28 June 2015

CapX Reviews: No Ordinary Disruption


The Danish philosopher Søren Kierkegaard once famously suggested that, “life can only be understood backwards, but it must be lived forwards.” We like to think that the past is a reliable guide to the future, and that intuition and collective wisdom are as robust as the laws of gravity. Ask any central banker or financier of recent years and they’ll tell you otherwise.  Directing an economy or a bank based on the events of the past is like driving a car by looking in its rear view mirror. It works when the conditions are benign, but becomes dangerous when the lie of the land changes.

Disruption is the major theme of a new book by Richard Dobbs, James Manyika and Jonathan Woetzel, three directors at the McKinsey Global Institute. The authors are concerned less with hazardous roadblocks – those big, unexpected Black Swan events – than they are with how business leaders are failing to perceive and respond to the gradual changes in the corporate lie of the land, which is both changing direction and becoming more bumpy. The competitive landscape of the global economy is being redrawn at a fast clip. The rise of new general purpose technologies, the emergence of hundreds of new megacities, and changing demographics are conspiring to move the world’s economic centre of gravity back to Asia.

The facts are extraordinary. In 2013, of the $1.8 trillion of new economic activity, 60% (or about $1 trillion) originated in China.  By 2050, for every child in a developed economy, there will be two citizens over the age of 65. In the next ten years, 440 cities in developing countries will account for half of global GDP growth, and by 2020, 60% of consumers with incomes greater than $20,000 will live in non-Western countries.

For those who believe markets work better when there is plenty of competition, one of the conclusions from this book is a hearty one. The best days of capitalism could well be ahead. It took 154 years from Britain with a population of 9 million to double economic output per head. It has taken China and India, each with over one hundred times as many people, just twelve and sixteen years respectively. Industrialisation today, the authors claim, is a force over 2,000 times as strong as Britain’s industrial revolution, and will dwarf the activity of the last century. This is being driven by large-scale urbanisation, as new cities appear on the map. Tianjin a city close to Beijing in China has a GDP of $130bn, which is already the same size as Stockholm. By 2025, it could have an economy half the size of Sweden.

By way of criticism, however, the book portrays the rise of the developing world in a deterministic, almost inevitable fashion, which is a shortcoming in an otherwise rich exposition of the changing world economy. While concerns are raised regarding the consequences of secular stagnation and immigration in Europe, there is an underlying tone that global capitalism is preordained, that open borders and the free flow of goods and capital are a foregone conclusion, and that the world, in the end, will be governed in the ideal McKinsey ‘best practices’ kind of way. Yet at the same time, concerns by the likes of economist Dani Rodrik, that many developing countries are deindustrialising prematurely – that is, building service sectors without the wealth, technological progress and infrastructural capital provided by strong manufacturing industry, are not addressed. Neither, indeed, are the great challenges of inequality and climate change which will define the success of market economies in the 21st century.

McKinsey advises some of the largest companies in the world, and while the focus of the authors’ analysis is very much geared towards how established incumbents can adapt in the new economy, plenty of scope is given to the threat from start-ups taking advantage from disruptive technological innovations. By slashing the fixed and marginal costs of operations, cloud computing and mobile internet have lowered barriers to market entry and made it easier for challengers to scale-up quickly. In 1950, an average company on the S&P 500 index could expect to stay there for sixty years. That figure is now down to 18 years. 75% of incumbents can expect to be replaced by 2027, as a combined consequence of mismanagement and the rise of global competition.

More than 143,000 internet-related businesses are started in the developing world each year, and among these are star players such as M-pesa, a Kenyan mobile-money service, and “micro-multinationals” like Jumia, a Nigerian e-commerce platform that also has a foothold in the Ivory Coast, Kenya and Morocco. Seven out of ten billion-dollar companies (by sales) can now be found in the developing world, and most of the growth in world trade has been emerging economies. South-south trade, as it is known, has grown from 6% of trade in global goods in 1990 to 24% in 2012.

It is on the back of this that authors issue their warnings to today’s big established firms, claiming that too many business leaders run their companies as hierarchical 19th century military units operating a single organisation strategy that treats new markets as fiefdoms. This would work if there were such a thing as a ‘global consumer’ who would have homogeneous needs and preferences. Consumption habits are typically embedded in local customs, traditions and habits, however.

Some companies, such as Frito-Lay, a subsidiary of American-owned Lay which captured 40% of India’s snack market, understand the need to be receptive to local markets and are willing to experiment, but most big multinationals still struggle to crack markets embedded in different cultures. In a McKinsey study of more than 300 executives at seventeen of the world’s leading companies, 60% admitted that local managers are better placed to understand diverse consumer landscapes but many appear loath to cede power because the legacy costs are too high and too many vested interests would be threatened. The preference seems to be for ‘what has worked in the past’.

The best strategy for these Western giants might be to simply acquire successful start ups and retain and embed their innovative culture. But with new companies such as Chinese e-commerce platform Alibaba able to reach prominence rapidly, the scope for the world’s biggest companies to keep their position at the top simply through acquisition may be limited.

While lacking a cohesive narrative, there are plenty of other interesting perspectives in the book, from the end of cheap credit, the economics of commodities, energy and waste, shrinking workforces, and the impact of new technologies on labour markets and education policy.

But the main focus of this book is disruption and adaptation. McKinsey research suggests that 50% of all efforts to reform companies fail either because senior role models fail to drive change or because of a tendency to defend the status quo. Søren Kierkegaard can help in this regard. His advice was as follows.

“I see it all perfectly; there are two possible situations – one can either do this or that. My honest opinion and my friendly advice is this: do it or do not do it – you will regret both.”

Existentialism is the philosophy of our time, and by reading this book, you’ll realise that the business world is no exception. Executives need to wake up and raise their game before their companies are thrown onto the scrapheap of history.

No Ordinary Disruption: The Four Global Forces Breaking All the Trends. Richard Dobbs, James Manyika, and Jonathan Woetzel, Public Affairs Books, RRP £18.99.

Zac Tate is Deputy Editor of CapX