Sunday, September 26, 2010

Introducing A New Linkedin Group: New Silk Road Business

If you like our posts and would like up-to-date access to our thought leadership content and rich discussion in our community of accomplished individuals, please sign up for our new Linkedin Group:

New Silk Road Business

You can network and collaborate with your peers on the New Silk Road to capitalize on new business and trading opportunities in the BRICs - Brazil, Russia, India and China - and the CIVETS - Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. This is meant to be an online matchmaking hub how professionals, dealmakers, traders seeking new markets, new partners and new deals in the new silk road where money will be made in the 21 st century!

How to Make M&A Work in Emerging Markets? Ten Proven Tips For Successful Deal Making

Global companies seeking a foothold in fast-growing countries such as Turkey, China, Russia and Brazil have pushed deal-making in emerging markets above that of Europe for the first time. According to Dealogic, emerging market targeted M&A volume is up by more two-thirds to $575.7 billion, while European volume has increased by barely 20% to $550.2 billion in the first half of 2010.

Deals by companies in emerging markets now account for 30% of global M&A activity, while Europe’s share has fallen to 29% – the lowest level in 12 years.

China, with about $133 billion in deals, has attracted most interest this year from acquirers. Brazil, India and Russia follow, with the four BRIC countries together accounting for more than half of emerging markets activity. In Turkey, M&A volume is almost double of FY 2009 in the first half of 2010.

Most multinationals need to look beyond developing nations for sustainable growth, particularly inorganic to secure access to high-growth markets and customers. The race to secure global energy resources has seen some of these companies use increasingly aggressive bidding tactics. This summer, Korea National Oil Corp, the state-owned energy explorer, launched the country’s first cross-border hostile takeover to try to win control of UK oil group Dana. 

According to McKinsey, the rapidly growing ranks of middle-class consumers span a dozen emerging nations ranging from Turkey to South Africa, not just the fast-growing BRIC countries and include almost two billion people, spending a total of $6.9 trillion annually. McKinsey research suggests that this figure will rise to $20 trillion during the next decade—about twice the current consumption in the United States.

US companies on the other companies have been more cautious in seeking growth in emerging economies. The largest such deal this year was Abbott Laboratories’s’ agreement to buy the healthcare solutions business of Piramal, the Indian conglomerate, for $3.8 billion.

Credit Suisse leads the announced emerging market advisor ranking with about $103 billion in deals so far this year, followed by Morgan Stanley and Bank of America Merrill Lynch.

Multinational companies planning M&A ventures in emerging countries will be breaking new ground. To succeed, they must be prepared to fundamentally adapt their deal-making mechanisms to the characteristics of the local market.

So what is different about deal making in - what I call - the New Silk Road? Aspiring buyers must consider the peculiar dynamics of the New Silk Road specifically, the fact that conventional approaches to M&A are inappropriate:

  1. Prepare to pay more but it may not be enough to close the deal: Valuation multiples tend to be relatively higher as there is more competition for increasingly smaller deals. You tend to price each deal based on growth potential driven off of some per capita basis penetration trajectory over the next decade, which can change drastically. Traditional valuation is often impossible, since benchmarks and reliable financial information are rare. Often, option value is everything.
  2. Look for sizeable target but be ready to settle for much smaller deal: Industries from which you will target your next emerging market M&A deal tend to be a lot more fragmented than developed economies. In a given industry, after only a few market leaders, you can easily end up with targets in the tens of million dollar range in size. Be ready to make smaller deals priced at large company multiples. For example in Turkey, billion-dollar size deals are limited to only a few industries such as energy and steel. State-owned enterprises are cleaning up their asset portfolios and improving standards of disclosure, making them attractive targets for foreign investors. A number of private companies better managed than their state-owned peers are also emerging as candidates.
  3. Every deal will be contested: Multinational companies face challenging competition in emerging markets, as these economies already boast aggressive local players that have captured a significant portion of spending. Each deal you would hope to seal will face stiff local competition with deep pockets.
  4. Local financing may require too much upfront work: Given the specific countries local regulations, complex financings tend to be more common. Dealing with targets existing local bankers would be a good starting position. Change of ownership would inevitably ignite such discussions anyway.
  5. Watch out for cultural nuances:  There are plenty of cultural differences that can make or break a deal. In the end, it is people that do business with one another, not companies.
  6. What you see may not be what you buy in the end:  The standards of corporate governance in these economies can be drastically different than the US for example. If they are listed, it might be a bit safer but still there are still no guarantees. The information needed for robust due diligence is elusive in China, where IT systems are generally weak, databases lack breadth and capacity, and legal systems and requirements remain opaque. Corporate governance standards in emerging markets still lag far behind those of developed markets.
  7. Complex local regulatory frameworks are most difficult to understand:  One of the biggest hurdles in deal making in the new Silk Road has to do with the uncertain regulatory environment. For example, in Turkey it is still not legal to delist a public company. Many private equity firms or multinationals that are also public in their home markets are forced to leave their investment listed in a second stock market.
  8. Cross-border transactions are inherently more time consuming:  A lack of experience in cross-border transactions can make the process more difficult. You need a dedicated team of experts that are heavily staffed locally and properly equipped on the local level to complete deals.

So what should your M&A teams do differently to make things work?

  1. Study the market closely, start early: Nothing can substitute a well-structured market assessment of your target geographies with a consulting company that preferably has a local branch and team.
  2. Commit to the market early for the long-term: as soon as you determine where you should invest, you need to recruit a small local team to build connections and learn. For example, Best Buy entered the Turkish market and studied it for 2 years prior to opening stores.  Try to visit the country several times in person. Seeing is believing. Make new local friends that can take time and effort to cultivate.  Build rapport with people and understand their value system:  Talk to close friends and hire people who understand both cultures.
  3. Source a hybrid M&A team staffed mostly with locals and manage your team closely: Plan your team early. Source and contract the best local legal and transaction execution advisory you can afford. M&A in emerging markets is different. For example, forecasting methods used routinely in more mature markets do not apply to emerging markets. Local legal and tax regulations can be so different and complex that can kill a deal. You want to know about them as soon as possible.
  4. Use a wider range of valuations and let your local team be your guide:  Relying heavily on a multiples-based valuation can almost automatically lead to highly distorted results, while these economies can be too dynamic for discounted-cash-flow analysis to be accurate; forecasting cash flows beyond three to five years is mere conjecture. In addition, local counterparties often use a statutory valuation, which is similar to valuing assets at book or asset value but does not take into account the level of cash flow the assets could generate. Past growth rates and margins do not provide an accurate guide on how an industry will develop in the New Silk Road economies. Yet the boards of multinational companies often insist that their valuation teams come up with a single, bottom-line number. As a result, deal teams frequently feel pressure to under- or overprice a purchase rather than explain why the value realized could be higher or lower, depending on the industry's evolution. Using a wider range of valuations would give a buyer leeway to assess the most likely outcomes and to base its decisions on the way emerging markets fit into the overall company and industry strategy.
  5. Be realistic about synergies:  Buyers often look to the synergies of deals to justify investments. But capturing synergies in the New Silk Road is difficult. Cross-selling products, for example, is unrealistic if brands and products are positioned for different market segments: it is just not feasible to try to cross-sell, say, a premium brand of beer through a largely rural distribution network. Synergies in revenues and labor (through massive layoffs of workers) are also hard to achieve. In addition, buyers must be aware of potential post acquisition cost increases owing to the expense of an expatriate staff and spending on health and safety improvements. Savings in production and operations are easier to capture, although sometimes a deal's value resides not in its synergies but in its long-term option value: capturing the potential and growth of the sizable emerging markets.
  6. Share upside and downside risk:  When differences over the valuation of a company cannot be bridged, buyers should seek to structure a deal so that it takes this uncertainty into account.You may for example in a joint-venture make an additional payment three years after the transaction date if the venture achieved an agreed-upon earnings target and if tax regulations changed. Such earn-out mechanisms can be useful when opinions vary over other external factors, such as industry growth and the cost of key inputs. The trick with earn-outs is to focus on matters that are generally beyond the influence of either negotiating party; otherwise, there is room for gamesmanship, which should be avoided.
  7. Work like a detective during due diligence:  Due diligence is the core of acquisition procedures. In my experience, buyers tend to be either overly cautious (thus missing potentially attractive opportunities) or overly optimistic (and likely to find surprises later on). The information needed for robust due diligence is elusive in emerging markets, where IT systems are generally weak, databases lack breadth and capacity, and legal systems and requirements remain opaque. Furthermore, agreements are often oral, and the high proportion of cash deals makes it difficult to validate the true ownership of stated assets.    Multinationals should expect a high level of liability and risk exposure and make sure that any team conducting due diligence on their behalf has enough time and people to dig for information. Accounting and legal advisers with local experience are absolute must haves. Wherever possible, teams should be based locally and have the insider knowledge and relationships needed to understand target companies fully.
  8. Deal structure should help you achieve your strategic goals:  Be flexible to structure the deal other than M&A with full control if it can’t be achieved due to local regulations or deal specifics; there is the option of joint-ventures where you can share local market leaders economic network and accelerate your market penetration. Or you can go for a minority equity investment with limited control like in the media sector in Turkey for example as an option to step up deal after relaxation of regulation, to preempt competition and to accumulate learning. Another successful approach to structuring deals involves outlining important areas of decision making and establishing mechanisms to exercise control over them. If direct control of the board is impossible, a buyer might push decisions down to a level where it can exercise authority through day-to-day operational decisions. Often multinationals combine them with an agreement to increase ownership and control over time.
  9. Leave your usual M&A mind-set at headquarters: Look at an acquisition as a partnership rather than an outright acquisition. If a company is listed in the public markets, in form it will obviously be an acquisition, but in substance it could be a very good partnership if we align the objectives across the organizations as if it is a partnership.  Don’t send plane loads of people into a new company. Instead, send in a few integrators. Make a concentrated effort to co-create a vision for the enlarged organization rather than just imposing your own from the headquarters. Ask key questions. What are our objectives? What are our strengths and our weaknesses? How do we leverage those strengths—such as people, R&D, access to new markets, and our organic-growth pipeline—to collectively achieve the vision? If the vision exercise isn’t shared or if the process isn’t participative, then the acquired organization’s willingness to be part of the future action plans and the consequent accountability will be much lower.
  10. Culture fit is still everything in emerging markets too: You have to accept that there will be differences in cultures; one cannot make a single-culture organization. But it is critical to build a uniform performance culture. By that, I mean how we think as one enterprise and set targets for the larger organization, how we go about realizing the group vision—including how we benchmark performance and identify sources of value—and how we measure less tangible actions and behavior. These things are especially relevant now because there are no standard operating procedures for overcoming a global financial crisis.
I sincerely hope you will benefit from these proven, practical tips I heavily relied upon in the past. Please feel free to email me to comment and probe each one of them.

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How ‘Wall Street’ changed Wall Street

I grew up in the old days of Gordon Gekko watching him in the famous movie "Wall Street". I am not sure how much the Gekko generation had to do with the last financial crisis that almost brought the global financial system to bankruptcy but I do know one thing, human nature is nothing but a fine balance of greed and fear...and no crisis can alter it.  The following post came out in Financial Times this morning by Francesco Guerrera:
Michael Douglas as Gordon Gekko in ‘Wall Street’
Michael Douglas as Gordon Gekko in ‘Wall Street’ (1987)

In late 1987, Frank Partnoy, then a maths student at the University of Kansas, had an epiphany. As he sat in a cinema watching Wall Street, Oliver Stone’s depiction of the corrosive effects of greed on the financial industry, Partnoy decided he wanted to be part of it.

