Transforming Public-Private Enterprises: Defense

National defense, and acquisition of weapon systems in particular, has long been a target of transformation.  The Packard Commission in 1985 provided a very reasonable set of recommendations for reforming defense acquisition processes.  These recommendations resulted in relatively minor changes.  Blue ribbon committees both before and after the Packard Commission had comparably minor impacts.

President Dwight Eisenhower highlighted the notion of a military-industrial complex in his farewell speech in January of 1961.  He cautioned that the often-cozy relationship between government and defense contractors could result in priorities that were less aligned with the nation’s defense than with the particular interests of the agencies, services, and companies involved.  Fifty years later, this perspective remains relevant.

The acquisition of weapon systems is an enormously complicated organizational process.  A few years ago, we focused on the acquisition of ships.  We learned that if the shipyards could produce ships instantaneously, it would take three years to get one.  The process of buying ships is so complicated that three years are consumed, on average, by the procedures and paperwork associated with acquiring a ship.

The problem, not surprisingly, is that all the various elements of the ship buying process has stakeholders who feel entitled to their roles in the process.  Streamlining the acquisition process would eliminate large numbers of jobs and many companies whose business models were designed to take advantage of how the acquisition system operates now.  Changing the acquisition system would obsolete many business models.  The owners of these business models will not go quietly.

There are also information issues.  There is a lack of transparency of how the system operates, what activities occur when, and how money flows accordingly.  It is very difficult, perhaps impossible, to improve a system when you cannot determine how it is currently operating.

A couple of years ago, I had a series of discussion with a senior defense official focused on what information I could get to employ with the economic models we were developing.  I commented that DoD seemed to collect and archive information on virtually everything, so they should easily be able to provide the information I was seeking.  He said, “You are assuming we have a financial management system.  We do not.  You are assuming we have a cost accounting system.  We do not.  All we have is a checkbook and, usually, we know who we write checks to.”

Finally, of course, there are issues of incentives.  Millions of people are buttering their bread because of how the acquisition system works now.  Thousands of companies were explicitly designed to succeed in the current system.  Hundreds of members of Congress see as their role the securing of as large a portion as possible of the jobs and money associated with the current system.  The incentives are overwhelmingly aligned with preserving the status quo.

Transforming Public-Private Enterprises: Education

We often see dire assessments of our educational systems.  K-12 is judged to be quite poor compared to other developed countries, as reflected in comparisons of educational achievements across countries.  This is particularly true for STEM — science, technology, engineering, and mathematics.  More broadly, our high school graduation rate of roughly two thirds means that one third of young adults are woefully under educated.

Higher education appears to deliver better results.  Our graduate schools still dominate the international rankings.  However, the costs of higher education continue to escalate – tuition in public institutions in many states is doubling every five years.  This is due to steadily declining support for public education by state legislatures.  This is also much evidence of “mission creep” and administrative bloat with an ever-increasing number of associate vice provosts and similar titles.

What is wrong and what needs to change?  These questions can be addressed using the three core transformation constructs introduced earlier – stakeholders, incentives, and entitlements.  There certainly are lots of stakeholders in education, including students, parents, teachers, administrators, employers, politicians and taxpayers.  There are many conflicts among the interests of these stakeholders, including the costs and benefits seen from their various perspectives.

It seems reasonable to assert that there are many instances where high quality education has resulted for well-prepared and motivated students, involved and supportive parents, well-trained and motivated teachers, and administrators, employers, politicians, and taxpayers willing to invest the necessary resources in these types of students, parents, and teachers.  This equation works well in some parts of the country, but does not work in general.

The overarching difficulties are that many students are not well prepared and motivated, many parents cannot be involved and supportive, and not all teachers are well trained, especially to teach ill-prepared, unmotivated, and unsupported students.  Further, high quality education can be expensive, particularly when small class sizes and one-on-one tutoring are needed.

