Chapter 6: Redefining the Interior

Live in the future. It's happening now—the Firesign Theater

As you exploit the power and ubiquity of digital technology, capitalizing on its ability to reduce transaction costs and create value-generating information products, severe pressure is applied to the organization you are today. Over time, old industrial structures fall away, and a new wired organization emerges. This event comes about not by means of planning for it but as the product of a natural and organic process. It is a function of the same forces that your digital strategy is shaping into killer apps. All you can do is help the new organization start to breathe.

The last four principles of designing killer apps, discussed in this chapter, focus on the creation of a new internal corporate self, one that is flexible enough to squeeze through the barrier between physical space and cyberspace. These principles are:

9. Treat your assets as liabilities.
10. Destroy your value chain.
11. Manage innovation as a portfolio of options.
12. Hire the children.

We start with the balance sheet, or rather the underlying business model it both represents and reproduces. Industrial cost accounting values the means of production (the trucks, the factories, the licenses) rather than the assets themselves; human capital, intellectual capital, and brand don't show up on the balance sheet. This kind of accounting looked right when competitors were effectively locked out without a physical plant; when, in other words, initial investments and operating costs of smokestack assets were the true barrier to competition.

The Law of Disruption changes the nature of these barriers, and the valuation of assets must change with them. Exposure to killer apps doesn't devalue physical assets so much as it reveals the disconnect between them and the actual production capacity of the firm. Lower transaction costs and low-cost technology help virtual competitors enter your markets with low start-up costs. When you compete in cyberspace, these asset-less firms often prove to be more nimble, flexible competitors precisely because they have few assets. What's more, they can generate brand of their own on an accelerated Metcalfe curve. They're not firms at all, some of our clients say, but just brokers, partnerships, and cherry-pickers, skimming off the most profitable customers, products, and channels. Thanks to the new forces, these are your competitors.

As the Law of Diminishing Firms operates, intermediaries in particular can no longer keep the link between the value they legitimately add and the commission they charge a secret, since everyone else on the chain (as well as everyone else not on the chain) can see the true costs. Long-standing, mutually supportive, and often implicit understandings (or maybe delusions) of each other's turf evaporate. An all-out information war is erupting in many information-intensive industries, with cheap technology as the ammunition. The battlefield is growing fast. Is that good news or bad? If you're the consumer, it's good news, because it turns out you were paying for a lot of inefficiently managed services you may not even need or want. If you're somewhere upstream, the answer depends on how fast you can rid yourself of underperforming assets and make the transition to value-based pricing.

As the operating model for your industry goes through major reconstruction, the last step is to get a lot smarter about planning and preparing for the next set of changes; even as you're replacing those permanent walls with modular units and trading today's expensive lighting, heating, and communications systems for digital alternatives, you need to begin planning for the day, which might come sooner than you think, when you won't have a physical office at all.

Such planning is rarely done today. Often, in fact, the staging and structuring of investments in future technology is given no attention at all. When it is done, most organizations demand that technology investments meet return on investment criteria, with detailed costs and benefits calculated in advance. We recommend something much closer to a portfolio approach, which includes a number of low-cost, high-risk, and high-potential options to spread risk and maximize coverage. Options valuation models are long established, and they are probably in place somewhere in your organization already. Now they must be adapted and used to create a new technology plan.

6.2: Treat Your Assets as Liabilities

Information providers, service firms, educational institutions, and even public utilities are struggling to become digital as quickly as possible. Doing so is hard for several reasons, not the least of which is the unsettling effect on your balance sheet. Organizations discover that the true value of their company is its information, but that value is now sunk into the various containers and equipment used to transform it from one good or service to another. Look at the annual report of a news organization and you'll see line items for printing presses and plants but not for expertise and intellectual capital—not, that is, for the organization's ability to generate, shape, and communicate the news. This is partly an accounting problem. Partly it is an attitude problem.

It isn't that the value of today's organization is disappearing so much as its form is changing. You must now rethink not only the value of the company's bits but also the true value of its atoms, some of which you may not need in the near future. It's important to shift your investment to bits, because those new competitors that have none of your fixed assets—no real estate, no manufacturing equipment, no distribution network—will suddenly look competitive in the new business environment. Your assets become liabilities.

