In Conversation with Nilofer Merchant

In Conversation with Nilofer Merchant

“You can’t tell how quickly the future is going to happen. But what you can know is that you need to go in that direction because all the things that you try and fail with in the meantime teach you how to get it right when the time is right.”

“The key for every firm—regardless of size—is to figure out how to consistently create value in a demanding, ever-changing market. That is hard no matter what size you are, no matter what industry you’re in.”

“I think the key shift isn’t what you make but how you make it and who you ask the right questions to inform what you’re thinking.”

What were some of your formative business experiences?
One of the experiences I had really early in my career was working with Steve Jobs. I did a presentation to him, and he told me that that what I was doing was going to be eliminated. It wasn’t necessary, it wasn’t even part of the picture, he said, and I was looking at him and thinking, “You are out of your mind,” because at that time it was delivering something like 20 percent of the total revenues of Apple and 47 percent of the profit of the company.

Was he right?
He was dead right. That’s given me so much perspective because it’s so easy to keep thinking that the base of revenue is what you need to protect. If anything, I now have the opposite instinct, which is that as soon as you know you’re succeeding, you have to figure out how to begin building the next thing.

You can’t tell how quickly the future is going to happen. But what you can know is that you need to go in that direction because all the things that you try and fail with in the meantime teach you how to get it right when the time is right. I always talk about building the innovation muscles so that you can be ready for that moment when you need to sprint.

Rita McGrath from Columbia Business School talks about the end of sustainable competitive advantage and the importance of being able to close things down as well as start things up. Do you agree?
I think she’s on to something. I reviewed her manuscript probably two years ago, and she hadn’t named it as The End of Competitive Advantage at that point. I wrote Rita a note to say that the first thing you actually have to say is to clarify what you’re saying, which is that it’s the end of competitive advantage, and complete that thought for business leaders, because that’s what’s going to help it land with people. The old operating rules are no longer the right operating rules. But yeah, I think she is right. You need to be able to wind things down or know how to transition, maybe. But mostly you need to know how to invest in the future

Companies don’t usually shut down profitable operations in order to migrate. Is that something new?

I’ve been doing all this work in boardrooms now for 15 years or so, and one of the things I started noticing was that all of them ask the exact same question: How much do I budget for the future development of the business? If I’m wanting to go faster in the new space, am I allocating 5 percent, am I allocating 10 or 15 percent? Give me a high, medium, low budget range so I can start thinking, at least with dollars and allocation of resources, start thinking about what’s next.

Is there a correct answer to that question?
I used to show leaders indexes of companies across industries and what they were doing because quite often we had a back-channel view of what equivalent companies were doing. I would share that these guys are investing about 7, these guys are investing about 15, and five years ago what they were investing was this.

We could show them a spectrum, and that helped them act, invest in the right direction. It usually turned out that the right number was around 10 or 15 percent. If you invested more, you actually didn’t get any more because the organization couldn’t handle it. Inventing the future is always as much about change management as anything else, and so even if you threw more money at it, you couldn’t make it go any faster.

You are increasingly well known as a business thinker, but you are also a practitioner. Your bio says you have personally launched more than 100 products, which netted $18 billion. Can you tell us about that part of your career and some of the products you were involved in?
Sure. Let’s go back to the Apple story. I was involved in pricing Apple products in different parts of the marketing mix at a relatively early point in my career. Then at one point I was asked to solve a problem that the business division had. The GM [general manger] of the Americas at that time just handed me a spreadsheet, and apparently, in retrospect, he’d been trying to hand it to virtually everybody. But he just tagged me, and I didn’t know enough to run.

He said, There’s one part of the business that is about 50 percent margin right now and making only a few million dollars. But if we could get this part to grow, it could actually sustain us with everything else, including the decline of every other part of the business. He said, Do you think you can help me solve this problem? And with the audacity of a 24- or 25-year-old, not knowing any better, I said, Sure, I can help you with that problem.

I went in to my boss and said I have no idea what I just picked up, and he said no, you don’t. And I said, well, I’ll figure it out. And that product line turned out to be the first $180 million of that $18 billion. This was in the early days of the web, basically preweb, and it was a matter of figuring out how to market the Apple server product, getting people to think about how to buy it.

