The future of entreprise – 7 – Towards new value proposals

Photo Nicolas Colin / Co-founder and Partner, TheFamily / February 19th, 2015

Business models that emerge today outline a world of hyper-competition: in the digital economy, it's always possible to find both better and cheaper elsewhere. Now, this tendency is spreading beyond the borders of the Net. How can a company survive in this ruthless world? How can it possibly stand out from others? New trends are emerging, new value proposals that could become the cornerstone of tomorrow's economy.

This article is the seventh of a series which will be completed within the next months.

ParisTech Review – New business models are stemming from the digital revolution. How do they foreshadow the models of the future?

Nicolas Colin – If we are to grasp the change, maybe even the revolution embodied by these companies and fully understand the transition that we are currently experiencing, we need to know where we came from and what we are now leaving behind.

The economy that is disappearing before our eyes is built around the paradigm forged during the technological revolution of the 20th Century. The growth of the automotive industry was achieved and amplified by the discovery of an abundant and cheap resource: oil. Oil is the cornerstone of a paradigm that determined the creation of value throughout the 20th Century. One industry after another, most companies based their organization on the model of the automotive field. What did the business profile that dominated this period look like? Large size, pyramidal organization, production chains that are timed, mapped and standardized according to the principles of scientific management. Mass production and scale economies were a prerequisite for creating added value. Their effectiveness was therefore based on two imperatives: offering standardized products (Ford’s famous T model) and optimizing continuously the process. The culture of these companies, their organizational choices and their development strategy were based on this initial model. All of it was fueled by an energy resource: oil. This is why higher oil prices since the 1970s caused this paradigm to waver and led to an acute crisis we never really escaped from.

Digital economy seems to overcome these constraints. Is its future guaranteed?

Indeed, in the digital economy, the abundant and cheap resource is no longer oil but… individuals. More specifically, the billions of increasingly educated, equipped and connected people. With the simultaneous use of the same applications, they have become autonomous agents of value creation in the economy. Out of their passivity, these active consumers, creators of value, form what Henri Verdier and I have called the “multitude”. The emergence of the multitude in value creation promoted the emergence of a radically different paradigm. Through their daily connections, these people supply entrepreneurs with a considerable pool of resources: data from applications, of course, but also apartments for AirBnB, cars for BlaBlaCar, money for loans between individuals and of course, time and workforce, as exemplified by collaborative economy.

The strategic challenge for a digital company, is not only to ensure a privileged access to oil – the lifeblood of mass economy – but to secure a privileged access to this new, essential resource, that generates positive externalities: the multitude.

However, this new resource is difficult to secure. Digital firms are therefore extremely fragile.

It is true that people cannot be tied up. They have fundamental rights and they may terminate their relationship with any company whose offer is judged no longer useful. Former search engines like Yahoo or Altavista are examples of it. Suddenly, for some mysterious reason, everyone migrated to Google and the oldest search engines were wiped off the map. Similarly, MySpace, the first large scale social networking application, was ousted by Facebook. Users swarm on a service or product, but they move away just as quickly. All the companies that stand out today, all of those that dominate their market, are the ones that have managed to forge a long-lasting alliance with the multitude.

This opportunity is certainly not restricted to companies originating from the digital revolution alone. A firm like Amazon sold physical goods long before becoming a digital company. But it has managed to escape from the complexity and decreasing returns of its core industry, logistics, by creating an alliance with the multitude. Amazon could simply have reached a large scale, operated large warehouses, and optimized its logistics system. Ultimately, it would have exposed itself to the risk of being struck down by the low margins imposed by the particularly harsh competition on the Internet. In short, it could have sunk because of the diminishing returns within a traditional business model. But Amazon wisely decided to complete its initial business based on mass retailing by a digital offer, which allowed it to forge an alliance with the multitude. Thanks to the interfaces developed in its applications, Amazon was able to integrate customers within its value chain and to harness network effects. User reviews and recommendations algorithms create network effects that add up with economies of scale. Amazon’s business performance has been growing ever since and allow it to continue to grow until this day without being carried away by its infrastructure logistics.

