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Corporate dealings with the network economy
ARTICLE IN PRESS FUTURES Futures 38 (2006) 1103–1118 www.elsevier.com/locate/futures
Corporate dealings with the network economy Wim J. de Ridder,1 Department of Business, Public Administration and Technology, University of Twente, P.O. Box 217, 7500 AE Enschede, The Netherlands Available online 19 April 2006
Abstract Many companies seek increasing returns and survive only by continually restructuring their organizations. Technological developments, changes in consumer behavior and economic drivers accelerate this process. Companies that want to deal with these phenomena, have to take into account the characteristics of the network economy. This article shows how, depending on the type of network, a corporate strategy with regard to research & development activities, production, sales and finance can be built. The conclusion is that the expected continued rise of the network economy will change the corporate landscape dramatically. Customers, searching for self-actualization, will succeed in their endeavor more often, and so will the companies that are most connected with the stakeholders in the networks in question. r 2006 Elsevier Ltd. All rights reserved.
1. Introduction Companies create new business opportunities by developing products and opening up markets. At the same time, they are continually reorganizing to cut costs and withstand competition. These two processes are influenced by the formation of networks, which is so characteristic for the network economy. This article focuses on network formation and network economy. First, some relevant statements (laws) are examined. Subsequently, technological, economic and socio-cultural developments that amplify these mechanisms, so-called drivers, are discussed. Then, some
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0016-3287/$ - see front matter r 2006 Elsevier Ltd. All rights reserved. doi:10.1016/j.futures.2006.02.014
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strategic company decisions are considered, which these drivers affect. Finally, some conclusions are drawn which apply to the business sector as a whole. 2. Patterns of network formation The Spanish sociologist Manuel Castells has stated that the current technological revolution is transforming the way we think, the way we produce, consume, communicate, act, live and even the way we experience love [1, p. 1]. At the same time social structures are changing, as dominant functions and processes increasingly become organized through networks [1, p. 469]. As Brian Arthur has put it: ‘networks are the first emergent structure, the first dominant pattern, that we are seeing in the digitally based economy’. These networks have become the focus of many scientific discourses and research projects. Amongst others these have led to the formulation of the following laws:
David Sarnoff’s Law, former-chairman of the RCA Corp: the value of a non-interactive network is proportional to the number of users. Bob Metcalfe’s Law, founder of 3Com Corporation and inventor of the Ethernet: the value of an interactive network increases with the square of the number of users. David Reed’s Law, researcher HP Laboratories and MIT Media Laboratory: the value of a social network (with open peer-to-peer information exchange) scales exponentially with the size of the network.
These ‘laws’ have received acclaim, especially during the recent dot-com boom. In 1996, Reed Hundt, chairman of the Federal Communications Commission at the time, claimed that Metcalfe’s Law (and Moore’s Law) gives us the best foundation to understand the Internet. Metcalfe’s Law was frequently cited to justify business plans that had the infamous ‘hockey-stick’ revenue and profit projections. The promise was that once a service or network attained sufficient size, the non-linear growth of Metcalfe’s Law would kick in, and network and bandwagon effects would start to operate and bring great riches to the venture’s backers [21, pp. 1 and 2]. However the end of the dot.com boom implied that the expectations concerning the value of network relations had been pitched high, and as became clear later on, too high. Andrew Odlyzko and Benjamin Tilly have recently published empirical proof that Metcalfe’s Law and Reed’s Law overestimate the value of networks, but at the same time, they focus on signals which show that when the number of participants expands, the value of networks increases faster than the linear value-increase predicted by Sarnoff’s Law [21]. The dot-com boom that started in the nineties of the last century and came to an abrupt end in 2001—at least as far as the stock exchanges come into it—co-evolved with the rising scientific interest for what has been called ‘the science of networks’ [3, p. 13]. We can even state that the ICT-hype and the recent theoretical breakthroughs in the science of networks do not only overlap in time, but in various respects also enjoy a joint empirical basis. Both have acknowledged that web-relationships exist on the Internet, which strongly influence information provision and communication. At the peak of the dot-com boom, when new and more settled internet companies tried to attract as much internet traffic as possible to themselves through mega-advertising budgets in order to acquire the position of ‘preferential attachment’, Baraba´si and Albert published the article ‘Emerging of scaling in Random Networks’ in Science [4, pp. 84 and 85]. The scale-free model, which they
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described—based on the so-called ‘power law’ as observed in actual networks—put an end to the random network models that to that point had been considered standard. These models presupposed that the majority of nodes in a network all have approximately the same number of links, and that nodes of great numbers of links are either non-existent or of little importance. As they assert, the ‘power law’ rules on the Internet. This law pertains to the observation that on the web a multitude of addresses exist which only link to one other address, whereas there are relatively few addresses which link to a great number of others. This Poisson distribution of the frequency of web links has been conclusively exhibited. Baraba´si describes random networks as national infrastructures in which the nodes are the cities and the links function as the roads that connect these cities. The Internet is best compared with an air traffic system where a large number of smaller airports are connected to a number of large ‘hubs’ [4, p. 71]. Watts [3, p. 109] points out that Baraba´si and Albert were not the first author to formulate this law. He refers to Herbert Simon who concluded in 1955 that the size of companies is distributed according to the same ‘power law’. George Kingley Zipf found frequency distributions in linguistics that comply to the ‘power law’. Simon and his colleague Yuii Ijin showed that cities grow in a more or less random fashion but that their probability of growing by a given amount is proportional to their current size [3, p. 110]. This structure of networks does not apply to all the types of networks described in this paper. Sarnoff’s Law applies to systems with one dominant actor and multiple dependent actors. This then, is not a network in which interactivity is a core characteristic. Metcalfe’s Law is used for random networks, where many actors share a more or less equal amount of influence. Reed’s Law connects to networks in which the ‘power law’ best approaches reality. The three laws that have been mentioned are in fact metaphors for worlds that can all be observed. Sarmoff’s Law applies to a reality in classical economics where companies serve their customers in a formal market relation. Customers are seen as solitary, rational actors who maintain a relation to the firm. Metcalfe’s Law shows us networks of customers that share information and make choices together. It is assumed that there are no dominant players in such a network. Reed’s Law connects to networks where a few dominant actors are present, but there are also a large number of participants that exert little or no influence in the network. In this article networks have been named according to the ‘laws’ that best describe the nature of the network concerned. The next section shows how technological, socio-cultural and economic drivers affect the various types of networks. 3. Drivers of the network economy 3.1. Technological drivers The 21st century is often called the age of genetics, nanotechnology and robotics. These technologies will greatly influence a number of basic products, sometimes referred to as commodities. In the agricultural sector, the ‘second green revolution’ has been put on the agenda, while consumers are, amongst others, increasingly confronted with functional food. In the domain of energy an intensive search for sustainable energy has begun. A selfenhancing process of economies of scale will occur if important breakthroughs are realized,
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such as expected in the field of hydrogen and nuclear and solar energy. Breakthroughs are also envisioned in health care, which may happen later and with more difficulty than foreseen, but which nevertheless already spur on investments in research and development. In these and other areas, knowledge resources are taking shape, which many people can use. Pearson and Lyons [5, pp. 35 and 36] have gone as far as to call these developments a technology explosion enabled partly by increasing storage and memory capacities, processor speeds, automatic search engines and convergence of biotechnology and computer science. In addition in the near future the semantic web should be on stream, with automated knowledge extraction tools [5, p. 35]. The semantic web, thought up by Tim Berners-Lee, inventor of the WWW, URLs, HTTP and HTML, is a mesh of information linked up in such a way as to be easily processed by machines, on a global scale. Interestingly to note, the end of the dot-com-hype on the financial market has not hindered these and many other technological developments [6]. 3.1.1. Sarnoff networks Sarnoff networks are about the implementation of the newest developments in production technology, as long as these contribute to, or promise to contribute to, lower costs of mass production. The continuing fall in prices of ICT-products, notably of robots, assures standardization of products in combination to a drop in costs. Similar developments can be seen in biotechnology that have comparable amounts of influence on large scale industrial production processes. 3.1.2. Metcalfe networks Many people want to do more than just query knowledge databases and look for opportunities to share knowledge. A lot of developments are relevant in this regard, such as the rise of technology that enables symbiotic networks, also called ad hoc or parasitic networks. In these networks, devices look for each other and seek to make mutual contact [5, p. 16]. In this way, people can get into contact with each other because they have connected the same tools, without knowing beforehand who they will meet. Pearson and Lyons expect that the fusion of these and other self-organizing and synthesized systems will lead to life forms applications that will themselves explore ways to survive and interact with each other. We need only to give the system the computer equivalent of bleu green algae and the watch as they go through their Cambrian explosion and rapidly develop to primate level. This will lead to a device that is significantly faster at processing than the human brain [5, pp. 27 and 28]. As Ray Kurzweil has often been quoted: ‘The intelligence of machines will exceed human intelligence early in this century.’ In his view processor power will reach this level in 2019, the software to deal with this—the software of intelligence—shall be available around 2029 [7]. We do not need to wait this long. Ambient technology progressively provides us with more opportunities to exhibit our identity to others and to invite matching personalities to make themselves known. Subsequently, these matches afford collective action, which can attain more than would have been possible individually. Such group formation contributes to the establishment of interactive networks. 3.1.3. Reed-networks Lately, a lot of attention has been devoted to technologies that have a lot in common with the theory of complex networks. The aim is to find out more about the origins of the