All I did was figure out why was it currently selling well, and then try to discover whether there was a secret to that that we could use to duplicate that success. That turned out to be hugely successful and got written up in the newspapers.

Let’s talk about your book 11 Rules for Creating Value in the #SocialEra. What are the big ideas in that book?
The genesis of the book is telling. I’d gone to a board meeting at which I was sitting in as a guest for a Fortune 100 company to see if I wanted to join that board. I heard the chairman of the board talking about how they needed to protect their existing market, how they needed to build a bigger moat around it, how they needed to manage the efficiency of the value chain.

I was sitting there cringing. Everything they were saying seemed so viscerally wrong to me because I don’t think that any customer is at the end of some value chain anymore. That construct is a very linear one and diminishes where value can actually come from. I came back to my desk wanting to write this e-mail, a personal thank you for the opportunity to join the board but explaining I wouldn’t be joining because I didn’t think it was a good match.

But the other emotion was that I really wanted to help them. With my background in consulting being what it is, I thought, Let me see if I can actually help you see something that you can’t see. I wanted to simply send them something someone else had written. I came back and looked around, and I looked at who else could have written this, and where is the argument, and I honestly couldn’t find it. And it was like, gosh, it seems so obvious.

So then I reached out to some other business thinkers—friends who I thought would be the right people who would have seen it or written it and who said hat customers are as much a part of the co-creation process, not just a recipient, and that the value chain construct is one of the past. Connected individuals can now connect to one another without the need for a large corporation to orchestrate their activities. Networks allow you to do what once only large centralized organizations could. If that’s the case, what is the point of all these existing organizations? Networks change the nature of competition by changing who you are competing with.

And they were all shaking their heads. No one’s written that, they said, but you should. I shook it off for two months, and then one day in this diatribe moment I wrote a 4,000-word initial take on what this argument was and sent it to my editor over at Harvard Business Review, and she said, “Oh, my gosh, we have to get this in the magazine right away.” I said, whoa, this is the first time I’ve even had the thought this clearly. How about we blog it? And that was what we did.

What was the idea behind it?
There are a few nuggets. The first point is that social is more than just media. It is an opportunity that cuts across every part of the business model. You can use it to build a product, ship a product, design a product. Every possible thing that you do in a business can be social. I’ve seen it in different parts. No one’s actually integrated them across eight functional areas of a business, but I’ve seen it work. That’s one big step forward.

Then the idea that’s controversial, that got me known, was the argument about why Michael Porter’s theories are no longer working. That was the headline of the piece. What I argue is that since connected individuals can now do what only large organizations could do before, it challenges two parts of fundamental management theory. One is the thesis of the firm—Ronald Coase’s original thesis of the firm and why it actually exists. And the other one is the notion of competitive advantage.

As information and knowledge flows are pervasive, it becomes impossible to protect business by hoarding information. The challenge going forward is to figure out how to actually expose that information and allow other people to build something with you. Advantages then happen because people want to work with you and solve problems faster through their ability to scan the environment and change it.

The social era book’s thesis was this idea of connected individuals being able to do what only centralized organizations could do before. The implication of that is that it changes what you do, how you do it, and then what form it takes, which changes the basis of how you compete.

Is this the death knell of large organizations? Are big corporations like GE obsolete in this new world?
I know a lot of people would like to say they are. I don’t think so. People say old companies can’t innovate and small companies are more inventive. That argument is both old and wrong. Joseph Schumpeter, the noted economist, said in I believe it was 1909 that small companies were more inventive than large ones. But then in 1942, Schumpeter reversed himself and argued that big companies had more ability and incentive to invest in new products. A look at any performance measure shows that innovation can come from either size and that both arguments are oversimplifications.

The key for every firm—regardless of size—is to figure out how to consistently create value in a demanding, ever-changing market. That is hard no matter what size you are, no matter what industry you’re in.

What I will say is that traditional organizations will have a very different basis. Let me give you an example. Years ago, IBM started doing something that I found truly profound, especially when I compared it with companies such as HP that didn’t do it. IBM started saying our expertise isn’t just what we ship, it isn’t just what we build, it isn’t just what we create all by ourselves. We could actually allow other people to shape that.

