CHAPTER FIVE

COMMERCIAL TRANSFORMATION

Rewriting Business and the Economy

INFORMATION, INTELLIGENCE, AND SPATIAL EQUIVALENCES are reshaping commerce and the economy at large. Tom Goodwin’s now-famous observation encapsulates just how thoroughly the rules are being rewritten:

Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.¹

The worlds of business and finance are changing rapidly: online retailing, the sharing economy, freemium business models, streaming media, crowd-sourcing, peer-to-peer lending, virtual currencies. All this and more, and the Autonomous Revolution has hardly begun. New forms of business, driven by these opportunities, plus an explosion of new enterprises made possible by autonomous vehicles, big data analytics, artificial intelligence, and the Internet of Things, are waiting in the wings.

The Autonomous Revolution will challenge every enterprise, big and small, to rethink the correct calculus of employees versus robots, internal operations versus crowd-sourcing, custom operations versus open-sourcing. How disruptive these transformations are at any given moment will depend on the complex interrelationships between the technological state-of-the-art and the social and political environments.

From our point of view, the four most important commercial trends are:

1. Virtualization. Many information-intensive service businesses that currently employ more than 80 percent of the workforce will virtualize. Some will melt away like ice in the physical world and adopt fluid forms as applications executing on smart devices.

2. Networking. New businesses will appear in the sharing economy, where core groups of permanent employees will leverage the efforts of much larger groups of work-for-hire contractors and content creators to build valuable businesses and vast fortunes for insiders. These businesses will be extremely capital-efficient, but will employ few people and have limited spillover effects.

3. Displacement. Many of these new businesses will be displacement businesses, meaning that they will take the place of the old ways of doing things without creating enough new opportunities to offset their displacement effects.

4. Non-Competition. Monopolies will become more prevalent and will be well-positioned to stifle their competition while exploiting their customers, contractors, and most replaceable workers.

In attempting to understand the commercial repercussions of societal phase change, it is important to remember that businesses today exist on a continuum. Some, such as restaurants and plumbing contractors, have low information content. Taking advantage of the benefits of information equivalence will have little effect on their forms and functions. They will be able to plan their work more effectively and will need fewer administrative employees. If they are restaurants, they may see a considerable expansion of their take-out operations, thanks to apps like Grubhub; but they will still have dining rooms and kitchens, in which people peel mountains of onions and grill steaks to order. Plumbers will still weld pipes. At the other end of the spectrum, the greatest impact of information equivalence will be felt in the service industries.²

Many service businesses, such as airlines, have both large information and large physical components. They will make use of autonomous workers to deliver higher-quality, lower-cost services, but, to an outside observer, the changed businesses will appear very similar to what existed before. Airlines are already using lots of autonomous workers. We interface with them when we check in using our credit cards or when our phone dings us with a message that our flight has been delayed, but airlines are still defined by the cities they serve, the uniforms of their cabin crews, and whether their seat pitch is 29 or 34 inches. Because these types of business are so strongly anchored in the physical world, the effects of the structural transformations may not be immediately apparent. But the processes embedded in the businesses will be starkly different as robots replace more and more of their human workers.

Other businesses, such as media companies and financial institutions, are mostly pure information-processing systems in disguise. Many of them are building equivalent business structures on top of new platforms in virtual space—on the Internet, in smartphone apps, and in the Cloud. A large percentage of them are displacement businesses. Apple Music, Spotify, and Pandora have grown into multibillion-dollar enterprises, while CD sales have fallen from $27 billion in 1999 to $15 billion in 2014 and are still plummeting, and chain record stores like Virgin Records and Tower have disappeared. While these streaming services provide a valuable service to customers, they have eliminated far more jobs than they’ve created, directly or indirectly, and they have greatly reduced the flow of revenue to artists.

Consumers now take photographs with their phones, store and share them with Snapchat, Flickr, and Photobucket, and use services such as Shutterfly to make albums for friends. At the same time, Kodak, whose scientists invented digital photography in the 1970s, has been driven into bankruptcy.

Think of the changes of form that took place in these businesses as a result of structural transformations. CDs and DVDs sold through retail outlets became bits that traveled down wires and through the air. Newsprint, printing presses, and newsstands are no longer needed. We still take photographs, but none of us purchases film or picks up prints at our local drugstores.

The transitions to these new business models occurred because the new services are more appealing to customers and can be produced very inexpensively. As a result of the low production costs, many things that customers once paid money for are now available for free. The rules these businesses operated under are different as well. Many adopted the freemium business model. They give away their services in order to capture the customer’s attention, which they then sell to advertisers.

