The Raider Nation outperformed market expectations, with the highest “NFL Alpha” for the second year in a row, a first in thirty years, says Analytic Investors. Barclays sees little threat to oil supplies and strong exports are accelerating growth in Japan and Taiwan. Americans are spending again. McKinsey says developed nations must get better at boosting productivity by matching technology and sophisticated knowledge workers.
Brian Haskin and Matthew Robinson, Analytic Investors.
As another turbulent NFL season comes to a close, the banter and speculation surrounding one of the world’s most viewed events, the Super Bowl, only intensifies. Leading up to the game, the pundits will be analyzing everything from Ben Roethlisberger’s hangnails to what Aaron Rodgers eats for breakfast.
While some of this conjecture may have merit for entertainment’s sake, very little of it comes from a purely objective, statistical standpoint. It is from this perspective that we present our annual review of the best and worst performing NFL teams. Since 2005, Analytic Investors has enjoyed applying its rigorous quantitative investment techniques to analyzing football. Specifically, we have published an analysis of NFL performance — NFL Alphas — ahead of the Super Bowl to quantify each team’s regular season performance. In last year’s matchup between the Indianapolis Colts and the New Orleans Saints, our research concluded that the Saints were undervalued vs. the Colts — and they beat the favored Colts, 31-17. Following is our review of regular season play and our Super Bowl forecast in NFL Alphas 2010-2011.
All of our post-season NFL matchup valuations hinge upon each respective team’s regular season alpha. A football team’s alpha1 is simply the return-on-investment (ROI) to a systematic wager on the team to win outright in every game of the regular season. In light of this description, it would be natural to think that the New England Patriots would lead our alpha rankings with an NFL-best 14-2 record. But this is not the case; in fact, since 1978, this has only happened four times. Notably, the undefeated Patriots of 2007 only earned the third best alpha of that season at 23%.
A football team’s alpha is simply the return-on-investment (ROI) to a systematic wager on the team to win outright in every game of the regular season.
Analogous to an alpha in finance, the teams only earn alpha by outperforming market expectations. In the case of the Patriots this year, they were favored in 14 out of 16 games, which gave them little opportunity to exceed expectations. To illustrate this effect further, consider the Indianapolis Colts (-5%) and the Tampa Bay Buccaneers (42%). Although they both finished with 10-6 records in the regular season, their alphas tell completely different stories. On one hand, the Colts were favored in 14 games and only won 10, which was well beneath market expectations. On the other hand, the Bucs were only favored in six games but went on to win 10. While an impressive win-loss record certainly doesn’t hurt a team’s alpha, we see that, quite ironically, winning is only half the battle.
For a second year in a row, the “Raider Nation” contingency managed to significantly outperform market expectations and claim the highest NFL Alpha. With data reaching back over three decades, this feat has never been accomplished. Furthermore, their combined alpha over the last two years (133%) is unrivaled. Although the Raiders had a mediocre year at 8-8, they were only favored in four of their 16 games. Unlike the Patriots, the figurative “bar” was set low for the Raiders, giving them ample opportunity to outperform. Taking a more granular look at their season, we see that the bulk of their season’s alpha came from a pair of shocking victories against their division rivals, the San Diego Chargers. Weighing in on their last two years of outperformance, does out-of-favor Al Davis deserve more credit than his critics are sending his way?
At the other end of the spectrum are the listless Panthers. With an alpha clocking in at -74%, they found themselves at the foot of our alpha rankings. While expectations were deservedly low (they were only favored in three games throughout the year), they failed to produce any results that were contrary to market expectations. Both of their wins came in competitions that were expected to be close as dictated by the point spread. They edged out the San Francisco 49ers when they were 2.5-point underdogs and then went on to beat the Arizona Cardinals as 2.5-point favorites later in the season. With an NFL-worst record and an abysmal alpha, the Panther faithful will at least find some consolation with the #1 pick in next year’s draft. There is light at the end of the tunnel.
