MIT Enterprise Forum

Below is an essay motivated by my presentation to The MIT Enterprise Forum's Annual Innovation and Technology Forecast conference. It is still a bit rough around the edges, comments and suggestions welcomed.

You can also download the essay in PDF form; and also get the presentation slides.

 
10 January 2006

Information Technology’s Disruption on Business:
Extend the Edges, Transform the Core

Whenever I am asked to make technology forecasts, a few words of caution jump to mind:

• Never mistake a clear view for a short distance.
• Existing technologies will continue to get better.
• We always overestimate technology in the short term and underestimate it in the long term.

With those provisos, a couple of recent examples highlight some of the major trends that I see playing out over the next few years. 

The first example started with a letter that I received last month from my mortgage holder, ABN AMRO.  The letter, a not so personalized one from the firm’s CEO, explained that a magnetic tape with all my account information had gone missing.  It had disappeared while being sent via DHL to one of the credit agencies.  The letter emphasized that there was no evidence of foul play. Still, as a precaution, the company suggested that I consider putting a fraud alert on my credit report and offered three months of free credit monitoring.  It apologized for any inconvenience.  A few weeks later, I received another letter from ABN AMRO.  This one happily reported that the tape had been recovered.  It seems that a DHL employee had come across an unlabelled package, opened it, and seeing some information inside, returned it to ABN.  There was still no evidence of foul play but the offer of free credit monitoring was extended to a year.

The second example comes from General Motors.  GM has launched a program where car owners with OnStar equipped cars (now available on about 75% of GM models) can sign up for a monthly email from their car.  The email gives status information on major car modules such as the engine, transmissions, airbags, etc.  It warns of any trouble signs and also reminds the owner about any scheduled maintenance.  In the course of compiling the email, GM retrieves and analyzes over 1,200 trouble codes from the car.  There is a range of obvious benefits for the customer.  GM also benefits, gaining a wealth of performance data about their vehicles in the field. 

As I look over the next five years, I think that the most exciting science and the most stunning inventions will happen in genomics, biotechnology and nanotechnology.  Even with the latest scandals in Korea, it’s clear that spectacular basic science has been done and we are poised for major scientific breakthroughs and inventions.

But as I think about business innovation, I think that the most economic value will be driven by information technology.   This is because the basic infrastructure has been laid to enable mass utilization of digital technologies.  New developments can ride on the coattails of the Internet and related technologies. We are poised for mass adoption.  In fact, one way of thinking about the next five years is that we will start fulfilling the promises of the last five years.  Because of its greater economic influence, I’d like to focus my comments on information technology and its influence on business. 

Unless you are a technology vendor or one of a few significant startups, the most common information technology related investment experience over the last five years could be characterized as “spend a lot to just stay in place.”  Companies were able to gain enormous efficiencies through information technology.  But those efficiencies were typically in the back office and competitors raced to do the same.  Rather than hitting the bottom line, savings were quickly competed away.  Customers reaped most of the benefits.

Over the next five years, technology’s fulcrum will move away from corporate back offices and out to their extremities.  Information technology won’t just facilitate efficiencies; IT will become embedded in the products and services that customers buy.   Information technology will become strategically intertwined with the front office, markets, and customers.  And rather than nibbling away at markets from the edges, slowly eating away at entrenched practices, technology-driven disruptions will affect core products and strategies.

For example, The OnStar case that I discussed earlier is not just an efficiency play, it represents a fundamental change in how GM interacts with its customers and gains knowledge about its products in the field.  Yet it is just an incremental extension of the system’s existing capabilities, building on both the capabilities that GM has developed and the fact that consumers have become wired.  GM only incurs the minor telecommunications cost of retrieving the data, analyzing it, and processing the emails.

At the same time, the ABN AMRO example points to the darker side of our digital development.  Each of us is exposed.  From a privacy and security standpoint, we live in glass houses without doors, much less locks.  We must make our most personal information available to every provider and hope that they safeguard our vitals.  But they don’t really have the mechanisms to do so.  Privacy and security safeguards are weak within most companies and the linkages between them are riddled with holes.  Like hunted animals on the Serengeti, our defense is huddling in masses and hoping that the predators attack someone else.  Unfortunately, more and more digital predators are massing.  Many of our fears about being digital will also come to pass.  And a major issue for business will be to address both the problems and the growing concern of customers.

Advances in capabilities will provoke new competitive strategies and disrupt industry structure.  Particular instantiations of these technologies are already transforming traditional bit-based products entertainment, music, news, insurance, and financial services.   They will also become the differentiating component of physical products like cars, white goods, and consumer electronics.  IT will also change the context in which customers live and competition occurs.

