Tuesday, February 27, 2007

McKinsey, Global Trends in Energy

This excellent article is subtitled "Energy and materials companies face a demanding future." They must start preparing for it now.

McKinsey Consulting have written a new entry in their "Energy, Resources, Materials: Strategy Analysis" entitled "Global Trends in Energy". Noting that we face a rather disruptive decade in which

"change and uncertainty as a combination of six macroeconomic, social, and business trends reshapes the competitive landscape."
"executives in these sectors will have to confront difficult strategic, organizational, operational, and technological choices".
I would certainly subscribe to these points and would boldly suggest the place to do that is here on this blog and the time is now.

The six macroeconomic trends include:
  • Booming demand for energy.
  • Basic materials resources.
  • Shifting of supplies to remote and geopolitical unstable locations.
  • Heightened security of the environmental effects of production.
  • Consumption of energy and materials.
  • Increasingly large capital investments needs at a time of regulatory uncertainty.

Such is the challenge we face today. This list accurately reflects MIT President' Professor Susan Hockfield comment that energy is now in what she considers a "perfect storm". Outside of World War II, I can't think of a more difficult time for the energy industry. McKinsey goes on to suggest
"Recently, McKinsey sought to identify the trends that will make the world of 2015 a very different place to do business from the world of today. In all, we identified ten of them: macroeconomic trends that will transform the global economy, social and environmental trends that will change the way people live and work, and business and industry trends that will generate new management approaches and business models. All ten will affect the energy and materials sectors to a certain extent, but we believe that six will shape their future and therefore deserve special attention."
In the area of human resources McKinsey defines a particular point about the demand for petroleum engineers;
"In the oil industry, the demand for petroleum engineers and development engineers could almost double over the next decade, and the hunt for scarce reserves will place commercial deal makers in high demand. It is a matter of concern that a shortage of experienced project managers who can handle complex capital projects (such as oil platforms or pipelines) may create bottle-necks that will determine whether multibillion dollar projects are finished on time and on budget."
A comment that I have made repeatedly in this blog regarding the increased volume of work necessary for each barrel of oil will increase, not decrease. The earth scientists and engineers are critical to the discovery and production of oil and gas. McKinsey closes the discussion with the excellent point;
"Executives who wish to exploit these trends must keep a watchful eye on them and be ready to respond swiftly to their implications."
And as McKinsey note in the above subtitle, the time is now. The scope of this problem is large and quite well quantified by their projection that $4.3 trillion dollars in capital expenditures from 2005 to 2030 will be needed for oil alone. In a related article, "Making the most of the world's energy resource" Mckinsey states
"New research... reveals that global energy demand is on a path to grow by 2.2 percent a year over the next 15 years."
The demand for energy has never been higher. The energy industry has never disappointed the market, and I don't expect them to do so now. Industry must organize themselves for these challenges and renew their focus on speed and innovativeness within their organizations. I agree the time is now and the place to start organizing is here, with this blogs software developments.

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Sunday, February 25, 2007

Scale without Mass: Business Process Replication and Industry Dynamics.

Written by;

Erik Brynjolfsson, MIT Sloan School

Andrew McAfee, Harvard Business School

Micheal Sorell, Harvard Business School

Feng Zhu, Harvard Business School

August 29, 2006

This is the first of two articles I noted earlier, that Professor Andrew McAfee co-authored. As I also indicated he writes a blog that provides some value to the entire Enterprise 2.0 term that he originally coined. I find the title they have chosen here resonates with the work we are doing here. However the title makes it is difficult to discern what they are talking about. The idea that software can be reused to replicate successful business processes across industries without the mass that would generally be involved in populating the industry with the new idea. Simply software Scales without Mass.

Application of Enterprise 2.0 principles indicates the use of Web Services. I tend to think that Web Services encompasses all the transaction processing and social network systems used within a commercial enterprise. The scope of the application that we are building is this, with the upstream energy industry as its focus the separation of the transaction processing from the content management components is not desired or functional. The two need to be available simultaneously, such that the users decisions, actions and directions are followed through on the transaction processing side of the system. I would hesitate to guess that I would be in disagreement with the authors in that I would suggest the scope of an Enterprise 2.0 application consists of more then their definition.

The authors start off with a number of case studies that they use in this research working paper. This is where I digress from their Enterprise 2.0 classification. My suggestion would be that there doesn't currently exist an Enterprise 2.0 platform operational today. The wiki's and blogs that are part of both of our definitions are possibly the limit of their case research. Nonetheless this has substantial value for review and comment in this blog. Starting off they indicate;

In a series of case studies, we find firms to more rapidly replicate improved business processes throughout an organization, thereby not only increasing productivity but also market share and market value. pp. 1

