Book Excerpt: The Future of Wealth

FRAMINGHAM (04/18/2000) - Browse through eBay Inc.'s bidding wars and you'll learn more than just the asking price for a Birthday Party Barbie or a Babe Ruth baseball card. The site's 2-million-plus auctions a day offer a quick lesson in one way the internet is reshaping our economy--namely, by making it possible to set up an efficient market for just about anything. In a new book, Future Wealth (Harvard Business School Press, April 2000), authors Stan Davis and Christopher Meyer take a far-reaching look at how the internet is fundamentally changing the nature of wealth. Davis is a well-known business futurist and author of 10 books, including another book with Meyer, Blur: The Speed of Change in the Connected Economy (Perseus Press, 1998); Meyer is director of the forward-looking Ernst & Young Center for Business Innovation in Cambridge, Massachusetts. As one might expect, this future-oriented duo foresees changes that have ramifications far beyond plastic dolls and baseball cards.

Among those changes, Davis and Meyer envision a time when efficient markets are developed for just about everything, including the connected economy's most scarce and precious resources: human talent and intellectual capital. In other words, one day we could be trading the talents and capabilities of doll collectors and sports memorabiliasts, even CIOs, on markets that have all the characteristics of capital markets for financial instruments, such as futures, derivatives and hedges. Davis and Meyer also expect individuals and businesses to adjust their attitudes toward risk: Rather than viewing risk as a problem to be avoided, they will begin to see it as a financial opportunity. The authors recommend that businesses develop risk-taking cultures and even think about establishing strategic risk units to help them manage, measure and trade their risks. "A company that won't take risks is taking the biggest risk of all," they write.

When there is a seismic shift in the foundation of the economy, there needs to be an equally radical shift in how we measure wealth--a shift that has huge implications for CIOs, the chief stewards of their organizations' information.

Davis and Meyer explore that shift in Chapter 12 of Future Wealth, "From Past to Future: Measures that Matter," excerpted below. -Sari Kalin, CIO senior editor FUTURE WEALTH By Stan Davis and Christopher Meyer Harvard Business School Press, $27.50, April 2000 MEASURE THE FUTURE Professional investors will tell you immediately that the way they value a company is to look at its future--specifically at the discounted future cash flows--and they do so all the time. A company should take the same approach in looking not only at itself but also at everything that impacts it, including competitors, suppliers, customers and the business it does.

Now that we're accustomed to paying $100 a share for internet startups that don't anticipate profits this side of Judgment Day, the future orientation seems obvious. Yet the systems that companies use to measure and manage their performance are still locked onto the rearview mirror.

In part, they're prisoners of their auditors, and if you use the same measure, you, too, will value a company by what it has amassed in the past. Value it by income, as security analysts do, and you are valuing it close to the present.

Value a company by its growth potential--where it is going and at what rate of acceleration--as venture capitalists do, and you are valuing it on its future.

You're also taking a greater risk. But in future wealth, risk is a good word.

No wonder the most hotly desired companies in today's markets, those with the highest price-earnings ratios, are the likes of Amazon, Yahoo and eBay.

The enormous multiples that these fly-by-tomorrow-night companies enjoy infuriate the disciplined managers who consistently generate strings of single-digit quarterly earnings increases at the 30 companies that comprise the Dow Jones Industrial Average. They learned to believe that managing current performance creates value, but now investors are parting ways with this dogma.

They place much greater value on promising future markets.

Companies need to make the same mind-set adjustment. This means that their perception of the future--its direction, its opportunities--should dictate how they manage. In every corporation we have seen, such perceptions are discounted because the information on which they are based is uncertain. To bet your capital on uncertainties would surely be seen as overly risky at some of the Dow companies. That's why their capital budgeting systems are designed to present returns as if they were certain.

MEASURE INTANGIBLES Not surprising, corporate measurement systems are based largely on what you can see: units in inventory, number of customers, bills payable, the replacement cost of a drill press, bank debt, the age of a steel mill, dollars. When the auditors prepare a balance sheet, they put a value on what they can count. But how do you count brand, capacity to innovate, quality of management, potential, relationships, knowledge, human capital?

