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Dive In Head First

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When I was growing up in india, my  family  ran a shoe shop in a town of 100,000 people forty miles north of Delhi. It was surrounded by farmland. Our customers were farmers, most of whom made a simple living. When the yearly monsoon came the farmers mainly stayed home. That was our dry spell: we sold very few pairs of shoes. We never knew exactly when the rain would start, how long it would last, or how heavy it would be—but we knew it would come, and we prepared for the dip in sales and potential cash shortage by reducing our inventory ahead of time. The precise timing of the monsoon was an operational uncertainty that we recognized and learned to manage around.

Now imagine that one day a construction crew arrives in my town and begins to lay the concrete and weld the steel that will soon become a superstore. This would be a structural uncertainty, and if we didn’t see it ahead of time, we would be out of business. The precise end of the monsoon doesn’t matter much when you’re being blown away by a structural uncertainty like this one.

You can manage an operational uncertainty with existing tools. But a structural uncertainty arises from your external environment. It is outside your control, and it can obliterate your business if you don’t detect it in time and create your own space in the new environment that is taking shape. A contemporary case in point is the decline of Dell Computer, one of the world’s most celebrated success stories. For three decades Michael Dell and his leadership team prospered with their “made-to-order model” as the heart of the business.

It enabled them to know precisely which components were needed when, so they could meet customer demand quickly and with minimal extra components in inventory. With its high velocity of inventory turns, low margins, and low prices, Dell gained market share; with negative working capital, it was a net cash generator on the order of a billion dollars every quarter. Dell became the highly profitable industry leader in market share.

Then Dell got hit with a double whammy. One was operational: IBM’s sale of its PC business to Lenovo in 2004. When the first two CEOs of Lenovo, both from the United States, didn’t work out, people said the Chinese company would never succeed. Then Yang Yuanging, a Chinese businessman and long-time leader at Lenovo, became CEO in 2009. He took an unusual approach by focusing on lower cost and innovation at the same time, and Lenovo attained number one market share in the world against Dell and HP. Lenovo’s lower prices put a squeeze on Dell’s margins and cash flow, resulting in a significant decline in Dell’s stock price.

Dell might have overcome this operational challenge, but at roughly the same time a killer structural change occurred: the introduction of tablets (Android based and Apple’s iPad) and smart phones. Like everyone else in the personal computer industry, Dell was blindsided by this development. It was one of the most dramatic shifts ever in that industry and signaled a fundamental decline in the desktop and laptop market. Dell’s great run came to an end because structural change meant that its core competencies were no longer a competitive advantage. (On a personal note, I have known Michael Dell for a long time, and no one should write him and his company off. He has taken Dell Computer private to give himself the freedom to place big bets on the future.)

A structural uncertainty does not arise as suddenly as it seems; more often than not there are early warning signals that go unnoticed. Nokia had a fantastic brand, was highly profitable, and built dominant market share. Its neardemise—with an almost vertical, steep decline in revenues, margins, cash, and market share—took less than three years.

The bend in the road was caused by Apple, which offered a new, compelling consumer experience. It was so enormously different that the consumer not only paid a high price but waited in line to gain access to it. Nokia was taken by surprise—but it shouldn’t have been.

My personal interaction with its CEO two years before the introduction of the iPhone indicated that the company was aware of it, with a particular early warning signal coming from people at Nokia reading Apple’s patent filings. But the leadership team found it hard to believe that a computer company would go into the cell phone business and thought that Apple would not be a threat even if it did, because it wasn’t big enough to pose a serious challenge.

True, Apple had successfully entered consumer electronics with the iPod, but that was a high-priced product with a fat margin. Apple’s phone would presumably be similarly positioned and not likely to gain a substantial market share. Apple would also have trouble going through telecommunication carriers, which Nokia dominated. Since Nokia was the largest carrier, had the largest market share, and had the best-recognized brand, the leadership team reasoned that they would be able to catch up even if they did miss a beat.

What confounded Nokia was the uniqueness of the iPhone and the ferocity with which Apple scaled up, creating a new customer experience and a new high-price, high-margin mass market that superseded the old one. The new market rapidly expanded, and its rate of growth increased.