A second wave of business virtualization is now starting to materialize. Instead of swallowing whole industries in one gulp, these new business forms chip away at them. Targeted applications take over small parts of the industry. Companies then combine these small applications to offer broader and more sophisticated services. This has already happened in the travel industry and it is beginning to happen in finance. The same type of thing will happen in other markets.

Eight million people work in the financial industries, almost 5 percent of the country’s workforce. Leading up to the financial crisis in 2008, the sector generated between 30 and 40 percent of domestic corporate profits. After falling precipitously, to 10 percent of profits in 2008, the sector clawed back up to the 20 percent level, where it stands today.³ Its lush profits and functional inefficiencies make it an ideal target for information equivalent services. That said, banks, credit card systems, financial advisory services, and so on will not go away. But their forms will change so completely that they will effectively become a different industry.

FROM PLASTIC TO CYBERSPACE

Financial, banking, and credit card institutions perform a number of valuable services:

1. They hold and protect customers’ assets.

2. They serve as trusted intermediaries that move money and assets between accounts, match sources of capital with users, and match buyers and sellers.

3. They manage risk.

4. They provide advice and manage assets.

5. They maintain a ledger to keep track of account activity.

Some financial entities do a few of these things; full-service banks do them all. All such businesses have information equivalents that can be moved to virtual environments. When this happens, autonomous people-less systems will take the place of service systems that used people to perform transactions and make judgments. By examining some of the shortcomings of the existing systems, we can develop a better feel for why and how these changes will come.

Credit cards are a perfect example of a business segment that is ripe for displacement by substitutional equivalent structures. They are very expensive for both consumers and merchants, highly vulnerable to theft and fraud, and complex and slow for the transaction clearing process.

In 2015, Americans charged $3.2 trillion on their credit cards and $2.6 trillion on debit cards.⁴ Users paid $90 billion and merchants around $60 billion in transaction fees.⁵ Credit card holders paid an additional $65 billion in interest at a rate of approximately 16 percent.⁶ One would think that, with $5.8 trillion of charges plus an additional $215 billion in fees and interest flowing through it, the system would have armed cyber-guards standing at every cyber-portal. But in fact, the credit card system has a long history of not paying adequate attention to security risks. According to Donn Parker, one of the nation’s early experts on computer crime, the credit card companies initially worried that if they added even basic security features (such as PINs) to their credit cards, it would slow consumer adoption.⁷ The companies assumed that losses would be so small that they could easily be absorbed as a cost of doing business.

This is a typical example of how intuition fails us when phase change is involved. How could someone in the 1960s possibly have conceived of bots that did not yet exist, stealing tens of millions of credit card numbers using the Internet, which also did not exist, by monitoring customer key strokes on personal computers that would not appear until the 1980s? The culture that believes that fraud losses are an acceptable cost of doing business still prevails, and the results are pouring in. Thieves stole information on 40 million credit card accounts at Target, 56 million accounts at Home Depot, and 94 million at TJX, the parent of the Marshalls and T. J. Maxx chains.⁸ Even the little guys suffered. Malware installed on cash registers at Arby’s, a relatively small fast-food chain, resulted in the theft of credit and debit card information for 355,000 customers.⁹ In 2015, credit and debit card fraud reached almost $22 billion.¹⁰ Ten percent of Americans have been directly affected.¹¹

One of the worst security breaches in consumer information history was reported on September 7, 2017, by Equifax, after thieves gained access to the records of 143 million Americans. The breach was discovered on July 29 and it took Equifax more than five weeks to inform consumers. Only 209,000 of those records contained credit card numbers, but the information on the other 143 million accounts will aid thieves in their efforts to commit consumer fraud.¹²

The credit card network consists of a number of layers. Those layers involve the merchant, the acquirer (the company that signed up the merchant on the system), the credit card network (Visa, Mastercard, American Express, Discover, etc.), and the bank that issued the card. The 2-percent fee the merchant pays is divided between those service providers. Even though transactions are authorized almost instantly, the actual payment process is slow. Frequently it takes three days for a transaction to show up on a cardholder’s account, because transactions are batch processed as they pass through different layers of the system.¹³

Information equivalents already exist that can save cardholders and merchants much of the $215 billion they pay in fees and interest. These systems can be made so secure that a lot of the $22 billion in losses due to credit card fraud can be eliminated. Increasing confidence in the system would restore another source of lost revenue—the 63 percent of consumers who have experienced fraud and use their cards less often as a result.¹⁴

In China, India, and many developing economies, this replacement is well under way. In some of these countries, credit cards never really became established, because merchants lacked point-of-sale machines and customers didn’t have bank accounts and credit. Now mobile payment systems supplied by the likes of Alibaba and Tencent are filling in the gap. Mobile payments in China reached $9 trillion in 2016, compared to just a little over $100 billion in the United States.¹⁵

