Opinion by Richard Adler

What a networked society means for businesses

As connecting to everyone becomes easier, big companies will get bigger, even as they’re confronted by a proliferation of small, specialized firms

Opinion by Richard Adler

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Does the growth of networks that make it easy for everyone to connect to everyone else encourage greater concentration of business enterprises (i.e., the big get bigger) or greater fragmentation (the proliferation of many small, specialized firms)? The answer to this question, it turns out, is “yes.”

On one hand, ubiquitous broadband networks are enabling organizations to grow by expanding the scope of their operations — sourcing inputs from everywhere, collaborating with partners anywhere, and selling goods or services globally. On the other hand, the evolution of computing and communications technologies is dramatically lowering the barriers to entry for new competitors, leading to disruption in almost every business sector.

But which way is the wind blowing? What determines whether more networking favors more concentration or more fragmentation? Way back in 1987, at the dawn of the networked age, three scholars — Tom Malone, Joanne Yates and Robert Benjamin — published a study that explored this question. 

In their study, titled “Electronic Markets and Electronic Hierarchies,” the authors identified two different ways of “organizing economic activity”: markets that coordinate the flow of goods or services through the process of negotiation among a disparate group of buyers and sellers, and hierarchies that manage the flow of goods and services within an established structure (such as a single firm). And they also described two different elements that determine the final cost of goods or services: production costs that are required to actually create a product or service and coordination costs that are involved with acquiring inputs and distributing the outputs of production.

Production costs are typically lower in markets where different sellers compete for a buyer’s business, and higher in hierarchies where competition is absent. At the same time, coordination costs are generally higher in markets, because of the greater effort required to gather information from multiple potential suppliers, and lower in hierarchies, where less negotiation is needed.

Relative Costs for Markets and Hierarchies

Organizational Form Production Costs Coordination Costs
Markets Low High
Hierarchies High Low

The study concluded that “new information technologies” will benefit both markets and hierarchies by making them more efficient. But because coordination is dependent on “communicating and processing information,” it is likely that information technology will have greater impact on markets than hierarchies, thereby helping tip the balance from the latter to the former. While firms should explore how networks can improve the efficiency of their hierarchical processes, they should also consider how they might participate in — or even create — new electronic marketplaces. 

The study ends with a vision of far-reaching change:

If our predictions are correct, we should not expect the electronically interconnected world of tomorrow to be simply a faster and more efficient version of the world we know today. Instead, we should expect fundamental changes in how firms and markets organize the flow of goods and services in our economy.

Looking ahead

Nearly three decades after the publication of this study, its lead author, Tom Malone, along with a group of other scholars, entrepreneurs and business leaders, got together to consider just how the world has changed and, more importantly, how it is likely to change in the future. In a workshop sponsored by the Aspen Institute Roundtable on Institutional Innovation, they explored the question of what we know now about the likely impact of networks on the fragmentation or the concentration of business activities.(For a more detailed report on this meeting, see Richard Adler, Fragmentation and Concentration in the New Digital Environment, the Aspen Institute, 2014.)

In the age of networks, the scale of international corporations and the speed with which they are able to grow have clearly never been greater. At the same time, the availability of a virtually unlimited array of resources in the cloud (including data storage, whose cost is rapidly approaching zero) has meant that startups can get started much more rapidly and with much lower capital requirements than in the past. Stories about disruptive new businesses that were launched in a garage or a dorm room are a familiar trope that illustrates how much technological progress has changed the rules of the game for new businesses. 

It is becoming increasingly apparent that an “either/or” answer to the question of fragmentation vs. concentration is inadequate to explain what is happening. The really interesting question is not which trend will prevail but how these two seemingly opposite trends are interacting and even reinforcing each other. 

The rise of platforms

The synergy between the two can be seen most clearly in the concept of the platform, which is one of the most distinctive manifestations of the new networked world. Platforms are typically created by one entity but are made widely available for others who use them to build and distribute their own products. As a platform becomes more popular and extends its reach, it can become a de facto standard that further reinforces its dominance. Because of their scale, platforms generally require a large organization to build and maintain them. But their success depends on their ability to attract and sustain a multitude of small entities. Effective platforms serve as catalysts for the creation of an ecosystem of separate but interdependent entities that interact with one another through the platform in pursuit of their individual goals. 

The Internet itself is an example of a platform that has provided an ideal medium within which innovations can be developed, launched and disseminated. In the case of the Internet, no single entity owns or controls it. But other highly effective platforms have been built and operated by a single party. Some are operated on a nonprofit basis to facilitate non-commercial sharing: for example, Wikipedia, which promotes information sharing, or Github, which enables the sharing of open-source software. 

Other platforms are very much part of profit-making enterprises. In fact, much of the success of the four dominant global tech companies known collectively as GAFA (Google/Apple/Facebook/Amazon) has been based on their success as platform providers. Google’s Android and Apple’s iOS mobile operating systems are platforms that allow developers to reach the majority of smartphone users; Facebook provides a platform that has enabled millions of individuals to build social networks; and Amazon’s Web Services has become a platform that both large and small companies depend on for access to cloud-based resources. 

