More Interesting Innovations

Interesting Innovations

  • Street Heat:
    Ever burn your foot walking on hot asphalt in the summer? That’s because black absorbs heat—while white reflects it. Well, in case you haven’t noticed, modern cities are covered in the black stuff. Dutch construction firm Ooms is now heading its headquarters by running water pipes under the street. Some of them collect heat in the summer and run deep into the ground where they heat water via a heat exchanger. That heated water is stored for winter—a sort of battery, if you will. In fact to take it a step further, the water is returned to the ground after heating the building, by passing under the street again. The residual heat in the water, now only a few degrees above freezing, melts any snow or ice on the road surface. The water is then stored—used cold to cool the building—before being run under the asphalt again to prepare for winter. Brilliant!
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strategy

A Secretary of Innovation? Great Idea!

In a recent article, Thomas D. Kuczmarskiwrites that he thinks President Obama could use a Secretary of Innovation.  I agree with him.

Kuczmarski writes that our current approach to stimulus is not likely to get the job done.  Again, I agree with him.

It strikes me that there is still a fundamental misunderstanding on the part of most people, including economists.  And that is that the global economy is not slowing down.  It has essentially stalled.  And the attempts at recovery are kind of like pulling the cord on a lawn mower.  You can pull, and pull, and pull, but if you’re not pulling really hard and fast at least once, all you do is use up your energy without the engine starting.  Well, all the relief and stimulus programs around the world—from China to Germany to the US—are basically just like using up energy, only instead we’re using up money.  That’s because it appears that no one has the courage to “jolt” the engine of the economy back into a growth mode.  We’re going to pour money into this problem for years before we see real growth again.  The lost decade is becoming a more likely scenario every day.  It’s very sad—and very frightening. 

Capitalism rules!

While the old saying, “when the US catches a cold, the rest of the world gets the flu,” can certainly serve to make us Americans feel a little guilty about our role in a global depression, at least we can take solace in knowing that it is our system of capitalism that actually should lead to us recovering faster than the rest of the world.

The reasons are simple.  Our employer friendly environment in the US—the very system that has allowed companies to quickly downsize—is precisely what is going to lead to our faster recovery.  Consider what would happen if, as in the cases of China and Germany, the government slowed the pace of layoffs.  That would force companies to continue to pay unneeded employees instead of investing in their recovery efforts.  In China, the government has ordered state owned businesses not to lay-off people and in Germany, the government has reached an agreement with the largest companies to refrain from layoffs for six months.  That all but assures that the time it will take for those companies—and those economies—to hit bottom will be extended, thereby extending the time it takes for recovery.  In the US, companies are finally starting to react and in a big way.  Were we to mitigate that reaction, we would simply lengthen the bottom of the bathtub curve that is going to define our depression.  Fortunately, as I’ve noted over the past few days, the government stimulus plan is going to take a lot of time, so we don’t have to worry too much about that elongating the tub, either.

It’s ironic that while capitalism is clearly the cause of our problems, it will be capitalism that saves us, too.

The Doomsday Scenario

On January 2nd, 2008, I didn’t predict that we’d enter a recession.  I went on the record and said the recession had started.  Despite another eleven months of denials by economists and politicians, at the end of November 08, the National Bureau of Economic Research (NBER) declared that the recession had in fact started back in December 07. Vindication!

In an earlier blog on November 26th, before the NBER had even declared that we were in a recession I went on record as saying that the depression HAD started.  Vindication again?  We’ll know soon enough.

Some in my
company have asked why I’m such a pessimist.  Why can’t I be more positive about things, they ask? The answer is simple.  Whenever my company has gone through a tough spot for one reason or another—inevitable in any young company—I could be the visionary optimist, boost people’s spirits, and they’d fight through it.  We always turned things around.  Unfortunately, my optimism can’t turn around our economy.  And I don’t think a new President can turn a structurally wounded, globally intertwined economy around, either.  So the much more responsible thing for me to do is to be a realist.  I promise everyone—when I believe things are starting to turn around, I will be the biggest economic cheerleader you’ve ever met. 

Now, what should you be doing about all this uncertainty? Managing risk is certainly the job of every CEO, but it may sound more like a
black belt’s topic to dive into the nitty gritty of mathematically defining different statistical interpretations of risk and the difference between downside risk and upside risk.  There are several algorithms that can be used, but here’s a layman’s interpretation of what I’m talking about.

I’ve had quite a few clients recently explain to me how they are working to:

“Avoid cutting so deep that we’re unprepared to reap the benefits of recovery.”

My reaction:  absurd!  I think that’s an irresponsible mindset for most companies.  Here are two examples of the difference between upside and downside risk:

  1. In the American system of justice, we consider the risk of sending an innocent person to prison much more severe than the risk of freeing an innocent person. Hence, the requirement to be “convinced beyond a reasonable doubt” and for conviction by a unanimous jury.

