The downside of Scale Enablers

In my previous post, I had described how structural capital can be used to have unlimited scale in a business. I had provided two examples – how Automatic Teller Machines were instrumental in scaling the operations of banks at negligible marginal cost and how the Internet itself had been used by Google to scale its advertising business to the point where it has become a near monopoly in a very short span of ten years. Readers will surely find other examples which fit the pattern of scale enablers. Here is one more - how about the invention of the moving assembly line in a manufacturing shop? The assembly line mechanism may be taken for granted in today’s manufacturing world but when it was first deployed by Henry Ford in the early 1910s, it revolutionized the automobile industry, enabling Ford to scale its manufacturing operations significantly and get a leg up on the competition within a short period of time. Note that scale enablers, by definition, need to create a massive impact for the firm that deploys them. For instance, all the scale enablers that I have described in the examples so far have created such a massive impact that they have become an industry standard – meaning that subsequent businesses have no option but to follow the scale enabling operational model of the leader. Here’s the proof - can you imagine a bank today that hopes to sustain and scale its operations without the help of ATMs? Can you imagine an automobile manufacturer producing cars without a moving assembly line in its plant? And can you imagine any Google competitor that can successfully best its advertising business without the help of the Internet? Even with the help of the Internet all of them are having a hard time at present – but that is another matter. The point I am trying to make is simply this - Scale enabling Intellectual Capital based on the deployment of Structural Capital is a sure recipe for the unlimited growth of any business.

Having being convinced of this fact, the question that naturally arises is – Is there any downside to scale enabling Intellectual Capital at all? Surely it cannot be a silver bullet. The answer in fact turns out to be in the positive. There is a downside to scale enablers and quite a significant downside. The problem with Structural Capital is that it does exactly what it is programmed to do. It is therefore both inhuman and unforgiving – and that is exactly its downside, especially when it has to deal with real human beings. This realization in fact dawned on me very recently while I was in the middle of one of my own experiences with scale enabling Intellectual Capital. However, let me illustrate this point using the same examples that I have used so far in describing Scale Enablers.

Let’s take the example of the ATM. Has it ever happened to you that an ATM has actually dispensed you the incorrect amount from what you requested and what has actually been debited from your bank account? The chances are quite rare that this could have happened to you, but have you heard or read about such incidents happening with others? What if the ATM dispensed the correct amount but the notes dispensed are soiled or even mutilated. This is more in the realm of possibility and this could have definitely happened to a few of us. More practically, have you ever had an ATM dispense you high denomination notes because it was out of smaller denominations? This has probably happened to all of us. All of these incidents lead to high customer dissatisfaction – the only problem is that the ATM cannot help you any further. If it was the bank teller, you could have a resolution there and then to these incidents, but when dealing with an ATM, resolving such incidents of Customer dissatisfaction are too time consuming and too costly. In fact more often than not, they go unmentioned and hence remain unresolved.

Let’s move to Google – I had mentioned how Google has become the undisputed king of the Internet advertising world using its scale enabling Internet interface that lets its Customers open an account, create ads, select distribution parameters, make payments, run those ads and browse through automatically collected and pre-analyzed ad diagnostics. However, have you had any reason to be dissatisfied with Google’s advertising service? You had better not, because if you were, you would have no idea whom to turn to. Google does not assign its Customers with a Relationship Manager who can be reached directly in times of a crisis. At best, you could reach Google’s Customer service and be confronted with its automated voice response system. Or you could drop Google an email? The resolution time and cost for both you and Google will be quite high though, because both of you would now have to work outside the boundaries of a scale enabling automated system whose marginal costs are designed to be next to zero.

The truth is that businesses that have driven their growth using the scale enabling Intellectual Capital model have first fine tuned their Structural Capital to be as close to being faultless as is humanly possible. This by itself is a capital intensive and time intensive process. Alternatively, other successful businesses have deployed “good-enough” systems and have backed up failure points in those systems with good old human capital – such as call centers, relationship managers, engagement managers, etc. The success of Intellectual Capital therefore depends on the quantum and mix of components deployed. Just as the secret to a good recipe is the right ingredients in the right proportions, so also the secret to business success with Intellectual Capital is a judicious mix of Human Capital, Structural Capital and Relational Capital. And that is exactly how I define Intellectual Capital in the first place.