Sudakshina Unnikrishnan, Kerri Maddock, Barclays Capital, Commodity review
There has been a strong and palpable sense of deja-vu across commodity markets over recent weeks. Spectres that raised themselves during the run-up in commodity prices in 2008 have returned, and indeed many of them appear to have taken on a more solid and alarming form this time. Some of these issues may in the first instance reveal themselves primarily as being political or moral, but what acts as the primary catalyst for all of them is the power of long-cycle economics. Development patterns and structural change in the global economy are moving at a sharp enough pace to necessitate some severe changes in relative prices, and most directly in the price of commodities relative to other goods and assets, in our view. Indeed, urbanisation, a massive expansion in the size of the global middle classes and the rise of new economic superpowers and super-regions mean that some key commodities sit right on top of the most dynamic of the long-cycle fault lines.
Even a global downturn as severe as that experienced in 2008-09 only postponed the reemergence of pressure very briefly. That pressure takes various forms as it seeks to vent itself, including increasing global competition over resources, heightened concerns about supply security and the potential for political shocks in resource-consuming and resource-producing areas when relative price shifts create friction. One of the potential outriders of that process is inflationary concerns and the policy risks attached, and food price inflation in particular seems set to be one of the key themes of the year.
This has made for the timely release of our latest edition of the bi-annual Commodity Refiner. In our view, positive exposure to commodities is best weighted towards markets that sit most precariously between strong long-cycle demand and supply-side concerns. That suggests copper, grains, tin and crude are the most natural favoured longs. However, not all commodity exposures reflect similar fundamentals; indeed, we expect considerably more dispersion in outcomes relative to last year. The favoured shorts should ideally contain only a modest degree of demand-side pressure and a relatively unconstrained or loosening structural supply-side environment. In our view, beyond weather-related gyrations, natural gas remains the commodity with the least positive outlook.
Geopolitical concerns have returned to the forefront of market concerns this week, focussed on the events in Egypt. We include three publications analysing the events and their effects on the oil and gas markets following our discussion last week on wheat prices and Egypt (the world’s largest wheat importer). Hopes of a smooth political transition in Egypt seemed to fade as thousands of pro-Mubarak gangs clashed with anti-government demonstrators in Tahrir Square in Cairo. The military largely stood on the sidelines during the melee, only firing warning shots late in the day in an effort to disperse the crowd. Hours before the unrest, Vice President Omar Suleiman, the longstanding Egyptian intelligence chief, had told the anti-government demonstrators to go home and allow Cairo to return to normal. Energy Flash: Egypt: How long can the center hold? discusses the political implications within Egypt of recent events, addresses concerns of wider contagion in the region and focusses on the oil market in light of the strategic importance of the Suez Canal to global oil trade.
Indeed, one of our key predictions for 2011 was that geopolitical tensions would simmer more vigorously this year, particularly in the context of an oil market in which incremental non-OPEC volumes are becoming more difficult to bring on stream and OPEC spare capacity gets more noticeably stretched. The ongoing crisis in Egypt has sparked fresh concerns about the security of the Suez Canal, and geopolitics has established itself as a major component of the oil market early in 2011. While a significant producer in its own right (650 thousand b/d), rising domestic consumption has turned Egypt into a small net importer of crude, and its key importance for oil lies in its role as a primary transit country.
The Suez Canal is a strategic conduit for the shipment of oil out of the Gulf into Europe, as well as from Europe into Asia, with its 120 miles connecting the Red Sea and Gulf of Suez with the Mediterranean Sea. Around 1.6 mb/d of liquids flow northbound through the Suez Canal to the Mediterranean Sea, while 0.8 mb/d travels southbound into the Red Sea. In the unlikely event that the Egyptian government opts to close the canal and the pipeline, the loss to oil trade flows would amount to about 2-3 mb/d of crude and 2 mb/d of products. In our view, there is a little significant threat to Egyptian oil output or transit routes and, indeed, the consequences of such events are likely easily containable even were they to occur. We also view the likelihood of a spill-over into key oil producers as very limited. However, the situation introduces risks and uncertainties that are likely to be highly significant in terms of the broader political evolution of the region, and we see the response of Brent prices so far as being fully commensurate with the move into a more geopolitically charged environment. We see events as being more unambiguously positive for the back of the curve rather than prompt prices.
Meanwhile, in the global gas market, LNG transit volumes through the Suez amounted to some 17.5 mt in 2009 (with over 90% travelling northwards), and with the growth of Qatar, Egypt and the newly added trains in Yemen, these volumes continued to rise through 2010. As we do not see the closing of the canal as a likely outcome, we note that a disruption in Egypt’s ability to export its own LNG accounted for 3.2% of global LNG supply in 2010. Spain, the US, and South Korea are Egypt’s key LNG export markets.
