CHAPTER 4

Principle Two: Vertical to Horizontal

AT A GLANCE

WE ARE TAUGHT TO look nearby—to our customers, competition, and suppliers—for sources of unique competitive advantage. Yet in the world of overfished oceans, risks and opportunities are hiding far away from the home grounds—among the suppliers of the suppliers of the suppliers, and customers of customers of customers. Expand your horizons.

We started this journey with a broad, bird’s-eye look at our global economy—the linear throwaway economy, to be precise. Now it’s time to take a much closer look—at each individual strand, each individual industry that plays a role within the complex weave that is our market.

Take your industry, for example. The global value chain of your industry can be drawn out as a line, consisting of many stages and companies—upstream through all the suppliers, reaching to your company, and downstream, touching your customers, consumers, and end-of-life enterprises. Growing up in business, we are taught to look downstream from our business, paying attention to our customers and consumers (the customer is king, right?). We are also naturally tracking the flow upstream leading to our company—suppliers can make or break our profit margin. But more than anything, we are asked to pay our utmost attention to the vertical cut in this chain: our competitors.

Surely, mainstream strategic thought invites us to pay attention to the whole of five forces in business (competitors, consumers, suppliers, new entrants, and substitutes).¹ But in reality, most managers dig into the competition, searching for a sweet spot for their businesses in that vertical cut of a global value chain.

And that might just be the thing that kills you—along with the entire competitive space.

Let me illustrate. If your company is Apple, when it comes to producing computers, in addition to customer needs, you are trained to look at your direct competitors, such as Sony, Dell, and many others. You are also invited to explore your strategic options by looking at substitute products and the most powerful suppliers. It is, however, very unlikely that as a part of your normal strategic thinking you are conditioned to look routinely into what is happening far and away in the global value chain—say, explore what is going on with tomato farms in Vietnam (I am, of course, just using this as an illustration). Yet it could well be one spot where future risk—and opportunity—hides.

In the world of rapidly declining resources and subsequent growing demands, the vertical orientation is a handicap to leave behind—fast. Surely, you might have the best price or the most unique, most unexpected combination of product features, but the failure to notice changes far away on the left or the right of the value chain might cause elimination of the entire product line, company, and even industry. Companies that have mastered the Overfished Ocean Strategy made the move from a vertical to a horizontal orientation, going beyond the safe boundaries of their companies to the risks—and opportunities—hiding within the entire system. And that is not an easy transition.

The coffee industry discovered the power of horizontal thinking the hard way. Until the 1990s, much of the coffee supply was regulated, with prices and quotas closely guarded by a series of International Coffee Agreements. Then, with changes in the political winds, most coffee-producing countries liberalized their coffee industries, letting the market forces run wild. On the other side of the supply chain, coffee-consuming countries were changing as well. Starbucks, which was founded in 1971, grew well beyond its humble roots, opening an average of two new stores a day between 1987 and 2007.² On the heels of this giant, Dunkin’ Donuts and McDonald’s both worked on their offerings, along with a range of new chains with coffee at the core of their menus. Huge food producers such as Kraft Foods reigned supreme in grocery stores and other retail environments. With their scale and thus their purchasing power, the humongous chains, being the good competitors that they are, relentlessly worked on driving the price of coffee down, engaging in nonstop price-cutting wars. And boy, did they succeed!

Apart from two short-lived price spikes in 1995 and 1997, brought about by the loss of the Brazilian crop to frost, coffee prices have plummeted to the lowest levels recorded in the past 30 years. Adjusted for inflation, the price points in this period have been the lowest in the past 100 years—dropping in 2001 to their historical minimum of just 30 cents per pound for the robusta variety and 60 cents per pound for arabica.³ For coffee roasters and retailers, what a victory to celebrate!

