Monday, May 30, 2011

Early Indications May 2011: Firms, Ecosystems, and Collaboratives

The Internet and mobility are changing how resources can be organized to do work. The limited liability joint stock corporation remains useful for assembling capital at scale, which helps build railroads, steel mills, and other industrial facilities. But with manufacturing growing less important in the U.S. economy in the past 50 years, and new tools facilitating coordination and collaboration at scale without need for 20th century firms, we are witnessing some fascinating new sizes, shapes, and types of organizations. As Erik Brynolfsson noted in Sloan Management Review, we need to rethink the very nature of firms, beginning with Ronald Coase's famous theory: "The traditionally sharp distinction between markets and firms is giving way to a multiplicity of different kinds of organizational forms that don't necessarily have those sharp boundaries." Rather than try to construct a typology or theory of these non-firm entities, I will give a series of examples in which people can get things done outside traditional governmental and company settings, then try to draw some preliminary conclusions.
How do art and creativity find funding? The answers have varied tremendously throughout human history: rich patrons, family members, credit card debt, and many forms of government funding. David Bowie issued an asset-backed security with the future revenue streams of the albums he recorded before 1990 as collateral. Given the decline in the audience for buying recorded music, Moody's downgraded the $55 million in debt to one step above junk bonds: Prudential, the buyer of the notes, looks to be the loser here while Bowie was either smart or lucky (but hasn't created much art of note since 1997 when the transaction occurred).

In 2009, a new model emerged: Kickstarter allows artists and other creators to post projects to which donors (not lenders) can commit. If I want to make an independent film, or catalog the works of a graffiti artist, or write a book, I can post the project, and any special rewards to funders, on the site. Donors might receive a signed copy of the finished work, or pdf updates while the work is in process, or tickets to the film's premiere, or other reciprocation.

Donors and artists alike are protected by a threshold requirement: if the required sum is not raised, the project never launches. Kickstarter takes 5% of the funds and Amazon Payments receives another 5% cut. Once completed, the works are permanently archived on the site. The site attracted some notice in 2010 when a user-controlled alternative to Facebook, called Diaspora, raised $200,000.

While it's too early to judge the longevity or scope of the model, Time named it one of the 50 best inventions of 2010.

Software developer networks

Microsoft enjoyed a huge competitive advantage here in the 1990s. As of 2002, one estimate showed about 3.25 million developers in the Microsoft camp. None of these men and women were employees, but were often trained, certified, and equipped with tool sets by Microsoft. The developers, in turn, could sense market demand for applications large and small and build solutions in the Windows environments for customers conditioned to seek out the Windows branding in the service provider.

More recently, the App Store model has attracted developers who seek a more direct path to monetization. Apple has hundreds of thousands of applications for the iPhone and iPad; Google's Android platform has nearly as many, depending on counting methodology. Tools are still important, but rather than certification programs, the app store model relies on the market for validation of an application. Obviously dry cleaners and other small businesses still need accounting programs, or whatever, and Google can't compete with Microsoft for this slice of the business. Even so, enterprise software vendors such as Adobe, Autodesk, Oracle, and SAP must navigate new territory as the app store model, along with Software as a Service, make such competitors as and its developer program a new kind of market entrant.

The app store developers aren't really a network in any meaningful sense of the word: they don't meet, don't know each other, don't exist in a directory of members, affiliates, or prospects. There are developer conferences, of course, but not in the same form that Microsoft pioneered. The networks, particularly the app store developers, certainly aren't even remotely an extension of Apple's, Google's, or HTC's corporate organization: the market model is much more central than any org chart an be.

The market sifts winners from the mass of losers. According to Dutch app counters at Distimo, "We found that only two paid applications have been downloaded more than half a million times in the Google Android Market worldwide to date, while six paid applications in the Apple App Store for iPhone generate the same number of downloads within a two month timeframe in the United States alone." This model shifts risk away from the platform company, which gets a slice no matter which applications emerge as winners and invests nothing in losers.

Not all of these developer networks play inside the lines, as it were. Despite robust security technologies, Sony PlayStations and Apple iPhones have been "unlocked" by 3rd-party teams. The iPhone Dev Team, described by the Wall Street Journal as "a loose-knit but exclusive group of highly-skilled technologists who are considered to be the leaders among iPhone hackers," has contributed a steady stream of software kits for Apple customers to "jailbreak" their devices. The procedure is not illegal but can void certain warranty provisions. The benefit to the user is greater control over the device, access to software not necessarily approved by Apple, and sometimes features not supported by the official operating system.

Because they create value for the user base at the same time they have developed deep understanding of the technical architecture, the Dev Team and similar groups cannot be attacked too vigorously by the platform owners, as Sony is discovering in the PlayStation matter: the online group Anonymous explicitly connected the attacks (while denying that the group conducted them) to Sony's efforts to stop users from unlocking PS3s. Thus far Sony has stated that the attacks have cost $170 million.

The iPhone Dev Team, meanwhile, is so loosely organized that it functioned quite effectively, solving truly difficult technical challenges in elegant ways, even if its members did not physically meet until they were invited to a German hackers conference.
Founded in 2005, is a non-profit microlending effort. The organization, headquartered in San Francisco, recruits both lenders and entrepreneurial organizations around the world. The Internet connects the individuals and groups who lend money to roughly 125 lending partners (intermediaries) in developing countries and in the United States, and the lending partners disburse and collect the loans. Kiva does not charge any interest, but the independent field partner for each loan can charge interest.