In the base metals markets, much of the recent attention on China has centred on its consumption patterns, but the country’s influence on base metals prices this year will also depend on trends in its domestic production. Chinese base metals mined and refined output for almost all the metals grew at an astonishing rate last year hitting record highs along the way. For many of the metals the strength in domestic raw material production resulted in a reduction in the proportion of imports used in refined metal production. How sustainable this trend proves to be will be a key factor behind relative price performance. Overall, the effect on prices and market balances of slower Chinese base metals production growth will depend on how this is counterbalanced with slower demand growth, with lead and zinc the metals in which this will be a key swing factor for 2011. An example of China’s effect on base metals markets in 2010 was evident in lead, which was close to the weakest of all the base metals, with the LME cash contract ending the year unchanged. This rather belied what appeared a pretty robust overall fundamental picture – an essentially negligible-sized market surplus combined with a low stocks-to-consumption ratio (2.5 weeks). Why did this not offer a better turnout? The answer to this question essentially came down to the muted impact China had on the international lead market. Despite a spectacular surge in domestic vehicle sales (+32% y/y, to 18m units) China was actually a net exporter of refined lead over the year (albeit only 5Kt), compared with being a net importer of 130kt in 2009. Indeed, lead was the only base metal in refined form that China was a net exporter of in 2010. Ultimately we expect the supply side in China to be far more constrained than in 2010 and, with fewer domestic stocks to lean on, drive a move to increased levels of metal imports. In turn, the price support from a close to balanced global market will be more perceptible in market indicators (such as LME stocks) than in 2010, and a relatively high degree of susceptibility to supply disruption could easily nudge the balance into deficit. Lead should certainly move up the base metals performance hierarchy, and this will become increasingly evident on a more supportive Chinese trade balance.
The unfolding of the situation in Egypt has injected a burst of volatility and uncertainty into oil markets. In our view, there is a little significant threat to Egyptian oil output or transit routes and, indeed, would view the consequences of such events as easily containable even were they to occur. In other words, despite the increase in violence on the ground, it is important to note that while losing those transit routes would affect the costs and the time taken of some oil trade, it would not affect the underlying supply and demand balance, as we highlighted in Energy Flash: Suez Canal and Oil. We also view the likelihood of a spillover into key oil producers as very limited. However, the situation introduces risks and uncertainties that are likely to be highly significant in terms of the broader political evolution of the region, and we see the response of Brent prices in moving past beyond $100/bbl so far as being fully commensurate with the move into a more geopolitically environment. We see events as being more unambiguously positive for the back of the curve rather than prompt prices. Indeed, 2011 is already turning out to be a year in which it would be risky to get heavily involved in the oil market without maintaining a fairly strong focus on the key geopolitical developments, rendered more acute in a world of phenomenal demand strength, reduced inventory overhang and less spare capacity.
U.S. Natural Gas
Natural gas prices remain rangebound, supported on the low end by colder-than-normal temperatures and bound on the high side by growing production. Regarding temperatures, the coldest point in the winter has passed, although inventories have been drawn near to normal levels. However, production trends continue to buffer this incremental demand, with the latest EIA-914 report showing a 0.7 Bcf/d increase in volumes to 66.5 Bcf/d, a new peak for lower-48 gross withdrawals.
Coal prices rose sharply last week, as a pending strike in Colombia supported sentiment. The certainty of a workforce strike at Cerrejon’s north-Colombian mine remained unclear, with a company source saying participants were still waiting for a final conclusion on the matter. Moreover, with the Australian flood situation not showing any signs of getting better and tropical cyclones still keeping exports restrained, the supply outlook looks far from positive. With Russian coal getting diverted to meet Asian demand and European stock levels thinning, API2 prices have, as a result, received a significant boost. We remain positive on the outlook for coal prices, as the pace of infrastructure investment fails to keep up with demand growth.
While the temporary suspension of the spot market continues, EUAs have stayed in the top of the current 14-15 €/t range (Dec 11 contract). With January being a record month of CER issuance (50.2 Mt) reflecting a large clearing out of a backlog of requests, prices should firm and consolidate. We expect another couple of months of muted trading before the market starts to see a more sustained bull run for EUAs, with forecast for prices above 16.5 €/t, from Q2 11.
