Structural Coherence and the Better Way to Make Cellphones

An interesting article in the Economist about the quagmire the Finnish cellphone giant Nokia finds itself in right now, lagging behind in the smartphone race against Apple and other phone makers. On the surface, this is an all too familiar story of creative destruction: the industry incumbent was too enamored of its own success, became tunneled-visioned, got caught off guard by the disruptive technology from new competitor(s), stumbled and fell... and the rest is history.

Of course the Nokia story can be told this way. However, this particular article raised a point that is not usually mentioned behind the success and failure of Nokia and its competitors:

"The first generations of modern mobile phones were purely devices for conversation and text messages. The money lay in designing desirable handsets, manufacturing them cheaply and distributing them widely. This played to European strengths. The necessary skills overlapped most of all in Finland... ... As microprocessors become more powerful, mobile phones are changing into hand-held computers. As a result, most of their value is now in software and data services. This is where America, in particular Silicon Valley, is hard to beat. ... ... the Valley boasts an unparalleled ecosystem of entrepreneurs, venture capitalists and software developers who regularly spawn innovative services."

In other words, Nokia used to be successful partly because its products and processes were "structurally coherent" to the economic fundamentals of its larger environment. Similarly, Apple and Google are successful today because their products and processes they invented are structurally coherent to THEIR economic environment. This is a piece of insight that lots of business narratives--mainly focusing on firms' innovative culture and visionary leadership-- largely ignored.

When I presented my research on structural coherence at various meetings, I told people that countries grow faster when the factor intensities of their industries are structurally coherent with the country's endowment fundamentals, and an industry has the best chance to grow if its production process uses the country's existing abundant factor intensively (see a previous post). Then I got asked the following question a lot: Ok, this may be true at industry level, but how about at firm level? Don't best firms succeed by innovating "ahead of the curve", thinking outside of the box, and not being constrained by existing "industry standards"? It seems that the formula for success at micro level is the complete opposite to that at macro level.

So is there a contradiction here? I don't think so. Of course there are countless factors that can determine a firm's fortune, but being structurally coherent with its larger economic environment, though not a sufficient condition for success on its own, is one of the basic necessary conditions. Nokia took advantage of the existing human capital in hardware engineering in its home country, applied it to the design & manufacturing of handsets and prospered. Apple tapped into the abundant resources in software design in Silicon Valley and flourished. The product strategies of both companies, at their best, are coherent with and fully exploit the fundamentals of their larger economic environments.

Of course, structural coherence alone doesn't make any single firm successful -- there may be tens of thousands of software companies in the Silicon Valley, but few achieved the same level of success as Apple or Google. Many factors play important roles in determining a firm's future. And some might say that such companies as Apple are successful because they are "innovative". However, although innovation is a much hyped word in our time, all innovations are not equal. The most successful innovations are "ahead of the curve" in terms of conceptualization of ideas and market judgment, but they are rarely ahead of the macro fundamentals of their economic environment. Just to the opposite, even the best idea can't fly high if its implementation demands inputs so different from what its macro environment can offer.

Therefore, structural coherence and product innovation are in fact complementary factors that make things happen. A country's specific factor endowment combination carries potential of success for specific types of firms and products, but this potential is only manifested in reality by firms' innovations that are structurally coherent with the environment.

Judging from this perspective, the best strategy for Nokia is to innovate on products and services that match its existing advantages and expertise, rather than trying to compete in a product (smartphone) that is more coherent with its competitors' environment. Unfortunately, it seems that the exact opposite is what they are doing.