Prepared Remarks of Everett M. Ehrlich Under Secretary for Economic Affairs U.S. Department of Commerce Before the University College University of Denver Denver, Colorado April 25, 1995
My topic this morning is technology and the economy, specifically, about how the dramatic acceleration of information-related technology, or as I'll call it, the "digital suite," is going to change our economic future. Thinking about my remarks today led me to remember other predictions about the future. Remember the Jetsons? Cars flew instead of rode. People moved about in pneumatic tubes. Robots with vacuum tubes for eyes rolled around and acted out the fantasy of homes without housework. The Jetsons was, in other words, a picture of a life driven by the products of technology and a life unchanged from its current pattern. Even more importantly, the Jetsons view of technology was centered around its use in the home -- the tube-eyed robot and the flying car. But, to my thinking, the most dramatic effects of the new technologies around us won't be felt most immediately in the home, but somewhere else -- in the firm. The digital suite is going to force our firms to change the way they behave, and by so doing, will change our economic lives. Firms are the place in our society where technological and economic change occur. That's their job -- they're supposed to figure out how to use new technology effectively. And they do that because they prosper if they do. Census Bureau research shows that firms that use advanced manufacturing technologies (and "advanced" means digital -- CAD/CAM, automated inventory handling, networked supplier relations, and so forth) hire more people, pay them more, have a lower failure rate, and have higher gross margins than their less innovative competitors. Firms grow, in essence, because they out-innovate the competition. So if we want to see where technology is going to take the economy, we have to start by examining how it will change our companies. When I was back in the computer industry, before I joined the Administration, a friend of mine showed me a quote that went like this: "You can tell that the computer is an epochal invention, because an epochal invention is one whose users make more money using it than its producers make producing it." That's right on the mark. The power of today's computers has become a commodity product -- it's cheap and easy to get and use. But the things that we do with those computers are infinitely differentiable, each application unique to its circumstances, each user exploring some different possibility opened by this burgeoning capability. And this, therefore, is where the power of the information revolution -- the "digital suite" -- will find its greatest expression -- in the firm, not the home.
A few on-line services probably to the contrary, our households demonstrate a fascination, but no burning interest, in a digital way of life. But the technology is already pouring into our companies. It is driving the wave of restructurings that have become commonplace in recent years, changing our concepts of business strategy, creating new dimensions of competition in the marketplace, and by so doing, changing the way our economy behaves. The question, therefore, is this: how will cheap and ubiquitous compute power change our productive organizations and, once they have changed, how will they change the world in turn? Forget tube-eyed robots cleaning up the "home of the future." The real question is, what will the "firm of the future" look like? The answer begins with the fact that the price that firms pay for information is falling at a staggering rate. Let me put that in historical context. James Watt invented the steam engine two centuries ago to pump water out of mine shafts. His invention, which began the Industrial Revolution, cut the price of mechanical work in half -- that's all. But, through stunning advances in technology, we are cutting the price of information, of data processing, and of telecommunications capability in half about every two years. How have firms responded to these changes? The first and most conspicuous change is that they have become flatter, disgorging layers of middle management that are now useless. The pyramidic organization was created earlier in this century to do precisely what computer networks now do for a pittance -- to collect, process, verify, and distribute information. Owing to the failings of human nature, of course, pyramidic organization dwellers often did exactly the opposite -- that is, they husbanded information, withheld it, and regulated it. Paperwork, routine decisions, presentation materials, and all other manners of work floated through the organization chart like Hamlet's father, searching for that elusive last act that would allow them to reach their final destination. But today, information networks make any type of information available to anybody within a firm, and the pyramid has become irrelevant. Corporate pyramid builders now share the fate of their ancient predecessors, entombed in the rubble of their once-glorious creations. Instead of a pyramid, the organization chart of the modern enterprise looks like the seating plan for an orchestra or, perhaps more apropos, the network diagram of the enterprise's information system, because in some basic sense they are appended to it. Indeed, the "flat company" is the first visible product of the Information Age.
