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The Deeper Message of Financial Markets’ Volatility

The Dow swung 600 points (high to low) in two days this week—and the week’s not over.

Key stock market indices in Indonesia and South Korea lost over 6% of their total value yesterday alone. Seoul’s Kospi Index had its biggest point drop ever

Katie Couric leads the CBS evening news with tales of homeowners who can’t find lenders to refinance massively increasing adjustable rate mortgages they (stupidly) assumed.

What’s it all mean?

The short story is the same as the long story—but the long story is much more interesting.

The short story starts with a classic housing bubble. People start borrowing to buy real estate. It becomes musical chairs, flip the property, sell to the greater fool. And use leverage.  Better yet, OPM (other people’s money).  Best—use both.

Lenders, like good drug pushers anywhere, develop new products and pitches.  Finance the first mortgage with the second; “liar’s” loans, no proof of income required. Wall Street packages loans, slices and repackages them and resells them. No one is left holding the bag—-everyone is left holding the bag.

National Public Radio reports that you can purchase complete lies about your income and employment history at sites like verifyemployment.net  to help fuel the game.

The short story is that the world has become so connected financially that a housing bubble in the US can decimate the stock market in Djakarta.  Everything is linked to everything.  This isn’t like 1929, where wealthy people lost money in the crash and soon couldn’t pay their employees.  This is far more integrated, international, intertwined, interdependent—and fast.  Butterflies flapping wings and all that.

True enough. But the financial markets are just a piece of a bigger puzzle. 

In the long story, the growth in connectedness of all things  exceeds the wildest dreams of rabid conspiracy theorists from just a few decades ago.

Tom Friedman’s The World is Flat is, at root, about how the world has become interconnected.  Time and space are being obliterated by always-on, high-bandwidth,  voice, data and video connections.  Capital flows easily around the world. The internet’s inherent freedom runs roughshod over the desires of industries and nations alike to maintain boundaries.  Even labor becomes mobile—if not through immigration, then through outsourcing.

Six degrees of separation has for some time now begun to look like an overstatement.

The first level of business implications is clear.  Pick one thing and do it the best in the world; outsource everything else to whomever is doing those things the best in the world.

But even that is old paradigm stuff—competing in a global world and all that. Increasingly, that’s so five minutes ago.

The really, really big lesson is this.

The game of competition is over. It’s not about vertical corporations competing against each other anymore.  It’s about collaboration and connectivity—with everyone. He who can get along with everyone better than everyone else will succeed.

Not “win”—succeed.

In a massively connected world, corporate strategy is less relevant than customer strategy.  It’s your ability to cut agreements with customers and suppliers that helps you—not your ability to squeeze pennies out of them.

This is a huge shift for people raised in business in the last 50 years, weaned on concepts like sustainable competitive advantage and shareholder wealth creation.

The business-strategic value of trust was always high.  It’s about to get far, far higher.  Those stuck with mental models built on inter-corporate competition are going to get left behind those who "get" the simple idea of service to customers, employees, and partners.

We’ve All Caught the Detroit Disease

Ward’s Automotive was for decades a major US auto industry trade publication. Each year, Ward’s published a yearbook, with a one-page market share table near the center.

Each year the book detailed share stats for not just GM, but Chevrolet, and within Chevy, Impalas and BelAirs. Plymouths, Dodges, Ramblers—all got detailed at the model level.

Except for one line.

Imports.

From the late 50s until the late 80s, the industry lumped together Rolls Royces and Volkswagens and Toyotas in one simple category. Imports.

Not until the late 80s—when “imports” finally exceeded 25% of the US market—did they get broken out. Last week, BusinessWeek reported that GM’s US market share was at 22.6% A reversal of fortune (in 1963, GM had 51% of the US market).

Over the years, Detroit came up with dozens of excuses. They blamed “deathtrap” used cars (whose only real threat, of course, was to prices of new cars). Roger Smith blamed technology. Detroit blamed fashion quirks in California. It blamed excise taxes. It blamed Japan, Inc.

As recently as May 8, 2005 (on George Stephanopoulos’ ABC News show), none other than Jack Welch blamed labor—high health care costs, “negotiated at a time of no competition”—and argued for a break. Welch conveniently forgets who negotiated all those contracts—Detroit. Without a gun to its head.

The truth is, Detroit had—and still has—an American disease. It has a few key symptoms:

• Belief that we are the biggest, standalone market—immune from global competition—and that the Big 3 had dominant market share

• Belief that GNP growth drives auto sales, that growth means growth in market share, and that buyers are price-driven

• Belief that, in the immortal words of Lee Iacocca, brought back a few years ago from the taxidermist to re-appear on TV, “the most important thing is—the deal!”

The Japanese in particular always believed it was a global market, far bigger than the US, and that they—including Toyota—were small players on a global stage. For them it was always about growth, not share. And for them, price was not something you jacked up with leader models and white-walls and radios—it was something you set low, for growth, and built in all the quality you could, until you earned the right to sell at higher price points. It was not "the deal"—it was, profoundly, the relationship.