Taxpayers are unwilling to make such investments.  In fact, they may be unable giving the increasing costs of healthcare (e.g., Medicaid) and prisons in most states.  Yet, a lack of education leads to poor health practices.  Lack of education also leads to unemployment and crime.  Thus, not investing in education now results in much higher costs later.

One can argue, therefore, that we have a traditional investment problem.  We need to invest now for later returns in terms of lower costs of healthcare and criminal justice, as well as increased tax revenues from healthy, educated citizens.  But, the investments are needed now and the returns will accrue years later.  No one seems to “own” that future.

Alternatively, the effective discount rate Americans apply to that future is so high that negative consequences are highly discounted, at least psychologically.  Transformation, therefore, does not make sense.  Current stakeholders will not accept the near-term pain of diminished entitlements and long-term stakeholders are not at the table.  There is no sense of urgency.

A Small Transformation Experiment

On November 15th of 2010, I began a small experiment.  The lease on my car ended that day, and I just turned the car in and took the bus home.  I decided to see what life would be like without a car.

My office is close to a subway stop and there is a bus stop near my home.  I only had to figure out how to get them connected, as well as the schedules of all the pieces of the route.  For those times when I would need a car, I joined Zipcar.  They have several cars located across the street from my office.

This experiment continued until June 18th of 2011 when I acquired a new vehicle.  Thus, it is obviously feasible to live without a car.  However, with hot summer upon us, and my ultimate admission that it is inconvenient to not have a vehicle, I am back among the driving public.

This experiment showed me that I could dramatically reduce my transportation costs, from $700 per month (for lease, gas, maintenance and insurance) to $60-80 per month (for subway and bus fares and an occasional Zipcar).  However, this does not include the cost of my time in transit, which increased substantially.

A cross-town meeting would require determining the mix of subways and buses needed to get from here to there and back.  I had to build in extra time to handle schedule variations.  This sometimes resulted in my arriving at a meeting an hour early because the connections happened to dovetail nicely.  I was only rarely late.

I would catch up on my email or read magazines and other materials during these transit times, so the time was not really lost.  Nevertheless, were I not on public transportation, or waiting at a transit stop; I would not have spent my time this way.  Thus, there was certainly some inefficiency.

I met quite a variety of people on the subway, and especially on buses.  For many cases, my first impressions were dead wrong.  Most people seemed poor, and perhaps unable to afford their own vehicles, but occasional conversations uncovered graduate students, aircraft pilots, and lawyers.  In general, people were quite friendly.

I have become a fan of public transportation.  However, for me to fully transform my mode of transportation from private to public, three things need to change:

  • The transportation network has to be more robust, enabling me to efficiently get between more places.
  • Route planning has to only require a glance, not a web search, either at a posted map or a smart phone app.
  • Schedules need to be much more predictable, with the time until next subway or bus arrival displayed at each stop or on another smart phone app.

Succinctly, I need a system much more like Washington’s than Atlanta’s.

Transforming Public-Private Enterprises: Healthcare

Healthcare presents a major challenge for the U.S.  We pay twice as much per capita as any other country; yet achieve much poorer results in terms of health and longevity.  The current system can be characterized as a federation of millions of entrepreneurs with no one in charge.  Even assuming that everyone is well intended, we have the overarching problem of everyone trying to optimize the system from his or her personal perspective.

Patients feel entitled to care and providers of care feel entitled to reimbursement for their costs.  Insurers and providers of medical equipment, devices, and supplies all feel entitled to profits.  These entitlements, both mandated and assumed, tend to be enormous barriers to change.  Everyone one wants the problem of healthcare costs solved, but no one is willing to compromise their entitlements.

All of these stakeholders have premised their business models on the assumption that the economic system will continue to operate as it has been since they made these commitments.  These business models will only be changed if these stakeholders have no choice.  We need a “burning platform” to motivate the needed changes.

