Inbetween

A meteor smashes into the planet (so the thinking goes) and almost overnight the game changes.The dinosaur, as dominant and powerful as it was at the time,  simply ceased to be a good fit for its environment. Evolution wasn’t selecting for the biggest , most powerful or most impressive beast,  just the best at surviving.  When the dinosaur’s environment was suddenly changed, its scale and size must have switched from advantage to disadvantage.  Whatever the specific cause, the rules of the game changed and the dinosaur was no longer fit for purpose. So it ceased to be.

Most people know that nothing is forever. Yet still, we find that if things stay the roughly the same for say 20 years, many people forget it was ever different and those in their 30s have never known anything different. It becomes the way things are.  The assumptions about the way things are soon become invisible, we don’t even notice the assumption……until things change that is. That is why it is so important to have a sense of history, of the way things have been as well as how they are.

Mental models once solidified can take a long time to change. There is an old saying that science advances one death at a time. That is the mental models and established reputations of scientists make it almost impossible for them to adopt a new paradigm. It is the up and coming generation that takes on board the new ideas and at some point they become the majority.  It is worth keeping in mind that what ever our mental model is, eventually it is likely to turn out to be wrong.

I am not an expert in the history of political economy, especially Marxism, but it provides an important background to understand the possibilities of tomorrow so I’ll invoke them anyway and take the chance of mistakes.

For a long time economists refined Adam Smiths ideas into ever more perfect models of equilibrium economics, equations borrowed from classical physics. If only you knew the exact staring conditions you could calculate exactly the best way in which labour, land and capital should be used for the greatest good. If you don’t  have enough spades, having more spades is progress.

This was the prevailing model that Marx used to extrapolate into the future when charting the domination of man on man through the ages and his view of where capitalism would ultimately lead.
Here is an extract from The Communist Manifesto - 1848

Owing to the extensive use of machinery, and to the division of labour, the work of the proletarians has lost all individual character, and, consequently, all charm for the workman. He becomes an appendage of the machine, and it is only the most simple, most monotonous, and most easily acquired knack, that is required of him. Hence, the cost of production of a workman is restricted, almost entirely, to the means of subsistence that he requires for maintenance, and for the propagation of his race. But the price of a commodity, and therefore also of labour, is equal to its cost of production. In proportion, therefore, as the repulsiveness of the work increases, the wage decreases. Nay more, in proportion as the use of machinery and division of labour increases, in the same proportion the burden of toil also increases, whether by prolongation of the working hours, by the increase of the work exacted in a given time or by increased speed of machinery, etc.

Given the prevailing understanding of political economy at the time I can understand why it may have seemed inevitable that capital  and therefore power would be concentrated in fewer and fewer hands, worker exploitation being the main means to reduce costs.

In fact, Marx was viewing economics as a zero sum game where for some to get ahead it had to be at the expense of others. In addition, Marx understood that technology was advancing but could not foresee the massive rising need for a highly educated population to make more technical advances, put to good use those advances  once made and the huge effort required to educate the population to highest level to enable them to participate productively in a high technology economy.

In a nut shell, it wasn’t until well into the middle of the 20th century that the true driving force of economic growth became clear. It turns out that it was not more spades we needed for economic progress, we needed to invent the JCB!!  Economists realised that innovation was the central driving force that explained most of the economic growth that had occurred.
Even so it wasn’t until 1990 with Paui Romer’s paper “Endogenous Technological Change” that economist could finally build technology change into their models of economic growth.

In this model, it is simply not the case that capitalism requires exploitation of workers at the bottom in order to succeed (although that may happen). The idea that for some to win big, they must have exploited others is a deep mental model we carry. If you still can’t shake that idea, try listening to this podcast by Russ Roberts from the Library of Economics and Liberty.

Now economists see the economy as complex and adaptive, not an equilibrium system at all.  It is better understood as an evolutionary system where different business models (which are like the DNA)  and businesses (which are like the creatures) compete in an environment (the free market economy) for survival.

That environment is shaped by the resources of the world that can be drawn upon. These include the physical resources but also the ideas and human skills in existence.  That environment  changes as we make more discoveries and put them into practice through innovation.

So now we can see the anatomy of disruption. Technology change alters the environment in which a business is competing. If the change is a small increment, then a company may be able to adapt and even thrive on the change. But here is the kicker: adopting a new technology takes time. There is a lag between when something becomes possible and when something becomes diffused. So it might have been pretty cool to have the first fax machine, but not a whole lot of business benefit. However, when most businesses had fax machines, it became damaging not to have one when everyone else did. This inertia (the technology adoption curve and network effects) which can be understood quite well through game and network theory, tends to mean that big technology change hits us in waves.

This rapid change of environment is often referred to as disruption. It starts slowly but then tips very quickly and often changes environment in such a way as to invalidate some of the existing business models. These businesses get disrupted.
These disruptions are happening all the time and the phenomena is well documented in Clayton Christian’s best selling  Innovators Dilemma.

And technology change is not only concerned with physical technology such as Morse’s law which is based on the physical technology of semiconductors. It includes the open source movement which is at heart a social technology  as was the invention of the limited liability company and the rule of law. Without these social technologies the economy can’t even function. It would seem though that social technologies change very sloooooooowly.