The opportunity in structural uncertainty was summed up for me by G. M. Rao, the chairman of GMR, India’s largest infrastructure business. He once told me that every bend in the road contains a message about a future growth trajectory that someone could explore and exploit if he or she looked at it through a different lens without being controlled by an existing core competency. Since the opportunity is by definition totally new, the instinctive reaction more often than not is “we know nothing about it; it doesn’t fit with our core concept of the business and our core capabilities.” The leaders who succeed because of uncertainty realize that a world in flux creates new possibilities and lowers the entry barriers. They are the attackers. They see clearly, move decisively, and act.

The Mathematical Corporation: The Algorithmic Revolution and the Rise of the Math House
The single greatest instrument of change—the one that is creating major uncertainties and opportunities for an ever-growing universe of today’s businesses—is the advancement of the mathematical tools called algorithms and their related sophisticated software. Never before has so much mental power been computerized and made available to so many—power to deconstruct and predict patterns and changes in everything from consumer behavior and human health to the maintenance requirements and operating lifetimes of industrial machinery. In combination with other technological factors, algorithms are dramatically changing both the structure of the global economy and the lifestyles of individual people. (The others include digitization, the Internet, broadband mobility, sensors, and faster and cheaper-by-the-day data-crunching abilities)

Companies that have the new mathematical capabilities possess a huge advantage over those that don’t, even those that have been highly successful in the past. They are not just digitized—they are math houses, as I call them, and they are creating structural uncertainty for all industries and the companies within them. Google, Facebook, and Amazon were created as mathematical corporations; they were, as some say, born digital. Apple became a math corporation after Steve Jobs returned as CEO. This trend will accelerate. Legacy companies that can’t make the shift will be vulnerable to digital competitors. Business leaders need competence in digitization—at least enough to know the right questions to ask the experts, along with the imagination to find ways for mathematics to help them redesign the consumer experience…

Redefining an Industrial Icon GE, one of only five firms on the original Dow Jones index still in existence, is now essentially turning itself into a math house. It had been a leader among industrial companies in generating new business by servicing the equipment it sold, from jet engines and locomotives to turbines and medical imaging equipment. Now it has parlayed that legacy into a huge and transformational leap into what it calls the Industrial Internet, a term it coined. As of mid-2014, this quintessential industrial company got about two-thirds of its $250 billion backlog in orders from services based on its mathematical intellectual property.

The big shift for GE management began around 2010, when they saw more clearly that IBM had been moving into the industrial space GE and other players occupied. IBM provided sophisticated software that worked in conjunction with industrial equipment and influenced customers’ purchases of that equipment. Leaders at GE saw an opportunity for new revenue in the software space, first to influence purchase decisions, and second to influence the design of its equipment and services. Software promised very high margins and low investment compared with the equipment itself. GE began to expand into the Industrial Internet. It moved decisively. Starting in 2011 it assembled a staff in Silicon Valley of experts in sophisticated software and algorithms.

The cost was small for a company of GE’s size but vast in its ramifications: since then GE has become the leader in the Industrial Internet. Along with ATT, Cisco, IBM, and Intel, it was a founder of the Industrial Internet Consortium, organized in 2014 to hasten development of the IoT, and through continuing collaborations it is expanding and shaping the space.

GE’s newly built expertise in software and algorithms has recast the entire company for the twenty-first century, positioning it—in CEO Jeffrey Immelt’s words—“to drive results through uncertainty.” He has sharpened the company’s focus by unloading GE Capital, keeping only the parts that will serve the company as a specialty finance division, and the legacy appliance business. This recasting is triggering changes in the selection and promotion of people, the content of training, career development plans, and operating mechanisms such as reviews in GE’s legendary operating system. At the same time, it is reducing costs across the company. His actions provide a textbook example of finding opportunity in uncertainty.

To take advantage of uncertainty, you must make the use of algorithms part of your vocabulary tomorrow as much as, say, profit margins and the supply chain are today. And your executive team must understand their role in growing the business. . This is a factor so powerful that I feel confident in stating that any organization that is not a math house now or is unable to become one soon is already a legacy company. 

With permission from Penguin India

(This story was published in BW | Businessworld Issue Dated 23-03-2015)