They were—oh, what’s the word?—right.

So, perhaps we should go outside Detroit? Maybe tap the American zeitgeist and come up with—private equity, and an industry outsider!

And so we have Bob Nardelli, late of Home Depot fame, coming in as CEO of Chrysler for Cerberus Capital, Chrysler’s new private equity owner. According to Newsweek, Detroit insiders say they expect Cerberus to shake up the moribund American auto industry. Private equity has a lot going for it—but long-term thinking tends not to be part of it. Industry expertise isn’t all bad—and Nardelli has none of it. Pardon my scepticism in this case—I don’t see this ending well.

True, Detroit is easy to pick on. But you’d think the rest of US industry would catch a clue.

On Wall Street, a new phrase was invented only a few years ago—IBGYBG. I’ll be gone, you’ll be gone—so let’s do the deal and let the suckers pay for it.

Now consumers are suckered into no-income second mortgages (“hey they wouldn’t lend me the money if they didn’t think I could pay it back, right?”) which are then sliced and diced and tranched and resold and leveraged and omigosh, looks like a credit crisis! The spirit of Iacocca lives.

In Bentonville, they learned the volume lesson, but not the price/quality lesson. WalMart is teaching a nation that anything worth having is worth having at half the price and one third the quality so you can get more things worth having—to replace yesterday’s list. Planned obsolescence lives.

In Washington, the courage to face long-term financial issues is in short supply, and the belief that we stand alone—politically, militarily, culturally—is the reverse.

We’ve ended up with: here-now, cheaper by the dozen, do the transaction, no money down, quarterly earnings—and get your buyout package just before you default on the schnooks’ pension plans.

We’ve learned well from Detroit—the wrong lessons.

Update: "We”ve All Caught the Detroit Disease" is a featured post at the the Huffington Post.  Trust Matters readers may want to check out the discussion there as well.

IQ, EQ and the Next Billion Banking Consumers

 

The Boston Consulting Group might house the world’s highest concentrations of brainpower per square foot.  BCG is to consulting what Goldman Sachs and Cravath are to banking and law.

When it comes to intelligence, they are tops.

In terms of IQ, that is.

EQ?  Well, that’s not so much what they’re aiming for.

Case in point—the most recent article from BCG’s Industry Insight series, The Next Billion Banking Consumers. (The piece shares two authors and whole paragraphs verbatim with a more general piece from BCG’s Perspectives article series, titled The Next Billion).

BCG’s article series—particularly Perspectives—have been the source of breakthrough thinking for several decades now, including the experience curve and the barnyard portfolio theory, and the general concept of strategy as the pursuit of sustainable competitive advantatage.

The article opens big:

The problem of financial exclusion—individuals’ limited access to or use of formal banking services—looms large around the world. It both reflects and contributes to the stark socioeconomic divide that pervades many emerging markets…

By embracing innovative business models, however, banks can upend the economics of reaching consumers long considered impossible or unattractive to serve.

Great—energizing the banking sector to help accomplish what microfinance suggested might be possible. Cutting-edge capitalism, bringing the next billion—“just above the poorest of the poor and just below those who are currently targeted by most banks”—into the mainstream of the global economy.

Indeed, much of the article addresses the need for changes in product development, distribution, marketing and organization structure, listing some exciting innovative practices.

Then there appears this paragraph:

Unfortunately, regulations sometimes make it difficult—if not impossible—to offer products that suit the financial means of the next billion consumers. Our analysis shows, for example, that Indian banks would need to charge a 32 percent interest rate just to break even on the kind of small, short-term personal loan that the next billion consumers would want.  Yet national regulations prohibit banks from charging interest rates to priority sectors that exceed the prime lending rate, which currently stands at about 12 percent.  This problem underscores the need for regulatory reform that complements initiatives to reach the next billion consumers.  (italics mine)

The need for regulatory reform?  Let me get this straight.  A banking industry in a country with 5% inflation and 6% one-year t-bill rates needs 32% interest rates to break even in a new market, and the problem is—the presence of usury laws?

How about—oh, I don’t know—a banking industry that can make money on less-than-32% interest rates?

Unless I am seriously missing something—always a possibility—the inclusion of this paragraph, alongside discussion of radical product and distribution redesign, is socially and politically tone-deaf.  Narrow.  Myopic.

It feels like a hammer seeing an all-nail world.  If your constant goal is the pursuit of corporate competitive strategic advantage, then of course regulatory “reform” is inconsequentially different from product innovation—it all adds to competitive advantage, right?  (Except of course for the poor schmoe trying to make a buck with his feet in plus-32% debt cement shoes). 

In an increasingly connected world, the view of competition as the be-all and end-all of business—even just of strategy—is antiquated.  Out of sync. Competition without commerce just doesn’t add up to much.

The world is connecting more.  And it isn’t about just the connections, or the connected.  It’s about the synergy in the combination.

Kind of like IQ and EQ.