After six years, Kiva has loaned more than $200 million, with a repayment rate of 98.65%. More than 500,000 donations have come in, and nearly 300,000 loans have been initiated, at an average size of slightly under $400 US. While the recipients often are featured on the Kiva website, lenders can no longer choose the recipients of their
loan, as was formerly the case. Still, the transparency of seeing the effect of money for a farmer's seeds, or a fishing boat repair, or a village water pump is strong encouragement to the donors, so most money that people give to Kiva is reloaned multiple times.

Kiva and other microfinance organizations challenge the conventional wisdom of economic development, as embodied in large capital projects funded by the World Bank and similar groups. Instead of building massive dams, for example, Kiva works at the individual or small-group level, with high success rates that relate in part to the emotional
and economic investment of the people rather than a country's elites, the traditional point of contact for the large aid organizations. Make no mistake: the scale of the macro aid organizations is truly substantial, and Kiva has never billed itself as a replacement for traditional economic development.

At the current time, Kiva faces substantial challenges:
• the quality of the local lending partners
• currency risk
• balancing supply and demand for microcredit at a global scale
• transparency into lending partners' practices.

Still, the point for our purposes relates to $200 million in loans to the world's poorest, with low overhead and emotional linkages between donors and recipients. 15 years ago such a model would have been impossible even to conceive.

Internet Engineering Task Force (IETF)

More than a decade ago, the Boston Globe's economics editor (yes, daily newspapers once had economics editors) David Warsh contrasted Microsoft's pursuit of features to the Internet Engineering Task Force. In the article, the IETF was personified by Harvard University's Scott Bradner, a true uber-geek who embraces a minimalist, functionalist perspective. "Which system of development," Warsh asked, "[Bill] Gates's or Bradner's, has been more advantageous to consumers? . . . Which technology has benefited you more?" Bradner contends that, like the Oxford English Dictionary, the IETF serves admirably as a case study in open-source methodology, though the people making both models work didn't call it that at the time.

Companies in any realm of intellectual property, especially, should consider Warsh's conclusion:

"Simpler standards [in contrast to those coming from governmental or other bureaucratic entities or lowest-common-denominator consensus, and in contrast to many proprietary standards that emphasize features over function] mean greater success. And it was the elegant standards of the IETF, simply written and speedily established, that have made possible the dissemination of innovations such as the World Wide Web and its browsers. . . ."

The IETF's structure and mission are straightforward and refreshingly apolitical:

"The IETF's mission is 'to make the Internet work better,' but it is the Internet _Engineering_ Task Force, so this means: make the Internet work better from a engineering point of view. We try to avoid policy and business questions, as much as possible. If you're interested in these general aspects, consider joining the Internet Society."

A famous aspect of its mission statement commits the group to "Rough consensus and running code." That is, the IETF makes "standards based on the combined engineering judgment of our participants and our real-world experience in implementing and deploying our specifications." The IETF has meetings, to be sure, and a disciplined process for considering and implementing proposed changes, but it remains remarkable that such a powerful and dynamic global communications network is not "owned" by any corporation, government, or individual.

There are several conclusions to this line of thinking.

The emergence of powerful information networks is shifting the load traditionally borne by public or other forms of infrastructure. The power grid, roads, schools, Internet service providers (ISPs) -- all will be utilized differently as the capital base further decentralizes. In addition, given contract manufacturing, offshore programming, cloud computing, and more and more examples of software as a service, the infrastructure requirements for starting a venture have plummeted: leadership, talent, and a few laptops and smartphones are often sufficient.

Rethinking size

The importance of scale can at times be diminished. For example, Jeff Vinik didn't need the resources of Fidelity Investments to run his hedge fund after he quit managing the giant Magellan mutual fund. In the 1950s, one reason a hotel investor would affiliate with Holiday Inn was for access to the brand and, later, the reservations network. Now small inns and other lodging providers can work word-of-mouth and other referral channels and be profitable standing alone.

As Linux and other developer networks grow in stature and viability, managing the people who remain in traditional organizations will likely become more difficult. What Dan Pink reasonably calls "the purpose motive" is a powerful spur to hard work: as grand challenges have shown, people will work for free on hard, worthy problems. Outside of those settings, bureaucracies are not known for proving either worthy challenges or worthy purposes.

One defining fact of many successful startups -- Netflix, Zappos, and Skype come to mind -- is their leaders' ability to put profitability in the context of doing something "insanely great," in the famous phrasing of Steve Jobs. Given alternatives to purpose-challenged cubicle-dwelling, an increasing number of attractive job candidates will opt out of traditional large organizations. Harvard Business School and other institutions are seeing strong growth of a cadre of students who resist traditional employment and more importantly, traditional motivation. Both non-profits and startups are challenging investment banking and consulting for ambitious, capable leaders of the next generation.

Revisiting Coase

In the end, the purpose of a firm, to be an alternative to market transactions, is being rescaled, rethought, and redefined. Firms will always be an option, to be sure, but as the examples have shown, no longer are they a default for delivering value. One major hint points to the magnitude of the shift that is well underway: contrasted to "firm," the English vocabulary lacks good words to describe Wikipedia, Linux, Skype, and other networked entities that can do much of what commercial firms might once have been formed to undertake.