Not so fast. Much of the coffee is grown by small farms selling their crop through cooperatives—a highly distributed supply system. It takes about five years for a coffee tree to reach the productive stage, which lasts about four additional years. Moreover, there is an inverse relationship between the quality of a coffee bean and the quantity of coffee that the plant can produce. Plants that produce high-quality coffee usually do not produce many beans. Eduardo Ambrocio, who serves the Guatemalan National Coffee Association as a master cupper and quality control expert, puts it this way: “Coffee is a lot like grapes and many other fruits. We have varieties that probably give you a good yield at times of production, but low quality. As a farmer, you are going to focus on either high quantity or high quality.”⁴

As the prices of coffee dropped, farmers around the world growing high-quality beans started leaving their vocation by the thousands, abandoning the trees in search of a better living for their families and communities. Because they were independent farmers, their flight was not immediately noticed by their partners upstream until it became a struggle to consistently secure good-quality beans in sufficient quantities. And with a long tree-growing cycle, filling in the gap was not so easy. Suddenly, the entire coffee-roasting industry was threatened.

PART OF WHAT YOU need to do in the supply chain is to help your company anticipate events and understand the environment you operate in—physical, political, economic—around the globe.

FRANCES TOWNSEND
CNN CONTRIBUTOR AND
FORMER HOMELAND SECURITY ADVISER

Learning from the coffee crisis, different companies took different paths toward securing their supply chains. In the premium roast category, for the longest time businesses have focused most of their efforts on differentiating themselves from the competition through a variety of unique roasts or strong brand identity. Clearly, the security of the supply chain was not that high on the list of competitive advantages. Now, this all had to change.

For Green Mountain Coffee Roasters, a publicly traded company founded in Waterbury, Vermont, during the height of coffee prices in 1981, the security of the supply chain became a source of real differentiation. For years, the company competed in the specialty coffee segment, crafting unique roasts from the highest-quality coffee beans. Understanding that there was no other option but to address this exploding risk, the company went through a reengineering of its supply-chain relationships and made the new relationships a core part of its brand identity. When I first encountered the company in 2003, it could boast of being the largest double-certified organic and fair-trade coffee roaster in the world—known for paying its suppliers a price set far above the market average set by a third party. The difference was used by the local coffee growers to secure a normal livelihood, including education and health opportunities, while the company’s badges of honor—certification—ensured a cozy share of the growing organic foods market and allowed it to distinguish itself from many other producers on the shelves of the Whole Foods Market and the like.

Today, the company has developed a comprehensive supply-chain resilience strategy. Here is how Green Mountain Coffee Roasters defines it: “Resilience, at its most basic level, refers to an ability to adapt quickly to, or recover from, changes. To GMCR, building a resilient supply chain means helping the producers and manufacturers in our supply chain, as well as their employees and wider communities, to adapt to the many challenges they face and to prosper over the short term and the long term.”⁵ And the strategy seemed to rub off on the company’s financial performance. In 2009, the company was ranked 11th on the Fortune 100 Fastest Growing Companies list. For 2012, the latest year for which I have data, Green Mountain reported a 40 percent year-over-year growth in net sales and 82 percent growth in net income—that is resilience, I’d say.⁶

Using horizontal thinking to drive new revenues is not the only way to turn supply-chain security into new value. For Portland Roasting Company, redesign of its value-chain relationships became a significant source of cost savings. Facing the same supply-security challenge as the rest of the industry, the company toyed with the idea of third-party certification—including fair trade, organic, Rainforest Alliance, Bird Friendly, and many others—and decided that the hefty cost of the certification process did not make sense for a company that sold heavily through HORECA (hotels, restaurants, and cafés) channels and thus had relatively little direct communication with the end consumer. Plus, if the company were to pursue retail distribution, it would be rather hard to compete with the big names playing in the certification field. Walmart launched six eco-friendly and ethical coffees under the Sam’s Choice brand. Whole Foods sold its 365 brand of coffee, promoted for its fair-trade practices and direct relationships with more than 40 growers, while Kraft General Foods advertised that 30 percent of all the coffee beans that went into Yuban coffee were officially certified by the Rainforest Alliance. The branding game seemed to have too many players. So instead, Portland Roasting Company decided to pass on that cash directly to the suppliers and created its own supply-chain security program, Farm Friendly Direct, which pays more than fair-trade prices to farmers and cooperatives. Founded in 2001 at the La Hilda Estate in Costa Rica, the program evolved by 2010 to include direct trade arrangements with farmers in Tanzania, El Salvador, Costa Rica, Indonesia, India, Papua New Guinea, Guatemala, and Ethiopia. So why such generosity?