This reallocation of value is happening on a broader scale as well, as the physical infrastructure of the overall marketplace is being replaced by a virtual market, or what Harvard Business School professors Jeffrey Rayport and John Sviokla call the marketspace. Because trade has until recently required a place where buyers and sellers could come together to safely exchange their goods and money, markets originally developed where there was good access to transportation and communications. Waterways and roads led to the creation of warehouses and factories. Urban centers continue to be the hub of commerce today where people still need to interact to complete transactions. But as commerce sheds its physical form, the need for the marketplace diminishes. This is not an evolutionary change, like the development of futures markets (which did away with the need to bring actual goods to the sale), but a revolutionary change. The Law of Disruption is eliminating the need for any physical marketplace.

Some organizations may turn out to have no information assets, or at least none that can't be quickly eliminated by a stroke of the deregulating pen or introduction of a killer app. As Nathan Myhrvold, Microsoft's chief technology architect, points out, banks (at least commercial banks) may soon be wiped out by the widespread use of digital money, which provides a superior alternative to cash, checks, and credit cards, and which could be offered just as easily by nonbanks (Myhrvold is thinking of his own organization here). Cash and other financial instruments are technologies created by governments and banks to reduce the transaction cost paid by buyers and sellers to exchange the value of their transaction (my goat for your land, my loyalty for your frequent-flier miles), and that transaction cost is rapidly falling as information flow improves.

Newspapers may be in similar trouble, since they rely on classified ads for up to 80 percent of their revenue. In their printed form, classifieds are nearly unusable compared to new digital forms offered in various city guides (Yahoo!'s and Digital City, for instance). Digital ads can be automatically searched, delivered, and linked to their advertisers, who can in turn test and target their ads with pinpoint accuracy. The New York Stock Exchange, real estate brokers, and many of today's television networks may find themselves similarly out of an industry. As the CEO of a large investment bank described his own situation to us, "Why does anyone need an investment bank or broker? Well, probably because he either doesn't have enough information or he does not have the means physically to execute what he wants to do. Technology is giving him the information and the means to execute. This disintermediates a lot of people in my business."

6.2.1: The Reincarnation of Printers

Not everyone is afraid to face the cold hard truth about their disappearing assets. Financial printing, a $1 billion specialty industry that prints millions of pages of securities-related filings for public offerings and quarterly reports, looks on the surface like an industry seriously at risk of disintermediation. It took its first big hit in the 1980s, when the need for typesetting and photographic plating, once high-margin components of document preparation, declined as desktop publishing software became available on even the least-powerful home computers.

In 1995, the Securities and Exchange Commission dropped an atomic bomb, announcing that starting the following year, companies could begin filing electronically through its Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system and avoid much of the need for printed reports. The killer app for financial printers had, it seemed, arrived.

The industry has not disappeared, however. Instead, it has flourished. Financial printers recognized quickly that competitors in the electronic filing market would need no fixed assets, and that this lack of assets would be a benefit rather than a hindrance in the new world. The printers responded quickly by aggressively going after the electronic market themselves, capitalizing on their long-standing relationship with the securities industry to obtain a first-mover advantage.

The strategy is working. Bowne & Company, one of the industry leaders, submitted almost 15 percent of all EDGAR filings in the first months that electronic filing was authorized. In total, financial printers were responsible for over 40 percent of the first electronic filings. Bowne has also expanded its capabilities to publish not just on paper but electronically and on the World Wide Web. Rather than quietly be eaten alive, the industry has embraced digital technology and used it to expand.

Financial printers, it turns out, are not their equipment. They are organizations with substantial expertise in the ins and outs of complicated government filings, the discipline to work under tight and exact deadlines, and a reputation for carefully handling highly confidential information. They have a brand. These are the assets that printers like Bowne are trading on in the digital world, not the equipment that shows up on their balance sheet. The ability to distinguish the two may very well mean the difference between surviving and disappearing.