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spontaneous order. The discovery by Christian Huygens, in 1665, that pendulums that are hung in close proximity to each other always oscillate together without variation, still inspires people today to the cause of this effect. Similar phenomena have been observed in the behavior of fireflies, and in trillions of electrons that march in lockstep in a superconductor enabling electricity to flow through it with zero resistance. Even in our own bodies there are symphonies of rhythm, kept alive by the relentless, coordinated firing of thousands of pacemaker cells in our hearts [8, p. 1]. These studies are performed under the headings such as functional genomics and integrative biology, where biologists are teaming up with computer scientists and mathematicians to try to make sense of the dance of life at the molecular level. Researchers at the Sante Fe Institute are struck by the ubiquity of evolution through natural selection, not only in biological populations, but also in immune systems, economies, and stock markets [8, pp. 287]. Strogatz assesses the study of synchronicity as a worthy successor of the attention devoted in the 1980s to chaos theory, and in the nineties to complexity theory. However, synchronicity is more than that. In his eyes, this interest is not a hype, but the beginning of the quest for the secret of the universe [8, p. 289]. It can be determined that technological drivers are at issue within two domains. On the one hand, there are evocative prospects for technological breakthroughs in dominant societal sectors, on the other hand there are expected technological developments in favour of the formation of interactive networks. 3.2. Socio-cultural drives Abraham Maslow distinguishes two categories in the hierarchy of human needs: deficiency needs and growth needs. Physiological needs such as hunger, thirst and clothing are part of the primary necessities of life. These are followed by safety and affection. The need for belongingness and esteem is also a basic human necessity. These needs are usually met with goods and services, which are of little emotional substance, however essential they may be to humans. The recipients are not or hardly prepared to pay suppliers for added value. When growth needs are at issue, there is more interest for aesthetic values and other concerns, because these play a part in the consumers’ wish for self-actualization. Often, attempts are made to meet these needs by suggesting a connection between emotions and ‘brands’. Building these relations offers the recipient the feeling that his own objectives are closer to being reached. Maslow suggests a stepping stone: after consumers have provided for their deficiency needs, their growth needs are put on the agenda. This may be relevant for large groups of people due to the general rise of the standard of living. 3.2.1. Sarnoff networks The most common networks are those in which only a few providers and many recipients participate. Suppliers prefer to build networks with ‘loyal’ customers. Employers usually prefer dedicated employees and political parties are attached to their devoted voters and dependable members. Sometimes, a network is a source of consumerism, or even of a consumer proletariat, through which people are influenced by the temptations of advertising and fail to reflect critically on offers [9, p. 114]. If such a network is large, this entails a large market.
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Meanwhile, the wishes of consumers are changing. Sarnoff networks are insufficient when the deficiency needs are already satisfied and consumers are looking for goods and services with more emotional content. 3.2.2. Metcalfe networks The development of the Internet made a larger impression on people in the last decade of the twentieth century than we can imagine today. For some, it signified no less than a big bang [10, p. 219]. As Margaret Wertheim put it in 1999, ‘we are witnessing here the birth of a new domain, a new space that simply did not exist before. With the exponential force of its own big bang, cyberspace is exploding into being before our eyes. Just as cosmologists tell us that the physical space of our universe burst into being out of nothing some fifteen billion years ago, so also ontology of cyberspace is ex nihilo.’ Six years after this statement, the notion of cyberspace, which is also known as commons or virtual space, has become commonplace. We have become familiar with this phenomenon, which has been called: our small world. People are separated by only six degrees of separation [3, p. 39]. This means that between every individual and any other human inhabitant of earth, contact can be made involving only six other persons as intermediaries. Society has thus become a close network, with all related consequences for people’s influence on each other’s thoughts and actions This issue of small worlds is especially relevant in respect to the acquisition of goods which meet people’s growth needs. In many markets power to the people has becomes a reality. 3.2.3. Reed networks The business community is a small world too. The boards of directors of major corporations are heavily ‘interlocked’. Buchanan [11, p. 118] added that the small-world structure within the corporate world emerges from the very same reason that it does in so many other networks. Not only do ‘old boys networks’ crop up in the network society, but also new power elites. These elites are not based on descent (such as in aristocracies) or on wealth (such as in capitalism) but on their meaning for relevant networks. As it happens, some networks have a hierarchical structure. Those who attract attention because they can dispose of valuable information and can analyze, order and transfer it, occupy the top. Bard and So¨derqvist [9, p. 117] call this top the netocratic class. They wield a great amount of power because they can significantly influence other people’s opinions. At the same time, there is a new lower class. This is formed by people ‘who’s opinion is never asked for’. Bard and So¨derqvist [9, p. 118] call this lower class the people who are solely occupied with their own problems and not with society. All those who only believe in themselves are hopeless ‘losers’ in a world dominated by the netocracy. If Maslow is right in saying that humanity is caught up in a hierarchy of needs, and holds dearest the realization of his own wishes, then the rise in standard of life and the increase in available information will result in the diminishing of proletariat elements in occupation and consumption. Consequently, this will lead to an augmentation of the power of the new elites. Recognizing the existence of a netocracy will lead to a strong urge felt by many to belong to this elite, which means that this development will spur itself forwards. When power elites develop, Reed networks are created which can be exceptionally forceful. This is especially true when considering that Maslow regard
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self-transcendence as the highest human ideal: to connect to something beyond the ego or to help others find self-fulfillment and realize their potential [12]. 3.3. Economic drivers As a rule, companies aim for growth and profit. When growth of turnover leads to greater profits, this is known as increasing returns. The extent to which returns increase is partly due to the nature of the networks in which companies operate. This observation is made plausible through the description of three types of networks. 3.3.1. Sarnoff networks In Sarnoff networks, the participants of the network (customers) have no or hardly any contact with each other. When the number of participants increases, the company can, accordingly, serve a greater number of participants, resulting in scale effects affecting production and sales. In this way, the fixed costs per unit decrease. When this reduction in costs is calculated into the price, demand will rise. Thus, a self-enhancing mechanism develops [13]. Companies will try to expand the scale of production as long as the increase in demand leads to more profit. This strategy is usually referred to with the concept economies of scale. Sarnoff networks entail market mechanisms such as interpreted by Walter W. Powell: ‘in markets the standard strategy is to drive the hardest possible bargain on the immediate exchange. In networks, the preferred option is often creating indebtedness and reliance over the long haul.’ Baraba´si [4, p. 209] adds to this: ‘in a network economy, buyers and suppliers are not competitors but partners. The relationship between them is often very long lasting and stable. 3.3.2. Metcalfe networks In Metcalfe networks, the network effects occur mainly on the demand side of the market. These networks derive their value from the number of participants who maintain contact with each other. Public auctions are an example. Electronic auction sites such as eBay highly depend for their turnover and profits on the number of participants. After all, their customers’ chances of concluding successful transactions increase exponentially when the number of participants grows. Examples abound in the online world where almost every web site has some form of content to attract visitors: CNN.com (news), Yahoo.com (sites), Amazon.com (books) etc. Newspapers, commercial radio and television are examples outside the web. In Metcalfe networks companies move from content to connectivity by adding user identification and features like ‘add comments’ functionality, reading circles, or classified ads. An example is the financial section on Yahoo where everybody can add comments about companies. Some businesses skip the content stage and start at this level; examples include mobile networks and dating sites. In these markets, where changes occur at great speed, companies seek to specialize in order to sell products in smaller amounts. This way, market demand can be met in a flexible manner. In these cases, one should speak of economies of scope. Skilled workers and general-purpose machinery together enable the production of goods adapted to consumer preferences. In essence, people who are looking for goods and services and who depend on others offering them relevant products or information, form these networks. As the freedom of choice of people augments, they will search all the more actively and depend less on
