Chapter 1
Knowledge Management: Why Now?

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“The effective management of knowledge is the key management challenge of the late twentieth and early twenty-first century,” observes Peter Drucker. Why is this so? After all, knowledge has always been important for business success. Medieval merchants and sea captains closely guarded navigational lore. Inventions and patents were vital to the growth of the American industrial economy in the nineteenth century. The promise of better information management has been driving the computer industry since the 1950s.

As vital as knowledge has been all along, powerful forces are converging in our time to move it ahead of land, capital, raw materials, and technology as the key to competitive advantage. These forces drive—and are driven by—an ever-faster pace of change. In previous eras, a trade secret, an invention, or other piece of highly valuable business knowledge could yield a competitive edge that endured for many years. Today, that “knowledge edge” has a much shorter life span.

Consider, for example, typewriters and computers as writing tools. A well-made typewriter of 1940 was just as useful in 1950—or 1960 (barring wear and tear). To stay ahead in the typewriter business, typewriter firms made incremental improvements from year to year while adapting to one major change, the emergence of electric typewriters. Remington, Smith-Corona, and Royal were all big American brands throughout those years. When it comes to computers, only a technological nostalgist would use a computer and word-processing software from 1990 in 2000. And many companies that competed in the personal computer and word-processing software markets of 1990 are memories today and will be utterly forgotten by 2010.

In this chapter, we explore six of the forces that have come together to change the way knowledge contributes to business success and sharply compress the time frame within which new knowledge has business value. These forces have forged a business environment in which creating new knowledge and managing its rapid application are the keys to competitive advantage, profitability, and market capitalization.

1.   Information is being created and shared at an unprecedented rate.

Knowledge is doubling about every seven years. In technical fields, half of what students learn in their first year of college is obsolete by the time they graduate.¹

The knowledge explosion has two facets: where it is coming from, and how people access it. On the source side, for reasons too complex to explore here, we are benefiting from a fifty-year-long boom in scientific and industrial research that has been accelerated even further in the past fifteen years by ever-faster, ever-cheaper computing power. The Human Genome Project is just one example of a major research undertaking that has gone much farther, much faster, than anyone thought possible even ten years ago. On the access side, awareness of the value of managing knowledge coincides with the huge growth in the installed base of personal computers, networking, and the widespread distribution of digital media.²

2.   Making sense of information is the challenge now.

Economists long held that getting information was a key constraint in creating efficient markets. It’s no longer so. With the rapid rise of information technology and the flowering of the Internet and the Web, the bottleneck now is extracting useful content and making sense of it. In financial services, for example, a staggering amount of potentially useful information is instantly accessible to any trader or portfolio manager. Trading operations must find ways to manage and prioritize information flow to remain competitive. An hour’s lead time integrating information and making a move on the trading floor is a huge competitive advantage.

Whether your time frame is an hour, a week, a month, or a year, making sense out of information and converting that sense-making into action is the process of creating, distributing, and applying knowledge. In this book, we will provide you with a framework for managing knowledge that helps you focus on approaches that can really help your organization.

3.   Knowledge is the key value added to goods and services.

Knowledge, or the know-how to turn information into action, is becoming an increasing percentage of the value of all goods and services produced. In the United States, service industries accounted for 77 percent of employment and 75 percent of all GNP in the early 1990s. Service activities—including advertising, marketing, and logistics— contribute most of the value added in manufacturing and constitute between 65 and 75 percent of most manufacturers’ costs.³

Traditionally, companies treated these kinds of costs as overhead and tried to keep them to a minimum. Today, firms increasingly recognize the opportunity to be more competitive through an investment in service-based labor. Investing in marketing and advertising can differentiate the product in the eye of the beholder. The new computers Apple has introduced since 1998 aren’t all that different on the inside from previous Apple products. But they look different on the outside. And through Apple’s “Think Different” marketing campaign, they are strongly linked to the idea of being different. In manufacturing companies, supply-chain management—which is all about managing the flow of information and knowledge across organizational boundaries—has been instrumental in reducing costs, inventories, and cycle times for commodity businesses that benefit from every fractional improvement in efficiency.

Focusing on the customer is another knowledge-intensive activity that can yield an excellent return on investment. Back in the 1950s, IBM Chairman Thomas Watson, Jr., was a firm believer in “systems knowledge”—customer service and technical support—and attention to these functions helped IBM attain preeminence in the days of the mainframe computer.⁴ Sir Colin Marshall, formerly the chairman of British Airways, noted that the “commodity mind-set is to think that a business is merely performing a function—in our case, transporting people from point A to point B on time and at the lowest possible price.” To go beyond that, according to Sir Colin, is to “compete on the basis of providing an experience that attempts to transform air travel into a respite from the traveler’s normally frenetic life.”⁵ Under his leadership, British Airways studied what its customers wanted, integrated its learnings into its flight experience, shook off its reputation for poor service, and become a preferred airline for international travelers.

