A human being should be able to change a diaper, plan an invasion, butcher a hog, conn a ship, design a building, write a sonnet, balance accounts, build a wall, set a bone, comfort the dying, take orders, give orders, cooperate, act alone, solve equations, analyze a new problem, pitch manure, program a computer, cook a tasty meal, fight efficiently, die gallantly. Specialization is for insects.
— Robert A. Heinlein
The economist Ronald Coase died today. I was saddened by the news because he touched my life in various ways.
I studied economics in college, but I discovered the field pretty late—my junior year. I had taken a class on economic development mainly because it satisfied two requirements and sounded kind of interesting. I loved it, and shortly thereafter changed my major. In one of my classes, we learned about Ronald Coase, and the simple elegance and power of his theories drew me further to economics.
Later, I went on to participate in auctions of wireless spectrum by the U.S. and Canadian governments. In the process, I learned that he advocated for the process of allocating spectrum in this manner, providing the U.S. and other governments with the intellectual underpinnings for spectrum auctions.
Most of all, though, I remember being inspired because he wrote the essay “The Nature of the Firm”—the first of his two essays that would go on to change the field of economics and together earn him the Nobel Prize—while he was an undergraduate student. The paper reconciled a key theory of economics with the observed reality.
The contradiction it addressed is as follows. On the one hand, Adam Smith articulated the idea of the invisible hand—that the machinery of production should function without coordination. Prices would adjust, supply and demand would fall into balance, and exchange would take place. On the other hand, we see that firms exist. We see what Coase called “islands of conscious power in this ocean of unconscious power.”
Coase reconciled this conflict by describing the role of transaction costs. A firm exists because certain transactions have such high transaction costs that it makes sense for there to be a higher degree of coordination than can exist in market transactions. Firms are a collection of these transactions.
This was a tremendous insight. According to the Royal Swedish Academy of Sciences in announcing his Nobel Prize, “Coase may be said to have identified a new set of ‘elementary particles’ in the economic system.”
What I found so inspiring about this is that Coase must have been sitting in class, learning the principles behind the idea of the invisible hand, supply and demand, and so forth, thinking through the implications of it all, and at some point, it must have occurred to him that it just doesn’t make sense.
He may have asked some tough questions of his professors and his peers. His professors, in a knowing, confident voice, may have talked down to him, thinking he’s just being difficult or just isn’t wrapping his head around the concepts properly. His peers may just not have cared. And, yet, the question must have bothered him. He must have really enjoyed what he was learning, and yet, here was a contradiction he couldn’t resolve.
Rather than give up, convincing himself he must just not be getting it, or file it away, thinking it’s just not worth pursuing, he dug into the question. And eventually—through no small amount of tremendously hard work and after many painful conversations, I’m sure—he produced a groundbreaking work. And it wasn’t even groundbreaking immediately. It took a long time for the idea to catch. But eventually it did.
And this wasn’t the only time this happened. The New York Times, in his obituary, recounts a fascinating story:
While teaching at Virginia, Professor Coase submitted his essay about the F.C.C. to The Journal of Law and Economics, a new periodical at the University of Chicago. The astonished faculty there wondered, according to one of their number, George J. Stigler, “how so fine an economist could make such an obvious mistake.” They invited Professor Coase to dine at the home of Aaron Director, the founder of the journal, and explain his views to a group that included Milton Friedman and several other Nobel laureates-to-be.
“In the course of two hours of argument, the vote went from 20 against and one for Coase, to 21 for Coase,” Professor Stigler later wrote. “What an exhilarating event! I lamented afterward that we had not had the clairvoyance to tape it.” Professor Coase was asked to expand on the ideas in that essay for the journal. The result was “The Problem of Social Cost.”
When I first learned about Coase, I remember being inspired by his tenacity and confidence, his unwillingness to compromise on the questions he had, his unwillingness to let people hold on to a conventional wisdom that just didn’t make sense.
Remembering this as I read about his death, I thought I’d write this to remind myself and others: question assumptions—and have the courage to follow where those questions take you, particularly if its scary.
When Marissa Mayer took over as CEO of Yahoo! last year, I became curious about what it takes for a technology company to sustain itself over the long-term. Consumer products create long-lasting assets in brands and distribution. They can be disrupted, but it tends to be hard. Think Coca-Cola. With technology, however, it’s almost a bygone conclusion that today’s winner will be tomorrow’s also-ran. Microsoft is struggling with this as well, and now with Ballmer out as CEO, they’ll be more explicitly trying to clarify their strategy as well.
Asking this question led me to read Lou Gerstner’s book on IBM’s turnaround, Who Says Elephants Can’t Dance? And it was a worthwhile read.
So, what did Gerstner, having joined IBM February of 1993, do to turn IBM around?