“I was naive but it actually inspired me. It made Wall Street seem exotic and alluring,” says Partnoy, 43, who went on to work for Credit Suisse First Boston and Morgan Stanley as a derivatives specialist, an experience he chronicled in his 1997 book Fiasco: Blood in the Water on Wall Street. Now a professor of law and finance at the University of San Diego, he says: “If you are a math major at the University of Kansas and you see a cheque with six zeroes, it is going to get your attention.”
He was not alone. In the two decades since its release, Wall Street and its lead characters, the father-of-all-evil Gordon Gekko (Michael Douglas in an Oscar-winning turn) and the corruptible ingénu Bud Fox (Charlie Sheen), have exuded an almost hypnotic attraction on scores of would-be bankers and traders.

“[The movie] became a cult phenomenon on business school campuses,” says Ken Moelis, 52, a former UBS banker who now runs his own advisory boutique and is one of Wall Street’s best-known dealmakers. “[After they joined the industry] these kids told me that they watched it so many times I thought they knew more about Gordon Gekko than their families.”

A full 23 years after its premiere, most of the 20-plus real Wall Street denizens interviewed for this article displayed an encyclopaedic knowledge of the plot; Gekko’s ruthless attempt to raid an airline, aided by Fox’s inside tips until the young protégé’s conscience launches a successful takeover of his soul and both get their comeuppance. The real Wall Street, however, appeared to embrace Fox’s rags-to-riches social climbing while overlooking the story’s moral underpinnings. Not quite the reaction that Stone, the son of a stockbroker but known for polemical, political films such as Platoon and JFK, intended when he conceived a tale of the dangers of unbridled capitalism.

The film, however, took on a life of its own, defining a financial era in the eyes of the public and the industry it portrayed. Despite being neither a big box office nor critical hit, its influence on popular culture remains strong. Gekko-esque wisdom, such as “lunch is for wimps” and “greed is good” (the actual quote is “greed, for lack of a better word, is good”), has long since passed into common currency.

Indeed, many of those buying tickets for the sequel, Wall Street: Money Never Sleeps, released next month, will be alumni of the first film: the crowds lining up at this week’s New York premiere were made up largely of middle-aged men in suits pressed against barricades typically reserved for screaming teenagers.

For the inhabitants of the Street, the film’s impact went deeper and further than a collection of terse one-liners. “[Wall Street] inspired generations of financial people to ape the characters,” recalls a senior banker who joined the industry at that time. “All of a sudden, on trading floors there was a proliferation of suspenders [braces], slicked-back hair and Sun Tzu’s The Art of War [Gekko’s favourite book].

Although modern-day mobile phones are smaller than Gekko’s brick-like late-1980s contraption, visitors to old-school haunts such as the 21 Club in midtown Manhattan can still bump into crinkly gentlemen with gummed-up hair and braces – a bizarre case of life imitating art imitating life (Gekko’s look was itself inspired by that of 1980s financiers such as Carl Icahn and T Boone Pickens).
Wall Street was both a mirror and a high-water mark for the financial industry of the period. It chronicled the dramatic change that daring corporate raiders and the availability of cheap debt had introduced into a world of gentlemen’s agreements and handshakes in a cosy, old-boys’ network. Stone’s shorthand for that fading culture is the character of Lou Mannheim, the ageing stockbroker named after Stone’s father Louis, whose moralising – “Man looks in the abyss, there’s nothing staring back at him. At that moment, man finds his character. And that is what keeps him out of the abyss” – proves a bland counterpoint to Gekko’s more watchable moral turpitude.

Jean-Yves Fillion, 51, a banker at BNP Paribas in New York, says: “The movie was a reflection of the industry as it was at the time but it also captured a turning point. Finance used to be about stability, values and about relationships. The movie was at the opposite end of the spectrum. It showed a different side of finance that was taking hold.”

Fillion, a self-confessed film buff, compares the original Wall Street to a “modern-day western, with a bad guy that was almost likeable – a good bad guy. That made the whole industry more attractive, more shiny and glamorous. Gordon Gekko is portrayed as an example of sophistication and innovation, he is almost seen as a hero”.
. . .
Charlie Sheen as Bud Fox and Michael Douglas as Gordon Gekko in ‘Wall Street’
Gordon Gekko shows Bud Fox the money
Why was Stone’s message in Wall Street undermined? Bill Winters, 48, a former head of JP Morgan’s investment bank, believes the filmmaker obscured the point he intended to make.

“I remember being surprised that a group of people was just figuring out that greed played a meaningful role in the way the business gets done on Wall Street,” he recalls. “I think the movie would have made a much more powerful point had the creators been a little bit subtler and cast the character not as a criminal but as ethically challenged, and styled him on those corporate raiders of the 1980s who took a tough, uncompromising stance against companies but did not actually break any laws.”

Yet the culture of greed that was obvious to a then 25-year-old banker such as Winters was still a surprise to most of the film’s non-Wall Street audience, partly because of the finance industry’s relatively low profile at that time among the wider public. Its release, just a few months after the stock market crash of October 1987, provided a timely account of an era of excess and revealed the ugly side of a money-making machine that has always tried to cover up its blemishes with fancy clothes and complex jargon. For the first time people were able to see not only the glory but the gory side of Wall Street.

Pat Huddleston, 48, a former official at the Securities and Exchange Commission (SEC), recalls how the movie played a part in his decision to become a regulator. “The way Oliver Stone wound up the story, with Bud seeing the light and embracing the values of his upbringing, reminded me that ordinary folks are the ones who suffer for the sins of the supposed kings of the universe represented by Gekko,” says Huddleston, who now runs Investor’s Watchdog, a private investor-protection firm that investigates suspected Ponzi schemes. “Given that I was following an impulse to work for David rather than Goliath, Wall Street helped me see that I could do that at the SEC. What I saw at the SEC, in the dark corners of the securities industry, confirmed the less than flattering portrait that the movie paints.”

Of course, others viewed it differently, seeing in this muscular, vivid portrait of money and its transformative social powers a modern parable for the American dream with braces replacing bootstraps. On Wall Street, as Gekko says to Bud, “If you are not on the inside, you are on the outside.”

Todd Thomson, 49, started his career as a management consultant before later joining the finance industry and for a period becoming an executive at Citigroup. He recalls how some of his classmates at Wharton Business School reacted to the film. “Wharton was my first exposure to people from Wall Street and people who wanted to go to Wall Street – and the focus was almost exclusively on making money,” says Thomson, who now runs his own investment fund. “A lot of people at Wharton came from nothing, a lot of them had backgrounds similar to Bud Fox. For them the life of Bud Fox was what they were aiming for: the dream of going from nothing and ending up with the penthouse apartment and a girlfriend with model looks.”
. . .
Shia LaBeouf, Josh Brolin and Douglas in the sequel ‘Money Never Sleeps’
Shia LaBeouf, Josh Brolin and Douglas in the sequel ‘Money Never Sleeps’ (2010)
Money Never Sleeps again stars Douglas as Gekko, newly out of jail and looking to rekindle the old magic. It arrives at a time when there is nothing glamorous about finance in the eyes of a public that has lost jobs and homes in the most devastating financial crisis since the 1930s.

Just as the first film was inspired by the famous insider trading scandal involving the real-life arbitrageur Ivan Boesky (who reportedly once said “greed is healthy”), Money Never Sleeps borrows liberally from contemporary events. A common parlour game among bankers who have seen previews is to speculate on which real-life Wall Street titans have influenced the character of the vulture-like executive Bretton James, played by Josh Brolin.
The film also reprises the relationship between Gekko and a young protégé. Shia LaBeouf plays a trader who falls for his master’s fraud (clearly he hasn’t seen the original movie) while romancing Gekko’s daughter.

But it is not just the size of Gekko’s mobile phone that has shrunk since 1987. With the free market shown to be a lot less perfect than late-1980s zealots such as Ronald Reagan, Margaret Thatcher and Gordon Gekko had us believe, the reputation and social standing of bankers has also been cut down to size.

Stone’s cautionary precepts may, therefore, stand a greater chance of being heeded this time round. But can his new film hope to achieve anything approaching the resonance of the original? Those longing for memorable lines will not be disappointed. (“I once said, ‘Greed is good.’ Now it seems it’s legal;” “You are so Wall Street you make me sick. I am going to take a shower.”) But Partnoy, the banker-turned-professor, believes modern viewers will be less wide-eyed than those of his generation.
“The maths major at the University of Kansas now knows all about collateralised debt obligations and Wall Street,” he says. “When I show the original movie in class, the ethics of the students have changed 180 degrees. In the 1990s, it was seen as inspiring, today students get the morality tale right away,” he says.

The spotlight thrown on unglitzy parts of high finance has reduced Wall Street’s mystique. Forget swashbuckling corporate raids and daring trading strategies, the latest turmoil was caused by poor people who were given mortgages they could not pay and the nerds who securitised them in windowless offices. As Gekko languished in jail, Wall Street was taken over by lunch-eating wimps.
Paradoxically, as the “quants” elbowed the dealmakers aside, and super-fast computers replaced human beings on the trading floors, this less colourful industry became better known to the public. A period of long prosperity encouraged more people to dabble in investments.

Try as he might, Stone cannot shock many people the way he did two decades ago because his audience is both more knowledgeable about, and more inured to, the perils of finance.
Will the new film’s depiction of Wall Street’s current, more workmanlike, incarnation still exercise a gravitational pull on would-be traders? Bill Winters believes it will. “The-greed-is-good movement of the 1980s and 1990s carries on today,” he says. “Finance has always been a dog-eat-dog profession where some people became fabulously wealthy and some people get fired. There are a lot of bright kids that studied engineering and maths who want to go into finance because of the promise of great riches.”

Wall Street veteran Peter Solomon, 72, who was an executive at Lehman Brothers before founding his own firm in 1989, is unconvinced that a more penitent Gekko will increase his industry’s ability to learn from past mistakes.

“You go to a dinner party today and two or three of the guys who are there were in jail,” says Solomon, who met Stone before he began shooting the new movie. “It’s a great world because it’s so redeeming ... but I don’t think people learn lessons.”

Which is why the most prescient line in the 1987 film is perhaps not “greed is good” but the warning offered by Mannheim to the young Fox: “The main thing about money, Bud: it makes you do things you don’t want to do”.

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Tuesday, September 21, 2010

Vestas Could Be A Takeover Target

Vestas, the listed Danish wind turbine manufacturer, is seen as a takeover candidate.  According to our sources, since Vestas’ share price dropped by 43% over the last year, the company now looks more attractive for a takeover.

Vestas has leading market share of installed wind power turbines and a possible acquisition would give a potential buyer both market share and access to premium wind turbine intellectual property and technology. Large Korean or Chinese companies are the most likely bidders. For example, Korean companies such as Hyundai and Samsung would make it easier for Vestas to compete against other large conglomerates such as GE and Mitsubishi.

As the oil prices have been coming down from their peaks most wind projects have been put on hold.  The rise of over-burdened governments with huge debt has inevitably led to the end of green subsidies coupled with much tougher price competition from larger competitors such as GE. All of these trends are making it very difficult for much smaller players like Vestas to compete for deals that getting smaller and lesser.