IBM’s Smarter Planet initiative started off as an effort to say, “We should do something in the green space, but we don’t know what.” They asked the questions to participants really broadly, drawing on talent that was outside the firm. They were eliminating the perimeter of the firm, not trying to help with an existing problem that was defined but saying, What problems should we solve?

They changed their perspective: the parameter of the question was open, and who could participate in solving that problem was also open. And with that Smarter Planet is now making a pretty sizable contribution to the business. Now, is that enough to sustain an entire business? No, but I think it’s indicative of how social can work to fuel new innovations.

Which is to say that within five years you can achieve a lot. Let’s take another example. You can’t do it today, but if in 5 years or 10 years I can take a picture of a jet engine and use a 3D printer type of thing to manufacture it, I no longer need to be inside your plant to know what that engine is. If I can take a picture of some functional thing and then get it to an engineer and have it produced, what is GE’s role in “making” that thing? It isn’t just about their ability to manufacture. It is about their ability to design it, and their know-how, and their ability to ask the right questions to customers.

I think the key shift isn’t what you make but how you make it and who you ask the right questions to inform what you’re thinking. IBM is one of the best at understanding how to solve really complex problems, so of course you would continue going to them, because they’ve done it before. That’s their advantage. But it’s not about defending turf or even saying we’re going to keep you out. It’s much more about IBM or GE saying come and build something with me.

What you’re describing is co-creation as a competitive advantage. It’s the opposite of building barriers to entry; it’s the ability to invite people in.
Yes, instead of all the stuff going on inside your building, in your architecture, with a big moat around it, and saying please don’t come here because this is ours, this is our hill that we’ve created and we’re the castle on top of the hill, it’s much more like an open playground where we invite a whole bunch of people to play and then see what we can create together. And what do we do after we have created something together? What do we do with all that stuff?

How do we sell it? How do we make money? All those other questions can come. Then you draw on talent that you couldn’t get any other way. That’s the advantage.

We’re talking about a new model where we see organizations as social systems. You’re talking about them competing with one another on the basis of how social they are.
I’m talking about moving from a closed system—closed meaning thinking about things as us versus them—to an open system that says we allow you to play in terms of what we create, what questions we’re asking, and who we invite. Who else could be involved in helping us solve these problems or creating this opportunity?

Where are we now with this social revolution? How far into it are we? Do we have critical mass?
We’re probably 10 years in. We’ve had 10 years with enough cognitive surplus and with the ability to do this connectivity stuff. But probably only in the last three years can you see something where you can make money at it. You can organize all that stuff pretty efficiently, so that’s why TED is an interesting case.

There are a couple of other examples of organizations. However, we’re at a very early stage, which is why my social era book is a hypothesis. I said I can’t prove this to you yet because there’s not enough evidence, but I’m going to use the weak signal to suggest there’s a directional shift. The question is: When does everyone do this?

Bill Gates said that with the impact of all the new technology we overestimate the change that will occur in next 2 years and underestimate the change that will occur in the next 10. I think that’s true, so we shouldn’t let ourselves be lulled into inaction by saying it’s far away. But building it into a business model and building it into really viable leadership constructs could take 20 years for us to see the results.

Do you see anything that could derail it, or is this inevitable?
Things could definitely derail it. There are a couple of things that you can point to right now that nobody knows the answer to. One is that way too many people are working for free. The idea that all of us can do the work together, blah, blah, blah, is really interesting. The dark side of this is that if you look at those 6,000 people who created TED events, most of them didn’t earn any money from that.

It gave them more media attention, gave them maybe more impact, all those things, yes, but sometimes people have got to buy shoes and feed the kids. We have to wrap the economic balance point around that, and until that’s fixed, I think we’re going to continue to really struggle. The other issue is that everyone tends to look at these social initiatives and ask why they failed. Why did Occupy Wall Street fail? Why did the Arab Spring fail?

Some people will say the Arab Spring succeeded. But I think we had one dictator and now we have a different one, and so we didn’t really see a big change in allowing people’s voices to come forward and create a new result. Thus, the question is about whether we can really effect change, tectonic change, not just the appearance of change. How can we get to outcomes we want, not just feel better for a while? There are very few signals that we’re there yet.

That’s the area where we need to see more evidence in order to make forward motion.