Some answers are beginning to emerge. Companies are beginning to get a handle, for example, on the value of their brands. Sophisticated market research techniques allow the likes of Bell Atlantic and MicroAge to learn just how much more--or less--a given product is worth if it carries their name. This can be substantial. "I'd like to buy the world a cola" doesn't have the same selling power as the branded, "I'd like to buy the world a Coke." At the other extreme, we know of no means of putting a value on relationships, though researchers are beginning to codify and quantify social networks. But we do know they have value, because without them a company fails.

Even if you can't yet measure all intangibles directly, the financial analysts have an implicit model that places value on them. Ernst & Young research shows that, on average, nonfinancial performance accounts for 35 percent of analysts' valuations. If you want to know where you are over- and underinvesting in intangibles, go ask those efficient financial markets. They'll always find a way to take account of all available information and set a value on it. It's an indirect feedback loop, but the most comprehensive one you've got. In the future, companies may produce simulation models of their markets to measure their intangibles.

Three things here: It's no secret that intangibles are growing faster than tangibles. How to measure their value is still elusive. And third, the financial markets will figure a way.

MEASURE CONTINUOUSLY One thing about measuring is very certain. It needs to be continuous. How often do you close the books, upgrade products, change prices, deliver or receive performance reviews and the like--periodically, quarterly, semiannually, yearly? In each case, moreover, the measurements and the changes are likely to be at the tail end of a drawn-out cycle that begins with the gathering of information, its analysis, endless discussion and committee work, and often-ponderous executive decision making. Then come rollout, response, results and more fine-tuning. And, of course, once you finally reach the end of the cycle, you must begin it again.

Contrast this with financial markets, where the price of a stock can change in the space of a busy signal while you're calling your broker and where whole sectors can tumble into near dust while you sleep. Such constant fluctuation remains the extreme, but we are all becoming accustomed to a world, in business and otherwise, in which connectivity-driven change is nearly continuous. It's reflected in spot pricing, once the arcane domain of oil traders and other commodity traders, and now a part of everybody's life. It's almost bad etiquette these days to ask the person next to you on an airline what he paid for his seat. The carriers change prices faster than you can figure out whether to even make the trip. Only those willing to pay a premium for the intangible value of complete flexibility pay full sticker price.

Continuous measurement is the way manufacturers control machinery. Since the 1970s, they have been installing real-time measurement and control systems to increase productivity and quality and to reduce labor costs. This same logic is inching into the intangible sector. Programmed trading and various circuit breakers are sensing devices. But they are reactive and limited. If we could install continual measurement and control systems in the intangible parts of our business, then we would also benefit from speed of reaction, improved quality and greater productivity. We'd also gain a set of tools that would help us manage risk. A stop-loss order controls the risk of losing money in a given security. What is the real-time intangible equivalent? If Sears had created a brand value measurement system in the 1960s, it could have reacted a lot quicker.

The movie industry comes close to continuous measurement. Always given to dailies--the end-of-the-day feedback loop for the director--studios now monitor the theater grosses every morning and make instant advertising and distribution decisions. Electrical utilities plug into online auctions for power, cruising North American and European grids and making real-time pricing decisions.

For continuous measurement, you first must increase the frequency of your traditional accounting-based measures. Cash flow, profits and the rest obviously continue to matter--no point planning for tomorrow if you haven't got a pulse today. How much longer, though, before the quarterly numbers become what annual statements already are--little more than archival documents? And how long will it be before weekly, daily and even moment-by-moment numbers evolve, providing continual market feedback? Cisco Systems has already announced that it will be closing its books daily. Wal-Mart provides profit-and-loss numbers to department mangers at the close of business each night. Right there you have a vision of future wealth accounting.

Today's software and local area networks provide continuous measurement but only within an organization. In the real dimension, process industries such as chemicals and paper rely on instant measurement and real-time control systems to optimize their operations but have no such infrastructure for managing wealth. The financial sector comes closer because risk and the financial markets are their primary concern. Even so, no bank today can, say, close its books in real-time. Continuous measurement requires electronic connectivity outside the enterprise--to customers, suppliers and markets. Only then can we begin to manage wealth in real-time.

Public schools, for example, have long divided the academic year into arbitrary grading periods and deliver measurements to parents every six to 10 weeks. But just as an annual corporate report has almost no meaning to serious investors--the information is ancient history--so a child's grade that is based in part on a failed test taken 10 weeks earlier is of little value to either a student or a parent. A ninth grader is only 728 weeks old himself, so a 10-week-old grade reflects how he or she did 1.4 percent of a lifetime ago. If you're 50 years old, 1.4 percent of your life would be 36 weeks ago, a long time for recriminations or praise (though not unheard of in many organizations).