But numerous mobile payment platforms—PayPal, Venmo, Popmoney, Snapcash, and so on—are now vying for Americans’ business.¹⁶ These platforms are frequently inexpensive and are tailored to individuals’ needs. Snapcash is a payment system designed to allow Snapchat users to “quickly and easily exchange money—such as splitting the bill at a restaurant or paying someone back for concert tickets.”¹⁷ Popmoney enables individuals who are online to send money to one another for a fee of $0.95 per transaction.¹⁸ Customers of Ally Bank pay nothing to use the service.¹⁹

The financial services area is a seething cauldron of innovation, as venture capitalists, entrepreneurs, existing financial firms, and platform providers such as Apple and Google pour billions into financial technology (fintech). There are more than 4,000 fintech start-ups around the world.²⁰

Let’s take a look at some of the other services being offered that are chipping away at the industry: managing assets, managing hedge funds, and transferring money.

Managing assets for clients is a big business. Registered investment advisers manage more than $2 trillion in assets.²¹ These advisers typically charge a commission of 1 percent of the assets they manage.²² Some of them invest clients’ money in actively managed funds that charge additional fees.²³

Hedge funds manage another $3 trillion.²⁴ In a fee structure called “two and twenty,” hedge fund managers typically charge clients 2 percent of the assets under management and 20 percent of the capital gains. Managers of other types of assets manage trillions more with a wide range of fee structures. BlackRock, the world’s largest asset manager, manages more than $5 trillion in assets and offers a wide range of financial products.²⁵ The top fifty money managers in the United States control more than $25 trillion.²⁶

This market creates a lush target for businesses hoping to replace human managers with automatons and move money management services to virtual space. A 0.1 percent reduction in fees would save investors $25 billion, and many of the automated systems charge as little as 0.5 percent. Vanguard uses robo-advisers to manage $4.2 billion in customer funds for a fee of just 0.3 percent of assets. There are lots of other choices if you don’t like the Vanguard robot. For example, in some cases Betterment will charge customers even less. Small accounts can choose Wealthfront.²⁷

Tellingly, 80 percent of the investment products managed by humans perform the same or worse than those managed by robots.²⁸ Needless to say, as those robots get smarter and more efficient, they will be even more competitive. And hardworking robots will be happy to earn a 0.25 to 0.5 percent fee. This is good for consumers, but thousands of jobs and billions of dollars in fees will vanish.

Transferring money between parties and countries has been a profitable business for financial institutions for hundreds of years. Many innovations are occurring in this space with a goal of making these systems more convenient, secure, and less expensive.

For as long as banks have existed, customers have searched for ways to reduce charges and eliminate the hassle in making payments. In 45 BCE, Cicero, who lived in Italy, needed Greek money to pay for his son Marcus’s education in Athens. Cicero had an Italian friend Atticus, who was owed money by Xeno, who lived in Greece. So, Cicero avoided getting bankers and money changers involved by paying money to Atticus, who then told Xeno to pay for Marcus’s education.²⁹

More than two millennia later, Patrick and John Collison stand ready to help modern-day Ciceros who are frustrated by complex international payment processes. Their company, Stripe, offers users a customizable payment platform that they can tailor to their needs, significantly reducing the hassle involved in conducting business across national borders.³⁰ The Collisons, brothers from rural Ireland who just crossed their thirtieth birthdays, are two of the world’s youngest billionaires. Their company has fewer than a thousand employees. It had fewer than one hundred as recently as 2014.³¹

WHEN MONEY GOES VIRTUAL

Then there are cybercurrencies such as Bitcoin. Bitcoin has proved that extremely secure, anonymous, inexpensive, and fast payment systems can be implemented using distributed ledgers, a system in which multiple copies of the same ledger are stored on geographically dispersed systems. The ledgers are virtually impossible to hack, because there are so many of them—thousands in Bitcoin’s case. If a hacker penetrated one of them to steal something, he would also have to figure out how to alter the records on the thousands of other systems.

By comparison, the single-copy ledgers that banks use to keep track of bank accounts and credit card transactions are much less secure. In payment systems based on distributed ledgers, only the source of a payment is identified; no account information is ever revealed to the payee. This makes it virtually impossible to acquire information from a payee, such as Arby’s, to access money from a payer’s account.

