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Dawn Levy, News Service (650) 725-1944; e-mail:

Managing the new economy demands new skills, focus

You ran out of Kellogg's Corn Flakes yesterday, and you went to the store to buy some more, and all they had was Post Toasties. Big deal. It's not as if you have to relearn how to eat cereal. You'll get over it. But suppose that suddenly you had to switch to some obscure computer operating system or word-processing software you'd never heard of. Now there's something to shudder about.

The contrast between cereal and software learning curves is merely one of several differences between the old and new economies, Former Stanford professor Brian Arthur told participants during a workshop held on Stanford's campus in June. And those differences necessitate different management skills: a shift of focus from making products to making sense.

"Getting product out the door is necessary, but it's not sufficient," Arthur said. "We're moving from an economy of optimization to one in which the challenge is cognization: defining a new problem rather than iterating ever-better solutions to an old one."

The question of how to best identify and teach those new skills was of considerable concern to attendees, mostly students and graduates of Stanford's Future Professors of Manufacturing (FPM) program, many of whom serve on university faculties.

The FPM program is interdisciplinary and designed to prepare talented professors who will develop advanced manufacturing programs and educate the manufacturing graduates needed by industry in the 21st century. It operates under the auspices of the Alliance for Innovative Manufacturing at Stanford, or AIMS, which sponsored the workshop. AIMS is a campus-based joint venture through which Stanford's schools of business and engineering exchange new ideas and techniques with corporate partners.

Arthur, now Citibank Professor at the Santa Fe Institute, a think tank located in New Mexico, elaborated on an analysis that has brought him a great deal of attention in recent years: In physical-resource-intensive "old economy" industries such as steel, coal, oil, agriculture or, for that matter, packaged cornflakes, the famous law of diminishing returns is at work. As you ramp up to ever-higher levels of production you eventually run into scarcities of labor, land or raw materials. That forces you to spend more and more for them and, perhaps, to make do with inferior resources.

In these industries, Arthur said, the key to success is the art of optimizing, or incorporating continual and incremental improvements in the production process. "If I have a plywood factory, my challenge is to keep units flowing smoothly out the door, keep quality up, get costs down. Operations are repeated, some week after week. The problems I'm facing today won't be all that different next month. The same goes for oil, steel or soap."

In "new economy" industries -- for example, aerospace, telecommunications, pharmaceuticals, biotechnology and information processing from semiconductors to software -- the major input is intellectual property: research, innovation, invention, design. New-economy companies spend fortunes to get the first unit of a product launched. But after that, the cost of the second -- or the second thousandth -- unit is minuscule. Microsoft's first Windows 95 disk cost $300 million; the second, several cents plus the cost of printing an additional manual. A pharmaceutical company may pay up to $500 million to get its first vial of a new drug through clinical trials to final regulatory approval, but unit costs fall enormously afterward.

Because these new-economy products typically have great value per unit of weight or size, it's relatively cheap to ship them far and wide. Until and unless someone finds a way to send fiber through a fiber-optic cable, the same can't be said about cornflakes or construction paper.

Brand loyalty and the new economy

Another advantage of establishing a big market share, Arthur noted, is that the more a sophisticated new-economy product is being used, the more people learn how to use it. It's no secret that people resist changing from a Mac to a PC, or from one operating system to another. "The more Air India uses Boeing, the more it learns to maintain, fly or order parts for Boeing," Arthur said. This effectively locks customers into a particular product.

Learning effects are largely absent in old-economy products, so old-economy consumer companies go to great lengths to lock in customer loyalty through other means, such as branding and advertising ("Our cornflakes don't mush up in milk"). While this works to an extent, it can be accomplished via constant marketing outlays that are themselves subject to diminishing returns. The point eventually comes where an extra dollar of advertising won't gain an additional dollar's worth of profit, even as increased output of the product may incur increasing per-unit costs for the reasons mentioned above.

The increasing returns that characterize new-economy industries mean that securing a big market share for a product can spell staggering profit margins and leave a company suddenly "awash in cash," Arthur said. But new-economy products can become obsolete pretty quickly. So, instead of saving nickels and dimes through perfecting production of an existing product, the big winner in an increasing-returns environment must immediately "return to the casino of technology" and identify the Next Big Thing before its competitors do.

The new vision thing

The spawning grounds for that sought-after creature often lie in academia, said another speaker, Mike Lyons, managing partner of Zilkha Venture Partners, a Palo Alto-based venture capital firm. "The amount of intellectual property Stanford pumps into the local economy is outrageous," Lyons said. "Half of the Bay Area's economic output comes from companies that are less than 10 years old."

Lyons, who holds a faculty appointment at Stanford's School of Engineering, co-founded a Stanford initiative to train promising new engineers. He noted that "50 percent of computer science grad students are dropping out, and it isn't because they can't hack it."

This poses a dilemma for manufacturing-oriented professors: Hard as it is to teach "vision" to students, it's harder when they're not in school anymore. And it's even harder when professors have to teach students to see around corners -- the high-tech sectors of the economy are moving and changing directions so fast that smart students may justifiably feel they're putting themselves at risk of obsolescence if they stick around until they get their degrees. But jumping into the high-tech fray is risky, too. About 20 new startups are born each day in the Silicon Valley, and not all them succeed. "There are lots of good ideas out there, and not many business opportunities," Lyons said. "You have to learn to tell the difference."

Among those braving the start-up headwinds are new companies such as Timbuk2 Designs of San Francisco, a pioneer in a growing trend known as mass customization. Timbuk2 makes customized messenger bags, each of which is built to order according to specifications -- color, fabric type, style, accessories, and so forth -- "clicked on" by online customers. "It's like a direct line to our production floor," said Brennan Mulligan, Timbuk2's president, who credited a project undertaken by students in a Stanford engineering course for solving one of his company's supply-chain management problems. "The project group's solution saved us $30,000 immediately and is going to continue to save us money."

Another company digging into the Internet motherlode with a novel concept is, an online business-to-business "reverse auctioneer." The outfit, which has 150 employees, is getting ready to go public, said Mark McVay, the company's director of business development.

In the auctions most of us are used to, prospective buyers bid up the price of the object for sale until one buyer, by virtue of entering the high bid, wins. In a reverse auction of the sort that runs for its manufacturing clients, said McVay, "the suppliers bid for the job. Each tries to come in with the low bid. The buyer finds a vendor with the capacity to produce parts at the lowest cost. Some smaller vendors, who typically couldn't reach a global market, now can."

On average, McVay said, his company's auctions save 17 percent for buyers. "Do vendors, then, lose 17 percent in their margin? Maybe. But if our auctions can increase their market reach, they may be better able to run their operations at full capacity, therefore reducing unit costs."

As companies like and eBay have shown, the Internet is an excellent medium for the more traditional, high-bid auctions as well. Indeed, fixed prices are a relatively new phenomenon in the world, having only become the norm in advanced industrial countries over the last century or so. Bargaining is still common among the majority of people populating the planet. Likewise, customization at the individual level preceded mass production.

The spread of auction-determined pricing and mass customization may take some getting used to, because they will place increasing demands upon our ability to make intelligent choices. But the payoff for consumers -- including intermediate and raw-materials consumers who assemble final products -- will be more control over the price and form of the goods and services they buy. Imagine the thrill of typing: "I'll give you $1.78 for a 15-ounce box, but the flakes have to average at least a half-inch across, I need them by tomorrow, and hold the sugar." SR


By Bruce Goldman

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