6.2.2: The Threat to Heavy Industry

For manufacturers and heavy industry, we suspect, the idea of outsourcing production and distribution activities seems ludicrous. But the threat of losing competitiveness by failing to realign assets is very real. In our work in the chemicals industry, we have already observed the emergence of a new breed of information companies, such as ChemConnect, which are building virtual markets for consolidating and trading on transactions that today are the private dealings of one buyer and one seller. These brokers, which have no fixed assets, can collect price and inventory information over the global information network and use it to coordinate the buying and selling of bulk and even specialty chemicals, activities they perform over the Internet. They are using technology to reduce transaction costs, and doing so as a new, information-intensive intermediary.

Perhaps over time these brokers will themselves be replaced by more automated markets, operated by software agents like those being developed by Firefly, Jango, and others. Today they threaten manufacturers where it counts—on the bottom line. By forcing a wedge between buyer and seller with superior information, these brokers have the potential to extract significant margin from all transactions, forcing producers increasingly to a commodity price set for the minimum profit. Information advantages have provided protection from such intermediaries in the past, but that time is coming quickly to an end. The information is nearly all there now, and those who can exploit it first will win.

This is not just the case in chemicals. Telecommunications brokers have been buying and selling communication bandwidth in bulk for years. The same thing will happen in power and energy, and it has already occurred for oil and gas. (Providence, Rhode Island, for example, recently switched its energy supplier to a buying consortium that does no generating of its own.) In these industries, producers and refiners have responded to the threat of information brokers by focusing more on specialty products, reducing costs with new technology, or by taking on the brokering function themselves. But to do so requires tremendous flexibility, flexibility that aging infrastructure and the mindset that goes with it make difficult to achieve.

For one large chemicals company, we helped develop a digital strategy that fights fire with fire. To cut off the emerging information brokers, the company is developing a rich "information pipeline"—modeled on the physical pipelines it has been building for almost fifty years—between itself and its customers and suppliers. The new pipeline would replace the ad hoc channels of communication that already exist, such as telephone, mail, and Electronic Data Interchange (EDI), a limited computer-to-computer communications protocol that allows basic information on purchases and invoices to be transferred. The pipeline is based on the open standards of the Internet, the equivalent of EDI raised to a power of ten.

Using digital technology to reduce inventory and duplicative handling (another transaction cost) has been the theme of cost savings in other industries, particularly retail sales, but our client's approach leapfrogs even these impressive developments. The information pipeline will enable the company to offer customers a virtual inventory of finished products, thereby reducing its own inventories for generic and specialized products without adding any risk of insufficient supply. In effect they plan to create the illusion of a build-to-order environment, a value-added service that encourages loyalty to the producer. In reality, with access to the requirements of all its customers, the producer could largely continue producing to stock.

On the other end, the suppliers, especially those from whom it purchases large volumes, can manage virtual inventories for the producer with equivalent savings. In both cases, the producer is fighting commoditization by adding new value. And in both cases, that new value comes from information, all of which has been available but waiting for suitably cheap and ubiquitous technologies to be useful.

What should you do? By now you should have a good sense of how your own industry is changing and where you stand relative to your current competitors and business partners. You should also have identified which of your current assets are most at risk, if by no other method than imagining how new competitors can use digital technology to compete against you without these assets. Use that information to begin the shift to a more digital existence, perhaps outsourcing some of the depreciated functions as an interim strategy.

6.3: Destroy Your Value Chain

(one paragraph omitted in the on-line version)

In fact, many are preemptively destroying their own value chains. Recognizing that change is coming that will make obsolete their infrastructure, force them into a commodity role or remove them from the process altogether, they are choosing to hasten the end of the old model. They use digital technology to break the rules, implicit or explicit, that dictate how buying, selling or producing goods and services is done. They form new relationships with customers and competitors by automating expensive processes or giving away proprietary tools others can use to evolve away from the industry entirely. The hope of these organizations is that by unleashing a killer app themselves, they will be able to exert control over how much earth is scorched in the process.

