Thursday, June 22, 2017

The Services Revolution: Why Social Networks Turned Into an Instituion

Last month I gave a talk (pdf) on innovation timing at OpenWay Club. The presentation covered, among other topics, the unfolding technology revolution in services. The talk drew on several key sources, including the work of Oliver E. Williamson, a Nobel Prize winner in economics from UC Berkeley, Cesar Hidalgo's book "Why Information Grows", and our book with Max Shtein "Scalable Innovation."

My goal was to show that new technologies have fundamentally changed the nature of services because they commoditized "specificity" and "recurrence." (see figures below). That is, in a networked digital world knowing your customers and interacting with them on a regular basis is dramatically less expensive than in a "stand alone brick-and-mortar" world. To illustrate the main points, here's a screen shot of a relevant page from Hidalgo's book (with my annotations) and several slides from the talk.

(The recent purchase of Whole Foods by Amazon is another example of the shift to Groceries-As-Service model, where Amazon leverages its customer insights into recurring retail sales.)

Even more importantly, the new service models have become a major global institution because they addressed the fundamental issue that plagued service businesses since ancient times. Douglas C North (Nobel Prize in Economics, 1993), described the problem in game theory terms:
In the world of personal exchange (recurring-specific - ES), it pays for parties to an exchange to cooperate, because the parties have personal knowledge of the other players and there is the possibility for repeat dealings between the parties. But in a world of impersonal exchange, it pays for the parties to defect, ceteris paribus. With impersonal exchange, the world is one in which there is not an iterated game.... One does not know anything about the other players, and indeed there are a large number of players.
That is, in traditional transactions players on both sides have incentives to cheat because they don't know each other personally or through a personal network. Therefore, in 1999 North suggested that to make the global marketplace efficient and scalable a new model had to be invented:
...we are going to have to devise institutions de novo that attempt to confront and deal with worlds of impersonal exchange.
Remarkably, new service models, such as Airbnb, Uber, Amazon, Alibaba, Instaply and others provide a glimpse of the institutions to come. Since identities of sellers, buyers and recommenders are known, parties are less likely to cheat; therefore, the number and quality of transactions shows rapid growth.  Although the solution is not perfect, it is a lot more efficient than all attempts to introduce global regulations. It's exciting to see how social networking technologies are redefining the rules of commerce and provide a working alternative to law.

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