First, he stabilized the immediate problem—mainframe:
Drop the price of the mainframe. Mainframe revenue had dropped from $13 billion in 1990 to projected $7 billion in 1993. Dropping the price wasn’t straightforward as it, in fact, made the cash position worse. But it was a customer-friendly move as IBM’s mainframe customers were its most important customers and mainframe pricing was almost 50 percent higher than competitors’. Mainframe pricing per unit of processing decreased from $63,000 to $2,500 over seven years.
Commit to mainframe research. Rather than exit, he doubled down. Gerstner lent support to the mainframe technical team’s efforts to migrate from bipolar to CMOS, which would lower the mainframe’s cost dramatically. IBM ended up spending $1 billion over the next four years, but it saved the mainframe business. Gerstner points out that, if not for that investment, IBM would have been out of mainframes by 1997. Staying in mainframe generated $19 billion of revenue from 1997 to 2001.
Second, he came up with a near-term plan to stabilize the company:
Keep the company together. The book goes into great depth about this decision, and it’s fascinating reading. Essentially, however, Gerstner initially felt intuitively and later confirmed that IBM had a unique ability to satisfy a significant need to become a technology integrator—the person that could help companies create value from technology by integrating all the pieces and delivering a working solution. This was huge because everyone assumed that the solution was for IBM to break itself apart. This decision drove every other decision. It took enormous vision and confidence.
Bring the expense base in line. Having made the decision to stay together and stay in the mainframe by dropping price, there was no other choice but to bring expenses in line. Gross margins on mainframe had dropped dramatically so it only made the problem worse. Gerstner had his CFO benchmark costs and found that IBM was spending 42 cents to generate $1 of revenue versus competitors that were spending 31 cents. This equated to $7 billion of expense that needed to be cut!
Improve every business process. The early expense cutting was unfortunately and predictably headcount. IBM cut 35,000 jobs in addition to the 45,000 the previous CEO had cut in 1992. Beyond that, however, it was necessary to improve every basic process, all of which had become cumbersome and bloated. Just one example was that IBM had 128 CIOs across 24 independent business units, each running their own systems and applications. This was unglamorous, grinding, and painful work. But necessary. And it worked. From 1994 to 1998, the expense reengineering effort saved $9.5 billion.
Sell unproductive assets to raise cash. IBM was almost out of cash in 1993. Bankruptcy was a possible yet unmentioned scenario. More likely was a painful restructuring with creditors that would have limited options. So Gerstner cut the dividend and moved quickly to sell unproductive assets like the Federal Systems Company for $1.5 billion.
Underlying all of this was improved customer and market awareness. A key aspect of changing the culture of the company was making everyone, from leadership down, more aware of customer needs and competitor actions.
Another amusing aspect of these early changes was Gerstner’s statement at an early press conference that “the last thing IBM needs right now is a vision.”
Gerstner’s point was:
IBM had drawers full of vision statements. We had never missed predicting correctly a major technological trend in the industry. In fact, we were still inventing most of the technology that created those changes.
Basically, “fixing IBM was all about execution.”
Underlying these tactics was a broader strategy:
Keep the company together.
Reinvest in the mainframe.
Remain in the core semiconductor technology business.
Protect the fundamental R&D business.
Drive all we did from the customer back and turn IBM into a market-driven rather than an internally-focused, process-driven enterprise.
Gerstner makes the point that “a lot of these decisions represented a return to Watson’s roots.”
I find this to be amazing. Many CEOs taking over a troubled enterprise would make dramatic, visible changes in strategy. Gerstner’s bold insight was that the basics of the business were, in fact, right. The issues were in execution and structure. The solution wasn’t dramatic and glamorous. It was dramatic yet behind the scenes.
I’m only scratching the surface here. These were just Gerstner’s first steps. He went on to address the leadership team, the reporting structure, the culture, the brand, marketing, the product and services lineup, geographic organization and reporting, etc.
The entire book is filled with insight. Gerstner had no coauthor or ghostwriter. He wrote it himself.
HubSpot’s Culture Code deck is incredibly insightful and very well put together.
I sent a friend some money via Twitter today using Dwolla.
Let’s try out this paying via Twitter thing! @ahadrk, here’s $102 for Neval’s clothes from Pakistan (thanks again, Fatima). #dwolla
— Farooq Javed (@farooqmjaved)
Overall, it was a very slick experience. It took me the time it takes to write a tweet (and I did it on my mobile so conceivably we could do it real time, say, as we settle a check at a restaurant).
The drawbacks/issues:
@ahadrk I sent you money on #dwolla. Go to http://t.co/TyS1KI0A3r to retrieve it. #realcash
— Farooq Javed (@farooqmjaved) August 1, 2013
So there’s some overhead in the process and some tweaks that I’m sure the team will iron out.