Is the problem with capitalism that people are trying to fix it?

Steve Brazell (@SteveBrazell) offered a provocative thought on Twitter, in response to my review of the Porter/Kramer article in HBR on “How to fix capitalism”:

The problem with capitalism is that people try and fix it. The solution: leave it alone - laissez faire markets work.

In one sense, I agree: whether managers realize or not, capitalism is currently going through massive process of destruction and re-creation.  Capitalism is indeed fixing itself. Yet in another sense, the process is taking so long and the social and political costs of that delay are so high that it is appropriate to accelerate the process of re-creation and point out those who are, for various reasons, trying to slow the process down.

Destruction and Creation

A simple and reasonably accurate picture of the broad orders of magniture of the massive process of creation and destruction now under way looks like this.

 

Capitalism 3.0

Thus Roger Martin’s landmark article in HBR of January 2010 entitled “The Age of Customer Capitalism" noted 'three ages of capitalism". Following the periods of “managerial capitalism” and “shareholder capitalism”, which one might call respectively “Capitalism 1.0” and “Capitalism 2.0” we are now entering a new and very different third era of capitalism - "customer capitalism" or “Capitalism 3.0”.

Capitalism 3.0 involves a wholesale revolution in management thinking focused on "delighting customers" and redefining managerial roles, coordination mechansisms, values and communications so that everyone and everything in the firm is oriented towards accomplishing this goal. It means reversing the value chain and starting from what would delight the client and focusing the entire organization on that goal. When this is done, as Apple (AAPL) shows, the returns can be extraordinary: its share price is more than fifteen times higher than a decade ago.

 

The share price of Amazon (AMZN) presents a similar trajectory.

As Ranjay Gulati points out in his wonderful book, Reorganize for Resilience, firms practicing Capitalism 3.0 have an outside-in perspective. The organization starts from looking at the needs of the customer or client and orienting the whole organization on meeting those needs. The reason for doing so is simple: the balance of power dramatically has shifted from seller to buyer: the customer is now the boss. Capitalism 3.0 is a recognition of this reality in the marketplace. The mindset is: “We will try to understand  the customers’ needs and do our best to help meet them.” The returns to firms that take the trouble to get into this mode are extraordinary.

Capitalism 2.0

Firms practicing shareholder capitalism or Capitalism 2.0 operate very differently and experience very different results. These firms, which include many firms in the Fortune 500, are focused on maximizing returns to their shareholders.

They typically do this by controlling costs in their value chain and achieving economies of scale. Rather than the outside-in perspective of Capitalism 3.0, they have an inside-out perspective. The mindset is: “You take what we make.” The firm adjusts its supply chain to the market by “parsing and manufacturing customer demand.” This mindset reflects a failure to recognize the shift in the balance of power from seller to buyer: the firm is still under the illusion that it can manipulate the customer to suit the firm's own needs.

Excellent exponents of Capitalism 2.0 are GE and Walmart (WMT). The ten-year trend of their stock price is very different from firms practicing Capitalism 3.0.

 

We are now fortunate to have the landmark study by Deloitte’s Center for the Edge: the Shift Index. This study examined of 20,000 US firms from 1965 to date. The study shows that the declining picture of GE and Walmart is part of pervasive and long-term problem.

The rate of return on assets of US firms is now only one quarter of what it was in 1965:

The life expectancy of a firm in the Fortune 500 is now down to 15 years, and is heading towards 5 years, unless there is change.

Underlying this disastrous performance is the fact that only one in five workers is fully engaged in his or her work. This is not simply a worker-satisfaction issue. In a knowledge economy, it is a fundamental productivity problem. When knowledge workers are not passionate about their work, they simply aren’t very productive. And the reason they aren’t passionate about their work is very clear: it’s the way that they are managed: hierarchical bureaucracy. Thus apparent savings achieved by streamlining the supply chain are more than outweighed by the failures of productivity and innovation from a disengaged workforce.

The writing is therefore on the wall for many firms in the Fortune 500. Whether they know it or not, the Apples and the Amazons are putting them out of business. The process of destruction and creation is well under way.  The social and political problem is that it is taking too long.

The high social and political costs

An obvious problem flowing from the slow pace of change is the shortage of jobs. A study by the Kaufmann Foundation showed that between 1980 and 2005, firms older than 5 years created zero net new jobs. It is hardly surprising therefore that low cost capital for large firms is doing little to decrease the unemployment rate from 10% to 5%,.

More seriously, as Richard Florida has so often pointed out, the more serious jobs crisis concerns the quality of the jobs, not the quantity.  When we have reports that 84% of the people who have jobs are planning to look for another job in 2011, we have a good indication of the desperation in the workforce today. Moreover, when most jobs suck, changing jobs isn’t going to do anyone any good.  It’s exchanging one bad job for another.

So reducing unemployment from 10% to 5% is important. But it’s not nearly as important as transforming the world of work so that most jobs are good jobs and provide deep satisfaction for those who hold them.

This is not just a matter of keeping the workers happy. In today’s knowledge economy, the motivation of workers is a key determinant of productivity. The lack of passion in today’s workforce is a fundamental cause of the continuing sharp decline in the performance of the Fortune 500.