Transactions using blockchain technology (a form of distributed ledger technology in which data can only be added to databases and not altered or deleted) can also be made very secure and anonymous. In the case of Bitcoin, a cryptographic algorithm is used to ensure that Bitcoins are transferred from the correct payer’s wallet to the correct recipient’s wallet.³²

In the credit card world, the typical fee for transferring money is about 2 percent of the size of the transaction, and a merchant will typically have to wait one to three days before money is deposited in its account. Things are very different with Bitcoin. The charge for the transfer is based on the length of the message required to specify the transfer and the current value of a Bitcoin. The fee is constant (typically 0.1 percent of the value of a single Bitcoin), whether one is transferring one dollar or a million. The transfer time can also be speeded up. Users willing to pay higher fees can usually get a transfer completed in two block times, or about twenty minutes. One of the features that Bitcoin users especially like is that, since users in different countries are all using the same currency, there are no charges associated with currency conversion.

In contrast to Bitcoin, even the most secure traditional systems are vulnerable. Hackers have attacked the SWIFT system by stealing the credentials of bank employees. Eighty-one million dollars was stolen from accounts at the Bangladesh Bank, and the hackers might have gotten access to $1 billion more were it not for a typo—the hackers misspelled “foundation” as “fandation,” attracting the attention of the New York Federal Reserve.³³

There are also many practical problems associated with Bitcoin, and for that reason Bitcoin itself will probably have a limited impact. But the blockchain technology it gave the world will be used in many applications with the goal of making transactions more secure. It is highly likely that new virtual currencies using blockchain will be more broadly adopted in the future.

Millions of dollars of Bitcoins have already been stolen from users. The attributes of the technology described above regarding the speed, security, and anonymity of the transfer process make it inherently more difficult to solve Bitcoin thefts. If a thief figures out how to get access to an individual’s Bitcoins they can transfer them securely and quickly, leaving no tracks to follow.

JUST BETWEEN US

Peer-to-peer lending and investment groups are springing up all over in virtual environments, with each of them focusing on a different market niche. The Lending Club, Prosper, and Upstart make loans to consumers while providing investors with higher returns and borrowers with lower interest rates. OnDeck, Kabbage, and Funding Circle focus on small businesses and other investment groups’ mortgages.³⁴

Peer-to-peer lending platforms use their Internet presence to attract investors who are seeking higher interest rates than they can get from bank CDs or by investing in bonds. They attract borrowers by offering lower interest rates or by making loans that banks are not interested in pursuing and they use automated systems to evaluate the creditworthiness of borrowers.

Many banks have found lending to small businesses unattractive. The ten largest banks loaned $72.5 billion to small businesses in 2006 but that number declined to $44.7 billion by 2014.³⁵ As a result, small businesses have been flocking to peer-to-peer lenders. In many cases, those small businesses generated most of their sales over the Internet. Peer-to-peer lenders who could monitor online businesses and their payment activities were in an excellent position to evaluate their receivables and consequently their loan risk.

Other new ways will be found for peer-to-peer lenders to manage risk. FICO scores will continue to be used, but a great deal of public information is available that correlates with credit risk as well, much of it accessible on social networks. Information about schools attended, area of study, academic performance, and work history all give clues about creditworthiness for both lenders and merchants. Then there are reviews by customers, who discuss their experiences in dealing with a business. Yelp-like systems can be employed. A business that gets lots of good reviews is probably a lower-risk customer.

The industry is small but rapidly growing. Lending Club, the U.S. leader, originated around only $8 billion in loans in 2015.³⁶ But one market research firm estimates that the worldwide market will grow faster than 50 percent per year and approach a half-trillion dollars in just five years.³⁷

As one might expect, entrepreneurs are offering peer-to-peer lending platforms for sale. A company can paste its name on the white-label product and become its own peer-to-peer lender.³⁸ Using a white-label platform, a company in need of credit could borrow money directly from consumers and become its own bank.

All of these platforms will create alternate sources of credit and investments for consumers and businesses. To compete, banks will offer some of their own peer-to-peer services.

THE VIRTUAL TELLER

At present, the effects of most of these developments on the financial industry have been small. In many cases, the applications are great in theory but do not work all that well in practice. Smartphones use near-field communication systems to talk with in-store payment systems. Sometimes those systems mesh perfectly and at other times they don’t. Frustrated customers then return to the old methods of doing business. It will take a number of years to perfect these applications so that they are simple, robust, widely accepted, and convenient.

We tend to forget that the first major credit card, Diners Club, appeared in 1950, and that it took until 1970 before the market began to really scale. Many different groups—consumers, banks, and merchants—had to adopt the technology before it would be broadly accepted. For similar reasons, the virtualization of finance will also take some time.

