Sunday 23 September 2012

The Perils of Relying on GDP in the Information Age

“What gets measured gets managed” is one of the fundamental principles of management. What would a business do if they realised that their one critical measurement tool was broken? If their primary performance indicator was found to be unfit for purpose?

What about a country? When it comes to measuring the health of an economy, the received wisdom is that Gross Domestic Product is the best measure we’ve got. It’s widely acknowledged to be imperfect, but is measured anyway, and used as a yard-stick for government competence almost everywhere.

There are two flaws with GDP that are usually cited in economics textbooks.

Firstly, GDP leaves out certain things that have economic value. It leaves out value-creating work that is unpaid, such as volunteer work and domestic care that parents provide to children or relatives to relatives. It leaves out the value of leisure time spent doing nothing but relaxing.

Secondly, GDP includes certain things that have no economic value (or negative value). Products that are bought then never used are one example. ‘White Elephant’ vanity projects, like the ones described here by the BBC’s Paul Mason, fall into this category.

Industrial activity that creates pollution and products that are harmful to health are often put in the second category: they add to GDP but have negative ‘externality’ effects for society. I would suggest treat these differently. They reveal another, deeper, flaw with GDP, which is that it ignores the ‘balance sheet’ effects of economic activity.  This is a major area of interest to environmental economists, but it has yet to make it into the mainstream of policy creation and debate.

Why do balance sheet effects matter? Because there are a range of economic activities that deplete our ‘stocks’ of natural capital (e.g. mining, oil extraction, fishing and some farming) and there are a range of activities that generate future economic liabilities (e.g. pollution, health deterioration). When economics was born hundreds of years ago, humanity’s impact on the environment was sufficiently small that balance sheet effects could be ignored. Now that the human race has grown to over 7 billion we are having a profound effect on our environment, and we can no longer ignore these effects. Just as it would be inconceivable to manage a business based solely on its profit and loss account, it is a fallacy for governments to concentrate so much on GDP, which measures only flows.

If this is not enough to convince you that GDP is a fatally flawed metric, consider another sort of good that it ignores: Free goods. GDP was developed in an age when most goods produced by businesses were products you could hold in your hand or services delivered face to face. Computing, software and the internet has changed all that. If I consider the most important services I use, most of them are information services, and most of them are provided to me for free by companies such as Google, Facebook and Skype, NFPs such as Wikipedia and the BBC, and individuals who share their thoughts through blogs. Advertising aside, none of this activity is captured by GDP, and yet lives all over the world have been made much richer by the easy availability of information and social contact for free.

GDP has been used consistently since WW2 because it has been a reasonable proxy for quality of life. But in the Information Age, the fundamental linkage between GDP and quality of life is broken (see also this HBR article). Infinitely scalable services with no marginal cost, given away for free, have changed the ball game and now we need a better stick with which to measure economic success.

Saturday 1 September 2012

Does this Apple look rotten to you? The World’s Largest Company and a $1bn Pyrrhic Victory

Apple, the world’s largest company by market capitalisation, reached two milestones last month. On 20th August, it became the most valuable company in history, in nominal terms, after surpassing the previous record set by Microsoft in 1999. And it was declared the victor in a long-running court case with Samsung over patent rights, in which it was awarded a cool $1 billion in damages.

Apple is a lot of people’s darling company. It has done incredible things: it has revolutionised many industries from computing to music through to mobile telecommunications. But its relentless pursuit of court cases based on intellectual property is a bad omen. It hints at a company that is paranoid, aggressive and insecure, not one that is cool, calm, and confident as Apple always used to seem.

Superficially the lawsuit is a rational manoeuvre: by disarming your competitors you can maintain your dominance in the market.

But that is precisely the problem. Not only does Apple come across as petty and bullying by pursuing its court cases, it appears to be aiming for a monopolistic position from which it can exploit its market power and dictate smartphone prices. This has been astutely ridiculed by Samsung which points out, “[it is] unfortunate that patent law can be manipulated to give one company a monopoly over rectangles with rounded corners.”

Courts around the world have refused to side with Apple. A judge in the UK dismissed Apple’s suit against Samsung, saying “[Samsung products] are not as cool. The overall impression produced is different.” In Germany, the Netherlands, Japan and Korea courts have found in Samsung’s favour. It is perhaps unsurprising that Apple’s only major victory was on its home turf in California – and the figure awarded in damages is absurd, like a number Dr Evil might pull out of the air.

What is also quite shocking is the fact that Samsung is one of Apple’s biggest suppliers. Plenty of management research shows that cooperative relationships across value chains contribute to long-run success – exemplified best by Toyota’s rise and longevity. Innovative technologies are shared, supply chain management can be optimised, best practices spread. Samsung is dangerously conflicted, acting as both supplier and competitor to Apple, and a long-running feud will do neither company any favours.

With regard to Apple’s new record market capitalisation this is only a nominal record. Accounting for inflation, Microsoft still holds the real record (peak valuation in $850bn 2012 dollars). Microsoft achieved that milestone in the late nineties, shortly before the tech bubble burst.  Apple is beginning to look like Microsoft in other respects. For starters it has transitioned from a rapid growth phase to the ‘mature company’ phase that stock analysts seem to dread (its first dividends, paid in July, are a key indicator of this). Microsoft adopted bullying tactics with its competitors (Netscape, BeInc…). And Microsoft did its utmost to maintain its monopolies over various software classes. It very quickly became an uncool company, its valuation flatlined, and right now it seems to be destined for decline.

Will Apple go the same way? It seems to be well on the way. Its products have been revolutionary – but its improvements with each new product generation are now more and more incremental. The release of a new iPhone (the 5th generation) will be a great test. The sales are likely to be strong, but sales numbers will be less important than the quality and originality of design when considering Apple’s long-run competitive advantage. Near field control, mobile wallet, or 4G technology cannot be considered revolutionary developments – they are already available so widely. On the other hand, soft-SIM technology, femtocells or something entirely novel could demonstrate that Apple still has what it takes to innovate.