The End of Power (34 page)

“I don't know how you could possibly have a high innovation environment at a big pharma. It's hard for me to imagine how you could nurture an environment of innovation and risk taking, and produce champions.” That statement came from John Maraganore, the CEO of a small, Cambridge, Mass., pharmaceutical company in 2007.
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From his point of view, it was merely an expression of the obvious. Compared with decades of corporate standard practice, however, it was nothing less than radical.

Radical, but true. The multibillion-dollar pharmaceutical companies such as Pfizer and Merck may market some of the most innovative and transforming new drugs, but chances are they did not develop them. Rather, small specialized companies—some formed out of biology research departments at universities, some in hothouse innovation regions like Hyderabad, India, also known as “Genome Valley”—synthesize these new drugs. They then sell the drugs—or, in some cases, the company itself—to the large corporate giant.
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Actually manufacturing the drugs may be the task of another outsourcing company. One example is FerroKin Biosciences, which has seven employees who work from home, and a collection of about sixty vendors and contractors who provide all the pieces of the drug development process. Started in 2007, it attracted $27 million on venture capital, moved its drug from development into Phase II clinical trials,
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and was purchased in 2012 by Shire Plc, a UK-based specialty biopharmaceutical company.

Companies like Shire, and Big Pharma majors like Merck, retain a distinct advantage over such homegrown efforts in advertising and distribution. It would not be realistic just yet for a small pharmaceutical manufacturer in Hyderabad or Shenzhen to outfit its own army of sales representatives to bring samples (and pens and bags and lunches) to doctors and hospital staff in Florida, Perth, or Dorset.

The change in the locus of major product innovation is nothing short of revolutionary. For years, large companies in every field from pharmaceuticals to automobiles, chemicals, and computers conducted their own
research and development in closely guarded and well-funded units that were essential to company pride and prestige. From the 1980s on, however, companies like Cisco and Genzyme gained prominence despite not having these in-house R&D capabilities. What business scholar Henry Chesbrough calls an “era of open innovation” has taken hold.
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In some industries, Chesbrough points out, open innovation was the norm all along: Hollywood, for instance. Now, chemicals and telephone and aircraft manufacturers have come closer to the Hollywood model, overturning the wisdom of the old titans in these fields. And new power players in their industries like Acer and HTC have gone from offshore innovation shops whose names never appeared on their products to full-fledged competitors with their own brand names.
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It makes sense: “We know this kind of product category a lot better than our customers do,” the CEO of Taiwan-based smartphone maker HTC told
Businessweek.
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A host of other still-obscure companies is primed to follow suit. In pharmaceuticals, outsourcing drug manufacture is a long-standing process, but drug discovery was long closely held. On the other hand, the outsourced drug discovery market has grown faster than overall drug R&D since 2001; it expanded from $2 billion in 2003 to $5.4 billion in 2007 and is estimated to be currently growing at 16 percent per year.
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None of this bodes well for large companies. As the business scholar Clayton Christensen argued in a famous book,
The Innovator's Dilemma
, even the very best large companies operate by a set of procedures that make them good at harnessing “sustaining technologies” (the new technologies that help make existing products better) but terrible at identifying and capitalizing on disruptive technologies (the new technologies that usually emerge at the margins of an existing market but eventually stand to remake it). Among classic disruptive technologies, Christensen lists the likes of mobile telephony, micro-turbines, angioplasty, PlayStation, distance learning, Internet Protocols, online retailing, and home patient care. New developments such as these, at first uneconomic relative to standard processes, ended up flummoxing the very same business giants that were always considered impeccable leaders in their field, leading to the eventual demise or decline of onetime paragons such as DEC or Sears Roebuck.
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Size and the operating procedures that come with it contributed mightily to these stories, Christensen explains. For instance, the need of large corporations to analyze market opportunities according to established metrics prevented them from grasping the contours of nascent markets
emerging around new technologies. Lower short-term profits from these new markets go against the culture of maximizing quarterly share prices. And the dilemma replicates itself with each wave of innovation: as the first companies to exploit disruptive technologies gain and grow, “it becomes progressively more difficult for them to enter the even newer smaller markets destined to become the large ones of the future.”
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Christensen offers principles for business leaders to confront the innovator's dilemma. But with research and development capital flowing more freely to more locations and less and less up-front investment required in physical plants, scarce inputs, communications, and marketing, the dilemma is poised to relentlessly grow, not decrease, in intensity.

Historically, government-imposed restrictions limited the competitive landscape in service of a higher goal: protecting fledgling local firms from cheaper imports, or advancing a particular social agenda by controlling the nature and location of investments.

But that trend crested about thirty years ago, brought down by poor results and a wholesale shift in global policy thinking. Now governments around the world have shed state-owned enterprises, unbundled monopolies, liberalized their trade and investment regimes, and improved the business environment for entrepreneurs in a process that has become well known. One telling indicator: In 1990, the average trade tariff was 23.9 percent worldwide (ranging from 38.6 percent in low-income economies to 9.3 percent in OECD countries). By 2007, it had fallen to 8.8 percent worldwide, ranging from a low 12 percent in low-income countries to a minuscule 2.9 percent among OECD members. Even the economic crash of 2008 failed to reverse the trend.
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As advanced economies were crashing, it became fashionable to predict that the natural reaction of these governments was to protect jobs and companies behind higher barriers to imports. That did not happen. The same was true about the possibility that countries would impose limits to the entry of foreign investors. That, too, didn't happen.