One of the bigger challenges these new systems face is the existence of legacy systems that use such things as credit card terminals. Mobile payment systems, such as Apple and Android Pay, use them now—but the systems supplied by the likes of Alibaba bypass them entirely. Eventually the legacy systems will be phased out altogether.

The future of virtualization in finance will progress as service providers glue together individual pieces and create broader and more comprehensive sets of consumer services. Those integrated services will run on mobile computing platforms; eventually they will do to cash, credit cards, payment systems, credit facilities, loyalty and gift cards, coupons, boarding passes, and event tickets what the smartphone did to the iPod.

We are beginning to see early signs of this integration. Only 2 percent of transactions in Sweden are made with cash. Nine hundred of its 1,600 banks keep no cash on hand and do not take cash deposits. Many are getting rid of ATMs.³⁹ Half of the country’s population has used Swish, a mobile phone application, to make payments. The country is well on its way to becoming a cashless society.

The banks of the future will be bits floating in cyberspace, their only real-world avatars the mobile payment systems that reside on customers’ smartphones. Customers will get their financial advice from a robot whose software is maintained in one of the world’s financial centers—London, New York, Tokyo. If they need a loan, there will be seamless interfaces to peer-to-peer lenders. They might choose to have their assets denominated in some form of cyber-currency.

What we have just outlined is speculation. What is certain is that the cumulative effects from these structural transformations will drive us down this path. We may get only a fraction of the way there, but our guess is that we will go all the way there and then much further. New forms using new tools following different rules will emerge.

The reason we choose to look at the financial industry in such detail is that it is a collection of service businesses that are, for the most part, information proxies. The transformation that will take place in other service businesses with high information proxy content will be similar.

A SHARED FUTURE

Many of the most disruptive new business models will emerge in what has been called the sharing economy.

Information equivalence is the primary driving force behind the sharing economy, which is also known as the shareconomy, collaborative consumption, collaborative economy, or peer economy. All of these terms are used to describe a broad range of economic activities.⁴⁰

Arun Sundararajan does an excellent job of characterizing this phenomenon in his book, The Sharing Economy.⁴¹ The sharing economy, he writes, is market based and facilitates the efficient exchange and sharing of goods, services, and human skills. It is crowd-based and not organized around corporate hierarchies. Its supply of labor and capital comes from decentralized sources and exchange is generally mediated by third parties. Full-time jobs frequently get replaced by contract work. Individuals migrate from being employees to “entrepreneurs.”

The sharing economy will have great impact in areas where expensive, privately owned assets are underutilized. Automobiles are one such asset. Privately owned automobiles spend as much as 95 percent of their time parked.⁴² That means the average car is driven approximately nine hours a week. A number of sharing services have emerged with a goal of monetizing those idle hours. Uber and Lyft are already household names. The twentieth-century relic Zipcar is now owned by Avis.⁴³ New aspirants keep emerging. Getaround allows neighbors to rent cars from other neighbors by the hour, while a competing service, Turo, focuses on longer-term rentals.⁴⁴

Turo’s website claims that owners can cover their monthly car payments by renting their cars for as few as nine days a month. It claims to operate from 4,700 cities, provide owners with liability insurance, and deliver cars directly to their renters.⁴⁵ BlaBlaCar, a European service, allows its more than 35 million members to locate other members who are going where they want to so they can hitch a ride.⁴⁶ Looming in the future, when the self-driving car arrives, are driverless types of Uber services. The vision is that you will be able to summon a car using your smartphone. It will pick you up, drive you to where you are going, and then speed away to pick up the next passenger.

Car sharing is one of the growth industries of the future. GM estimates that 5 to 6 million people globally already share cars and that that number will grow to 20 to 30 million in the next few years.⁴⁷ To capitalize on this trend, GM has launched its Maven car-sharing service, which allows part-time workers in the gig economy to rent a car when they need it to do such things as delivering groceries to paying customers.⁴⁸ Maven competes with Mercedes’ Car2Go, which “allows customers to take cars one-way inside of a set perimeter and charges by the minute.”⁴⁹

Our first thought is that these services compete with cabs and limousine services, but that may be overlooking the depth of the structural transformation. Jeremy Rifkin has speculated, “Twenty-five years from now, car sharing will be the norm, and car ownership an anomaly.”⁵⁰ That trend is already under way. Only 78 percent of millennials own cars, compared with 91 percent of the older generations.⁵¹

Think of what might happen to the automotive manufacturing, services, insurance, and parking businesses if car ownership declined by 25 percent, 50 percent, or even more.

A MATTER OF RATIOS

Office space, temporary accommodations, and vacation rentals are another area where capital assets are underutilized, and the sharing economy is ready to help.

