Everything we say today needs to be placed in the broader context of long-term decision-making in business. I can think of no better place to start than by reminding you of the best long-term business decisions which have been made in the last two or three decades. When Steve jobs returned to Apple as Chief Executive in 1997, Dick Rumelt, professor of business strategy at Berkeley, interviewed him. Asked what his strategy for the business was, Jobs responded ‘I’m going to wait for the next big thing’.
The next big thing turned out to be music. As the Internet spread in the late 1990s, more and more people began downloading music. Such downloads were mostly illegal. Some of you in this audience may remember the hugely but briefly popular file sharing service, Napster. Music publishers responded ineptly. Instead of coming to terms with the new technology, they tried to prohibit it. They failed, as large companies so often do, by misunderstanding where the future lies and by trying to preserve their existing, established, business models. Apple launched the iPod in 2001, under the slogan ‘a thousand songs in your pocket.’
The other big new thing was SMS messaging. Networks initially envisaged this as an adjunct to their phone service. A text would tell you that a voicemail had been left. But a little imagination revealed that this involved many unnecessary steps. Once a keyboard was added to phones, people could send messages as well as receive them. Text messaging achieved a popularity no-one had anticiapated. And that was the beginning of what we now call social media.
The next step was to put these two innovations together, and that was the origin of the smart phone. When the iPhone was launched in 2007, Steve Ballmer, then Microsoft CEO laughed and asked rhetorically ‘who is going to pay $500 for a phone?’. The answer turned out to be hundreds of millions of people.
People speculated over decades as to how the computer industry would evolve from the giant machines which IBM pioneered in the 1960s. None anticipated that today everyone in this room would have a computer in their pocket.
Good long-term decision-making is not, as many seem to think, a matter of successfully predicting the future. Steve Jobs couldn’t do it, and nor can we. I’m struck today by how much people in this room think they know about the future. I think I know that we don’t know very much. If in 30 or 50 years time we have, as we all hope, a largely carbon free environment , the history of innovation suggests that it will be the result of technologies – in generation, in storage and transmission – which none of us have yet imagined. The future is radically uncertain. It is not just that we don’t know what will happen; we don’t even know the kind of things that will happen.
How do we cope with such radical uncertainty? Not by listening to the gurus who demonstrate by their certainty that they know nothing. We need to make decisions that are robust and resilient enough to be sustainable, and enable us to prosper, in these futures we cannot imagine. Our organisations need to be nimble enough to cope with changes we cannot easily anticipate. And we need to build ourselves options which will remain valuable in many different scenarios. We need to be ready for the next big thing.
Let me provide some illustrations of what I mean. My favourite example of a successful and sustainable long-term investment is the construction of the embankments along the River Thames in London – a visionary project undertaken in reaction the the “Great Stink” of 1858. I sometimes ask myself what would happen if we were to apppraise that project in the ways that are demanded today by cost benefit analyses and impact assessments. We would be calculating how much faster hansom cabs would be able to travel along Fleet Street if congestion were relieved. We would be adding estimates of benefits to public health based on fundamental misconceptions about the causes of infectious diseases. Not knowing that the internal combustion engine and the underground railway were on the way, or that disease was caused by germs not miasma, our assessments of benefits would have been ludicrously wrong.
And yet the decision was brilliant. Without it London could not have emerged as a modern city. The basic intuitions – the narrative – that told the decision makers of the time that a great 20th-century city could not have an open sewer flowing through the middle of it, were magnificently right. And the advantages of a central traffic artery above the sewers which proved robust to new technologies and gave future generations options which were of immense value.
We hold this meeting today in the headquarters of the European Union. Some of you may recall the origins of that project. The European cooperation began with the European Coal and Steel Community. The founding fathers of modern Europe, John Monet and Robert Schumann, formed the view that the best way to stop Europeans fighting each other, as they had done for centuries, was to bind their economies in a manner that would obstruct the militarists of the future. So their initial plan was to put the coal and steel industries of the founders under a common authority. That plan was essentially a flop. Emphasising energy, they also established Euratom – a success, but a minor one; Europe’s founders had a wildly exaggerated idea of the role that nuclear energy would play in postwar economic development. But the stroke of genius of the founding fathers, which was achieved later, was the creation of the free trade area which eventually became a customs union. And in the 1980s that customs union became the single market, aiming to eliminate non-tariff as well as tariff barriers. And the single market led to the European Union which exists today, an achievement of which some of us even in Britain still feel proud.
My third example of good long-term decision making – maintaining a broad narrative while recognising that specific detail is unknowable; acquiring options which may prove valuable in an uncertain future; building organisations robust to unanticipated developments – comes from the world chemical industry. Between the first and second world wars, world chemical markets were divided territorially between three large companies. DuPont owned the Americas, Imperial Chemical Industries spanned the British Empire and Commonwealth, Germany’s IG Farben were dominant in much of continental Europe. These companies constantly reinvented themselves. From beginnings in dyestuffs and explosives, they moved into petrochemicals, fertilisers, plastics and artificial fibres. IG Farben, which had played a dishonourable role in the Nazi era, was broken up by the Allies after the Second World War, but DuPont and ICI continued to stride the world.