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information of the supplier and more on others in their orientation on the right deal. This is often enough the way that products assume a place in consumption behavior. These products find themselves in a position, which is called ‘lock-in’. More and more people choose the same product, which in this way becomes a de facto standard. Companies, which succeed in maneuvering their product into such a position, can realize high and increasing yields. Usually, the market only offers a limited amount of space for such products. This is why competitors fear that ‘success breeds success’ and ‘the winner takes all’. Such would be a case of increasing returns. After all, as more people opt for this standard, the value of the product increases. Prices can go up when turnover is on the rise. 3.3.3. Reed networks In Reed networks there are mayor actors who influence the selling parties. In these networks, information externalities are at issue. These occur when actors do not possess the necessary information to make up their mind themselves. Often, such customers inquire among their ‘peers’ and let them influence their buying behavior. It has been empirically shown that the supposed economic rationality of individual buyers is usually not the most obvious assumption to explain their economic behavior. It is more likely that actors often adapt to the preferences of their peers and conform to their buying advice without judging for themselves [3, pp. 209 and 210]. It is partially for this reason that the best sellers often are not the best products. It is of great importance for businesses to know how their customers make their buying decisions and even more important to know who their ‘peers’ or their reference groups are. One can call such orientation to the market forces the economies of connectivity. This description of the various forms of networks shows how the prospect of realizing increasing returns is an important driver to identify networks and to take advantage of their presence. Since the highest returns can be expected from networks, which activate the demand side of the market, companies will specifically search for opportunities to form or to join such networks (Table 1). 3.4. Macro developments and timing 3.4.1. Timing The question occurs whether these drivers are affected by a specific timeframe. If we follow Carlota Perez in her perspective on the time-aspect of technological developments, then The Age of Information and Telecommunication began in 1971 with the introduction of the first Intel microprocessor, the big bang of this development. In the so-called installation period, which started at that point in time, this technology was applied in many places, but mainly within the frames of existing products and production processes. In the Table 1 Technological, socio-cultural and economic metaphors in different types of networks
Technology Culture Economy
Sarnoff networks
Metcalfe networks
Reed networks
Production technology Consumerism Economies of scale
Intelligence of machines Power to the people Economies of scope
Synchronicity Power elite Economies of connectivity
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last part of this period, the crazy phase began during which the euphoria about the multitude of possible applications grew enormously. According to Perez, the crazy phase started in 1987 when the Dow Jones structurally grew faster than the real GNP of the United States. This phase ended in 2001 with the crash on the international stock markets. After this, the deployment period began during which society is adapting itself to the new techno-economic paradigm and the potential of the technological revolution matures. The first phase of this new period is called the synergy phase, during which the technological possibilities and the institutional framework are adjusted to each other. The deployment period will end in the maturity phase in which the power of the new technology will diminish and the world waits for the next big bang [2, p. 71–77]. The synergy phase of previous technological revolutions took 10–15 years, as did the maturity phase. The year 2019 can be placed against this backdrop, the year in which Ray Kurzweil predicts the break of singularity. Perez calls the present times, the transition from the installation to the deployment phase, the turning point. In this period, institutional reconstructions are effected, which determine the degree in which deployment can take place. According to her vision, fast deployment will lead to the coming of a golden age, at least in economic terms [2, p. 53]. Within the socio-cultural domain, it is significant that the development of cyberspace keeps pace with the crazy phase observed by Perez. At the end of this phase, and especially at the end of the previous millennium, cyberspace bloomed and scientists started looking for the associated power elite. It is plausible that the institutional adjustments that Perez refers to are occurring through the emergence of Reed networks. The technological and the socio-cultural developments to a great extent determine the force of the economic drivers. This is why it may be assumed that opportunities for high yields as a result of the prospect of increasing returns will grow significantly. This has large effects for corporate strategies. These strategies are the subject of the next section. 4. Networks and the company strategy The emergence of Metcalfe and Reed networks is a topical subject in private enterprise. Businesses can join networks that may benefit them. In certain circumstances, they can form networks themselves to create advantageous conditions. In this context, the following examples of Sarnoff, Metcalfe and Reed networks are offered. We have limited this summation to the main points of the entrepreneurial strategy, specifically Research and Development, Production, Sales and Finance. 4.1. Corporate strategy in Sarnoff networks 4.1.1. Research & development A typical well-managed company in a Sarnoff network utilizes a formal, top down innovation strategy to develop new products and production processes, in which concepts such as cost, quality, speed and modularity are of most importance. The innovation network is dominated by bilateral relationships entered in by the R&D department with other companies and organizations [14, pp. 50 and 71] Because of this modus operandi, it is implicitly suggested that the company itself has the ability to guide the processes of innovation. In practice, most companies are faced with substantial amounts of insecurities so that strict procedures and guidelines offer only the semblance of control. Clayton
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Christensen has described the functioning of formalized bargaining procedures in his book: ‘The Innovation Dilemma’ [15]. He states that well organized companies may be able to substantiate their decisions, but in the case of breakthrough innovations their actions are systematically wrong. This is an interesting statement, because these companies are not irrationally run and do not lack knowledge of the relevant market developments. Christensen states that these companies are only able to estimate profits for existing customers on the basis of marginal technological improvements. 4.1.2. Production Production efforts are becoming increasingly standardized, fit into protocols and connected to automated systems. These production systems are adjusted when manufacture can ensue at lower costs. For labor-intensive activities, outsourcing is a common phenomenon, including contracting out to companies in low wage countries. At the same time, increasing numbers of robots are put to work. Because of this practice, the volume of wages as part of the total costs is diminishing, which is stalling the ‘export of labor’ to low wage countries. Through standardizing, it has in many cases become easier to employ flexible occupational terms, which offer employees the option of determining to some extent what their working time and working hours should be. Thus, internal labor pools are created which can be supplemented with external, temporary employees. 4.1.3. Sales As far as sales are concerned, many Sarnoff networks have emerged through the rise of e-commerce. After all, the acquisition of goods and services via the Internet enables the ordering of products. Advertisements and other marketing instruments have to draw attention to the products. In fact push marketing applies. This can boost competition, since electronically facilitated price and quality comparisons make the market transparent. Downes and Mui [16] state that transaction costs will fall more quickly in the open market than in networks controlled by companies themselves. The reasoning is that the market will sooner adopt new technology. In their Law of Diminishing Firms they postulate that when transaction costs approach zero, the size of the firm also reduces to almost zero. 4.1.4. Finance In business relationships with banks and shareholders, Sarnoff networks rule. Through financing based on collateral, such as in most leasing constructions and business mortgages, the bank keeps the relation to the operational activities of the enterprise to a minimum and the transaction costs remain low. The control of the company remains mostly with the original owners, although in some cases institutional investors and private equity suppliers are in control of these companies to some extent. Transparency is one of the few means used to gain and keep the trust of shareholders and other financial stakeholders. The recently introduced International Financial Reporting Standards (IFRS) and the requirements concerning corporate governance can easily be understood in the context of Sarnoff networks. In the setting of these demands, hardly any informal interaction between the actors occurs. But even the highest quality corporate governance is no guarantee for success. Charles Perrow, sociologist at Yale University, looked at the causes of organizational disasters and concluded that these occurrences should normally be interpreted as normal accidents. They consist of a combination of several ‘normal’ mistakes, often compounded in an
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unanticipated way by the very same routines, reporting procedures, and responses that ordinarily keep things running smoothly. Therefore accidents are best understood as the unexpected consequences of normal behavior, they are not only normal, but also inevitable. Doyle en Carlson conclude that real world complex systems are invariably robust and fragile [3 pp. 250–251]. 4.1.5. Future of corporations in Sarnoff networks The previous chapter showed that the near future will bring deployment of technology. New applications will enable a further reduction of production and transaction costs. For this reason, the search for economies of scale will be a constant battle against time. Market competitors will also try to realize increasing returns by using cost reductions to lower the selling price. Sarnoff networks will in particular bring forth commodities and this development will be strongest in such networks. Merges and takeovers will likely prove to be inevitable, as will be the loss of employment. Possibly, the largest threat Sarnoff networks contain is embedded in the low value of the informal networks concerned. The formalization of the organization, often through empowering protocol and formalized relations, limits the ability of these companies to adjust to not only to new technology, but also to new developments in their market. Where the level of uncertainty rises in the years to come, and the success of organizations will be more dependant on their ability to adjust to new, barely predictable developments, companies based on a Sarnoff network will struggle, in spite of their relative size and financial power. Barbaba´si adds: ‘These days the value is in ideas and information. We have gotten to the point that we can produce anything we can dream of. The expensive question now is: what should that be?’ [4, p. 201] Nonetheless, a market for mass produced goods will always remain. This market in developed nations may be mature, developing economies offer many chances. Several companies, such as Unilever and Procter & Gamble have already been successful with so called Bottum-of-the-Pyramid products; cheap mass-produced goods in small packaging offered to poor consumers in, mostly, urban areas in the third world. 4.2. Corporate strategy in Metcalfe networks 4.2.1. Research & development Chesbrough [17] has described the difference between the Bell Laboratories innovation policy (now known as Lucent Technologies) and the Cisco Systems policy. Bell Laboratories develops, patents, and commercializes new knowledge, ranging from fundamental research into new materials to the development of software within the corporate organization. Cisco by contrast hardly invests in fundamental research, but collaborates with external partners. Their credo is: ‘Not all the smart people work for us’. Where are the smart people and what are they working on? Shaping teams of external experts and entering into multiple cooperation contracts can be attractive to all participants. This introduces open innovation. This way of dealing with innovation has in many places been tagged as the most successful development, and is increasingly being implemented. Open innovation networks are at least of the Metcalfe-type and seem to be winning, now that large corporations such as Philips, DSM and other multinationals are opting for them.
