These exponential times

Faster innovation. More churn? But no egalitarian paradise.

1.  A plummeting Coasean floor means we can do more things outside of traditional organizations like businesses.

Here’s a question that I try not to ask in earshot of my bosses.  Instead of employing me on a salary, why don’t my firm put out a tender for every piece of work I deliver?  In an open market, with other people competing to perform broken down chunks of my job, my company could end up paying less.  Reassuringly for me, Ronald Coase explained why in The Nature of the Firm in 1937.  It is because of the additional transaction costs that my firm would incur – in particular of finding a contractor and enforcing a contract for every piece of work I currently undertake. We can describe these kinds of costs as the cost of cooperating.   Companies exist in order to manage these cooperation costs.  They do things like employ managers and pay for HR departments  – and create, for the most part, hierarchical organizational structures – because, for the activities that they’re engaged in, this is a more effective way of directing a workforce than an open market.  But of course this management has a cost, much of it fixed.  Firms exist, therefore, when the costs of employing and directing staff to undertake a particular activity are less than the potential gain from that activity.

But what if those cooperation costs exceed the potential gain of an activity?  Even if it is a valuable activity it won’t happen because the cost of performing it is greater than the gain.  When neither firms nor markets can afford to undertake an activity, that activity doesn’t happen.  The significance of this is that there’s a bunch of locked up value out there:  stuff that would be great if it happened because it would improve our lives, but it’s just not cost effective to make it happen.  Unless the conditions change.  Coase goes on to say that if cooperation costs fall, for example when new technology makes communication easier, then some activities that were previously not worth doing become viable.  In addition, big firms can get bigger and small firms can get more efficient.   This has basically been the story of the impact of communication technology in the twentieth century.

Enter, Clay Shirky.  He says in Here Comes Everybody that Coase’s explanation is limited to describing what happens when cooperation costs fall moderately.  What happens if these costs collapse?  What happens if revolutionary technologies come along – like the internet and the web and those related innovations that have exploded since – that dramatically reduce the cost of cooperating?  If cooperation costs collapse then something new occurs.  There are still activities that have value but can’t be undertaken by a firm because their value is not greater than that firm’s cooperation costs, but, crucially, some of these activities can be undertake outside of the structures of formal organizations.  These activities ‘which were previously out of reach for any other organisational structure, because they lay under the Coasean floor’ can now be undertaken not by a firm (with their fixed cooperation costs) but by ‘loosely coordinated groups’.  These groups do not have the same, and in some instances any, fixed cooperation costs.  Shirky provides many examples of this, from the aggregating of amateur documentation of the London transit bombings to the collection and collation of thousands of photos of public events on Flickr.

As cooperation costs plummet this opens up the possibility for productive activity to occur outside of formal organizations.  As Clay Shirky tells us, it enables organizing without organizations.  I think this leads to more experimentation and faster innovation, throwing down a massive, existential, challenge to traditional forms of organization – including the familiar business models of the last century.

 

2.  This doesn’t mean we’re in an egalitarian paradise.  In these exponential times we still have big businesses that rise rapidly.  But are they also more likely to decline rapidly?

This social, technological and economic shift means that it is easier than it has ever been to engage a large audience and undertake some kind of group effort; and it means that you don’t necessarily need the hierarchical structure of a firm to do it.  This does not mean, however, that we have been immediately thrust into some kind of egalitarian paradise.  We still have businesses, and we still have big businesses. How do we explain that?

It is the effect of the internet and the web on communication that has most radically lowered cooperation costs.  One of the effects of the web has been the emergence of a link economy – one where you are more powerful if more people link to you.  In this link economy Michael’s Matthew’s Law exists:  “For everyone who has will be given more”, i.e. links beget links; the more you have the more you’ll get, the quicker you can grow and the more powerful you can become.  (Check this post out and the further reading at the bottom of it.) This is the other side of the story of the Long Tail, as many have pointed out.  Whilst the internet has enabled millions of tiny niche interests to be fulfilled and niche markets to be created, there remain major blockbusting companies, products and services.   Although, of course, not just products and services created by companies; loosely coordinated groups can emerge from below the Coasean floor to generate huge value and to challenge traditional organizations. The point is that once you start growing you can grow quickly in the internet age.  In these exponential times that much is evident.

The question for anyone looking for an egalitarian, or at least meritocratic, paradise is how much churn are we expecting to see over time in the head of this Long Tail?  Are we simply solidifying a small, new-ish, comparably static elite as has been the norm in politics and economics throughout most of history, or is the internet dramatically altering how secure those at the top should feel?  Might it be the case that the internet facilitates meteoric rises and rapid declines?

In this last year in America the political fortunes of the Democratic party might seem to suggest so.  Or rather, as I wrote in this blog post, because the communication tools of the internet are powerful and ubiquitous, and because it is so much easier to exercise an (informed) choice as a voter or a consumer, anybody seeking our loyalty cannot let up and take us for granted for even a moment.  I hope it won’t end up being the permanent tactical revolution that Obama in his State of the Union decried, but I do think political parties need to adopt a philosophy of permanent strategic, or persuasive, revolution (I’m not sure of the phrase yet, I want to develop this idea).  And the same is true of companies.  Stop fighting for my custom for a second, get a bit sloppy with your delivery, and the massive information availability and tiny switching costs of the internet age mean I can leave you in an instant.  Losing my custom to a competitor has a greater potential to snowball, pitching you into a steep decline, than ever before.

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10 thoughts on “These exponential times”

  1. Speaking of “links beget links,” I now have a few more books and articles to read — very interesting sources. I’ll admit in advance that I haven’t read of all your posts, so forgive me if you’ve already rejected any of my points.

