Irving Wladawsky-Berger

Knowledge Capital

A couple of weeks ago I participated in a conference at the National Academies on Intangible Assets: Measuring and Enhancing Their Contribution to Corporate Value and Economic Growth.  The conference was sponsored by the Board on Science, Technology and Economy Policy (STEP).   

What are intangible assets?  Wikipedia defines them as "identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset."  A more vernacular definition might be "an asset that cannot be dropped on your foot." 

STEP convened the conference because "US investment in intangibles, according to a 2006 Federal Reserve Board staff analysis, exceeds all investment in tangible property and, if properly accounted for, would raise productivity growth significantly.  These assets - computer software, R&D, intellectual property, workforce training, and spending to raise the efficiency and brand identification of firms - are a subset of services, which now account for three quarters of economic activity. Increasingly, they are a principal driver of the competitiveness of US-based firms, economic growth, and opportunities for American workers.  Some intangibles, like intellectual property, are being securitized, auctioned, and traded; a few years ago hardly anyone contemplated the existence, let alone the extent, of such ‘technology markets.’  Yet despite these developments, many intangible assets are not reported and are treated in the national economic accounts as expenses rather than investments.  And there is no coordinated national strategy for promoting intangible investments apart, perhaps, from R&D."

Tangible assets generally have a physical existence, which makes them easy to see, feel and measure.  They include real estate, equipment, and financial instruments like cash and accounts receivable.  Intangible asset, on the other hand, have value but no physical existence, and include some of the most critical assets needed to compete in the 21st century, such as knowledge, R&D, organizational know-how, software, brands, patents, trademarks, copyrights and so on.  Intangible assets – just like services - constitute a huge part of the economy. They determine competitiveness, innovation and jobs, yet economists struggle on how best to measure and deal with them.

As one of the speakers succinctly put it, to appreciate the seemingly mysterious nature of intangible assets, ask yourself the following question: What is the most important aspect of the iPod - its design and use in the marketplace, or the physical device and the factories that produce it?  The design, branding, music distribution and overall market activities around the iPod are being done by Apple, mostly in the US.  The manufacturing of the iPod is outsourced to other companies with factories in China.  There is little doubt that the bulk of the value of the iPod lies in the mostly intangible assets that belong to Apple and that have contributed to Apple's strong financial performance in the last few years.  The tangible assets of the iPod - the commodity components that go into the devices, the factories that produce them, and the tools used in their manufacturing - are much easier to see and measure, but have a lower economic value and yield lower profits.   

The STEP conference included mostly economists from government and academia.  I was pretty much the lone technologist among the speakers, and was likely invited because of my work in services sciences, innovation, intellectual property and related subjects.  I have been quite intrigued about the increasing importance of these advanced capabilities, along with the talented people to make them real for leadership in the 21st century.  I thought that participating in this conference on intangible assets – which all of these capabilities and talent clearly are – would be a good way to help organize my thoughts on the subject.  I was not disappointed, and in fact, my ideas got focused around the concept of knowledge capital, as I will describe later.         

Even though I know little about the formal field of economics, I felt that I had to display some semblance of economic bona fides out of respect for the audience.  So I chose to organize my talk around a framework inspired by Adam Smith.

Adam Smith is widely acknowledged as the father of economics.  The ideas he pioneered provided the intellectual underpinnings for free-market, free-trade capitalism.  I told the audience at the conference that I chose Adam Smith as the inspiration for my talk not only because of my great admiration for his work, but because he is one of the few economists whose writings I am able to understand.  Economists are well known for dealing in abstract concepts and in a language all their own, which is often inaccessible to non-economists - not unlike computer scientists, physicists and many other professionals.  Since Adam Smith was one of the first economists, he wrote in simple language for a general readership, and that makes it much easier for me to understand his concepts and follow his reasoning. I said this only partly in jest.

Smith's writings were very influential in helping his contemporaries make sense of the economic forces around them that were giving rise to what became known as the Industrial Revolution.  The essence of the Industrial Revolution was the application of technology, tools and process innovations to increase productivity and quality radically in the production of physical assets. 

I find three Adam Smith concepts particularly noteworthy in this regard: the division of labor, the invisible hand, and moral sentiments.  Could these same three concepts help us understand how technology, tools and process innovations are now increasing the productivity and quality of intangible assets and services in general in our emerging knowledge economy?

