does extend mean pretend? six challenges to conventional wisdom
Posted on | August 13, 2010 | No Comments
This is a re-print of a new blog column established by Wrightwood Capital called The Credit [r.e.]View In these posts, Gunnar Branson sits down with Wrightwood Capital executives and examines the implications, the insights, the opportunities and the risks that can be understood from a “credit view” of Commercial Real Estate.
(click here for print version) Just as the most brilliant among us have made decisions at the height of the bubble that we might want to take back, some unexamined assumptions may cause us to miss what is actually taking place.
In recent conversations with Bruce Cohen, CEO of Wrightwood Capital, he expressed his frustration with one industry premise in particular; as he put it, “Everyone points to ‘extend and pretend’ as the source of market paralysis and yet few are really thinking through the assumptions inherent in that phrase. Banks are certainly extending terms on loans, but is that pretence or a prudent strategy for recovery?”
Bruce’s point is well-taken, but his is a lonely voice these days. The conventional wisdom is that regulators and bankers are, at worst, preventing recovery and, at best, slowing it down. “Extend and pretend” has been repeated like a drumbeat in financial pages, congressional testimonies and trade events by brokers, television pundits and hopeful private equity investors since the beginning of this recession. They believe that the market is held in stasis by owners and clueless lenders who are unwilling to accept reality and to sell assets at a loss. Many make the argument, “If only banks would force more defaults for their troubled loans, accept their losses and liquidate, then private equity could buy assets at a discount and restart the market.”
Many critics, including reporters Carrick Mollenkamp and Lingling Wei in their recent Wall Street Journal article, (“To Fix Sour Property Deals, Lenders ‘Extend and Pretend’” – July 7, 2010), worry that, “rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets.”
There may be examples of asset managers in denial, as were cited in that article, but there is also a strong case to be made that at a macro-level there is very little pretending going on. The notion of clueless banks is a favorite cliché, and it is possible that the corrosive effects of large bureaucracies with access to nearly free capital from deposits can lead to some cognitive laziness, but are they pretending?
According to Bruce, “Most of the banks know exactly what they are doing – extending is the most rational, most fiscally responsible strategy for them to take at this point in the cycle. Is it reasonable to assume that lenders don’t understand or are unwilling to acknowledge the loss of value in their portfolio? By extending the term of troubled mortgages, are they hoping or even praying for some sort of deus ex machina event? Are they only delaying the inevitable loss? I don’t think so.”
Maybe bankers are smarter than they have been given credit for, “Perhaps by extending maturities, they are protecting their portfolios, their depositors, their borrowers, the tenants and, ultimately, the entire real estate community. Done correctly, extension strategies can help build a foundation for a market recovery,” said Bruce. “It is a prudent strategy based on a clear assessment of their current portfolios and their best opportunities for recovery.”
But it is difficult to put aside the myth of clueless bankers. And the chorus of complaints seems reasonable when it declares that the “pretense” of extended loan maturities is slowing down the necessary deleveraging, re-pricing and re-starting of commercial real estate activity. To answer those complaints, Bruce laid out the following six challenges to the conventional wisdom of “extend and pretend”:
- Most financing provided by commercial banks is more than the extension of credit, it’s an investment in a business plan. The investments made in 2007 and 2008 have had their strategies delayed, not necessarily invalidated by the recession. Lenders are rational to give more time for the business plans of those real estate businesses (aka properties) to be executed and for tenant demand and property values to rise again. As businesses get back to business, they will need more space to do it. In an economy as massive as the U.S., real estate demand must grow – and this is already playing out. Despite a slow recovery, leasing activity is picking up and space is getting leased, albeit at lower rents. As a result, previously underperforming assets are seeing their values increase through increased occupancies and net operating income.
- Not “extend and pretend” – Extend and MODIFY. Extending is not a passive avoidance of a problem, it is the first step in a smart and orderly process that drives towards an ultimate realization. A foreclosure proceeding is difficult, expensive, and may take in excess of 12 months to complete. There are many ways to lose additional asset value during that time. In exchange for an extension, lenders are modifying their loan agreements – by requiring the borrower to put the title in escrow or give up rights to defend foreclosure, and obtaining additional capital – all to gain tools to make the process faster and reduce their exposure to adverse outcomes. Extending, then, is a way to facilitate and accelerate the banks efforts towards ultimate recovery.
- Liquidating now hurts banks’ ability to make new loans. A large part of the argument for banks to stop extending their loan maturities revolves around the notion that if they recognize these losses, the banks will be able to resume lending. Unfortunately, most people making this argument overlook the multiplier effect of leverage. For every dollar of capital on banks’ balance sheets, they typically lend $10. Conversely, a reduction of a bank’s capital base, due to recognized losses, will lead to a similar multiplier effect that reduces the loans the bank can carry. In some cases, excessive writedowns will lead to a determination that those banks are undercapitalized and in the absence of new capital may be shut down. Generally, recognized losses will not lead to a resumption of lending, but rather, a material reduction in the amount of new loans that bank can make.