The upward momentum in prices has been strong, with copper and tin setting new records and the rest of the complex trading at multi-year highs. In our view, industrial metals are well positioned for further price strength given their close tie to global economic growth, which is forecast to be above trend this year. To some extent, this is already playing out, and we would caution that the scale and nature of the price gains makes the market vulnerable to a short-term correction. Although we forecast another year of higher prices for the base metals, we expect absolute price performance to be diverse, given the variety of individual metal fundamentals. Copper and tin fundamentals still appear the tightest of all the metals due to the cumulative effect of successive years of poor raw material supply growth matched against booming metal demand. To plug the gap, the call on inventories will be huge, reducing the stocks-to-consumption ratio to levels never seen before. Nickel demand, particularly in Asia, appears to be heating up earlier than the other metals, leading to an earlier-than-usual draw in inventories. This, together with supply risks from high-pressure acid leach operations and higher coal prices, leads us to expect another move up in prices. Lead has taken a bashing from big increases in inventory, and the peak of the winter demand season is now behind us. However, the outlook later in the year is more constructive. Zinc is the metal with the least supportive fundamentals, in our view, and we expect prices to underperform, at least for now, as a result.
Gold and silver prices have stabilised after dipping towards two-month lows, but good physical gold demand has materialised upon price dips, in China in particular, where regional bar premiums have risen to fresh highs. However, gold’s upside has been capped by the easing investor interest, with January ETP flows the second weakest on record and gross speculative shorts at 51/2 year highs. Although gold is facing short-term external market headwinds, we believe longer-term investment demand remains intact, given low interest rates, concerns about currency debasement, medium-term inflation, as well as rising geopolitical tensions. Silver prices continue to take gold’s cue but are likely to remain volatile given their weak fundamentals. Actual and potential supply disruptions, coupled with healthy investment demand, have boosted PGM prices. In addition to delays to the new coal-fired power station in South Africa, recent production reports have reported weaker output y/y, while auto demand has continued to recover globally, supporting PGM demand.
We are still bullish on grain price prospects, even at current high levels, as market fundamentals remain supportive due to supply downgrades induced by adverse weather conditions, positive demand and inventories declining as the Northern Hemisphere spring planting season starts and the battle for acreage heats up. Sugar prices have been volatile this week, rising to fresh three decade highs and breaching 36 cents/lb on concerns about the effect of cyclone Yasi on the sugarcane crop in Queensland. Prices later in this week have come off sharply with the damage expected to be less than initially feared. With the importance of Australia to global sugar trade, supply concerns have been piqued, especially in an environment of low inventories and India’s lack of exports. The relentless move up in ICE cotton prices continues, with prices hitting an all-time high of 181.2 cents/lb. Current competitive prices are likely to spur higher cotton acreage, but the current market balance is likely to remain tight over coming months, with 2010-11 marking a fifth successive global deficit and the global stocks-to-use ratio at its lowest level in over a decade and a half.
Dean Maki, Barclays Capital, Global Economics Weekly: Asia Rising.
We estimate that Q4 10 was the slowest quarter of growth for the global economy since the recession began, with the slowdown centered on Asia. Our view has been that this softening in growth would prove temporary and that a re-acceleration in Q1 11 would be driven in part by a turn in the global electronics cycle. Incoming data confirm that this is now taking place. After contracting during the summer and fall, industrial production rose 3.1% in Japan and 2.8% in Korea in December; both were the largest increases in nearly a year. In Japan, recent data have been so upbeat that this week we dramatically raised our forecast for growth in Q1 11 (3.6% saar from 1.6%) and Q2 11 (2.7% from 0.8%). For calendar 2011, we now look for Japanese growth of 2.4%, up from our previous estimate of 1.6%. A key reason is exports, which rose sharply in November and December. Improving export growth is also a key driver of the acceleration in Korean output; in January, exports rose 46.0% y/y , up sharply from 22.6% in December and the fastest pace since1988. Export strength was one factor that led us last week to raise our forecast for 2011growth in Korea. This week, we also raised our 2011 growth forecast for Taiwan (5.2% from4.0%), where a stronger-than-expected Q4 10 GDP report was fueled in part by net exports. The bottom line is that output across a wide swath of Asia is reaccelerating in Q1 11, and this, combined with the recent pickup in US economic growth, is why we believe that the modest slowdown in the global economy is over.