If you are looking for vacation rentals, Airbnb is just one of many services that you can use. Tripping.com has more than 8 million vacation properties listed. Tripping.com competes with Flip-Key, Roomorama, VacayHero, and Wimdu.⁵² ShareDesk lets you find on-demand workspace in more than four hundred cities.⁵³

A sharing economy service or equivalent exists for just about anything you can think of. That includes sharing people as well. If you want to hire freelance labor for everyday work, TaskRabbit is operating in approximately thirty cities. If you are interested in food delivery, Postmates might be a better alternative.

Sundararajan’s book on the sharing economy carries a subtitle, The End of Employment and the Rise of Crowd-Based Capitalism. The implication is that, as more work migrates to the sharing economy, it will be less valuable.

Part-time workers now perform jobs that once came with salaries, health care, and other benefits. A part-time Uber worker displaces the fleet taxi driver. A skilled union electrician suddenly finds himself doing part-time work via TaskRabbit. A lot more people are going to be working in the gig economy.

But perhaps the most significant phenomenon of all is what we would call the hub-and-spoke business model, in which a small, highly compensated core group works for a company that organizes the work of hundreds, thousands, and tens of thousands of subcontractors.

Uber has about 12,000 employees and contracts with approximately 1.5 million drivers worldwide—a 100 to 1 ratio.⁵⁴ Facebook tops that, with about 25,000 employees and approximately 2 billion active users who provide the company with monetizable content for free, a ratio of 8,000 to 1.⁵⁵

These companies illustrate another of the important commercial trends identified at the start of this chapter: that the sharing economy will drive the transformation of a whole range of commercial enterprises. In some cases, businesses that were capital-intensive will become applications. A hotel is capital-intensive, but Airbnb is an application. Hertz and Avis have large investments in their fleets and pay a lot of money for rental locations and parking lots. Getaround and Turo make use of idle assets, parked cars owned by individuals, and do not have lots of leases to worry about.

Companies that leverage idle assets put great competitive pressures on established companies that own them. Hotels will not go away. Many people will never use shared office space or even consider sharing a stranger’s car. But new business models will exert price pressures on many capital-intensive businesses, making it much more difficult for them to grow and compete.

From a commercial and social point of view, the hub-and-spoke model of business in the shared economy may be of greater significance than the asset-sharing aspect. It might be said that the “secret sauce” of the shared economy is the principle that the more workers you can outsource, the better it will be for the owners and senior management.

A permanent employee is a double-edged sword. Loyal, skilled, and committed employees are a great asset. No business can succeed without them. But they are also an expensive burden. Companies have to provide them with health insurance, retirement benefits, vacations, time off for emergencies, and pay them when they come to work, even if there is no work to do. So, in a sense, the Uber and TaskRabbit business models are ideal for employers. The beauty of it is that the free market sets the value of the work done by the non-core employees. Since the company takes a cut of what the contractors make, its fixed costs are very low.

WHEN SUCCESS MEANS SMALLER

In 1997, Clayton Christensen published one of the most influential business books of all time, The Innovator’s Dilemma. He describes how the very processes that enable market leaders to succeed also set them up for failure when disruptive new products and technologies appear. A common reason is that the market for a new service is too small to meet its needs for growth, so the large company doesn’t pay much attention to it—until that market explodes, led by a suddenly powerful new competitor. And then it is too late.

In 1994, when Amazon still only sold books, it probably made a lot of sense for Walmart to keep investing in big stores that sold everything—especially since books were probably not a very important product category for its customers. But in hindsight, it is obvious that Walmart should have taken Amazon on directly from day one. It is the same with new technologies. In retrospect, record companies made a serious mistake when they licensed their music to iTunes and other streaming services. But at the time they saw them as providers of incremental revenue, not as direct competitors. Newspapers probably should have competed directly with Craigslist when they put their content online, but they thought of themselves as purveyors of journalism instead of advertisements.

In coming years, equivalences will power the innovator’s dilemma across broad swaths of the economy. But this time things will also be different, because many of the businesses that will replace existing ones will make markets smaller. The great new businesses will be shadows of the ones they replaced. Newspapers were big businesses, but the online news services that replaced them employ fewer people and make less money. An application that facilitates the direct transfer of funds will generate less revenue per customer than a credit card company does.

Management will increasingly be bringing a hard-to-swallow message to shareholders: “The investments we are making in this new technology are massive and will allow us to be the leader in a new form of our old business. Unfortunately, the company will be much smaller as a result. You should support our decision to shrink the company, because if we do not take control of the shrinkage, we will be even smaller and less relevant. Or dead.” If the shareholders balk, management can point to Sears, Blockbuster, and Toys “R” Us to make their point.