- The Bid-Ask Spread isn’t caused by lender denial – it’s from excessive investor yield expectations. In the last 12 to 18 months, it has become apparent that investors’ expectations were too high, especially in a low inflation, low interest rate environment such as we have today. Those expectations are now normalizing and transactions are starting to happen once more. Were the lenders and owners clueless when they didn’t panic and sell at the bottom of the market? Or were private equity investors overly optimistic to think they would find massive discounting?
- The Resolution Trust Corporate (RTC) did not restart the real estate market in the 1990’s. Contrary to the popular mythology, the liquidation of the failed savings and loan portfolios was not the catalyst for real estate’s recovery. Rather, it was the resumption of growth in the broader economy, coupled with the introduction of securitization to commercial real estate that allowed the industry to stabilize more quickly than expected. Consequently, the liquidation of large portfolios by the RTC into a recovering economy with accelerating capital flows merely led to one of the largest transfers of wealth from the taxpayers to private investors.
- The liquidation of bank portfolios doesn’t serve the market, it serves the vulture. Isn’t it interesting that the loudest voices criticizing banks for holding on to distressed assets come from the people most interested in acquiring those assets? These new investors certainly perceive long-term value in commercial real estate. Should new investors be the only ones to realize the returns from the hard work of owners, operators and investors that have been in the market for years? Is it necessary to transfer the assets and the associated wealth to new entities simply because there has been an economic slowdown?Consider the cost of foreclose to the lender and the community. During a lengthy foreclosure process, the asset frequently languishes and value is further reduced. When the asset is finally sold at a discount in a soft market, the values of neighboring assets are hurt as well – and the economic vitality of commercial districts takes yet another hit. Foreclosure is often a strategy of last resort – as it produces a less than satisfactory outcome for the bank, the investors, the community, the tenants, and the owner…everyone except for the vulture investors who benefit from an aggressively discounted purchase of the asset. If lenders wait before initiating foreclosure proceedings, the only way they will lose more money is if the property drops further in value a year from now. However, most people, including the hopeful vulture funds, believe the real estate market and each asset in that market will be worth more. If that’s the case and if it is possible to wait, why sell now?
Who benefits from a forced liquidation? – new private equity investors
Who benefits from extensions?” - existing owners, tenants, depositors, lenders and the communities surrounding each troubled real estate asset
Is extending pretending? Or is it a rational response to a downturn? Bruce’s six challenges suggest that we all need to re-examine our assumptions.
the hidden cost of the status quo
Posted on | August 2, 2010 | No Comments
I am haunted by the cautionary tale that is illustrated by the chart to the left. It was first pointed out to me by Dan Wallace of Launchpad Partners during his discussion of the post-recession economy. The chart compares the fortunes, approximated by share price, of two American computer companies, Dell and Apple, for the last dozen years or so.
In the fall of 1997, during a Seybold conference, Dell Computer CEO Michael Dell was asked what Apple should do about their weak market position. His answer was very direct, “What would I do? I’d shut it down and give the money back to the shareholders.”
His statement reflected most of the conventional wisdom in the computer industry at that time and was based on the recent lackluster performance of Apple after a series of disappointing innovations such as the Newton PDA. It was a reasonable, if harsh, assessment of Apple’s prospects.
Apple, of course, had been quite innovative in its early years, and had invented several breakthrough products, such as the personal computer. The Apple II, then the MacIntosh and laptop computers led to explosive growth. But in the 1990’s, Apple became a “status quo” company. Their visionary and, at times eccentric, founders were replaced by professional managers who focused on their core customers, drove incremental change, and avoided riskier innovation. After an extended period with little meaningful change or innovation, their market share steadily shrank, their share price stagnated, and there was real question about their continued survival.
But a few years after Mr. Dell’s comment, after Apple once again embraced innovation as a way of life, then introduced iPods, iTunes, iPhones and iPads, there is less doubt about their continued financial success.
If you look closely at the first 20 years of Apple, it is oddly similar to the first 20 years of Dell Computers. Started twelve years later by Michael Dell in his college dorm room and based on a powerful and distruptive innovation, the company managed to change the entire production and distribution process of the computer manufacturing business – with direct sales to customers. For ten years, after that fundamental change, Dell experienced phenomenal growth – as can be seen in the following stock chart:
This fantastic growth curve was the context for Michael Dells seemingly arrogant comment regarding Apple Computers in 1997. Dell had changed the entire market for computers with their innovation and was reaping the rewards.
The only problem was, direct sales of computers may have been Dell’s first and last innovation. After 2000, instead of finding new areas to innovate or new changes that could transform their customers’ businesses and lives, the company decided, just as Apple had in the 1990’s, to focus on consolidating their winnings, incrementally improving their product and distribution network, and establishing themselves as the status quo of their industry. They wisely decided to play it safe.
And just like Apple before them, once Dell stopped innovating, they began to stop growing. Look at their stock performance in the following ten years:
Innovation is a risky pursuit. It takes more time, more money, and more humility than anyone really wants to risk. It can cannibalize existing businesses, it can threaten existing power structures, and it can destroy careers. And yet, as illustrated by the haunting chart at the beginning of this article, playing it safe may be even more dangerous.