That’s the question I tried to answer.  The division of labor helps to improve productivity by allowing workers to specialize and become experts in specific tasks; by encouraging the development of tools and machines to assist in such specialized labor; and by helping to organize the overall production system as a collection of such specialized tasks.  The bigger the market you are aiming at, the more important the benefits of organizing production along these lines. 

Clearly, these concepts apply with a vengeance to our present integrated, fast-changing global economy, where the tasks and markets are so much bigger and more complex than those in Smith's days.  Service oriented architectures, services sciences, complex systems studies and similar efforts are our attempts to bring advanced technologies and innovation to these incredibly tough and important problems.

In The Wealth of Nations, arguably the most famous and influential economic treatise ever, Smith cautioned us not to try to control and predict the unpredictable, but to trust the invisible hand , his poetic metaphor for the workings of open, free markets.  He wrote that when the individual "intends only his own gain, . . . he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.  Nor is it always the worse for the society that it was not part of it.  By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."

While open, free markets are far from perfect, they have historically fared a lot better than the alternatives, and are today accepted in most societies around the world as the preferred economic system.  Given our unpredictable, emergent, digital economy, including the rise of globally integrated enterprises and industries, it would be a fool’s errand not to build your overall governance around the principles of open, free markets.   And, in fact, our faith in free markets can be considerably strengthened by our recent ability to access and analyze real-time information in order to get a better handle on market vagaries and erratic behaviors.

We may not be able to control hurricanes, but we can do a lot to identify them, track them, and anticipate their strength and direction, as well as build infrastructures that are as resilient to the power of hurricanes as possible.  In the same way, in our knowledge economy we should leverage the advanced technologies now at our disposal to deploy sophisticated information-based decision support and management, predictive analysis and simulations, and robust organizational structures. They help us stay on the lookout for outlying, perhaps cataclysmic, economic events, and minimize their impact on our business and societal institutions.

The last Adam Smith concept - moral sentiments - is a bit more subtle.  Some have misinterpreted free market capitalism and the metaphor of the invisible hand as a kind of survival of the fittest competition in which anything goes.  This is far from correct. 

Adam Smith was a deeply moral man, in addition to being a brilliant economist and philosopher.  He believed that human beings have strong principles that cause them to be interested in the fortunes of others, and to worry about others’ happiness even though they themselves may derive nothing from it.  He wrote in his second major book, The Theory of Moral Sentiments, "Individuals in society find it in their self-interest to develop sympathy as they seek approval of what he calls the impartial spectator.  The self-interest he speaks of is not a narrow selfishness but something that involves sympathy.”

It is easier to appreciate the balance between the fierce competition inherent in open, free markets, and the supportive community behavior found in well functioning human societies when talking about villages and neighborhoods, where people personally know each other, and where bad behavior can cause a businessman to lose his customers.  But do moral sentiments scale in our global, anonymous, flat world, where unethical actions to enrich ourselves at the expense of others can hurt not our neighbors, but far away people we will never meet?  Can technology and innovation help us deal with moral sentiments on a global scale?

It is fascinating, perhaps a re-affirmation of the power of the invisible hand, that one of the most innovative uses of technology in the last decade has been the rise of Internet-based social networks, open source communities and collaborative innovation platforms.  These innovative technologies are bringing us closer together on a global scale, and are enabling us to scale the human sympathy that Adam Smith wrote about almost 250 years ago to today’s global dimensions.

There will clearly still be rogue executives, like those that ran Enron and WorldCom into the ground, as well as the kind of unethical financial behavior that led to the sub-prime lending crisis, just as there were undoubtedly bad merchants and con artists in Adam Smith's time.  But, we are beginning to see the emergence of a kind of Sympathy 2.0 that will, we can hope, help keep companies honest, help temper their worst excesses and encourage and reward good behavior and corporate social responsibility.

I closed my talk by pointing out that talent is more important than ever in the knowledge economy, given the sophistication of the technologies, tools and innovations needed for leadership in our fiercely competitive world.  In the Q&A session following my talk, someone in the audience pointed out that talent usually refers to a person's natural endowments or aptitudes.  What I really meant, he offered advice, was something like knowledge capital. 

Knowledge capital includes human capital, which generally refers to the skills and expertise that a person has.  It also encompasses everything that is known about a particular business, industry, discipline or even a whole nation.  As part of knowledge capital, I would also include most of the intangible assets that were being discussed in the conference, such as innovation, processes, R&D and intellectual property.

