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22 April 2007

A virtual world

Long-held precepts of Big and Small have been at the heart of conventional business wisdom since the industrial revolution.

The more a company has on its balance sheet and the greater the scale of its international operations and investments, the more powerful and successful it is supposed to be in terms of financial clout and market influence. Role models for this management theory were the first monolithic, gigantic corporations like Deutsche Bank, Standard Oil Trust or the great railroad companies.

This was a time when the economy revolved around energy sources and raw materials. Today it’s information. Where once factories would have been located close to coal fields or sources of steel, modern information businesses from the Bay Area to Bangalore are staying near the new neighbourhoods of innovation and knowledge: universities.

And since, thanks to the internet, the costs of communication and coordination have practically disappeared - with transaction costs not far behind - it no longer pays for firms to manage as much as possible under one roof. Businesses often grow bigger these days in terms of revenue, profits and stock market value by reducing the physical infrastructure they own and the assets on their books: owning less and partnering and sub-contracting more. If you’re manufacturing physical goods you still need factories assembling atoms somewhere, but you don’t need to own these buildings, they don’t need to be physically nearby, and they certainly don’t need as many staff to operate them.

Furthermore, as Thomas Friedman points out in The World is Flat, the information revolution lets multinational businesses break their operations into many tiny pieces so they can think and act in much smaller ways, while giving small firms enough power and reach to make it big on a global stage.

On the demand side, large firms customise goods and services for much narrower segments, down to the individual customer. Companies from Nike and Starbucks to Google are all allowing their customers to build products to order. Eric von Hippel notes that in the market for custom integrated circuits, manufacturers provide over $15 billion worth of goods a year based on individual customer specifications.

On the supply side Big operates Small by using internet technology to cut up work processes into discrete chunks and co-ordinate partner and supplier networks to make and distribute things more competitively. (Friedman characterises the nimble orchestration of 2.3 billion cartons a year through one of the world’s largest supply chains as: the “Wal-Mart symphony in multiple movements”).

For information-based goods, the combination of new software systems to share and analyse data, raw computing power and online connectivity has changed industries beyond recognition. Financial products can now be taken apart and individual components traded separately in startlingly sophisticated ways that simply wouldn’t have been feasible before. Take a straightforward financial instrument insuring businesses against bad weather; this can now be sliced into different slivers of risk which are dynamically and digitally traded between banks based on atmospheric temperature changes.

Meanwhile, this same global IT infrastructure has also allowed a new breed of internationalised small businesses, so called micro-multinationals, to flourish. These tiny firms, even individuals, can punch far above their weight and act like multinational corporations many thousands of times their size. (For instance, the electronics company Apex Digital mentioned in the Introduction).

The idea of multinational operations isn’t something traditionally associated with small businesses. However, today because of information technologies, and the globalisation it has fuelled, you don’t need a lot of money or staff to operate in many countries simultaneously. And by orchestrating a network of remote partnerships or handing over international supply chain logistics to the likes of UPS rather than owning a lot of buildings and staff, today’s start-ups don’t have to dream of going global when they eventually get big and successful enough, they can start life as transnational entities from day one.

I’ve recently been reading Illicit by Foreign Policy magazine editor Moisés Naím who shines a torch on the digital information scuttling around the grey and black underbelly of the economy. About six years ago in the FT I wrote about a Colombian cocaine trading extranet using hacked Drug Enforcement Agency lines for a secure communication link. Today, as Naím proves, using  international IT networks to find, make, assemble or distribute products is now a part of all markets and economies, whether informal, unofficial or downright illegal.

The same globalised information and communications systems that allow Dell to assemble computers with 400 networked supply chain partners across Asia, Europe and North America, also let Nigerian heroin labs “process opium from Afghanistan or Myanmar that has transited through Pakistan, Uzbekistan, Thailand, or China” and mean Malaysian plants can assemble “centrifuges for Libya with Pakistani blueprints under Sri Lankan supervision and funding from banks in Dubai.”

Still, it’s probably a mistake to think that even the most sophisticated organized crime operations run on a purely virtual basis. The threat of personal violence is always there to back-up business agreements. When you can’t rely on the government to enforce the execution of contracts, a denial-of-service attack isn't quite as intimidating as extremely large, hairy men with baseball bats smashing up your servers.


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corporations like Deutsche Bank, Standard Oil Trust or the great railroad companies.

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This could be the next industry standards for electronics. Greener and much more power efficient electric items will be beneficial in a tight economy.

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Thank you for sharing your thoughts. I have to agree with you that because of the internet, the costs of communication and coordination have practically disappeared.

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