Every time someone makes the decision to avoid change for now, to perfect process, to avoid cannibalization of existing products, are they engaging in risker strategy than they realize?
Change is hard – but the alternative may be worse.
debt for growth: “no surge, but you can eat again”
Posted on | July 20, 2010 | No Comments
This is a re-print of a new blog column established by Wrightwood Capital. In these posts, Gunnar Branson sits down with Wrightwood Capital executives and examines the implications, the insights, the opportunities and the risks that can be understood from a “credit view” of Commercial Real Estate.
Right now, conventional wisdom declares that debt can only be found from insurance companies and some banks in a tight range of 50% to 65% loan-to-value (“LTV”), and can only be had for the most “perfect” assets. CMBS is just starting to happen, but forget about value-add, or distressed asset acquisitions – the only action right now is in stabilized institutional quality properties. As such, there is fierce competition and fast sinking cap rates for those few deals. Everywhere else, the market sleeps.
But conventional wisdom may be an incomplete view of the market. Structured debt does exist, select opportunistic investments are happening, and operators can begin to build a portfolio of value-add investments ripe for harvesting as the market recovers, but don’t expect it to be obvious or easy. There isn’t yet a consistent flow of opportunities or debt, but the landscape is changing quickly.
“Very few even realize that 65% to 80% LTV debt exists – but it does.” Bob Dennis , a debt fund manager at Wrightwood Capital told me recently. There are a small number of players, including NXT Capital, Mesa West Capital andWrightwood Capital that are providing structured debt to real estate investors willing to take advantage of select new opportunities beginning to trickle into the market. Even though the market for oppportunistic asset sales is nowhere near the level industry players expected 12 months ago, there is a growing number of owners and lenders that are finally willing to unload their more troubled assets. According to Bob, “Sellers are fatigued and feeling pressure, values have improved from the lowest of lows a year ago and some are starting to sell assets at a discount. The economics of acquiring these assets are starting to make sense, especially with an appropriate amount of leverage to help the parties narrow the bid-ask gap and produce an attractive leveraged return to the new equity.”
From a lender’s perspective, Bob likes the way this market is starting to move, and contrasts it starkly with the market of 12 to 18 months ago: ”Last year, not only was there a significant bid-ask gap that brought transaction flow to a virtual standstill, but, sponsors and equity partners were reluctant to take on the default risk of senior debt. In an environment of falling values and continued uncertainty regarding the timing of an eventual recovery, it’s difficult to justify taking on a significant debt load. After all, it’s hard to default if you don’t have any debt.” The only problem is, without leverage, the bid-ask gap will persist and most value-add business plans are not economically feasible. Investors won’t default if they go the all-equity route, but it is very difficult to make attractive returns without leverage at a price that sellers are willing to accept.
But in the last six months, even though markets have not returned to robust growth, there is more stability and it is possible to to be more confident that property fundamentals are nearing the bottom amid the modest economic recovery now underway. Some are starting to believe that future rent growth will take place, and are actually projecting rent increases in the years to come. As of yet, there is no landslide of opportunities, but there are a select few. According to Bob, “We’re starting to see transactions with sensible economics more frequently – but it’s still much like finding a needle in a haystack. There’s no growth surge, but you can eat again.”
Essential to this kind of needle-in-a-haystack market is a developer/operator’s ability to find the assets, understand them thoroughly and build a solid business plan. According to Bob, “This isn’t about placing bets in a few markets, instead it’s about building opportunistic business plans around each acquisition that will produce attractive risk adjusted returns.” There is no easy way to do this, but it can be done. “Anyone who is providing high leverage debt has to underwrite the real estate, the business plan and the sponsor – not just count on capital flows to move in their direction. There is a real discipline required in this kind of market – to find and appropriately structure the deals that are somewhere between straight debt and equity and possess a degree of complexity and execution risk that defy mainstream trends, including financing non-performing loan acquisitions that require a successful work out with the existing property owner in addition to the implementation of a property level improvement plan.” Essentially, this entrepreneurial caplital, and it requires a disciplined but entrepreneurial lender to provide it.
Whenever I reflect on the last couple of years of post-crash, recessionary times, it is difficult not to compare this market with the real estate market of the early 1990’s. After the S&L’s collapsed, taking their real estate portfolios down with them, it was at least two years before the RTC was able to ignite the opportunistic frenzy of discounted real estate sales where out-sized returns were achieved through the RTC’s singular goal to liquidate assets coupled with the absence of a developed equity market. If there is any kind of wholesale distressed asset bonanza to come, it will most likely unfold differently than it did then – but it’s a pretty safe bet that it will last longer, due to the significant scope of today’s over leveraging, but generate lower returns, given the amount of idle equity targeting this sector. Until real growth happens, it is encouraging to see some leverage return to the market as well as select value creation transactions.
video: hacking real estate
Posted on | February 2, 2010 | No Comments
A six part video of Gunnar discussing “Hacking Innovation in Real Estate” has been posted at Real Invest 2.0 – take a look!
the gift of complaints
Posted on | December 2, 2009 | 4 Comments
Oddly, it isn’t always a good idea to discourage or disallow negative thinking.