… thanks to the “network” effect that seems to work at the heart of these new business models: could you tell us more about these? 

Network effects are an observable phenomena, especially in the economy of telecommunications. When several telecom operators implement an autonomous network, consumers opt fairly systematically for the network already with the largest number of customers: what good indeed in subscribing to a telecommunications network with only few connected users? On a market based on the net, the largest operator always has the advantage. Moreover, that is governments have strongly regulated the telecommunications sector for decades. Network effects are summarized by the famous Metcalfe’s law, according to which the marginal utility of a network is proportional to the square of its number of users: the greater the number of connected users in the network, the greater the value of being connected to the network – in fact, the ratio is exponential!

In the digital economy, network effects have stayed marginal during a long time. But nowadays, digital network effects have pervaded all sectors. From the onset of the speculative bubble of the 1990s, companies began to be valued according to their number of users. The Internet economy immediately produced strong network effects. But it’s only in recent years that we understood their importance. They determine the life and death of businesses and they allow some to hold dominant positions in their market. Amazon, for example, is a company that has managed to generate strong network effects in an industry, mass retailing, with small-scale and relatively marginal effects.

Is network effect also behind the success of Google?

Absolutely. Historically, the first search engines were launched through hiring students to browse the web and attach keywords to pages. Google devised an algorithm that runs through hyperlinks and ranks pages based on the number of links pointing to these pages. Therefore, they used information that had already been created by others and networked pages that were interconnected by links. The initial success of its search application was based on its sleek design and its performance in terms of load times. This allowed Google to create network effects and generate increasing returns, eventually widening the gap to the extent of ousting competitors. If Google – with the largest number of indexed pages and the largest number of people using its search engine on a daily basis – is both more relevant and more effective, why bother using a search engine operated by a competitor? And that’s how the company gained a position of “natural monopoly.”

Isn’t speed also apparently one of the keys of these new business models? 

That’s right. To get ahead of the race, you need a competitive edge. As such, being free is a crucial point. This is what allows, among other things, people to save time. That’s why new players need to gather immediately significant capital to invest massively. To hope to become a leader, you need to raise a lot of money. The example of Uber is particularly relevant: we’re speaking of a company that attacked huge market, on a global scale, ie the transport of individual passengers. At the heart of its business model, there are some powerful network effects, both from customers and drivers’ side. Since activity increases based on returns, a single company will eventually dominate the entire market. To conquer such a position is priceless: basically, the difference between life and death! That’s why these companies are willing to invest so much money and prefer to opt for staying free (or cheaper prices). Not only does this accelerate their growth but it offers them a chance to dominate the market. That’s also why they enjoy such valuations: investors know they are betting big, but they also expect an important return on investment.

However, digital businesses cannot become predators for their customers. They must honor the terms of the alliance and continue to serve them with lower prices, a constantly improved quality of service and a sustained effort of innovation. Swift response in case of a problem, immediate repayment, freedom to terminate at any time, are all services intended at the multitude. This requirement also contaminates all the other dimensions of the company, up to its financial strategy. The choice made by Alibaba or Google not to distribute dividends to their shareholders is a message sent to the multitude to show them that the company’s profits are reinvested in services for their customers rather than benefits for their shareholders. Communication is also evolving. The leaders of digital companies are also trying to have a freer communication style: less institutional, more sincere and authentic. The multitude is indeed reluctant to waffle.

What is the role of innovation in these new business models?  

It is crucial. Customers are even more loyal when the offer changes constantly. Innovation is a requirement. In the world of digital economy, players constantly offer new services. Facebook, for example, tests new features every week on small segments of its huge user community. Obviously, they don’t hit the mark every time: sometimes a new design or feature is not received positevely. Innovating is as much a marketing strategy than a retention tool. Better having unhappy customers who express themselves than silent customers who may be preparing to leave without any explanation. Constant innovation also creates a constant feedback from multitude, which helps maintain the relationship and integrate criticisms. The multitude appreciates the investments aimed at improving its experience. It is also sensitive the company’s ability to listen. This culture shows a profound change from mass production economy. In the past, when you were unhappy, you just had to live with it – and at the same price!