But a second and even more profound change has to do with the "right-sizing" of our companies, and I use "right-sizing" as an alternative to "down-sizing." Let's contemplate for a moment the following economic question: just how large should the "average" firm be? A fellow named Coase thought this through some while ago and was awarded the Nobel Prize years later for his answer. It was that the size of the "typical" firm is determined by its ability to process information more effectively than the market -- it will continue to grow so long as it can manage its activities better than a group of firms could by coordinating their activities through the market. Let me give you a practical example of this theory in action, if only to assure you that some of the esoteric thoughts that economists have are of value. About seventy years ago, Ford Motor built its famed River Rouge plant outside Detroit. Iron ore and coal come in one end, finished automobiles out the other. Ford built a plant of this grand scale because it felt -- correctly at the time -- that it could coordinate all of these activities -- metals refining, electricity generation, parts machining, body construction, final assembly -- better than could a series of firms coordinating their activities through transactions. Today, the successful model of automobile companies is exactly the opposite. The most successful U.S. automobile manufacturers -- Chrysler and Ford -- focus on what they do best -- product design and engineering, and mass marketing. They produce only 25 percent to 30 percent of their own components, while General Motors produces about two-thirds, much to its dismay and disadvantage. And the reason for this dramatic -- and recent -- change in the auto industry is the rise of the digital suite. Powerful and accessible computer networks have eroded the distinction between what is inside and outside the firm. Parts suppliers no longer need be within the organizational boundary of the enterprise: they can now be part of a "virtual company" that shares information and acts on it in concert, sending computer-designed parts specifications over networks, changing them in real-time fashion as appropriate, and controlling the flow of parts and components better than the pyramidic model ever could, all because the digital suite allows them to do so. In Coase's terms, the ability to process information cheaply has shrunk our companies. And, by so doing, it has increased the economy's productive potential. If a firm can coordinate most -- if not all -- of its processes with other firms, then each of its stages of production, each of its product lines, each of its market segments is subject to a market test. If they are not "best in class" in that stage, or that product, then they can build a networked relationship with somebody who is. As a consequence, the new technology is a wake-up call for those firms that thought that their size was a sustainable competitive advantage. Cheap information networks allow partnership and specialization to substitute for size or scale. Thus, the companies most shaken by the forces of corporate restructuring -- GM, Sears, IBM -- are those who thought that their size would sustain them. To their surprise, they're being challenged not by other integrated Goliaths, but by a network of specialized Davids.
Thus, just as it is creating "flatter" companies, the new technology is producing more specialized, or "focused," companies who are winnowing themselves back to their true value-creating skills, where their "best in class" competence lies. Our productive system is evolving into a constellation of such companies bound together by flows of information. And as is true of the heavens, to be in such a constellation, every company must be a star. The trend towards more specialized competitors does not always mean smaller ones. Paradoxically, information technology has finally provided a basis for achieving greater scale in many service industries, for precisely the same set of reasons that it appears to be dis-integrating the production of goods. The problem in service industries is that their product is consumed at the moment it's produced. When you go to the doctor, that moment happens in the examining room; at the store, it takes place at the cash register. Inventories, the part of the system that makes scale-based production possible, don't exist. How then do we lever the service provider -- the doctor, the store clerk, the banker -- at this point of consumption in order to achieve scale and productivity growth? The answer is -- through information-based administrative and logistical systems. The ability to process information cheaply now makes a large health care provider better able to manage its operations than a series of smaller competitors, as it does for banks, or even for retailers -- witness Wal-Mart, Dillard, Toys 'R' Us, or any of the other new giants of retailing, all of whom are little more than sophisticated computer networks with stores appended to their nodes. Just as the falling price of information is creating vertical dis-integration in the production of goods, it is creating opportunities for horizontal integration in services with the same effect -- greater specialization and potential productivity growth. So, technology is making our firms flatter and more focused, and -- one more "f" -- faster. Information systems have allowed firms to compete on the basis of time, not only because they allow firms to act more rapidly, but because they make time more visible, whether it be the lag between product design and manufacturing, or order and shipment, or between claim processing and payment, or between proposals and approvals, or the time it takes for a customer to call an 800 number and get a satisfactory response. Time-based competition is only one example of an answer to the following question: if I could know everything about my company in a real-time fashion, then what would I do? Shortening up my company's cycle time is only one of the possible answers. Another answer is better customer service, particularly through customization. Customization means changing the information that goes into the production of every unit of output -- be it a good or a service -- it provides. Which auto company is the one that says "Let us build one for you?" In the future, they're going to mean it. Mass production will give way to mass customization. Moreover, as the economy rises to a higher level of specialization and competition, margins and profits are going to come under pressure, and the ability to compete on the basis of time, customer responsiveness, and product customization will be an important way to maintain earnings -- in essence, they are all ways to add a value-added service layer to a more commodity-like manufacturing product.