The development of antibiotics had contributed to the Allied war effort and the Board of ICI presciently conjectured that the future of chemistry in business might lie in pharmaceuticals. The company bought a long term option. It established a pharmaceutical division, and recruited a team of capable young scientists from universities. The division lost money for 20 years until 1960s a research team under James Black discovered beta-blockers, the first effective antihypertensive drugs. That discovery was the genesis of the business which would by the late 80s become the principal profit generator for the firm. And ICI’s research capabilities provided the foundation of the successfull British pharmaceutical industry.
My purpose in elaborating these three examples is to emphasise how little we really know about the future. The good decisions I have described were made, not by people with crystal balls, but by people who had placed themselves and their organisations to take advantage of ‘the next big thing’.
I hate to challenge the mood of harmony which has prevailed in these proceedings up to now. But before lunch Vice President Valdis Dombrovskis told us that the answer to the problem of sustainable finance has been found, and that answer was capital markets. I could not disagree more fundamentally. We are right to worry about short-term decision-making, and capital markets are more part of the problem than the solution.
Every one in this room is apprised of the long-term horizons appropriate to sound business, political and environmental decisions. And most investors are saving for the long term – their retirement, their children. Short termism is the product of the intervention of intermediaries. Evolution of the financial system over the last 40 years has been characterised by the steady growth of the process of intermediation, a process which has taken finance further and further away from meeting the real needs of the underlying users and suppliers of finance. Market-based capital allocation and long-term decision-making do not fit easily together.
I described the development of ICI’s pharmaceutical division. A similar company today would not be able to lose money for 20 years in a new business area. If the board failed to stop the drain of cash, activist investors would intervene. No asset manager judged on a three-year time horizon – and three years is a long time in asset management – is interested in the remote possibility of payoffs in 20 years time.
That ICI of old never bothered to talk to investors. When it made the long term decisions, it didn’t feel threatened by activists, and when it was threatened by activists in 1990 the board’s response led to the disintegration of the company. The fate of DuPont in the United States has not been very different. Today the largest chemical company in the world is BASF which, although it would not relish the title, is the successor to IG Farben. The notion that Europe’s economic problems are in significant part attributable to the absence of an Anglo-American model of the financial system is one which requires rather more challenge than is currently receiving in Brussels. I hope that one of the few upsides of Brexit is the opportunity it gives the remaining 27 members to make that challenge more effectively.
ICI could do what it did because it was effectively independent of capital markets. Capital markets were almost irrelevant to Steve Jobs. Apart from pieces of elaborate financial engineering which I will not detail, Apple’s engagement with capital markets has consisted the hundred million dollars which it raised at its IPO. When when Apple was revolutionising the information technology business in the way I have described, capital markets had no understanding of what was going on. In 2004, you have picked up the corporation’s shares for two dollars each, and I shall not taunt you by telling you how much that investment would be worth today. If you look at the yoyo performance of Apple stock in the past 20 years was almost unrelated to the underlying strengths and weaknesses of the business
The capital markets with which we are familiar today came into being in the 19th century to finance railways and railroads. They created long-term infrastructure which we still use. In a manner which is all too familiar, most investors in these stocks and bonds did not do well, although the promoters generally did. In the 20th century, these equity and corporate bond markets adapted well to the needs of oil companies andthe manufacturin corporations which dominated business in the 20th century.
Such organisations are dominant no longer. By market capitalisation, the largest companies in the world today are companies like Apple, Amazon, Microsoft and Google, which are not dependent on capital markets and never will be. The relationship of investment institutions and business will need to be very different in the 20th century from that with which we are accustomed.
I should like to end by adding a footnote to one of the stories I have told. Some years before he died in 2010, I went to talk to the Nobel prizewinner James Black, the man who discovered beta-blockers at ICI. I asked why he had left ICI, and then joined another British pharmaceutical company, SmithKline, where he discovered Tagamet, the first pharmacological treatment for stomach ulcers. That blockbuster drug made SmithKline a major player in the pharmaceutical industry, and an imitative product called Zantac established Glaxo as an even more successful global leader in drug research and sales.
Black said the rationale of his move was simple. ICI, he told me, wanted him to go on roadshows promoting beta blockers; he wanted to be in a laboratory finding new compounds. He went on to say “I used to tell my colleagues that if they wanted to make a lot of money, there were easier ways to do it than pharmaceutical research”. He then shook his head and said ‘how wrong could I have been!?’. I called it, he said, the principle of obliquity. That conversation gave me the title for a book, Obliquity, I published a few years ago. Complex goals are often better achieved indirectly.
Black probably created more shareholder value than anyone else in the history of British business. But that was not his objective. He wanted to create great products that benefited consumers, and he did. That is the real purpose of business, and if we remember it well we will achieve the sustainable prosperity we all seek.
Picture: Lucas Spanos