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4.2.2. Production Christopher Meyer and Stan Davis see an evolutionary movement in which bottom-up interactions of agents create adaptive systems [18, p. 101]. Employees, according to their ideas, are agents who employ self-organizing control systems to do their job. Increasingly, systems are implemented where the system itself programs the activities to be carried out. This is called co-production. In services and logistics, many examples exist in which systems determine the optimal route for the ‘to be transported’ goods and assign service mechanics automatically a new customer. These methods are described as adaptive management systems and are, in fact, based on the typical mechanisms that make up Metcalfe networks. As the number of goods and customers grow, the system becomes more efficient and the rate of return becomes higher. 4.2.3. Sales In sales there are also opportunities to develop Metcalfe networks. A growing number of websites that offer products tries to stimulate communication between the visitors (potential buyers). E-commerce firms as Amazon and Bol selling books, magazines, music, DVDs, electronics, and some even shoes, ask their customers to put a review of their purchases on the site. Others can then follow up on their opinions, by either agreeing or disagreeing with the original comment. Administrative bodies in social security have developed Internet portals with the rehabilitation of disability benefit recipients in mind. Clients can use these portals to get in touch with other people in the same situation and discuss their possibilities for rehabilitation into the labor market. At present, such instruments that take the experience of others into account are being developed more and more. Such Metcalfe networks work most successfully if the product is an experience for the customer, rather than when products are commodities. Stimulating interaction between customers in order to boost the demand for the product is often called a pull-marketing instrument, as contrasted with push marketing, which is applied in most Sarnoff type markets. 4.2.4. Finance In case companies belonging to Metcalfe networks have a relatively small customer base, a situation that causes specific risks. Many of these organizations do not have a substantial need for capital and a limited desire for expansion. Workers participation in the company capital is an obvious choice, as is a family based structure for the firm. In this way these kinds of businesses are an important, if not the most important provider of employment opportunities in society. The owner and the major shareholders, often the most important staffmembers control the company. Shared ownership is the appropriate financial system. 4.2.5. Future of corporations in Metcalfe networks Many companies focus on the opportunities that a network organization may offer them. Amongst others they look after the possibility of reducing the number of management layers emphasizes horizontal organizational structures. New external alliances are sought and found. Increasingly, companies realize that they cannot survive without these networks. Connectivity with other organizations and institutions has progressively become a prerequisite. Management literature of recent years is filled with analyses, prognoses and recommendations concerning these issues. Consequently the network-company has matured on the drawing boards.
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But practice is unruly. Even if an organization attains a high quality level, success is not guaranteed. Even more frustrating is the observation that when a business is successful, this success cannot always be attributed to the quality of its products. Watts has remarked: ‘The difference between a hugely successful innovation and an abject failure can be generated entirely through the dynamics of interactions between players who might have had nothing to do with its introduction.’ [3, p. 250] In recent research it has become abundantly clear that random networks and rational actors are not common in reality. The future of Metcalfe networks in a growing network economy lies with smaller companies or parts of companies in which personal service based activities are the core business. Especially many smaller and medium sized businesses serve many customers that can be described as actors in a random network. As long as they realize the limits of this situation, chances are slim that these organizations will expect too much of their innovation, production and sales efforts. Ambitious companies focus on Reed networks. Quite possibly they are a part of such networks already without realizing it themselves. 4.3. Corporate strategy in Reed networks 4.3.1. Research & development Presently, the important question has become whether and how much products developed in the laboratory will find an interested market. In case potential customers don’t have any experience with completely new products, regular market research is often useless. This implies that the strength of innovation is not limited to the exchange of expert knowledge in and outside the firm, but also requires a strong, direct connection to the market. As stated earlier the market contains a cultural driver that can be termed using Maslows’ hierarchy of needs. Open innovation networks as such will have to reach out to the groups of customers that position themselves as pioneers and early adaptors. These customers belong to the Creative Class, as defined by Richard Florida, and is becoming more outspoken within society [19]. This will lead to more and more R&D activities taking place within the frame of an experience environment. 4.3.2. Production Dealing with uncertainty and change requires more than just networking. It requires people to communicate as if the company is a network of information processors, where the role of the network is to handle large volumes of information efficiently without overloading any individual processor [3, p. 283]. Watts uses the ‘power law’ that Baraba´si exhibited on the Internet to shape his organization. He looks for people to whom the largest quantity of information is delivered and adjusts the flow of information if the information load of these people is too large. To this end, Baraba´si creates so-called metateams, which consist of information nodes that relieve other parts of the organization. By positioning the flow of information as being the central scope of the organizational structure, these teams are not connected to any level within the organizational hierarchy. This concentration on information nodes leads to organizational structures that are similar to the structure of air traffic networks, and to the structure of the Internet [4, p. 71]. This concept resembles that of the network centric organization that may be considered ultra robust because of the multi-scale connectivity [3, pp. 283–286].
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4.3.3. Sales Within organizations as they are described in the previous section, functional boundaries fade. The orientation on the flow of information integrates production and sales efforts as much as possible. This approach is primarily applicable in markets where customers look for products that satisfy their emotional needs. Increasingly they want to influence the design, the color and other features as much as possible aiming products reflecting the customer’s desired identity. This commercial approach may be called network marketing, emphasizing the dominant role of customer networks in the production and selling of goods and services. 4.3.4. Finance The financing of companies based on Reed networks is often dependent on private equity provided by specialized institutions. The reason is that private equity providers offer specialized sources of information and expert knowledge. These organizations that grant risk capital and subordinated loans will often enough form networks that facilitate information gathering by mutual exchange. This includes subjective information, which means that opinions that are formed within these networks can be of great influence to capital-seeking businesses. It turns out that organizing open forums leads to better results than shielding knowledge for companies that do not maintain a financial relation with a qualified private equity provider. 4.3.5. Future of corporations in Reed networks Companies that sell products that satisfy the growth needs of the buyer and serve markets containing a distribution system typified by the ‘power law’ are part of Reed networks. They find themselves in a structure that contains certain characteristics. The most important of these may be the existence of dominant companies and, because of this, the lack of a large segment of middle-sized firms. As a result of this there is a quest for a dominant role in the market. This position is attractive, not in the least from a financial viewpoint. It is this position that often leads to enormous profit. The battle for the largest share of the market is magnified by the expectation that these markets will exhibit a great amount of growth over the following years (Table 2). 5. Institutional adjustments According to Carlota Perez, the end of the dot-com boom in 2001 launched the deployment phase in technological development. As a result, the technological drivers will influence culture and economy to a greater extent than prior to the dot-com boom. The Table 2 Metaphors in research & development, production, sales and finance in different types of networks
Research & development Production Sales Finance
Sarnoff networks
Metcalfe networks
Reed networks
Top down innovation strategy Labor pools Push marketing Corporate governance
Open innovation Co-production Pull marketing Shared ownership
Experience environment Network-centric organization Network marketing Private equity
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consequences for the business sector are significant. Companies in Sarnoff networks observe how the costs of mass production are dropping and have to adapt their organization accordingly within a short time span. They will take measures to increase flexibility, such as diminishing of dismissal protection levels. Companies in Reed networks are confronted with market forces, making profitable companies more profitable and marginal firms weaker. Increasing inequality is hard to accept for politicians. Nevertheless, the most important political action should be to stimulate the markets of so-called growth needs, as described by Maslow. This markets consists of an important art and culture component, including science, as well as the so-called life style scenes which among other things reflect on esoteric values. It is known that in these worlds too, inequality is great, signifying another uncomfortable policy terrain for politicians. Yet, the increasing importance of these markets touch on both the business sector and the society at large. In this field the Reed networks dominate, most of the new jobs are created in these sectors and most of the taxes collected. In the end, there is nothing new to tell the world. When discussing the consequences of the network society, the sociologist Robert Merton quoted Matthew 13:12: For unto every one that hath shall be given, and he shall have abundance; but from him that hath not shall be taken away even that which he hath [20].
References [1] M. Castells, The information Age: Economy, Society and Culture, Vol. III: End of Millennium, Blackwell, Oxford, 2000. [2] C. Perez, Technological Revolutions and Financial Capital, The Dynamics of Bubbles and Golden Ages’, Edwatd Elger, Cheltenham, UK, 2002. [3] D.J. Watts, Six degrees, the science of a connected age, W.W. Norton & Company, New York, 2003. [4] A.-L. Baraba´si, Linked, How Everything Is Connected to Everything Else and What it Means for Business, Science, and Everyday Life, Plume, New York, 2003. [5] I. Pearson, M. Lyons, Business 2010, Mapping the new commercial Landscape, Spiro Press, London, 2003. [6] D. Bradbury, Making more of Moore’s Law, ComputerWeekly.com, 1 October 2004. [7] R. Kurzweil, The evolution of mind in the twenty-first century, in: J.W. Richards (Ed.), Are We Spiritual Machines, Discovery Institute, Seattle, 2002. [8] S. Strogatz, Sync, The Emerging Science of Spontaneous Order, Penguin, London, 2003. [9] A. Bard, J. So¨derqvist, Netocracy, The new Power Elite and Life after Capitalism, Pearson Education, London, 2002. [10] M. Wertheim, The Pearly Gates of Cyberspace: History of Space from Dante to the Internet, Virago Press, London, 1999. [11] M. Buchanan, Nexus, Small Worlds and the Groundbreaking Science of Networks, W.W. Norton & Company, New York, 2002. [12] W. Huitt, Maslow’s hierarchy of needs. Educational Psychology Interactive. Valdosta, GA: Valdosta State University. Retrieved (May 2005) from http://chiron.valdosta.edu/whuitt/col/regsys/maslow.html. [13] H.R. Commandeur, De betekenis van marktstructuren voor de scope van de onderneming, Erasmus Research Institute of Management, 2003 (in Dutch). [14] C.K. Prahalad, V. Ramaswamy, The Future of Competition, Co-creation Unique Value with Customers, Harvard Business School Press, Boston, 2004. [15] C.M. Christensen, The Innovation Dilemma, When New technologies Cause Great Firms to Fail, Harvard Business School Press, Boston, 1997. [16] L. Downes, C. Mui, Unleashing the Killer App: Digital Strategies for Market Dominance, Harvard Business School Press, Boston, 1998. [17] H. Chesbrough, Open Innovation, Harvard Business School Press, Boston, 2003.