Going directly to the coffee farmers allows for elimination of costly brokers and other supply-chain steps, providing a financial cushion—an opportunity for investment. Because it is a specialty coffee company, quality is at the center of Portland Roasting Company’s competitive advantage. Much of the final quality of the product depends on the conditions of harvest, milling, and storage. Coffee may leave the processing mill at the ideal 12 percent moisture content, but if it isn’t handled right, quality plummets.⁷ Humidity is a critical variable: if coffee absorbs too much moisture, especially from exposure to humid environments when stored for long periods of time, its flavor may take on a moldy overtone. Working directly with the farmers allowed the company to have increased quality control at a decreased cost—and avoid the risk of poor quality stemming from long journeys through brokers’ hands. For Portland Roasting Company, that simply made sense.

The pioneering companies of the coffee industry have found a way to transform resource scarcity into a real competitive edge. But they also were very lucky: the coffee crisis of the 1990s served as an excellent catalyst, pushing the entire industry into innovation mode. Most of our industries, however, are not so lucky, and working with suppliers way downstream or customers upstream in the value chain is not an easy task.

WE ALL HAVE PROBABLY spent too much time thinking about “smart individuals” That’s one of the problems with schools They are very individualistic, very much about “the smart kids and the dumb kids.” That’s not the kind of smartness we need.

The smartness we need is collective We need cities that work differently. We need industrial sectors that work differently We need value chains and supply chains that are managed from the beginning until the end to purely produce social, ecological, and economic well-being. That is the concept of intelligence we need, and it will never be achieved by a handful of smart individuals.

It’s not about “the smartest guys in the room.” It’s about what we can do collectively. So the intelligence that matters is collective intelligence, and that’s the concept of “smart” that I think will really tell the tale.

PETER SENGE
SCIENTIST, AUTHOR, AND DIRECTOR OF THE
CENTER FOR ORGANIZATIONAL LEARNING AT
THE MIT SLOAN SCHOOL OF MANAGEMENT

Innovation at the Scale of the Whole: The Curious Case of Fairmount Minerals

“Not since the days of the Great Depression has there been such a severe decline of public trust in business and in our economic system—nor has there been a better opportunity to build a new era of business-led excellence and leadership in our industry and beyond.” With her strong words and animated gestures, Jenniffer Deckard looked every inch the CFO of a major mining company—the role she had held for many years. But the audience she was addressing was anything but straightforward. The year was 2005, and for the first time ever, Fair-mount, then a $300 million company and the third-largest producer of industrial sand in the United States, decided to bring together customers, suppliers, employees, NGOs (nongovernmental organizations), local community leaders, and many other stakeholders to collaboratively chart out the new survival strategy.

In the face of increasing resource scarcity and growing pressures from legislators, communities, and the media, mining companies faced greater challenges in winning bids for new mines—obtaining licenses to operate from the local community. When a few hundred participants at the strategic summit came face-to-face, few of them were sure that such an unconventional way to approach strategy had any merit at all. But for the company, this seemed to be the most efficient and productive way to address this big chunk of its value chain at once—and discover new value potential along the way.

And productive it was! The multistakeholder summit resulted in a number of innovation initiatives. Among them was the idea to engage 850 additional stakeholders—customers, neighboring farmers, suppliers, and more—in finding new solutions for growing challenges. New minds working on old problems brought about unusual results. One of them was an accidental line-to-circle discovery. Chuck Fowler, then CEO and now chairman of Fairmount Minerals, sat down with me for a video interview to share one of many innovation stories stemming from the 2005 launch: “We use a Caterpillar in-loader in our quarries to get the sand through the process. When we finish with processing, we send that sand to Caterpillar, and they produce a core, which makes up the inside dimensions of the castings that are needed to make the engine blocks for a tractor. Once the castings are produced, the sand comes back as ‘spent’ sand in the foundry.” Chuck, whom I’ve had the pleasure of working with for many years, picked up two differently colored dishes of sand, examples of sand that is beautifully white at the beginning of the process and nearly dark when it’s spent. “We’ve got an excellent process where we take this spent sand, and it goes back to the farmers to spread on the fields, producing higher yields of corn, and that corn gets sold to a company that makes ethanol and biodiesel. We use the biodiesel at our plants for Caterpillar’s in-loaders.” Without deep engagement of a wide range of stakeholders along the entire horizon of the Fairmount Minerals value chain—upstream and downstream—the idea of reselling the spent sand and closing the loop would never have come about. So how did it happen, exactly?