Scale Enablers

In my last post I wrote about how reach-enabling Intellectual Capital is helping businesses overcome the scarce availability of talented human capital, such as teachers and doctors. This time I will extend the analogy to include the average line worker and in the process reveal yet another paradigm in the successful deployment of Intellectual Capital, something I call ‘Scale Enablers’.

Let me start by asking you to recollect the last time when you had to personally visit your bank. No, not a drive-through ATM, but your actual bank premise in order to conduct a banking transaction with the personal guided help of your bank teller. Do you remember the approximate time frame, even within the ballpark of a month or two, when you had to this? I bet you can’t. Because neither can I. You can put the blame on the lack of your personal bank visits solely on the ubiquitous ATM or Automatic Teller Machine, which have mushroomed by the hundreds in every possible heavily frequented nook and corner of your city and which have made available your bank to you 24x7. These ATMs enable banking functions such as cash withdrawals, check deposits, money transfers, balance information, account queries and many other common banking transactions, eliminating the need for you to ever visit your bank again. As surely as these ATMs have made your life easier, they have also incurred huge capital expenditures on your bank. Why then, you ask, are banks incurring such huge costs? Well for one, they have figured out that deploying ATMs not only reduce the requirement for hiring bank tellers (saving monthly salaries, office space, pensions, etc.) but also the need for having full fledged branches itself, thus shaving off huge amounts costs of their lease and rental expenses. But more importantly, the bank is able to serve more customers using ATMs which directly enhances the scale of operations of the bank at no marginal cost. This is because an ATM, once installed, can easily serve 100 customers or even twice or thrice that number each day without any additional cost. ATMs therefore are the scale enablers of the bank. A business that can scale its operations without significant requirements of either talent or variable cost is a business worth investing into because such a business can target unlimited growth. ATMs cause banks to fall into just such a category. But ATMs after all are a part of the structural capital of the bank, aren’t they? Perhaps you are beginning to realize now how powerful the impact of Intellectual Capital can be, when it is deployed as a scale enabler.

Once you have understood the value of ATMs for banks, you can easily understand the value of all other types of automatic vending machines (AVMs). They follow the same principle as ATMs except that they dispense various items of consumer interest such as cola, coffee, fruit beverages, snacks, newspapers, magazines and even condoms, instead of cash. Although the dispensed item varies, in each case AVMs extend the scale of operations of the corresponding business, enabling it to operate from remote locations such as highway rest areas, airport lounges and rail stations, office cafeterias, mall entrances and sidewalks and even from public restrooms! Next time you spot a humble ATM or an AVM therefore, try to look at it more respectfully. These humble machines have eliminated the need for human labor in the same way that industrialization era machines replaced farm hands. They have contributed to the smooth scaling of the businesses that own them, contributing to cost effective growth of the business which in turn has generated more wealth for the owners of those businesses.

One of the best examples that I have encountered of a business that has used the Scale Enabling Intellectual paradigm not only to grow its business by leaps and bounds but in fact to create an overpowering dominance so as to block out all competition, is our very own friendly search engine company aka Google. Such is the overwhelming influence of Google in the Internet search world that most Internet users are not aware that other search engines even exist. Google is not only the undisputed king of search but it has also very cleverly extended its reign into the world of online advertising. Online ad revenue is the single largest source of income for Google. Hence you would be forgiven for thinking that Google has armies of sales personnel interacting with its customers every day for generating those online ad revenues every day. Nothing could be further from the truth. I have been a customer of Google for more than three years now and to this day I have not yet interacted with any Google personnel. Most of my interactions so far have been through the Google web site and on the rare occasion I have also used e-mail. Yet I cannot think of any other business which has served me for over three years without the need of human intervention for a single business process, including account opening, which is typically the most human intensive of all customer facing processes. Can you? In business parlance, this means that for every additional revenue dollar that Google pulls in, it Cost of Goods Sold (COGS) is negligible or perhaps even zero, which means that its Operating Margin is very high. All Google has to do then is to manage its staff salaries and Administrative expenses to ensure that its Net Profit Margin remains high (27.57% for Year ending Dec 2009). Are you surprised then that Google is so highly valued by the Capital Markets? In a short span of just 12 years (it was founded on 7 Sep 1998), Google has come out of nowhere to occupy the 12th slot in the list of top companies in the US by market capitalization. Its market cap as on 31 Aug 2010 was a whopping $143.7bn, just behind well established behemoths such as General Electric, AT&T and IBM. That is the power of the Scale enabling Intellectual Capital model.