I suggest that two changes of the incentive system will create this burning platform.  First, providers of care, as well as equipment, devices, and supplies, should be paid for outcomes in terms of improved health and decreased risks of disease.  They should not be paid for the costs of their procedures or the number of procedures conducted.  Their payment should be linked to the extent to which a patient is better off than they would have been without the providers’ services.  Ideally, we would create market mechanisms that would enable and motivate people to determine the extent to which they are better off, and then pay accordingly.

Second, it should be illegal for providers to charge patients with employer-based insurance more than they are allowed to charge Medicare and Medicaid patients.  If such “cost shifting’ was illegal, the system would have to change because either all providers would soon go out of business or Medicare and Medicaid patients would not receive any care.  The invisible tax embodied in cost shifting has significantly depressed wage levels across the U.S. for the past two decades.  Making this practice visible – and then illegal – would force change.

One might argue that these two suggestions would result in poor and elderly people receiving inadequate care.  However, the opposite would happen.  If one is only paid for improving people’s health, then one needs to finds lots of unhealthy and at-risk people.  That is where improvements can be achieved and money made.  Focusing on healthy, low-risk people would be a poor choice as one cannot improve their health sufficiently to stay in business.

Transforming Public-Private Enterprises: Introduction

It is difficult to transform a large enterprise.  Leaders of many private sector enterprises have told me that their toughest job is managing the enterprise they have while trying to create the enterprise they want.  Not surprisingly, the failure rate is very high, as illustrated by 200% turnover in the Fortune 500 in the past 25 years.

Much more difficult, however, is the transformation of large public-private enterprises such as healthcare, education, energy, and defense.  These types of enterprise are composed of large numbers of smaller enterprises that typically have conflicting interests and priorities.  Further, there is no one really in charge, so these many smaller enterprises cannot be commanded or controlled to do anything.

This posting is the first of a five-part series that will address the transformation of public-private enterprises.  Parts 2-5 will address healthcare, education, energy, and defense, respectively.  My intent is to find some common ground and perhaps a few good practices across these domains.

First, however, we need to define and discuss a few concepts.  The notion of a public-private enterprise reflects the reality that truly large enterprises have to seek some form of symbiosis with the governments that enable their operations.  Government licenses, regulates, and taxes commerce.  Government also legislates and, in the process, often strongly impacts the business environment.

But, government can be more than just an “externality.”  Government invests in education and research that business consumes in terms of employees and research results.  Government is also often a major consumer, ranging from Medicare and Medicaid payments to Department of Defense weapon system procurements.  Few companies really want the government to totally leave them alone.  At the very least, they want tax breaks for oil exploration and subsidies for agricultural production.

Another important concept is entitlements.  This term tends to prompt thoughts of Social Security, Medicare, and Medicaid.  There are, however, much mores subtle entitlements.  The agricultural industry acts as though it is entitled to subsidies for corn and cotton production.  The defense industry acts as though it is entitled to the production quantities originally planned for weapon systems contracts.

Both mandated entitlements and assumed entitlements tend to be enormous barriers to change.  Attempting to change Social Security or Medicare for current recipients of these benefits is likely to result in a firestorm of protests from retirees.  They will argue, quite reasonably, that their personal financial plans were totally premised on the promised benefits from these programs.  As a consequence, we have tended to make changes for future beneficiaries so that, in theory as least, they have time to adapt their plans to these anticipated changes.

More subtle are industries and companies whose structures, processes, and investments – their business models — have all been premised on the economic system operating as it has been since they made these commitments.  Fundamental changes of the economic system could obsolete many of these investments, putting people out of work and hurting shareholders.  It is not surprising that companies fight such changes.

If the Department of Defense were to stop buying military aircraft, for example, and instead lease them by the hour, the business models of defense contractors would be significantly disrupted.  Who, for instance, would put up the capital to buy the airplanes in the first place? Who would insure weapon systems quite likely to be destroyed?  In general, who would take the risks that defense companies have never had to take?