Imagine, though, a school where test grades are entered, not in a ring-binder gradebook, but on a teacher's ThinkPad, and from there transferred at the speed of light to a student's Personal Data Bank account. Absences and late days would go into the same account, along with commendations, referrals to the principal's office and anything else that might help paint a real-time portrait of a student's academic and social progress. Parents would be given a PIN so that they could use their own computers to access their children's account at any time. Yes, moms and dads could become awfully intrusive in their children's lives and in the affairs of the school. But then one of the points of continuous measurement is that it enables you to meddle or, to put it positively, to fine-tune continuously.

Measurements that are continuous, intangible and future- oriented are essential underpinnings of future wealth. While this sounds a little like hearing the update of a hurricane warning every hour, the upside is the end of the tyranny of budgets that don't improve decision making and a relaxation of financial markets' overreactions to quarterly earnings. Since the ability to form a more robust and credible picture of the future distinguishes primates from lower mammals, perhaps it will help homo economicus reach a more balanced society.

Reprinted by permission of Harvard Business School Press. Excerpt of Future Wealth by Stan Davis and Christopher Meyer. Copyright 2000 by Stanley M. Davis and Christopher Meyer; all rights reserved.

THE MARKETPLACE RULES CIOs need to run at the speed of the connected economy--or risk running their companies into the ground, says Stan Davis, coauthor of Future Wealth. CIO Senior Editor Sari Kalin spoke with Davis to find out how the theories in Future Wealth affect CIOs.

CIO: Do today's corporate leaders have what it takes to adapt to the radical economic changes you forecast in Future Wealth?

Well, we've got two generations of leadership in corporate America--and I mean this more psychologically than chronologically. You've got the white males with white hair and suits who are 50 or older and who are hoping they can get through to retirement in time before things crash around them. Contrast them with the twentysomething, purple-haired, body-pierced, roller-blading geeks who are issuing their IPOs and becoming millionaires and billionaires. This is hyperbole of course, a caricature of both extremes. But it is very, very difficult for these two types of leaders to talk to each other. They create fundamentally different corporate cultures. And it's very difficult for the old-style leaders to totally deconstruct the culture, management structures and ways of doing things that they've built up over decades in order to institute the new cyberspace approach.

Which generation do CIOs represent?

They represent the old type of leader. I make a distinction between the first and second half of the information economy. In the first half, the computer was used as a crunching tool. In the second half, with the internet, everything is connected. Most CIOs grew up during the crunching era. So the very role of the CIO is going to end up fundamentally redefined [in the internet era]. It will be an essential role, but it's a very, very different one from what it was for the previous four decades.

What will change about the CIO's role?

The old model drew a circle: Inside the circle was the corporation, and outside the circle was the marketplace. But we are moving from the real to the virtual; we are moving into cyberspace. The internet is leading us to a connected world in which that circle is so permeable and so permeated that it is losing its efficacy to think of it as a boundary that distinguishes internal from external. And when you start erasing that boundary and mind-set, you begin to open the internalities of the company to operate by the rules of the externalities. Externally, you're run by the economic laws of the marketplace.

Internally, you're run by laws of power, status, psychology and corporate culture. The marketplace changes so fast that in order for a CIO's internal organization to change that fast, it has to operate by external economic rules, not by power, status and psychology.

How can CIOs run their IS departments by marketplace rules?

They have to set themselves up as a business, not just an internal transfer charge for services rendered. And they have to be competitive in the external marketplace. If they decide they're not good enough compared with the external marketplace, they ought to outsource. Let's say there's an IS capability that you're running internally. You're doing it as an overhead function, you're not doing it full time--by full time, I mean that to the corporation itself, it's a sideshow, it's a support function. If there are other people out there who do it full time and are best in class, outsourcing is a rational decision. Of course, some CIOs will build walls around their domain and hold out as long as they can, but they'll be a noose around the neck of the business. Then there are some CIOs who would say, "We can be best in class, therefore, we ought to offer it to the marketplace and not keep it only as an internal function."

So are CIOs good guys or bad guys here?

They can either be a negative force or an extremely positive force. And there are CIOs on both sides of that ledger. A lot of negative forces hang around in legacy corporations. It would be ironic that the CIO should become that.

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