Dr. Norman Vincent Peale
In 1952, Dr. Norman Vincent Peale published a very successful book titled, The Power of Positive Thinking. It sold over 5 million copies and has been published in at least 15 languages, and despite being dismissed by a good number of psychologists, the ideas in the book have endured to this day. Central to his philosophy of positive thinking is the idea that any challenge or obstacle should be faced with a positive outlook – that negative thinking and complaints should be avoided. This idea has become a pervasive view of how successful people, companies and institutions should approach challenges.
And yet, despite the incredible success of some people who are optimistic and sunny in their outlook, when innovation is required the need for negative thinking and complaints is overwhelming. As the psychiatrist R. C. Murphy wrote in The Nation in 1955, “Think Right: Reverend Peale’s Panacea”, positive thinking “..is not only inadequate for our needs but even undertakes to drown out the fragile inner voice which is the spur to inner growth.”
If no one complains, there is no reason for change and ultimately innovation stops. Negative thinking is ultimately…a positive force for change.
Fundamentally and paradoxically, complaints are an expression of hope and optimism. In order to complain about something today, one must imagine that it could be better in the future. Without hope of a better option, complaints are not only a waste of time and energy, they are by definition…impossible. When a customer complains, they are implicitly telling a company that they believe it can be better.
A lack of complaints, therefore, should not be seen as a sign that things can not be improved. Rather, it suggests that customers are resigned to the way things are. It can also indicate a hopelessness and ultimately a lack of loyalty. Customers who do not complain have given up on you, even if, for the moment, they keep purchasing a product or using your services. If someone isn’t complaining, there is a good chance that they are no longer truly committed to your company, your product, your mission…they no longer believe in a better future.
Most people, including myself, would rather avoid hearing complaints and understand that complaining can be unpleasant for others. That is why most official communications avoid the negative. The attempt to put a “positive spin” on problems is not only a smart tactic for keeping everyone calm and happy, it is a fundamentally polite thing to do. We avoid complaining because we want to be nice – even if it means witholding the greatest gift we can give: a belief that someone or something can be better.
Listening to complaints can be so unpleasant that it is very difficult to perceive them as gifts. Most companies, instead of asking customers to complain, will conduct elaborate “satisfaction surveys”. Instead of asking, “How can we do a better job?” they ask, “How satisfied are you with us right now?” No matter how a customer answers a satisfaction question, it is very difficult for them to help a company do better in the future.
As an example, if a customer says that they are “somewhat satisfied” with a product or service, (the typical responsed to a multiple choice satisfaction survey), what can a company do with that information? Is there any way for a customer to tell a company, even if they decide to write in some comments, how to better satisfy them? Satisfaction is such a passive and vague concept that it is difficult to imagine any reasonable quantitative measure for more or less satisfaction.
Interestingly, people become more vague the happier they are with something. Ask someone to describe what they love about their sweatheart and they will likely speak in generalities such as, “she is so sweet,” or “he’s the best.”
But if you ask the same person what is wrong with their true love, they start to get very specific, and they start describing exactly how that person could be better. “I love him, but he’s such a sloppy guy. If he would just spend a little time grooming himself, he would be georgeous.”
Baked into that complaint, no matter how annoying it may be to the recipient, is a belief in potential…as well as a blueprint for innovation. The man who listens to that complaint – and to the complainer – will likely learn how to become the more elegant, handsome man he has the potential to become. Ignoring or not listening to that complaint is an implicit decision not to innovate.
Instead of asking a customer how satisfied they are, a company can gain actionable intelligence if they allow their customers to complain. As an example, Apple Computers has some of the most devoted customers in the electronics industry. There are, perhaps, hundreds if not thousands of web sites, blogs, publications and associations devoted to analyzing, criticizing, and prosthletizing for Apple’s products and services, including MacWorld, Apple Insider, Mac Rumors, Cult of Mac, Mac Mojo and countless others. Devoted customers are constantly complaining about their Apple products in these sites…and constantly giving the development teams at Apple Computers their faith, and instructions about how they might improve.
Of course, too much negative thinking and complaining can be just as dangerous as too much positive. There is a difficult balance between the need to nurture something and the need to find out what can be improved. And quite often complaints need to be decoded – when understood in the context of the complainer’s position, many should be ignored. But the next time someone complains, perhaps it would make sense to overcome any discomfort and encourage them to complain even more, understand what is driving the complaint and to find out precisely how to become as good as that customer believes you can be.
Are you ready to accept the gift of complaints?
innovation desire lines
Posted on | November 3, 2009 | 1 Comment
Once a solution to a problem has been found, the biggest challenge is to get others to accept it. Often there’s quite a bit of selling and convincing that has to be done, but why force it? Is it possible to innovate without selling change?