One of our clients is in the business of selling home heating oil, a part of its larger oil and gas retail operation. It is a depressingly difficult business. The company sells to a deeply fragmented market, in which our client controls 17 percent of total sales for its market area but only 4 percent of direct sales to residents. Sales to residents, ironically, generate 75 percent of its profits. Sales to independent local dealers are made at much lower profit margins. The company's brand name is not strong, and it is limited by restrictions from its parent company in how far it can expand into new markets and products. Exit costs, finally, are too high for the company to simply walk away from the business.

This, in an odd sense, is the good news. The prospects are so poor that the company has very little to lose in breaking the industry rules and purposefully destroying its value chain. The company has decided, therefore, to expand direct selling to the residential market, even though doing so will very likely upset the independent dealers. And it is adopting this strategy despite the fact that dealers currently have the advantage of personal relationships with customers, more flexibility on terms and delivery, and lower distribution costs.

Rather than compete with the independents on their own terms, the oil company has designed an entirely new business model, which it calls the Virtual Fuel Company (VFC). Once complete (there are several interim stages), the company will physically exist only as the producer of heating oil, handling the remainder of activities through partners or virtually in cyberspace. In the early stages, customers will be given the opportunity to order over the telephone or through the Web, but the longer-term plan is to connect sensors in the home heating oil tanks to the production facility over a wireless network or through the home's connection to the Internet. The VFC will then tell the customer when it is time to refill rather than wait for an order. And delivery logistics will be coordinated through partnerships with leading transport companies already serving the VFC's markets, which have plenty of excess warehousing and transport capacity. The VFC will route pickup and delivery schedules to the transportation companies' systems based on its projected sales.

Advantages of the new model for our client are obvious. The company will not need an expensive sales or distribution function because it will outsource order processing to the customer. The supply and distribution network will be virtual. And the company can use its new information channel with the customer to form alliances on matters of mutual interest, such as environmental and regulatory issues. All of this will make it possible to compete aggressively with the local dealers on price, at the same time reversing the advantages of location and personal relationships the local dealers have today. Instead of the very limited hours during which the parties can transact today, the VFC will be available to its customers for information or deliveries 24 hours a day.

6.3.1: . . . Or Someone Else Will

In the case of the virtual fuel Company, a disadvantaged player already in the industry decided to solve its problems by wrecking the business model for everyone. It remains to be seen if this company can maintain the will to complete its strategy and what moves its former customers (and new competitors) will make in response. The market for home heating oil in the VFC's market, in any case, will never be the same.

More often, it is a startup or an organization from an entirely different industry that will destroy your value chain. These new entrants have even less of a vested interest in the old model and often can do much more damage much more quickly. Companies focused on competing in the current market often overlook these new players, dismissing them and the technology they employ as insignificant until it's too late to respond strategically.

(Three sections omitted in the on-line version)

The well known Web-based virtual bookstore Amazon.com had no competition from the traditional players for over a year, even though Amazon's approach to retailing posed a threat to the big-chain bookstores' value chain at several vital links. Afraid of cannibalizing its own expensive bookstores, Borders has yet to provide a virtual service of any kind, and Barnes & Noble went online only recently. (In an ironic gesture pitting the old world against the new, Barnes & Noble filed suit against Amazon on the same day it launched its Web site, arguing that Amazon's claim to be "Earth's Largest Bookstore" was false advertising, since Amazon didn't physically have the books.) Amazon had a year in which to develop its own brand—a cyberspace year, the equivalent of seven years in the physical world—and the traditional booksellers will now need to match Amazon not only on price but on the features that have made Amazon's interface unique.

6.3.2: Death of the Middleman

Examples of organizations destroying their own value chains so far have come from companies at either end-companies, that is, that produce goods and services or that distribute them. What about everybody in the middle? Another of our clients, a division of a global transportation giant, specialized in expediting cargo between European countries based on its expertise in various import and export rules and regulations. The business disappeared one day in 1992, when Europe dropped its borders.

Middlemen are perhaps the most vulnerable to the killer app that disrupts today's industry structure. Pity the warehouser whose retailer customer decides to distribute directly to its customers using package delivery partners. Pity the bookkeeper whose job it is to consolidate financial information that the bank decides to offer as a free electronic giveaway. The death of the middleman has been a theme sounded by the academic and business trade press for years. But in many sectors these intermediaries have proved to be remarkably robust. Long chains are being taken apart, but they are also being put back together in new configurations. To paraphrase Mark Twain, reports of the death of middlemen have been greatly exaggerated.