The Web is being used as a tool for gaining increased customer knowledge that can be converted into personalized experience. American Airlines upgraded its website in June 1998, enabling customers to enter personalized options for air travel, and offering attractive discounts on numerous flights. After this initiative, American Airlines had one of the most heavily trafficked airline reservation sites on the Web with $6 million worth of bookings per week and increased revenues for American Airlines Advantage partners.⁶ At the website of Land’s End, a form of instant messaging enables a live Land’s End employee to “step in” and offer assistance to online shoppers whose clicking patterns suggest that they are having trouble finding what they need.

All of these areas offer real opportunities to win competitive advantage by creating and applying knowledge. But they require structured, focused approaches to knowledge management to filter out inessentials and zero in on what will work for your products, processes, services, customers, and brand. Land’s End’s personalized Web shopping help is a targeted, logical, and smart way to extend the firm’s excellent reputation for customer service.

4.   The market values knowledge more than physical assets.

Investors are highly attuned to the shift away from physical assets to knowledge and the innovative capability it supports. One way to think of the business value of knowledge is in terms of a formula known as Tobin’s Q. Named after James Tobin, a Nobel-prize-winning economist, Tobin’s Q is the ratio of a company’s value in the securities markets to the value of its tangible assets. If the company’s market value exceeds its asset value, investors are presumably valuing an intangible asset such as knowledge. (Tobin suggests other possibilities as well, such as good will or a monopoly position.)⁷

Consider, for example, how investors value GM and Microsoft. GM’s market value in November 2000 was approximately $30 billion. Its assets in 1999 were valued at $405 billion. Microsoft’s market value in November 2000 was approximately $361 billion, against assets of $37 billion. In other words, while GM’s market value was one-thirteenth of its assets, Microsoft’s market value was ten times its assets. GM is saddled with tangible assets, including an enormous physical plant and a worldwide inventory of cars, whose replacement cost is far greater than the company’s value to investors. Microsoft, on the other hand, is rich in intangible value, generated by its software and the marketing know-how of its staff—and, no doubt, by its near-monopoly in some of its markets.

Tobin’s Q can also be read as a measure of how well the market perceives the current management team’s ability to exploit these assets. Here again, companies in knowledge-intensive industries are favored in the market. SBC Communications, a successful Baby Bell with significant infrastructure, has assets of $83 billion and a market value (in November 2000) of $194 billion—a ratio of more than two to one, reflecting investors’ sense that SBC has the know-how to succeed in the rapidly evolving telecommunications industry. Alcoa, a well-managed company in a process-intensive, commodity industry, has assets of $17 billion and a market value of $24 billion. The lower ratio reflects, in part, the limited enthusiasm investors feel about the value of a traditional industrial firm, however well-run.

5.   Globalization requires new knowledge-coordinating structures.

The globalization of business is a phenomenon that is easier to cite than describe. Many companies are globalizing in one way or another, but the process is different for each. Globalization, for example, means entering new markets. European media conglomerates are buying American media assets and competing in American markets, and vice versa. GM is gearing up to sell an economy car in China (based on an economy sedan from Opel, a German line of the Michigan-based company). Financial services firms, from Fidelity to Scudder & Zurich Kemper, are marketing investment instruments (modified to meet specific regulations) across national borders.

Globalization means pursuing new resources—raw materials, labor, manufacturing capabilities, and knowledge— anywhere in the world you can. Chevron is painstakingly securing access to Russian oil and gas reserves. Clothing companies from the Gap to Old Navy and J.Crew to L.L. Bean farm out the making of their khakis, t-shirts, and the like to a plethora of developing nations. U.S. software companies get programming help in a tight job market from programmers in India, a country with a strong mathematical heritage. Business-to-Business (B2B) websites with auction/bidding capabilities enable truly global market exchange while breaking down traditional organizational structures.

Globalization means new kinds of alliances, partnerships, and joint ventures that also give companies access to markets and resources. These shared enterprises require collaboration and knowledge exchange between companies that may have been competitors in the past.

These examples only scratch the surface of the drive to globalize that is changing many companies. Without new kinds of knowledge-coordinating structures, none of these new globalized processes—in production, marketing, sales, human resources, and many other realms—will work very well. Teams must be able to form and share knowledge and results without gathering in one place or even having a physical home base. Departments, divisions, and regional structures need to shed old habits of information-hoarding and collaborate to develop best practices that can then be customized by function or region. Companies need to learn how to share knowledge and resources in alliances and joint ventures that bring people from different organizational and social cultures together. Companies are also grappling with how to make the most of the Web, which replaces hierarchical information exchange with a dynamic, horizontal flow and enables fluid, team-based collaboration.