Consider the notion of “Desire Lines”. Originally described by Gaston Bachelard in his 1958 book, The Poetics of Space, a desire line is a path left by people’s use of space. A particularly graphic example is the erosion created in the ground as people and animals walk over vegetation towards their destination. Most parks and college campuses have desire lines etched in the grass lawns – areas where people took short cuts off the carefully designed, planned and constructed concrete footpaths. Frustrated landscapers have long tried to keep people from destroying the grass and flowers by creating fences and other obstacles – but they rarely work, as people tend to simply walk around those obstacles, creating new desire lines.
Most of the roads in older communities were built on top of desire lines created by horses, people and carts as they made their way from destination to destination. Never a perfect geometric grid, these roads responded directly to the actual needs and behaviors of those who used them. Instead of fighting desire lines – it is possible to put them to use. Many designers will intentionally delay the building of walkways for several months and instead just plant grass around and between buildings. After a few months, the natural traffic of students will create desire lines in the grass that can be “read” as a plan for final concrete walkways. A wider path is built in the deeper areas of erosion and a smaller path in the light areas because the desire lines illustrate where more or less people walk.
By building on the desire line – it is possible to outsource the design to the hundreds of people who use the paths every day and unconsciously improvise their own course.
Desire lines can be found everywhere – not just on the ground. Whenever people move through their lives, interact with others, buy things, change things and improvise things, they leave a path. Everyone doesn’t always follow precisely the same path, but the desire lines can be read and understood.
A company that sells products to customers can often find desire lines right in their own balance sheet. A clear customer desire line was found when accounting discovered that one of their most profitable and steadily growing areas of business, despite falling new bike sales, was their after-market parts business. In other words, customers were changing their Harley Davidson motorcycles themselves, using parts provided by the company.
Up until the 1970’s, Harley Davidson focused primarily on supplying transportation to military and police organizations. The motorcycle gangs and tough guys that were modifying surplus bikes to their own needs were seen as an annoyance, and perhaps even a threat to their core business. Much as an eroded path through a field could threaten the beauty of a college campus.
Harley Davidson followed the desire line. They started to sell more customization, club membership and the romance of an old-fashioned, rebellious, and incredibly loud experience that had been developed by their customers. Motorcycle sales moved upwards, along with branded clothing, accessories, tattoos, and of course, after-market parts.
Harley-Davidson built their new business model on the desire lines laid down by their customers. Despite some difficulties in recent years, this remains one of the more innovative re-inventions of a company in great part because, instead of trying to stop the desire lines, they followed them and strengthened them.
Finding desire lines should not be confused with typical customer research or focus group work. Whenever a customer is asked, “what do you want?” the answer is always a version of “what I have, but cheaper, easier, or more.” As valuable as customer research is, it should never be relied upon solely to help companies and leaders chart an innovative path – largely because it reflects what exists today versus what could exist tomorrow.
One way to find a desire line in research is to ask customers or voters to fix something that bothers them. Here’s an idea for a new product – how would you make it work better? Here’s a new idea, how would you make it more attractive to others?
But even more powerful than asking questions is to watch behavior. The Internet in particular has become a very good tool for finding desire lines – by aggregating data on what people look at, how they interact with it, how they change it, how they talk about it and ultimately, how they make it their own.
The desire lines are even easier to find and harness on the Internet. Google, Wikipedia, Netflix, and now Twitter are all examples of on-line businesses that have figured out ways to harness the power of desire lines. As Eric von Hippel, author of “Democratizing Innovation” (NYT Monday October 26, 2009) put it, “Twitter’s smart enough, or lucky enough, to say, ‘Gee, let’s not try to compete with our users in designing this stuff, let’s outsource design to them.’” The same thing can be said of many newer on-line businesses. In an environment of transparency, where the behaviors of millions of people can be tracked and translated into data, the strange attractors become easier and easier to understand.
Whoever can follow desire lines is more likely to find successful innovation.
the innovation trade-off
Posted on | October 28, 2009 | No Comments
Innovation doesn’t come for nothing.
Innovation requires that something is given up in return. There’s always some kind of trade-off; resources, a process, a job, a machine or even an identity has to be abandoned in order to make room for innovation. The old way of doing things has to be left behind, or at the very least, re-contextualized.
If someone were to innovate the English language too much – perhaps in order to make writing and reading more efficient, to create more consistent spellings and grammatical rules, or to improve certainty of comprehension – they might create a better or more effective communication tool, but many will likely have to do without the benefits of understanding writings that are the bedrock of a shared culture and language such as Shakespeare, Dickens, or Wharton. Any innovation has to be compelling enough to give up the benefits of the old, and any innovation that dismisses the importance of an existing system, no matter how flawed, is unlikely to succeed.
But that doesn’t mean that people are unwilling to trade for innovation. When a new approach is compelling enough or when the old approach is too cumbersome or difficult, people will even give up things they are passionately in love with. When compact discs and then MP3 files replaced vinyl records – those records and everything that was built up around it, such as record players, cover art and vinyl record cleaners was abandoned by millions of music lovers. It was difficult to believe that vinyl records could be abandoned in just a few years, as everyone had to buy new disc players, re-build their libraries, and build new furniture to house their collections. And yet, CD’s became the dominant form of music distribution in as little as ten years. MP3 players, once introduced to the masses by Apple’s iPod and iTunes, took less than a decade to sell over 100 Million players, and 2.5 billion songs. (“Apple: 100 million iPods sold, and counting” by Peter Cohen, Playlist Magazine 4.27.07) Effectively, most people gave up their vinyl records even though they loved them.