Yet another new dimension of competition is the higher level of attention paid to a very old objective -- asset use. Information networks allow our companies, perhaps for the first time, to have a meaningful, real-time handle on where their working assets are -- receivables, parts and components, works in progress, even cash and liquid assets. Balance sheet engineering is now a vital business practice -- the equivalent of keeping the sail perfectly positioned against the wind -- because we now have the means to do it. In fact, if you put all of these precepts together -- asset management (or, more generally "lean production"), time-based competition, and customer response, you get what we've come to call TQM -- Total Quality Management -- which is little more than working quickly, smartly, and efficiently to create value through customer satisfaction. Does anybody really believe that these weren't business goals before TQM became popular? Are today's managers really that much more insightful than their predecessors? At the risk of challenging this hubris, it's no wonder that TQM and the re-engineering revolution it has unleashed have become the business fashion of choice in recent years. They are in vogue today because they call up aspects of business practice that are only now being brought to the fore by the capabilities of the digital suite. This, therefore, is my outline of the "firm of the future" -- the ways that firms will be driven to reconfigure and reorient themselves in order to manage the remarkable possibilities that the digital suite is creating: in other words, how they will change in order to survive. They will become more atomistic, specialized competitors, that continually redefine their boundaries in order to focus on their most formidable value-creating skills and let others do the rest. They will compete on their ability to respond quickly to changing conditions and customer preferences or, in essence, their ability to use information. Their transactions will take the form of partnerships that stretch across their organization boundaries, and will resemble embraces rather than handshakes. I've taken a good amount of everybody's time talking about these changes in the firm. But I've done so because these changes have repercussions for how every other aspect of economic life will be organized. The digital suite is more than just "technology:" calling it "technology" is like calling Watt's steam engine a "machine." For just like the steam engine, or the invention of interchangeable parts, or the assembly line system, the digital suite will not only reorganize production, but the world around it. Let me give you three examples from three different areas. The first concerns how our people find opportunity and security in our society.
In every corner of the industrialized world, we have gradually moved the firm into a loco parentis relationship with its employees. In the U.S., we've come to view the firm as the vehicle for delivering much of our social well-being. Our firms train us, promote us, and provide us with health care, sometimes child care, and finally retirement incomes. And a career with one such employer was the ideal, if not the norm. But that bargain looks ever harder to fulfill. As firms continually redefine themselves and adjust to more rapidly changing competitive conditions, and as job content changes in response to technology, it seems likely that a higher level of job turnover will become a fact of life. And that means that the entire system by which we provided our workers with security and advancement is going to come under stress. The Administration's health care proposal was in part a response to this trend. It allowed small and large employers equal access to delivering health care to their employees, and it allowed workers to move from job to job without losing their benefits. In essence, it separated the provision of health care from a worker's tenure with any one workplace. Health care isn't the only example of our need to deliver security and opportunity in the context of a career based on moving from job to job. For example, we need to consider ways to shift gradually to a more portable retirement income system based on defined contributions instead of benefits, partly to encourage labor force mobility, partly to highlight the need for individual saving, and partly to assure greater consistency in funding. We should consider, for example, whether to allow employers with fully funded defined benefit plans to retire those plans and allow the assets to revert to participants' IRAs, for example, as such a transition device. And if we are going to develop a new model of security in a world of constant change, then we need to give our workers assets equal to the challenge. One exciting possibility is national skill standards. What if we had a set of truly national skill standards -- something that established a common definition of a "class C systems engineer" or a "level 4 laboratory technician" everywhere in the U.S.? I think that a variety of things would happen. First, the existence of a "standardized" product could induce new private sector providers into the market for adult skills training. For if we believe that the pace of technology is going to continue to accelerate, then there are going to be millions of mid-career adult workers in need of such skills development. The government alone can't do it -- private sector providers will have to be a major part of the answer. But even more important, skills standards would give the worker an asset that would assist in their mobility -- standards would grant them a credential that turned the skills they had acquired in their worklives into a portable asset. Thus, it would help to insure them against the de-skilling that is too often associated with leaving a job. It would be a credential that preserved the value of their skill, and therefore provided exactly what the system will be forced to provide -- security in the face of change.
A second interesting aspect of the "firm of the future" and the digital suite concerns their implications for the prospects for the American economy in the years ahead. Let me ask you another economics question -- what makes an economy distinct in today's world? We live in a world of cross-border alliances, joint ventures, and partnerships, transnational firms, cross-border capital flows, and increasingly significant migration. When you get right down to it, the rising level of global economic integration allows any company in any leading nation to get its hands on almost any resource around the world -- any skill, any material, almost any technology, and so forth. So in one sense, the world's economies are becoming more alike. I think that the answer is this: the last remaining national economic attribute is, in a broad sense, our "system." We are defined by our macroeconomic rules, our corporate governance, our business culture, the beliefs of our managers, executives, and suppliers of capital, and our view of individuals and organizations. After all, if markets can bring you "anything" -- any factor, almost any technology, any resource -- then our "competitiveness" will be determined by the way in which we put together what markets offer us. If this is the case, then our economic future looks strong. The "firm of the future" is one that can redeploy itself to fit changing conditions and demands. It is one that digs out entrenched bureaucracies and reorganizes itself to live without them. It is able to redeploy its boundaries to take advantage of excellence in its partners and suppliers. And our economy has a system that gives executives precisely this free hand. Our executives have every incentive to adjust their boundaries expeditiously, and our capital markets have the depth and liquidity to facilitate these rearrangements. There was a time when these aspects of the system were condemned as myopic. And perhaps that tendency is the price we pay for the benefits of the way we do business. But those benefits cannot be denied -- they are the reason why our economy looks vibrant, and our competitors' listless by comparison. And there is one aspect of our "system" that receives special mention -- openness. Economists have long preached the theoretical virtues of open trade. It's time that we endorsed it as a competitive strategy. We add engineering to foreign memory devices and produce computers. We add design to foreign componentry to produce automobiles. We add imagination to foreign video equipment to produce filmed entertainment. As Japanese firms are learning as they watch U.S. firms emerge from their restructuring -- and as they are relearning as they dispose of U.S. entertainment properties -- a great deal of time and money can be wasted by denying the value of what markets already bring to you. Our system's opposite inclination will be an even more important strength in the future.