As another illustration, if Medicare decided to no longer reimburse costs – via fees for services – and instead just paid for outcomes, healthcare providers would find their business models very much disrupted.  Perhaps providers would only accept healthy patients.  What if Medicare only paid for unhealthy patients made well, or at-risk people whose risks were reduced?  It might then be worth providers paying high-risk people to avail themselves of their services because they could make so much off the risk reduction.

Not surprisingly, defense contractors would lobby against the “power by the hour” model and healthcare providers would lobby against “pay for outcomes.”  These changes would disrupt their business models and probably marginalize many of their investments.  This leads to a general principle.

When considering transformation of a public-private enterprise, first consider how changes being entertained will affect benefits seen as entitlements, people’s incomes, and companies’ business models.  The more disruptions these changes will create, the greater the difficulty of proceeding and the lower the probability of success.

System-Enabled Incompetence

I wrote early last year about Delta Air Lines transforming a great airline into a bus line.  I really did not anticipate how bad Delta’s performance could get.

I was in Houston on Thursday waiting for a flight to Atlanta. When I checked in at the kiosk, Delta offered me the opportunity to stand by for an earlier flight, which I gladly accepted. Then the kiosk said “processing error” and printed a boarding pass that did not make sense.

I proceeded to a human agent who, after much typing, informed me that my non-sensical boarding pass reflected a change of equipment (i.e., aircraft type).  She also put me on standby for the earlier flight, which she informed me was two hours late due to “weather in Atlanta.”  I called Atlanta to learn that the weather was beautiful with sunny, blue skies.

There are certainly quite appropriate reasons for delays. Why not use these as plausible explanations?  Instead, Delta provides explanations that are obviously wrong.  They apparently do not care that no one believes them. It does not matter — quality service, once their hallmark, is no longer a corporate value.

I went to the gate and asked the gate agent when they would process standbys. He said 45 minutes before departure and, oh by the way, I was not on the standby list. He added me and I jumped to the top of the list — I fly a lot.

Finally 15 minutes before departure the standby list was cleared and several people made it but not me. I pointed to the list and asked him how I, being on the top of the list, did not make the cut. He said that I was not really at the top of the list.

I waited a half hour or so and went back to the gate. I saw that I was on the top of the standby list for the next flight, which would depart an hour or two earlier than my now delayed original flight. I asked the agent if I was really at the top of the list. He told me that I was not on the list at all. Despite what he and I could clearly see on the publicly displayed standby list, his computer terminal said that I was not on the list.

Then good news, he told me that he could confirm me on this earlier flight, in fact in first class. He then typed for the next five minutes and finally handed me a boarding pass — Eureka!

I asked him why it took so long to generate a boarding pass. It seemed to me like an enormous number of keystrokes. He said. “This is not point and click. You have to memorize many, many codes, and then type them all in correctly.”

Waiting an extra couple of hours is irritating but not a major issue, especially if you fly often with Delta. However, dealing with pervasive organizational failure is very frustrating. Delta’s personnel have no idea if they are telling you things that have any basis in reality. Delta has, in effect, fostered system-enabled incompetence.

I am not suggesting that Delta’s gate agents and flight attendants are incompetent individuals. They tend to be well intended and very courteous as they try to meet your needs. However, Delta’s organizational system — their work processes and information systems — have resulted in their personnel not knowing what is patently clear to passengers, e.g., the weather in Atlanta is great and my name is right there at the top of the list.

So, the Delta bus line is increasingly becoming a really bad bus line. There may be some hope as Southwest has acquired AirTran and will become a major presence in Atlanta. They really know how to run a first-rate bus line.

A Tsunami of Talent

I am in Beijing and Shanghai for a few days.  The reason for my being in China is to chair the International Review Board at Tsinghua University where we are reviewing the Department of Industrial Engineering.

The basic statistics are chilling.  In the U.S., 4% of undergraduates matriculate in engineering. Of those that graduate, 12% continue to graduate school.  Thus, roughly 0.5% of college graduates in the U.S. have advanced degrees in engineering.