What's going on? We have worked with several traditional middlemen and come to the conclusion that dramatic changes are transforming but not destroying the business of many intermediates. Wholesalers and others have been operating in a largely static environment for some time, and part of the problem is that there is a serious breakdown between what intermediates do and how they charge for their services. For convenience, most intermediates' charges are based on commissions, percentages or markups on the goods they handle. Producers and retailers eager to improve their own profit margin are determined to eliminate as many of these charges as possible. What many seem to forget, however, is that middlemen are more than just what their name suggests. They add value to the goods and services that pass through their trucks, warehouses, consolidations and so on; it's just that the connections between the value and the fees charged have been lost.

Now, thanks to the new forces of digitalization, globalization and deregulation, these connections must be found, and middlemen, like everyone else, will need to inflict serious damage to their current business models to exploit them successfully. Today's wholesaler will need to take a cold hard look at current activities and extract from them the valuable skills and other information assets that it can begin offering outside the traditional industry structure. Wholesalers will become financers, logistics specialists, outsourced presales and postsales support providers, and more. They need to wrap information around the products they handle, adding measurable value in the process. As one client from the travel industry put it, "Add value or adios."

6.4: Manage Innovation as a Portfolio of Options

Organizations unleash killer apps when they combine ideas, digital technology, and the will to change. We'll talk in Part 3 about generating the ideas and finding the will, but what about the technology? Where does that come from? How does a FedEx or Charles Schwab even know what Internet-based customer interfaces are possible and when to upgrade them with new media? How does the Virtual Fuel Company know that wired fuel tanks are a likely option in the near future? How did financial printer Bowne & Company learn how to develop Web sites and format electronic filings?

In most organizations that we are familiar with, investments in innovation almost always follow a conservative model. Up to 90 percent of I/S funds are spent developing and operating current systems, most of which run on older or even outdated technology. Of the 10 percent remaining for research or technology advancement, another 90 percent may be spent studying technologies that are almost mature, like the next release of Microsoft Windows or application suites like SAP. For developments that are more than 18 months from commercial use, there is usually no activity, except for the kind of skunkworks investigations that a field manager might perform. Yet Moore's Law and Metcalfe's Law guarantee that innovations will be arriving and achieving critical mass during that time.

The problem is a mismatch between investment styles and investment instruments. At a recent meeting of the Diamond Exchange, executives described their investment strategies. At best, investments in innovations are justified using rolling five-year plans and the exacting business case approach of return on investment (ROI). If projects cannot guarantee satisfactory returns, they are not funded.

While this approach is appropriate for incremental efforts, it can't possibly work for investing in new technologies, new ventures, or in innovation generally. How can senior management, let alone I/S professionals often untrained in either finance or strategy, hope to estimate the benefit of a technology that doesn't even exist in the form of a good or service? How can you calculate the return on investment of an experiment that could destroy your value chain or turn assets into liabilities? At the same time, no responsible manager would simply toss financial analysis out the window and throw research dollars wildly at new ideas, hoping that something will stick.

The key to this deadlock has already been mentioned, and it is the approach of technology leader Microsoft and venture capital's Kleiner Perkins Caufield & Byers. These firms invest in dozens of promising technologies and developments, not as an owner but as a stakeholder. Taking a small stake keeps the exit price low for investments that fizzle, leaving the possibility for a dramatic upside—killer app upside—for investments that do pay off. By diversifying the innovation investment, the 10 percent of the I/S budget set aside for research could be managed not as a series of discrete projects, but as a portfolio.

Portfolio management, using the tools of risk analysis rather than ROI, has been the byword of venture capitalists for years. These financiers have not only made their investors rich but have driven the innovation powerhouse of Silicon Valley to become the preeminent source of economic growth in the global economy. Now it's time to follow their lead with your own funds.