Three or four generations of music lovers had grown up with vinyl, how could they give it up so fast? It turns out that despite our love for vinyl, there were shortcomings. The music degraded too easily, dust and scratches made distracting sounds; the records took up too much room on the shelves and dancing in a room with a record player tended to jump the needle off the turntable. Everyone was willing to live with those problems until someone better made those minor irritations seem unreasonable. Now, the only vinyl records that remain are essentially a nostalgic collectors’ item, and record companies are fast losing revenues as fewer and fewer people are even buying CD’s.
In the 1880’s, most homes were lit by gas lights. Thomas Edison had invented the electric light, but most reasonable people thought it was an impractical idea. In order to light people’s homes with electricity, an entirely new infrastructure of power generation and distribution would have to be built. As long as the gas light didn’t set your house on fire or poison the occupants, it just wasn’t worth the trouble and the investment to change. Gas companies didn’t want to lose the lighting market, (though they eventually got into the business of generating electricity in addition to providing for heating and cooking).
But over the next quarter century, electric lighting was adopted. Despite objections that electric light was less attractive than gas lights, the danger, cost and dimness of gas lighting became difficult enough that everyone abandoned gas lights and embraced electricity.
It seems likely that we will give up gasoline powered automobiles in the near future. Once a majority of drivers embrace a new form of locomotion, such as electric cars, those gasoline powered engines, along with all the companies, products and practices that surround the use and maintenance of those engines will have to be abandoned and or changed. That is one of the main reasons it has been so difficult for electric cars to be successful commercially – not because the technology is especially difficult, electric cars have been around at least as long as their gasoline cousins, but because companies and individuals who service and use the cars will have to give up a lot.
And yet, according to William Clay Ford, current Executive Chairman of Ford Motor Company, “Customers don’t want to give anything up. So our job as manufacturers is to deliver these new technologies in a way that doesn’t require any trade-offs.” (Ford Looks to the Future, by Bill Vlasic, NYT, 10.20.9)
Drivers will likely have to give up the satisfaction of a powerful rumbling engine as well as the particular look and feel of a gas-powered car we have grown accustomed to. Cars have to become smaller. “Refueling” an electric car takes a bit more time and perhaps some advanced planning. Driving ranges are different. Oil companies, refineries, and gasoline retailers will have to come up with different markets for their products or different products to manufacture and sell. Manufacturers of engines and support services will have to find new customers and new applications as well – and it is very likely that those new markets will not be as large as the ones they have today. There’s quite a bit to give up.
But it is a mistake to believe that no one will give up anything. Mr. Ford, though long a vocal supporter of alternative energy and sustainable manufacturing, has been limited by the conventional wisdom of automobile manufacturers in the US. If you take as a given that customers won’t give up anything, then you have accepted that innovation is impossible. Even if electric cars can deliver precisely the same performance that a gasoline powered car, they will not come without some kind of trade-off. The moment drivers are irritated enough with the price, the inconvenience and the implications of the internal combustion engine, they will be willing to give up the particular thrills of gasoline – no matter how much they may love it now. The instant drivers are seduced by alternative thrills, they will also likely drop their old love as quickly as an old scratched record.
A new buyer of a Tesla electric roadster, a sports car enthusiast and no stranger to the excitement of high octane driving recently confessed to me the thrills of never visiting a gas station, of silent exits and entrances and of unbelievable acceleration that only an electric motor can deliver. The pleasures of gasoline powered cars may begin to appear quaint in comparison, and giving up the advantages may not be as difficult as Mr. Ford imagines.
Just as electric lighting required us to abandon gas lights in the 19th century, electric transportation will require us to abandon gasoline cars and much of what is associated with it. Just like the gas lighting industry, those engines, the technology, fueling and the support of those engines will be re-focused on task specific applications such as construction vehicles or on-site generation of electricity.
When innovating, make sure you understand the trade-off as well as the benefit, and don’t be afraid to give up the old in return for something better.
Tags: change > Cover Art > Edison > electric cars > Innovation > Process > Vinyl LP's
does innovation happen in the middle of a forest?
Posted on | October 19, 2009 | 2 Comments
It is a common mistake to believe that innovation happens when someone comes up with a new idea. New ideas are a common occurrence – every day, people all over the world come up with great new ideas, new solutions and brilliant potential innovations that could possibly end poverty, build a successful company, or make peeling an orange much easier.
Experiments, though crucial to discovering what is possible and how something might be innovated, aren’t innovation. Prototypes and inventions aren’t innovation either, though they are an important step towards proving how innovation could happen.
Innovation doesn’t happen in the lab, the skunkworks or the strategy off-site. It doesn’t happen in the garage of a genius, nor does it happen when a government task force comes up with an innovation blueprint. Innovation might happen afterwards when the products of everyone’s labors are used by others, but there are quite a few good projects and initiatives that are easily forgotten in a few years.