Each of these massive companies has the scale to maintain a robust, reliable platform. And it is probably not accidental that each company and its platform is embodied in the person of a charismatic leader: Sergey Brin at Google, Steve Jobs (and more recently, Tim Cook) at Apple, Mark Zuckerberg at Facebook, and Jeff Bezos at Amazon. (Other examples include Marc Benioff at Salesforce, Larry Ellison at Oracle, and Jimmy Wales at Wikipedia.) An important role for these individuals is to assure platform users that if something goes wrong, they will take responsibility for fixing it.

Peers, Inc.

In a book to be published this month, Robin Chase, the founder of Zipcar, argues that as a result of the growing power of network-based platforms, we are seeing a remarkable “phase shift” from the traditional hierarchical model of the firm, which prevailed for more than a century, to a new model, which she calls Peers, Inc. (Headline Book Publishing). In the old model, the driving motivation was to become as big as possible to reduce transaction costs and realize the benefits of scale economies. In the emerging collaborative economy, we are seeing the emergence of a new model that combines the best features of both large and small entities.

Large companies have the resources to finance big, multiyear projects that involve many diverse parts, and they have the ability to establish rules regarding standards and consistency. At the same time, smaller participants can deliver localization, specialization and customization that larger entities cannot easily provide. By working together, each side in the partnership can provide what the other side cannot or does not want to do. The result is a new organizational structure that can deliver innovation at low cost, use resources efficiently, and can scale very quickly. 

To illustrate the power of this new model, Chase cites the example of the lodging industry, which has traditionally been dominated by a few multinational chains. For example, over a period of 93 years, Hilton Worldwide built a network of 4,100 hotels (under brands such as Waldorf Astoria, Hilton Hotels, Doubletree and Embassy Suites) that provide a total of 610,000 rooms in 91 different countries. In 65 years, the Intercontinental Hotels Group was able to build 4,400 hotels under several brands (Intercontinental, Crowne Plaza, Holiday Inn, Candlewood Suites) that operate in 100 countries and offer 645,000 rooms. 

But in just the past five years, Airbnb has been able to assemble a global network of 650,000 rooms in nearly 200 countries. And Couchsurfing, founded in 2003 as a not-for-profit organization (and operated since 2011 as a “mission-driven for-profit corporation”), now provides access to 2.5 million rooms located in more than 200 countries by matching travelers with hosts who offer free lodging in their homes.

Unlike the traditional hotel chains that have to build and operate (or franchise) their own facilities, these services have figured out a way to make more efficient use of an existing resource (private residences). Car services such as Uber and Lyft represent another version of this model. Rather than creating new capacity, they have created platforms that leverage the infrastructure of the Internet to match people with excess capacity with other people who can make use of that capacity. In other words, their value-added is software not hardware.

Back to 1987

The same year that the paper by Malone and his colleagues appeared, another prescient study was published. As part of the first “Triennial Review” of the breakup of the old Bell System, Peter Huber, a lawyer who held a doctorate in electrical engineering, was commissioned to examine the impact of evolving communications capabilities on the state of competition in telecommunications. The result was a 600-page report titled The Geodesic Network that turned out to be a surprise best seller (the first edition quickly sold out and had to be reprinted by the Government Printing Office).

Huber’s main conclusion in the report was that the proliferation of computer-based intelligence was having a transformative effect on the architecture of the national public telecommunications network. According to Huber, the network was evolving from a hierarchical structure to one that resembled a geodesic dome in which control was increasingly distributed among multiple participants and end users. 

While the primary focus of the report was the old public switched telephone network (PSTN), Huber recognized the rapidly growing importance of computer-driven data services and stated that “getting the regulation of data communications right will be enormously important for economic prosperity and national security in the age of information.”

Since then, technology has continued to evolve to the point that we need a fundamental paradigm shift in how modern communications platforms and services are governed. The time has come for a new Communications Act that recognizes we now live in a world where Internet Protocol networks are not just the preferred platform for innovators, but also the dominant medium through which the majority of Americans communicate by voice, text, video and other electronic means.

Instead of continuing to apply differing regulatory schemes to different media based on the legacy of how they came to exist, a new Communications Act should treat them consistently, since they all deliver comparable Internet-based services. By abolishing outmoded regulatory silos, a new Communications Act can help create an environment that will foster the growth of platforms that support greater collaboration.

Huber’s nearly 30-year-old vision of a geodesic network remains an excellent image for the new network-driven economic environment that is simultaneously encouraging the growth of very large entities that provide far-reaching platforms and a multitude of small entities that depend on these platforms for their success. Now we need a regulatory framework that is appropriate to this reality.

Richard Adler is a distinguished fellow at the Institute for the Future in Palo Alto, Calif. He has written widely about the future of broadband and its impact on fields such as education, healthcare, government and commerce.


Copyright © 2015 IDG Communications, Inc.

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