As with knowledge itself, it is unlikely that we will come up with a definition of knowledge capital that suits everyone.  But as with intangible assets, what we really need is something less academic and more functional and pragmatic.  What are the key characteristics of knowledge capital that contribute to economic growth, corporate value, increased productivity, job creation and overall competitiveness?  What are the key indicators we should be carefully tracking to understand the contributions that knowledge capital is making to a company, an industry and the economy in general?  What actions can we take to significantly enhance the value of knowledge capital to business and society?  Hopefully, in the years ahead we will make progress in providing answers to these important questions.

The Innovator's Prescription: A Disruptive Solution to Health Care

Clayton Christensen is Professor of Business Administration at the Harvard Business School.  He is one of the world's foremost thinkers in strategy and innovation. In particular, Clay – since I know him personally, I feel I can call him by his first name - is an expert in dealing with disruptive innovations, developing organizational capabilities and finding new markets for new technologies.  In addition, he has a major quality that distinguishes him from most experts.  Not only does he repeatedly come up with great ideas, but he also comes up with innovative ways of communicating his ideas so that they are accessible to lots of people in the business world and the general population. 

Clay is also an accomplished writer.  His first book, The Innovator's Dilemma is a classic.  His second book, The Innovator's Solution - co-written with Michael Raynor – is a comprehensive guide to innovation in all aspects of a business.  I use it extensively in my MIT graduate seminar.

His new book, The Innovator's Prescription: A Disruptive Solution to Health Care - co-authored with Jerome Grossman and Jason Hwang, - is scheduled to come out on September 19 of this year.  When I learned that he is co-author of a new book on health care, I quickly invited him to MIT to give a public lecture on the subject.  Clay came to MIT last month, and not only was his seminar - which can be seen here - excellent because of its fascinating content, but it could also serve as a master class on how to discuss a very complex subject in an accessible, interesting and elegant way.

Since Clay’s talk was about how disruptive innovations could help us address our healthcare crisis, he first reminded us what disruptive innovation is all about. 

There is a well established pattern.  First, a new technology shows up in the marketplace, which initially is nowhere near as good as the existing technologies it will ultimately displace.  But, since the new technology is much less expensive, it starts getting used in applications that don’t require the highest quality and performance, where an inexpensive solution is "good enough." 

After a while, the new technology, - having significantly improved as it made its way through the learning curve that all technologies go through, - can now be used in more demanding applications, where it now starts to compete head-on against entrenched technologies.  It then starts winning away those customers of the older technology who are happy to now have a product that is much less expensive and generally simpler to use. 

Soon, a new low-cost innovative business model begins to develop around the new technology, which the old one cannot possibly compete with because its business model is based on a whole different set of more expensive assumptions.  Eventually, an entirely new eco-system and value chain is built around the new technology, which now has essentially displaced, - and often finished off, - the older technology in the marketplace.  Examples abound, from mini-mills in the steel industry, to digital photography, to microprocessors and the personal computer.

How about health care?  Are there any new technologies that could act as disruptive innovation enablers and propel the industry toward higher quality, lower cost, more accessible services, business models and value chains? The answer is of course - yes.

However, technology is only an enabler of innovation.  To be able to translate technology advances into major market improvements, the business models, as well as the overall industry ecosystems must embrace the technology, adapt to it, and change as appropriate.  That has not happened in health care.   

Why is health care different from other industries?  In the introduction to his book, a draft of which Clay was kind enough to make available to me, he offers some simple, common sense answers. 

In the practice of medicine, a different diagnostic approach is called for depending on the nature of the disease.  "When precise diagnosis isn’t possible, then treatment must be provided through what we call intuitive medicine, where highly trained and expensive professionals solve medical problems through intuitive experimentation and pattern recognition.  As patterns in these patients become clearer, care evolves into the realm of evidence-based, or empirical medicine – where data is amassed to show that certain ways of treating patients are, on average, better than others.  Only when diseases are diagnosed precisely, however, can therapy that is predictably effective for each patient be developed and standardized.  We term this domain precision medicine." 

A hundred years ago, just about all medicine was intuitive in nature.  Over the years, advances of all sorts have resulted in the ability to apply empirical and precision medicine to the diagnosis and treatment of many diseases.  Most infectious diseases now fall into this category - from strep throat to tuberculosis - where a relatively simple test, administered by a nurse or medical technician, can identify the causes of symptoms with a high degree of precision.  The causes can then be attacked with a therapy specifically targeted to that particular disease.  Hospitalization is rarely required.

