The Declining Power Of The Firm

I am a fan of Umair Haque‘s thinking and writing. I find it refreshingly original and often quite thought provoking. Umair’s central tenet is that we are in the midst of a groundbreaking shift from a centralized economy dominated by large "orthodox" companies to a "edge economy" dominated by end users. 

Umair’s most recent post at the Harvard Business School blog really got me thinking. If you care about business, markets, and the impact of technology on them, then the following five paragraphs are truly mind bending.

It’s simple: orthodox strategy doesn’t stop at finance. Strategy as
shadow-making, moral hazard, and market subversion is rife across the
economic landscape, from food, to pharma, to autos, to media. It’s what the industrial-era firm has hardwired into its stale, tired DNA.

If you really want to see the bankruptcy of orthodox strategy in
action, click those links – and spend a few minutes thinking about how
those industries (and more besides) have spent the better part of a century and countless billions creating more and more elaborate shadows to hide behind.

As in finance, the victimizer is becoming the victim: as interaction
accelerates, these industries are increasingly falling victim to the
games orthodox strategy so earnestly taught them to play.

Orthodox strategy was made for an industrial massconomy. And that, I
think, is the real root cause of the macro crisis: the exploding
divergence between today’s economics, and strategy trapped in a
distant, faded, rusting past – consigning firms to act out, like mute
players on a stage, moves bereft of imagination, meaning, and purpose.

The macro crisis isn’t really just about Bear Stearns and a handful
of banks: rather, as we’re all belatedly discovering, orthodox strategy
itself is no longer sustainable. For society, for people, and most of
all, for the corporation.

When I read Umair’s thoughts on this, I am reminded of Ronald Coase’s seminal paper The Nature Of The Firm in which he argues that firms exist because:

there are a number of transaction costs
to using the market; the cost of obtaining a good or service via the
market is actually more than just the price of the good. Other costs,
including search and information costs, bargaining costs, keeping trade secrets,
and policing and enforcement costs, can all potentially add to the cost
of procuring something with a firm. This suggests that firms will arise
when they can arrange to produce what they need internally and somehow
avoid these costs

What Umair is suggesting is that technology, particularly Internet technology, has changed that equation fundamentally. That the transaction and other costs are declining rapidly and the "nature of the firm" must change as well.

And I agree completely with that thinking. To me, the idea that Microsoft should purchase Yahoo! in order to build a better infrastructure for online advertising (and profit from that) is just old school thinking. What should happen is the exact opposite. Yahoo! should break itself up into a number of smaller firms that can be more agile, more nimble, and more connected to the market.

Yahoo! owns an online advertising marketplace called Right Media. In the Right Media marketplace, advertisers and publisher’s inventory come together in real time to create the optimal ad placement for the advertiser and the publisher. It’s still a immature market, even though it’s become a very big business. There is so much more than can be done and will be done in online advertising with marketplace structures like Right Media. I think a distributed marketplace model is so much more powerful than a few companies building enormous scale and dominating an industry.

Umair’s post was inspired by the mess that the financial markets are in because of big firms’ inability to understand everything that is going on inside their firms and inside the markets they trade in. It appears that our government will respond to this crisis with more regulation, fostering the creation of ever larger companies (JP Morgan + Bear), and bailouts of many of the "bad actors" who brought this crisis upon us.

But, like the government’s pursuit of Microsoft in the 90s, it will not be any of these moves that ultimately bring change to the marketplace. It will be the rise of a new way, like the open source movement fundamentally changed the software marketplace, that will bring the change that is badly needed to the financial markets.

I can’t honestly say that I have any idea how this is going to happen and I certainly don’t yet to know how to profit from it. But I want to solve both of those riddles and I know that talking about this stuff openly and honestly with all of you is a good place to start.