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[18] C. Meyer, S. Davis, It’s Alive, The Coming Convergence of Information, Biology, and Business, Crown Business, New York, 2002. [19] R. Florida, The Rise of the Creative Class and How It’s Transforming Work, Leisure, Community and Everyday Life, Basic Books, Cambridge, 2002. [20] R.K. Merton, The Matthew Effect in Science, Science 159 (1968) 56–63. [21] A. Odlyzko, B. Tilly, A refutation of Metcalfe’s Law and a better estimate for the value of networks and network interconnections, Preliminary version, Digital Technology Center, University of Minnesota, March 2005.
Corporate dealings with the network economy Wim J. de Ridder,1 Department of Business, Public Administration and Technology, University of Twente, P.O. Box 217, 7500 AE Enschede, The Netherlands Available online 19 April 2006
Abstract Many companies seek increasing returns and survive only by continually restructuring their organizations. Technological developments, changes in consumer behavior and economic drivers accelerate this process. Companies that want to deal with these phenomena, have to take into account the characteristics of the network economy. This article shows how, depending on the type of network, a corporate strategy with regard to research & development activities, production, sales and finance can be built. The conclusion is that the expected continued rise of the network economy will change the corporate landscape dramatically. Customers, searching for self-actualization, will succeed in their endeavor more often, and so will the companies that are most connected with the stakeholders in the networks in question. r 2006 Elsevier Ltd. All rights reserved.
1. Introduction Companies create new business opportunities by developing products and opening up markets. At the same time, they are continually reorganizing to cut costs and withstand competition. These two processes are influenced by the formation of networks, which is so characteristic for the network economy. This article focuses on network formation and network economy. First, some relevant statements (laws) are examined. Subsequently, technological, economic and socio-cultural developments that amplify these mechanisms, so-called drivers, are discussed. Then, some
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E-mail address: [email protected]. STT/Beweton professor futures studies and director of The Society and Enterprise Foundation, The Hague, The Netherlands. 1
0016-3287/$ - see front matter r 2006 Elsevier Ltd. All rights reserved. doi:10.1016/j.futures.2006.02.014
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strategic company decisions are considered, which these drivers affect. Finally, some conclusions are drawn which apply to the business sector as a whole. 2. Patterns of network formation The Spanish sociologist Manuel Castells has stated that the current technological revolution is transforming the way we think, the way we produce, consume, communicate, act, live and even the way we experience love [1, p. 1]. At the same time social structures are changing, as dominant functions and processes increasingly become organized through networks [1, p. 469]. As Brian Arthur has put it: ‘networks are the first emergent structure, the first dominant pattern, that we are seeing in the digitally based economy’. These networks have become the focus of many scientific discourses and research projects. Amongst others these have led to the formulation of the following laws:
David Sarnoff’s Law, former-chairman of the RCA Corp: the value of a non-interactive network is proportional to the number of users. Bob Metcalfe’s Law, founder of 3Com Corporation and inventor of the Ethernet: the value of an interactive network increases with the square of the number of users. David Reed’s Law, researcher HP Laboratories and MIT Media Laboratory: the value of a social network (with open peer-to-peer information exchange) scales exponentially with the size of the network.
These ‘laws’ have received acclaim, especially during the recent dot-com boom. In 1996, Reed Hundt, chairman of the Federal Communications Commission at the time, claimed that Metcalfe’s Law (and Moore’s Law) gives us the best foundation to understand the Internet. Metcalfe’s Law was frequently cited to justify business plans that had the infamous ‘hockey-stick’ revenue and profit projections. The promise was that once a service or network attained sufficient size, the non-linear growth of Metcalfe’s Law would kick in, and network and bandwagon effects would start to operate and bring great riches to the venture’s backers [21, pp. 1 and 2]. However the end of the dot.com boom implied that the expectations concerning the value of network relations had been pitched high, and as became clear later on, too high. Andrew Odlyzko and Benjamin Tilly have recently published empirical proof that Metcalfe’s Law and Reed’s Law overestimate the value of networks, but at the same time, they focus on signals which show that when the number of participants expands, the value of networks increases faster than the linear value-increase predicted by Sarnoff’s Law [21]. The dot-com boom that started in the nineties of the last century and came to an abrupt end in 2001—at least as far as the stock exchanges come into it—co-evolved with the rising scientific interest for what has been called ‘the science of networks’ [3, p. 13]. We can even state that the ICT-hype and the recent theoretical breakthroughs in the science of networks do not only overlap in time, but in various respects also enjoy a joint empirical basis. Both have acknowledged that web-relationships exist on the Internet, which strongly influence information provision and communication. At the peak of the dot-com boom, when new and more settled internet companies tried to attract as much internet traffic as possible to themselves through mega-advertising budgets in order to acquire the position of ‘preferential attachment’, Baraba´si and Albert published the article ‘Emerging of scaling in Random Networks’ in Science [4, pp. 84 and 85]. The scale-free model, which they
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described—based on the so-called ‘power law’ as observed in actual networks—put an end to the random network models that to that point had been considered standard. These models presupposed that the majority of nodes in a network all have approximately the same number of links, and that nodes of great numbers of links are either non-existent or of little importance. As they assert, the ‘power law’ rules on the Internet. This law pertains to the observation that on the web a multitude of addresses exist which only link to one other address, whereas there are relatively few addresses which link to a great number of others. This Poisson distribution of the frequency of web links has been conclusively exhibited. Baraba´si describes random networks as national infrastructures in which the nodes are the cities and the links function as the roads that connect these cities. The Internet is best compared with an air traffic system where a large number of smaller airports are connected to a number of large ‘hubs’ [4, p. 71]. Watts [3, p. 109] points out that Baraba´si and Albert were not the first author to formulate this law. He refers to Herbert Simon who concluded in 1955 that the size of companies is distributed according to the same ‘power law’. George Kingley Zipf found frequency distributions in linguistics that comply to the ‘power law’. Simon and his colleague Yuii Ijin showed that cities grow in a more or less random fashion but that their probability of growing by a given amount is proportional to their current size [3, p. 110]. This structure of networks does not apply to all the types of networks described in this paper. Sarnoff’s Law applies to systems with one dominant actor and multiple dependent actors. This then, is not a network in which interactivity is a core characteristic. Metcalfe’s Law is used for random networks, where many actors share a more or less equal amount of influence. Reed’s Law connects to networks in which the ‘power law’ best approaches reality. The three laws that have been mentioned are in fact metaphors for worlds that can all be observed. Sarmoff’s Law applies to a reality in classical economics where companies serve their customers in a formal market relation. Customers are seen as solitary, rational actors who maintain a relation to the firm. Metcalfe’s Law shows us networks of customers that share information and make choices together. It is assumed that there are no dominant players in such a network. Reed’s Law connects to networks where a few dominant actors are present, but there are also a large number of participants that exert little or no influence in the network. In this article networks have been named according to the ‘laws’ that best describe the nature of the network concerned. The next section shows how technological, socio-cultural and economic drivers affect the various types of networks. 3. Drivers of the network economy 3.1. Technological drivers The 21st century is often called the age of genetics, nanotechnology and robotics. These technologies will greatly influence a number of basic products, sometimes referred to as commodities. In the agricultural sector, the ‘second green revolution’ has been put on the agenda, while consumers are, amongst others, increasingly confronted with functional food. In the domain of energy an intensive search for sustainable energy has begun. A selfenhancing process of economies of scale will occur if important breakthroughs are realized,
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such as expected in the field of hydrogen and nuclear and solar energy. Breakthroughs are also envisioned in health care, which may happen later and with more difficulty than foreseen, but which nevertheless already spur on investments in research and development. In these and other areas, knowledge resources are taking shape, which many people can use. Pearson and Lyons [5, pp. 35 and 36] have gone as far as to call these developments a technology explosion enabled partly by increasing storage and memory capacities, processor speeds, automatic search engines and convergence of biotechnology and computer science. In addition in the near future the semantic web should be on stream, with automated knowledge extraction tools [5, p. 35]. The semantic web, thought up by Tim Berners-Lee, inventor of the WWW, URLs, HTTP and HTML, is a mesh of information linked up in such a way as to be easily processed by machines, on a global scale. Interestingly to note, the end of the dot-com-hype on the financial market has not hindered these and many other technological developments [6]. 3.1.1. Sarnoff networks Sarnoff networks are about the implementation of the newest developments in production technology, as long as these contribute to, or promise to contribute to, lower costs of mass production. The continuing fall in prices of ICT-products, notably of robots, assures standardization of products in combination to a drop in costs. Similar developments can be seen in biotechnology that have comparable amounts of influence on large scale industrial production processes. 3.1.2. Metcalfe networks Many people want to do more than just query knowledge databases and look for opportunities to share knowledge. A lot of developments are relevant in this regard, such as the rise of technology that enables symbiotic networks, also called ad hoc or parasitic networks. In these networks, devices look for each other and seek to make mutual contact [5, p. 16]. In this way, people can get into contact with each other because they have connected the same tools, without knowing beforehand who they will meet. Pearson and Lyons expect that the fusion of these and other self-organizing and synthesized systems will lead to life forms applications that will themselves explore ways to survive and interact with each other. We need only to give the system the computer equivalent of bleu green algae and the watch as they go through their Cambrian explosion and rapidly develop to primate level. This will lead to a device that is significantly faster at processing than the human brain [5, pp. 27 and 28]. As Ray Kurzweil has often been quoted: ‘The intelligence of machines will exceed human intelligence early in this century.’ In his view processor power will reach this level in 2019, the software to deal with this—the software of intelligence—shall be available around 2029 [7]. We do not need to wait this long. Ambient technology progressively provides us with more opportunities to exhibit our identity to others and to invite matching personalities to make themselves known. Subsequently, these matches afford collective action, which can attain more than would have been possible individually. Such group formation contributes to the establishment of interactive networks. 3.1.3. Reed-networks Lately, a lot of attention has been devoted to technologies that have a lot in common with the theory of complex networks. The aim is to find out more about the origins of the
