A group of elite firms has established a sustained lead. This is not a good thing
Posted by hkarner - 12. November 2016
Source: The Economist: Schumpeter
Subject: The great divergence
ONE of Joseph Schumpeter’s best-known observations was that successful businesses stand on ground that is “crumbling beneath their feet”. A danger is that standing still and resting on your laurels can precipitate a swift tumble. Rivals, meanwhile, can draw on the available stock of knowledge and technology to catch up with the leaders. To stay ahead, front-runners must keep inventing new things. This means that capitalism is inherently unforgiving: today’s leader is tomorrow’s failure. But it also means that it is inherently progressive, since clever ideas are quickly spread through the economy.
Some striking new research suggests that this Schumpeterian mechanism may have broken down. The leaders are staying ahead much longer than is desirable. A group of researchers at the OECD, a club of mostly rich countries, examined the performance of a representative set of companies in 24 of its 35 member countries between 2001 and 2013. They discovered that the top 5% of them, dubbed “frontier firms”, have continued to increase their productivity while the other 95% (the laggards) have been stagnant in this regard.Plenty of economists have noted what they call a “great stagnation” in the global economy in recent times. The OECD researchers, Dan Andrews, Chiara Criscuolo and Peter Gal, show that beneath the stagnation lies a deeper pattern: rising productivity at the frontier and a widening gap between the leaders and the laggards. Three-quarters of the gap emerged before the global financial crisis of 2008. The divergence varies between sectors: in manufacturing, for example, top-tier firms saw their labour productivity increasing by 2.8% a year, against 0.6% a year for the rest. The gap was even bigger in services: 3.6% compared with 0.4%.
The frontier firms appear to have certain things in common. Unsurprisingly, they are ahead of the pack in technological terms, and they make much more intensive use of patents. Perhaps the most striking difference is that frontier firms are always citizens of the world. They are frequently part of multinational groups and they constantly benchmark themselves against other frontier companies across the globe. So technological innovations from the frontier are spreading more rapidly across countries than they are within them. The gap between an elite British firm and an elite Chinese firm is narrowing even as the gap between an elite British firm and its laggardly compatriot is expanding.
The emergence of frontier firms is in many ways surprising. Management gurus have been arguing for years that the balance of advantage is shifting from incumbents to challengers. Small firms can easily buy computing power that used to be reserved for corporate giants. Valuable MBA graduates are now being minted by the million and are waiting to be hired. If that is the case, why are the elite pulling ahead in so many different countries at the same time?
An obvious explanation is that digital technology is unleashing a phenomenon of “winner-take-most” markets thanks to a combination of low marginal costs (which allow first movers to expand quickly) and network effects (which make popularity its own, profitable, reward). The OECD notes that the information-technology industry is producing a class of super-frontier firms: the productivity of the top 2% of IT companies has risen relative to that of other elite firms. Other studies show that this is not because the top tier are investing more in technology (everybody is throwing money at it) but because they are investing more intelligently to enable their workers to do new things and to reinvent their business models.
A second explanation is that frontier firms (the 5%) have each discovered their own secret sauce. Some have learned how to foster management techniques that are largely inimitable. This seems to be so at 3G Capital, a Brazilian private-equity group, which takes over mature businesses and squeezes out costs that no one else can. Some are combining skills in unusual ways: Amazon mixes digital prowess with just-in-time logistics. Some have devised rare material inputs. BMW, a carmaker, is using a special carbon fibre, stronger and lighter than steel, for its i3 and i8 electric cars. The material starts life in a Japanese rayon factory, goes to America to be carbonised and is then sent to Germany, where the strands are woven into sheets.
The chosen ones
Third, technological diffusion has stalled: cutting-edge ideas are not spreading through the economy in the way that they used to, leaving productivity-improving ideas stuck at the frontier. Such diffusion may be harder in a knowledge-intensive economy because frontier firms can hire the most talented workers and cultivate relations with the best universities and consultancies. But it is also made worse by bad policy. The OECD notes that divergence in productivity is particularly marked in sectors which have been sheltered from competition and globalisation, most notably services.
Can anything be done to fix the diffusion problem? One approach is to try to get frontier firms to spread their best practices to the laggards. In Britain, which is dogged by a long tail of poorly performing firms, a group of businesspeople, led by Charlie Mayfield, chairman of the John Lewis Partnership, a retail group, have formed an initiative to encourage them to improve their productivity. Another tack is for policymakers to try to open protected areas of the economy to more competition: the European Union has been eyeing the service sector for years. There are problems with both approaches. Frontier companies will certainly not share all their secrets with the laggards. The EU will become more unpopular than it already is if it tries to take on the continent’s coddled service firms. But policymakers nevertheless need to find a way of addressing this problem if the rich world is to stand any chance of getting out of its productivity funk.