In early July I participated in the 2013 Roundtable on Institutional Innovation sponsored by the Aspen Institute’s Communications and Society Program. The Aspen Institute is an educational and policy studies organization that aims “to provide a nonpartisan venue for dealing with critical issues.” It holds a variety of seminars, public conferences and other events throughout the year in its Aspen, Colorado and Wye River, Maryland campuses.
This year’s Roundtable took a close look at the impact of digital technologies on institutions and organizations. Over a number of sessions we discussed the various factors that are transforming the basic structure of companies. In particular, we explored whether the continuing advances in IT infrastructures and the accompanying emergence of a global digital economy are likely to lead to increased economic concentration or to increased economic fragmentation.
The Roundtable was sponsored by Deloitte’s Center for the Edge. The Center’s co-leaders John Hagel and John Seely Brown, recently published Institutional Innovation, an article on the evolution of organizations. A short pre-read paper based on the article was distributed to Roundtable attendees, in which the authors wrote:
“There are two dominant narratives about the institutional changes we are experiencing and neither one of them gives anyone much respite: the first is that companies will fragment to smaller and smaller entities and even down to individual providers; the second is a winner take all world where only the largest survive. We believe that both of these narratives are too simplistic. We see a world where both of these narratives co-exist and are mutually reinforcing rather than conflicting. Scale and fragmentation interact in a symbiotic relationship where the growth of each is what drives the growth of the other.”
50 years later, IT systems and networks were already having an impact on the nature of firms, although the huge impact of the Internet was still about a decade away. In 1987, MIT professor Tom Malone co-authored Electronic Markets and Electronic Hierarchies, an article that analyzed the impact of IT on business. The article concluded that “by reducing the costs of coordination, information technology will lead to an overall shift toward proportionately more use of markets - rather than hierarchies - to coordinate economic activity. . . 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.”
Professor Malone led the first session in the Aspen Roundtable. In his introductory remarks, he reviewed some of the fundamental changes in the structure of firms in our Internet-based economy, most of which he predicted 25 years ago. His remarks focused on three key drivers of change: cheap transportation, cheap communications and cheap automation. As you would expect in something as complex as the global economy, the impact of these various drivers will span the full spectrum from fragmentation to consolidation, including both larger and smaller organizations, as well as more specialization, individual empowerment and decentralized decision-making.
For example, cheap transportation means that a larger market can be served from the same location, with the resulting economies of scale leading to more large companies. But, combined with cheap communications, cheap transportation will also lead to more innovation, as individuals with access to lots of information can now feel empowered to make decisions for themselves. This individual freedom leads to innovation, specialization, economic fragmentation and the formation of lots of companies of all sorts. Work from large companies can now be outsourced to these innovative small companies.
Similarly, cheap technology and automation will lead to more digital businesses, which generally results in more natural monopolies because of network effects and thus more large companies. But, automation also leads to more outsourcing, innovation and specialization, leading to the formation of supply chains involving both large and small companies which together get the work done more efficiently than was previously possible.
I led a panel on the evolution of the firm in the digital economy. In my introductory remarks, I reminded the Roundtable participants that a firm, business or organization is not an abstract entity, but rather a collection of people working together to create value. Firms will keep expanding and adding people as long as doing so is less expensive than securing the additional services in the marketplace. But, there are limits to what can be produced efficiently within the firm, as well as to how big a firm can get and still remain competitive against faster moving companies. All that growth generally leads to ever larger, multi-layered hierarchical organizations and bureaucracies. A well managed company strives to achieve an optimal balance between what work gets done within and outside its boundaries.
The Internet has radically lowered the transactions costs of obtaining goods and services outside the firm. So, more than ever, companies need to focus their energies on their true point of differentiation instead of squandering competitive advantage by dispersing focus and investment. Given the intense, global and unpredictable nature of competition, firms need to realistically assess their strengths across the board. They need to decompose their organization into its key component parts so they can understand what is truly differentiating, - where the organization has strengths and weaknesses, - and then make decisions about how to build, buy or partner for world-class capability. They should essentially become an aggregation of specialized entities with complementary interests - expanding, contracting and reconfiguring themselves in a way that best adapts to or even anticipates market dynamics.
But, as firms are increasingly relying on business partners for many of the functions once done in-house, one of their major organizational challenges is how to best manage their distributed operations across a network of interconnected companies. This is particularly important because of the growing complexity of the products, services, systems and solutions companies are now developing. Complexity generally results in unanticipated consequences and increases the risks of something going seriously wrong.
Managing such complexities within the organization and across its ecosystem of partners should be one of the top priorities of firms. It requires not just good IT systems and well defined, data-driven processes, but also good human communications and coordination. Consequently, firms that aspire to be effective ecosystem leaders need to be good not only at managing their distributed operations; they must also have good social skills and trust-based working relationships with the various groups that comprise the ecosystem, so they can better collaborate, innovate and deal with the unexpected problems that will surely arise now and then. Given the increasing importance of the business ecosystem to a firms’s overall success, embracing a scalable leadership model through all levels of an organization facilitates extending that leadership to now apply to key external relationships as well.
In Institutional Innovation, John Seely Brown and John Hagel nicely summarize the key changes institutions must make so they can adapt to and thrive in a world of exponential change:
“Economic history to date is primarily a story of scalable efficiency. As infrastructures and technology have improved, companies have grown larger to take advantage of the benefits of scale - producing at greater volume to decrease costs and improve margins. To coordinate the efforts of larger groups of people to service larger markets, some companies create command-and-control hierarchies, rigid silos, and inflexible processes to create consistency and predictability.”
“Unfortunately, these institutional architectures have a downside: The consistency and predictability they create to promote efficiency also limit an organization’s ability to try new things or change. As such, the scalable efficiency model forces a trade-off between efficiency and the ability to learn. While institutional architectures are effective during times of stability, companies that embrace them will face extreme difficulties during times of disruption and rapid change. . .”
“Institutional innovation requires embracing a new rationale of scalable learning with the goal of creating smarter institutions that can thrive in a world of exponential change. . . Institutions that can drive accelerated learning will be the most likely to thrive in today’s environment of exponential technology change and market uncertainty. . . redefining the rationale for institutions and developing new relationship architectures within and across institutions to break existing performance trade-offs and expand the realm of what is possible.”