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spontaneous order. The discovery by Christian Huygens, in 1665, that pendulums that are hung in close proximity to each other always oscillate together without variation, still inspires people today to the cause of this effect. Similar phenomena have been observed in the behavior of fireflies, and in trillions of electrons that march in lockstep in a superconductor enabling electricity to flow through it with zero resistance. Even in our own bodies there are symphonies of rhythm, kept alive by the relentless, coordinated firing of thousands of pacemaker cells in our hearts [8, p. 1]. These studies are performed under the headings such as functional genomics and integrative biology, where biologists are teaming up with computer scientists and mathematicians to try to make sense of the dance of life at the molecular level. Researchers at the Sante Fe Institute are struck by the ubiquity of evolution through natural selection, not only in biological populations, but also in immune systems, economies, and stock markets [8, pp. 287]. Strogatz assesses the study of synchronicity as a worthy successor of the attention devoted in the 1980s to chaos theory, and in the nineties to complexity theory. However, synchronicity is more than that. In his eyes, this interest is not a hype, but the beginning of the quest for the secret of the universe [8, p. 289]. It can be determined that technological drivers are at issue within two domains. On the one hand, there are evocative prospects for technological breakthroughs in dominant societal sectors, on the other hand there are expected technological developments in favour of the formation of interactive networks. 3.2. Socio-cultural drives Abraham Maslow distinguishes two categories in the hierarchy of human needs: deficiency needs and growth needs. Physiological needs such as hunger, thirst and clothing are part of the primary necessities of life. These are followed by safety and affection. The need for belongingness and esteem is also a basic human necessity. These needs are usually met with goods and services, which are of little emotional substance, however essential they may be to humans. The recipients are not or hardly prepared to pay suppliers for added value. When growth needs are at issue, there is more interest for aesthetic values and other concerns, because these play a part in the consumers’ wish for self-actualization. Often, attempts are made to meet these needs by suggesting a connection between emotions and ‘brands’. Building these relations offers the recipient the feeling that his own objectives are closer to being reached. Maslow suggests a stepping stone: after consumers have provided for their deficiency needs, their growth needs are put on the agenda. This may be relevant for large groups of people due to the general rise of the standard of living. 3.2.1. Sarnoff networks The most common networks are those in which only a few providers and many recipients participate. Suppliers prefer to build networks with ‘loyal’ customers. Employers usually prefer dedicated employees and political parties are attached to their devoted voters and dependable members. Sometimes, a network is a source of consumerism, or even of a consumer proletariat, through which people are influenced by the temptations of advertising and fail to reflect critically on offers [9, p. 114]. If such a network is large, this entails a large market.
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Meanwhile, the wishes of consumers are changing. Sarnoff networks are insufficient when the deficiency needs are already satisfied and consumers are looking for goods and services with more emotional content. 3.2.2. Metcalfe networks The development of the Internet made a larger impression on people in the last decade of the twentieth century than we can imagine today. For some, it signified no less than a big bang [10, p. 219]. As Margaret Wertheim put it in 1999, ‘we are witnessing here the birth of a new domain, a new space that simply did not exist before. With the exponential force of its own big bang, cyberspace is exploding into being before our eyes. Just as cosmologists tell us that the physical space of our universe burst into being out of nothing some fifteen billion years ago, so also ontology of cyberspace is ex nihilo.’ Six years after this statement, the notion of cyberspace, which is also known as commons or virtual space, has become commonplace. We have become familiar with this phenomenon, which has been called: our small world. People are separated by only six degrees of separation [3, p. 39]. This means that between every individual and any other human inhabitant of earth, contact can be made involving only six other persons as intermediaries. Society has thus become a close network, with all related consequences for people’s influence on each other’s thoughts and actions This issue of small worlds is especially relevant in respect to the acquisition of goods which meet people’s growth needs. In many markets power to the people has becomes a reality. 3.2.3. Reed networks The business community is a small world too. The boards of directors of major corporations are heavily ‘interlocked’. Buchanan [11, p. 118] added that the small-world structure within the corporate world emerges from the very same reason that it does in so many other networks. Not only do ‘old boys networks’ crop up in the network society, but also new power elites. These elites are not based on descent (such as in aristocracies) or on wealth (such as in capitalism) but on their meaning for relevant networks. As it happens, some networks have a hierarchical structure. Those who attract attention because they can dispose of valuable information and can analyze, order and transfer it, occupy the top. Bard and So¨derqvist [9, p. 117] call this top the netocratic class. They wield a great amount of power because they can significantly influence other people’s opinions. At the same time, there is a new lower class. This is formed by people ‘who’s opinion is never asked for’. Bard and So¨derqvist [9, p. 118] call this lower class the people who are solely occupied with their own problems and not with society. All those who only believe in themselves are hopeless ‘losers’ in a world dominated by the netocracy. If Maslow is right in saying that humanity is caught up in a hierarchy of needs, and holds dearest the realization of his own wishes, then the rise in standard of life and the increase in available information will result in the diminishing of proletariat elements in occupation and consumption. Consequently, this will lead to an augmentation of the power of the new elites. Recognizing the existence of a netocracy will lead to a strong urge felt by many to belong to this elite, which means that this development will spur itself forwards. When power elites develop, Reed networks are created which can be exceptionally forceful. This is especially true when considering that Maslow regard
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self-transcendence as the highest human ideal: to connect to something beyond the ego or to help others find self-fulfillment and realize their potential [12]. 3.3. Economic drivers As a rule, companies aim for growth and profit. When growth of turnover leads to greater profits, this is known as increasing returns. The extent to which returns increase is partly due to the nature of the networks in which companies operate. This observation is made plausible through the description of three types of networks. 3.3.1. Sarnoff networks In Sarnoff networks, the participants of the network (customers) have no or hardly any contact with each other. When the number of participants increases, the company can, accordingly, serve a greater number of participants, resulting in scale effects affecting production and sales. In this way, the fixed costs per unit decrease. When this reduction in costs is calculated into the price, demand will rise. Thus, a self-enhancing mechanism develops [13]. Companies will try to expand the scale of production as long as the increase in demand leads to more profit. This strategy is usually referred to with the concept economies of scale. Sarnoff networks entail market mechanisms such as interpreted by Walter W. Powell: ‘in markets the standard strategy is to drive the hardest possible bargain on the immediate exchange. In networks, the preferred option is often creating indebtedness and reliance over the long haul.’ Baraba´si [4, p. 209] adds to this: ‘in a network economy, buyers and suppliers are not competitors but partners. The relationship between them is often very long lasting and stable. 3.3.2. Metcalfe networks In Metcalfe networks, the network effects occur mainly on the demand side of the market. These networks derive their value from the number of participants who maintain contact with each other. Public auctions are an example. Electronic auction sites such as eBay highly depend for their turnover and profits on the number of participants. After all, their customers’ chances of concluding successful transactions increase exponentially when the number of participants grows. Examples abound in the online world where almost every web site has some form of content to attract visitors: CNN.com (news), Yahoo.com (sites), Amazon.com (books) etc. Newspapers, commercial radio and television are examples outside the web. In Metcalfe networks companies move from content to connectivity by adding user identification and features like ‘add comments’ functionality, reading circles, or classified ads. An example is the financial section on Yahoo where everybody can add comments about companies. Some businesses skip the content stage and start at this level; examples include mobile networks and dating sites. In these markets, where changes occur at great speed, companies seek to specialize in order to sell products in smaller amounts. This way, market demand can be met in a flexible manner. In these cases, one should speak of economies of scope. Skilled workers and general-purpose machinery together enable the production of goods adapted to consumer preferences. In essence, people who are looking for goods and services and who depend on others offering them relevant products or information, form these networks. As the freedom of choice of people augments, they will search all the more actively and depend less on