Companies such as Google have proved that structural capital can be deployed successfully for achieving unlimited scale in the shortest amount of time and with maximum profitability. Can we therefore afford to write away Google’s success as a one-time fluke instead of recognizing and understanding the pattern of Intellectual Capital embedded in its business model so that we may spot other winners early on in their growth cycle? The message is clear – always be on the lookout for businesses that are working on or have already devised scale enablers. Businesses with such scale enabling assets are the ones that will generate massive value for themselves and their owners in the future. And with a little smartness and a healthy dose of diligence you could benefit from their future too!

Reach Multipliers

Teachers are a scarce lot nowadays. Teaching is a noble profession no doubt and a highly honorable one too, but like a lot of other noble professions nowadays it is losing its shin in this modern age. There is no glamor in being a teacher anymore; hence not very many of the younger generation aspire to become teachers these days. Consequently their tribe is only decreasing. Paradoxically with the increasing population, school enrollments are on the rise. With the result that the demand for teachers today is more than it was ever before. I see a shortage of teachers in primary schools, secondary schools, junior colleges, engineering colleges, medical colleges and Universities. In short, I see a shortage of teachers in the whole teaching system. Yet I also see more and more schools and colleges coming up everyday. It requires an explanation. How are these schools and colleges managing to teach their increasing number of students with lesser numbers of teachers? I was prepared to see visiting teachers from other faculties, cramped classrooms reflecting a higher student to teacher ratio and self-study student groups in those schools where teachers were missing altogether. And I did see all of these. But I also saw something else. A handful of innovative institutions had attacked this problem by multiplying the reach of their teachers. They had installed video conferencing equipment in their classrooms using which multiple students at dispersed locations could attend the lecture of a single teacher at the same time using the power of video conferencing. In effect these institutions had managed to solve the problem of scarcity of human capital by strapping structural capital in the form of video conferencing equipment to their human capital, the combined effect of which enabled them to reach out to a larger number of students in geographically dispersed locations!

I was hardly surprised this time when I saw the same solution being applied effectively in another noble profession – medicine. Like good teachers, good doctors are also becoming a rarity of late. And patients who can afford it always seek a second opinion especially when they have to make a decision based on the opinion of their doctor. Some innovative hospitals have resorted to video conferencing technology to enable their patients to seek a second opinion from doctors in other hospitals, perhaps those in their own network of hospitals. Case history of the patient is available to the remote doctor electronically which he can browse and consult with the patient simultaneously over video. This much is becoming pretty common. Meanwhile medical solution providers are working on building technology solutions that will enable doctors to remotely examine patients and even conduct surgeries remotely using remote controlled robotic arms. This may sound like science fiction right now, but we are getting there slowly but surely. This is one more instance of specialists reaching out to a larger audience beyond the confines of their own physical boundaries through the leveraged use of structural capital.

While video conferencing has been enabled in leaps and bounds by gigantic advances in telephony, the Internet has also been a great enabler in this regard. One example of this is webcasting, a medium that is being increasingly adopted by businesses nowadays to peddle their products and services. The traditional approach would have been to invite a select audience into an attractive downtown location, make the sales pitch, feed them lunch or dinner and offer them networking opportunities with their peers. This high cost approach is a rarity nowadays. Webcasts are not only cost-effective for the business itself but also time-effective for the target audience, since they do not have to commute anywhere but can attend the conference right from their desktop. Moreover, webcasts enable the business to reach out to a worldwide audience at the same time which would be physically impossible using the traditional approach.

Structural capital that enables businesses to address much larger audiences than they can do at present is a very attractive proposition to every business. It is so attractive that I have coined the term “Reach Multipliers’ to denote such capital. Reach multipliers are critical for any business to increase the reach of its human capital manifold. Those businesses that have devised reach multipliers are well on their way to achieving the next level of growth in their business lifecycle. Others will be constrained by the limits of reach of their human capital.