“During the summit, an engineer in one group shared how spent sand, when placed on farmland, has been shown to help grow higher yields of biomass. Another person declared that the company’s sand-mining facilities are located in rural locations near many farms. Between the two observations, a light bulb goes off. How might we create a new business for spent sand? Why not create a new partnership with farmers—a partnership where sand-assisted biomass growth becomes the basis for lower-cost, green biofuels to power the heavy truck fleet,” reports 2012 research led by David Cooperrider of Case Western Reserve University and Michelle McQuaid of the University of Melbourne.⁸

The company now uses the multistakeholder whole-system approach when bidding for new mines. In 2006, Fairmount set its sights on a potential mine in Wisconsin and engaged stakeholders in the community in a discussion about coplanning mine operations—well before making the bid. When the town of Tainter selected it over a larger competitor seen as less agile, whole system, and sustainable, the local newspaper published a telling story titled “The Tale of Two Sand Companies.” Going way beyond mere compliance in mining operations made all the difference in the company’s ability to get preferential access to new strategic assets.

The financial side of the story speaks even louder. Between 2005 and 2007, Fairmount Minerals’ revenues from the new “resource intelligent” products almost doubled, while earnings from growth and operational efficiencies took a colossal leap of more than 40 percent per year.⁹

Jenniffer Deckard, who championed the vertical-to-horizontal transition in the company with great support from Chuck Fowler, then Fairmount Minerals’ president and CEO, and Bill Conway, the company’s founder and chairman, speaks to the benefit of a company’s widening its horizons this way: “Today’s customers, supply-chain partners, community leaders, and employees want to be engaged in a radically new way. Now, I realize that it is not a pipe dream to manage important targets as a whole system—in fact, it’s fast. I call it my management macro-moment.”¹⁰ In May 2013, Jenniffer succeeded Chuck as company president and CEO.

While some companies find the transition from vertical to horizontal innovation a bit daunting, others seem to be born right into it. Indeed, most of us find it hard to move from function to function within the same company (remember the usual wars between sales and production, or product developers and the finance department?). Horizontal thinking demands that we move far beyond the functional or organizational divide within a company and look for value hidden between the companies. A few start-ups are finding success by building on outstanding experiments in the very competence that our businesses and business schools find so foreign and cumbersome. Meet one of them.

Sourcemap: Crowdsourcing on Steroids

“People have a right to know where products come from, what they’re made of, and how they impact people and the environment. Source-map is the first crowdsourced directory of supply chains and environmental footprints. Join a vibrant community of individuals, businesses, and NGOs using Sourcemap to share information about how things are made.” This is the first thing that Sourcemap’s website says about the company.¹¹

As I type these words, my auto-correct is highlighting the word crowdsourced with bright red squiggles, suggesting that this word is not yet part of everyone’s vocabulary, so I’d better give a short definition. The practice of crowdsourcing (which was coined in 2006 by editors at Wired magazine¹²) means, simply put, sourcing your ideas for products, processes, or solutions from a big crowd—often making an open call for contributions online—rather than the usual small number of employees or suppliers.

While the word is new, the practice is well tested. The Oxford English Dictionary is one of the earliest examples of crowdsourcing. An open call was made for volunteers to help identify all the words in the English language and provide real-life examples of their use for each one. Over a period of 70 years, more than six million submissions were received. Wikipedia is the modern take on this process. Source-map works about the same way.