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information of the supplier and more on others in their orientation on the right deal. This is often enough the way that products assume a place in consumption behavior. These products find themselves in a position, which is called ‘lock-in’. More and more people choose the same product, which in this way becomes a de facto standard. Companies, which succeed in maneuvering their product into such a position, can realize high and increasing yields. Usually, the market only offers a limited amount of space for such products. This is why competitors fear that ‘success breeds success’ and ‘the winner takes all’. Such would be a case of increasing returns. After all, as more people opt for this standard, the value of the product increases. Prices can go up when turnover is on the rise. 3.3.3. Reed networks In Reed networks there are mayor actors who influence the selling parties. In these networks, information externalities are at issue. These occur when actors do not possess the necessary information to make up their mind themselves. Often, such customers inquire among their ‘peers’ and let them influence their buying behavior. It has been empirically shown that the supposed economic rationality of individual buyers is usually not the most obvious assumption to explain their economic behavior. It is more likely that actors often adapt to the preferences of their peers and conform to their buying advice without judging for themselves [3, pp. 209 and 210]. It is partially for this reason that the best sellers often are not the best products. It is of great importance for businesses to know how their customers make their buying decisions and even more important to know who their ‘peers’ or their reference groups are. One can call such orientation to the market forces the economies of connectivity. This description of the various forms of networks shows how the prospect of realizing increasing returns is an important driver to identify networks and to take advantage of their presence. Since the highest returns can be expected from networks, which activate the demand side of the market, companies will specifically search for opportunities to form or to join such networks (Table 1). 3.4. Macro developments and timing 3.4.1. Timing The question occurs whether these drivers are affected by a specific timeframe. If we follow Carlota Perez in her perspective on the time-aspect of technological developments, then The Age of Information and Telecommunication began in 1971 with the introduction of the first Intel microprocessor, the big bang of this development. In the so-called installation period, which started at that point in time, this technology was applied in many places, but mainly within the frames of existing products and production processes. In the Table 1 Technological, socio-cultural and economic metaphors in different types of networks
Technology Culture Economy
Sarnoff networks
Metcalfe networks
Reed networks
Production technology Consumerism Economies of scale
Intelligence of machines Power to the people Economies of scope
Synchronicity Power elite Economies of connectivity
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last part of this period, the crazy phase began during which the euphoria about the multitude of possible applications grew enormously. According to Perez, the crazy phase started in 1987 when the Dow Jones structurally grew faster than the real GNP of the United States. This phase ended in 2001 with the crash on the international stock markets. After this, the deployment period began during which society is adapting itself to the new techno-economic paradigm and the potential of the technological revolution matures. The first phase of this new period is called the synergy phase, during which the technological possibilities and the institutional framework are adjusted to each other. The deployment period will end in the maturity phase in which the power of the new technology will diminish and the world waits for the next big bang [2, p. 71–77]. The synergy phase of previous technological revolutions took 10–15 years, as did the maturity phase. The year 2019 can be placed against this backdrop, the year in which Ray Kurzweil predicts the break of singularity. Perez calls the present times, the transition from the installation to the deployment phase, the turning point. In this period, institutional reconstructions are effected, which determine the degree in which deployment can take place. According to her vision, fast deployment will lead to the coming of a golden age, at least in economic terms [2, p. 53]. Within the socio-cultural domain, it is significant that the development of cyberspace keeps pace with the crazy phase observed by Perez. At the end of this phase, and especially at the end of the previous millennium, cyberspace bloomed and scientists started looking for the associated power elite. It is plausible that the institutional adjustments that Perez refers to are occurring through the emergence of Reed networks. The technological and the socio-cultural developments to a great extent determine the force of the economic drivers. This is why it may be assumed that opportunities for high yields as a result of the prospect of increasing returns will grow significantly. This has large effects for corporate strategies. These strategies are the subject of the next section. 4. Networks and the company strategy The emergence of Metcalfe and Reed networks is a topical subject in private enterprise. Businesses can join networks that may benefit them. In certain circumstances, they can form networks themselves to create advantageous conditions. In this context, the following examples of Sarnoff, Metcalfe and Reed networks are offered. We have limited this summation to the main points of the entrepreneurial strategy, specifically Research and Development, Production, Sales and Finance. 4.1. Corporate strategy in Sarnoff networks 4.1.1. Research & development A typical well-managed company in a Sarnoff network utilizes a formal, top down innovation strategy to develop new products and production processes, in which concepts such as cost, quality, speed and modularity are of most importance. The innovation network is dominated by bilateral relationships entered in by the R&D department with other companies and organizations [14, pp. 50 and 71] Because of this modus operandi, it is implicitly suggested that the company itself has the ability to guide the processes of innovation. In practice, most companies are faced with substantial amounts of insecurities so that strict procedures and guidelines offer only the semblance of control. Clayton
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Christensen has described the functioning of formalized bargaining procedures in his book: ‘The Innovation Dilemma’ [15]. He states that well organized companies may be able to substantiate their decisions, but in the case of breakthrough innovations their actions are systematically wrong. This is an interesting statement, because these companies are not irrationally run and do not lack knowledge of the relevant market developments. Christensen states that these companies are only able to estimate profits for existing customers on the basis of marginal technological improvements. 4.1.2. Production Production efforts are becoming increasingly standardized, fit into protocols and connected to automated systems. These production systems are adjusted when manufacture can ensue at lower costs. For labor-intensive activities, outsourcing is a common phenomenon, including contracting out to companies in low wage countries. At the same time, increasing numbers of robots are put to work. Because of this practice, the volume of wages as part of the total costs is diminishing, which is stalling the ‘export of labor’ to low wage countries. Through standardizing, it has in many cases become easier to employ flexible occupational terms, which offer employees the option of determining to some extent what their working time and working hours should be. Thus, internal labor pools are created which can be supplemented with external, temporary employees. 4.1.3. Sales As far as sales are concerned, many Sarnoff networks have emerged through the rise of e-commerce. After all, the acquisition of goods and services via the Internet enables the ordering of products. Advertisements and other marketing instruments have to draw attention to the products. In fact push marketing applies. This can boost competition, since electronically facilitated price and quality comparisons make the market transparent. Downes and Mui [16] state that transaction costs will fall more quickly in the open market than in networks controlled by companies themselves. The reasoning is that the market will sooner adopt new technology. In their Law of Diminishing Firms they postulate that when transaction costs approach zero, the size of the firm also reduces to almost zero. 4.1.4. Finance In business relationships with banks and shareholders, Sarnoff networks rule. Through financing based on collateral, such as in most leasing constructions and business mortgages, the bank keeps the relation to the operational activities of the enterprise to a minimum and the transaction costs remain low. The control of the company remains mostly with the original owners, although in some cases institutional investors and private equity suppliers are in control of these companies to some extent. Transparency is one of the few means used to gain and keep the trust of shareholders and other financial stakeholders. The recently introduced International Financial Reporting Standards (IFRS) and the requirements concerning corporate governance can easily be understood in the context of Sarnoff networks. In the setting of these demands, hardly any informal interaction between the actors occurs. But even the highest quality corporate governance is no guarantee for success. Charles Perrow, sociologist at Yale University, looked at the causes of organizational disasters and concluded that these occurrences should normally be interpreted as normal accidents. They consist of a combination of several ‘normal’ mistakes, often compounded in an
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unanticipated way by the very same routines, reporting procedures, and responses that ordinarily keep things running smoothly. Therefore accidents are best understood as the unexpected consequences of normal behavior, they are not only normal, but also inevitable. Doyle en Carlson conclude that real world complex systems are invariably robust and fragile [3 pp. 250–251]. 4.1.5. Future of corporations in Sarnoff networks The previous chapter showed that the near future will bring deployment of technology. New applications will enable a further reduction of production and transaction costs. For this reason, the search for economies of scale will be a constant battle against time. Market competitors will also try to realize increasing returns by using cost reductions to lower the selling price. Sarnoff networks will in particular bring forth commodities and this development will be strongest in such networks. Merges and takeovers will likely prove to be inevitable, as will be the loss of employment. Possibly, the largest threat Sarnoff networks contain is embedded in the low value of the informal networks concerned. The formalization of the organization, often through empowering protocol and formalized relations, limits the ability of these companies to adjust to not only to new technology, but also to new developments in their market. Where the level of uncertainty rises in the years to come, and the success of organizations will be more dependant on their ability to adjust to new, barely predictable developments, companies based on a Sarnoff network will struggle, in spite of their relative size and financial power. Barbaba´si adds: ‘These days the value is in ideas and information. We have gotten to the point that we can produce anything we can dream of. The expensive question now is: what should that be?’ [4, p. 201] Nonetheless, a market for mass produced goods will always remain. This market in developed nations may be mature, developing economies offer many chances. Several companies, such as Unilever and Procter & Gamble have already been successful with so called Bottum-of-the-Pyramid products; cheap mass-produced goods in small packaging offered to poor consumers in, mostly, urban areas in the third world. 4.2. Corporate strategy in Metcalfe networks 4.2.1. Research & development Chesbrough [17] has described the difference between the Bell Laboratories innovation policy (now known as Lucent Technologies) and the Cisco Systems policy. Bell Laboratories develops, patents, and commercializes new knowledge, ranging from fundamental research into new materials to the development of software within the corporate organization. Cisco by contrast hardly invests in fundamental research, but collaborates with external partners. Their credo is: ‘Not all the smart people work for us’. Where are the smart people and what are they working on? Shaping teams of external experts and entering into multiple cooperation contracts can be attractive to all participants. This introduces open innovation. This way of dealing with innovation has in many places been tagged as the most successful development, and is increasingly being implemented. Open innovation networks are at least of the Metcalfe-type and seem to be winning, now that large corporations such as Philips, DSM and other multinationals are opting for them.