As attractive as Reach multipliers are they still are dependent on the presence of human capital in the back-end. The scale that can be achieved using Reach multipliers is a limited therefore by the amount of human capital in the back-end. The question that arises then is – Is there a way of achieving unlimited scale? Turns out that there is and some have already done it. Wait to read about it in my next post.

The Power of Personalization

Have you ever wondered why in this day and age of giant shopping malls, branded retail chains, self help shopping and barcode based point of sale systems, there are still some Mom and Pop stores that manage to survive and even do well despite having none of the above mentioned advantages? Perhaps, you yourself frequent one or more such stores regularly – it could be your neighborhood baker, convenience store, grocery store or even your local co-operative bank – without realizing why it is you do so. Here are some clues - Does the owner of the store greet you with a smile? Does she know you by name and address you by your name? Does he go out of his way to suggest good deals? Does he even engage in a bit of a casual conversation with you at times? In short, does he try to personalize your visit to the store? Do you leave the store with the feeling that you have been served well, served personally and have been given preference over other customers. That last point is the essence of generating repeat business. As human beings, we all have the innate need to be recognized and for our desires to be pampered. Personalization is just a high sounding term that satisfies this need.

Mom and Pop stores have known for years that big name commercial chains cannot compete with them on the personalization front – it is just impossible to know every customer by name when you have thousands of them. And hence they have leveraged this knowledge to their advantage and managed to survive and even thrive during the retail boom of recent years. Yet what I am about to discuss today is not the friendly personalization in neighborhood stores that you and I have come to experience often. I am going to discuss the commercialization of personalization itself. Yes, you read it right – the commercialization of personalization itself. But wait a minute - Isn’t personalization an intangible thing? – is the thought that crosses your mind immediately. How can you even describe an intangible, leave alone make any attempt to commercialize it? This sounds insane.

Does it? I could have perhaps agreed with your thinking had I not had two very compelling experiences of the commercialization of personalization. The first one was when a good friend of mine had a need to hand out corporate gifts in his company’s name to a select list of his prospects in order to promote his business. I short-listed a corporate gift provider for him and together along with him visited the provider’s office. There we were presented with a variety of gift articles ranging from pens, cups, mugs, key-chains, card holders, stress busters, T-shirts, etc. all of which could be personalized with the corporate logo and the tag line. The shape of the gift did not matter. Neither did its size nor the material from which it was made of. The corporate logo could either be printed or it could be embossed or outlined or even engraved on the gift. Having being sufficiently impressed by this personalized display, all that was left for us to do was to select the gifts that fitted our budget and place our order, which we did right then and there. The gifts were delivered to my client after three days, which he is handing out to his clients and prospects and impressing them every day. Business is also picking up of late, he informs me.

My next experience was more personal. I recently came across a retail chain which sells T-shirts, mugs, clocks, picture frames and other articles that can be personalized with your picture and slogan of your choice. They have a variety of such articles on display in their store, which you can browse through and select. In the middle of the store is a table full of sleek computers where you can choose the background design of your choice. Having done that, you get your photo clicked (handy nowadays due to mobile cameras), add a slogan and hand it over to the designer behind the computer to put it all together. Within 15 minutes or so the designer mixes your picture, the selected background pattern and the slogan text to create a design that will fit on the article that you have selected. After you are satisfied with the design, it is finalized and the design is printed on the article in the store itself. After 30 minutes or so you can walk out of the store with your personalized article.

Do you see now how personalization is being commercialized? Yet you ask, what is so great about it? It looks so straightforward and simple. Let me tell you, it wouldn’t be great if it wasn’t simple. And in hindsight things always look straight forward. But if you apply your mind you will realize that commercialization of personalization requires a mixture of human, structural and relational capital. The human capital is by way of skilled designers who can apply their creative and designing skills to quickly create computer based designs. The structural capital is by way of having computers, a catalog of readymade designs and special transparency printers and embossing machines that can transfer the design to the article at hand. And finally relational capital is by way of having links with suppliers who supply the bland gift articles of the desired quality and of course customers such as yourself who will go out and spread the word once you have experienced delight with this service.

What about price? My experience was that personalized articles are being sold at a price which is at least two to three times the price of the bland article. Can you imagine what that does to the seller’s profit margins? Your guess is as good as mine. The power of personalization is in not only leaving the Customer with a sense of delight but also in doing it in a highly profitable manner.