Emerging Asia central banks continue along the tightening path
With worries about growth fading, the focus of many central banks in Asia is firmly on inflation. The recent news in many Asian economies on this score has been unsettling. InIndonesia, the CPI rose 7.0% y/y in December and January (Figure 3), above the 4-6%target, and as we expected, Bank Indonesia this week raised its policy rate 25bp, to 6.75%,in response. The Korean CPI increased 4.1% y/y in January, above expectations of 3.8%.While we are not projecting a rate hike from the Bank of Korea next week, we see thedecision as a close call and continue to look for a 25bp increase in March. We also look for a50bp increase in China by the end of March in response to inflation concerns there.
Developed market central banks remain on hold despite healthy growth
In contrast to the tightening in Emerging Asia, G4 central banks remain on hold. Despite the upward revision to the Japan forecast, overall CPI inflation was flat, core measures remained in negative territory in December, and the upcoming rebasing (see the Japan InFocus) isexpected to lower the CPI figures further, so we do not expect a sustained move intopositive territory this year. We believe this means that tightening from the Bank of Japan isoff the table, and we continue to look for unchanged policy rates over the next two years. The likelihood of the other G4 central banks raising rates soon is closely related to their divergent inflation rates (Figure 4). In the US, despite a pickup in GDP growth, generally better job gains and a falling unemployment rate in recent months, Chairman Bernanke thisweek made clear that he sees no reason for the Fed even to stop its asset purchases. In fact,he said that with unemployment “stubbornly above” and inflation “persistently below” theFed’s mandate, the Federal Reserve “would typically ease monetary policy,” and the asset purchases are the way Fed can ease when the funds rate is close to zero. Given that undermost forecasts (including ours and the Fed’s), unemployment will still be above and inflation below the Fed’s interpretation of its mandate in June, it is not obvious the Fed will want to stop its asset purchases when the current program is completed.While his remarks were viewed as less hawkish than market participants expected, ECB President Trichet’s press conference provided a stark contrast to Chairman Bernanke’s. WhileTrichet gave no signal to suggest that rate increases should be expected soon, he said that theanchoring of inflation expectations was “of the essence” and that current expectations were anchored but that “we have to be alert.” We interpret his comments as signalling that a ratehike would be likely if inflation expectations were to get out of line with the ECB’s price stability definition. With the “flash” CPI at 2.4% in January, above the ECB’s definition of price stability, the ECB is much more likely to react to rising expectations than is the Fed. The UK MPC is in aneven more difficult position, with CPI inflation at 3.7% y/y in December and, in our view, set tomove above 4% in Q1 11. Indeed, we do not rule out a rate hike over the next few months if the Inflation Report released later this month is notably hawkish. However, given high unemployment and the recent weak GDP report, our baseline view remains that the MPC will remain on hold until Q4 11.
Michael Gapen, Barclays Capital , Global Economics Weekly U.S. Consumers Back in the Driver’s Seat.
A slew of incoming data suggests the recovery has broadened, and strength in auto sales shows improved consumer confidence.
Wealth effects should have a neutral to small positive contribution on consumption as the lagged effects of rises in financial wealth are partially offset by lower home prices.
We expect the saving rate to stay near current levels in 2011 as consumption grows in line with personal income; households should continue to drive the recovery.
Incoming data continue to indicate that US economic expansion has broadened. The surge in the ISM manufacturing index in January points toward a renewed acceleration in manufacturing activity, while the nonmanufacturing index, which had been lagging for much of the recovery,
rose to levels last observed in 2005. Personal incomes grew at 4.4% 3m/3m (saar) in Q4 10 and domestic vehicle sales showed persistent strength, a sign that consumers are increasingly willing to take on larger discretionary purchases. Furthermore, the drop in the unemployment rate from 9.4% to 9.0% is consistent with the growth in household employment after stripping out the impact of the population control effects from the household survey. Controlling for this effect, which is implemented annually, household employment grew 589k instead of 117k as published. The increase in headline payrolls of 36k appears to have been affected by recent weather, as hiring in construction and other service sectors was much weaker than recent trends. We expect payrolls to rebound once these weather-related factors subside. Although the headline growth rate in the Q4 10 GDP report was slightly below expectations ,the composition was more favorable than expected. The 4.4% rise in real consumer spendingwas the largest in nearly five years and a clear sign that consumers are now the driving force behind the expansion, in contrast to the early stages of the recovery, when the inventory cycle fuelled the rebound. The growth of consumer spending outpaced disposable personalincome, resulting in a decline in the saving rate from 5.9% in Q3 10 to 5.3% in Q4 10 (Figure1). Although we do not expect spending growth to stay at the elevated rate seen in Q4, we do forecast real consumption growth of 3.0-3.5% in coming quarters, generally in line withour outlook for disposable income. One factor contributing to this view is that we do not expect saving rates to return to the levels of the 1960s and 70s.
