Melissa Wilson's address to CEDA's 2023 State of the Nation

CEDA Senior Economist Melissa Wilson's address to CEDA's 2023 State of the Nation

Good afternoon, everybody.

And can I also acknowledge and pay my respects to the traditional owners of the lands of which we meet today.

I'm very pleased to share the results of this first broad survey of the dynamic capabilities of Australian businesses, which is the result of joint research between Cedar and the University of Technology, Sydney.

The motivation for this work is that Australia has a productivity problem, and we've heard a bit about this already today.

The gap between Australia and the best in the world is widening and our productivity growth today is also much worse than in the past and we care about productivity because it has a direct impact on the prosperity and living standards of all Australians.

In fact, over the past 30 years, 80 per cent of our growth in real incomes has come from productivity.

And Diane spoke this morning about the reduction in the government's annual productivity growth assumption that implies that in 40 years’ time, every Australian will be 20 per cent poorer than otherwise.

Now I'd like some of this back, and I'm sure I'm not alone.

To make matters worse, we have some major challenges: climate, technological change and an ageing population, and we're in a difficult economic environment with broad-based skills shortages and rapidly rising inflation.

Last week's national accounts show that productivity hasn't budged since late 2019, and the RBA governor spoke last week about looking for a pickup in productivity to counteract the impact of rising wages on inflation.

So what are we going to do?

Well, the debate is often focused on the policy levers that we can pull.

But businesses are also critical, and that's why our research has focused on the capabilities within business.

There are two types of these capabilities.

The first are what's called ordinary capabilities. These are the basic skills needed to run a business in normal times as efficiently as possible.

And they really do matter. In fact, there's research that suggests that ordinary capabilities could explain up to half of the productivity gap between Australia and leaders like the US.

The limitation of ordinary capabilities, though, is that they assume that firms are operating in a static environment, and we know that the real world just isn't like this.

This conference is all about navigating disruption and firms operate in an uncertain world full of disruption, and that future is looking more uncertain than ever.

In this environment, businesses must be prepared if they want to thrive and survive, and that's where they need dynamic capabilities.

These are more forward-looking and they're more strategic. In a world that is highly volatile and uncertain, dynamic capabilities are what will help businesses to maximise their chances of long-run survival and success.

We think about these capabilities in three buckets.

The first is sensing – that's about having the capability to explore opportunities to see threats coming and to explore customer needs.

Then, after sensing comes seizing, does the business have the capability to capture the value from these opportunities to avoid some of the threats and to find new ways to satisfy customers and to shape markets.

And then finally, after sensing and seizing is transforming and that's about the renewal that is needed from time to time to pursue these opportunities or to change the structure of the business.

A great example of this from our research from a small company called the International Medical Robotics Academy, or IMRA.

IMRA started out providing training on robotic surgical procedures for training surgeons and as they were doing this, they identified a growing problem around the ethics and availability of the real patients and cadavers and animals that training surgeons typically practise on.

And they sensed that there was an unmet demand for a better option and then they seized on this opportunity and started developing synthetic human tissue models.

Finally, IMRA transformed, now they're not just in the business of providing training, they're also an advanced manufacturer of these models.

Really little is known about the dynamic capabilities of Australian firms, which is why we've conducted this research with UTS.

So we surveyed 149 businesses of all sizes and across various industries, and we asked them about three key areas.

The first is what we call enablers, which are the cultural, structural and other business-specific factors which encourage the development of these capabilities.

Then we asked them about the capabilities themselves, the sensing, seizing and transforming.

And then finally, we asked them about their performance and innovation outcomes and we focused on the COVID period as an example of really deep uncertainty where these capabilities come to the fore and what we found is that better enablers lead to better capabilities and better dynamic capabilities lead to better performance and innovation.

So our first result here is that firms with stronger dynamic capabilities were more innovative when COVID hit.

The most dynamic firms were more likely to improve their organisational and managerial processes and to introduce new and better marketing methods compared to the least dynamic firms.