The right strategy for businesses going forward is to attempt to anticipate the effect of the equivalences and to make the commitment to be the leader in the new form of the existing business, even if that business cannibalizes the existing one. In many cases, the new form of business may depend on a new platform—a smart device like an iPhone, an online retail platform like Amazon, a blogging platform like Pinterest, a peer-to-peer payment system, a virtual currency, and so on.

If a business can figure out how to maintain its leadership on these new platforms, its chances of surviving the phase change are greatly increased.

BIG BAADD COMPANIES

In recent years, the public, business leaders, and government officials have become increasingly concerned about the monopoly power of the platform companies—Facebook, Apple, Google, and Amazon. In the words of The Economist, these companies and their like are being accused of being BAADD—big, anti-competitive, addictive, and destructive to democracy.⁵⁶

In addition, gaming platforms, which we will discuss further in chapter 8, are accused of using operant conditioning techniques to create addictive behaviors in their users in order to dominate their attention.

The complaints against the behavior and power of dominant platform providers are legion—and growing. Unlike publishers, they do not take responsibility for their content. As a result, they empower trolls and fake news, and enable foreign powers to interfere with elections. They spy on individuals using GPS, Internet cookies, and other techniques to generate advertising revenue. They subtly (and not-so-subtly) steer customers to their own proprietary offerings, putting competitors at a disadvantage. One could go on, but it is safe to say that the monopolies arising in our phase-changed world are no better-behaved than the trusts that arose in John D. Rockefeller’s time.

A phenomenon called “network effects” has been powering monopolies in the virtual world. The term refers to the fact that, as networks add nodes, their power increases. These effects have been with us for a very long time—since long before the Internet. Coauthor William Davidow was first introduced to network effects when he was eight years old and his mother told him stories about her own childhood in Reading, Pennsylvania. Three telephone companies served the city. If you were on one network, you could not talk with someone who subscribed to another. Ultimately, one network got ahead in the number of subscribers, and pretty soon, if you wanted to talk with most of your friends, you had to be on that network.

In short, network effects occur because each new user added increases the value of the network to other users. Network effects powered Microsoft’s dominance in personal computer applications. As more and more people used its Word program to generate documents, it became easier and easier to exchange documents with others. As a result, it became more desirable to be a Word user.

Similarly, as applications for the iPhone became available, the iPhone became more appealing, and Apple sold more of them. And as Apple sold more iPhones, more and more application providers were motivated to produce applications for it. Today, there are more than 2 million iPhone applications.⁵⁷

The issue of greatest concern is the platforms themselves. In many cases, either it does not make sense or it is extremely difficult to have numerous competing platforms. Today, we essentially have one major social network, Facebook, a dominant online retailer and search engine with Amazon and Google, and two mobile operating systems, Apple’s and Google’s Android. These BAADD guys are finding all sorts of creative ways to exercise market power, control suppliers, and limit consumer choices.

The platforms have aggressively supported the idea that information, though valuable, should be free. Publishers lacked the market power to resist the trend and, to remain relevant, gave away much of their content, while the platforms made money selling advertising attached to it. Put simply, ads moved from the pages of publications to the servers at Google—and so did the revenues they represented.

Other less publicized battles are being fought as well. Amazon’s battle with Hachette is but one example. Amazon’s share of online sales grew from 25 percent in 2012, to 33 percent in 2015, to 43 percent in 2016. In 2016, Amazon accounted for 53 percent of the growth in online sales.⁵⁸ In books, it accounts for 41 percent of all new book purchases, 67 percent of e-book sales, and 64 percent of online book sales.⁵⁹ Fifty-five percent of shoppers start their searches for online purchases on Amazon.

Amazon has made attempts to use its market power to set consumer pricing. For example, Amazon wanted to cut the prices on Hachette’s e-books from $14.99 to $9.99, dividing the revenue three ways—30 percent for Amazon and 35 percent each for the author and publisher.⁶⁰

Hachette balked and Amazon retaliated, according to Hachette, by failing to keep Hachette’s print books in inventory, which slowed their delivery time from days to two to four weeks.⁶¹ Authors were so disturbed that more than nine hundred of them signed an advertisement in the New York Times to protest.⁶²

Now, $9.99 is probably an okay price for an e-book (customers certainly like it better than $14.99); but what is not okay is the leverage a company like Amazon will have as its market share grows. In the future, a more powerful Amazon might be able to push that price all the way down to $2.99 and take half. At that point, authors, most of whom are already struggling, might have to supplement their income by flipping burgers.

One of the most concerning aspects of platforms is that they, too, are linked together by network effects. If you control a mobile platform, it gives you the leverage to control a payments platform that uses it. In the case of Amazon, control of a retail platform sets the company up to control a delivery platform.

