by Don Tapscott
The trouble is that, in recent business history, many hierarchies have not been effective, to the point of ridicule. Exhibit A is The Dilbert Principle, most likely one of the best-selling management books of all time, by Scott Adams. Here’s Dilbert on blockchain technology from a recent cartoon:
Manager: I think we should build a blockchain.
Dilbert: Uh-oh. Does he understand what he said or is it something he saw in a trade magazine ad?
Dilbert: What color do you want your blockchain?
Manager: I think mauve has the most RAM.
In the cartoon, Adams captures one of the marks of hierarchies gone wrong—that managers often rise to a level of power where they lack the knowledge required for effective leadership.
Combined with progressive management thinking about how to build effective, innovative organizations, the first generation of the Internet enabled progressive thinking managers to change the top-down assignment of work and appropriation of credit, recognition, and promotion.
For better or for worse, centralized hierarchies are the norm. Decentralization, networking, and empowerment have been sensible since the early days of the Internet. Teams and projects have become the foundation of internal organization. E-mail enabled people to collaborate across organizational silos. Social media dropped some collaboration costs internally and dropped transaction costs and made the boundaries of corporations more porous as companies could link up with suppliers, customers, and partners more easily.
However, today’s commercial social media tools are helping many firms achieve new levels of internal collaboration. Empowerment, the real decentralization of power, is an important focus in business; and companies have experimented or implemented new concepts ranging from matrix management to holacracy—with varying degrees of success.
In fact, there is widespread agreement that when firms distribute responsibility, authority, and power, the result will typically be positive: better business function, customer service, and innovation. But this practice is easier said than done.
The Internet also hasn’t dropped what economists call “agency costs”—the cost of making sure that everybody inside the firm is acting in the owner’s interest. In fact, another Nobel Prize–winning economist (yes, there do seem to be a lot of them in this story), Joseph Stiglitz, argued that the sheer size and seeming complexity of these firms have increased agency costs even as a firm’s transaction costs have plummeted. Hence, the huge pay gap between CEO and front line.
So where does blockchain technology come in and how can it change how firms are managed and coordinated internally? With smart contracts and unprecedented transparency, the blockchain should not only reduce transaction costs inside and outside of the firm, but it should also dramatically reduce agency costs at all levels of management. These changes will in turn make it harder to game the system. So firms could go beyond transaction cost to tackle the elephant in the boardroom—agency cost. Yochai Benkler told us, “What’s exciting to me about blockchain technology is that it can enable people to function together with the persistence and stability of an organization, but without the hierarchy.”27
It also suggests that managers should brace themselves for radical transparency in how they do coordinate and conduct themselves because shareholders will now be able to see the inefficiencies, the unnecessary complexity, and the huge gap between executive pay and the value executives actually contribute. Remember, managers aren’t agents of owners; they’re intermediaries.
4. Costs of (Re-)Building Trust—Why Should We Trust One Another?
As we have explained, trust in business and society is the expectation that another party will be honest, considerate, accountable, and transparent—that he or she will act with integrity.28 It’s a lot of work to establish trust, and many economists and other academics argue that we have vertically integrated firms because establishing trust is easier within corporate boundaries than in an open market. With trust at an all-time low, the challenge for firms is not simply figuring out whom to trust, but how to get outside capability to trust them.
Indeed, economist Michael Jensen and colleagues made the case that integrity is a factor of production. Not the first but among the most eloquent on the topic, they explain that the seemingly never-ending scandals in the world of finance with their damaging effects on value and human welfare argue strongly for the addition of integrity to financial operations. To them this is not an issue of virtue, but an opportunity in financial economics to “create significant increases in economic efficiency, productivity, and aggregate human welfare.” To them, “Integrity . . . on the part of individuals or organizations has enormous economic implications (for value, productivity, quality of life, etc.). Indeed, integrity is a factor of production as important as labor, capital, and technology.”29
Wall Street lost trust (and nearly killed capitalism) because of a set of integrity violations. But has it changed? And will it change? In the past, corporate social responsibility advocates argued that companies “do well by doing good.” We haven’t seen the evidence. Many companies did well by doing bad—by having bad labor practices in the developing world, by externalizing their costs onto society such as pollution, by being monopolies and gouging customers. The collapse of 2008 taught us for sure that companies “do badly by being bad.” The major banks found this out the hard way. Prior to 2008 many were making upwards of 20 percent return on equity. For many today it is well below 5 percent, with some not even making their cost of capital. From a shareholder perspective, they should no longer exist.30
What are the chances, realistically, that Wall Street will wake up to Jensen’s exhortations and act with integrity? Surely, expedience and short-term gain are coded into the DNA of the Western financial system.
Enter blockchain technology and digital currencies. What if parties didn’t have to trust one another, but could still act with honesty, accountability, consideration, and transparency because it was the foundation of the technological platform of finance?
