Hedge

by Nicolas Colin

  For a time microelectronics emerged as the digital equivalent of oil in the age of the automobile and mass production or cheap labor in the Dark Ages. Driven by the famous “Moore’s law”, microelectronic components made it possible to produce ever cheaper and smaller computing devices[206]. But now Moore’s law is entering a phase of exhaustion. We can finally see that the Entrepreneurial Age’s essential resource is not the computing devices provided to individuals so much as it is the individuals themselves.

  This is what the Entrepreneurial Age is about. In a techno-economic paradigm where individuals are more equipped and connected than ever, the multitude that they form has become a greater, autonomous power—one that companies must harness to fuel increasing returns to scale, best their competition and create even more value.

  But joining with the multitude comes with a price. An alliance is necessarily balanced. Individuals do not lend their active, even enthusiastic support to corporations unless they can find aligned interests. The terms of this alliance are key to understanding what makes tech companies different and why they are bound to dominate the global economy in the Entrepreneurial Age.

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  What’s a tech company, anyway?

  The publishing of L’ge de la multitude in 2012 caught the attention of the French government. As I went back to the public sector for a brief period, they asked me to write a report, alongside Pierre Collin (a respected tax judge in the French Conseil d’Etat), on taxation and the digital economy[207]. The engagement letter initially written by the ministers was long and polished. But the subtext was quite clear. Indeed you could sum it up in two direct questions: “Why don’t tech companies pay taxes?” and “What should we change so that they pay more?”.

  Working on corporate taxation in the digital economy was a rewarding experience. It introduced me to how the current transition redistributes wealth and power at a global scale. The “Collin & Colin” report was published in early 2013. It became an input for the work on corporate taxation by the Organization for Economic Co-operation and Development (OECD) and the G20. It also inspired widespread discussions in the global community of tax practitioners, landing Pierre and I on the International Tax Review’s list of the ten most influential individuals and organizations in the tax world in 2013. (Admittedly, I believe this distinction brought me fewer Twitter followers than did the defamation lawsuit I mentioned in the introduction!)

  Considering what the government demanded, Pierre and I had started our work by reflecting on something basic: the definition of a tech company. And we realized defining a tech company is not as easy as it sounds. It is not simply a company that uses technology. Every modern corporation uses a lot of computers and is wired to networks, yet obviously not all corporations are tech companies.

  Nor is a tech company just about a business model that presents increasing returns to scale (what developers, entrepreneurs and venture capitalists call “scalability”[208]). A telecommunications company also enjoys such returns, and yet such a company is quite different from Silicon Valley-style tech companies. It mostly sits back and makes a living off its rent while mistreating its customers, whereas tech companies such as Facebook, Uber, and Amazon seem to remain constantly on edge.

  To be fair, Pierre and I were not the only ones feeling our way through the dark. With the emergence of new models relying on the power of the multitude, new words have emerged to qualify and better explain them. Jeff Howe calls it “crowdsourcing”[209]. Don Tapscott speaks of "wikinomics"[210]. Yochai Benkler evokes "co-production" and "peer production"[211]. Shoshana Zuboff coined the term “distributed capitalism”[212] whereas Clay Shirky stresses the importance of “cognitive surplus”[213]. Yann Moulier Boutang studies "pollination"[214]. And Trebor Scholz denounces the massive use of poorly paid "digital labor"[215]. In our book, Henri Verdier and I spoke of the "Age of the Multitude" in order to evoke the unprecedented power deployed by networked individuals[216]. Tim O'Reilly forged the term which has become most widely used thanks in large part to its simplicity: "Web 2.0"[217]. Yet all in all, no concept has truly stuck to describe the principle of a corporation harnessing the power of the multitude.

  The coexistence of so many concepts shows just how far the notion of customers taking a more active part is from becoming mainstream. But the corporate contract as reshaped by the rise of the multitude has nevertheless become a source of inspiration for entrepreneurs. A better understanding of this new paradigm has propelled the growth of tech companies, leading them on a different path than that taken by the traditional corporate world.

  Tech entrepreneurs succeed precisely because they realize the competitive advantages of working with the multitude rather than embracing a more traditional approach. From startup to startup, initial motives for inviting users into the supply chain are varied. Some entrepreneurs arrive there by idealism; others by cynicism; many, in fact, arrive by chance. Through many trials and errors, they end up discovering that allying with the multitude is the only sustainable way to offer the highest quality at a large scale[218]. What is the point of relying on a traditional business model if you can go faster and increase returns on invested capital by relying on the multitude?

  The evolution of industry-wide value chains illustrates the emergence of the new breed of corporation. As the current techno-economic transition goes forward, the dominant companies are no longer those that operate factories in the middle of the value chain, but companies that design applications down the value chain, gaining the trust of the multitude and forging an alliance with it. The dominant tech companies are now operating consumer-oriented applications, frequently used by hundreds of millions—if not billions—of individuals at a global scale[219]. Factories still exist and add value, but they don’t command as large a slice of the total value added as they did in the previous age. Even the emblematic car industry will soon be less dominated by car manufacturers than by the likes of Google, Uber and Tesla, whose main asset is a direct and trusted relationship with their end users through well-designed applications[220].