Smaller businesses that might have been successful if those network effects were weaker get sucked up in the vortex. In many cases, the entrepreneurs of smaller companies feel that if they do not let themselves be acquired, the giant suitor will develop its own competing application and drive them out of business. That is what happened to Snapchat. The company reportedly turned down a $3 billion offer from Facebook. So Facebook added popular Snapchat-like offerings to its own messaging applications—such as new camera filters and a sharing feature called Stories.⁶³

Snapchat still managed to go public in 2017 at $17 per share, at a market cap of about $20 billion.⁶⁴ But since that time its stock has struggled, and there are many concerns about how the company will fare over the long term in the platform wars.

Instagram was sold to Facebook for $1 billion.⁶⁵ Google bought YouTube for $1.65 billion, and Amazon acquired Zappos, the online shoe retailer, for $1.2 billion.⁶⁶ In a less connected world, these businesses might have made the decision to remain independent. They might have grown and become competitors with the companies that bought them. Instead, they ultimately served only to further consolidate industry control for an established giant.

In the larger picture, network effects may be slowing down the growth of the economy—or at least that is what some economists speculate. The claim is that big business has become so powerful that we are experiencing a slump in start-ups. Today, companies that have been in business less than a year account for only 8.1 percent of the total number of businesses—as opposed to nearly 15 percent in 1980.⁶⁷ Because small businesses have been one of the engines of growth powering the economy—and a major source of new jobs—the concern is that this shortage of fast-growing new start-ups will retard overall economic growth.

The commercial transformation driven by societal phase change is creating a very different business environment. Regulations designed to deal with virtual world issues will be significantly different than regulations designed to solve physical world problems. Of those new issues, the platform monopoly issue is the one of greatest concern to us.

In the physical world, it is pretty easy to agree that it only makes sense to have one electric, gas, or water platform company serving the needs of the community. Increasingly, there is discussion about regulating broadband Internet services in a similar way as a public utility.

But broadband is different. Electricity, gas, and water are consumed directly; the consumer controls and owns the application layer associated with them. For example, the application layer for electricity is the light bulb, for gas the furnace, and for water the shower or faucet.

But in the virtual world, broadband is pretty useless unless it is bundled with the application layer. Try using the Internet without the apps on your smartphone, Google, or Facebook. In order for the free market to work well from the consumer’s point of view, there have to be viable choices from a competitive market, and this goes not just for the broadband supplier but also for the application layers.

We are just now waking up to the threats posed by the BAADD guys. Congress is starting to investigate their effects. Europe is substantially ahead of the United States in its thinking. In 2017, Google was fined $2.7 billion by E.U. antitrust regulators for unfairly recommending its platform services over those of competitors.⁶⁸ In 2018, Google got hit again when it was fined $5 billion for forcing Android users to preinstall Google’s search engine, Chrome.⁶⁹

As the power of the platform companies increases, as more and more platforms come under the control of a few providers, and as the public and regulators become more aware of platform power and the difficulty in making virtual markets truly competitive, there will be more and more pressure to treat the BAADD guys as if they were public utilities.

The commercial transformations discussed in this chapter will present us with many challenging but solvable issues. One of the most difficult will be how we deal with jobs—or the lack of them—in the future. In the next chapter we will look at how phase change has affected work and jobs in the past and how it will likely do so in the future. We will suggest how we can best respond.

To successfully deal with some of the other issues presented in this chapter, we will have to constantly look through the lens of “phase change”—or, in the words of the old Apple ad, we will have to “Think different.”

When the telephone and other ways to use electricity were invented, the companies that supplied those services were private enterprises, not regulated utilities. If we were capable of converting them into utilities in the early twentieth century to better serve the public interest, we should be capable of defining the new utilities of the future, perhaps creating them from existing private enterprises, and in the process determining effective ways to regulate their behavior.

This chapter also raised the issue of the few who control these new enterprises becoming very wealthy by living off the labors of part-time, contract—“gig”—workers. The Autonomous Revolution will tend to increase this wealth concentration and exacerbate wealth disparity. If you believe wealth concentration is a problem, and we do, there are tax solutions to this problem.

Again, the new forms of the Autonomous Revolution will require new rules and tools. If we try to deal with the new forms using only the existing methods, significant problems will arise. If we experiment, debate, and search for creative solutions to the challenges, we will find them.

Ultimately, this chapter is a story about abundance. Numerous new, better, and less expensive products and services will be available that will materially improve our lives. But to benefit from them and reduce their undesirable side effects, we are going to have to think differently—and take action, starting now.