Five Overlooked Principles Shaping the Destiny of Your Business

Until you grasp Turing’s theory of computability, Coase theorem of transaction costs, Bell’s law of computer classes, Baldwin and Clarke’s concept of modularity, and Nakamoto’s law of the distributed ledger, you’re not prepared to lead a digital company.

 

by John Sviokla

https://www.strategy-business.com/article/Five-Overlooked-Principles-Shaping-the-Destiny-of-Your-Business?gko=c5d7a&utm_source=itw&utm_medium=20170419&utm_campaign=resp

On the surface, this may seem highly technical but take the approach of extracting the insights on the possible but potentially profound impact on your businesses.

The most important changes are often the least obvious. That’s especially true in business, where changes are taking place on a greater scale than ever before. The advent of digital technology has brought a number of these dynamics to the forefront. They can be thought of as principles. Like Moore’s law or Murphy’s law, they explain the way the world works.

If you’re in business in the 2010s, an understanding of these five principles is crucial, because digital disruption is quickly becoming the new normal. Many growth strategies that may have worked well in the past no longer pack a punch. The principles help explain not just what will happen to your company next, but why.

Turing’s theory of computability: Machines can calculate any of the ever-growing number of problems that are possible to calculate… He identified what he called “computable” activities: any task that a theoretical machine (in this case, a mathematical model with a process similar to a computer) can address. Having determined that computability can be identified mathematically, Turing then postulated that machines have the capacity to perform computable tasks as well as human beings can….

…. It would be hard to exaggerate the significance of Turing’s work on computability and artificial intelligence. It launched the computer age, establishing the fact that everything digital, from the first computer to the cell phones that are ubiquitous today, has the potential to overtake work currently done by people. When highly valued digital technologies emerge, such as search engines, ride-hailing apps, automated teller machines, travel-booking websites, and many others, they inevitably displace human effort — and in the process, they fundamentally change their industries.

The impact of increasing computability explains why established companies are so strongly affected by digitization. In a world where anything businesses do might soon be done by a computer, they have to continually redefine themselves along digital lines — whether it’s Walmart acquiring Internet retailer Jet, GE making its industrial products “smart,” or John Deere developing robotic lawn mowers. Among the tasks expected to become computable before long are basic due diligence in M&A transactions, real-time language-to-language translation (such as English to Chinese), some forms of programming, and most of the world’s motor vehicle driving.

Coase theorem of transaction costs: Aside from transaction costs, the most efficient outcome will prevail in any market. The critical phrase in this theorem is aside from transaction costs. The theorem means that the investment of money, time, and attention devoted to the exchange of goods and services will determine how well your company competes. Or, put another way, the only companies with growth potential are those that keep their internal transaction costs (their own expenses) lower than their external transaction costs (the expense of doing business with others)…

….. A company can grow only as long as its internal costs, including all overhead, are lower than its external costs. Once internal costs equal or surpass external costs and the company has reached the point of diminishing returns, it will stop expanding. Because internal transaction costs are often difficult to spot, the leaders of the company may not realize why it’s struggling…

… As digitization continues, transaction costs will continue to decline. This will affect decisions about which activities to keep inside an organization and which to acquire from the outside. Some things that used to be cheaper on the inside will now become more expensive — for example, the maintenance of R&D staffs. Hence the value of open innovation. Meanwhile, things that used to benefit from outsourcing, such as HR and training, may now become less expensive internally, because the de-layering of hierarchies may allow more informal (and therefore less expensive) talent management and recruiting. The only thing that won’t change is the basic equation: The lower your internal costs compared with your external costs, the more likely your company is to grow.

Bell’s law on the birth and death of computer classes: Roughly every decade, a new class of lower-priced computing devices emerges — and changes everything…..

…. When highly valued digital technologies emerge, they inevitably displace human effort — and fundamentally change their industries.

Every time a shift in computer classes takes place, the impact goes far beyond technology. New platforms, new forms of programming, and new types of network interfaces appear. In business, a distinct new industry emerges, often with completely different companies in the lead. The old companies either adapt (as Apple did with the smartphone and Microsoft did with the cloud) or decline (like Digital Equipment Corporation, Gateway, Kaypro, Osborne, and many others).

Baldwin and Clark’s concept of modularity: Breaking a technology or process into functionally relevant components facilitates innovation…. It breaks a complex technological project into a number of functionally relevant components — standardized where standardization is called for, and individually designed where differentiation is needed.

In a system with high modularity, the standardized parts, or modules, can easily be swapped out, upgraded, and adapted in different ways for different systems. Modularity makes it easier (and less expensive) to manage the complexity of a design…. A truly modular system can be tailored to individual customers without the entire design needing to be reinvented.

Nakamoto’s law of the distributed ledger (discussed the concept of Blockchain in our March 6 posting): Transactions improve when trust is managed by the system, not by mediators:… the Internet commerce of that time relied on financial institutions as a trusted third party to process electronic payments. This was unnecessarily complex and was vulnerable to deceit or failure. He posited that if two parties could electronically transact with one another without the need for an external overseer, online transactions would be easier and cheaper.

A few months later, Nakamoto released the first version of bitcoin: a digital currency with a distributed ledger, a peer-to-peer data technology that ensures verification through a software process called blockchain. Blockchain uses a digital distributed ledger to record transactions electronically, linking each new entry by code to the entry that came before. Verification takes place through network coordination. Computers all through the network contribute to bitcoin’s computation, storing the ledger and exchanging the codes that create new bitcoins. This distributed approach ensures that all the posted transactions are legitimate. No single member or group can compromise the integrity of a ledger distributed among so many participants.

The Power of the Five Principles

Taken together, these five principles have enormous economic ramifications. Although it’s impossible to predict the full extent of their impact, it’s clear they will change the structure and source of profit in a variety of industries around the world. Already, the shifts in computability, computer classes, transaction-cost dynamics, and modularity have enabled companies such as Amazon and Google to reach untold numbers of vendors and customers without racking up crushing operating expenses.

These principles also help us better understand the ways in which winning companies compete in today’s rapidly digitizing market. At the end of the day, great strategy depends on understanding the fundamentals of innovation, economics, and marketing, which are changing in terms of value creation. Power will flow to enterprises that embrace automation, reduce internal costs, make better use of advanced devices, design modularity into their products and services, and participate in blockchain-style verification systems. To be sure, the optimal approach will vary from one industry to another: A human third party may be enough to guarantee the security of transactions in some markets, whereas other markets will require virtual third-party validation through a blockchain system.