Vestas’ chairman Bent Erik Carlsen said that he doubts the Danish company will receive any takeover offers, but added that Vestas’ board will naturally have to consider an offer if one were to be made.

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IBM to buy Netezza for $1.7B in cash. Is a counterbid from HP in the cards?

IBM on Monday announced an agreement to buy Netezza for $1.7 billion in cash, in a deal which adds to recent deal-making momentum in business software and services. On September 10th, we reported Netezza as an attractive takeover target for HP following the company's dispute with Oracle over its ex-Chief Hurd. According to Wall-Street Journal today, after weeks of mudslinging, HP and Oracle agreed to settle a legal dispute over the hiring of Mark Hurd.

We still think that similar to 3Par acquisition, HP may get aggressive to quickly ramp up it's database stack in lieu of Oracle. Therefore, investors should watch out that a counter bid from HP might be in the cards. HP recently won victory over Dell in the battle to acquire storage technology company 3Par for $2.4 billion at about 90 times its projected earnings. 

There was no immediate sign of a rival to IBM’s bid, but Netezza’s share price climbed 13% to $27.80 on Monday, above IBM’s offer of $27 a share.According to the media sources, Netezza would have to pay IBM $56 million if it terminates the deal. 3Par paid Dell a $72 million break fee in order to accept HP’s final offer of $33 a share, which was more than three times the $9.65 3Par was trading at before Dell’s initial $18 bid.

We expect to see accelerating momentum in the M&A activity across the technology landscape with likely future investor interest in technology companies such as CommVault, Compellent, Isilon and NetApp.

IBM reported that the Netezza deal would help it expand its business information and analytics offerings. Netezza’s 500-strong workforce would supplement 6,000 IBM consultants in this area. IBM’s analytics business grew 14% year-on-year in the second quarter and it has spent $12 billion in 23 analytics-related acquisitions over the past four years. Sam Palmisano, IBM chief executive, said in May he was planning $20 billion in acquisitions over the next five years.

Netezza offers products that integrate databases, servers and storage into a single appliance that is easy to install and requires little administration. Its service competes directly with Oracle’s Exadata data warehousing appliance.  Following this deal provided that it will close of course, IBM would compete head-on to Oracle’s Exadata solution. As the technology market further consolidates, we expect IBM and HP to lead the pack followed by Oracle, Microsoft, Cisco and Dell.

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Wednesday, September 15, 2010

Following HP/ArcSight Deal, Symantec Circled by Oracle, IBM and Microsoft

Symantec, the Cupertino, California security software company, could face increased pressure to sell the company according to our media sources.

Hewlett-Packard's acquisition of ArcSight, could increase the pressure on Symantec to sell the company while the security market is getting a lot of attention.

Symantec's business is big enough to narrow the field of buyers to a few, especially given the share price premiums ArcSight and McAfee are getting in their sales. For Symantec to get a similar premium a buyer would have to pay around $20 a share or an enterprise value of over $14.2 billion.

Potential suitors for Symantec include Oracle, IBM and Microsoft.

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Cognizant Close to Buying Genpact

According our industry sources, Cognizant Technology Solutions, the New Jersey-headquartered IT-services company, has been carrying out due diligence at the IT-services company, Genpact, for acquisition of a controlling holding. The due diligence has been going on for about a month.

In 2009, Genpact's revenue was $1.12 billion and net income $127 million. Genpact’s investors could be seeking a premium of 30% over the company’s market value of about $3.5 billion according to yesteday's market close.

Consolidation among back offfice outsourcers is inevitable as we have witnessesd it in the Human Resources Outsourcing (HRO) sector. Xerox bought ACS,HP bought EDS, Hewitt and Aon got merged....Cognizant has been transforming itself from a pure offhsore labor arbitrage player into a full service outsourcing services provider.  However, Cognizant along with all Indian offshore outsourcers will have tough days ahead trying to compete with IBM, HP, Accenture and Xerox/ACS that have substantial R&D and technology assests and IP that can be applied to digitization and automation of most customer pain points that Indian outfits have long addressed by labor arbitrage.

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Tuesday, September 14, 2010

HP and IBM Rumored to Chase More Networking & Security Firms; Who Else Might They Acquire?

Today, shares of networking and security technology vendor Radware (RDWR) have shot up $8.93, or almost 33%, to $28.75, after an Israeli business publication the company, which is based in Tel Aviv, is “in talks to be sold to either HP or IBM” for an expected deal value of $945 million, or $45 per share — obviously, a lot higher than the current price.

There has been rumors initiated by local newspapers in Israel about takeover valuations in the past that ended up false. While I would anticipate more deals in storage and security particularly with cloud services capabilties, they will likely be more uncontested deals given in today's WSJ IBM CEO Samuel Palmisano publicly criticized rival H-P's decision to spend heavily to acquire 3PAR .

"H-P used to be a very inventive company," Mr. Palmisano said. IBM would never have paid as heavily as H-P did to acquire a company such as computer-storage provider 3PAR, he said. "[H-P] had no choice," said Mr. Palmisano. "Hurd cut out all the research and development."  H-P earlier this month acquired 3PAR for $2.4 billion, beating out Dell Inc. in a bidding war by paying more than three times the company's closing stock price before Dell's initial bid.

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HP Buys ArcSight - Hardware Makers Rush to Software Security But At What Price?

HP and ArcSight Inc. yesterday announced that they have signed a definitive agreement for HP to acquire ArcSight, a leading security and compliance management company, for USD 43.50 per share, or an enterprise value of $1.5 billion.

The following is the official company release but does the make sense at 90 timesthe future EBITDA?  I would seriously doubt it. Chipmaker Intel paid $7.2 billion for Mcfee last month with a strategic rationale of being able to embed security sofwtare into the hardware layers in the future. And HP buys ArcSight which makes software that helps monitor human behaviour on computer networks. Once again hardware firms are rushing into software and services overpaying for tiny companies with unproven management and ability to consistently deliver profits. Only two weeks after having paid a fortune for 3Par in an emotional bidding war with Dell, HP makes another outrageously expensive buy. In my opinion, with Mark Hurd gone, undisciplined dealmaking is peaking at HP. However, what is more important is the fdiciary responsabilities of the Board of Directors and of course the shareholders to really hold the management accountable.

Software security is a highly fragmented industry with the largest player being Symantec that has been acquiring companies in the industry with

Here's the company press release following the acquisition:

“From a security perspective, the perimeter of today’s enterprise is porous, putting enormous pressure on clients’ risk and compliance systems”

The combination of HP and ArcSight will improve security, reduce risk and facilitate compliance at a lower cost for customers. ArcSight’s superior technology is highly complementary to HP’s existing security portfolio of hardware, software and services.

Today’s successful enterprises must provide their employees, partners and customers with more access to applications, services and information. This access and connectivity exposes enterprises to escalating threats, increasing complexity and regulatory challenges. Together, HP and ArcSight will be well-positioned to secure even the most demanding environments by delivering:
  • Broader visibility: A comprehensive view of all events across IT operations, security and compliance
  • Deeper context: The ability to detect threats and risks by correlating both activity and state changes in real time
  • Better continuity: A constant feedback loop between build, manage and monitor to ensure that enterprises remain secure
“From a security perspective, the perimeter of today’s enterprise is porous, putting enormous pressure on clients’ risk and compliance systems,” said Bill Veghte, executive vice president, Software and Solutions, HP. “The combination of HP and ArcSight will provide clients with the ability to fortify their applications, proactively monitor events and respond to threats."

“HP’s acquisition of ArcSight will enable the creation of a new type of security solution, one that serves the modern enterprise,” said Tom Reilly, president and chief executive officer, ArcSight. “By combining ArcSight’s Enterprise Threat and Risk Management Platform with HP’s breadth of application development and operations management solutions, HP will be able to offer an integrated security platform that delivers broader visibility, deeper context and faster remediation of enterprise-wide security and risk-related events. In a world where perimeter security is no longer enough, businesses need this holistic approach to securing their networks, applications and sensitive data.”

The acquisition will be conducted by means of a cash tender offer for all of ArcSight’s outstanding shares of common stock. The closing of the acquisition, which is subject to customary closing conditions, is expected to occur by the end of the calendar year.

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Friday, September 10, 2010

Oracle Clash May Force HP to Partner with SAP and Look for Acquisitions Aggressively. Who Might HP Buy?

Hewlett-Packard is expected to assess its data center partnership with Oracle as relations between the two companies sour due to emotional reactions from both sides over ex-HP chief Mark Hurd.

Oracle CEO Larry Ellison yesterday issued a terse response to HP’s filing a lawsuit against its former CEO Mark Hurd, stating HP’s legal attack was putting the partnership at risk. HP is alleging that Hurd will inevitably disclose trade secrets to his new employer.

In addition to seeking new partners, HP could strengthen its data center offering with buys to hedge its bets in case of a further break-down in its relationship with Oracle. Companies that would bolster HP’s database offering and help it compete with Oracle include business intelligence companies MicroStrategy and SAS Institute, data integration specialist Informatica or data warehousing company Netezza. We tend to think that similar to 3Par acquisition, HP may get aggressive to quickly ramp up it's database stack in lieu of Oracle.

Netezza shares jumped about 5% in trading since yesterday morning on takeover rumors and reports that the Marlborough, Massachusetts-based company canceled a planned dinner with investors. Netezza did not respond to a request for comment.

Palo Alto, California-based HP and Oracle have been moving apart since Oracle acquired hardware vendor and HP rival Sun Microsystems in April 2009. Oracle is seen as beefing up its offering to match that of HP in the data center space, but HP is still without a strong product to match Oracle on the database side.

SAP, which bought database management company Sybase earlier this year, would be the most logical partner for HP. The German software giant would likely welcome closer ties to help compete against Oracle. The two could replicate “Acadia”, a joint sales venture between EMC, VMware, and Cisco built around their data center products.

The latest conflict between HP and Oracle is an opportunity for SAP to build closer ties with HP. SAP would clearly benefit from such partnership having aligned itself with one of the 800-lb gorillas of the IT. The future of standalone SAP frequently comes up as analysts speculate a likely takeover by Microsoft or IBM may be compelling to SAP shareholders. Microsoft also could see Hurd’s move to Oracle as a chance to bring Microsoft and Oracle closer together, the executive said.

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Wednesday, September 08, 2010

HP vs Oracle Fighting Over $7 billion Man Mark Hurd: A Silicon Valley Soap Opera

After first reported by The Akbas Post on early Sunday, Oracle yesterday announced that Mark V. Hurd has joined Oracle as President and has been named to Oracle’s Board of Directors. Mr. Hurd will report to Larry Ellison. He replaces Chuck Phillips who left the company. The news cheered up Wall Street so much that Oracle added $7 billion to its market cap while Ellison offered Hurd $950,000 salary with bonuses that could go up to $10 million. That's what I would call magnificent double dipping since Hurd got his severance package in the $20+ millions just a month ago. Ellison on the other hand got himself another great deal.

Oracle's move to bring in Hurd is a coup for Oracle. Despite his ethical challenges at HP, he was the most successful CEO HP ever had. Replacing him would prove to be a very difficult task for the HP board. Hurd will do a much more aggressive job at Oracle aiming at his old employer and of course IBM. We would expect more hardware acquisitions in the enterprise storage and networking while also expanding into services which is another missing domain. Similar to his move of buying EDS at HP, we could see a similar large services deal. Accenture for example would not only give them a global services footprint but also proven Information Technology and Business Process Outsourcing clients in the top Global 500 accounts.