The result of that decline in performance is that the economy is no longer providing good living for its citizens.  The economic pie is no longer large enough for everyone to get a fair slice:  Real average hourly earnings (excluding fringe benefits) now stand roughly at 1974 levels.

This decline in performance is also what underlies the political gridlock in Washington DC. After you puncture the Internet bubble of the 1990s and real estate bubble of the 2000s, and allow for the funny numbers created by the financial tricks that accompanied these debacles, it turns out that the real economy hasn’t been growing fast enough to accommodate gains for everyone. Once the rich and powerful take their cut, there’s nothing left for those in the middle or the bottom. So politics becomes a zero sum game: very little gets done.

Government 2.0 vs Government 3.0

Where does government itself fit into this picture?

“Government 2.0” has been much talked about as the application of technology to government as we now know it: the use of social media by government agencies, government transparency assisted data APIs, or cloud computing, wikis, crowdsourcing, mobile applications, mashups, developer contests, or all of the other epiphenomena of Web 2.0 as applied to the job of government conventionally defined. As so conceived, Government 2.0 has much in common with Capitalism 2.0. It's grinding out existing services with somewhat better technology.

As properly conceived by Tim O’Reilly, however, it is much more than those things. It is a government stripped down to its core, rediscovered and reimagined as if for the first time and focused on delighting its primary stakeholders. It is government aided and abetted by technology, but technology is a means, not the end. In education, it means “students first”. In health, it means “patients first”. In law, it means “litigants first”. It means shifting the idea of government from shaking the vending machine to get more or better services out of it, and over to the idea of government building frameworks that enable people to build new services of their own.

As this vision is so different from the limited vision of a technology-assisted version of government as we know it, might it not be usefully be distinguished from that by calling it Government 3.0?

Why is change taking so long?

Meanwhile in the private sector, one has to wonder why is the creation of Capitalism 3.0 taking so long?

The senior managers of the Fortune 500 are among the most intelligent and best educated people on the planet. They have been to business school. They are tops in analysis. With executive turnover accelerating, it’s not obvious that managers as a group have an interest in preserving the status quo. Why don’t they see the writing on the wall and switch from Capitalism 2.0 to Capitalism 3.0?

One explanation is that changing habits is hard, even when the cost of not changing is death:

For instance, a study of heart patients by Dr. Edward Miller, the dean of the medical school and CEO of the hospital at Johns Hopkins University was cited in Fast Company. It showed that the gains from heart surgery are temporary unless patients change their life style: less smoking, drinking, eating, and stress, and more exercise. The option is simple: change or die. Yet very few do. "If you look at people after coronary-artery bypass grafting two years later, 90% of them have not changed their lifestyle," Miller said. "And that's been studied over and over and over again. And so we're missing some link in there. Even though they know they have a very bad disease and they know they should change their lifestyle, for whatever reason, they can't."

Business schools and management journals also have a role to play. The positive contribution that Harvard Business Review makes by publishing wonderful articles pointing to the future and Capitalism 3.0, such as Gary Hamel’s Moon Shots for Management (February 2009) and Roger Martin’s The Age of Customer Capitalism (January 2010), can be undone by hyping the Porter/Kramer article on How to Fix Capitalism (January 2011), which is essentially an argument for preserving and prolonging Capitalism 2.0.

Financial conflicts of interest

At the same time, it would be remiss not to point out the serious financial conflicts of interest with which management and management consulting are riddled.

Thus managers, management journals and management consultants have often built businesses developing techniques and skills based on the practices of Capitalism 2.0. They sometimes have a financial interest in preserving those businesses, even if intellectually they may be able to understand the logic of doing the opposite and moving into the future.

As Upton Sinclair once remarked: It is difficult to get a man to understand something, when his salary depends upon his not understanding it.

Looking to the future

For those who would like to learn more about the history of dying age of Capitalism 2.0 and the future of management (Capitalism 3.0), you can read my synthesis of recent books on the subject, The Death—And Reinvention—of Management. Or you can read the books themselves, such as  The Power of Pull by John Hagel, John Seely Brown and Lang Davison, or Reorganize for Resilience by Ranjay Gulati, or The New Capitalist Manifesto by Umair Haque, or Leadership in a Wiki World by Rod Collins, or my own book, The Leader's Guide to Radical Management: Reinventing the Workplace for the 21st Century.

Comments

[Tim Wright]

laissez faire markets work - hmm? like the wild west eh? Great model Steve Brazell

[Steve Denning]

Tim--Even the wild west needed the occasional sheriff! Steve

[Dscofield]

Steve, thank you for another great post. Since capitalism is dependent on people (until robots make, sell and buy :) ), the problem, and solution will always be people. Too much discussion, til now with you and others, has focused on the theory of capitalism vs the reality.

[Steve Denning]

Deborah,

Couldn't agree more. This is about a transition from focusing on things to focusing on people. Is that really radical? What's radical is that we spent a hundred years focusing on things, all the time wondering why it made people miserable. Duh!

Steve

[seo arizona]

People depended on it. I myself is capable of doing it alone.

[Birthstone Charms]

So coincidentally, I am to write an article about the subject that you are talking about. I think you really have a wonderful point and the information you have provided has indeed helped me a lot. I really needed this, thanks so much for posting!