  2. In the casino, if you only have $100 and lose it, you go home.  You’re out of money so you can’t gamble more to win it back.  If you win $1,000, you can keep playing until you lose it all, including your $100, so you still go home.  You could quit, but many don’t.

What’s the point? The point is that making excuses not to cut as deep as you can has almost become a part time job for many executive teams. Which risk would you rather come to fruition: the risk of not making as much money in 2010 and 2011 as you otherwise might, or the risk of not being around in 2010 in the first place?

 To help you think it through, here are all the reasons you SHOULD be cutting deeper:

  1. How do you know what you’re really capable of until you cross that limit by taking a chance on cutting too deep?

  2. With skyrocketing unemployment, you can always hire someone if you need to.

  3. In fact in many cases, you might be able to hire back the same person you let go given that the time to find new work has been growing fast.

  4. You can tell your people you expect them to work longer hours and weekends to survive the depression, but until you actually push them to do it, many won’t.

  5. When you have enough people to do things that no longer matter, they keep doing them.  Only after you cut deeper are people forced to truly prioritize.

Here are some additional considerations that many are still avoiding:

  1. Start reducing salaries and do it fast.  Do it on an individual by individual basis.  In good times, we are perfectly happy paying someone inside a “band” and as long as they are in the band we pay them 5%, 10% or more to get them to move from another company.  We wind up with two people doing the same job but one makes more money than the other.  The “market rate” for people becomes less the driver than the desire or need to get them on board as long as they are in the band.  In tough times, their market value means everything.  So assess market value and start renegotiating salaries down to the bottom of the range for everyone.

  2. Make it clear that salary cuts are not temporary. They’re indefinite.  If and when the economy turns around and you or your employee feel they are underpaid because their market rate has risen, a raise is always negotiable.  But do not set an expectation that you’re giving automatic raises back to the “old” salary when the economists declare the depression is over.

  3. Treat someone making $150,000 a year differently than someone making $30,000.  A ten percent hit to someone making $30,000 a year might mean they can’t pay their mortgage.  For the person making $150,000, it means they can’t contribute as much to their 401K.  One can take it—the other can’t.  You need to cut AS MUCH AS YOU CAN, but no further than each person’s personal financial limit.

  4. Stop making excuses for not doing the things above.  There is no massive defection happening at companies that are more aggressively cutting headcount and wages.  In fact, there’s substantial anecdotal data that says:
    • When you layoff a big group of people, but then you only cut my salary, you’re actually signaling that I’m valued and you want to keep me.  You’re cutting other people and costs so you CAN keep me. That actually gives me a sense of job security.

    • I know that if you do lay me off, you’re going to give me a decent severance package.  If I go to another company and a week later they shut down my business unit unexpectedly, I’m the last hired and my severance is next to nothing.

    • The unknown is very frightening.  If you’ve been keeping people in the loop on what’s going on and how the layoffs and cuts are going to stabilize things, that’s a psychologically safer place for me to be than a new company where I know nothing but the propaganda I got in the interview.

The bottom line is that when faced with situations we’ve never had to deal with before, bold action is something we avoid because we don’t want to get it wrong.  In this particular case, however, the risk of inaction or insufficient action is MUCH greater than the risk of overreacting.  Everyone knows that old saying, “plan for the worst, hope for the best.”  Well, we’re all hoping for the best. It’s time for those in charge to do their jobs and start planning for the worst.

Understanding Deflation

As with most things, I read a lot of the arrival of deflation and how bad it is.  But no one does a particularly good job of explaining WHY!  I suspect part of the reason is that the “why” doesn’t make for great headlines and that there’s a perception among the media that people either won’t take the time to understand—or can’t understand.  I don’t believe either, so here’s an explanation of WHY deflation is going to be so problematic.


Consider that you are one of the lucky few that can still afford to buy a new car.  You still have your job, your current car is aging, so you figure now is the time.  After all, the automakers are offering screaming deals right now.  That $50,000 BMW you’ve wanted for some time is on sale for $43,000.  Let’s make a deal, you say to the sales guy!


What you just benefited from was a price decrease due to oversupply.  But how do you distinguish between deflation and price decreases?  They’re not the same.

Ever think to yourself that around June it’s time to buy a new PC for the house, or a new DVD player? You say to yourself, “nah, I’ll wait a few months—the price will come down.”  That has been a common phenomenon in consumer electronics for a couple of decades now, but that’s never been the case with much of anything else.  Have you ever said, “I’m going to wait to buy those fish sticks because next week they might be cheaper?”  Of course not, because our general expectation is that the price of just about everything (except electronics) goes up, not down.