Yesterday following Oracle's announcement of hiring Hurd, HP sued to block his appointment based on the grounds that Hurd signed a confidentiality agreement and he could not perform his new job without violating it. Having worked in the high tech industry in California, enforcing non competes or confidentiality agreements (for a so-called crime that is yet to be committed) to block employment in the state of California is practically impossible. We have seen many of these for executives changing jobs among Dell, EMC, IBM and HP and nothing changed the outcome. We tend to think Mark Hurd saga at HP turned into a soap opera in the Silicon Valley.

“Mark did a brilliant job at HP and I expect he’ll do even better at Oracle,” said Oracle CEO Larry Ellison. “There is no executive in the IT world with more relevant experience than Mark. Oracle’s future is engineering complete and integrated hardware and software systems for the enterprise. Mark pioneered the integration of hardware with software when Teradata was a part of NCR.”

“Mark is an outstanding executive and a proven winner,” said Oracle President Safra Catz. “I look forward to working with him for years to come. As Oracle continues to grow we need people experienced in operating a 100 billion business.”

“I believe Oracle’s strategy of combining software with hardware will enable Oracle to beat IBM in both enterprise servers and storage,” said Mark Hurd. “Exadata is just the beginning. We have some exciting new systems we are going to announce later this month at Oracle OpenWorld. I’m excited to be a part of the most innovative technology team in the IT industry.”

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Sunday, September 05, 2010

Oracle May Appoint Mark Hurd President

Just few weeks after being fired from HP after a 5-year great track record, Mark Hurd was quick to land a top job at Oracle. Apparently, HP Board fired him because the expense reports he filed were inappropriate over a marketing assignment with a female consultant.

By hiring a talented CEO with deep knowledge of the enterprise hardware industry and dealmaking talent, Oracle’s efforts to compete head-on against HP, IBM and others in selling a variety of computing hardware will accelerate. Early this year, Oracle completed its purchase of sophisticated computer maker Sun Microsystems for about $7 billion after IBM and HP dropped out of the bidding process. With Hurd on board Oracle can better inetgrate and achieve synergies with Sun acquisition and may make more hardware acquisitions. Co-President Phillips said that they had billions earmarked for more acquisitions over the next 5 years.

Terms of the expected employment offer had yet to be finalized by the Board by sunday according our industry contracts in the Silicon Valley. Oracle has two co-presidents, former Wall Street analyst Charles Phillips and Safra Catz, a former investment banker who also served as Oracle’s chief financial officer until 2008. In my opinion Mark Hurd may get the leading role as President while Ellison staying on as Founder and CEO.

Larry Ellison is friends with Mark Hurd and has supported him in public comments, calling his dismissal “the worst personnel decision since the idiots on the Apple board fired Steve Jobs many years ago”. I tend to agree with Larry that HP Board was to quick to dismiss its best performing CEO in the midst of a massive consolidation and industry's shift to cloud computing.

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Friday, September 03, 2010

Can you survive the five global forces reshaping the world economy?

This is a great survey by McKinsey Global Institute that sums up in depth why developping markets (aka the new silk road) will relentelessly grow much faster than the developped world and therefore will get lion share of any corporate business development executives' attention and resources.

Five crucibles of change will restructure the world economy for the foreseeable future. Companies that understand them will stand the best chance of shaping it. Chief Development Officer and Dealmakers that have internalized them will discover new sources of growth and hidden targets with huge economic potential.

“I never think of the future,” Albert Einstein once observed. “It comes soon enough.” Most business managers, confronted with the global forces shaping the business landscape, also assume that their ability to sculpt the future is minimal. They are right that they can do little to change a demographic trend or a widespread shift in consumer consciousness. But they can react to such forces or, even better, anticipate them to their own advantage. Above all, they ignore these forces at their peril.

Business history is littered with examples of companies that missed important trends; think digitization and the music industry. Yet this history also shines with examples of companies that spied the forces changing the global business scene and used them to protect or contribute to the bottom line. Companies ranging from insurers to energy producers did precisely that in embracing the growing social concern about climate change. So did Wal-Mart Stores in applying technology to automate inventory management and reduce costs dramatically for the company and its suppliers.

The fact is, trends matter. Systematically spotting and acting on emerging ones helps companies to capture market opportunities, test risks, and spur innovation. Today, when the biggest business challenge is responding to a world in which the frame and basis of competition are always changing, any effort to set corporate strategy must consider more than traditional performance measures, such as a company’s core capabilities and the structure of the industry in which it competes. Managers must also gain an understanding of deep external forces and the narrower trends they can unleash. In our experience, if senior executives wait for the full impact of global forces to manifest themselves at an industry and company level, they will have waited too long.

For much of the past year, a team at McKinsey has revisited and retested our assumptions about the key global trends that will define the coming era. We have identified five forces, or crucibles, where the stresses and tensions will be greatest and thus offer the richest opportunities for companies to innovate and change:

•  The great rebalancing. The coming decade will be the first in 200 years when emerging-market countries contribute more growth than the developed ones. This growth will not only create a wave of new middle-class consumers but also drive profound innovations in product design, market infrastructure, and value chains.

•  The productivity imperative. Developed-world economies will need to generate pronounced gains in productivity to power continued economic growth. The most dramatic innovations in the Western world are likely to be those that accelerate economic productivity.

•  The global grid. The global economy is growing ever more connected. Complex flows of capital, goods, information, and people are creating an interlinked network that spans geographies, social groups, and economies in ways that permit large-scale interactions at any moment. This expanding grid is seeding new business models and accelerating the pace of innovation. It also makes destabilizing cycles of volatility more likely.

•  Pricing the planet. A collision is shaping up among the rising demand for resources, constrained supplies, and changing social attitudes toward environmental protection. The next decade will see an increased focus on resource productivity, the emergence of substantial clean-tech industries, and regulatory initiatives.

•  The market state. The often contradictory demands of driving economic growth and providing the necessary safety nets to maintain social stability have put governments under extraordinary pressure. Globalization applies additional heat: how will distinctly national entities govern in an increasingly globalized world?

Our thinking is exploratory rather than definitive. Precisely how these forces will unfold—and, as important, how they interact—is very much a work in progress. Still, our research, extensive one-on-one contacts, and broader survey data give us confidence that these topics should be framing every organization’s strategic conversations about how best to chart its future course. Over the coming year, McKinsey will dive deeper into each of these five areas to draw out the business implications and inform the strategic debate. We can be certain that this new era will not evolve smoothly. Future economic crises—quite likely, major ones—are inevitable. And management theory for the 21st century, the first with truly global enterprises, is being invented in real time, as thousands upon thousands of companies make it up as they go.

What we do know is that the forces driving the emergence of this new world are too powerful to be denied and that running a 21st-century company is exponentially more complex than running a 20th-century one, of any size. Companies must pay attention to more stakeholders, more regulations, and more risks—and watch to see what their customers are tweeting about them. That complexity is greater, but so, we believe, is the opportunity.

Even the most talented strategists will have, at best, incomplete knowledge of what comes next. But from our experience, we know that an understanding of the forces defining the future will also provide the best chance for seizing it.


The great rebalancing

As the center of economic growth shifts from developed to developing countries, global companies should focus on innovation to win in low-cost, high-growth countries. Their survival elsewhere may depend on it.

The vibrancy of emerging-market growth will not be the only major disruption reshaping the global economy in the next ten years, but it may prove the most profound. This decade will mark the tipping point in a fundamental long-term economic rebalancing that will likely leave traditional Western economies with a lower share of global GDP in 2050 than they had in 1700.

Two socioeconomic movements are under way.

• Declining dependency ratios. Virtually all major emerging markets are undergoing demographic shifts that historically have unleashed dynamic economic change: simultaneous labor force growth and rapidly declining birthrates. Simply put, there will be more workers, with fewer mouths to feed, leaving more disposable income.

• The largest urban migration in history. Each week, nearly one-and-a-half-million people move to cities, almost all in developing markets. The economic impact: dramatic gains in output per worker as people move off subsistence farms and into urban jobs. China and India are seeing labor productivity grow at more than five times the rate of most Western countries as traditionally agrarian economies become manufacturing and service powerhouses.

These same factors powered Western economic growth for the better part of two centuries. (And they should last well into the next decade—at least until China’s population, finally seeing the full effects of the one-child policy, begins to go gray.)

In the next decade, emerging-market economies will rapidly evolve from being peripheral players, largely reacting to events set in motion by wealthy Western nations, into powerful economic actors in their own right. They will shed their role as suppliers of low-cost goods and services—the world’s factory—to become large-scale providers of capital, talent, and innovation. (One hint of what’s to come: the number of BRIC companies on the Fortune 500 has more than doubled in the past four years alone.)

Nor is this trend just about China and India. To varying degrees, ASEAN Latin American, and Eastern European nations, as well as portions of the Middle East and North Africa, are taking part in this economic renaissance. Even pockets of sub-Saharan Africa now demonstrate vigor after decades of stagnation.

For all companies—both established multinationals and emerging-market challengers—this great rebalancing will force major adjustments in strategic focus. No longer can established companies treat emerging markets as a sideshow. Emerging markets will increasingly become the locus of growth in consumption, production, and—most of all—innovation. More and more, global leadership will depend on winning in the emerging markets first.

Opportunity and adversity are the mothers of invention—emerging markets will be the world’s next fount of innovation

Consider that more than 70 million people are crossing the threshold to the middle class each year, virtually all in emerging economies. By the end of the decade, roughly 40 percent of the world’s population will have achieved middle-class status by global standards, up from less than 20 percent today. This means opportunity in consumer markets: P&G, for example, hopes to add a billion new customers to its ranks in the next decade, adding to the nearly four billion the company touches today. In recent quarterly earnings reports, nearly every global consumer products company—from Kraft to Nestlé—noted upticks in profits, driven primarily by unexpected gains in emerging markets.

The $2,200 Nano car, made by India’s Tata Motors, is just one among hundreds of new products that can turn traditional price and cost structures on their heads.

Seizing that opportunity won’t be easy. These new consumers come from a bewildering array of ethnic and cultural backgrounds. They have little loyalty to—or even knowledge of—established global brands. Their tastes and preferences will evolve just as rapidly, if not more so, than those of consumers in developed markets, and they will demand products with every bit as much quality. Yet, on average, they will wield just 15 percent of the spending power, in real dollars, of their developed-world counterparts.

Companies that can reduce cost structures to 20 or 30 percent of developed-world levels, or lower, will be in position to ride a swelling wave of unmet demand. While much has been made of the Nano, Tata’s $2,200 car, the truth is that hundreds of products now being developed promise to reinvent price and cost structures radically—from Hindustan Lever’s $43 water purifier, in use in more than three million Indian homes, to the Zero, a proxy ATM that costs less than $50 a month to operate (essentially a revamped cell phone with an attached fingerprint scanner, used by local merchants).

To tap the riches rising from these new markets, established organizations must reinvent business models. Hindustan Lever, for example, unable to find reliable distribution in large reaches of India, uses everything from bicycles to bullock carts to deliver products to market. When the Indian refrigerator manufacturer Godrej decided to release a refrigerator for the rural market, it worked with villagers to codesign a product that worked for their needs. The result: the ChotuKool, a $69 fridge that not only shattered price barriers but also included features that allow it to work in an environment where consumers cannot depend on their electricity to stay on.

