I’ll tell you a bit about strategy andits relationship to technology. We tend to think of business strategy as a rather abstract body essentially of economic thinking, perhaps rather timeless. I amgoing to argue that, in fact, business strategy has always been based on assumptions about technology, that those assumptions are changing,and indeed changing dramatically, andthat is therefore going to lead us to a different concept of what we mean by business strategy.
I will begin, if I may, with a bit of history. The idea of strategy in business owes its origins to two intellectual giants: Bruce Henderson, founder of BCG, andMichael Porter, professor at Harvard Business School.
how will data transform business?
Henderson’s central idea was what we might call the Napoleonic idea of mass concentration against weakness, of overwhelming the enemy.What Henderson identified was that, in the business world, there are many phenomena characterized by what economists would call increasing returns: scale, experience.
The more you do something, disproportionately you get the better. And so hecame up with a rationale for investing in such kinds of overwhelming mass in order to achieve competitive advantage.And that was the first introduction of an essentially military concept of strategy into the business world
Porter agreed with that premise, but qualified it. He pointed out, correctly, that that’s all well and good, but companies really have multiple steps to it. They have different components, andeach of those components might be driven by a different kind of strategy. A company or a business might actually be favored in some activities, but disadvantaged in others.
He formulated the concept of the value chain, essentially the sequence of steps by which a, say, raw material, becomes a component, which is assembled into a finished product, andthen distributed, for example, andargued that the cumulative advantage toeach of those components, andthe advantage of the whole was, in a sense, the sum or the average of that of its parts
And this idea of the value chain is based on the recognition thatwhat holds a business together is transaction costs, which, in essence, are needed to coordinate, that organizations are more efficient at coordinating than markets, very often, andthat therefore the nature and role and boundaries of cooperation are defined by transaction costs
It was on these two ideas, Henderson’s idea of increasing returns toscale and experience, andPorter’s idea of the value chain, with heterogeneous elements, that the whole edifice of business strategy was subsequently erected
Now, what I argue is that those premises are, in fact, invalidated. First, let’s think about transaction costs.
There are actually two components to transaction costs.one, information processing, and the other is about communication. These are the economics of processing and communicating as they have evolved over a long periodof time
As we all know from so many contexts, these have been radically transformed since the days when Porter and Henderson first formulated their theories. In particular, since the mid-1990s, communication costs have been falling even faster than transaction costs, which is why communication, the Internet, has exploded so dramatically
Now, falling transaction costs have profound consequences, because if transaction costs are the glue that holds value chains together, and they are falling, there is less to economize. There is less need for a vertically integrated organization, andvalue chains, at least, can be broken. Not necessarily, but they can. In particular, it then becomes possible for a competitor in one business to use its position in a single link of the value chain in order to penetrate or attack ordisintermediate the competitor in another
That is not an abstract proposition. There are many specific stories about how it actually happened. An illustrative example is the encyclopedia business. The encyclopedia business in the days of leather bound books was basically a distribution business.
Most of the cost was commission to the sellers. Then came the CD and then the Internet,new technologies that make the distribution of knowledge cheaper by many orders of magnitude andthe encyclopedia industry collapsed. It is now, of course, a familiar story. More generally this was, in fact, the story of the first generation of the Internet economy. It was about falling transaction costs breaking down value chains and thusenabling disintermediation, orwhat we call deconstruction
One of the questions I was asked from time to time is, well, what will replace the encyclopedia whenBritannica no longer has a business model? Andit was a little while before the answer manifested itself. Now, of course, we know what it is: it’s Wikipedia.
What is special about Wikipedia is not its distribution. What is special about Wikipedia is the way it is produced. Wikipedia, of course, is an encyclopedia created by its users. Andthis, in fact, defines what we might call the second decade of the Internet economy, the decade in which the Internet as a noun became the Internet as a verb
It became a series of conversations, the era when user-generated content and social networking became the dominant phenomenon. What really meant in termsof the Porter-Henderson structure was the collapse of certain types of economies of scale
It turns out that tens of thousands of self-employed individuals writing an encyclopedia could do just as good a job, andcertainly much cheaper work, than professionals in a hierarchical organization. So basically what happens is that a layer of this value chain began to fragment, as individuals took over where organizations were no longer needed
But there’s another question that obviously this chart raises, which is, okay, we’ve gone through two decades... does anything distinguish the third one? Andwhat I’ll argue is that, indeed, something distinguishes the third one, andit corresponds exactly to the kind of Porter-Henderson logic that we’ve been talking about. Andit’s about data.