    I agree that both of your arguments are true, but to a much smaller degree than you seem to say.

    Firstly, the notion of zero transaction costs is argumentum ad absurdum: strangers may be able to collaborate over the Internet, but organizations must still expend energy (expense) to define and convey norms, set universally agreed upon goals, and define systems of responsibility. Furthermore, game theory indicates that individuals are more likely to behave cooperatively when interactions are repeated many times. If transaction costs don’t bind individuals to projects, relationships, and collaboration, how many projects will fail for every ad hoc success?
    Shirky is right that ad hoc organizations will be able to fill a niche – as non-profits have always done. When people come together with clear expectations of less personal gain and a common goal, they are able to do things that cannot be done profitably, often with the help of donations. And that is the crux – these ad hoc organizations you cite are subsisting on donations: of time and content. It is genius to craft a service that makes people want to donate, but this will always be constrained to a small portion of the GDP. The model can’t be shifted to building uniform tangible goods, airplanes, an industry-leading search engine, or a good espresso.

    Airplanes are a touchy subject in Seattle as Boeing continues to extract itself from the area, but consider their new 787 – whereas Boeing has traditional been a very insular organization, this new plane was designed and build through unprecedented collaboration with firms across Asia, North America and Europe. It was novel, but the results were disastrous. Partners were late in delivering key components, which held up other partners; partners made mistakes; and in some cases, misrepresented their ability to perform the tasks they were contracted to perform. Boeing had to re-internalize some critical design processes. I don’t think the project was fundamentally flawed, but it was poorly executed. This was poised to be a testament to decreased transaction costs, but instead it memorializes the difficulties of collaboration. We need to be careful that selection bias doesn’t lead us to believe that ad hoc organizations are free to substantial challenges and costs.

    Saying that Google would have been an impossible creation for an ad hoc organization may be more contentious, but part of what has made Google so successful is its IP — it had a new idea that its competitors were unable to imitate. The nature of collectivization makes discovery a public good, which reduces incentives to invest. Additionally, radical discoveries provoke skepticism: although Google wasn’t utterly radical, how can you incite tens, hundreds, or thousands of people to come together for common purpose in something that may well fail, or may sound ridiculous at the time.
    In fact, many Internet “successes” were solutions looking for a problem. In many cases they didn’t know what they had built until it was finished. Many great discoveries are borne that way, but not by amorphous and multiply interested mobs. I would like to talk with Malcolm Gladwell about this – in the Tipping Point he discusses the ways products/ideas are taken up by millions seemingly without provocation, but what if that item only becomes valuable precisely because it has been taken up by millions. In fact, that was one thing I found disappointing about that book – it didn’t really discuss true tipping points, as it did discuss how fads are sparked, but that’s another comment.

    Also, what of VC? In a collectivized world, who are the investors, and who holds the ultimate risk? Twitter, Facebook, Google, etc… are fantastically expensive to operate (servers, electricity, etc…); you can’t run these companies without a startup capital. This is also true of Flickr—a thoroughly conventional organizatin, which made possibly Shirky’s evidence (London).
    Additionally, many forward-thinking traditional firms are capitalizing on the collapse of communication costs. I have friends at P&G that were given funds to set up a home office from which they can work several days a week, and they share reformatted common space while at the office. Google is a remarkably flat organization with few levels of hierarchy. I expect to see more of this.

    This is getting long so I’ll be brief. I think you’re right about switching costs, but established firms are creatively designing ways to build fuller, stickier consumer relationships: adding email to Facebook and MySpace, adding social to Gmail, customizing output, making it more difficult to output critical information (Google Orkut), etc… Also, network effects are strong in many of these services, which raises barriers to entry for providers without a novel hook.

  2. You make some good points, Jamie, and you’re right to caution against believing the world has turned, or will turn, upside down over night. You said my basic points are right, but to a far smaller degree than I imply. I think your argument underestimates that degree too much. Let’s converge on an agreement closer to my side of the argument! 😉

    You make a couple of minor points that I think are wrong but not the crux of the matter: I think the trend we’re seeing (on the social web at least) is against barriers, switching costs and network effects and towards platform and device agnostic interaction, in which data is portable. But, the bigger point, I think is…

    I don’t think zero transaction costs is argumentum ad absurdum. The pace at which social behavior adapts to new technology lags behind the pace at which that technology is adopted.
    So, I don’t agree that organizations as we know them now will still need to ‘expend energy (expense) to define and convey norms, set universally agreed upon goals, and define systems of responsibility’. What I’m most excited about is the way that those kinds of aims could be achieved by different organisational structures. And I think we’re already seeing some of that. In the political context, I can’t remember who I heard say it, but I love the idea that if you want to find the most groundbreaking political philosophy today you should observe the governance discussions surrounding Wikipedia. And creative commons licenses, for example, have altered our economic context – decentralizing the way that one particular ‘system of responsibility’ used to work. What if similar thinking was applied in other areas? What if individuals could legally come together as a collective quickly, and incorporate to undertake a particular aim – defined to a greater or lesser extent depending on the kind of incorporation? I’m excited by the potential of virtual company projects like this (I owe this thinking and this find to a Clay Shirky podcast).

    My point is that we are seeing most clearly right now an explosion of new tools that foster cooperation and collaboration. From these I think we can expect to see new forms of organization, new behaviours, new forms of social contracts and new forms of collective action that will mean that loosely coordinated groups can, perhaps not build 787s, but certainly capitalize themselves; hold and allocate risk; make effective use of IP etc…

    And, if this is the case, then I don’t think we’ll see the death of companies, but they will be drastically altered by a form of competition that can always be more agile than them.

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