Originally a nonprofit venture, Sourcemap grew into a for-profit enterprise against all odds. Leonardo Bonanni, company CEO, told the story in an extensive Forbes interview:

Products are incredibly complex…. In the past it was almost impossible to know where a product came from, but that has changed with the advent of the Web, new mapping and satellite techniques, crowd sourcing and social networking…. About five years ago I set out to solve the problem of finding out where things come from. It turns out the way to do it is very much like Wikipedia or YouTube, which is to allow everybody to contribute to the collective intelligence…. Sourcemap was the first crowd-sourced directory for finding out where things come from and measuring the associated cost.¹³

That is when I learned about Sourcemap—a Robin Hood kind of venture exposing the dirty deeds of industry. In 2010, it took me barely five seconds to discover, for instance, where IKEA’s Sultan Alsarp bed comes from, and what kind of environmental impact its ingredients have made along the way. In a matter of a few clicks, I learned that in the making of one bed, 10 kilos of Polish-made indoor plywood are used, with 130.28 kg of CO₂ embedded in plywood production. Galvanized steel from Russia (39.84 kg of CO₂), epoxy resin from China (0.25 kg of CO₂), hydraulics from Germany (4.02 kg of CO₂)—the list was long. None of it was approved by IKEA—and if I were representing the global giant of affordable design furniture, having all this information on display would not make me feel at ease.

Yet surprisingly, companies big and small thought differently. The 2007 nonprofit experiment of the MIT Media Lab went for-profit in April 2011. “The reason for the spinoff from MIT was companies were coming to me and asking if we could help them see what their sourcing maps looked like. The demand from industry has been huge,” Bonanni explained. Companies that decide to increase the level of transparency in communicating with clients, suppliers, government, media, and all other stakeholders create an account with Sourcemap.com. Then, they get a chance to upload and share information about their suppliers and publish it for all the world to see—and thus get greater trust in the products sold. The increasing frequency of crises of every kind—whether it is a volcanic eruption, a tsunami, or an oil spill—has also been driving businesses to find a place where they can see the full picture of the supply chain and see what can be affected and how to manage this risk.¹⁴

Figure 3. Sourcemap.com helps everyone figure out where things come from—and how to better organize their supply chain. Here is the Colgate Toothpaste supply-chain map created by user paigemeagher. Source: http://free.sourcemap.com/.

If you are Colgate, the map for toothpaste you are producing might look like the one in Figure 3 that I copied from my screen a minute ago.

Sourcemap took an unrecognized but very real need and turned it into a viable business model—selling subscriptions to its services for $1,000–$10,000 a month to a range of companies, “including EADS and Office Depot, to help them communicate with their suppliers and calculate the risk operations could be disrupted,” Bloomberg Business-week reports, awarding Sourcemap a proud place on its “America’s Most Promising Social Entrepreneurs 2012” list.¹⁵ The company secured $100,000 in revenues in the first four months of operations.

Building Your Tool Kit

The transition from vertical to horizontal is, perhaps, the most difficult, cumbersome, and demanding principle of the Overfished Ocean Strategy. For more than a century, we have been taught to treat business as a conveyor: divide labor, focus on specific functions, master your competition, build high walls protecting your company. As the linear economy gives way to the circular one, the only way to make it work well is to start by understanding—and working—across the entire line. The good news is that a number of great vertical to horizontal resources have already been developed and mastered to serve you as you build your own Overfished Ocean Strategy tool kit:

• Appreciative Inquiry is a philosophy of change at the scale of the whole—engaging partners up, down, and all around the stream to transform together with your company. Developed by David Cooperrider, Ron Fry, and Suresh Srivastva at Case Western Reserve University, this is exactly the approach that Fairmount Minerals (along with Walmart, Green Mountain Coffee Roasters, and many others) has been using in its multistakeholder strategic-change efforts. A number of unique principles ensure that the adversarial positions that stakeholders bring to the table are transformed into fuel for disruptive innovation—like the spent-sand discovery of Fairmount Minerals. The art of Appreciative Inquiry has been polished for more than 20 years, and the approach has been hailed as the most important innovation in organizational development of the last several decades. And a bonus: instead of protecting the know-how, the creators of Appreciative Inquiry decided to make it “open source,” sharing endless amounts of resources for the world to use. You can find these resources in a global online depository at Appreciative Inquiry Commons: http://appreciativeinquiry.case.edu/.

