Protection from the Storm

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Thinking about investment-management outsourcing? Here are seven of the biggest myths and realities
“If it is raining, you are looking for the best umbrella,” says Joshua Dietch, Managing Director at Waltham, Massachusetts-based Chatham Partners, a market research and consulting company. Some employers—who sponsor underfunded defined benefit (DB) plans that need better risk management or defined contribution (DC) plans that need less-costly, more-customized investment options, for example—have looked to the expertise of investment-management outsourcers as that protection from the current storm.

However, this complex field is ripe for confusion among employers considering it. Sources talked about several of the most common investment-outsourcing myths:

1. It is just for mid-size sponsors. “The real sweet spot for outsourcing is mid-size companies,” says Seth Masters, CIO of AllianceBernstein Blend Strategies and Defined Contribution, and most of the first wave of deals did, in fact, happen with these plans. These employers often do not have the in-house resources to do all the work effectively, but have enough in assets to make deals scalable for an outsourcer.

Image via WikipediaWhile the mid-size market remains active, “we also see much more of a trend at the larger end,” says Joseph Gelly, Russell Investments Investment Outsourcing Practice Leader. “It is less around ‘I do not have buying power’ or ‘I do not have the resources or the technical competence’ and more around ‘I need to focus on running my company,’” he says, adding that many of those larger employers have frozen DB plans and want to devote their time and resources to core parts of their business rather than legacy benefits.

2. It is just about managing managers. Many sponsors traditionally see outsourcing in terms of investment oversight, says Clint Cary, Senior Vice President at Aon Investment Consulting. “It is not just managing assets; it is managing the funded status,” he says. Sponsors of active DB plans “are migrating to a risk-management approach, where they are trying to improve the funded status of the plan and de-risking the plan as they get better funded,” he says, “and they do not have the risk managers internally.”…

Image via Wikipedia3. Only defined benefit plans get outsourced. These plans have used outsourcing the most, but defined contribution (DC) sponsors increasingly consider it, says Jennifer Tretheway, a Senior Vice President and Managing Director at Northern Trust Global Advisors. “The most common thing we see from DC plans is an interest in having some type of oversight done, anything from overseeing the mutual fund options on a recordkeeper’s platform to something more proactive, in terms of having discretion on which investment-management firms to utilize,” she says.

DC plans may need outsourcers’ expertise even more than DB plans, Masters says. “Historically, DC plans did a kind of outsourcing by hiring recordkeepers that provided a bunch of options, mostly in mutual fund form and often, frankly, at a fairly high cost,” he says. However, DC plans have become most Americans’ primary retirement-savings vehicle, leading employers to want to limit the cost to participants as much as reasonably possible.
“The single biggest thing that people will get help with is customizing target-date funds,” Masters predicts. “In the next 10 years, virtually all growth in DC assets will be in target-date assets. So, as that unfolds, it becomes increasingly important for plan sponsors to get the target-date decision right.” Designing and implementing a customized target-date structure so that it comes as close to the cost of a DB plan as possible “is a fairly specialized task,” he says, and many employers lack that in-house expertise.
4. It costs a lot, or saves a lot. “Another primary misconception is that outsourcing is more expensive than doing it in-house,” Tretheway says. “The majority of our clients do recognize some savings, in the form of hard-dollar expenses for investment management, custody, and performance measurement. On average, clients might recognize a savings of around 10%.”…
“[Sponsors] do not go in thinking the overall fees are lower; they go in thinking they will get a more comprehensive service set,” Cary says. “They see it as a cost-neutral solution. Cost is not a main driver, and is also not a hindrance.”
Remember that the cost of administration for a DB plan pales compared with the cost of funding the plan, Dietch says. The argument for outsourcing a pension plan is “you reduce your cost of funding if you generate higher returns and less volatility, and reduce tracking error,” he explains.
5. Sponsors can offload their fiduciary responsibility. Dietch wonders if most employers realize that they retain significant fiduciary obligations if they outsource. Even if they think they can transfer that responsibility legally, Masters says, “I think you cannot morally: The reputational risks are too great.”
Yet, the desire to forgo as much fiduciary responsibility as possible “is a big motivator” to outsource, Dietch says. “It is certainly being aggressively marketed.” However, an ERISA plan sponsor remains a fiduciary, he adds, and has to operate with that standard in selecting and monitoring an outsourcer.
“That fiduciary role does not go away,” Gelly says. “The responsibility shifts from day-to-day to more strategic. Their involvement is extremely critical, but it is more at the strategic level,” such as approving the investment policy. The employer also still needs to evaluate the investment outsourcer’s performance regularly, Tretheway says, and most clients look at quarterly committee meetings as a good time to cover that.
6. It means giving up all control. “One thing I hear a lot is that people feel like, ‘Oh, I am giving up control,’” Gelly says of employers thinking about outsourcing. In reality, Tretheway says, clients’ ongoing involvement level really ranges. For instance, some clients delegate to Northern Trust the authority to hire and fire investment managers but, in other cases, it does not have complete discretion. For those with less day-to-day involvement, she believes, they ultimately have more control because they can track progress more closely to meet their goals.
There is no one right answer on how involved in day-to-day workings a sponsor should stay after outsourcing, Masters says. …
7. Outsourcers only sell pre-packaged solutions. “There is a little bit of a myth out there around, ‘This is a black box,’” Gelly says. “Unfortunately, some people think that everybody is treated the same.” Sometimes yes and sometimes no. For instance, Gelly says that Russell highly customizes the weighting among plan clients’ asset classes based on factors such as a plan’s liabilities.
Outsourcing has a lot of different permutations in the marketplace, Dietch says, but to do this business profitably, outsourcers have to create something scalable. As for customizing to specific clients, he says, “a lot of it comes down to what the contractual terms say.” Some outsourcing providers take a more-standard approach: “They have one fund, and everybody goes into that fund,” Tretheway says, “but all of our clients have a unique asset allocation, and a unique investment policy statement. We really have a hard time believing that any two organizations have identical needs.”
Judy Ward
editors@plansponsor.com