Franchising – Structural Capital in action

I had the opportunity to visit a franchising exhibition recently where more than 100 different businesses of various types had put up stalls staffed with smartly attired and neatly groomed salespeople trying their best to convince visitors why their franchise business model was the best choice to opt for as a new franchisee. The businesses on hand ranged from education (coaching classes), fashion clothing, food and beverages, jewelry, real estate agencies, healthcare, solar energy, finance and securities, libraries, childcare, coffee shops, etc. While the diversity of businesses present was tremendous, there was a uniform thread running through all of them that had brought them together to that exhibition in the first place – all of these businesses were capable of growing through the franchisee route. Franchising as a business model is hugely popular and successful especially in the retail world. Next time you have a value meal at McDonald’s realize that you are actually at a franchise of McDonald’s and not at a Company owned Store. If you still have doubts, look at the top of your receipt and you will read the name of the franchisee that is actually operating that particular McDonalds location. It is estimated that more than 50% of all retail sales in the US and one third of all retail sales in the UK come from franchises. Such is the reach and penetration of this model.

Franchising in its simplest form is an arrangement in which the owner of a product, process or service (franchisor) licenses the distribution of these products by someone else (franchisee) in the name of the franchisor in exchange for royalty income. The franchisee brings physical and financial capital to the relationship in the form of location space and cash, while the franchisor provides the know-how of the products and services and the process of selling them. Franchising is therefore an instance where the monetization of intangible assets of the business (in this case, of the franchisor) is easily demonstrated.

The question however is why do franchisors opt for franchising instead of opting for the traditional route of opening company owned stores? Aren’t they giving up some of their profits to the franchisee in the process? Indeed they are, but they are also avoiding the risk of opening a store in a new location when they do not have knowledge of the local business climate. Secondly, they avoid bloating their own employee rolls since the staff at the new location belongs on the roster of the franchise. Finally by opting for the franchise route they convert the need for capital expenditure for opening a company owned store into capital income by way of franchise agreement fees from the franchisee. Isn’t that terrific?

The next question that arises then is that if franchising is such an inviting proposition, what are the key drivers for its success? What are the critical success factors for this model to be successful? The answer to that question in simple words is Structural Capital, in this case the franchisor’s Structural Capital. This has to be developed to such an existence that it can be leveraged in far-away locations without too much of an additional effort on the franchisor. Let’s take an example. Suppose you have decided to open a coffee cafe franchise in your neighborhood because you can feel the business potential for just such a café. You have also identified the franchisor and have signed the franchise agreement and paid the initial fees. This is when the franchisor’s work begins. Based on the size of your shop, the franchisor has to provide you the interior décor plan and organize to have the décor made to specifications including the all important front signage. The signage by the way reflects the franchisor’s brand which itself is a significant portion of its structural capital. Brand building is a long term and capital intensive process. Suffice it to say that a well known brand is highly critical to the success of the franchising model. Next, the franchisor has to provide your café with bean crushing and coffee dispensing machines. Cash registers are next, loaded hopefully with Point of Sale software that connects directly to the franchisor’s central database everyday for sales data updates. Next, the franchisor has to give you access to his ordering system, either phone or web based, using which you can re-order supplies like cups, spoons, stirrers, etc. and maintain your minimum inventory levels. In order to deliver your orders, the franchisor has to update its delivery schedules and processes to include you in the loop. Once you have started your café, the franchisor has to keep track of your daily sales in its central database and invoice you for supplies and royalty income on a monthly basis. If your coffee dispensers develop any type of snag the franchisor has to be able to dispatch technicians to your location as soon as possible. This is the scenario for a simple coffee café. Multiple products/services create more demands on the structural capital of the franchisor. However one thing is clear, the structural capital has to be automated as much as possible in order to accommodate increasing volumes. Structural Capital riding on human hands is a sure sign of non-scalability and hence failure of the franchise model.

In summary, franchising is a very mature business model which has been used successfully the world over by many businesses, especially in the Retail sector, to grow their businesses very quickly. It works because franchise owners are entrepreneurs who are highly interested in their own success unlike store managers whose primary interest is their monthly paycheck. Franchise owners bring local business climate knowledge to the table and they undertake the risk of running the business successfully. A franchisor whose structural capital is automated and scalable has a very good chance of expanding his business through franchising.