We find that a positive relationship has existed since the mid - 1990's between an industry's IT intensity and its levels of turbulence and concentration growth. We hypothesis that this is the case because IT has become a means of embedding business innovation, then replicating them across an increasingly large intra-firm "footprint". Today, managers can scale up their process innovations rapidly via technology without the degree of inertia historically associated with larger firms. In other words, they can achieve scale without mass." pp. 2
I have asserted on many occasions that the upstream oil and gas industry has a high level of IT intensity. Since it is now competing on the basis of the earth sciences and engineering, this intensity will increase with the continuation of Moore's Law, and higher volumes of processors being manufactured. Denoting a golden era of abundance of processing at continually cheaper rates. Irrespective of the future processing capabilities the oil and gas firms. The industry has spent heavily in these science areas and will continue to do so. The golden era of processing power will also provide the commercial side of the energy business with new opportunities and activities that McAfee et al are discussing in this paper. If an industry's "IT intensity leads to turbulence and concentration growth" as the authors suggest then those that are able to acquire these resources and skills have secured new and expanding competitive advantages. These competitive advantages are the purpose of this development project discussed here. The faster the processes are developed, the quicker they can be rolled out to those that are able to use them. McAfee's point here is that software can scale quickly without the mass and inertia that many have grown accustomed too over the past twenty years.
When a software engineer improves a sorting algorithm in an database management program, a digital copy of that improved process can be instantly copied and included in thousands or even millions of copies of the next release of that program. pp. 4
"It is easy to see the power of replication in these purely digital domains. But economic impacts also derive from business process changes that involve technology, people and physical products. pp. 4
IT can also assist with the propagation of other types of innovation; technologies such as email, instant messaging, groupware, information portals, blogs and wikis let employees share information and ideas widely and, in many cases generate them collaboratively. Like Enterprise Information Technology (EIT), these technologies are also tools for replicating valuable business innovation, albeit ones that are less formal or structured than entire processes. pp. 6
It is important to note that business process replication is perfectly consistent with decentralized decision rights, and with local innovation. In many cases, the myriad small innovations and improvements generated by line employees are collectively more important that any centrally conceived business process changes. pp. 7
Even with EIT, process replication can be difficult. Commercial EIT and the Internet have lowered many technical barriers, but other impediments exist. Business process design and deployment is organizationally challenging, as is the imposition of greater monitoring.
Across these investigations, a consensus emerges that the observed failures have organizational root causes, not technical or budgetary ones. As one review of the literature concluded, "...extant empirical research supports the assertion that economic and technical considerations are unlikely to feature prominently when IT fails to deliver." (McDonagh 2001). pp. 7
"Organizational root causes." Thankfully the energy industry has determined the Joint Operating Committee is their key organizational construct. This alleviates them from the onerous task that many industries will now conduct to determine what their optimal structures are. However, this does not relieve the energy industry from some serious pain nonetheless.
As difficult as intra-firm propagation of novel business processes can be, propagating them across firms is typically far more challenging. The process configuration that works well in one firm might not transfer well to one with a different culture, set of pre-existing routine, mix of incentive, asset base, and approach to human resources. Empirical research show that many beneficial managerial practices are not universally diffused across firms (Bloom and Van Reenen 2005) and highlights the importance of complementarities in explaining the difficulty of diffusion (Ichiowski et al. 1997)
This work suggests that the boundary of the firm is a significant barrier to the diffusion of IT-enabled work changes. This conclusion is supported by research on the heterogeneity of workplace reorganizations in the presence of IT (Bresnahan et al. 2002) and by research that reveals large differences in firm - level outcomes such as productivity growth even after controlling for IT investment (Brynjolfsson and Hitt 2000). pp. 8
First, the theory asserts that while knowledge is non-rival, it is at least somewhat excludable (Romer 1990). That is, trade secrets, path dependence, intellectual property protection, and other mechanisms combine to give the generator of new knowledge the ability to at least partially exclude others from its benefits. Second, new growth theory maintains that knowledge based competition tends to become monopolistic over time (Romer 1992). Increasing returns to knowledge, a cornerstone of new growth theory, implies that leading firms will build up significant advantages over their rivals such that they become monopolies. This idea is consistent with the insight that information itself can create economies of scale because of its relative ease of replication (Wilson 1975). Monopolies are not eternal, however, because of a third stylized fact labeled "creative destruction" by Joseph Schumpeter. Competitive equilibria are repeatedly disturbed by innovation and new knowledge; consequently, new ways of working displace old ones. Outcomes and end states, as a result, become very difficult to predict (Romer 1994, Arthur 1996). One result that can be anticipated is that, as competition revolves increasingly around knowledge, Schumpeterian creative destruction becomes increasingly pronounced. pp. 9
We argue, however, that IT-based capabilities such as business process replication and standardization, monitoring, and remote collaboration are just as likely to be beneficial to larger firms.
This hypothesis is consistent with White's speculation that "Improved technologies of managing and monitoring may have helped overcome the inherent difficulties of managing larger organizations (Williamson 1967) and thus encouraged larger enterprises" (White 2002).
Our broad hypothesis is that because the capabilities IT delivers are valuable, difficult to acquire, and often transient, IT in recent years has become the opposite of a competitive leveler, or a "cost of business that must be paid by all but provides distinction to none" (Carr 2003). pp. 10
This suggests that assets and people are all the same. Which of course is not the case. How a firm, a producer and an individual would approach the Genesys application in this context would be different in terms of their needs, skills and capabilities. I can assure you that they manner in which I use Goolge would be fundamentally different then what most people understand of the resource. I would further refute that a homogenization is progressively more difficult to carry out for sophisticated tasks. As the hardware and software concepts increase in complexity, and their speed of implementation provides those that are aware and can accommodate them, can and will accelerate their business position over those that are not as quick.
That is, the volatility of market shares increase as the total IT stock in the industry increases. pp. 12
As a result, firms are able to more rapidly and completely replicate their innovations in business processes, achieving scale without mass. Other types of IT, such as email, knowledge management systems, wikis, and instant messaging allow firms to propagate innovation that are less structured than entire business processes (McAfee 2006). IT makes it possible for better techniques and processes to become rapidly known and adopted throughout the organization. pp. 19
We show through a formal model how this process can lead to increased turbulence and concentration. In particular, competition becomes increasingly Schumpeterian as innovators are able to leverage their best practices to rapidly gain market share. At the same time, competitors and new entrants have the opportunity to more rapidly leap-frog and displace leading firms. Our model is consistent not only with the increase in productivity growth since the mid-1990's but also with the higher levels of turbulence. Furthermore, as predicted by our model, concentration levels have also increased in IT intensive industries, an outcome that is not consistent with other explanations for higher turbulence. pp.19
Further research could also help determine the duration of IT's competitive impact. pp. 20
Professor Sydney Winter had some additional comments that are in the vein of what these authors are discussing. The document is the Economics of Strategic Opportunity and these following quotations provide some guidance regarding the homogenization of an industry. (Italics for emphasis.)
The resource allocation decisions that shape the path of advancing knowledge are necessarily made, at each point of the path, on the basis of the limited knowledge then available. Surveying available knowledge from such a vantage point is like surveying a landscape on a hazy day. Some things are close enough to be seen clearly, other remote enough to be totally invisible. The intermediate conditions cover a broad range and are complex to describe. In that range, the verdict on the visibility of a particular feature depends crucially on what definition of "visible" is chosen from a range of plausible alternative. Similarly, whether something is to be regarded as "known" or not will often depend on what one chooses to mean by "known" and why one cares; ultimately it depends on the degree of indefiniteness concerning details that is regarded as consistent with the thing being "known".
Visibility across the landscape of productive knowledge is arguably an even more complex phenomenon than ordinary visibility. A particularly complex type of haze arise from the fact that, in all sphere, practical knowledge consists in large measure of knowledge of how to try to find solutions to problems that have not previously been encountered. pp. 19
Thus, decisions near the knowledge frontier are made in the face of a lot of haziness about the details and significant uncertainty as to how the general picture will develop down the road. ... ...Thus, decisions are made in a haze that arises partly from exogenous constraints, but is partly a chosen response to a recognized trade off between thinking and doing, between analyzing prospects and making progress. pp. 20
There is a substantial theoretical literature on induced innovation, though the attention devoted to it falls far short of what it deserves. Most of it models the problem in a recognizably mainstream style, with a logic that parallels quite closely the standard analysis of choice of technique. This is unfortunate, since it means that the limitations of standard production theory are extended into a domain that could potentially afford an escape from them. Evolutionary modeling in the area has mostly been done incidental to other purposes, and has not been featured in its own right. pp. 22

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Innovation and Talent in the Indian IT industry.

John Hagel III has written many good articles and topics on the effects of IT on organizations. Through his writtings he has also introduced us to many other good authors like Professor Richard Langlois'. Today Hagel has posted a great blog entry that accurately captures some of the technical risk that I anticipate we will experience here in the oil and gas industry. The conclusion he comes to at an Indian IT conference reinforces the division of labor theories of Adam Smith. I had noted the number of individuals that were involved in drilling a well, from the Chairman of the Joint Operating Committee to the billing clerk at the water trucking company would expand in their numbers to facilitate faster and more abundant and effective economic output. Hagel states the same thing for business in general and states that the Indian development community will need to address this problem. His conclusion is stated here;

These efforts in turn would expose the Indian IT service companies to the challenges of coordinating activities across large networks of partners given existing IT architectures. By gaining firsthand experience in the limitations of these architectures, Indian IT service companies would be well-positioned to drive another wave of innovation in IT architectures. In my talk on Web 2.0 at NASSCOM, I suggested that Indian IT service companies are natural candidates to define and deploy fundamentally new IT architectures that work from the “outside-in”.
In contrast to traditional IT architectures that emerged in the center of the firm and imperfectly extend their reach beyond the boundaries of individual enterprises, we are in desperate need of IT architectures that start with the assumption that the task is to coordinate activities across hundreds, if not thousands of firms. By starting with this perspective, we would need to re-think the nature of transactions and define roles and governance processes accordingly. In fact, we would likely move from today’s transactional architectures to much more helpful relational architectures designed to support enduring and deepening relationships across individuals and institutions.
I think in order to achieve this there needs to be a Military Styled Command and Control structure to replace the hierarchy. One that provides the flexibility of many firms working together to achieve common objectives. Flexibility to have staff of all the associated firms with the knowledge of who conducts what and at what level of authority. This intermixing can then, and only then achieve the types of results that we are all seeking here.

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Friday, February 23, 2007

The Economics of Strategic Opportunity

Authored by;

Jereker Denrell, Institute of International Business,
Christina Fang, Department of Management The Wharton School and
Professor Sidney G. Winter, Department of Management The Wharton School.

February 2003.

Continuing on with the review of the LEM Working Paper series, Winter et al wrote "The Economics of Strategic Opportunity" to address the interesting topic of how strategic opportunities arise. This article has many worthwhile points and is available here. During July 2006 I also wrote a blog entry on a similar topic from Harvard Business School Working Knowledge series. Review of these three articles is highly recommended.