There are three main reasons we do not see saving rates returning to the levels of past decades. First, even after the successive shocks to housing and asset markets, the ratio of net wealth to disposable income stands at 4.8, which is at or above the level observedbetween 1960 and 1990. This is particularly true relative to the 1970s, when the ratio of netwealth to disposable income fluctuated between 3.0 and 3.5 and the saving rate averaged 9.6%. Second, interest rates are much lower now and, third, an older population tilts the consumption-saving profile in favor of consumption over saving.
Our consumption model assumes that consumption adjusts in the long run to changes in household income and wealth and in the short run to changes in cyclical factors, such as labor market conditions, monetary policy, and credit conditions. The model also incorporates the lagbetween when wealth changes occur and when they fully affect consumption. Our model suggests that the fall in the ratio of net financial wealth to disposable income in recent years (Figure 2) increased the saving rate by about 4%.Regarding housing wealth, the model suggests that the decline in net housing wealth to disposable income increased the saving rate by about 3%. Transfers, including unemployment benefits, that tend to be spent quickly, offset this rise. The negative net wealth effect from lower financial and household wealth, however, has gradually subsided during the past year. Our equilibrium estimate of the saving rate at end-2010 was about 5.3% (4qma),just below the observed saving rate (Figure 4).
Looking ahead, we expect disposable income to be supported by employment growth and the recently enacted fiscal package. We expect wealth effects to make a neutral to small positive contribution to consumption as the lagged effects of increases in financial wealth are only partially offset by those from modestly lower home prices. Taken together, these factors suggest that the saving rate is likely to stay near current levels in the coming year and thathouseholds will continue to drive the economic recovery. This is not to suggest that the savingrate cannot rise; there have been some large deviations between observed saving rates and our long-run estimate in recent years and revisions to income and spending data can be substantial. However, we are confident that the evidence suggests that saving rates will not return to the elevated levels that would drag down consumption growth.
Peter Bisson, Elizabeth Stephenson, and S. Patrick Viguerie, Mckinsey Quarterly
Emerging markets are riding a virtuous growth cycle, propelled by larger and younger working populations. In the wealthy nations of the developed world, by contrast, low birthrates and graying workforces will make it enormously difficult to maintain what economist Adam Smith called “the natural progress of opulence.”
These countries’ best hope for keeping the wealth creation engine stoked is improved productivity—producing more with fewer workers. Paradoxically, doing that well across an economy is also the only way to generate lasting employment gains. In the United States, for example, every point of productivity-led GDP growth has historically generated an incremental 750,000 follow-on jobs.
The great tension here arises at the level of politics. Over time, the world’s rebalancing demands greater consumption and lower savings among the large developing countries, even as developed ones, the United States foremost among them, save, invest, and export more. Fostering policies that raise productivity, and avoiding or altering polices that impede it, will help ensure a smooth transition. Getting this wrong—failing to generate at least modest and broad-based continued income and employment gains in developed countries—raises the odds of a political backlash that will hurt the citizens of wealthy nations and of those moving up the wealth curve alike.
We call the productivity challenge an imperative because the need is so compelling. But to eke out even modest GDP increases, OECD1 nations must achieve nothing short of Herculean gains in productivity. In the 1970s, the United States could rely on a growing labor force to generate roughly 80 cents of every $1 gain in GDP. During the coming decade, assuming no dramatic increase in hours worked, that ratio will roughly invert: labor force gains will contribute less than 30 cents to each additional dollar of economic growth. To maintain a GDP growth rate of 2 to 3 percent a year, productivity gains will have to make up the other 70 percent.