Tim Andrews and Jay Kingley, partners with Diamond Technology Partners, developed this new approach to innovation management. Both Andrews and Kingley spent part of their careers as senior executives of technology start-ups, where they learned firsthand how investors cover their risk of loss by hedging, taking options rather than ownership, and spreading risk over a number of promising technologies. Rather than looking for specific ROIs, the "option-creating initiative" (OCI) weighs the option price, strike price (the price to turn the option into full ownership of the technology, or a bigger stake), and volatility of the investment against the potential value of the option. Options serve to decrease uncertainty about the value of the underlying transaction, a powerful tool given the uncertainty-generating potential of the Law of Disruption.

In addition to the new discipline of risk analysis, which ensures regular and frequent evaluation of the portfolio, OCI requires a working mechanism for abandoning options that fail as quickly as possible. According to Andrews, "The exit strategy forces corporate leadership—not the project team—to revisit regularly the decision to let the option lapse, or to exercise, turning the experiment into a full-scale product development."

Even an organization as venerable as the British Post Office has learned the value of operating a miniature venture capital firm within its I/S department. In 1997, the Post Office's executive committee created an innovation fund to give business managers a way to experiment with technology pilots and trials without being trapped in the business case morass of the regular budget process. Successful proposals must satisfy two of three evaluation criteria. They must (1) deal with a technology wholly new to the Post Office, (2) propose a creative new application, one that has the possibility of becoming a new service, or (3) involve a substantial technical or business risk.

With seed money of 4.5 million dollars a year, the fund received over thirty proposals in its first six months of operation. The first project to be approved is a pilot for improved vehicle navigation systems for postal vehicles and will include experiments with global positioning satellites for navigation, collision avoidance technology, and real-time congestion reporting. A one-day meeting convened to launch the innovation fund drew more than 200 executives. As the Post Office's experience shows, there are plenty of ideas floating around in every organization. People just need an opportunity and a forum to express them.

6.4.1: The Story of Lotus Notes

David Reed, former chief scientist for Lotus Development Corporation and now a technology investor himself, recently told us the story of how the OCI approach worked for the development of Lotus Notes, a software product that allows organizations to create collaborative work spaces over local and wide area networks (and now the Internet as well). Notes was released in 1990, when Lotus's chief product offerings, the 1-2-3 spreadsheet program and the Symphony suite of related products—themselves killer apps—had largely died out. Notes became the company's principal source of revenue until 1994, when IBM acquired Lotus for $3.3 billion, a price that largely reflected its valuation of Notes.

Ray Ozzie, a talented programmer who had designed Lotus's Symphony product, came up with the idea for Notes in late 1984. Ozzie wanted to develop a new approach to sharing information among PC users in a group. "In those days," says Reed, "the idea sounded totally off the wall. PCs had barely penetrated the market. Local-area-networks (LANs) were just starting and it was not obvious what they were good for. E-mail had been heavily used by programmers in DEC and Software Arts, where Ozzie had worked earlier, but Lotus did not use E-mail at all. Windows 1.0 was a cute idea, but a technical dog, and Ray's product idea depended on the multitasking capabilities of Windows. There was no market case for such a product, and most people could not imagine why anyone should care."

Nonetheless, Ozzie believed that the idea would take off once a critical mass of networking applications and PCs with the power to support graphical interfaces and multiple applications running simultaneously were available at reasonable cost. Lotus founder Mitch Kapor shared that belief, but neither could say when the prerequisites would be met. There was no sensible way to make a business case for investing the resources it would take to develop the Notes concept sufficiently to decide whether it was a winner or not.

Kapor, a leader as well as a visionary, found a way to keep Ozzie involved with Lotus. The solution was a new investment model that aligned the interests of both parties while managing the uncertainties of the Notes project. Kapor formed a new corporation called Iris Corp., which was founded solely to develop the Notes concept into a product. The structure of the transaction was unique. According to Reed, "Lotus was committed by contract to fund the development of the product, but Lotus did not own the product. Instead, Lotus had the right to review progress periodically and decide whether to continue funding the project. As long as Lotus continued to fund the project, Lotus had the right to take the product to market at the point when it was ready. If Lotus stopped funding the project or decided not to bring it to market, Iris was free to take the product to market by any means it chose, including working with another company, such as Microsoft."