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The Pros and Cons of 401(k) Annuities

Retirement Income Journal

By Kerry Pechter Thu, Sep 16, 2010

One witness at the DoL/Treasury hearings this week asserted that mandatory annuitization of DC assets at retirement is needed. The government, as well as sponsors and plan providers, have largely ruled that out.
The prominence of the witnesses testified to the significance of the DoL/Treasury Department hearings this week on so-called "401k annuities" and other tools that can help plan participants turn their savings into income--either while they save, when they reach retirement, or in retirement. …
Trade, labor, and consumer advocacy groups also contributed their thoughts. The AFL-CIO, the Investment Company Institute, the Profit-Sharing and 401(k) Council of America, the American Council of Life Insurers, the American Society of Pension Professionals and Actuaries and the Spark Institute all gave testimony. Other groups and firms can contribute statements via e-mail over the next month.
Some witnesses praised in-plan annuities, while others, like Steve Utkus of Vanguard, tried to bury them. To be sure, there are plenty of good reasons for putting income options in plans, either as savings vehicles (deferred annuities) or exit options (immediate annuities, payout funds).
Big plan sponsors have economies of scale and bargaining power that lower the costs of products, administration, and education. Plan sponsors are also in a unique position to set up a program that applies the employer match to the purchase of future income… . Like contributions to a defined benefit plan, that kind of program would leverage the time value of money and mitigate the interest rate risk and timing risk associated with the lump sum purchase of an annuity at retirement.   
Counter-arguments
But there are plenty of … counter-arguments for putting annuities in DC plans. For plan sponsors, there are potentially huge expenses associated with evaluating the costs and benefits of different income product vendors and in educating employees. Above, all liability for picking the wrong provider or for giving employers bad (in retrospect) advice scares them. “Fiduciaries are paranoid and rightly so,” says Sheldon Smith, an ERISA attorney and president of ASPPA.
As for participants, most of them won’t retire from their current employer/plan sponsor. From the participant perspective, the average person spends only 4.2 years in any particular job and might participate in several 401(k) plans. There are also portability issues. Participants may want to change employers or get out of income products. Employers may want to change annuity providers.
Adapting recordkeeping systems to multiple income options, or options that might change suddenly, could also pose problems, especially for small employers. Ninety-percent of plans have fewer than 100 participants. Only the largest 10% of plans, which account for 85% of all participants, may be able to cope with the legal, educational, and recordkeeping challenges of in-plan options.  
Other problems: most 401(k) accounts, even at retirement, are too small to annuitize at all, let alone big enough to allow for the ideal solution: partial annuitization. Annuity purchases can also trigger the need for spousal approval, potentially increasing paperwork for sponsors. Gender-neutral pricing rules in 401(k) plans also mean that retail annuities, which have gender-specific pricing, can offer men much higher payout rates than in-plan annuities.
Alternate vision
The zeal for putting guaranteed income options in DC plans is limited mainly to insurers. Asset managers … which are the custodians of millions of rollover IRAs, believe that most people will consolidate their tax-deferred savings in an IRAs and then buy an annuity—or simply take systematic withdrawals. Investment advisors think along the same lines, and millions of Americans are likely to take this path.
Even if you build in-plan annuities, will they come? There’s a lot of disagreement over whether Americans want in-plan annuity options. Even in DB plans, 90% of retirees who have the option choose lump sum payouts over lifetime income streams. Shlomo Benartzi of UCLA, and an Allianz Life consultant, cited evidence of high annuitization rates in some companies, and MetLife said participants like a partial annuitization option. But the evidence is inconsistent. Most people don’t want to give up control over their assets or even part of their assets, especially not at time they stop working, when their retirement plans are still unsettled.
There’s also the crowding-out problem. Thanks to Social Security, most middle-class plan participants will get at least half of their retirement income coming from an annuity, and have no compelling reason to annuitize their DC savings. On the contrary, they may need their DC assets to stay liquid for emergencies, bequests, weddings or simply long-deferred pleasures.
To overcome this resistance or inertia, some witnesses said, the government might have to approve a qualified default annuity option, analogous to auto-enrollment and the qualified default investment options in 401(k) plans. One witness, Josh Shapiro of the National Coordinating Committee for Multiemployer Plans, asserted that nothing short of mandatory annuitization of DC assets at retirement will really change the game. The DoL and Treasury, as well as sponsors and plan providers, have already ruled that out.
© 2010 RIJ Publishing LLC. All rights reserved.