In China, 40% of undergraduates matriculate in engineering.  At Tsinghua at least, of those that graduate, 67% continue to graduate school.  While it is risky to generalize, this leads to an estimate that 25% of college graduates in China have advanced degrees in engineering.

I may be off, perhaps by quite a bit, but 0.5% versus 25% is a rather daunting difference.  If this compounds year are year, decade after decade, the consequences could be astounding.

The students at Tsinghua are extraordinary.  One in ten thousand Chinese young people qualify for acceptance.  Their English proficiency is rather amazing; their abilities to articulate their views in English are even more impressive.  This is due in part to their use of English textbooks for their classes, as well as a wealth of project-oriented courses where they must put the content of these books to use.

The department head, Gavriel Salvendy, a Hungarian-born American, has spearheaded an effort to enhance the abilities of these students for creative and independent thinking.  When these abilities are combined with the students’ diligent mastery of math, science, and language, Tsinghua is fostering a large cadre of formidable competitors in the global talent pool.

My first impression of Beijing is laced with adjectives such as big, new, modern and busy. Soaring modern buildings are steadily replacing somber grey buildings of the 1960s, 70s and perhaps 80s.  As we drive through the city, pedestrians and cars jostle to make their ways across the street or around other vehicles, some have stopped in the middle of a crowded thoroughfare on one errand or another.

On this holiday weekend (the Chinese equivalent of Memorial Day in the U.S.), I join hoards of people streaming up and down the irregular steps of the Great Wall.  It is quite the exercise, compared to the stroll I expected.  The next morning, my upper legs know that I used them quite differently than usual.  But hiking on a beautiful crisp, sunny day is a favorite of mine.

The next day, the sky is overcast with pollution, replacing the sunny bright blue sky of the day before.  The day after that, it is worse, the mountains having disappeared. Every day and every hour, we encounter huge numbers of people first learning to drive late in life, combined with herds of pedestrians who wander across streets into oncoming traffic.  This provides a strong visual image of change. Beijing, and China in general, has challenges of not only transportation, but also energy and healthcare.

The talented undergraduates and graduates at Tsinghua and other increasingly strong Chinese universities will help the nation to address these challenges.  My sense is that the solutions they devise will have value beyond China.  This will create increasing competitive advantage and economic benefits for this tsunami of talent.  0.5% versus 25% is really a big difference.

On the Cutting Edge

Last week, I was a visiting faculty member as a Spine Symposium.  I gave three talks related to a systems approach to healthcare delivery.  The context of spine surgery was purely serendipitous, as the folks inviting me did not know in advance that I have spent several years doing my best to avoid spine surgery.  I used my case history, and that of a colleague, to make the case that poor care coordination is a major issue, as the many specialties involved seem to have difficulty adopting a perspective that is broader than their specialty.

Why does this happen?  How does a group of highly motivated, well-educated physicians end up taking such a myopic view of back problems?  The answer is rather simple.  We, collectively, incentivize them to do this.  We only pay them for exercising their specialties, not for understanding the relationships across the various aspects of back problems and treatments.  If the orthopedic surgeon or neurosurgeon helps you to avoid spine surgery, he or she loses significant income.  If they help you to achieve a better outcome with much less pain and suffering, they are penalized.

Why do we do this?  I think it is our preoccupation with minimizing healthcare costs rather than maximizing health.  We have lost track of what really matters.  The goal should be a healthy, educated, productive population that is competitive in the global marketplace.  Everyone seems to agree that this should be the goal, but we somehow cannot collectively commit to making it happen.  We want to minimize healthcare expenditures.  Now, that is really simple.  Why don’t we eliminate Medicare and Medicaid, zero out NIH research budgets, and start closing down hospitals and nursing homes.  After this, politicians can run for office on platforms that extol the merits of zero healthcare costs – at least, for the voters that are still with us.