But the impact of all technology changes is not equal. Technology changes which alter our capabilities to collaborate and coordinate or innovate have profound effects. The very existence of companies and their structure and size is a function of the costs of coordinating activities. Check out Coase The nature of the firm 1937 for a detailed explanation. Coase considered the question of why there should be a firm at all if the market is such an efficient way to organise production. Inside a company we do not use the price mechanism, why? Basically there is a transaction cost to sourcing from the market. Whenever it is more expensive to contract out work than to hire and train internally, the company will grow in size.

In short, the economic efficient size of companies in the economy is based on the relative costs to organise an activity internally using command and control versus contracting for that activity in the market. For example, most companies no longer have a fleet of delivery vans, they contract with UPS or FedEx etc.

We saw a macro economic effect from the simple technology of containerisation. By lowering the cost of international shipping, it became far more effective for many companies to outsource manufacturing to countries with lower costs and ship the goods back to the consuming market. Thus the economic efficient size of these companies became smaller.

When the costs of coordination between companies falls, we see an increase in the modularity of the business i.e. a white label manufacture allows many companies access to the marginal costs of manufacture without the need to fund the whole cost of the capital to build a factory of there own i.e. modularity.

An increase in modularity fundamentally changes where the value lies in an industry. For example, the modular architecture of the PC moved nearly all the value out of assembly and into the components (Nvidia graphics card, intel processor anyone) or the layer above, the operating system.

So what about mass extinction of big business?

For the last 150 years,  communications technology progress has been essentially a centralising force. The high costs of capital, the complexity, the skills required to maintain and operate and above all else, the high costs of integration and interoperability have all lead to technology being concentrated in the hands of large companies or government.
The high speed printing press, television, radio, mainframe computers, CRM\ERP systems.  Because only companies of a certain scale could build sophisticated technology infrastructures, it gave a major scale  advantages to big business.

It had become easier and easier to organise complex and efficient processes internally within an company and had been very expensive to use technology to organise activities across multiple disparate organisations. Very small companies had no real ability to put information technology to work to efficiently between themselves at all.

There were significant scale advantages to being bigger.

But here comes the meteorite. About 15 years ago this process of centralisation was thrust violently into reverse with the advent and adoption of the web. It is really only just starting to get under way now and still is mainly allowing humans to work with each other better. Then next wave of web evolution (the semantic web & SaaS) will allow data and software to break out of the centralised silos and radically reduce the costs of using information technology to organise business activities across many firms NO MATTER HOW SMALL!!!!

It is my view that we are at the beginning of a radically new level organisational sophistication. It will become possible for businesses to become far more modular, opening their capabilities up to reuse by many other companies (this is exactly what Amazon is pioneering with its Warehouse on demand, S3, EC2 etc).

Small companies working together in flexible sophisticated networks,  the topologies of which are determined by demand should be able to outperform a large more monolithic traditional industrial age organisation.
In fact, it may well be that all the investment in technology infrastructure that was such a scale advantage, may in short measure, become a scale disadvantage.

With an increase in modularity there should be a reduction in the capital required to start a business as more functions can be done on a marginal basis through outsourcing than on a capital intensive basis. We see this at the margins today with extremely small businesses built on the facebook platform or Amazon platform.

So I find it hard to see why the technology direction is not going to create a vast increase in the number of smaller businesses and a shift away from big business.

The economic system is not interested in selecting the biggest and most profitable businesses.  The ability to make large centralised profits is not a right, it is just a possibility under certain circumstances.
Take the many small open source businesses. Almost none of them will ever become large or generate huge profits. But they don’t have to, as long as the owner workers are happy with the modest amounts they make, then these small businesses will exist. If, as a side effect, that undermines the market for  a large centralised propriety software business, that is just tough.

Lowering the barrier to starting businesses and there being many more businesses in total should accelerate the rate of economic evolution. More experiments to select winners from.

And, much smaller companies raise the possibility of being employee owned in a meaningful way (not like having a few shares in a multi-national public company). 

To go out on a very optimistic limb :-)
Is there perhaps a resolution to the age old dialectic between worker and owner?
Is there here the possibility of resolving the bourgeoisie domination of the proletariat (in socialist language)?

When company size is small and talented individuals not capital is the scare resource needed, then maybe bourgeoisie and proletariat become one and the same. Small employee owner companies rather than factory committees. Not a revolution in which one form of class domination is replaced by another, but an evolution which dissolves domination itself?  If, in addition, the barrier to a worker starting their own company is much lower, then this should raise the market rate for the workers skills since if the rate or conditions are not good enough, the worker will strike out on his own. Socialism and capitalism reconciled??

Hmmm maybe to much red bull. But ultimately Marx’s view of bourgeoisie domination only holds true when the means of economic production are not available to all. In the information economy at least, the means of production is already in the hands of the worker.

I don’t know if this does mean mass extinction for big business, this is a complex topic. But I find it impossible to think that such fundamental changes in information technology will not mean fundamental changes in business.