traditionally restricted ones have become more broadly available.

One major trend of the last two decades is the spread of “VCs” and “angels”—types of investors once largely based in the United States—to major new markets in Europe, Russia, Asia, and Latin America. As previously noted in the context of the Mobility revolution, one of the forces behind the international dissemination of venture capital and the private equity models has been the movement of bankers, investors, and engineers who cut their teeth in the United States, then returned home to replicate its investment methods. In Taiwan, the first venture funds set up on the American model were born in 1986–1987, led by managers who had returned from engineering studies and careers in the United States. More recently, venture capital firms have proliferated in India and even China, where they face comparatively more restrictions; returnees and financiers with feet in both worlds—say, in Bangalore and Silicon Valley—
have been central to this growth. Berkeley scholar AnnaLee Saxenian, an expert on this topic, considers “emerging technology areas” like Shanghai and Bangalore to be no longer copies but, rather, extensions of Silicon Valley. She says that the apt analogy for the movement of talent and entrepreneurial ideas and funding is no longer “brain drain” but, as mentioned in
Chapter 4
, “brain circulation.”
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