If you go back to around 2000, a lot of people were talking about the information revolution, andit was true that the world’s stock of data was growing, in fact growing very fast. But they were still at that point overwhelmingly analog. We go forward to 2007, not only did the world’s stock of data explode, there had also been this massive substitution from digital to analog
And even more important than that, if you look more closely at this chart, what you’ll see is that about half of that digital data is information that has an IP address. It’s on a server or it’s on a PC. But having an IP address means that can be connected to any other data that has an IP address. It means that it may be possible to gather half of the world’s knowledge to see patterns, a whole new thing
If we follow the numbers forward to today,you’ll probably see something like this. We’re not really sure. If we crunch the numbers to 2020, of course, we have an exact number, courtesy of IDC. It’s funny that the future is more predictable than the present. Andwhat it implies is a hundredfold increase in the stock of information that is connected through an IP address
If the number of connections we can make is proportional to the number of pairs of data points, a hundredfold multiplication in the amount of data is a ten thousandfold multiplication in the number of patterns we can see in that data, this just in the last 10 or 11 years. This, I would say, is a radical change, a profound change in the economics of the world we live in
The first human genome, that of James Watson, was billed as the culmination of the Human Genome Project in 2000, and itcost about $200 million andabout 10 years of work to map the genomic makeup of a single person.
Since then, the costs of mapping the genome have come down. In fact, they have come down in recent years very dramatically,to the point where the cost is now below $1,000, andit is confidently predicted that by 2015 it will be below $100, a drop of five or six orders of magnitude in the cost of genomic mapping in just a 15-year period, an extraordinary phenomenon
In the days when mapping a genome cost millions, or even, hundreds of thousands, was basically a research task. Scientists would gather a few representative individuals, andlook for patterns and experiment andmake generalizations about human nature and disease from the abstract models they found from these particular selected individuals
But when the genome can be mapped for $100, $99 while they wait, then what happens is that it becomes retail. It becomes mostly clinical. They go to the doctor with a cold, andif they don’t have it yet, the first thing they do to them is map their genome, to the point where what they are now doing is they are no longer starting from some abstract knowledge of genomic medicine andtrying to figure out how it would apply to you, but you are starting from your particular genome. Now think about the power of that
Think about where takes uswhen we can combine genomic data with clinical data with data on drug effects with data from the environment that devices like our phones and medical sensors will increasingly collect. Think about what would happen when we gather all that data andput it together in order tofind patterns that we didn’t see before. This, I suggest, maybe it will take a while,but it’s going to lead to a revolution in medicine. Fabulous, a lot of people are talking about this
But there’s one thing that doesn’t get a lot of attention. How is that model of colossal sharing of all kinds of databases compatible with the business models of the institutions and organizations and corporations that are involved in this business today? If your business is based on proprietary data, if your competitive advantage is defined by data, how is that company or that corporation going to achieve the value that is implicit in the technology? They can’t.
So essentially what is happening here, andgenomics is simply an example of this, is that technology is taking the natural scale of activity beyond the institutional boundaries within which we have become accustomed to thinking, and, in particular, beyond the institutional boundaries in the terms that business strategy is formulated as a discipline.
The basic story here is that what used to be vertically integrated, oligopolistic competition between essentially similar types of competitors, is evolving, by one means or another, from a vertical to a horizontal structure. Why is that happening? It is happening because transaction costs are plummeting andbecause scale is polarizing. Plummeting transaction costs weaken the glue that holds value chains together, andallows them to separate
Polarizing economies of scale toward the very small, “small is beautiful,” allows scalable communities to replace conventional corporate production. Scaling in the opposite direction, toward things like big data, drives business structure toward creating new kinds of institutions that can achieve that scale. But either way, typically vertical structures allow them to become more horizontal
The logic is not just about big data. If we were to look, for example, at the telecommunications industry, can tell the same story about fiber optics. If we look at the pharmaceutical industry, or, for that matter, university research, you can tell exactly the same story about so-called “big science.”
And in the opposite direction, if we look at, say, the energy sector, where there is only talk about how households will be the efficient producers of green energy andefficient conservers of energy, which is, in fact, the reverse phenomenon. That is the fragmentation of scale because the very small can replace the traditional corporate scale
Anyway, what drives us to this horizontalization of the structure of industries, andthat implies fundamental changes in how we think about strategy. It means, for example, that we need to think about strategy as the cure for these kinds of horizontal structures, where things like the definition of business andeven more so the definition of industry, are actually the result of strategy, not something that strategy presupposes.
This means, for example, that we have to work on how to accommodate collaboration andcompetition simultaneously.Think about the genome. We have to accommodate the very large andthe very small simultaneously. And we need industrial structures that accommodate the very, very different motivations, from the amateur motivations of people in communities to, perhaps, the social motivations of infrastructure built by governments, or, for that matter, the cooperative institutions built by companies that would compete in another scenario, because that’s the only way they can get to scale
These kinds of transformations make the traditional assumptions of business strategy obsolete. They lead us into a whole new world. They need us, whether we are in the public sector or the private sector, to think in a fundamentally different way about the structure of business, and, finally, it makes strategy interesting again.