6.   New organizational and decision-making structures depend on knowledge management.

Many companies have changed enormously in the past fifteen years. Waves of downsizing, reengineering, quality management, and delayering, not to mention mergers, demergers, consolidations, and spin-offs, have seriously weakened the command-and-control environment of the old industrial giants.

In disrepair, too, are the cumbersome, hierarchical planning, analysis, and decision-making structures that used to support corporate strategy. Now companies know that they need to be nimble, adaptive, responsive, and customer-focused.

They need to be prepared to master new competencies and markets, and do so in a team-based, project-focused way that gets results without excessive corporate guidance. Rather than using single-point forecasts and strategic goals, they need to stay on top of multiple objectives and shifting priorities. Yet they are still evolving the support structures that can provide consistency and efficiency for these new ways of working.

Knowledge management is the keystone of those structures—and companies are showing an awareness of that fact in their budgets. On the technology side of knowledge management alone, companies are expected to be spending $35 billion a year to implement systems by 2004. The e-mail and intranet systems now in place already seem awkward and inefficient to many users who must prioritize, read, sort, respond to, and attempt to file dozens, if not hundreds of e-mails every day on topics from the sublime to the ridiculous and laboriously click through stale intranet pages in search of useful information. Often, the easiest thing to do is still to pick up the phone and call the unofficial expert everyone in your group calls—even though “on-call expert” isn’t in her job description. That’s the irony of the current environment: the more rapidly technology changes, the more individual talent and capability matter.

Take a Moment

Have the changes sweeping through industry reached your organization? The following questions can help you determine the extent to which knowledge management is becoming or could become a key to competitive advantage in your organization. Total up the numbers of your answers. The higher your total score, the more important knowledge management could be in your business environment.

•   What percentage of your organization’s workers are involved in knowledge work or knowledge services?

(1) 25 percent or less

(2) 50 percent

(3) 75 percent

(4) 90 percent

(5) More than 90 percent

•   What percentage of the wholesale price of your product is in the cost of raw materials?

(1) 75 percent or more

(2) 50 percent

(3) 25 percent

(4) 10 percent

(5) Less than 10 percent

•   To be an expert in your domain, how rapidly do you have to update your skills?

(1) Every five years

(2) Every three years

(3) Every two years

(4) Every year

(5) More than once a year

•   Look at the industry leader in your competitive environment. What percent of the market capitalization comes from tangible assets or book value?

(1) 100 percent

(2) 75 percent

(3) 50 percent

(4) 25 percent

(5) 10 percent or less

• What percentage of your current product offering is less than five years old?

(1) 10 percent

(2) 25 percent

(3) 50 percent

(4) 75 percent

(5) 90 percent

•   What percentage of the human talent required to create your product is outsourced or obtained through alliances with other companies?

(1) 10 percent

(2) 25 percent

(3) 50 percent

(4) 75 percent

(5) 90 percent

•   What percentage of your firm’s revenues comes from markets outside your home country?

(1) 10 percent

(2) 25 percent

(3) 50 percent

(4) 75 percent

(5) 90 percent or more

Taking the Next Step

If knowledge management is so important, where does a company begin? Assessing the importance of knowledge to your enterprise is a start. Equally important is defining the knowledge challenge and the steps you need to take in terms that make sense for your business. In the following chapters, we will take you through a business definition of knowledge and knowledge management and construct a practical framework for aligning knowledge management efforts with company objectives. While we talk a lot about definitions and structures, our focus is really people. In the end, knowledge management is about giving people the tools they need to do their best for your company, helping them share their best thinking, and bringing them together in effective, productive teams and communities that bring success—and, we hope, enjoyment and passion—to the pursuit of business goals.

Recap

In this chapter we have described how several powerful forces have come together to create a new business environment. In this environment, creating knowledge and managing its rapid application have become the critical success factors for achieving competitive advantage, profitability, and market capitalization. The forces creating this new environment are:

•   The explosion of new knowledge

•   The urgent need to quickly understand and apply new knowledge

•   The rise of knowledge as the key value added to goods and services

•   Financial markets that value knowledge over physical assets

•   The globalization of markets

•   The appearance of new team-based organizational structures

Building effective collaboration and knowledge coordinating mechanisms has become key to taking advantage of the global marketplace.

Endnotes

¹ Davis, Stan, and J. Botkin, “The Coming of Knowledge Based Business,” Harvard Business Review, Sept-Oct. 1994, 170. Reprint #94505.

² CAP Ventures report.

³ James Brian Quinn, The Intelligent Enterprise: A Knowledge and Service Based Paradigm for Industry.

⁴ Brown University website, November 2000.

⁵ “An Interview with Sir Colin Marshall,” Harvard Business Review, November-December 1995.

⁶ “Leveraging Knowledge” GIGA Conference, March 16–18, 1999, Walt Disney World, Florida.

⁷ Interview with James Tobin, The Region, Federal Reserve Bank of Minneapolis, December 1996.