The truly global movement toward relatively free, open economies with broad capital markets and limited state ownership is one of the well-told tales of the last generation. With it often comes the caution that at some point the pendulum might swing back—if not fully, then to a considerable extent. And indeed, it might appear at first glance that with the
global recession of 2008–2009 came a swing back toward more government regulation and control in key industries.

But measures such as bank bailouts in the United States, temporary nationalizations in the UK, and efforts to update regulations in the financial sector to handle the trade of exotic derivatives should not be mistaken for a reversal of the much larger global trend. In fact, according to the World Bank, the pace of pro-business reform worldwide hit a record high in 2008–2009, in the midst of the global slowdown. In that year, the bank counted a record 287 reforms, enacted in 131 countries, that made business easier. In total since 2004, three-quarters of the world's economies have made it easier to start a business. Almost two-thirds have made credit easier to obtain. More than half have made registering property, paying taxes, and trading across borders easier. Add the significant number of countries that have made it easier to go through bankruptcy, enforce contracts, obtain construction permits, and the like, and the overall picture is one of dramatically lightened government obstacles to business activity—thereby exposing once-sheltered companies to competition. All kinds of barriers to the entry of new competitors are falling, and contrary to the common wisdom those imposed by governments are among those declining the most. And staying down.
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This is not the place to proclaim the death of all old industries, companies, and names. Plenty of evidence indicates the contrary. Many centenarian firms are doing just fine. Some massive and established corporations such as Coca-Cola, Nestlé, ExxonMobil, and Toyota will be here for a good while longer; others perhaps less so. But whereas getting caught up in predicting the prospects of a particular major corporation is a useful exercise for stockholders, it is a distraction from the big story taking place all around us—namely, the advent of a whole parade of new competitors. Following are a few.

Meet Alejandro Ramirez, a young entrepreneur from Morelia, Mexico, who is one of the leading players in the Cineplex business—in India.

India is famously the country with the world's largest film industry, at least when measured by the number of commercial movies made each
year. Where India lags significantly, however, is in modern multiplex cinemas that offer the country's exploding middle class domestic and foreign films on high-quality screens. There are only about a thousand modern film screens in this country of over 1.2 billion people. Ramirez's company, Cinepolis, will fill this gap by adding five hundred more screens in the next few years. Cinepolis, which began as a one-screen movie house in the 1940s in a provincial Michoacán state, has grown to become the largest multiplex company in Mexico and across Central America.
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Not only is Cinepolis the most aggressive new player in Indian movie houses; it is the first foreign investor to enter that sector in India. “How did it occur to you to diversify to the Indian market?” I asked Ramirez. “It wasn't my idea,” he replied. “Two students at Stanford's business school had to prepare a business plan for one of their courses and came up with this opportunity and brought it to me. We worked together, refined it, got the capital, and were on our way. Almost immediately we discovered that the potential was even larger than we had anticipated.”
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Cinepolis is just one of a growing number of players from countries like Mexico, India, Brazil, South Africa, and Turkey in other developing economies—that is, in sectors that previously were undeveloped, limited to domestic investment, or controlled by larger, Western-based multinationals. South-South cooperation was a dream of the Third Worldist movement of the 1970s, whereby economies of the developing world would help empower one another through direct trade, investment, and aid that bypassed the “North.” It was a state-led, socialist dream, and the kind of investment now flourishing is quite different from what it imagined. Nevertheless, South-South investment is today one of the shaping trends of global business.
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United Nations data show that outward foreign direct investment (OFDI) from developing and transition economies began to outpace OFDI from rich countries in 2003.

Twenty of the fifty-four bilateral investment treaties signed in 2010 were between developing countries, and they increased further in importance, both as recipients of FDI and as outward investors. Foreign direct investment outflows from developing countries reached an unprecedented 29 percent of total direct investment flows in 2010, and this strong growth continued in 2011 and 2012 despite global economic woes.
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The number of developing-country firms in the league tables of the world's largest companies is continually growing. And researchers from the World Bank and OECD have argued that official statistics underestimate the scale of OFDI from developing countries, in part because it is a
new and often unanticipated reporting category, and in part because of the volume of unreported capital flight.
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Among the beneficiaries of this trend are a host of companies, in sectors ranging from construction and telecommunications to textiles and oil, that are largely unknown in Europe or North America but increasingly recognized brands in the rest of the world. In mobile phones, for instance, India's Bharti Airtel and Reliance, South Africa's MTN, Egypt's Orascom, and United Arab Emirates' Etisalat all rank within the world's top fifteen. Others are less known yet significant in their respective industries: for instance, Sri Lankan textile manufacturers have spread operations elsewhere in South Asia and the Indian Ocean, and Turkish multisector conglomerates have become major players in Russia, the Balkans, and the Middle East. (Indeed, Turkish companies have been big beneficiaries of the international effort to rebuild and develop Afghanistan's infrastructure, including construction of the US Embassy in Kabul.) Increasingly, firms such as these have been taking the jump away from their regional comfort zone, where there are language or cultural commonalities, to invest (like Cinepolis) when they detect opportunity far from their home base. Antoine van Agtmael, who coined the term
emerging markets
, told me that he feels confident that by 2030 firms based in emerging markets will outnumber those in today's advanced economies.
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