Today’s unit share leaders will be tomorrow’s revenue winners—ignore them at your peril

Thanks to a low price structure, such innovations capture massive unit share long before they generate meaningful revenue share. This distinction matters. CEOs who miss it risk being overtaken by low-cost innovators that race up the value chain until they have a commanding lead.

Caterpillar, for example, is the world’s largest construction-equipment manufacturer. Its revenues are twice those of the next-largest player. No Chinese company makes the top ten by this measure, so China might appear to be a distant threat. But unit sales numbers tell a different story. Ranked by the number of vehicles sold, 9 of the industry’s 12 largest manufacturers of wheel loaders—the second-largest-selling piece of construction equipment—are Chinese. Nor do these players have an advantage only in their home market: Chinese manufacturers now supply a third of the wheel-loader volume in emerging markets outside China and are beginning to hit their stride in developed markets too. No wonder traditional industry leaders, including Cat, have raced to get a piece of the action, rushing to forge joint ventures with Chinese competitors.

Even luxury brands such as L’Occitane appeal to consumers in emerging markets—the French company’s fastest-growing segment. It is floating its upcoming IPO on the Hong Kong exchange rather than the Euronext.

Significantly, while emerging-market upstarts often gain market share by trading away margin to build position, that is not always the case. The best, forced to innovate by the harsh conditions of their home markets, are developing leaner business models that both boost low-cost demand and deliver enviable financial returns.

Consider Bharti Airtel, India’s leading wireless provider. In 2003, Bharti founder Sunil Mittal, struggling to hire telecommunications engineers and build out a network fast enough to keep pace with exploding demand for mobile services, made a controversial decision to outsource the construction and management of Bharti’s wireless network to Ericsson and Siemens. The result, a fundamentally new approach to managing a mobile-services company, allows Bharti to reap profit margins higher than most Western telecommunications companies do—despite average revenues per user just 10 to 15 percent of those of its developed-world counterparts.

The allure of emerging-market consumers touches even luxury companies. The privately held French beauty products company L’Occitane, for example, is floating its upcoming IPO not on the Euronext, in Paris, but rather on the exchange in Hong Kong. The reason: emerging-market consumers are the fastest-growing segment for this affordable luxury brand.

Don’t assume that emerging markets are just a cost play—technological innovation will be the next frontier

Last year marked the first ever when an emerging-market company—the Chinese telecom manufacturer Huawei—led the world in patent applications. No US company made the top ten. An imperfect measure? Perhaps, but it captures a deep underlying trend. Today, India supplies more technology workers than any other country, and China is on track to pass the United States as the home of the world’s largest R&D workforce. As more and more talent centers spring up across emerging markets and skills deepen, new innovation ecosystems will emerge. Already, more than 1,000 multinational companies operate R&D facilities in China, five times the level a decade ago.

In electronics, computing, and clean energy, among other fields, emerging-market companies increasingly define the future. Huawei, long dismissed as a perennially weak upstart to the likes of Cisco Systems or Ericsson, is now the world’s third-largest telecom-equipment manufacturer and builds some of the most sophisticated network equipment anywhere. It counts nearly every leading telecom operator as a customer.

Learn to manage multiple business models—or why the West still matters

For established Western multinationals, the biggest dilemma will be figuring out how to thrive while competing across highly different types of markets. Since both developed and emerging markets require innovation at breakneck speed, many companies may be tempted to underinvest in potential long-term revenue growth in new markets in order to pursue here-and-now profit gains in established ones. That’s understandable: while more than 50 percent of future global growth will occur in emerging markets—and in many industries much more than that—the lion’s share of profits so far remains in the OECD. But that’s shortsighted. Companies need to figure out how to win in both.

The mobile-phone handset market epitomizes the paradox: cutting-edge smartphones make up just 6 percent of global handset volumes, yet Apple, Research in Motion (RIM), and HTC now earn more than 50 percent of total industry profits. On the lower end, ultra-low-cost handsets from OEM manufacturers such as TCL and ZTE are capturing significant volume share in emerging markets. Traditional players such as Motorola, Nokia, and Samsung find themselves squeezed in the middle, fending off assaults on both top and bottom—largely from competitors that barely registered less than five years ago. Managing multiple business models is hard.

Blowback is real—so why not drive it yourself?

A few innovative companies are starting to get it right. GE, for example, has devised an electrocardiograph machine for the Indian market that can be sold profitably for $1,500, less than a fifth of the price of traditional ECG monitors in Europe and the United States. The new model has helped GE not only to extend a new level of health care to millions of Indians but also to figure out how to create a monitor it could sell for $2,500 in developed markets. Based on this experience and others like it, GE is now developing more than 25 percent of its new health care products in India—with explicit plans to deploy them both in emerging and advanced economies.

Shoppers in São Paulo, Brazil—just one country where investments by companies based in developed markets have spurred an “innovation blowback” in developing ones: the emergence of lower-priced, high-quality products that raise the stakes for global competition.

The prospect of this innovation wave unleashed by the great rebalancing should serve as a wake-up call to any CEO. Emerging markets are more than enormous growth opportunities; they are where tomorrow’s champions will hone their long-term competitiveness. Pursuing incremental product line extensions in developed markets, though profitable in the short run, will not suffice to build the critical muscle required. Innovation “blowback” is coming as lower-priced, high-quality products created for the mass markets of tomorrow move from the developing to the developed world. Buoyed by strengthening currencies and improved balance sheets, emerging-market challengers will move further up the value chain by acquiring more Western companies. Learning to win in low-cost, high-growth countries means winning not just there but everywhere.

The productivity imperative

To sustain wealth creation, developed nations must find ways to boost productivity; product and process innovation will be key.

Emerging markets are riding a virtuous growth cycle, propelled by larger and younger working populations. In the wealthy nations of the developed world, by contrast, low birthrates and graying workforces will make it enormously difficult to maintain what economist Adam Smith called “the natural progress of opulence.”

These countries’ best hope for keeping the wealth creation engine stoked is improved productivity—producing more with fewer workers. Paradoxically, doing that well across an economy is also the only way to generate lasting employment gains. In the United States, for example, every point of productivity-led GDP growth has historically generated an incremental 750,000 follow-on jobs.

The great tension here arises at the level of politics. Over time, the world’s rebalancing demands greater consumption and lower savings among the large developing countries, even as developed ones, the United States foremost among them, save, invest, and export more. Fostering policies that raise productivity, and avoiding or altering polices that impede it, will help ensure a smooth transition. Getting this wrong—failing to generate at least modest and broad-based continued income and employment gains in developed countries—raises the odds of a political backlash that will hurt the citizens of wealthy nations and of those moving up the wealth curve alike.

We call the productivity challenge an imperative because the need is so compelling. But to eke out even modest GDP increases, OECD nations must achieve nothing short of Herculean gains in productivity. In the 1970s, the United States could rely on a growing labor force to generate roughly 80 cents of every $1 gain in GDP. During the coming decade, assuming no dramatic increase in hours worked, that ratio will roughly invert: labor force gains will contribute less than 30 cents to each additional dollar of economic growth. To maintain a GDP growth rate of 2 to 3 percent a year, productivity gains will have to make up the other 70 percent.

The challenge is even greater in Western Europe, where no growth in the workforce is expected. Here, in other words, 100 percent of GDP growth must come from productivity gains. And in Japan, the hurdle is higher still: because of a shrinking labor force, each worker will have to increase output by 160 yen to generate an additional 100 yen of growth.
To complicate things further, we are seeing a growing talent mismatch. The Western economies have built a workforce optimized for mid-20th-century national industries, yet the jobs now being created are for 21st-century global ones—we need knowledge workers, not factory workers. And there just aren’t enough of the former. Anywhere. Companies across the globe consistently cite talent as their top constraint to growth.

In the United States, for example, 85 percent of the new jobs created in the past decade required complex knowledge skills: analyzing information, problem solving, rendering judgment, and thinking creatively. And with good reason: by a number of estimates, intellectual property, brand value, process know-how, and other manifestations of brain power generated more than 70 percent of all US market value created over the past three decades.

Western economies can do many things to change the equation. Deregulation has often raised productivity in the past and can continue to do so. Changing the boundaries around the work–life balance—encouraging people to stay in the workforce longer or increasing the numbers of hours worked each week—could add a few points of absolute growth too. Improving education is a no-brainer.

Businesses can and should advocate these and other policy changes that could have a long-term impact, such as easing immigration restrictions. But in the end, the real game changers will be breakthrough innovations created by companies: history shows that a majority of productivity growth—more than two-thirds—comes from product and process innovation.

The productivity economy will reward ‘do it smarter’ companies that build a better business model

Besides providing powerful incentives for companies to deliver their traditional products and services more efficiently, the new environment may make selling productivity—finding marketable ways to “do it smarter”—the most transformative business model of the next decade.

Western economies can boost productivity not only through deregulation but also by adjusting the work–life balance—keeping flexible hours and staying in the workforce longer, as 95-year-old Sydney Prior of Britain has.

This push is bound to have a “no pain, no gain” dynamic. Innovation, by definition, is a disruptive process. Think about the book-publishing industry. Only two years after the release of the Kindle, now sells half of its books electronically for the titles it offers customers in both bound and digital formats. The Kindle is short-circuiting the entire physical supply chain, and Apple’s new iPad is sure to accelerate that process.

Something similar is shaking up the world of computing. It’s considered the poster child of productivity—and for good reason. But probe further and it’s not hard to find evidence of waste. Companies spend, on average, 5 to 10 percent of their total revenues on IT. Yet reliable estimates suggest that upward of 70 percent of server capacity goes unused—even more at midsize and small companies, since they can’t achieve scale. Advances in “cloud computing” (sharing computer resources remotely rather than storing software or data on a local server or PC) have vast potential to raise utilization rates and simultaneously help companies to increase their computing capacity, while slashing IT costs by 20 percent or more. Little wonder tech giants as divergent as Google, IBM, and India’s Wipro Technologies are investing furiously to win the battle for the cloud.

Companies that can master productivity techniques, such as robotics, and sell that expertise may capture the coming decade’s most transformative business model.

Health care is another arena where do-it-smarter businesses will thrive. On average, health care spending in OECD countries has outpaced GDP growth by nearly two percentage points a year, and even more in the United States. Still, in most countries, increased health care spending actually creates a productivity drag on the economy overall, because the sector has lagged behind in adopting productivity measures. (To take just one indicator, health care organizations spend, on average, only 20 percent of what financial-services companies do on IT.)

But multiple innovations promise to improve outcomes significantly while reducing costs. For example, some 75 percent of health care spending in many OECD countries pays for chronic-disease management. France Telecom’s Orange is partnering with health care providers to offer services that constantly monitor diabetics and cardiac patients remotely. Low-cost mobile-monitoring devices ensure better compliance with treatments and reduce the number of high-cost, life-threatening events. Germany’s T-Systems has linked up with the health insurance provider Barmer to provide mobile systems that track and monitor exercise patterns, so patients—and doctors—can monitor progress and reduce risk more effectively.
A raft of industries and services are poised to benefit from productivity improvements. Huge gains could be extracted just by applying the insights learned over the past 15 years in the most productive sectors, such as telecoms and financial services, to less productive ones, such as health care, education, and government.

The best companies will learn how to maximize returns from people who think for a living

Just as the early 20th century saw the development of management theory for improving the productivity of factory workers, the 21st century will see the evolution of myriad better techniques for managing people who think for a living.