Winter et al start off their working paper by noting that the ability to earn exceptional returns is contrary to what is assumed to be the instance in business. The Efficient Market Hypothesis assumes that all knowledge is available to all. In the Abstract they write;

"As emphasized by Barney (1986), any explanation of superior profitability must account for why the resources supporting such profitability could have been acquired for a price below their rent generating capacity. Building upon the literature in economics on coordination failures and incomplete markets, we suggest a framework for analyzing such strategic factor market inefficiencies. Our point of departure is that a strategic opportunity exists whenever prices fail to reflect the value of a resource's best use. this paper examines the challenges of imputing a resource's value in the absence of explicit price guidance and suggests the likely characteristics or strategic opportunities. Our framework also suggests that the discovery of strategic opportunity is often a matter of "serendipity" and access to relevant idiosyncratic resources. This latter observation provides prescriptive advice, although the analysis also explains why more detailed guidance has to be firm specific." Abstract
In energy I have seen many people who assume their role and responsibility is to spend the money on exploration and development. The inexperienced assume that the act of doing is all that is required. These people stay in business for the approximate same period of time they have a positive cash balance. On the other hand, I have seen how individuals who are given an opportunity and struggle to lay in wait for the right time, develop sophisticated business strategies, engineering or geophysical ideas that can only be proven through a methodical and painstaking process. A process they have learned through several decades of experience and study. Needless to say, the latter groups are far more successful in any type of financial metric comparison to the former.

I have also written about the reckless acquisitions some CEO's pursue and am reminded of Carly Finorina's failed attempt to acquire PriceWaterhouse Coopers technology group for $19 billion. And the subsequent purchase of these same assets a year later by Lou Gerstner at IBM for $3 billion. Is this luck that provides these people with their enhanced returns? Anyone can spend money, and the amount of money available for any transaction is truly unlimited. Self delusion comes into play and a contagious enthusiasm for the failed theory can support any size of investment or any size bank loan. Because the banker has provided you with the resources to purchase a house, doesn't mean that you do it. How the Efficient Market Hypothesis fails is somewhat based on the discussion that Winter et al write about in this article.

1. Introduction
"Barney sets forth what might be called the "bad news" about resource valuation: in general it is difficult to purchase things for less than they are worth. The interests of both the seller and rivals should stand in the way of such an accomplishment. This paper sets forth the good news about resource valuation: our stance is that "the good news is that the bad news is wrong". (Or at least, the bad news is valid only within it proper sphere.)" pp. 1
"Whether the opportunities seen are actually seized is, however, an important question. We argue that the discovery of a valuable strategic opportunity is often a matter of "serendipity" in the strict sense - not just luck, but effort and luck joined by alertness and flexibility." pp. 1
"To appreciate these points it is necessary to break out of the equilibrium mindset that dominates so much of economic theory - including, of course, the Efficient Market Hypothesis (EMH)". pp. 1
I would also ask how much does time play in making the superior returns. If one is to compete on assets based on the EMH, with its staunch believers, one will be forced to acquire the assets they need at or near the market top. The timing, effort and finding yourself going against the grain are the keys to long term success and exceptional returns. As in my case on this project, I have kept the powder dry and the candle lit and have waited for the puck to arrive, as Wayne Gretzky would say. Now that the puck has landed on my stick, it would take a significant amount of money to purchase a similar strategic opportunity / position / asset. My costs are marginal.

2. Some Fundamentals
"Financial performance and profitability. In the strategic management literature, business success is generally equated with financial performance, and financial performance with "sustained abnormal profitability". pp. 2
And here is the key to a long term competitive financial performance. If the cost of the asset is overpriced at the time of acquisition, the amortization of the assets cost over the life of asset / business will consistently lower the returns realized. Winter et al take this concept further with the following;
"Our view is that net present value - or expected net present value, where risk is involved - is the basic measure of success in the quest for strategic opportunity. It is "basic" in the sense that it stands at the limit set by Einstein's famous dictum that "everything should be made as simple as possible, but not simpler." It is possible to employ more general or sophisticated measures that NPV, and to invoke NPV in more sophisticated ways. It is difficult to make basic economic sense with a simpler analytical apparatus than the NPV concept provides. Hence, our discussion of "strategic opportunity" relates to opportunities for positive NPV undertakings, with merit understood to be measured by the amount of NPV." pp. 3
"In this "basic" economic approach, we set aside some considerations, such as organizational survival, which might make something other than the NPV of an isolated opportunity matter to management. We also set aside more important complications associated with the long term interdependency among opportunities that arise from, and affect the development of, the same set of underlying capabilities and competences." pp. 3
The importance of this discussion is of particular interest in the energy industry. The reason is that almost all metrics of valuation of what is "real" are subjective. As I stated before the costs can be comprised and reflect only the ability to spend money. That does not find or produce oil and gas. Intellectual property is the key asset of an oil and gas firm. The producers capability and capacity to find and produce energy is the key metric. How to value something that is in the ground with many possibles and probables are unknown. What one man sees as garbage, another may see is gold. The subjective nature of the industry leaves the cost based measurements as meaningless. NPV when compared to these historical cost metrics will provide the superior returns that an effective management team provides.
"These consideration do not, of course, rule out a purely cost-based approach to valuation. With some effort it is possible to measure the investment involved in the creation of a particular complex resource, although the result is partly determined by luck. Cost data, however, clearly cannot answer by themselves the question of what the resource is worth. The demand side information is missing." pp. 4
3. Market Completeness and Strategic Search

Not to harp on the theme of the plodding along approach is the better method. The experience of the management staff that are able to "plod" along generally know that they are in a long term battle with the market. A battle for the type of results they know that they can achieve, and at less cost (and higher returns) then other methods. This model of business development is borne of a significant period of understanding and education in essentially the school of hard knocks. This struggle continues unabated irrespective of the monetary success that is achieved. These authors appear to be commenting about what the majority of successful companies have experienced.
"In summary, a realistic appraisal of market systems compels recognition that markets are incomplete, and drastically so in the domain of currently untried activities. As a result, since the value of existing activities may depend on untried activities, it cannot be guaranteed that existing activities are priced correctly. Thus when markets are incomplete, the prices prevailing in an apparent equilibrium do not preclude the existence of valuable unexploited opportunities. To exclude strategic arbitrage, a much stronger condition than market-clearing prices is necessary - we might call it "exhaustive entrepreneurship." It would have to be that for each good, traded or un-traded, there has to be someone who has considered the value of this good in all possible uses. As discussed in the next section, such a condition imposes a massively implausible information requirement on the actors in the system. Moreover, although actors can probably learn to identify the value of some of these resources, we argue that the local and decentralized character of the learning process implies that certain strategic opportunities are likely to remain. The challenges of the learning process also suggest some clues about the likely characteristics of such remaining opportunities." pp. 6
Or, in other words, irrespective of the market dynamics and the quality of the NPV, the strategic opportunities exist despite the market successes and failures. If a market participant eliminates themselves from the game before he / she even tries, then he / she will have lost for certain.

4. Valuation of Complex Resources: The Challenge of Imputation.

When I think of Google, I think of the resource that it provides me. I have 7,000 of maybe the smartest and most competent development and business people, and possibly the top 50 super computers all working actively to provide me with better processed information. A level of, essentially, artificial intelligence that has never before even been imagined. The dynamic that these Google resources provides everyone in business will allow generations of prosperous entrepreneurs. And that is maybe the point, Google's resources are available to everyone and to not use them at their optimal level eliminates you from the business environment of tomorrow.

On the other hand, how the structured hierarchy exists in this environment is of question. If individuals are provided with these opportunities in a fast pace economy, how can the structured hierarchy prosper? It would be my assertion, the longer that businesses exists under the structure of the hierarchy, the harder the change will become and the greater risk of total loss increases. These risks being the market dynamic that Winter et al are heading toward.
"To be capable of accurate calculation of this sort, an entrepreneur would require not only vast computational capacity but, more important, extensive knowledge of the transformation that are possible in the economy. Obviously, in many cases, individuals do not have immediate access to this knowledge. This raises the important question of how resources are valued in incomplete markets. In particular, when and for what types of resources can economic agents, on the basis of search and learning from experience, determine the value of resources and thus the basis of search and learning from experience, determine the value of resources and thus recognize any arbitrage opportunities? Formulated differently: when will the condition of "exhaustive entrepreneurship" be satisfied? Formally, this learning challenge is equivalent to the problems of learning to identify the value function of a large dynamic programming problem without initial knowledge of the set of possible transitions or the costs and rewards associated with each transition." pp. 8
In a nutshell the number and volume of arbitrage opportunities is incalculable. The time to be an entrepreneur and apply these principles exist as in no time in the history of mankind.