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Some 401(k) Plans Are Adding an Annuity Option

NYTimes.com
By FRAN HAWTHORNE
Published: September 15, 2010

BURDENED with a reputation for being inflexible and expensive, annuities have never been popular in retirement plans. But insurance companies and Wall Street investment firms have produced a new crop of products that fiddle with the standard structure.
Enlarge This Image

Minh Uong/The New York Times

Their idea is that these products can promise employees the security of a traditional pension, while freeing employers from the task of paying for it. However, they are still having trouble breaking through the A-barrier.

Image via WikipediaOnly 2 percent of 401(k) plans include some sort of annuity or insurance option as an investment choice alongside standard stock and bond funds, according to Hewitt Associates, a benefits consulting firm in Lincolnshire, Ill. An additional 3 percent are “very likely” and 17 percent are “somewhat likely” to add the category this year, Hewitt says.

Promoters hope that hearings this week, sponsored by the Treasury and Labor Departments, will lead to federal regulations that clarify some of the administrative concerns.

“Most people would want, as they approach age 50, to have some sense of what level of income they would have at retirement,” said Thomas J. Fontaine, global head of defined contributions at the investment management firm AllianceBernstein, one of more than a half-dozen insurance companies and money managers devising these products. “And they will want to know that they will have that income for life.”

The products work in two basic ways. The most common varieties are tied to target-date funds — premixed funds that base their investment strategy on the date the employee hopes to retire, automatically changing the mix as the date draws nearer.

In the AllianceBernstein model, an increasing portion of the target-date assets are shifted to a special guaranteed fund starting at age 50, with 100 percent in that fund by five years before the retirement date. Although the product isn’t complete, Mr. Fontaine said he expected it to guarantee a 5 percent rate of return for life, for a fee of about 1 percent of the assets.

Prudential Retirement has a product that combines a group variable annuity with a target-date fund, basically insuring against market downturns, also for a 1 percent fee. It guarantees that each year for the first 20 years of retirement, an investor can withdraw an amount equal to 5 percent of the assets that were in the target-date fund at its highest year, even if the market crashed the year before retirement. After 20 years, Prudential starts paying that 5 percent.

Image via WikipediaMetLife’s Personal Pension Builder takes a wholly different approach, akin to a deferred fixed annuity. Each time someone makes a 401(k) contribution, all or part of the money essentially buys a mini-annuity (also known as a laddered annuity), getting the prevailing interest rate at that time. Thus, a person who contributed every two weeks would be purchasing 26 mini-annuities that year.