The potential stakes are enormous. Companies that have higher concentrations of knowledge workers (above 35 percent of the workforce) create, on average, returns per employee three times higher than those of companies with fewer knowledge workers (20 percent or less of the workforce). Yet companies with more knowledge workers also show more variable returns: differences between competitors in the same industry with fewer knowledge workers.

Turning this gap into a key source of competitive advantage requires much more than reverting to the well-worn “attract, deploy, develop, and retain” talent wheel found in HR manuals everywhere. Yes, the road to success still starts with capturing more of the right talent. But to increase productivity dramatically, companies will then need to think aggressively about how to increase the pace of talent development, to deploy the best talent against the highest-value opportunities, and to improve the way such workers engage with their peers. Our analysis suggests that at many large multinationals, nearly half of all interactions between knowledge workers do not create the intended value—because people have to hunt for information, do not know where to find what they need, or get caught in the maws of inefficient bureaucracies.

Companies will need to reinvent work—what, where, when, how, who, and why

Companies such as Best Buy have increasingly recognized that work is not a place where you go but rather something you do. To get the most out of its corporate workforce, the company has adopted a “results-only work environment,” which gives workers big targets but lets them meet these goals any way they see fit. This approach has improved worker productivity by as much as 35 percent in departments that have deployed it.

Transforming process flows will also unlock new kinds of productivity. Companies such as Cisco and IBM are aggressively developing approaches—from social networks to videoconferencing—that tear down silos and reinvent how far-flung employees collaborate and exchange knowledge. What’s more, these approaches work: UK grocer Tesco, for example, saved up to 45 percent of the travel budgets of key departments by substituting videoconferencing for long-haul travel. The Hong Kong apparel supplier Li & Fung now uses videoconferencing to connect clothing designers with fabric and notions suppliers around the world, dramatically speeding the design process. That’s no mean feat for a company known for its ability to turn around “fast fashion” in weeks, not months.

Although the demand for knowledge workers is sure to grow, the supply will not. Governments aren’t moving fast enough to educate workers with the skills needed to meet the productivity imperative, and businesses can’t afford to wait. That means companies must get much more innovative at sourcing talent, whether by tapping global labor markets, building part-time workforces, or making better use of older workers. Firms also will need to rethink work progressions in a world with much flatter age pyramids—young workers no longer outnumber old ones, which has been the premise for role advancement in most companies for decades. BMW has experimented with auto production lines geared for older workers. Retailers such as CVS and Home Depot are pioneering “snowbird” programs, which let retirees go to warm climates in the winter and to work in stores there, returning to their original stores in the summer.

Information streams are the infinite by-product of a knowledge economy—the best companies will turn this free good into gold

A final productivity driver will be something businesses are creating in digital bucket loads: information. Although the volume of data created is expected to increase fivefold over the next five years, best-guess estimates suggest that less than 10 percent of the information created is meaningfully organized or deployed. That number will only shrink as the rate of information production goes up.

Enter business analytics software, which increasingly allows companies to make sense of data “noise”—helping them “de-average” data to eliminate waste, more closely target customers, and identify new opportunities. In general, companies that are aggressive adopters of business analytics are proving twice as good at predicting outcomes and three times as good at predicting risk as those that aren’t.

The Swiss telecom operator Cablecom, for example, reduced customer churn nearly tenfold through the better use of customer information. Both Amazon and Google have developed predictive models that use enormous amounts of data to figure out what products customers might like, based on past searches and clicks. IBM, Microsoft, Oracle, and SAP have spent a combined $15 billion in the past several years snapping up companies that develop software for advanced data analytics. Expect a host of new offerings that help turn information into gold.

Soon, Web 3.0 technologies—which create “smart” data, or data that can be combined intelligently with other data, mostly without direct human involvement—should extend the power of information even further. We fully expect Web 3.0 to begin disrupting information networks within the decade.

In short, companies that deploy technology more successfully to get more from the higher-quality knowledge employees they attract will gain large business model advantages—and drive substantial growth and productivity gains.

Pricing the planet

Understanding a company’s full exposure to energy and environmental risks will in many cases be a—if not the—decisive factor determining its long-term viability.

The tension between rapidly rising resource consumption and environmental sustainability is sure to prove to be one of the next decade’s critical pressure points. Natural resources and commodities account for roughly 10 percent of global GDP and underpin every single sector in the economy. No one will sit on the sidelines in this debate.

The interplay of three powerful forces will determine what resources we use, how we use them, and what we pay for them:

•  Growing demand. Even the most conservative projections for global economic growth over the next decade suggest that demand for oil, coal, iron ore, and other natural resources will rise by at least a third. About 90 percent of that increase will come from growth in emerging markets.

•  Constrained supply. As easy-to-tap and high-quality reserves are depleted, supply will come from harder-to-access, more costly, and more politically unstable environments.

•  Increased regulatory and social scrutiny. Around the world, political leaders, regulators, scientific experts, and consumers are gravitating to a new consensus that is based on fostering environmental sustainability. Climate change may be the most highly charged and visible battleground, but other issues loom: water scarcity, pollution, food safety, and the depletion of global fishing stocks, among other things. For businesses, this new sensibility will present itself in two ways: stricter environmental regulations and increasing demands from consumers—and employees—that companies demonstrate greater environmental responsibility.

To understand how the world is likely to change as these forces collide, start by distinguishing between resource stocks, which are not likely to change much over the next decade, and resource flows, which will change enormously.

The fossil fuel consumption infrastructure is so large that, despite recent clean-energy investments, the ratio of fossil fuel to renewable and nuclear power use in 2020 will still be 80 percent, as it is today.

Despite huge investments in clean energy, in 2020 the ratio of fossil fuel consumption to renewable and nuclear power will remain largely as it is today—roughly 80 percent. No realistic scenario will move the needle: the embedded resource infrastructure is so large that any transition away from fossil fuels will take decades.

But the view changes dramatically when you look beneath the supply stock to the flows of new investment. Suddenly, clean tech emerges as one of the next decade’s biggest growth industries. Upward of $2 trillion will probably be invested in building clean-energy capacity globally over the next ten years. In the United States, 90 percent of this expanded capacity will be in renewable or nuclear energy—66 percent in the European Union and China. Before 2020, this investment will probably create a clean-tech industry generating well over $1 trillion a year in sales.

No country better epitomizes this contradictory dynamic than China, which in recent years has emerged as both the world’s biggest carbon emitter and—if future actions speak louder than words—arguably its leading clean-energy champion. Buoyed by strong economic tailwinds, Chinese electricity demand is growing by 15 percent a year, creating the world’s largest market for power generation equipment. To date, China has kept pace by adding a slew of coal-burning power plants that emit a lot of carbon. But motivated both by the huge costs of environmental degradation and by fears of overdependence on Middle Eastern oil, Beijing has moved decisively to support the development of clean-energy technologies. China may be the world’s number-one polluter, but it is also the world’s largest consumer—and manufacturer—of wind turbines and solar panels. And it will soon take a commanding lead in the use of clean-coal and nuclear technology.

In fact, China is building the clean-energy businesses of the 21st century—not just locally but globally too. Suntech Power, China’s largest manufacturer of solar panels, now commands 12 percent of the US solar market. The company, which will soon open its first factory in the United States, hopes to capture 20 percent of the US solar-panel market over the next two years.

As a result of this enormous shift in flows, some business models will be obliterated, others will thrive, and yet others, especially outside the resource sector, may barely change. For CEOs, understanding their true exposure to energy and environmental risk will require more sophistication than ever and will emerge for many as a—if not the—decisive factor determining the long-term viability of their companies.

Commodity prices will rise higher—and fall harder

For most resource commodities, the question is not whether supply will be sufficient but rather what will happen to the price. And that depends in part on what it takes to gain access to resources.

With 12 percent of the US solar market, China’s Suntech Power leads the country in solar-panel manufacturing and in building the 21st century’s clean-energy businesses, both at home and abroad.

Just four countries—Iran, Iraq, Saudi Arabia, and Venezuela—hold some 50 percent of known oil and gas reserves. Nationally owned oil companies now control over 85 percent of them. Many of the key providers are highly exposed to broader geopolitical instability, which makes security of supply a major risk. Meanwhile, new supply is proving harder to find. Most new sources, such as deep-sea reserves or oil sands, require high-priced, environmentally controversial approaches to extraction.

These factors all suggest that oil prices will be both higher and more volatile. Adding to the complexity is the fickle nature of global commodities markets. The number of “virtual” barrels of oil, in the form of futures and derivatives, traded on global exchanges each day exceeds the number of real barrels by an estimated ratio of 30 to 1. This “market effect,” enabled by the global grid, amplifies any market tremor—a key reason oil prices collapsed to just 20 percent of pre-crisis levels in the immediate wake of the financial crisis, falling from above $150 to roughly $30 a barrel. Few other industries could experience such pricing changes in just six months.

Yet oil isn’t the only commodity susceptible to wild price swings. For example, more than half of the world’s copper production is concentrated in a handful of countries with limited infrastructure and high extraction costs. Producers know that over the long term, demand for copper can only grow. At the same time, they’re wary of investing in infrastructure ahead of the demand cycle—a strategy that practically guarantees future pricing volatility.

In uncertain times, the need to plan for widely different outcomes is the one clear certainty

Regulation will prove another wild card. Virtually every major economy in the world is contemplating stricter rules, but there’s little consensus over which regulatory schemes will be adopted, much less how they will be enforced. Some could dramatically transform business models. How, and if, carbon is priced, for example, could fundamentally alter many industries. The same is true with water.

Large regulatory changes are sure to disrupt entire value chains. Agriculture, for example, is one of the world’s leading carbon emitters. If it becomes regulated under a carbon regime, that will affect not just farmers but also their suppliers—for example, equipment manufacturers, seed producers, and fertilizer providers—as farmers scramble to adopt emission-reducing agronomic techniques, such as no-till planting.

Consumer behavior may prove the great unknown. Although consumers are becoming much more environmentally aware, to date they have not shown much proclivity either to reduce their resource consumption or to pay for environmentally friendly products—and certainly not if such products cost more. (There are some notable exceptions, such as the Toyota Prius, which captured more than 2 percent of the US market, despite being 20 percent more expensive than a similar vehicle powered only by gasoline.) That resistance could change dramatically as we have seen before: recall the backlash against chemical companies in the 1960s, following the publication of Rachel Carson’s Silent Spring.

The implication: companies can no longer rely on business-as-usual scenarios when it comes to resources; they must factor in higher base-level prices and increased volatility. They also need to weigh any number of factors that are not yet—but may become—priced in the future, such as carbon and water. And they need to understand how customers might respond. Since these are huge uncertainties, companies will have to consider their options and outcomes under multiple scenarios.

Business models that drive resource productivity will be just as important as those that drive labor productivity

Despite the hype over clean energy, the biggest impact from rising pressure to price the planet may well come from something much more mundane: conservation. Boosting resource productivity—like labor productivity—will become an increasingly important way for businesses to reduce both their costs and their pricing exposure. Many of these gains require low capital investments and are comparatively easy to adopt.

Advances in fields such as environmental product design and “green software” (which helps optimize resource usage) will become important ways for companies to reduce resource consumption. UPS, for example, has saved 2 percent on fuel costs by using software that helps plan delivery routes with fewer left turns (which use more fuel than right turns). Similarly, Apple has created approaches to reduce waste in its products: since it launched the iMac, it has reduced raw-material content by 50 percent and energy consumption by 40 percent. Boeing designed its new Dreamliner with both the environment and costs in mind: by using lightweight composite materials, the company improved fuel efficiency by more than 20 percent, reducing both a customer’s lifetime ownership costs and potential future environmental exposures.