5. The Character of Strategic Opportunity.

The Architecture of Strategic Opportunities.

Staying with the way that Google does its business, if we look at this weeks announcement of Google Apps for your Domain, these products provide completely different metrics for the computer user. Microsoft Office has had its way with this market since it dispatched Lotus and Word Perfect to the scrapheap. Now they find that Google Apps will be offered at a fraction of Microsoft's prices. This is the heart and soul of Microsoft's revenues and profits. If at the same time Microsoft experiences similar difficulties on the operating system market. Say if Apple were to provide a better product for far cheaper. Microsoft would have effectively lost the lion share of their revenue and the profits will disappear in rapid fashion. Google has now effectively done this by becoming the worlds largest advertising firm. A business model that is far more resilient and valuable then Microsoft's, in my opinion.

Many might say that Google has been lucky, and there would be general agreement that it was. It is now ten years into their existence and they now have new revenue being generated through the sale of their software and services. One that strikes deeply into the competitive framework of Microsoft and provides better value to the consumer. How could someone be so bold, be so farsighted and be that smart. Well in my opinion Google is, and they got there on the basis of Winter et al's discussion here.
"Based on the above discussion of market incompleteness and the challenge of imputation, it is possible to say something about when and for what type of resources strategic opportunities may be located. As emphasized by Shleifer (2000), any systematic theory of market inefficiency, which simultaneously acknowledges the competitive forces that push markets towards efficiency, needs to answer when and why inefficiencies can occur and remain in the presence of competitive forces and the search for arbitrage opportunities." pp. 9
"The above arguments suggest that part of the answer lies in the complex, combinatorial, character of strategic opportunities. Specifically, it is unlikely that a valuable strategic opportunity can be seized simply by trading in existing resources. It is much more likely that a strategic opportunity can be found if the strategy involves trading in resources whose values are contingent upon one or several other resources being used in a new or different way, including the creation of novel types of complex resources. Unless several other actors have already recognized the opportunity and acted, resource values will not be aligned with the new uses. If these other resources are of an entirely different character or used by a completely different set of firms, identifying such an opportunity can be very challenging. Thus, there can be no presumption that this has already occurred." pp. 10
It is not to say that driving a truck through Microsoft's Office revenues and profits is something that was not considered by many. It is the foresight to see these opportunities and build, over the long term the solution that is necessary. Trading stocks based on the Efficient Market Hypothesis is a fools game, not a business. Building a business with customers and revenues and profits is a long term fight that can only be secured in the discovery of the strategic opportunities that Winter discusses here.
"This does not imply, however, that it would necessarily take a heroic effort to identify such opportunities. If a firm has preferential access to the missing piece of the puzzle, identifying the opportunity might be easy. In general, firms can be expected to differ considerably in the information they possess, even in the absence of deliberate effort to create the sorts of informational advantages that Barney referred to. Such differences in information - and differences in complementary assets - typically imply differences in positioning relative to new opportunities. Thus, in contrast to financial markets where blatant arbitrage opportunities are rare, we submit that the discovery of strategic opportunities is a normal occurrence in the product markets." pp. 10
"As emphasized above, in such situations, strategic opportunities are possible, although not guaranteed. Restated in this way, the argument of Dierickx and Cool suggests a class of resources whose values are very difficult to identify and thus could represent a strategic opportunity." pp. 10
"While such examples of accidental discovery may seem to be unlikely, we argue that the character of strategic opportunities implies that they should be expected in accounts of business success. More precisely, we argue that given that a strategic opportunity is only first discovered after some time, the discovery of this strategic opportunity is likely to have been serendipitous." pp. 11
Serendipity, as I mentioned in July of last year is a good thing. With this project coming up on it's 15th year in May, I have struggled in defining what it is I was trying to do. I started on the basis of the fresh knowledge that the Alberta Governments "Royalty Simplification" initiative would be the opportunity to provide the market place with new and better applications. I quickly promoted Oracle into following my lead and we partnered up. They decided to rename the product Oracle Energy and I was left with relatively angry shareholders. Along came PriceWaterhouse who was unhappy with their partner for Oil and Gas and we had a new deal almost right away. However, Coopers and Lybrand owned Qbyte, the market leader, and their merger with Price Waterhouse left me out of business to say the least. Stumbling as I did into what the optimal organizational structure for oil and gas was the consummate definition of serendipity.

I think that Winter et al are on to something here. I want to go back to an entry that I made late last year about Abraham Lincoln. Ralph Waldo Emerson said something in his eulogy that strikes me as incremental to what Winter et al have been able to state. The quotation is...
"The ancients believed in a serene and beautiful Genius which ruled in the affairs of nations; which, with a slow but stern justice, carried for-ward the fortunes of certain chosen houses, weeding out single offenders or offending families, and securing at last the firm prosperity of the favorites of Heaven. It was too narrow a view of the Eternal Nemesis. There is a serene Providence which rules the fate of nations, which makes little account of time, little of one generation or race, makes no account of disasters, conquers alike by what is called defeat or by what is called victory, thrusts aside enemy and obstruction, crushes everything immoral as in-human, and obtains the ultimate triumph of the best race by the sacrifice of everything which resists the moral laws of the world.' It makes its own instruments, creates the man for the time, trains him in poverty, inspires his genius, and arms him for his task. It has given every race its own talent, and ordains that only that race which combines perfectly with the virtues of all shall endure."
Words to live by. Winter et al take much of this point and clarify it and categorize it in the following:
"Rather, it is likely that the necessary subsystems were only available to or considered valuable by the firm that discovered the opportunity. There are, at least, four possible reasons for this. First, only this firm had the strategic insight into the eventual value of these subsystems. Second, by deviating from existing practice, only this firm had the complementary set of activities that made these subsystems valuable. Third, this firm is "pre-adapted"; it was endowed with the subsystems by its previous history, for reasons unrelated to their application in the new opportunity (Cattani, 2002). Fourth, this firm made a mistake and thought that these subsystems were valuable by themselves even if all reasonable firms would agree that they were not. Although all of these reasons are possible, we suggest that the complex character of the strategic opportunity makes the first reason less likely than the others. Furthermore, although mistakes are not uncommon, we would argue that the second reason and third reasons are the most important." pp. 11

"Overall, this argument suggests that strategy process leading up to the discovery of a strategic opportunity is likely to have had the following characteristics. By deviating from existing practices, perhaps by intentionally choosing an unusual strategy or by necessity due to a lack of resources required to compete in the established manner, a firm develops a set of idiosyncratic resources. Although perhaps not very valuable by themselves, these resources could be used profitably in combination with other resources. By being the only firm with access to these components the firm is thus much more likely to discover the value of this combination." pp. 12