The challenge is even greater in Western Europe, where no growth in the workforce is expected. Here, in other words, 100 percent of GDP growth must come from productivity gains. And in Japan, the hurdle is higher still: because of a shrinking labor force, each worker will have to increase output by 160 yen to generate an additional 100 yen of growth.
To complicate things further, we are seeing a growing talent mismatch. The Western economies have built a workforce optimized for mid-20th-century national industries, yet the jobs now being created are for 21st-century global ones—we need knowledge workers, not factory workers. And there just aren’t enough of the former. Anywhere. Companies across the globe consistently cite talent as their top constraint to growth.
In the United States, for example, 85 percent of the new jobs created in the past decade required complex knowledge skills: analyzing information, problem solving, rendering judgment, and thinking creatively. And with good reason: by a number of estimates, intellectual property, brand value, process know-how, and other manifestations of brain power generated more than 70 percent of all US market value created over the past three decades.
Western economies can do many things to change the equation. Deregulation has often raised productivity in the past and can continue to do so. Changing the boundaries around the work–life balance—encouraging people to stay in the workforce longer or increasing the numbers of hours worked each week—could add a few points of absolute growth too. Improving education is a no-brainer.
Businesses can and should advocate these and other policy changes that could have a long-term impact, such as easing immigration restrictions. But in the end, the real game changers will be breakthrough innovations created by companies: history shows that a majority of productivity growth—more than two-thirds—comes from product and process innovation.
The productivity economy will reward ‘do it smarter’ companies that build a better business model
Besides providing powerful incentives for companies to deliver their traditional products and services more efficiently, the new environment may make selling productivity—finding marketable ways to “do it smarter”—the most transformative business model of the next decade.
Besides providing powerful incentives for companies to deliver their traditional products and services more efficiently, the new environment may make selling productivity—finding marketable ways to “do it smarter”—the most transformative business model of the next decade.
Western economies can boost productivity not only through deregulation but also by adjusting the work–life balance—keeping flexible hours and staying in the workforce longer, as 95-year-old Sydney Prior of Britain has.
This push is bound to have a “no pain, no gain” dynamic. Innovation, by definition, is a disruptive process. Think about the book-publishing industry. Only two years after the release of the Kindle, Amazon.com now sells half of its books electronically for the titles it offers customers in both bound and digital formats. The Kindle is short-circuiting the entire physical supply chain, and Apple’s new iPad is sure to accelerate that process.
Something similar is shaking up the world of computing. It’s considered the poster child of productivity—and for good reason. But probe further and it’s not hard to find evidence of waste. Companies spend, on average, 5 to 10 percent of their total revenues on IT. Yet reliable estimates suggest that upward of 70 percent of server capacity goes unused—even more at midsize and small companies, since they can’t achieve scale. Advances in “cloud computing” (sharing computer resources remotely rather than storing software or data on a local server or PC) have vast potential to raise utilization rates and simultaneously help companies to increase their computing capacity, while slashing IT costs by 20 percent or more. Little wonder tech giants as divergent as Google, IBM, and India’s Wipro Technologies are investing furiously to win the battle for the cloud.
Companies that can master productivity techniques, such as robotics, and sell that expertise may capture the coming decade’s most transformative business model.
Health care is another arena where do-it-smarter businesses will thrive. On average, health care spending in OECD countries has outpaced GDP growth by nearly two percentage points a year, and even more in the United States. Still, in most countries, increased health care spending actually creates a productivity drag on the economy overall, because the sector has lagged behind in adopting productivity measures. (To take just one indicator, health care organizations spend, on average, only 20 percent of what financial-services companies do on IT.)
But multiple innovations promise to improve outcomes significantly while reducing costs. For example, some 75 percent of health care spending in many OECD countries pays for chronic-disease management. France Telecom’s Orange is partnering with health care providers to offer services that constantly monitor diabetics and cardiac patients remotely. Low-cost mobile-monitoring devices ensure better compliance with treatments and reduce the number of high-cost, life-threatening events. Germany’s T-Systems has linked up with the health insurance provider Barmer to provide mobile systems that track and monitor exercise patterns, so patients—and doctors—can monitor progress and reduce risk more effectively.
A raft of industries and services are poised to benefit from productivity improvements. Huge gains could be extracted just by applying the insights learned over the past 15 years in the most productive sectors, such as telecoms and financial services, to less productive ones, such as health care, education, and government.