  For a long time in the business world, the drive to become bigger was motivated by the pursuit of supply-side economies of scale[221]. As centuries of business have taught us, the bigger you are, the lower your marginal cost. Lowering unit costs is what economies of scale were all about. And yet economies of scale reach their limits soon enough. Commodities get scarcer, factories reach peak capacity, distribution routes get longer, and prospective customers become more difficult to convert. At that point scale ceases to be an advantage and turns into a liability. This is why most traditional companies fail to grow beyond a certain market share and most markets end up being dominated by oligopolies[222].

  But tech companies behave differently as they add a key feature to traditional supply-side economies of scale: network effects. Most digital businesses connect their users with one another, enabling communication between them either directly (sharing content within our Facebook social graph) or indirectly (reading another user’s review on an Amazon product page). Such connections turn users into nodes and trigger the needed network effects. When these are at work, the value created for each single user increases dynamically[223] (and up to a certain point[224]) as the number of users gets higher. As a result, the more a tech business grows, the cheaper it is to acquire new users and the easier it is to retain current users. These demand-side economies of scale, which are exponential up to a certain point, are critical when it comes to generating increasing returns to scale[225].

  As tech companies get bigger, those various positive feedback loops sustain each other[226]. On the one hand, the stronger the network effects, the easier it is to achieve supply-side economies of scale in unprecedented proportions. For example, Amazon’s network effects are the main reason why it keeps on growing and exerts an increased market power on its suppliers, forcing them to bring their prices down. Conversely, the higher the supply-side economies of scale, the more resources the company can inv
est in an improved customer experience that fuels even stronger network effects.

  This virtuous circle of supply-side economies of scale and network effects explains why tech companies so easily challenge our understanding of corporate strategy. Their increasing returns to scale, a byproduct of the technology they masterfully exploit, is their true competitive advantage. With increasing returns, those companies’ large scale is synonymous with acceleration instead of exhaustion.

  Because of this rare characteristic, the Entrepreneurial Age is governed by the rule of “winner-takes-most”[227]. When several competitors fight to conquer one market, at some point one will come out on top, distancing themselves from the others and ultimately winning most of their market.

  Because of their increasing returns to scale, we would traditionally presume that tech companies will all act like old networked business such as telecommunication companies and energy utilities: they’ll cease efforts to innovate and begin preying on their customers.

  But this is a key misunderstanding of what is at stake. Because their increasing returns to scale depend on the multitude, the network effects it generates and the data they collect from it, tech companies must maintain the trusted alliance with their customers at any cost. Tech companies can’t try to hide like other corporations did in the past behind tangible infrastructures or regulatory barriers. Rather, they must innovate on a continuous basis, constantly improving their value proposition and meeting the evolving needs of every single customer connected to their network.

  And so a tech company can be defined as a firm that features increasing returns to scale together with two other additional criteria. One is that it must provide its customers with an exceptional experience (high quality at scale), as serving customers well is the only way to inspire trust and retain those users that are so critical for sustaining network effects. The other is that a tech company must collect user-generated data on a regular and systematic basis — an additional positive feedback loop that enables it to constantly improve the experience and, again, sustain increasing returns to scale (notably through machine learning)[228].

  In other words, a tech company is not defined as such simply because it uses technology. A tech company deserves the label because it uses ubiquitous computing and networks for what they do best: providing users with an exceptional experience, putting them to work through the collection of user-generated data, and using all of that to generate increasing returns up to a scale that was previously unimaginable.

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  Key takeaways

  ● Using ubiquitous computing and networks, individuals now form the mighty multitude. As empowered customers, they’re gaining the upper hand over both employees and shareholders.

  ● The reason why tech companies must cater to the multitude is that today’s individuals aren’t only passive consumers. Rather, they have become an essential force in creating value.

  ● To sustain increasing returns to scale, tech companies need to collect data from their customers, which requires trust. Therefore they must provide the multitude with an exceptional experience.

  Chapter 6

  Consumer Power: The Modern-Day Janus

  “Diminishing returns hold sway in the traditional part of the economy—the processing industries. Increasing returns reign in the newer part—the knowledge-based industries. Modern economies have therefore bifurcated into two interrelated worlds of business corresponding to the two types of returns. The two worlds have different economics. They differ in behavior, style, and culture. They call for different management techniques, strategies, and codes of government regulation. They call for different understandings.”

  —W. Brian Arthur[229]

  We’re all undergoing the ‘Wal-Mart Effect’

  Amazon is my favorite example when it comes to explaining the Entrepreneurial Age. After more than 20 years of operations, it is one of the oldest tech companies around. And contrary to most of its peers, from the beginning it operated a business that included tangible assets (operating warehouses, delivering stuff) and lots of employees. Headquartered in Seattle, Amazon was reportedly despised in Silicon Valley for that very reason. Why would an entrepreneur bother founding a low-margin, difficult-to-scale retail venture when they could make tons of money in the ad-clicking business?