The most important information technologies will differ by industry and company context but, in large part, Moore's Law governing technology improvements and Reed’s Law describing network value, acting on the Internet, will drive their development.  Such advances will matter strategically because they will have a material effect on transaction costs.

Five characteristics describe the technological disruptions in front of us. 

1.    Connectivity will be pervasive.  Even though driven by an underlying alphabet soup of wired and wireless technologies, corporate networks will interact with products, customers, suppliers, regulators, and even competitors, blurring notions of enterprise boundaries. 

2.    Miniaturization is expanding the information networks with smaller, cheaper, and more pervasive nodes.  Depending on the industry, this expansion comes in the form of wallets, handsets, sensors, monitors, cards, or tags, all of which could be standalone or embedded. 

3.    Increased intelligence allows these new devices to monitor, store, and analyze all sorts of information.  Some of this information is not conceptually new, e.g. scanner or transaction data, but is now collectable at a massive scale and detail.  Other information represents new classes previously impractical to gather or maintain, such as real time location, diagnostic, and preference information.

4.    Data will be increasingly tied to identity, i.e., to unique individuals or objects, rather than being anonymous. This allows better insight but also raise enormous issues around ownership, privacy, and security. 

5.    Network nodes communicate not just at the network level, but also at the software level.  Software technologies like web-services or service-oriented architectures will enable robust applications across widely distributed networks.

As tempting as it is to look at flashy startups and highflying media darlings, let me instead point to a large mature company as an illustrative example.  Incumbents have do deal with the challenges of legacy systems and competition for management attention and corporate resources. Thus their experiences are perhaps more indicative of how the mainstream economy will evolve.

Of existing companies, perhaps none has more of legacy challenges than General Motors.  So let me look at the recent past and the possible future through the lens GM’s OnStar. 

OnStar embodies many of the general characteristics that mentioned above.  It taps into the car’s onboard sensors and computers to access performance and location information and, though a cellular connection to GM service centers, allows remote diagnostics of the vehicle’s condition and some remote control of some car operations.

The 2000 hype

At the height of the Internet bubble, OnStar was seen as the platform to bring connectivity, entertainment, and e-commerce to car-bound passengers.  The markets were enamored with eyeballs and car-bound drivers and passengers were seen as the next great, untapped audience.  The numbers seemed attractive, there are 200 million cars in North America alone and people spent an estimated 700 million hours a week in them.  A new term was coined—“eardrops.”  Fortune magazine referred to it as “transforming the car from a 3,500-pound, $25,000 transportation appliance into a multimedia data center and productivity tool.”   Ron Zarrella, GM's president of North America at the time, predicted that OnStar would soon produce $1 billion in annual profits.   Industry analysts at UBS Warburg predicted that the global market for connected car services would be $24B by 2005.

It didn’t turn out that way.  Neither the technology nor the applications materialized to enable that vision. Consumers didn’t seem to miss it.  Few drivers demanded the ability to surf the web.  Few complained that promised “proximity marketing” capabilities, where local retailers could beam ads and coupons to cars as they passed by, did not materialized.  By 2003, Ford after investing over $150 million shut down Wingcast, its OnStar-like offering.  Pundits who previously touted the OnStar service were encouraging GM to bury it. Fortune Magazine summed up the sentiment with this headline: “OnStar is a non-starter.” It concluded, “Instead of becoming GM's best new idea since the electric self-starter, OnStar looks more like EV1, the now defunct electric car.”

The 2005 reality

As usual, the realty is quite different from the forecasts.  Rather than a car portal to the Internet, OnStar’s services are mostly focused on the driving experience. OnStar currently has approximately 4 million subscribers.  OnStar is offered as standard equipment on approximately half of GM vehicles and optional on another 25%.  GM has announced that it will move over the next few years to make OnStar standard on all vehicles.  Each month OnStar handles over 1,000 automatic air bag deployments and crash notifications.  It fields almost 15,000 calls for emergency services, 25,000 calls for roadside assistance, 29,000 calls for remote trouble diagnostics, 42,000 calls to remotely unlock doors, and 380,000 calls for directions.  The closest OnStar comes to being a communications gateway is as an alternative hands-free cell phone.  It sells about 20 million cell phone minutes a month, making it the largest (though not by far) reseller of airtime.

As a standalone business, OnStar is in the black but hardly a killer app.  But a simple running of the numbers doesn’t tell the whole OnStar story. The rest of the story is significant value that the OnStar platform delivers to to the larger GM enterprise.  This value comes in the form of reduced costs, improved products, and enhanced customer relationships. 