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4.2.2. Production Christopher Meyer and Stan Davis see an evolutionary movement in which bottom-up interactions of agents create adaptive systems [18, p. 101]. Employees, according to their ideas, are agents who employ self-organizing control systems to do their job. Increasingly, systems are implemented where the system itself programs the activities to be carried out. This is called co-production. In services and logistics, many examples exist in which systems determine the optimal route for the ‘to be transported’ goods and assign service mechanics automatically a new customer. These methods are described as adaptive management systems and are, in fact, based on the typical mechanisms that make up Metcalfe networks. As the number of goods and customers grow, the system becomes more efficient and the rate of return becomes higher. 4.2.3. Sales In sales there are also opportunities to develop Metcalfe networks. A growing number of websites that offer products tries to stimulate communication between the visitors (potential buyers). E-commerce firms as Amazon and Bol selling books, magazines, music, DVDs, electronics, and some even shoes, ask their customers to put a review of their purchases on the site. Others can then follow up on their opinions, by either agreeing or disagreeing with the original comment. Administrative bodies in social security have developed Internet portals with the rehabilitation of disability benefit recipients in mind. Clients can use these portals to get in touch with other people in the same situation and discuss their possibilities for rehabilitation into the labor market. At present, such instruments that take the experience of others into account are being developed more and more. Such Metcalfe networks work most successfully if the product is an experience for the customer, rather than when products are commodities. Stimulating interaction between customers in order to boost the demand for the product is often called a pull-marketing instrument, as contrasted with push marketing, which is applied in most Sarnoff type markets. 4.2.4. Finance In case companies belonging to Metcalfe networks have a relatively small customer base, a situation that causes specific risks. Many of these organizations do not have a substantial need for capital and a limited desire for expansion. Workers participation in the company capital is an obvious choice, as is a family based structure for the firm. In this way these kinds of businesses are an important, if not the most important provider of employment opportunities in society. The owner and the major shareholders, often the most important staffmembers control the company. Shared ownership is the appropriate financial system. 4.2.5. Future of corporations in Metcalfe networks Many companies focus on the opportunities that a network organization may offer them. Amongst others they look after the possibility of reducing the number of management layers emphasizes horizontal organizational structures. New external alliances are sought and found. Increasingly, companies realize that they cannot survive without these networks. Connectivity with other organizations and institutions has progressively become a prerequisite. Management literature of recent years is filled with analyses, prognoses and recommendations concerning these issues. Consequently the network-company has matured on the drawing boards.
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But practice is unruly. Even if an organization attains a high quality level, success is not guaranteed. Even more frustrating is the observation that when a business is successful, this success cannot always be attributed to the quality of its products. Watts has remarked: ‘The difference between a hugely successful innovation and an abject failure can be generated entirely through the dynamics of interactions between players who might have had nothing to do with its introduction.’ [3, p. 250] In recent research it has become abundantly clear that random networks and rational actors are not common in reality. The future of Metcalfe networks in a growing network economy lies with smaller companies or parts of companies in which personal service based activities are the core business. Especially many smaller and medium sized businesses serve many customers that can be described as actors in a random network. As long as they realize the limits of this situation, chances are slim that these organizations will expect too much of their innovation, production and sales efforts. Ambitious companies focus on Reed networks. Quite possibly they are a part of such networks already without realizing it themselves. 4.3. Corporate strategy in Reed networks 4.3.1. Research & development Presently, the important question has become whether and how much products developed in the laboratory will find an interested market. In case potential customers don’t have any experience with completely new products, regular market research is often useless. This implies that the strength of innovation is not limited to the exchange of expert knowledge in and outside the firm, but also requires a strong, direct connection to the market. As stated earlier the market contains a cultural driver that can be termed using Maslows’ hierarchy of needs. Open innovation networks as such will have to reach out to the groups of customers that position themselves as pioneers and early adaptors. These customers belong to the Creative Class, as defined by Richard Florida, and is becoming more outspoken within society [19]. This will lead to more and more R&D activities taking place within the frame of an experience environment. 4.3.2. Production Dealing with uncertainty and change requires more than just networking. It requires people to communicate as if the company is a network of information processors, where the role of the network is to handle large volumes of information efficiently without overloading any individual processor [3, p. 283]. Watts uses the ‘power law’ that Baraba´si exhibited on the Internet to shape his organization. He looks for people to whom the largest quantity of information is delivered and adjusts the flow of information if the information load of these people is too large. To this end, Baraba´si creates so-called metateams, which consist of information nodes that relieve other parts of the organization. By positioning the flow of information as being the central scope of the organizational structure, these teams are not connected to any level within the organizational hierarchy. This concentration on information nodes leads to organizational structures that are similar to the structure of air traffic networks, and to the structure of the Internet [4, p. 71]. This concept resembles that of the network centric organization that may be considered ultra robust because of the multi-scale connectivity [3, pp. 283–286].
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4.3.3. Sales Within organizations as they are described in the previous section, functional boundaries fade. The orientation on the flow of information integrates production and sales efforts as much as possible. This approach is primarily applicable in markets where customers look for products that satisfy their emotional needs. Increasingly they want to influence the design, the color and other features as much as possible aiming products reflecting the customer’s desired identity. This commercial approach may be called network marketing, emphasizing the dominant role of customer networks in the production and selling of goods and services. 4.3.4. Finance The financing of companies based on Reed networks is often dependent on private equity provided by specialized institutions. The reason is that private equity providers offer specialized sources of information and expert knowledge. These organizations that grant risk capital and subordinated loans will often enough form networks that facilitate information gathering by mutual exchange. This includes subjective information, which means that opinions that are formed within these networks can be of great influence to capital-seeking businesses. It turns out that organizing open forums leads to better results than shielding knowledge for companies that do not maintain a financial relation with a qualified private equity provider. 4.3.5. Future of corporations in Reed networks Companies that sell products that satisfy the growth needs of the buyer and serve markets containing a distribution system typified by the ‘power law’ are part of Reed networks. They find themselves in a structure that contains certain characteristics. The most important of these may be the existence of dominant companies and, because of this, the lack of a large segment of middle-sized firms. As a result of this there is a quest for a dominant role in the market. This position is attractive, not in the least from a financial viewpoint. It is this position that often leads to enormous profit. The battle for the largest share of the market is magnified by the expectation that these markets will exhibit a great amount of growth over the following years (Table 2). 5. Institutional adjustments According to Carlota Perez, the end of the dot-com boom in 2001 launched the deployment phase in technological development. As a result, the technological drivers will influence culture and economy to a greater extent than prior to the dot-com boom. The Table 2 Metaphors in research & development, production, sales and finance in different types of networks
Research & development Production Sales Finance
Sarnoff networks
Metcalfe networks
Reed networks
Top down innovation strategy Labor pools Push marketing Corporate governance
Open innovation Co-production Pull marketing Shared ownership
Experience environment Network-centric organization Network marketing Private equity
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consequences for the business sector are significant. Companies in Sarnoff networks observe how the costs of mass production are dropping and have to adapt their organization accordingly within a short time span. They will take measures to increase flexibility, such as diminishing of dismissal protection levels. Companies in Reed networks are confronted with market forces, making profitable companies more profitable and marginal firms weaker. Increasing inequality is hard to accept for politicians. Nevertheless, the most important political action should be to stimulate the markets of so-called growth needs, as described by Maslow. This markets consists of an important art and culture component, including science, as well as the so-called life style scenes which among other things reflect on esoteric values. It is known that in these worlds too, inequality is great, signifying another uncomfortable policy terrain for politicians. Yet, the increasing importance of these markets touch on both the business sector and the society at large. In this field the Reed networks dominate, most of the new jobs are created in these sectors and most of the taxes collected. In the end, there is nothing new to tell the world. When discussing the consequences of the network society, the sociologist Robert Merton quoted Matthew 13:12: For unto every one that hath shall be given, and he shall have abundance; but from him that hath not shall be taken away even that which he hath [20].
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[18] C. Meyer, S. Davis, It’s Alive, The Coming Convergence of Information, Biology, and Business, Crown Business, New York, 2002. [19] R. Florida, The Rise of the Creative Class and How It’s Transforming Work, Leisure, Community and Everyday Life, Basic Books, Cambridge, 2002. [20] R.K. Merton, The Matthew Effect in Science, Science 159 (1968) 56–63. [21] A. Odlyzko, B. Tilly, A refutation of Metcalfe’s Law and a better estimate for the value of networks and network interconnections, Preliminary version, Digital Technology Center, University of Minnesota, March 2005.