Steve Omohundro gave us a compelling example. “If somebody from Nigeria wants to buy something that I’m selling, I’m going to be very skeptical, I’m not going to accept a credit card or a check from Nigeria. With the new platform, I know I can trust it and I don’t have to incur the costs of establishing trust. So it enables transactions which simply couldn’t happen otherwise.”31
So Wall Street banks don’t have to splice integrity into their DNA and behavior; the founders of blockchains have coded it into their software protocols and deployed it across the network—enabling a new utility for the financial services industry. The good news is that the industry can reestablish trust and maintain it in an ongoing way.
With blockchain technology causing the costs of searching, contracting, coordinating, and creating trust to plummet, it should be easier for firms not just to open up, but also to forge trusting relationships with external parties. Acting in one’s self-interest serves everybody’s interests. Cheating the system costs more than using it as designed.
This is not to say that corporate brands or for that matter acting ethically is unimportant or no longer required. Blockchain helps ensure integrity and therefore trust in transactions between peers. It also helps achieve transparency—a critical factor in trust. However, as author and technology theorist David Ticoll says: “Trust and brand are about more than vouchsafing a transaction. They are also about quality, enjoyment, safety of a device or service, cachet and coolness. In today’s COP21 world, the best brands transparently and verifiably signify outcomes that are environmentally, socially, and economically responsible.”32
Still, through smart contracts, executives can be held accountable—they must abide by their commitments as enforced and settled by software. Companies can program relationships with radical transparency so everyone has a better understanding about what each party has signed up to do. And overall, like it or not, they must conduct business in a way that is considerate of the interests of
other parties. The platform demands it.
DETERMINING CORPORATE BOUNDARIES
Overall, the boundaries that separate a company from its vendors, consultants, customers, external peer communities, and others will become harder to define. Perhaps as important, they will constantly change.
Firms will still exist, blockchain notwithstanding, because the mechanisms for searching, contracting, coordinating, and establishing trust within corporate boundaries will be more cost-effective than those in the open market, at least for many activities. The idea of the so-called free agent nation, where individuals execute work outside the boundaries of corporations, is illusory. Melanie Swan, who founded the Institute for Blockchain Studies, said, “What’s the right size of the corporation for optimal transactibility? Well, it’s not a unitary thing, of people working only as individuals or e-lancers.” To her, there will be new kinds of “flexible business entities of individuals and groups partnering around projects.” She views the new model of the firm more like the guild, the preindustrial associations of merchants or tradesmen who worked together in a particular town. “We still need organizations acting as coordinating mechanisms. But the new models of team collaboration are not yet fully clear.”33
Today we often hear that firms should focus on their core. But when considering how blockchain technology drops transaction costs, what is core? And how do you define that when a company’s core is constantly changing?
It seems that everyone has a different definition of what the optimal firm size should be to maximize productivity and competitive advantage. Many firms we examined didn’t have a clear view, seeming to choose the Bob Dylan approach to determining what’s in and what should be out (“You don’t need a weatherman to know which way the wind blows”). Back-office processing, for example, was described as a no-brainer, without any clear criteria as to why.
Some are more rigorous. From the core competencies view developed by Gary Hamel and C. K. Prahalad, firms gain competitive advantage through competence mastery. Those competencies mastered are central to the firm, while others can be acquired from outside.34 However, a firm may have mastery over some activities that are not mission critical. Should they still be kept inside?
Strategist Michael Porter has an implicit view that competitive advantage stems from activities, in particular from networks of reinforcing activities that are hard to replicate in their totality. It’s not the individual parts of the business that matter, but how they are strung together and built to reinforce one another in a unique activity system. Competitive advantage comes from the entire system of activities; while any individual activity within the system may be copied, competitors cannot produce the same benefit unless they manage to duplicate the entire system.35
Others argue that companies should always retain functions or capabilities that are mission critical—those that firms must absolutely get right for survival and success. But making computers is mission critical for computer companies; yet Dell, HP, and IBM outsource much of this activity to electronics manufacturing services companies like Celestica, Flextronics, or Jabil. Final assembly of vehicles is mission critical for an auto manufacturer; yet BMW and Mercedes contract with Magna to do this activity.
Stanford Graduate School of Business professor Susan Athey argues persuasively: “There may be some mission-critical functions, like the collection and analysis of big data, that are just too risky to move outside corporate boundaries, even if you don’t have unique abilities in that area.”36 True, there may be some functions like data analytics where survival depends on being uniquely good, and there may be existential risks of partnering. Still, external resources can be deployed strategically to build internal capability.
Our view is that the starting point for corporate boundary decisions is to understand your industry, competitors, and opportunities for profitable growth—and use this knowledge as the basis for developing a business strategy. From there, the blockchain opens up new opportunities for networking that every manager and knowledge worker needs to consider at all times. Boundary choices are not simply for senior executives, they are for anyone who cares about marshaling the best capability for innovation and high performance. We should add—and this is no small point—that you can’t outsource your corporate culture.