What all these products have in common is that employees use their 401(k) assets to buy a guaranteed, steady payout for the rest of their lives after they retire. The cost is usually around 1 percent of the assets guaranteed, on top of the regular 401(k) fees.
For many people, the added security is worth the price.

“We insure everything — disability, our car, our house — but we don’t insure the risk that we could outlive our assets,” said Pamela Hess, Hewitt’s director of retirement research. She recommended that people use this kind of guarantee for around half of their 401(k) assets.
There are other concerns, however. Because so many parts are movable — including the interest rate, the retirement date and the amount of the contribution — companies worry about the administrative difficulties. It is not as simple as having one small-company stock fund for the whole work force.

Like a standard annuity, some of the new products depend on a single insurance company’s staying in business long enough to keep paying out the guarantees, maybe for decades.
“How do you fix this if it’s not the right provider?” Ms. Hess asked.
Jody Strakosch, MetLife’s director of retirement products in the United States, has a ready reply for that sort of criticism: “MetLife has been meeting our financial obligations for 140 years.”

And John Kalamarides, the senior vice president of retirement strategies and solutions at Prudential, said new “safe harbor” rules from Washington could relieve some employers’ fiduciary concerns in selecting insurance companies.
On the plus side, the target-date-related products are more flexible than annuities. Investors can pull out their money at any time, although that means they will have paid the extra fee for nothing.

The firms pitching these products say demand is growing. In a survey of 1,300 companies last fall, MetLife found that 44 percent of employees “would like my employer to offer an annuity option” in their 401(k) or similar retirement plan. A MetLife spokeswoman acknowledged that the statement could refer to rolling over the 401(k) into an annuity at retirement, as well as having an investment option.

Stephen P. Utkus, who runs the Center for Retirement Research at the Vanguard Group — which does not sell any of these new products — said that trying to buy security with a 401(k) investment was a mistake. The best approach, he says, is simply to build a bigger nest egg.
“Our clients view having a portfolio of assets itself as a form of security,” he said.

A version of this article appeared in print on September 16, 2010, on page F2 of the New York edition.

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Pros and Cons of Cashing Out Your 401(k) to Start a Business

BlogHerImage via CrunchBase

September 09, 2010 11:36 am by paulag01 in Money
The combination of a bad lending environment, the economy, and the uptick in people starting businesses have made tapping retirement funds a very tempting business financing option.  Is it right for you?
If you listen to any of the financial experts, the message "never touch your 401(k)" gets repeated over and over.  …  Yet it is happening more frequently than you think, it is legal (if certain tax code provisions are followed), and it doesn't have to be the all-or-nothing doomsday scenario.
A recent article in Inc. Magazine details "How to Finance a Business with your 401(k)".  Here's how it works.  Essentially you establish a C corporation for your new business that has been created but has not issued stock.  The new corporation adopts a retirement plan.  You roll over your 401(k) to the new corporation's plan. The new corporation issues all of its stock and transfers it to the new profit-sharing plan in exchange for the cash.  Voila, instant cash flow.
The process of using a rollover as business start-up is often referred to as "ROBS." You can read more about this in Tapping Retirement Money for Your Business? Be Careful.  It is particularly appealing for franchise opportunities:

But an article published in Franchise Times cited compelling figures from franchise-data firm FranData that showed more than 4,000 businesses started using ROBS funding last year. More than 60 percent of those businesses were franchises.

Back in 2008, the IRS did express its displeasure about the ROBS plans in a retirement-plan newsletter, so Uncle Sam may not be as enthusiastic about this approach as some entrepreneurs.
So is it right for you or not?
The Franchise King had this to say about using your 401(k) to fund your franchise business.  Bottom line?  Get educated, make an educated decision ... for you.
Here are some pros and cons to consider:

Pros

• Relatively quick and easy access to potentially large sums of cash without having to qualify for a loan.
• You leverage your own cash to build something of value, essentially becoming your own venture capitalist (needless to say, this is only a positive if the business thrives).
• Up to 100 percent of your retirement funds can be used, but you can diversify and use only a portion to fund your business venture leaving the rest of your retirement assets intact.

Cons

• You put your future retirement and financial security at risk should the business fail.
• Must hire a tax attorney or CPA to handle the formation of the corporation and retirement plan.
• These provisions may be under scrutiny (or that is the picture some paint) by the IRS.