Regulatory decisions will foster clean-energy innovation as well. Long-term Spanish subsidies of wind power are major reasons for the rise of two Spanish companies, Iberdrola Renewables and Gamesa, as global leaders in wind energy.

Customers, too, are pushing companies to become more environmentally friendly—and helping to spawn some great new businesses. Clorox, for example, captured 40 percent of the US natural-cleaning-products market within the first quarter of launching its GreenWorks line, increasing the size of the overall category substantially. Moreover, it did so by offering a suite of products that were up to 25 percent cheaper than other natural products. That made customers happy, and GreenWorks pleased shareholders as well by generating margins 20 to 25 percent higher than the company’s average.

Of course, not every green investment is a good investment, so companies need to assess the puts and takes on their options carefully. The future of some green businesses, such as carbon trading, depends hugely on still-murky regulatory environments. Other opportunities, particularly in clean energy, will take years to scale. Still others, such as “smart” building technologies, may have an immediate payoff today, both for customers adopting them and businesses selling them.

Plan for regulatory change—but don’t count on global consensus

Governments everywhere hear the clamor for sustainability, but most also know they will retain power only if they keep delivering economic growth. Couple that imperative with the high coordination costs and fundamental resource usage inequities that persist across countries—China, for example, emits less than a fifth of the carbon dioxide per capita that the United States does—and it’s hard not to conclude that while broad agreements may be possible, they will more likely prove elusive, as first Kyoto and now Copenhagen have demonstrated.

Future natural disasters seem inevitable, and so does the rise of “adaptation” businesses and offerings—for instance, new insurance and building products that respond to environmental challenges.

Nonetheless, we should fully expect a flurry of environmental regulations at the regional and local level. Local environmental problems, especially those (such as water safety) with immediate health consequences, will be solved more easily than global ones. Companies should identify where regulation is most likely to occur and get ahead of potential challenges—not always by taking action but, at least as a first step, by having a plan for what to do if laws change.

Without coordination, this likely future patchwork of varied global regulatory standards may create unexpected opportunities. The model example is hybrid-electric-motor technology. First commercialized in Japan in response to stricter emission guidelines there, it later proved a commercial hit with US consumers, even though US regulations did not require the same standards. Expect more such arbitrage plays in the years ahead.

Finally—and sadly for regions especially exposed to climate change and other forms of environmental degradation—we should prepare for the strong likelihood that an effective global regulatory regime will not appear in time. Look for the emergence of “adaptation” businesses, which develop in response to environmental disasters or challenges. New kinds of insurance products, building products, commercial fisheries, and other businesses designed to respond to tomorrow’s environmental realities may well grow and thrive.

The global grid

The global economy is becoming increasingly interconnected, and innovative businesses are harnessing the power of this network.

Over the past two decades, globalization and digital technology have combined to create vast, complex networks that weave themselves through every economic and social activity. Money, goods, data, and people now cross borders in huge volumes and at unprecedented speed. Since 1990, trade flows have grown 1.5 times faster than global GDP. Cross-border capital flows have expanded at three times the rate of GDP growth. Information flows have increased exponentially.

These networks form a global communications and information grid that enables large-scale interactions in an instant. Within this digital fabric, old boundaries begin to blur; cross-border capital flows also become information flows; and just-in-time supply chains also serve as just-in-time information chains. Case in point: only one in ten US dollars in circulation today is a physical note—the kind you can hold in your hand or put in your wallet. The other nine are virtual.

On this grid, trillions of large and small transactions synchronize instantly. The striking thing about the recent economic downturn wasn’t just the rapidity of the decline but the fact that so many seemingly diverse markets plunged at once. By the end of 2008, the volume of trade had fallen by more than 10 percent in more than 90 percent of OECD1 economies. Why? Trade declined everywhere because, increasingly, products are made everywhere. These days, a typical manufacturing company relies on more than 35 different contract manufacturers around the world to provide the necessary parts for its goods, which for some companies, such as auto and airplane manufacturers, can range in the tens of thousands. No wonder that over the past 40 years, trade in intermediate goods as a percentage of total trade has doubled.

These interconnections are even more pronounced in capital markets. Who would have imagined that Iceland’s financial system might collapse when mortgages in Las Vegas went belly up?

Such complex adaptive systems create their own organizing dynamic. In the absence of direction from a single center, they grow, evolve, interconnect, disrupt, and—quite important—heal themselves. Even as capital flows temporarily shut down during the crisis’s darkest days in the winter of 2008–09, for example, the global information grid kept growing. Estimates by Cisco Systems suggest that in 2009, global data flows expanded by nearly 50 percent. In China alone, more than 150 million new people connected to the Internet last year, giving that country a digital population almost as large as the world’s biggest social-networking site, Facebook. And last year, Facebook’s user base more than tripled, to upward of 400 million members—a population that would make it the world’s third-largest country.

Alongside this relentless advance in digital connectivity, the financial crisis has underscored the commitment by most countries to maintain market-based economies and free flows of capital and trade—though the precise shape of new regulations remains to be determined. On average, governments across the globe have passed three protectionist measures a day since the advent of the crisis, but they haven’t added up to much: less than 1 percent of global trade has been affected by these rulings.

Meanwhile, links form in new directions. Trade flows between China and Africa, for example, have been growing by 30 percent annually, creating robust commercial networks that barely existed a few years ago. Similarly, Asia has supplanted North America and Europe as the Middle East’s largest trading partner. Transactions between emerging markets are on the rise. The Indian wireless operator Bharti’s recent bid to acquire Kuwait-based Zain’s African assets could create a global wireless giant that would reach across more than 20 countries in South Asia and Africa.

Every company is now a global company—and the most innovative ones are building the global grid into their DNA

Innovative businesses will grow by harnessing the interlocking power of these new grids. Some will be disruptive newcomers like Skype. Formed less than seven years ago, and lacking any network infrastructure, Skype nonetheless ranks as the world’s largest carrier of transnational telephone calls. Even if companies eschew such radical business models, they need to think strategically about how to use these new networks to advance their existing business models. Techniques such as “near-shoring,” “crowd sourcing,” and sophisticated labor arbitrage help companies efficiently build products, source ideas, find employees, deliver services, and reach customers efficiently.

Similarly, companies that can figure out how to capture winning positions in the global supply chain will thrive. Japanese companies have mastered that strategy as no others have. In 30 different technology sectors with revenues of more than $1 billion, Japanese companies control 70 percent or more of global market share. They have done so by creating an array of “choke point” technologies on which much larger industries depend. Mabuchi Motor, for instance, makes 90 percent of the micromotors used to adjust car mirrors worldwide. Nidec makes 75 percent of the world’s hard-disk drives. Japanese companies own nearly 100 percent of the global market for the substrates and bonding chemicals used in microprocessors and other integrated circuits.

The information grid makes every company, no matter how small, a global company. Even individual proprietors now sell to customers around the world via sales platforms such as eBay or Alibaba. Snaproducts, a US-based product-development company with fewer than 40 employees worldwide, uses virtual sourcing to supply US retailers with an array of low-cost seasonal and basic products: summer flip-flops, Christmas decorations, beauty products, socks—more than 50 million pairs in the past three years. The company marries a high-touch, customer-centric design process with low-cost production; it collaborates with retailers to predict fickle consumer trends and then designs and sources products in collaboration with a range of low-cost manufacturers across Southeast Asia. This approach provides retailers with rapid sales on high-margin products and allows Snaproducts to deliver year-over-year growth rates as high as 400 percent, without ever taking ownership of inventory.

Your customer is tweeting—how will you answer?

The global grid’s most important impact on business over the next decade may come from the disruptive changes in consumer behavior that it will spur. These changes may well overshadow the radical pricing transparency, ubiquitous information availability, and massive new networks of engaged consumers that we have already witnessed. Recall that 15 years ago, less than 3 percent of the world’s population had a cell phone and less than 1 percent was online. Today, those numbers are 50 percent and 25 percent, respectively.

These technological changes are altering behavior that was once thought impossible to shift. For example, Americans now spend 30 percent more time reading than they did a decade ago, thanks to the explosion of text messaging, e-mail, and social networking.

The complex digital networks that form the current global communications and information grid have brought mobile phones and Internet access o nearly every corner of the world.

What’s more, these readers also write. More than 15 million Americans (or 10 percent of the US workforce) now post online product reviews every week. Aside from recommendations by friends, US buyers now rate online user reviews as the top influencer of their buying decisions—nearly twice as influential as old-style advertising. Traditional media companies know just how large a hole this behavioral shift has blown in their bottom lines.

But it’s not just Big Media’s problem. Companies everywhere are struggling both to capture the benefits of this always-on, user-driven world—and to contain the damage it can cause. Product problems can become global issues overnight, putting a premium on constant monitoring. Viral networks also help inflame nationalist passions around formerly isolated incidents. (Carrefour learned that lesson when negative remarks made by French politicians promoted an overnight boycott of its Chinese stores in the run-up to the 2008 Beijing Olympics.) In such situations, speed and agility in crafting a response can make the difference between successful crisis control and enormous economic harm.

Imagine the power of four billion connected minds—are you prepared for the innovation about to be unleashed?

The spread of mobile broadband will multiply these challenges and opportunities. Users of the iPhone surf the Internet 75 percent more than do users of regular cell phones, and more than half use their phones to watch video. In just three years since the iPhone’s launch, developers have created more than 200,000 applications, and this is only the beginning: nearly 50 percent of all new mobile phones purchased in developed markets are now Web-enabled smartphones. That rush of new Net surfers includes a growing number of emerging-market users too: in China last year, more than 100 million people logged on using the country’s new 3G network, which is why global mobile data usage rose 2.5 times in 2009.

Emerging markets are where the information grid’s influence may be most profound. The explosion of mobile networks is giving billions of people their first real entry point into the global economy, helping them become more informed consumers, connecting them with jobs, and providing much better access to credit and finance. The economic impact is tangible: every 10 percent increase in cell phone penetration in India corresponds to a nearly 0.6 percent rise in national GDP.

Kenya shows how the future might unfold: just four in ten Kenyans have cell phones, yet half of all users—or one in five Kenyans—now make purchases via mobile-payment systems. Kenya’s largest employer is txteagle, an SMS-messaging company, which provides jobs to more than 10,000 Kenyan citizens by doling out “microwork”: small tasks that can be accomplished over mobile networks.

A world where not just everyone but also everything is connected opens up radically new possibilities

Increasingly, people plugging into the planet’s digital nervous system will be joined by inanimate objects in a phenomenon we call “the Internet of Things.” At present, more than 35 billion “things” are connected to the Internet—sensors, routers, cameras, and the like—but this phenomenon is just getting started. More than two-thirds of new products feature some form of smart technology.

For example, John Deere tractors now deploy GPS guidance systems to apply fertilizers to cropland precisely, reducing farmers’ costs and increasing annual yields. The Dutch start-up TomTom has created systems of “smart” traffic lights that improve traffic flows. Nortura, Norway’s largest food supplier, uses radio-frequency identification (RFID) technology to trace chickens from the farm to the store shelf, helping to monitor optimal refrigeration temperatures throughout the supply chain. Kraft and Samsung have partnered to develop the Diji-Touch, a Web-enabled vending machine that allows real-time updates of rich-media images of products for sale. The stakes are high: as objects and devices connect online, some estimates suggest that at least $3 trillion of current spending could be disrupted.