• Many companies have developed comprehensive approaches to managing the risks hidden in the supply chain, thus having data to transform such risks into opportunities. Most such approaches include a scorecard for all suppliers. In recent years, I myself have had to fill out countless forms contributing to scorecards of companies large and small in a wide range of industries, including none other than a missile company! Yet with an abundance of scorecards comes an abundance of data, which is often hard to make sense of. To aid with this challenge, the Sustainability Accounting Standards Board (SASB) developed an approach that aids companies in assessing how material (read important) particular risks are and which risk might have the most profound impact on the company’s ability to create shareholder value. By 2013, SASB created Materiality Maps for 88 industries in 10 sectors. Each map works with 43 different environmental, social, and government issues, ranking the materiality of each issue for a particular industry. A perfect way to start with SASB’s Materiality Maps is an article in the Harvard Business Review by Robert G. Eccles and George Serafeim titled “The Performance Frontier: Innovating for a Sustainable Strategy.”¹⁶

• The discipline of systems thinking has developed a diverse set of tools that allow you to understand the elements of a system and the relationships between them—your own value chain being one such system. While “feedback loops” and “system archetypes” may appear complicated at first, these terms for analyzing and depicting the whole system become incredibly handy when you are discovering the mechanism for disruptive innovation across the life cycle of your product. One classic book has made the discipline of systems thinking accessible to business: Fifth Discipline: The Art and Practice of the Learning Organization, by Peter M. Senge (New York: Currency Doubleday, 1990), has been enlightening businesspeople around the world since it was first released in 1990, but it seems more relevant today than ever before. A very easy and practical read on its own, the book was followed up by The Fifth Discipline Fieldbook: Strategies and Tools for Building a Learning Organization, by Peter M. Senge, Art Kleiner, Charlotte Roberts, Richard B. Ross, and Bryan J. Smith (New York: Crown Business, 1994), featuring many real-life stories of making systems thinking work at the scale of the whole.

• Open innovation is a close relative of the concept of crowdsourcing that we visited in this chapter, but it offers a broader view, championed by Henry William Chesbrough, author of Open Innovation: The New Imperative for Creating and Profiting from Technology (Boston: Harvard Business School Press, 2006), along with a number of other books and articles, and professor at the University of California, Berkeley. When it comes to innovation, most companies take a protective stance, guarding it with all their might (and all the might of patent law). The realities of the global transition toward the circular economy are so complex that no single company can tackle it alone. Partnership in innovation is a much more efficient way to figure it all out, and open innovation is one such model of partnership. 100%Open, a specialist open innovation agency that has achieved a tenfold return on investment with its innovation programs,¹⁷ gives the most appealing definition of the model: “innovating with partners by sharing risk and sharing reward.” The open innovation model has been tested in a variety of industries and borne real financial fruit. In 2011, Henry Chesbrough published new research for all of us working in service industries in Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era (San Francisco: Jossey-Bass, 2011).

• Stakeholder mapping is perhaps the simplest yet most essential tool for your tool kit. It is surprising how few managers I meet are able to think in terms of stakeholder needs and risks—even within their organization, let alone outside of it. Today, stakeholder mapping is offered as a part of many project management frameworks, and it can also be practiced on its own. See “Stakeholder analysis,” Wikipedia: http://en.wikipedia.org/wiki/Stakeholder_analysis.

From vertical to horizontal is the second of five essential principles that make the Overfished Ocean Strategy work—and perhaps the one that is hardest to master. The collapse of the linear throwaway economy demands a new approach to make business work: the one where you bring down the castle walls and expand your horizons beyond the competition to include the entire value chain. Value is the key term here: companies that make it happen discover immense value-creation opportunities they never thought possible—opportunities that can drive new and (here the term actually makes total sense!) sustainable growth. A very different kind of growth.