Paula Gregorowicz, owner of The Paula G. Company, offers life and career coaching for women to help you figure out what you want to do with your life and career and cultivate the confidence to be the person you most want to be so you succeed on your own terms. Learn more about The Life Alchemy Success Formula™ and Get the free eCourse "5 Steps to Move from Fear to Freedom & Experience Greater Confidence" at her website.

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Creating value in the age of distributed capitalism

As mass consumption gives way to the wants of individuals, a historic transition in capitalism is unfolding.

McKinsey Quarterly - Strategy - Strategic Thinking
SEPTEMBER 2010 • Shoshana Zuboff



Capitalism is a book of many chapters—and we are beginning a new one. Every century or so, fundamental changes in the nature of consumption create new demand patterns that existing enterprises can’t meet. When a majority of people want things that remain priced at a premium under the old institutional regime—a condition I call the “premium puzzle”—the ground becomes extremely fertile for wholly new classes of competitors that can fulfill the new demands at an affordable price. A premium puzzle existed in the auto industry before Henry Ford and the Model T and in the music industry before Steve Jobs and the iPod.

The consumption shift in Ford’s time was from the elite to the masses; today, we are moving from an era of mass consumption to one focused on the individual. Sharp increases in higher education, standards of living, social complexity, and longevity over the past century gave rise to a new desire for individual self-determination: having control over what matters, having one’s voice heard, and having social connections on one’s own terms. The leading edge of consumption is now moving from products and services to tools and relationships enabled by interactive technologies. Amazon.com, Apple, eBay, and YouTube are familiar examples of companies solving today’s premium puzzle. Lesser-known companies like CellBazaar (in emerging-market mobile commerce), TutorVista (in tutoring), and Livemocha (in language education) also abound.

It would be easy to construe these as isolated cases of innovation and industry change, but I believe they represent much more: a mutation in capitalism itself. … Innovations improve the framework in which enterprises produce and deliver goods and services. Mutations create new frameworks; they are not simply new technologies, though they do leverage technologies to do new things. Historically, mutations have superseded innovations when fundamental shifts in what people want require a new approach to enterprise: new purposes, new methods, new outcomes.

In the same way that mass production moved the locus of industry from small shops to huge factories, today’s mutations have the potential to shift us away from business models based on economies of scale, asset intensification, concentration, and central control. That’s not to say factories are going away; their role in supplying quality, low-cost goods, including the technologies underpinning the shift to more individualized consumption, is secure. Yet even mass production is becoming less homogenous (consider the ability to order custom sneakers from Nike). And for many goods and services, new business frameworks are emerging: federations of enterprises—from a variety of sectors—that share collaborative values and goals are increasingly capable of distributing valued assets directly to individuals, enabling them to determine exactly what they will consume, as well as when and how. This shift not only changes the basis of competition for companies but also blurs—and even removes—the boundaries between entire industries, along with those that have existed between producers and consumers. The music and newspaper industries ignored this shift, to their great detriment. I believe all businesses will have to find ways to adapt to this new world if they want to grow.
The economist Joseph Schumpeter cautioned his readers not to expect new forms of economic development to announce themselves with a grand flourish. “The ‘new thing,’” he wrote, “need not be Bessemer steel or the explosion motor. It can be the Deerfoot sausage.”¹ My hope is that this article will help executives see the links between today’s “Deerfoot sausages,” recognize the magnitude of the economic transition these mutations portend, and begin setting—or at least contemplating—a new course in this changing world.

It won’t be easy. But enterprises that can leverage technology and real-world social connections to solve their piece of the premium puzzle—creating individualized ways to consume goods and services at a radically reduced cost—will prosper as they realize wholly new sources of value that remain invisible to companies still bound by conventional business models.

Mutation and distributed capitalism

The last chapter of capitalism unfolded in the early 20th century and was epitomized by Henry Ford and his Model T. …The Model T embodied a mutation we now call mass production. It solved the premium puzzle of its time, reducing the price of an automobile by 60 percent or more, and thrived in the emerging environment of mass consumption.

Ford’s Model T not only changed the entire framework of production but also set the stage for another automotive pioneer, Alfred Sloan, to establish the modern, professionally managed, multidivisional company as the basis for wealth creation in the 20th century. In the end, the Model T’s power had nothing to do with cars per se. Mass production could be applied to anything—and it was. It provided the gateway to a new era because it revealed a parallel universe of economic value hidden in mass-market consumers and accessible to companies that could create affordable versions of previously unattainable goods such as cars. That potential for wealth creation remained invisible to those who clung to the 19th-century framework of small-factory, proprietary capitalism.