Cost savings and improved products go hand in hand because OnStar enables real time observation of a large number of vehicles, under myriad driving, weather, and traffic conditions that would otherwise be impossible to simulate. In pre-production, design problems can be identified before full-scale production.  During production, manufacturing problems can be detected before vehicles leave the assembly line.  After the vehicles are in service, remote diagnostics allow predictive and proactive servicing. This allows mechanical problems to be detected earlier, perhaps heading off a cascading spiral in which a 10-cent part causes damage to a $1,000 part.  Fleet level design and durability issues can also be detected and used to improve later production runs or spark design improvements before the normal engineering cycle. Conservative estimates are that hundreds of millions of dollars in warranty costs have been averted.

OnStar improves customer relationships by giving the automaker continuous, direct contact with individual customers. Historically, GM‘s interactions with its customers have been infrequent and indirect. Automakers traditionally dealt with customers about once every six years, when it was time to buy a new car. To see them more frequently was usually a bad sign, because that meant customers were having problems with their cars.  And, even then, automakers worked through independent franchised dealers to sell and service their vehicles. Direct interaction was limited to advertising, which was expensive and impersonal. 

Now OnStar’s safety and security services offer GM the opportunity to have positive relevance in customers’ daily lives.  GM studies show that 68% of drivers feel more comfortable with OnStar like services.  80% of subscribers would recommend OnStar.  70% would prefer or will only purchase OnStar-equipped vehicles.  Perhaps most critical for GM, OnStar increases appeal of GM vehicles for non-GM owners, especially among Hispanic/Latinos (nearly 20% over base scores) and African-Americans (nearly 15% over base scores.)  And the relationship doesn’t have to stop with the first owner. GM is already using OnStar to differentiate its vehicles in the highly competitive used car market and to establish relationships with used car buyers.   It currently has about 300,000 used vehicle subscribers.

The 2006 - 2010 Forecast

OnStar will not save GM from its pension and healthcare problems.  But, if the company survives those issues, OnStar will be a platform for significant strategic innovations that continue to reduce cost, improve the core product, and enhance customer experiences.  OnStar readily integrates streams of data about a car’s status and location, making that data available for analysis and use.  It has a modular architecture for that allows for innovation beyond the initial applications and serves the needs of the entire GM enterprise. 

For example, one recently launched program is the ability for customers to get regular diagnostic emails from their cars.  The email triggers remote diagnostics of key vehicle modules, such as engine, transmission, airbags, etc., advising customers of any issues or scheduled maintenance.  To prepare the email, GM is able to retrieve over 1,200 diagnostic trouble codes from each subscriber’s vehicle.  The GM engineering organization will benefit from having live field data about a growing number of vehicle modules.  The OnStar platform allows GM to do this for no incremental cost, except for the communications cost of retrieving the data, processing it, and sending the emails.  No modifications of OnStar were necessary.

Other innovations revolve around adjacent business offerings enabled by the information captured by OnStar.  For example, OnStar allows GMAC Insurance to launch a program where it is offering insurance premium discounts to low mileage drivers, where the driver consents to have actual mileage verified by OnStar.

The largest innovation might well be the transformation of the GM business model itself.  Traditionally the automotive business is cyclical, with profits dependent on the sale and financing of new vehicles.  OnStar and the adjacent businesses that it enables gives GM inroads to annuity-based sources of revenue, for such as subscription, service, and insurance.  You could even imagine a scenario where GM manages a fleet of vehicles and sells transportation time, much the way that GE manages a fleet of aircraft engines and sells hours of service.

***

OnStar is just one illustration of the power of how advances in information technology might not only change the nature of the products themselves but also customer relationships and the underlying economic models of manufacturers.  It is not clear whether GM will survive its legacy contract, pension, and healthcare issues of realize the OnStar’s potential.  But it is clear that the sort of technology advances illustrated by OnStar will find their way throughout the economy.

Notes:

1.  For an extensive discussion of Moore’s Law, network economics, and transaction costs, see Unleashing the Killer App.   Note that our discussion on network economics is in part superceded by the work of David Reed.  For a discussion of Reed’s Law, see the Wikipedia discussion and related links at http://en.wikipedia.org/wiki/Reed's_law.

2.  “Bandwidth on wheels.” Alex Taylor. Fortune. October 9, 2000.

3.  "OnStar Is a Nonstarter for GM.”  Alex Taylor.  Fortune.  July 21, 2003.

4.  “Bandwidth on wheels.” Alex Taylor. Fortune. October 9, 2000.

5.  Based on GM-supplied three-month rolling average of services from July through September 2005.  Numbers are actual cases in which OnStar successfully provided services to subscribers.