What about all the patents? According to the U.S. Patent office, over 350,000 new patent applications are filed every year with less than 200,000 patents secured – but a patent is no guarantee of innovation. U.S. registered Patents in the last few years for the “Insect Death Ray”, the “Beerbrella”, (illustrated at left), the “Flush Toilet for Dogs”, and the “Electro Shock Game”, are interesting, but can they be described as innovations? They may be useful as entries in the Museum of Obscure Patents, but I question if they are innovation.
According to Richard Maulsby, director of the office of Public Affairs for the US Patent and Trademark Office, “There are around 1.5 million patents in effect and in force in this country, and of those, maybe 3,000 are commercially viable.” (Karen E. Klein, “Avoiding the Inventor’s Lament,” Business Week, November 10, 2005)
If someone invents something that no one buys, did innovation occur?
A good analogue to that question, surprisingly, can be found in metaphysics. In the early eighteenth century, the philosopher and developer of “subjective idealism” George Berkeley introduced the idea of “To be is to be perceived”. His ideas are usually introduced with the question, “If a tree falls in the forest and no one hears it, did it really fall?”
Rephrased by Charles Riborg Mann and George Ransom Twiss in their 1910 book, Physics, the question became easier to answer, “When a tree falls in a lonely forest, and no animal is nearby to hear it, does it make a sound?” When addressed as a physics question versus a metaphysical question, the answer is straightforward: Sound, as explained by Mann and Twiss, is made up of three things:
- A source of waves – such as a tree falling and creating vibrations as it hits the ground.
- A medium for those waves to travel – such as the air
- A receiver – such as an ear, which translates changes in air pressure into what animals perceive as “sound”
Without any animals around to hear the sound, there are only rippling changes in air pressure – no actual sound has been created.
Much like sound in a forest, innovation requires three things:
- A source of innovation – a person or a team that is motivated enough to not only to come up with good ideas – but to develop them and influence others to follow.
- A medium for their ideas to travel – such as the marketplace, writing, broadcasting, the Internet, classrooms, churches or any other gathering of people.
- Receivers – People pay for the innovation, who will change their lives, collaborate with the source, give up something in order to innovate. The more people who receive it, the more innovative it becomes.
And just like the theoretical forest with no animals to listen – if no one adapts the new idea, process, concept or machine – innovation has not occurred. Put another way, “If someone doesn’t pay for it, then it didn’t happen.”
Innovation then, happens when others do it. When customers buy a new technology, when a community stops doing what they did before and begins using a new rule of behavior, when an old paradigm is abandoned for a new one – that’s when innovation happens.
Innovation occurs, not when a new idea or invention is discovered, but when everyone else innovates.
This all suggests three conclusions,
- In order for innovation to happen, society must agree to that innovation – in effect, to subvert the formerly agreed to rules and participate in that innovation.
- Innovators are persuaders as much as they are inventors – in effect, they must persuade others to innovate.
- We all have to start innovating. Now.
what is innovation, really, and how do we get some?
Posted on | September 28, 2009 | 1 Comment
Innovation is both more difficult and less mysterious than we have been led to believe.
Innovation goes far beyond the laboratory – far beyond Silicon Valley startups, institutes or technology incubators. Innovation is less an activity or product as it is a lifestyle or way of thinking. The best innovators are able to change their frame of reference, see a system, a process or a problem in a way that few others can – then find ways to manipulate, change and ultimately improve what they see. And their innovation can occur anywhere, anytime – lab or no lab.
Innovation can be high-tech; but more often it happens at the level of an individual charting a new path for their life, a company creating a new business model or a new way to sell to their customers, an organization finding a more direct path to their objectives. Innovation isn’t just the creation of a new technology, but also the everyday thinking required of anyone to survive and succeed in a rapidly changing environment.
Anyone can innovate and everyone must innovate…every day.
Too often, innovation is described as something done only by magical geniuses. Stories dwell mostly on the flash of insight, or “Eureka” moment. How many profiles of innovative companies describe the beginning with a brilliant ideas that led to great success? Scott Berkun, in his marvelous book, The Myths of Innovation, describes this as “They myth of epiphany”
“Even if there existed an epiphany genie, granting big ideas to worthy innovators, they would still have piles of rather ordinary work to do to actualize those ideas. It is an achievement to find a great idea, but it is a greater one to successfully use it to improve the world.”
I worry that too many people are waiting for the “great idea” to solve their problems. For every Fortune 100 company that started from a brilliant invention in a garage – there are millions of people with great ideas that never went anywhere. And yet, entire industries have been built up to serve the faith of ideas. Consultants, executives and businesses spend money and time to brainstorm, to elicit and evaluate new ideas. Investors often make decisions based on a valuation of an idea or business model. Politicians are evaluated by voters based on the perceived value of their ideas.
And yet, the success of the company or the government is only partly determined by the quality of the ideas. Ultimately, inventors are only successful if someone is willing to pay for their invention. Businesses become profitable not because they have a great business model, but because they persuade enough customers to pay more for something than it costs. Politicians become good leaders through competent management, sound decision making, and quite a bit of slogging back and forth in order to persuade people to work together…the ideas they sold during the election are often left behind or reworked once they enter office.