Are there new technologies in the horizon that could significantly accelerate the move toward empirical and precision medicine for more complicated diseases?  Christensen identifies three families of technologies as offering great promise for the future - molecular diagnostics, imaging diagnostics, and high-bandwidth telecommunications.  However, don't expect these exciting new technologies to make a different to our healthcare crisis on their own, any more than has been the case with past technologies. 

"The delivery of care has been frozen in two business models – the general hospital and the physician’s practice – which were designed a hundred years ago when almost all care was in the realm of intuitive medicine.  What causes products and services to become more affordable and accessible is the delivery of the technological enabler through disruptive business models.  It is due to the lack of business model innovation in the healthcare industry – in many cases because regulators have not permitted it – that we are fast becoming unable to afford healthcare."

Many physician practices and general hospitals are essentially custom solution shops, treating whatever ails their patients and solving whatever new problems need solving.  In Christensen’s opinion, these solutions shops are needed to solve unstructured problems, but two other business models have a great potential to help improve the healthcare industry - value-adding process businesses (VAP) and facilitated user networks. 

A VAP model is essentially the application of classic engineering to a custom solution.  If when solving problems, certain tasks keep coming up over and over, it makes sense to then turn those tasks into well defined, repeatable processes, whose performance can be measured and continuously improved.  This is what is done in manufacturing, retailing, refineries, restaurants, and so on.  A good program for continuous process improvements will result in significantly higher quality and lower costs - think of the Toyota Way or Six Sigma. 

Facilitated user networks are a newer concept.  These networks take advantage of the Internet, social networks and Web 2.0 methods to help in the treatment of chronic illnesses that rely heavily on modifying patient behavior to achieve success.  Diabetes and a number of mental health ailments could be particularly well suited to this approach.  So could diseases whose symptoms can be treated but for which there is no cure, like certain forms of cancer and autoimmune ailments, where a properly managed patient network can provide both emotional support and helpful advice to its members.   

"The health care system has trapped many disruption-enabling technologies in high-cost institutions that have conflated two and often three business models under the same roof", writes Christensen.  "The situation screams for business model innovation.  The first wave of innovation must separate different business models into separate institutions, whose resources, processes, and profit models are matched to the nature and degree of precision by which the disease is understood.  Solution shops need to become focused so they can deliver and price the services of intuitive medicine accurately.  Focused value-adding process hospitals need to absorb those procedures that historically general hospitals have performed after definitive diagnosis.  And user networks need to be cultivated to manage the care of many behavior-dependent chronic diseases. Solution shops and VAP hospitals can be created as hospitals-within-hospitals if done correctly. The reason why this basic division must occur at beginning, however, is that it will enable accurate measurements of value, costs, pricing and profit."

Business model innovation is absolutely necessary, but not sufficient to significantly improve healthcare.  As has been pointed out over and over, the healthcare system is not a system; the whole is much less than the sum of its parts.  "Disruptions are rarely plug-compatible into the prior commercial system.  When disruptive innovators assume that relying on the existing commercial system is a cheaper, faster way to succeed, they invariably find that the old commercial system kills their innovation, or co-opts and re-shapes their disruptive business model so that it conforms to the system.  Vice-versa never happens.  Piecemeal attempts at disruption leave the forces of reform mired in their trenches, working solely on their individual pieces of the problem, inserting their improvements into the existing system, but never enabling a new disruptive commercial system to arise."    

This is why so many good ideas, improvements and innovations in individual components of health care have had such a limited overall impact.  They succeed in improving their slice of the system, but that's all.  When disruptive innovations take hold, a new system-wide value chain emerges around the new technologies and business models. 

When that happens, the new components of the system have to be integrated, coordinated and optimized by some entity charged with improving the whole.  Christensen mentions Kaiser Permanente, Intermountain Health Care, the Mayo Clinic, and the Veterans Administration as healthcare institutions that have made significant progress in their approach to health care because of their ability to manage, overhaul and keep making improvements to their overall, integrated operations.

But what happens when there is no provider like Kaiser or Intermountain to develop a well managed, efficient, high quality integrated healthcare system?  Some other entity must take the lead.  In the talk, Clay observed that "The ideal entity responsible for healthcare should have a long-term horizon, strong motivations to keep people healthy, and the ability to make care convenient.  Who might that be? 