Digital companies are doomed to constant innovation. Is it not a dangerous game? 

Yes, especially since it is becoming increasingly difficult to put up barriers at the entry of digital markets. It’s difficult, for example, to secure such a resource as the multitude. Individuals are free to leave and use a competitor’s application. Similarly, it becomes increasingly complicated to protect the features that can consolidate the alliance with the multitude, more specifically, application innovation and design: all of this can be viewed online and patents aren’t of any good use. Companies, including large ones, should get used to this kind of vulnerability. But slowing down the effort and the pace of innovation endangers the alliance with the multitude. It’s a dangerous gamble in which one can lose everything because of a failed innovation. But we will certainly lose everything, if we stop innovating and become predators.

If the key of power is control over the multitude, will we see companies pay their customers to maintain and secure their value? What are the different possible options?

In an expanding part of collaborative economy, users are no longer active for free. They make resources available (their time, their money, their creativity) in exchange for a share of the created value. But there is no general rule – rather a kind of empiric rule: in the digital economy, you can always find a contractor that can produce better and cheaper. Securing the multitude, the crucial resource, is priceless. The multitude needs to find clear benefits – whether financial or of another kind.

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In this world where the possibility of being copied lurks in every corner, which features would enable companies to stand out? Will design or price have any influence?

The only way for companies to survive in this economy is to distract their users from a vulgar price comparison. Let’s not forget that in the digital economy, you can always better and cheaper. For this same reason, companies whose value proposition is merely transactional will eventually disappear, crushed by the harshness of price competition. But if you create an experience that goes beyond mere transaction – one that extends to inspiration, recommendation, service, valuation and interaction – then, there is a chance your customers will no longer look only the price but face a much more subtle question: which firm am I most comfortable with? Which one gives me a high level of quality? That’s the challenge faced by Amazon. It allows the firm to stand out from all the other e-tailers. While the later only compete in terms of price, Amazon has developed an extraordinary experience of inspiration, purchase and service for its customers, where price is a variable among others.

The creation of value of these business models primarily benefits the consumer, eventually. But will it create jobs?

The digital economy will create jobs – mostly unskilled jobs – as soon as our institutions are updated. To create jobs in the digital economy, we still need three things: an adapted funding of economy that leave more room for risk capital; sectorial regulations in line with the new regime of value creation; finally, a welfare system that will cover risks that become increasingly important in the digital economy. Problems such as housing and intermittency. Indeed, we will change jobs and employers much more often and our careers will be characterized by discontinuity. These are the most acute risks in the digital economy of the future. Our welfare system doesn’t know how to hedge against these risks, which were minimal or non-existent in the economy of the 20th Century. The digital economy will not create jobs as long as it doesn’t learn manage the risks. But we can read the situation in an optimistic way: if the digital economy is able to implement an adequate social protection, it will create jobs massively, especially unskilled jobs!

What kind of crisis (data crisis, innovation crisis) could jeopardize these business models?

The worst crisis is already happening: the lack of institutions that enable the development of the digital economy. During the 20th century, for the economy of mass production to expand and allow us to live the postwar boom, appropriate institutions were needed: the banking system, large transport networks and infrastructure, social dialogue, social protection.

These institutions were built on the old paradigm and we owe them to Roosevelt and the “New Dealers” in the United States, to the National Council of Resistance in France (let’s note that they were long in the making). For a long time, they worked well. But today, they are no longer appropriate. And no contemporary leader cares to invent institutions adapted to the new paradigm. We are victims of a crisis of inadequacy. We still need a regulation adapted to the digital economy for the sector of private transport as we need a bank or a social protection system adapted to the digital economy. All these new institutions must be invented! Beyond this infancy crisis, we will also face, inevitably, a senile crisis in a few decades: countries that have seized the opportunity of the digital economy will arrive sooner or later at the end of the model. But it is still too early to guess how this will happen. Could we imagine one day a multitude shock of the same magnitude as the oil shock? Will the multitude ask for payment in exchange for its resources? As a consequence of this brutal inflation, the mechanics of value creation could be completely destroyed, again…

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