Richard Florida
by Richard Florida
Tue Jun 30th 2009 at 11:00am UTC

The Big Shift

Two of my favorite management thinkers, John Hagel and John Seely Brown, have just released an important new study, The Big Shift. I’ve read the research, which expands on some of my own constructs, and had a chance to talk with Hagel about it at length last week. One of the most important findings is that return on assets for American companies has been declining for decades. Here’s a short-form version that appeared over at Harvard Business Review online.

The 2009 Shift Index reveals a disquieting performance paradox in the US corporate sector. On the one hand, labor productivity has nearly doubled since 1965. During those same years, however, US companies’ Return on Assets (ROA) progressively dropped 75 percent from their 1965 level.

How can firms be getting lower returns even as they’re becoming more efficient? The answer resides in the heightened competition among firms. Competitive intensity nearly doubled between 1965 and 2008, forcing firms to compete away the benefits of productivity gains, which were instead captured by creative talent in the form of higher compensation and numbers of consumers through increasing performance/price ratios and wider choice.

It’s little surprise to find also that the highest-performing companies are struggling to maintain their ROA rates and are increasingly losing market leadership positions. Taken as a whole, the findings portray a U.S. corporate sector in which long-term forces of change are undercutting normal sources of economic value. “Normal” may in fact be a thing of the past: even after the economy resumes growing, companies’ returns will remain under pressure.

To respond to this performance challenge, U.S. companies will need to let go of industrial- era organizational structures (and the reporting relationships, incentive systems, and managerial processes that go with them) and operational practices in favor of the new institutional architectures and business practices needed to create and capture economic value in the era of the Big Shift.

Companies must move beyond their fixation on getting bigger and more cost-effective to make the institutional innovations necessary to accelerate performance improvement as they add participants to their ecosystems, expanding learning and innovation in collaboration curves and creation spaces. Companies must move, in other words, from scalable efficiency to scalable learning and performance. Only then will they make the most of our new era’s fast-moving digital infrastructure.

The full report is here. The section on creative cities begins on p. 60. It shows strong relationships between cities with high scores on the Creativity Index and economic output (measured as GDP), returns to talent and economic freedom, as well as a large performance gap between high and low scoring cities on that index.

8 Responses to “The Big Shift”

  1. Creative Class: The Big Shift | Lies My Gantt Chart Told Me Says:

    [...] to get the economy moving and sustain growth. It is nice to see that the data shows that. Check out The Big Shift . It’s right on. The single biggest program that the US governement should invest in is making [...]

  2. Ron Wilson Says:

    Richard,

    I also read the study report and am not ready to conclude that things are as dire as portrayed. There are too many variables to investigate to say that the drop in ROA signifies a weakening of US corporations.

    Off the top of my head I can think of one way that labor productivity can increase while ROA decreases: replacing labor and cheap equipment with modern, more expensive equipment.

    For example, a machine shop with 10 employees and several old mills, lathes and polishers on the books for scrap value determines that it can produce the same amount of output, and make more net profit, by replacing the old equipment with a couple of new CNC machines (at several times the cost of the scrap value of the old machines) and eliminate 5 jobs. Voila! Labor productivity has increased and ROA has decreased. But the company is better off.

    Sorry to nitpick, but I think it’s important to understand ALL of what’s going on behind the data in order to make the conclusions drawn from statistics meaningful.

    R

  3. Lang Davison Says:

    Great post about our report, Richard. Thanks!

    Just wanted to respond to Ron Wilson by pointing out that asset intensity (at least for the kind of tangible assets to which he refers) has actually fallen in the US since 1965: total US-economy wide Property, Plant, and Equipment as a percentage of Net Sales in 2008 was 40 percent of what it was in 1965.

    So US companies are using fewer tangible assets to produce their returns, which would seem to point to higher ROA, even after taking into account the increase in intangible assets over the same time period.

    So who’s getting the benefit of increased labor productivity? We suggest it’s consumers (in the form of higher performance/price ratios and greater choice) and the creative classes, in the form of higher total compensation.

  4. Mike L. Says:

    Lang asks: “So who’s getting the benefit of increased labor productivity?”
    Could we add “the corporate executives” and “the taxman”?

  5. Buzzcut Says:

    How do you deal with the fact that the official statistics don’t track changes in imports properly? The bureacrats seem to be having trouble dealing with products that change over time.

    Could it be that the productivity and ROA stats are skewed because of multinationals importing goods from offshore? It seems like they’re doing more with less, but maybe the stats just aren’t capturing value added in China and elsewhere.

  6. Ron Wilson Says:

    Lang,

    I think I get what you’re saying. If I do, then one of more of the following must be true:

    1) Corporate net income as a percentage of sales has decreased since 1965.
    2) Intangible assets, as a percentage of sales, have increased more than tangible assets have decreased.
    3) Salaries and Wages – in total – have increased faster than the rate of productivity growth.

    Or is there something I’m missing?

    As for you conclusion: “So who’s getting the benefit of increased labor productivity? We suggest it’s consumers (in the form of higher performance/price ratios and greater choice) and the creative classes, in the form of higher total compensation.”

    Is this necessarily a bad thing? And is it automatically evidence of declining US competitiveness?

    Please don’t think I’m harping. I find this fascinating and really do want to get to the heart of what you guys found.

    R

  7. RS Says:

    Seems to me to be suggesting two things, one of which has already been stated:

    1.) That workers are appropriating a larger piece of the corporate pie.
    2.) That positive “economic” profits are trending toward zero.

    I have two comments about this. First, it seems to imply a competative structure more closely resembling perfect competition in which economic profits are zero. Given the emergence of globalization over the discussed period… seems rather logical as more competition should erode economic (and acounting) profits. Second, given that the dataset is based on U.S. companies, it seems to suggest technological diffusion, which is indeed an important source of globalization in the first place.

    What does this imply? That globalization (at least on the technologically leading end of the spectrum) benefits workers (perhaps only knowledge workers) and consumers at the expense of corporate executives and firm profits.

    I guess I could say that this finding is both inline with fundemental economic theory (under globalization) and is a good thing for many workers.

    If labor productivity is indeed rising… why shouldn’t the workers be compensated for that.

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