Between the time the project was initiated and the time Lotus brought Notes to market five years later, there were many inside Lotus, Reed says, who felt that the investment in Iris was a bad idea and urged Lotus's senior management to cut Iris's budget. "Typical questions raised were: `Why are we wasting some really talented people on a wild goose chase?' `Before we cancel project XYZ, shouldn't we look at the money we're pouring into Iris?' and `What does Iris have to do with our strategy?'" Unlike other projects, however, Iris had a contract in hand that gave it leverage in such discussions. Their leverage, however, was limited to the value Notes had outside of Lotus—if the project really had no value to the market, then Lotus could easily drop its funding. "As a result," Reed says, "Lotus was highly motivated to invest resources to learn how to bring Notes to market in the most effective way. If the best possible analysis determined that Notes had no value, then Lotus would suffer no remorse at writing off its sunk costs."

After several years and multiple senior management reorganizations (including the departure of Kapor), an entrepreneurial manager brought the product to market, and after a shaky start in 1990, Notes gradually evolved to become the centerpiece of Lotus's strategy and the basis for IBM's hostile takeover in 1994. Says Reed, "I'm convinced that had Notes been handled as a `normal' internal development project, the pressures to apply the best talent to short-term crises, plus the uncertainty about when the market would materialize and what the demand would be, would have caused Ray and his team to be reassigned, and the project would never have happened. Or, alternatively, had Notes become known as the `chairman's pet project' it would have been overprotected and would not have had the close scrutiny that it did receive, resulting in a much more polished product and positioning when it was finally introduced."

Managing innovation as a portfolio of options, as these stories suggest, requires new skills. It also requires leadership and will. As we will explain in Chapter 7, the disruptive power of digital technology alters the roles and relationships between I/S executives and the rest of the management team in many ways. From the standpoint of innovation, senior executives must now be involved in technology investment decisions. They must take ownership of the portfolio and manage it, as Mitch Kapor did, as if the future of the organization depended on its paying off. Because it does.

6.5: Hire the Children

Young people, especially children, implicitly understand digital technology in a way that the rest of us can only watch and admire. John Perry Barlow calls them the "natives" of cyberspace. MIT's Andy Lippman makes the point even more poignantly. Speaking to a large European industrial company struggling to understand how it could turn itself into a digital-ready company, and fast, Lippman said there was only one way: "Hire the children."

Tomorrow's customers, competitors, and business partners, born and raised on digital technology in their homes, schools, and toys, will not only expect but demand commercial relationships that are technology enabled. Children who grow up playing with 64-bit networked video games won't simply reject text-based interfaces and suboptimal communication speeds, they will find them incomprehensible, like some form of hieroglyphics. And their attention spans for new goods and services are themselves expressed in Internet years—that is, they are about one-seventh as patient as adults.

The good news, however, is that today's children will be the product designers, customer service providers, and business managers of tomorrow. One way to understand the needs of the next generation is by talking to them and creating an environment where they can build the structures that will take today's organization forward. You can succeed at digital strategy, quite simply, by putting them in charge.

Organizations need not wait for tomorrow's managers to grow up before they can begin to learn from them. A recent Business Week article on the potential benefits to child development of extensive video game play told the story of a demonstration by network game company Total Entertainment Network to senior computer simulation experts from the U.S. Department of Defense. The company's CEO was trying to demonstrate how to play Quake, the hugely popular game that has taken over the Internet gaming world, and failing miserably. As it happened, the thirteen-year-old son of one of the meeting's organizers was in the room. He took over the keyboard and blew away all of the CEO's opponents.

MIT sociologist Sherry Turkle has made a formal study of the changing way in which children respond to technology. Following on the classic work of child development expert Jean Piaget in the 1920s and 1930s, Turkle has been watching children use technology to form order and structure in their universe, creating theories about space, time, causality, and life. She began this work in the early 1980s, but in the 1990s, Turkle writes, she found that children's response to computers, in particular, had changed significantly. "[C]hildren still talk about computers as `just machines' but describe them as sentient and intentional. The very notion of a machine has been reconfigured to include an object with a psychology."