  Today, Amazon has become one of the most fascinating tech companies out there. It even sets an inspiring example for traditional brick-and-mortar companies that are looking to become more digital. If Amazon can operate a business model that is both digital and tangible, why can’t the US Postal Service, Ford, or American Airlines?

  The problem I encounter while trying to communicate my passion for Amazon is that it also inspires mistrust and hostility. “That is all very interesting, but why do they treat their employees so badly?” is a frequent reaction. “Where are the profits?” is another. From union workers to corporate CFOs, everyone seems to have good reasons to hate Amazon or, at the very least, to refuse to draw lessons from its success. And this sentiment can be explained by the enduring shadow of one of Amazon’s mighty predecessors: Walmart.

  Walmart was long considered an exceptional company. It earned a lot of money, served its customers well, embodied proud American values[230], turned every member of the Walton family into a billionaire, created lots of jobs all around America, and even helped maintain inflation at record-low levels[231]. Yet in 2005, the reporter Charles Fishman published his best-selling book The Wal-Mart Effect[232]. In it he described in great detail how Walmart also contributed, at its unusually large scale, to the relocation of American businesses overseas, a lowered quality of manufactured goods consumed in the US, and the economic inequalities that are still today crippling the US economy.

  No one could have foreseen those kinds of impacts back at the beginning. Sam Walton entered the retail store business in 1945. Then around 1950 he opened his own store in Rogers, Arkansas—certainly neither the city nor state that one would have predicted to be the home of global economic upheaval. Walmart’s headquarters are still in Bentonville, Arkansas, even though the company quickly outgrew its roots: employing more than 1.5 million people, it is one of the largest corporate employers in the world.

  Walmart also became one of the first big corporations to use computing and networks at a large scale[233]. The company collected vast amounts of data in its many stores. Then it used that information to make operations more efficient and push suppliers into constantly lowering their prices. Walmart ultimately grew so big, in no small part thanks to its advanced information system, that it transformed the American economy. Charles Fishman’s “Wal-Mart Effect” involves both good and bad features: lower prices for consumers, but also lower wages for workers and an unbearable pressure on suppliers.

  A large part of the Entrepreneurial Age’s future can easily be predicted by those who know Walmart well. Tech companies resemble Walmart in many ways. They grow at an exponential pace. Customers are their priority, and the best tech CEOs make sure it stays that way. They obviously use technology extensively. And they have an ambivalent effect on the economy: as consumers, individuals enjoy the convenience, wide choice, lower prices, and ever-improved customer experience; but they also worry about tech companies’ formidable economic power over the rest of economy—most particularly over themselves as they try to earn a living as workers. Questions abound: Isn’t the tech industry too hard on workers[234]? Can society stand the pressure[235] of its exponential growth? Are tech CEOs bad? Should governments ally with incumbents to strike back against tech entrepreneurs? Should the power of consumers be restrained to alleviate the pressure on society as a whole?

  Curbing consumer power would be a sharp reversal from the legacy of the past century. In the US consumer empowerment became an issue as early as 1906 with the shocking reporting by Upton Sinclair on the hygiene and working conditions in the meatpacking industry in Chicago, resulting in his landmark book The Jungle. It took an unexpected alliance bet
ween Sinclair and the progressive then-president Theodore Roosevelt to impose meat inspection as the law of the land and to enact the Pure Food and Drug Act, which became the cornerstone of hygiene enforcement in the food industry[236].

  At the time, a distaste for trusts such as Standard Oil Co. already united farmers, laborers, the middle class, and entrepreneurial business owners[237]. This shared distrust was then turned into a powerful drive for advancing consumer empowerment with the unprecedented intervention of the federal government. This was all the more necessary because the age of the automobile and mass production led to complex products hitting consumer markets, not simply raw materials. With these products came frequent technical hazards, more complex value chains, distribution challenges, maintenance issues, and pricing uncertainties.

  Antitrust, however, was not yet seen as a lever for consumer empowerment like regulations regarding hygiene and safety. The Progressive Era version of antitrust, that which led to the dismemberment of Standard Oil in 1911, was not meant to protect or promote individual consumers. Rather its goal was to empower small businesses against big corporations. Early in the twentieth century, future Supreme Court Justice Louis Brandeis came to embody the liberal approach to antitrust policy of that time—saying in one speech in defense of small businesses that “if the Lord had intended things to be big, he would have made man bigger—in brains and character”, and in another that “thoughtless or weak, [the consumer] yields to the temptation of trifling immediate gain, and, selling his birthright for a mess of pottage, becomes himself an instrument of monopoly”[238].

  As a result, consumers had to wait until after World War II for antitrust law to be adjusted in their favor. The new focus on consumers was promoted by advocates such as Ralph Nader. It was made more critical by the vertical disintegration of the firm that gave birth to longer value chains. The conservative revolution played a role, too. Under the influence of legal scholars such as Robert Bork and Richard Posner, conservatives settled for an antitrust policy focused on the consumer because it effectively led to lighter regulations on corporations up the value chain. Businesses were left alone to fight amongst themselves so long as they didn’t hurt the end consumer in broad daylight.