"In a similar way, when a firm has assembled many of the necessary components, it may be able to see that these resources could be valuable if complemented with some others. As a result, the search for the last components will be intentional rather than serendipitous."
The word entrepreneur means a lot of things to a lot of people. Generally it is considered a favourable term and one that is used by most people who do not describe themselves as one. It is not something that one can pick up a book and read about how to become an entrepreneur. It is not something that a college or university can teach. It is something that drives the person to continue the pursuit, irrespective of the costs and consequences. It is a drive to complete some part of their life that is well defined in this paper of Winters. To say that Entrepreneur's are different would be an understatement.
"This characterization also suggests that there may be little to learn from examining the strategic process of successful firms. At least for firms that discovered path - breaking strategic opportunities it is likely that they deviated from established practice by necessity or mistake rather than as part of a plan. To assemble the components required for spotting a path -breaking strategic opportunity, a firm needs to have assembled several components that individually are believed to be of little value. As a result, the firm needs to engage in an unusual amount of exploration. To be motivated to do so, a firm may need to be forced to adopt some of the elements or may need to adopt them by mistake (Denrell and March 2001). If this is so, the strategic opportunities of the most successful firms are likely to have developed through a process that it would be unwise to try." pp. 12
To close out this entry, I want to say this paper really resonates with me and the life that I have lived for the past 15 years. It is a tough and difficult struggle, but one that has defined me as Emerson said. These last few paragraph's display for me that the writers clearly have captured the essence of being an entrepreneur and related it well in these final words.
"...being the first in the know may enable an entrepreneur to create limits to post competition. Thus in this sense, ex post limits to competition may be a direct outcome of ex-ante limits to competition. Several examples of such situations have been outlined in the literature, including investments in over capacity to deter entrants (Dixit 1980) and tying up favorable locations and suppliers (Porter 1980)." pp. 14
"Although this analysis implies that detailed strategic guidance is necessarily specific to the firm and its situation, the notion of serendipity does have some general prescriptive force. While good luck may befall the inert or lazy, serendipitous discovery occurs only in the course of an energetic quest - a quest in which lucky discoveries of an unanticipated kind can be recognized through alertness and then flexiblly exploited." pp. 14
"This perspective on strategy is consistent with a large and growing body of evidence on the relationship of firm attributes to their entry decisions, innovations and other strategic moves, much of it recently reviewed by Helfat and Lieverman (2002) (see also Usselman 1993, Klepper and Simons 2000) In general the evidence shows that opportunities are specific and firms that seize them are usually specifically prepared for them by their "pre-history". This mechanism is the counterpart of "pre-adaptation" in biologic evolution (Cattani 2002). Our perspective is also well aligned with the discussion by (Sarasvathy 2001) about the characteristics of the thought process used by entrepreneurs. Using verbal protocols from experienced entrepreneurs faced with a hypothetical venture problem, Sarasvathy (2001) demonstrated that the thought process of entrepreneurs is more likely to start from the givens of a situation and to proceed by investigating the possible effects and market opportunities that could be created with these means. Goal directed thinking, which a market opportunity was identified at first and the means to achieve directed thinking, in which a market opportunity was identified at first and the means to achieve this opportunity were discussed later, was much less frequent." pp. 15
"The challenge of strategy is the challenge of assessing the opportunities that open to an idiosyncratically positioned actor in a changing environment. For this, the challenge of stock picking provides a poor analogy, because in the context actor idiosyncrasy plays a much smaller role. This assessment is clearly consistent with the central tenets of the RBV, but not with the discouraging words sometimes about resource pricing." pp. 15
Photo: Getty Museum by Troels

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Monday, February 19, 2007

Towards an Evolutionary Theory of Production Part B

In Part A of this secondary research review of Professor Winter's document. Winter raised two important points that provide companies with the opportunities, risks and rewards involved in the theory of production. The two key points were firstly, the production set of possibilities, and secondly the development and deployment of that knowledge. Suggesting that the production methods employed and operational today were based on the less then optimal choices. Winter suggests that today provides an opportune time to revisit the "evolution of production" and I concur.

There are some nasty pitfalls documented by Professor Winter in Part A of this document review. The software being built here for the oil and gas industry must avoid these pitfalls. But, also provide a production set of possibilities and opportunities for the producer to select the optimal solution for the situation at hand. Part B of this paper will discuss Winter's theories on "replication". Or how to deploy the optimal production process across the organization.

3. Replication
Thus, if management wishes to replicate at B the success it is having at A, a first challenge it faces is to devise methods to evoke the transfer of details of which it is unaware, including some of which nobody is aware, and some that represent information that is in various ways "impacted". This is a tall order that can never be filled completely; the gaps in the transfer will be filled by independent re-invention.
It is at this point I need to ask whom does "own" the "production set" of possibilities? Does a specific company or team of individuals? No one? Whom can effectively aggregate, develop and deploy the production set of possibilities. The competitive differentiating factors of the producer are based on its scientific capability, innovativeness and land base. These form what John Seeley Brown and John Hagel classified as an Innovation Management business. A new classification of either Innovation, Infrastructure or Customer Management would apply to all businesses within an industry. I find these theories resonate with my perception of the future. I see the producer filling the role of innovation, software developers providing the infrastructure and therefore these questions are valid. Who owns the knowledge of the production set of possibilities? Who is in the best position for their development, and whom is also responsible for them?

This ownership issue is a very fine point of conflict that will need to be determined through this software development project. The determination may involve whom provides the best solution to the energy industry. A large portion of these points fall within the domain of intellectual property and specifically, Patents. This topic will be discussed extensively due to the sensitive nature of the conflict. The solution to this issue will need to select the appropriate environment to which area (Innovation or Infrastructure) "should" be responsible for providing the definition of the production set and then replicating it from A to B, C,...
The literature of situated cognition points to the fact that the productive knowledge exercised at A exists in an intimate interconnection with the context of activity at A, both in its designed and coincidental feature. Of particular importance here are the "artefact's," tools and / or equipment used in the work (Hutchins 1995; Hutchins and Klausen 1996). In contemporary work settings, crucially important knowledge is often embedded in the equipment, and the local understanding of its functioning is narrowly instrumental. Computers and software are the most ubiquitous and familiar examples of this issue, but there are "low tech" examples as well. The spatial organization of activity at the micro level affects patterns of interaction and communication, and this can affect outcomes in ways that are not fully recognized or understood. (Bechky 2001). pp. 34
This last quote makes it appear that Winter would site the artefact's of tools, equipment have been the traditional area where the knowledge was embedded. In current times the computers and software "are the most ubiquitous and familiar examples of this issue". Possibly denoting where the analysis of this conflict will lead.
In some cases, top management may be totally unaware of the fact that considerations in these various categories are relevant to success. For example, this is inevitably so for procedural details that have been learned without awareness. In many cases, however, it is fairly obvious that the success of an activity depends in various ways on features of its context. Management may understand very well, for example, that the skills and personalities of employees have considerable bearing on the results achieved. pp. 36
Replication in Practice.

Winter has some particular salient warnings in the following quotations. That management may not take these points in consideration at their peril.
The above discussion suggests that replication is potentially quite challenging. It is not necessarily viewed as such, however. Often, management seem to take quite a relaxed attitude toward such challenges. While the relaxed attitude may be justified in some cases, it is arguable that many managers still have a good deal to learn about the subject. Where special circumstances force the issues to management attention, such as the technological peculiarities of semiconductor production (Intel), or MacDonalds' strategic devotion to a uniform customer experience, we do see managerial practices that are consistent with the general picture offered above. The example of Intel's Copy EXACTLY! policy (McDonald 1998) is particularly valuable because it rests precisely on the recognition that there is more productive knowledge implied in achieved high yields than the organization can capture in the form of comprehensive causal understanding of the method in use. pp. 37
And secondly, the exponential difficulty that is evident when interactions are populated with additional options.
This is not at all the case; the point is to control the amount of new learning and problem solving required. Every decision to create a difference between the sites makes an addition to an invisible list of unintended and hidden differences that will occur in spite of the policy. Interaction effects tend to make complexity rise exponentially with the number of discrepancies to be dealt with; it is better to keep the list as short as possible. There will be no shortage of problems to solve. There are several reasons why the problematic aspects of replication often go unnoticed. A basic one, surely, is that exploiting existing knowledge from the original site is rarely an end in itself. pp. 37

4. Production Theory Evolving

One of the competitive advantages of this software offering that differs from SAP and Oracle is the ability to exercise the fact that the costs of goods sold for the second and subsequent copies of the software is zero. This value is being captured by the Energy Industry in a lower cost offering through this development. Industry pays for the developments once. Then pays the associated costs of supporting and improving the application over its life time. Not each time there is a sale, but once and only once. This is where I would assert that these issues being discussed reside for the betterment of the energy industry. Professor Winter touches on these points with the following and final comments:
That knowledge and information are not exhausted by use in a kind of economic magic, a cheerful exception to the manifold scarcities that give the dismal science its name. pp. 39
To extend the use of existing knowledge in time and space is not at all the trivial matter it is often made out to be. pp. 39
Intra-firm homogeneity of method across establishments is definitely not something that just happens; it is something that happens when managements work hard to achieve it and devote substantial resources to the task. pp. 40