In this regard, the wave of restructurings in corporate America, as it races towards this new model, stands in stark contrast to our major competitors. Japanese keiretsu-style relationships look rigid and unyielding by comparison. And they will look even more so as Japan inevitably becomes a more open economy and these firms compete in a global market in which each practitioner exists not because they are "in the family" or "on the board" but because they are "best in class." European state enterprises or co-determined companies also seem to lack the footwork needed to navigate these changes. That's not to dismiss these regions as competitive failures. But it is to note that they face formidable challenges as they try to do what our system is designed to do -- to change. And that ability may be the reason to be confident that the restructuring process in the U.S. contains the seeds for a long term positive economic transformation. A final phenomenon I'd like to discuss goes to a precept of our business culture. One important aspect of the digital suite is that it's easy to use -- the more sophisticated it gets, the less you need to know about it. In that sense, computing and networks are more like automobiles, as opposed to televisions. That is, as automobiles got "better", they became simpler to operate. Televisions, of course, are the opposite, or so it occurs to me as I stare blankly at my VCR. The more capability, the harder they are to figure out. Computing is going the automotive route -- as its embodied technology becomes more powerful, the easier it is to use and the more accessible it becomes. "Point and click" computing has taken this to a new level: voice recognition promises to advance it even further, and it is not that far away. The gating item is database management. Today, armed with a single fact, you can speak directly to probably more than half the population of the Earth. That fact, of course, is their phone number. One day we will have a comparable system for data. Anybody will be able to access and manipulate almost every conceivable type of data. "Which of our inventories have the fastest turns?" "What are the truck versus rail rates for transporting a turbine from St. Louis to Chicago?" "How do the volatility of company earnings among our competitors compare to the spreads on their paper against the London interbank rate?" Each of these questions will be as easy as "Open the pod bay doors, Hal." The skills that this evolution in technology will reward are, of course, the skills that are most complementary with the capabilities of the technology. When we are overloaded by data, the people who succeed will be those who know how to triage the flow and create something from it, rather than those who add to the clutter. Thus, ironically, the Information Age will reward not those who have a great deal of information, or know how to manage it, or even produce it, but who know what to do once they get it. The technology will favor judgment, intuition, creativity, and insight -- right-brained stuff. It will be the ultimate triumph of the liberal arts majors. They will be tomorrow's CEOs.
There is a certain gleeful irony in this "right-brained economy." The power of information technology is automating the analytic, data-manipulating, left half of our brains. This improves the market power of the complimentary and creative right side. No less a seer than Timothy Leary agrees, stating: "Computers...will replace you only to the extent that you...think like a bureaucrat, a functionary, a manager, an unquestioning member of a large organization, or a chess player."
And so, those are my messages today. Yes, technology will allow us to have intelligent software agents to find us the best prices for ski weekends, and we might well be able to take a virtual walk down the beach one day with our sister, Winston Churchill, or Sophia Loren. Our living rooms may yet become shopping malls and amusement parks.
But we will first see a restructuring of our private sector, the advent of the "firm of the future." And the ways that they change will have implications for all of us. For in the final analysis, technology changes more than the things we have -- it changes the way we do things. And the "firm of the future" will reflect that basic tendency.
A last point that I'll make this afternoon relates to the following. Consider the topics we just discussed. We talked about how individuals will find security in society. We talked about our nation's economic prospects. And we talked about the emerging aspects of our culture.
They're all important items, but they all came up because they are all related to how the firm of the future uses technology. The way firms use technology is big stuff, that the innovative process in our private sector will have a great deal to say about the kind of society we become. We have to pay attention to that process, to nurture it, and to frame it in a partnership with the public sector that moves us all ahead.
Thanks very much for your attention.
Comments