The mass-production business model has come under assault during the past decade, perhaps most successfully by the combination of Apple’s iPod and its music service, iTunes. The iPod is … also a gateway product, one of the first to achieve both scale and commercial success while expressing a new mutation. The iPod and iTunes reinvented music consumption by starting with the listener’s individual space, which I call “I-space.” Apple rescued musical assets from a faltering business model…. It supported users in reconfiguring their music as they saw fit. … But I would argue that the real breakthrough had nothing to do with music per se. The true source of value, which had been invisible to the music industry, resided in Apple’s ability to reinvent the consumption experience from the viewpoint of the individual, at a fraction of the old cost.

The iPod—and its successors, the iPhone and the iPad—are part of the first wave of what I call “distributed capitalism,” which encompasses the myriad ways in which production and consumption increasingly depend on distributed assets, distributed information, and distributed social and management systems.² Distributed capitalism could not thrive without the technologies associated with the Internet, mobile computing, wireless broadband, and related developments in digitization and software applications. But just using these technologies does not ensure success.

Winning mutations—those that create value by offering consumers individualized goods and services at a radically reduced cost—express a convergence of technological capabilities and the values associated with individual self-determination. The iPod and scores of other successful mutations have infiltrated the economy sufficiently to provide preferred alternatives to established sources of goods and services across many industries. Taken together, they have begun expressing a distinctly new “genetic code” that encompasses five essential functions:

Inversion

The old logic of wealth creation worked from the perspective of the organization and its requirements—for efficiency, cost reductions, revenues, growth, earnings per share (EPS), and returns on investment (ROI)—and pointed inward. The new logic starts with the individual end user. … This inverted thinking makes it possible to identify the assets that represent real value for each individual. Cash flow and profitability are derived from those assets.

Rescue

Once valuable assets have been identified, they must be rescued from old, costly industry structures. … Rescuing assets means digitizing them whenever possible for easy and affordable distribution to users in I-space.

Bypass

… By leveraging digital technologies and new social arrangements, these mutations are bypassing existing institutional structures … and connecting individuals directly to the assets they seek. Just as a coronary bypass ignores a damaged blood vessel and takes blood to its destination another way, so mutations like iTunes or distance learning simply bypass the unnecessary costs, outdated assumptions, and value-destroying practices of legacy systems.

Reconfiguration

Once individuals have the assets they want, they must be able to reconfigure those assets according to their own values, interests, convenience, and pleasure. A teenager, for instance, may use her iPod Touch … to assemble an entire personalized “radio station” while at the same time learning Mandarin Chinese … through an online classroom based thousands of miles from her home.

Support

… The new sources of economic value can be discovered and realized in I-space only when consumption strengthens the sense of personal control, delivers opportunities for voicing ideas, and enables freely chosen social connections. The emerging logic of distributed capitalism rewards enterprises that realign their practices with the interests of the end consumer and punishes enterprises that try to impose their own internal requirements or, worse yet, maximize their own benefit at the expense of the individual end user.

…[Early] mutations address individual needs that are invisible from the perspective of a typical company and target the kinds of trapped assets that are both valuable to individuals and easily digitized (to learn more about how mutations vary in the degree to which they incorporate these five functions, see the interactive exhibit, “A taxomony of mutations” ).

A taxonomy of mutations
Mutations in capitalism vary in the degree to which they have developed each of the five functions essential to the new "genetic code."
Launch Interactive

The next test for distributed capitalism

Can distributed capitalism go further? What happens when it confronts … arenas where face-to-face experience is essential? This is when distributed capitalism, … will begin to mature as it takes aim at core economic functions with a second wave of more complex mutations that combine virtual and real-world assets.

Early mutations in health care

The premium puzzle has become the defining characteristic of most individuals’ health care experiences: the health care one can afford is rarely the health care one wants. … But it is sure to intensify elsewhere as aging populations make it harder for governments to finance today’s systems.

In the vacuum created by these frustrations, many people concluded that they must first try to help themselves and their families before turning to professionals. Mutations such as WebMD arose, aimed at capturing, interpreting, and distributing information once held closely within the medical enclave. Such sites are now credible ways to acess information that doctors just won’t provide at a price people can afford—and sometimes at any price.