So suppose that your expectations changed and you started to figure that the cost of the BMW might come down even more in a few months.  You wait.  And in a few months you see that the price continues to slide—perhaps you wait some more.  After all, why would I pay $43,000 today for something that might cost $42,000 later?  Eventually you make the purchase because your car died, but think about what that waiting does.  Consider what it would do to the price of a house, or just about anything else.  This constant “waiting,” for prices to come down causes consumers to delay or cancel many planned purchases.  Instead of booking your family vacation six months out, you wait—and the fact that the resorts aren’t booked actually causes them to lower their prices even more. As this downward spiral goes on for a while (this is called:  Demand Destruction), more people are laid off and investments decline—this reinforces the problem as the spiral continues.

Over capacity in manufacturing eventually leads to consumer prices at or below production costs.  Because factories have idle capacity, they start to be less concerned with fixed costs and more with variable costs, the largest of which is labor, so reduction in wages becomes inevitable.  Individual or “across the board” wage reductions are becoming more common already, but most people still think they’re temporary.  Only in sectors such as housing, or where union contracts are being negotiated, is it becoming clear to people that their wages are going down just as they go up during deflationary times. Anyone thinking that a wage cut is “temporary” is kidding themselves. Sure, when growth resumes people will again be entitled to cost of living and merit based raises, but it’s not as though wages are going to instantly “jump” back to where they were the day the recession (or depression) is declared over.  We will be starting at a new base.


As demand destruction drives deflationary trends, production destruction is one of the results that follow. Already we’re seeing manufacturing capacity idled.  Ramping back up after a sustained shut down period is a slow process.  Skills have been lost.  Factories sold off.  Supplier capacity to deliver the goods has shrunk.  Already we’re seeing big oil companies pull back on their investment in new drilling or refining capacity, which means future growth, will be more limited than it otherwise would have been.  When things do turn around, the lack of available supply can result in a rapid shortage of goods and services.  Hyperinflation is the risk—not for the reasons people think—not because the government has been printing money, but because the productive capacity we entered this recession with isn’t present when we start to come out of it.  We will need to “grow back” to where we were.  This is one of many reasons the Great Depression dragged on for so long.  But there are many others.


I read a good example today of the food cycle:  Food is an easy example to consider because we’re all consumers. As prices drop, and families become more worried about layoffs, they begin to use the food inventory in the freezer and pantry.  Some don’t even realize they’re doing it—they’re just being a little stingier, sometimes unconsciously, at the grocery store.  Everything gets used, even the old cans of tomato paste, half-eaten boxes of cereal, and the fish sticks in the back of the freezer.  The rapid reduction in sales causes the grocery store to cancel or severely reduce orders to restock.  The elimination in orders cause the food processing companies to lay off workers and idle plants.  With no demand from those processing plants, farmers and ranchers curtail future production: for example if corn is not selling, then fewer acres will be planted and less fertilizer used (leading to a destruction of the ability to produce fertilizer); if chickens are not selling, or the price keeps dropping, fewer will be kept to produce, instead most will be sold or eaten. This effect is compounded by livestock sold and acres unplanted due to bankruptcies. Commodity futures are likely to exacerbate this effect.  By the time inventory at the consumer, retailer, and wholesaler levels have been depleted and demand returns to the vital minimum, the supply deficit may take more than a year to correct, since the fields are not planted and the brood stock has been sold off.  At this point, people become acutely aware that no amount of money can correct the gap between what is required to feed people and what is available.


Exacerbating the problem is that we’ve never experienced deflation in such a heavily (or even moderately) leveraged economy.  While prices and wages are coming down, anyone with a loan outstanding is still stuck paying yesterday’s price for their goods. The one thing that doesn’t come down during deflation is the principle on money you’ve already borrowed.  Thus, as wages for homeowners or profits for business are coming down, the burden of repaying past debt becomes even heavier.  Similarly, the ability to refinance debt becomes all but impossible.  In tough times of the past, the one kind of lending that was sustainable was asset backed loans. Whether it’s your house, office building, or farm equipment; borrowing against assets has never been severely limited.  But in deflationary times, the lender knows the values of the assets you’re trying to borrow against are likely to come down, so their willingness to lend against those assets is much more limited.  And even things like credit scores mean less—what good is a high credit score if you’re at as much risk as everyone else of losing your job and being out of work for a year?


Deflation can and will have a horrible impact on the economy.  And if we experience any real or sustained deflation, it will be yet another sign that we’re in for a depression that will last many years.


Those who survive are not going to be the ones that simply hunker down.  Financial survival is going to require making smart sacrifices—early. And it’s going to mean getting creative.  New value propositions, new ways of getting to customers, and new ways of managing business are going to emerge over the next couple of years.  We’re about to experience the most incredible period of business model innovation the world has ever seen in such a short period of time.  The key, of course, is figuring out how to be a participant, not a spectator.  The key is becoming an innovator yourself!