He showed us a list that included governments, insurance companies, doctors and hospitals, employees and employers.  I did not expect the answer he gave.  "Doctors and hospitals make money when people get sick.  But employers make money when their employees are healthy and productive. Even though many of them say they want to be freed from the burden of paying for employees’ health care, if you watch what major employers are doing, they are investing heavily to attract, train, and retain the best employees possible.  As a result, employers increasingly are integrating backwards to contract directly with hospitals and clinics themselves, cutting insurance companies out of the decision-making loop."

There are few challenges in our society as important and complicated as transforming our healthcare system for the better.  The Innovator's Prescription is a major contribution to this very tough challenge.

A Dialogue on Sexism

In the last few weeks there have been lots of articles in the press about the alleged sexist media coverage of Hillary Rodham Clinton's bid for the Democratic presidential nomination.  Many have suggested that, just like the historical candidacy of Barack Obama has presented us with the opportunity to have a serious dialogue on race, the equally historical candidacy of Senator Clinton should lead to an equally serious dialogue on sexism in US society.

I could not agree more.  As the father of a young woman, and as someone who has worked closely with female colleagues throughout my long professional career, I strongly believe that we will become a much better society if we take stock of where we are in our battle against sexism, and what we need to do to keep making progress into the future. 

Over the last thirty years, women have made huge advances in the US - and in the world in general.  But, one would have to be very naive or ideologically driven not to agree that sexism continues to be a serious negative force in our country.  The facts speak for themselves. 

In 2006, women earned on average 77 cents for every dollar men earned, - up from 60 cents in 1960.  In the US Congress, 74 out of 435 members in the House of Representatives are female, as are 16 out of 100 in the Senate - the highest numbers of women in the history of Congress, but still under 20 per cent.  In business, 12 of the Fortune 500 companies are run by women, as are 24 in the Fortune 1000.

Most statistics show a similar picture.  The glass is most definitely getting fuller - but, there is a ways to go.

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Breaking the Petaflops Barrier

Last week, the US Department of Energy announced the first supercomputer to achieve a petaflop of sustained performance.  It will be housed at the Los Alamos National Laboratory in New Mexico.  The machine designed and built by IBM, is named Roadrunner, after New Mexico's state bird. 

A petaflop is a million billion calculations per second, that is, a 1 followed by fifteen zeros.  That is how many calculations per second Roadrunner can perform.  When talking about petaflops, the numbers are so large that it is hard to comprehend what they mean.  We are almost into numbers of astronomical dimensions. 

The IBM press release used a few analogies to describe the power of Roadrunner, such as "The combined computing power of 100,000 of today's fastest laptop computers";  and, "It would take the entire population of the earth, - about six billion - each of us working a handheld calculator at the rate of one second per calculation, more than 46 years to do what Roadrunner can do in one day."

The previous major milestone for supercomputers was the teraflop - which is a 1 followed by twelve zeros.  Crossing the teraflops barrier was a huge deal for the supercomputing community when we did it in the late 90s.  And here we are - only ten years later - with a machine which is 1000 times more powerful than a teraflop machine.

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Trip to Portugal

I spent the past week in Portugal at the invitation of the MIT Portugal Program.  I gave a talk on Complex Engineering Systems in the Knowledge Economy, and had meetings with faculty members and government officials involved in the program.   I also spent some time with colleagues from IBM Portugal.

The MIT Portugal Program was started in 2006 as a collaboration between MIT and government, academia, and industry in Portugal.  The program aims to foster education, research and economic development in areas related to engineering systems.  It has targeted bio-engineering, sustainable energy, transportation, and engineering design and advanced manufacturing as its key focus areas.

The MIT side of the program is being coordinated by the Engineering Systems Division (ESD).  For ESD, the program is an invaluable learning experience as it explores, together with Portuguese universities, government and the private sector how to best leverage engineering systems for the benefit of society and business.   

For Portugal, the program represents a strategic commitment to science, technology and higher education.  Similar programs have been established by the Portuguese government with UT Austin - which has a focus on digital media, advanced computing and math; with CMU - whose focus is on IT, critical infrastructures, innovation and applied math; and with Harvard focusing on biomedical sciences.  These international programs are an investment in human capital, designed to make Portugal a relevant partner for future joint ventures in the emerging knowledge-based, global economy.

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