Turkle tells the remarkable story of a thirteen year old playing SimLife, a sophisticated game that simulates the life of an ecosystem the player designs. The child is clearly unaware of much of what was going on in the game. After Turkle asked repeatedly if the game's confusing messages bothered him, the child sought to reassure the adult: "Don't let it bother you if you don't understand. I just say to myself that I probably won't be able to understand the whole game any time soon. So I just play."

It isn't just children who are different, but young adults as well. We recently took a group of twenty executives from different European postal agencies on a technology tour of Silicon Valley and stopped in for a day at Rocket Science, a game company headquartered in San Francisco's growing multimedia neighborhood. The oldest employee we could find was well under forty, and the environment clearly reflected a generational difference in attitudes toward work. The executives were amazed at the work styles they saw—people everywhere, running in and out of each other's offices, holding impromptu meetings and resolving problems as they came up. There was no sign of bureaucracy or authority and little structure to the work or the work space. Yet it was clear that Rocket Science's game developers were working with tremendous energy and productivity.

Most remarkable of all, as an I/S officer from the British Post Office observed, was the attitude of Rocket Science's employees. "Everyone is smiling," she said. "They actually seem to be enjoying themselves." She thought about that for a moment and added, "They're not working, they're having fun."

Creating work environments like Rocket Science-environments suitable for children—isn't easy. As the CEO of a major banking organization told us recently, "How do you change a culture from one of hierarchy with the normal pyramid to an open, flat culture where the 25-year-old kid can say to me, `You're crazy. That won't work. Where did you get that dumb idea? We have to do it this way.' And I willingly sit there and listen to him?"

Hiring the children—or including them in the process of product development, strategy formation, and workplace design—is the easy part. What is more difficult is learning to see through their eyes and trying, as best we can, to live in their world. But that is the only way, in the end, to develop a process that sustains the discovery, formation, and unleashing of killer apps.

At a recent workshop on digital strategy we conducted for an international management consulting firm, we began by giving two ten year olds (the children of some of the participants) each an unopened box containing a Sony PlayStation. The PlayStation is a powerful game computer with more raw processing power than most high-end desktop computers that cost thirty times as much. We asked them to put it together, connect it to a television and start playing with it, which they were able to do in less than ten minutes. Along the way they described what they were doing. "Now, this is the CD. I don't really know how this works, but you need it to play different games."

While we started our speech about the power and unpredictable nature of killer apps, the children drove three-dimensional race cars across the Golden Gate bridge, projected on screens behind us. The children were so absorbed by the game that they soon forgot they were standing in front of an audience of adults, and one of the parents tried to quiet the children lest they interrupt the presentation. No, we said, don't stop them. Their joy in playing the game was precisely the point we were trying to make.

This last design principle brings us full circle, since we began by talking about the need to think more about our dealings with business partners, including those business partners—our employees—with whom we transact the most business. The next generation of managers, laborers, and CEOs are the children of Moore and Metcalfe, born under the sign of the Law of Disruption and uttering Ronald Coase's name, figuratively, as their first word. This group already controls a sizable chunk of the economy, and that chunk is growing exponentially along with Moore's Law. So now is the time to introduce yourself to these mutated creatures, otherwise known as your own children. The sooner you can incorporate their values and their energy into your organization, the more likely you'll be remembered by them with some emotion other than nostalgia. They might even admire you.

6.6: Summary

The final four design principles round out the key techniques organizations are using to implement their digital strategies and design killer apps of their own making. Here we have stressed the necessary evolution that moving to cyberspace will require of your internal organization—your market, your assets, and most importantly, your people. The rehabbing and reinvention of the corporate self in many organizations will require trauma equivalent in force (but faster in velocity) to the movement in the nineteenth century from an agrarian economy to an industrial one. Much of the change will occur as a natural by-product of responses to the new business environment described by the first eight design principles.

We have left many questions unanswered. How do companies utilize the design principles in practical terms? How do they make themselves ready for a new strategy, generate ideas, and operate the emerging new business in a way that maximizes the potential for future success while preserving today's cash flow? How, in short, do they learn to unleash killer apps in practice? That is the subject of the next part of the book.