Sit inside a coffee shop and you can hear any number of brilliant ideas. But unless those ideas are turned into something real, the ideas are worth less than the coffee.
The best ideas don’t win. Good ideas that are used for actions, products and new behaviors can win…sometimes.
Think about the most successful companies, the most successful leaders, the most successful countries. Did they have the best ideas? Or did they have good ideas that they translated into good products, services, markets, companies, laws, governments, and treaties. If you look close enough, you can find any number of really bad ideas that those successful entities have used to succeed despite themselves.
So why do we think that ideas are so valuable? Why do otherwise rational people believe that the best ideas will save their company, their country, their family?
Perhaps it’s because ideas, brainstorming, planning are much more fun than the reality of innovation. The reality of innovation is much like the reality of scientific discovery – as exciting as it is to imagine how something works, that imagining is only part of the process.
In very broad terms, the process known as “the scientific method” can be broken down into the following steps: Observation, Hypothesis, Testing/Experiment and Evaluation. Innovation follows the same process:
First, in order to innovate, it is necessary to Observe reality as closely as you can to discover what is currently happening.
Second, the innovator gets to have fun with ideas – (s)he forms a Hypothesis of what might work better.
Third, that hypothesis needs to be tested in an Experiment prototype or pilot, where a small form of reality is compared to the hypothesis.
Fourth, measurements from the experiment are used to Evaluate the original hypothesis – did it do what was expected? Can that hypothesis be changed in order to affect the desired change?
Mysterious? not really. Both scientists and innovators follow a process, evaluate data and find new answers to old problems. Science and innovation isn’t magic, it’s just a way to find the truth – about physics, about business, about politics or about how we live – and then act on that truth in a better way than before. As the Harvard business professor and author Theodore Levitt once said, “Creativity is thinking up new things. Innovation is doing new things.”
Easy to understand, but quite often hard to do…and yet, innovation can become a little easier when faith in “the great idea” is put aside – and “good enough” ideas are put to the test of a scientific or innovative method.
how new should new be?
Posted on | September 17, 2009 | 1 Comment
At a time of unprecedented change, economic challenge and technology shifts, everything is new and innovation seems to be the solution to many of our challenges.
But can the new thrive without the old? How much new can people take at once?
Once the first adopters of an innovation have latched on to something, can the rest of the world catch on without some form of help? Or as Geoffrey Moore in his excellent book, Crossing the Chasm might ask, “How can we move from Early Adopters of an innovation to the Early Majority?”
This is an interesting problem for innovation: most marketers would agree that something completely new is a difficult sell…even though marketing is all about selling something new.
In other words, innovation needs to be new, without feeling too new.
Do we need a bridge from the old way of doing things to a new way of doing things? If so, what is that bridge and how do we build it?
Let’s look at one area of innovation growth: the Internet innovation attracting the most attention these days is the explosive growth of social media networking tools such as Facebook, LinkedIn, MySpace, YouTube, Helium, Craigslist and Wikipedia…new Internet environments that allow people to connect and collaborate in ways never thought possible before. The book of the moment by Charlene Li and Josh Bernoff describes all these social technologies as a Groundswell. This stuff is so ubiquitous, so easy-to-use and so inexpensive that more people are engaging with it at an exponential pace every day. It has become so mainstream, that many people credit these networking tools for changing the very nature of advertising, job hunting, education and the US political process.
One potential reason for why these innovative ideas became mainstream so quickly is that they aren’t really that new.
Each of these tools are in some way based upon systems that already exist, that people are already comfortable with, that are entirely familiar. Address books, bulletin boards, diaries, episodic storytelling, videos and networking have been a part of every one’s life for generations. Although these technologies are transforming our work and our lives, none of these innovations explicitly ask users to change what they are doing – instead they seem to be a simple augmentation of activities that are familiar and commonplace. And successful users of these technologies have to combine them with some sort of actual connection in the real world. A business person may keep their address book in LinkedIn, but they still call someone up to get to know them better, or share a cup of coffee with them between Twitter posts.
Another example comes from the beginning of the World Wide Web in the 1990’s, when everyone extolled the power of virtual businesses. Someday, it was assumed, there would be no more “bricks and mortar” stores – everything would be virtual. Perhaps that future is possible – but it hasn’t happened yet. Instead, there has been a gradual redefinition of retail to a hybrid that combines both the Internet and actual visits to stores. Old style retailers ranging from J.Crew to Sears, to Barnes & Noble and Best Buy discovered the power of the Internet to expand sales and communicate directly to their customers. Customers of the stores became customers on the Internet, because they found everything to be just like going to a store – even a “shopping cart” was provided.
And why am I typing this blog post with a QWERTY keyboard…
designed to help slow down a typist’s speed so that a mechanical typewriter wouldn’t jam quite so often?
As we pursue the new, it is well advised for innovators and change agents to take full advantage of the old. Innovation needs to be old as well as new, familiar as well as novel if it is to be adopted.
keep looking »