A Fridge in the Arctic, or the Effect of Exponentials on the Firm

Just like the water that a fish swims in has profound effects on our finned friends, an exponential world, and concretely, an exponential environment and market, has profound effects on how businesses operate.

One of the foundational articles in business theory was published a long time ago, in 1937, by Ronald Coase. Despite that, the paper got pretty much Coase the Nobel Prize in Economics (technically, the Nobel Memorial Prize in Economics Sciences), and it has been cited more than 40,000 times, "The Nature of the Firm" hasn't been an overly popular article among the general public, but it offers an economic explanation on why individuals prefer to form partnerships, companies, and other businesses rather than just trading in a market bilaterally. The Nature of the Firm argues that the main reason why these organizations exist and get formed, is because they allow smaller transaction costs within the walls of the organization than outside of them. Firms are basically transaction efficiency machines.

These transaction costs must be understood in a relative fashion and also as highly technology-dependent. The ownership of certain technologies plays a disproportionate role in this relative cost. I will use the example of music production and the recording industry. Some time ago, real empires were forged around the ownership of the recording studios, the hundreds of thousands of equipment inside them, and the ability to press vinyl records and distribute them. The riches produced by this industry were vast and reserved for a few insiders. Because of this, there were also huge barriers to entry for independent labels, and self-production was mostly nonexistent.

But the nature of technologies is such that as they become more powerful, they also become more widely available, and consequentially, products and services produced or aided by these technologies become better quality, less expensive, and appear on the market faster. Throughout several decades, the recording industry was affected by technology trends. Today, a musician, even an aficionado, can put together a fairly competent studio at home with a few thousand dollars and doesn't have to invest any money in getting their content on an online platform.

The point is, the recording industry was doing great, they did not have to "do" anything to change their reality. The externalities took care of that.

As technology trends accelerate, and especially if there is Digitization involved, changes enter into an irreversible spiral. In general, the six trends (or six "Ds") identified in Exponential Organizations start to feed on each other. Four of them are particularly important in the context discussed and are summarized here:

Digitization:

With digitization, assets, once digitized, are easier to replicate, usually with no degradation and with a very low marginal cost. Making one more copy of something costs almost zero. They are also easier to transmit to deliver to someone else without degrading either. The fact that it is easier to make perfect and inexpensive copies not only allows the copies to exist in different places simultaneously but also at different times, at the convenience of the consumer.

Time and place are no longer a barrier.

Dematerialization:

The act of digitization has further consequences. Once a digital incarnation of something carries with it the perception and the experience of the actual thing, it becomes the actual thing. Dematerialization may not happen with every instance of digitization, but there are a few examples that cannot be ignored.

As a few examples, we may still have some actual cash in circulation, but the vast majority of money is a number on a ledger, and these numbers are much more important than the pieces of paper we may have in our wallets. Money has been dematerialized to the extent that the way most governments create new money in their sovereign currency is just by changing those numbers on the ledger. Nothing has to be printed or minted. Another example may be the way we currently do authentication (identification). When we sign up for any service, we may have to establish our identity in person or by telephone -to the extent of guaranteeing payment-, and in the process, we may provide an email address. From there on, we are off to the races. Every time we are required to transact, we have to provide proof that we can access the systems through those credentials, and if for any reason something goes astray, we may have to demonstrate that we have access to that email address we provided at the beginning. Having access to the email address is proof that we have access. Email becomes identity.

The commodity a firm deals in is not relevant. What counts is what the customer values.

Demonetization:

Digitization can take things even further. The flexibility allowed by digitization and the introduction of innovative business models allows for decoupling revenue from the traditional model. Models like subscription-based use, "freemium", and advertising eventually drive some services to be demonetized. The disruption this can generate for organizations attempting to stick to the traditional models can be significant.

Exponentials have the capacity to wipe out complete business models.

Democratization:

Once something is dematerialized and demonetized, it becomes available to most people. Anybody around the globe can access the digital platforms we have built sometimes for free. The level of democratization is such that some governments have to go out of their way to prevent their citizens from accessing these platforms. The consequence of democratization, besides the fact that it makes things massively distributed and that whatever disruption was being created through the business model employed is amplified, is that it universally levels the playing field and makes tremendous resources available to everybody on the planet, lifting them up, allowing them to be more effective in what they do and have more impact, which feeds into the ecosystem of innovation and progress forward.

Abundance shifts where, when, and how value is created.

While these are amply discussed in Exponential Organizations, I have listed these out for context and to be able to refer to them to show how they affect a firm's competitiveness.

In general, the exponential trend towards better, cheaper, and faster also reduces the transaction cost for everybody, regardless if they are inside the walls of a firm or not, and works like a great equalizer, effectively rendering the advantage of transacting inside the firm basically null.

Once this point is reached, the competitiveness, and arguably the reason for the existence of the firm, disappears.

The new firm as a village

Let's imagine a scenario where we have "freelancers" (to call them somehow), and these freelancers have access to tools and resources that formerly only the biggest and most capable corporations had access to. Also, let's make those resources and tools available on a "pay as you go" basis, or even better, for free. These tools would include everything that is required to perform the work: software, actual tools, vehicles, etc., even including manufacturing facilities that could be used to produce one unit. This scenario is not that difficult to imagine now that we have sophisticated time management software, open source tools, etc., available for very little cost or for free, and that there is 3-D printing capable of making working parts in a few minutes.

Among these "freelancers," you may even find legal professionals structuring contracts for a project, HR specialists hiring other freelancers, and managing their benefits as part of their compensation package. I may ask, setting aside important things like the management of intellectual property and others we may come up with: What's the difference between this and a large corporation? In this scenario, this "motley crew of misfits" would be able to compete effectively with any corporation for any project.

In essence, in this scenario, it is easy to see how the capacity of traditional organizations to create (and accumulate) value is challenged in an exponential environment. However, organizations must accelerate their operations to stay ahead of the curve, to guarantee that they continue to provide value and subsist. The only way for organizations to continue to exist and to stay competitive is to embrace the attributes that create these exponentials and become exponential themselves.

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