Another group of mutations has emerged in the areas of home-based diagnosis, monitoring, and testing. … Distribution has even gone mobile with cell phones that monitor blood glucose levels and heart rates, connect you to hot lines, signal the calorie count of your cheeseburger, or register the energy you burn as you walk your dog.

Radical mutation in elder care: A case study

One of the most intractable premium puzzles in the health care system today is elder care. The average annual cost of nursing-home care in the United States approaches $80,000. Only a small percentage of US residents can afford these prices, while state and federal funding is shrinking. Further, nursing homes tend to be for-profit businesses in which cost imperatives lead to understaffing and low wages. Dismal data on bedsores, medical errors, and elder abuse suggest that elder care as generally practiced is a euphemism for human warehousing on the cheap.

A Maine-based start-up called Elder Power (EP) has taken direct aim at the elder care premium puzzle. It showcases new capabilities and strategies that integrate digital and face-to-face support, and its initial success provides important guidance on solving today’s premium puzzle in the physical world. …The average monthly cost in Maine exceeds that in the United States as a whole … In contrast, EP has enabled seniors to remain at home at an average monthly cost of $702–$378 for technology and $324 for personalized support. EP enables seniors to be secure, socially enriched, and personally empowered for 3 percent of the average cost of conventional home care in Maine, 10 percent of the average cost of a nursing home, and 18 percent of the average cost of assisted living.

Before explaining how this is possible, I want to offer two caveats. First, the reason I have such detailed information about EP is that my husband and collaborator, Jim Maxmin, is one of its architects. Jim holds shares in the company, which is a for-profit community network whose profits are entirely reinvested in the network to support its neediest participants. Second, EP is a tiny experiment, with (as of March 2010) 56 members. This group does not, however, represent an easy-to-serve population: many have mild to severe Alzheimer’s disease.
EP has a significant technology component. Each elder person’s home is equipped with a “digital spine,” with members opting for various technology levels, from the basic tools (emergency alert, a stationary webcam, a videophone, and a computer interface) to more elaborate systems that include multiple webcams, sensors, and around-the-clock monitoring. A Web site provides access to a community calendar, local services, a story and poetry corner, video clips, advice, e-mail, and an EP Facebook page. There is also a Web-based Elder Power TV network, which features local events such as plays and church services. The technology reassures families that the elder person is well and the network is there to help.
As is crucial to second-wave mutations, the EP model extends beyond the digital realm. EP is a social network that includes members; their families, friends, and neighbors; volunteers; paid staff; and professionals. Each member has a personal advocate within the network who helps coordinate the use of EP’s services. In addition, EP expects members to take an active role in their own well-being and to help others in the network. A partially disabled housebound member, for example, oversees the daily monitoring.

Financial surpluses generated by the EP model help to offset the expenses of volunteers and to reward them with meal vouchers, gasoline, film tickets, and the like. This combination of paid and unpaid support services means that one registered nurse employed by EP can serve more than 60 remote seniors. EP estimates it would take 40 to 50 volunteers to support 1,000 seniors.

Strategies for radical mutation

Elder Power exemplifies four new strategies for pulling off radical mutations in arenas where real-world—not just digital—assets are integral to the individual experience. First, it’s a federation, by which I mean a branded constellation of enterprises drawn from many industry sectors that revolves around the individual—such as a local utility that gives EP members top priority in the monitoring and emergency maintenance of home electrical and heating systems. Second, EP identifies, uses, and remunerates underutilized community and network resources (services, spaces, people, capabilities, and goods) that are “hidden in plain sight,” such as the local high-school cafeteria, where elders dine weekly after the regular lunch period ends, or an extra bedroom in a member’s home that can be used for another elder to recuperate after a hospital stay.

Third, EP leverages available resources by distributing work: one volunteer or member might make two daily phone calls. Another might transport a group of seniors to lunch once a week. A third might coordinate the evening meal for three seniors in her neighborhood. Finally, EP relies on what I call “I-metrics,” which realign business practices with the experience, values, and priorities of the people an enterprise serves. For EP, I-metrics reflect subjective evaluations such as “I feel safe and happy at home,” “I feel needed,” or “I can get down to the back meadow to see the spring flowers.”