Expect a bumpy ride—a connected world will be a volatile world

A profound tension remains at the core of this expanding global grid. In theory, all this interconnectedness is supposed to increase stability by helping to diversify risk. But while the ability to diversify risk has risen, so has the ability to identify and channel resources instantaneously toward or away from opportunities. The global financial crisis painfully underscored how interconnectedness can actually amplify the impact of a particular shock, so the key will be to focus on building in greater redundancy and resilience. In the meantime, we should not be surprised if the years ahead bring long stretches of stability—the payoff from a larger and more resilient system that is still subject to bubbles and powerful shocks.

The next few years in particular may well be bumpy as a massive deleveraging process rolls through many Western economies. The eurozone will prove especially tumultuous as structural imbalances get worked out between savers, such as Germany, and debt-laden countries, such as Greece, Ireland, Portugal, and Spain. It’s important to note that these bumps will occur across all markets—capital and currency markets, trade markets, and labor markets.

In response, businesses should strive to improve their peripheral vision by gaining a better understanding of the full range of areas where disruptions could emerge and by scanning the horizon for potential shocks. Volatility is here to stay. Learn to recognize it, prepare for it, adapt to it, manage it, and profit from it. But don’t ignore it.

The market state

Governments around the world are facing complex, difficult decisions. Business leaders would do well to work with them to develop solutions.

While we expect the steady advance of market capitalism to continue, the state—far from withering away—is likely to play an ever-larger role over the next decade, for three reasons.

First, even before the financial crisis hit, governments everywhere found themselves increasingly called upon to mitigate the sometimes negative impact of globalization on individual citizens.

Second, the crisis itself has prompted large-scale direct government intervention, both through fiscal stimulus and calls for increased regulation. That tilt in the power balance has been reinforced in much of the world by the perceived failings of the US-led free-market model and the success so far of a Chinese model that, while market-oriented, assumes that the state’s guiding hand will stay firmly clasped around many levers of power.

Third, the spread and dispersal of economic power around the world is making it harder to reach consensus on multilateral approaches to setting the rules of the global game. Bilateral and regional deal making is increasingly common, and these more local arrangements will remain largely market-based. Yet for business, this continuing shift away from a single set of rules will inevitably make it more challenging to seize opportunities globally. It will also require companies to engage across many fronts with many critical regional and national government actors.

Business executives, of course, face no shortage of challenges. But the tensions confronting policy makers in the coming years are truly daunting. On the one hand, states have been charged with driving prosperity by fostering economic growth and job creation. Most of them understand that this goal requires a strong role for the market rather than a reverse march toward command economies (hence our term, “market states”). On the other, governments must also ensure social stability and maintain social-safety nets. What’s more, they must accomplish these ends for citizens who continue to live within distinct national borders, even though those citizens’ ultimate fortunes will be hugely influenced by transformative shifts in flows of capital, goods, labor, and information that recognize no borders. How governments respond to these pressures, both individually and collectively, will do more to shape outcomes over the next decade than the actions of any other single kind of economic actor.

Let’s drill into the complications. In the developed world, virtually all major economies are struggling with expanded claims for government services, rising debt-to-GDP ratios, and looming entitlement time bombs. Debt levels in OECD1 countries will, on average, likely rise to 120 percent by 2014—up from less than 80 percent today. In emerging economies, governments may enjoy better demographics, but their aspiring citizens and growing economies demand huge investments in physical and social infrastructure—from roads to education to health care—if they are to avoid social disruptions and build thriving 21st-century economies.

Then there’s this consideration: over the past 100 years, an income inequality gap split the world into two large camps—Western economies buoyed by an increasingly prosperous middle class, and other nations caught in a seemingly endless cycle of poverty. Now, while inequality among nations (and across this former divide) is thankfully shrinking, the gaps between rich and poor within individual nations are widening.

While overall standards of living have risen across the globe, the gap between rich and poor has grown in almost three-quarters of OECD countries over the past two decades. Inequality is rising even faster in emerging markets: in China, it is increasing more quickly than in any Western economy.

This shift is partly structural. As economies develop, overall living standards tend to rise but so does income inequality. Manufacturing economies tend to be less equal than agrarian ones, service-based economies less equal than manufacturing ones. (The Gini coefficient—the measure of the difference between top and bottom earners—is two-thirds higher for service sectors than manufacturing sectors, and 150 percent higher for service sectors than agrarian sectors.)

Globalization further compounds the problem—and not in ways that are intuitive. Trade, though often blamed for aggravating income inequality, is not the key culprit. Instead, the rate of technology adoption is by far the biggest driver, accounting for more than three-quarters of the impact, mainly by automating away many low-skill jobs. The shortage of knowledge workers and capital deepening (which increases the productivity of top talent, hence raising its earning potential) accentuate the problem by causing salaries for top earners to soar.

The effect can be eye-popping. While a US unemployment rate topping 10 percent has drawn headlines in the current recession, the reality is starker. The unemployment rate in the top income decile of the population is barely 3 percent, but in the bottom decile, it’s ten times higher—more than 30 percent. Upward of a third of the US unemployed are now considered to be long-term (or structurally) unemployed and thus unlikely to rejoin the workforce any time soon.

While the gaps in Europe and Japan are generally smaller—Spain is a notable exception, with unemployment now approaching 20 percent—these nations pay a price. Estimates suggest that Germany and Japan, for example, have given up over a point of GDP growth a year for at least the past decade as a result of labor and taxation structures designed to produce a more robust safety net. In other words, to ensure a more equal society, they give up a third of the potential growth they could achieve each year.

Income volatility is another key issue. Despite the “great moderation”—the decline in overall economic volatility in the years preceding the recent downturn—the volatility of individual incomes has actually been increasing. In the United States, from the 1970s to 2008, it rose by as much as one-third. On average, 15 percent of US households can now expect their incomes to fall by as much as 50 percent each year. This isn’t just a US issue: more than 50 percent of middle-class Brazilians worry that they are at risk of losing their jobs or otherwise seeing their incomes plummet.

The bottom line: risk is shifting to individuals in a market-driven global economy—and governments are increasingly responsible to help pick up the pieces.

Businesses need to recognize that governments bear the burden of legitimate challenges—and work in partnership to help solve them

In such a world, companies can no longer shrug off policy makers and legislators as interfering meddlers to be managed. Governments are facing legitimate and difficult decisions and will be forced to make trade-offs. Business leaders would do well to acknowledge these problems and to work with governments to help solve them. The risk of a populist antibusiness backlash is high—and companies will need to continue to earn “the right to operate” in relatively unconstrained, probusiness environments.

Successful business leaders already recognize this reality. Wal-Mart Stores, for example, has worked alongside national and local governments, as well as other stakeholders, to help reshape US health policy. Innovative approaches born of the effort, such as the company’s $4 prescription plans and in-store clinics, are helping to reduce the cost of health care delivery in the United States, while also helping Wal-Mart’s customers and employees to pay less for care.

Helping governments to improve the public sector’s productivity will not only save them money but can also generate profits for the providers

Some of the most agile businesses will turn the ability to help solve the state’s challenge into an opportunity. As the tax base for many governments shrinks and burdens grow, states too face a productivity imperative: how to increase services and decrease costs. Governments have been notoriously bad at adopting the lean processes and IT improvements that have driven years of productivity gains in the private sector. Creative approaches by businesses to help solve the public sector’s problems will be part of the solution. In Spain, the health insurance provider Adeslas is partnering with the provincial government of Valencia to run hospitals and clinics more efficiently. In the United Kingdom, when the British Airport Authority built Terminal 5 at Heathrow Airport, it created an incentive plan to get private suppliers to finish the project faster and under budget. (And that example showed both how these new approaches can be successes and also hit bumps along the way—more than 50,000 pieces of luggage got hung up when the terminal opened, as baggage systems worked out kinks.)

States will be competing for jobs and growth, and selecting the right nations to partner with can be a competitive advantage for companies

While politicians will continue to be pressured by—and may sometimes pander to—the antibusiness backlash, most governments will continue to see working well with business as the best way to resolve their biggest dilemmas. Just as businesses need to recognize the legitimate challenges facing governments, governments must recognize the legitimate role businesses must play in contributing to the solution. After all, only a strong, expanding private sector can provide the revenue required to meet the state’s burgeoning needs. More and more, countries will be competing for investment and wooing enterprises to generate jobs and growth.

Two cases in point: Poland has recently created special tax breaks for companies relocating operations there, and both HP and IBM have put centers in Wroclaw to take advantage of these provisions. Similarly, Singapore’s government has invested heavily in education and training in an effort to attract investment by leading multinational firms and also offers subsidies to companies locating there. As corporations think about where to invest, build factories, locate offices, and source talent, they should explore such opportunities actively.

In an interesting twist, governments sometimes turn to private-sector businesses to enhance their prospects of attracting more private-sector business. For example, the city of Shanghai enlisted the employment-services firm Manpower to help it qualify entrepreneurs for government subsidies.

Global companies need to learn to work within and across multiple—and often divergent—regulatory environments

As companies expand globally, they will need to become even more sophisticated about navigating an increasingly complex regulatory landscape. Take financial services as an example. In Europe and the United States, banks have traditionally been managed as a profit-maximizing industry—an approach that has generated no end of second-guessing given the tumultuous outcomes of the past two years. By contrast, banks in Asia have, in effect, been treated as capital-providing utilities. However these regulatory regimes evolve, they will not soon converge.

Google’s recent challenges show just how hard it can be to drive a global business model while coping with widely different political and social cultures. In China, the company has strongly reasserted its own right to privacy, maintaining that data stored on its servers cannot be probed by the state. Meanwhile, in Italy, Google executives have been convicted for impinging on the privacy rights of others; several executives received suspended jail sentences for providing a platform, via YouTube, that allowed individuals to post videos with no oversight from the company.

Information standards, such as those for safety and labor, will remain fragmented and variable across countries and regions. Continued globalization will not homogenize cultural norms and expectations. Yet, as the global grid expands, the reaction and interaction from a single misstep in one country will ripple at the speed of light to more and more places, in new ways that will make the earlier experiences of companies such as BP and Nike seem relatively simple. Companies will need to become even more proactive and dynamic to cope effectively.

Finally, if national governments feel challenged, the multinational institutions established under US leadership after World War II—the traditional enforcers of the “Washington consensus”—are doubly challenged. With little true authority, they struggle to gain agreement from an expanding group of key global players with divergent interests. That’s why the Doha Development Round of trade talks has been in limbo since 2001, despite the ongoing struggle to revive it. Efforts at coordinated regulation on issues as diverse as intellectual property, environmental protection, and capital markets may well see important progress on some fronts, but achieving large-scale solutions will continue to be a daunting task.

Business leaders must recognize their vested interest in the success of the state—perhaps the biggest risk of all is its failure to meet its challenges

Business executives should wish the leaders of aspiring market states well, wherever their leaders may fall on the light-versus-heavy-touch spectrum of government intervention. The reason is simple and compelling: no single factor is more likely to reverse the global economic expansion than a widespread failure by these states to meet the challenges that face them. This threat cannot be taken lightly. Suboptimal policy choices will dampen economic growth; bad choices could, in the worst-case scenarios, threaten geopolitical stability and this may well be the biggest macro-risk business faces in the decade ahead.