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Sunday, February 18, 2007

Toward an Evolutionary Theory of Production, Part A

Professor Sidney G. Winter, December 2002

With over 2700 words of quotation I am well beyond the fair use doctrine of using Professor Winter's paper. As I mentioned before I will make him whole when I have completed this comprehensive and valuable secondary research. What we have discovered to this point was nicely summarized in the table I published here. The "Production Costs" were assigned to the market with the secondary assignment being to the firm. The topic of discussion at this point is associated with these "Production Costs" however in the form of their interaction and determining the production function. Winter states this nicely in the following quotes, and points to an evolutionary theory of the production process. So the topic of this discussion is deeply related to "Production Costs" although it is more to do with the development of production possibilities based on multiple cost scenarios.
"It should be obvious that evolutionary economics needs to strike quite a different balance. Evolutionary thinking sees questions of production as tightly and reciprocally connected with questions of coordination, organization and incentives. Also, production activity is embedded - now more then ever - in a variety of processes of knowledge creation; theory needs to make room for those links. A major deficiency of the mainstream theory is its isolation from the realities of organizational knowledge. Above all, the evolutionary economy needs theory to address questions of economic change, not the principles of resource allocation in a hypothetical static world." pp. 1
Why we are now discussing the topics of the boundaries of the firm, the Schumpeterian thinking and theory of production is well articulated in Winters argument. What he is essentially saying is the production method chosen may have been selected for other then optimal reasons. That the time frame in which we find ourselves in is an ideal time to readdress these previous decisions, more with an eye to the optimal solution.
"The dominance of the production function apparatus in contemporary mainstream treatments of technological change is also a "Panda's thumb" phenomenon; it reflects the logic of path-dependent evolution (Gould). The apparatus was created and developed for various other reasons, and when questions of technological change came to be confronted it was conveniently available. The inherited apparatus was then extended and supplemented by a variety of formal treatments of technological change, the simplest being the introduction of the multiplicative fact A in the relation Q = Af(x). Negligible attention was paid to the question of whether plausible real-world mechanisms might actually produce knowledge changes with effects that correspond to these formalisms; the formalisms are convenient and hence chosen for reasons other than micro-level verisimilitude. The major investment in building a truly knowledge-based production theory, well-suited to close analysis of the problems of change, was never made. Recently, however, some beginnings have at least been made." pp. 2
Professor Winter provides support for a theory of how the various inputs and outputs of a production process provide an essentially known set of production possibilities. That a production set of possibilities provides a means to provide for a multitude of options in a business. This accurately describes the oil and gas industry. There are many ways to proceed with the drilling and completion of wells, and how the variety of possibilities provides little in terms of a consistent standard manner of interpreting and optimizing production. The scientists and engineers' craft is augmented by the strategic opportunities and issues that the industry face as well. Winter provides this as somewhat of a direction towards a new or "evolutionary theory of the firm".
"It was in introducing this problem that he (Wicksteed 1894 An Essay on the Coordination of the Laws of Distribution) made the notion of the production function explicitly in economic analysis for the first time in the following terms: The Product being a function of the factors of production we have P = f(a, b, c, ...)2. Neither in this statement nor in Wicksteed's subsequent analysis is there any hint that there is anything conceptually problematic about the idea of such a function; it is merely a mathematically explicitly expression of the long familiar idea that if the input quantities vary, the output quantity will vary as well, and in certain characteristic ways." pp. 5

"It is the production set concept that stands, in contemporary formal theory, for the classical idea of a "state of the arts" or for an "existing state of technical knowledge." Arrow and Hahn concisely say"
"Thus the production possibility set is a description of the state of the firms knowledge about the possibilities of transforming commodities."
"To assume that the production set has certain properties - for example, those that correspond to the linear activity analysis model - is thus an indirect way of imputing analogous properties to the "state of knowledge" that the production set describes. I have proposed here that this indirect approach may be understood as a reflection of the historical development of the theory. In the modern synthesis of the subject, production sets are a fundamental concept, production functions are a derived construct, and marginal productivity schedules are an implied attribute of production functions." pp. 9
It is at this point that Professor Winter opens the doors wide on the possibilities of more. What would happen in oil and gas if all the known methods and procedures that were available and could be immediately quantified to determine the optimal route to pursue the optimal production. I am suggesting here that a large collaboration with in the oil and gas industry, through the joint account, in real time, where I have suggested that the industry capability be determined in terms of the whole industry as opposed to the knowledge and understanding that is currently constrained by the individual or silo-ed companies. That this resource is commanded and controlled within the industry to what I have suggested as the Military Styled Command and Control governance structure. But Winter doesn't stop there, he takes it further to suggest that the limits to production knowledge have been constrained over the years. Hence the potential of yielding greater returns is suggested by Winter in;
Thus it happened that it became much easier for the theorist to describe the logical connection between the production set and the production than to explain the substance of what the production set supposedly represents - a state of knowledge. This neglect of the independent conceptual anchoring of the production set idea has inhibited both the recognition of its limitations and the development of alternative and complementary theoretical treatments of productive knowledge. The following section initiates the discussion of such treatments by exploring the central concept itself. pp. 10
2. The Nature of Productive Knowledge

Dr. Winter begins to deal with the human element of organizations as he discusses what an organization knows. The "learning by doing" and "learning by using" covered in my May 2004 publication provides an understanding of how organizations and people obtain tacit knowledge. Learning is a key competitive tool of the oil and gas industry. Next to NASA, the oil and gas industry is the most scientific business there is. The knowledge contained within each company is massive. How this information is managed could have benefits for the industry, particularly at a time when the expected retirements of senior staff is expected in the 5 to 15 year time frame. The following is a series of quotes that offer some salient criticisms and issues for the oil and gas industry.
However, an important implication of the discussion to follow is that a narrow focus on what goes on in human minds can seriously impede understanding what goes on when organizations produce things. That sort of understanding is the true objective here, and the scope of the term "productive knowledge" is therefore deemed to be expandable as necessary to cover whatever needs to be understood. pp. 11
"For engineers, production managers and corporate strategists, the visible face of the validity problem is the question of transferability across time and space. The process worked well today, will it also work well tomorrow? If we build similar facility in a remote location, can we confidently expect that one to work as well? The salience of these questions depends critically on the degree to which the answers seem to be in doubt. When experience seems to confirm the temporal and spatial transferability of the knowledge in use, it quickly acquires a "taken for granted" character. When problems arise, attention is directed to them until they are solved 'for practical purposes." Under both conditions, the judgements made are not those of philosophers or scientists who care about the validity question for its own sake, but of practical people who need to get a job done and have other urgent demands on their attention." pp. 12
Hence the paradox that employees face each day. The motivational and cognitive paradox were discussed in my May 2004 paper. In it, it refers to Dr. Wanda Orlikowski's Model of Technology Structuration which incorporates the motivational and cognitive paradox. Her paper is available on DSpace. We are running the risk of hopping down a bunny trail if we are not careful, however these two paradox are important to refresh our memories.
"Based on extensive studies of user's experience with word processors, Carroll and Rosson (1988) identified two significant paradoxes; The motivational paradox arises from the production bias. That is, users lack the time to learn new applications due to the overwhelming concern for throughput. Their work is hampered by this lack of learning, and consequently productivity suffers. The cognitive paradox has its root in the assimilation bias. People tend to apply what they already know in coping with new situations, and can be bound by the irrelevant and misleading similarities between the old and new situations. This can prevent people from learning and applying new and more effective solutions." (Cox, Delisle 2003)
Professor Winter shifts gears again and immediately begins to discuss the risks of too much change, too many changes without the full recognition of the processes in operation.
While modern thinking may dismiss some beliefs and related practices as plainly superstitious and others as ill-founded, the line between superstition and practical knowledge is oftentimes difficult to draw. pp. 13
A striking and well documented example of the issues concerns the role of the water temples in the irrigated rice agriculture of Bali. In the traditional system that had developed over a period of more that a thousand years, the allocation of water among hundreds of farming communities was governed by the priests of the water temples. The temple system was responsive to the variation of rainfall by elevation, seasonally, and from year to year. Implicitly, it dealt with an underlying trade off between the requirements of pest control, which is facilitated by synchronized planting and harvesting among the farms, and the problems of allocation, which is complicated by synchronized decisions. This traditional system was disrupted when the government promoted change in agricultural practices a the time of the "Green Revolution" in the early 70's. The result was a brief period of increased productive, followed by a collapse caused by increasing pest problems and water shortages. Fortunately, the traditional system had been under scholarly examination by anthropologist J. Stephen Lansing, who extended his investigation into a systematic comparison of the ecological consequences and economic effectiveness of the traditional and officially promoted systems. Ultimately - but only after many years - this research led to a reversal of policy and an ensuing recovery of productivity (Lansing 1991; Lansing, Kremer et al. 1998) Professor Lansing commented, "These ancient traditions have wisdom we can learn from."
The unifying generalization here is that agricultural production is highly exposed to contextual influences arising in imperfectly understood natural systems of great dynamic complexity. pp. 14
These components need to be dealt with during this software development. If the wrong processes are baked into the software, that would be a disaster. Hence the important role that a user provides in making these developments driven by their collective needs. Dr. Winter provides a real time example in a highly controlled, scientific business, that being of Intel and their change processes.
"A semiconductor factory (a "fab") and its operating procedures can be viewed as an enormous and costly effort to achieve strong "experimental control" on the production process for semiconductor devices, made in the interest of attaining consistently high yields." pp. 14
"Elements that might (superficially) appear to be superstitious even appear in codified organizational practice, as in Intel's "Copy EXACTLY" technology transfer policy:
Everything which might affect the process or how it is run is to be copied down to the finest detail, unless it is either physically impossible to do so, or there is an overwhelming competitive benefit to introducing a change. Of course its true basis is not superstition, but a very rational adaptation to the reality that understanding of what does matter is limited." pp. 15
"Finally, there is one major consideration limiting the validity of productive knowledge that the examples of agriculture and semiconductor production may not adequately suggest: people are involved. People are also involved as the customers, the consumers, the ultimate arbiters of productive achievement. When the product is corn or computer chips, it may be reasonable to consider that the "experiment" ends when the product appears, and set the customer response aside as a separate problem. But what if the product is education business consulting health care, elder care or day care, entertainment, or just "the dining experience"?" pp. 17
Quite rational satisficing principles dictate that investment in the quest for understanding be deferred until there is a symptom of trouble to deal with. When the pace is fast and the competitive pressure intense, such deferral may even involve suppression of ordinary skepticism about the rationale for prevailing ways of doing things. Paradoxically, "practical men" are constrained to be gullible, while high standards of proof are a luxury reserved to certain cliques among the inhabitants of the ivory tower. pp. 18
Distributed Character.