Elder Power is far from the only place where the importance (and sometimes the difficulty) of implementing these strategies is revealing itself. Consider federation: since Apple understood that its iPod users wanted to be connected to one another, … it broadened the scope of its offerings, creating new partnerships and business models at each turn as the stand-alone iPod morphed into the iPhone. The choice to host applications on the iPhone further accelerated this process, reimagining the iPhone as a portal to an ever-widening “protofederation” of support providers.

But creating effective federations is challenging. … [Apple and Facebook] began by regarding applications as simply hosted transactions … but are evolving toward a recognition that applications are a seamless extension of their end users’ experience. And both are confronting the following challenge: how much control will they, as the coordinators of their respective federations, exercise, compared with other member enterprises and with end users? …These kinds of relationships are the early building blocks of federated support networks.

Embracing distributed capitalism

While Elder Power is operating on a tiny scale, its way of solving the premium puzzle in elder care offers a vivid demonstration of what I believe will be core features of the 21st-century economy: creating new social and enterprise frameworks that operate on behalf of individual end users, enabling them with the tools, platforms, and relationships to live their lives as they choose. The range of individual support underlying many of today’s mutations is wide.
What should executives do to ensure that their organizations will grow in this new world? For starters, it’s critical to question the old logic and vocabulary of competitive strategy. …[Mutations] do not arise within industries; they arise as reconfigurations of assets defined by the unmet needs of individual end users. Mutations take root in individual space, and they quickly blur the boundaries of industries, sectors, and enterprises—ultimately making those boundaries obsolete. Is Amazon.com, for instance, in the retail, the logistics, or the Web-services industry? The question no longer makes sense.

One way for executives to shake up their strategic thinking is to start with the radical question of how a mutation could destroy the boundaries of their industries.

As mutations move into the physical world, it’s easy to imagine a similar blurring of boundaries: … In short, mutations that upend industries can come from anywhere, and conventional forms of market analysis and competitive strategy will miss those mutations.

One way for executives to shake up their strategic thinking is to start with the radical question of how a mutation could destroy the boundaries of their industries. In my mind, that danger increases under the following circumstances:

1. The products or services you offer are affordable to few but desired by many.
2. Trust between you and your customer has fractured. The average person’s trust in business has been in steep decline for the past 30 years, and the distance between what today’s businesses can deliver and what individuals want is only growing. This problem makes all consumer-facing industries—especially financial services, health care, insurance, autos, airlines, utilities, media, education, and pharmaceuticals—particularly vulnerable.
3. Your business model is concentrated, with a high level of fixed costs, a large percentage of which could be distributed, delegated to collaborators, or shifted to the virtual world. Here, too, most existing industries are deeply vulnerable.
4. Your organizational structures, systems, and activities can be replaced by flexible, responsive, low-cost networks. A neighborhood watch, citizen journalists, online peer support, and peer-to-peer reviews and information sharing are all examples.
5. There are hidden assets, outside institutional boundaries, that are underutilized but could replace your fixed costs, add capacity, or add new capabilities.
6. You don’t have all the tangible or intangible assets required to meet your customers’ needs.
7. Your end users have needs and desires that you haven’t imagined and have no way to learn about. Unless you make a strategic commitment to explore I-space, you’ll learn about this vulnerability only when your end users migrate elsewhere. This has already been the experience of executives in industries such as recorded music, newspapers, broadcast news, and travel.

Despite the drama and significance of historic transitions in capitalism, they do not announce themselves. The pattern of change is one of overlapping and interwoven fields of transition rather than clean, unidirectional breaks. For those of us living through these transitions, they can be confusing and frustrating; resources invested in innovation serve only to fix what was, bringing us no closer to the future. But these times are also rich with unique opportunities for companies able to decipher the emerging pattern of mutation and to convert that understanding into new business models that support the complex needs of the 21st-century individual.

About the Author

Shoshana Zuboff, the former Charles Edward Wilson Professor of Business Administration at the Harvard Business School, is the author of In the Age of the Smart Machine: The Future of Work and Power (Basic Books, 1989), among other books.

Notes

¹ Joseph Schumpeter, “The creative response in economic history,” Journal of Economic History, 1947, Volume 7, Number 2, pp. 149–59.
² Distributed capitalism—and the shift away from business models based on economies of scale, asset intensification, concentration, and central control—was first described in my 2002 book, The Support Economy: Why Corporations Are Failing Individuals and the Next Episode of Capitalism, which I wrote with Jim Maxmin.

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