Floods, Cyclones, Earthquakes and Avalanches

I have been in Australia and New Zealand for the past two weeks – I am in Sydney right now.  The first week was a workshop at Gold Coast in Australia.  This workshop was to have been held in Brisbane, but floods reached the second floor of the hotel where the workshop was to be held.  Consequently, the meeting was relocated to Gold Coast.  However, a Level 5 Cyclone also threatened this location shortly after the flood.  Fortunately, the cyclone passed through much farther north and additional changes were not needed.

After the workshop, my long-time friend Ken and I headed to New Zealand for a week of hiking and sightseeing.  We spent February 19-20 in Christchurch and then headed west to Mt. Cook and the Tasman Glacier.  On February 22 we arrived in Cromwell to learn that there had been a 6.3 earthquake in Christchurch at roughly 1:00PM that day.  The next day we learned that there had been an avalanche on the Tasman Glacier, less than 24 hours after we had been there.  It was attributed to the earthquake.

This sequence of natural events in Australia and New Zealand show how change can be forced by nature rather than markets, politics and so on.  Brisbane and Christchurch will need to do much rebuilding.  There will be new buildings and infrastructure.  This will require money, of course, but will also create opportunity.  This is not the type of “creative destruction” that Schumpeter had in mind, but it will prompt construction that is more resistant to floods and earthquakes.

There is, however, another type of legacy.  The mood in New Zealand is quite somber.  Two earthquakes in six months have many people thinking about whether they want to rebuild their lives, not just their homes, in Christchurch.  In Wellington yesterday, I heard of many people migrating to the North Island, saying they could not bring themselves to stay in Christchurch.  Thus, the near-term impacts of change can be quite negative despite the prospects of long-term benefits from successfully addressing the change.  This pattern is quite common.

Causes of Transformation in Academia

Our graduate seminar on “Transforming Academia” started this week. We focused on the roots of the modern university in the Middle Ages, Renaissance, and The Enlightenment. We debated the interpretation of developments in terms of transformational versus evolutionary changes.

Also of central interest were the causes of change. The plague, printing press and paper all had substantial impacts. Literacy, for instance, became more important when things to read became more widely available. In general, there seemed to be a confluence of causes rather than a single overarching cause.

I will be co-leading a workshop in Australia in two weeks on “Understanding and Influencing the Causality of Change.” The participants are coming from a wide range of disciplines and domains, so there are many emerging contrasts among people’s points of view.

One debate concerns the extent to which one can “know” the cause of anything. If I slide my now empty coffee mug off the desk, I expect it will fall to the floor. Why?  Gravity will typically be the response. How do we “know” that, other than via rote learning in grade school?  The simple fact is that we just do not have a better explanation of the mug falling.

The workshop will not spend much time on coffee mugs. Instead, we will consider the causes of bank failures during the Great Depression, the recent housing market collapse in the United States, soaring healthcare costs in the United States, and Pickett’s Charge in the American Civil War.  Why did these things happen?

There are proximal causes like a run on a particular bank or the absence of a particular army general. However, there are also deeper, more fundamental causes such as institutional decisions to disassociate risks and returns or a substantial mismatch of resources between adversaries. Thus, there is often a cascading set of causes and catalysts that precipitate major events.

In our seminar, we are tracing the emergence and development of a network of causes that collectively may trigger the transformation of academia. Rapidly increasing costs are a major driver. At some point, students and their parents will be forced to find other means to higher education. Information and computer technologies are likely to be among those means.

It is, however, unlikely to be as simple as people going to college at their desks in the bedrooms of their parents’ homes. Young people will still need to go away to grow up and mature. However, this may not require massive infrastructures of bricks and mortar, football stadiums, and scores of senior vice provosts, associate vice provosts, and deputy assistant vice provosts.

New value propositions will emerge – indeed, are emerging. New means for delivering value will be created, developed, and refined. The result will be the transformation of academia.