The best companies will learn how to maximize returns from people who think for a living
Just as the early 20th century saw the development of management theory for improving the productivity of factory workers, the 21st century will see the evolution of myriad better techniques for managing people who think for a living.
The potential stakes are enormous. Companies that have higher concentrations of knowledge workers (above 35 percent of the workforce) create, on average, returns per employee three times higher than those of companies with fewer knowledge workers (20 percent or less of the workforce). Yet companies with more knowledge workers also show more variable returns: differences between competitors in the same industry with fewer knowledge workers.
Turning this gap into a key source of competitive advantage requires much more than reverting to the well-worn “attract, deploy, develop, and retain” talent wheel found in HR manuals everywhere. Yes, the road to success still starts with capturing more of the right talent. But to increase productivity dramatically, companies will then need to think aggressively about how to increase the pace of talent development, to deploy the best talent against the highest-value opportunities, and to improve the way such workers engage with their peers. Our analysis suggests that at many large multinationals, nearly half of all interactions between knowledge workers do not create the intended value—because people have to hunt for information, do not know where to find what they need, or get caught in the maws of inefficient bureaucracies.
Companies will need to reinvent work—what, where, when, how, who, and why
Companies such as Best Buy have increasingly recognized that work is not a place where you go but rather something you do. To get the most out of its corporate workforce, the company has adopted a “results-only work environment,” which gives workers big targets but lets them meet these goals any way they see fit. This approach has improved worker productivity by as much as 35 percent in departments that have deployed it.
Transforming process flows will also unlock new kinds of productivity. Companies such as Cisco and IBM are aggressively developing approaches—from social networks to videoconferencing—that tear down silos and reinvent how far-flung employees collaborate and exchange knowledge. What’s more, these approaches work: UK grocer Tesco, for example, saved up to 45 percent of the travel budgets of key departments by substituting videoconferencing for long-haul travel. The Hong Kong apparel supplier Li & Fung now uses videoconferencing to connect clothing designers with fabric and notions suppliers around the world, dramatically speeding the design process. That’s no mean feat for a company known for its ability to turn around “fast fashion” in weeks, not months.
Although the demand for knowledge workers is sure to grow, the supply will not. Governments aren’t moving fast enough to educate workers with the skills needed to meet the productivity imperative, and businesses can’t afford to wait. That means companies must get much more innovative at sourcing talent, whether by tapping global labor markets, building part-time workforces, or making better use of older workers. Firms also will need to rethink work progressions in a world with much flatter age pyramids—young workers no longer outnumber old ones, which has been the premise for role advancement in most companies for decades. BMW has experimented with auto production lines geared for older workers. Retailers such as CVS and Home Depot are pioneering “snowbird” programs, which let retirees go to warm climates in the winter and to work in stores there, returning to their original stores in the summer.
Information streams are the infinite by-product of a knowledge economy—the best companies will turn this free good into gold
A final productivity driver will be something businesses are creating in digital bucket loads: information. Although the volume of data created is expected to increase fivefold over the next five years, best-guess estimates suggest that less than 10 percent of the information created is meaningfully organized or deployed. That number will only shrink as the rate of information production goes up.
Enter business analytics software, which increasingly allows companies to make sense of data “noise”—helping them “de-average” data to eliminate waste, more closely target customers, and identify new opportunities. In general, companies that are aggressive adopters of business analytics are proving twice as good at predicting outcomes and three times as good at predicting risk as those that aren’t.
The Swiss telecom operator Cablecom, for example, reduced customer churn nearly tenfold through the better use of customer information. Both Amazon and Google have developed predictive models that use enormous amounts of data to figure out what products customers might like, based on past searches and clicks. IBM, Microsoft, Oracle, and SAP have spent a combined $15 billion in the past several years snapping up companies that develop software for advanced data analytics. Expect a host of new offerings that help turn information into gold.
Soon, Web 3.0 technologies—which create “smart” data, or data that can be combined intelligently with other data, mostly without direct human involvement—should extend the power of information even further. We fully expect Web 3.0 to begin disrupting information networks within the decade.
In short, companies that deploy technology more successfully to get more from the higher-quality knowledge employees they attract will gain large business model advantages—and drive substantial growth and productivity gains
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