Professor Winter brings up the point that the individual knowledge is one issue, other issues such as work groups, teams, organizations and I am going to suggest clusters, such as Calgary, Houston and Aberdeen, each contain bodies of knowledge that may be both competitive and complementary.
A third distinctive attribute of productive knowledge is that it frequently resides in work groups or organizations rather than in individuals. This is not simply a matter of the same knowledge being held by several individuals, although such common knowledge may play an important role. Neither is it adequately captured by the image of complementary specialized skills being coordinated in the execution often exists only as it is evoked in the actual activity of the group. It is crucially a matter of distributed knowledge, i.e., of complementary parts of the same functional unit of knowledge being held by several individuals and applied in a coordinated way - the coordination itself being a crucial aspect of the knowledge. pp. 22

Accepting the view that knowledge can reside in a group is in this sense a "forced move". Just as practice allows an individual to improve in the performance of a complex skill through improved coordination, so the shared practice of a group permits patterns of multi-person coordinated action to arise, improve and stabilize. pp. 23

In recent years, the fact that productive knowledge often resides in groups rather than in individuals has received increasing attention both from business firms and from scholars outside of the economics discipline. There has been a striking degree of mutual reinforcement between the interest in these issues on the business side, driven by the practical concerns of an increasingly knowledge - based economy, and academic scholarship. pp. 25

To put it another way, it is hard to find a potential barrier to the movement of knowledge that does not function significantly as an actual barrier: national boundaries matter, firm boundaries matter, plant boundaries matter and even within - plant boundaries matter (Dyer 1998). To explicate the functioning of such a complex, multi-level system of distributed knowledge stands as a major challenge for theorists. pp. 28
These last few quotes reflecting the energy industry is not alone in approaching these issues. Clearly the majority of all businesses face similar knowledge and employee retention systems. It appears to me that the level and quality of the research in these specific areas is increasing. However, the difficulty ahead is accurately reflected by the two concepts that Winter has put forward in this paper. The interactions between these cause the complexity of the problem to accelerate in my opinion. The production set of possibilities that an individual, group, organization or cluster has at its disposal is one aspect of how the knowledge is deployed, the problem being where did it come from, how reliable and accurate is it. These issues can best be summed as the underlying issues around tacit knowledge. Its value, difficulty in obtaining and relying upon. The next issue that Winter brings is one of how the capture of tacit knowledge can be replicated throughout an organization or even an industry. That will be discussed in a Part B of this paper.

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Wednesday, February 14, 2007

New working papers from Harvard.

Two documents that are directly on topic of this blog were recently published at Harvard University. Both have been co-authored by Associate Professor Andrew McAfee of Harvard University. As I subscribe to his blog, readers should be fairly familiar with his work if you follow the "Google Reader My Starred Items" list on this blog, there is also a convenient RSS Feed.

The new working papers are entitled:

Electronic Hierarchies and Electronic Heterarchies: Relationship Specific Asset and the Governance of Inter-firm IT

Authored by: Professor Andrew McAfee, Harvard Business School, Marco Bettiol, University of Padua, and Maria Chiarvesio, University of Udine.

Scale without Mass: Business Process Replication and Industry Dynamics

Authored by: Erik Brynolfsson, MIT Sloan School, Andrew McAfee, Harvard Business School, Michael Sorell, Harvard Business School, Feng Zhu Harvard Business School.

I am adding these two working papers to the LEM Working Paper series review of Dosi, Winter, Langlois and others. As these working papers are current, I will be reviewing them right after the document that I have started now entitled "Toward an Evolutionary Theory of Production".

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Tuesday, February 13, 2007

Growing pains - transitioning to a sustainable energy economy.

This excellent video is part of the MIT Museum Soap Box series sponsored by the MIT Energy Research Council. I wrote about the first installment of this presentation here, and this video goes off in two completely different directions. These new directions provide prescient discussion on key issues of the day. At one hour and thirty five minutes it is a worthwhile review. This presentation is primarily with Professor John B. Heywood who is the Director of the Sloan Automotive Laboratory and Co-Director, Lab for 21st Century Energy, and Professor Stephen Ansolabehere. John Durant, Director of the MIT Museum is the moderator of this presentation.

The introduction provides the standard fare comment that greenhouse gas emissions is the major issue of today. My opinion regarding green house gases is based more on the inability to grasp how humans could be responsible for the alleged damage. Raised during the time when the risks of the ice age was returning, I place as much weight on the frantic calls to reduce green house gases at any cost, as I do on the ice age returning. If you aggregated and assigned a square meter to each and every human on the face of the earth they would fill an area of approximately 50 square miles. Green house gases from this concentration of people is a bit of a stretch for me. However, this video has changed my opinion on the whole global warning issue.

Professor Heywood starts with the desire to change the title of the topic to "Making our energy use less unsustainable." Noting the discussion of the previous MIT energy related video was how much energy is produced today, and how the alternatives to coal, oil and gas pale in comparison to our current demands. Unsustainable for two reasons. The scale of our energy use, and the way we use energy is very efficient. The problem is the scale and growth in our demand shows a further unsustainability of our energy use. Dr. Heywood notes three areas that may provide value in approaching these problems.

  • "Conserve needs to be a good word"
  • "Improve mainstream technology to reduce demand."
  • "Finding new ways to produce and consume energy."

All these points seem to be a reasonable approaches to the problem. Professor Heywood then notes that new technology will not "save us". Commenting that technology will have a role but that it is a false wish and a hope to expect that technology will provide a magic bullet. Growth is making the energy problem more difficult each day. Growth being the growth in demand, growth from economic activity, growth from population and industrialization.