Enter the Matrix
Taking into account how blockchain technology can enable access to unique capabilities outside corporate boundaries, firms can now define those business activities or functions that are fundamental to competitiveness—that are both mission critical and also unique enough to ensure differentiated value.
However, this In-Out Matrix is just a starting point for defining corporate boundaries at any given point. What other factors should firms consider in determining what is fundamental? What extenuating circumstances are there that might affect choices to outsource or nurture internally?
Hacking Your Future: Boundary Decisions
When making boundary choices, firms should start using the blockchain to marshal a 360-degree view and reach consensus on what is unique and what is mission critical in their business. Let’s return to Joe Lubin and ConsenSys, as they foreshadow the modus operandi of the blockchain-based enterprise. Remember that ConsenSys is in its infancy, and much can go wrong to undermine its business. We can still learn from this company’s example.
1. Are there possible partners who could do the work better? In particular, could we benefit from harnessing new peer production communities, ideagoras, open platforms, and other blockchain business models? The company ConsenSys is able to orchestrate extraordinary expertise to do its work, even though many are outside its boundaries.
2. Given blockchain technology, what are the new economics of corporate boundaries—the transaction costs of partnering, versus keeping/developing in-house? Can you develop a suite of smart contracts whose core elements are modular and reusable? ConsenSys uses smart contracts to reduce coordination costs.
3. What is the extent of technological interdependence versus modularity? If you can define business components that are modular, then you can easily reconfigure them outside corporate boundaries. ConsenSys sets standards for software development and provides access to various software modules that its partners can build upon.
4. What are your firm’s competencies with regard to the managing of outsourced work? Can smart contracts enhance those competencies and lower costs? From the get-go, ConsenSys was a blockchain business. CEO Joe Lubin embraces the technology and a modified holacracy, and we can see the seven design principles at work.
5. What are the risks of opportunism where a partner might encroach on fundamental parts of your business, as some have suggested Foxconn may do to smart phone companies? ConsenSys tries to mitigate this challenge by building loyalty through incentive structures whereby its talent shares in the wealth they create.
6. Are there legal, regulatory, or political obstacles to deeper networking (and shrinking) of the organization? Not a problem for ConsenSys yet.
7. Speed and pace of innovation are important to boundary decisions. Sometimes firms have no choice but to partner for a strategic function because they cannot develop it in-house fast enough. A partner arrangement can be a placeholder. Will partnering help us build an ecosystem that will improve our competitive advantage? This is ConsenSys’s strategy: build a network of collaborators around the Ethereum platform, grow the platform and ecosystem, and increase the probability of success for all components.
8. Is there a danger of losing control of something fundamental—for example, a product or network architecture? Firms must have a sense of which parts of the value chain will be key to creating and capturing value in the future. If these are farmed out, the firm will lose. The Ethereum platform provides a basic architecture for ConsenSys.
9. Is there a capability, like the exploitation of data assets, that must be part of the fabric of your enterprise and all its operations? Even though you lack a unique capability, you should view partnering
as a transitional tactic to develop extraordinary internal expertise and capacity. Blockchain technologies will introduce a new set of capacities that need to reside in the cranium of every employee. You can’t move culture outside your boundaries.
CHAPTER 5
NEW BUSINESS MODELS:
MAKING IT RAIN ON THE BLOCKCHAIN
Founded a month before the market crashed in 2008, Airbnb has become a $25 billion platform, now the world’s largest supplier of rooms as measured by market value and rooms occupied. But the providers of rooms receive only part of the value they create. International payments go through Western Union, which takes $10 of every transaction and big foreign exchange off the top. Settlements take a long time. Airbnb stores and monetizes all the data. Both renters and customers alike have concerns about privacy.
We brainstormed with blockchain expert Dino Mark Angaritis to design an Airbnb competitor on the blockchain. We decided to call our new business bAirbnb. It would look more like a member-owned cooperative. All revenues, except for overhead, would go to its members, who would control the platform and make decisions.
BAIRBNB VERSUS AIRBNB
bAirbnb is a distributed application (DApp), a set of smart contracts that stores data on a home-listings blockchain. The bAirbnb app has an elegant interface: owners can upload information and pictures of their property.1 The platform maintains reputation scores of both providers and renters to improve everyone’s business decisions.
When you want to rent, the bAirbnb software scans and filters the blockchain for all the listings that meet your criteria (e.g., ten miles from the Eiffel Tower, two bedrooms, four-plus star ratings only). Your user experience is identical to that in Airbnb, except that you communicate peer to peer on the network, through encrypted and cryptographically signed messages not stored in Airbnb’s database.2 You and the room owner are the only two people who can read these messages. You can swap phone numbers, an exchange that Airbnb blocks to preserve future revenues. On bAirbnb you and the owner could communicate off-chain and complete the transaction entirely off-chain, but you are better off completing the transaction on-chain for a few reasons.