And these innovations really set them up for success as the pandemic wore on and we saw that in their performance results, because firms were stronger, dynamic capabilities also performed better.

During COVID the most dynamic firms were more profitable than the least dynamic firms.

They were also more productive, and they had better customer satisfaction, headcount and other employee-related outcomes.

Our second major finding was that Australian businesses have plenty of room for improvement.

On our dynamic capabilities scale, there was one firm right at the end scoring a minimum of one out of six and then two at the other end of the spectrum with a maximum score of six out of six.

For every other business we surveyed was somewhere in the middle and this tells us that almost all businesses have room for improvement.

The main area that businesses can improve is in transforming.

On average, Australian firms, are strongest at sensing but weakest at transforming

Now transforming is hard. It involves companies taking a bold leap of faith and taking some risks.

But ultimately, if firms don't transform, they can fall victim to structural inertia and cultural locking, which can ultimately be their downfall.

There are a lot of high-profile examples of transformation fails and perhaps the most classic example is Kodak.

Kodak was the world's leading filmmaker and actually invented the first digital camera.

But as digital photography grew, Kodak failed to transform.

Instead, they went on the defensive and ultimately went bankrupt.

A third key finding is on the importance of space. Of the enablers we looked at, it was slack and agility that had the strongest relationship to dynamic capabilities and in particular to transforming.

Now this is about having the people and time and money not tied up in business as usual to build capabilities and to pursue new opportunities and innovation.

And this is challenging for firms and they tell us that, particularly at the moment they're under constant pressure and running as fast as they can.

But for long-run success, it's not enough for firms to just focus on their core business.

They also need to plan and position for the future and our results in this research show that currently, they're not doing enough of this.

And if that continues, then Australia's innovation and productivity growth will continue to suffer as a result.

Our last key finding is on the importance of diversity, our results show that firms with stronger dynamic capabilities have more diverse boards.

So 81 per cent of the most dynamic firms that we surveyed have at least one director who is female, at least one with science, technology or engineering expertise and at least one with international experience.

So 81 per cent of the most dynamic firms can tickle three boxes, compared to only 26 per cent of the least dynamic firms who have one director in each category.

There's a lot of focus on gender diversity, but functional diversity really matters, too.

Boards are often made up of compliance-oriented professionals in Australia.

We know that 40 per cent of directors have financial or legal experience compared with only 7 per cent who have tech experience.

And one reason for this is the focus on compliance and regulation.

That relates to huge regulatory burdens that businesses are under and this burden is growing is taking up more and more resources and time and energy.

Our survey shows that this means it comes at the cost of capability building and innovation and forward thinking.

Of course, not all regulation is bad, and in fact, simple and clear regulation can help companies navigate uncertainty.

The point here is that we must remember that new regulations come with costs as well as benefits.

Putting all of this together, what we want leaders to know is that dynamic capabilities help businesses to perform better in an uncertain environment.

Firms with stronger dynamic capabilities are more profitable, more productive and more innovative, and ultimately that improves their chances of long-run survival and success.

Businesses must build their capabilities, and almost all firms have room for improvement, especially in the area of transforming.

Transforming is hard to do, but if firms don't do it, they risk getting left behind.

And governments can help encourage businesses to develop their capabilities and in fact, governments will need to be dynamic themselves as they look to deliver services while facing a lot of the same pressures as businesses.

Firms need space for people, time and money to build capabilities to innovate and to position for the future.

It’s not enough to just focus on business as usual and onerous regulatory burdens can make this more difficult.

For firms looking for quick wins on their dynamic capabilities journey can look to improving the diversity of their leadership and also to be open to feedback on where the capabilities are currently at.

In Australia, we have a long and enviable history of economic prosperity and high living standards, but the world is uncertain and if we want this to continue, we need to boost our productivity, innovation and resilience.

Building the capabilities of Australian businesses today could be one of the most practical, effective ways to ensure success and prosperity tomorrow.