In my mind I have to ask why has the Segway not caught on? The ability to travel 20 km at up to 20 km / hour for the cost of a little under $1.00 in electricity is an obvious solution to the problem. When given a hammer, a child will hammer at everything in sight. Why does everything have to be solved through the auto industry? Is the car necessary for all that we do, or could there be alternative means to get around? I sometimes think that the world should have invented the Segway before they developed the car. Nonetheless the device is fast and efficient and is cheaper then transit, it must be one of those acceptance issues.

Professor Stephen Ansolabehere begins his commentary and notes that the existing known global coal reserves provide energy for 300 to 3000 years. Coal can also be the worst in terms in CO2 emissions. We have this as the issue in which the abundance of coal is a cost of pollution that is not taxed. What Dr. Ansolabehere means by this is that the cost to produce one unit of energy values coal at $1 per unit, nuclear at $2 per unit, and solar is at $5 per unit. A carbon tax would deal with raising the coal costs to be uncompetitive to solar so that investment in solar can be made to reduce the reliance on coal. This makes sense to me. It does not make sense to attach a carbon tax to the oil and gas industry. These products are less damaging then coal and the reserve life does not last nearly as long. (50 years by most estimates). Oil and gas would also benefit in its development in the same manner as solar would with a carbon tax.

Professor Ansolabehere then notes the scale at which the public is willing to pay for a carbon like tax. Noting that the average home heating bill in the U.S. is $100 per month. He states that his tracking the U.S. attitude to solve global warming is assessed at $14 / month a number of years ago, and currently this has been raised to $21 as global warming has become the number one concern. There is a very clear disconnect with people on how serious the issue of the global warming issue is. Yes my grammar is correct, in order that a carbon tax effect a change to the alternatives would require the costs of the average home heating bill to skyrocket by several hundred dollars. What the global warming issue needs is more people that don't want it in their back yards.

I am also concerned that this may lead to a carbon tax be assessed on the oil and gas producers. This is a critical time for oil and gas as we bridge the easy and cheap production of the 20th century with the costly and difficult 21st century. An assessment on the industry will only slow down the research, exploration and development. Not a choice that anyone wants to truly consider. As I believe any assessment can not be on the producer level. The competitive advantages of a country are dependent on the low costs of energy. The tax should be at the consumer level, which indirectly reduces energy demand.

So how has this video changed my opinion? I would now support a carbon tax on coal users to the point where research and development, and use of alternatives could be done profitably. If people are willing to pay extra to heat their home, and coal is the devil in these details, they must be the solution. To tax the oil and gas industry as the Canadian government is now suspected to be doing as early as March will have no effect on the reduction of green house gas emissions, but will have a remarkable effect in making our energy problems worse.

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Monday, February 12, 2007

Greg Papadopolous of Sun Microsystems.

In what is dubbed as "Sun Analysts Summit 2007," Sun Microsystem co-founder and Executive Vice President of Research, Dr. Greg Papadopolous makes his presentation entitled "Redshift: The Explosion of Massive-Scale Systems. This presentation should be viewed by most users of computers today. An important video that details where the demand for computer processing is coming from, and where the solution to satisfying those demand resides. At 46 minutes it is a worthwhile review. So much of what I expect in this oil and gas software development project needs to be addressed from the hardware side. The demand for processing of an entire segment of the oil and gas industry is not something that can be taken likely. Recall that we have selected Sun as our key vendor for their support of the Java platform. This extends to Sun's Niagara Chip set, Solaris their Operating System, their Grid Computing offering, Crossbow their virtualization offering and finally the Java Programming Language.

Starting off with "Project BlackBox" which is a standard shipping container that provides substantial computing performance in one "BlackBox". Two rows of 19' standard racks, with each rack capable of housing 42 units of servers, blades and / or storage devices. The cooling of 200 kw of processing is the defining capacity of a project Blackbox. One should ask what / who would need to use such a large unit? That is the purpose of this talk. Many of these systems will be used by the market, and most importantly this software development project will use BlackBoxes in order to host the application for the oil and gas industry. The system we will be using will be owned and operated by Sun Microsystems and hence provides not only the solid reliability, performance, and availability of computing power but also the security that each producer knows their data is as secure and as confidential as possible.

"Red Shift" is a leading observation of Sun's marketplace of computing. The costs of computing is halving each year, yet the demands continue to grow. Where is this demand coming from? Core Enterprise demand has been satisfied by Moore's Law for a number of years. Dr. Papadopolous says that Band Width is the key driver to the current and future increases in computer processing demand. Band width has grown exponentially from 56 kilo-bites of analog capacity in 1995, to now 10 Gigabit Ethernet being available today. This band width is fueling an increase in the number of devices that are networked. It is clear that the proliferation of these devices assumes that processing is centralized in one location. This Band Width related demand is consistent with the technical vision I noted here, and the proliferation of IPv6 related devices. I agree with Dr. Papadopolous that the computer demand in the future will be difficult to satisfy.

Bandwidth is driving the increased demand for computing in far greater volumes then what Moore's Law provides. In addition to the conventional business market, the High Performance Computing market makes the demand for computing processing insatiable. Papadopolous notes demand from small and midsized firms that are using hosted services like Gmail, Salesforce.com and other web applications is a trend that he suspects will be showing up soon in large firms as well. Running an email server is an arduous task for any and all users. Aggregating the demand for email in the hands of large service providers provides economies of scale and better application functionality over the long term. A variety of customers are beginning to realize Service Oriented Architectures are the most effective and efficient means of managing these services.

Dr. Papadopolous notes that what he calls "Redshift" is a move to massive scale. Where scale and efficiency are available and afford-ably provided to users, when the users need them, wherever they may be. Sun believes RedShift will be redefining to the computing industry. Coporate strategies regarding Red Shift are of two possible scenarios. First Sun could be disintermediated such as what Google is doing in building their own servers. Or alternatively, follow the Sun school of thought that high levels of engineering are needed to build systems for today and the long term future. This latter strategy is also where strong integration of both software and hardware engineering is needed. "Efficiency and Predictability at massive scale are as Mission Critical to Redshift as Remote Access Servers (RAS) has been to the core enterprise."

Papadopolous is keen to differentiate what he means by the "Commoditization of computing" is not the "Commoditization of computers." The engineering of complex systems is necessary in this "RedShift" era. The cobbling together of many single core systems will only provide so much value. The approach of providing the City of New York with electrical power generated by a series of portable generators is inefficient, impractical and costly. This is the analogy he draws between what Sun is providing with their services and what many of the smaller service providers are doing.

Speaking on the Sun offering Papadopolous notes that computing infrastructure consists of three things. And to Sun's credit they have been able to integrate these components and provide commoditization of computing in an efficient manner.

  • Core Services and Platforms
  • O/S Instances
  • Base HW Plant (Server, Storage and Switches)
Base Hardware Plant.

What had happened in the past 20 years to distill the microprocessor down to a single chip is today what Symmetrical Multi-Processing (SMP) systems are being codified into one chip. That which was a full rack of servers in 1997 is contained on one Sun Niagara chip. Providing lower costs in almost any metric of computing power.

Taking these concepts further, Neptune, Sun's next processor will contain a 10 G Ethernet card embedded in the chip.

Operating System Instances

Solaris, Sun's open source operating system, Crossbow their operating system virtualization tool, and Java which is integrated into Solaris. "The Java RTS (Real Time Systems) + Solaris = Real time Application Server". With real time results, providing a solid application system performance that mirrors and exploits the value of their hardware. It is my opinion that both Apple and Sun's futures are brighter based on their ability to integrate their own operating systems on their own and x86 hardware. Companies such as Dell, IBM and HP are unable to compete in this arena due to their inability to provide the integration at this high level.

NetBeans which is the open source version of Sun's development tool is one of the best Integrated Development Environments (IDE's) available today. BlackBox as mentioned above defines the shape of Sun's very bright future.

Core Services and Platforms
  • Identity and Security
  • Procedural languages and scripting.
  • Service Oriented Architecture and Web 2.0
  • New Clients.
Finally Dr. Papadopolous notes a key component of Sun's open source business model is that "Open Source" does not apply to the binary or run time application. The Binary requires the use and service contract with the in this instance. Genesys will be paying for the use of Solaris and Java services, support and use agreements. This is in addition to the processing power purchased by the hour off the grid. All in all an excellent video, one that provides a vision of the future of computing.

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